Statutory Accounting Principles Working Group s1

Ref #2016-39

Statutory Accounting Principles (E) Working Group

Maintenance Agenda Submission Form

Form A

Issue: Mortgage Loans With Multiple Lenders

Check (applicable entity):

P/C Life Health

Modification of existing SSAP

New Issue or SSAP

Interpretation

Description of Issue:

The Investment Classification Project (detailed in agenda item #2013-36) supported a review of the investment SSAPs to address a variety of application questions, mostly focusing on definitions and scope limitations of each of the noted SSAPs. In response to an industry inquiry, SSAP No. 37—Mortgage Loans was included within the Investment Classification Project, with a specific focus to consider whether a partial interest in a mortgage loan (in which there is one borrower, with more than one lender identified in a single lending agreement, and all lenders are secured with the same real estate) should be in scope of SSAP No. 37, and reported in a similar manner as other mortgage loans on Schedule B.

The mortgage loan structures intended to be the focus of this agenda item are investments when the reporting entity/ investor is a “participant in a mortgage loan.” This focus intends to consider standard mortgage loan agreements (with principal and interest payments) in which the mortgage loan agreement identifies more than one lender providing the funds to a sole borrower in a single loan agreement. These generally occur for larger commercial mortgage loans. The use of the term “participant” to identify these mortgage loan structures shall not be interpreted as encompassing “participating mortgages.” In a “participating mortgage” the lender is entitled to share in the rental or resale proceeds from the property by the borrower, generally as a certain percentage of the cash flows generated from the real estate acquired with the mortgage loan. Furthermore, this agenda item is not intended to encompass an interest in a “fund” with underlying real estate assets (such as a Real Estate Investment Trust—REIT).

A scenario of the structure intended to be captured within this agenda item is listed below:

· Five reporting entities each provide a $400,000 commercial mortgage loan to a single borrower.

· Mortgage loan is secured by a single $2,000,000 commercial real estate structure.

· None of the lenders can foreclose on the borrower without all lenders agreeing to foreclose.

· This is not a “securitization” in which the lenders are issued a security representing an interest in cash flows, supported by the real estate collateral held in trust. Instead, the five lenders are all identified as lenders in the single loan agreement (“as participants in a mortgage loan”).

Pursuant to the guidance in SSAP No. 37, mortgage loans are defined as a debt obligation that is not a security, which is secured by a mortgage on real estate. Within the definition of a
“security” in SSAP No. 37 (definition adopted from U.S. GAAP), a “participation” is specifically noted. As such, some have concluded that an insurer as a “participant” in a group mortgage loan agreement results with these mortgage loan structures being outside the scope of SSAP No. 37.

Excerpt from SSAP No. 37:

2. A mortgage loan is defined as a debt obligation that is not a security, which is secured by a mortgage on real estate. (A security is a share, participation, or other interest in property or in an enterprise of the issuer or an obligation of the issuer that (a) either is represented by an instrument issued in bearer or registered form, or if not represented by an instrument, is registered in books maintained to record transfers by or on behalf of the issuer, (b) is of a type commonly dealt in on securities exchanges or markets or, when represented by an instrument, is commonly recognized in any area in which it is issued or dealt in as a medium for investment, and (c) either is one of a class or series or by its terms is divisible into a class or series of shares, participations, interests, or obligations).

From comments originally received, these transactions reflect “loan participation agreements” backed by real estate, in which a mortgage loan is made by multiple lenders to a single borrower. It has been communicated that the key difference between this “participant” agreement and a standard mortgage loan (one lender) is that the reporting entity is unable to unilaterally foreclose on the loan. Instead, all lenders identified as a “participant” in the group transaction must agree to foreclose on the mortgage loan. This structure appears to be similar to a bank loan acquired through a syndication, except that the loan is secured with real estate collateral. (Bank loans are captured within SSAP No. 26—Bonds; the Investment Classification Project revisions currently being considered for that SSAP would clarify that bank loans are not securities, but are fixed-income investments specifically noted for inclusion in SSAP No. 26. Definitions for bank loans acquired by assignment, participation or syndication are also proposed with the current exposures under the Investment Classification Project.)

Although this “group mortgage loan” issue was requested to be considered by the Working Group as part of the Investment Classification Project, the Annual Statement Instructions already include guidance which implies that “loans subject to a participation agreement” would be captured in Schedule B – Part 1:

Column 14 – Value of Land and Buildings:

Report the appraisal value of the property (for land and buildings). For loans subject to a participation agreement, include only the reporting entity’s pro rata share of the appraised value as it relates to the reporting entity’s interest in the mortgage loan.

The intent of this agenda item is to clarify the SSAP that should address these transactions, and clarify the appropriate reporting schedule for consistency purposes. Based on the substance of these items, as well as the current guidance in Schedule B-Part 1, initial proposed revisions (detailed in the staff recommendation) propose to clarify the inclusion of these agreements in SSAP No. 37—Mortgage Loans. However, the Working Group could consider other SSAPs / reporting structures. Regardless of the SSAP identified, it is anticipated that revisions would be needed to clarify the inclusion of these items within that SSAP.

