Sharpening the conduit process to a science

TransAtlantic president and CEO Larry Brown has learned much in his nearly 10 years playing the game.

After building conduit operations at Donaldson, Lufkin & Jenrette and First Union, Larry Brown joined WMF Group in February 1998 to set up the company's Charlotte-based real estate operation. Brown took his licks while president of WMF Capital. Though the operation wrote about $900 million of mortgages, it was hit hard when CMBS spreads widened during summer 1998. WMF had to absorb a $30 million pre-tax loss after selling a large number of loans to Merrill Lynch. Brown left the firm when WMF closed the conduit in favor of acting as a mortgage broker.

The 36-year-old market veteran has now joined Deutsche Bank, another firm that took its share of licks during the fall 1998 credit crunch. The company purchased TransAtlantic Capital and named Brown its president and CEO. He has learned from his mistakes, but credits his "process" to his past successes and remains confident it will bring him more success in the future.

NREI: Having worked at WMF Capital, First Union and Donaldson, Lufkin & Jenrette, how do you view your move to Deutsche?

BROWN: I believe that, in today's market, having a good balance sheet is important. And there's nothing like going to the largest bank in the world to make you feel good about your balance sheet (laughs).

NREI: Was the balance sheet the main reason, or just one of many?

BROWN: The primary reason was this vehicle. What I think Utopia is, and I didn't think I would find it necessarily (pauses)... wouldn't it be great to have a small, nimble finance company that had a guerrilla balance sheet? I figured, that's a very nice dream, Brown, but that doesn't exist in real life. And boom, I found it here.

As of about a month ago, the company [Deutsche Bank] owns about 100% of TransAtlantic Capital. Now, suddenly, we're a small, nimble company with the benefits of the balance sheet of Deutsche Bank. It really enables me to flex our muscle when we need to get a deal that we like and do all the things that are associated with a big balance sheet, not to mention weather the storm. If the fourth quarter of 1998 happens again, small companies and even the not-so-small companies, like the Wall Street shops, who borrow their money from folks like Deutsche Bank, are having their wings clipped this year and are not as aggressive as they have been.

But whereas when you're with a big firm like Deutsche bank, you're always going to be prudent but you don't have to necessarily let those kind of market factors impact your business.

NREI: Is the conduit market too competitive right now? In other words, is there too much money chasing too few deals?

BROWN: It's certainly near there if it's not there yet. The quote-unquote good news is some of the larger players are not as aggressive as they have been. First Boston is not up there, basically Nomura doesn't exist anymore, Ameresco is now a broker, WMF is now a broker... so, some of the players that were swooping down and getting loans, competing for loans, aren't as aggressive as they had been. There's less money, if you will, chasing loans. But, because of the combination of folks who were burned in the fourth quarter of 1998 and rates going higher, there are fewer loans out there. You still have the issue of a lot of money chasing only a limited number of loans, but I don't think it's terminal.

NREI: There's a new trend toward big firms - such as Deutsche Bank, Chase Securities, First Union and NationsBank - partnering on big conduit deals. Do you think this trend will continue and why?

BROWN: Put that under the category of probably.

I think what simply happened is when volumes are great, you're looking for around the billion-dollar range to get a deal off. Temper that by the fact that most shops want loans on their balance sheet that they have securitized for as short a period as possible. So what's happening is when volumes are down, instead of doing $1 billion in four months, people are always doing $500 million in four months. What's happening then is banks starting to get these loans off their books, after they've holding them for quite awhile. So they say, "You know what, instead of doing my stand-alone billion-dollar deal, I'm going to team up with whatever bank and take my $500 million and their $500 million and still do my $1 billion deal."

