The Rapid Rise of Second Tier Financing Structures

By Thomas J. Wise

Managing Director, Credit & Asset Management for Trimont

Warehouse and Repurchase (W&R) facility issuers must find efficient ways to address critical administration and risk aspects in managing their portfolios. With many complicating factors and the sheer volume of facilities and collateral deals we are seeing, the management of these portfolios for Warehouse and Repo issuers is becoming time-consuming at best to potentially overwhelming at worst. 

W&R’s have traditionally been used by CRE lenders to leverage their investable funds and maintain or maximize the volume of loan originations, while they effectuate a longer-term solution by note sale, syndication, participation, or pooling loans for a CMBS or CLO offering. These longer-term capital recycling opportunities have become less attractive for large institutions looking to shore up their balance sheets quickly due to increased scrutiny from internal credit/risk departments, regulators and investors about their exposure to commercial real estate (CRE); particularly as it relates to collateral values and considering regulatory changes to their cost of capital. Consequently, the popularity of second tier financing structures such as W&R as a longer-term solution unto themselves has mushroomed.

CMBS, and even CLOs to a lesser degree, tend to be somewhat homogenous in structure, regulated in administration and less flexible with variations in the collateral. Alternately, W&R facilities vary greatly in structure from one provider to the next, even from facility to facility, and offer greater flexibility to their borrowers regarding additions to the collateral loan pool, property types, future funding, and even overall commitment amounts etc. In return for this flexibility, the W&R providers are typically including document provisions to protect them from additional risk. Critical at this point in the market cycle, these range from margin calls when triggered by the portfolio exceeding concentration limits on property types (office being the most common recently but also retail and hotel), to not meeting standard performance thresholds such as DSCR or Debt Yield to unfunded/commitment ratios, collateral values and, of course, underlying loan defaults.

With most deals at mark-to-credit instead of mark-to-market, lenders are delaying taking action on value concerns partly due to the reduction in transaction volume, with investors seemingly waiting on the sidelines for someone else to take the first action and partly due to expectations for Fed interest rate adjustments in 2024. However, they are preparing by focusing on fully understanding collateral performance and obtaining valuations that properly reflect going forward realities. 

With overall real estate markets beginning to acknowledge the decline in collateral values and all parties beginning to quantify the extent of collateral value degradation (Green Street’s all-property index-a measure of pricing for institutional-quality commercial real estate- is 22% below its March 2022 peak as of December 2023), requests for broker opinions of value have skyrocketed. Margin calls will likely drive a major repricing in the market and potentially a call for further security or an unloading of assets should the W&R lenders become the owners of the underlying collateral loans. A proper readjustment to valuations reflective of a more normalized interest rate environment, or range, combined with the significant liquidity still in the market right now, will likely, if history is any indicator, drive a transfer cycle of repricing that will create both stress and opportunity.

Properly administering W&R facilities involves underlying servicer oversight and covenant/compliance monitoring, multi-tranche interest calculations and approvals for collateral loan additions and payoffs. Credit monitoring covers performance of the underlying loans, real estate and the facility itself. Risk analysis ranges from hurdle and trigger calculations specified in the documents, to general proactive concerns such as exposure in particular markets and lender-specific criteria and to potential bankruptcies of national tenants (i.e., Bed Bath and Beyond and WeWork). The complexity of W&R facilities compounds with individual rates and participants specific to each underlying loan, future funding commensurate with the future funding of the underlying loans and underlying loan specific loan servicers each with their own systems and reporting.

As a highly rated Primary Servicer and Special Servicer with 35 years of experience guiding clients through multiple market cycles, Trimont assists W&R facility issuers across the scope of work spectrum. This spectrum ranges from large scale data tape validations (Trimont reviewed an 8,000 field data tape recently on 118 asset level positions across 20 different warehouse lines in a condensed timeframe) and servicer data consolidations, to client tailored scope/task outsourcing for services like covenant and compliance verification, margin calls, threshold triggers, quarterly and annual summaries, watchlist management and far more detailed smaller scale projects such as dedicated client staffing, and U/W, Re-U/W and client risk rating reporting.

For more information, please contact us at info@trimont.com.