The Wall Street Journal-20080206-Real-Estate Finance- Hilton Debt Tests the Market- Banks That Financed Buyout By Blackstone Look To Sell- Complex Deal is a Harbinger

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Real-Estate Finance: Hilton Debt Tests the Market; Banks That Financed Buyout By Blackstone Look To Sell; Complex Deal is a Harbinger

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In October, private-equity firm Blackstone Group LP pulled off a big coup by closing its $20 billion buyout of Hilton Hotels Corp. in the midst of a near shutdown in the credit markets.

Now the market is watching to see whether the banks that provided the financing for the Blackstone deal will be able to sell the debt -- in what likely would be one of the largest commercial real-estate securitizations ever.

Over the past few years, commercial-backed securities, or CMBS -- which are pooled mortgages that are sliced up and sold as bonds -- largely fueled the commercial-real-estate frenzy. But for the past six months, the CMBS market has been at a near standstill, hit by fears that commercial defaults will rise.

Undaunted, a group of lenders is planning to launch an $8.4 billion CMBS offering in the next seven weeks as a means of selling the debt related to Blackstone's Hilton acquisition. The lenders' success likely will forecast whether the CMBS market finally will be uncorked.

The stakes are high: A less-than-successful offering could send the market into a longtime funk, exposing banks to more write-downs at a time when they have recorded more than $100 billion of losses on residential-mortgage-related securities over the past few months. In a report issued Friday, analysts at Goldman Sachs Group Inc. estimated that banks could book $23 billion of commercial-real-estate-related losses this year alone, consisting mainly of write-downs on CMBS's and related securities.

All told, Goldman Sachs predicts that U.S. commercial-real-estate prices could fall as much as 26% though 2009, driving the total of related loan losses to more than $180 billion over time, of which global banks and brokers might bear over $80 billion.

That is why the lenders would like to push through the Hilton CMBS offering. At a time when spreads are widening, the longer those loans stay with the banks, the greater the risk that the banks will lose money on the financing as well as face mark-downs on the value of the debt.

Already, the Hilton debt is sitting on the banks' books longer than it would have before the credit-market crunch took hold in August, some say. In a normal market, "they would have blown out of the door," says Bill Adamski, senior managing director of NY Credit Advisors, a private-equity firm specializing in commercial real-estate debt.

In some ways, the Hilton offering is an odd test case. Most issuances are about half the size of the Hilton deal and consist of loans made to many different borrowers and on different types of properties, such as office, industrial and retail. The diversity lessens the risk because not all of the borrowers in a pool likely would default.

What makes the Hilton deal stand out is not only the sheer size of the deal, which, if successful, would be the largest CMBS issuance ever, but also that Blackstone is the only borrower in the pool. Moreover, unlike most CMBS deals, which typically are backed by the borrower's properties -- that can be grabbed in the event of a default -- about half of the collateral on these bonds will be backed by Hilton franchise fees, making the offering more complex for traditional real-estate investors to grasp.

In this environment, the banks involved in the Hilton offering -- led by Bear Stearns Cos. -- will have their work cut out for them. In December, Moody's Investors Service cut its ratings of Bear Stearns, blaming, in part, the firm's "concentrated risk" from its participation in the Hilton transaction. A Bear Stearns spokesman said the firm can't comment on "a deal that is in progress."

"It's a very challenging market," says Sam Chandan, chief economist at Reis Inc., a real-estate research firm in New York. "It wouldn't be surprising to see pieces of the deal come to the market in more than one issuance."

Yet, some investors say the Hilton offering has its attractions. Among them: Blackstone's solid track record of managing hotels, its $6 billion equity investment in the buyout and the growth potential for the Hilton franchise. That is why the banks -- including Bear Stearns, Bank of America Corp., Deutsche Bank AG, Goldman Sachs and Morgan Stanley -- had a relatively easy time selling the riskiest slices of the $20 billion floating-rate debt package, which totaled about $3 billion, according to several investors. (For deals like this, banks usually sell first the portions of the debt that aren't rated as investment grade to private investors.)

And while some traditional buyers of CMBS's may worry that the hotels aren't the only source of collateral, some potential investors say they think the franchise fees generated by Hilton are a plus because of the potential for growth.

A predictor of how the market might respond to the Hilton offering came last summer when Wachovia and other banks issued another large single-borrower offering. Today, Wachovia is still trying to sell some of its $3 billion portion of the $7.4 billion offering, which was used to help finance Lightstone Group LLC's $8 billion purchase of Extended Stay Hotels from Blackstone.

A Wachovia spokeswoman declined to say how much of its Lightstone debt remains on its books but said the bank intends to sell the remaining debt by the end of this year.