STATESIDE: Securities check

Last month, $3.5 billion in bonds for Hilton Worldwide were issued through the commercial mortgage-backed securities market in advance of The Blackstone Group’s anticipated initial public offering for the hotel chain next year. The CMBS sale, which was part of a larger refinancing plan for Hilton’s $13.5 billion of debt, was the largest such offering since the global financial crisis. 
Along with the $2.5 billion CMBS issuance for Blackstone’s Extended Stay America hospitality portfolio, the Hilton deal was one of the most high-profile securitizations to occur in recent months. Indeed, the CMBS market has been experiencing a wave of megadeals – transactions that are $1 billion in size or larger – as of late, and these megadeals themselves are part of a surge in CMBS offerings overall. 
According to data provider Trepp, CMBS issuance could reach up to $90 billion this year and between $140 billion and $160 billion in 2014. Moreover, this year’s volume is anticipated to approximately double from last year – much of it being driven by the private equity industry, says Stephen Renna, president and chief executive of the Commercial Real Estate Finance Council.
“Certainly, private equity is becoming increasingly comfortable with CMBS,” Renna says. Large single-borrower transactions currently make up about 20 percent of CMBS volume, compared with just six percent in 2007, according to Trepp. Pre-crisis, the securitization market primarily consisted of conduit deals, where hundreds of smaller loans were packaged into one securitization by the lending bank.
One of the reasons for the increase in single-borrower transactions is because of the massive amounts of real estate capital that a select number of private equity firms have raised in recent years. To deploy the capital raised within a set investment period, private equity firms have had to pursue equally large transactions, many of which will need to be financed. Meanwhile, firms also are taking advantage of low interest rates to refinance entire portfolios, especially in anticipation of rising interest rates in the coming years. 
With both of these types of transactions, the industry has found the CMBS market to be particularly attractive because of its ability to raise billions of dollars in debt financing. Traditional banks and insurance companies simply do not have that level of lending capacity, even when teaming with other lenders.
Private equity firms, however, also have been active as investors and typically are the buyers of the non-rated – the highest risk and therefore the highest-yielding – portions of CMBS bonds, as well as the lower-rated pieces below AA. The lower-rated bond pieces make up about 20 percent of the CMBS market, while non-rated, or B-piece, transactions account for about five percent of securitization activity, according to Renna. 
From the borrowing and investing sides alone, the industry therefore is tied to about 45 percent of CMBS volume. This doesn’t even take into account the role of private equity firms as lenders in the CMBS market. While figures on lending volumes by private equity sponsors were not available, Blackstone, Colony Capital and Silverpeak Real Estate Partners all have recently announced the launch of new lending platforms through which the firms plan to originate loans that eventually would be securitized.
Private equity’s multiple roles in the CMBS market today consequently represents a stark change from the securitization market of 2007, when firms primarily were focused on buying B-pieces. By becoming more active, the industry is helping to ensure that the CMBS market will be healthier than it was pre-crisis. 
Private equity’s most significant contribution in this respect is as a borrower, as lenders are taking a very conservative approach to underwriting big-ticket securitized real estate deals, for which private equity firms are the main driver. As a recent report by tax and advisory services firm EY noted: “Due diligence in this wave of CMBS is a strong reflection of the hard lessons investors faced from CMBS 1.0. The process is extremely rigid for megadeals especially, with lenders paying careful attention to individual properties and markets and contextualizing the overall portfolio within a broader industry scope.” 
Moreover, single-borrower transactions are frequently structured as club deals in order to allow lenders to split the exposure of a large deal – another sign of banks’ lower risk appetite. Anywhere from two to five of the major investment banks are “clubbing” together to back such $1 billion-plus portfolio financing deals, according to EY. 
Lastly, with private equity firms financing and refinancing significant portfolios through securitizations, the pool of CMBS borrowers overall is more financially sound than it was during CMBS 1.0. “This era is going to be different because the players are sophisticated players,” said Phil Feder, a partner in the real estate department at law firm Paul Hastings, “whereas pre-2007, the CMBS market made a lot of loans to people who should never have gotten the loans.”
Feder noted that now is a great time for real estate “as long as we don’t become drunken sailors and go crazy.” While there may be remnants of some risky behavior in the securitization market, irresponsible actions are less likely to happen today and lenders overall have stayed sober. The last hangover was bad enough.