A summary of possible SSAPs that could be considered by the Working Group is listed below:

· SSAP No. 37—Mortgage Loan: This SSAP would reflect the investment as a mortgage loan (secured by real estate), and would allow the mortgage loan to be recorded at the principal amount of the loan made by a specific reporting entity. Revisions to the SSAP are recommended to clarify the inclusion of these structures within scope, as well as propose guidance for the assessment of impairment to ensure comparisons based on the full amount loaned by the group of lenders to the fair value of the real estate, rather than a comparison of the amount loaned by the reporting entity to the full fair value of the real estate. If included within this SSAP, the mortgage loan would be reported on Schedule B. Under current RBC factors, for health and p/c companies, the RBC would be .05, and for life companies, RBC would depend on the type of loan, status (good standing, 90-days past due, or in foreclosure) and loan-to-value and debt-service coverage.

o Staff Note: As identified above, staff recommends SSAP No. 37 for these agreements. This is also consistent with existing Annual Statement Instructions.

· SSAP No. 21—Other Admitted Assets: This SSAP would reflect that the transaction is a “collateral loan” as an unconditional obligation for the payment of money secured by the pledge of an investment. This standard allows the loan balance to be admitted if the collateral qualifies as an investment to the extent that the collateral equals or exceeds the outstanding loan balance. If captured within SSAP No. 21, the investment would be reported on BA and the RBC for p/c and health companies would be 20%, and the RBC companies for life companies would be 30%.

o Staff Note: If the decision is made to not include these transactions within SSAP No. 37 (perhaps as a result of the group foreclosure restrictions), staff would recommend inclusion within SSAP No. 21 as a collateral loan. This would continue to reflect that a reporting entity acting as a “participant” in a mortgage loan agreement (as defined in this agenda item) does not result with the loan being considered a “security.” Classification within SSAP No. 21 (reported on Schedule BA) would result with a much higher RBC, particularly for mortgage loans that are in good standing. As the life RBC for mortgage loans (Schedule B) considers a variety of components (loan standing, loan-to-value ratio and debt service coverage), inclusion on BA may be perceived to result with an uncorrelated RBC as it does not consider elements specific to the mortgage loan.

· SSAP No. 26—Bonds: This SSAP would reflect the reporting entity’s “participant” structure as a “security” representing a creditor relationship whereby there is a fixed schedule for one or more future payments. If captured under this SSAP, the accounting and reporting of the loan would depend on an NAIC designation (requiring a credit assessment of the borrower), with either an amortized cost or fair value measurement method. (This SSAP would not consider the real estate collateral in valuation.) Although this approach could result with a more desirable RBC (on Schedule D-1), the original comments identified that obtaining an NRSRO rating for commercial mortgages is prohibitively expensive. If these items cannot be filed with the NAIC SVO, this could result with these structures being classified as 5* or 6*, with less desirable RBC.

o Staff Notes: It is staff’s initial interpretation that the “participant” lending structure is not intended to be captured within the “security” definition. Furthermore, the mortgage loan terms and real estate collateral is perceived to be a more relevant factor in determining valuation (e.g., impairment) and RBC then a credit assessment of the borrower (particularly if credit assessments are not feasible and the item is reported as a 5*).

· SSAP No. 43R—Loan-backed and Structured Securities: This SSAP would reflect the cash-flow nature of the transaction, as the reporting entity is entitled to a share of cash flows from the borrower’s repayment of mortgage loan. However, the security does not currently fit within the construct of SSAP No. 43R as the real asset collateral is not held in trust. If the investment was captured within this SSAP, the transactions would be reported on Schedule D-1, with RBC based on NAIC designation. (For SSAP No. 43R securities, the NAIC designation can be impacted if the security is financially modeled or not financially modeled, but with a CRP rating.)

o Staff Notes: Similar to the comments on SSAP No. 26, it is staff’s initial interpretation that the “participant lending” structure is not intended to be captured within the “security” definition. Also consistent, the mortgage loan terms and real estate collateral is perceived to be a more relevant factor in determining valuation (e.g., impairment) and RBC then a credit assessment of the borrower. Lastly, as this investment does not place the real estate collateral in a trust, revisions to incorporate an exception to the current SSAP No. 43R provisions would be necessary for inclusion in this SSAP.

· SSAP No. 48—Joint Ventures, Partnership and LLC: This SSAP could reflect the investment as a joint venture or partnership interest, but it does not seem that this mortgage loan structure would fit the intent of structures envisioned to be in scope, as this SSAP requires audited financial statements of the investee for admittance. If captured within this SSAP, the structure would be reported on Schedule BA as an other-than-invested asset with the underlying characteristic of a mortgage loan. If reported on BA, RBC for p/c and health companies would be 20%, and the RBC companies for life companies would be 30% unless the reporting entity filed the investment with the NAIC to receive a lower RBC.

o Staff Notes: As noted above, staff does not believe that this mortgage loan structure reflects the intent of what was to be captured within the scope of SSAP No. 48 as a joint venture or partnership. If captured within the scope of this SSAP, the reporting entity would need audited financial statements to be admitted.

Existing Authoritative Literature (underlining added for emphasis):

SSAP No. 37—Mortgage Loans

Schedule B – Part 1: Mortgage Loans Owned December 31 of Current Year

Column 14 – Value of Land and Buildings: