Bad news from S&P on the mortgage insurers. The rating agency on Tuesday night downgraded four guarantors, MGIC, Radian, PMI and Old Republic, cutting their financial strength ratings by two notches.
The explanation for the downgrade was rather bleak, after record payouts hit third and fourth quarter results. And the outlook has deteriorated further.
When we resolved the CreditWatch status of several mortgage insurer ratings on Nov. 21, 2007, we stated that if unemployment rose above 6%, incurred losses for all mortgage insurers would be significantly higher than our expectations. Our most recent macroeconomic forecast shows unemployment reaching 5.8% in 2009, and there is considerable uncertainty in the job markets. The deterioration in the housing markets has also been worse than our expectations. Now, we believe median home prices will decline 20% from the peak in 2006. By contrast, the forecasts we used in November 2007 assumed a decline of 11%. As a result of the deterioration in the housing and job markets, Standard & Poor’s believes mortgage insurers’ operating results for 2008 and 2009 will compare unfavorably with our previous expectations. Our current forecasts predict that most companies will not generate an underwriting profit until 2010, but individual results will vary.
The mortgage insurers provide cover for banks and lenders in the event of a homeowner default. Such insurance is typically required where a buyer puts down less than 20 per cent of the value of their home as downpayment.
The downgrades create a renewed headache for the GSEs, Freddie Mac and Fannie Mae, who rely on such insurance to buy up loans. Previously, insurers rated below AA- would not have been eligible to write policies for the GSEs.
That now includes the largest mortgage insurer MGIC, as well as PMI and Radian. The GSEs will now review the mortgage insurers with ratings below AA- to decide whether they can continue to guarantee their loans.
The answer, faced with the total seizure of the US mortgage market, must be ‘yes’. Freddie Mac has already indicated that it might allow a sub-AA- insurer to retain its eligibility if the GSE approved a “remediation plan” submitted within 90 days of the downgrade. But the mortgage market can’t do without them. S&P noted:
In the short term, replacing the capacity provided by those mortgage insurers that Standard & Poor’s rates below ‘AA-’ would be extremely difficult. Standard & Poor’s estimates that firms now rated below ‘AA-’ accounted for 58% of the industry’s flow market share in 2007.
So the three insurers that have fallen below AA- are now busying themselves with plans to submit to Freddie for approval.
S&P did note that the insurers are currently deemed to have adequate capital to meet claims from existing resources – though capital adequacy ratios are expected to decline through 2008. Radian was the only one of the three to on Tuesday add that it is considering ways to strengthen its capital base, through an equity issue or infusion from outside investors.
Related links
S&P release via Reuters
Freddie Mac alters rules for private insurers – FT.com, February