Fitch: U.S. Life Insurers Facing Heated Commercial Mortgage Market

Investment in mortgages grew 6.0% in 2014 to $350 billion for life insurers in the Fitch Ratings' universe, an increase over the prior-year growth rate of 4.4%, according to a new report published by Fitch. While commercial mortgages were the dominant type of new mortgage, net growth in multifamily mortgages was especially strong in 2014. Commercial properties accounted for 78% of mortgage portfolios, followed by multifamily mortgages at12%.

Mortgages continued their six-year run of strong performance driven by low credit impairments and good relative yield versus bonds. Nonperforming mortgages remained very low at 0.1%. Mortgage allocation remains in the 8%-12% range of general account investment portfolios for many insurers. The market continues to be dominated by the larger life insurers, particularly the large mutual companies.

Mortgage portfolio yields declined to 5.36% for 2014 from 5.46% for 2013 following the general direction of low interest rates for new money investments, but remain attractive versus investment-grade bonds.

Overall credit quality as measured by NAIC rating methodology was high at year-end 2014 as more than 63% of mortgages are were rated NAIC CM1 with strong credit metrics, while 31% have adequate metrics of CM2. Under the NAIC methodology, individual mortgage ratings are based on debt coverage ratios (DCRs), loan-to-value (LTV) and property type metrics.

Life insurer's net investment in commercial mortgage-backed securities (CMBS) increased 2.1% in 2014 to $156 billion or 4.3% of investment portfolios. Overall CMBS loan delinquencies declined precipitously to approximately 4.7% at the end of first-quarter 2015, the lowest level since 2008, with improvement across all property types. Fitch's concerns about more aggressive underwriting, higher leverage and weaker loan structures persist. Refinance activity is anticipated to increase over the next few years as a significant amount of maturing loans come due from 2015 to 2017.

In the Appendix, Fitch reviews the fundamentals for various commercial property types including multifamily, retail, office, industrial and hotels, with a focus on rent growth and vacancy. Real estate sector fundamentals continue to build on the positive trends observed in recent years. However, new construction in certain property types, such as multifamily, hotels and industrial, bear watching.