NEW YORK - While the use of lender-paid or "deep" mortgage insurance (deep MI) has become very popular as a form of credit enhancement in traditional, Alt-A MBS, subprime ABS deals and most recently, net interest margin (NIM) transactions, there are still many unknown factors and variables that have left analysts and market participants worried about potential pitfalls with its use.
At a Mortgage Market Update conference sponsored by Fitch in New York last week, analysts explained the basics of deep MI and how this type of policy differs from standard primary mortgage insurance (PMI), and reviewed some of the risks associated with this increasingly popular insurance option. They also discussed the advantages of using deep MI for NIM transactions.
Basically, deep MI is a series of individual loan policies that provide loss coverage at higher (deeper) levels than the GSE-mandated standards in the conforming prime sector. Premiums for lender-paid MI are paid from available funds in the cashflow waterfall, instead of being paid by the borrower. According to Fitch, this deeper MI can substantially reduce the need for additional credit enhancement (e.g. excess spread, overcollateralization, and/or subordination) for the pool.
The policies are now offered by several MI companies such as PMI Mortgage Insurance Co., Mortgage Guaranty Insurance Corp. and General Electric Mortgage Insurance Corp.
One of the most basic differences between standard, borrower-paid PMI and deep MI is that lender-paid MI lasts for the life of the loan and provides deep coverage often down to 60%, 50% or 40%, although 40 LTV is unusual, the analysts said. Standard coverage provides enhancement down to 75% LTV.
Additionally, standard PMI is arranged pursuant to GSE requirements, while deep MI is arranged pursuant to the economics of the deal. Further, with deep MI, coverage percentage and policy limitations are the same.
While deep MI can add value to a deal, Fitch managing director Steven Grundleger noted that certain credit concerns and historical payment issues are still being addressed by analysts. In particular, many insurance companies are rated AA, even though they are insuring AAA mortgage bonds. "It's important for us to know what the sources of credit enhancement are. When subordination is replaced by double-A insurance companies to protect the triple-A [bonds], we are not necessarily comfortable with it," Grundleger said. "We are not comfortable with more than two-thirds insurance coming from double-A mortgage insurers."
Of course, the rating of the mortgage insurer is key to the ratings of the securities, so if a downgrade occurs for a double-A-rated insurer, the triple-A-rated securities will be downgraded as well.
Moreover, the application of deep MI to the subprime sector is problematic: there is limited MI claims history on subprime mortgage defaults. That means that there is a real risk of less-than- 100% claim recoveries that has not yet been quantified. Therefore, Fitch has been canvassing insurers, servicers and other participants to gather more information about non-MI credit enhancement requirements in light of these risks.
Lender-paid MI, bond
insurance and NIMs
The Fitch analysts also pointed out a growing trend of using lender-paid MI for net interest margin (NIM) transactions, which are securitizations of excess spread receivables and other cash flows from existing ABS transactions, and the newer "NIMlet" deals, which have been backed by residuals of a single transaction, usually securitized at the same time.
Since NIM transactions provide a method for monetizing residual cashflows, and the cashflow to the NIM is subordinated to the cash flow requirements of the underlying deal, lender-paid MI's effect on excess spread cashflows can improve deals in two ways, according to Stephen Lei of Fitch.
First, the premiums paid out of available funds reduce the amount of excess spread. Secondly, the mortgage insurance lowers the potential loss severity on the mortgage loans with the insurance coverage. This results in lower-than-expected losses for those loans and the entire collateral pool. Thus, less excess spread would be expected to be used to cover collateral losses.
According to a recent Fitch report, "Generally, this results in a larger NIM transaction relative to the size of the underlying deal than would be the case without lender-paid mortgage insurance. "
"Mortgage insurance provides funding for NIM cashflows," said Lei at the conference. "This is good, since the more losses on underlying collateral, the less cash to the NIM."
Other trends within NIM securitizations is the increasing use of bond insurance for additional credit enhancement purposes. Although bond insurance is different from monoline surety wraps, it functions essentially the same way, by guaranteeing the timely payment of interest and the ultimate payment of principal on the NIM bond.
"A NIM structured to withstand Fitch's BB' stress scenarios can be enhanced by bond insurance to obtain a A' or AA' rating," said the recent Fitch report. "The NIM bond can then be further enhanced, if desired, to a AAA' rating with the support of one of the AAA' rated financial guarantors."
Still, analysts scrutinize these NIM deals intensely and are very particular about which deals they choose to rate. "We don't rate every NIM we see," Lei said. "We rate them if we feel comfortable with them."
