Mortgage allocations for U.S. life insurers will increase further given good relative value, strong originations, and strong medium-term performance despite a decline in mortgage underwriting, according to a new report from Fitch Ratings. Investment in mortgages grew 7.7 percent in 2015 to $360 billion for life insurers in Fitch’s universe, an increase over the prior-year growth rate of 5.8 percent.
“Loan selectivity and credit discipline may start to differentiate investors further down the road, as U.S. life insurers have increased their allocations to mortgages despite an increase in originations of riskier loans and property types,” says Fitch Ratings Director Nelson Ma. “Almost 80 percent of U.S. life insurance companies experienced some degree of growth in their mortgage portfolios.”
Mortgage allocations increased to 12.4 percent of invested assets for life insurers in the Fitch universe from 11.6 percent the prior year. Over 2015, there was an increase in the number of large insurers with above-average mortgage allocations, plus few relatively newer entrants in the mortgage loan space with large year-over-year increases. Increased competition for yield among investors in the low rate environment has resulted in declines in mortgage loan underwriting.
The trend is reflected in:
higher originations in riskier property types such as mezzanine and construction loans;
an increase in riskier interest-only loans and higher loan-to-values (LTVs) in commercial mortgage-backed securities; and
in discussions with senior management of life insurers.
Mortgages continued their run of strong performance driven by low credit impairments, Fitch writes. Mortgage portfolio yields declined to 5.1 percent in 2015 from 5.3 percent in 2014 following the general direction of low interest rates for new money investments, but remained attractive relative to investment-grade bonds.
Competition has been growing for mortgages due to the increasing pool of life insurers in this asset class that are willing to trade liquidity for yield, Fitch says. Credit quality of the mortgage portfolios, as measured by the National Association of Insurance Commissioners (NAIC) rating methodology, remained high at year-end 2015. More than 6 in 10 (62 percent) of mortgages were rated ‘CM1’ with strong credit metrics and 31 percent were rated ‘CM2’ with adequate metrics.
Under the NAIC methodology, individual mortgage ratings are based on debt coverage ratios (DCRs), LTV, and property type metrics. Contrary to the increase in mortgage loan investments by life insurers, net investment in commercial mortgage-backed securities decreased 5 percent at year-end 2015 to $111.8 billion, or 3.8 percent of cash and invested assets. CMBS loan delinquencies declined precipitously to 2.9 percent at the end of first-quarter 2016, 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 2016 to 2017.
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