Securitized Debt: Hot Source of Capital
Reprinted with permission
By Anna Robaton

Securitized debt financing, which has resurrected during the peak of the credit crunch, is becoming a potent source of capital for commercial real estate owners, industry experts say.

In 1993, an estimated $17.2 billion in securitized commercial-property debt was issued, up from $1.6 billion in 1990, according to a 1993 report by Kenneth Leventhal & Co., a Los-Angeles-based national accounting firm that specializes in real estate and related financial industries. This year total volume is expected to hit $18 billion to $22 billion, the report said.
1990-1993 Total Securitized Debt Activity
Market Remains Strong in 1993
($ in Billions)

Securitized debt financing is viewed along with real estate investment trusts as a means of tapping public money and as a sign that the credit crunch is easing. The complex financing tool usually involves pooling loans and having the pools evaluated by at least one of the major credit rating agencies. The pools are used to issue various risk classes of securities backed by the loans, and the securities are sold to investors.

"There is anywhere between $200 [billion] and $400 billion worth of bullet loans that will be coming due in the next few years, and securitization will likely become the bulwark of that refinancing activity," said Carl H. Kane, managing director of management advisory services for Kenneth Leventhal & Co.

Securitized debt financing made its debut in the early 1980s because commercial banks, insurance companies, pension funds and other lenders flooded the market with capital that was less expensive and easier to obtain, experts say.

The Resolution Trust Corp. (RTC) touched off the current wave of activity in 1991 by using debt securitization as part of its liquidation strategy, financial observers say. The RTC began to wrap up its asset disposition program in 1993, when it issued only $2.8 billion in securities, down from $9.1 billion in 1992, according to the Leventhal report.
"What the RTC did paved the way for the private-sector owners and investors to take the same route," explained William E. Hauser, a New Canaan, CT-based consultant specializing in real estate finance and investment issues. "In a lot of regards, the [RTC's] activities were unprecedented and untested."

Although rates for securitized debt financing generally are competitive with those for conventional financing, the deals are subject to exhaustive examinations by the rating agencies, observers say. What's more, borrowers may be saddled with fees charged by the multiple parties needed to carry out the complex transactions, they note.

The cost of financing typically is determined by such factors as loan-to-value ratios and debt-service coverage. Pools that contain loans with relatively low loan-to-value ratios (below 70%) and high debt-coverage ratios (such as a minimum of 1 to 1.3) are considered low-risk by the rating agencies and, therefore, produce offerings with high numbers of senior securities, experts say. (Debt-coverage ratio is calculated by dividing net operating income by annual debt service.)

Senior securities offer relatively modest yields, but they are attractive to investors because they get priority over junior securities in terms of payments. Rating officials also examine such factors as loan maturity, the risk of tenant rollover, deferred maintenance, potential environmental liabilities, charges for management fees and even the strength of insurance policies.

Cash-strapped shopping center owners apparently have been willing to undergo the scrutiny.

Retail property activity topped the commercial-mortgage-backed securitized debt market in 1993 as measured by the number of deals by property type, according to the Kenneth Leventhal report. By comparison, multifamily transactions dominated the market in 1992.
1990-1993 Non-RTC Securitized Debt Activity
Non-RTC Activity Surges in 1993
($ in Billions)

Commercial property owners and developers with the critical mass to put together their own offerings were the largest group of borrowers in 1993. Working with investment bankers and financial advisors, they generated about 44% of the market's transactions, or $6 billion in volume, in 1993, according to Kenneth Leventhal & Co.

Insurance companies --- many of which are unloading or repositioning assets because of new risk-based capital requirement --- and REITs were the second- and third-largest players, respectively, in 1993, Kenneth Leventhal officials said.

President of Liberty Mortgage

"There was not a lot of need for commercial-loan securitizations in the late 1980s," said Joseph Cunningham, president and co-founder of Sacramento, CA-based Liberty Mortgage Acceptance Corporation. "There were ample sums of money available from banks, life insurance companies, and savings and loans. Money was there for new construction, and money was there for permanent loans."

Founded in 1992, Liberty is one of a number of mortgage conduits that have sprung up because of a demand for refinancing from small- and medium-sized real estate companies. In fact, experts say, most future securitized-debt activity will be done through conduits, which typically earn their money from fees.

A tax-favored vehicle established in 1986, conduits usually assemble loan pools of about $100 million and then team up with investment banks to offer the packaged loans as securities.

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