Interesting Times

Major life insurers are starting to ease terms and lower interest rates for commercial real estate loan portfolios.

By DON JACOBSON, The Star Tribune, 6-20-10

Life insurers, who after the real estate collapse of 2008 were counted on to provide a financing lifeline for commercial real estate deals when banks wouldn't touch them anymore, are again showing some faith in the recently maligned investments.

Soured commercial real estate loans have been blamed for many of the bank failures that continue to dot the country and Minnesota. But major life insurers such as Prudential Financial Group Inc. and MetLife Inc. have indicated that, while they expect to take hits on their massive commercial real estate portfolios again this year, those losses are now lower and quite manageable because of wise investment choices and strong overall capital structures.

And some are publicly claiming the commercial real estate market is on the road to recovery.

"We believe the real estate market is returning to stability and values will be stable to rising going forward," Terry Lillis, CFO of Des Moines-based Principal Financial Group, said in a statement last month. He expects his company's commercial real estate losses to be $100 million less this year than in 2009, and contended Principal has plenty of excess capital to deal with any trouble.

American Equity Investment Life Insurance Co. of Des Moines said that during the first quarter it funded $45.3 million of new commercial mortgage loans.

Bernard Winograd, executive vice president of U.S. businesses for Prudential Financial Inc., the country's second-biggest life insurer, told investors in a May 6 conference call the company is "happy to be a real estate lender at this point in general because we feel good about the upside opportunity for valuations relative to the downside risk."

Part of the interest is of necessity. They have cash to spend. U.S. life insurers raised $26 billion in capital in 2009 and the first quarter of this year, according to Fitch Ratings.

And despite the still-weak U.S. economy, life insurers' appetite for commercial real estate has been rekindled as the European sovereign debt crisis has shaken confidence in the developing-nation debt market and corporate bonds have fallen out of favor, said Tony Carlson, a senior analyst with the Minneapolis office of Grandbridge Real Estate Capital.

Arthur Pasquarella, 2010 chairman of the Counselors of Real Estate -- which issues the CRE credential needed by commercial brokers -- said that with less capital available in the market, conservative lenders with good track records -- such as insurers -- are seeing very high yield spreads.

"The yields they can obtain today are quite attractive relative to alternative investments," Pasquarella wrote in an e-mail. "It is simply a result of supply and demand factors."

And make no mistake, life insurers have a very good track record on commercial real estate investments, even with recent losses. UNIFI Companies, the Lincoln, Neb.-based parent company of Ameritas Life, reported in December it has lost only $30,000 on $2.1 billion in commercial loans made since 2000.

During the boom years, there were a lot of ways to obtain financing for commercial real estate deals, beyond just banks and insurers. Commercial mortgage-backed securities (CMBS), typically issued by the big Wall Street investment banks but also by life insurers, are secured by the loans on commercial properties. They were a tremendous source of liquidity for developers before the market crash, but were also blamed in driving up real estate prices and helping to create a dangerous bubble.

Conduit financing was also plentiful before the crash. This type of short-term commercial paper was issued by "special purpose vehicles" created by banks and backed with assets such as commercial loans -- they were not held on the banks' own balance sheets.

All fell out of favor when the market crashed. "Then, all of a sudden, there was nothing," Carlson said. "Life insurers were counted on to pick up the slack, but there was always the question of how much they could do."

The answer was "not much" at first. Life insurers issue about 10 percent of all commercial mortgages in the United States and invest in CMBs instruments, which make up about 25 to 35 percent of the mortgage market. Their loans tend to be longer than those issued by banks, usually 10 years rather than five, generating more predictable cash flows and featuring moderate loan-to-value ratios, or LTVs.

Like banks, insurers were applying tough terms to their lending in real estate ventures during the worst of the downturn, charging interest rates of 7 percent or higher and demanding stringent LTV ratios of 65 percent. But unlike banks, insurers are now loosening those requirements because they're once again seeing some types of commercial real estate as quality assets.

"Now we're seeing life insurers allowing up to 75 percent LTVs and interest rates at 6 percent, which is good," Carlson said. They're also again financing construction loans, which they had ratcheted back on during the crisis. "When tenants are found to lease up the building, they convert to permanent, fixed-rate loans."

To be sure, like nearly everyone involved in commercial real estate, life insurers have taken a substantial hit to their balance sheets in the last two years and will again this year. But their commercial mortgage losses will be lower than those suffered by banks and the general market, analysts have concluded.

For instance, Moody's Investor Services said in December that life insurers, applying lessons learned from the previous commercial real estate crisis of the late 1980s and early 1990s, have limited their exposure to dodgy investments thanks to a policy of diversifying the types of assets backed and spreading them out geographically. Moody's predicted $10 billion in real estate losses for life insurers this year, which it termed "manageable."

Another analyst, Eric Berg of the British firm Barclays PLC, opined in a January research report that life insurers are in such good financial shape they stand to lose "little, if anything" even if their CMBS portfolio values keep falling.

But just how much this will mean in terms of liquidity in the commercial real estate financing market is debatable. Bill Nimmo of Minneapolis-based Presidium Asset Solutions agrees there has been more activity by life insurers in the commercial real estate market, but he contends the damage wrought by the credit crunch has been too extensive to be much affected by their investments.

"Things are somewhat better, but we have a long way to go to really see a substantial improvement in liquidity," he said.