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Mortgage Insurers Start Passing the Hat
Asset Backed Alert, Harrison Scott Publications Inc. (February 8, 2008)

Hoping to stave off downgrades, the three largest private mortgage insurers are in talks with private equity firms that might bolster their capital reserves.

What's known so far is that Mortgage Guaranty Insurance, PMI Group and Radian have held such discussions in the past week or so, and that the firms they have met with include J.C. Flowers & Co., Lightyear Capital and Stone Point Capital.

The mortgage insurers' rating outlook has already been unsteady for a while. About a week ago, Moody's added to the uncertainty by placing the "Aa2" grades of MGIC and PMI and the "Aa3" mark for Radian on review for possible downgrades.

At issue, again, are failing residential mortgages. Private mortgage insurers write policies for home buyers who can't come up with the 20% down payments typically required by lenders, agreeing to cover portions of the debts in the event of default.

That leaves the companies especially exposed to subprime borrowers, who frequently have little or no equity in their homes - and who have been missing payments with increasing frequency. Defaults among insured mortgages rose 37% in December from a year earlier, to more than 64,000, according to trade group Mortgage Insurance Cos. of America.

By fattening reserves, the insurers would boost their abilities to pay claims related to those defaults, and thus seek to avoid the threatened downgrades. MGIC, for example, recently said it expects to book $1.8 billion to $2 billion of losses this year due to a rise in claims, up from the $1.2 billion to $1.5 billion it was projecting a few months ago.

The Milwaukee company, which ranks as the most active player in its business with $212 billion of outstanding policies, incurred $1.3 billion of such losses during the fourth quarter of 2007. It also stopped writing policies on securitized mortgages.

But the company's guarantees, and those of its peers, still have broad implications for loans that remain in securitization pools. In the event of an insurer downgrade, the credits would be viewed less favorably by bond investors. And if mortgage insurers are unable to cover their obligations, that could set off a domino effect that would worsen losses among defaulted loans, and thus bonds backed by those assets. That, in turn, would increase losses for bondholders that have already taken tremendous writedowns as the performance and values of such investments have deteriorated in recent months (see table on Page 9).

The threats are in many ways reminiscent of what has been happening in the bond-insurance business - another area that has been hit hard by mortgage defaults. As loan performance has tanked, the prospect that bond insurers will get buried in claims on bonds and credit derivatives tied to those cashflows has caused many to question their claims-paying ability, and thus their ratings. All of the major bond insurers are now on watch for downgrades as they seek to boost reserves, and some action has already been taken against ACA Financial, Ambac, FGIC and XL Capital.

There are some key differences between the perils of bond insurers and those of mortgage insurers, however. For starters, the mortgage insurers are seen as having a longer timeframe in which they can raise money before facing downgrades. "We tried to help [the bond insurers] in several instances. We talked with the companies, but in most cases it was just too late to give them what they needed," said one source at a private equity firm.

Buyout shops, banks and others that have been talking to the bond insurers have also been faced with the time-consuming and often uncertain task of unraveling those companies' exposures to troubled assets, which were often assumed through several layers of complex transactions.

Mortgage insurers operate in a comparatively simple business, typically covering just home-loan payments and writing title policies. "There is a feeling that we still have time to help the mortgage insurers out," another private equity player said.

That said, bond insurer bailouts have been progressing. Warburg Pincus, for instance, agreed in December to supply MBIA with $1 billion of backing. It will take down any unsold portion of a $750 million stock offering that MBIA announced this week as part of an expansion of that agreement.

A bank group led by Calyon is also in talks to prop up FGIC, of which PMI is a part owner.

Unlike mortgage insurers, bond insurers typically rely on triple-A ratings to survive, since demand for lower-rated guarantees is virtually non-existent. Bond insurance policies also have a greater and more direct influence on the grades of securities than mortgage insurance.



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