Freddie Mac seeks 20 new reinsurers on its $3bn placement
Freddie Mac, the US government-sponsored enterprise (GSE) that provides liquidity to the US mortgage markets by buying mortgages from lenders, wants to increase the panel of reinsurers it works with over time to as many as 50—a move intended to ensure its credit risk transfer programme will remain stable and sustainable in the long term.
Kevin Palmer, senior vice president, portfolio management, single family, Freddie Mac, told PCI Today that the programme works with around 30 reinsurers at present but new reinsurers are joining every year. In addition to the risk transfer programme’s steady growth in transactions and investors, Freddie Mac has innovated in the types of risk it has transferred.
“We’d like to build our panel to around 50 reinsurers, which would be a sizable chunk of the reinsurance marketplace,” Palmer said. “We transfer some $3 billion of risk annually and we expect that to remain steady.
“But having more participants allows us to ensure we always have dry powder from a capital perspective and it should make for more stable, predictable pricing over time as well.”
Palmer has been involved in Freddie Mac’s credit risk transfer programme since it was first conceived in 2013—at that time a completely new asset class for reinsurers. In the aftermath of the financial crisis, the programme took the strategic decision to provide liquidity and stability to the mortgage market by structuring its mortgage credit risk into securities and insurance offerings, thereby transferring credit risk exposure from US taxpayers to private investors. It turned to the capital markets and reinsurance sector to achieve this.
Palmer estimates Freddie Mac has transferred credit risk on more than $1 trillion worth of single-family mortgages with over $38 billion of securities issued and insurance coverage placed in the past five years.
“We went into this with high aspirations, but we have easily exceeded those,” he said.
The biggest challenge was getting the reinsurance side of the programme up and running because his team had never dealt with this industry.
“Even though we had engaged in the mortgage insurance space a little, we had not really dealt with reinsurers before,” he said.
“That did require a substantial period of education so that the insurance market had sufficient information to understand and price the risks. We started working with just one player on the first transaction and it has grown steadily since then.
“We see this as sustainable capital, uncorrelated to other sectors, which means great diversification for us.”
He added that the first transaction was the hardest. “We had to move from being a risk taker, to being completely transparent and sharing data and information with partners. That was a significant cultural shift for us, but we have embraced it.
“We now regularly have reinsurers come into the business and sit with us to understand what we do and how we do it. That is one of our key value propositions.”
New risks
To date, Freddie Mac’s risk transfer programme has dealt with only traditional mortgage reinsurance—reinsurers take on a specific part of the default risk of a portfolio of mortgages with a predetermined risk profile bundled together after origination.
But Freddie Mac is now experimenting with offering reinsurers two new forms of risk.
Its Integrated Mortgage Insurance (IMAGIN) programme allows reinsurers to provide insurance coverage on a loan-level basis and participate in the low down-payment market and partner with Freddie Mac to help expand first-time homebuyers.
On mortgages with a loan to value ratio of more than 80 percent, GSEs are required to have some form of credit enhancement in place. Typically, primary mortgage insurers fill this space but Freddie Mac is providing an opportunity to enable reinsurers that are also qualified carriers in the US to participate in this business.
Palmer said a pilot for this programme has gone well. “We will now look to roll it out further,” he said.
The other innovation will be around offering reinsurers the opportunity to participate on mortgages from the moment they are originated—essentially by entering into forward-looking contracts. They would agree a level of participation and a risk profile of the mortgages in advance and the credit risk would immediately be transferred to the reinsurance markets as the mortgages are originated.
“This innovation is essentially forward-looking risk transfer and protects us from pipeline risk,” Palmer said.
He added that Freddie Mac is looking to start to introduce more first loss risk to the market. “We are seeing strong demand and we think it is possible, it is just a question of ensuring an alignment of interests and everyone has skin in the game.”
He stressed that the fundamental shift Freddie Mac has been through since 2014 has meant it is in a much more stable place than it was before—and that is partly thanks to the support of reinsurers.
“Our risk profile is now very different. We work with 250 investors, of which 30 are reinsurers, all of whom are good risk managers, giving us protection and feedback all the time,” he said.
“There is a very healthy feedback loop in place that makes us much better prepared for another downturn.
“We represent roughly 50 percent of the US mortgage market. Now, instead of all the burden being on us, there are some 250 entities bearing the burden. That leaves us in a much better position to withstand financial shocks.
“For that reason, we see our relationship with reinsurers as a long-term partnership in which we are always happy to listen and improve how we do things,” he concluded.
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