Even amid the most active income-property lending environment ever, life insurance companies – historically conservative investors – face frantic competition in the multifamily field, led by Wall Street conduit lenders and big government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. That is translating into important new options for developers.

As one veteran mortgage banker put it, life companies “are dying on the vine,” at least in the apartment arena, as conduits offer liberal leverage and ultrathin loan spreads, while the housing-focused GSEs continue innovating with increasingly sophisticated multifamily loan products.

But ambitious life company lending teams at the likes of John Hancock and Massachusetts Mutual are nevertheless aiming to become bigger players in multifamily financing. Though they acknowledge inherent competitive challenges, executives say they can be formidable players by targeting niches where their portfolio-lender flexibility attracts important – and loyal – borrower relationships.

As some recent deals and new policies from John Hancock Real Estate Finance and MassMutual’s Babson Capital Management units illustrate, life companies are winning deals through something akin to baseball’s “hit ’em where they ain’t” approach.

These strategies include streamlining underwriting documentation for strong borrower relationships, funding mortgages before property stabilization, rolling construction loans into permanent mortgages, negotiating customized declining-balance prepayment penalties, waiving capital-reserve requirements, lending to nontraditional borrower types and lending against nontraditional property types.

Those ploys are helping insurers overcome some significant competitive handicaps related to pricing and leverage, according to life company officials. One of these handicaps is the inherent cost of capital relative to the GSEs and Wall Street lenders, said Tom Corrigan, a Hancock senior investment officer. Likewise, life companies intent on holding multifamily mortgages in their investment portfolios are typically restricted to loan-to-value (LTV) ratios of 75% or less, whereas conduits and GSEs in many cases are comfortable at 80%, Corrigan added.

Fight for borrowers

Notwithstanding portfolio lenders’ superior term flexibility and loan-servicing attentiveness, a lot of borrowers are now willing to put up with impersonal third-party servicing in order to get Wall Street’s relatively high leverage and tight loan spreads, said Tucker Knight, a director with financial intermediary Holliday Fenoglio Fowler, L.P. “People who said they’d never do a conduit deal are doing them.”

Knight echoed Corrigan in stressing that life companies need to focus on product and service niches that the relatively homogeneous Wall Street conduits tend to avoid. “The life companies have been so squeezed, especially by the conduit lenders, that they’re all trying to find niches where they can compete.”

MassMutual’s Babson Capital managed to exploit a few of its chosen niches and literally quadruple its multifamily financing activities last year to reach the $1 billion mark, according to Managing Director David Lauretti. It helps that Babson’s capabilities now run the gamut from low-leverage permanent financing to “equity-like” risk and yield structures, said Lauretti.

Meanwhile, with its megamerger with Manulife Financial behind it, John Hancock’s property finance group is looking to place as much as $2 billion in domestic income-property debt (all property types combined) this year, said Corrigan.

The MassMutual/Babson and Hancock teams and a few other life companies are aiming to emulate some of the household-name insurance giants – Prudential, MetLife, New York Life and Northwestern – that have managed to keep placing large amounts of commercial mortgage debt even as they struggle to win deals within the strongly competitive multifamily finance arena. For example, The Hartford’s investment management unit has also been staffing up a direct originations team to source commercial mortgage loans, having recently recruited veterans Rick Van Steenbergen from Citigroup/ Travelers and Jack Maher from Aetna.

Expansion efforts

Statistics from 2005 and its final quarter appear to suggest that life companies face something of an uphill battle in the multifamily field. The Mortgage Bankers Association reports that life company commercial mortgage lending to all property types last year was up about 25%, compared to 83% for conduit lenders. Multifamily lending activity expanded by 44% last year.

For the fourth quarter, life companies funded $1.86 billion in multifamily mortgages, up from $1.56 billion (or 19%) in the year-earlier period, according to the American Council of Life Insurers. For the full year, apartment lending totaled $7.62 billion, or nearly 18% of the $43 billion in overall life company income-property lending. Meanwhile, Fannie’s multifamily activity hit $25.6 billion, up from $21.2 billion (or 21%) in 2004, and Freddie’s totaled $26.2 billion, up from $23.8 billion (10%) (see the articles on the GSEs’ 2005 volume, pages 14 and 16).

But by exploiting their attentive servicing capabilities and other competitive advantages, life company execs expect to keep narrowing those originations gaps.

