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One would have to be Rip Van Winkle to miss the burgeoning subprime mortgage crisis. Since July, when news about the collapse of the mortgage-backed securities market started to surface, those losses have grown astronomically into the multibillion-dollar range with no relief in sight. Yet one real estate sector has, so far, been virtually unscathed by the subprime mortgage crisis: the vacation ownership industry, specifically timesharing and fractional ownership. The industry attributes this success to the rigorous underwriting criteria imposed on timeshare developers by industry lenders and securitizers, which results in higher borrower credit scores, a lower rate of delinquency on consumer loans, and overall better-performing consumer receivables portfolios. Since being introduced in the United States in the 1970s, timesharing has evolved into the fastest-growing segment of the hospitality industry. According to the American Resort Development Association, the trade association that represents the industry, timeshare and fractional sales for 2006 topped $10 billion and more than 4 million U.S. families own timeshare interests. The entrance of major hotel and entertainment companies into timesharing — including branded developers such as Marriott, Disney, Hilton, Hyatt, Wyndham, Four Seasons, and Fairmont — contributed to the industry’s increasing growth and consumer acceptance. Another factor responsible for the industry’s growth has been the evolution from a single fixed or floating week product to multi-resort vacation clubs and other vacation ownership products offering a more flexible vacation experience with varying lengths of stays and size of units in multiple destinations. Although successful developers certainly earn a profit on the sale of timeshare interests, most timeshare developers, and particularly the major brands, now make a substantial percentage of their overall profits from the financing side of the timeshare business. More than 90 percent of timeshare buyers finance their purchases. A fundamental part of any timeshare developer’s business is monetizing the portfolio of consumer notes and mortgages, generated by the financed sale of the timeshare interests, into cash. This monetization typically occurs through hypothecation financing or securitizations, both of which provide developers with a relatively inexpensive way of generating cash from their receivables portfolios. A developer’s receivables portfolio generally consists of consumer promissory notes with an average principal balance, depending on the nature of the project, in the range of $15,000 to $25,000.The typical buyer makes a down payment of 10 percent to 20 percent on his or her purchase of a timeshare interest. The balance of the purchase price, about 80 percent to 90 percent of the price, is financed by the developer in the form of purchase-money financing. At the time of purchase, a buyer signs a promissory note in favor of the developer for 80 percent to 90 percent of the purchase price. The average term of the promissory notes is between five and 10 years and the average interest rate payable by the timeshare buyer is fixed at 12 percent or 13 percent, or in some cases higher, based on the monthly payment and term of the particular financing transaction. Depending on the nature of the timeshare interest sold, the note is often secured by a mortgage in favor of the developer. Even though in many cases the promissory notes are secured by mortgages, the transaction is more appropriately characterized as a consumer credit transaction more akin to a car loan than a real estate transaction. Non-branded developers (in other words, developers without a recognizable brand) typically secure hypothecation financing from one of the specialized receivables lenders and finance companies serving this industry. This form of financing is commonly referred to as factoring or receivables financing, and allows the developer to monetize its promissory notes (receivables) in order to pay sales, marketing, and management expenses in connection with the timeshare resort. In hypothecation financing, the pool of consumer notes and mortgages in favor of the developer is assigned to the lender as collateral for the receivables loan, which is generally made in a series of weekly advances over the revolving credit period secured by the notes and mortgages generated that week from financed sales by the developer. The lender makes a revolving loan for an agreed-upon amount to the developer with a floating interest rate that averages one or two percentage points above the existing prime rate. For a typical timeshare developer, the interest rate difference between the amount of interest paid on the consumer notes and the amount of interest paid by the developer to its lender translates into substantial profit from the receivables financing transaction. Although developers and lenders are not involved with residential mortgage loans per se in the timeshare industry, the collateral for the developer loans consists of large pools of consumer receivables generated from financed sales of timeshare interests. During the subprime mortgage crisis, both timeshare developers and their receivables lenders have been anxious to determine whether the performance of their receivables portfolios of timeshare loans would substantially deteriorate in the same manner as the subprime residential mortgage loan portfolios. FIXED THE PROBLEM The good news for the timeshare industry is that receivables lenders foresaw this underwriting problem and addressed it several years ago, before the subprime mortgage troubles. Most of the receivables lenders require minimum FICO or credit scores for the timeshare buyer before making that buyer’s promissory note eligible collateral for the developer’s loan. In most cases, the average