The mortgage insurance industry has so far survived the greatest housing downturn since the Great Depression. Now, it’s ready to expand its shrunken market share in a bid to ensure its future.
Mortgage Banking
January 2011
By Robert Stowe England
If the private mortgage insurance (MI) industry were a rock song, it might be Last Man Standing, by Sweden’s heavy-metal band Hammerfall. This song of a beleaguered man determined to “stand my ground at all costs” and who sees “everything a fight to win” was released on an album in 2007, when giants of the mortgage industry were falling left and right.
When even financial behemoths Fannie Mae and Freddie Mac--the primary customers for the private MI industry--had to be taken over by the government and put on financial life support from the U.S. Treasury, survival to date by all but one of the private MIs is something to be duly recognized. However, the struggle is not over.
Private MI has been battered and weakened, and has lost a huge chunk of its market share to government mortgage insurers, the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA). One private MI player, Triad Guaranty Insurance Corporation, Winston-Salem, North Carolina, has been in runoff since July 2008.
“I think the industry as a whole experienced some of the toughest issues facing the housing finance system, because we’re structured to be in that first-loss position on low-down-payment loans,” says David Katkov, executive vice president and chief business officer of The PMI Group Inc., Walnut Creek, California. “As a result, we have all incurred substantial losses,” he adds.
Survival of the remaining six mortgage insurers through the worst of the downturn is no guarantee of making it all the way through the current cycle. Only three have maintained investment-grade credit ratings, and none meet the AA- ranking the government-sponsored enterprises (GSEs) normally require.
Why has private MI been able to survive? It is the industry’s “unique reserving process” that enabled it to absorb the enormous losses that have come its way, Katkov says.
“We are required by statute to reserve 50 percent of every premium dollar [and set it aside for 10 years]. This is immutable. We can’t reserve 10 cents on the dollar, for example,” Katkov says.
“That is countercyclical reserving, and it’s the reason the industry survived this crisis,” he adds. “[The high level of reserving] did what it was supposed to do, which was to pay all of the legitimate claims to the insured –which largely is Fannie Mae and Freddie Mac,” Katkov says. “That’s a huge success story,” he adds.
Other private MI executives share Katkov’s views on this point. “The whole concept is that we are putting aside in good times to have it be available in bad times,” explains Teresa Bryce, president of Radian Guaranty Inc., Philadelphia. “I believe that is one of the reasons our industry is still standing and still paying claims, as it is supposed to be,” Bryce states.
The industry’s survival also validates the appropriateness of the 50 percent reserving requirement, say Katkov, Bryce and other executives at mortgage insurance companies.
There is also another requirement that private MI companies have to start reserving for losses when loans go into default. “Obviously, depending on loan and vintage, it might get to be a larger reserve, as [a book of insured business] ages,” Bryce says.
In the case of Radian, for example, “Our loss reserve is much larger than what we are predicting in claims paid for next year,” she notes. At the end of the third quarter of 2010, Radian’s risk-to-capital ratio was 17 to 1--“the lowest in the industry,” Bryce says.
Under state insurance laws, private MIs are required to have a risk-to-capital ratio no higher than 25 to 1, which is equivalent to a 4 percent capital ratio.
Learning from history
The plight of the private MI industry in the modern era stands in contrast to the catastrophic collapse during the Great Depression of the entire mortgage insurance industry that had prospered under the oversight of New York’s state insurance department during the Roaring ’20s.
The recommendations from a commissioned study of that collapse, the Alger Report, called for stringent capital and reserve requirements, as well as the adoption of sound appraisal investment and accounting procedures. (The Report on the Operation, Conduct and Management of Title and Mortgage Guarantee Corporations was authored by George Alger and published in 1934.)
Those recommendations became an integral part of the regulatory framework among state insurance commissioners in the post-World War II era.
The industry’s survival also got a little assist from the state insurance commissioners who allowed some forbearance on the risk-to-capital ratio on a case-by-case basis.
The breach of that 25-to-1 risk-to-capital ratio was one reason that Triad went into runoff, explains Bryce. “The rest of us focused on working with the states for an opportunity to go above 25-to-1 if it looked like it would be a temporary situation and the company was safe and sound,” she explains.
Below AA-minus
Along the way, as claims mounted, the credit ratings of all the surviving companies have been cut below the AA-minus level at New York-based Standard & Poor’s (S&P) or its equivalent at New York-based Moody’s Investors Service and Fitch Ratings. This pushed the ratings of the entire industry below the threshold requirement that the GSEs--Fannie and Freddie--have traditionally required before a mortgage insurer would be eligible to participate in their programs.
