Yield-hunting European insurers are slowly reshaping commercial real estate (CRE) loan structures, as they step in to fill the hole left by banks' withdrawal from the sector, market experts say.
Traditional bank-like arrangements with floating interest rates and flexible call options remain predominant, but tailored structures that mitigate pre-payment and other risks designed to suit insurers' profiles are on the rise.
The insurance industry is stepping up its exposure to CRE loans to take advantage of an expected wave of refinancing in the market, as pre-crisis loans reach maturity. Simon Richards, London-based head of insurance solutions at Insight Investment, says: "The excess demand for commercial property loans is such that capital providers are, within reason, able to dictate the nature and terms of the loans they are prepared to offer".
Experts say the risk-adjusted yield – one to two percentage points above corporate bonds – and the low levels of default and high recovery rates due to the collateral's quality, help to explain why insurers favour these investments.
Since insurers rely on predictable cashflows from their assets to meet policyholder liabilities, loans that permit early repayment add unwelcome reinvestment risk into the portfolio, experts explain.
The floating nature of the interest rate is another feature that makes some of the traditional loan deals less attractive to insurers, as this makes the cashflow of the asset unpredictable.
But experts acknowledge that the pace of transformation remains sluggish and the amount of unattractive structures is preventing some insurers from investing more into this asset class. Many loans made immediately before the financial crisis will reach maturity soon. In addition, loans with very short durations that have been repeatedly refinanced in the aftermath of the crisis also make up a large number of outstanding instruments. Many borrowers are now seeking longer maturities.
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