With detail finalization complete on a 184,000 square foot industrial building in Salt Lake City, Money360 has become the first peer-to-peer lender to successfully offer a tranche loan in the United States.
Based on the benefits it definitely will not be the last.
The french word for slice, tranching, occurs when the total value of a loan is “sliced” into different sections or tranches, each one paying a different interest rate. Money360 President Dan Vetter provides an example:
“Assume you have a property worth $100 and a loan worth $70. The ‘A’ tranche might be worth $50, giving that tranche a loan-to-value (LTV) of 50 per cent. That could pay six percent. Any bank right now would be thrilled to get five or six percent on an LTV of 50 per cent.”
“The ‘B’ tranche covers the remaining 20 percent and may earn 15 percent interest. Combined the loan pays 8.6 percent interest which is a lot lower than the borrower would have to pay if they were to go to a traditional hard-money lender who may charge rates in the low to mid teens with several points up front and maybe a point or two on the way out.”
Structured properly, a tranche loan can benefit all sides. A well-thought-out interest rate places the loan in between the rates offered by banks and those of the private money industry.
“Right now there is a huge rift,” Mr. Vetter explained. “There is nothing in between so this is helping to bridge that gap and enabling both types of lenders to participate in that loan.”
The whole loan is secured by a first trust deed on the property, with the A tranche in first position should the property go into foreclosure. That makes it different from mezzanine loans, where creditors are farther back in line to be repaid.
Mr. Vetter summarized the differences. “Unlike a mezzanine loan, a ‘unitranche’ loan has first lien on the property, but the A-tranche lender has priority over the B-tranche lender in the event of default. From the borrower’s perspective, there’s just one loan that is secured by a first mortgage / deed of trust. The A-tranche and B-tranche lenders have an agreement among them (“Agreement Among Lenders”) that stipulates the priority of cash flow, disposition proceeds in the event of default, foreclosure, and liquidation.”
Given this was their first tranche loan, Money360 took longer to complete it because they had to create new legal frameworks which would accommodate the novel structure.
“We didn’t have the legal infrastructure or framework, and this gave us an opportunity to build that out. Now we have a template we can replicate over and over again,” Mr. Vetter said, while explaining that future opportunities should occur much more quickly. “We think this is going to be a big deal. We intend on doing many more of these types of transactions.”
Mr. Vetter believes tranche loans will become popular and his reasoning begins in the financial crisis.
“One of the problems that led to the financial crisis was this whole issue of blind mortgage pools. People didn’t know what the collateral was for the securities they were investing in. There wasn’t a lot of transparency.”
“Here there is complete transparency. You are only talking about one property, so it is easier to do your homework and figure out what that property is worth and what cash flow it is generating. It is very easy to do that analysis. It also enables investors to calibrate their risk and return preferences at the individual loan stage.”
Before loan facilitators can maximize the popularity of tranche loans they have to do some work in order for them to be feasible for lower value loans, Mr. Vetter reports.
“Tranches are very new at the $1 million to $10 million level. They usually start at $20, $30 or $50 million. We’re trying to streamline the process to make these particular types of loans workable at much smaller sizes.”
Another benefit of tranche loans is the lower operating and overhead costs associated with them.
“Borrower acquisition is a huge part of that,” Mr. Vetter said. “Our website can be viewed by anyone anywhere in the country. If you want to apply for a loan you go to the website and submit an application.”
Applicants fill out their basic information, the type that if answered wrong causes the application to be rejected, in a few minutes online. If they pass that initial screening, which they will know in minutes, they fill out a whole loan application.
It also weeds out the tire-kickers because Money360 can request information that only a few are privy to, such as rent rolls and property operating statements.
As we have seen in many different areas of alternative finance, once the mainstream institutions are interested, the concept has some legs. Early interest in tranches bodes well for its future, based on who Money360 is speaking with.
“A lot of loan applications are actually coming through brokers,” Mr. Vetter said. “That community will be a huge source of deal flow for our platform.”
That group offers benefits of scale.
“We see strategic value in catering to the mortgage brokers because we see them as being a likely source of repeat customers. A mortgage broker may bring in three properties in a month.”
“Beyond mortgage brokers others are interested too. It’s a compelling model and we’re pitching it to plenty of banks right now,” Mr. Vetter said.