As losses began to mount from poorly underwritten loans from the period of the housing and mortgage bubbles and from the loss of 8 million jobs in the economy, the rating agencies took a new, tougher line toward how they rated the MIs. That development could, in the end, have shut them down, according to Mike Zimmerman, director of investor relations at Mortgage Guaranty Insurance Corporation (MGIC), Milwaukee, Wisconsin.
“Despite their analysis that the industry and mortgage insurance companies have triple-A capital on a claims-paying basis--that is, the ability to honor all its expected claims obligation--[the credit-rating agencies] disconnected from that to the actual rating that they assigned to the company,” Zimmerman says.
“It used to be that in order to have a double A minus rating, it was all about capital--it was called the capital adequacy ratio--and they started to shift more from a quantitative to a more qualitative assessment of the rating,” he adds.
“They started looking at GAAP [(generally accepted accounting principles)] earnings more, almost, if you will, from an equity investment perspective than from a capital adequacy perspective,” Zimmerman says.
These downgrades raised questions among the counterparty lenders for private MI about whether or not the MIs would continue to be approved by Fannie and Freddie. If not, they would effectively be out of business and destined to runoff their legacy business and shut their doors to new business.
The two GSEs, however, cut the MIs some slack. “Both issued waivers or suspended their eligibility requirements and stopped relying on the rating agencies,” Zimmerman says. Under the law that governs the regulation of the GSEs--the Federal Housing Enterprises Financial Safety and Soundness Act of 1992—loans purchased by Fannie and Freddie are required to carry mortgage insurance to cover potential losses for balances above 80 percent of loan-to-value (LTV).
“Usually, coverage is in excess of the minimum,” says Stanislas Rouyer, senior vice president and team leader at Moody’s Investors Service. “If there is a 95 percent LTV, they don’t just get 15 percent, but tend to get 25 percent coverage,” he adds.
The GSEs specify the level of mortgage insurance required by loan type in their seller guides, which are periodically updated. In Fannie Mae’s seller guide for Sept. 22, 2009, for example, the agency announced several changes to Desktop Underwriter® Version 8.0, including those regarding mortgage insurance coverage levels. For loans representing more than 95 percent of a home’s value, for example, Fannie Mae required 35 percent mortgage insurance for both fixed-rate mortgages (FRMs) and adjustable-rate mortgages (ARMs).
In a departure from prior policy, Fannie Mae also offered another option with less mortgage insurance coverage--18 percent--for loans at less than 95 percent LTV. This lower MI requirement, however, also comes with required loan-level price adjustments or fees based on credit scores. Fees in this LTV category range from 1 point or percent of the value of the loan for credit scores greater than 740 to 3 percent for scores below 620, but no lower than 580, the minimum score allowable in Fannie Mae’s seller guide.
Credit ratings
The six surviving private MIs have separated into two broad categories--those that have maintained at least an investment-grade rating and those whose credit ratings have slipped below investment-grade.
With the industry’s highest credit rating from both Standard & Poor’s (BBB) and Moody’s (A3), United Guaranty has regained enough confidence in its future that it has developed a sales pitch based on its ranking by credit-rating agencies.
“Buy insurance from a company that is financially strong. It’s a promise for the future,” says Kim Garland, chief operating officer at United Guaranty Residential Insurance Co., Greensboro, North Carolina.
Moody’s Rouyer, however, suggests that United Guaranty’s high rating is “mostly due to support from its parent, AIG [American International Group].”
Indeed, United Guaranty remains cautious about the future. “We project that 2011 will be our highest year of claims payments, and that will probably be the moment of truth for the MIs,” Garland says.
“We’re not sure that all the players will necessarily make it” through this critical year [2011], he adds. “So, there’s still a little more shakeout, we think, to go on at the financially stronger and the financially weaker players.”
Of the surviving six private MIs, three are investment-grade and three are not. In addition to United Guaranty, Standard & Poor’s rates the following two companies with the investment grade of BBB-minus: Genworth Mortgage Insurance Corporation, Raleigh, North Carolina; and Republic Mortgage Insurance Com. (RMIC), Winston-Salem, North Carolina.
Moody’s Investors Services only rates one other private MI as investment-grade, and that’s Genworth at Baa2. RMIC is rated Ba1, which is not investment-grade. Fitch rates only one mortgage insurer, RMIC, with an investment-grade rating of BBB-minus.
