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Rating Action: Moody's assigns provisional ratings to mortgage insurance credit risk transfer notes issued by Bellemeade Re 2020-4 Ltd.
Global Credit Research - 10 Dec 2020
New York, December 10, 2020 -- Moody's Investors Service, ("Moody's") has assigned provisional ratings to one class of mortgage insurance credit risk transfer notes issued by Bellemeade Re 2020-4 Ltd.
Bellemeade Re 2020-4 Ltd. (Bellemeade Re 2020-4 or issuer) is the fourteenth transaction issued under the Bellemeade Re program since inception and the fourth transaction issued in 2020, which transfers to the capital markets the credit risk of private mortgage insurance (MI) policies issued by Arch Mortgage Insurance Company (Arch) and United Guaranty Residential Insurance Company (UGRIC) (each, a subsidiary of Arch Capital Group Ltd., and collectively, the ceding insurer) on a portfolio of residential mortgage loans. The notes are exposed to the risk of claims payments on the MI policies, and depending on the notes' priority, may incur principal and interest losses when the ceding insurer makes claims payments on the MI policies.
In this transaction, the notes are part of a single series of mortgage insurance-linked notes designated as "Series 2020-4." The reference pool is a subset of the Bellemeade Re 2020-1 transaction and is comprised of all non-cancelled and clean pay policies (131,047 by count). Bellemeade Re 2020-4 is collateralized by a separate reinsurance trust account and is governed by separate legal documents. The new issuance will have no impact on the outstanding Bellemeade 2020-1 transaction.
On the closing date, the issuer and the ceding insurer will enter into a reinsurance agreement providing excess of loss reinsurance on mortgage insurance policies issued by the ceding insurer on a portfolio of residential mortgage loans. Proceeds from the sale of the notes will be deposited into the reinsurance trust account for the benefit of the ceding insurer and as security for the issuer's obligations to the ceding insurer under the reinsurance agreement. The funds in the reinsurance trust account will also be available to pay noteholders, following the termination of the trust and payment of amounts due to the ceding insurer. Funds in the reinsurance trust account will be used to purchase eligible investments and will be subject to the terms of the reinsurance trust agreement.
Following the instruction of the ceding insurer, the trustee will liquidate assets in the reinsurance trust account to (1) make principal payments to the notes as the insurance coverage in the reference pool reduces due to loan amortization or policy termination, and (2) reimburse the ceding insurer whenever it pays MI claims after the coverage level B-2 is written off. While income earned on eligible investments is used to pay interest on the notes, the ceding insurer is responsible for covering any difference between the investment income and interest accrued on the notes' coverage levels.
The complete rating actions are as follows:
Issuer: Bellemeade Re 2020-4 Ltd.
Cl. M-2A, Assigned (P)Ba3 (sf)
Summary Credit Analysis and Rating Rationale
We expect this insured pool's aggregate exposed principal balance (AEPB) to incur 3.16% losses in a base case scenario, and 18.02% losses under a Aaa stress scenario. The AEPB is the portion of the pool's risk in force that is not covered by existing third-party reinsurance. The AEPB is the aggregate product of (i) loan unpaid balance, (ii) the MI coverage percentage of each loan, and (iii) one minus existing quota share reinsurance percentage. Approximately 9.9% (by UPB) of the loans have 7.5% existing quota share reinsurance covered by unaffiliated third parties, hence 92.5% pro rata share of MI losses of such loans will be taken by this transaction. For the rest of loans having zero existing quota share reinsurance, the transaction will bear 100% of their MI losses.
The coronavirus outbreak, the government measures put in place to contain it, and the weak global economic outlook continue to disrupt economies and credit markets across sectors and regions. Our analysis has considered the effect on the performance of residential mortgage loans from the current weak US economic activity and a gradual recovery for the coming months. Although an economic recovery is underway, it is tenuous and its continuation will be closely tied to containment of the virus. As a result, the degree of uncertainty around our forecasts is unusually high. We increased our model-derived median expected losses by 15% (mean expected losses by 13.58%) and our Aaa losses by 5% to reflect the likely performance deterioration resulting from of a slowdown in US economic activity in 2020 due to the coronavirus outbreak.
