Life Companies Seek Survival in Commercial Finance

The explosion in the issuance of real estate investment trusts (REITs) and commercial mortgage-backed securities (CMBS) since the early 1990s has many people questioning the future of life insurance companies in the commercial real estate mortgage industry. With total market capitalization of REITs and CMBS approaching $300 billion, nearly 25 percent of the $1.3 trillion institutional real estate universe is securitized. Capital placement has shifted dramatically from the private debt and equity markets to the public markets.

Life Companies’ Decline
From 1991 through 1997, life company holdings of commercial mortgages declined by $47 billion to less than $200 billion, and life companies’ percentage of the commercial mortgage market dropped from 23 percent to just under 17 percent. Two primary factors produced this trend: increased risk-based capital requirements and the emergence of the CMBS market.

The impetus for regulatory reform was the dramatic default rates of the early 1990s: life companies’ commercial mortgage default rate soared from 2.8 percent in 1988 to 7.5 percent in 1992. In response, the National Association of Insurance Commissioners enacted risk- based capital standards that dramatically increased the reserve capital for commercial real estate mortgages, thus encouraging life companies to downsize their commercial mortgage holdings.

Record-level CMBS issuance volume of $44 billion in 1997 and projected 1998 volume of $60 billion to $70 billion indicate that the CMBS market has emerged as a strong alternative to traditional mortgage sources such as life companies. Tight restrictions placed on life company lending practices left a large universe of commercial debt unserved that CMBS conduit programs addressed. Life companies soon found themselves competing with the CMBS market and have adapted by creating their own programs that funnel mortgages into the CMBS market.

Today’s Life Companies
John Hancock Real Estate Finance, Inc., is leveraging its existing origination infrastructure to perform balance-sheet and off-balance-sheet lending. To capture nonconforming mortgage business, John Hancock has begun its own securitization program to allow quality nonconforming loans to be processed through its origination infrastructure, creating a new origination and securitization revenue stream. John Hancock’s securitization objective is $500 million for 1988 and $750 million to $1 billion for 1999.

Prudential Mortgage Capital Co., LLC, was formed in 1997 to serve as a capital placement provider. Its objective is to work with clients to find the best source of mortgage debt. The placement sources being tapped include Prudential’s general account, private placements, and conduits. Prudential recently announced its participation in CRIIMI Mae, Inc.’s no-lockout CMBS program, which allows borrowers to refinance by paying a sliding scale of exit fees. With real estate offices around the country, Prudential is positioned to market its services on a national basis. The company plans to place $1.2 billion in 1998 and strives to enter the top tier of capital placement organizations with a volume goal of $3 billion in 2000.

The programs at John Hancock and Prudential indicate that life companies are restructuring to remain competitive. However, competition from other conduit programs means that they will have to settle for a smaller slice of the commercial real estate finance pie.

George Green

George Green is a policy representative/senior economist for investment real estate at the National Association of Realtors in Washington, D.C.