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FHFA's PMI changes will burden legacy companies but not newer entrants

MGIC, Radian, Genworth hit hardest

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The Federal Housing Finance Agency's proposed revision of private mortgage insurance requirements will be a burden for legacy companies, but not so much for newer PMI industry entrants, a note to clients from Compass Point Trading & Research says.

On Thursday, the FHFA announced it is seeking input on drafting new requirements that would apply to private mortgage insurance companies that insure mortgage loans owned or guaranteed by Fannie Mae and Freddie Mac, opening up for comment until Sept. 8.   

“Mortgage insurance counterparties must be able to fulfill their intended role of providing private capital, even in adverse market conditions,” said FHFA Director Mel Watt.

Compass Point analyst Jason Stewart says that the risk-based proposal at the heart of the draft is comparatively burdensome for legacy companies - MGIC (MTG), Radian Group (RDN), and Genworth Financial (GNW).

“Newer PMI industry entrants - NMI Holdings (NMIH) and Essent Group (ESNT) - are not burdened by the onerous capital treatment of 2005-2008 vintage loans and therefore appear better positioned based on this proposal than their legacy competitors,” Stewart says. “We expect considerable industry and Congressional pushback to this proposal which is likely to result in a softening of this rule prior to its finalization. We include our initial takeaways below.”

The core of the proposal is a shift from the broader risk-to-capital requirement to a more granular risk-based approach.

As the FHFA explains: “Approved Insurer using a grid of factors based on vintage (origination year), original loan-to-value ratio (LTV) and credit score for performing loans, and the depth of delinquency for non-performing loans.”

Pages 37 to 42 of the draft detail the proposed calculation. While the proposal effectively sets a 17.9:1 risk-to-cap, the introduction of risk-based overlays and the definition of eligible assets are far more onerous than expected.

Points of concern and focus for Compass Point include the following:

Two-Year Transition and the Effective Date

The proposal would become effective 180 days after finalization but if an “Approved Insurer” is unable to comply at that time it would be given an additional transition period of up to two years. With the comment period closing on September 8, the rule could conceivable be finalized by the end of 2014. Given the two-year transition buffer, this timeline suggests that the new PMI standards could be fully effective by January 1, 2017.

Subsidiary Capital. Rather than applying a haircut to the total amount of subsidiary capital, the proposal addresses the issue by counting subsidiary dividends to be paid over a one or two-year period if certain conditions are met.

Operational Expenses Likely to Increase

Our sense is that the entire PMI industry is likely to see an increase in operational expenses as a result of the proposed capital requirements. As we have witnessed in the banking sector, the cost to comply with risk-based capital requirements can prove comparatively costly.

Industry and Congressional Pushback Expected

We believe that the PMI industry will argue that these proposals, if enacted without changes, would result in tighter mortgage credit for borrowers and an expansion of the government’s footprint in the mortgage market as borrowers would shift to the FHA. For example, our sense is that MTG’s initial release was primarily intended to begin influencing the public debate over this proposal’s impact. Both lawmakers and regulators have expressed their concern about the state of mortgage credit availability, which suggests that the calls for softening this proposal are likely to gain traction.

Comment Period Will Influence Outcome 

We believe that the PMI industry will focus its comments on credit availability and the potential unintended consequence of the FHA's market share increasing as a result of this proposal. Our sense is that the political climate in D.C. will be receptive to this argument and that the FHFA will ultimately soften this proposal. 

Following the comment period, we believe that a number of specific elements of this proposal could be altered including: (1) the exclusion of future contractual premiums from the definition of available assets; (2) the risk-based required asset factors for borrowers in lower credit bands for post-2008 vintages; and (3) the pro-cyclical treatment of new business given both the requirement for additional assets to be held against delinquent loans as well as the lack of a provision which would release assets held against performing loans after a certain period of time.

“We expect MTG, RDN, and GNW to argue aggressively that the risk-based treatment of 2005-2008 vintages is unnecessarily burdensome but it remains to be seen if the new entrants to the industry will support their legacy competitors on this issue,” the note says. “We include a table detailing the risk-based differences between vintages on page 3 in order to illustrate the legacy firm's disadvantage under this proposal.”

Radian’s leadership has reservations with the initial draft and wants to work with FHFA to guide the drafting process.

“Radian fully supports the need for strong counterparties to Fannie Mae and Freddie Mac, and the need for well-defined standards against which private mortgage insurers should be measured,” said Radian Guaranty President Teresa Bryce Bazemore. “We believe appropriately structured PMIERs will better position our industry to continue serving its critical role in the housing finance market, including providing worthy borrowers with access to homeownership.”

The company’s comments will also outline how the proposed PMIERs are inconsistent with the FHFA’s stated goal of expanding access to mortgage credit and reducing taxpayer risk by increasing the role of private capital in the mortgage market.

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