It's almost as if David Jackson, now president and CEO of First Security Commercial Mortgage, entered a time machine in 1988 that offered him a glimpse into the future. While working as a CPA for the Chicago auditing firm of Altschuler, Melvoin and Glasser, Jackson authored an article on trends in securitized debt that, in retrospect, proved to be remarkably accurate.
The piece, titled "Beyond the cycle: The role of securitization," drew parallels between the fledgling concept of securitization of commercial real estate and the earlier evolution of residential mortgage debt.
The article concluded that securitization - then a relatively obscure term that would ultimately revolutionize the commercial real estate industry in the 1990s - offered lenders liquidity in their portfolios. Jackson predicted that this new method of matching borrowers with lenders would gain momentum in the years ahead.
Jackson's dream was to link his commercial real estate interests with securitization, but he realized in the 1980s that certain market conditions would have to unfold before that would become possible. So, he waited.
Indeed, his conclusion was visionary because it came at the height of the real estate cycle - before the savings and loan debacle and the subsequent rescue efforts of the Resolution Trust Corp. in the late 1980s and early 1990s paved the way for the conduits as we know them today.
"Conceptualizing multi-class securities for residential alone was something new," Jackson recalls. "To take it a step further, and then draw a parallel to a future commercial mortgage world, was just in the range of a small amount of people."
Fast-forward Ten years later, Jackson is living his dream. His Chicago-based company is a nationwide conduit lender for a multitude of property types: office, industrial, retail, hospitality, multifamily, senior living, self-storage and manufactured-home community properties.
From its inception in 1994 to the midpoint of this year, First Security has grown exponentially, in terms of loan origination, product types served and number of employees (see timeline). For example, in 1995 the firm originated $125 million in loans. The next year, the figure rose to $250 million. By the end of 1997, the figure had risen to $400 million.
But the recent drop in demand for CMBS loan products - the direct result of a scare by risk-averse investors amid an unsettled global economy - has forced the company to reorganize and reduce its staff from 100 to 80 employees. While the job cuts are undoubtedly a setback, Jackson vows that his firm will weather the storm.
"First Security Commercial Mortgage will continue to originate loans in all property niches in an aggressive manner through 1999 and beyond," says Jackson. "However, we felt it was realistic to scale back our closing projections due to decreased marketplace demand for CMBS loan products."
Barry Powell, executive vice president and general counsel, adds, "We have said all along that we expected consolidation among CMBS lenders, and the recent market volatility has perhaps accelerated this process. Our servicing and investor reporting companies continue to grow and be as strong as ever; we have made no employee reductions in these groups."
As part of the new structure, business groups have been created for the company's major loan product categories - commercial, self-storage, hotel and manufactured-home community - with underwriting and closing teams dedicated to these real estate niches. The change is designed to enable underwriting and closing teams to work more closely with the business unit heads and their origination staffs.
Meanwhile, the company is moving ahead with plans to open offices in Los Angeles and Sacramento, Calif., and has hired regional directors for these operations.
Barry L. Axelrod, a longtime mortgage banker who joined First Security about a year ago as senior vice president and Midwest regional manager, acknowledges that the current CMBS crisis caught the industry napping. But, he emphasizes, "It is a temporary glitch caused by incidents overseas. It is not a real estate issue; it is a capital markets issue."
Finding a niche From the outset, Jackson knew his company had to distinguish itself from the competition. Consequently, it carved out a niche for itself by securitizing self-storage loans, and capturing 15% of the national market share in the process.
"It was an underserved product type and, to my way of thinking, was fungible," explains Jackson. "There is not much differentiation between one self-storage facility and another. When you are doing securitization, you want a lot of similar units."
The next product niche the company delved into was mobile home parks, but because plenty of competitors were already doing securitization deals in the manufactured-housing business, Jackson says, this product niche proved to be a bigger challenge.
Ultimately, as its client base grew, the company expanded into other product types, not the least of which is retail. Among the company's competitors are GE Capital, Lehman Brothers and Morgan Stanley.
Loan terms A typical First Security loan amount ranges from $3 million to $5 million; the minimum is approximately $1 million. First Security also services its loans. Generally, loans are quoted as a 10-year deal with amortizations ranging from 15 to 30 years, depending on the quality and age of properties. The majority of deals are refinancings, with another large chunk involving acquisitions.
For the most part, First Security is not a lender on a to-be-built property. "We could do a certain deal if a lease were in place and you want to build a building," Axelrod says. "My guess is you're going to have a little difficulty doing that because the further you go, it's harder to lock the rate. The deals are not quite as competitive."
In the CMBS world, the difference between, for example, 10-year Treasury bond yields and the interest rate ultimately locked in by the borrower is commonly referred to as the spread. The trend in recentmonths has been for spreads to widen, which means higher interest rates for borrowers. Whereas six months ago spreads ranged from 150 to 175 basis points over 10-year Treasuries, today they are fluctuating between 200 and 300 basis points (100 basis points equals 1%.)
First Security has a purchase agreement with ContiFinancial (NYSE: CFN), which has a 33% equity interest in First Security Commercial Mortgage. Once the loan is approved by committee, First Security simultaneously commits that loan to the borrower and sells it to ContiFinancial.
What distinguishes lending in the 1990s from lending in the 1980s, Axelrod says, is that lenders today scrutinize historical information (on borrowers' expenses, income and leasing) as well as current market rent conditions. No deal is approved until third-party reports are completed: appraisal, environmental and engineering.
