Research — 20 Sep, 2024
Relative value search leads US life insurers to boost mortgage positions
By Tim Zawacki
Prospects for attractive risk-adjusted returns led US life insurers to incrementally accelerate their investments in mortgage loans during the second quarter even as they continue to face questions about the risks associated with their exposure to certain embattled property types.
➤ Data compiled by S&P Global Market Intelligence show that the aggregate value of mortgage loans held by US life insurers increased 6.1% year over year and 1.5% sequentially to a new all-time high of $752.77 billion, or just over 13.7% of net admitted cash and invested assets. Net flows into mortgages were positive by $13.98 billion, reflecting an aggregate cost of $34.55 billion in loans acquired net of $20.57 billion in proceeds on loan disposals. This compares favorably to positive flows of $10.67 billion in the first quarter and $10.96 billion in the second quarter.
➤ Acquisitions of commercial mortgages continued to emphasize industrial and multifamily properties, with offices still decidedly out of favor. More broadly, however, the industry continues to rotate into residential mortgages as that property type accounted for 36.2% of new loans acquired.
➤ We estimate weighted average effective interest rates of 7.01% on the mortgage loans acquired by US life insurers during the first half of the year and 6.78% for those added during the second quarter. This puts the industry on pace for its highest new money yield on mortgage loans since 2009, when the weighted average effective interest rates on loans acquired in the sector totaled 6.97%. They also compare quite favorably to the US life industry's book yield on mortgages held as of year-end 2023 of 4.63%, representing earned income as a percentage of average net admitted loans. New money yields hit an estimated 6.62% in 2023.
➤ Measures of mortgage loan asset quality continued to deteriorate during the second quarter but at levels that remained de minimis relative to aggregate portfolios. Other-than-temporary impairments on mortgage loans spiked by nearly 142.5% year over year to $531.9 million. The mortgage loan valuation allowance increased to $1.76 billion as of June 30 from $1.42 billion at year-end 2023. While that represented only 0.24% of the aggregate statement value of the industry's mortgage loan holdings, the valuation allowance marked a new high on an absolute basis and, on a relative basis, climbed to its highest point since 2010.
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Life insurers' acquisitions of uninsured commercial mortgage loans, which have traditionally constituted the lion's share of their investments in the asset class, remained below historical levels on both an absolute and relative basis, driven largely by sluggish activity in the office sector.
At $17.29 billion, acquisitions of uninsured commercial mortgages marked an increase of 25.4% from the year-earlier period, but they remained short of the second-quarter average of $19.16 billion for the 10-year period ended in 2023. The shortfall to the historical average, which is not adjusted for inflation, comes as acquisitions of loans on office properties fell 27.6% year over year to only $1.28 billion. The second-quarter average for that property type during the 10 years ended in 2023 was $4.46 billion.
Industrial properties, which primarily include logistics facilities, have picked up much of the slack. Acquisitions of loans backed by industrial properties in the second quarter surged 87.1% year over year to $5.62 billion. Six of the nine largest loan acquisitions during the reporting period by individual life entities involved industrial properties. These included a $265 million The Northwestern Mutual Life Insurance Co. loan on an industrial property in California's Inland Empire, a $230 million Athene Annuity and Life Co. loan on an industrial property in Fremont, Calif., and a $215 million Northwestern Mutual loan on an industrial property in Huntington Beach, Calif. The Apollo Global Management Inc.-backed Athene Annuity and Life also acquired other sizable commercial mortgages on industrial properties during the second quarter that S&P Global Market Intelligence's Commercial Properties US dataset suggests involves portfolios of self-storage facilities.
An industry-level analysis of the aggregate amounts of mortgage loans acquired by property type relative to the aggregate book value of loans disposed finds net flows out of office properties for a sixth consecutive quarter. Net flows into industrial and multifamily properties remained decidedly positive.
The emphasis on multifamily properties is evidence of a more residential focus on life insurers' lending activities at the industry level, if not necessarily among all industry participants. Acquisitions of uninsured multifamily loans on commercial residential properties increased 32.7% year over year in the second quarter to $5.83 billion. Uninsured residential mortgages, which include loans on single-family, apartment and condominium dwellings, increased less rapidly at a year-over-year rate of 5.8%. The aggregate amount of uninsured residential mortgages acquired in the second quarter of $10.70 billion was more than three times the 10-year second-quarter average.
The industry's continued rotation into residential mortgage loans, particularly nonconforming loans not eligible for sale to the Federal National Mortgage Association and Federal Home Loan Mortgage Corp., has contributed to the attractive new money spreads. We calculate a weighted average effective interest rate of 7.13% on the residential mortgages acquired by US life insurers during the first half of 2024, 12 basis points higher than for the asset class overall. In contrast, the weighted average interest rate on new industrial loans was 6.62%.
