Rocking The SIFI Boat

Will Prudential and AIG Try To Throw Their ‘Too Big To Fail’ Tag Overboard?
MetLife and GE have been rocking the SIFI boat, with MetLife winning a U.S. District Court decision to shed its designation as being “too big to fail” and GE filing a request with federal regulators last month to remove the systemically important label.What impact will the ruling have on commercial real estate lending for AIG and Prudential, the other two life insurance companies designated as systemically important financial institutions?

Prudential and AIG surely are paying close attention to what happens with MetLife–not just its District Court victory, but also the consequences of an expected government appeal. They have not publicly said, however, that they will follow in MetLife’s footsteps in the hope that the precedent set by U.S. District Judge Rosemary Collyer will get them a SIFI pass too.

Keep Still or Jump Ship

There are good reasons for Prudential and AIG to try to ditch the systemically important tag.

One reason for Prudential and AIG to take action is that, if the District Court ruling is upheld, they would be at some disadvantage by being up against a company that is more nimble because it is subject to fewer regulatory and capital restrictions. MetLife could have an additional $2.5 billion or more to give back to shareholders or use in other ways by virtue of not having to adhere to the tighter capital rules that come with being a SIFI, Piper Jaffray Cos. analyst John Nadel said in a note to clients.

In contrast to a non-SIFI, Prudential and AIG would either have to set more capital aside for the same risk or minimize risky lending activities, which could make growth more expensive or slow it down altogether.

Prudential has an additional reason to try to get out from under SIFI: The federal oversight rules established under the Dodd-Frank Act hit Prudential harder than MetLife, the Wall Street Journal reported last year because New York-based MetLife was already subject to the state’s stricter capital regulations than those in New Jersey, where Prudential is based. Insurance regulations in all states require varying levels of capital and reserves.

Yet both Prudential and AIG have made comments indicating that they are not planning on doing anything to jettison their systemically important designation, at least for now.

Prudential CEO John Strangfeld said in February he was comfortable with the company’s current mix of businesses – indicating that, unlike the other non-bank SIFis, Prudential “is not considering or pursuing a big divestiture,” the Wall Street Journal reported.

And AIG CEO Peter Hancock said last year that even if the company were to pursue the removal of SIFI status through asset sales, there would still be many other regulators keeping watch, “so it’s not clear to me that getting off that off-ramp changes management’s flexibility in any material way.” In addition to federal regulations, state regulations and international regulations could also apply.

All the same, AIG says that, since the recession, it has sold almost 50 companies, shrunk its balance sheet and reduced leverage. It also said it would spin off its mortgage insurance unit and sell its broker-dealer network.

What About CRE?

While MetLife , AIG and Prudential are the three insurance company SIFIs, let’s not forget the other non–bank SIFI: GE,which essentially got out of the real estate business when it unloaded most of its finance arm, GE Capital,for $23 billion about a year ago.

This move made sense for GE because its prime function is not as a financial institution and its extra capital became a liability when the economy went south and investors didn’t want it.

“During the financial crisis, in 2008, we were frequently criticized about the size of GEmCapital,” GE said in a February letter from CEO Jeffrey Immelt. “Investors would ask,‘Why do you have so much commercial real estate?’ They had a point.”

Could Prudential and AIG also end up dumping their commercial real estate?

It’s unlikely that insurance companies will follow in GE’s footsteps in the sense of dumping all real estate en route to losing their SIFI tag. Unlike GE, insurance companies are financial institutions at their core and need somewhere to put their funds so they can make money for their policyholders.

“I think that if you look at our business, it still has the need to invest the premiums of our policyholders over the long term,” AIG ’s Hancock recently said on CNBC ’s “Squawk Box .” Though most of the company’s funds are in bonds, Hancock added: “We have a balance sheet of over $300 billion that has to be diversified.”

