Update on Mortgage Insurers as Enterprise Counterparties

Federal Housing Finance Agency

Office of Inspector General

Update on Mortgage Insurers as

Enterprise Counterparties

White Paper

•

WPR-2021-001

•

March 8, 2021

WPR-2021-001

March 8, 2021

Executive Summary

Under their charters, Fannie Mae and Freddie Mac (the Enterprises) may only

purchase conventional single-family residential mortgages with loan-to-value

ratios greater than 80% if these mortgages are supported by one of three types

of credit enhancements. The credit enhancement used for the vast majority of

these Enterprise mortgage purchases is mortgage insurance. Mortgage

insurance transfers a portion of the risk arising from default of a mortgage to

an insurer. Counterparty risk arises from the potential that mortgage insurers

may fail to pay claims. According to the Federal Housing Finance Agency

(FHFA or Agency) and the Enterprises, mortgage insurers represent a

significant counterparty exposure to the Enterprises.

We published a white paper in February 2018 explaining the then-current and

emerging risks for the Enterprises associated with private mortgage insurers.

Over the past three years, the industry landscape has continued to evolve.

Additionally, the COVID-19 pandemic represents the first significant

challenge mortgage insurers have faced since the financial crisis. We are

issuing this white paper to provide an overview of key developments affecting

the mortgage insurance industry and an explanation of how those changes

affect risks to the Enterprises.

OIG • WPR-2021-001 • March 8, 2021 3

TABLE OF CONTENTS ................................................................

EXECUTIVE SUMMARY .............................................................................................................2

ABBREVIATIONS .........................................................................................................................4

BACKGROUND .............................................................................................................................5

INDUSTRY COMPOSITION .........................................................................................................5

TOOLS TO REDUCE RISK ...........................................................................................................6

Eligibility Requirements ...........................................................................................................6

Rescission Relief and Master Policies ......................................................................................7

Credit-Risk Transfer Tools .......................................................................................................7

Risk-Based Pricing ...................................................................................................................8

Pilots to Address Industry Concentration .................................................................................8

CHALLENGES ...............................................................................................................................8

Pandemic and Economic Environment .....................................................................................8

Use of Risk Mitigation Tools in Response to Pandemic and Economic

Environment ......................................................................................................................9

Volume ...................................................................................................................................10

RISK IMPLICATIONS .................................................................................................................10

CONCLUSION ..............................................................................................................................11

OBJECTIVE, SCOPE, AND METHODOLOGY .........................................................................12

ADDITIONAL INFORMATION AND COPIES .........................................................................13

OIG • WPR-2021-001 • March 8, 2021 4

ABBREVIATIONS .......................................................................

Enterprises Fannie Mae and Freddie Mac

FHFA or Agency Federal Housing Finance Agency

OIG Federal Housing Finance Agency Office of Inspector General

PMIERs Private Mortgage Insurer Eligibility Requirements

OIG • WPR-2021-001 • March 8, 2021 5

BACKGROUND ..........................................................................

Under their charters, Fannie Mae and Freddie Mac may only purchase conventional single-

family residential mortgages with loan-to-value ratios greater than 80% if these mortgages are

supported by one of three types of credit enhancements. The credit enhancement used for the

vast majority of these Enterprise mortgage purchases is mortgage insurance. Mortgage

insurance transfers a portion of the risk arising from default of a mortgage to an insurer in

exchange for an insurance premium that is usually paid by the borrower.

According to FHFA and the Enterprises, mortgage insurers represent a significant

counterparty exposure. Counterparty risk arises from the potential that mortgage insurers may

fail to pay claims, for example, due to insolvency. As an industry, mortgage insurers

sustained significant losses during the 2008 financial crisis. Three mortgage insurers were

found by their respective state regulators to lack sufficient capital and were placed into “run-

off,” meaning they were not allowed to write new insurance. These insurers partially deferred

claim payments due to the Enterprises. Further, some mortgage insurers rescinded coverage

on a greater share of loans, canceling the policies as improperly issued and returning the

premiums. In such circumstances, the Enterprises could require that the originating lender

repurchase the mortgage.

