Saturday, May 09, 2009

Seemed Like a Good Idea at the Time
The use of conduit financing in tenant in common transactions will be a major obstacle for the TIC industry. Conduit financing allowed for high leverage and low interest rates. Conduit debt were loans that were originated by large commercial or investment banks and then sold into Commercial Mortgage Backed Securities (CMBS). This process, repeated hundreds of times on all types of commercial properites, accelerated the commercial real estate boom of the 2000s. While it was easy to get a commercial loan and easy for banks to get these loans into a CMBS, but once a is in a CMBS it is difficult to modify or refinance the loan. This inflexibility will hinder the TIC industry.

CMBS are dictated by the terms of the security and CMBSs' trustees and special trustees' obligation is to security holders of the various tranches, not property owners. If a property owner can not make debt service payments, the special trustees have limited negotiating authority and are tasked with maximizing the return for CMBS holders. The best decision, in view of the special trustee, may be to foreclose on a property. Extensions are possible, but usually only for short periods. Third parties, like private equity firms or other entities that acquire distressed debt at discounts, cannot buy loans that are in CMBS. Each CMBS was divided into various tranches, each with their own credit rating and investors, but all backed by the same pool of mortgages. This is why it is virtually impossible to "break up" a CMBS, there are just too many investors with differing priorities involved.

Conduit loans were pushed by commercial mortgage brokers and were commonplace financing until the credit crisis started. A conduit loan typically saved a borrower 15 basis points to 25 basis points over loans that banks or insurance companies originated and kept as "portfolio" loans. Before the credit crisis started, many commercial banks were not even making portfolio loans, opting instead for origination and sale into CMBS. Loans sold into CMBS typically had interest-only components that lowered mortgage payments for one to five years, or longer, which borrowers found attracitve because it allowed them to boost yields to investors.

The TIC industry and the CMBS market are going to mirror each other for the near future. The heartaches caused by a savings of 15 to 25 basis points show how yield hungry investors were and competition in the TIC and banking industries.

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