The main insurers that sponsor mortgage insurance-linked securities (ILS), or mortgage insurance-linked notes (ILN), as a way to secure reinsurance from the capital markets to protect their mortgage insurance books, have all had their ratings placed on a negative watch by S&P.
S&P Global Ratings said that is has revised its outlook to negative from stable on Arch Capital Group Ltd., Essent Guaranty Inc., MGIC Investment Corp., and Radian Group Inc., while the outlook has been revised to negative from positive on NMI Holdings Inc.
These five private mortgage insurers make up most of the mortgage insurance-linked securities (ILS) issuance since those transactions began to be issued back in 2015.
S&P Global Ratings explained the reason for the negative outlook on the ratings of the private mortgage insurers, citing the Covid-19 coronavirus pandemic and the elevated credit risk these insurers now face as a result of the crisis.
“The U.S. private mortgage insurers (PMIs) are facing the prospect of much higher losses as uncertainty abounds with the current state of the U.S. economy,” the rating agency explained.
S&P forecasts that the hit to the United States economy will be significant, which will impact the mortgage insurers.
“A sudden shock to the U.S. economy will raise mortgage delinquencies, potentially leading to private mortgage insurers recognizing higher credit losses,” S&P said.
“S&P Global Ratings is projecting a sharp GDP contraction in the second quarter of 2020 of almost double the 6% from last week’s estimate and a contraction in the first quarter as well, due to containment measures undertaken to stop the outbreak of COVID-19. There is a high degree of uncertainty about the size of the downside risk and the path of recovery will depend on the outbreak containment, the government’s policy responses, and any resulting lasting damage to the economy,” the rating agency noted.
Adding, “The focus on containment and lockdown of large swaths of the population is leading to a sudden slump in consumer spending, leading to a jump in unemployment, which could be higher than originally anticipated in our economic projections. Higher mortgage payment delinquencies would naturally follow.”
Mortgage insurers will have to recognise those delinquencies that are coming, due to the coronavirus, through their earnings and loss reserves, with ramifications for their reinsurance arrangements if mortgage delinquencies move high enough.
“The current portfolios are protected to varying degrees by reinsurance, with most of the PMIs relying on a mix of traditional reinsurance and insurance linked notes (ILNs), although ILNs have become an increasingly important part of PMIs’ capital management due to cheaper costs,” S&P said.
These reinsurance and capital markets backed reinsurance protection products could prove invaluable should losses from credit delinquencies rise significantly.
Should that happen the mortgage reinsurance and mortgage ILS will provide these insurers, “A level of earnings and capital protection for their current exposures, which may help contain the losses within their earnings,” S&P explained.
It’s far too early to forecast whether any of the mortgage ILS transactions could face losses over the coming months, as at this time there is little hard data that suggests how bad the rate of mortgage delinquencies could be.
But even if the mortgage ILS deals aren’t triggered, S&P notes that conditions for issuing more have likely changed.
As we explained a week ago, the coronavirus pandemic is likely to slowdown issuance of mortgage ILS anyway, as the capital markets digests the broader financial market volatility caused by the pandemic.
“In view of the current market volatility, we believe the credit spreads in the ILN markets have widened and traditional reinsurance capacity could be scarce as well,” S&P said.
Adding that, “If there is any appetite, the reinsurance capacity will come at an increased cost, and for excess covers, would likely attach higher compared with previous transactions.”
Constrained access to reinsurance and the capital markets for mortgage ILS issuance, could hit mortgage insurers risk-adjusted capitalisation, as well as their earnings, S&P notes.
Looking ahead, S&P will update its view on the mortgage insurers health depending on how bad mortgage delinquencies driven by unemployment caused by the coronavirus pandemic turn out to be.
The rating agency warns, “This could become a capital event, which could ultimately weaken the PMIs’ risk-adjusted capitalization relative to our ratings expectations, exacerbated by the potential scarcity of reinsurance capacity (including ILN).”