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U.S. Life Insurers May Face Spike in Mortgage Loan Losses: Fitch

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Fitch Ratings expects life insurers to see 50% more losses on mortgage loans than what they saw during the 2007-2009 Great Recession.

Fitch says these elevated losses reflect both the severity of the pandemic fallout and the slow pace of the expected recovery. It expects these losses to start emerging when insurers file their statutory statements for the third quarter with state insurance regulators.

(Related: Life Insurers’ Commercial Mortgage Investments Did Great in Q2: Trepp)

“Loss expectations are vulnerable to revisions given the high degree of uncertainty associated with the pandemic’s longer-term economic fallout,” Fitch said in a release.

Under its base-case loss assumptions, Fitch anticipates commercial mortgage loan losses to amount to 180 basis points. Since loss recognition on commercial mortgage loans typically is behind other asset classes, there may be a lag before the full extent of those problems are known. The timing of losses is also subject to regulatory forbearance actions, which may extend into next year.

Exposure to losses on investments, including commercial mortgage loans, is a crucial rating sensitivity and driver of the negative outlook on the US life insurance sector, Fitch says. While the credit metrics of life insurers’ performing commercial mortgages are high, the credit quality of commercial mortgages declined for the second consecutive year, denoting a weakening trend, according to the rating agency.

Fitch lowered its U.S. commercial mortgage-backed security (CMBS) property outlooks for hotel, office and multifamily to negative from stable in March. Before it faced more significant pressure from the pandemic, retail had already been negative. Hotel and retail experienced the largest increases in delinquencies in 2020. Barring material forbearance activity, U.S. CMBS delinquencies are expected to be near the previous peak range of 8.25% to 8.75% by the fourth quarter of this year.

On average, Fitch says, U.S. life insurers granted relief measures on 9% of commercial real estate mortgages by outstanding balance. Retail and hotel borrowers accounted for 52% and 26%, respectively, of all mortgage loans held by life insurers with approved relief measures. Retail loans account for 19% of total commercial mortgages held by U.S. life insurers, while hotel loans only account for 4%.

Commercial real estate has been hit incredibly hard by COVID-19. The hospitality sector has been severely affected by a significant decline in business and leisure travel, and stay-at-home orders have caused a substantial drop in short-term retail income. Long term, the sector will probably experience reduced demand. The office segment faces questions with the greater adoption of work-from-home policies that could create less demand for space, especially in urban areas.

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