EU Rescue Fund Insurance Plan May Not Translate Into Debt Crisis ‘Bazooka’

The bond-insurance program European Union leaders are considering to boost their bailout fund’s firepower may not prove convincing to investors as a solution to the sovereign debt crisis, analysts and economists said.

Even if euro-area leaders agree to leverage the temporary 440 billion-euro ($609 billion) European Financial Stability Facility by using it to insure a portion of national bond sales, it may not have enough capacity to provide loans to countries and support banks.
Turning the fund into a “bond insurer is not enough unless it’s well capitalized in advance, so markets understand that EU governments are ready and willing to take losses and make good on obligations of either Greece or of the banks that will be impaired when Greece et al default,” Phillip Swagel, assistant U.S. Treasury secretary for economic policy in the George W. Bush administration, said by e-mail late yesterday.

As EU leaders prepare for an Oct. 23 summit, momentum has gathered around a proposal for the EFSF to guarantee a portion of new borrowing by countries under pressure and for bondholders to take bigger losses on Greece. European Economic and Monetary Affairs Commissioner Olli Rehn said yesterday that Greek bondholders need to play a bigger role. German Finance Minister Wolfgang Schaeuble, who has consistently opposed expanding the fund’s resources, has told lawmakers that its leverage should be increased, according to Financial Times Deutschland.
‘Insufficient Firepower’

Both ideas represent deviations from plans set at a July 21 summit, when EU leaders agreed to give the rescue fund more flexibility and to work with banks and other investors on a Greek debt swap. Group of 20 finance ministers and central bankers last week set this weekend’s summit as a deadline for the EU to come up with an expanded crisis-fighting strategy.

“It seems clear that, even with leverage, there is insufficient firepower to meet all the potential liquidity needs,” David Mackie, chief European economist at JPMorgan Chase & Co., wrote in a note to clients yesterday.

The EFSF might be allowed to insure 20 percent to 30 percent of new bonds sold by distressed euro-area governments, a person familiar with the deliberations said.

The upgraded facility may still prove too small to deter investors from targeting the bigger economies, according to Mackie, who calculates that given its existing commitments, the fund has about 270 billion euros left. His figures suggest that with Italy, Spain and Belgium facing funding needs of more than 1 trillion euros over the next three years, guaranteeing the first 20 percent of losses would leave less than 100 billion euros for other fire-fighting tasks.
New Issuance

“This might be sufficient, but it is not exactly a bazooka,” Mackie said, referring to former U.S. Treasury Secretary Henry Paulson’s 2008 request for “bazooka”-like powers to take over Fannie Mae and Freddie Mac, the two government-backed companies that dominate the U.S. mortgage market.

As a bond insurer, the EFSF would focus on new issuance rather than taking advantage of its new powers to buy debt on the secondary market, said Marc Chandler, chief currency strategist at Brown Brothers Harriman in New York. This means it won’t be able to relieve the burden on the European Central Bank, which had hoped to pass on some of its crisis-fighting duties and return to its focus on monetary policy.

“The insurance model likely means that it will not be able to buy sovereign bonds in the secondary market as some have proposed,” Chandler said. “While some at the ECB may not be pleased, its continued involvement is an important element of support the financial system.”
Capital Shortfall

The EFSF might not have the resources to help recapitalize Europe’s banks, another issue that European leaders have pledged to address. And it would face highly concentrated and correlated risks by insuring the debt of multiple European countries with high debt levels like Italy, Spain and Belgium, said Jacques Cailloux, the chief European economist at Royal Bank of Scotland Group Plc (RBS) in London, in a research note.

Some requirements under consideration would lead to a 220 billion-euro capital shortfall at 66 of the participating banks, with the biggest gaps at Edinburgh-based RBS, Deutsche Bank and Paris-based BNP Paribas SA, according to a note published by Credit Suisse Group AG analysts on Oct. 13.

“We believe it is very risky for euro-area policy makers to rush out some quick deal on leverage or insurance schemes given the risks associated with such mechanisms and the limited actual firepower of the EFSF,” Cailloux said. “There are more downsides than upsides” and “ultimately a fuller involvement of the ECB will be needed.” source: www.bloomberg.com

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Insurers See an Opening in Commercial Mortgages

Over the past several months, the commercial mortgage market has been volatile, plagued by weak investor appetite, wary lenders and warnings by ratings agencies of increasing risk. But one bright spot is emerging, as life insurance companies have taken advantage of the lull to become major lenders.

In the second quarter of this year, the life insurance industry underwrote $15.7 billion in new commercial mortgages — the largest volume on record since the American Council of Life Insurers began tracking the number in 1965.
This represents a doubling of the volume of mortgages underwritten in the first quarter and a nearly 26 percent increase over the second-highest number on record, $12.5 billion, reached in the fourth quarter of 2005.

A lack of activity from investment banks has opened the door for life insurers. Pummeled by a weak economy, many Wall Street banks, traditionally the largest commercial mortgage lenders, have gone quiet, leaving little competition for life insurers.

