Several trends are coming together that spell an optimistic outlook for this private mortgage insurer.
Mortgage Banking Magazine
By Robert Stowe England
The mortgage insurance (MI) industry--devastated in the aftermath of the 2008 financial crisis--had by mid-2013 clawed its way back from the brink to profitability.
The industry’s fortunes have been helped by declining delinquencies and improving cure rates on claims from its legacy business, according to Ron Joas, credit rating analyst for New York-based Standard & Poor’s (S&P). Prospects for a brighter future are also being boosted, in turn, by a growing book of high-credit-quality business written since the beginning of 2009.
What the industry needs now is for the economy to pick up the pace, according to Curt Culver, chairman and chief executive officer of Milwaukee-based Mortgage Guaranty Insurance Corporation (MGIC).
“It’s a plow horse economy and it should be a race horse economy at this point,” says Culver. “And so we’re muddling through it. But at some point in time, I think you’ll see a real takeoff relative to demands as household formations surge when people are assured of their future,” he says.
Culver points to the forecast by the Joint Center for Housing Studies at Harvard University, Cambridge, Massachusetts, as one of the reasons he sees an improving future.
Ten years ago, he notes, the Joint Center was forecasting 1 million new household formations a year, based on demographic trends. However, in the last five years, that actual pace has been only 500,000 a year, rising to 1 million in 2012.
“So far, many young adults prevented by the Great Recession from living on their own have still not formed independent households,” according to the Joint Center’s State of the Nation’s Housing 2013 report, published in June 2013.
Because of this pent-up demand, the Joint Center has forecast that household formation will expand by 1.2 million a year “over the remainder of the decade.” This means the industry is on the verge of “huge demand” for purchase mortgages that will likely require mortgage insurance, because most first-time homebuyers will not have a 20 percent down payment, according to Culver.
What a difference a year makes
As Culver looks to a brighter future for the industry and MGIC, he recounts three broad trends that have helped buoy MGIC’s financial performance: lower delinquencies, higher cure rates and lower severities in losses on claims.
The delinquency rate for loans insured by MGIC, excluding bulk loans, was 9.69 percent on Sept. 30, 2013. This compares with 12.34 percent as of a year earlier. Including bulk loans, the percentage of delinquent loans was 11.51 percent on Sept. 30, 2013.
Insurance policy losses incurred in the third quarter of 2013 fell to $180.2 million versus $490.1 million in the third quarter of 2012. That was offset chiefly by premiums earned ($231.9 million) and investment income ($20.2 million).
The good performance of loans originated since 2009 also contributed to the company’s improving outlook, according to Culver.
“We have $23 billion that we’ve insured year-to-date,” Culver said in late November 2013. “Importantly, the loss ratios on each book of business over the last five years have been outstanding.”
For the 2009 book of business, the loss ratio was 13 percent at the end of the third quarter of 2013. For 2010, it was 6 percent at the end of the third quarter of 2013. For 2011, it was 4 percent; for 2012, 2 percent. And, finally, for 2013, the loss ratio was only 0.9 percent.
The company’s outlook further benefits from a surge in 2013 in the volume of business, according to Culver. S&P also finds it a positive for MGIC that its new business volume grew in 2013, according to Joas. For the first nine months of 2013, MGIC wrote $23.1 billion in new insurance, compared with $17.1 billion for the same period in 2012.
Home Affordable Refinance Program (HARP) activity for the first nine months totaled $8.6 billion, compared with $7.7 billion in the same period of 2012. If you take out the HARP activity, MGIC’s new business grew an impressive 71 percent in the first nine months of 2013, rising to $14.5 billion from $8.5 billion in the first nine months of 2012.
MGIC’s rising volume of new business is due in part to the fact the company typically has “a higher penetration” of the purchase mortgage insurance market when compared with other players in the industry, according to Culver.
“As a result of that, in the third quarter we also had a milestone,” he says. “We grew insurance in force for the first time since 2008.”
As of Sept. 30, 2013, MGIC had $159.2 billion in primary insurance in force, up marginally from $158.6 billion on June 30, 2013. It was nevertheless down modestly from $162.1 billion at year-end 2012.
MGIC turned a profit for the first time since the financial crisis of 2008 in the second quarter of 2013 and did it again in the third quarter. That turnaround marked a turning point for the company.
“It’s an important step,” says Culver, speaking of the two quarterly profits. “I think it indicates two things. One, our legacy book is becoming a smaller part of our company,” he says--falling to below 50 percent by year-end 2013. Second, “the quality of the new business we’ve insured since 2009” is boosting the bottom line.
