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It's not just about mortgage insurance anymore.

In the fall of 1988, Bill Lacy, currently chairman and chief executive officer of Mortgage Guaranty Insurance Corporation (MGIC), wrote an article that appeared in this publication. Titled "MIs: After the Losses, a Second Chance," the article relived the sobering details of the 1980s, a decade in which the nation's private mortgage insurance industry shrank from 14 to seven companies and paid nearly $7 billion in claims.

At the time, the private mortgage insurance industry had just lived through three of the toughest years it ever faced. Several mortgage insurance companies were forced to stop writing new business in order to preserve what capital they had to pay claims. By 1988, the bulk of the losses had been paid and things were turning around. As Bill Lacy wrote: "Though the private mortgage insurance industry has suffered unprecedented losses in the last five years, the industry remains strong and viable. In the years ahead, the industry will serve an essential role in helping more people buy homes of their own."

His prediction was correct. In the last 10 years, the private mortgage insurance industry has played an essential role in helping lenders meet the burgeoning need for low-down-payment financing. But today's industry is different in many respects than the industry that paid the heavy losses of the 1980s. Fundamentally, private mortgage insurance is the same. Lenders buy mortgage insurance to reduce the exposure to losses that occur when borrowers with little or no equity interest lose their homes through foreclosure [ILLUSTRATION FOR FIGURE 1 OMITTED]. Since its inception in 1957, the industry has served more than 18 million households; become the most popular form of first-mortgage credit enhancement, insuring more than 1 million mortgages annually; and paid more than $14 billion in claims to lenders and investors.

But while the fundamentals of this business may be the same, the characteristics of the industry and its competitive environment have changed. Ten years ago, the industry was rebuilding, demand for its guaranty was expected to be static, and lenders were primarily focused on an insurer's ability to pay claims. Today, as we look to the next millennium, demand for low-down-payment financing is strong and expected to continue to grow; private mortgage insurers are well capitalized and financially strong; and competition within the industry and from alternative credit enhancements has never been more intense.

While an insurer's claims-paying ability is still of paramount importance, lenders today are sharply focused on finding ways to enhance productivity and profitability. That's where private mortgage insurers are stepping up, offering products and services that align their interests with the interests of the nation's home mortgage lenders.

Through structured transactions with private mortgage insurers, such as captive reinsurance, lenders share in the risk of loss and the potential for profit. Either directly or through affiliates, insurers provide lenders services for a fee that make the lending process more effective and efficient. For example, contract underwriting offered through insurers makes the cost of underwriting more manageable for lenders. By employing strategic technologies developed by insurers, lenders are able to streamline processes and, in the case of scoring models, focus resources on those loans that offer the greatest business opportunity. Private mortgage insurers also provide training, capital markets support and a myriad of other services to lenders, further aligning organizational interests.

With a vast and growing market for low-down-payment mortgages, capital strength and a competitive spirit, private mortgage insurers are well positioned to be lenders' strategic partners for years to come.

A vast and growing market

As the 1990s approached, economists foresaw slow growth in the nation's population and household formations - both leading indicators of housing market expansion. Additionally, housing affordability, a function of interest rates, was not expected to improve greatly. It was widely expected that the 1990s, barring unforeseen circumstances, would be marked by slow growth in housing and mortgage lending.


Through the recession of 1991, it appeared as though economists' predictions were on target. Then, the unforeseen happened - interest rates fell sharply. The Federal Reserve, in an effort to jump-start the economy, lowered the cost of money. Soon, loan demand perked up, businesses began hiring and consumer confidence rose. Spending increased, adding fuel to the recovery, and the clouds of recession lifted.

From behind the clouds emerged the longest period of economic expansion this nation has seen since World War II. Low interest rates increased housing affordability and drew renters with minimal savings into the housing market. A boom in mortgage originations, and an even bigger boom in private mortgage insurance, ensued.

From 1990 through 1995, the percentage of mortgages originated annually with private mortgage insurance doubled (see Figure 2). Proportionately more borrowers bought homes with less than 20 percent down payments, and more borrowers than ever before made less than 10 percent down payments. In fact, the percent of purchase-money mortgages insured by MGIC with less than 10 percent down has more than doubled from 20 percent in 1990 to around 50 percent.

If sharply lower interest rates was one unforeseen circumstance, the other was a wave of immigration rivaled only by the influx of Europeans that occurred during the nation's "gateway" years of the early 1900s. This time, it is Hispanics and Asians who are leading the unexpectedly enormous influx of immigrants in the 1990s. It is estimated that the wave of immigrants this decade will reach 10 million people and account for between 30 and 40 percent of the nation's population growth for the decade.

