1. Managing Director
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Insurance commercial loan Nationwide Funding
A = Apartment H/M = Hotel/Motel I/W = Industrial/Warehouse MU = Mixed Use O = Office R = Retail

Hedge fund lending may provide the liquidity you need to pursue your goals while giving you the flexibility to maintain your desired investment strategy. Hedge fund loan proceeds may be used for a variety of reasons, including:
  • Making quarterly and annual tax payments
  • Providing bridge-loan liquidity for personal expenses that occur before receiving a bonus or payout
  • Making other investments, including other hedge fund investments
  • Utilizing relatively low cost financing to invest in potentially higher yield investments
  • Providing liquidity for capital calls
  • Making large purchases, including homes, residential and commercial investment, real estate, yachts or aircraft
  • Bridging liquidity to take advantage of a new investment opportunity before current investments can be redeemed
  • Diversifying your overall portfolio by providing additional liquidity to fund the purchase of non-correlated investments

You may be able to obtain a hedge fund loan from AMD private placement group, if you are a limited partner or investor in a fund, or a family office with a significant position in a fund or group of funds. AMD private group looks for low levels of personal debt, sufficient liquidity and sources of repayment beyond the hedge fund itself that can cover the repayment of the line of credit and interest expense.

The loans may be structured to serve short to medium term liquidity needs, with terms of one to three years. The amount you may borrow is generally dependent on the size of your hedge fund position, frequency of redemption, the diversification of your balance sheet, available personal liquidity, credit worthiness and the nature of the hedge fund strategy itself.

Before a hedge fund can be used as collateral, it must undergo review by our underwriter team. The review process focuses on several factors including but not limited to: the fund’s financial standing and longevity; details of the fund’s management and operations; investment strategy; and offering terms.

In general, a hedge fund must meet several requirements to be eligible for use as collateral in a loan. Below is a selection of some of these requirements.
  • A minimum net asset value in excess of $150 million
  • Three years of satisfactory operating experience and management with more than 10 years of experience
  • Availability of unqualified audited financial statements from a “Big 4” accounting firm
  • Use of independent third-party administrators for client reporting
  • Judicious use of leverage and non-traditional instruments
  • Incorporation in the United States or Cayman Islands
  • Registration by the fund Investment Advisor with the SEC (unless a family office vehicle)

An Insurance Commercial Real Estate Loan is a mortgage that is provided by a life insurance company or conglomerate of life insurance companies and is secured by a first lien position on the subject property being financed. Most life insurance companies favor the “four food groups,” for their collateral (apartment, office, retail, and industrial properties), but may finance other property types (i.e. hotel or mixed used) on a case-by-case basis. These loans are typically best suited for transactions that have strong borrowers with good credit, newer, well-maintained properties, low leverage, and where the collateral is situated in or around a major MSA.

Underwriting Parameters

For life insurance loans, Lenders have continued and even strengthened their conservative approach toward underwriting the cash flow of the collateral as well as the borrowers and sponsors. As part of the underwriting process, Insurance Companies are simultaneously assessing the risks of default while trying to minimize such risks, so they require detailed borrower and property information. Underwritten cash flows are based on “in place” income and rents rather than anticipated income or further rent escalations and leases are analyzed with closer scrutiny to ensure market rates. Insurance Loans require a more conservative loan to value (LTV) with maximums for most lenders between 60-75%, and debt service coverage ratios (DSCRs) of at least 1.25-1.35x, Lenders are also calculating the anticipated debt yield (net operating income/loan amount) of at least 8-10%. Additionally, Borrowers should expect to have “hard cash” equity invested in their projects, while being able to maintain a reasonable post-closing liquidity. Prior commercial real estate ownership experience is highly desirable.

Loan Features

Term Length and Amortization: The length of term and amortization depends heavily on the institution providing the funding as well as the property type. Terms can vary from 5-30 years with amortizations ranging from 15-30 years. Depending on the way the loan is structured, it may “balloon” at the end of the term, meaning at the loan balance will need to either be refinanced or paid off; otherwise the loan is self-amortizing, meaning that the loan will be fully paid off when the loan matures, so there is no loan balance to pay off (unless the loan is prepaid before it matures).

Recourse:Life insurance loans may be non-recourse, limited recourse, or full recourse loans. If it is non-recourse, the Borrowers are not personally liable for the repayment of the loan and that the collateralized property and its cash flows would be the sole source of repayment of the debt in the event of a default or foreclosure. However, in the event the Borrower actively participates in an activity that could cause harm to the property, Lender, or investors, there could be springing recourse in some limited circumstances; this may include loan fraud, property transfer or subordinate financing without consent of the Lender, voluntary or collusive activity leading to a bankruptcy filing or failure to maintain SPE status, among other such actions. Limited recourse loans makes the sponsors guarantying the loan responsible for a percentage of any shortfall between the loan balance and sales price in the event of default and foreclosure, where the property must be auctioned off as well as any applicable legal and ancillary fees. The carve-outs for the non-recourse loans would also apply. Full recourse loans make the sponsors guarantying the loan responsible for any and all shortfalls between the loan balance and sales price in the event of default and foreclosure as well as any applicable legal and ancillary fees.

