Insurer Arch Capital Group Causes Turmoil in Debt Market with Surprise Call of $1.7 Billion Securities at Par

Arch Capital Group Ltd., an insurer that provides insurance for mortgages, recently called $1.7 billion of securities at par, causing disruption in the debt markets. These securities are used by the finance industry to transfer mortgage default risk and had been trading at a premium. The move by Arch Capital has raised concerns among investors about the potential for losses when their credit risk transfer bonds can be called away at face value.

The implications of this move could be far-reaching, as more financial institutions, including banks, are looking to use bonds to shift credit risk to other investors and reduce their capital requirements. Bond buyers are being reminded to carefully review the documents to understand what qualifies as callable.

S&P Global Ratings recently simplified its capital requirements for mortgage insurance, limiting the benefits of structured reinsurance, which is what insurance-linked securities offer. This change likely influenced Arch Capital’s decision to call the securities, as they were becoming less effective at reducing the company’s capital requirements under the new guidelines.

The unexpected call by Arch Capital surprised the market, as the bonds were typically trading above par. This move could have a significant impact on the mortgage insurance credit risk transfer market, potentially leading to decreased issuance and higher premiums demanded by bond investors.

The $7.5 billion market where insurers sell risk tied to mortgage insurance debt has been undergoing changes this year, and the S&P ratings changes may further reduce the role of credit risk transfer bonds in managing insurers’ capital. Some issuers have already been buying back their bonds at a premium to par, but Arch Capital appears to be the first and only issuer to call its bonds instead of buying them back at market value.

The full impact of this call on the market remains to be seen, but uncertainty is never a good sign. Investors in insurance-linked securities will need to closely monitor the situation and adjust their strategies accordingly.