The need to raise capital
Standard & Poor’s remains worried about the three companies that remain below investment-grade: MGIC, PMI and Radian. All three are rated B-plus and all three are stand-alone mortgage insurers without a parent company.
“That’s certainly an indication that, from a ratings perspective, they are under significant stress--and have been,” says Ron Joas, director at S&P and the lead analyst for the mortgage insurance industry.
“Who knows what would have happened if each one of these companies had not been able to go to the market to raise additional capital?” asks Joas. In 2010, MGIC raised $1.2 billion, PMI raised $740 million and Radian went to the market twice to raise a total of $800 million. “And I guess what was surprising about those [debt] issuances was the rates that they got for them,” Joas says. “PMI got 4.75 percent in their issuance. MGIC did 5 percent and Radian did 3 percent for their coupon,” he says.
Another positive sign cited by both S&P and Moody’s is that a new company, Essent Guaranty Inc., Radnor, Pennsylvania, began writing business last year, Joas says. Essent raised $600 million from investors and used $30 million to buy mortgage insurance hardware and software from Triad.
All together, S&P calculates, more than $3.34 billion was raised in capital in 2010 for MI companies. According to Gupta at Genworth, in the last 3.5 years, the MI industry has raised $8.489 billion of “fresh capital” as follows: MGIC, $2.301 billion; PMI, $1.731 billion; RMIC, $316 million; Genworth, $2.014 billion; Radian, $1.527 billion; and Essent, $600 million.
In June 2010, for example, S&P was predicting that, in spite of the new capital, the “the companies’ ongoing operating losses are likely to burn through the majority of the capital they raised.”
Moody’s, by comparison, has a positive outlook on ratings for PMI, MGIC and Radian. Meanwhile, the outlook for ratings for higher-rated Genworth, RMIC and United Guarantee are negative. “In terms of our view, Genworth, United Guaranty, Radian, MGIC and RMIC are all affected by the same issues,” says Arlene Isaacs-Lowe, senior vice president at Moody’s.
Moody’s has developed a metric it calls claims-paying resources as a multiple of expected claims to measure how well prepared the MIs are for the claims they are expected to pay. In this measure, Genworth is ranked highest, with a ratio about 1.5, followed by United Guaranty and Radian. Both MGIC and RMIC have about 1.2 times the claims-paying resources they need to pay claims, while PMI is last with only a ratio just barely above 1.0.
“Many of the mortgage insurers are still undercapitalized,” says Rouyer at Moody’s. “If some of them were to deteriorate, they would face a capital adequacy problem,” he adds. While Moody’s recognizes signs of improvement at the private MIs, “We are still looking at companies to strengthen their balance sheets if they want to demonstrate to counterparties they are strong,” says Rouyer.
S&P sees glimmers of hope from the investor interest in recapitalizing the private MIs. Certainly, “investors are looking at this sector as still viable,” Joas says. What they are seeing, he says, is the “very high credit quality” of the new business being written by the mortgage insurers, with FICO® scores “above 700” and lower-LTV mortgages.
The cure-default ratio
It was likely a dramatic improvement in the ratio of loans cured versus new defaults in the first half of 2010 that impressed investors, according to Joas. Even so, the ratio “took a dive in the second half,” he adds.
The Mortgage Insurance Companies of America (MICA), a trade association for the private MIs, releases data monthly on cures and defaults.
In February 2010, the cure-default ratio, which had been below 90 percent since March 2007, jumped to 117.6 percent (80,758 cures and 68,675 defaults), according to MICA. That meant the MIs were successfully modifying more loans than they were seeing come in as new defaults.
For five straight months, February through May 2010, there were more cures than defaults. Then in June, defaults pushed ahead of cures and the cure-default ratio fell to 91.7 percent, then plunged to 81.4 percent in July. During August, September and October, it hovered around 88 percent to 91 percent.
Thus, Joas expects the key factor affecting ongoing delinquencies will be determined more and more by the extent to which the economy can generate jobs. So the outlook for private MIs will increasingly be determined by the outlook for employment, he says.
The FHA factor
While FHA has been eating the lunch of the private MIs in recent years, rising delinquencies for FHA mortgage insurance led the agency to raise its premiums. This has created an opening for private MIs to expand their fairly small piece of the mortgage insurance business.
Effective October 4, 2010, FHA raised its annual premium from 0.55 percent to 0.9 percent after Congress during the summer gave the agency authority to raise the premium to as high as 1.55 percent of the principal balance. At the same time, the upfront premium was lowered from 2.25 percent to 1.0 percent. Further, borrowers with credit scores below 580 have to put down 10 percent instead of 3.5 percent, while those with credit scores below 500 or no longer eligible for FHA insured loans.
