Insurance companies are increasingly opting for a bold strategy: bypassing mortgage-backed securities in favor of purchasing whole loans directly. This trend has gained momentum over recent years, with a significant 45% rise in residential mortgage loan holdings reported in the last year, translating to an increase of approximately $20 billion, as per Ellington Management Group’s analysis.
Typically, these loans do not qualify for bundling into securities supported by government-backed entities such as Fannie Mae or Freddie Mac. The borrowers involved tend to be riskier, and managing these loans directly requires considerable effort that many firms are not equipped to handle, leaving the field open for larger alternative asset managers like Apollo Global Management and KKR & Co.
The incentive for this shift lies in the enhanced yields associated with direct loan ownership. While exact figures are difficult to pin down, insurance firms that can manage mortgages directly potentially save between 35 to 45 basis points compared to the costs incurred in securitization, along with improved capital efficiency on their balance sheets, according to Ryan Singer, head of global residential investments at Balbec Capital.
Douglas Dupont, head of insurance strategies at Ellington, noted that this move challenges the traditional views within the insurance sector, which often favors established investments like fixed income and commercial real estate loans. He emphasized that these firms, experienced in managing complex assets, are merely pursuing better risk-adjusted yields.
Apollo, which acquired Athene Holding in 2022, has significantly increased its exposure to residential mortgage loans, nearly doubling its portfolio from $11.8 billion to $21.9 billion over the past year. KKR has also expanded its whole loan investments, increasing its holdings by about 20% to reach $12.7 billion. Blackstone Inc. is similarly involved, managing funds for major insurance companies and seeing strong performance in its credit and insurance sectors.
The appeal of non-agency mortgages, particularly non-qualified mortgages (non-QM), is gaining traction among insurers. Following a lull in non-QM lending during the pandemic, the sector has rebounded, drawing strong demand that is reducing the volume of mortgages available for securitization. A recent Bank of America report indicates that the percentage of non-QM mortgages securitized into RMBS fell from about 80% in 2021 to around 50% in 2023.
While most investors continue to favor mortgage securitization—which comprises about $8.7 trillion of RMBS backed by agencies like Freddie Mac and Fannie Mae—insurance firms are increasingly making direct purchases, having amassed over $60 billion in residential whole mortgages by the end of last year, tripling their holdings since 2018.
However, the complexities involved in owning these mortgages—such as managing physical documents and payment collections—mean that only a few large insurers dominate this space. Smaller insurers are beginning to outsource these responsibilities to specialized firms like Bayview Asset Management, which has launched an asset management division dedicated to this sector.
Several factors are driving this transition, including favorable risk regulations and substantial inflows from annuities. Under guidelines from the National Association of Insurance Commissioners, whole loans receive risk treatment akin to A-rated corporate bonds, but with higher yields. With annuity sales soaring to $385 billion last year, up over 75% since 2020, insurers are finding attractive opportunities in whole loans, particularly as the duration of these loans aligns with the life of most annuities.
Additionally, the recent banking crisis has shifted dynamics, as banks have moved away from retaining whole loans, instead opting to sell them, creating further opportunities for insurance companies to acquire these assets. The current environment of rising interest rates has further enhanced the attractiveness of owning whole loans, as it elevates yields to meet insurers’ liabilities effectively.
