U.S. Mortgage Insurance Linked Note Credit Remains on Recovery Trend

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According to a new report from DBRS Morningstar, the overall performance of U.S. mortgage insurance bond-backed reinsurance (MILN) transactions continues to improve as defaults have fallen, bond credit enhancement has increased and market volatility kept trading volume at bay.

“Major credit variables have remained on trend year-to-date,” said Mark Fontanilla, US residential mortgage-backed security consultant at DBRS Morningstar. “The delinquencies have continued to improve, 180-[day]-plus defaults on a nominal basis continue to decline and B-coin write-downs remain minimal.”

Total delinquencies for most transactions issued before the coronavirus pandemic fell 1% for in-progress transactions and 0.6% for seasoned transactions. The delinquency rate of transactions issued during the pandemic stands at 0.84% ​​on average.

As borrowers continue to emerge from forbearance, the 180+ day default rate has declined slightly to around 2.4% of total principal balance exposed, with the total number of loans falling by 9.5 % at 12,103.

And modification and foreclosure activity remained subdued, according to the DBRS Morningstar report, “US RMBS August 2022 MILN Sector Overview,” authored by Fontanilla, Yash Shah, Kartika Kankariya, Jinesh Chheda, Sagar Kongettira and Quincy Tang. The report is based on trade performance as of August 25, 2022.

Bond credit enhancement (CE) continues to rise steadily, according to the report. Senior CE for in-progress deals issued pre-pandemic is approximately 3.5 times the senior CE target, compared to nearly 2.3 times higher for seasoned deals issued pre-pandemic. The CE for junior-rated bonds also remains healthy above 60+ day delinquency levels.

“Bond credit enhancement has benefited from historically above-average prepayment speeds, as well as low realized losses despite the rise in COVID-related delinquencies in recent years,” Fontanilla explained, in addition to the real estate price appreciation and decent economic trends.

Fontanilla expects credit improvement to continue along current trends, “unless delinquencies begin to rise again and realized losses increase rapidly and dramatically.”

Higher credit enhancements will obviously translate into better loss protection for the classes of bonds issued, he said.

Despite continued improvements, MILN transaction volume has cooled compared to recent years.

“MILN’s historic year-to-date issuance represents approximately $20 billion in issued securities,” Fontanilla said. “New deals did not exceed $1 billion after amounting to around $6 billion in 2021, the highest annual total yet.”

The execution of higher issuance costs due to market volatility likely kept the sector’s few issuers in the holding space, he said. Another possibility is that they have other risk transfer options that may be more profitable under current market conditions.

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