Compared to conduit lenders in particular, one meaningful borrower benefit from a tight relationship with the likes of Babson is fast, reliable, efficient and consistent underwriting and processing, said Lauretti. Multiple-transaction familiarity allows Babson to essentially customize prenegotiated term sheets, allowing easy replication of documentation from one deal to the next.

That’s made a happy customer out of Jerry Fink, a principal at Bascom Group, an apartment value-added specialist in Irvine, Calif, and a Babson client. The portfolio lender’s “streamlined” due diligence and related documentation requirements entailed significantly less brain damage, and legal fees were far more “modest,” relative to a conduit execution, Fink said.

Though conduit lenders “rely solely on the numbers and third-party assessments,” Babson officials demonstrated confidence in Bascom’s proven ability to execute its business plans and boost cash flows, said Fink. Balance-sheet lenders offer familiar, personalized loan-servicing attention, but with a conduit loan the borrower risks being “dished off to some anonymous servicing department who usually doesn’t understand the deal,” he added.

Like some other life companies, Hancock and Babson also look to beat conduits to the punch through their inherent flexibility to fund permanent mortgages before new developments (or otherwise impaired properties, in some cases) reach stabilization.

“We don’t have to require a 90/90 stabilization [90% occupancy for 90 days] before considering a property,” said Corrigan. Hancock instead might propose structuring some sort of temporary credit enhancement until a property achieves stability, or perhaps agree to provide supplemental first-priority loan proceeds as operating income improves.

Babson occasionally funds fixed- and floating-rate construction facilities administered by commercial banks, in some cases rolling into permanent financing. The company just provided a $102 million construction/permanent loan to developer Sares-Regis Group for a large project in the San Diego suburb Rancho Bernardo.

On the back end, life companies are also generally more able than their primary competitors to meet borrowers’ preferences for flexible prepayment. Although the bond buyers collectively holding all those securitized conduit mortgages require yield-maintenance prepayment penalties, portfolio lenders can customize programs calling for flat fees based on principal balances.

A typical customized approach entails compensating for a lowered early-payoff fee schedule through a slight interest-rate adjustment over the life of a loan, Corrigan noted. “If they’ve got a good idea when they’ll want to sell, we can usually arrange something that works out well.”

As portfolio lenders, life companies possess greater leeway than the GSEs and conduits when it comes to waiving certain reserve requirements, particularly concerning capital-improvement funds.

“Depending on the condition of the property, we might take a look, and if there’s no deferred maintenance, we might agree to waive the improvement reserves,” said Corrigan.

Nontraditional borrowers welcome

Some life companies have also boosted multifamily originations by catering to a fast-growing nontraditional borrower type that the GSEs have been slow to embrace. Specifically, that is the tenancy-in-common structure, which syndicates ownership among multiple – mostly tax-motivated – investors. There is also a newer subset structure known as a Delaware Statutory Trust (DST), which allows for up to 99 investors but entails a single-purpose trust created as sole owner and borrower.

For example, in late December Hancock funded a $27 million senior mortgage to help San Antonio syndicator Internacional Realty, Inc., acquire a new 436-unit community in suburban Dallas – three months before ownership transfers once again to a newly formed DST.

Hancock even allowed a temporary 15% LTV mezzanine slice subordinate to the life company’s seven-year, 75% LTV first mortgage, senior real estate officer Doug Courtney explained. Internacional’s principal, Hugh L. Caraway Jr., will pay off the mezz loan when the new DST assumes ownership, Courtney said, adding that Hancock’s senior mortgage pays interest-only through the first four years.

Hancock and Babson have also actively targeted some of the “special use” multi-housing property types some conduits tend to avoid, such as student housing and age-restricted independent-living communities. And Lauretti stressed that Babson continues to uncover opportunities to finance mixed-use developments whose inherent complications make some other lenders uncomfortable.

Babson also has provided $104 million in 10-year financing for the high-profile Sunset + Vine development at the famed namesake intersection in the heart of Hollywood. In addition to the 300 upper-level apartments, the development includes destination ground-floor shops and restaurants and even takes in substantial income from its high-visibility billboards.

“We view ourselves as a lender that’s willing to come in and try to understand a complex urban infill mixed-use project like this when we think the risk is appropriate,” said Lauretti.