The initial recovery in commercial real estate investment activity has been rewarding for life company lenders. Absent robust competition to originate mortgages to institutional borrowers, life companies have expanded their share of the secured debt market while working to hold the line on underwriting standards. It has not been a volume game. The enhanced liquidity from life company lending has been narrowly focused, with the lion’s share of the benefits accruing to a privileged class of well-heeled borrowers. In this segment of the market, life companies offer their most competitive terms. As debt market conditions improve, they are butting up against other lenders. For life companies, this more crowded landscape is a counterweight to improving economic projections and growth in the number of qualified borrowers.
From their crisis nadir, life companies’ commercial mortgage balance sheets have inched up by little more than 10 percent. They could easily have grown more when lending opportunities were uncontested. Instead, life company gains are dwarfed by the dramatic expansion of agency lending for apartment properties. Rather than gorging themselves on a larger slice of the commercial property pie, life companies have instead remained targeted in their activities. That is not to suggest they are peripheral to the broader debt market. At more than 12 percent, life companies’ share of real estate loans outstanding is not very far behind agency multifamily portfolios and agency mortgage-backed securities. The life company share is also more than half of the balance of all CMBS outstanding.
How has the life company mortgage book changed during and after the financial crisis? Reporting by the American Council of Life Insurers shows new mortgage commitments dropped from $9.6 billion in 2008 to a low of $2.6 billion in 2009. In contrast, CMBS issuance collapsed over the same brief period, dropping 95 percent. Along with agency-backed lenders, life companies were among the first to resume their commercial property lending activities. Their mortgage commitments rebounded, nearly doubling from 2009 to 2010.
Holding true to form, life companies’ mortgages have been concentrated in a relatively small number of liquid markets. Where a lender has strayed from its safe harbors, it has typically been in support of an existing relationship with strong sponsor. The support for the market has not been broad-based, either geographically or in terms of borrower or asset quality. The conservative bent has served the life companies well. Across institutions, the ACLI reports that the 60-day delinquency rate hardly budged during the financial crisis, never rising as high as 0.4 percent. Life companies were the only class of lenders to register lower levels of distress than the agencies’ multifamily books of business.
The most recent cycle is in marked contrast to life companies’ historical experience, which belies their latter-day profile as the industry’s most reserved sources of financing. In the aftermath of the savings and loan crisis, the 60-day delinquency rate on life company loans peaked at roughly 7.5 percent, on par with banks and thrifts. Even well-diversified portfolios came under systematic pressures that could only be offset by consistent underwriting.
Notwithstanding the frustratingly weak economic and labor market recoveries, the last few years have played into life companies’ strengths. When market-wide underwriting standards are conservative, life companies are in their element. To the dismay of regulators and credit risk officers, industry attention to risk is once again proving a cyclical feature of the market more than a structural shift.
The lending environment is now changing and not always to the advantage of the life companies. As the recovery has progressed, a larger number of bank and conduit lenders have reengaged in quoting loans. That is not a problem in itself. After all, the next few years’ schedule of maturities point to ample lending opportunities for risk-seeking sources of capital. Life companies are not among the obvious risk seekers, but the participation of other lenders does spill over into their preferred turf. Even if the lending profiles of the different classes of institutions vary dramatically, the extent of overlap has increased as lenders of all stripes have gravitated to higher-quality borrowers.
Prone to walking away from aggressive underwriting scenarios, life companies are nonetheless taking risks. Like other lenders, they are faced with a changing interest rate environment that will bear on pending refinancing, as well as the exit performance of current originations. Some life companies are pushing the envelope in competing with agency lenders for coveted apartment financing opportunities. Overall, the list of qualified borrowers is growing longer. At the same time, changes in the market are not playing to the life companies’ strengths.
Sam Chandan, Ph.D., is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School. The views expressed here are his own. He can be reached at email@example.com.