In addition, FHA also considering reducing the amount of funds that sellers can contribute to the homebuyer’s closing costs, from 6 percent to 3 percent.
A sharp drop in reserves prompted the moves by FHA for the year ending September 2009, when its capital reserve ratio fell to 0.53 percent total insurance in force. This was below the 2 percent requirement established by Congress. In 2007, the ratio stood at 6.4 percent and fell to 3 percent in 2008.
For the year ending September 2010, FHA’s capital reserve ratio fell slightly more to 0.50 percent in spite of the fact the agency had increased its reserves by $1.5 billion to $33.3 billion. FHA also reported claim expenses for 2010 were 21 percent lower than they had been predicted to be in the 2009 actuarial report.
Size of the insurable market
How big is the mortgage insurance market? For the last 21 years, going back to 1990, roughly 20 percent of all mortgages in the country were higher than 80 percent loan-to-value, which traditionally represents “the insurable marketplace,” says MGIC’s Zimmerman.
Within the market slice that was 80 percent LTV or higher, the private MI companies insured about two-thirds of that business while the federal government, through FHA and VA, insured one-third, Zimmerman explains. That fell to 10 percent in late 2009 and has recovered recently to, at most, 25 percent, Zimmerman estimates.
Private MI’s total insurance in force--the key measure of the size of the industry--peaked in December 2008 at $952 billion, according to the Mortgage Insurance Companies of America. (The industry’s total insurance in force probably peaked at more than $1 trillion in May 2008; MICA’s figures do not include Radian’s numbers prior to December 2008.) In 2005, by comparison, there was $615 billion of insurance in force. The peak year for new private insurance written was 2007, when $300 billion was written. In 2005 and 2006, there was about $225 billion written.
From June 2008 forward, total insurance in force declined every month but one, falling to $765 billion by October 2010--one-fourth less than what was in force in May 2008.
As Fannie and Freddie expanded their market share against FHA, the mortgage insurers also expanded their market share. “Then, at the height of the bubble--2003 to 2006, in particular--people started to avoid mortgage insurance” and turned to piggyback loans, says Zimmerman. This, in turn, began to take away market share from the mortgage insurers and even, to some extent, FHA.
“Lending institutions and depository institutions were seeking to deploy their capital more aggressively, so they began to expand out their second mortgages in lieu of a down payment and/or mortgage insurance,” Zimmerman explains.
“Then, as the recession began to unfold and the credit crisis began, we as an industry collectively tightened our underwriting standards,” Zimmerman says. “For example, we used to do 100 percent loan-to-value, we would do stated-income loans--all the various instruments that were out there.” The industry also did investor properties and cash-out refinances. “Those were all eliminated from the menu, and you ended up with the plain-vanilla, 30-year fixed-rate mortgage with full documentation,” he adds.
Private MIs also put a floor on credits. Instead of going as low as 575, which Fannie used to allow before raising the minimum to 580 in April 2008, MGIC now requires at least a 660 or 680 credit score, “depending on the situation,” Zimmerman says. Freddie Mac does not identify a specific minimum score.
Further, private MI companies also declined to insure condos in Florida, and in some markets they would not go above a 90 percent LTV. During this time (2008 and 2009), FHA would still do its 97 percent LTV programs in Florida, Arizona and Nevada.
Competitive factors
Changing policies at both FHA and at the GSEs have affected the competitive positions of private MI versus government insurance. In that regard, the decision by Fannie and Freddie to institute additional loan-level fees based on the loan-to-value or FICO scores is proving to be a competitive disadvantage for private MIs, according to Zimmerman and others in the private MI industry.
“When the borrower sits down and says, ‘I want to buy this $200,000 house--what’s my cheapest monthly payment?,’ not only were there broader underwriting criteria at the FHA, but the cost on a monthly basis was much more affordable at a lower price point,” Zimmerman contends.
“First, [the GSEs] would charge a 25-basis-points adverse market charge, and then they would also charge up to 250 basis points, depending on loan-to-value and credit score,” says Zimmerman. “So, in addition to our price [for mortgage insurance], other additional fees were added on to the borrower, either as a one-time fee or higher note rate,” he adds.
Until FHA raised its annual premium to 90 basis points, pushing close to the 94 basis points charged by many private MIs, FHA could offer borrowers a better monthly payment on a loan of the same size and similar characteristics.
