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Another private mortgage insurer taps capital markets for reinsurance

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Essent Guaranty is marketing $360.75 million of notes whose performance is linked to that of a pool of mortgages that the company insures. Should losses on the mortgage reach a predetermined level, investors will forfeit some of their principal.

It’s following in the footsteps of Arch Capital, which completed a similar transaction last year.

Both transactions are similar to programs that Fannie Mae and Freddie Mac have used since 2013 to offload the risk of losses on mortgages that they insure. In both Essent and Arch’s transactions, however, what’s being reinsured is no more than 20% of the balance of the mortgages.

To qualify for a conforming mortgage, borrowers must either make a 20% down payment or purchase a private policy that reimburses the servicer a portion of the difference between the outstanding balance of the defaulted mortgage and what's recovered from the real estate owned property sale. The GSEs insure the remaining balance of a loan.

The underlying balance of mortgage loans covered by the policies is $40.55 billion, but the mortgage-insurance policy coverage amount is $9.98 billion, according to Morningstar Credit Ratings.

Most of the loans being reinsured in this transaction, dubbed Radnor Re 2018-1, meet criteria to be acquired and reinsured by Fannie or Freddie. So, in theory, at least, investors purchasing notes could be acquiring exposure to some of the same loans reinsured by Fannie’s Connecticut Avenue Securities or Freddie’s Structured Agency Credit Risk deals.

Three classes of floating-rate notes are on offer: $161.3 million of Class M-1 notes with a preliminary BBB rating; $178.3 million of Class M-2 notes rated BB-; and $21.1 million of Class B-1 notes rated B+. The most subordinate tranche of notes to be issued, the $224.6 million Class B-2 notes, represent the first-loss position.

The final scheduled payment for all of the notes is March 2028.

Among the strengths of the deal, according to Morningstar, is the fact that the overwhelming majority of the loans being reinsured conform to Fannie and Freddie’s underwriting guidelines. To date, none of the loans have been reported as being in default and none have been modified. There are no interest-only loans, and 99.8% of loans have full documentation.

Moreover, the pool is diverse, with 175,653 loans, which reduces geographic concentration risks.

Also, Essent is retaining at least 50% of the Class B-2H notes, which represent the first dollar of losses, which keeps its interests aligned with those of investors.

Morningstar cites as a risk the fact that Essent samples only a fraction, typically less than 7%, of the loan population for quality control. And none of the mortgage loans, regardless of the due diligence grades assigned, will be removed from the pool. The sampling was not expanded to seek out other loans with possible similar defects. “This might lead to inclusion of loans that would otherwise be excluded with a full-population quality-control,” the presale report states.

Essent was formed in 2008 and underwrote its first private mortgage insurance policy in May 2010. It had approximately $103.9 billion of insurance in force and was issuing over 150 master policies a month as of Sept. 30, 2017.

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Credit risk transfers RMBS PMI GSEs Fannie Mae Freddie Mac