Exploring the ‘spillover effect’ in the wake of the pandemic
–(BUSINESS WIRE)–With mortgage delinquency rates expected to dramatically increase due to COVID-19 pandemic-related forbearance and job loss, AM Best has explored the spillover effect into the mortgage-related activities of the reinsurance industry.
Reinsurers have been assuming incrementally more U.S. mortgage risk from two main sources: Fannie Mae and Freddie Mac (i.e., the government-sponsored enterprises [GSEs]); and private mortgage insurers. In recent weeks since the start of the outbreak, jobless claims have skyrocketed, resulting in the highest unemployment rate since the Great Depression.
Although the CARES Act and loan forbearance, deferral and modification programs are designed to moderate the impact of the pandemic on borrowers, mortgage delinquencies nevertheless are expected to soar. Although the rate with which loans move from delinquency to claims is not clear at this point due to the unprecedented nature of the pandemic, it is inevitable that higher losses are in the cards for the GSEs and private mortgage insurers.
Factors that affect the primary mortgage market also influence the broad secondary markets, such as mortgage-backed securities and mortgage reinsurance.
A new Best’s Special Report, “Mortgage Reinsurance and the COVID-19 Pandemic,” explores the dynamics of the mortgage reinsurance market and how it is affected by the fortunes of the GSEs and the private mortgage insurers. It explains the significant roles the reinsurers play in helping the:
GSEs de-risk their balance sheets by shedding mortgage credit risk through their credit risk transfer programs; from 2013 through 2019, the GSEs transferred approximately $24.5 billion of exposure limit to the traditional reinsurance market; and private mortgage insurers implement their so-called “originate, manage, and distribute” business model and facilitate their compliance with the Private Mortgage Insurers Eligibility Requirements (PMIERs) imposed by the GSEs; from 2016 through 2019, private mortgage insurers have ceded about 13.4% of their gross written premium to the traditional reinsurance market.
The report further explains how the dynamics of the capital markets, the rise in mortgage losses and PMIERs compliance all interact to affect the supply and demand of mortgage reinsurance. Finally, the report addresses the issue of how the fallout of the pandemic may affect the capitalization and operating performance of reinsurers that cover mortgage risk.
AM Best revised its market segment outlook for the private mortgage insurance segment to negative in April 2020, owing to the expected increase in losses on mortgages. Time will tell if the economic fallout of the pandemic will increase realized losses beyond those projected by the disaster scenarios devised by mortgage insurers and reinsurers.
Excerpts from the AM Best April 20, 2020 Market Segment Outlook
The mortgage market is considerably healthier than it was during the 2008 credit crisis, and the private mortgage insurance segment in recent years has generated strong operating results due to positive macroeconomic conditions, improving home affordability and better underwriting standards.
However, in its new Best’s Market Segment Report, “Market Segment Outlook: US Private Mortgage Insurers,” AM Best notes that the COVID-19 pandemic has progressed from a health crisis to a liquidity crisis, and may turn into a solvency crisis for the balance sheets of individuals and corporations alike. This could have serious consequences for private mortgage insurers, given that their business and the fortunes of the U.S. economy are inexorably linked.
Key factors weighed in the outlook revision to negative include:
- A rapid deterioration in U.S. macroeconomic conditions, including an increase in the U.S. unemployment rate;
- Higher mortgage delinquency rates that likely will impact reserves and earnings;
- An expectation of higher credit losses;
- Diminished access to reinsurance in the mortgage insurance-linked securities market and potentially higher costs in the traditional reinsurance market; and
- A potential decline in new insurance written.
According to the report, private mortgage insurers will not know the extent of mortgage delinquencies until they receive their updated reports from servicers; however, delinquencies are sure to increase due to a spike in jobless claims, and an anticipated double digit contraction in gross domestic product for the second quarter of 2020. The coming weeks and months also will reveal the long-term effects of the Fed’s recent emergency rate cuts and the $2 trillion CARES Act on mortgage rates and the economy.
COVID-19-related forbearance programs by Fannie Mae, Freddie Mac and the Federal Housing Administration can help mitigate the liquidity problems of individual borrowers and limit foreclosures. However, investors in mortgage-backed securities still must receive their payments, which are derived from the cash flows of individual mortgages, some of which may be in forbearance.
Mortgage servicers will have to advance the principal, interest, taxes and insurance premiums necessary to keep mortgages current while borrowers are in forbearance. This may cause liquidity problems for some servicers if the forbearance take-up rate is high and the duration of the pandemic crisis is long, possibly resulting in systematic risk to the mortgage industry. Mortgage market industry participants are hopeful for a comprehensive solution to avert such a risk to the mortgage distribution pipeline.
To access the full copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=297430.
AM Best is a global credit rating agency, news publisher and data analytics provider specializing in the insurance industry. Headquartered in the United States, the company does business in over 100 countries with regional offices in New York, London, Amsterdam, Dubai, Hong Kong, Singapore and Mexico City. For more information, visit www.ambest.com.