Life Companies Are Well-Cushioned Against Commercial Mortgage Loan Losses
Stress on the commercial mortgage loan (CML) portfolios of U.S. life insurers alone won’t lead to rating downgrades, Fitch Ratings says in a new report. The rating agency cites strong industry capitalization, current loan quality and historical loss experience as mitigating factors. CMLs are around 13% of total invested assets for life companies, which have long enjoyed one of the lowest default rates across the spectrum of commercial real estate lenders.
Fitch estimates that the top 15 U.S. life insurers by CML exposure could absorb an aggregate CML default rate of approximately 60%, given current levels of capital headroom. “This is roughly 14.0x the aggregate default rate experienced cumulatively by these insurers during the 2008-2010 global financial crisis (GFC),” says Fitch.
Life companies’ CML delinquencies peaked at 30 basis points during the GFC, compared with peaks of about 870 bps for CMBS and bank-originated loans. Fitch says the quality of CMLs held by U.S. life insurers has only deteriorated modestly in recent years and remains strong compared with the GFC.
“The substantial cushion between the rating headroom default rate and the GFC default rate is primarily reflective of the robust capitalization across the life insurance industry and favorable historical performance of the life insurers’ CML portfolio,” Fitch says. “This favorable performance is a result of the high quality of the underlying loans.
Although the losses taken on CMLs were relatively modest in 2020, they’re expected to increase between 2021 and 2023. Hotel and retail have accounted for the majority of losses since the onset of the pandemic.
That being said, Fitch reported separately that the lodging sector’s long-term RevPAR recovery trajectory remains on track, despite the recent sharp uptrend in coronavirus infections. Retail properties were negatively affected by pandemic-related social distancing guidelines and closure of non-essential footprints, and the sector remains in a period of transition.
Fitch notes that office properties remain vulnerable to a severe and prolonged downturn, “driven by a potential large-scale shift toward increased remote working habits that could negatively affect demand for office space longer term. While long leases have protected office cash flows over the near term, valuations could remain pressured over the intermediate term due to increasing vacancies pressuring same property net operating income, and increased capitalization rates.”