We regard the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety. Servicing practices, including tracking coronavirus related loss mitigation activities, may vary among servicers in the transaction. These inconsistencies could impact reported collateral performance and affect the timing of any breach of performance triggers, the timing of policy terminations and the amount of ultimate net loss.
We may infer and extrapolate from the information provided based on this or other transactions or industry information, or make stressed assumptions. We calculated losses on the pool using our US Moody's Individual Loan Analysis (MILAN) model based on the loan-level collateral information as of the cut-off date. Loan-level adjustments to the model results included, but were not limited to, adjustments for origination quality.
The reference pool consists of 131,047 prime, fixed- and adjustable-rate, one- to four-unit, first-lien fully-amortizing conforming mortgage loans with a total insured loan balance of approximately $33 billion. Nearly all loans in the reference pool had a loan-to-value (LTV) ratio at origination that was greater than 80%, with a weighted average of 91.6%. The borrowers in the pool have a weighted average FICO score of 747, a weighted average debt-to-income ratio of 36.0% and a weighted average mortgage rate of 3.9%. The weighted average risk in force (MI coverage percentage) is approximately 24.4% of the reference pool total unpaid principal balance. Approximately 99.8% of the mortgage loans have a mortgage insurance coverage effective date from July 1, 2019 through December 31, 2019, both days inclusive (by cut-off date AEPB).
The weighted average LTV of 91.6% is far higher than those of recent private label prime jumbo deals, which typically have LTVs in the high 60's range, however, it is in line with those of recent STACR high LTV CRT transactions and other MI CRT transactions rated by Moody's. Except for 1 loan, all other insured loans in the reference pool were originated with LTV ratios greater than 80%. 100% of insured loans were covered by mortgage insurance at origination with 97.97% covered by BPMI and 2.03% covered by LPMI (by cut-off date aggregate exposed principal balance).
We took into account the quality of Arch's insurance underwriting, risk management and claims payment process in our analysis. Arch's underwriting requirements address credit, capacity (income), capital (asset/equity) and collateral. It has a licensed in-house appraiser to review appraisals.
Lenders submit mortgage loans to Arch for insurance either through delegated underwriting or non-delegated underwriting program. Under the delegated underwriting program, lenders can submit loans for insurance without Arch re-underwriting the loan file. Arch issues an MI commitment based on the lender's representation that the loan meets the insurer's underwriting requirement. Arch does not allow exceptions for loans approved through its delegated underwriting program. Lenders eligible under this program must be pre-approved by Arch. Under the non-delegated underwriting program, insurance coverage is approved after full-file underwriting by the insurer's underwriters. For Arch's overall portfolio, approximately 57.1% of the loans are insured through delegated underwriting and 42.9% through non-delegated. Arch follows the GSE underwriting guidelines via DU/LP but applies additional overlays.
Servicers provide Arch monthly reports of insured loans that are 60-day delinquent prior to any submission of claims. Claims are typically submitted when servicers have taken possession of the title to the properties. Claims are submitted by uploading or entering on Arch's website, electronic transfer or paper.
Arch performs an internal quality assurance review on a sample basis of delegated and non-delegated underwritten loans to ensure that (i) the risk exposure of insured mortgage loans is accurately represented, (ii) lenders submitting loans via delegated underwriting program are adhering to Arch's guidelines, and (iii) internal underwriters are following guidelines and maintaining consistent underwriting standards and processes.
Arch has a solid quality control process to ensure claims are paid timely and accurately. Similar to the above procedure, Arch's claims management reviews a sample of paid claims each month. Findings are used for performance management as well as identified trends. In addition, there is strong oversight and review from internal and external parties such as GSE audits, Department of Insurance audits, audits from an independent account firm, and Arch's internal audits and compliance. Arch is also SOX compliant.
PwC, an independent account firm, performs a thorough audit of Arch's claim payment process.
