Tuesday, March 30, 2010

CATALYST ALERT Impact of Potential Increased Commercial Mortgage Capital Charge $SRS $SPY

Action/Event: In a surprise announcement, the NAIC Capital Adequacy Task Force recently proposed increasing the capital charge on direct commercial mortgages to 4.0% from 2.6% currently. In a worst case scenario, the increased capital charge could reduce risk based capital ratios in the sector by 6% on average. See Exhibit 1 & 2 for estimated individual company impacts.

Details of the Proposal: The proposal would increase the base capital charge to 4% from 2.6% for direct commercial mortgage loans. Longer term, the proposal also considers replacing the MEAF (Mortgage Experience Adjustment Factor) with a more dynamic approach tied to debt service coverage levels rather than a more static approach tied to industry delinquency/default trends. Another possibility is that the band of capital charges for the MEAF
could be expanded from its new range of 75% to 125% of the base capital charge. The comment period ends on April 16th at which time the Capital Adequacy Task Force can send the proposal to the Financial Conditions Committee prior to the Executive Board taking up the proposal.

The changes may get watered down as negotiations between the ACLI (the insurance industry trade group) and the NAIC (national regulatory council) play out, so we view the 4% charge as a worst case. We are assuming that all of the public life insurance companies are at the lower end of the MEAF band (75%) so the incremental impact is 75% of the 1.4% proposed change. There may be tax and covariance offsets that could further mitigate here

Impact of Potential Increased Commercial Mortgage Capital Charge

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