(Bloomberg) -- A normally sedate part of the debt markets used by the finance industry to transfer mortgage default risk has been roiled after insurer Arch Capital Group Ltd. called $1.7 billion of the securities at par when they had been trading at a premium.
The implications of Arch’s move could be felt widely. More financial institutions including banks are looking to use bonds to shift credit risk to other investors, and cut their capital requirements in the process. Investors were reminded that they need to look carefully at when their credit risk transfer bonds can be pulled away from them at face value, potentially handing them losses.
“Bond buyers need to look at the documents closely,” said Ben Hunsaker, head of structured credit at Beach Point Capital Management. “There’s going to be a question for what qualifies as callable.”
Arch Capital provided insurance for mortgages, and sold bonds that allowed it to share some of that risk with investors: holders of the notes would take losses if enough homeowners defaulted on their loans. Selling these insurance-linked securities had lowered its capital requirements for ratings purposes.
But S&P Global Ratings last month simplified its capital requirements for mortgage insurance, in a way that limited the benefits of structured reinsurance, which is essentially what insurance-linked securities offer.
On Monday, Nov. 20, soon before the US Thanksgiving holiday, Arch Capital announced it was calling eight securities. The company elected to call the debt because it became less effective at reducing its capital requirements under S&P’s new guidelines. Bonds that traded for as much as about 106 cents on the dollar were bought back at face value.
“The decision took the market by surprise as those bonds were typically trading above par,” said Pratik Gupta, mortgage backed security strategist at Bank of America in an interview.
A representative for Arch Capital declined to comment beyond the public statement, while a spokesperson for S&P also declined to comment.
More banks have been selling credit risk transfer notes to effectively offload exposure from pools of loans, such as auto debt. The market’s tentative comeback attracted buyers such as Ares Management Corp. and Blackstone Inc. this year, Bloomberg reported in October, drawn by yields that range from high single digits to mid-double digits.
For insurance linked securities, trading volumes, though usually fairly low, will remain below previous levels for now for those bonds, one holder of the securities predicted, asking not to be identified as they weren’t authorized to speak publicly.
Even before the S&P ratings changes that became effective last month, the $7.5 billion market where insurers sell the risk tied to mortgage insurance debt had been going through changes this year. For some insurers, the S&P changes may end up reducing the role of credit risk transfer bonds in managing their capital. Old deals no longer provide as much relief as they used to given the changes, so issuers have been slowly buying them back.
Some issuers have been buying back their bonds at a premium to par mostly, according to BofA Securities. Investors in insurance linked securities believe that Arch is so far the first and only issuer to call its bonds instead of buying them back at their market value. Arch Capital’s bonds will be redeemed on Dec. 27, the filing said.
“We have yet to see the full impact of the call on the mortgage insurance CRT market, but I would expect issuance to decrease after this and bond investors will demand premiums,” Hunsaker said. “Uncertainty is never good.”
Week in Review
- The rapid rise of private credit may pose unforeseen threats to the US banking system, according to two senior Democratic senators, who asked US regulators to do more to assess the potential dangers
- Austrian tycoon Rene Benko’s Signa filed for insolvency after a last-ditch attempt to raise emergency funding failed, making the co-owner of New York’s Chrysler building one of the most prominent casualties of Europe’s property crisis
- Investors are bullish on duration risk next year, from investment grade credit to Treasuries, at the expense of leveraged loans, high-yield bonds and cryptocurrencies, according to JPMorgan Chase & Co.’s investor survey
- India’s cricket governing body has filed a case against the parent of cash-starved education provider Byju’s, a setback for Byju Raveendran, the founder of what was once India’s hottest startup
- The Philippines priced its first US-currency Islamic note, aiming to expand its funding base and capitalizing on a compression in spreads
- Casino Guichard-Perrachon SA has received preliminary expressions of interest for some of its hypermarkets and supermarkets as the ailing French grocer pushes ahead with its restructuring
- Chinese builder Powerlong Real Estate Holdings Ltd. defaulted on one of its dollar bonds as it struggles with sluggish sales and worsening liquidity. The Shanghai-based company said it hadn’t made a $15.9 million interest payment on its 5.95% notes due April 2025 as its liquidity position continues to deteriorate
- China Aoyuan Group is set to join a handful of local developers who have entered debt restructuring deals. The defaulted developer said it obtained sufficient support from creditors on Tuesday for a restructuring plan that also involves its unit. It has $2.8 billion of onshore and offshore bonds outstanding, data compiled by Bloomberg show
On the Move
- Sumitomo Mitsui Financial Group’s US arm has tapped Paul Burke as head of the capital solutions group, leading a new team that will work across the structured debt and capital markets businesses.
- Strategic Value Partners is targeting structured capital in Europe and has hired Ahmed Khan from KKR to build the strategy.
- Ralf Ackermann is set to leave Searchlight Capital Partners and is preparing to launch his own investment firm that will seize on opportunities from companies facing higher interest rates
- Varun Khanna and George Mueller at KKR & Co.’s Credit & Markets team were promoted to partner
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