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Does Greystone Securitization Portend Greater Liquidity?

March 15, 2011

In a development that may well bode well for liquidity in the small-balance finance space, property-heavy lender Greystone Bank is securitizing nearly $100 million in long-term, fully amortizing small-balance commercial mortgages. A successful privately placed sale of the bond deal's various tranches would seem to suggest solid secondary-market demand for securities backed by pools of small-balance loans.

The Raleigh-based bank, an affiliate of real estate-minded (and New York-based) financial services conglomerate Greystone & Co., funded and acquired the pool's 175 loans - pre-recession in most cases.

The vast bulk of the collateral backing the pooled loans are smallish mixed-used and multifamily properties - most of them in the Los Angeles, San Francisco and New York metro areas. The average balance is a bit over $558,000.

Greystone declined to discuss the offering with SmallBalance.com, other than to say the unit that originated the deal's mortgages isn't actively funding small-balance loans for securitization these days. And the researchers at DBRS Ratings who gave provisional ratings to the issue's half-dozen bond tranches didn't respond to inquiries about bond-buyer demand and private-placement pricing trends.

Veteran mortgage banker David Stepanchak at George Smith Partners in Los Angeles shared his thoughts on Greystone's likely motivations for securitizing the portfolio - and on prospects for a successful bond sale.

Today may not be an ideal environment for privately placing bonds backed by small-balance commercial mortgages - but Greystone's intentions suggest executives there are comfortable with prevailing secondary-market demand for these privately placed securities, Stepanchak observes

Clearly, demand is recovering for large-scale CMBS offered through public securities markets. Securitization activity remains a shadow of the pre-recession bubble years (issuance peaked at $230 billion in 2007), but projections have issuance climbing back toward $50 billion this year from less than $10 billion in 2010.

Yield spreads (over comparable-term interest-rate swaps) by which bonds are priced have generally tightened with each subsequent "conduit"-type (large and diversified) CMBS issue going to market so far this year - an indication of solid bond-buyer demand. Nevertheless Stepanchak worries that demand for the subordinate so-called "first loss" (or "B-piece") tranches remains far thinner than was the case pre-recession when numerous and aggressive B-piece buyers competed for these high-yield securities.

As Stepanchak notes, less than a handful of expert special servicing operations are actively looking to acquire subordinate bonds of the new CMBS issues coming to market these days.

"We need a deeper market than that" to maintain a strong, high-volume marketplace, he cautions. "If one of active players exits the market for some reason, then what will we have?"

As subordinate CMBS losses have mounted, many of the formerly most active B-piece buyers have been sold or otherwise recapitalized. But a few others have stepped up, with the likes of Elliott Management, Rialto Capital, BlackRock Realty and H/2 Capital Partners actively acquiring B-piece positions of late (and in most cases the special servicing rights that come with these investments).

Likewise Stepanchak is concerned that in today's distress-tinged, note-sale environment, most investors pursuing commercial mortgage portfolios are driven by a "discount" mentality. The market's perception today is that available pools are either mostly distressed loans, or offered by distressed lenders, he elaborates.

"Either way, discount rules," Stepanchak laments. "Perception trumps reality."

However, loans backing the bonds Greystone's Waterfall Victoria fund is offering through Citigroup and Merrill Lynch are far from standard conduit fare.

For one, they don't balloon within 10 years like most loans originated for securitization. More than 90 percent of the 175 mortgages are fully amortizing - the vast bulk over 30 years and others over 15. While that won't prevent term defaults, it does eliminate balloon refinancing risks.

And while conduit loans are typically non-recourse, the Greystone pool's loans are all full recourse to the borrowers. They're also far more "seasoned" than is usually the case with the CMBS pools that have come to market over the past decade.

The average seasoning level is 33 months - which also seems to suggest that many of the loans were originated at the height of the economic cycle when underwriting was most liberal. Indeed DBRS calculates that nearly a third of the loans now have debt-coverage ratios below 1.0x.

Nevertheless, their collective performance to date is pretty much spotless. As DBRS analysts Kevin Mammoser and Mary Jane Potthoff point out, all of the loans are current, and none has ever been more than 30 days delinquent. Nor have any been modified.

That's apparently about par for the course with Greystone Bank loans. According to DBRS research, loans that the bank has originated or purchased since 2006 have performed pretty well, with a 3.3 percent 60-day delinquency rate and a 2.2 percent cumulative charge-off rate. That's impressive, given that the CMBS arena's collective delinquency rate is now closing in on double-digits.

Other tidbits of interest: Current interest rates average about 7.1 percent, but about 80 percent of the loans have some kind of adjustable feature over the course of their terms. Also, KeyCorp Real Estate is the primary loan servicer and special servicer for the portfolio.

The bond issue is broken into classes including a tranche of just under $70 million carrying a provisional AAA rating; an approximately $4.4 million AA-rated class; A and BBB tranches of $3.9 million each, and a pair of $7.8 million unrated classes.

With such a diminutive average balance, these aren't the kinds of loans traditionally contributed to large CMBS issues. However, before the real estate bubble burst three-plus years ago there was a budding movement toward forming to-be-securitized pools comprised solely of small-balance loans. As is the case with the Greystone issue, they were mostly targeted at private placements rather than public securities markets.

Stepanchak for one wouldn't be surprised to see more such activity ahead in the small-balance space as real estate and capital markets continue to recover - and as a burgeoning "glut" of debt targeting larger-balance loans (and corresponding CMBS) continues to build. In fact, he's convinced more debt investors will shift in coming months toward small-balance loans generally.

"As the number of (larger-balance) originators continues to grow and current players continue to staff up, the (loan-size) threshold will have to compress if originators want to keep writing new business," Stepanchak suggests. "We are still a few months out, but the number of sub-$5-million players is bound to grow."

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