We published a white paper in February 2018 explaining the then-current and emerging risks

for the Enterprises associated with private mortgage insurers.

Over the last three years, the

industry landscape has continued to evolve, both increasing and decreasing counterparty risk

to the Enterprises. The COVID-19 pandemic, beginning in 2020, represents the first

significant challenge mortgage insurers have faced since the financial crisis. We are issuing

this white paper to provide an overview of key developments affecting the mortgage

insurance industry over the past three years and an explanation of how those changes affect

risks to the Enterprises.

INDUSTRY COMPOSITION .........................................................

The mortgage insurance industry is concentrated. Currently, six private mortgage insurers are

active: Arch Mortgage Insurance Company; Radian Guaranty Inc.; Mortgage Guaranty

The mortgage insurer assumes the first-loss position in the event of foreclosure and reimburses the Enterprise

for losses up to the level specified in the policy, typically about 5% to 35% of the loan amount.

See OIG, Enterprise Counterparties: Mortgage Insurers (Feb. 26, 2018) (WPR-2018-002) (online at

www.fhfaoig.gov/sites/default/files/WPR-2018-002.pdf

OIG • WPR-2021-001 • March 8, 2021 6

Insurance Corporation; Essent Guaranty, Inc.; Genworth Mortgage Insurance Corporation;

and National Mortgage Insurance Corporation.

TOOLS TO REDUCE RISK ............................................................

Over the past three years, a number of tools have been implemented or refined, purportedly to

help reduce the Enterprises’ mortgage insurance counterparty risk.

Eligibility Requirements

At FHFA’s direction, the Enterprises published Private Mortgage Insurer Eligibility

Requirements (PMIERs), which became effective in December 2015.

Among other things,

PMIERs established a minimum level of available assets, or PMIERs capital, for private

mortgage insurers to do business with the Enterprises. In 2018, FHFA directed the

Enterprises to modify PMIERs to address changes in Enterprise counterparty risk

management as well as in the mortgage insurance industry and economy. The revision,

known as PMIERs 2.0, became effective in March 2019. The Enterprises have provided

additional guidance to mortgage insurers since then.

An FHFA official told us that PMIERs 2.0 strengthened the financial requirements for

mortgage insurers that do business with the Enterprises. However, a Fannie Mae official

noted that the change was somewhat modest, increasing required assets by 5 to 10%.

Nevertheless, another official said that mortgage insurers are much stronger counterparties for

Fannie Mae under PMIERs 2.0. A Freddie Mac official said that the change to PMIERs 2.0

Our 2018 white paper noted a pending acquisition of Genworth Financial, Inc. by China Oceanwide Holdings

Group Co., Ltd. However, as of February 2021, that transaction faces uncertainty. Genworth announced that

in the interim it will focus on executing a contingency plan, including a potential initial public offering of the

mortgage insurance business. Although a Fannie Mae official told us that the potential failure of the

transaction represents more risk in the short term, officials from both Enterprises told us that the concern is

with the parent company, not the mortgage insurance counterparty.

Arch Capital owns both Arch Mortgage Insurance Company and United Guaranty Residential Insurance

Company, which technically also is approved as a mortgage insurer. MassHousing, a state housing finance

agency, also is approved by the Enterprises. PMI Mortgage Insurance Co., Republic Mortgage Insurance

Company, and Triad Guaranty Insurance Corporation remain in run-off and unable to write new policies. The

mortgage volume backed by these three companies and the proportion of their payments being deferred have

declined.

Before the financial crisis, a minimum credit rating was part of the criteria the Enterprises used to approve

mortgage insurers. Over the past three years, a number of mortgage insurers have received credit rating

upgrades. A Freddie Mac official confirmed to us that Genworth is the only mortgage insurer rated below

investment grade at this time. According to FHFA, PMIERs now drive eligibility standards instead of ratings.

