One of the roadblocks for lender credit risk transfer (CRT) has been a lack of knowledge and understanding of the risk/reward profile of a potential lender CRT transaction. This article by Milliman’s Madeline Johnson and Jonathan Glowacki provides an overview of lender CRT and uses public information to demonstrate the expected premium and loss rates for a potential lender CRT transaction.
This article was originally published in the March/April 2017 issue of Secondary Marketing Executive.
Credit risk sharing transactions offered by Fannie Mae and Freddie Mac present a new business opportunity for insurance companies seeking to invest capital. Milliman’s Jonathan Glowacki and Michael Jacobson say insurers must first understand the risks associated with these transactions before investing in or insuring them. Their Contingencies article “The trillion-dollar marketplace” provides some perspective.
Here’s an excerpt from the article:
Given FHFA’s focus on de-risking the GSEs, mortgage credit risk offerings are likely to continue to become more prevalent in the marketplace as the GSEs seek to meet their annual conservatorship scorecard requirements and reduce capital. According to FHFA’s 2015 conservatorship scorecard, Fannie Mae and Freddie Mac were instructed to collectively transact credit risk transfers on reference pools of mortgages of at least $270 billion for the year. In actuality, the GSEs’ transactions covered reference pools exceeding $400 billion of the nearly $1 trillion of mortgages acquired by the GSEs in 2015. The 2016 scorecard requires the GSEs to transfer the credit risk on at least 90 percent of the unpaid principal balance of targeted groups of newly acquired mortgages, which represents the majority of expected acquisitions. Thus, it can be assumed that there will be a similar level or greater amount of credit risk transferred in 2016, assuming GSE mortgage acquisition levels remain consistent with 2015 acquisitions.
Insurance companies will have the opportunity to participate in this marketplace in 2016 through investment opportunities in the STACR and CAS debt structures as well as by writing credit insurance through anticipated ACIS and CIRT transactions. While the debt offerings require principal outlays equal to 100 percent of the notional amount of the securities, the credit insurance transactions to date have typically only required collateral between 15 and 20 percent of the credit risk assumed. The collateral requirements for the credit insurance transactions vary based on the rating of the insurance entities assuming the risk and the type of participation. For context, the $2.8 billion of credit insurance risk placed through the 10 Freddie Mac ACIS transactions in 2015 required minimum collateral of approximately $440 million (or approximately 16 percent of the risk assumed).
These debt securities and insurance opportunities may offer attractive risk/return profiles to strategic companies in the insurance sector. However, before entering into such agreements, it is important to understand the risk profile of the underlying collateral and the performance volatility inherent in the structure of the transactions. With data being published by the GSEs, it is now easier than ever before to evaluate the risk profiles of these exposures.