It got to a point in late 2009 where 85 percent to 90 percent of all insurable mortgages were going through government programs, Zimmerman notes.
Tiered pricing
In May 2010, MGIC began to set up a tiered-pricing approach based on geographical markets. In Tier 1 markets, prices were lowered on borrowers with FICO scores of 720 or higher--a market segment that is profitable and which had been turning to FHA instead of private MI, Zimmerman explains.
The most restrictive credit was targeted for Tier 2 markets: Arizona, Florida and Nevada. California was also in Tier 2 originally, but the coastal areas have been reclassified as Tier 1 markets, while the Central Valley and Inland Empire areas are still in Tier 2, according to Zimmerman.
Within Tier 1, MGIC engaged in further tiered pricing based on credit scores--a risk-based approach to pricing. “We lowered the price on 720 and higher scores. We left the price the same for the 680-to-719 category and then actually raised the price on loans from 660 to 680,” says Zimmerman.
In Texas, for example, you can get insurance on a 97 percent LTV, 660 credit-score mortgage with full documentation, according to Zimmerman. “As the overall economy recovers, the product offering will expand and then it will be about sales competition,” he says.
Fannie Mae has reduced the amount of mortgage insurance required in some instances, which does not really improve the competitive position for private MIs, according to Zimmerman. Generally in the past, both Fannie and Freddie have required a 30 percent MI coverage for a 95 LTV mortgage, he explains. Last year Fannie reduced that to 18 percent coverage in exchange for a fee of 87.5 basis points charged to the borrower.
Because for the borrower the extra fee “was a lot of money,” the program created an incentive to push business to FHA and away from private MI, says Zimmerman. It was to counter this incentive that MGIC introduced credit-tiered pricing. From the prevailing 94 basis points monthly for 95 percent LTV mortgages, MGIC lowered the price to 67 basis points for credit scores of 720 and higher.
This not only gave MGIC an advantage compared to FHA, but also retained the 30 percent coverage level, which provided more premium, revenue and profits for MGIC.. Absent the credit tiering, borrowers with higher credit scores would opt for FHA to get lower payments, while MGIC and other private MI insurers would get the lower-credit-score customers, according to Zimmerman.
Private MI still has a long way to go to recover its traditional two-thirds share of the market, however.
Expanding risk-based pricing
United Guaranty embraced an expanded approach to risk-based in January 2010, five months before MGIC adopted its risk-based pricing with credit scores. Garland is one of the people involved with advancing the risk-based pricing strategy at United Guaranty. He came to the company with a background in the risk-based pricing strategies of personalized automobile insurance, with 14 years at GEICO, Chevy Chase, Maryland, and seven years at Safeco Insurance Co. (Safeco was the abbreviation for Selective Auto and Fire Ensurance Co.), Seattle.
The change in pricing came after United Guaranty completed a review of its pricing “to see what went wrong” during the period from 2006 to 2008, when mortgage insurance for so many problematic loans was written, according to Garland.
“What struck us as odd at United Guaranty is that variables like geography, credit score and debt-to-income ratios have not been used in the rating algorithms of mortgage insurers,” he says. Such a policy, the company realized, would help ensure that the company wrote more insurance for good credit risks and less for poorer-quality credit risks.
“We think that over the next couple of years, [risk-based pricing] will become the dominant rating algorithm in the marketplace” for mortgage insurers, he adds. Some mortgage insurers, however, may continue to take the traditional approach of varying premiums based on loan-to-value, and owner-occupied versus investor properties.
United Guaranty is writing insurance based on four geographic categories: very-high-risk, high-risk, medium-risk and low-risk areas. “We charge 100 percent more for the very-high-risk geography than we do for the low-risk,” says Garland. “So we will charge 100 percent more for a loan in Las Vegas than we will charge in Topeka, Kansas, because we just think it’s riskier.”
United Guaranty is also varying premiums based on debt-to-income ratios of borrowers. The company has also expanded the number of bands or pricing categories for premiums based on credit, according to Garland. “PMI had used credit score as a variable before United Guaranty started to use it,” Garland acknowledges. “We have implemented many more credit-score bands,” he adds.
United Guaranty also charges more for broker loans than it does for retail loans and recently “updated the algorithm,” Garland says, to add a new wrinkle: lower premiums for two occupying borrower loans than for one occupying borrower loan. “We believe we have superior pricing segmentation, and that gives us an advantage in the marketplace,” Garland says.