Together the 2015 PMIERs and PMIERs 2.0 nearly doubled the mortgage insurers’ capital requirement.

OIG • WPR-2021-001 • March 8, 2021 7

served to increase the quality and liquidity of mortgage insurer assets, and PMIERs help

mitigate risk. FHFA and the Enterprises said that they believe PMIERs 2.0 are sufficient to

protect the Enterprises in a stress scenario generally. (See section on Use of Risk Mitigation

Tools in Response to Pandemic and Economic Environment for additional information about

capital adequacy relative to the ongoing pandemic.)

As of year-end 2020, all six active private mortgage insurers comply with PMIERs. The

mortgage insurers have generally been operating profitably and adding to their PMIERs

capital. According to Fannie Mae, as of December 2020, the industry’s collective surplus

over the total PMIERs required assets stood at $6.5 billion, which is approximately 145% of

the requirement.

A surplus can help a mortgage insurer weather stress.

Rescission Relief and Master Policies

FHFA directed the Enterprises to align and implement rescission relief principles, which

specify conditions that must be met before a mortgage insurer can rescind coverage. The

most recent major revision was in December 2017. The principles generally align with the

Enterprises’ representation and warranty framework, providing automatic relief from

rescission after specified periods of timely payments and also after a mortgage insurer has

completed a full review of the loan and its underwriting that does not identify any significant

defect. At FHFA’s direction, the Enterprises also developed and implemented aligned

mortgage insurance master policy provisions, with the most recent versions becoming

effective in March 2020. The March 2020 master policies incorporated the December 2017

rescission relief principles and included a few other provisions.

Credit-Risk Transfer Tools

All six active private mortgage insurers currently use reinsurance and other credit-risk transfer

tools to transfer risk and diversify their capital strategy. Over the last three years, use of these

tools has grown substantially. As of October 2020, private mortgage insurers had transferred

nearly $41.4 billion in risk on approximately $1.8 trillion of insurance-in-force since 2015

according to U.S. Mortgage Insurers, a mortgage insurance trade association. A white paper

issued by that insurance trade association described the use of reinsurance and credit-risk

transfers as changing the mortgage insurance business model from “buy-and-hold” to

“aggregate-manage-distribute.”

As of the third quarter of 2020, each mortgage insurance company had a surplus above its requirement, based

on OIG calculations of information reported in their 10-Qs, as follows: Arch Mortgage Insurance Company,

158%; Radian Guaranty Inc., 129%; Mortgage Guaranty Insurance Corporation, 138%; Essent Guaranty, Inc.,

156%; Genworth Mortgage Insurance Corporation, 132%; and National Mortgage Insurance Corporation,

167%.

OIG • WPR-2021-001 • March 8, 2021 8

By engaging in risk transfers and utilizing reinsurance, mortgage insurers can reduce their

PMIERs-required asset requirements. An internal Enterprise document credits the mortgage

insurance industry’s strong asset surpluses in large part to reinsurance utilization.

Risk-Based Pricing

By 2019, the entire mortgage insurance sector had shifted to use of dynamic, risk-based

pricing engines incorporating a multitude of variables specific to each loan. Risk-based

pricing engines enable mortgage insurers to respond quickly to changing market conditions.

According to a mortgage insurance CEO, approximately 75% of new insurance written is now

through pricing engines, with the expectation that the proportion will increase to nearly 100%.

The change to risk-based pricing has allowed mortgage insurers to tailor pricing in a granular

manner. An FHFA official explained that it provided mortgage insurers with the ability to

manage and reduce risk in a way that was not previously possible. A Freddie Mac official

agreed that risk-based pricing allowed better management of risk exposures, underscoring its

efficiency.

Pilots to Address Industry Concentration

According to FHFA, the limited number of mortgage insurers results in concentration risk.

During the past three years, each Enterprise launched a relatively small pilot program under

which, simultaneous with purchasing single-family mortgages, the Enterprises effectively

purchase mortgage insurance from a panel including preapproved reinsurance companies.

