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Deutsche Bank Loan Signals Rental Home Bond Dreams*

By Heather Perlberg, Jody Shenn and John Gittelsohn – Bloomberg - Apr 19, 2013

Deutsche Bank AG is moving closer to turning U.S. rental home payments into bonds, which would be one of the first new types of securitization since the 2008 credit crisis, and pave the way for an infusion of capital.

A $100 million credit facility the bank arranged for investment firm Five Ten Capital LLC is backed by mortgages on rental houses, according to Chief Executive Officer Rob Bloemker. The structure includes separate loans on each property, helping address one concern raised by Moody’s Investors Service and Fitch Ratings, whose blessings could help sell the debt.

“This has huge implications for the securitization of these assets,” said Steve Blevit, a Sidley Austin LLP attorney in Los Angeles, who worked on the credit line on behalf of Deutsche Bank. “This is the first deal that anyone’s done in this space that has mortgages on each of the properties.”

Single-family rental properties have attracted more than $10 billion from investors including Blackstone Group LP, the world’s largest private-equity firm, which more than tripled its loan led by Deutsche Bank last month. The sale of asset-backed bonds to extract cash and boost returns with borrowed money may aid the transformation of a business once dominated by small investors, which according to Goldman Sachs Group Inc. may total $2.8 trillion, into a new asset class.

Additional Capital

Investors have rushed to acquire single-family properties to rent after home prices fell as much as 35 percent from the peak in 2006. Even with an expanding pool of buyers competing for properties, prices are still down 29 percent. Private equity firms and companies have sought to raise additional funds through borrowing from banks and initial public offerings.

Blackstone, which has invested more than $4 billion to buy 24,000 homes, expanded its Deutsche Bank-led loan in March to $2.1 billion from $600 million. Citigroup Inc. extended a $245 million line of credit in October to Waypoint Homes, an Oakland, California-based firm that owns more than 3,000 rental homes and said this month it planned to sell shares to the public.

“As people see that the single-family for-rent business is a long-term operation you’ll see more financing come into the sector,” Jonathan Gray, global head of real estate for Blackstone, said during an interview in Los Angeles. “I don’t know how it’ll end up with us in terms of the best way to finance it, but I do think securitization will start to be a source of financing.”

Renee Calabro, a Deutsche Bank spokeswoman, declined to comment.

Key Enablers

Securitizations, which involve pooling debt ranging from subprime mortgages to car loans and student debt, were blamed for fueling the housing bubble and subsequent financial crisis by making credit too easily available.

Standard & Poor’s, Moody’s and Fitch were “key enablers of the financial meltdown,” the Financial Crisis Inquiry Commission, created by Congress with a 10-member bipartisan board, said in its January 2011 report. “This crisis could not have happened without the rating agencies.”

The commission’s report also blamed the crisis on lenders’ irresponsible and sometimes fraudulent practices; regulators’ inattention and overconfidence; and the recklessness of borrowers and investors.

Still, reviving the market was a key part of the Federal Reserve’s response to the crisis as it sought to restart lending and boost asset prices.

Rating Comments

Ratings companies began commenting last year on how they would approach an assessment of securities backed by rental homes as private-equity firms accelerated their purchases.

Moody’s said in a report in January that the bonds would be safest if backed by mortgages on each property, rather than secured by a trust that owns a pool of houses. The credit grader said it wouldn’t offer its highest ratings to deals backed by equity structures and that adding mortgages on individual homes carries costs to create and register the loans.

Structures without mortgages would also limit Kroll Bond Rating Agency’s grades, according to analyst Glenn Costello.

If securities were backed by a pool of properties, a bankruptcy could lead to new debt on the homes that would disadvantage bondholders, the ratings companies have said.

That’s not the only concern that Fitch would have about potential deals that could limit its ratings, Dan Chambers, an analyst, said in a telephone interview. There’s also too little history on the skills of operators and data on the performance of the asset, he said.

With institutional investors buying large numbers of homes to rent out in some markets, “if they all go on at the same time, what’s that going to do with occupancies and rents?” he said. “I don’t think we’re going to be at AA for a long time.”

Systematic Basis

Deutsche Bank’s loan to Piedmont, California-based Five Ten “shows mortgages can be documented for each property on a low-cost basis,” Blevit said. “We figured out how to do it on a systematic basis so that it’s not expensive to do.”

Five Ten, which owns about 1,000 homes in seven states, including Florida and Arizona, plans to use its additional funding to buy, renovate and rent more houses, CEO Bloemker said.

“We felt having mortgages on all the properties would give us more flexibility in long term financing going forward,” Bloemker said in a telephone interview from Texas, where the firm is expanding along with Missouri. “It will give us access to better terms and lower rates as this market matures.”

Available financing has “really gone up” with most of the largest banks already offering loans, according to Silver Bay Realty Trust Corp. CEO David N. Miller, whose Minnetonka, Minnesota-based rental-home firm raised $245 million in an IPO in December. The shares rose 2 percent to $20 at 4:15 p.m. in New York extending the gain since the offering to 8.1 percent.

Near Future

Securitization is “certainly a possibility and a strong possibility over time, but I just don’t see it very much in the near future,” he said on a conference call last month.

Laurie S. Goodman, the Amherst Securities Group LP researcher who’s in the Fixed Income Analysts Society’s Hall of Fame, is also skeptical that the bond market will be a significant source of funding for firms renting out homes bought in foreclosures, known as real-estate owned, or REO.

“I don’t think securitization will be the best outlet for the REO-to-rental operators, at least in the near term,” she said in an e-mail. “The rating agencies will be very conservative, and don’t have a rental history they are comfortable with to forecast cash flows.”

Perfect Environment

Part of the reason securitizations may be slow to develop is that the companies involved aren’t sure whether they would want long- or short-term financing, which would affect the nature of their deals, Fitch’s Chambers said. Chris Hentemann, chief investment officer at hedge fund 400 Capital Management LLC, which oversees about $700 million, said it would be a natural progression for the securitized markets to replace bank lending.

Right now would be “the perfect environment for securitizations like this to come to market,” said Hentemann, a former head of global structured products at Bank of America Corp.’s securities unit through 2007. “There’s a lot of capital out there chasing higher yields, so the pricing has become much more normalized and it’s much more efficient for people to bring securitizations to market at good economic levels.”