How does the Teachers Insurance and Annuity Association maintain an AAA rating when 25% of its $20.2 billion commercial mortgage portfolio - which accounts for 28% of total assets -is described as having underperforming mortgages and foreclosed properties?
Other insurance companies with similar percentages of troubled mortgages required cash infusions or went out of business.
One reason the insurance company/pension fund didn't have similar problems is its liability structure, allowing 10 years to pay policyholders that decide to exit the system. The $73 billion annuitant can operate with a long time horizon because of this stable and orderly call for money.
The other reason is the portfolio isn't as bad as the numbers indicate. Insurance company regulations force TIAA to reclassify as "restructured" mortgages with altered terms, even if those mortgages pay above-market rates.
According to John Somers, senior vice president of TIAA's mortgage and real estate division, about 40% of the insurer's restructured loans, which total $3.8 billion, were made in the 1970s and 1980s. Those loans had 30-year terms, high coupons by today's standards, and gave TIAA equity participation.
When the real estate depression hit and borrowers were unable to meet the original terms, TIAA restructured the mortgages, setting the new rate at 100 basis points below the property's cash flow.
Also as part of the restructuring agreements, the spread between the cash flow and the interest rate of the mortgage is put into escrow, and a capital infusion by the borrower is required, which also goes to escrow.
TIAA forecloses if the borrower can't meet these criteria, Mr. Somers said. Foreclosed properties constituted $244 million of the TIAA mortgage portfolio at the end of 1994.
TIAA isn't in a hurry to get its money back from borrowers, according to Mr. Somers.
"We insist that we stay in for 10 years," said Mr. Somers."If we think the property (turnaround) will be profitable for the borrower, he has to stay in with us.
"I could sell our restructured portfolio at par and get our money back. (But) I won't accept it."
Mr. Somers reasons TIAA couldn't reinvest the money at a rate equal to what it could earn on its restructured mortgages.
"They (policyholders) understand that while these are restructured loans, they are not underperforming, compared with market rates of return today," said Mr. Somers.
Other insurance companies with problem commercial mortgages had to dispose of them quicker because the mortgages - known as bullets - were matched to maturing guaranteed investment contract obligations, which TIAA doesn't have.
Underperforming mortgages at The Travelers Corp. made up 38% of all mortgages in 1993, 42% in 1992, and 25% in 1991. For Aetna Life and Casualty Co., underperforming mortgages comprised 24% of the total portfolio in 1993, 21% in 1992, and 12% in 1991.
Underperforming mortgages and foreclosed real estate made up almost 26% of TIAA's commercial mortgage portfolio at the end of 1994, a slight improvement from 1993's 27.5%. Underperforming mortgages and foreclosed real estate totaled 21.5% in 1992.
TIAA does have bullets; $900 million comes due in 1996, rising to $1.1 billion in 1998. Mr. Somers said those mortgages are in good shape.
"None of them is bad," he said. "The rates are in excess of 10%. Those loans (written) today are yielding 8% to 81/4%. The benefit of them maturing is to the borrower," he said.
TIAA does have a continuing problem with mortgages on property in Southern California. The region was the last to go into recession in the early 1990s and remains troubled for pre-1992 lenders.
Almost 27% of TIAA's commercial mortgage geographic exposure is in the West; 84% of these mortgages are in California, and Mr. Somers estimates the value between $300 million and $400 million.
Most of TIAA's problems in California are in the five-county area surrounding Los Angeles. But Mr. Somers said he expects the problems in that region to be resolved by the end of the year.
"The offices have been the problem," said Mr. Somers. "We'll probably have a few foreclosures.
"It's difficult when rents drop 40%, 50%, 60%," said Mr. Somers, who attributed the cutback in defense spending for the decline in the region's property market.
Mr. Somers noted bullet loans maturing in 1996 were well diversified, with the West accounting for about 23% of the maturities beginning in 1996.