Commercial real estate (CRE) remains a large exposure for U.S. life insurers, who hold more than $900 billion of CRE, or about 17% of their total invested assets, in commercial mortgages (CMLs) and commercial mortgage-backed securities (CMBS), but weaknesses have begun to emerge across the sector in recent years, according to a new Moody's report.
According to the agency, rising refinancing costs, especially in the office sector, have led to a decline in property valuations, ultimately weakening loan-to-value (LTV) ratios and increasing insurers' capital burden.
Notably, U.S. life insurers have over $600 billion in outstanding mortgage loans, and as lower office occupancy rates due to working from home and sharp declines in valuations have made refinancing difficult, insurers have reduced their exposure to the office sector.
Looking ahead to 2023, Moody's noted that weakness in commercial real estate, particularly the office sector, has prompted insurers to reassess their exposures.
In fact, from July 2022 to the first quarter of 2024, multifamily values fell 18% as a result of rising interest rates, while office values peaked at 24%.
At the same time, Moody's noted that valuations continue to fall due to deteriorating mortgage quality, while loan-to-value ratios and loan delinquencies are increasing.
The agency explained that it expects insurers to work with borrowers to address maturities over the next 12 to 18 months and take advantage of the benefit of time, “as long as their immediate liquidity needs remain stable.”
Looking ahead, the agency noted that U.S. life insurers' CMBS holdings are dominated by high-quality conduit transactions that tend to be well-matched to insurers' long-term liabilities.
However, one-third of mortgage investments are allocated to large loans or single-asset/single-borrower mortgages (LL/SASB), which typically tend to receive higher credit enhancements to compensate for property and borrower concentrations, Moody's added.
Additionally, the company explains that it has minimal exposure to other commercial real estate investments.
“U.S. life insurance companies have very limited holdings in REITs and even less exposure to office-related REITs. The prolonged high interest rate environment has increased financing costs, reduced liquidity in the real estate transaction market and depressed real estate valuations,” Moody's said.
He added: “Lower interest rates this year will likely increase transaction activity, but asset values could fall further if the economic downturn dampens demand for property. The slowing economy will put further pressure on net operating profit growth over the next 12 to 18 months, while operating expenses such as insurance, labour and materials will remain elevated, weighing on profit margins as demand slows.”