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Balancing Act

Mortgage insurers could face new barriers

What's the cost of stronger underwriting?

rocks in the road

Events of the past few years, specifically those related to the housing meltdown, showed how vulnerable mortgage insurers (MI) can be when the stress of mass defaults fall upon their shoulders, analysts say.

But if regulators put too much pressure on the MIs in terms of underwriting guidelines, the rules could spook MIs and investors, derailing a fluid return to a private-label mortgage securities market where MIs share in the risk, market experts say.

But for insurers, it looks like the possibility of more regulation is gaining some traction.

The Basel Committee on Banking Supervision issued a set of recommendations directed at policymakers to reduce the likelihood of excessive MI stress to ensure the right balance is struck when insurers underwrite mortgages for originators in an effort to guarantee the monthly mortgage payments.

In jurisdictions where mortgage insurance is used, it can provide a strong safeguard against market risk, but when it’s used incorrectly, risks are only multiplied during times of distress, market observers point out.

But if regulations governing MI underwriting are too strong, it will make it more difficult to bring private capital back into the market due to increasing regulations turning investors off from wanting to deploy capital into the sector, explained CreditSights senior analyst Rob Haines and analyst Eric Axon, who covers MIs for the same firm.

"While there’s a need for regulation, it becomes overly publicized and develops into unintended consequences for these types of actions," they explained.  

While there will always be pressure on mortgage originators and insurers to lower their underwriting standards, lowering standards in either sector will increase the pressure on other parties to lower their benchmarks, the Basel Committee said.

"Lower standards in one sector will in turn increase the pressure on the other sector to lower its standards ultimately resulting in a potential crisis," members of the committee warned.

They added, "Supervisors must therefore remain vigilant to ensure that strong underwriting practices are maintained by all parties and that the underwriting cycle does not enter a weak [scenario]."

To maintain the right balance, the Basel Committee believes underwriting examinations should be balanced, meaning that both insurers and originators should be within the same benchmarks. And where supervisors do not have the authority to examine the underwriting standards, they should request the power to do so, the committee says.

Going forward, Haines and Axon believe the market shift is leaning toward a competitive MI sector as these companies have earned enough capital over the past few years and are trying to write more business while offsetting the weaker legacy portfolios tied to the 2007 vintage books.

However, if additional regulations hit insurers on the underwriting side, pressure would be applied to tighten standards and this would hinder the MIs' top line growth, the CreditSights analysts noted.

Overall, the market agrees stronger underwriting standards are needed to secure the place of mortgage insurers. The only question is how far should these guidelines go?

"We agree with the need to maintain strong underwriting standards; our industry was among the first to raise concerns about the rise in risky products in the years leading up to the housing crisis," said Genworth U.S. Mortgage Insurance (GNW) president and CEO Rohit Gupta.

Gupta is comfortable with the general move toward stronger underwriting standards and supports the ongoing push for stronger capital reserves at the MIs.

But from the viewpoint of Haines and Axon, there also is a potential price for going to far—namely a system that is unable to woo the private capital that is needed to create a robust secondary market again.

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