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More potential upside to US life industry's rising mortgage loan concentration

After the U.S. life insurance industry's relative portfolio allocation to mortgage loans hit a new high for a seventh consecutive quarter, several signs point to continued incremental growth.

Life insurers with established origination and/or acquisition capabilities continued to turn through the third quarter to commercial and, to lesser extents, residential and agricultural mortgages in their search for higher-yielding assets. At the same time, at least two large life groups continued their recent efforts to accelerate their presence in the asset class. And with only one-third of the U.S. life groups and stand-alone U.S. life entities for which third-quarter statutory data is available holding mortgage loans in any amount, there remains the potential for a continued broadening in industry participation.

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U.S. life industry investments in loans on real estate increased to $510.71 billion as of Sept. 30, according to data compiled by S&P Global Market Intelligence on Dec. 12, representing nearly 12.5% of net admitted cash and invested assets in general accounts. Those figures marked increases from $498.32 billion, or 12.3% of net admitted cash and invested assets, as of June 30, and from $468.77 billion, or 11.6%, on the same date in 2017. It has been since the first quarter of 2015 since the industry last experienced a sequential decline in the aggregate amount of its mortgage loan investments; there has not been such a retreat on a year-over-year basis since the first quarter of 2011.

Investments in first-lien mortgage loans crossed the $500 billion threshold for the first time, rising to nearly $501.90 billion as of Sept. 30 from $489.58 billion three months prior and $460.07 billion a year earlier. The 9.1% year-over-year growth in first-lien mortgages marked the industry's fastest rate of expansion since the third quarter of 2017, and it was an 11th straight quarter in which that growth rate exceeded 8%.

The growth occurred as the Mortgage Bankers Association reported Dec. 13 that commercial and multifamily mortgage debt outstanding increased to an all-time high of $3.32 billion in the third quarter. The trade organization cited factors such as strength in multifamily activity and high lender demand.

'Alpha from CUSIPs is dead'

Seven U.S. life groups acquired mortgage loans valued at $1 billion or more in the aggregate during the third quarter, led by MetLife Inc.'s $2.66 billion.

MetLife's U.S. life units led the industry with net admitted mortgage loans of $56.26 billion in the aggregate as of Sept. 30. Five of the six other groups with more than $20 billion in net admitted mortgage loans on their U.S. life group-level balance sheets also were among those with acquisitions worth at least $1 billion: Prudential Financial Inc., American International Group Inc. and the groups led by New York Life Insurance Co., Northwestern Mutual Life Insurance Co. and Massachusetts Mutual Life Insurance Co.

Joining those well-established mortgage originators and/or investors was a relative newcomer to the asset class, in general, and direct mortgage origination, more specifically. The U.S. life units of Athene Holding Ltd., highlighting the group's newfound focus on mortgage loans, made acquisitions in the asset class of nearly $2.10 billion. It marked the second straight quarter of more than $1.40 billion in mortgage loan acquisitions for a group whose acquisitions of the kind had once exceeded $700 million during the previous 24 quarters.

Athene Chairman, CEO and Chief Investment Officer James Belardi, speaking during a September investor day, said the focus on direct origination was part of the next phase of the company's strategy to pursue a differentiated, opportunistic approach to investing.

"Essentially any alpha from CUSIPs is dead," he said in explaining the decision to pursue direct origination of a variety of assets, including residential mortgages, through Athene's relationship with Apollo Global Management LLC. "You can't find it and that's pretty much across-the-board as passive funds ha[ve] just overwhelmed active trading."

The residential mortgage capability serves to differentiate Athene's mix of acquisitions by property type relative to many of its peers. Approximately 99.4% of the number of mortgages Athene's U.S. life units acquired during the third quarter were backed by residential properties, though only 62.3% of the aggregate dollar value of those acquisitions fit that description. Residential mortgages accounted for only 4.5% of the aggregate dollar value of the third-quarter mortgage acquisitions of the rest of the industry (including farm mortgages).

