It should be no surprise that the private mortgage insurance industry was nearly decimated in the wake of the housing crisis. During that tumultuous time, the private mortgage insurers that survived lost a combined $20 billion. However, it appears that the tide has finally begun to turn.
Diana Olick of CNBC reports that private mortgage insurers are “back in black” after posting their best quarter in 6 years. Olick reports that this comeback has been fueled by (1) lower mortgage delinquencies, (2) growing business, and (3) the Federal Housing Administration (“FHA”) reducing its role in the industry.
The federal government housing bailout has also benefitted private companies by introducing mortgage refinance programs for borrowers who would have otherwise defaulted. Private mortgage insurers now back a third of that market, and their role could increase if proposed legislation, requiring risk-sharing by private capital, is passed - ending Fannie Mae and Freddie Mac.
According to data from Inside Mortgage Finance, together, six private mortgage insurers wrote nearly $49 billion in new business in the second quarter, an increase of 27% from the previous quarter. Publicly traded insurers, such as MGIC, Genworth, and Untied Guaranty (part of AIG) all reported positive income, with the exception being Radian still in the red.
FHA Taking a Step Back
Private mortgage insurance is generally required for borrowers taking out riskier loans with down-payments of less than 20%. It allows people with not enough money for a down-payment, but otherwise good credit, to break into the housing market.
Many think that the system worked until banks got too greedy by encouraging 100% financing of residential mortgage loans, with both first and second mortgages. This caused insurers to lower their standards in order to compete, which led to increased rates of default.
The government offers an alternative to private mortgage insurance by providing mortgage insurance on loans made by FHA-approved lenders. Unlike conventional loans that adhere to strict underwriting guidelines, FHA-insured loans require very little cash investment to close a loan. There is more flexibility in calculating household income and payment ratios.
The FHA is the largest insurer of mortgages in the world, insuring over 34 million properties since its inception in 1934. Notably, the FHA claims that it is the only government agency that operates entirely from its self-generated income and costs the taxpayers nothing.
During the housing boom, the FHA backed just 3% of new loans, compared to 80% of the market during the crash, putting the squeeze on private insurers who competed for the little remaining new business. The FHA is now taking a step back by raising its premiums, ultimately letting private insurers back into the marketplace.
Mortgage Insurance Rescinded!
Loan originators are frequently confronted with repurchase demands from big banks and aggregators, in part, based on the rescission of mortgage insurance by private companies when loans ultimately default. This prompts a basic question…what was the point of the insurance anyway?
The contractual basis for rescission is often even weaker than the buyback demand under the originator’s contract with the aggregator that follows. It is also important to remember that originators are not parties to the contracts between banks and private mortgage insurers, which are governed by a different set of representations and warranties than those contained in the purchase agreements between the originators and the banks.
Therefore, a rescission of mortgage insurance is not necessarily tantamount to a breach of contract by a loan originator. Moreover, the merits of the rescission are often not heavily disputed or litigated largely due to an effort by the banks and aggregators to maintain relationships with the private companies. Indeed, an originator may not even learn of a rescission by the insurer until much later.
Even when banks do contest the basis of the rescission, it’s not uncommon for them to hypocritically use the same defenses employed by originators. By using their shield as a sword against originators, banks may be forced to eat their words later during the course of litigation with the originators.
It will be interesting to see whether the return to profitability for private mortgage insurers will help keep them honest when the next down turn invariably occurs. But it seems that the industry is quick to forget the rash of rescissions and ensuing litigation that followed the most recent mortgage crisis.