The credit crunch and recession are testing the endurance of mortgage bankers. After two years of slack demand for commercial real estate loans, the thinned ranks of financial intermediaries have grown lean and hungry for business.

“As capital service providers we've gone through an absolute nightmare, from a peak of capital availability to a trough like we've never seen before,” says Edward Padilla, CEO of Bloomington, Minn.-based NorthMarq Capital.

Indeed, the mortgage banking industry posted a 79% drop in loan volume over a two-year period through the third quarter of 2009, according to the Commercial/Multifamily Mortgage Bankers Originations Index (see chart).

“Our peers that are hanging in there are doing things to put themselves in position to have a successful rebound,” Padilla says. “We also have some companies that are either already gone or won't survive the cycle.” Padilla adds that his company's production has kept pace with the slowing trend tracked by the Mortgage Bankers Association's (MBA) index.

Mortgage banking firms are supplementing their anemic loan origination businesses by launching consulting services for loan workouts, brokering loan portfolio and note sales, raising equity and even valuing bank assets for federal regulators.

NorthMarq is still doing a brisk business in loans backed by Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs) that enjoy support from the Obama administration despite their financial troubles stemming from the faltering single-family home market.

Including the company's AmeriSphere Multifamily Finance subsidiary, NorthMarq will arrange about $2 billion in GSE-backed loans this year. But that financing is limited to apartment deals, and can't make up for the major contraction in lending volume across other property sectors.

Remarkably, some mortgage banking companies have not only stayed in business, but are also expanding through key hires, new relationships and expanded service lines (see sidebar). The common link between their varied survival strategies is a twin focus on cost control and making the most of every morsel of revenue.

Harsh landscape

An entire swath of commercial mortgage activity — namely the creation of loans earmarked for syndication in commercial mortgage-backed securities (CMBS) or collateralized debt obligations (CDO) — has evaporated.

CMBS and CDO issuance combined was just $2.83 billion in the first three quarters of 2009, down 99% from the $222.1 billion issued in the corresponding period of 2007, according to the MBA.

Demand for loans is also down, says Jamie Woodwell, vice president of commercial real estate research at the MBA. For one, most of the unprecedented number of loans originated from 2005 through 2007 won't mature for a few H years, limiting the need for replacement financing this year. Secondly, few property owners are interested in selling into a depressed market, and that sentiment has curtailed transaction activity.

Transaction volume has fallen even more precipitously than loan originations. Sales of office, industrial, retail, apartment and hotel properties in the third quarter of 2009 totaled $13 billion, down 88% from nearly $110.8 billion two years earlier, according to Real Capital Analytics, which tracks deals valued at $5 million or more.

That's over the same period that the MBA's loan origination index fell by 79%. “We've seen a much bigger drop in transactions than we've seen in mortgage originations,” Woodwell says.

Until lenders loosen the reins on credit and the commercial real estate industry resumes a more normal pace of transaction activity, mortgage bankers are sustaining themselves by selling other, less profitable financial services.

Some firms have knuckled down to find more work for their existing service lines. That's the strategy at Holliday Fenoglio Fowler (HFF), says John Pelusi, the company's vice chairman and chief executive officer.

Core businesses for the Pittsburgh-based financial intermediary include multifamily debt and investment sales, loan workouts and servicing. “We have continued to focus on our traditional business,” Pelusi says, “and there is still traditional business being consummated.”

That's not to say the going has been easy. In late 2008, HFF cut its headcount by 12%, or 57 employees. In April 2009, the company eliminated another 44 positions, suspended 401(k) matching contributions and slashed salaries for top executives, Pelusi included.

The trimmed-down firm posted a net loss of $39,000 in the third quarter of 2009, but a 25% increase in revenues over the previous quarter. The company's stock (NYSE: HF) closed at $6.47 per share on Jan. 15, up from a 52-week low of $1.05 in March 2009.

To garner business in a devastated sector, HFF has drawn on its experiences in past real estate cycles to project and anticipate client needs. Recognizing that lenders would be ill equipped to deal with large numbers of distressed loans and real estate owned (REO) properties, the company organized a special assets group some 18 months ago.

That team is now providing special servicers with advice on distressed loans and helping lenders to dispose of their REO properties. The company also is advising both borrowers and lenders with debt restructuring.

“We've been able to survive and maintain the firm, and we'll take advantage of opportunities we think are coming in 2010,” Pelusi says. “We're optimistic and excited about what 2010 and beyond will bring because we don't believe it could get much worse than 2008 and 2009.”