Other life insurers also meaningfully expanded their mortgage loan positions during the third quarter, though not necessarily to the same extent as Athene.

Brighthouse Financial Inc.'s acquisitions increased 161.8% year over year to $581.8 million in the third quarter. It was the second consecutive reporting period in which the group's mortgage acquisitions more than doubled as it engaged more broadly in portfolio repositioning activities that target an additional $125 million in pretax net investment income by 2020.

The U.S. life units of AIG also continued to boost their relative concentration in mortgages, driven by $1.74 billion of acquisitions during the third quarter, to 14.7% of net admitted cash and invested assets as of Sept. 30 from 12.9% on the same date in 2017. AIG's American General Life Insurance Co. was responsible for the single largest mortgage acquired by an individual life entity during the third quarter: a $302.3 million loan on a multifamily property in Copenhagen, Denmark.

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Picking their spots

Despite the rising levels of investment in the asset class, life insurers appear to be proceeding selectively.

Investments in the embattled retail sector, for example, fell to their lowest point on a relative basis since property type information first appeared in mortgage acquisition data at the start of 2014. Acquisitions of loans backed by retail properties accounted for less than 10.4% of the total amount of new investments in the third quarter, down from 12.8% in the second quarter, 15.6% in the year-earlier period and the previous post-2013 low of 10.9% in the first quarter of 2018. Investments in loans on retail properties amounted to nearly 16.3% of all of the mortgages acquired by U.S. life insurers since the start of 2014.

Then-Prudential CFO Robert Falzon said during a November call that his company was "overweight multifamily and industrial, and we're underweight in office and retail" in its mortgage portfolio. The industry's third-quarter loan acquisitions, overall, showed growth in loans on multifamily, mixed-use and, fueled by Athene, residential properties; the allocations to loans on office and industrial properties fell on a year-over-year basis, but not nearly to the extent of the decline in retail. Loans on multifamily or apartment properties of $7.97 billion accounted for more than 31.2% of the industry's third-quarter acquisitions. Both figures represented new highs for the industry going back to the start of 2014.

Credit quality remained strong as nearly 99.6% of the industry's mortgage holdings were deemed to be in good standing as of Sept. 30.

Strong supply and demand

Banks and insurance companies, alike, have been increasingly fielding questions from analysts during quarterly earnings conference calls and other public forums about the sustainability of commercial real estate market fundamentals and what preparations they might be making for a downturn in the credit cycle. But to date, those concerns do not appear to have impacted insurance company investment strategies at least in the mortgage asset class.

Twenty of the 26 U.S. life groups with net admitted cash and invested assets of $50 billion or more as of Sept. 30 increased their mortgage loan allocations on a relative basis during the third quarter relative to the year-earlier period. Three of the 26 groups maintained allocations of less than 10%, several percentage points below the industry. Executives at American Equity Investment Life Holding Co., one of the three, indicated during a November call that they are continuing to consider increasing allocations to commercial mortgage loans. They view that asset class and investments in collateralized loan obligations as ways to position a portion of the investment portfolio to benefit from increases in short-term interest rates.

Among the 22 U.S. life groups and stand-alone entities with between $20 billion and $50 billion in net admitted cash and invested assets, 12 had allocations to mortgage loans of less than 10% as of Sept. 30. Sixty-four of the 86 U.S. life groups and stand-alone entities with between $1 billion and $20 billion in net admitted cash and invested assets fit the same description, and 24 of them held no mortgage loans at all.

Smaller life insurers may lack the infrastructure, underwriting expertise and other competitive advantages of their larger peers in originating or acquiring mortgages. But the potential for some of them to at least begin dabbling in the asset class offers a prospective boost to the industry's overall holdings at a time in which many of the largest lenders remain historically active. To that end, five of the U.S. life groups and stand-alone entities that held no mortgage loans as of Sept. 30, 2017, reported some amount one year later, highlighted by Torchmark Corp. The life insurer entered a new mortgage loan participation agreement in 2017.