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January 06, 2017  

Portfolio Lenders Eye Further Growth in 2017

Bank and insurance-company lenders have booked another robust year and are looking ahead to more of the same, while keeping an eye out for interest-rate volatility and other potential headwinds.

Portfolio lenders expect the final tallies of their 2016 originations to set records or at least come close. Among the reasons: a fallback by commercial MBS platforms, particularly in the first quarter of last year, that allowed balance-sheet lenders to increase market share.

A preliminary estimate from Trepp puts 2016 originations by U.S. banks at $329.3 billion, up from $311.4 billion the previous year. Meanwhile, the word from insurance sources in recent weeks was that aggregate annual production would be up 10-15% from 2015, when the top 30 insurance-company lenders wrote $76.2 billion of commercial mortgages.

The outlook for the new year is generally optimistic, in part due to expectations that the incoming Trump Administration and Republican-controlled Congress will take a business-friendly approach and perhaps ease up on regulations that affect commercial lenders.

“I think 2017 is the year, with a new president, when we’re going to figure out some things,” said Greg Michaud, head of real estate finance for Voya Investment. “How much regulation are we going to get, and how much is going to get laid off by the new administration?”

Banks have been grappling with sharpened government oversight for the past few years. Rules that took effect in 2015 tightened the capital-reserve treatment of some mortgages, including high-leverage development loans. U.S. regulators have watched banks’ commercial loan books closely and occasionally issued warnings against slipping underwriting standards. In particular, they’ve expressed concern about rapidly growing mortgage portfolios at small and regional banks.

Many large, national banks say they continue to navigate the new regulatory environment carefully — but that it hasn’t prevented them from expanding their commercial mortgage business.

“We had a very good year,” said Mark Myers, an executive vice president at Wells Fargo who heads up its commercial real estate group. For his bank, he said, “I wouldn’t call it a record year, but it got close in terms of originations.” Wells is easily the largest U.S. portfolio lender, with annual balance-sheet loan production generally in the range of $30 billion to $35 billion.

Beginning this year, Myers’ group will handle originations both for CMBS and the bank’s own portfolio. For the securitization side, he said, “my guess is 2017 won’t be a robust year. So I think there will be some opportunities for balance-sheet lenders.”

Among the uncertainties facing lenders are the future course of interest rates and of property valuations. Yields on 10-year Treasury bonds, a pricing benchmark for long-term loans, are running some 50 bp higher than just before the election, and the Federal Reserve last month began what’s expected to be a gradual series of hikes in short-term rates. Meanwhile, property price appreciation has cooled off: Green Street Advisors’ most recent Commercial Property Price Index showed values were flat from September through November and up only 3% from a year earlier.

“We’ve got to remain increasingly flexible,” said Chad Tredway, a managing director at J.P. Morgan and head of its term-lending business in the Eastern region. He noted that one way his bank has mitigated risk is with its focus on multi-family assets, particularly “working-class” apartment properties, which tend to be resistant to market fluctuations. “They don’t have lease-up risk, they don’t have construction risk. And for the most part, rents are below what the market will bear,” Tredway added.

One area where banks have been especially cautious over the past year is construction lending. That’s partly due to the risk-capital regulations, but there is also real uncertainty about whether the market can absorb the frenzied development of recent years.

“Overall it’s still a very healthy market. But we’re seeing trends that are more negative — as opposed to positive and growing — for the first time, compared with the past few years,” said Peter D’Arcy, who oversees commercial real estate lending at M&T Bank. He pointed, for example, to concerns about an oversupply of hotels in New York and apartments in certain markets.

Spreads for a typical development loan widened out through last year, by 100-150 bp or more. For 2017, market pros expect that securing construction financing will continue to be a tough proposition.

Like bankers, insurers are watching out for signs of softening in property markets.

“Valuations in the market held up reasonably well [in 2016], but my sense from talking to investors more active on the equity side of the business is that it’s been more choppy than it has been in the past few years,” said Paige Hood, chief investment officer and senior portfolio manager for Prudential Mortgage Capital.

But there hasn’t been any sign of insurers shifting away from commercial mortgages toward other fixed-income products. If anything, they’re likely to increase their originations this year.

Ted Norman, who heads originations for TH Real Estate, a division of TIAA Global Asset Management, said the unit “is definitely allocating significantly more dollars to mortgages next year, so we’re looking to have a very big year in both the core-mortgage and subordinate-debt space, including increased mandates from third-party investors.” Norman said his firm also intends to become more active in writing large-loan floaters in 2017, which could have it bumping up against the few other life companies that have significant floating-rate programs, like MetLife.

Balance-sheet lenders, particularly insurers, benefited last year from a slackening of CMBS lending. That was partly due to disruptions in bond markets that made pricing of securitized loans dicey — pushing some business to insurers, which can fix coupons further in advance.

“When you have Treasury-rate volatility, which you did at the beginning of the year, or which there was around Brexit and the U.S. presidential election, that just helps people realize the value of a 90-day rate-lock,” said Gary Otten, managing director and head of real estate debt strategies for MetLife, which has been the leading insurance-company originator for many years.

Securitization shops appeared to be competing somewhat more aggressively toward the end of the year, but were still proceeding with caution because of uncertainty about the pricing impact of impending risk-retention regulations.

Some insurers, meanwhile, showed greater willingness to offer flexible prepayment terms to win loans. Several sources said they’ve seen quotes that provided for a modified exit fee, rather than the standard requirement that some of the interest for the remaining term be paid as a lump sum. While the reasons behind that strategy are unclear, it could reflect an expectation that with interest rates starting to move up, early payoffs of certain loans would provide an opportunity to reinvest capital at higher yields.