Kansas City, Mo., home of savory barbecue, jazz legends, and more fountains than Rome also serves as home to one of the fastest growing conduit lenders in the nation. In two short years, National Realty Funding LC (NRF) has originated more than $1.7 billion of commercial property loans and boasts a servicing portfolio of $2.5 billion.

Since funding its first loan in June 1997, the firm has grown from its three founding members to a staff of 70 located in four offices across the country. NRF has found success in the competitive lending business by employing a somewhat different strategy. NRF originates, securitizes and then services its own loans. "We are one of the few capital market lenders that not only originates, but provides servicing for the life of the loan," says E.J. Burke, president of NRF. "The value of the company is greatly enhanced by having the various servicing functions, as well as origination, all under one roof."

Power of its people Leading NRF's charge into the capital market fray are three founding professionals who each possess an average of 20 years of experience in the commercial mortgage industry. With the CMBS market roaring in early 1997, Burke, Michael Caffrey and Clay Sublett, all former Midland Loan Service employees, chose to capitalize on the favorable business climate and start a new company. Leaving Midland, the group did not have a capital partner, but they did have a strong business plan, a good track record of originating loans and a solid reputation with secondary market players.

This was enough to attract the capital of two institutional investors - Newark, N.J.-based Prudential Securities Inc. and Darien, Conn.-based Progressive Investment Co. "We ended up with two capital partners that knew us very well," recalls Burke, adding that each institutional partner holds a 25% stake in the company. "It took us very little time to get up to speed with Prudential since we had worked with them at Midland. We were also close with Progressive. They bought subordinate CMBS during the Midland days."

With institutional capital secured, the newly forged firm was able to ramp up infrastructure and has extended loans on multifamily, office, lodging, healthcare and light-industrial facilities. Loan amounts typically fall between $1 million and $15 million, though NRF also offers a program covering loan sizes between $250,000 and $1 million.

"The short-term program was designed to be a feeder system for the long-term program," says Burke, adding that the company also provides bridge loans. "We see a lot of borrowers seeking loans through our long-term program that are not fully stabilized. Rather than turn the loan down, we provide short-term financing until the property is stabilized, then we refinance for the long term."

NRF's strategy of originating solid loans followed by in-house servicing of the loan portfolio after securitization is at the center of the firm's business plan and, according to Burke, the primary factor in the company's success. "We look at our business and the mortgage pipeline as having two areas of focus: the front end and the back end," he says. "Front-end issues concern the mortgage bankers, brokers and borrowers. We have spent a great deal of time and money developing a quality delivery system for these front-end clients, and we feel our process compares favorably with the competition."

NRF employs what it calls a "customer-focused" approach. "Unlike other lenders who utilize the capital markets, we do not require esoteric and complicated loan terms," notes Burke. "For example, we would not require the owner of a $4 million property to transfer ownership to a bankruptcy remote entity as a condition for making the loan. We prefer more user-friendly, common-sense loan terms."

NRF also differentiates itself by emphasizing reliability, and has sent many deals back to the table for retrading. "Capital market lenders have had problems with retrading," says Burke. "When NRF delivers loan applications to clients there is a high degree of confidence that the loan will be closed according to those terms. We have put special emphasis on not promising something that we cannot deliver."

Back-end issues concerning CMBS investors and rating agencies are addressed by the various servicing functions that NRF accepts following securitization. "Our servicing strategy aims to enhance the long-term performance of the loans for CMBS investors by focusing on quality servicing," says Burke.

In its deals, Burke explains that NRF acts as master and primary servicer, as well as provider of special servicing should a loan slip into delinquency.

"This brings focus to our servicing activities," he says. "NRF presently services close to 600 loans vs. the competition that service anywhere from 5,000 to 50,000 loans. We think this focus is attractive to borrowers and brokers. Most borrowers are used to developing a relationship with a lender so that future approval is not a major task. This can be difficult if your loan is only one of 50,000 loans that the lender services."

First securitization, tough timing By August 1998, NRF had been approved and rated as a loan servicer and was ready to proceed with its first securitization. NRF contributed $571 million in loans with the balance of the $1.15 billion portfolio funded by two other originators. Burke recalls how the deal suffered from a bit of ironic timing.

"The day we priced the investment-grade section of our first securitization portfolio was the same day that Russia defaulted on some of its debt obligations," he says. "Spreads on CMBS widened anywhere from 10 basis points on the AAA classes to 25 basis points on BBB-." The capital market dislocation that was to wreak havoc on many conduit lenders' portfolios, nudging some out of the business altogether, had begun.

NRF was not on the list of casualties, however. By fulfilling its commitments and staying in the market, NRF was able to withstand the capital market turbulence. "If we had waited another month we would have lost five times the money since spreads continued to widen," says Burke. "We had a substantial number of loans in the pipeline that were committed but not closed, and during September and October when spreads were widest we did have to fund loans that were under water. We stood by those commitments, though, and continued to fund loans that reflected the current market conditions."

Staying active in the hard-hit market began to pay off for NRF. "We were able to capture some good business during October and November," says Burke. "Our newly originated loans raised the weighted average pricing on our subsequent pool to a level where we were able to dispose of the loans in March of this year at a profit."

Despite sidestepping the dire consequences of last year's widening spreads, NRF felt it was necessary to mitigate the risks associated with future capital market volatility. "After the dislocation in 1998, we took a close look at how we accumulate and securitize loans," explains Burke. "Previously, we had securitized loans twice a year. This meant we had to commit to spreads for nine months as we accumulated the appropriate volume for securitization. To cut down on this warehousing risk and to bolster our overall capital levels, we adopted a quarterly securitization schedule. On a quarterly schedule we empty the warehouse sooner, cutting down the amount of time we are committed to specific loan terms from nine months to 90 days."

NRF, like most capital market players after spreads widened, also adjusted its loan pricing to fully reflect spread volatility. "The markets were very tight during the summer of 1998 and there was very little room for error," says Burke. "Through our partnership with Prudential, we took a look back at corporate bond spreads and found that every four to six years an external event causes a dislocation. As a result, we now try to build in a little more margin for error in our loan pricing."

After emerging from capital market volatility, NRF hopes to complete four securitizations per year while holding to its quality underwriting criteria and long-term lending philosophy. The second transaction of the year, a $1 billion securitization expected to close this month, will keep the company on track to meet this goal. Recent market conditions have provided some resistance to the firm's goals, however. "The first half of this year has been tough, so reaching some of our yearly goals will be a challenge," says Burke.

NRF has non-monetary goals that have gained importance as the company has grown. Hiring seasoned professionals has become the firm's No. 1 priority. "We have hired many new people, but we have a need for more," says Burke. "It is not an easy task to find people who subscribe to our philosophy of lending for the long term."

Personnel challenges aside, Burke believes NRF is well positioned for today's competitive lending environment. "There are clearly more lenders than there are loans today," he says. "This means that only firms that have experience, a sound approach, and access to capital will survive. For those lenders that meet the test the business environment will be greatly improved after this consolidation. We are excited about the future of NRF because we believe we are only limited by the talent we can attract to the organization."