weighted credit score of any borrower, which is listed as one of the eligibility criteria for funding a qualified note, is about 650 or higher. The lender may take a certain percentage of its portfolio of notes from each developer with borrower credit scores between 600 and 650, but this percentage of buyers is very limited. In contrast, most subprime residential mortgages were originated to buyers with credit scores in the 400s or 500s, which is evidence of tainted credit histories. In other words, the timeshare receivables lenders imposed a discipline on timeshare developers that did not occur in the residential mortgage industry. These more rigorous underwriting standards can be attributed in large part to the smaller, more specialized nature of the timeshare lending industry. Significantly, however, this lender approach exercised a discipline on timeshare developers, since the developer’s potential interest in selling to buyers with lower FICO scores was outweighed by the knowledge that such a buyer’s promissory note would not qualify as eligible collateral under the developer’s loan. Under the ground rules set by the lenders, if the developer expected to pledge or assign consumer timeshare loans to the lender, then the developer had no choice but to be sufficiently disciplined and refrain from selling to unqualified subprime buyers whose financed notes could not be monetized by the developer. I have recently talked with two national receivables lenders in the timeshare industry as part of researching this article. Both lenders, each of whom has timeshare receivables portfolios in excess of $1 billion, are, of course, monitoring their receivables portfolios extremely closely. Each of them has confirmed only a slight uptick in delinquencies in their timeshare loan portfolios since July and sees no cause for alarm. Furthermore, they have stated their intention and desire to continue to make credit available to qualified developers in the vacation ownership industry, following existing underwriting guidelines. While the non-branded developers rely almost exclusively on the receivables financing discussed above, the branded developers since 2000 have relied on timeshare securitizations as their primary financing vehicle. Timeshare securitizations involve bundling a large pool of promissory notes and mortgages (typically more than $100 million), which back the issuance of notes or securities in different classes or tranches to investors or purchasers. Since the first quarter of 2001, Standard & Poor’s, the rating agency, has rated 25 timeshare securitizations with initial principal balances totaling $6.75 billion. The aggregate outstanding issuance amount in 2006 was $1.4 billion and the expectation is that total issuance for 2007 will be in line with this number. In the last few months, the enormous write-downs being taken by the Wall Street firms and major banking institutions has resulted from their investments in residential mortgage-backed securitizations. Regardless of the ratings given to these securitizations and collateralized debt obligations at the time of issuance, the large number of subprime mortgage delinquencies arising in these pools has caused the value of the investments to drop precipitously, making it hard to determine the current value of these investments. As a consequence, it is very difficult in the current climate to rate, price, or close a securitization backed by residential mortgages, which has given rise to a credit crunch in the residential mortgage industry. IN CONTRAST In contrast, four major timeshare developers have closed term securitizations in September and during the fourth quarter of this year, including Marriott, Wyndham, Sunterra, and Bluegreen. The securitizations were at attractive fixed rates of interest on a tranche by tranche basis with substantial excess spreads over the weighted average coupon rate of the underlying consumer timeshare loans so as to continue to constitute a cheap source of financing for the developer. In addition, Standard & Poor’s has reported that it took no rating changes on transactions backed by timeshare loan receivables during the third quarter of 2007. Although the rating agency has reported that there was some uptick in timeshare portfolio delinquencies toward the end of the third quarter of 2007, this delinquency is generally in line with prior years as the timeshare sector moves out of the peak travel months in the fall and winter. The reason why timeshare securitizers have continued to move forward with these deals is due in large part to the higher credit ratings of the underlying consumer borrowers across all rated timeshare securitizations, averaging in the high 600s and above 700 for certain developer’s portfolios. As a consequence, timeshare securitizations have avoided the problems of subprime borrowers. As an attorney, I have learned to avoid the prediction business. However, as a practitioner who has observed the industry for many years, I see continued demand during the coming years for securitizations in the timeshare industry, particularly for branded developers who require liquidity, extremely cost-effective funding sources, and the ability to book a gain in a particular calendar quarter or year. As lenders and investors flee from mortgage risks and as residential mortgage loan portfolios continue to deteriorate and housing prices threaten to fall further, it is noteworthy that one real estate sector — timesharing — continues to flourish. No credit crunch exists in the timeshare industry and timeshare receivables lenders and securitizers aggressively continue to seek new deals and financing opportunities.
Jeffrey B. Stern is a partner in Holland & Knight’s Washington, D.C., office and is the head of the timeshare and resort communities team in the firm’s real estate section.

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