Life Companies Are Back and Strategically Competing Against Big Banks. Here’s How.
Matt Egan Nov. 27, 2013, 2 p.m.
It’s easy to see why life companies continue to plow money into commercial and multifamily real estate mortgages: They have provided strong returns, inflicted virtually no losses and match up perfectly with their long-term liabilities.
“Mortgages have proven to be really good, solid investments for life companies,” said Robert Merck, head of real estate investors for MetLife, the top life insurer in this space and the subject of a longer profile in this month’s Mortgage Observer.
“As long as the financing doesn’t get too aggressive as it did back in 2005, 2006 and 2007, you’ll see the life companies continue to play a big role in the market. We see good relative value in continuing to grow and maintain that business,” he added.
MetLife originated more than $9.6 billion in commercial real estate mortgages in 2012 and has topped the Mortgage Bankers Association’s list of annual lending volume for each of the past eight years among life companies. Prudential and New York Life round out the top three among life insurance companies, originating $7.73 billion and $5.12 billion of commercial mortgages, respectively, last year.
In the easy-credit years before the financial crisis, life insurers battled with big banks, Fannie Mae and Freddie Mac, the CMBS market, and pension funds to put capital to work in the commercial real estate market.
“It was hard to put out money as a life company then. It ended up being a good problem,” said Gregory Michaud, head of real estate finance at ING Investment Management Americas, which was the No. 7 life company in commercial mortgages last year with $1.96 billion of originations. “One factor that stopped life insurers from making bad decisions was CMBS.”
But then the party ended, and, like virtually all lenders, life insurers fled the commercial real estate market in 2008 and 2009 amid the credit crunch.
“Other than Fannie and Freddie, hardly anybody was lending money. Everybody retrenched,” said Gerard Sansosti, an executive managing director at brokerage HFF who specializes in originating debt. “The banks stepped away until they could get their balance sheets cleaned up and CMBS evaporated completely.”
According to MBA data, annual commercial mortgage originations for life companies tumbled from a pre-crisis peak of $53.53 billion in 2006 to $30.87 billion in 2008 and then just $16.99 billion in 2009. That represents a 68 percent plunge from peak to trough.
By comparison, CMBS topped out at $230.17 billion of commercial real estate origination in 2007 but then plunged 95 percent to $12.15 billion in 2008 and then to just $4.97 billion in 2010.
But after weathering the storm far better than their banking peers, life insurance companies were among the first players to return to the commercial mortgage market. In 2010, commercial mortgage originations for life companies soared 80 percent to $30.61 billion. That number climbed another 61 percent year over year to $49.31 billion in 2011, representing a 190 percent surge from the crisis low in 2009.
Banks eventually returned to the commercial real estate financing market, growing commercial mortgage originations by 150 percent year over year in the second quarter of 2011.
However, despite the return of big banks, whose financing prowess has been bolstered by the Federal Reserve’s extremely easy monetary policies, life companies stuck around.
“The Fed is basically giving banks money for free,” said ING’s Mr. Michaud. “Their cost of capital is cheaper. As long as [Fed Chair Ben] Bernanke is out there pumping money out there, the banks are going to have tighter priced money.”
Overall, commercial and multifamily mortgage origination volumes increased 7 percent in the second quarter year over year and 36 percent quarter over quarter, according to the MBA. This was driven by a 31 percent rise in originations for multifamily properties.
Life companies generated $50.48 billion of commercial mortgage originations in 2012, up 2.4 percent from the year before. Through three quarters of 2013, life company commercial mortgage originations were up 19 percent from the same period in 2012.
In fact, the MBA said it’s a safe bet life companies will generate a record amount of commercial mortgages this year.
“There is a strong appetite out there by life insurers to put money into commercial and multifamily properties, and they’ve had a lot of success in placing that money,” said Jamie Woodwell, vice president of commercial/multifamily research at the MBA.
According to a survey by the Commercial Real Estate Finance Council and Trepp, life insurers held an average of 15.25 percent of commercial mortgage assets at the end of 2012, up from just 3.88 percent the year before.
Still, while life companies continue to generate strong amounts of commercial mortgages, their share of the overall pie has slipped.
The amount of commercial and multifamily mortgage debt outstanding increased to $2.45 trillion in the second quarter of 2013, with life companies holding about $326 billion, or 13.3 percent.
