US Life Insurers Bracing for Second Wave of Losses From Commercial Real Estate

Many U.S. life insurers are likely bracing for losses linked to their investments in commercial real estate but unlike 2008's residential mortgage market crisis, this time around, it's different. And the industry should be trying to raise money for what's ahead, says one former insurance regulator.

Commercial real estate losses will be worse and will go beyond 2010, said Ernst Csiszar, director of insurance for Bridge Strategy Group, a consulting firm, and the former insurance commissioner of South Carolina.

The industry's main exposures to real estate such as shopping malls, office buildings, warehouses and apartment buildings are in direct commercial mortgage loans and in commercial mortgage-backed securities, said Steven Schwartz, an equity analyst with Raymond James.

The situation is "a double whammy," as they have exposures on the loans they've made to commercial developers but also on the securitization side with the CMBS, said Csiszar, the former head of the Property Casualty Insurers Association of America.

"They only had one foot in the bucket" last year, Csiszar said, referring to residential-mortgage-backed securities. Life insurers, he noted, generally don't make individual residential loans.

At year-end 2008, almost 21% of the industry's investable assets were tied up in commercial real estate, said Greg Smith, an analyst at Conning Research & Consulting.

Some have dubbed commercial real estate as the second round of exposure because of high unemployment and the drop in consumer spending, said Kenneth Miller, an attorney with Ervin Cohen & Jessup in Beverly Hills. Life insurers make loans to owners of shopping centers who pay their mortgage payments from the rents they receive from their retail store tenants, which are dwindling in this economy, said Miller, who represents lenders on commercial real estate loans.

The borrowers can't make their payments and the life insurer may get the property but is not able to sell it at a price that covers the loan, said Schwartz.

About $1.5 trillion in commercial mortgages are due to be refinanced over the next 18 months, and another roughly $1 trillion in 2012-2013, Csiszar said. This impacts life insurers' direct mortgage loans and their investments in CMBS and commercial property-related derivatives.

At the time of refinance, the commercial property that collateralizes these instruments will be, on average, at least 40% lower than at the height of the market in 2006 and early 2007, Csiszar said.

Collateral is "underwater" and life insurers' cash flow is no longer there, he said.

Miller said he's seeing many borrowers defaulting on their loans. They are "trying to hold on and their tenants just can't make it," he said.

Many life insurers are telling them they want to see the money fast, and if not, they'll "proceed aggressively" to enforce the loan, such as starting foreclosure proceedings, Miller said.

Once the economy turns around and consumers again spend money, then "hopefully the tenants make their lease payments, the borrowers make their loan payments, and boom, boom, boom," said Miller.

Meanwhile, more big hits to earnings are likely ahead.

But any earnings losses "are irrelevant," said Csiszar. Companies will take hits to their balance sheets -- their surplus, he said. "What firms really need to do is line up capital for what's to come."

Pointing to recent changes in accounting practices, federal and state regulators aren't forcing insurers to mark-to-market, said Csiszar, noting they're trying to "wait the problem out."

However, Smith said the industry's exposure to commercial real estate is "manageable" and doesn't think it imperils surplus to a great extent, based on what Conning has seen so far.