AMERICAS NEWS: Thinking outside the box

Call it CMBS 2.0. While new issuances of commercial mortgage-backed securities are expected to rise over the next several years, 2012 also has seen the first securitisations of nonperforming loans (NPLs) since the 1990s, when the Resolution Trust Corporation (RTC) liquidated the mortgages of hundreds of insolvent US savings and loan institutions. Private equity real estate firms have been at the forefront of such securitisations, with a handful of players making offerings for the first time in their respective histories as a way of financing NPL portfolio purchases.

The resurgence began in April, when New York’s Rialto Capital closed on a $132 million offering backed by 282 loans and 38 real estate-owned (REO) assets. Another New York-based firm – Square Mile Capital Management, through a joint venture with The Blackstone Group – followed suit a few months later with the completion of a $159.5 million offering collateralised by 26 loans and five REO properties.

Most recently, Oaktree Capital Management, a Los Angeles-based alternative asset manager, securitised a group of nonperforming loans in a $195 million offering that closed at the end of September. The notes, which are backed by 686 loans and 78 REO assets, were purchased by multiple undisclosed institutional buyers.

To return capital to investors, the firms are using securitisation as a financing vehicle, where the proceeds from the sale of the notes will help to repay investors in its funds. Securitisations have been more commonly associated with newly originated loans, as in the case of commercial mortgage-backed securities, where the investors earn back their capital through the cash flow of mortgage payments. In the case of NPL securitisations, however, returns would be generated through the liquidation, resolution or restructuring of distressed loans. 

Such offerings represent “a meaningful increase in leverage” for firms like Oaktree, says Mark Zytko, co-founder and co-chief executive officer at Mesa West Capital, a Los Angeles-based debt fund manager. “It’s hard to borrow against these pools of loans because there’s only a couple of banks that will give loans for pools of loans.”

The involvement of private equity real estate firms like Oaktree in NPL securitisations is a strong indicator of the rebound in both the real estate and securitisation markets, according to Philip Feder, head of the global real estate practice at law firm Paul Hastings, which represented Oaktree in the offering. He anticipates that more NPL securitisations are on the horizon as the real estate market improves and banks sell more distressed debt to clear up their balance sheets. 

“The appetite for this is pretty keen,” Feder said, noting that institutional buyers are looking for yields that are more attractive than that of US Treasuries. “There will continue to be a market for the foreseeable future on the acquisition of NPLs, and there will be a market for the securitisation or financing of those portfolios during that same period.”

This year’s NPL securitisations are a strong sign that bond buyers now “are willing to go outside the box,” added Zytko, who worked on such offerings at SunAmerica Investments during the RTC years. “Two years ago, there was no appetite to take any risk. If there were 31 ice cream flavours, they wanted them all to be vanilla.” 

Because private equity real estate firms want to make a profit as quickly as possible, the distressed loans that they acquire “will get resolved more quickly than if they stayed on the bank’s balance sheet,” said Zytko. “That’s good for the real estate market because it’s clearing old issues.”

However, “I don’t see a tidal wave” of securitisations, Zytko countered. “There will be a steady stream, but a small stream.” He projects about $1 billion to $2 billion of offerings per year – at most, 5 percent to 10 percent of the overall securitisation market. 

For one thing, securitisations require some scale on the part of the issuer – usually at least half a billion dollars in equity – in order to pay for the high transaction costs of an offering and to accommodate other transactions being made by the same investment fund. 

In addition, while private equity real estate firms have been major buyers of NPL pools, there haven’t been enough pools for them to buy. Unlike with RTC, the US government has not pushed for the liquidation of troubled loans. Instead, banks have only written off loans on a selective basis, and there have been fewer failed banks, which are a primary source of NPL sales. Additionally, some distressed mortgages are getting resolved as property values rise.  

In fact, some firms have exited from NPL investments because of the lack of deal flow. While Oaktree and Colony Capital have been active buyers of NPL portfolios, many opportunistic fund managers have stopped focusing on this area because there have been few transactions.

That said, the beneficial impact of NPL securitisations on the market can’t be ignored. Because securitisation encourages the resolution of a distressed loan, “that property is going to have a new owner and new capitalisation so it can move forward,” said Zytko.