REAL ESTATE LENDING

UNIVERSITA’ DI TOR VERGATA PAPER DISCUSSION- Francesco Di Leo

PAPER: W. Hardin and Z. Wu (2010), “Banking Relationships and

REIT Capital Structure”, Real estate Economics, V38 (2): 257-384

• Capital structure in REIT is an interesting research topic because REITs

do not pay corporate taxes (advantage from take debt) and are capital

intensive firms to pay dividend.

• Which is the optimal mixture of debt and equity?

• Why REITs use debt at all given minimal tax benefits?

• How much debt REITs should use in total?

• Over the past 15 years REITs increase in the use of bank debt for

property acquisition, development and mergers; repeated borrowing from

the same bank (banking relationship) and expand range of capital

sources including bank lines of credit and capital market debt.

• The authors investigate how the use of bank debt and the

development of banking relationship influence REIT capital

structure.

• Banking relationship help REIT to access to the public debt markets?

• Banking relationship does reduce REITs’ secured debt liability?

• Which is the effect of banking relationship on REITs’ leverage?

INTRODUCTION AND AIM (1/3)

INTRODUCTION AND AIM (2/3)

• REITs use debt financing to the emergence of bank debt standard in

the form of mortgage and limits management’ s operating meanwhile

lines of credit are more flexible.

• Glass-Steagall-Act in 1999 permit commercial banks to underwrite

public security this is a new help to REITs to access capital markets

• Effect of banking relationships on leverage are ambiguous on

literature but the characteristics of secured lending underwritten

and the value of collateral point toward lower leverage with the use of

lines of credit. Higher leverage it could not be the best practice

• This paper finds that REITs with banking relationships are more

likely to have a long term bond rating so to issue public debt,

have less secured debt ratio and use less leverage (robust find). The

authors finally test that REITs use bank debt and equity to fund

property acquisition and then issue public securities to change capital

structure.

INTRODUCTION AND AIM (3/3)

• The results evidence new trend in REITs finance management to

shift from mortgages and secured debt to unsecured debt

financing(mature industry), use bank debt despite no tax

advantage to take quick action in property acquisitions and finally

test that REITs with banking relationship have lower leverage. It

is important that REITs use unsecured public debt and banking lines

of credit are able to improve financing and move flexibility and to

reduce secured debt and leverage.

• This is the first research that empirically study relation between

banking relationship and corporate capital structure, the

authors think that is an empirical question studying if REITs involved

in banking relation should be higher or lower leveraged

• In their history REITs debt structure move from secured single-asset

liabilities(mortgages), revolving bank credit (unsecured) and

unsecured public debt. Is important the role of banks in REITs new

liability structures

LITTERATURE REVIEW (1/4)

Brown and Riddiough(2003): previous research on REIT capital structure

focusing on public debt and equity offering

Howe and Shilling(1988): signaling effect of bank debt. Positive effect to

stock price but negative reaction to equity issuances

Elayan, Meyer and Li(2004): signaling effect of bank debt. Announcement

of bank debt is a positive outstanding signal about the firm value

Diamond-1984, Boot 2000: banking relationship help firms to mitigate

capital market friction

Diamond-1991: banks offer monitoring services- firms young and small

track records – access to capital market (good reputation)

Boot-2000: banking relationship improve REITs capital market access

LITTERATURE REVIEW (2/4)

Ooi,Ong andLi (2010): because public debt is often unsecured, public

bondholders care about REITs’ strategy this reduce capital market friction

and help access to capital market. They also investigate timing of public

offering

Boot, Thakor (1994): Banking relationship mitigate capital friction so banks

require less collateral to finance REITs

Dennis, Nandy and Sharpe (2000): provide evidence that collateral is

more likely to be request in the presence of capital market frictions.

Informational asymmetries and other market frictions are reduced allowing

more use unsecured debt

Johnson (1998): banking relationship mitigate capital market frictions

helping REITs to access to the debt markets in general (Leverage)

Brown and Marble (2007): asset substitution problem decreases in the

proportion of the original debt that is secured so firms with lower secured

debt would have lower leverage

LITTERATURE REVIEW (3/4)

Brown and Riddiough (2003): REITs want to improve their credit rating

to access to capital market so they have to reduce leverage. REITs use

bank debt and equity to fund property acquisition and then issue public

securities to change capital structure

Faulkender and Petersen (2006): sources of capital (private vs. public

debt markets) affect the capital structure

Hackbarth, Hennessy and Leland’s (2007): large or mature firms use

mixed debt financing (bank and market debt)

Diamond 1984, James 1987, Houston and James 2001: bank debt

provides firms liquidity, mitigates informational asymmetries in the

markets and adds monitoring benefits to shareholders

LITTERATURE REVIEW (4/4)

Datta, Datta e Patel 1999, Drucker and Puri 2005, Yasuda 2005:

banks and borrower improve interaction to reduce loan pricing and

public security underwriter fees

Myers (1977): argued that high-growth firms tend to use more short-

term debt to mitigate under-investment problems

SAMPLE (1/4)

Three data sources are used to obtain information on REITs loans,

public securities offerings and firm financial information.

