In The Media – Articles About Impact

Impact Community Capital Closes Second Deal, Expands Outside California

Property Insurance Report

June 3, 2002

Impact Community Capital, the investment firm founded in 1999 by insurers to help them invest in low-income areas, has closed its second deal by purchasing $124 million in af-fordable multi-family mortgages from Bank of America. Though the organization was formed initially to focus on California, the national nature of the mortgage markets has led Impact to expand into mortgages in other states as well. The newly acquired Bank of America portfolio contains ap-proximately $67 million in mort-gages for properties outside of California.

By purchasing the mortgages, Impact frees up capital for bankers, enabling them to make additional loans for this type of housing. Though there have been some attempts at selling these loans previously, without an entity like Impact it was not possible to get the consistent stream of deals necessary to attract secondary mortgage market support.

The investors in Impact are Allstate, Farmers, Nationwide, Pacific Life, PMI, SAFECO, State Farm, TIAA/CREF and 21st Century.

As we reported nearly two years ago when Impact closed its first deal, as a packager and investor in mortgages Impact has nothing to do with insurance. But the organization has everything to do with the future of insurance regulation. For the past decade at least, insurance companies have been under pressure to invest more of their assets in urban areas. The federal Community Reinvestment Act has successfully pushed bankers to make more loans and investments in urban areas and minority communities, and regulators give each bank a CRA score based on their activity. Fail to invest properly, and the regulators start to put the squeeze on a bank.

This is precisely the structure that some politicians and neighborhood groups have had in mind for insurers. Critics of insurance company commitment to urban areas have been emboldened by their dramatic success in the 1990s in forcing insurers to change their underwriting and marketing strategies to better serve the inner city.

But there is a major problem in trying to extend the Community Reinvestment Act to insurers: insurers don’t make loans, they invest in them.

Impact was formed to enable insurers to participate in community reinvestment in a way that fits their business structure. Insurers have no infrastructure for making loans, servicing loans, managing foreclosed collateral, etc. Banks, and non-profit community reinvestment lenders make loans. But urban development loans are rarely of the quality that banks can hold as capital acceptable to bank regulators, so the volume of such loans is limited. Banks have a limit on how many unrated loans they can keep on their books before bank regulators begin to question their capital strength. In buying up these loans, insurers free banks to go back to the streets and make more loans.

The trick is in making it possible for insurers to do something with the loans without running afoul of their regulators.

That’s where the magic of securitization comes in. We visited this topic in April 1999, but it bears reviewing because we believe that Impact has clearly come up with a structure that could enable insurers to proactively invest hundreds of millions of dollars, indeed billions of dollars, into urban areas with most of the investment being investment grade, and the remainder becoming part of the insurers’ high-risk investment portfolio. Though the Impact deals aren’t exactly a chief investment officer’s favorite way to make money, it is far from charity. And if used correctly, insurers can put themselves in a position where they will not only do a great deal of good for others, but they will also protect themselves from costly regulation.

The basics of the deal: Impact served as a broker, taking the $124 million in loans made by Bank of America and repackaging them into bonds. As pure investments, no one would want to touch them, and the rating agencies would call them junk bonds. But through an investment banking practice called credit enhancement, a portion of the bonds are made strong enough to earn an investment grade rating.

The $124 million was cut up into three pieces, or “tranches.” The first receives the highest rating because it receives the first dollars paid by the mortgage holders.

This part of the deal represented 80% of the mortgages, and received a “AAA” rating from Standard & Poors.

The second tranche was 8.5% of the mortgages, which were slightly riskier, but still investment grade.

The third piece is the “subordinate piece,” which means if a mortgage defaults, it bears all the risk up to 11.5% of the deal.

This final part of the deal is not rated. If it was held by a bank or insurer, these mortgages could not be counted as capital against which loans could be made or insurance risk underwritten.

By holding out 11.5% of the mortgages to protect the other bond holders, the rating agencies were comfortable giving an investment rating to the rest of the pool. The insurance company investors hold the mortgages in their investment portfolio, right alongside hundreds of millions of dollars of very similar bonds that they buy and sell every day in the capital markets.

As for the unrated subordinate bonds, those will stay with Impact for its own account.

The "charity" in this deal is in the willingness of insurers to take a lower interest rate for its money than could be found elsewhere in the market.

The fact that these mortgages are tied up with a nice bow doesn’t change the fact that the properties are designed to collect below-market rents to help out low-income families and fixed-income senior citizens. But Impact tries to maximize the value of the mortgages, to maximize the efficiency of capital available for such invest-ment so the most good can be done.