Mortgage insurers are no longer an endangered species, but it will be more than a year before they return to profitability and healthy capital levels.
To nurse themselves back to health, the insurers are depending on a new crop of quality mortgages that will bring in premiums to offset losses on loans made during the bubble years. Trouble is, new business is hard to come by — at least business that meets the insurers' tightened underwriting standards.
"It's important that the companies write new mortgage insurance that is at very high profitability to overcome some of those earlier books of business," said Elizabeth Malone, a senior vice president at Wunderlich Securities. But "you can't write a lot of mortgage insurance if people aren't buying a lot of houses."
That's a problem for home lenders, which need private mortgage insurance to make certain loans. A slow recovery for the insurers could seriously impede lending once borrower demand finally comes back.
"When you have difficult periods such as we've been exposed to of late, there is a need for new business," said Al Zucaro, chairman and chief executive of Old Republic International Corp., the parent of Republic Mortgage Insurance Co. "If you stopped the music … then the system doesn't work. That's a situation that exists because very little lending is taking place."
The private mortgage insurance industry is relatively small, with a handful of players. They include Old Republic, MGIC Investment Corp., PMI Group Inc., Genworth Financial Inc., Radian Group Inc., and United Guaranty (a unit of American International Group Inc.). There's also Triad Guaranty Inc., which is in runoff mode, and Essent Guaranty Inc., a start-up that is not yet writing business.
Mortgage insurers play an important role in the housing industry by enabling loans with low down payments to be sold to Fannie Mae and Freddie Mac. By law, the government-sponsored enterprises may not touch a mortgage if the borrower has equity of less than 20% unless it carries private insurance. And if lenders can't sell loans to the GSEs, they won't have funds to make new loans.
Less than a year ago, mortgage insurers' survival was in serious doubt. Many paid out much more in claims than they were bringing in with new business and were forced to set aside significant reserves to cover future losses.
Fourth-quarter results from the insurers that have reported so far suggest that the pace of delinquencies is slowing, a good indicator defaults could be near their peak.
At Genworth, for example, the number of delinquent loans the company insures rose 7% from the third quarter to the fourth quarter, compared with a 14% increase from the second quarter to the third quarter. Growth in the number of past-due loans in the mortgage guarantee unit at Old Republic slowed from 12.8% in the third quarter to 8.9% in the fourth quarter. (Old Republic also sells title insurance; Genworth sells investment products and life and long-term care insurance.)
But losses across the industry remain high, and given the fragility of employment and the housing market, many executives aren't forecasting a profit until some time next year.
Michael Grasher, an equity research analyst at Piper Jaffray, said thin capital levels remain a huge problem for the insurers.
"From a capital perspective, they are no better off than they were a year ago," he said. "The biggest issue facing these companies right now is risk-to-capital ratios."
The risk-to-capital ratio, a closely watched benchmark, measures how many times over an insurer's resources would be consumed if every loan it insures were to default. Sixteen states won't permit a mortgage insurer to write business if its ratio exceeds 25 to 1. (Three of those states, North Carolina, Arizona and California, recently enacted laws that let the respective state's insurance regulator make exceptions.)
Risk-to-capital ratios have been creeping up, and at some companies they are approaching the 25-to-1 threshold. That's forced the companies to seek alternative ways to keep writing business.
MGIC, for example, formed a new subsidiary to let it write business in the instance that its main operating unit cannot. Fannie has granted the unit, MGIC Indemnity Corp., approval to insure loans headed for the GSE through next year. But MGIC is still waiting for approval from Freddie.
Old Republic, which expects to reach and potentially cross the 25-to-1 threshold this quarter, said it has already received a waiver from the North Carolina insurance department, its main regulator, to write new business if it surpasses the 25-to-1 limit.
There is, of course, another, highly visible guarantor for mortgages with small down payments today — the Federal Housing Administration, whose market share (and credit problems) have swelled in the past few years.
Recently, the FHA announced steps to improve the quality of its loans, such as by requiring higher down payments for borrowers with lower credit scores. Some say this could help the private mortgage insurers win more business.
"I would expect as the FHA continues to tighten up … that should expand the size of the private mortgage insurance market," Kevin Schneider, the president and CEO of Genworth's mortgage insurance unit, said on a conference call last month.
But David Katkov, the chief business officer at PMI Group, said in a December interview that for now he does not view FHA as a rival. "Because of our own capital management issues, it's a good thing that FHA is in the market. … Every participant in housing will benefit, if houses are starting to be taken out of inventory," he said. "There will be a day when that conversation will change to say, 'Damn, they are a tough competitor and I want to get their business.' That's not how I'm looking at them today."
Adding to private insurers' woes are mounting legal disputes with lenders over payment of claims on soured mortgages and the uncertain future of Fannie and Freddie.
More than 18 months after the government took over the GSEs, its plans for them are still largely in question. "The ultimate future of private mortgage insurance in the U.S. remains to be decided," Fitch Inc. analysts led by Jeffrey Berkes said in a recent report, "and that decision is tied to the ultimate future form and operating structure of the housing GSEs."