NMI Holdings Inc., which raised $550 million in April to open a mortgage insurer, faces a lawsuit from an Arizona regulator, highlighting the role of state watchdogs as the industry seeks to recover from years of losses.

Arizona officials, acting as receivers for PMI Mortgage Insurance, which they seized last year, sued NMI and at least six of its employees on Aug. 8, saying some PMI workers stole information and did tasks for NMI over at least seven months before joining the upstart. Along with damages, the state wants NMI to be forced to withdraw any applications with insurance agencies and mortgage financiers Fannie Mae and Freddie Mac that relied even partly on material taken from PMI.

State commissioners have stopped PMI, Triad Guaranty Inc. and Old Republic International Corp. from selling new mortgage insurance after claims costs drained funds. Some regulators, along with government-sponsored enterprises Fannie Mae and Freddie Mac, have pressured remaining companies to maintain capital standards. Upstarts such as NMI need the blessing of states and the GSEs as they seek to take market share.

"It does complicate the investment and it's another variable to think about that makes it less transparent," said Jason Stewart, managing director at Compass Point Research & Trading LLC. "It becomes a lot more complicated, because you have to try to factor in what sometimes aren't the most rational bodies of people, the GSEs and the regulatory bodies."

A delay or derailment of Emeryville, California-based NMI's plan to start writing coverage would strip potential capital for loans with low down payments from a housing market stabilizing after a six-year slump. Germaine Marks, the acting director of the Arizona Department of Insurance, declined to comment on regulatory approval of NMI. Wisconsin, where the insurer is domiciled, is in the process of reviewing the company.

NMI's shareholders can take their money back if its National Mortgage Insurance Corp. unit doesn't receive necessary approvals by mid-January, though it could ask for an extension, said Glen Corso, NMI's general counsel. Investment bank FBR & Co.'s fees on NMI's private stock offering are contingent on the deal not being unwound.

"NMI denies that we have used any information over which PMI has any rights in any way whatsoever in connection with any application," Corso said in an e-mail. The company is working toward completing regulatory approvals in the fourth quarter and "will not let this lawsuit distract us."

Regulators typically defer to their colleagues in the state where the mortgage insurer is domiciled on questions of financial stability, said Sean Dilweg, a vice president at CUNA Mutual Group and a former Wisconsin insurance commissioner. Still, each state can decide whether to allow a firm to operate within its borders, he said.

"The expertise for the regulation of these companies is really lodged in the domestic regulators." Dilweg said in an interview. "It's very important to stay close to your domestic regulator, to reach out and let them know the stresses that you're facing."

NMI was licensed by Wisconsin regulators in 2009, said J.P. Wieske, a spokesman for the state insurance regulator. The approval is contingent on a review of the firm's computer system, he said, declining to comment on whether the lawsuit may affect the approval process.

Private mortgage insurers, which have lost more than $18 billion since mid-2007, wrote $40.1 billion of coverage last quarter, or almost 10 percent of the $405 billion of new loans, according to newsletter Inside Mortgage Finance. Three of the guarantors have been forced out of business, while others are have received regulatory waivers to remain active.

Mortgage insurance is typically required for loans exceeding 80 percent of a property's value, paid for by consumers and selected by debt originators. The protection covers some or all of foreclosure losses for lenders or Fannie Mae and Freddie Mac, the government-supported mortgage-bond guarantors that are the industry's biggest clients.

MGIC Investment Corp. the largest insurer by outstanding policies, has declined 68 percent in New York trading this year as shrinking capital and a dispute with Freddie Mac threaten its ability to sell coverage. MGIC's preliminary ratio of risk relative to capital breached the level some regulators require to write new policies as of June 30, the insurer said Aug. 2.

Radian Group Inc., which sold the most private mortgage insurance in the first half, is counting on profits from those sales to boost reserves and make up for losses on older policies. The shares have rallied 47 percent this year.

While NMI could deprive existing insurers of potential business, a new rival might create a sense that the industry is a worthwhile investment as the firms seek additional capital, regulatory aid and to be viewed as valuable by policy makers rewriting mortgage-market rules, said Rob Haines, a CreditSights Inc. analyst.

"It's a double-edged sword," he said. "Any kind of negative impact of a new market entrant would be offset by the positive perception that this could be a viable industry."

Goldman Sachs Group Inc., JPMorgan Chase & Co, private- equity firm Pine Brook and reinsurer PartnerRe Ltd. are among backers of the industry's other startup, Essent Guaranty Inc. The Radnor, Pennsylvania-based firm raised $600 million in 2009 and 2010 and began writing policies last year, providing 5.3 percent of coverage in the first half of this year.

In 2009, Essent said it agreed to pay as much as $30 million for software and other assets of Triad, which that year began paying only parts of claims under an order from its Illinois regulator.

Arizona's suit, filed in state court in Alameda County, California, alleges that NMI officials met in December with the receivers of PMI as potential acquirers of some of its assets. The insurer began paying claims at 50 cents on the dollar in October as its depleted capital led to a state takeover.

At least as early as September, PMI employees had begun "secretly working" for NMI, providing the insurer's analysis of the industry and information about lenders and helping to craft its marketing pitch for potential investors, according to the suit, which cited e-mails from the workers.

"The documentary trail uncovered to date leaves little doubt as to what occurred here," the regulators said in the suit. Douglas Winthrop, a partner at Arnold & Porter LLP in San Francisco who's representing them, declined to comment.

NMI's Corso said that "much of the information that the suit claims is proprietary is in fact publicly available or via widely-used subscription services."

Nathaniel Garnick, a spokesman for FBR, the Arlington, Virginia-based investment bank that took a stake of less than 5 percent in NMI, declined to comment on the lawsuit.

In the insurer's share sale, the bank's placement fee was an estimated $38.3 million, according to a Securities and Exchange Commission filing. It reported first-quarter revenue of $39.1 million. The "fee is contingent and will not be earned unless and until all of the necessary agency and regulatory approvals have been granted," Garnick said in April.

The case is Marks v. NMI Holdings, Inc., California Superior Court, RG12642872 (Alameda County).

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