Updated from 8:52 a.m. EST
The private mortgage insurance industry is under severe pressure from rising delinquencies and mounting losses. Now questions are swirling about how a potential blow-up in that sector will affect
As the largest purchaser of U.S. mortgages, Fannie Mae provides an essential backstop to the housing market. The government-sponsored entity, like its brother
, purchases mostly standard 80% loan-to-value mortgages -- those for which the homebuyer puts down 20% equity.
Due to a quirk in its charter, Fannie Mae is allowed to purchase mortgages with loan-to-value, or LTV, ratios greater than 80% -- and as high as 100%. Generally, these are allowed only if the homeowner purchases mortgage insurance to cover the amount of the loan above 80%.
This business model works fine as long as Fannie Mae believes it can be reimbursed from the private mortgage insurers.
But as housing prices fall, borrowers are defaulting at a faster pace on high-LTV mortgages. In turn, private mortgage insurers -- who cover these risky loans -- have had their stocks crushed.
Shares of the three leading private mortgage insurers --
(MTG - Get Report)
(RDN - Get Report)
-- have tumbled 30% to 70% over the past three months as investors worry about whether the companies can fund their payments to lenders as mortgage defaults rise.
There are a few looming questions regarding Fannie Mae's exposure to the private mortgage insurers. One is whether Fannie Mae has adequately reserved for possible losses, because the company operates with the understanding that the insurers will pay it back.
The other issue is that if one of these insurers takes a massive hit, then Fannie Mae's underwriting standards may come under scrutiny, and the firm may be forced into buying fewer high-LTV mortgages in the future.
A Fannie Mae representative declined to comment on the issues.
Rival to Subprime Crisis
In November, defaults on privately insured mortgages rose 35%, to a record high of 61,000 nationwide, according to the Mortgage Insurance Companies of America, an industry trade group.
Worries about high-LTV mortgages are now replacing the worries about loans written to borrowers with low FICO scores -- so-called subprime borrowers. That's because falling housing prices across the country are creating situations in which homeowners are facing negative equity in their homes.
For instance, imagine taking out a 95% LTV loan and seeing you're home price fall 20%. You now have a 119% LTV loan.
In a recent research note, CIBC analysts said the "highest losses will be driven by LTVs, not FICO scores."
"Today, as a higher percentage of people own homes and many of them have taken on 'too much house' or high LTV loans, things are different," CIBC analyst Meredith Whitney wrote. "Many previously considered 'prime' customers who took on 80+% LTVs are performing closer to sub-prime loans."
Fannie Mae has $227 billion of exposure to mortgage loans in which the LTV ratios are greater than 90%. Overall, about 19% of the company's $2.4 trillion single-family mortgage book of business has private mortgage insurance or some other form of credit enhancement.
Troubles among bond insurers may provide a clue about how Fannie Mae would be forced to act if mortgage insurers' troubles grow.
decided to err on the side of caution by fully writing off $2.6 billion of default protection from bond insurers such as ACA Capital Holdings, because Merrill felt it was worthless. Specifically, $1.9 billion of the insurance came from ACA Capital, a financially distressed firm that is currently controlled by the Maryland Insurance Administration.