It is one of the small ironies of the subprime crisis that
the very competition that private mortgage insurers thought was ruining their
bottom line may have actually saved their hide.
Just a little over two years ago - August
9, 2005 to be exact - we wrote about the panic in the headquarters of many
companies that write private mortgage insurance (PMI) as they watched their
revenues decline as more and more homebuyers caught on to the utility of "piggy
Typically, when a borrower lacks sufficient money to make a 20 percent down
payment on a home, banks have made that borrower buy PMI to insure the bank
against loss in the event of a foreclosure. Borrowers were learning that they
could take out a second mortgage to cover the difference between their cash
and the 20 percent down and avoid PMI entirely. Interest on the second mortgage
is tax deductible while PMI premiums were not and, borrowers maintained that
their payments were going toward building equity rather than an insurance premium
that benefited only the bank.
The PMI companies pressured Congress and did get a limited short-term income
tax deduction for PMI premiums but borrowers continued to flock to piggy-backs.
Well, talk about dodging a bullet. There were probably hundreds of thousands
of buyers who opted for a piggy-back arrangement rather than PMI in the last
half dozen years. The Federal Reserve has reported that 22 percent of new loans
written in 2005 and 2006 used the second mortgage approach. Think of all of
the potential foreclosures for which the PMI companies are not going to be on
Still, the next shoe has not yet dropped for these companies. One of the big
ones, American International Group (AIG) last week reported
a drop of 27 percent in its income for the third quarter. Net income for the
quarter will be $3.09 billion or 1.19 a share compared to $4.22 billion or $1.61
a share in the third quarter of 2006.
It was unclear how much of this decline could be accounted for by the company's
mortgage guaranty business as AIG also invests heavily in derivatives impacted
by the subprime situation. AIG is involved in other business sectors as well
so its stock has not been punished as badly as some. It was trading around $56.50
on Friday compared to a 52-week high of about $73.00.
According to The Street.com, mortgage insurers like PMI Group,
MGIC Investment, and Radian Group are all posting year-to-date declines of over
70%, and their stocks have fallen precipitously.
For example, the price of PMI Group stock rallied strongly late last week (up
$2.21 mid-day) but was still selling at $13.45. The 52-week high for the stock
was 51.46. MGIC Investment was selling at around 19.40 against a 52-week high
of slightly over $70.00.
Bear in mind that the worst of the expected rush of foreclosures probably are
not even in the system as yet and one can see why private insurers should be
watched. It is probably a good bet that at least one of them will join dozens
of lenders as a permanent casualty of the housing mess. On the other hand, how
much worse might it have been had borrowers not gotten so creative with their
Some good news for the PMI companies came from The Associated
Press which reported that the market for second mortgages has
virtually disappeared. The article cited a survey of 1,000 mortgage bankers
and brokers conducted in October and published by Inside Mortgage Finance which
reported that the secondary market for second mortgages used to finance purchases
is now non-existent so banks can no longer afford to make these loans. It has
always been a risky market as typically the junior lien holder receives next
to nothing if a senior lien holder forecloses.
The AP said that the survey found second mortgages are still available for borrowers
with A credit, but even strong borrowers are increasingly defaulting on second
As of July, the percentage of second-mortgage borrowers with strong credit who
were 60 or more days delinquent had more than doubled from a year earlier to
1.3 percent, according to research firm FirstAmerican LoanPerformance.
So maybe the PMI companies do have the Midas touch. They may have avoided millions
of dollars in claims from insured banks because of the business they lost to
piggy-backs and yet will emerge into a new world where, for the borrower who
is short on cash, they will be the only game in town.