Banc One Corp. has become the first company to receive approval from federal banking regulators to set up a captive mortgage reinsurance subsidiary since the New York State Insurance Department questioned the legality of mortgage reinsurance.

Lenders have turned to captive mortgage reinsurance as a way to partake in the profits of the mortgage insurance industry. Though competition has caused substantial margin erosion for mortgage banks, mortgage insurers have enjoyed a prolonged period of profit growth.

With a captive structure, a lender must work with a mortgage insurer to establish a subsidiary that will reinsure mortgage loans. The lender would receive a portion of the insurance premiums from the mortgage insurer but also must assume some of the risks.

In March the New York State Insurance Department issued a stern warning regarding captive reinsurance in a letter sent to mortgage insurers licensed in the state.

New York's Insurance Department was concerned that the payment of insurance premiums to lenders would amount to a kickback if the lender wasn't investing adequate capital to set up the reinsurance subsidiary. Such kickbacks would violate the state's insurance laws.

Lenders said concerns about captives being declared illegal by New York have been overblown. "As long as there is legitimate risk transfer, there won't be any problem with New York," one mortgage banker said.

Several mortgage insurers have met with New York's Insurance Department to discuss its concerns. The department has not issued any guidelines for reinsurance subsidiaries.

Banc One, which joins Chase Manhattan Corp. and PNC Bank Corp. as lenders approved to set up mortgage reinsurance subsidiaries, received the go-ahead from the Office of the Comptroller of the Currency earlier this month. The OCC declared in October that mortgage reinsurance was a permissible activity for banks to engage in.

In the approval letter to Banc One, chief counsel Julie L. Williams wrote that the OCC will monitor the amount of capital at the reinsurance subsidiary quarterly to "verify that the level of bank capital is sufficient to support the risk."

Officials at Banc One's mortgage division would not discuss how it intends to set up the subsidiary or which mortgage insurers it would be partnering with.

Amerin Guaranty Corp., United Guaranty Corp., and MGIC Investment Corp. are mortgage insurers that have been active in setting up captive reinsurance arrangements.

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