Mortgage Insurance Woes Grow for Fannie, Freddie

Imagine paying full premium for an insurance contract, and receiving only 60 percent on any claim you make — that’s the unsavory situation now being faced by both Fannie Mae (FNM: 1.02 -0.97%) and Freddie Mac (FRE: 1.14 -1.72%), as well as a bevy of private-market lenders, on their mortgage insurance contracts with troubled mortgage insurer Triad Guaranty Inc. (TGIC: 0.54 -8.47%).

The insurer, which put itself into run-off and ceased writing new mortgage insurance policies in the middle of last year, said late Wednesday that it had received a corrective order from its regulator, the Illinois Director of Insurance, limiting its payout on claims to 60 percent. The remaining 40 percent of a claim will essentially take the form of an IOU, or a deferred payment obligation (DPO), meaning the lender/investor will not immediately be able recover the full amount of its claim.

Which means one thing: get ready for loss severities to go up, as servicers recover less on a growing number of bad loans. Especially so if other mortgage insurers are eventually forced to follow Triad’s lead, as some analysts say they expect.

For the GSEs, the pain of the change at Triad is likely to be immediately felt. More than half of Triad’s roughly $17 billion risk-in-force is written on mortgages held or otherwise guaranteed by Fannie and Freddie; Bank of America Corp. (BAC: 16.09 +0.06%) and Wells Fargo & Co. (WFC: 27.87 -1.59%) are the insurer’s largest private market customers, Triad CEO Ken Jones told reporters on a call Thursday morning.

In a frequently asked questions document, Triad noted that policyholders will still be required to pay the full premium, since “Triad is recognizing its entire claim obligation at the time of the claim through the cash payment and DPO, with the intent of paying the DPO amount in the future.” But when that future is seems pretty uncertain, to say the least: the future payment on the DPO can only occur when the insurer’s regulator sees the insurer achieve specified minimum surplus balances and risk-to-capital ratios. It’s unclear how a company that is not bringing in new revenue via new policies can be expected to bolster its level of capital.

“Continuing volatility in the housing and mortgage markets, as well as the overall economy, make it very difficult to forecast Triad’s future financial position with certainty,” the company said Wednesday evening. Auditors slapped the insurer with a ‘going concern’ warning for its 2008 financials earlier in the year, as well.

“This is regulated highway robbery,” said one senior banking executive, who said he expected the move and expects to see more. “Banks and others depending on MI to mitigate some losses now have to at least ask themselves ‘what is the likelihood my insurer decides or is forced to cut my claims coverage?’” It’s a question that auditors may also ask, he said, in terms of estimating a bank’s exposure to bad loans.

In February, Moody’s Investors Service downgraded all mortgage insurers over concerns with capital adequacy amid a worsening U.S. housing market.

Write to Paul Jackson at paul.jackson@housingwire.com.