As the phenomenon of large-loan pool commercial mortgage-backed securities deals slowly becomes a thing of the past in the minds of CMBS players, Standard & Poor's Ratings Group issued a special report last week concerning past performance and future prospects of the large-loan pool market.
Introduced and popularized by Nomura Securities International Inc. under its MegaDeal label, large-loan transactions, to date, have consisted of 12 or fewer loans to significant borrowers. Viewed as hybrid pools, large-loan transactions are analyzed on a property-specific basis, but received credit support levels reflecting the benefit derived from aggregating a portfolio of loans.
However, despite a favorable track record - to date, there have been no delinquencies in the deals rated by Standard & Poor's, and the properties have generally performed well - there have not been any large-loan transactions in all of 1999, according to the report.
"There is no secret why there are fewer large-loan transactions happening," said Michael Youngblood, managing director of real estate research at Banc of America Securities. "The innovation was deeply undermined in October 1998, and since then, dealers have been keener to have well diversified pools in smaller conduit pipelines as a matter of general prudent management."
"Because of the types of concentrations you have in large-loan pools, you need some true expertise in real estate to evaluate cash flow runs, and even to visit properties if it is a very large loan secured by one property," added Larry Kay, the S&P analyst who wrote the report. "For large-loan deals, it is a much more intense analysis, whereas on the conduits, because there are so many more loans and properties, it becomes more of a statistical approach, and it is really based on numbers."
According to the report, as the CMBS investor base grew beyond the traditional, experienced real estate investor, the demand for conduit securities increased. Conduit diversity comes in the form of greater numbers of loans, borrowers and properties. Conduits are also more dispersed by property types and geography than large-loan transactions.
Because the conduits became the preferred issuance, some of the large loans eventually ended up in the larger conduits, and, to the extent they did not dramatically skew the pool's concentrations, they were accepted by the conduit investor base.
"Investors accept a mixture of large and small loans as long as the large loans do not represent a significant portion of a fusion or conduit transaction," Kay said. "But once a large loan, even in a conduit, is significant, I think investors would shy away from that."
And large-loan transactions will not be making a comeback anytime soon. Many of these deals have been transformed into floating-rate transactions, like the current General Electric/Merrill Lynch conduit hitting the CMBS market.
"I would not describe the disappearance of the large-loan transactions as a negative for our market," added B of A's Youngblood. "It is just simply that a semi-speculative product that had a brief appearance has now essentially disappeared."
Youngblood added that the only group that is still concerned about large-loan deals are the life insurance companies, because this class of borrowers desires to diversify their funding sources away from conduits.