Arch MI does its first insurance-linked noted deal of 2020

Arch MI has completed its first insurance-linked notes offering of the year, getting $528 million of indemnity reinsurance on a pool of 163,292 mortgages with an unpaid principal balance of $44 billion.

The coverage was obtained by issuing approximately $450 million in bonds and $78.5 million in direct reinsurance. The loans involved were originated in the second half of 2019.

"We're pleased that we were able to bring this transaction to market during this period of uncertainty related to COVID-19," said Jim Bennison, executive vice president of alternative markets for Arch MI. "The response from both fixed income investors and reinsurers speaks to the attractiveness of our program. This is our eleventh Bellemeade transaction and the program remains an important tool for managing the risk and capital requirements of our U.S. Mortgage Insurance business."

The company claimed this deal was the first mortgage credit-risk transfer transaction since the pandemic started.

The first transaction with Bellemeade, a Bermuda-domiciled special purpose insurer, took place in 2015. United Guaranty — now a part of Arch MI but at the time a subsidiary of American International Group — obtained $299 million in coverage for mortgages written between 2009 and 2013.

There are three classes in this deal:
● The M-1A class with an unpaid principal balance of $252.1 million with a coupon equal to one-month Libor plus 265 basis points.

● The M-1B class of $171.5 million with a coupon equal to one-month Libor plus 340 basis points.
● The B-1 class of $26.4 million with a coupon equal to one-month Libor plus 440 basis points.

All Bellemeade transactions have incorporated language that accounts for a transition away from Libor when publication of that index is discontinued, an Arch spokesman said. It is anticipated that the changes for these will follow along the lines of the government-sponsored enterprises' credit risk transfer transactions.

A presale report issued by DBRS Morningstar gave the M-1A class an A (low) rating; the other two classes, M-1B and B-1 received BBB ratings.

Moody's also rated this transaction, with the M-1A class rated at A1, the M-1B at Baa1 and the B-1 at Baa2.

Both rating agencies accounted for a potential rise in coronavirus-related delinquencies in their respective assessments of the transaction.

One of the strengths of the deal, according to DBRS Morningstar, is the fact that nearly all of the loans included are agency-eligible, with high credit quality and no mortgages that are currently delinquent.

Another strength: 95.2% of the MI policies are of the borrower-paid type. That means they are automatically cancellable when a borrower who is current on their payments reaches a 78% loan-to-value ratio.

"Once terminated, this removes the ceding insurer's exposure to the mortgage loan and therefore reduces the risk to the transaction," DBRS Morningstar explained.

On the other hand, there is counterparty exposure, due to the servicer's obligation to ensure that any missed coverage premium payments are paid to the investors.

Another potential downside lies within the representation and warranty framework.

"The transaction is backed by MI policies and no loans are pledged to the trust. Hence, the ceding insurer will not directly make any R&W to noteholders regarding the underlying insured mortgage loans," DBRS Morningstar said.

For Moody's, the factors that could lead to a downgrade of the Bellemeade Re 2020-1 ratings include:
● Credit protection is insufficient to protect investors against current loss expectations.
● Losses are above the original expectations as a result of a higher number of defaults or deterioration in the value of the mortgaged property.
● The performance of the U.S. economy and housing market; and poor servicing, error on the part of transaction parties, inadequate transaction governance and fraud.

"Servicing practices, including tracking COVID-19-related loss mitigation activities, may vary among servicers in the transaction. These inconsistencies could impact reported collateral performance and affect the timing of any breach of performance triggers, the timing of policy terminations and the amount of ultimate net loss," Moody's said.