Arch, Essent go head-to-head with credit risk transfer deals
Arch Capital’s next offering of credit risk transfer notes features heavy exposure to residential mortgages that have been modified by Fannie Mae or Freddie Mac.
Bellemeade Re 2019-1 will issue six tranches of notes that reference a pool of $22.97 billion of mortgages, nearly three-quarters of them made before 2010; two of Arch’s affiliates, Arch Mortgage Insurance and United Guaranty Residential Insurance, provide $5.94 billion of insurance on the pool. The transaction will transfer $351.8 million of this risk to investors who purchase the rated notes.
Nearly half of the mortgages have been modified either under government-sponsored enterprise modification programs (HARP, 31.6%, and HAMP, 10.5%) or servicer modification programs (7%). Approximately 35.7% of the loans have experienced delinquencies, but about 88.2% of the loans by cutoff balance have been reported current for at least 24 months.
This is far more exposure to modified loans than any of Arch’s other credit risk transfer notes, according to Morningstar Credit Ratings. By comparison, the only other deal Arch completed reinsuring seasoned loans, Bellemeade Re 2018-2, had only 0.05% exposure to modified loans, and 98.2% of the loans had never been delinquent.
While the loans in the pool have benefited from the home price appreciation over the past few years, modified loans are generally considered to be at higher risk of defaulting than loans that have never defaulted.
Adding to the risk, according to Morningstar, is the fact that the Arch has entered into a settlement agreement for approximately 38.3% of the loans that restricts it from denying or curtailing claims or terminating coverage on the basis of most origination defects and servicing-related conduct. And for a 4.3% subset of these loans, Arch is required to pay claims based on original balance of the loan and a fixed factor (either 1.12 or 1.02). This increases the amount that the ceding insurer has to pay.
About 24.5% of the loans by balance are in Florida, Illinois, Texas and California.
This increased risk is reflected in Morningstar’s ratings for the notes, which are lower than those of comparable tranches of Arch’s prior credit risk transfer deals.
The Level B-2 notes, which represent the first-loss position, are being retained by Arch and so are unrated.
The Class B-1 notes, which provide coverage when losses on the reference pool reach 3.5% of the original principal, are rated B+, several notches lower than the A on the comparable tranche of Bellemeade Re 2018-2.
The Class M-2 notes, which provide coverage when losses on the pool reach 3.75%, are rated BB-; the comparable tranche of Bellemeade Re 2018-2 was also rated A.
The Class M-1B notes, which provide coverage when losses on the pool reach 5.3%, are rated BBB-; the comparable tranche of Bellemeade Re 2018-2 was rated AA.
The Class M-1A notes which provide coverage when losses on the pool reach 7.1%, are rated A-; the comparable tranche of Bellemeade Re 2018-2 was rated AAA.
And the most senior tranche of notes, which provide coverage when losses on the pool reach 9.25%, are unrated and are being retained by Arch.
Proceeds from issuance of the notes will be deposited into a trust and will be available to reimburse Arch for losses covered by the insurance policies; if any funds are withdrawn, the balance of most junior notes outstanding will be written down by a corresponding amount. Interest payments on the notes will be funded through insurance coverage premiums collected by Arch from the borrowers.
Arch’s deal was launched the same day as a transaction by Essent Guaranty that references a larger pool of mortgages that were originated much more recently and have never been delinquent.
Radnor Re 2019-1 transfers the credit risk on $45.04 billion of loans with aggregate mortgage insurance of $11.27 billion. The notes to be issued reinsure $443.9 million of this coverage.
By some measures, the loans that Radnor Re 2019-1 reinsures are safer. The weighted average balance is higher, at $244,834 (versus $150,579 for Bellemeade Re 2019-1), but the weighted average original FICO is also higher at 745 (707).
While none of the loans Radnor Re reinsures have ever been delinquent, the weighted average seasoning is only six months, compared with 126 months for Bellemeade Re.
The two deals have identical weighted average coupons of 4.07%.
However, borrowers that Radnor reinsures have less equity in their homes; the weighted average current loan-to-value ratio is 90%, significantly higher than 76.9% for Bellemeade Re. And Morningstar expects that valuations could fall more sharply in a scenario similar to the housing crisis, by up to 38.1% on a weighted average basis, compared with 37.5% for homes in Bellemeade Re’s pool.
Radnor Re also resinsures a larger portion of credit risk than does Bellemeade Re; coverage kicks in when losses reach 2.25%, versus 3.5% for Bellemeade.
Essent is retaining the Class B-2H notes, which take the first loss; the Class B-1 notes, which provide coverage when losses on the reference pool reach 2.25%, are rated B+; while the Class M-2 notes, which provide coverage at 2.5%, are rated BB-; the Class M-1B notes, which provide coverage at 4.6%, are rated BBB-; and the Class M-1A notes, which provide coverage at 6.5%, are rated A-. Essent is retaining the senior tranche of notes, which provide coverage at 7.5% and are unrated.