US Life Insurers to withstand commercial real estate deterioration (CRE) exposure thanks to their stable investment portfolios, which include high-quality, diversified exposures, conservative underwriting, strong liquidity and effective asset-liability management (ALM), according to Fitch Ratings.
Therefore, analysts expect CRE losses to remain within ratings sensitivities, given the strength of diversified portfolios, despite Fitch’s expectation for monetary policy to lead to a mild recession in the first half of 2024.
US life insurers’ CRE exposure is largely comprised of commercial mortgages, with commercial mortgage backed securities (CMBS) representing less than 5% of cash and invested assets and non-meaningful allocation to equity real estate.
Mortgage loans comprised 13% of US life insurers’ portfolios, or 1.6x capital, at YE22, above historic levels of 8%-12%, but stable year-on-year. Approximately 85% were commercial mortgage loans (CML), with 90% of CMLs rated CM1 or CM2 on an NAIC basis, along with de minimis troubled mortgages and an average loan-to-value ratio of 54% at YE22.
CRE charge-offs in the second quarter of 2023 jumped fourfold yoy to $1.17 billion across the US banking industry, according to Fitch Ratings and S&P Global data.
“Life insurer debt service coverage ratios are starting to deteriorate and material unrealized losses are emerging, portending higher losses, but are expected to remain within ratings sensitivities,” analysts noted.
Adding: “Office properties in particular are under pressure in urban areas due to enduring remote work trends. However, overall loan losses remain near historical averages. Office property valuations are being pressured from low occupancy, rising rates and lower rent, increasing the potential for defaults.
“However, Fitch expects a majority of near-term maturing office loans to be extended rather than paid off. Office mortgages will continue to deteriorate into 2024. Hotel and retail segments are performing relatively better, as hotels benefitted from resurgence of summer travel, while retail has had little to no additional construction the last decade, though brick-and-mortar retail has been stressed by the movement toward e-commerce.”
Fitch’s report also found that, though materially stronger than office, multifamily has started to see women weakness as a small percentage of properties have negative cashflow. This is mainly due to higher rates and outsized supply pressure valuations.
In some areas, insurance costs are rising dramatically due to increased frequency and severity of losses, amid more volatile weather-induced flooding and fires, with rising costs in the sunbelt due to climate-driven risks.
According to S&P data, more than $1 trillion of multifamily debt has been underwritten with floating rates since 2020, Approximately 12% of multifamily properties have a floating rate 150-200bps higher than origination; however, a majority of floating rate loans have cap rates and hedges in place to limit losses.
Analysts also stated that they have seen an increase in delinquencies in multi-family, although they remain at manageable levels.
Fitch concluded: “Life insurers’ significant capital and short-term liquidity make them unlikely to be forced sellers of real estate assets at distressed valuations. Most insurers that invest directly in real estate have a long holding period.
“Surrenders have remained at or below pricing expectations, given robust surrender charge protection and strong ALM mitigating risks. Rising rates are also expected to continue to reduce investment maintenance reserve (IMR) balances for U.S. life insurers, but strong liquidity and effective ALM will mitigate the negative effects on statutory capital and cash flows.”