Freddie Mac adopted its pilot program, called IMAGIN, in an effort to reduce concentration

risk from mortgage insurers. Fannie Mae told us that it is not overly concerned about

concentration right now, but the Enterprise also is testing its pilot program, Enterprise Paid

Mortgage Insurance. An FHFA official indicated that other Enterprise tools including credit-

risk transfers also lower concentration risk.

CHALLENGES ............................................................................

Pandemic and Economic Environment

While FHFA and the Enterprises have taken steps to reduce mortgage insurer counterparty

risk, the pandemic and economic environment present challenges.

For additional information, see OIG, Freddie Mac’s IMAGIN Pilot (Sept. 12, 2018) (WPR-2018-005) (online

at www.fhfaoig.gov/sites/default/files/WPR-2018-005.pdf

). Since that white paper, Freddie Mac has entered

into IMAGIN transactions in which a mortgage insurer directly insures the risk without reinsurance.

OIG • WPR-2021-001 • March 8, 2021 9

Under the Coronavirus Aid, Relief, and Economic Security Act, the Enterprises provided

forbearance options for borrowers affected by the pandemic.

Borrowers were eligible for up

to one year of forbearance and then have various repayment, loan modification, or deferral

options.

On February 25, 2021, FHFA announced that borrowers with Enterprise mortgages

meeting certain conditions would be eligible for up to a total of 18 months of pandemic-

related forbearance. According to data from mortgage software and analytics firm Black

Knight, the number of Enterprise mortgages in forbearance peaked around mid-2020. Even

with the subsequent decline, FHFA reported that more than 900,000 Enterprise mortgages

remained in forbearance as of October 2020, representing more than 3% of Enterprise

mortgages.

FHFA officials told us that it was too early to know the outcome for mortgages in

forbearance. Moody’s Investors Service reported in November 2020 that the impact of the

pandemic-related downturn on the mortgage insurance sector would take at least a year to

play out, with the caveat that insurers entered the downturn from a relatively strong position.

Use of Risk Mitigation Tools in Response to Pandemic and Economic Environment

In response to pandemic-related stresses, the Enterprises and mortgage insurers took a number

of steps to mitigate risk. Officials at both Enterprises told us that the mortgage insurers took

action to proactively raise capital. According to the mortgage insurance trade association, the

industry has secured more than $2.2 billion in new capital during the pandemic through equity

and debt offerings.

PMIERs also required mortgage insurers to have capital plans should it

become necessary to access new sources. At FHFA’s direction, the Enterprises took steps to

prevent mortgage insurance companies from extracting capital through dividends or asset

transfers without Enterprise approval until June 30, 2021, thereby locking down capital within

the mortgage insurance counterparty. According to a Fannie Mae document, mortgage

insurer asset surpluses were enhanced by freezing dividends to the parent companies at the

For more information about pandemic-related forbearance for Enterprise mortgages, see OIG, Oversight by

Fannie Mae and Freddie Mac of Compliance with Forbearance Requirements Under the CARES Act and

Implementing Guidance by Mortgage Servicers (July 27, 2020) (OIG-2020-004) (online at

www.fhfaoig.gov/sites/default/files/OIG-2020-004.pdf

) and OIG, Impact of Pandemic-Related Forbearance

and Foreclosure Relief for Single-Family Mortgages on the Enterprises’ Implementation of CECL (Sept. 3,

2020) (WPR-2020-007) (online at

www.fhfaoig.gov/sites/default/files/WPR-2020-007.pdf).

The Enterprises use forbearance for major natural disasters. In that event, the amount of capital that

mortgage insurers are required to hold for the non-performing loans is reduced, because loans in forbearance

due to disasters are considered more likely to return to on-time payments than other delinquent loans. The

same treatment was used by the Enterprises for pandemic-related forbearance. Fitch Ratings has noted that the

current situation is unprecedented, and the historical tendency for the cure rate of loans in forbearance to be

better than average may not hold. In November 2020, however, mortgage insurer Essent called the cure

pattern of COVID defaults encouraging.

