While a major bank cannot be expected to work closely with non-bank financial institutions (NBFIs), Capital One sees their value in helping to provide new benefits to its commercial real estate the company and its customers. Partner Insights spoke with Josh Howes, Head of Institutional Specialties for Capital One CRE, about what NBFIs have to offer Capital One and its clients.
Trade Observer: What are some of the key factors currently driving the growth of debt funds and NBFIs?
Josh Howe: Two main factors are driving the growth of debt funds and NBFIs. One is the continued institutionalization of real estate. Today, CRE debt has become an accepted part of an institutional investor’s credit or fixed income portfolio.
Second, the persistence of low global interest rates has contributed to this growth. Low interest rates have forced institutional investors to seek other yield alternatives, and commercial real estate debt offers high relative value compared to other non-ERC credit investments.
Describe the general relationship between banks and NBFIs, and how the relationship has changed over the years.
Prior to the Great Financial Crisis, non-bank investors and debt funds focused primarily on investing in subordinated investment structures, such as mezzanine loans, B-notes and non-investment grade CMBS. [or commercial mortgage-backed securities]. They would work with a bank – mostly investment banks – to store those investments and then exit into the CDO [or collateralized debt obligation] Marlet.
It ended with the Great Financial Crisis when it became clear that these transactions, and the risk and leverage they entailed, were not sustainable. However, it has allowed institutional capital to enter the real estate finance market in a more traditional, lower-risk form.
Today, debt funds focus primarily on traditional mortgages. They have moved down the risk spectrum, which means they can work with experienced banks in a more traditional borrower-lender relationship. They can access banks for permanent funding to fund their positions. And to the extent a debt fund or NBFI wants to tap into the CLO [or collateralized loan obligation] market, they can work with a bank that also has experience in this area. Thus, it has developed into a broader relationship that includes traditional bank financing as well as capital market executions.
Talk about how Capital One works with debt funds and NBFIs.
Some banks view debt funds and non-bank lenders as competitors. At Capital One, we see them as key market players with whom we can work in a variety of ways. First and foremost, we consider them valued customers. We finance their operations with a wide range of dedicated financing products for both their assets and the funds themselves, and we provide other banking services such as cash management. But we also work alongside debt funds and NBFIs in some cases to fund our other clients.
Our portfolio of debt funds is strategically important and we are looking to grow it. It’s an effective arrangement where we can engage the original network of debt funds, fund them and reach out to new sponsors. We have also leveraged our relationship with debt funds to provide capital to our own clients who have funding requests that are outside the norm for us. Our debt fund partners may hold the share of capital that does not correspond to our balance sheet. Through this network, we are also able to provide creative solutions to our non-debt fund clients.
What are some of the more creative financing solutions that Capital One has developed with such institutions?
When we first entered this space, the market was stiff. To differentiate ourselves from the market, we have developed our flagship principal repo product to be flexible and user-friendly. It provides term funding, so that our clients face no mismatch between their assets and their funding, and we only charge usage-based fees, recognizing the uncommitted nature of the facility. This product allows us to efficiently fund multiple loans across a diverse set of property types, business plans and borrower profiles.
How do you ensure that Capital One and the NBFIs align their respective risk appetites?
Before onboarding a debt fund client, we spend a lot of time ensuring alignment between our respective credit practice areas. We talk to them about our appetite for credit and have detailed conversations about their typical transaction profiles, structures and return requirements. This way, if we spend resources to set up a funding facility, both parties have the certainty that the facility will be used. Having these conversations in advance helps provide a better experience for our customers.
Talk a little more about the benefits of these collaborations for Capital One customers.
With our debt fund clients, we view the relationship as a two-way street. We fund them and they can help us grow strategically. By working alongside debt funds, we can synthetically expand our balance sheet and fund assets we wouldn’t otherwise. There have been many instances where we have seen a funding request with a client and asset that we really like, but at a leverage point that was outside of our strike zone. We can pre-identify these loans with our debt fund clients and work together to provide the financing.
How is Capital One philosophically similar to institutions such as debt funds and NBFIs?
Debt funds often pride themselves on being fast and nimble. Likewise, Capital One’s strategy is rooted in providing flexible financing solutions to our debt fund and NBFI clients in a highly efficient and responsive manner. We have developed a suite of products that allows us to offer across the financing spectrum in a very thoughtful and bespoke way. Our solutions can be customized to meet client strategies, sensitivities or constraints. We have also invested significantly in our internal infrastructure and processes to ensure we can execute efficiently and seamlessly.
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