A recent swap deal for $100 million of repackaged seasoned adjustable-rate mortgage-backed securities issued by real estate investment trust Thornburg Mortgage Asset Corp. may have presented the first instance ever in which a mortgage pool insurer - PMI Mortgage Insurance Corp. - decided to extend the term of its coverage for old loan pools at the issuer's request, sources say.
According to PMI and Thornburg officials, this unusual policy exception was made in order to accomplish credit enhancement goals and achieve a reduced loss amount on the securitized loans.
This decision is particularly surprising to most market players, however, because the majority of mortgage insurance companies stopped writing pool insurance in the mid-nineties, and almost all MI companies - including General Electric Mortgage Insurance Co., which flat-out refused to extend coverage for Thornburg on the same deal - will certainly not insure brand new pools, let alone old ones.
"People are divided on this subject, even within the same mortgage insurance company," said Larry Goldstone, president of Thornburg. "They generally fall into two camps: Either they think the extension of coverage looks attractive from an economic standpoint, and they want to reduce exposure. Or, on the other side, there are forward-looking people who think that capital should not be allocated for old lines of businesses, such as pool insurance. But we certainly were surprised and pleased that PMI agreed to do it, even though they've been trying to get out of that business since the early 90s."
An Unusual Deal
The private placement transaction at issue was launched during the summer (MBSL 7/26/99) and was backed by hybrid ARM loans securitized and packaged by Donaldson, Lufkin & Jenrette Securities. The offering was based on the collateral backing six securities that were called by the master servicer, PNC Mortgage Securities Corp., and then the collateral was sold.
DLJ then bought the loans from PNC and issued Thornburg a new security collateralized by the remaining loans.
All of the previous ARM collateral, which was six- and seven-year-old paper, carried pool insurance from prior deals from both PMI and Gemico. According to Deborah Burns, director of securitization for Thornburg, the company asked PMI if it would roll over or issue a modified pool policy for all the loans in the DLJ security, which they agreed to do.
The new security was rated AA by Standard & Poor's Ratings Group because PMI is a double-A-rated insurer. Thornburg did not sell the security, and instead kept it for its own portfolio, a strategy it has adopted in order to get the lowest cost financing for its own securities.
"This was a nice piece of paper to hold indefinitely," Burns said. "There was good execution on the securitization and it fit our portfolio nicely. We asked the insurers if they'd extend the pool insurance to the new security, since it is the same collateral it has insured all along. S&P gave stop-loss levels, and PMI priced out the premium, issuing a new policy number to replace the old one. It was a great deal for us, and if I ever have a seasoned pool of loans that have insurance, I would take a run on it again.
"But if it was [insured by] GE, I wouldn't have a shot," she said.
Dissension At The Top?
According to market sources, extension of insurance for seasoned loans is a thorny issue, purportedly causing disagreements at the highest levels of management at many mortgage insurance companies.
Though a large part of the reason that PMI agreed to the Thornburg deal was the nature of the loans - it is easier to price risk on seven-year-old loans with a good track record than on a blind pool - mortgage-insurance companies are still grappling with their policies as they weigh the pros and cons of granting extended coverage.
"The Thornburg deal was an exception to the rule," said Mark Berkowitz, vice president and assistant controller of structured transactions operations at San Francisco-based PMI. "This is not something we are looking to do a lot of in the future. In the past the trust has been collapsed and we only insured, perhaps, those loans in a delinquent status. However, in this case, this was a relatively small transaction for us, and we were providing the credit enhancement already for PNC, so we saw it as a natural extension."
According to Berkowitz, the company will take similar situations on a case-by-case situation going forward. "Our goal going forward is to devote our capital to new business in primary mortgage insurance, which is our core business. To do this coverage for old agency pool businesses from the early 90s does not make sense, because there is just a limited amount of capital within our industry."
Even though the company has not been presented with many similar transactions, there could be a potential that PMI would extend the coverage again. After all, Berkowitz says, there are many older businesses that have paid down dramatically, and firms such as PNC might be looking to sell these portfolios.
Maybe It's Logical
In fact, according to Mark Norton, director of institutional markets at PMI, it even makes sense to have a policy of accommodating customer requests, mainly because all mortgage-insurance companies have the same incentives: Lowering risk exposure and the amount of capital it has to reserve against these policies; in essence, this amounts to lowering liabilities, says Norton.
"If you have a $100 million pool and a rating agency said you need $10 million of credit enhancement for a triple-A rating, as the mortgage portfolio pays down, maybe the pool goes to $40 million or $50 million, but the credit enhancement still stays at $10 million," said Norton. "The credit insurer has to allocate capital against 100% of that allocation. The stop-loss will go up, but there are fewer loans. So, if we consolidate these old policies, we will lower stop-loss and give an appropriate one according to the rating agency's requirements."
Therefore, a lowering of the stop-loss will cause premiums to go down - a "win-win" situation, explains Norton. "In this way, we don't have to devote as much capital, and the customer saves money because of a reduced premium, and now the stop-loss is more appropriate."
"In terms of a pure risk-versus-rate-of-returns standpoint, I think the transaction made good economic sense for [PMI]," added Thornburg's Goldstone.
Still, it is not clear whether this will be an ongoing business strategy for either PMI or Thornburg.
Thornburg, after all, is an important client for PMI, and the decision to comply might have been an attempt to bolster that business relationship.
Though Norton seemed to recall a "smattering" of past instances where PMI "complied with issuers' requests," the Thornburg deal seems to have been an unusual situation overall.
"As far as I know, this is the first instance," said Berkowitz.
Neither PMI official could confirm whether the company had a backlog of similar loans outstanding or whether this would happen again in the future.
"Let's just say that frequently it is in our economic interest," Norton said. "We are sometimes better off lowering our capital and lowering our liability. But we don't have a sign put out saying that we will do this for companies."
