National Mortgage Insurance is preparing its first rated offering of notes linked to the performance of mortgages that the company insures. Should losses on a pool of $5.47 billion of mortgage insurance policies reach a predetermined level, investors in the $264.5 million of rated notes to be issued in Oaktown Re II will forfeit some of their principal.

NMI follows on the heels of Arch Capital and Essent Guaranty, which completed similar transactions over the past year.

All three 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 NMI, 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 policies that NMI is reinsuring are linked to conforming residential loans with a total balance of $30.21 billion, according to Morningstar Credit Ratings. These loans are fully amortizing, fixed and variable-rate, first-lien loans that have never been reported as in default. The pool is geographically diverse, with the largest state concentration in California at approximately 14.1% of the balance. There are no interest-only loans, and all loans fully document borrower income.

Morningstar has assigned preliminary ratings to a three classes of notes totaling $264.55 million: The Class M-1, which benefit from 4.6% credit support, are provisionally rated BBB-; The Class M-2 notes, which have 2.6% credit support, are rated BB-; and the Class B-1 notes with 2.25% credit support are rated B+.

The the $5.18 billion senior tranche of Class A notes will not be rated, nor will the $125,311 tranche of Class B2 notes, which is the most subordinate tranche and first in line to take losses.

Among the strengths of the deal, according to Morningstar, is the fact that it is scheduled to mature by July 2028, and so subjects investors to fewer losses then they might have to absorb if the notes remained outstanding as long as the 30-year mortgages being reinsured.

Also, NMI is keeping skin in the game, by holding on at least 5% of the unrated B-2 notes, which are last in line to be repaid and so stand to absorb the first dollar of losses.

Risks to the deal include the fact that a third-party diligence provider sampled less than 0.5% of the loan population for quality control. None of the mortgage loans, regardless of the due diligence grades assigned, will be removed from the pool. The sampling was not expanded to identify other loans with similar defects. “This might lead to including loans that would otherwise be excluded with a quality control review of the entire loan population,” Morningstar stated in its presale report.

NMI was founded in 2012 and issued its first mortgage insurance policy in 2013. As of March 31, 2018, it had $53.4 billion of primary insurance in force with a weighted-average 749 FICO score. The company has over 300 employees and is headquartered in Emeryville, Calif.

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