Will Affordable US Houses Hurt Private Mortgage Insurers?

In a new drive to make home buying more affordable, President Obama announced yesterday that annual mortgage premiums charged by the Federal Housing Administration (“FHA”) will be trimmed by 50 basis points – from 1.35% to 0.85%.

The reduction in mortgage premium will slash the annual mortgage payment for new home buyers as well as existing home owners. As a result, creditworthy families that can afford a home but have been shut out of the market because of tight lending requirements will be hugely benefited.

Protection for FHA

The FHA is an agency that insures housing loans that meet its guidelines. This move will shield FHA which was witnessing erosion in its market share as result of its high premium. The FHA's share of mortgage insurance, which ballooned to a high of around 71% in 2009, declined to 38% in the second quarter of 2014, due to reduced market exposure.

The agency was consistently increasing premiums since 2011 to build up capital after incurring losses from defaults on mortgages it backed after the housing bubble burst. The agency's net worth in 2012 was a negative $16.3 billion. Then, in 2014, the FHA started operating in the black. The reduction in FHA fees will increase its volume of business.

Boon to the Housing Market

This announcement comes at the right time since the housing market needs a push to set itself in motion after a sluggish 2014. The immediate consequence of this cut will be an increase in home ownership and a step-up in the housing market.

Notably, the housing market is an important component of the U.S. economy. In spite of historically lifting the economy after downturns, the market lagged in 2014 and continues to be a drag on economic growth. This action will make home ownership less expensive for over two million Americans during the next three years according to Julián Castro, the U.S. Department of Housing and Urban Development Secretary.

A Pushback for Private Mortgage Insurers

While Obama tries to win favor of Americans with his mass drive, private mortgage insurers smell trouble. With the government backing FHA, private mortgage insurers will face heightened competition from the agency. To make the matter even worse, private mortgage insurers are trying hard to comply with the new capital maintenance guidelines as stated by the Federal Housing Finance Agency ("FHFA").

The Private Mortgage Insurer Eligibility Requirements (“PMIERs”), released by FHFA last July, represent the eligibility standards for private mortgage insurers in providing mortgage insurance on loans owned or guaranteed by Fannie Mae and Freddie Mac. If the insurers fail to comply with the capital standards, they do not get business from Fannie and Freddie.

This is a transition period for mortgage insurers striving to comply with the new capital requirements. The players are trying out almost everything from raising additional capital, using additional reinsurance, or selling units to release funds. In Dec, Radian sold its subsidiary Radian Asset Assurance Inc. to Assured Guaranty Corp., a subsidiary of Assured Guaranty Ltd. (AGO). The sale will release cash of $810 million, which is to be used in fortifying its balance sheet.

Past Challenges of Mortgage Insurers

During the 2008 financial crisis, mortgage insurance companies faced huge claims as most of the housing loans they guaranteed were subprime. As the low credit worthy loans defaulted, claim liability for mortgage insurers built up. Since the claims were so huge, these ate away their capital reserves.

A number of players were forced to exit the market after they were left with insufficient capital 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. cut down its mortgage insurance business after suffering huge losses.

Recent Revival

Shares of veteran payers like Radian and MGIC Investment have risen more than 7 and 2.6 times, respectively, from 2012 to 2014 as result of recapturing market share from FHA and a rebound in the U.S. housing market. Also, new players have entered the industry. An improving mortgage market encouraged three of the present seven private mortgage insurers – NMI Holdings, Arch Capital Group Ltd and Essent Guaranty Inc –enter the business by acquiring the operating platform of a company that had stopped writing new insurance.

Private Mortgage Insurance Stocks Slide

The initial report itself about the rate cut which came on Jan 7, left the mortgage insurers jittery. This reflected in investor trading, and shares of Essent Group Ltd. (ESNT), Radian Group Inc. (RDN), MGIC Investment Corp. (MTG) and Genworth Financial, Inc. (GNW) fell 7.6%, 4.5%, 3.6%, 3.9%, respectively, in the following session.

Possible Outcome

The housing initiative by Obama can lead to friction in the new Republican-controlled Congress, which is yet to approve the cut. Though it is also being said that the President could take executive action to force the change, the effect of it remains to be seen.