U.S. life insurers’ commercial mortgage fundamentals have largely recovered since the pandemic, with stable property outlooks for hotel, office retail and multifamily sectors, Fitch Ratings says. However, the Fed’s monetary tightening and the current recession will pressure some sectors of commercial mortgages over the midterm, with consistently high inflation and rising interest rates negatively affecting some property valuations.
U.S. life issuers allocated 13% of their total investment portfolios to mortgages in 2021, in line with 2020 but above historical levels of 8%–12%. This above-average concentration could leave investment portfolios potentially more vulnerable in a declining real estate scenario. However, life insurers have moderate exposure to retail and office properties and limited exposure to hotel, the sectors expected to be the most affected from an economic slowdown and elevated inflation pressures.
Given rising rates, insurer mortgage growth is expected to moderate and focus on high quality investments to manage risk. The level of higher quality loans stabilized after slight declines prior to the pandemic, with 53% of mortgage loans at the CM1 level, or the strongest quality.
Life insurers also maintained favorable loan-to-value ratios (LTVs) of 53.5% in 1H22, down from 55.1% in 2021, 55.3% in 2020 and 58.0% in 2019. Conservative LTVs are expected to remain at current levels over the near term, which should help life insurers manage investment risks in a weaker economy with slowing demand.
U.S. commercial mortgage-backed securities (CMBS) loan delinquencies were 2.1% as of June 2022, down from a peak of 5.0% in July 2020. We expect U.S. CMBS delinquencies to decline to 1.25% by YE 2022 based on healthy new issuance volume, improved resolution volume outpacing defaults, and an increased number of maturing loans able to refinance versus the prior two years. However, uncertainty is growing around the effects of inflation and rising rates on resolution velocity, new issuance volume and property valuations.