Yield-obsessed insurers are adopting an unconventional strategy: Instead of buying mortgage-backed bonds, they're buying the entire loans that underpin them.
The trend has accelerated in recent years: Last year alone, insurers increased their mortgage holdings by 45%, or about $20 billion, according to an analysis by Ellington Management Group.
Such loans typically don't qualify to be rolled into bonds guaranteed by Fannie Mae or Freddie Mac, the government-sponsored companies that guarantee most investors' mortgages in the United States. The borrowers are typically riskier, and investors owning the mortgages directly, rather than as part of a secured bond, means firms must take on hard work that's often left to specialists. Not all firms have the scale or sophistication to do that, so big alternative asset managers such as Apollo Global Management and KKR are leading the transition.
So why go to the trouble of owning these loans directly rather than securitizing them? Higher yields. While it's hard to quantify precisely, insurers that can own mortgages directly could save about 35 to 45 basis points on the cost of securitization itself. And that doesn't take into account the significant amount of capital that improved risk treatment would free up on insurers' balance sheets, says Ryan Singer, head of global residential investments at Balbec Capital.
“You have to get past the traditional insurance industry's cognitive bias against investing in anything other than traditional products like fixed-rate mortgages and commercial real estate mortgages,” said Douglas Dupont, head of insurance strategy at Ellington Inc. “But these insurers have experience managing complex assets, and all they do is pursue the highest risk-adjusted return.”
New York-based Apollo, which acquired insurer Athenee Holdings Inc. in 2022, has been betting big on the insurance industry. Last year, Athenee nearly doubled the size of its mortgage portfolio from the previous year, growing to $21.9 billion from $11.8 billion, Apollo's full-year earnings report showed.
Others are getting in. Buyout giant KKR, which bought a controlling stake in insurance group Global Atlantic in 2021 and now makes it a wholly owned subsidiary, increased its mortgage holdings last year by nearly 20% from 2022 to $12.7 billion, according to its full-year results. Meanwhile, Blackstone manages assets for Resolution Life as well as insurer giants American International Group Inc. and Allstate Inc. The private-equity giant's credit and insurance business is its best-performing division.
“This isn't something we started overnight. We first identified an opportunity in this space many years ago and have been steadily building our capabilities since then,” said Chris Melia, co-head of global asset-backed finance at KKR.
Apollo and Blackstone declined to comment.
Insurers are increasing their interest in a variety of non-agency mortgages, but the appeal of non-qualified mortgages is particularly strong. The COVID-19 pandemic halted non-qualified mortgage lending in 2020, but issuance has rebounded and now shows few signs of slowing. Demand is so strong that more mortgages are being pulled from securitizable pools. According to a report released last month by Bank of America, the share of non-qualified mortgages securitized into RMBS has fallen from about 80% in 2021 to about 50% in 2023.
“Typically, securitization is an attractive way to finance assets,” said Pratik Gupta, a strategist at Bank of America. But now, “the non-QM market is experiencing competitive bidding from both securitizers and insurers, which is driving down securitization rates.”
Insurers held more than $60 billion in mortgage loans as of the end of last year, roughly triple the amount in 2018, according to Ellington's analysis.
To be sure, most investors still prefer to hold mortgages through securitizations, which bundle loans into bonds with different risks and rewards. Wells Fargo estimates that the market for RMBS guaranteed by institutions created by Congress to securitize mortgages, such as Freddie Mac and Fannie Mae, is about $8.7 trillion, still far larger than the $640 billion market for non-agency RMBS, which includes non-QM mortgages.
Administrative power
Just a handful of insurers own the vast majority of the total mortgage balance, according to Bank of America Corp. Holding loans involves a lot of tedious work, including handling physical documents like promissory notes and deeds of trust, collecting various forms of data and collecting payments from borrowers, says Fred Matera, chief investment officer at Redwood Trust Co., which acquires loans from loan originators and helps securitize or sell them.
“It takes a lot of effort to directly own these loans,” said Deva Mishra, CEO of Prosperity Asset Management, which specializes in credit and niche assets. “Not everyone has the appetite or sophistication to do it.”
Smaller insurers, or those not owned by large asset managers, are increasingly outsourcing such work. Bayview Asset Management has created an insurance asset-management unit just for that purpose, and appointed Nancy Mueller Handal, a former head of private fixed-income and alternatives at MetLife, to lead it.
Pensions, Regulation and Fees
The shift is being driven by a combination of favorable industry risk regulations and inflows from pensions. Under insurance regulations overseen by the National Association of Insurance Commissioners, whole loans are treated similarly to A-rated corporate bonds, but they offer higher yields. What's more, pools of mortgages in the form of whole loans represent a better risk treatment on insurers' balance sheets than holding the same pools of mortgages in the form of bonds, DuPont said.
Insurers have also been receiving a ton of cash recently from people buying annuities: Insurers sold $385 billion in annuities last year, up more than 75% from 2020, according to Limra data. Investing that cash in whole loans is attractive, said Bayview's Mueller Handal, because the average term of annuities being sold today roughly matches the average term of a mortgage, which is roughly five years or more.
The recent community banking crisis has led banks to pull back from buying entire loans. In recent quarters, Mattera said, banks that previously bought loans from Redwood are now selling to Redwood. “Banks are doing the opposite of what insurance companies are doing, which is they have no interest in holding these loans in their portfolios,” he added.
Meanwhile, rising interest rates are making it more attractive to own the entire loan.
“Rising interest rates have caused disruption in some of the areas that insurance companies typically invest in, such as commercial real estate and private equity,” Matera said. “At the same time, rising interest rates have made mortgages look more attractive to insurance companies because yields have risen enough to justify the amount they need to pay on the debt.”
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