CHICAGO Record numbers of mortgage defaults during the U.S. housing crisis are likely, for the first time, to trigger significant payments from lender-operated reinsurance companies that provide a backstop to traditional mortgage insurance.
Since mortgage default rates have typically been among the lowest of all consumer loans, so-called captive reinsurance on mortgage guarantees has long been a high-margin, low-payout kind of business for the lenders that offer it.
Mortgage insurers, which cover potential lender losses on loans to borrowers who can't come up with a 20 percent down payment, say that their losses on the amounts insured will reach levels that will result in calls to reinsurance policies to cover some of the losses.
Insurance giant Genworth Financial Inc. said earlier this week during a meeting with investors that it expects claims on its mortgage insurance business to trigger reinsurance payments in 2009. Other mortgage insurers, including the three largest in the United States MGIC Investment Corp., PMI Group and Radian Group Inc. could also expect some relief from reinsurance in the next few years.
The captive reinsurance arrangements will help support the financial strength of major mortgage insurers that have seen their share prices tumble and credit ratings come under pressure amid the turmoil in the housing and credit markets. The deals could also represent another blow for beleaguered mortgage lenders, turning what was once a profitable sideline into yet another housing market casualty, at least for the next couple of years.
For Genworth, which has captive reinsurance arrangements for 61 percent of its portfolio, the $840 million held in trust by captive reinsurers will supply a boost to net income of as much as $388 million in 2009. That will help the mortgage insurance unit post a profit in 2009 even if it turns in a loss in 2008, the company reported this week. In 2006, Genworth's mortgage insurance unit contributed just over 40 percent of Genworth's operating income.
"As we head into a down cycle for housing and as mortgage defaults ramp up, it is clear that captive reinsurance arrangements will provide meaningful downside protection both for Genworth and for the industry as a whole," Kevin Schneider, president of Genworth's mortgage insurance unit, said in an e-mail Thursday. "As the environment shifts to higher default rates and higher claim severity, it's likely that reinsurers will cover a significant amount of future losses."
Mortgage insurers have seen claims skyrocket over the last year, as the lack of liquidity in the housing market makes it difficult for borrowers to refinance or for lenders to resell foreclosed properties at profitable prices, forcing mortgage insurers to pay up.
But virtually all the major mortgage lenders have captive reinsurance arrangements, according to Fitch Ratings analyst Thomas Abruzzo, who has noted in recent reports that the captive reinsurance offsets some of the risk that the mortgage insurers face.
MGIC, which was forced to scrap a plan to acquire rival Radian Group Inc. and reported a $372.5 million third-quarter loss amid the housing crisis, expects to tap its captive reinsurance for coverage on loans written in 2006 and 2007, the most-troubled years, spokesman Michael Zimmerman said in an interview.
He estimated that about 42 percent of its direct-written policies had some type of reinsurance coverage. All told, MGIC has $640 million in reinsurance trust accounts, he said.
Last month, Standard & Poor's Ratings Services lowered its credit ratings on MGIC to "A-" from "A," citing the "bleak" prospects for the mortgage and housing sectors. On Wednesday, Goldman Sachs cut its recommendation on MGIC shares to sell, pointing to prospects for fourth-quarter losses, sending the insurer's shares down more than 7 percent on Thursday.
PMI, like MGIC, has about a 20 percent share of the U.S. mortgage insurance market, according to industry publication Inside Mortgage Finance. PMI had about $660 million in captive reinsurance trust balances at the end of September.
CEO L. Stephen Smith said during the company's third-quarter earnings conference call that PMI expects captive reinsurance to reduce total incurred losses by about $30 million in 2008 and about $170 million in 2009.
Radian, the No. 3 mortgage insurer with a 17 percent market share, "will realize meaningful benefit" from its captive reinsurance arrangements, Fitch Ratings said last month in a report, noting that about 40.6 percent of Radian's mortgage insurance risk in force is included in captive deals.
Under a typical captive reinsurance arrangement, Genworth's Schneider said during the investor meeting, Genworth would put 40 percent of the premiums it collects into a third party trust that is administered separately and invests in highly rated, liquid investments.
The reinsurance normally starts covering losses after they reach 4 percent of the total amount insured, and continues to cover losses of up to 14 percent of the total amount insured.
Lenders who offer reinsurance to mortgage insurers get the opportunity to make an extra profit on loans they write, as long as mortgage losses stay below the level at which the reinsurance subsidiary has to start contributing to cover the losses. Typically, losses on mortgage portfolios stay well below the approximately 4 percent loss rate that would trigger reinsurance payments.
If ultimate losses stay below the value of the trust, lenders get to keep the difference. If the trust fund is depleted a scenario Schneider called "draconian" the reinsurer would have to replenish it.
Mortgage insurers don't disclose the names of lenders with which they have reinsurance agreements, but most large lenders likely participate, according to MGIC's Zimmerman.