Most of the new capital was retained at the parent company but available for contribution to the mortgage

insurer if needed.

OIG • WPR-2021-001 • March 8, 2021 10

pandemic onset. Fannie Mae and Freddie Mac conducted stress testing and found that, even

with anticipated stress losses, the mortgage insurers have sufficient capital to weather the

crisis.

According to FHFA, mortgage insurers were able to utilize their risk-based pricing engines

to respond quickly to pandemic-related risk and uncertainty. During the early stage of the

pandemic, all six active mortgage insurers increased pricing, with some firms now lowering

those increases.

In March 2020, the pandemic disrupted the reinsurance and credit-risk transfer markets,

raising questions about whether the mortgage insurers would be able to continue executing

such transactions. Subsequently, the market thawed and all six private mortgage insurers

have come back to the market for additional transactions.

Volume

Typically, mortgage production falls in a stress environment. Despite the pandemic

environment, however, the six private mortgage insurers wrote $558 billion of primary

coverage on loans sold to the Enterprises in 2020, an increase of 65% from 2019 and a record

volume, according to Inside Mortgage Finance. Fannie Mae explained to us that much of this

increase was attributed to refinancings.

RISK IMPLICATIONS ..................................................................

Over the past three years, the mortgage insurance industry and economic environment have

changed in ways that both theoretically increase and decrease counterparty risk to the

Enterprises. FHFA cautioned, however, that it could not say whether the counterparty risk

that mortgage insurers pose to the Enterprises increased or decreased overall. Risk exposure

is viewed as tied to volume, and when volume increases, risk theoretically increases. As

FHFA and the Enterprises caution, risk exposure must be considered against the quality of the

mortgages purchased by the Enterprises and, in their view, the current books of mortgages

carry less risk.

According to FHFA officials, various policy initiatives have decreased the probability of

failure by a mortgage insurer counterparty. These officials identified updated PMIERs capital

requirements as well as transfer of risks by mortgage insurers onto investors. Both

Enterprises concurred with those observations.

OIG • WPR-2021-001 • March 8, 2021 11

CONCLUSION ............................................................................

According to FHFA and the Enterprises, mortgage insurers represent a significant

counterparty exposure to the Enterprises. Over the past three years, the mortgage insurance

industry and economic environment have changed in ways that both theoretically increase and

decrease their counterparty risk. FHFA cautioned, however, that it could not say whether the

counterparty risk that mortgage insurers pose to the Enterprises increased or decreased

overall.

OIG • WPR-2021-001 • March 8, 2021 12

OBJECTIVE, SCOPE, AND METHODOLOGY .................................

The objective of this white paper was to provide updated information on the mortgage

insurance industry and to provide FHFA and Enterprise views of how developments over the

past three years have affected risks to the Enterprises. To achieve this objective, we reviewed

FHFA and Enterprise documents as well as publicly available documents. We also

interviewed FHFA and Enterprise officials.

We provided FHFA with the opportunity to respond to a draft of this white paper. We

appreciate the cooperation of FHFA staff, as well as the assistance of all those who

contributed to the preparation of this white paper.

OIG • WPR-2021-001 • March 8, 2021 13

ADDITIONAL INFORMATION AND COPIES .................................

For additional copies of this report:

• Call: 202-730-0880

• Fax: 202-318-0239

• Visit: www.fhfaoig.gov

To report potential fraud, waste, abuse, mismanagement, or any other kind of criminal or

noncriminal misconduct relative to FHFA’s programs or operations:

• Call: 1-800-793-7724

• Fax: 202-318-0358

• Visit: www.fhfaoig.gov/ReportFraud

• Write:

FHFA Office of Inspector General

Attn: Office of Investigations – Hotline

400 Seventh Street SW

Washington, DC 20219