Commercial Real Estate Direct Staff Report

Some of the country's largest life insurers should see little or no actual losses from their CMBS holdings.

That's basically what they've been saying all along. But given the expectation that commercial mortgage delinquencies are expected to continue climbing - Fitch Ratings, for instance, expects them to hit 12 percent by 2012 - losses will plague CMBS, especially subordinate tranches.

But Barclays Capital, with help from Bloomberg for CMBS and Property and Portfolio Research, has confirmed what insurers have been saying. It did that by poring over the CMBS that 10 large insurers hold and analyzing how they would be impacted by property-level operating declines that are projected by PPR.

The project was arduous - the CMBS held by the 10 insurers is backed by loans on some 300,000 properties.

Those insurers include MetLife, which held CMBS with a value of $15.5 billion as of the end of the third quarter, Prudential Life, which held $11.5 billion of CMBS, and Hartford Financial Services, with $9 billion of CMBS.

Insurance-industry analysts at Barclays, led by Eric N. Berg, relied on filings insurers make quarterly with state insurance departments to identify exactly what bonds each of the 10 largest insurers that they track held.

Then, using Bloomberg, they determined exactly what loans collateralized each bond. And relying on net operating income projections provided by PPR, the analysts determined how individual loans would fare through next year. They also used PPR projections of capitalization rates to determine the value of properties underlying the loans in every CMBS transaction.

They then assumed that a mortgage would default if its loan-to-value ratio was more than 100 percent. They also assumed that in the event of a mortgage default, the collateral property would be taken in foreclosure and sold within a year, resulting in a loss determined by the loan's leverage level.

Commercial property values, which last October had fallen by 43.7 percent from their 2007 peaks, according to the Moody's/Real Commercial Property Price Indices, are expected to continue softening. Indeed, CBRE Econometric Advisors recently projected that property values wouldn't start to improve until next year and cap rates would continue to climb through the middle of next year.

But the typical CMBS held by the insurers has 26 percent subordination. That means that losses totaling at least 26 percent of a given deal would have to materialize before impacting the insurers' holdings. And the CMBS holdings of none of the insurers are projected to see losses of that magnitude. Barclays projects that the typical CMBS transaction will suffer losses of 7.5 percent, which indicates that the typical CMBS held by life insurers will be left unscathed.

The 211 CMBS bonds held by Prudential, for instance, have a weighted average subordination level of 28.8 percent. And based on the projections by Barclays, those bonds will suffer an aggregate 13.2 percent of losses.

Even the CMBS portfolio of Reinsurance Group of America, which is projected to be hit with the greatest losses of the insurers analyzed by Barclays, is well insulated. It has an average subordination level of 26.1 percent and is projected to get hit with 18.7 percent of losses.

MetLife's portfolio, comprising 206 bonds from 108 transactions, has a subordination level of 26.2 percent. It is projected to get hit with 9.9 percent of losses.

"While it is certainly understandable that investors are concerned about possible losses from life insurers' CMBS portfolios, given the absolute and relative size of these portfolios and the fact that commercial real estate can lag the general economy, the data don't support these concerns," Barclays noted. "When we move from the realm of anecdote and hunch to examine real analysis on the subject, the output that emerges is unmistakable: Little or no CMBS losses for life insurance companies."

The largest insurers "expect to recover virtually every penny they invested in the asset class," according to Barclays.

The insurers have already written down the value of their CMBS, because of widening credit spreads, but they haven't taken other charges to reflect potential losses of principal. And Barclay's study indicates they shouldn't.

Comments? E-mail Orest Mandzy or call him at (215) 504-2860, Ext. 211.