Shares of private mortgage insurer (PMI)
MGIC Investment Corp.
) fell 9.5%, following the release of a draft regarding new capital
requirements by the Federal Housing Finance Agency (FHFA). The
draft - Private Mortgage Insurer Eligibility Requirements (PMIERS)
- proposes new capital requirements that private mortgage insurers
are required to meet in order to carry on business with the
government-sponsored enterprises Fannie Mae and Freddie Mac.
The proposed rules will allow a two-year transition period to the
insurers to equip themselves with the desired capital.
The PMIER will be open for public comment till Sep 8, 2014.
After this, the FHFA is expected to review and consider input
before publishing the final requirements. PMIERs in its full
force will become effective 180 days after the final
publication. Approved insurers will be given an extended
transition period, of up to two years from the final publication
date, to comply with the financial requirements.
This regulation, which was in the making for a long time, pulled
back shares of all the players in the mortgage insurance industry.
In Friday's trading, shares of
) fell 5.4%,
Essent Group Ltd.
) was down 2.4% and
Genworth Financial, Inc.
) lost 2.6%.
While the regulations would prove arduous for all the companies,
MGIC is the worst sufferer. It will be an uphill task for the
company to fortify its capital as it backs more riskier delinquent
and older loans compared to its ilk. Moreover, its debt
obligations, materially exceeding cash and investments, will make
it difficult for the company to gather new capital.
Role of Private Mortgage Insurers
PMI is a critical component of the housing finance industry,
providing it with necessary lubrication. Fannie and Freddie require
borrowers who put down less than 20% for private mortgage
For most homebuyers, the biggest hurdle to owning a home is the
down payment of 20% without which even lenders' hands are tied.
Mortgage insurers here play a critical role of stepping in to
provide financial guarantee to lenders, should a loan go into
foreclosure. It is this guaranty that allows many lenders to
sidestep the 20% down payment. The biggest benefit of PMI to the
housing finance industry is that it increases the buying power.
Why Such Stringent Regulations?
These rules are intended to resurrect and protect the housing
industry which suffered tremendously when the housing bubble
burst. During the financial crisis in 2008, mortgage
insurance companies were left unable to pay for insurance
obligations as claims on bad loans chipped away at capital
reserves. A default by these mortgage insurers led to huge losses
for Fannie Mae and Freddie Mac since these had relied on mortgage
insurers to pay the former in case the borrower defaulted on loan.
A number of players were forced to exit the market after they were
left with insufficient capital to pay for claim payments. PMI Group
filed for bankruptcy protection in Nov 2011 after the Arizona
Department of Insurance took over the main unit as claims on soured
mortgages drained capital. Triad Guaranty Inc. also had to stop
selling new policies when capital ran short, and Old Republic
International Corp. (ORI) also cut down its mortgage insurance
business after suffering huge losses.
The new regulation is a measure sought by the government to build
the inherent strength of mortgage insurers to better manage and
avoid the kind of loss and failure faced during the 2008 financial
crisis. Government is also trying to shore up the market share of
private mortgage insurance by limiting the role of its insurer, the
Will MGIC Investment be Able to Comply with
According to MGIC Investment, its Available Assets would be
materially less than the Minimum Required Assets at both the
projected effective date and two years thereafter.
We believe that raising capital could prove challenging for MGIC
Investment which carries older, riskier insurance and has a high
debt on its balance sheet.
The draft PMIERs requires MGIC Investment to carry required minimum
assets of $5.9 billion as of Dec 31, 2014, but the company
estimates $5.3 billion in assets by then, resulting in shortage of
$600 million. MGIC Investment expects to cover $300 million of
shortage from its ongoing operations over the two-year transition
But the company has a considerable amount of debt to redeem
during this period. At Mar 31, 2014, it had approximately $542
million in cash and investments and debt obligations of $1,297
million, out of which $407 million has to be paid back by 2017.
MGIC also incurs $66 million annually as interest on debt. With a
substantial amount of debt to service it will be a herculean task
for MGIC to gather the required capital.
Though MGIC expects to utilize other options including external
reinsurance and issuance of debt capital, it will only lead to
increased financial leverage in the company's capital structure.
Mix of Business
MGIC is exposed to a portion of business that carries higher
probabilities of claims even when housing values are stable or
rising. These characteristics include loans with loan-to-value
ratios over 95%, FICO credit scores below 620, limited
underwriting, including limited borrower documentation, or higher
total debt-to-income ratios.
As of Mar 31, 2014, approximately 21.6% of the company's primary
risk in force consisted of loans with loan-to-value ratios greater
than 95%, 6.5% had FICO credit scores below 620, and 6.7% had
limited underwriting, including limited borrower documentation.
Going forward, there is a huge possibility of these loans getting
soured and resulting in operating loss.
Of the other players, Radian needs $850 million to cover the
shortfall now and Genworth Financial needs $550 million by Jun 30,
2015, to maintain the capital standards.
Increased Activity Among Players
In order to arrange capital under the new regulation we expect
players to resort to various measures such as external reinsurance
which reduces capital that needs to be set aside as reserves;
spinning out non-core business units and assets; raising of debt
and also bringing out locked-up cash.
We also expect to see aggressive lobbying from the industry group
to make the regulations easier. Players are of the opinion that
rather than strengthening the industry, the new regulations would
restrict access to credit and increase the cost of homeownership
thus driving away creditworthy borrowers. This would also increase
the share of FHA in the mortgage market and drain out the share of
private mortgage insurance.
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