Capital markets innovations seldom benefit home builders directly. Collateralized Mortgage Obligations (CMO), for example, drive mortgage finance and investment, which in turn benefits home builders. But, when a new capital market tool comes along that can drop benefit down to the bottom line, it's worth a look. JMP Securities' Trust Preferred (TP) Securities can sound dauntingly complex on first blush, but executives at both public and private home builders should consider carefully what they are and what they offer.
Simply, TP Securities are a lower-cost unsecured long-term corporate debt, designed to resemble equity on the balance sheet. “Unsecured” by definition, it requires no piece of land or units under construction to secure the obligation, which is junior to all other debt. The term of the security can range 10 to 30 years, hence the “long-term” designation. More common unsecured long-term corporate debt, such as mezzanine debt, costs more. Also, TP Securities do not require a road show with management presentations to court investors, and there is no need to obtain a credit rating from Standard & Poor's or Moody's. Finally, JMP Securities has been able to raise the Securities in amounts as low as $15 million. So, smaller and mid-sized builders—as well as the big guys—can avail of this security.
TP Securities involve two financial transactions. First, though, your company must set up a wholly owned business trust for the single purpose of issuing cumulative preferred stock. Investors then buy the preferred stock from the business trust (the first transaction), and the business trust subsequently uses that money to purchase a debt security from the parent company (the second transaction). This infuses cash into the parent company to run its business. The parent company makes interest payments to the trust, which get distributed as dividends to the preferred stock holders. The debt security's term is the same as cumulative preferred stock. When the preferred stock comes due, the parent company repays its debt to the business trust, which then pays investors the value of the stock. The debt obligation from the parent to the trust serves as the security for the investors in the preferred stock.
Interest paid by the parent company to the trust is tax deductible, which gives the instrument an edge over issuing preferred stock directly. Moreover, on consolidated financial statements, the loan from the trust to the parent is eliminated, removing the debt obligation from the financial statements. The preferred stock remains after consolidation, thereby improving the consolidated financial balance sheet. Of course, the trust arrangement will be disclosed in the financial statement footnotes.
According to Tony Avila, managing director with JMP Securities, JMP pools home builder TP Securities with other Securities issued by REITS and lodging companies, and then issues a Collateralized Debt Obligation (CDO) to investors. This allows JMP to issue TP Securities in smaller amounts than would otherwise be required by the capital markets. “We can obtain favorable pricing for the home builder by piggy-backing on the REITs,” says Avila.
Since last year, JMP Securities has acted as the placement agent in 12 transactions totaling nearly $700 million. Of the 12 transactions, four have been public builders, including Orleans Home Builders and Levitt Corp., and eight have been private builders, including Dunmore Homes and Trend Homes of Arizona.
“It's just a better mousetrap,” says Avila. And it's a mousetrap all of us would do well to investigate.
Jamie Pirrello is the COO of Mandrin Homes, an Annapolis, Md.–based home builder.