Hot Fun in D.C., Part 2: Resurrected Mortgage Insurers

 | Aug 25, 2013 | 5:00 PM EDT
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Note: Please see part one of this piece here.

Even as the newly reenergized Consumer Financial Protection Bureau (CFPB) has issued a report on its vigilance toward non-bank mortgage servicers, Bank of America's (BAC)  $11.6 billion settlement with Fannie Mae (FNMA) draws attention to just how coyote ugly the banks now see mortgage-servicing rights, in the wake of new Basel capital rules that force higher related capital charges. This was the largest deal yet, and another footnote to the Countrywide legacy and subprime disaster.

Bank of America was ultimately compelled to cut the deal only after Fannie threatened to veto the sale of BofA servicing rights to Nationstar (NSM) and Walter Investment. Thus, mortgage servicers to also include Ocwen (OCN) have been considered home runs within the housing finance space.

Also among companies affected by news on housing-finance policy are the high-flying, back-from-the-dead mortgage insurers (MIs). Mortgage Guarantee Insurance Corp (MTG) has gained 518% over the past 12 months, while Radian (RDN) has added 285% and Genworth (GNW) 133%.

You'd be right in surmising that the surprisingly elevated discussion of Fannie-Freddie reform could have a big impact on the MIs - and that the bipartisan policy thrust of restoring a primary role for private capital bespeaks an even bigger potential future role for mortgage insurance as a credit enhancement tool.

But there's one reality that could keep the newly faithful in the MI pews despite their big gains to date -- even in the face of likely volatility until investors come to terms with Fed tapering and its potential effect upon the housing sector. Specifically, both the Senate's Corker-Warner bill and the House's PATH Act would arguably already be constructive for the MIs, but they'll likely need to become even more so before they have a chance of enactment.

Corker-Warner would require a minimum 5% borrower down payment, and private MI for another 20% of a typical loan -- a level long associated with the requirements in the Fannie-Freddie charters. But the "standard cover" in the market today requires deeper enhancement, to as much as 35%.

• Ask anybody in the business, and they'll tell you to forget about the old rules: The only way to get a loan today via Fannie and Freddie is to either pay a steep up-front "loan level price adjustment" (LLPA) fee or, conversely, to hit this new and deeper bogey covering nearly one-third of risk or a loan's value.

• Meanwhile, Corker-Warner would try to partly match this new standard by insisting upon 10% private capital at the loan level. Many observers believe this is all but unworkable, in no small part because such funding sources would likely dry up (again) in the event of another crisis.

• Thus, a likely fix for the Corker-Warner approach, should it be seriously considered, would be to give more favorable treatment to "deep cover" loans with even more MI attached. The policy pace-setting Mortgage Bankers Association recently endorsed the idea as part of a plan for FHFA to pursue while it awaits congressional action on GSE reform. It could be magic, moreover, for Mortgage Guarantee Insurance, Radian and Genworth, among other, newer players in the industry.

Might A Positive PATH Emerge for the MIs?   

As for House Financial Services Chairman Jeb Hensarling's (R-Texas) PATH Act, that's generally been seen as pro-MI because it would seriously pare back the role of the Federal Housing Administration which similarly insures high LTV loans. Individual loan coverage would drop from 100% to 50%; minimum down-payments would rise from 3.5% to 5%; premiums would likely be hiked and/or made risk-based; and the agency's reserve fund would be required to hold twice as high a minimum balance.  How could this be bad for the MIs, which compete, every day, with the FHA?

Nevertheless, it is the other half of the Hensarling bill that could be worrisome. Specifically, by phasing out but not replacing the role of Fannie and Freddie, the PATH Act would provide no federal credit enhancement for private high-LTV loans, which, almost assuredly, would find their way to an already bloated, though improving, FHA loan book. This might more than offset the well-aimed goals of the bill's FHA reforms, and thus tip the result negatively for the MIs, not to mention the broader housing sector and U.S. economy. Folks can differ on this score, but few doubt that a transition might prove unbearably risky -- which is why the PATH Act is highly unlikely to win enactment, except perhaps on the House floor this fall.

The net of these factors might legitimately leave MI stakeholders to drool over a compromise in which a Corker-Warner derivative, likely to be introduced this fall by Senate Banking Chairman and Ranking Republican, Tim Johnson (D-S.D.) and Mike Crapo (R-Idaho), could be amended to allow "deeper" cover from MI while the House might go along with a federal role in backing private MBS in exchange for a healthy portion of the PATH Act's FHA curbs.  

Of course, reform legislation is anything but a given -- even in the next Congress, much less this one. We've raised odds to 40% from one-in-four, given all the excitement, but see major obstacles in their rising much further. We ultimately could see any number of permutations in a final bill. But we think it's well worth reiterating that virtually all roads lead positively for the MIs.

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