The shop I'm working with this summer is arranging financing for a mixed use project in the pipeline. This is the kicker... the LifeCo partner is funding this by offering senior debt AND will be taking on 70 percent of the remaining equity stake.
How can this work? The equity portion needs higher leverage and a lower rate to juice return and the debt portion seeks the opposite. Is this typical? Can someone explain the rationality behind this...
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This is simple. Most LifeCos have debt and equity to lend. It looks like the want to invest in the senior debt piece and a preff equity slugg?
You didn't explain it completely well, so what is the LTV of the debt and what is the equity stake? E.g. 65%/35% debt/equity. so on a 100mm deal they want to invest around 25mm in equity and 65 million in debt. Each has a different risk reward profile since thy are different places in the capital stack and not opposing bets.
I'd like to help you figure this out, does this makes sense so far?
The debt is 65% LTC where the remaining portion is a 70/30 equity split. The LifeCo is the majority equity partner.
What I'm trying to figure out is how they manage the conflict of interest when structuring the deal. Is it as simple as them saying we will provide debt at market leverage at a market rate and realize some upside by taking the equity stake? They aren't opposing bets because both are tied to the assets performance. What I don't understand is how they decide on terms. If they are confident in the project couldn't they fund it with say... 75% LTC and a low interest rate to juice the equity return?
The LifeCo. is limiting the downside for a portion of their committed capital using the debt piece and also capturing the upside with their committed equity piece. The amount of dollars they want in a senior debt position with limited downside and the amount of dollars in an equity position with upside potential is a bit of an art based on the risk tolerance of the LifeCo. Insurance companies can be tricky because they sometimes invest from their own balance sheet, sometimes from separate capital arms, and some asset-liability matching concerns...but at its essence the LifeCo. has capital to put to work, and wants the riskiness of the capital to be diversified.
This is right. *This is to the OP Mark Queban From a risk perspective anything over 65% will result in a higher blended rate because it would likely result in an A and a B Note structure. Now to protect your equity let's say there is a downturn and your debt leverage is 75% LTV, and your value of the property gets to 74% LTV, you have essentially wiped out your whole equity position. That's one of the reasons why LifeCos lend at max 65% LTV, it is less risky. If there is no money to pay the sponsor then there is not enough money to pay the debt service and since I am sure said LIfeCo doesn't service the loan then it would likely go into default. Not good for the books.
This makes sense... Appreciate the responses.
I think you guys are giving the lifeco's way to much credit. A lot of the lifecos have different teams for equity investments + debt origination's and I'm sure they look at their blended exposure and yields across the capital stack. At the end of the day lifeco debt has very strict leverage limits (I have never seen a lifeco lend over 65% LTC on new construction) and the origination guys (debt+equity) are normally on separate teams that are incentivized by different things. I bet their bonus's are based on how much capital they deploy not the yields so each team (debt/equity) would want to deploy more capital.
Depending on how competitive the deal was they either excepted what the market would bare for debt terms or the combo offer won the deal for them so the top dogs of the firm just blended all the returns together and liked what they saw.
The problem with doing this is that they lose their put option on the debt, if shit hits the fan. Additionally, if they are acting as a fiduciary for outside investors there could be conflict of interests if the deal went bad but I'm sure they have some mechanism on the downside for either an board (possibly outside) to handle decisions for one part of the deal and the real estate committee to handle the other side .
Generally speaking, this is a great way for firms to get money out the door if they like the deal because the debt team spends less time and effort defending the deal to a committee since the equity team likely cleared a path right down the middle for a easy score.
"put option" are you saying this is considered in high level decision making. I've always assumed it was more of a qualatative "feels", like "we have too much exposure to x", but based on nothing but hunches.
The put option really isn't discussed openly besides in academic circles around lending. They'd rather not think about the scenario in which the highest value is negative and thus jingle mail is necessary. I've brought it up before but no most lifeco's don't discuss this at a high level. Yes Lifeco's invest general account money in development but it is so small in comparison to their bond portfolios, loan portfolios , treasuries, that it is like .00000001% of assets.
i had the impression that any time a life co provides equity to a dev or value-add deal, it is because they manage an equity fund with OPM in it. i could be wrong, though.
Life co.'s can and will put money into development and value add deals that are not OPM. They can do it with their general account.
whats opm
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