1) Loan Pricing Corporation’s (LPC’s) DealScan database it provides

information about loans terms such amount, maturity, spread, lender

information. 1434 REITs are identified from the database. The data set

include 1061 bank lines of credit and revolvers, 303 term loans and 70

other loans from 1992 to 2003.

2) SDC Global New Issues database: from 1970 provides information

as offer amount, issuers, offer price, yield, underwriting fees

3) SNL REIT database: matches information from DealScan and SDC

to obtain more detailed financial information as total assets, real estate

investments and market capitalization.

SAMPLE (2/4)

• Sample criteria: they consider REITs listed and elected tax status

from 1992, registered with NAREIT, be an equity REIT.

• REITs with banking relationship have lower standard deviation,

are not necessary old REIT, are interesting to obtain long-term

credit rating. Access to public debt markets and reduce secured

debt ratios.

• Bank debt is about 33%-55% of total capital issue each year,

REITs increase use of short-term bank debt for they property

acquisition and development

• Seasoned equity issuance fluctuate from year to year this suggest

that REITs prefer bank credit but when capital condition are more

beneficial to the firm they adjust their capital structure with capital

issuance

• They shows descriptive statistics of REIT public debt, equity and

bank loan issuance

SAMPLE (3/4)

SAMPLE (4/4)

METHODOLOGY (1/3)

• Descriptive statistics

• They first measure banking relationship effects to increase their

access to public debt market

• Probit model, based on the previous literature ( Johnson 1998 and

Faulkender and Petersen -2006) dependent variable is regressed to

two relationship variable: RELATION (0-1 if REIT borrows from the

same bank twice a year) and DURATION (number of years since the

firm established the relationship with the bank)

• The dependent variable is a dummy variable indicating if a firm has

got a rating (proxy to access to the public debt markets)

• They compute the marginal probability following Faulkender and

Petersen -2006 to mesure the magnitude of the effects when a REIT

changes from no relationship to relationship or increasing duration fro

10th percentile to 90th percentile

METHODOLOGY (2/3)

• They add two instrumental variables:

• NYSEdummy and Age<5 (REIT’s age)

• To conduct robustness checks they add two relationship variables:

• Multiple: REITs borrow from different banks

• Mduration: REITs duration of their banking relationship with the same

banks

• They change dependent variable using public debt issuance

information:

• PCdummy (0-1 if REIT at time t has a public debt offering)

• Then they analyze banking relationship with the amount of secured

debt

• Two measures of secured debt ratios are used: SECUREDRATIO

(secured debt/total debt) and SECUREMARKET (Secured Debt/Total

Assets at market value)

METHODOLOGY (3/3)

• Because using rating as a proxy affects leverage with different

specifications they test two different rating variable: one constructed

from the S&P long-term rating and the other the predicted rating from

the first-stage regression (model 3) to mitigate the effect of access to

public capital and leverage

• More over they study the influence of banking relationship on

leverage: the outside-variable is LEVERAGE (Total Debt/Total Assets

at market value)

• Finally they examine the interaction among bank debt, public debt and

equity to evidence the evolution of REITs capital structure analyzing

the purpose for the period of 1992 to 2004 with descriptive statistics

and using Tobit model: bank debt is independent variable, equity and

bank debt the dependent variables. To measure bank debt they use two

variable LOC (bank debt use in year t) and DLOC (change in bank debt

use from t-1 to t)

RESULTS (1/10)

• There is a positive relation between the two relationship variables and

rating

• Magnitudes: with banking relationship the probability of having a bond

rating increases by 5%, whereas increasing duration raises the

probability of having a bond rating by 6,8%

• Magnitudes with robustness banking relationship: with multiple

relationship the probability of having a bond rating increases by 8%,

whereas increasing multiple duration raises the probability of having a

bond rating by 5,9%

• Changing dependent variable in PCdummy instead of Rating

results are qualitatively similar: good bank relationship increase public

debt offering

• Magnitudes: with banking relationship the probability of having a public

debt offering increases by 10,5%, whereas increasing duration raises

the probability of having a public debt offering by 5,8%

• There is clear evidence that REIT that exstabilishes a relationship

with a bank gains access to the public market debt and many

banks who lend to REITs are also part of the underwriter team for the

REITs’ first public offering issuance

RESULTS (2/10)