What's more, that trend is expected to continue well into the next century, giving rise to the so-called "millennium generation," which is expected to be larger than the baby boomers. These future borrowers will be fundamentally different from the first-time homebuyers of 25 years ago. They will likely have little or no experience with credit, minimal savings for down payments and closing costs, higher debt ratios and smaller cash reserves after closing. They will join minorities, low- to moderate-income households and young families groups with rates of homeownership that lag far behind the national homeownership rate of 66 percent as the first-timers of the new millennium.

Together, these groups will fuel the need for low-down-payment financing, as well as the need for credit enhancement and protection from losses that private mortgage insurance provides to the conventional mortgage market. To serve this emerging market, a lender will need private mortgage insurance, as well as a strategic relationship with its mortgage insurance partner.

A financially strong industry

As the industry prepares to meet the needs of homebuyers and lenders in the next millennium, it does so from a position of financial strength. By the end of 1988, after mortgage insurers had digested $5 billion in losses over the prior five years, the industry was left with about $3.5 billion in assets and policyholders' surplus and contingency reserves of approximately $2 billion. By comparison, the industry today has more than $10.5 billion in assets and approximately $7.5 billion in policyholders' surplus and contingency reserves. The industry's risk-to-capital ratio - a measure of an insurer's capacity to write more new insurance - peaked at the uncomfortably high level of 22.2-to-1 in 1991 and has since fallen to 17.8-to-1.

Today, the industry insures approximately $550 billion, or about 13.5 percent of the nation's outstanding $4.1 trillion in mortgage debt. And its loss ratio has come down from 180 percent in 1987 to 41 percent in 1997, meaning for every dollar in premium earned, insurers are putting 41 cents toward losses [ILLUSTRATION FOR FIGURE 3 OMITTED].

The industry's financial strength is a function of its regulatory environment. For every $25 of risk in force, regulators generally require a minimum of $1 in capital (a 25-to-1 risk-to-capital ratio). Regulators also require that insurers are monoline companies that only insure first mortgages on one- to four-family homes. This prevents the use of capital to support other lines of business. Why are mortgage insurers subject to strict capital ratios and a monoline structure? Because regulators recognize that when the losses come in mortgage insurance, they come in bunches. In fact, regulation of the industry is such that an insurer must show an ability to withstand losses equal to those encountered during the Great Depression, when 10 percent to 15 percent of homeowners defaulted on their mortgages.

Private mortgage insurance is a long-term commitment. As a result, it is difficult to predict when the losses will hit or how large they will be. Sound underwriting can minimize losses. But the catastrophic risk that private mortgage insurers protect lenders from is collateral risk, or the risk that property values will fall in a given real estate market and increase default incidence and the severity of subsequent losses.

While more lenders today are using scoring models to predict credit risk, there is no model that can accurately predict collateral risk because real estate markets are unpredictable over the long term. That makes high-LTV (loan-to-value) lending particularly risky. Financial institution regulators recognize the nature of collateral risk and require banks, thrifts and the agencies to set aside more capital when booking high-LTV mortgages that are not insured. Therefore, lenders choose to lay off collateral risk on private mortgage insurers, which are well capitalized, benefit from national geographic risk dispersion and are structured to withstand catastrophic losses, should they occur.

The sustained profitability of the private mortgage insurance industry is vital to ensuring its continued financial strength. Profits become reserves, and reserves pay tomorrow's losses. In good times, mortgage insurers must build reserves to weather the storms like the regional recessions that hit home in the 1980s. While insurers' ability to weather such storms remains important to lenders, a growing number of lenders also are recognizing the importance of having a strategic relationship with their insurance providers.

Forging strategic partnerships

Lenders today aren't as concerned about the private mortgage insurance industry's financial strength because economic times are good and both lenders and insurers are enjoying a period of unrivaled financial health. Losses in virtually all lines of lending, with the exception of credit-card lending, have remained low throughout the 1990s. Low losses, high net interest margins and surging growth in fee income have equipped commercial banks with ample capital, and many banks are using that capital to increase their presence in the dynamic mortgage lending business. This is a fundamental difference from 1988 when regulators were pressuring both banks and thrifts to boost capital reserves in the wake of rising losses on loans and other investments.

Another fundamental difference in the industry today versus one decade ago is the degree of consolidation [ILLUSTRATION FOR FIGURE 4 OMITTED]. Many commercial banks have entered the mortgage banking business or increased their presence in the market through acquisitions. The 1990s have seen the rise of mega-servicers - companies that have built huge servicing portfolios and have equally huge origination appetites. These large, capital-rich mortgage banking entities are redefining their relationships with private mortgage insurers. They are sharing with private mortgage insurers their organizational needs with the expectation that insurers bring more to the business relationship than simply their ability to pay claims.

