Rejection sucks. But not having a backup is worse.
Relationships with lenders are a wonderful thing.

If you’re not very experienced with the industry, understand that lenders typically provide the *majority* of the capital required to buy a building. Just like buying a home. Home buyers ask a lender for money on top of their down payment to make the purchase. That loan request gets underwritten almost entirely based upon a consumer’s credit score, income history, and current financial metrics.

Unlike a home mortgage, though, commercial mortgages don’t get doled out strictly by the numbers. Commercial mortgages are more of a business investment. Sure, there is heavy underwriting and analysis of the property’s numbers — but the borrower’s wherewithal is absolutely critical. A lender needs to trust the borrower to deliver a return on the property investment.

# Lender Relationships

Two people interacting with each other over a period of time is a relationship. Two people interacting with *trust* is a healthy relationship.

Healthy relationships with financiers can be a huge advantage for a real estate investor. Those relationships can:

* Float the borrower’s loan request to the top of a pile of similar requests
* Score the borrower a loan where one may not have been given
* Lead to better loan terms because the borrower is seen as less risky
* Earn the borrower an invitation to a fancy holiday party (hey, it’s true)

Relationships with lenders are great. It’s highly recommended. By the way, these lenders are people — you might even enjoy being around (some of) them.

## When the relationship fails to deliver

Let’s say you have a great relationship with a local banker, and let’s call him John. John’s bank has funded four of your investments, each one growing in size which has helped you develop the start of a nice portfolio. He’s even your [golf](https://www.youtube.com/watch?v=dklMT75BT1I) buddy at this point.

You have a fifth deal lined up and John is sure to lend on this one as well. Right?

*“The loan was turned down in credit committee yesterday. They said we have too much exposure in…”*

Woah woah, turned down? John gave you a term sheet weeks ago. You’ve already paid for an appraisal. You’re only three and a half weeks away from closing at this point. For that matter, how are you going to close? You don’t have enough liquidity without John coming through with that loan.

# How the commercial credit process works

Credit, or the decision to extend credit (a loan), is handled differently depending on the type of institution. Let’s walk through the common ones.

## How banks and credit unions handle credit decisions

Final decisions on a loan typically come down to an institution’s **credit committee**. This group takes in a write-up on the deal from the loan officer you are dealing with, and makes sure the loan is appropriate in light of the lender’s underwriting criteria. A lender’s underwriting criteria may be influenced by several factors: their outlook on the market, the make-up of their existing loan portfolio, and regulations they are subject to.

Keeping up with regulations is actually pretty intensive work for financial institutions. Based on their size and regulatory status, banks and credit unions are beholden to different regulatory bodies at the state and federal level. You won’t find a deep dive on the regulatory side here in this blog post, but the important part to understand is that financial institutions need to follow various credit policies at both the *loan level* and the *portfolio level*. So when John said one key word, *exposure*, that is communicating that the bank has a problem at the portfolio level that prevents them from extending the loan they had outlined in their term sheet.

As an aside, a Term Sheet is not legally a commitment to lend, ever. It’s like an engagement, not a marriage.

## How CMBS issuers makes credit decisions

In addition to their own credit evaluation, CMBS lenders also rely on their **trading desk** to help give the go/no-go decision on a loan. The reason for this is because **B piece buyers**, who are going to hold a key high-yield high-risk tranche of the CMBS bonds, are typically consulted on loans that will be securitized ahead of time. While the big banks running the CMBS world are beholden to **risk retention** rules requiring them to keep 5% exposure on the bonds they create, they really don’t have the appetite for holding more of these bonds at the B-piece level. The pool of B-piece buyers is small, so if the lender chats with a few and they don’t like the loan, that loan will be shut down.

## Agency credit boxes

Government-sponsored entities (“GSEs”) like Fannie Mae, Freddie Mac, and HUD operate in a similar fashion to CMBS where bonds are created out of loans. What differs, however, is that rather than putting bonds out to market and looking for someone that will absorb most of the risk, these GSEs put bonds out to market while *absorbing* risk for the buyers. The way each agency does this differs, and we can cover it in another post, but it’s important to understand that those companies define a particular set of underwriting rules for the loans put out by the loan officer you’ll talk with. The loan officer’s knowledge of the ins and outs of that underwriting is helpful, but ultimately, the approval still sits with a committee behind the scenes.

# Minimizing the chance of disaster

Now you are realizing that, unfortunately, loan officers (like John in our example above) are far from in charge when it comes to seeing your loan through to commitment. There are layers, sometimes multiple layers, of approval for the average commercial mortgage origination.

That means you need reliable loan officers that understand which loans are at risk of being kicked out.