In the second quarter of 2013, MGIC reported a net profit of $12.4 million, compared with a net loss of $274 million in the same period of 2012. In the third quarter, the company reported a profit of $12.1 million, compared with a net loss of $247 million the same quarter of 2012.
MGIC’s credit rating, like most in the private MI industry, remains low with an outlook that ranges from stable to positive. For example, S&P has a rating of B- with a stable outlook for MGIC Investment Corporation, the holding company for MGIC. The operating company has a B rating with a positive outlook. Both ratings are several steps below the lowest investment grade rating of BBB-.
The turnaround at MGIC comes from improving fundamentals for the housing sector. Beginning in the second quarter of 2013, MGIC made a positive adjustment in the reserves it had set aside for delinquent loans.
“Rather than 1 in 4 going to claims, they are thinking along the lines of 1 in 5,” Joas says. “That’s pretty consistent with what we’ve seen across the [mortgage insurance] sector.” Given that MGIC still has “a fairly large delinquent inventory, when less of those are going to claims, that’s a good thing.”
In the third quarter, MGIC’s financial statements reflected another improving trend in the industry. For the month of September 2013, the rates of cures to the rate of defaults for the industry was 83 percent in data released by the Mortgage Insurance Companies of America (MICA), a trade organization. MICA represents MGIC, as well as Radian Guaranty and Genworth Mortgage Insurance Corp.
This compares with a cure-to-default rate of 76 percent for September 2012. Importantly, the higher cure rate in September 2013 for the industry is impressive because typically there’s a seasonal decline in cure rates in the second half of the year, coupled with higher delinquencies, according to Joas.
“The trends you’re seeing in the industry in terms of delinquencies going to claims, you can see this on a monthly basis in trends for declining new notices of default,” says Joas. “At the same time, the cures are staying strong and they are staying strong in the face of the [seasonal downward trend] you might otherwise expect.”
There are other positive trends as well. The housing market continues to demonstrate some healing. Shadow inventory no longer appears to be an issue. “It seems to have been absorbed into the market,” Joas says. There might still be some real estate-owned (REO) properties by lenders coming onto the market, “but it doesn’t seem to be an issue in holding down house prices,” he says.
New York-based Moody’s Investors Service upgraded MGIC’s financial rating last August from B1 to Ba3 with a stable outlook, partly on the additional $1.2 billion capital raise done early in 2013, according to Helen Remeza, vice president and analyst at Moody’s. The new capital improved the company’s standalone regulatory-risk-to-capital ratio from close to 45 to 1 to about 20 to 1, according to Moody’s.
“They continue to write high-quality business in today’s improving housing environment,” adds Remeza.
Journey back to profitability
It has been a long and difficult journey back to profitability for MGIC, as with other mortgage insurers. When asked how MGIC got from the stark aftermath of the financial crisis of 2008 to its return to profits in 2013, Culver replies, “Well, we prayed a lot.”
It is still painful to look back at the hard times the company has endured. “I still cringe when I remember,” he adds. “In 2008, as the world was falling apart in mortgage finance, it was a difficult time.”
Culver, who has been chief executive officer since 2000 and chairman since 2005, says the first step toward survival was taken by the management team in March 2008 to raise $850 million in new capital. New York-based Fitch Ratings, in fact, had issued a warning at the time that it would lower MGIC’s credit rating if it did not raise more capital, a warning it also issued to MGIC’s rivals--Radian Group and PMI Group.
MGIC took another step in early 2009 that proved to be critical to its survival and turnaround. The company went to the Wisconsin Office of the Commissioner of Insurance to seek permission to create a new subsidiary named the Mortgage Insurance Corporation (MIC) with $1 billion in capital to back the writing of new mortgage insurance policies.
Under the company’s proposal to the insurance commissioner, the parent company MGIC would continue to pay claims on the legacy business from its “strong position relative to paying claims,” Culver recalls. The Wisconsin insurance regulator approved MGIC’s plan to create MIC. This gave MGIC a way to stay in business and, with MIC, not risk breaching the 25-to-1 capital ratio that would prevent it from writing new policies in many states.
After Wisconsin approved the creation of MIC, MGIC also had to get permission from Fannie Mae and Freddie Mac to write new business under MIC.
