In response to continuing pressures from the commercial mortgage-backed securities market on public companies to maintain consistent quarterly earnings in the origination and securitization sectors, Finova Realty Co. announced last week that it was quitting the securitization business and will instead act as an origination arm for J.P. Morgan & Co. According to company officials, the newly formed alliance will first securitize Finova collateral at the end of the first quarter 2000, with three securitizations slated for next year in total.
In a similar turn of events, at week's end Dallas-based Amresco Inc. finally agreed to sell its commercial mortgage business to Lend Lease Services Inc. in New York. Amresco also sold its structured finance business to the company.
Market observers say that such alliances and sales will become more frequent in CMBS next year, as it becomes more and more difficult to process enough origination to meet the typical securitization level of $1 billion.
"The driving force for this was the dynamics in the CMBS marketplace," said Glenn Gray, senior vice president of Finova's corporate development department. "To be efficient and to be accepted the trend has been to do the securitization offering in the $1 billion range. That is approximately what we originate in a year. To do our own securitization would therefore mean that we'd have to be warehousing those loans for almost a full year.
"That introduces a level of volatility to our earnings, and we just weren't comfortable forecasting that."
Moreover, Gray says that if a company has to accumulate up to that level before doing an effective securitization, that is $1 billion on top of a $13 billion balance sheet, presenting a concentration problem as well.
"So we had to deal with those issues but stay in the market as well," Gray said. "We still like the CMBS business, we have a good back shop to process it all, a good origination force, and a good source of cross-sell leads for us. The alternative clearly was not to sell the business, because it is a good business. We had to find a way to keep it and not have that balance sheet accumulate risk."
"It is a function of both volume and profitability," added Jeff Tomei, managing director of Finova Realty. "We are certainly committed to the business, but it will be fewer folks fighting for fewer deals."
But under its new arrangement with J.P. Morgan, Finova Realty Capital will only originate and close loans. Morgan will fund the loans, warehouse them on its balance sheet, and securitize them with other loans the banking company itself has originated.
Shrinking CMBS Market May Subdue Positive Effects
Though the companies involved claim that the two companies together can achieve bigger volume and securitize more frequently than either could on its own, some market observers say that the overall decrease in CMBS supply next year puts a damper on any high expectations.
"We see many firms enter the securitization business and forge alliances, and find both parties are disappointed despite best intentions," said Michael Youngblood, managing director of real estate at Banc of America Securities. "One can think of Amresco's alliance with Morgan Stanley and any number of traditional lenders. One can also think of certain major life insurance companies that established and staffed conduit operations only to find that it did not meet their business plans in terms of originations.
"While we expect [Finova and J.P. Morgan] to do more business rather than less, we anticipate declining originations of most kinds of mortgage loans in the first half of 2000. Therefore...they will be competing for a share of a smaller pie."
Partnership Is Unusual
The pact between the two companies is considered very atypical in the marketplace, mainly because two very strong forces with good credit qualities are forging a formal partnership.
"You're aligning a single-A credit company like Finova with J.P. Morgan, and these are very strong forces," said Tomei. "Finova is the only relationship that they have that is like this. As for us, it's business as usual here at Finova. We have origination and processing people in place, and the loan we make is the same as always.
"It still looks like a Finova loan and smells like a Finova loan. And that is perfect, since we wanted this partnership to be as little disrupting to our existing process as possible."
Finova's Gray also mentioned that the decision to work with J.P. Morgan was based on several factors, including the fact that "the economics of the transaction are very attractive, and [J.P. Morgan's] approach to the business - their credit philosophy and culture - is virtually identical to ours. So integration risk is just absent." The decision to make the alliance took a very short period of time - perhaps 30 days.
Finova is hopeful to do $1 billion in CMBS volume next year, Gray said. However, the company's origination force does much more than deliver loans to J.P. Morgan. It will also do some on-balance-sheet lending in the small bridge loans.
"And if something doesn't fit a CMBS product or it doesn't fit a bridge but fits somebody else's product, we may do some of that too," he added.
CMBS 2000: A Service-Oriented Business
As for whether this will become a trend or not, Tomei believes that a significantly lower volume in CMBS next year and uncertainties in the secondary market will cause other companies to follow suit.
"I wouldn't be surprised if other companies got out of securitization for similar reasons," Tomei said. "When you make a portfolio loan, you can quantify it - we know what our break-even is and we know what the spread is. And that can move on us if we sell in the secondary market - that's what is annoying"
"Those who can provide a very streamlined service and process in CMBS will be the survivors."