Though Hancock was specifically referring to hedge funds – AIG had invested $11 billion in about 100 hedge funds and is planning to cut the number of those hedge funds in half due to a slump in returns – the idea applies to alternative investments in general.

While a total real estate dump is unlikely, it is conceivable that under certain circumstances, insurance companies could potentially reduce their CRE exposure just as AIG is scaling back its hedge fund exposure and as the California Public Employees’ Retirement System, or CalPERS, did when it sold $3 billion of its real estate holdings late last year to a unit of Blackstone, the private-equity firm that (along with Wells Fargo) scooped up most of GE’s real estate assets earlier in the year.

As for Prudential and AIG’s current real estate exposure, let’s take a look at some of the commercial real estate they’re financing.

The more upmarket buildings recently financed by Prudential include 1700 Broadway, a midtown Manhattan office tower owned by New York real estate firm Ruben Companies, for which the insurer issued a $254 million acquisition loan last year. Another is Instrata Ashton Uptown, luxury residences in Dallas, for which Prudential subsidiary Prudential Multifamily Mortgage issued a $300 million loan last year.

As for AIG, its real estate arm, AIG Global Real Estate, consists of a group of international companies within AIG that invests in and managaes more than $16 billion of real estate, including upscale apartment complexes Venn on Market, at 1844 Market St. in San Francisco, and 1 North 4th Place, on the Williamsburg waterfront in Brooklyn. Though AIG features these properties in its portfolio, the lenders are listed as other insurance companies in the group: National Union Fire Insurance Company of Pittsburgh, which issued a $54 million loan for the Market Street apartments in 2014, and New York Life Insurance Compant and Northwestern Mutual Life Insurance Company, which issued loans totaling $184.5 million for 1 North 4th Place and Brooklyn parcels of land with which it is cross-collaterized.

The Next Step: Shedding SIFI the GE Way vs. The MetLife Way

If AIG and Prudential do make an effort to get rid of their SIFI tag, they have two models on which to base their approach: the GE way and the MetLife way.

GE reduced its size and then requested that its SIFI designation be lifted. It is working within the regulatory system to become less systemically important and to be recognized as such.

By contrast, MetLife circumvented the regulatory system to fight its status in the courts. Though it also announced plans to shrink, saying in January that it was planning to separate much of its retail segment in a spin-off, sale or IPO, ultimately MetLife sued to get rid of the extra oversight.

It’s not clear that Prudential or AIG will follow either of these paths, but AIG’s Hancock indicated recently that, of the two he prefers the GE route.

When asked whether AIG might follow MetLife’s litigious lead in wake of the ruling, Hancock said on CNBC: “We prefer to work with our regulators, and I think have equally dramatic reduction in risk as GE, that were actually executed earlier.”

If AIG does intend to pursue a SIFI-less future, it would have to get over a huge hump the other companies don’t face: the large role it played in the government bailouts that helped prompt the push towards more regulation in the first place. AIG was awarded $23 billion in bailout funds because it was deemed too big to fail – the precise scenario the Dodd-Frank regulations were aimed at changing.

We should not underestimate the challenge posed by the political and symbolic significance of exempting AIG from the very regulations it helped spur.

MetLife’s District Court victory is a big deal for non-bank SIFIs, and could potentially set a precedent for fellow major insurers AIG and Prudential. But that doesn’t mean we’ll be seeing them court right away. The insurers could very well wait it out, keeping the SIFI boat steady for a while as they post a lookout to see whether the MetLife ruling is upheld and whether GE gets its request granted. Then they can figure out whether to make a move and if so, in which direction to steer.

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Alex Veksler has 16 years of finance, data analysis and project management experience. He is a former vice president at Morgan Stanley, where he worked on product control of equity and fixed-income derivatives products as well as various projects involving finance and technology, such as revamping risk attribution and balance-sheet systems for profits and losses. Alex has previously worked at hedge funds, most recently as a director at Exigent Capital. He has a bachelor’s in computer science from Yeshiva University and an MBA from New York University.

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