Alexandra Riggs
Vice president, loan production, Essex Financial, Denver
As 2016 begins to wind down, now is the time to reflect on what has been accomplished so far this year and to contemplate what the next year may hold. Without looking into a crystal ball, I can say with confidence that 2017 holds one thing for certain: uncertainty. With the upcoming election, potential Fed rate hike and new risk retention legislation for commercial mortgage backed securities loans, what will 2017 look like for commercial mortgages? In a nutshell, we will see life insurance companies continuing to originate at record levels, while CMBS lenders will bear the brunt of market volatility.
What’s driving life insurance companies’ appetite for commercial mortgages? Since 2000, commercial mortgages have provided a 100 basis-point spread premium, on average, relative to comparable corporate bonds (single-A). While corporate bonds comprise the largest share of life insurance companies’ invested assets, typically 40 to 60 percent, life insurance companies are actively increasing their holdings in mortgages every year in order to capture more yield. In fact, life insurance mortgage originations rose almost 50 percent from 2007 ($42.69 billion) to 2015 ($63.45 billion). While CMBS still makes up a large portion of all commercial mortgages ($95 billion originated in 2015), life insurers are growing their market share. In second quarter 2016, CMBS volume decreased precipitously due to widened spreads required by investors, resulting in a 40 percent year-over-year decrease in origination. In that same period, life companies saw a 15 percent year-over-year increase in origination. With yields compressed across alternative asset classes, life companies expect their voracious appetite for commercial mortgages to continue into 2017, forcing CMBS lenders to compete for a smaller portion of the commercial mortgage market.
Meanwhile, CMBS lenders are facing a unique challenge in new government imposed regulations, effective as of Dec. 24, 2016. Going forward, CMBS issuers will have to grapple with risk retention. To satisfy the new requirement, a CMBS issuer will be required to hold a “vertical” slice of the securitization, 5 percent of each class of securities in a deal, for at least five years. Alternatively, they may sell a “horizontal” slice to a designated third party (the B-Buyer), the riskiest 5 percent of the securitization. The B-Buyers in that scenario will be required to hold the securities for five years, preventing them from selling to a third party for a return. In essence, such regulations aim to force CMBS issuers to keep “skin in the game.” CMBS pricing implications given the new risk retention requirements are unknown, and CMBS shops are currently flooded with borrowers hoping to close loans by mid-November, in order to avoid securitizing in the unprecedented regulatory environment of 2017. As the deadline nears, we anticipate traditional CMBS borrowers to shift to life insurance lenders for surety of execution. The uncertainty in the CMBS market will continue to drive more life insurance origination in 2017.
Denver is well-poised to absorb added life insurance mortgage appetite. With headline-grabbing population and employment growth, Denver is rapidly becoming a global investment market. Investment sales volume reached $10.3 billion in 2015, with increased foreign investment. The heightened investment activity directly influences the mortgage market, creating more consumer demand for commercial mortgages. Accordingly, life insurance companies are becoming more active and aggressive in Denver, as the commercial real estate market grows. We expect to see more insurance companies entering the market and driving debt origination in Denver in 2017 that historically haven’t had a large footprint in the area.
As a correspondent for 25 life companies, we are optimistic about the opportunities that Denver will see next year with large maturity balances coming due. While uncertainty in the CMBS market and beyond will influence 2017, life company lenders will be ready to step into the gap.
