Risk Management

REITs Using SPVs to Get Cheaper Loans

The number of special-purpose vehicles owned by real estate investment trusts has been growing rapidly since the summer of 2013.
David KatzMay 13, 2014
REITs Using SPVs to Get Cheaper Loans

Increasing numbers of real estate investment trusts (REITs) are making use of special-purpose vehicles (SPVs) to gain entry into the Federal Home Loan Banks system and thus get lower borrowing rates, according to a recent report on captive insurance.

Currently, there are about 40 REIT-owned captive insurance companies under the management of Marsh, one of the largest managers of captives, said Arthur Koritzinsky, Marsh’s North American captive advisory leader, during a press conference on the firm’s annual captive report at the recent Risk and Insurance Management Society conference in Denver.

Like other kinds of captives, those formed by REITs provide the REIT with insurance coverage – in their case, mostly errors and omissions coverage and directors and officers liability insurance. But some of the captives also function as SPVs – meaning that they are set up to issue debt. “And the number of such REIT-owned SPVs has been growing at a rapid rate since the summer of 2013,” according to the report, which only reflects results for 2013.

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“We are working with REIT clients to create captives for the purpose of accessing funding at favorable rates via the [FHLB] system,” the report’s authors write. If a REIT captive has on its books a requisite dollar amount of insurance losses to qualify as an insurance company and it’s domiciled in the territory of one of the 12 FHLB lenders, it may qualify for FHLB membership — which would entitle it to cheap interest rates on secured loans. (Only banks and insurance companies can be FHLB members.)

“It’s not proved out in our statistics this year, but we have the benefit of knowing that since January there are a large number of securities REITs, mortgage REITs and other real estate financial firms forming captives to fund [insurable risk] retentions,” Koritzinsky said, noting that there’s a “new kind of boom going on, with securities REITs in particular.”

Such REITs, which are responsible for the equity of their real estate assets and collect their revenues mainly from their properties’ rents, are starting to broaden their scope, he said. The trusts have begun originating whole loans to home and business owners, according to the broker, who noted that these REITs are looking to use the licenses of their captives to apply for membership and get preferential rates.

The trend is not really new, said Koritzinsky.  In the late 1990s, during the last mortgage boom, a large number of non-bank firms that were originating residential mortgages applied through their captives for FHLB membership. In addition to insuring mortgages, titles and other risks, the captives were able to access the FHLB lending system.

In contrast to the previous trend, however, the current wave of such captive use “is based on a lot of commercial banks not doing what they used to do since the crisis of 2008 to 2012,” he said.

Although the REITs “don’t really have to have this financing,” he added, they “need to have alternatives if the banks retrench and financing becomes tougher.”

Still, while interest rates are lower for the FHLB financing, the leverage terms might not be as good. A securities-issuing REIT may be able to borrow as much as 97 percent of its required financing, while a REIT that is merely originating commercial loans may be able to get only 50 percent leverage, Koritzinsky explained, noting that “it’s really about the quality of the collateral.

To be sure, as a result of Enron’s use of special-purpose entities to hide shady dealings from investors, SPVs have been the subject of intense regulatory scrutiny. But originally and often today they are used to separate financial liabilities and are a legitimate way to minimize risk, SPV advocates contend.

Overall, the number of SPVs amounted to 9 percent of the 1,148 captives managed by Marsh that formed the basis for its report. Most of the SPVs are owned by financial institutions as part of their risk-mitigation strategy, according to Marsh.