Despite initial trepidation, investors of subprime real estate product are warming to the idea of purchasing paper with exposure to loans backed by deep MI, or lender-purchased insurance.
Now, following deals from benchmark issuers Chase Funding, Countrywide Home Loans and Residential Funding Corp., investors are forced to learn the intricacies of this relatively new risk-management tool.
Due to the additional analysis needed on the part of investors, some buysiders had chosen to avoid exposure to paper with insured loans in the pool. But the recent acceptance of deep MI on the part of major issuers and subsequent success of the offerings signals a general acceptance in the market with more such deals to come.
"Since top-tier issuers are now bringing more deals with deep MI, investors are forced to pay attention to MI, as this practice is becoming more mainstream," said Ivan Gjaja, analyst at Salomon Smith Barney, who tackled the subject in a recent research report.
Gjaja pointed out the rapid evolution of this development within the subprime sector, noting that as recently as March, there "was a fair amount of skepticism" on the part of investors regarding buying MI-insured paper.
Rating agencies increase awareness
Helping its evolution are the rating agencies, who have control over setting subordination levels for individual offerings. The agencies have been instrumental in showing the economic benefits of purchasing deep MI, rather than a monoline wrap.
Even once-leery issuer Residential Funding Corp., for example, has changed its tune and brought MI deals to market. "While deep MI has been in the marketplace for the last 12 months, it took us a long time to get comfortable with it," said RFC executive vice president of capital markets Eric Scholts in a recent interview.
But some of the most frequent names in the subprime sector are still skeptical, notably Jeff Upperman of Centex Corp., who reports that for Centex's most recent offering some investors indicated no interest in purchasing paper with MI exposure.
Upperman added that the primary sticking points for investors centered on the ability of claims to be paid on the insured loans. "To investors it is unknown how many claims will be rejected," he said.
Countering, Tim Edwards at mortgage insurer MGIC Investment Corp. said that insurers are "fighting the misperception that we (insurers) can arbitrarily deny claims."
Unlike monoline wraps, which insure the payment of interest and principal, deep MI more closely resembles standard insurance products. Insurers assess each claim individually and decide what percentage, if any, will be recouped.
While Centex's Upperman added that he takes a deal-by-deal approach to analyzing what features to include in potential new issues and that they have looked into MI-loan backed offerings, "the economics weren't in favor" of insuring past offerings with deep MI. "We had to think of the all-in rate, if certain investors hadn't participated in our deal," Upperman said.
"This is a problem of assessing the risk of the unknown," according to Matthew Whalen, vp of the ABS group for JP Morgan Securities. "If there were years of empirical data on the subject, investors would be lining up. But until there is enough data on the subject there will be some investors staying out."
Helping the cause, Whalen added, is the fact that benchmark issuers have embraced deep MI: "From an investor standpoint you want to see an issuer like RFC with an (insured) deal. You want issuers who will be thorough in evaluating whether to get into the area of the market."