“Freddie Mac agreed with us but Fannie Mae didn’t,” Culver recalls. “And so we had to continue to operate MGIC and utilize MIC to write business in states where we might exceed the 25-to-1 ratio,” he recalls. The MGIC/MIC combination “allowed us to continue to be the largest counterparties for Fannie and Freddie, although there were difficult meetings we went through, as did our counterparties,” Culver recalls.
In March 2010, as losses mounted from the legacy business “and the recession continued to get deeper,” MGIC did a second capital raise of $1.1 billion, Culver recalls. There was an expectation at the time that the housing market would recover sufficiently so that another capital raise would not be necessary. However, the struggle to turn around the company would continue as the onset of a housing recovery was delayed by another two years.
“If we had known how long it would last, as I look back at it now, I don’t know--it would have been very depressing,” recalls Culver. “But we kept hanging in there to live for another day.”
Like other mortgage insurers, MGIC, beginning in early 2009, “eliminated a lot of the high-risk underwriting, the alt-As, 100s [100 percent of loan-to-value (LTV) ratio], the NINAs [no-income/no-asset loans] and the option ARMs [option adjustable-rate mortgages],” says Mike Zimmerman, chief investor officer at MGIC.
The company also suspended its dividend. It then sold an ownership stake back to Sherman Financial Group LLC, a consumer asset and servicing company specializing in charge-off and bankruptcy plan consumer assets that was in a joint venture with MGIC.
The mortgage insurer also stopped writing mortgage insurance policies outside the United States. “We were in Australia and we were just about ready to start writing in Canada,” recalls Culver. “We hired a management team and a board there [in Canada] and discontinued both because we needed the capital here.”
MGIC also took another big step--risk-based pricing for its premiums. Before the financial crisis, everything with a FICO® score above 620 got pretty much the same pricing, regardless of loan-to-value or the credit score, Zimmerman recalls. All that changed in 2008. “We broke out pricing into three credit-score bands within LTV buckets,” he says.
This approach, which other mortgage insurers also adopted, allowed MGIC and the industry “to maximize the amount of profitable business we could write and reward the good credit,” says Zimmerman. It also allowed MGIC “to begin to regain share from the Federal Housing Administration [FHA],” he says. FHA provides federal government insurance for mortgages that meet its criteria.
Because of its capital raisings in 2008 and 2010, MGIC was able to maintain a sufficient capital buffer to operate without resorting to writing business under MIC)--that is, until the third quarter of 2012. That’s when MGIC’s risk-to-capital ratio rose to 27.8 to 1.
In January 2012, as claims and losses began to push MGIC’s ratio higher, the company moved $440 million of capital into MIC so that it could continue writing policies in about 12 states that have a 25-to-1 risk-to-capital limit. “With the other states, we had a waiver from Wisconsin because they analyzed our financials along the way and said this company is in a strong position to pay all its claims,” Culver says.
Then in the fourth quarter of 2012, MGIC took a combined capital charge of $370 million to settle two broad areas of litigation. MGIC had a dispute with Freddie Mac over pool insurance. The company also had a separate dispute with Bank of America over the extent of rescissions by MGIC of its insurance coverage for loans originated by Countrywide Financial Corporation.
“We were already above 25 to 1 in the third quarter, just as part of the natural progression of the recovery,” recalls Zimmerman. “And then it jumped to 45 to 1 as a result of the two charges.”
Looking back, if MGIC had not set up the legal structure for MIC in 2008, it would not have been able to write business in the last half of 2012 and part of 2013 in all states. Even so, Cutler believes it would still have been better to be able to move all the new business into MIC back in 2009. Absent that, however, the existence of MIC saved the day in 2012.
“The people I work with are outstanding businesspeople and I commend them for thinking outside the box to make sure we always had an ability to write on a national basis,” Culver says.
In early 2013, MGIC was again facing the need to raise capital one more time. “People had been looking at the improvement on the legacy books of business in particular and the outstanding quality of the business written since 2009, and things felt better,” Culver recalls. So, in February 2013, MGIC decided to try its hand again at raising more capital.
This time MGIC was pleasantly surprised at the speed and ease with which it was able to raise new capital.
“It was a Thursday when Goldman Sachs called us to recommend a capital raise,” recalls Culver. Goldman Sachs did not think MGIC could raise as much capital as MGIC wanted to raise, Culver recalls. Nor did it think MGIC could achieve the share price it preferred. Nevertheless, Culver wanted to go forward and have the board of directors consider the public offering.
“I got it approved by our board the next morning, Friday morning, and by Tuesday basically the share price doubled and the size of the deal was a couple times larger than what Goldman said it could have been,” he says. Instead of raising $800 million, MGIC raised $1.2 billion.