Two large residential loan acquisitions by Massachusetts Mutual Life Insurance Co. catalyzed the quarter's expansion. The insurer, which regularly adds seasoned pools of residential mortgages backed by guarantees from the Federal Housing Administration and Veterans Administration, reported separate additions in the amounts of $313.8 million and $233.5 million. Athene Annuity and Life, along with three US-domiciled subsidiaries of the KKR & Co. Inc.-backed Global Atlantic Financial Ltd., combined to account for 56.8% of the uninsured residential mortgages added by the industry in the second quarter.
Strong growth in mortgage portfolios at Athene and Global Atlantic, both sequentially and year over year, have helped drive the life industry's expansion in the asset class. They have been complemented by rapid growth among several smaller entities. Among them, GBU Financial Life, which boosted its holdings by 147.6% sequentially in the second quarter, and CL Life & Annuity Insurance Co., which had mortgages worth $111.0 million on its books as of June 30 as compared with only $5 million on the same date in 2023. CL Life has been growing rapidly since it entered the annuity market under new ownership, supported by a flow modified coinsurance agreement with a Cayman Islands-domiciled affiliate.
Deterioration in some credit metrics not cause for alarm
Despite the allowance build and rise in impairments during the second quarter, the overall credit picture continues to hold up.
The percentage of US life insurer commercial mortgages classified as being in good standing, or those loans where all of the basic, original terms of the loans are being met, has remained remarkably high even in a challenging post-pandemic environment for certain property types. It rose to nearly 99.6% in the second quarter from 99.4% at the end of 2023. Loans in the process of foreclosure dipped to $638.6 million from $988.5 million. On the other hand, the amount of loans 90-plus days past-due increased to $2.03 billion as of June 30 from $1.84 billion as of March 31.
Reliance Standard Life Insurance Co., part of Tokio Marine Holdings Inc.'s Delphi Financial Group Inc., had the highest dollar amount and largest sequential increase in 90-plus-day commercial mortgage delinquencies at $727.4 million and $244.3 million, respectively, based on disclosures in the general interrogatories section of its quarterly statements. Metropolitan Life Insurance Co. had the second-highest amount of 90-plus-day delinquencies at $199.9 million, which marked an increase of $147.4 million from the first quarter.
MetLife Inc. CFO John McCallion said during a Sept. 5 appearance at an investor conference that he expects the company's mortgage loan charge-offs to rise in 2024 to a level "south of $100 million" from about $20 million, relative to an overall portfolio worth $50 billion. In that context, he said, "[it is a] very modest kind of loss expectation relative to what some have said is a very stressful real estate environment."
McCallion credited conservative underwriting standards, a resilient US economy and prospects for moderating interest rates for MetLife's ability to persevere and his generally favorable outlook on where the portfolio stands.
"We probably think we're kind of close to the trough of this cycle," he said.
Beyond whole loans, insurers maintain exposure to commercial real estate debt in the form of limited partnership interests in mortgage funds and investments in tranches of commercial mortgage-backed securities (CMBS). Our analysis of CUSIP-level disclosures of impairments on loan-backed and structured securities in the notes to quarterly statements finds that the aggregate tally related to CMBS investments exceeded $96 million in the second quarter, with $42.2 million of that amount taken by American General Life Insurance Co. in connection with its holding of a junior tranche of Morgan Stanley Capital I Trust 2021-2030P. That single-asset transaction was backed by a loan on the Manhattan office tower known as the Helmsley Building. S&P Global Ratings, a separate division of S&P Global, reported that the loan had been transferred to special servicing in late 2023 and that unrated junior tranches (including the class G certificates held by American General Life) had begun to experience monthly interest payment shortfalls.
Methodology
Results reflect disclosures on annual and quarterly statutory statements filed with the National Association of Insurance Commissioners as compiled by S&P Global Market Intelligence at the group and industry levels. For the third quarter of 2022 through the second quarter of 2024, results include a manual adjustment to add data for The Prudential Insurance Co. of America. Quarterly statement data for New Jersey-domiciled insurers is precluded from public dissemination by state law. Due to this adjustment and the significance of Prudential Financial Inc.'s subsidiary's mortgage holdings, the industry totals in this article will not align with those presented on S&P Capital IQ Pro. Values calculated based on loan-level data, such as weighted average effective interest rates on newly acquired loans, exclude activity by the primary Prudential subsidiary.
For more information on the industry's exposure to CMBS, mortgage funds, real estate equity and real estate debt please see the 2024 US Insurance Investments Market Report.
This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.