Fitch Sees Challenges Growing for Mortgage Insurance Business

Fitch Ratings here has dropped its outlook on the entire private mortgage insurance industry from "Stable" down to "Negative."

The rating agency is pessimistic about what it terms "systemic concerns that are challenging the industry's core fundamentals," said analysts Brett Lawless, Michael J. Barry and Frank A. Meyers.

"These include the continuation of severe competition from within and outside the industry, resulting in the proliferation of various risk-sharing arrangements; the industry's increasing involvement in the subprime market, primarily through the bulk channel; and likely adverse selection related to increased levels of 'piggyback' loans, which may increase insurers' natural default rate on prime business," the report said.

While there should be little impact on future earnings and capital formation over the near terms, these trends, the agency continued, could result in a deterioration of the industry's long-term credit fundamentals.

Fitch also expressed concern about whether several of the private mortgage insurers management teams would "re- evaluate the cost/benefit relationship" of maintaining at least an "AA" financial strength rating.

Among the issues addressed in the report is Milwaukee-based Mortgage Guaranty Insurance Corp.'s decision not to do captive reinsurance arrangements where the ceded premium is above 25%.

"Since MGIC's announcement, none of its competitors have publicly announced their intention to institute similar restrictions. Many, if not all, competitors appear to be viewing MGIC's move as an opportunity to increase market share (or avoid a loss of market share if other insurers do not also follow suit) among the coveted large lenders. Due to the strong demand for high-premium cede captives among large lenders, which account for the majority of captive activity, the market share impact stemming from an insurers' decision to limit cession rates to 25% could be meaningful," Fitch said.

The rating agency noted that MGIC now shares its view that the captive arrangements are sharing premiums at a disproportionate level of risk.

But even at that 40% premium cede level that MGIC objects to, Fitch believes that if loan loss levels were equal to those in the mid-1980's, the "high-premium cede captives would provide protection."

The agency also commented on an alternative to captives for the smaller to midsized lender, where the MI pays a one-time upfront fee of between 12 and 40 basis points for the lender delivering "high-quality loans."

"Fitch views these programs as unequal risk-based pricing. On one hand, the insurer ends up 'sharing' the mortgage insurance premium with the lender (the fee paid is a return of a portion of the premium), resulting in lower premiums for the high-quality loans included in the transaction. On the other hand, the insurer does not get any additional premium from the lower-quality loans, leading to the risk that insurers will end up with the same book of business but with lower overall premiums."

It later commented "the introduction of these programs is yet further evidence of individual insurers' strong propensity to focus on initiatives designed to capture market share at the expense of prudent industry business practices."

Fitch noted that one competitive threat to the mortgage insurers, the piggyback or 80-10-10 loan, has seen its volume increase significantly in the past couple of years; estimates Fitch cites from Geosegment Systems, places piggybacks as one-quarter of all high loan-to-value originations.

Fitch has two concerns for mortgage insurers. First, the piggybacks are leaving mortgage insurers with an adverse selection of loans for their portfolios.

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