“The Goldman Sachs partner involved with the transaction has been doing deals 25 years and he said it was the most amazing deal he’s ever been associated with,” recalls Culver.
S&P cheered the new capital raise. “It raised their competitive profile. It assuaged the fears of regulators and counterparties alike,” says Joas.
After the capital raise brought the company’s risk-to-capital ratio back below 25 to 1, the company moved all its MIC business back to MGIC in August 2013. “We only had to utilize MIC on a limited basis in a few states for a little less than a year,” says Zimmerman. “We project staying below 25 to 1, so there’s no need for MIC.”
Higher capital requirements
Like other MIs, MGIC faces the potential challenge of “tighter eligibility criteria from their counterparties, including Freddie Mac and Fannie Mae,” says Remeza at Moody’s.
The two government-sponsored enterprises (GSEs) are expected to release revised standards that will require higher capital levels for the private MIs than the 25-to-1 level in the current standard.
“The GSEs have been working on that for years now, trying to refine the criteria for what makes a mortgage insurer eligible for writing insurance for conforming loans,” says Stanislas Rouyer, associate managing director at Moody’s Investors Service.
“The GSEs and FHFA [Federal Housing Finance Agency], which are very influential on what should go into eligibility criteria, don’t want to make them so onerous that most mortgage insurers aren’t able to meet them,” says Rouyer. “They also don’t want to make them too easy so they end up facing counterparties that don’t have a reasonably strong credit profile.”
S&P also sees the new standards as a challenge for MGIC. Joas says that some in the industry expect the new capital ratio to be 18 to 1 or 16 to 1--a higher capital level than the current “20-to-1 or 20-plus-to-1” capital level at MGIC. If the GSEs propose 18 to 1, MGIC would need to raise capital for the new business it writes, according to Joas, although there would likely be a transition period of one or two years to give private MIs time to meet the higher standard.
The GSEs have not changed their requirement for an AA credit rating or better--a standard that no mortgage insurer could meet today. Instead, they have waived the requirement to allow mortgage insurers to continue to write business. It is not clear what levels of credit rating that the GSEs might require.
“The new eligibility criteria will probably be less constrained credit-quality-wise than before, but would probably require more capital than MGIC’s current capital profile can support,” says Rouyer. MGIC and probably some of the other mortgage insurers will probably have to find ways to improve their capital profile. “It could mean using more reinsurance. It could mean going back to the capital markets,” Rouyer says.
Hit the ground running
The number of employees at MGIC, once as high as 1,250, is now down to 800. The entire senior management team stayed with the company during its difficult years. The remaining salespeople and underwriters have an average tenure of 16 years at the home office and 18 years in the field, according to Culver.
That level of experience is proving to be an advantage. “The relationships [of our employees] with our customers are very, very important relative to meeting the needs of those customers, whether it be on the origination side or the servicing side of the business,” Culver says.
Pat Sinks, president and chief operating officer since 2006, agrees. “I think our sales and underwriting organization is the best in the business and the most experienced,” he says.
With the troubled times now behind it, MGIC is ready to step up the competition, according to Sinks. MGIC has about 250 people employed in sales and underwriting working with about 3,000 lenders with which MGIC does business.
“One of our strengths is that we do business with everybody, large and small,” says Sinks. “Quite frankly, it was our sales organization that kept us in the game in terms of the market share we had over the last five years,” says Sinks. “So now they are pretty excited about going back to being on the offense and leveraging all those relationships.”
MGIC and the industry as whole are also benefiting from an improving competitive advantage for private mortgage insurance. Historically two-thirds of the mortgage insurance written has been by the private sector. However, “through the troubled years, we were at 10 percent to 20 percent,” says Culver.
In the third quarter of 2013, the private mortgage insurance industry surpassed FHA for first time since early 2008, with 39.4 percent of the market, compared with 38.5 percent for FHA and 22.1 percent for the Department of Veterans Administration (VA), according to Inside Mortgage Finance.
“Private mortgage insurance is in a much better financial execution for the consumers, given the price raises FHA had to put in place and given the huge deficits they’re running,” says Culver.
“We should be getting a lot of FHA business back in the future and grow market share even more,” he adds. “That, coupled with the household formations and the outstanding quality of new business, makes a wonderful story and a wonderful future for people in our industry.” MB
Copyright © 2014 by Mortgage Banking Magazine
Reprinted With Permission