Prepayment Penalty Structures

Prepayment penalty structures vary greatly depending on the insurance company funding the transaction. It may be structured as Yield Maintenance, Breakfunding, Declining (or step-down) prepayment penalty, or may be specially structured to suit a construction or mini-perm loan.
Yield Maintenance The goal of Yield Maintenance is to allow the bond investors to maintain the same yield as if the borrower made all scheduled mortgage payments until maturity. The penalty is typically calculated by a formula contained in the Note of the Loan Documents. The language will vary between different institutions, but will typically have the same two amounts to be repaid, namely: 1) The loan’s unpaid principal balance and 2) a prepayment penalty, which is typically determined by calculating the difference between the loan’s interest rate and the replacement rate (based on the US Treasury or other index that most closely corresponds to the maturity date), with the remaining loan payments discounted back for the time value of money. One thing to keep in mind is that yield maintenance provisions usually contain a prepayment penalty “floor” of at least 1% and allow for prepayment without penalty in the lat 3-6 months of the loan. See the following example for a more mathematical representation of this calculation: (Loan balance at time of payoff) * (note rate - new cost of funds) * (# years left in loan) * (365/360)

Breakfunding: Breakfunding is used in order to prevent the Lender from taking an economic loss due to prepayment of the loan before the maturity date, but the Lender doesn’t make money from the amount due. Breakfunding compares the original cost of funds to the cost of funds at the time of the loan prepayment this difference is then multiplied by the then loan balance and the remaining time on the loan, with the total being discounted back for the time value of money. See the following example for a more mathematical representation of this calculation: (Loan balance at time of payoff) * (original cost of funds - new cost of funds) * (# years left in loan) * (365/360)
Declining (Step-Down) Prepayment Penalty. A declining prepayment penalty may be structured in a variety of ways, but always has the same feature of the prepayment penalty lessening by 1% per step with the last 3-12 (or more) months open to prepay or refinance without penalty. These are usually offered on shorter-term loans (i.e. 5-10 years), but could potentially be offered on longer terms as well. An example of a 5 and 10 year declining prepayment penalty would be the following:
5 Year Declining: 5% of loan amount if prepaid in the first year, 4% if prepaid in the second year, 3% if prepaid in the third year, 2% if prepaid in the fourth year, and 1% if prepaid in the fifth year, also represented as 5-4-3-2-1% or 5% declining.
10 Year Declining: 5% of loan amount if prepaid in the first or second year, 4% if prepaid in the third or fourth year, 3% if prepaid in the fifth or sixth year, 2% if prepaid in the seventh or eighth year, and 1% if prepaid in the ninth or final year, also represented as 5-5-4-4-3-3-2-2-1-1% or 5% declining.

The Holy Grail: A Life Insurance Company Mortgage

Equating lenders to various tranches of a commercial mortgage-backed securities pool, the hard-money lenders are the C, or unrated, slice—and the life insurance companies are the AAA tranche. It is likely hyperbole to discuss the impact of another potential meltdown of the capital markets on life insurance lenders. As one originator recently told me, “Insurance companies are unwilling to sacrifice credit quality, and they will not increase their lending volume simply because there is more demand for their product.” Therefore, any comments about eroding credit quality or lending bubbles do not directly apply to the life companies. But any credit risk officer would quickly agree that we cannot just put our heads in the sand since—as we saw in the last crisis—when the subprime loans default, it affects the entire capital stack.

Currently, insurance lenders have a huge competitive advantage on CMBS. During the peak of the securitized commercial real estate debt market in 2006, the interest rate coupon of the two groups was essentially the same. In fact, since the CMBS lenders had essentially the same spreads as the life companies, CMBS briefly became preferable because they would generate higher loan proceeds.

Today, a typical life company quote is 160 to 170 basis points over swaps, approximately 100 to 130 basis points below CMBS pricing. The latter have no choice as the AAA tranche has widened out to 150 basis points over swaps and the junior tranches have widened substantially too. The real estate lending world has become bifurcated with the top quality deals going to the insurance companies and the CMBS and other lenders getting the remainder.
For non-multifamily deals, insurance lenders should always be the first call. What are their preferences? Class A office buildings in gateway markets and grocery-anchored shopping centers with strong sales. The life companies are far less active when it comes to Class B properties and markets that are susceptible to economic slumps, such as Houston. Many of them also cautiously underwrite deals in markets that are experiencing massive development, such as Los Angeles and Miami. Hospitality loans from the life companies are reserved only for top-tier hotels.

Insurance lenders now hold $362.7 billion of commercial real estate loans, according to Federal Reserve data. This is a 12.7 percent market share for non-multifamily and a 5.3 percent market share for multifamily (the disparity due to Freddie Mac and Fannie Mae). The top 30 insurers wrote $59.1 billion of real estate loans in 2015, according to Trepp. The biggest players in 2016 are MetLife, Prudential, Northwestern Mutual, Pacific Life, Mass Mutual, New York Life Insurance Company, Principal Financial Group and TIAA-CREF.

MetLife remains the largest of them all, having originated more than $12 billion in each of the last two years. And with $230 billion of maturing CMBS in 2016 and 2017—which is more than the combined amount from 2010 to 2014—the life companies could increase their market share substantially if they wanted.

However, insurance lenders have historically shown that they won’t stretch to win deals and they won’t lend on tertiary or transitory assets. With Reg AB II now being imposed on issuers of CMBS, those lenders have little room to maneuver. Meanwhile, banks are feeling the pressure to hold more reserves against their $1.77 trillion of commercial real estate loans and are also burdened by their poor performing commercial and industrial loan portfolios. So if the CMBS lenders can’t digest all of the maturities and the life companies won’t budge on their standards at the same time that banks are already showing limitations due to increased regulation, how can all of the borrowers refinance these loans?
Opportunity funds and other alternative lenders will have to fill the void and the resulting effect will be increasing cap rates.
The recent stock market sell-off was a long time coming. A few bold souls have stated that it could actually have a positive effect on real estate, as investors will eschew stocks for property. But if the contagion effect overflows into real estate, few will be spared. The ones who will be the beneficiaries will be those with the dry powder to pick up bargains, owners with little or no leverage, and insurance companies who will simply keep doing their thing—writing conservative loans on high quality assets.