NREI's 12th annual Top Lender Survey might best be described as a battle of the banking titans from Charlotte, N.C. In the direct lending category, Wachovia, which merged with First Union nearly 18 months ago to become a heavyweight in the banking world, captured the No. 1 ranking with $21.4 billion financed in 2002. Cross-town rival Bank of America, last year's top lender, finished in second place with $18.9 billion financed. Among intermediaries, Bank of America retained its top spot with $37.3 billion arranged in 2002.

Rounding out the list of top five finishers among direct lenders for 2002 are GMAC Commercial Mortgage Holding Corp. ($16.3 billion), Lehman Brothers ($9.5 billion), while Credit Suisse First Boston and KeyBank Real Estate Capital, tied for fifth place ($6.5 billion).

Among financial intermediaries, Holliday Fenoglio Fowler claimed the No. 2 spot ($10.4 billion), followed by GMAC ($4.3 billion), NorthMarq Capital ($3.7 billion) and, in a three-way tie for fifth place at $2.8 billion, iCap Realty Advisors, Secured Capital Corp. and Sonnenblick-Goldman Co.

Difficult Year for Deal Making

A slow economic recovery combined with weak real estate fundamentals, most notably in the office and apartment sectors, had a negative effect on lending totals. Volume dropped slightly in 2002 for many direct lenders and intermediaries. For example, Teachers Insurance and Annuity Association College Retirement Equities Fund (TIAA-CREF) — a bellwether institution for direct lending activity — reports that in 2002 it provided $3.4 billion in financing to commercial real estate, down about 9% from $3.7 billion in 2001.

Similarly, on the intermediary side, Holliday Fenoglio Fowler arranged $10.4 billion in financing during 2002 compared with $11.6 billion in 2001, a 10% decline. There were exceptions to the general downward trend, however. Credit Suisse First Boston's $6.5 billion total, up slightly from $6.4 billion in 2001.

The performance of the regional economies throughout the U.S. is going to dictate how quickly recovery occurs, according to E.J. Burke, executive vice president with the commercial mortgage group for KeyBank Real Estate Capital.

“There's not a particular property type that's strong across the country,” he says. In the Midwest, the manufacturing, telecommunications and steel industries have suffered greatly. For example, Kansas City-based Sprint laid off thousands of workers during this downturn. “The office, multifamily and retail sectors seem to be weakening in the Midwest,” says Burke.

But in Southern California and Washington, D.C., the real estate fundamentals are in better balance, leading to more lending activity in those regions, according to Burke. Still, the build-to-suit activity that occurred nationally in the industrial and office sectors in 2002 has dried up, he says.

Mezz-Debt Remains Popular

The high volume of refinancing activity, sparked by a historically low 10-year Treasury yield that has hovered around 4% for nearly a year, is a major reason lending totals haven't fallen dramatically. Furthermore, borrowers' growing interest in moving beyond conventional financing and into mezzanine-debt structures has created new opportunities for lenders.

In 2002, Wachovia completed $150 million in mezz-debt transactions, according to Bill Green, managing director and head of real estate capital markets for the company. The financial services giant plans to increase the volume to between $350 million and $400 million this year.

From an investor's standpoint, the concern in the secondary market centers on loans made between 1998 and 2000. “Back then, there was a tendency to underwrite to a more robust economy,” Green says. Today, lenders take into account the negative absorption that's occurring in several property sectors, as well as increasing insurance premiums. The net effect is that borrowers must adhere to more stringent debt-service coverage ratios and settle for lower loan-to values.

Green points out that real estate today is routinely trading at 300 to 400 basis points over the 10-year Treasury yield, or the risk-free rate of return. “Real estate has never traded like that before,” he says. The significance, he explains, is that even though borrowers are buying product at low cap rates due to higher pricing, their rate of return is still favorable because interest rates remain so low.