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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.