The reason to get it off your books every four months and the reason to do the $1 billion deal is that investors like deals that are liquid and the larger the deal, the larger the tranches. There are AA tranch or A tranch, which may be only 9% of your deal. In a $500 million deal, that's a $45 million traunch; in a $1 billion deal, that's a $90 million traunch. So you're more likely to sell your bonds at better prices and investors will snap them up quicker if there are larger traunches. The flip side is you can get too big a deal; if you have a deal worth more than $2 billion or $3 billion, investors might balk because there are only so many bonds you can sell in a one-week marketing period.

NREI: Do you expect the trend of industry consolidation to continue?

BROWN: Yes, my sort of "End of the World" speech is that, with the arbitrage imitating what happened in the residential market years ago, where it became more commodity-like and so there was less money out there to do this, I believe that the fringe players, as well as most of the Wall Street houses, will slowly exit the business. I think they'll still stay in the business to be bond underwriters for the GMACs, the GEs and the Hellers who are good loan originators but don't have broker/dealers. I think from an origination standpoint, you'll see those folks exit the business and only primarily money centers, such as banks, will stay in the business of originating.

So, yes, I think you'll see fewer players out there.

NREI: How does the present market compare to previous markets you've seen?

BROWN: When I started the business, I was sort of doing the first post-RTC, CMBS deals back at DLJ in 1991 or 1992. Back then, it was sort of a new immature market and there weren't that many deals to be done. By the same token, investors were just starting to get their hands dirty. So, there weren't as many interested as there are now. Then you enter 1994 through 1997, when a double-A rating was the same as a corporate double-A, but these bonds were trading to corporates and you couldn't make them fast enough. Investors would say, "Hey, wait a minute... This is Moody's AA, and this corporate is Moody's AA, but I'm getting a wider spread. This is great!"

Then, come late-1998, it seemed like the big market had a collective belch, if you will, that, "Why are we having an over-saturation of paper here? There is only so much we want." And this came at a time when people had huge warehouses full of stuff because they thought the party was going to last forever. So, we had a significant widening because the market, like investors, almost collectively said, "Whew, we want to sit out for awhile." Not to mention what was happening with rates and uncertainty of the market.

I feel like it's 1993 or 1994 again, where borrowers are sort of deciding whether they want to be interested in the conduit. And you have investors who are saying "OK, I want this to be some of my portfolio, I'll figure out how much. I want the diversity. I've got corporates, I 've got governments. I'd like some CMBS', just let me decide how much I want."

I feel like it's more on the precipice of that opportunity again. And since I believe there will be less players going forward, I feel like those who sort of invest today and stick it out, the originators who stick it out, will wake up in perhaps less than a year and say, "Glad I stuck it out - There are fewer players, the borrowers are back, the rates are still historically low, even in today's environment, and I want to do this for a living."

NREI: What's the most important thing you've learned along the way that will help you in your new position?

BROWN: Process is king. Since we all have the same execution strategy, everybody's going to be similar in terms of where they're pricing the deals and what they can do in their execution strategy. Because again, we're all trying to get rated by the rating agencies. So, in terms of the loan dollars you come up with, everyone's going to be within spitting distance of each other.

The only thing that's going to separate me from the competition is, "Did I keep my borrower sane in the process? Did I have a pretty smooth assembly line, or were there hitches and glitches? Or, they took loan one from me, but did the other guy get loans two through 102?" One of the things I've tried to pride myself on is someone may beat me out for the first loan, but I'll probably get loans two through 102 because my process is a lot smoother. q

NREI: What property types do you prefer and why?

Brown: What I call the low-risk sector of multifamily and anchor retail are the most favored simply because since we don't hold these things on our portfolio but we sell them off as bonds to investors. The higher percentage of your pool with the lower risk product, the better your bonds are going to be perceived as having performed, which means you're going to get better prices for your bonds. The flip side is you want a little bit of each kind of product, whether that means hotel or office, because they [investors] especially like to know you've got diversity.

Once the sticker shock settles in with borrowers, once their confidence is restored that the conduits in business are closing the business and that the players that are left have a real commitment to the business and aren't going anywhere, the deals will become greater again.

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