Mortgage insurers face ILS issuance challenge, higher reinsurance costs: A.M. Best

U.S. mortgage insurers are likely to face challenges in issuing new mortgage insurance-linked securities (ILS) at this time and their reinsurance costs are expected to rise on the back of the Covid-19 coronavirus pandemic, according to A.M. Best.

The rating agency highlights the challenging situation facing the largest private mortgage insurers in the United States, as access to capital in general is likely to prove more challenging going forwards.

Key in their capital provisions is reinsurance capital, with the capital markets playing an increasingly vital role through growing issuance of mortgage insurance-linked securities (ILS) or mortgage insurance-linked notes (ILN).

Given the challenges in financial markets caused by the coronavirus uncertainty, which has heightened volatility across most asset classes and shrunken access to capital, issuing mortgage ILS’ may not be as easy for now, while at the same time A.M. Best thinks traditional reinsurance rates will also rise.

The mortgage insurers face potential credit issues, as delinquencies are likely to rise due to unemployment and financial challenges mortgage holders will now face due to the coronavirus pandemic.

As we explained earlier this week, S&P placed the credit ratings of the main mortgage insurers that sponsor ILS transactions on a negative watch, citing the Covid-19 coronavirus pandemic and the elevated credit risk these insurers now face as a result of the crisis.

Analysts had also recently pointed to the potential for mortgage ILS issuance to slow due to the coronavirus.

A.M. Best highlights that all the main private mortgage insurers transfer significant portions of their risks to traditional reinsurance and the capital markets through ILS.

The main private mortgage insurers have quota share reinsurance arrangements with the traditional reinsurance market, but A.M. Best believes that “future reinsurance cost may be higher given the expected increase in mortgage credit losses for the private mortgage insurers.”

Also, as these are largely quota shares, “reinsurance that is already in place may become more expensive if such losses rise, since the cost of the reinsurance takes profit commission into account (which goes back to the private mortgage insurers if their losses are below specified loss ratio thresholds).”

The mortgage ILS transactions, which A.M. Best sees as “highly effective” forms of reinsurance for the mortgage insurers, “may now be extremely difficult to consummate,” the rating agency believes.

Adding, “Although the Fed’s decision to cut the benchmark rate and to buy Treasuries and other securities is designed to help stabilize the bond market, the effectiveness of these actions may not be clear for some time. Volatility in the bond markets affects investor demand for the MILS transactions.”

“The ability of these private mortgage insurers to continue accessing the MILS market is tied to the volatility in the bond market, where sellers looking to dump securities to achieve their liquidity targets had led to price declines. AM Best believes that, given the market’s dislocation, these private mortgage insurers will have to delay any plans to sponsor more MILS transactions, pending more certainty in rates and more information on their COVID-19-affected operational results,” A.M. Best further explained.

The investors that back mortgage ILS deals are not, in the main, the typical ILS fund market. In fact they are largely more generalist bond and alternatives investors, or multi-strategy funds, so the same class of investor that has been largely selling out of the catastrophe bond market in recent weeks.

So, without a dedicated set of investors to support these deals, as the catastrophe bond market benefits from with the dedicated ILS funds who specialise in reinsurance linked assets, the mortgage ILS market could actually find itself on-hold for longer than the cat bond market, perhaps.