Private mortgage insurer PMI Group Inc. acknowledged it will need to raise "significant additional capital" in order to continue writing new business after posting a $1 billion net loss in the fourth quarter — much of it through its ownership stake in troubled bond insurer FGIC Corp.
Although PMIs own mortgage insurance operations generated a $236 million net loss in the final quarter of 2007, it was the company’s 42 percent stake in FGIC that put the biggest dent in the company’s bottom line, accounting for $776.1 million of the net loss for the quarter. PMI’s net loss for the full year was $915.3 million.
FGIC, meanwhile, saw shareholder equity plunge from $2.4 billion at the end of 2006 to $584.4 million as of Dec. 31, as the company recognized $1.9 billion in potential losses in 2007 related to derivative contracts issued on mortgage-related collateralized debt obligations (CDOs). FGIC, which insurers bonds and structured debt issued by governments and corporations, also boosted loss reserves by $1.2 billion.
FGIC’s losses resulted in downgrades by rating agencies that could prevent it from taking on more business unless it can raise additional capital.
PMI Group’s exposure to FGIC’s losses could in turn threaten the ratings PMI must maintain in order to insure mortgages eligible for purchase or guarantee by Fannie Mae and Freddie Mac.
The government-sponsored enterprises, or GSEs, require mortgage insurers to be rated "AA-" or by at least two of the national rating agencies, and may limit mortgage insurers that have been downgraded by one rating agency below "AA-" from engaging in certain practices such as offering captive reinsurance. Captive reinsurance agreements cover 62 percent of PMI’s "risk in force" and are a growing portion of PMI’s business.
PMI’s primary insurance in force — the outstanding balance of all mortgages it insures — stood at $123.6 billion at the end of 2007, up 20 percent from a year ago. The "risk in force" — the amount PMI is obligated to cover on those loans — stood at $31 billion.
PMI and its insurance subsidiaries hold "AA" insurer financial strength ratings from Fitch Ratings and Standard & Poor’s Ratings Services, and the equivalent Aa2 rating by Moody’s Investor’s Services. But beginning with Moody’s on Jan. 31, all three agencies placed PMI’s ratings on review for potential downgrades.
Fitch analysts said they believed PMI’s investment in FGIC Corp. and its "large exposure" to alt-A, interest-only and high-loan-to-value-ratio loans have produced a capital shortfall and that failure to execute a plan to raise money could result in a downgrade of up to two notches.
FGIC faces similar pressures to raise capital, which could dilute PMI Group’s ownership interest in the company and lead to further losses.
In their annual report to investors, PMI Group executives warned the company will likely need to raise "significant additional capital in 2008" to maintain PMI’s insurer financial strength ratings.
In addition to raising capital, PMI has tightened its underwriting standards — as have nearly all mortgage insurers and lenders.
PMI has stopped insuring "Above 97s" — loans with down payments of less than 3 percent. The default rate on those loans, which represented 24.6 percent of PMI’s primary risk in force, was 9.1 percent at the end of December, up from 6.6 percent a year ago.
At the end of the year, alt-A loans represented 22.8 percent of PMI’s primary risk in force, and the default rate on those loans hit 13.9 percent, up from 5.7 percent a year ago.
As a result, borrowers taking out alt-A loans must have minimum FICO scores of 680, and at least 50 percent of qualifying income must come from nonsalaried sources. Alt-A borrowers must be able to make a 10 percent down payment in all markets, and a 15 percent down payment in "distressed markets" where prices have been falling. PMI has stopped guaranteeing pay-option adjustable-rate mortgages.
In "distressed markets" where prices have been falling, PMI won’t insure loans with down payments of less than 10 percent, and borrowers must have a FICO score of 620 or better. Pay-option adjustable-rate mortgage (ARM) loans are not an option in distressed markets, and limited-documentation loans require minimum down payments of 15 percent.
Interest-only loans with loan-to-value (LTV) ratios greater than 95 percent must meet Fannie Mae’s and Freddie Mac’s standards and allow at least five years of interest-only payments. Borrowers must qualify at the fully amortizing payment rate.
Although PMI’s U.S. mortgage insurance operations brought in about $800 million in premiums in 2007 — up 21.4 percent from 2006 — the division’s net loss for the year was $190.8 million, thanks to higher losses and expectations of future losses.
During the fourth quarter, PMI’s mortgage insurance division paid $114.5 million in claims and added $434.8 million to reserves for losses and loss adjustment expenses.
Losses and loss adjustment expenses increased to $1.1 billion in 2007, up from $263 million in 2006, and company officials say it will take some time for the tightened underwriting standards to stem losses.
"We expect claim rates and average claim sizes to continue to increase and our 2007 loss reserve increases reflect this expectation," PMI warned investors in the company’s annual report.
PMI’s competitors, including Radian Group Inc. and MGIC Investment Corp., are facing similar issues, with MGIC reporting $1.47 billion in fourth-quarter losses, and Radian Group $618 million in losses.
MCIG has stopped insuring loans with down payments of less than 5 percent in 30 declining markets including Denver; Washington, D.C.; Atlanta; Honolulu; Chicago; Baltimore; Boston; Detroit; Minneapolis; Newark, N.J.; New York City; Portland, Ore.; Vancouver, Wash.; and all of California, Florida, Arizona and Nevada (see story).
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