08/12/2011

Insurers Slow Originations Amid Volatility

Life companies have turned more cautious about lending over the past few weeks, taking steps to protect themselves from growing market volatility.

Insurers have widened loan spreads across the board. Most that weren’t already setting minimum coupon levels have started to do so. And some have taken the unusual step of using an artificially high Treasury yield as the benchmark for loan rates.

At the same time, insurers have slowed the pace of originations, wary of locking into loans amid wild market turbulence. Only a month ago, life companies generally were running well ahead of this year’s plans for originations and were expected to keep up the accelerated pace over the rest of 2011. But now, the yellow flag is out.

“There is a slowdown as folks become more selective,” said one lender.

Added an executive at a large life company: “I think everybody’s going to be a little more cautious now because of the uncertainty. It’s not only the downgrade of Treasurys by S&P, but you’ve got the overall slowing of the U.S. economy, the European economies — it’s just a very uncertain period of time right now.”

After loading up on loans since January, insurers generally feel they can afford to stay cautious until the market settles down. Life companies “had a great first half of the year and are able to take a wait-and-see attitude a little bit here,” said one lender.

“You don’t want to lock up a $100 million deal in a volatile week,” said another lender. “You don’t want to be sitting there with a 5 coupon if we could’ve had a 6 if we waited three days.”

Ironically, the slowdown has come at a time when the competitive position of insurers has been strengthened by turmoil in the securitization market. Many commercial MBS lenders are quoting higher loan spreads than insurers, effectively putting themselves on the sidelines. Also, borrowers are wary that CMBS lenders will raise rates before loans close if market conditions continue to deteriorate — a practice that is less likely with insurers, according to many market players.

“A lender always has a whole variety of ways of backing out of a deal, but what you find with insurance companies is that they tend to stick with their quote no matter what happens,” said one lender at an insurance company. “That’s not the case with the CMBS guys, who are always at the mercy of where their bonds are trading.”

As a result, large insurers have seen borrower inquiries triple over the past few weeks, as property owners bypass CMBS shops, said one executive at a major insurance company.

Before the recent market downturn, life companies were quoting spreads as low as 150 bp over Treasurys for 10-year office loans with a 60-65% loan-to-value ratio. Spreads have since widened by about 75-100 bp, to about 225-250 bp, more or less offsetting the decline in Treasury yields.

Some lenders at CMBS shops and banks are wondering why insurers have not increased the spreads even more, given their strong market position. “They should go wide because, you know, they’ve got no competition,” said a balance-sheet lender at a large commercial bank.

But by setting minimum coupon levels, insurers can effectively increase the spread. Many insurers have set coupon floors in the 5% area. They quote a spread over Treasurys, but don’t permit the coupon to fall below the minimum. For example, the quote might be 200 bp over Treasurys, but no lower than 5%. That protects the insurer from ending up with a sub-5% return because of the breathtaking rally in Treasurys. The 10-year Treasury rate fell to as low as 2.1% Wednesday from 3% on July 27. A loan pegged to a 2.1% Treasury yield would end up with a 290-bp spread if subject to a 5% floor rate.

In another way to widen the effective spread, some lenders over the past two weeks were quoting loans based on the Treasury yield in late July — before the yield started plunging. That’s unusual, insurers acknowledged, but provided a way to limit risk while still taking advantage of lending opportunities.

Because CMBS spreads have widened, some insurers may be tempted to divert capital to bond investments from loans. “I think that the dramatic widening in the CMBS market may create some buying opportunities for life companies, but I don’t see a big pullback from the direct lending market,” said one executive at a major insurer.

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