Traditionally, Garland explains, high-quality loans subsidized the cost of lower-quality loans in the mortgage insurance business. In that model, “Good risks pay too much for mortgage insurance and bad risks pay too little; but when they add up everything together, it kind of worked out OK,” Garland says.
“What we’re trying to do [at United Guaranty] is give the better loans a better rate and the higher-risk loans--we’ll write them, but we want to get more premium for them,” Garland explains.
“We’ve segmented the market in a way our competitors haven’t, so we have a price advantage on higher-quality loans and price disadvantage on higher-risk loans he adds. “We’ve seen our book skewed toward higher-quality loans that some of our competitors have been writing.” In this way, United Guaranty is ensuring that it does not repeat the mistakes of 2006 to 2008, Garland contends.
“We are very happy with the outcome of risk-based pricing. We’re writing a high-quality business, and we believe that it is appropriately priced. It’s actually turned out very well for us.”
United Guaranty has signed up 1,000 lenders for risk-based pricing--more than it expected--and about 75 percent of new business volume is coming through on the company’s new pricing model.
Loan modifications
One of the reasons the private MI business has done as well as it has during the financial crisis is due to its high success rate in modifying loans and preventing delinquencies from turning into foreclosures and then claims.
The ability to be more successful at loan modifications highlights the difference between the role of mortgage insurance and of second mortgages in high-LTV lending. During the bubble, mortgage insurers were being pushed aside in a rush to do piggyback lending from 2003 through its peak in 2006, according to PMI’s Katkov. There is a little bit of overlap, in that some mortgage insurers actually insured first and second mortgages during the piggyback craze, but not PMI, Katkov adds.
Why are private MIs better at loan modification? It’s driven by the desire to limits losses against the very companies that are in the first-loss position for high-LTV lending, says Katkov. “When the homeowner loses, the mortgage insurer loses,” he explains. “We couldn’t be more aligned with keeping people in their homes. If they lose, we lose. That’s a pretty powerful [correlation]. So we have every motivation to keep deserving homeowners in their home,” he says.
United Guaranty has done a huge volume of loan modifications as part of its ongoing efforts to deal with more than 100,000 delinquencies, says Garland.
Through the first nine months of 2010, United Guaranty cured 31,787 first-lien delinquent loans) due to modifications, according to Brian Gould, senior vice president, loss management at United Guaranty. Of that total, 18,904 “appear to be HAMP [Home Affordable Modification Program]” modifications, he says. “Some of these have re-defaulted,” Gould adds. United Guaranty, like other private MIs, has been able to approval of such things as short sales.
Radian developed a proactive campaign to help borrowers know their options in the event they were facing financial difficulties and unable to make payments. “We offered to give the servicer an advance claim payment to help restructure the loan,” says. This program was in effect before Treasury introduced the Home Affordable Modification Program or HAMP, she adds. “You can use it to pay arrearages or get a lower interest rate,” Bryce says.
“The whole point is to use it so the borrower is in a better position to pay on a going-forward basis.” The good thing about the program is that if the borrower continued to pay, no one had to repay the claims advance. “The borrower didn’t have to repay. The servicer didn’t have to repay,” Bryce explains. “If the borrower re-defaulted in the future and it went to foreclosure and claim, [the advance] just offset the claim.” The claims-advance program led to a better cure rate for Radian, Bryce says.
One of the problems Radian and other private MIs have is to get borrowers to respond to queries about participating in a loan-modification program. Radian would call on homeowners or send a mailing, but it was getting only a pitiful 3 percent response to efforts to establish contact.
“The key to what we have done is outreach,” Bryce explains. “You have to get out in front of the borrower.” To get a better response, Radian gave a grant to a nonprofit organization, Consumer Credit Counseling Service of Delaware Valley (CCCSDV), Philadelphia, to try to make contact with borrowers. The result was a higher response rate and a higher cure rate. From this, Bryce says, Radian learned “that a third party makes people feel more comfortable.”
The general lack of second mortgages has also been helpful. “I believe that’s part of the reason the cure rate is better” with private MI insurance than for loans without insurance that relied on piggyback second mortgages, says Bryce.
“Not only do you have a party participating to help facilitate loan modifications,” meaning the mortgage insurer, says Bryce. “You also don’t have a party that makes it almost impossible to do [modifications],” referring to the owners of the second mortgages. “There is really an alignment of interest between the mortgage insurer and borrower,” she says.
Rohit Gupta, chief commercial officer at Genworth, also sees an advantage for private MI over not only simultaneous second mortgages but also the derivatives model used in private-label mortgage securities--those without a government or GSE guarantee.