That also means you need a backup plan, especially if you’re asking for a loan that is riskier or more unique. The only way to do that is **to shop multiple lenders** on a deal by deal basis, even when you have good relationships with a few. Not only can you line up a backup, but you may find that the intended “backup” simply has better rates and terms for the type of deal you’re currently pursuing. It’s not personal, it’s business.
[{"id": "glmmlry", "text": "This is great information and exactly what this sub needs", "replies": [], "depth": 1}, {"id": "glmnxcj", "text": "I'm on the credit side at a commercial bank and this is an excellent introduction for those unfamiliar with the process. I would add that credit decision makers at Banks change and not every credit person has the same appetite for certain deals. So, if your relationship manager has a change of heart about certain deals or exposure that you may have completed in the past, don't take it out on them. RMs typically have no credit approval authority.", "replies": [], "depth": 1}, {"id": "glmojhb", "text": "Exceptional post.\n\n*(And for the record, I never trusted John.  His eyes are too close together, sure sign of criminal intent).*", "replies": [], "depth": 1}, {"id": "glmu0df", "text": "I just read about 7 or 8 of your blog posts on your website.  All exceptionally written.\n\nWebsite bookmarked for future reference.", "replies": [{"id": "glmvplu", "text": "Why thank you kind sir/madam!", "replies": [{"id": "glu50pb", "text": "what is your blog? I'd like to read it as well, please.", "replies": [{"id": "glup9yi", "text": "StackSource.com/blog", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "glmw1ek", "text": "Great post! In this situation, if John was a halfway decent loan officer, he would have known exposure is a concern and cured it by scheduling a quick meeting/conference call with credit to discuss exposure issues (or whatever issues might kill a deal) prior to ordering the appraisal, prior to the borrower spending $$ on the appraisal and other pre closing costs. \n\n\u201cAssuming there are no other issues that arise during underwriting, we feel confident any concerns about exposure limits are mitigated by __insert reasons__ and we request credit\u2019s approval to proceed accordingly\u201d  Now credit will either give a thumbs down or a thumbs up, and John knows any potential issues with exposure are resolved and can proceed accordingly. \n\nHappy to give my two cents on why the Johns of the world don\u2019t do this important step in maintaining relationships with borrowers, but let\u2019s keep the conversation productive instead. \n\n**Here\u2019s how to formulate a back up plan 3 weeks before closing:**\n\nBe ready to provide everything back up bank needs for underwriting all at once. \n\n* Ask for an electronic copy of your appraisal as soon as it is finished. You are entitled to it if you have already paid for it. Same thing goes for any other 3rd party reports ordered by the bank you have already paid for. Keep in mind it is a tricky process sending an appraisal ordered by one bank to another bank. The bank that orders the appraisal needs to assign/release the appraisal to the other bank, and they usually won\u2019t do that unless the loan is turned down. \n\n* All of the due diligence you sent to John needs to be sent to back up bank as soon as you know the loan was turned down. Literally, that same day. Time is of the essence. \n\n* There will be a team of 2-3 people behind the scenes working 12 hour days at back up bank to get you approved and to close on time. Feel free to send over a couple pizzas and sodas. Trust me, it\u2019s a classy gesture. \n\nA good chunk of my loan portfolio was built by being \u201cback up\u201d bank in very similar scenarios so feel free to ask questions.", "replies": [], "depth": 1}, {"id": "glqb24i", "text": "\"Certainty of Execution\" is the phrase you'll hear often when working through this process. It's what the borrower wants, and what the lender is promising. Working with a balance sheet lender (bank, credit union, or Life Insurance Company) increases the odds in the borrower's favor but there's still some level of uncertainty. It comes down to the borrower or *broker's* knowledge of the lender's *current* lending program. As a mortgage broker myself, I wanted to point out that a strong relationship with a loan broker can be just as productive/valuable for the borrower, if not more so than going to the lender directly themselves. I say the *current* lending program because as we're still dealing with the effects of Covid, lenders are adjusting their programs frequently. A phrase we're hearing from lenders right now, especially for office and retail deals, is \"every deal is its own conversation,\" meaning they don't want to paint any one type of deal with a broad brush. Shopping it to multiple lenders is a viable strategy, but having a clear understanding of lenders' lending program allows you to take a sniper's approach to just a few lenders who are likely to greenlight your deal. If you're playing golf with John, ask him what types of deals he's closing right now.", "replies": [{"id": "glr46fh", "text": "Yep, I'm also with an [intermediary](https://www.StackSource.com), which is the ideal way to shop multiple lenders. But I also like giving away knowledge.", "replies": [], "depth": 2}], "depth": 1}]