After dropping off in the fourth quarter of last year, private mortgage insurance has made a resurgence in the first half of 2002. This pace is expected to remain steady or increase slightly in the second half of the year, as insurers, investors, and issuers all become more familiar with each other's preferences in the asset-backed market.
Driven by the market's appetite for both triple-B rated sub tranches and net-interest-margin securitizations that are not available in wrapped transactions, Standard & Poor's estimates that mortgage insurance was backing the collateral on 22% of the subprime home equity securitizations in the first six months of 2002. Going forward, this percentage could increase by 10%, according to some estimates, depending upon how aggressively the insurers want to take on subprime risk.
In the wake of the terrorist attacks and the economic downturn seen late last year, investors had demanded the additional security of a financial guaranty. Also, the explosion of private insurance had insurers reaching last year's saturation targets earlier than expected.
The fourth quarter of 2001 was a banner quarter for the monolines, as $5 billion of wrapped home equity issuance priced. By contrast, there had been no home equity deals in the third quarter of 2001 to feature a financial surety.
During 3Q01, general market acceptance from both issuers and investors led to peak PMI usage. Thomas Warrack, a director at S&P, estimates that exposure had grown to roughly half of the subprime MBS sector's securitizations during the quarter. Warrack added that in the fourth quarter - while the monolines were so busy - PMI exposure was estimated at just 14%.
Reasons for this are fairly simple: in addition to the economic uncertainty at the time, many mortgage insurers had already reached their growth targets for the year. Going forward, however, conditions are ripe for a pick up once again.
"While I would doubt that we reach the levels seen at last year's peak, I do anticipate mortgage insurance growth to continue," added Warrack. Warrack estimates exposure to maintain a minimum of one-quarter of the subprime sector, and could top off at one-third going forward.
One thing set to propel PMI back to lofty levels is the persistently lower interest rates and the possibility of future refinancings. A driver of the record home equity supply in the first half of the year has been refinance activity. While it is unclear whether refinancings can maintain the current pace, it is certain that when originations spike upward, mortgage insurance will be sure to follow.
Tim Edwards, capital markets manager at leading insurer Mortgage Guaranty Insurance Corp., says the strategy is to keep what is called "bulk" business - the insuring of entire loan pools - somewhere in the to 20% to 30% area of total loan underwritings. Last year's third quarter spike in business was partly the result of investor and issuer comfort with insured product, spurred by the leading issuers - such as Countrywide Home Loans Inc. and GMAC-Residential Funding Corp. - acceptance of PMI as a surety alternative.
Judging from MGIC's numbers so far this year, it appears that private insurance will wane in the second half. In the first half of the year, MGIC has underwritten roughly $45.4 billion of total mortgage insurance, of which $12.3 billion, or 27%, has been bulk business.
But as is typically the case with such things, it comes down to a question of economics. Just as issuers carefully weigh the benefits of a monoline wrap with those of a senior subordinated structure, issuers and bankers have to decide whether purchasing insurance on an entire loan pool is worth it. Bruce Fabrikant, in Moody's Investors Service ratings group, notes the cost of private mortgage insurance has risen over the past year, from when the insurers were making more of a push into the "bulk" aspect of the market.