The third-party review was originally performed by the third-party diligence provider in March 2020 in connection with the Bellemeade Re 2020-1 transaction, prior to the widespread impact of COVID-19 pandemic in the United States. The scope of the third-party review remains weaker than private label RMBS transactions because it covers only a limited sample of loans (0.20% by total loan count in the reference pool) and only includes credit, data and valuation. No updates have been made to the sampling or results of the third-party diligence review since it was originally performed in March 2020. The third-party review assessment for Bellemeade 2020-1 can be found here:
Reps & Warranties Framework
The ceding insurer does not make any representations and warranties to the noteholders in this transaction. Since the insured mortgages are predominantly GSE loans, the individual sellers would provide exhaustive representations and warranties to the GSEs that are negotiated and actively monitored. In addition, the ceding insurer may rescind the MI policy for certain material misrepresentation and fraud in the origination of a loan, which would benefit the MI CRT noteholders.
The transaction structure is very similar to the Bellemeade Re 2020-1 transaction that we have rated. The ceding insurer will retain the coverage levels A, M-1C, and B-2. After closing, the ceding insurer will maintain the 50% minimal retained share of coverage level B-2 throughout the transaction. The offered notes benefit from a sequential pay structure. The transaction incorporates structural features such as a 9.5-year bullet maturity and a sequential pay structure for the non-senior tranches, resulting in a shorter expected weighted average life on the offered notes.
Funds raised through the issuance of the notes are deposited into a reinsurance trust account and are distributed either to the noteholders, when insured loans amortize or MI policies terminate, or to the ceding insurer for reimbursement of claims paid when loans default. Interest on the notes is paid from income earned on the eligible investments and the coverage premium from the ceding insurer. Interest on the notes will accrue based on the outstanding balance of the notes, but the ceding insurer will only be obligated to remit coverage premium based on each note's coverage level.
Credit enhancement in this transaction is comprised of subordination provided by junior notes. The rated M-2A offered note has a credit enhancement level of 4.25%. The credit risk exposure of the notes depends on the actual MI losses incurred by the insured pool. The loss is allocated in a reverse sequential order. MI loss is allocated starting from coverage level B-2, while investment losses are allocated starting from class B-1 note.
So long as the senior coverage level is outstanding, and no performance trigger event occurs, the transaction structure allocates principal payments on a pro-rata basis between the senior and non-senior reference tranches. Principal is then allocated sequentially amongst the non-senior tranches. Principal payments are all allocated to senior reference tranches when trigger event occurs.
A trigger event with respect to any payment date will be in effect if the coverage level amount of coverage level A for such payment date has not been reduced to zero and either (i) the preceding three month average of the sixty-plus delinquency amount for that payment date equals or exceeds 75.00% of coverage level A subordination amount or (ii) the subordinate percentage (or with respect to the first payment date, the original subordinate percentage) for that payment date is less than the target CE percentage (minimum C/E test: 8.00%).
Premium Deposit Account (PDA)
The premium deposit account will benefit the transaction upon a mandatory termination event (e.g. the ceding insurer fails to pay the coverage premium and does not cure, triggering a default under the reinsurance agreement), by providing interest liquidity to the noteholders for 70 days while the assets of the reinsurance trust account are being liquidated to repay the principal of the notes.
On the closing date, the ceding insurer will establish a cash and securities account (the PDA) but no initial deposit amount will be made to the account by the ceding insurer unless the premium deposit event is triggered. The premium deposit event will be triggered if the rating of the notes exceed the insurance financial strength (IFS) rating of the ceding insurer or the ceding insurer's IFS rating falls below Baa2. If the note ratings exceed that of the ceding insurer, the insurer will be obligated to deposit into the premium deposit account the coverage premium only for the notes that exceeded the ceding insurer's rating. If the ceding insurer's rating falls below Baa2, it is obligated to deposit coverage premium for all reinsurance coverage levels.
The required PDA amount for each class of notes and each month is equal to the excess, if any, of (i) the coupon rate of the note multiplied by (a) the applicable funded percentage, (b) the coverage level amount for the coverage level corresponding to such class of notes and (c) a fraction equal to 70/360, over (ii) two times the investment income collected on the eligible investments.
