Arch says Covid-19 unlikely to trigger Bellemeade Re mortgage ILS

Arch Capital Group Ltd., the Bermuda headquartered insurance and reinsurance specialist, has said that it expects the amortisation of its Bellemeade Re mortgage insurance-linked securities (ILS) transactions may be halted by an expected rise in delinquencies due to the coronavirus pandemic.

But, Arch does not at this time expect that losses to its mortgage insurance portfolio will rise sufficiently high to trigger any reinsurance recoveries under the Bellemeade Re series of mortgage insurance-linked notes deals.

Arch has been sponsoring Bellemeade Re mortgage ILS deals for a number of years now, with the insurance-linked securities a key source of capital markets backed mortgage reinsurance protection for the firms portfolios of U.S. mortgage insurance risk.

Currently Arch Capital has issued more than $4.7 billion of mortgage ILS transactions, a significant boost to its reinsurance arrangements.

But, while these mortgage ILS deals have long tenures, the outstanding protection is not the same as the amount of mortgage insurance-linked notes issued, as these securities amortise over time, paying down to the investors that backed them.

But, in exceptional circumstances, there are clauses in the Bellemeade Re mortgage ILS and other similar mortgage ILN transactions, that mean the amortisation can be stopped, so that the available reinsurance coverage doesn’t continue to shrink while potential losses continue to develop.

Covid-19 is such an exceptional circumstance, as it threatens to elevate mortgage delinquencies significantly and as a result could drive potentially significant mortgage insurance losses to specialist underwriters of that risk like Arch.

Speaking recently, François Morin, Arch Capital’s Chief Financial Officer, explained how the Bellemeade Re mortgage ILS may respond to the expected increase in mortgage delinquencies that are coming as a result of the Covid-19 pandemic and the related economic fall-out in the United States.

“The Bellemeade protections, as you probably know, amortise over time, but there’s a trigger on them that once you exceed a certain level of delinquencies, they stop amortising,” Morin explained.

“And that, we expect will happen most likely sometime in 2020, maybe in the second quarter, maybe in the third quarter, maybe later,” he continued.

He further said, “That will basically freeze, at least for some period, the amount of coverage that is available to us and would remain most likely for the duration of each of those structures.”

The Bellemeade Re mortgage ILS have specific terms to halt the amortisation for a period of time, we understand, before it restarts again.

The feature is there to ensure that if mortgage insurance losses are developing from what constitutes a covered event, such as a recession, that the mortgage reinsurance coverage hasn’t amortised away before the mortgage ILS transactions get a chance to pay out to the benefit of their sponsor

However, Morin went on to explain that this doesn’t mean Arch is expecting to make any reinsurance recoveries under the Bellemeade Re series of mortgage ILS deals.

“We do not expect, under most scenarios, that we would trigger the coverage provided by the Bellemeade protections,” Morin said. “So the $3 billion of excess-of-loss cover that we talk about, we know its available, we know it’s there, but at this time under most scenarios we don’t expect to pierce the attachment where we’d start to receive coverage or cede some of our exposures.”

Morin explained that its very difficult at this time to talk about how much of the deductible beneath the mortgage reinsurance protection provided by the Bellemeade Re deals has been eroded, as there is still so much uncertainty over how bad a recession and therefore mortgage delinquencies could get.

He pointed to the fact that parts of the U.S. are starting to release some of the pandemic lockdown restrictions, meaning some people may be able to return to work and perhaps now not reach the stage of defaulting on their mortgage repayments.

As a result, he expects that after a challenging 2020 for mortgage delinquencies, during which this trigger to halt the amortisation of the Bellemeade Re mortgage ILS is expected to be hit, the loss ratio from the mortgage delinquencies should begin to tail off.

“I would think that the 2021 loss ratio would be better, or lower than, 2020, but not at the same level or as low as it was in 2019, for sure,” Morin said.

Morin went into more detail, saying that under most modelled scenarios for the mortgage related impact of the pandemic, “We get close, but we don’t expect to attach with the Bellemeade transactions.”

Under the most severe scenarios they could attach a few years down the road, Morin continued to explain, but the expected recovery should negate that risk.

Of course, should there be a second wave of the coronavirus pandemic in the United States alongside which tigter lockdown restrictions could come, then all bets may be off and the Bellemeade Re mortgage ILS’ may come under increasing risk of loss.

Marc Grandisson, CEO of Arch Capital, further explained that when thinking about the Bellemeade Re ILS transactions and what they mean to Arch, “if you think of the Bellemeade retention, we have about $1.5 billion to $1.6 billion of retention.”

Adding that on a potential recovery under the Bellemeade Re ILS program, “The level of retention is high enough that we don’t expect it in the next couple of years.”

Details of every mortgage insurance-linked notes issuance can be found here in our Deal Directory.