Cost cutting is near universal among mortgage bankers today. Chicago-based Cohen Financial has closed some offices and lowered its headcount while retaining staff with experience from previous downturns, according to Adrian Corbiere, the company's executive vice president of capital markets.

Cohen Financial has formed pools of specialists to avoid redundancy. When a loan producer in San Francisco needs underwriting help, for example, he or she will contact the underwriting pool and may end up working with someone from the Chicago office.

“Gone are the days in mortgage banking when every senior producer had an analyst or two helping them out,” says Corbiere. “Whoever has some free time will work on that deal.”

Sharing resources and skills across offices has become easier thanks to mobile technology that can keep team members in constant contact, says Corbiere. “It's efficient, it's cheaper and we've found it works pretty well.”

Fees, please

Many of the firms that once relied on high-volume loan originations to generate fees are now focused on consulting services that help borrowers to restructure their debt.

“Loan restructuring is by far the biggest line of business that wasn't big two years ago. We were too busy doing deals then,” says F. Brock Walter, owner of Cleveland-based Pinnacle Financial Group.

Walter is also president of Strategic Alliance Mortgage, which is a network of 20 commercial real estate investment banking and mortgage banking firms across the country. Strategic Alliance Mortgage arranged $8 billion in commercial real estate financing in 2008, ranking fifth on NREI's list of top financial intermediaries published in May 2009.

This year, Strategic Alliance Mortgage will generate between 5% and 10% of its revenue by restructuring loans, Walter predicts. Typically, a financial adviser earns a retaining fee when it takes on a loan restructuring assignment and earns an additional percentage fee based on the amount of debt reduction. All fees are paid by the borrower.

George Smith Partners has taken a page from its playbook in the 1990s in the wake of the savings and loan crisis to anticipate demand for discounted payoffs, according to David Rifkind, managing director of the Los Angeles-based investment banking firm.

Today the company helps borrowers with troubled loans by either modifying terms on an existing mortgage or negotiating a reduced payoff amount.

The company can then provide the borrower with a bridge loan to pay off the old loan at the discounted amount. “We had anticipated that discounted payoffs would become an active business as the market reset,” says Rifkind.

Some mortgage bankers are marketing loan portfolios for sale on behalf of lenders, or helping investors buy portfolios of existing loans. Others are applying the methods they used to structure debt financing in the past in order to raise and arrange equity today, according to Corbiere of Cohen Financial.

“The fees you get for raising equity are substantial,” he says. “If you raise $10 million in equity, you can get 200 or 300 basis points on that,” or $200,000 to $300,000 in fees.

A few firms designated by the Federal Deposit Insurance Corp., including CB Richard Ellis Capital Markets and Cohen Financial, are even using their grasp of real estate, CMBS and commercial mortgages to value REO assets of banks earmarked to be closed down.

“We have a valuation team that will go in and help value the collateral in their portfolio for a fee,” Corbiere says. “These are all kinds of revenue sources that don't generate big fees, but they keep the lights on.”

New resources ahead

Mortgage bankers today must be familiar and work with a widening array of capital providers, according to Pelusi of HFF. In addition to life insurers and new mortgage investment funds, many small banks that refrained from commercial real estate lending earlier in the decade have become important sources of leverage for the industry.

“There are local banks that weren't very active in commercial real estate in 2005 because they couldn't compete with CMBS lenders,” Pelusi says. “A lot of them have balance sheets that are very clean, and they are ready to lend.”

In 2010, opportunistic investment funds with $300 million to $500 million to lend are emerging with an appetite for real estate, according to John Cannon, executive vice president of Horsham, Pa.-based Berkadia Commercial Mortgage.

While myriad small funds may be more challenging to work with than traditional lenders, borrowers will appreciate the capital they have to offer, Cannon predicts. “A thirsty man doesn't necessarily question the coolness or the quality of the water,” he says. “The market is starving for liquidity and will take it in any way, shape or form.”

Created in 2009 and owned jointly by Leucadia International and Berkshire Hathaway, Berkadia acquired Capmark Financial Group's North American mortgage origination and servicing business in December.

Out of the valley

There is a growing mood in the industry that mortgage bankers refer to as “paranoid optimism,” a feeling that maybe, just maybe, the mortgage market will loosen up this year. Life insurance companies have begun to increase their lending for commercial real estate for one, and new sources of debt and equity capital are entering the market.