This approach to the lender-insurer relationship is expanding from the largest of lenders to mid-size and even smaller lenders, which just as avidly are pursuing strategic relationships with their mortgage insurance partners. Today, an insurer must clearly understand a lender's organizational needs and goals. An insurer must have a full slate of products and services it can offer to meet those needs, and it must be willing to share with the lender the risks and rewards of insuring mortgages.

While some have cast lenders' changing expectations as a negative for the private mortgage insurance industry, they tend to overlook the long-term benefits that accrue to insurers as they forge strategic partnerships with the nation's home mortgage lenders. The strategic partnership a mortgage insurer forms with a lender creates an inextricable bond. It aligns the lender's interests with the insurer's interests, making the insurer less of a vendor and the loan guaranty less of a commodity.

The successful private mortgage insurer will "decommoditize" its loan guaranty by providing its lenders, either directly or through affiliates, fee-based products and services that further integrate the two organizations and enhance the lender's ability to meet its operating goals.

How is this being done today? Many ways:

* With structured transactions, such as captive reinsurance, a lender has the potential to enhance profitability in return for assuming risk. For example, in a captive reinsurance arrangement, a lender, through a subsidiary, reinsures a portion of the risk assumed by the private mortgage insurer in return for a commensurate reinsurance premium. This increases a lender's exposure to loss, but also provides the lender an opportunity to enhance profitability should loss performance be favorable.

* By outsourcing underwriting to an insurer's contract underwriting unit, a lender can turn a significant fixed cost of the origination process into a variable cost that rises and falls with production.

* Insurers today are providing lenders access to Fannie Mae's Desktop Underwriter and Freddie Mac's Loan Prospector. This can reduce the fixed costs associated with establishing direct connections to the agency systems and the collateral expenses of training staff to use the systems. It also increases a lender's secondary market execution flexibility, giving them pay-as-you-go access to both Desktop Underwriter and Loan Prospector.

* Insurers are expanding the traditional mortgage banker's market through the offering of A-minus insurance. With A-minus coverage, a lender can offer low down-payment financing to borrowers with blemished credit without taking on undue risk. Lenders that already have A-minus programs are using A-minus insurance to reduce the note rate charged to consumers.

* Private mortgage insurers through the years have developed mortgage-scoring models for various internal uses. In the last few years, insurers have offered these models to lenders, delivering to them the benefits of improved decision-making and efficiency. At MGIC, we developed a mortgage-scoring model that predicts the probability a newly originated loan will go through foreclosure within four years. In 1996, we began marketing that model, the MGIC Loan Performance Score, to our customers.
Figure 5

Snapshot: The New Federal Mortgage Insurance Cancellation Law

The Homeowners Protection Act of 1998 succeeds in providing
consumers with disclosure about their rights to have private
mortgage insurance canceled, and it establishes equity thresholds
for automatic termination of private mortgage insurance policies. In
summary, the new law sets forth four new consumer-protective

Initial Disclosure Lenders must inform borrowers at closing
 that they have private mortgage insurance
 and that they will have the right to have it
 canceled at some future point in time.

Annual Disclosure Lenders must inform borrowers annually with
 a written statement that they continue to
 have private mortgage insurance and have the
 right to have it canceled upon request and
 subsequent to meeting the lender's
 cancellation criteria.

Borrower-Initiated For most conventional loans closed beginning
Cancellation on July 29, 1999, the borrower will have the
 right to cancel private mortgage insurance
 coverage by written request (if the borrower
 has a good credit history and there is no
 decline in property value) at a
 loan-to-value ratio (LTV) of 80 percent.

Automatic Termination For most conventional loans closed beginning
 July 29, 1999, private mortgage insurance
 will automatically cancel at 78 percent LTV
 based solely on the initial amortization
 schedule. There are exceptions to this rule
 for loans deemed to be "high-risk" and for
 borrowers without a good payment history.


Later in 1996, we began licensing lenders to use the MGIC Loss Mitigation Score, a model developed initially for our Claims Administration, which predicts the probability a delinquent loan will cure. We since have joined forces with Freddie Mac, combining our loss mitigation-scoring expertise with Freddie Mac's knowledge of collections and loss mitigation, to produce Early-Indicator, a leading default-scoring model. More recently, we introduced the MGIC Mortgage Prepayment Score, which is helping lenders estimate prepayment speeds on a loan-level basis to assist their portfolio-retention efforts and servicing strategies. Mortgage insurers have invested time and money into developing cutting-edge analytics, making the mortgage insurance industry a leading provider of technology solutions to lenders.

