Insurance companies and their coinciding real estate arms steeped in the mortgage world are holding momentum through market headwinds, signaling a potentially strong recovery to form for commercial mortgage-backed securities deals and related loan activities.
The increased use of mortgages to improve insurer portfolio yields has in turn generated more allocations toward the vehicles as of 2021, and according to an August 3 Fitch Ratings report, allocation pace is expected to hold steady even through continued inflationary and interest rate pressure.
In 2021, US life insurers directed 13 percent of their total portfolios to mortgages in excess of the 8 to 12 percent historical range. Credit quality has also been maintained with 53 percent of mortgage loans at the strongest quality level of CM1.
“The higher-quality loans stabilized after slight declines after several years leading into the coronavirus pandemic,” Fitch analysts said. “Given the recent rise in rates, Fitch Ratings believes insurers will have moderate but stable growth.”
The New York-based ratings agency noted that insurers will continue their focus on high-quality investments and maintain a similar stance when it comes to disciplined underwriting. Life insurers opted for favorable loan-to-value ratios of 52.5 percent in the first half of 2022 compared to 55.1 percent in 2021, 55.3 percent in 2020 and 58 percent in 2019.
“This will help life insurers navigate potential downside pressures from economic risks,” the analysts said. “Fitch believes this trend will continue in the near term, as US life insurers manage investment risks in a weaker economy with slowing demand.”
With underwriting and allocation in stable condition, commercial mortgages are set for what Fitch describes as a strong recovery while the market endures the remainder of the pandemic. Notably, in Fitch’s view, headwinds such as deterioration in consumer spending from high inflation and the US Federal Reserve’s interest rate programming could still adversely affect property valuations moving forward.
“Life insurers have moderate exposure to retail and office properties and limited exposure to hotel,” Fitch’s analysts said. “However, these sectors are expected to be the most affected economically from a slowdown due to elevated inflation pressures.” The ratings agency anticipates brick-and-mortar retail will see some improvement in the near term but will be disrupted with consumer income taking a hit atop continual supply chain issues and reduced demand.
“Favorably, the majority of life insurers avoid higher-risk retail investments, such as malls, and focus on grocery-anchored retail,” Fitch said. “The movement toward hybrid working could lessen real estate footprints, pressuring the office sector and leading property owners to look to repurpose and sublease space.”
On par with other lending and investment managers, insurers maintain a meaningful tilt toward industrial and multifamily with the latter accounting for the largest allocation from life insurers because of strong housing demand across the Sunbelt market and beyond.
The US CMBS market tracks a similar pattern at present with stability across hotel, office, retail and multifamily. US CMBS loan delinquencies have dropped from 5 percent in July 2020 to 2.1 percent as of June 2022, according to Fitch data.
“We forecast US CMBS delinquencies will further decline to 1.25 percent by year-end 2022 based on healthy new issuance volume, higher resolution volume outpacing fewer defaults, and a higher volume of maturing loans able to refinance versus the prior two years,” the ratings agency said. At the same time, inflation and rising interest rates are creating some uncertainty around new issuance volume, valuations and resolution velocity, which could all lead to a waned pace for delinquency improvement.
US CMBS issuance volume kicked off the first half of 2022 with $50 billion of new volume compared to $45.7 billion over the same span in 2021. Fitch said it expects CMBS volume to slow in the second half of the year because of the interest rate programming put into effect in the second quarter of 2022. “Rate hikes by the Fed combined with wider credit spreads caused mortgage rates on CMBS loans to rise more than 5.5 percent on newly originated loans in June 2022 from 3.5 percent in 2021,” Fitch said.
Refinancing efforts are anticipated to be modest in 2022 because of what Fitch described as low issuance volume in 2012, which translates to a manageable amount of 10-year maturing loans due this year. An estimated $13.1 billion of US CMBS fixed-rate multi-borrower loans are set to mature through the end of the year, according to Fitch data.
Life insurers’ net investments in CMBS jumped by 3 percent at the end of 2021 to $147 billion, representing less than 5 percent of cash and invested assets. Fitch said the modest year-over-year growth in CMBS investment in 2021 was supported by about 60 percent of the life insurers in its universe.
“These insurers reported an increase in CMBS portfolios, with roughly one-third of life insurers seeing double-digit rates of growth,” Fitch said. “However, the CMBS growth trend was not industrywide. Of the 40 percent of life insurers reporting declines in their CMBS portfolios during 2021, nearly half of life insurers reported double-digit declines in CMBS exposure.”
Direct investments and defaults
In tandem with CMBS investment, direct real estate investment remained relatively small, and the 2 percent uptick recorded in the market was driven by increases in real estate exposure by Nuveen and to a lesser degree Sun Life Financial and Northwestern Mutual, according to Fitch.
US CMBS defaults have largely held their same shape in recent quarters too. At year-end 2021, cumulative defaults clocked in at 18 percent and were on par with lifetime cumulative defaults at the end of 2020. Retail and office represented the bulk of default situations.
“Fitch expects loan default to remain low in 2022, however, maturity defaults will accelerate as the volume of maturing loans increases and higher interest rates make it costlier for borrowers to refinance,” the ratings agency said. Urban hotels relying heavily on business and international travel, Class B and Class C regional malls, and offices are still expected to encounter more default trouble over the medium to long term.