When the housing bubble burst several years ago, mortgage
insurers were prime casualties.
Lenders for years had thrown money at anyone who could ink his
initials, knowing they could then package mortgages of dubious
quality into securities that yield-hungry investors would eagerly
For the insurers, it meant a nightmarish roster of defaulting
loans. Most mortgage insurers bled red ink for years. Several
were forced to stop writing new business.
But that only created opportunity for a new, well-capitalized
insurer that was not weighed down with bad legacy loans. A group
of investors -- includingGoldman Sachs (
) andJPMorgan Chase (
) -- saw a chance to establish an insurance upstart that could
wrest new business from struggling rivals.
EnterEssent Group (
), newly capitalized in 2008 with $600 million from Goldman,
JPMorgan and other investors. Organized as a limited liability
corporation, and domiciled in Bermuda to lighten its tax
obligations, Essent wrote its first policy in the spring of
As rivals continued to struggle, Essent captured new business
swiftly. By June of last year, it had over 12% of the private
mortgage insurance market. Last October, it raised more than $300
million in an IPO.
Observers with a moralistic bent may fret and fume that two
banking behemoths that have agreed to pay huge fines for their
roles in packaging and selling sour mortgages should now profit
in the bubble aftermath. Even after selling some of its shares in
the Essent IPO, Goldman still owns nearly 7% of Essent. JPMorgan
holds just over 5.4%.
"They're opportunistic investors," said Compass Point Research
& Trading analyst Jason Stewart.
That's one way to look at it. Private mortgage insurance now
promises opportunity in an important niche.
On mortgages where borrowers contribute down payments of less
than 20%,Fannie Mae (
) andFreddie Mac (
) will not guarantee the full mortgage. A buyer, for example, may
commit to purchase a $200,000 home with a down payment of just
$10,000. Fannie Mae and Freddie Mac might insure against the
first $160,000 in mortgage debt. But they can not purchase
low-down-payment mortgages unless some other insurer steps in and
covers the other $30,000.
By providing such supplemental coverage, private mortgage
insurers help "extend affordable homeownership by facilitating
the sale of low-down-payment loans into the secondary market,"
Essent's IPO filings contend.
Essent competes against entrenched private mortgage insurers
such asRadian Group (RDN) andGenworth Financial (GNW), as well as
two government agencies -- the Federal Housing Administration and
Department of Veterans Affairs -- that also offer insurance on
certain loans. With the FHA recently backing away from the
market, the competitive landscape right now is very
The FHA had increased its insurance operations after the
housing bubble burst, filling the vacuum left by loss-riddled
private insurers. Together, the FHA and VA accounted for 85% of
total new insurance volume in 2009.
A New Option
The FHA has more recently been raising rates, however, making
it a less-attractive mortgage insurance option. FHA insurance
rates were down to a 50-basis-point annual premium in early 2010.
But they've since risen dramatically -- to around 130 basis
points, Stewart added.
"It's made private capital more competitive," he said.
"The FHA has been pulling back from the industry," said
Christine Worley, analyst at JMP Securities.
She expects the retreat to continue. "The government wants
taxpayers to be less exposed to the housing market," Worley
Since it began writing mortgage insurance only in 2010, Essent
is not exposed to the shoddy deals of the loose-lending era that
instigated the housing crash. With its capital cushion from "too
big to fail" banks and other well-heeled investors, Essent was
seen as a safe counterparty to lenders wanting to protect against
"Essent was seen as the place to go by mortgage originators,"
With tighter credit conditions now in force, post-bubble
mortgages have been far less likely to default. Those private
mortgage insurers that were running losses for years on weak
mortgages were soon losing market share to the newly capitalized,
financially solid Essent.
What could go wrong? Plenty, actually. As Essent's IPO filings
openly state: "Investing in our shares involves substantial
Any pullback in either the housing recovery or the general
economic recovery would hurt.
"The main risks are probably economic," said Worley.
A reversal in the long but fairly modest recovery could put
pressure on even the stronger mortgages of recent years.
"Post-legacy mortgages could perform less strongly if the
economy faltered and unemployment started rising again," she
Apart from business cycle risks, private mortgage insurers
face risk from the unsettled status of Government-Sponsored
Enterprises (GSEs) such as Fannie Mae and Freddie Mac. Any number
of "legislative or regulatory actions" could adversely affect
Essent revenue and profit, according to the IPO offering
The problem is that while many want to reform the GSEs, there
is scant agreement on how to do it. "GSE reform is a huge risk,"
But it is impossible to predict now what sorts of changes,
particularly those affecting a private insurer like Essent, will
"There are too many proposals," said Stewart, "to define or
quantify" the risk to Essent.