It wouldn't be an understatement to say Mitchell A. Sabshon was present at the creation of many pioneering transactions in capital markets mortgage finance. The lawyer turned financier played a pivotal role in the launching of the first commercial mortgage REMIC and the first Financial Asset Securitization Investment Trusts (FASIT), as well as the first multiple-tranche, single-asset securitization and other innovations in commercial mortgage securitization.

Sabshon, the president and CEO of Archon Financial in Irving, Texas, is both an investment banker and a securities attorney. Not only does he head Archon - a wholly-owned, full-service conduit subsidiary of New York-based Goldman, Sachs & Co. - but he is a vice president in Goldman's Real Estate Investment Banking Group as well.

Prior to joining Goldman Sachs more than two years ago, Sabshon was a senior vice president in the Real Estate Investment Banking Group of Lehman Brothers, where he provided capital markets mortgage financing to real estate developers and investors, as well as secondary commercial mortgage market liquidity to life insurance companies, commercial banks and other financial institutions.

Before joining Wall Street in 1991, Sabshon practiced securities law at Skadden, Arps, Slate, Meagher & Flom in New York City. There, Sabshon specialized in representing issuers and underwriters of commercial and single-family mortgage-backed securities.

National Real Estate Investor interviewed Sabshon during a hectic - but typical - day at Archon Financial.

NREI: The conduit industry has had a roller-coaster ride over the past 10 months. What is the current state of the industry today?

Sabshon: It's a tough time for the conduit market. This industry is barely 8 years old, so it's almost as if there are no expectations or norms, and the industry is still figuring itself out. Superimpose that on the fact that real estate in general is cyclical and a complex picture emerges. Production is down and firms in the conduit business are scratching their heads trying to figure out how to generate more - profitable - business and how to position themselves for the long haul.

We're coming out of the fall of 1998 and the effect the bond market crisis had on mortgage lending in general and conduit lending in particular. The direction of interest rates is not helping the business, and the life insurance companies have attempted to take advantage of the situation by aggressively marketing their mortgage products in the first half of 1999.

We don't see any fundamental weaknesses in the basic business of conduit as long as the economy remains strong. But if it takes a turn for the worse, the real estate industry in general will be affected and conduits will not be insulated.

NREI: The conduit business is off from its high volume of 1998, when production totaled some $80 billion. Will companies become more aggressive to boost business? Will they loosen underwriting standards?

Sabshon: Those in the conduit industry want to produce volume, of course, but they also want to maintain responsible credit guidelines. We don't see a decay in credit underwriting, but invariably something around the next corner or two may drive aggressive underwriting. I'm not suggesting conduits are overly aggressive in underwriting now, but conduit lending is a volume business. There is a high probability that some other conduit companies could become overly optimistic in their underwriting.

NREI: So what will that mean for the industry?

Sabshon: Conduit lenders are prepared to make as many loans as they can. Volume is an important part, and there are different pressures in the conduit business. But I also think "mistakes" can be dealt with more quickly. In the past, loan officers made real estate loans. The loan officers were judged on the volumes they generated. If some of those loans went bad, it wasn't in anyone's interest to acknowledge that there was a problem with the loans until they could no longer deny the loans were in trouble, that is, until the borrower stopped paying.

However, if a lender jumped on the situation early, the lender could make the situation less severe. The lender could work with the borrower, maybe helping the borrower reduce expenses early on. Sometimes it is better for the lender to restructure the loan early before it gets too late. Why is this germane to conduits? Because in the capital markets, you don't have the same concern with keeping a problem loan quiet.

On the contrary, in the capital markets, as soon as bondholders realize there is a problem, they act. CMBS investors want action taken right away. The servicer is not responsible for making the loan, so no one is going to point the finger. The special servicer wants the problem fixed with the lowest possible loss. Thus everyone on the capital markets side is motivated to fix the problem as soon as possible. When problems are dealt with rapidly, losses are not as significant. With conduits, it's proactive rather than reactive in addressing any problems.

NREI: You study the real estate market every day. What types of properties do you like in the current market?

Sabshon: Anchored retail. We happen to think a lot of retail in America. Clearly, retail is an industry affected by the Internet, but we think the jury is still out. Many say retail is going to be a mere shadow of what it once was because so much business is being transacted on the Internet. But several weeks ago, The New York Times reported a story about an outdoor sporting company that found it far cheaper to open a retail store than to operate business on the Internet. It doesn't suggest some Internet gurus are wrong, but merely that the situational analysis is not as clear cut as some would have you believe.

