Two years ago Amerin Guaranty Corp. of Chicago, an upstart mortgage insurer, launched an aggressive drive to make lender paid mortgage insurance-or LPMI-a household word in the home finance industry.
With the backing of $200 million in seed capital-including commitments from Aetna Life & Casualty Co., J.P. Morgan Capital and General Motors Corp.'s pension plan, among others-Amerin had hoped to muscle in on the traditional "borrower paid" insurance territory of such industry stalwarts as MGIC, General Electric Mortgage Insurance and PMI.
Amerin's LPMI concept was radical but simple. Borrowers who can't afford a down payment of 20% or greater typically must pay an extra $20 to $30 per month-or more depending on the loan amount-for private mortgage insurance.
The payment, which goes into the pockets of mortgage insurance companies, is not tax-deductible. The traditional mortgage insurance (MI) policy, which can be canceled by the borrower, typically covers 20% of the loan amount should the mortgage go into default.
Amerin decided that instead of tapping the borrower for the extra MI money each month, why not increase their note rate to pay for the coverage and let them finance it? For example, a borrower with LPMI would obtain a mortgage for 8.50% compared to the going rate of 8.00%. The extra 50 basis points would pay for the MI coverage that the lender would get from Amerin.
It is called "lender paid" because the lender obtains an MI policy, pays for it itself and passes the cost on to the borrower through the higher note rate. The higher rate allows the borrower to deduct additional interest from his or her taxes.
Sounds like a great idea, doesn't it? Well, that all depends on where you sit.
An LPMI Fire Storm
When Amerin introduced its LPMI product in 1993, traditional MI companies such as GE, MGIC and PMI were not pleased. Their business was predicated on the borrower paying an extra fee each month that was then tacked on to the loan amount. The lender in turn would pass that payment on to them. The three insurers, which write the lion's share of MI business in this country, clearly felt threatened.
Some even felt that Amerin and the LPMI concept might hurt their grip on the MI business. Thus they've tried their best to paint LPMI as anti-consumer, and have urged regulators and state consumer advocates to fight the product. As one MI official put it: "We don't like the product for the simple reason that the consumer cannot reduce their interest rate once the equity in their home turns their loan into a 80% LTV loan. With traditional MI they can do that." With BPMI the borrower is allowed to cancel the MI policy once the equity in his/her home rises and the loan-to-value ratio reaches 80%.
For the most part, regulators listened to their arguments, agreed to some extent, but took little or no action. The road was then paved for LPMI to take off-or at least that's what Amerin and its backers had hoped.
Ironically, Amerin is now doing quite well, but it appears that little of its success is tied to LPMI. At year-end 1993 it had just $272.4 million of insurance in force. Today it has more than $5 billion of insurance in force-a small portion of which is tied to LPMI.
How well is Amerin doing? The company is now set to sell its shares to the public in an initial offering that could raise as much as $200 million. Company officials, including its founders, former MGIC chief operating officer Gerald Friedman and former thrift regulator Stuart Brafman, declined to be interviewed for this article. A company spokesman said that because Amerin "is in registration" with the Securities and Exchange Commission for an initial public offering, its officers are legally barred from talking about the company or its finances until the offering has been completed.
However, documents do talk. And Amerin's SEC filing is very revealing-especially on the topic of LPMI. According to the filing, Amerin is doing well chiefly because of its borrower paid mortgage insurance (BPMI) products, not LPMI. BPMI, quite simply, is traditional mortgage insurance-the kind offered by MGIC, GE, PMI, Commonwealth and others. In fact, borrower paid policies account for most of Amerin's business.
"The company began offering BPMI products nationwide in February 1994," it writes in its offering circular. "In 1994 and for the six months ended June 30, 1995, BPMI accounted for approximately 65% and 77%, respectively, of the company's net premiums written."
In other words, Amerin has succeeded by offering traditional mortgage insurance products. Company statements issued before the IPO filing credit their success to three things: "Reduced premiums, typically five basis points cheaper across the board than its competitors; fully (100%) delegated underwriting, which provides instant mortgage insurance approval and speeds the process; and predetermined claim amounts, which speeds payments in the event of a claim and eliminates lengthy negotiations."
