Credit enhancement for multi-family bond market.

The abandonment of the bond market by many traditional providers of credit enhancement has created tremendous opportunity for companies ready to pursue the specialized niche of financing for the multi-family bond market. The credit of the enhancer is critical to the marketability of the bonds since the bondholders are, in effect, buying the security provided by the enhancer's letter of credit.

Credit enhancement, long thought of as an area of opportunity because of the fee income and cash flow it can generate, is now a financing niche reserved for financially strong companies that can combine traditional real estate underwriting skills with a thorough understanding of bond structures.

Heller Real Estate Financial Services has been an active provider of credit enhancements for the tax-exempt multifamily bond market and has closed over $200 million in transactions throughout the past two years.

Understanding that bond structures can be complicated and vary considerably by the many municipal issuers, Heller has developed the expertise to structure around unique project or bond situations. To date, Heller's Credit enhancement opportunities have generally taken three forms: 1) converting high fixed-rate tax free bonds to low floaters to significantly reduce debt service; 2) providing aggressive leverage for the acquisition of projects driven by the benefits of inexpensive low floater financing; and 3) re-enhancing existing projects based on based on today's economics, given the previous enhancer's willingness to accept a discount.

In one recent example of such a project, Heller Real Estate's Northeast Region, based in New York, issued a $26 million "low floater" bond enhancement on a portfolio of four properties consisting of two apartment complexes totalling 456 units and two industrial buildings in excess of (300,000 square feet) built in the late 1980s in suburban Philadelphia and Reading, Pennsylvania.

When the properties were developed, a local S&L was both the joint venture partner and the enhancer of fixed-rate bonds for 100 percent of construction costs, which totalled over $35 million. Unfortunately, the S&L was soon taken over by the RTC.

The RTC wanted to liquify their position quickly and Heller was brought in to do so. The RTC was willing to discount their bonds and agreed that any "excess" bonds would be retired.

The structure of Heller's transaction involved reissuing the bonds on a "low floater" basis, enhanced by a Heller Financial Inc. letter of credit. Heller received an annual enhancement fee of approximately 2 percent and 50 percent of excess cash flow and appreciation in residual value. Heller's "low floater" bond expertise and quick turnaround were critical to both the borrower and the RTC.

All parties to the transaction benefitted from Heller's bond enhancement. The RTC received a quick liquidation and maximum bond proceeds; the borrower retained ownership and management of the property and received a substantial reduction in total leverage; and Heller was able to grant an attractively-priced enhancement on institutional quality collateral while providing liquidity to the multi-family market.

Although the opportunities to enhance multi-family bond transactions should remain strong in the coming years, this niche will be reserved for the limited group of companies which enjoy favorable debt ratings, understand both the complexities of bonds and the dynamics of the underlying real estate, and have the ability to respond quickly to opportunistic situations.