Is It Safe? Prudential's Billions in Mortgages

By Gavin Magor
May 4, 2009


Moody's expects $375 billion in losses in the $3.5 trillion commercial mortgage and commercial mortgage-backed securities markets in the next 18 months. Standard & Poor's predicts "unprecedented stress" in those markets.

Life insurers held $328 billion in commercial mortgages at the end of December. Prudential Financial (PRU) is more exposed than most, with $32 billion in mortgage loans representing 296% of the company's capital and surplus plus reserves. But does it matter?

The following is a breakdown of insurers and their mortgage loans:

As is known, insurers, including Prudential, hold commercial mortgage-backed securities (CMBS). Life insurers also offer mortgages, mainly commercial (including farm and mezzanine loans), and residential loans totaling $5 billion.

Pacific Investment Management, a unit of Allianz (ALV), which has $5 billion invested in mortgage loans, said last week the commercial market is a "bust."

In 2008, insurers didn't appear to take significant losses in mortgages, with only 26 companies recording so-called 90-days-past-due  accounts totaling $108 million. But there was $89 million in restructured loans. Foreclosures were low at $190 million and only $546 million was recorded in losses.

Prudential reported that it had just $3 million in payments overdue 90 days or more as of Dec. 31. It restructured $1 million in loans and had no foreclosures.

Most insurers reported no delinquencies, restructurings or foreclosures. Those companies included Genworth Financial (GNW) and Lincoln National (LNC), each with $8 billion loan books.

One exception was Aegon (AEG), which had $15 billion in mortgage loans but had restructured $26 million and foreclosed on another $49 million.

So is Pimco right?

If analysts are correct, 2009 could become an extremely uncomfortable year for Prudential and other exposed companies, including American International Group (AIG), which has the fifth-largest loan book, at $17 billion.

Life insurers' exposure is similar to the $306 billion of troubled assets that Citigroup (C) identified in November when seeking a bailout, and the off-balance-sheet value of $667 billion in mortgage-related securities is the same amount as life insurers hold as security.

Although 2008 was difficult, there is positive news. S&P says insurers can withstand the stress because they were well-capitalized over the previous two years. Still, some credit downgrades are inevitable, S&P said.

Downgrades may involve Prudential, which previously said it was banking on the S&P 500 index growing at 2% each quarter of this year from a base of 900 to maintain its credit rating. Currently, the S&P 500 is at about 870, and it would need to rise more than 100 points to meet Prudential's estimate.

As for its own shares, Prudential has fallen 62% over the past year, more than the 47% average for companies on the SNL Insurance index.

Prudential's low loan-to-value ratio of 40% provides a cushion. Even if Prudential had losses of 2%, or $640 million, on its loan portfolio, that would represent only 7% of the $11 billion in capital and surplus, including asset valuation reserves.

Dismal forecasts for the commercial mortgage market ensure that companies including MetLife (MET), which has the largest mortgage loan book at $46 billion, and Manulife Financial (MFC), with $13 billion, will have plenty to worry about as the economy continues to slump.

Unlike banks, insurers don't appear to be funding construction loans, which are loss leaders. Prudential's 90-days-past-due figures hardly register as a percentage of loan totals.

Prudential has significant exposure in dollar value and multiples of capital and surplus, together with the asset valuation reserve. But, assuming the value of the real estate is even close to the recorded worth, any losses from commercial mortgages look as if they shouldn't be big enough to concern stockholders.

The insurer's stock carries a D-plus, or "sell," recommendation from TSC Ratings

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