FASIT: A Potential New Source for Commercial Real Estate Finance
In March 1996, the commercial mortgage-backed securities (CMBS) market reached a new milestone: $100 billion in total issuance. The viability of the CMBS market has demonstrated investor willingness to invest in relatively new forms of asset-backed securities on a large scale. The rapid expansion of the CMBS market coupled with the success of other asset-backed securities has provided the impetus for Wall Street's support of legislation that would create a new class of asset-backed securities, the financial asset securitization investment trust (FASIT). FASITs would reduce restrictions on the types of debt instruments that could be securitized. Items such as automotive loans, home equity loans, trade receivables, real estate, and leases would qualify for FASIT treatment.
U.S. Representative Clay Shaw (R-Florida) originally introduced FASIT legislation in 1991. Since then, FASIT legislation has received mounting congressional support. The Securitization Enhancement Act of 1995, which amended the Internal Revenue Code to allow FASITs, was never enacted despite passage of the legislation by both the House and Senate. Because of the budgetary rift between the Republicans and President Clinton, the legislation became a casualty of the vetoed budget. Nonetheless, FASIT legislation has unwavering bipartisan support in Congress, which will enact it when budgetary and tax policy wrangling subsides. There is general consensus among legislative analysts that some form of FASIT legislation will be enacted this year or in 1997 after the presidential elections.
FASIT was loosely patterned after the real estate mortgage investment conduit (REMIC) that was a component of the Tax Reform Act of 1986. REMIC enabled commercial loans to be securitized. This allowed banks and other primary lenders to sell mortgages that were later securitized, which freed up their balance sheets for additional lending. Because securitization created a secondary market for real estate loans, primary lenders had the ability to dramatically increase their loan volume, which increased capital availability to real estate borrowers. FASIT is intended to mirror this positive impact but on a much larger scale. The potential size of the FASIT market is much larger than the CMBS market, given the categories of assets that FASIT would open for securitization: automotive loans, credit card receivables, home equity mortgages, and more. The FASIT legislation would permit any instrument treated as debt for tax purposes to be eligible for FASIT securitization. The structural benefits of a FASIT as compared to a REMIC are presented below.
- Unlike the REMIC structure, assets can be added or subtracted from FASITs on an ongoing basis. The size of the FASIT can be expanded or decreased to capitalize on changing market conditions. This feature makes it possible to securitize revolving credit accounts such as credit card receivables and revolving home equity loans as well as other asset-backed receivables.
- Unlike the REMIC structure, which is limited to real estate debt, FASITs allow for a host of asset classes to be commingled in a securitization. This overcomes REMICs' systemic problem of a lack of asset class diversification. By combining multiple asset categories, the overall risk profile of a pool can be reduced by featuring assets that are negatively correlated in terms of their price fluctuations. In other words, the peaks and valleys of different asset groups have the ability to cancel each other out, reducing the volatility of the return.
- FASITs would permit the securitization of real estate loans that previously have not been securitized under the REMIC structure. Construction and interim financing could be included in FASITs. However, interest rates on these loans would reflect the market's pricing of their higher risk profile. FASITs have the potential to increase the volume of construction and interim financing loans in much the same manner as the CMBS market increased the loan volume on performing commercial projects.
Although FASITs offer considerable flexibility in the types of assets that comprise the pool, there are some specific requirements that have been placed on FASITs. FASITs have some limitations when compared to REMICs, including:
- Issuer's recognition of gains and losses are both recognized to the extent securities are sold in REMICs. However, gains in FASITs are recognized in full upon contribution and losses are deferred. Regulations may permit deferral of gains as under REMICs.
- Income from high-yielding regular interests and ownership interests cannot be offset with losses.
- For pass-through income that is free of corporate tax, FASITs' interest must be fixed or objective floating; it may not be issued at substantial premium or have a maturity over 30 years. FASITs can be subordinated but may not yield more than the applicable Treasury rate plus 500 basis points, and an issue price may be no greater than 125 percent of par.
FASIT is a major step forward in the asset-backed securities market because of its mixture of a myriad of securitized asset categories. FASIT will also have a positive impact on commercial real estate because construction loans and interim financing can be securitized. However, a commercial real estate plan sponsor should carefully weigh both the attributes and drawbacks of a FASIT before choosing a FASIT or REMIC structure.