* With the increase in wholesale lending, private mortgage insurers are playing a key role in matchmaking loan producers with investors. In addition to wholesaler-seller matchmaking, other capital markets support services being provided to lenders include portfolio valuation, due diligence and servicing rights brokering.

* Given the emerging demographic profile of first-time homebuyers, private mortgage insurers are being called on more than ever before to assist in the prepurchase homebuyer education process, providing educational materials and telecounseling. MGIC's tele-education unit handles some 6,000 calls a month. Bilingual specialists work with both English-speaking and Spanish-speaking applicants to certify they have completed prepurchase homebuyer education requirements.

* Training is another area where insurers serve lenders. By properly training a lender's staff to work with self-employed borrowers, or helping them maximize the benefit of the technology link insurers provide to Desktop Underwriter and Loan Prospector, insurers increase their productivity and their customers' productivity. By doing this, they also improve the risks they insure.

* While still monoline, today's private mortgage insurers offer other insurance products through affiliated companies. At MGIC, for example, we recently announced the availability of second-mortgage insurance up to a combined loan-to-value ratio of 100 percent. Some lenders are using this insurance to expand their mortgage product line, while others are using it to reduce the interest rate charged to consumers.

In the 1980s, the need for private mortgage insurance was validated. The billions of claims dollars paid to policyholders saved the nation's deposit insurance funds and large investors from heavier, possibly catastrophic losses. In the 1990s, the value of doing business with a private mortgage insurer is being further validated in a different way. Though claims-paying ability is still important to lenders, private mortgage insurers today are strengthening their ties as strategic partners to the nation's mortgage lenders by providing essential products and services.

Rekindling the spirit of expanding homeownership

Twenty-five years ago, The Wall Street Journal featured MGIC and private mortgage insurance in a page one article. At the time, the private mortgage insurance industry was just 15 years old, a fledgling sector of the booming housing market. The article lauded MGIC founder Max Karl for his innovation in creating an attractive alternative to the government guaranty provided by the Federal Housing Administration (FHA). MGIC and Karl were crowned as white knights providing a way to slay the housing affordability dragon and open the gates to homeownership for millions of American families.

What a difference a quarter century makes. In recent years, private mortgage insurance has been cast in the role of the dragon. Consumers have been bombarded with articles urging them to avoid private mortgage insurance at all costs. Consumer columnists write that it is impossible to have private mortgage insurance canceled, even when it is no longer needed by the lender. The resulting furor attracted the attention of Capitol Hill and the anti-mortgage insurance rhetoric became even more heated as Congress debated various mortgage insurance cancellation and disclosure bills before passing one and having President Clinton sign it into law July 29 (see Figure 5).
Figure 6

Private Mortgage Insurance More Expensive? Think Again. . .

 80-10-10 Self-Insurance Private MI

Monthly Payments $919.05 $932.87 $919.27

Total Payments
(5 years) $55,143 $55,972 $55,156

Total Interest Payments
(5 years) $47,047 $48,553 $47,103

Tax Reduction at 28%
(5 years) $13,295 $13,595 $13,173

MI Refund, (60th month) $0 $0 $1,270

Total Cost (5 years) $41,848 $42,377 $40,713


$150,000 home purchase price with 10% borrower down payment

First mortgage rate of 7% for 80-10-10 and Private Mortgage
Insurance, 7.38% for Self-Insurance

Second mortgage rate of 9% for 80-10-10

MGIC's Financed Single rate plan with 40% refund at 60th month

Cancellation of private mortgage insurance after five years


The 200 basis point spread between the first and second mortgage in
the 80-10-10 structure represents fairly aggressive pricing offered
only to the most creditworthy borrowers, typically those with credit
scores exceeding 680. Spreads on seconds can go as high as 600 basis
points, depending on a borrower's creditworthiness. The cost of
standard private mortgage insurance neither varies on the basis of
borrower creditworthiness, nor is impacted by interest rate


The confusion over cancellation led to the emergence of alternative credit enhancements, such as 80-10-10 loan structures, and the reemergence of self-insurance. The concern over cancellation was terribly overblown. The number of borrowers believed to be needlessly paying for private mortgage insurance was overstated, as was the number of mortgage servicers alleged to be denying consumers' requests for cancellation that should have been granted. Nonetheless, a new law was created to demystify private mortgage insurance cancellation.

