CML, Real Estate Losses, the One Cloud in a Sunnier Forecast

Several interesting reports have recently been released by rating agencies. One of the common threads is the impact of commercial mortgage loans and real estate on insurers.

Standard & Poor’s Corporation, New York, addressed the topic and how it would affect insurance groups. The rating agency said that it had lowered its ratings on three North American life insurance groups and their subsidiaries: NLV Financial Corp; Pacific LifeCorp and Principal Financial Group.

The actions followed a review of U.S. life insurance groups using stress scenarios based on an updated methodology for incorporating different economic events into its assessment of capital adequacy. For instance, S&P took a rating such as an insurer financial strength rating of ‘AAA’ and applied a stress scenario consistent with that rating: the Great Depression. It then examined whether the company withstood the scenario that matched its current rating. The stress test is just one of a number of factors such as liquidity that are used to assess a company’s capital adequacy, according to S&P.

Commercial real estate was the main reason that the ratings were lowered. During a conference call, S&P analyst Kevin Ahern noted that as an example Pacific Life had exposure to commercial real estate in the form of construction loans and high-end properties that totaled $6 billion.

S&P also affirmed its rating of Teachers Insurance & Annuity Association of America, New York, at ‘negative.’ The company’s exposure to commercial mortgage-backed securities and commercial whole loans was $15 billion, according to the rating agency.

However, S&P also noted that TIAA’s earnings power and financial flexibility will enable it to restore capital adequacy to an ‘AAA’ level within two years.
But S&P revised its outlook on New York Life Insurance Co. to stable from negative and affirmed its ‘AAA’ rating. While NYL has $10 billion in CMBS, it has outperformed the industry in high quality CMBS, according to Ahern. The rating agency expects that the company will restore its ‘AAA’ capital adequacy through organic earnings within one year.

The ratings on MetLife Inc. and subsidiaries remain on CreditWatch, where they were placed on Feb. 3 of this year.

From Moody’s Investors Service, New York, comes a report announcing that the U.S. life insurance outlook has returned to ‘stable.’ The report, authored by the analyst team of Laura Bazer, Ann Perry and Scott Robinson, starts by noting improving economic trends such as elevated stock market values will help life insurers’ variable annuity portfolios and pension and asset management fees. Lower corporate defaults and bond rating downgrades are also a positive prospect going forward, according to Moody’s.

These more positive indicators will help improve the ratings of many companies, according to the report. Currently, roughly a third of Moody’s rated life insurers have negative outlooks, the report finds.

The one cloud darkening this sunnier forecast is higher-than-average asset losses in 2010-11 from commercial mortgage loans, CMBS and other housing-related assets, according to Moody’s. Still, these losses should remain “manageable” over the medium term due to improved operating earnings and capital generation. And, if a second downturn occurs, life insurers are more equipped to handle it due to more liquidity and better levels of capital, the rating agency noted.

Even so, Moody’s estimates that life insurers’ commercial mortgage loan (CML) delinquencies, foreclosures, impairments and valuation allowances will “rise significantly” over historical averages over the next 2-3 years. CML expected and stress case losses could reach 3 percent and 10 percent respectively, it continued. Those losses could total between approximately $6 billion-$25 billion respectively.
For CMBS, ultimate lifetime losses could rise to 2% from 1% with a possible $2 billion to $13 billion of additional losses anticipated.

Moody’s says that bad news for troubled residential housing asset classes could impact life insurers’ RMBS securities and add roughly $15 billion of losses with a stress test case of approximately $45 billion.

The good news, the rating agency underscores, is that while CML, CMBS and RMBS losses could lead to losses, it will probably not lead to downgrades.