Mortgage conduits emerge as new capital source

Real Estate Weekly, Oct 13, 1993

They were virtually non-existent in 1992, but mortgage conduits this year will refinance nearly $2 billion of smaller income properties, helping to restore liquidity to the real estate market as they proliferate.

So reports a comprehensive study of income-property securitization, issued this week by the national accounting firm of Kenneth Leventhal & Company.

The study also reports that the Resolution Trust Corporation (RTC) ceased to dominate income-property securitization in the first six months of 1993, as non-RTC volume grew to $3.9 billion while RTC issues fell to $2.2 billion.

Securitization is the issuance of bonds for which mortgages or real property assets serve as collateral. Mortgage conduits are vehicles by which various groups such as mortgage banks and investment banks create pools of small loans and package them as collateralized securities.

"Two important trends emerge from the data," says Carl Kane, managing director of Kenneth Leventhal's management services practice in New York, who directed the study. "One is that the securitization market finally appears ready to make it on its own in the private sector, as the RTC winds down its activities.

"Not only is non-government volume growing, but so are the types of issuers and the classes of investors," Mr. Kane says. "Insurance companies and mortgage conduits, in particular, are becoming major players in an arena where the only major non-RTC issuers had been big owner/developers."

The second significant trend, he explains, is the emergence of securitization as a capital source for owners of smaller properties, through mortgage conduits.

"This market is no longer the sole province of the major property owners," he says, observing that more than $600 million of mortgage notes, generally under $10 million each, were packaged into securities through the conduits from January through July of this year. "We expect to see a bigger number for the second half of 1993," he adds.

Mr. Kane also cites a growing diversity of investors in the market. This is reflected, he says, in the increasing complexity of recent security structures, some of which have as many as eight "tranches."

"We're even beginning to see the emergence of mezzanine commercial mortgage securities as a new asset class," he adds. The Kenneth Leventhal survey, which will be updated semiannually, covers all rated transactions - both publicly and privately offered - completed by private-sector and government issuers.

It shows total volume for the first six months of 1993 to be $6.12 billion, compared with $16.62 billion for all of 1992. However, the apparent decline indicated for this year is attributed entirely to the sharp fall-off in issuance activity by the RTC, which is in the latter stages of its asset disposition program.

By contrast, private-sector volume in the first six months 1993 was approximately equal to its volume for all of last year.

Other notable findings of the study include:

(*) Retail properties surpassed multi-family as the leading constituent in non-RTC securitizations during the first half of 1993. Retail accounted for $1.31 billion of volume, compared with $1.09 billion for multi-family. In the ful1 year of 1992, multifamily was $1.37 billion; retail was $842 million.

(*) Owner/developers accounted for about 47% of the non-RTC issues in the f irst half of 1993, up modestly from 43% for all of last year.

(*) Goldman Sachs, Lehman Brothers and Kidder Peabody so far are the leading underwriters of non-RTC securitizations, with First Boston; Daiwa; and Donaldson, Lufkin & Jenrette also playing significant roles.

The study also indicates that spreads are tightening on comparably rated issues; the average transaction size is increasing; the number of AAA-rated tranches is up sharply; and debt-service coverage and loan-to-value ratios have remained at conservative levels.

Predicting continued growth in non-RTC securitizations, especially among mortgage conduits, Mr. Kane cites a Goldman Sachs report estimating that at least $340 billion of "bullet loans" will come due for refinancing in the next few years.

Other factors may also militate in favor of a growing securitization market, he says, including changes in accounting rules and tax law, and new guidelines by the National Association of Insurance Companies that encourage securitized-asset investments in place of whole loans as a way of meeting risk-based capital requirements.

"Barring some unexpected interest rate jolt, the deepening market, with its increasingly competitive pricing, may prove to be an attractive capital source for everything from small owners to portfolio institutions," Mr. Kane says, adding,

"The potential participants in this budding industry should be taking note of the critical changes taking place and setting an appropriate strategic course."

Copies of the complete Kenneth Leventhal survey are available on request from the firm's offices around the country. Kenneth Leventhal & Company is the nation's eighth largest accounting firm, and is known for its expertise in real estate and related financial industries. The Los Angeles-based firm is associated internationally with Clark Kenneth Leventhal.