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Understanding Conduit Loans

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Conduit Lending Overview

Conduit loans have been around since the late 1990s and are somewhat unfamiliar to most commercial real estate investors.

 

What is a conduit loan? A conduit loan - also known as a CMBS loan (Commercial Mortgage Backed Security) - is a type of commercial mortgage that is packaged into a pool with other similar type commercial loans and securitized and sold in the secondary market to institutional investors. This process is known as securitization. The loans in the pool are held in trust and serve as collateral for the mortgage backed security.

 

The secondary market for these type of securities is extremely large and provides a great deal of liquidity to the commercial mortgage market. The mortgage backed security is typically broken up into to tranches (a security that is broken up into different parts but has various levels of risk, return and maturities). Lower risk investors such as pension funds take the least amount of risk while higher risk investors such as hedge funds will take the higher risk.

 

A conduit loan is structured as a permanent, fixed-rate commercial real estate loan on a non-recourse basis according to specific, but standardized underwriting and documentation requirements. These standards facilitate the loan's ultimate securitization.

 

Conduit loans typically provide lower fixed-rates when compared with traditionally commercial real estate loans. They are priced based on the comparable "on the run" treasury rate plus a spread. Property quality grade, tenant quality, tenant bond grade, property location, management, seasoning, and property cash-flow (DSCR) all affect the interest rate spread, either positively or negatively.

 

Prepayment on a conduit loan is much different than with traditional commercial loans. Prepayment on a conduit loan is typically defeasance.

 

Defeasance allows the borrower to purchase substitute collateral for the conduit loan. With conduit loan defeasance, single or multiple US Treasury securities with varying maturities must be purchased in order to complete the defeasance. There is no minimum prepayment under conduit loan defeasance, and in some circumstances, the borrower could actually receive a payment when the conduit loan is defeased.

 

Other forms of prepayment penalties include yield maintenance. Yield maintenance is based on a minimum yield to the investor that purchased the conduit loan (or the Fannie Mae security backed by the loan) and is basically the present value of the difference between the conduit loan’s interest rate and current rates with a similar maturity date as the original conduit loan. Historically, Yield Maintenance terms have been 6 months less than the actual conduit loan term.

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This article is protected under the copyright laws of the United States (title 17 U.S. Code). Any unauthorized use is strictly prohibited. If you would like to reprint this article for use on a commercial website, please contact Crefcoa for more information. Crefcoa is an commercial real estate finance company and financial intermediary providing borrowers with a simplified way to obtain commercial financing and apartment financing through standardization and a product driven online platform.

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