U.S. life insurers’ exposure to any downturn in the commercial mortgage backed market will be manageable and will not affect ratings although investment losses could impact earnings, say analysts at Fitch Ratings, Chicago.
Among the reasons cited in a conference call discussing a just released report, ‘U.S. Life Insurers: Large Commercial Mortgage Exposure Under Control,’ are strong capitalization and investment holdings of more highly rated commercial mortgage-backed securities (CMBS) and collateralized debt obligations (CDO).
In its report, Fitch estimates that “aggregate investment exposure to commercial mortgages for U.S. life insurers accounts for approximately 19% of general account invested assets and 191% of industry capital, and largely consists of directly placed mortgage loans and commercial mortgage-backed securities, including commercial real estate collateralized debt obligations (CRE CDOs).
“In comparison, Fitch estimates that the industry’s exposure to investments backed by subprime or Alt-A residential mortgages equates to 5% of general account invested assets and 51% of industry capital.”
During the conference call, Robert Vrchota, a managing director in Fitch’s CMBS group, said that although both residential and commercial real estate were aggressively underwritten recently, there are major differences including the fact that commercial real estate is backed by income producing properties, and 90% of commercial loans are fixed-rate and do not face resets like some residential properties.
The rating agency added that “commercial mortgage security exposure (CMBS and CRE CDOs [commercial real estate collateralized debt obligations]) exceeded $182 billion, or approximately 7% of total invested assets, at year-end 2007. The majority of CMBS investments are investment-grade securities, with less than 2% estimated as below-investment-grade securities at year-end 2007.”
It added that delinquency rates of 180 days or more for commercial mortgage loans were approximately .02%, near “record lows.”
Analysts on the call were quick to point out that there was not currently reason for concern. Fitch has looked at ratings of securities in the ‘BBB’ and lower range and there is no reason for concern in relation to life insurers’ earnings and capital levels, noted Doug Meyer, Fitch’s managing director and U.S. life insurance sector head.
Citing the development of Fitch’s recent Prism model for assessing capital, Julie Burke, Fitch managing director-North America life & non-life, said life insurers have built up excess capital in the last few years so that “the industry has some room to absorb any excess credit losses.”
Meyer did say one potential concern is that the risk of further deterioration in the residential and commercial real estate markets could impact other sectors of the credit markets and market liquidity and ultimately impact the economy.
Currently, U.S. delinquencies in the commercial mortgage-backed securities market is in the 30 basis-point range, which is actually down from last year’s 34 basis points range, said Vrchota. A 100 basis points equals 1%.
The amount is expected to “double or triple by year-end 2008,” he continued. However, he balanced that prediction by noting that a 90 basis points delinquency rate by year-end is still in keeping with the long-term delinquency average of 80 basis points over the last 13 years.
For buyers of CMBS, issuance will probably drop significantly in 2008 to around $50 billion compared with $200 billion in 2007, Vrchota said. In the U.S., commercial mortgage-backed securities have totaled about $6 billion to date this year with only a few new deals in the pipeline, he added.
There is concern that commercial real estate will experience some of the same problems that residential mortgages have had, Vrchota added.
The widening of spreads on CMBS is having some pretty serious ramifications for those institutional investors that have them and are forced to mark-to-market at losses, he said.