Arch Capital Group, the Bermuda headquartered specialist insurance and reinsurance underwriter, had tried to come back to the insurance-linked securities (ILS) market with a new Bellemeade Re 2020-1 Ltd. issuance of mortgage insurance-linked notes, a deal that would have been the largest ever example of a mortgage ILS issuance.
But we understand that the transaction, which could have been targeting as much as $957 million (perhaps more) of mortgage reinsurance for the firm, was withdrawn.
We believe due to the continued volatility in capital markets related to Covid-19, which has been affecting investor appetite.
Arch Capital is a seasoned mortgage insurance-linked securities (ILS) sponsor, having in total brought more than $4.7 billion of transactions to market.
It’s most recent in October 2019 was the firm’s tenth mortgage ILS issuance so far, including the first two Bellemeade’s that were sponsored by United Guaranty, a company it subsequently acquired and inherited the amortising coverage from.
After its tenth deal, Arch’s mortgage ILS transactions accounted for $4.74 billion of mortgage insurance risk capital issued and sold to capital markets investors, and excess of loss mortgage reinsurance secured for the firm.
U.S. mortgage insurers began tapping the capital markets for a collateralised form of excess of loss reinsurance with the first Bellemeade Deal, sponsored by United Guaranty, an AIG subsidiary that was acquired by Arch, since when a number of major players have come to market and mortgage ILS have become a growing component of the overall market.
While not an attractive investment for many of the more typical ILS funds and investors, for whom the catastrophe risk focus and lack of correlation to broader capital markets remain key. Mortgage ILS deals (or mortgage insurance linked notes ILN’s) have become an increasingly core part of insurers like Arch’s reinsurance arrangements and also a key capital lever for them, helping them to be more expansive in assumption of mortgage insurance risks and writing of policies.
We understand that Arch Capital returned to the ILS market with a new Bellemeade Re 2020-1 Ltd. issuance of mortgage insurance-linked notes back in March, with the deal finally pulled and issuance abandoned by May, it seems.
The timing couldn’t have been worse for Arch, given the global lockdown and financial crisis from the coronavirus outbreak all began widely in March as well.
We understand that, as with other Bellemeade Re mortgage ILS deals, Arch would have been seeking a significant addition to its excess of loss mortgage reinsurance protection from the capital markets with this new deal.
In fact, sources told us that the initial target for what would have been Arch’s eleventh mortgage ILS deal was as high as $957 million, which would have made it the largest single mortgage ILS issuance to-date.
But, as our regular readers will know, the capital markets have been particularly volatile since the Covid-19 pandemic spread across the world and it has been particularly challenging for sponsors issuing certain types of securities.
While this hasn’t significantly affected the catastrophe bond market, given the relatively uncorrelated nature of catastrophe risk and reinsurance, it has impacted the mortgage ILS market.
These structures are linked to the risk of mortgage delinquencies, which could cause elevated mortgage insurance claims levels to occur. The pandemic is expected to drive higher mortgage delinquencies, although significant uncertainty over how serious this could be remains.
As a result, it’s been seen as particularly challenging to issue new mortgage ILS right now, with investor appetite dampened by the pandemic. Even though the majority of mortgage ILS seem likely to be relatively safe from losses of principal, being high up in reinsurance towers and requiring significant claims to come through for them to be triggered.
Arch itself said that Covid-19 losses are unlikely to result in sufficient mortgage insurance claims to trigger any of its Bellemeade ILS.
But the company did say 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
Given the pandemic related capital markets volatility and its impact on investor appetite for mortgage risk (even mortgage insurance risk), we understand that Arch Capital elected to pull this new issuance, with a view to returning to the capital markets for mortgage reinsurance in the coming months, when conditions have perhaps settled a little more.
As we explained in a recent article, the dislocation of the mortgage ILS market and the challenge to issue fresh deals is likely to elevate reinsurance costs for mortgage insurers and could also threaten some business models that have relied on reinsurance from the capital markets to fund their front-end underwriting expansion, to a degree.
Arch, being one of the largest players with a sophisticated business model for originating risk, as well as hedging it, may not be as affected as some of the private mortgage insurers.
But if the capital markets remain closed to mortgage ILS sponsors for a prolonged period, then it could become more challenging to source the necessary excess of loss mortgage reinsurance needed to keep assuming so much mortgage insurance risk on the front-end of its business.
At around $957 million, or even larger we’re told, this would have been a landmark mortgage ILS deal.
Once greater clarity over the level of mortgage delinquencies and mortgage insurance losses emerges over the coming months, the mortgage ILS market is likely to come back to life and at that point we’d expect to see a resurgence of issuance from the repeat sponsors that have made it a core of their reinsurance programs.