SEC documents indicate that BPMI, and to a minor extent, LPMI, have allowed Amerin to increase its market share substantially. In 1993, its first year of operation, Amerin had a share of just 0.2%. That figure increased to 1.9% in 1994 and currently stands at 4.9%. (According to SEC documents, the MI market leaders at mid-year 1995 were MGIC with a 28.8% share; GE with 20.3%; United Guaranty Residential Insurance at 12.2%; Commonwealth Mortgage Assurance with 9.6%; and Republic Mortgage Insurance Co., holding 8.8%.
Risks and Rewards
Amerin's numbers do look pretty good. The company even earned $4.5 million on a pro forma basis for the first six months of the year, documents show.
But as always, there are risks. SEC documents show that Amerin is dependent on a small number of lenders for a substantial part of its business. "Ten lenders were responsible for 98.7%, 89.9% and 86.9% of Amerin Guaranty's direct risk in force at December 31, 1993 and 1994, and at June 30, respectively." Among its top clients are Countrywide Funding Corp., Pasadena, CA; Norwest Mortgage Corp., Des Moines, IA; Prudential Home Mortgage Corp., Clayton, MO; and BankAmerica Corp. in San Francisco, to name a few.
Investment banking officials and equity analysts will tell you that it's never a good sign to have so much of your business concentrated with just a few clients. On the other hand, with the mortgage industry consolidating so quickly in five years, it may not mean much of anything.
Documents also show that a "majority of claims under private mortgage insurance policies" are paid during the third through the sixth years after issuance. The coming 12 months will be crucial for Amerin as the process of curing troubled loans starts. If the company has done its underwriting homework, claims payments shouldn't affect it any more than they will MGIC, GE and PMI.
Moody's and Standard & Poor's have rated the claims-paying ability of Amerin as "Aa3" and "AA," respectively. Mortgage investors, including the Congressionally-chartered secondary marketing enterprises, will not buy loans unless the MI company is rated a minimum of Aa3 and AA. If Amerin is ever downgraded, it will hurt its balance sheet. But that applies to any other MI company as well.
Whither LPMI?
But what about LPMI, the product that was supposed to put Amerin on the map?
If the SEC filing is any indication, lenders have not been trampling one another to use LPMI. MGIC spokesman Geoff Cooper notes that LPMI has actually been around for at least 25 years. "You have to look at the product this way," he says. "The lender passes on the loan payments, the escrow, the taxes, the MI and everything else. The MI company, in theory, may not know that the MI policy is being paid for by a higher rate. It doesn't ask where the premium comes from. It just takes it."
Amerin is believed to be the first MI company to heavily promote LPMI in an "open" manner by disclosing where the MI money is coming from.
The MGIC spokesman says his company offers LPMI-type products under a "risk sharing" relationship. "In some cases we know it's being paid for by a higher rate," he said. "But overall, it's a very small part of our business."
GE, on the other hand, says it doesn't offer LPMI "as it is currently being marketed by Amerin." A company spokesman says the company believes that Amerin's version of LPMI is anti-consumer because the borrower cannot reduce the note rate which pays for the MI policy. There is also some fear that the Internal Revenue Service may one day declare that the "extra" portion of the note rate used to fund LPMI is not tax-deductible.
Still, LPMI does have some fans besides Amerin. Joe Anderson, executive vice president of Countrywide Funding, the nation's largest lender, says his firm is very happy and "comfortable" with LPMI.
He estimates that one-third of Countrywide borrowers who need an MI policy are now using LPMI products. "It's not so easy explaining all the nuances to the consumer," he says, "but dollar for dollar we think it's a better deal for the consumer-after the tax benefit is figured in."
As one MI official put it, "If Countrywide's still using it, there has to be something to it."
Paul Muolo is assistant managing editor of the National Mortgage News, a Faulkner & Gray publication.