The underwriter, the bank, “may have all the incentive in the world” to modify the loan, Gupta says, “but if someone else owns the triple-A tranche on that security and that investor is not willing to do a principal write-down or an advance claim, then the investor that owns the last tranche, the riskiest tranche, has an incentive but no ability to impact the modification.”
Loan-level fees
Now that mortgage insurers are well along in their efforts to expand their market share through the expansion of their guidelines, there is growing criticism of loan-level fees at Fannie Mae and Freddie Mac that appear to impede their ability to do new business. Mortgage insurers are ready “to put more private capital at risk in front of taxpayer money,” says Gupta. “It’s time for the private MI sector to gradually expand its role “and be a more mainstream player moving forward” while the FHA scales back, he explains.
Genworth did not provide mortgage insurance for subprime loans from Fannie and Freddie, and it also did not do second liens and only a minimal amount of alternative-A and alternative-documentation products, according to Gupta. “Private MI as an industry insured alt-A somewhere in the low teens, [while we at Genworth] were somewhere at 5 to 7 percent of the book of business. Right now we’re at 4 percent.”
“As we came into the cycle, we had a clean portfolio that gave us an advantage of navigating the cycle better. We have navigated the cycle with a self-contained capital plan up to this point,” says Gupta.
“In addition to that, we led a lot of prudent guidelines and pricing actions in the marketplace,” he says. Genworth raised its base premiums 20 percent in July 2008, which translates into a 10-basis-point addition for a 95 percent LTV product. “What we saw in terms of home-price decline, we thought it was a prudent price increase. The mortgage insurance industry had not increased prices since 1987,” says Gupta.
Gupta faults Fannie Mae for allowing a lower share of the mortgage to be covered by mortgage insurance than has been past policy, while at the same time imposing loan-level fees as their own substitute for the part of the mortgage that does not now have mortgage insurance. Freddie simply tacked on delivery fees to certain loan products, while not combining that with lower mortgage insurance requirements. The higher loan-level fees charged by the GSEs raise the total cost of some loans so high that private MI companies say they cannot compete against FHA--even with FHA’s increase in premiums. “There has been a lot of pushback on GSEs--policymakers, as well as consumer groups, lending groups, mortgage insurance companies,” says Gupta. Yet, the GSEs have not responded to these complaints, he adds.
Gupta identifies a couple of categories of high-LTV and lower FICO scores that the GSEs have priced out of the market. “Despite the fact that most MI companies will go down to 660 FICO at 95 LTV or 680 FICO at 97 LTV, we still can’t get much business in lower FICOs because of the GSEs’ loan-level price adjustments,” he says.
Gupta contends the GSE price adjustments make the price of the loan and the mortgage note rate so high that most borrowers will choose to go with FHA even when private capital is at play in the market.”
The fees being charged by the GSEs are stacked on one another and can make loan pricing prohibitively expensive, according to Gupta. For example, there is the basic adverse market fee of 25 basis points across the board for all loan products. Then there are loan-level charges “that can go from an additional 25 basis points to anywhere to 6 to 9 points [600 to 900 basis points] on the loan,” he says.
Loan pricing that high “is essentially telling the borrower, ‘We don’t want to lend to you, because any prudent borrower won’t get a mortgage with 6 to 9 points upfront cost or amortized on the mortgage,’” Gupta says.
The base fees alone can quickly rise to the level of paying 2 or 3 points (200 or 300 basis points) in just the base fees. Then there are “adders,” explains Gupta, “based on risk attributes like jumbos, cash-out,” which can be anywhere from no basis points “to as high as 6 points.”
So far, the GSEs have stonewalled criticism from the private MIs, according to Gupta. “We’ve been very vocal on this point. We haven’t seen any movement. The most recent action [in November] by Freddie Mac would appear to indicate that Freddie still wants to move higher on these fees,” he says. Freddie Mac increased delivery fees based on FICO score and loan-to-value. For example, the delivery fee was 175 basis points for borrowers with FICO scores from 660 to 680 with loan amounts of more than 85 percent of the value of the home.
Gupta says the GSEs might be raising fees to raise capital to offset their losses from their legacy business. “Unfortunately, raising $3 billion through the fees will not offset $150 billion of bailout money,” he says.
Fannie Mae did not return repeated phone calls or respond to multiple e-mails for comments on the complaints about high loan-level fees by mortgage insurers.
