NEW YORK (TheStreet) -- Private mortgage insurers, which underwrite loans for homebuyers who can't afford a 20% down payment, stand to benefit from looser capital requirements that give them the cash to expand just as the largest insurer, the federal government, faces pressure to pull back.
The criteria for companies such as Mortgage Guaranty Insurance (MTG) - Get Report and Radian (RDN) - Get Report to obtain "approved insurer" status -- which lets them insure loans bought or held by big government-backed lenders like Fannie Mae (FNMA) -- were spelled out in an update of the Private Mortgage Insurer Eligibility Requirements that relaxed standards proposed in July. The requirements have been under review for years by lenders and government officials seeking to prevent a repeat of the 2008 financial crisis while keeping credit available for buyers.
The changes, effective Dec. 31 for existing insurers and immediately for new applicants, boost investor confidence by eliminating uncertainty about how exacting new criteria would be. They also free up cash for the mortgage insurers, which control 15% of the market in the U.S., to expand their customer base. By far the largest insurer is the U.S. government, which has insured more than 34 million properties through the Federal Housing Administration since 1934.
"It's now time to accelerate the discussions regarding proposals that would allow private mortgage insurers to further reduce [risk]" -- the risk of unpaid mortgages shouldered by Fannie Mae, Freddie Mac (FMCC) and, ultimately, taxpayers -- said Mortgage Guaranty CEO Patrick Sinks to investors on a conference call Tuesday. Such proposals include replacing government insurance on loans with down payments above the 20% level, and deepening coverage on loans requiring smaller down payments.
Mortgage Guaranty shares have jumped 6% since the new rules were announced Friday, benefiting partly from a better-than-expected earnings report Tuesday and comparatively low customer delinquencies in the first quarter. Shares of Radian, a competitor set to report earnings on April 30, have climbed 5%.
The new rules were approved at the same time the FHA faces pressure to send business to the private sector in order to comply with its own capital requirements mandated by Congress, said Mark Palmer, an analyst with BTIG.
"Technically, the government needs to feed more of its business to private players," he said.
The new requirements are designed to prevent a recurrence of mortgage-insurance failures, which were common during the financial crisis. Companies lacked sufficient capital to pay mounting claims, intensifying losses at Fannie Mae and Freddie Mac. Both of these government-sponsored enterprises buy loans from original lenders, freeing them to extend more credit. They're required by their charters to obtain "credit enhancement," typically mortgage insurance, for loans made with a down payment of less than 20%.
The revised standards make certain that "private mortgage insurer counterparties are able to fulfill their role of providing reliable credit enhancement for loans acquired by Fannie Mae, even in adverse market conditions," said Andrew Bon Salle, the organization's executive vice president for single-family business, in a statement Friday.
Both the new requirements and last summer's draft require "approved insurers" to maintain liquid assets of at least $400 million or a variable amount tied to a risk-based schedule, whichever is greater. The biggest change from last summer's proposal relates to mortgages issued prior to the 2008 financial crisis, or "legacy loans," which will now require insurers to post substantially less capital relative to risk, said Bose George, a managing director with Keefe Bruyette & Woods.
"In the near term, the announcement doesn't do anything but provide stability," he said. "But they now know what their capital is so they can move forward."