A new report issued by Moody’s Investors Service, New York, offers some comfort to insurers, policyholders and investors who fear that commercial mortgages will hurt companies’ ratings.
The agency starts its report by noting that “Insurers’ commercial mortgage losses will grow, but will not result in many rating downgrades unless commercial property values fall much further than expected.”
The concern is that despite the recent rebound of credit and equity markets, commercial real estate is a lagging indicator, and thus, loss rates on both commercial mortgage loans and commercial mortgage-backed securities held as investments by U.S. life insurers will continue to grow.
The saving grace for many insurers, according to the report titled, “U.S. Life Insurers’ Commercial Mortgage Exposure & Losses Are Manageable,” is the high quality of their investment holdings. Investments in CMBS are “primarily originally rated Aaa-rated tranches (mostly super-senior and mezzanine Aaa) with modest exposure to recent problematic vintages of 2006-2008.”
While life insurers could face losses of $9-11 billion over the next 2-3 years that “will dampen earnings,” it will not result in many ratings downgrades, he added.
But the remote scenario run in stress testing that results in $40-45 billion would have a major capital impact that would result in “many downgrades-some being multi-notch.”
Approximately 16% of invested assets of U.S. life insurers are in CMLs and CMBS, Moody’s says. This amounts to 150% of regulatory capital. And, roughly $28-$36 billion, or 10-12% of CML portfolios annually will be maturing over the next two years, good news for insurers, according to the report. And, life insurers have the capacity to work with borrowers to extend or refinance loans, the Moody’s report notes.
“Commercial mortgages loans, while the second largest asset class after bonds, have been maintained at a moderate-sized 9% of invested assets for many years during the CRE boom over the past decade. In addition, we estimate that the industry held around $200 billion of CMBS as of year-end 2008 representing about 7% of invested assets,” Moody’s estimates. Additionally, “life insurers hold less than 1% of invested assets in real estate equity,” the rating agency continued. And, Moody’s notes the diversification of commercial loan portfolios by type and geography.
However, Moody’s says that the one area that bears watching is how CML portfolios are evaluated. The report explains that there are differences among companies in their use of external and internal property appraisals, the frequency of those appraisals and the discount rate used in evaluating properties.