We believe the PDA arrangement does not establish a linkage between the ratings of the notes and the IFS rating of the ceding insurer because, 1) the required PDA amount is small relative to the entire deal, 2) the risk of PDA not being funded could theoretically occur if the ceding insurer suddenly defaults, causing a rating downgrade from investment grade to default in a very short period; which is a highly unlikely scenario, and 3) even if the insurer becomes insolvent, there would be a strong incentive for the insurer's insolvency regulator to continue to make the interest payments to avoid losing reinsurance protection provided by the deal.
To mitigate risks associated with the ceding insurer's control of the trust account and discretion to unilaterally determine the MI claims amounts (i.e. ultimate net losses), the ceding insurer will engage Opus Capital Markets, as claims consultant, to verify MI claims and reimbursement amounts withdrawn from the reinsurance trust account once the coverage level B-2 has been written down. The claims consultant will review on a quarterly basis a sample of claims paid by the ceding insurer covered by the reinsurance agreement. In verifying the amount, the claims consultant will apply a permitted variance to the total paid loss for each MI Policy of +/- 2%. The claims consultant will provide a preliminary report to the ceding insurer containing results of the verification. If there are findings that cannot be resolved between the ceding insurer and the claims consultant, the claims consultant will increase the sample size. A final report will be delivered by the claims consultant to the trustee, the issuer and the ceding insurer. The issuer will be required to provide a copy of the final report to the noteholders and the rating agencies.
Unlike RMBS transactions where there is typically some level of independent third party oversight by the trustee, the master servicer and/or the securities administrator, MI CRT transactions typically do not have such oversight. For example, the ceding insurer not only has full control of the trust account but can also determine, at its discretion, the MI claims amount. The ceding insurer will then direct the trustee to withdraw the funds to reimburse for the claims paid. Since the trustee is not required to verify the MI claims amount, there could be a scenario where funds are withdrawn from the reinsurance trust account in excess of the amounts necessary to reimburse the ceding insurer. As such, we believe the claims consultant in this transaction will provide the oversight to mitigate such risks.
Factors that would lead to an upgrade or downgrade of the rating:
Levels of credit protection that are insufficient to protect investors against current expectations of loss could drive the ratings down. Losses could rise above Moody's original expectations as a result of a higher number of obligor defaults or deterioration in the value of the mortgaged property securing an obligor's promise of payment. Transaction performance also depends greatly on the US macro economy and housing market. Other reasons for worse-than-expected performance include poor servicing, error on the part of transaction parties, inadequate transaction governance and fraud.
Levels of credit protection that are higher than necessary to protect investors against current expectations of loss could drive the ratings of the subordinate bonds up. Losses could decline from Moody's original expectations as a result of a lower number of obligor defaults or appreciation in the value of the mortgaged property securing an obligor's promise of payment. Transaction performance also depends greatly on the US macro economy and housing market.
The principal methodology used in this rating was "Moody's Approach to Rating US RMBS Using the MILAN Framework" published in April 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBS_1201303. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
In addition, Moody's publishes a weekly summary of structured finance credit ratings and methodologies, available to all registered users of our website, www.moodys.com/SFQuickCheck.
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
The analysis relies on an assessment of collateral characteristics to determine the collateral loss distribution, that is, the function that correlates to an assumption about the likelihood of occurrence to each level of possible losses in the collateral. As a second step, Moody's evaluates each possible collateral loss scenario using a model that replicates the relevant structural features to derive payments and therefore the ultimate potential losses for each rated instrument. The loss a rated instrument incurs in each collateral loss scenario, weighted by assumptions about the likelihood of events in that scenario occurring, results in the expected loss of the rated instrument.
Moody's quantitative analysis entails an evaluation of scenarios that stress factors contributing to sensitivity of ratings and take into account the likelihood of severe collateral losses or impaired cash flows. Moody's weights the impact on the rated instruments based on its assumptions of the likelihood of the events in such scenarios occurring.
For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.
The rating has been disclosed to the rated entity or its designated agent (s) and issued with no amendment resulting from that disclosure.
This rating is solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.
At least one ESG consideration was material to the credit rating action(s) announced and described above.
The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.
Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.
Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.
Philip Rukosuev Analyst Structured Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Sonny Weng Vice President - Senior Analyst Structured Finance Group JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653
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