“It is as if these guys died and went to heaven,” said Lawrence J. Longua, a clinical associate professor at the Schack Institute of Real Estate at New York University. “Life insurance companies are pretty much the only game in town.”

Life insurers are typically conservative, favoring high-quality borrowers and trophy properties, and keeping the bulk of their loans on their balance sheets. Investment banks, on the other hand, pool most of their mortgages and issue bonds against these loans. This allows the banks to transfer the risk off their balance sheets, enabling them to underwrite more, and riskier, loans.

Investment banks typically dwarf life insurance companies. Banks and savings institutions, for example, held 33.4 percent of the $2.4 trillion of total outstanding commercial real estate debt as of the second quarter, compared with the 12.8 percent held by life insurance companies, according to the Mortgage Bankers Association. But while the total amount of commercial mortgages increased 0.1 percent in the second quarter over the previous quarter, the amount held by life insurers increased 1.5 percent.

“Now is a good time to be a first-mortgage lender,” said Robert R. Merck, a senior managing director and the head of real estate investments for Metropolitan Life.

MetLife originated $8 billion in real estate loans last year and has already lent that amount in the first three quarters of this year. The company recently financed two loans to a joint venture that includes General Growth Properties, the mall company.

“There is less competition,” Mr. Merck said, “which has allowed lenders like ourselves to put a lot of very good loans on the books for properties that meet our guidelines.”

There are several reasons that banks have been driven to the sidelines, including a difficult economic environment and the sovereign debt crisis in Europe. The market for bonds backed by mortgages has also been weak, and this summer it hit a speed bump when Standard & Poor’s refused to issue a rating on a commercial mortgage bond offering, spooking the investment community. As a result, experts now estimate that what had been expected to be a $50 billion market this year will instead amount to less than $35 billion.

“It was a very optimistic winter and spring, then we turned 180 degrees and it has been nothing but negative,” said Manus Clancy, a managing director at Trepp, a commercial mortgage information provider. “We have seen a vastly different mentality than what we saw in late May.”

Many insurers have responded by increasing their 2011 mortgage allocations. “In 2007 through 2009, these companies sold off a lot of their mortgages,” said Richard D. Jones, a co-chairman of the finance and real estate practice groups at the law firm Dechert, “so now they are trying to rebalance their portfolios.”

For borrowers, life insurance companies can offer a price advantage over investment banks, experts said. Because banks pool their loans into bonds, they have to satisfy skittish bond buyers by offering them higher rates. The banks then pass on these higher rates to the borrower. But because most life insurers do not pool their loans into bonds, they can offer lower rates.

“It is a temporary consequence of a very fractured market,” Mr. Jones said. “Right now, the insurance companies are eating Wall Street’s lunch. If a life company wants to get a deal done, there is nothing anyone can do to compete with them.”

Also, life insurers’ mortgages are performing comparatively well. Some 99.6 percent of mortgages held by life insurance companies were in good standing as of the end of last year, according to Fitch Ratings. This is in large part because of their conservative lending approach and their “active management” of mortgage portfolios, Fitch said in a recent report.

Coming off such a strong performance, some life insurers are now exploring entering the mortgage bond market, an arena traditionally dominated by investment banks. Some insurers are becoming partners with banks to offer mortgage bond products. Under the agreements, the life insurers find the borrowers and originate the loans, and the banks pool those loans into bonds to sell. In this way, the life insurers earn fees for sourcing and originating the loans and the investment banks profit from selling mortgage bonds.

Life insurers want to team up with banks rather than go it alone because it allows them to be involved in more real estate lending without exceeding their asset guidelines. Typically, life insurers allocate less than 15 percent of their total assets to real estate, but because these loans are not on their balance sheets, they can be involved without bumping against these levels.

“Life insurance companies have risk management limits, but their relationships and their origination capabilities often exceed these limits, so this strategy of partnering with Wall Street makes sense,” said Tad Philipp, the director of commercial real estate research at Moody’s Investors Service. Offering mortgage bonds “also helps broaden the suite of loans they can offer borrowers,” he said.

Wall Street banks also do not want to allocate the resources to originate loans. “It is expensive to originate and service a loan, but we already have a team of 45 who this is all they do,” said Christine Hurtsellers, the chief investment officer for fixed income and proprietary investments at ING Investment Management, which is in talks to create a partnership with a bank.

This summer, the Prudential Mortgage Capital Company, a unit of Prudential Financial, announced it would join with Perella Weinberg Partners to create such a venture.

“There is only so much balance sheet capacity for the life insurance companies,” said David Twardock, the president of Prudential Mortgage Capital, “and there needs to be other loan products in the market that provide long-term fixed-rate financing.”

If the life insurance teams work with banks, that could help broaden the commercial mortgage market, Ms. Hurtsellers said. ING estimates that in the next year and a half, about $60 billion in commercial mortgage bonds are maturing, “so given that wave, these partnerships can help refinance the loans, extend them and just help generally solve the problem.” source: www.nytimes.com

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