It’s been all over the news—reported from the Wall Street Journal to Morningstar—that the commercial real estate market is within view of a record amount of maturing loans and with it the potential for credit default.
Fitch Ratings projects the delinquency rate of commercial mortgage loans that have been converted into securities will increase to 4.5% in 2024 and to 4.9% in 2025—more than doubling the 2.25% rate in 2023 as of November.
As interest rates have risen over the past two years, traditional commercial banks have tightened lending and investing activities. Insurers have seen an opportunity to step in and capitalize on commercial and private credit, as well as alternatives. Additionally, economic conditions have shifted and brought the potential for added risk to commercial and private credit investments. The perfect storm of higher inflation, a slower “return to office” trend and significantly higher interest rates are increasing the default rate on commercial real estate debt. This, coupled with lower values of the underlying collateral for these loans, further exacerbates the potential losses in a default scenario.
Faced with the likelihood of increasing default rates, what can insurers do to manage and hedge against this risk in their current investment portfolios?
Minimize Risk
As asset portfolios have changed over the years in the direction of a marked increase in credit-intensive securities, some insurers are struggling to obtain a single view of risk across the enterprise; this makes it even more challenging to set and monitor risk appetite. Poorly defined frameworks can impact an organization in multiple ways: first with a potential for unwanted concentration risk across the portfolio, but also with the potential for overly conservative investment decisions, higher credit losses and lower returns on investment. Insurance firms require state-of-the-art technology backed by experienced servicing staff that understand the nuances and complexities of risk management and insurance investment accounting across both public and private markets.
Here are a few things to consider in your operations:
- Technology and infrastructure that can support bespoke Commercial Mortgage Loan (CML) deals, terms and conditions.
- Operational, accounting and reporting systems designed to effectively manage commercial loans.
- Ability to efficiently ingest structured and unstructured data around loan terms, events and notices.
- Ability to collaborate and communicate with all constituents:
- Issuers
- Correspondents
- Property managers
- Deal Expertise – the ability to identify, evaluate and properly price distressed lending opportunities.
- Advanced risk analytics capabilities to jointly manage:
- Credit migration and default risk
- Cash flow projections
- Liquidity monitoring
- Market risk
- Scenarios analysis (sensitivities, key rates, stress tests, Monte Carlo)
- Operational expertise – internal staff or outsourcing partner that understands commercial loan origination, accounting, operations and administrative nuances and requirements.
With the wave of downgrades across the lending industry, there is a lot more insurers need to know and consider. Our "Is Your Insurance Investment Portfolio Prepared for Increased Default Risk?" report dives into the market factors and headwinds facing insurers, struggles when setting and monitoring risk, and considerations to minimize risk.
Download the "Is Your Insurance Investment Portfolio Prepared for Increased Default Risk?" report to learn more.
Vishal Sodha, Senior Credit Risk Solutions Advisor, SS&C Algorithmics; Paulo Laureti, Director, Product Management, Insurance, SS&C Algorithmics; and Tony Johnson, Sr. Director, Product Management, SS&C Algorithmics also contributed to this article.
