Lenders -
I understand sizing of a loan usually depends on LTV, DY, DSCR (which takes into account of interest rate). How exactly do lenders price a loan? What I can't fully understand is the pricing consideration for spread/coupon. Are there any specific metrics/threshold lenders price to? Or is it a more qualitative approach (ie look at recent execution and benchmark spread and apply some qualitative adjustments?
Much appreciated
When lending, your primary concern needs to be with getting paid back. Then, after getting comfortable with your loan sizing, you price the debt based on the market, and what you consider to be an adequate return for the risk, given the specific project and sponsorship.
Much of it is market driven and “feel.” The reason being if a lender is offering market covenants / structure and pricing 30 bps lower than everyone else, the borrower will probably go with this lender. If this keeps happening, the market moves lower. If you’re seeing enough dealflow you’ll know where the market is and with time, hopefully you gain a better understanding of risk. This will allow you to understand if the spread you are thinking of quoting is enough for this specific deal, or should you pass on this deal and move to a different one because the market spread doesn’t match what you feel the risk is.
A combination of cost of funds, comfort/excitement about the deal (in regards to risk profile) and market.
In other words, fundamental/risk metrics decided your bottom line. Recent execution determines your range. Feel of the asset concludes your final pricing of specific spread.
Spread is based on the market (what spread/pricing are other deals, similar to the one in question, being done at in the market currently) and, as others have previously stated, what your team/firm feels is appropriate for the perceived risk. I've also seen scenarios where a bank will try to undercut a competitor on pricing (usually 25 bps lower than the competitor) to try to win not-so-appealing loan economics in order to position them-self for higher economic business (i.e. M&A, HY bond offerings, etc.)
Definitely market driven, however, when referring to "market" I want to specify between a primary and secondary. The primary being the typical real estate market as we know it and the credit behind each of deal. A retail deal is going to be priced differently to a multifamily or industrial deals. A deal in Minnesota will have a higher spread than a deal in San Francisco. A deal at 80% LTC will have a higher spread than a deal at 65% LTC.
The secondary market is the leverage market (i.e. how debt funds/alternative lenders make a sizable return on their debt) and this is more complicated. However, just how equity shops use debt to increase returns, debt shops essentially lever their debt positions to do so as well. How we price our loans has a lot to do with how our leverage partners are pricing their risk... This is hard to picture so quick example:
We are originating a $100M loan at 5% rate. Of the $100M we go to Wells Fargo to fund 75% ($75m) at a 2.5% rate. Therefore we are levering our position and making 5% on the $25M and 2.5% on the $25M.
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