Sunday, 04 November 2012 00:00
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Insurers see opening in commercial mortgages

Over the past several months, the commercial mortgage market has been volatile, plagued by weak investor appetite, wary lenders and warnings by ratings agencies of increasing risk. But one bright spot is emerging, as life insurance companies have taken advantage of the lull to become major lenders.

In the second quarter of this year, the life insurance industry underwrote $15.7bn in new commercial mortgages — the largest volume on record since the American Council of Life Insurers began tracking the number in 1965.

This represents a doubling of the volume of mortgages underwritten in the first quarter and a nearly 26 per cent increase over the second-highest number on record, $12.5bn, reached in the fourth quarter of 2005.

A lack of activity from investment banks has opened the door for life insurers. Pummeled by a weak economy, many Wall Street banks, traditionally the largest commercial mortgage lenders, have gone quiet, leaving little competition for life insurers.

“It is as if these guys died and went to heaven,” said Lawrence J. Longua, a clinical associate professor at the Schack Institute of Real Estate at New York University. “Life insurance companies are pretty much the only game in town.”

New York Times reports that life insurers are typically conservative, favouring high-quality borrowers and trophy properties, and keeping the bulk of their loans on their balance sheets. Investment banks, on the other hand, pool most of their mortgages and issue bonds against these loans. This allows the banks to transfer the risk off their balance sheets, enabling them to underwrite more, and riskier, loans.

Investment banks typically dwarf life insurance companies. Banks and savings institutions, for example, held 33.4 per cent of the $2.4tn of total outstanding commercial real estate debt as of the second quarter, compared with the 12. 8 per cent held by life insurance companies, according to the Mortgage Bankers Association. But while the total amount of commercial mortgages increased by 0.1 per cent in the second quarter over the previous quarter, the amount held by life insurers increased by  1.5 per cent.

“Now is a good time to be a first-mortgage lender,” said Robert R. Merck, a senior managing director and the head of real estate investments for Metropolitan Life.

MetLife originated $8bn in real estate loans last year and has already lent that amount in the first three quarters of this year. The company recently financed two loans to a joint venture that includes General Growth Properties, the mall company.

“There is less competition,”  Merck said, “which has allowed lenders like ourselves to put a lot of very good loans on the books for properties that meet our guidelines.”

There are several reasons that banks have been driven to the sidelines, including a difficult economic environment and the sovereign debt crisis in Europe. The market for bonds backed by mortgages has also been weak, and this summer it hit a speed bump when Standard & Poor’s refused to issue a rating on a commercial mortgage bond offering, spooking the investment community. As a result, experts now estimate that what had been expected to be a $50bn market this year will instead amount to less than $35bn.

“It was a very optimistic winter and spring, then we turned 180 degrees and it has been nothing but negative,” said Manus Clancy, a managing director at Trepp, a commercial mortgage information provider. “We have seen a vastly different mentality than what we saw in late May.”

Many insurers have responded by increasing their 2011 mortgage allocations. “In 2007 through 2009, these companies sold off a lot of their mortgages,” said Richard D. Jones, a co-chairman of the finance and real estate practice groups at the law firm Dechert, “so now they are trying to rebalance their portfolios.”

For borrowers, life insurance companies can offer a price advantage over investment banks, experts said. Because banks pool their loans into bonds, they have to satisfy skittish bond buyers by offering them higher rates. The banks then pass on these higher rates to the borrower. But because most life insurers do not pool their loans into bonds, they can offer lower rates.

“It is a temporary consequence of a very fractured market,” Mr. Jones said. “Right now, the insurance companies are eating Wall Street’s lunch. If a life company wants to get a deal done, there is nothing anyone can do to compete with them.”

Also, life insurers’ mortgages are performing comparatively well. Some 99.6 per cent of mortgages held by life insurance companies were in good standing as of the end of last year, according to Fitch Ratings. This is in large part because of their conservative lending approach and their “active management” of mortgage portfolios, Fitch said in a recent report.