“I'm starting this year feeling more optimistic than I was at the same period last year,” says Brian Stoffers, president of CBRE Capital Markets. Stoffers says that most life insurers are interested in increasing their allocations to commercial real estate, although they will remain conservative by offering loan-to-value ratios ranging between 55% and 65%.

Stoffers and other mortgage brokers point to recent CMBS activity as signs the conduit market will live again, although no one expects to see significant origination volume in that sector this year.

Those deals include a $400 million bond offering by Developers Diversified Realty, Coral Gables-based Flagler's $460 million CMBS loan on office and industrial collateral, and JP Morgan Chase & Co.'s sale of $500 million in CMBS backed by Inland Western Real Estate Trust.

“There are also several large foreign banks, both from Asia and Europe, that have become active in the United States and we've become active with them,” Stoffers says.

Dealing with crises comes with the ever-changing territory of mortgage banking, Stoffers says. “It's not going to be an easy business in the next two years, but I'm excited about 2010 and what it might bring,” he says. “The surprises in 2010, in my book, will likely be more on the upside than the downside.”

It will be many years before commercial real estate lending activity returns to the peak levels reached in 2006 and 2007, experts say, but the market will recover and provide plenty of work to the financial services providers who survive this downturn. In 2010, distress will help fuel transaction volume, even as healthy loans mature and require new financing.

“There still is $3.4 trillion of commercial/multifamily mortgages outstanding in the United States,” says Woodwell. “Those loans need to be serviced, and the owners of those properties are constantly looking for assistance either in obtaining or assessing new loans or other capital.”

— Matt Hudgins is an Austin-based writer.

Mortgage bankers survive now to thrive later

When the going gets tough, tough mortgage banking firms start growing. The newly formed Berkadia Commercial Mortgage hit the ground running in December by buying Capmark Financial Group's North American loan origination and servicing business. Owned equally by Berkshire Hathaway and Leucadia National Corp., Berkadia has hired about 1,000 former Capmark employees and is on the lookout for top talent.

“We are going to be making strategic hires throughout the country to take advantage of what we think are going to be improved market conditions,” says John Cannon, executive vice president and head of government-sponsored enterprise lending at Horsham, Pa.-based Berkadia. “There is a window of opportunity whenever you make hires, and that window is typically in the first quarter.”

Despite a 79% decline nationally in commercial loan originations since 2007, a surprising number of mortgage banking companies are expanding their operations and forging new relationships with lenders.

Holliday Fenoglio Fowler (HFF) has been increasing staff in parts of the country where it wants more of a presence, especially in investment sales, say John Pelusi, vice chairman and CEO of the Pittsburgh-based financial intermediary. “Even in this difficult period, we've been bringing on new talent.”

Downturns have long been recognized as an opportune time to gain market share, but the current expansion trend has more to do with surviving than stomping the competition. Diversification is essential because the once-lucrative mortgage origination business is on the rocks, experts say.

For example, NorthMarq Capital, a financial intermediary based in Bloomington, Minn., opened new offices in Seattle, San Diego and San Antonio in 2009. In October, NorthMarq purchased Opus Corp.'s property management business for an undisclosed sum.

“In addition to arranging capital, we're also expanding our leasing, property management and other services,” says Edward Padilla, NorthMarq Capital's CEO who also oversees NorthMarq Investment Sales.

“Once the cycle starts to turn, those of us left standing will enjoy a larger market share, there will be fewer legitimate players left in the market and we should have an enjoyable period in the business,” Padilla says. “If we didn't believe that, we certainly wouldn't be investing more money in expanding our platform right now.”

Los Angeles-based George Smith Partners began hiring experienced mortgage professionals in the third quarter after more than a year of periodic staff cuts. Recently, the company added an advisory business to help borrowers and lenders with workouts on troubled loans in commercial mortgage-backed securities (CMBS).

“That is becoming a robust line of work and is a new business we were not in previously,” says David Rifkind, the company's principal and managing director. “It has enabled us to retain our top analysts and underwriters when there was little new CMBS origination for them to work on.”

Meanwhile, Marcus & Millichap Capital Corp. launched a debt advisory services division in January. Bill Hughes, senior vice president and managing director, says the Irvine, Calif.-based firm is evaluating growth options that could include mergers and acquisitions and additional service lines. “We are aggressively looking to reinvent ourselves in order to stay aligned with the marketplace,” he says. Hughes is quick to add: “You don't wake up one day, decide you want to grow, and go out and buy a bunch of companies. We're quite particular in what we want to accomplish through that growth initiative.”
— Matt Hudgins