By comparison, they held $320 billion, or 14 percent, in the same period of 2012, according to the MBA.
Banks and thrifts held 34.9 percent of the commercial and multifamily mortgage debt outstanding in the second quarter of 2013, up from 34 percent in the second quarter of 2012.
But Mr. Merck, at MetLife, isn’t worried about the smaller market share for life companies.
“There is a lot of competition between banks, CMBS and life companies. There are a lot more opportunities for financing than there were three years ago,” he said. “There’s a bigger pie to go around. Spreads are still attractive in the commercial mortgage market.”
In recent quarters, MetLife has participated in a slew of commercial mortgage deals worth more than $200 million, including a $362 million loan on Waterside Plaza, a 1,471-unit apartment complex in Manhattan, and a $253 million loan on 101 California, a Class A office tower in San Francisco.
With corporate bonds still sporting relatively low yields, it makes sense for life insurers to continue to deploy their cash in the commercial real estate market.
Commercial mortgages have proven to be reliably safe for life companies, which tend to make more conservative loans than CMBS and banks.
According to MBA data, the 60-day delinquency rate for commercial and multifamily mortgages held in life company portfolios dipped to just 0.08 percent in the second quarter. That metric is all that much more impressive when compared with the peak delinquency rate of 7.53 percent in 1992 for life companies.
“The lessons learned have been worked into the system,” said Mr. Woodwell.
The data also highlight how much more conservative life insurers tend to be by backing more stable properties. The 90-day delinquency rate for loans held by FDIC-backed banks and thrifts stood at 2.16 percent as of the second quarter, down 0.26 percentage points. The MBA said the 30-day delinquency rate for loans held in CMBS stood at 7.81 percent, down 0.74 percentage points.
Average vacancy rates are also down, dipping 0.3 percentage points year over year in the retail sector to 10.5 percent in the second quarter, which is the lowest level since the third quarter of 2009.
Industry executives say life companies typically offer financing with lower loan-to-value ratios, which are calculated by dividing the mortgage amount by the appraised value of the property. This means they have lower risk and cost the borrower less.
Mr. Michaud said ING’s average LTV this year is approximately 53 percent for commercial real estate financing. By comparison, he said loans held in CMBS often carry LTVs of around 65 percent to 70 percent.
Likewise, CMBS loans can offer borrowers 10-year, interest-only periods, adding to the leverage. Life companies don’t typically offer interest-only periods like that. However, Mr. Sansosti at HFF said he recently brokered a 20-year loan by Lincoln Financial for the Carriage Park Apartment complex in suburban Pittsburgh that had 10 years of interest-only. He said Lincoln, which originated $912 million in commercial mortgages last year, didn’t have any issues with the interest-only period, because the $14.25 million loan’s LTV was just 40 percent.
Life companies tend to have a longer time horizon than other lenders, because they generally get their funds from life insurance policies and annuities, which match up nicely with medium and long-term commercial mortgages.
On shorter-term loans, life companies can struggle to compete against banks. Mr. Michaud said he’s seeing banks win business at just 140 basis points over Libor, or roughly 2.5 percent.
Banks are also going on the offensive by including language in construction loans that force borrowers to let them also make the permanent loan or face a fee, Mr. Sansosti said. “It’s almost like an exit fee. They’ve been very, very aggressive,” he said, adding that Wells Fargo and Key Bank are among the lenders doing this.
In the medium to longer-term, life companies are often competing against other life companies as well as Fannie and Freddie for multifamily loans.
Life insurers tend to be smaller players on the multifamily front, holding just $51.17 billion, or 5.8 percent, of the mortgage debt outstanding in this category, the MBA said. That puts life insurers behind GSEs, banks, CMBSs and even state and local governments.
So as the economy continues to recover, look for life companies to continue generating a steady amount of commercial mortgage originations in the coming years, despite interest rate movements and especially if corporate bond yields don’t creep too high.
“We’re always going to be in that $50 billion to $60 billion range and never get much above that unless people start buying life insurance contracts like crazy fiends. There’s only a finite amount of money,” said Mr. Michaud.
Mr. Woodwell, for his part, added that interest rates, which the Fed expects to eventually begin increasing in late 2014 or early 2015, probably won’t mute demand for commercial real estate mortgages.