Capital Re Corp., a top player in the municipal bond reinsurance business, yesterday said it plans to diversify with a major push into the residential mortgage market.

At a meeting for investors and analyst, firm officials said that they will start a new unit early next year, to be called Capital Mortgage Reinsurance Co. The subsidiary will offer reinsurance to private insurance companies that guarantee residential mortgages.

Capital Re executives stressed their continued commitment to the municipal bond market and said that mortgage guaranty reinsurance is an "appropriate and logical" area for expansion.

"While, maintaining a focus on municipal bond reinsurance, Capital Re has over the past several years pioneered several mortgage guaranty reinsurance transactions on a highly structured basis," said Michael E. Statz, chairman and chief executive officer. "With the creation of Capital Mortgage Reinsurance Co., Capital Re will have expanded its line of specialty reinsurance products into a growth industry with proven profitability parameters."

The firm intends to establish Capital Mortgage Reinsurance as the leading reinsurer of mortgage guaranty insurance, "just as Capital Re has established itself as the leading reinsurer of financial guaranties of municipal and nonmunicipal debt obligations," Satz said.

Standard & Poor's Corp. is expected to assign an AA rating to the new firm, which may also pursue ratings from other agencies, he said.

Richard P. Smith, managing director at Standard & Poor's said he could not discuss the rating before it is officially assigned. But, Smith said, the diversification would be positive in the long term for Capital Re Corp.

Capital Mortgage Reinsurance will be capitalized by a $75 million preferred stock offering in January. Capital Re filed a resignation statement for the issue in November.

Standard & Poor's has assigned an A-minus rating to the offering, which is slated to be made through a new special purpose corporation, Capital Re LLC.

Satz said the $75 million represents an "over-capitalization" for the new firm, which was done to ensure that Capital Mortgage Reinsurance gets a double-A rating -- the standard in the residential mortgage market. In contrast, municipal investors typically demand AAA ratings from insurers and reinsurers.

Laurence C. Donnelly, a senior vice president in Capital Re's marketing group, will head up the venture. Stephen Donnarumma, formerly vice president in Financial Guaranty Insurance Co.'s mortgagebacked securities group, has been hired by Capital Re as a senior vice president and will be the head underwriter for the unit. Capital Re officials say more hirings are expected.

In the primary insurance of residential mortgages, premiums are generally paid in annual installments, as opposed to the municipal market, where the premium is paid up front and then deferred over the life of the bond.

As a result, the mortgage unit is expected to provide more of an immediate boost to Capital Re's profitability with target returns in the 15%-20% range, Satz said.

Capital Re shares closed yesterday on the New York Stock Exchange at 23 1/2 down 1/8.

Earlier last week, Standard & Poor's lowered its rating on Capital Re Corp.'s senior debt to A from A-plus, and revised its long-term outlook on the company to stable from positive. The agency affirmed its AAA rating on Capital Re's claimspaying ability.

Capital Re's diversification plans, which contribute to higher leverage rates and lower coverage ratios, were a factor in the corporate debt downgrade, said Robert Green, a Standard & Poor's director.

The one-notch downgrade on the company's outstanding corporate bonds reflects Capital Re's "assumption of a somewhat more aggressive consolidated capital plan and business strategy and a corresponding decrease in financial flexibility," a Standard & Poor's statement said.

The downgrade coves $75 million of debentures due in 2002 that Capital Re sold in 1992.

The primary market for residential mortgage insurance consists of eight active companies: Mortgage Guaranty Insurance Co.; GE Mortgage Insurance Co.; Commonwealth Mortgage Assurance Co.; PMI Insurance Co.; Amerin; Triad; Republic Mortgage Insurance Co.; and United Guaranty Residential Insurance Co.

Satz said Capital Re Corp. has conducted preliminary talks with the primary insurers but no formal agreeents have been reached.

The main competition for the primary firms comes from the federal government and from banks who "self-insure" their mortgages, but that is no longer a viable option for many banks because of stricter capital requirements.

As a result, demand for primary mortgage insurance is expected to grow. Other factors contributing to the demand for insurance include population growth, the increase in home ownership spurred by firsttime buyers, the declining role of federal programs, and the overall growth of mortgage securitization, Satz said.

The Capital Re executive noted that there is "no focused competition" for reinsurance in the residential mortgage market. There are European multi-line firms which offer mortgage reinsurance, Satz said, but they have a "checkered history" in terms of commitment and performance.

In 1992, total origination in the residential mortgage market was $893 billion, according to Capital Re. Of that, $175 billion was considered insurable, comprised of issues with a loan-to-value ratio of more than 80%, known as "low down payment originations." A loan-to-value ration, or LTV, is the ratio of the mortgage balance to the market value of the property. The lower the LTV, the less the loan amount relative to the property value and the greater the safety.

The eight private firms enhanced $101.4 billion of the insurable market last year. Historically, the private insurers cede between 5% and 15% of that, said David Buzen, Capital Re's chief financial officer.

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