In an odd twist of fate, the new law is a stroke of good news for an industry beset by image problems. By requiring disclosure to consumers about their right to cancel private mortgage insurance and mandating automatic termination at a future point in time, Congress took the mystery out of private mortgage insurance cancellation. Consumers now will understand their cancellation rights; and, in time, I believe skepticism and misconceptions about private mortgage insurance will erode. The marketplace will again come to understand what The Wall Street Journal so accurately captured 25 years ago - that private mortgage insurance expands homeownership opportunities, is an inexpensive and flexible type of credit-enhancing loan guarantee, can be canceled once it's no longer needed and is routinely being improved to maximize affordability for the most price-sensitive borrowing prospects.

With the cancellation cloud now lifted, the outlook for private mortgage insurance relative to alternative credit enhancements is much more positive. Private mortgage insurance industry innovations such as financed single premiums, insurance plans that allow borrowers to finance a one-time lump-sum premium over the life of the loan, are minimizing monthly payments and stacking up more favorably than alternatives in terms of the ultimate cost to the borrower (see Figure 6). And monthly premium programs, introduced four years ago, reduced by hundreds of dollars the amount of prepaid premiums required of borrowers at closing. Within the last two years, insurers added a twist to monthly premium plans - borrowers now can post-pay for private mortgage insurance and pay no premiums at closing.

A golden opportunity

Summarizing his article 10 years ago, Bill Lacy wrote that the industry's goal is to help lenders expand homeownership in America. Ten years ago, insurers met that goal by providing a credit enhancement that freed up more mortgage money for cash-strapped families with little savings. Today, in addition to that credit enhancement, the industry has an arsenal of products and services it is using to help lenders put more people into homes and keep them there.

Even with the industry's strong focus on forging strategic partnerships with lenders, the credit enhancement provided by mortgage guaranty insurance is the most important contribution private mortgage insurers make to the quest to expand homeownership. When Max Karl invented private mortgage insurance in 1957 he knew the industry would have good times and bad times. He knew there would be profits and, eventually, losses. He built the private mortgage insurance franchise to be profitable in good times so that it could build enough reserves to weather the bad times.

Today's mortgage guaranty insurers are functionally the same as the one Max Karl created 41 years ago. After paying record claims in the 1980s, insurers have enjoyed record profitability in the 1990s. Losses in mortgage lending have remained low because of the nation's economic stability and steady growth in home prices. But losses will return. Economies and real estate markets, after all, are cyclical and unpredictable.

While it is important not to live in the past, let's not forget the lesson learned in the 1980s when regional recessions led to huge claims payouts by private mortgage insurers. The lesson we learned is this: Because real estate markets are unpredictable, sound underwriting and fair pricing are paramount in good times and bad.

The recent performance of the stock market provides an interesting glimpse at the nature of the unpredictable. Given the seemingly unflappable strength of the 1990s' bull market, how many people figured the Dow Jones Industrial Average would fall 20 percent in August? As analysts focused on inflation and corporate profits to predict the stock market, devaluations of world currencies, recessions in emerging countries and political unrest in foreign lands sneaked up on them. Nobody figured a weak ruble and the threat of communists returning to power in Russia would plague stocks markets in other countries, including the United States. But that's the nature of the unpredictable - hard times don't announce when they're coming, why they're coming or how long they'll last.

In the mortgage industry, private mortgage insurance provides lenders and investors substantial protection from the unpredictability of the collateral risk present in high-LTV lending. While loan performance is not the first thing on lenders' minds these days, there will come a time when mortgage defaults rise and losses throughout the industry increase - possibly to catastrophic levels. It is in those tough times that the real value of private mortgage insurance shines through. Private mortgage insurance reduces lenders' and investors' losses and ensures that when the tough times hit, capital for low-down-payment loans doesn't dry up.

The private mortgage insurance industry's goals are the same today as they were in 1988. But times have changed. Ten years ago, we were looking for a second chance. As Lacy wrote, "Very few businesses get a second chance. We not only have a second chance, but also a golden opportunity." That same golden opportunity that Bill Lacy wrote about exists today. In fact, given the expected demand for low-down-payment financing, the aligning of insurer and lender interests, the private mortgage insurance industry's financial strength, and the prospects for greater understanding and acceptance of our product among consumers - the opportunity has never been so golden.

Curt S. Culver is president and chief operating officer at Mortgage Guaranty Insurance Corporation, in Milwaukee, Wisconsin. MGIC is the nation's largest private mortgage insurer. As of June 30, 1998, it insured more than 1.3 million mortgages totaling $137.5 billion.
COPYRIGHT 1998 Mortgage Bankers Association of America
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1998 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Cover Report: Global Change
Author:Culver, Curt S.
Publication:Mortgage Banking
Article Type:Industry Overview
Date:Oct 1, 1998
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