Mortgage Insurer's Quarterly Report is a Litany of Troubles

MGIC Investment Corporation reported its First Quarter 2012 financial results this morning in which it said its net losses for the quarter totaled $19.6 million, a significant improvement over the $33.7 million it lost during the same period in 2011.  The financial information however was secondary to the litany of problems outlined in the report. 

MGIC is the nation's largest private mortgage insurer (PMI) with $169.0 billion primary insurance in force covering 1.1 million mortgages.  It said, however, that it is facing substantial problems as it moves forward.  Two of the other major PMI companies, RMIC and PMI have been taken over by state regulators in the past months and PMI has filed for bankruptcy.

Many of the dozens of problems MGIC sees itself facing were the types of caveats accountants and lawyers insist on including in financial reports.  However, some of the hurdles MGIC outlines struck us as significant and unusual enough to warrant discussion.

Regulatory capital requirements may prevent MGIC from continuing to write new insurance on an uninterrupted basis.

Sixteen of the jurisdictions in which MGIC does business, including its home state Wisconsin, require a mortgage insurer to maintain a minimum level of statutory capital (Capital Requirements) to write new business.  The most common requirement is a maximum risk-to-capital ratio of 25 to 1.  Wisconsin's measure is a minimum policyholder position (MPP) - the net worth of surplus, contingency reserve, and a portion of the reserves for unearned premiums.

As of March 31, MGIC had a risk-to-capital ratio of 20.3 to 1 and its preliminary policyholder position exceeded the MPP by $197 million.  The company expects that ratio to exceed 25 to 1 in the second half of the year and under new accounting principles, approaching that number takes away the ability to include some assets in the amount of available statutory capital, exacerbating the problem.  There are other issues which may negatively impact the company's compliance with Capital Requirements.

Despite meeting requirements MGIC has been operating under waivers in Wisconsin and other jurisdictions and has been denied waivers in others.  Some of the waivers have expired and the company is reapplying.  If Wisconsin or another state denies or terminates its waiver or fails to grant or renew a waiver MGIC could be prevented from writing new business there  or, should the lack of waiver come from Wisconsin, be prevented from writing new business anywhere. 

Fifty percent of new business written in 2011 and Q1 2012 was written in jurisdictions with Capital Requirements.  "If we were prevented from writing new business in all jurisdictions, our insurance operations in MGIC would be in run-off (meaning no new loans would be insured but loans previously insured would continue to be covered, with premiums continuing to be received and losses continuing to be paid on those loans) until MGIC either met the Capital Requirements or obtained a necessary waiver to allow it to once again write new business."

In anticipation of such a problem, MGIC formed and funded MIC, a direct subsidiary, which is licensed to write businesses in all jurisdictions and approved by the GSEs to write insurance where it is expected MGIC, may fail the capital requirements.  However, there are jurisdictional issues between Wisconsin and the GSEs and the Freddie Mac approval expires at the end of the year.

MGIC said a failure to meet the Capital Requirements to write new business does not necessarily mean that it cannot pay claims on its liabilities however it cannot assert that events that led to it failing to meet those requirements might not also result in it lacking the resources to pay claims.

Estimates of MGIC's claims paying resources and claim obligations are based on various assumptions including anticipated rescission activity, the timing of the receipt of claims on loans in the delinquency inventory and future anticipated claims, future housing values and future unemployment rates.   All of these assumptions are currently subject to significant volatility.

The amount of new business could be adversely affected if the definition of Qualified Residential Mortgage results in a reduction of the number of low down payment loans or if lenders and investors select alternatives to private mortgage insurance.

The Dodd-Frank Act requires a securitizer to retain at least 5% of the risk associated with mortgage loans that are securitized, however a Qualified Residential Mortgage (QRM) is exempted from that requirement. The proposed definition of QRM contains many underwriting requirements, including a maximum loan-to-value ratio ("LTV") of 80% on a home purchase transaction.  The LTV is to be calculated without including mortgage insurance. The following table shows the percentage of new risk written by LTV for 2011 and the first quarter of 2012.

An alternative QRM definition would allow loans with a maximum LTV of 90% and higher debt-to-income ratios and may consider mortgage insurance in determining whether the LTV requirement is met. MGIC estimates that approximately 22% of new risk written in 2011 and 24% written in the first quarter of 2012 would have met the alternative QRM definition.

"Depending on, among other things, the final definition of QRM and its requirements for LTV, seller contribution and debt-to-income ratio, to what extent, if any, the presence of mortgage insurance would allow for a higher LTV in the definition of QRM, and whether lenders choose mortgage insurance for non-QRM loans, the amount of new insurance that we write may be materially adversely affected."

Changes in the business practices of the GSEs, federal legislation that changes their charters or a restructuring of the GSEs could reduce revenues or increase losses.