We like anchored centers because the economy is doing very well right now, and there is a lot of retail out there. But eventually, we think, the retail industry will be impacted by lower spending, and the first properties to feel this effect of shrinkage are going to be the unanchored centers. Centers with national tenants are more resistant to cycle downturns in the marketplace.

We also think the multifamily business is good, given the current population growth. The so-called "echo baby boomer group" of Americans is in need of apartment-type housing, and they will eventually turn into permanent housing. But in the meantime, they'll remain in multifamily projects.

NREI: What firms in the real estate business do you admire, and why?

Sabshon: We do business with some mortgage banking firms that I think have had some vision in mortgage banking - Holliday Fenoglio Fowler and L. J. Melody, both headquartered in Houston, and Cohen Financial in Chicago. The senior management of those firms had a vision of the nature of commercial lending, and the potential role of the capital markets. Each of them embraced conduit lenders as players who are here to stay. They looked at conduit lenders not as something unique, but as one new source of capital among the traditional sources. Depending on their client's needs, Holliday, Melody or Cohen may go for funding to a life insurance company, commercial banks, Freddie Mac or Fannie Mae, a mezzanine fund - or a conduit.

In addition, they have been visionary in realizing that real estate is a national business. If you operate in Chicago, you may be financing a property in Miami and the borrower may be in Seattle. All three firms have been proactive and visionary in building a national network of offices. Finally, they understood real estate is not just about lending money but also about other services such as investment sales, managing real estate money, advising on acquisitions or dispositions, operating investment funds, and so forth. They have turned the fairly simple, "I'll find someone to lend you some money," into full-service companies with a national focus. I think these guys have done a fabulous job!

NREI: With conduit volume down, competition is up. Will the industry see more consolidation in the coming months?

Sabshon: We are a relatively new industry, still going through our growth years. This is an attractive industry and many players jumped in. Of course, many players have gone also, but it is still a business with too many participants, and I do believe simple economics will ultimately mean fewer players. There will be consolidation. Some organizations will say that the returns don't justify their participation. I see the conduit business ultimately becoming 30 or 40 players, but in reality no more than five to seven major players. It's like life insurance companies. There are hundreds of life companies out there, but when you think of the industry, the real players are only eight to 10 firms.

The characteristics that will likely determine who the successful participants are are firms that have large balance sheets, the ability to distribute bonds themselves, or very strong indirect access to bond distribution. Players who come to market three times a year by hiring a Wall Street firm will be greatly disadvantaged. A successful conduit lender will need to have a national network of origination staff. And conduits will have to be staffed by quality real estate people as opposed to trying to remake finance and investment people into real estate professionals.

Q: What about insurance companies in the business?

Sabshon: There will always be a place for insurance companies. The question is really what their market share will be and what does their lending look like. Basically, insurance companies have liabilities on their books. They sell insurance policies and annuities and create liabilities. They collect money and give it back sometime down the road. You have to have an asset to offset that liability. All they need to make their business work is to have the asset sufficient to offset the liability. If an insurance company needs a 7% return to pay off policyholders, all they need is an asset that pays at least 7% compounded. If the asset is in the 8% or 9% range, all the better.

Life companies can afford to make loans on terms that are not economical in the resale market. We see life companies financing most of what I would call Class-A real estate in particular, where borrowers are willing to have a lesser degree of leverage.

Conduits are a very different business. They have no comparable liabilities. Conduit lenders make mortgage loans not to offset existing liabilities, but because they can make loans at "x" and can sell them at "x plus." Conduits are constrained to make only those loans they think they can sell. They can't make a loan for $100 and turn around and sell it for $96. But if a life company makes a $100 loan at 7.5% to offset a 7% liability, they're happy, even if that loan could only fetch $96 in the resale market. That's because the life company is, in all likelihood, not going to sell that loan, but hold on to it until maturity.

I think life insurance companies will continue to be a significant part of commercial mortgage lending, but a far greater percentage of their loans will be on Class-A real estate because they can afford to make loans at less than par. Conduits typically go to 80% leverage on Class-B real estate. That kind of lending the life companies have difficulty competing with.

Q: Archon Financial stresses the experience level of its top managers. How important is this in today's real estate market?

Sabshon: I think it's absolutely imperative to have experienced professionals. A number of early participants in the conduit business tried to make it almost a back-office operation. Some investment banks tried to staff their conduit operations with young people right out of school. Maybe they had very competent skills to simply plug in numbers, but conduit lenders have to have broad, hands-on real estate experience to know whether a transaction is a good one. Archon has always operated as a stand-alone origination firm, populated by experienced lenders. We believe the firms that will survive will be the ones staffed by experienced real estate professionals.