Tapping the capital markets for reinsurance does more for mortgage insurers than just reduce their exposure to a downturn in the housing market. It also provides them with information about how others view this credit risk.
One day, this information could be used to adjust premiums.
Arch Capital Group, the largest private mortgage insurer, comes to market twice a year with notes whose performance is linked to insurance policies underwritten over the previous six months. Pricing of these notes provides information about investors views of credit risk that flows back to Arch's premium pricing team.
"To date, there have not been any actual adjustments on the front end, [credit risk transfer] execution has been good," Jim Bennison, executive vice president for capital markets, said at the Structured Finance Industry Group's annual conference in Las Vegas. "But at some point that will likely change as we go through a normal housing cycle."
Bennison noted that the private mortgage insurance industry traditionally used a fairly flat premium that was cross-subsidized; borrowers paid the same rate, regardless of credit quality. The financial crisis demonstrated that this credit risk had been underpriced, as many private mortgage insurers sustained losses. Arch moved to risk-based pricing in 2009.
Similarly, the capital market transactions that Fannie Mae and Freddie Mac use to offload credit risk provide information about how the market views the guarantee fees, or g-fees, that the two companies charge lenders.
"There’s no current linkage, but the FHFA does monitor CRT execution," said Mike Reynolds, vice president for credit risk transfer at Freddie Mac, referring to the Federal Housing Finance Agency.
Reynolds, who was speaking on the same panel, noted that pricing of Freddie's benchmark Structured Agency Credit Risk program is becoming more transparent as the company has been offloading the riskiest tranches of securities issued in these deals. And with over 200 investors, the market for GSE credit risk transfer is very robust, he said. "At a minimum, it’s very informative to the FHFA."