Technology matters Although one could argue that the past few months have suddenly turned from a borrower's market to a lender's market, First Security officials are convinced that survivors in the low-margin conduit business will be those firms that can effectively use technology. That means having the ability to effectively communicate across the organization in a very rapid format.
For example, the originator of a loan must be up to speed on the status of the loan, when it is going to committee and whether there are any borrower requests that need to be addressed. "They should be able to do that at any time, from any hotel room, or from any pay phone, by plugging in their laptop computer and accessing a centralized information system," says Jackson.
The company has put its money where its mouth is by investing $500,000 in a database-oriented underwriting platform. The combination of process changes and technology has had a measurable effect, says Jackson. The company has been able to approximately double its volume of underwriting of product from $600 million to $1.2 billion while increasing personnel by only 20%.
The dilemma facing smaller conduit players, those companies that do an annual volume of $500 million or less, is that they can't afford the technology, explains Jackson. And a lack of technology will not make it possible for them to compete at a low enough cost per unit of doing loans.
Relationships are key While First Security officials value the benefits of technology, Axelrod, himself a frequent user of e-mail and computers, is convinced that the interpersonal relationship will endure. "You can't go into the computer and think you are going to find the same thing you would by picking up the phone and visiting with someone."
That philosophy is commonly accepted and reinforced in the company. Axelrod says First Security employees attend more trade shows than any other company he's worked for. "People need to meet you; they need to talk with you. You are not going to get away from that interpersonal communication," he says.
Several of Axelrod's longtime associates have followed a similar path - mortgage bankers who opted to work for lenders. "We are hired not just for our knowledge, we are hired because we had a Rolodex and that Rolodex is not just mortgage bankers, it's borrowers, it's everyone," says Axelrod.
It's not magic Jackson's five-year vision is for his company to reach $3 billion in volume in what he thinks will become a highly consolidated market. While he acknowledges that the Asian flu and natural market cycles may prove to be obstacles in achieving these goals, Jackson likes his chances.
"We have the management, the technological platform, the economies of scale to bring down our costs," he says. "We understand and can respond to the changing environments. It's not a huge amount of magic."
Known for his analytical mind, Jackson stops for a minute to ponder his future. "When you look down the road in this business, how far can you really look? Two years? Five years? I certainly want to achieve great things 10 years out. Hopefully, I will. I can't tell you yet what that will be."
Chances are, though, that Jackson has another article in his head on what the future holds for the world of commercial mortgage-backed securities.
What is a CMBS? Commercial mortgage-backed securities are sold to investors. These securities are collateralized by commercial mortgages and operate like bonds. In this process, the mortgages are pooled, securitized and sold to investors. For borrowers, CMBS offers another option to refinance, acquire property or, in some cases, develop. For investors, CMBS affords liquidity.
$125 million originated; 20 employees.
* June 1996 *
FSCM enters manufactured-home
* October 1996 *
FSCM acquires The Capsource Co., Boulder,
Colo.; broadens lending to hospitality, office,
commercial, retail and industrial properties.
* 1996 *
$250 million originated; 40 employees.
* January 1997 *
Headquarters moves to present location
at 150 S. Wacker Drive, Chicago; quadruples
office space to 17,000 sq. ft.
* April 1997 *
Enters car wash niche.
* June 1997 *
ContiFinancial acquires 33% equity
interest in FSCM and 49% equity interest in
First Security Commercial Servicing.
* July 1997 *
Enters senior living niche.
* October 1997 *
Midwest regional office opens in Chicago.
* November 1997 *
Northeast regional office opens
in New York City.
* 1997 *
$400 million originated; 80 employees.
* January 1998 *
Southwest regional office opens in Phoenix.
* April 1998 *
Mid-Atlantic office opens in Washington, D.C.
* June 1998 *
$300 million originated in first six months
of 1998; 100 employees.
* October 1998 *
Due to volatility in CMBS market, FSCM
reduces staff to 80 and reorganizes.
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David Jackson, a native of Port Elizabeth, South Africa, and president and CEO of First Security Commercial Mortgage, has real estate roots that run deep in his homeland.
His father, Bert, owned a prosperous construction and development business, David Jackson recalls proudly, pointing out that his father had no formal university education and at one time worked as a boilermaker.
"As a kid of 10, I used to go out with him to see these big tracts of land," Jackson says, "and he would explain what kind of development was going to take place. I was very attuned to the real estate and financial aspects of what it takes to create housing stock."
The younger Jackson figured his path in life was clear: When he grew up, he would eventually take over his father's business. He had no designs on coming to America. But all that changed dramatically for the 17-year-old when his father died.
"I had grown up in this sheltered environment of maybe being the president of my father's company one day," he says, "to seeing all of that go away and not a lot of people stepping up to the plate to help preserve my situation. I became keenly aware of that. It forced me to be a decision-maker."
He enrolled in the University of Cape Town, where he earned various academic degrees. The tutoring fees he earned from the university along with scholarships helped defray the cost of his education. Jackson then spent three and a half years working for the Cape Town office of Arthur Andersen as an audit senior before coming to the United States in December 1985.
Prior to launching First Security Commercial Mortgage in 1994, Jackson, a CPA, worked as a supervisor with the Chicago auditing firm of Altschuler, Melvoin and Glasser.
- Matthew J. Valley
Following in his father's footsteps