• Analyzing the interrelation between banking relationship and

secured debt ratios there are six empirical specification using the

original and predicted rating variable (model 3), there is a strong

negative relation between banking relationship and secured debt

ratios: the coefficients of relation and duration are all statistically

significant and negative and all the inside variables in the regression

are negative: negative rating means with better access to public debt

markets REIT decrease secured debt, negative size means that

smaller REITs decrease secured debt

• The results with robustness checks using SECUREMARKET as

dependent variable are qualitative similar and confirm that REITs with

banking relationship has lowered secured debt ratios

• Analyzing the interrelation between banking relationship and

market leverage there are six empirical specification using the original

and predicted rating variable suggesting REIT leverage is inversely

related to banking relationship (different from Johnson 1998),

negative coefficients on MTB and PROFIT are consistent with

literature, negative RATING differ from Faulkender and Petersen

(2006).

RESULTS (3/10)

• The relation between banking relationship, less secured debt and

less leverage supports researches by Brown and Marble (2003) and

Brown and Riddiough (2003) (controlling leverage permit to keep

unchanging credit rating level) and on the authors’ opinion depends on

the unique characteristics of REITs environment and to real estate.

Using bank debt and the public debt financing REITs are more flexibly

and maintain adequate level of financing liquidity but too much debt

could be counterproductive to access to the public capital markets.

• Analyzing REITs capital structure they evidence that 36,4% of the

equity offerings are used to pay down bank debt meanwhile 30,5% of

bank loans are issued for capital structure purposes, interesting is the

result that 22,7% of bank loan are used for acquisition confident with

Brown and Riddiough (2003) that evidence as public debt is used for

reconfigure liability structure whereas bank loan and equity are

used for acquisition and investment. The findings are also

consistant with Ooi, Ong and Li (2010) about assessment of market

timing of capital activities.

RESULTS (4/10)

Analyzing timing pattern of public debt issuance they show that there

is a negative and statistically relevant correlation between debt issuance

and bank debt use, this does it means that REITs during the same year

don’t increase at the same time bank debt and public debt, this

suggest that there a total debt limit. This results are consistent with

lower leverage ratio. Bank debt has limitations (Huston and James, 2001)

and REITs have a mixed capital structure (Hackbarth, Hennessy and

Leland, 2007)

RESULTS (5/10)

RESULTS (6/10)

RESULTS (7/10)

RESULTS (8/10)

RESULTS (9/10)

RESULTS (10/10)

VALUE ADDED RESPECT TO LITERATURE (1/2)

• The article combine banking relationship literature and capital

structure literature, it is the first research that link banking relationship

and firm capital structure.

• Respect Johnson (1998) that analyze relation between bank debt and

capital structure they focusing on banking relationship found better

result about the effect of bank debt use and the optimal debt and

capital structure.

• Studing REITs debt structure progresses, to a stage that mix unsecured

bank debt to unsecured public debt where bank have an important

role.

• Banking relationship help REITs to reach public debt markets

(Diamond 1991), they use more corporate unsecured finance lowering

their leverage ratios (Brown and Marble 2007)

VALUE ADDED RESPECT TO LITERATURE (2/2)

• Results support Brown and Riddiough (2003) which show that public

debt issuers target leverage ratio to preserve investment-grade

credit rating (markets and investors recognize lower risk). Empirical

evidences show that REITs use debt without any tax advantage to reduce

property markets frictions and take quick action in acquisition.

• As in Faulkender and Petersen (2006) the source of capital (bank debt)

affects capital structure (public capital markets) and banking

relationships (Hackbarth, Hennessy and Leland, 2007) influences

capital structure decreasing secured bank ratio and leverage

IMPLICATIONS AND FURTHER DEVOLPMENT (1/1)

• This study has relevant implication on REITs best efficient financing

policies. Good banking relationship and flexible use of banking facilities

give an instrument to monitoring liquid capital needs also in the prevision

to reach bond or equity market.

• Next step in research fields it could be to extend the implication about

best capital structure and how bank relationship influence firms

corporate finance in other economic sector.

• It could be interesting analyze if there are other variables that influence

banking relationship.

• More studies can investigate better if and how Rating influence

liabilities structure compering also with outstanding economic

variable strength to the economic cycle.