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

INTRODUCTION AND AIM (1/3)

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 (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 Lelands (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 shortterm 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 Corporations (LPCs) 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

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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 (REITs 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 dont 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)

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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.