The majority of MGIC's insurance is for loans sold to Fannie Mae and Freddie Mac. The business practices of the GSEs affect the entire relationship between them, lenders and mortgage insurers.  The increasing role that the government has assumed in the residential mortgage market, the industry's inability due to capital constraints to write sufficient business to meet the needs of the GSEs may increase the likelihood that the business practices of the GSE's may change in ways that adversely affect MGIC.  The Treasury Department's recommendation to end the conservatorship of the GSEs would use a combination of policy changes to wind down the GSEs, shrink the government footprint in housing finance, and bring private capital back into the market.  It is uncertain what role the GSEs, FHA, and private capital including PMI will play

MGIC may not continue to meet the GSEs' mortgage insurer eligibility requirements.

The majority of MGIC's insurance is for loans sold to Fannie Mae and Freddie Mac, each of which has mortgage insurer eligibility requirements to maintain the highest level of eligibility, including a financial strength rating of Aa3/AA- which MGIC does not currently have.  MGIC is currently operating as an eligible GSE insurer under a remediation plans with no guarantee of continuing and with discussions underway to make the requirements more stringent.   If MGIC ceases to be eligible to insure loans purchased by one or both of the GSEs, it would significantly reduce the volume of new business.

MGIC has reported net losses for the last five years and expects to continue to do so, with no assurance of when it might return to profitability.

Losses could increase if rescission rates decrease faster than projections or if the company does not prevail in proceedings challenging the propriety of their rescissions.

Historically, rescissions of coverage on loans for which claims have been submitted were not a material portion of claims resolved during a year. However, beginning in 2008, MGIC's rescission of coverage on loans has materially mitigated paid losses. In each of 2009 and 2010, rescissions mitigated paid losses by approximately $1.2 billion; in 2011 by approximately $0.6 billion; and in the first quarter of 2012, by approximately $80 million.

In the second half of 2011, Countrywide materially increased the percentage of loans for which it is rebutting the assertions made prior to rescinding a loan and MBIC is in mediation in an effort to resolve this dispute.   A variance between ultimate actual rescission and reversal rates and these estimates, as a result of the outcome of claims investigations, litigation, settlements or other factors, could materially affect losses.  If the insured disputes the right to rescind coverage, the outcome of the dispute ultimately would be determined by legal proceedings brought up to three years after the lender has obtained title to the property, and for the majority of pending rescissions since 2009 the period in which a dispute may be brought has not ended.  A loss over this issue to Countrywide could open the company up to challenges from other lenders.

We are defendants in private and government litigation and are subject to the risk of additional private litigation, government litigation and regulatory proceedings in the future.

The company is currently involved in lawsuits alleging violations of RESPA, a Consumer Financial Protection Bureau investigation into captive mortgage reinsurance ceding practices, a discrimination lawsuit under the Fair Housing Act, a suit brought by Countrywide regarding the rescission issues detailed above, and several suits growing out of a subsidiary partnership with MERS.

Loan modification and other similar programs may not continue to provide material benefits to us and our losses on loans that re-default can be higher than what we would have paid had the loan not been modified.

The GSE's and several lenders have adopted programs to modify loans to make them more affordable to borrowers with the goal of reducing the number of foreclosures. During 2010, 2011 and the first quarter of 2012, MGIC was notified of modifications that cured delinquencies that had they become paid claims would have resulted in approximately $3.2 billion, $1.8 billion and $300 million, respectively, of estimated claim payments.   The company cannot predict what the ultimate re-default rate will be or the future claim payments.  Because modifications cure the defaults with respect to the previously defaulted loans, our loss reserves do not account for potential re-defaults unless at the time the reserve is established, the re-default has already occurred.  MGIC said it does not receive all of the information from such sources that is required to determine with certainty the number of loans that are participating in, or have successfully completed, HAMP.

In 2009, the GSEs began offering the Home Affordable Refinance Program (HARP) and MGIC allows the HARP refinances on its insured loans regardless of whether the loan meets our current underwriting standards, accounting for it as a modification rather than new business. MGIC has also agreed to allow refinancing under HARP 2.0 including releasing the insured in certain circumstances from certain rescission rights.

It is uncertain what effect foreclosure moratoriums and issues arising from the investigation of servicers' foreclosure procedures will have on us.

Various government entities and private parties have from time to time enacted moratoriums and suspensions and various government agencies have been investigating large mortgage servicers and other parties to determine whether they acted improperly in foreclosure proceedings. MGIC is unclear about what effect improprieties in a particular foreclosure may have on its claims.  

Our Australian operations may suffer significant losses.

We began international operations in Australia, where we started to write business in June 2007. Since 2008, we are no longer writing new business in Australia. Our existing risk in force in Australia is subject to the risks described in the general economic and insurance business-related factors discussed above. In addition to these risks, we are subject to a number of other risks from having deployed capital in Australia, including foreign currency exchange rate fluctuations and interest-rate volatility particular to Australia.