A spokesman for Freddie Mac downplayed the significance of the fees. “This is not new. We have been assigning fees based on risk for many years--for decades,” says Brad German, senior director of public relations “Our feeling is that by appropriately pricing appropriate risk, the fee changes that we recently published will enable us to continue to fill our mission to provide liquidity to a wide range of borrowers across the country, while simultaneously underscoring our commitment to be serious stewards of taxpayer dollars,” he says.
“The changes are going to have a nominal impact on most borrowers,” German says. “For a $200,000 mortgage with 5 percent down, the change would add $10 to the monthly housing payment for a fully amortized 30-year, fixed-rate loan.”
In response to the complaints that Freddie is refusing to do business in the categories of 95 percent LTV with 660 to 680 credit scores and 97 LTV with a 680 or higher credit score, German says Freddie Mac still has the Home Possible® program, which is exempted from the increased fees.
German contends that the flexibility provided in the mortgage insurance part of the fee (less mortgage insurance is required when the loan-level fees are added) “would probably give the MIs a better all-in execution.” That is, when you add in all the different fees charged by the lender by the MI itself and Freddie. The private MIs have vigorously disagreed with that view.
The new loan-level fees have also attracted the attention of a group of lawmakers. On Oct. 4, Representatives Dennis Moore (D-Kansas) and Scott Garrett (R-New Jersey) wrote a letter to Edward DeMarco, acting director of the Federal Housing Finance Agency (FHFA) to complain about the fees. Another 17 members of Congress also signed the letter.
“We are writing to express our concern regarding additional fees being imposed on borrowers by Fannie Mae and Freddie Mac that are potentially putting taxpayers at risk, prohibitively raising the cost of conventional mortgages and discouraging private-sector capital from stepping in and contributing to a recovery in the housing market,” the letter began.
“It is clear that the GSEs are charging these fees as a credit-risk mitigation tool,” the congressmen wrote. “There is no indication, however, that these fees are going into a regulated reserve structure similar to the reserve structure required for private mortgage insurers,” the members stated.
“These fees increase the potential burden on taxpayers in another important way, by driving business to FHA,” the congressmen wrote. “FHA does not review the underwriting of the individual mortgage loans it insures; it covers 100 percent of the loan amount if the borrower defaults, and it can insure loans as high as $729,750 in some areas of the country,” the letter continues.
“If FHA’s financial condition were to deteriorate, the total cost of FHA losses would be borne by taxpayers,” the letter claimed. “It would be far less expensive for the borrowers and safer for taxpayers if the GSEs simply required deeper mortgage insurance coverage rather than charging these fees.”
The letter concluded: “For these reasons, we urge the FHFA to act now and prevent the GSEs from imposing these fees.”
The Federal Housing Finance Agency declined to comment to Mortgage Banking about the complaints made by mortgage insurers or to the letter sent to the FHFA by members of Congress. DeMarco responded by letter to the congressmen on Dec. 6.
Congressman Garrett released to Mortgage Banking a copy of the letter he received from DeMarco, who said the fee charges came as a result of a study by FHFA completed in July 2010 that found the GSEs had underpriced risk prior to 2008 when setting a price for its guarantee on a number of loan products. To remedy this mispricing, FHFA gave Fannie and Freddie the green light to raise prices and fees based on loan product type.
“The fee changes were to better align fees with updated model estimates of expected future cost” for specific loan products, DeMarco wrote. These fees also take into consideration modeling of “the expected recoveries” from MIs in the event of the GSEs file claims for losses covered by the MIs.
“While your letter suggests that the Enterprises could rely on deeper mortgage insurance coverage instead of those fees,” DeMarco wrote, “the current financial condition of the private mortgage insurers calls into question the suitability of that approach.” Ouch.
“While there have been some improvements in the mortgage insurers’ circumstances recently, these are still far from sufficient to permit the industry generally to meet the Enterprises’ reasonable, standard counterparty requirements,” DeMarco wrote to Garrett. He points out that all private MIs fail to meet the AA-minus standard set by Fannie and Freddie.
“As it is, the industry remains at risk of being unable to meet all future claims on existing business. Substituting deeper mortgage coverage for the current fees would add to the Enterprises already sizeable counterparty credit risk with mortgage insurers while foregoing the added guarantee fee income to help cover the credit risk on higher-risk mortgages.”
DeMarco left the door open for a larger role for mortgage insurers if and when their financial condition were to become “strong.”
This battle over loan level fees is likely to continue and the outcome could determine the pace at which private MIs regain some of their lost market share. Stay tuned. MB
bio: Robert Stowe England is a freelance writer based in Arlington, Virginia. He can be reached at
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