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  • Writer's pictureMark Ritchie

How Best to Leverage Life Insurance Debt

Economies change, cycles shift, and what a difference six months can make when putting that in context. Following a banner 2021, most life company lenders saw themselves increasing their commercial mortgage allocations in 2022. The relatively favorable macro rate environment at the start of the year pointed to optimistic conditions for commercial lenders, even as the Federal Reserve promised a measured return to rate hikes to offset the inflationary pressures of the economic recovery post COVID. Conditions changed in late February.

Ukraine conflict disruption was the final straw to a system still processing the effects of inflation, supply chain disruption and intermittent lockdowns. The subsequent roiling of global energy markets, compounded distribution issues and resulting hyperincreases in inflation has also led to a dislocation in the corporate bond market. These factors have challenged the market fundamentals for CRE and, in turn, slowed down the pace of commercial lending.

Let’s be clear. Life company lenders are not shying away from commercial mortgage lending. While their expanded allocation targets remain, life company lenders are becoming more disciplined. So expect a pursuit of quality assets and experienced sponsorship to result in a slower pace for the second half. They may not meet their targets, but will remain active. Debt is becoming more expensive for borrowers and underwriting is becoming more risk averse. A clear sign of market disruption has been the wide range of pricing coming in on individual deals as lenders consider the nuances of their specific portfolios, risk tolerance and performance goals. Rates are moving up across the board as spreads grow, a reflection of increasing treasury yields.

Due to these factors, originations are down overall as borrowers recalibrate for new investments and lenders become more selective, even in popular classes like industrial and multifamily. Office and hotel assets were already struggling to return to pre-pandemic levels and will continue to struggle to find loan sources without paying a price for both rate volatility and performance risk in 2022. Retail seems to be a tale of two asset classes, with essentials-anchored centers continuing to outperform traditional mall retail space. Overall, rate volatility has significantly impacted hedging costs, with upfront costs becoming very expensive compared to early 2022.

Life Company Advantage

There are some bright spots, however. Life companies still offer a premium capital solution and what can still be considered the most attractive rates for qualified borrowers. In today’s market, life companies that have their own balance sheet are benefiting from better quality deals at lower leverage. That is a plus for them, and keeps them actively pursuing new originations, although from a smaller pool of options. Rate lock at time of origination is even more attractive in the current cycle and should be prioritized by borrowers.

Also, the current inflationary climate has encouraged life company lenders to become more enthusiastic about short- and mid-term loans with variable rates as these lenders seek to hedge inflation and increase their near-term returns. And while the cost of fixed-rate loans for high-quality assets has returned to what can be considered generational rate norms after enjoying years of generational lows, these are still reasonable rates in that historical context.

So now that we are in a new cycle, there are a few ways to best leverage life company debt. Life companies are still offering their best rates to borrowers at low leverage. This allows lenders to reward borrowers for putting skin in the game and confidently fund at appealing rates. That should also be encouraging for borrowers refinancing existing debt in the coming months and capturing appreciated value. Cashing out at the right leverage point is still achievable. Another important consideration is the ability to lock your rate at origination, a competitive life company advantage. Locking your rate at origination mitigates volatility concerns, as chances are we will see continued increases in rates moving into late 2022 and early 2023. As life insurance companies become more selective about placing long-term, fixed-rate loans, opportunities to secure short- and mid-term financing through life company sources at attractive rates and terms is increasing. These lenders are still offering what can be considered a premier solution for commercial real estate loans.

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