Rialto Capital – Series 2012-LT1 is a done deal. It represents a huge innovation in commercial real estate structured finance. This is the first liquidating trust vehicle successfully securitized in the United States since the famous RTC N Series and its progeny of the mid-1990s. Briefly, the transaction involved the pooling of sub-performing, non-performing and REO assets pursuant to a plan to liquidate the assets in a measured but reasonably expeditious fashion. The sponsor holds the equity and a single class of debt was sold to investors. The deal has closed; the sponsor has stable, predictable match term financing. Bond buyers got a transparent and robust structure with strong subordination, management and downside protection. A powerful new tool has been provided to the commercial mortgage finance industry.
We began writing about liquidating trusts well over a year ago. We were delighted to have played an important role in bringing the Rialto transaction to the marketplace. This transaction has many innovative features and was structured to address a range of complex legal and tax related problems that are incident to the pooling of sub-performing and non-performing loans. For a general discussion of tax implications of pooling these sorts of battered assets, see this previous post.
At about the same time that Rialto came to the market, another deal we worked on – the A10 Securitization 2012-1 – closed. This was an offering backed by a pool of bridge or unstabilized loans. Some of the loans included in this transaction had future funding components. The structure was a melding of traditional CMBS and CLO technologies which balanced the sponsor’s need to manage and nurture bridge product while providing investors with substantial credit enhancement, downsize structural protection and certainty.
Both these transactions are fascinating in their own respects and each had a relatively long gestation as innovation takes both considerable time and effort. But what is most interesting about these two, and a handful of other recent transactions including such things as the L-Star Securitization from 2011 and a number of other bespoke private transactions, is that innovation in the real estate capital markets is alive and well.
The late unpleasantness (as the Civil War is still today described in parts of the South) taught tough lessons about fundamental underwriting and deal structure. Along with the “Lessons of the Fall”, now canonized as received wisdom, such as “no income, no doc” resi underwriting is an oxymoron, B notes will not continue to pay a coupon during a severe market downdraft and never get involved in a land war in Asia, came an enervating anxiety about structure and change, a conviction that keep it simple stupid needed to be the touchstone of our industry for many years to come.
Really hard lessons tend to be overlearnt and that happened here. Innovation, sophisticated engineering and change are not the enemy. They are central to what we do and mid-wife capital formation. We need to embrace our ability to innovate and adapt.
There are lots of good ideas out there and the industry must continue to be open to them. A10 and Rialto are all about using capital market solutions to provide financing for asset accumulators. CMBS and its analogs are easily adapted to a leverage and not a sale technology. Whether it is par product or a non-performing pool, the capital markets can offer nifty solutions. Innovation married to the basics of credit blocking and tackling, conservative underwriting and robust structures is simply a good thing.
Look, there may not be adequate capital in the banking sector to meet the needs of the users of capital. That niche is where we play. Do some of these leverage structures look a bit like the late lamented CRE CDOs? Maybe it looks more like a securitized repo or securities contract. Maybe there will be elements of covered bonds and synthetics. There are answers here!
So let’s get over our post-traumatic stress syndrome, stop trying to fight the last war and embrace innovation! As we’ve said before in this Blog, the market knows how to underwrite commercial real estate mortgages and knows how to underwrite managers. Putting those two together to provide accumulation leverage technology for high-quality whole loans or, in fact, non- and sub-performing whole loans, in the rights hands, is doable, so let’s do.
By: Rick Jones