The problems in the private mortgage insurance industry may get worse before they get better, analysts at Fitch Ratings say, with loans insured in 2007 showing "significantly higher levels" of first-year delinquencies than the 2006 and 2005 "vintages."

In their most in-depth report on the mortgage insurance industry this year, Fitch analysts said that even though mortgage insurers instituted tighter underwriting standards in 2007, most of the changes did not completely go into effect until the first quarter of 2008 (see story).

In addition, because of the decline in "piggyback" second loans, a greater proportion of loans insured in 2007 had high initial loan-to-value ratios in which with borrowers put less than 5 percent down — which could magnify claims.

"In Fitch’s view, 2007 will likely prove to be one of the worst underwriting years in the modern history of the U.S. mortgage industry," the report said. "Unfortunately, for a number of key mortgage insurers 2007 was a year of rapid growth, and this vintage will increasingly account for losses in 2008 and 2009 that will stress the mortgage insurers’ balance sheets over the intermediate term."

The expected losses could limit the ability of existing mortgage insurers to grow their portfolios, and open the door for startup companies to meet the needs of Fannie Mae and Freddie Mac, Fitch analysts said.

At the end of the year, the delinquency rate on loans insured in 2007 was a record 3.55 percent. If past trends are any indication, the second-year delinquency rate for those loans could exceed the 9.37 percent delinquency rate on mortgages insured in 2006, which have two years of "seasoning."

The financial implications for insurers are ominous, as the reduced availability of piggyback seconds — employed during the boom to avoid requirements that borrowers putting down less than 20 percent take out private mortgage insurance — helped the industry boosted primary insurance in force by 22.7 percent in 2007, to $959.9 billion.

"Over the course of 2008 and 2009, given the relative performance and size of the 2007 vintage compared to the 2006 and prior vintages, Fitch expects that the mortgage insurance industry will need to continue posting very high loss reserves as the industry’s pipeline of troubled mortgages becomes increasingly made up of 2007 vintage loans and current loss reserves are paid out as claims," the report said.

Although mortgage insurers should be able to pay claims, their ability to insure more loans will depend on their ability to raise capital, Fitch analysts said. The ability of existing private mortgage insurers to raise capital could be complicated if new companies enter the market.

"Fundamental questions now exist concerning the future composition of the industry, particularly the extent to which new capital will be directed into weaker established participants or into new start-up companies which are unburdened by underperforming legacy portfolios," Fitch analysts said.

Fannie Mae and Freddie Mac may play "pivotal" roles in shaping the structure of the industry in years to come, Fitch analysts said. The government-sponsored entities, or GSEs, "will have an incentive to channel more demand for mortgage insurance toward healthy, growing mortgage insurance companies."

If existing mortgage insurers can’t raise the capital they need to insure more loans, Fitch analysts said, "their importance to the GSEs may become somewhat diminished. This would make it more difficult for them to write future profitable business, which is essential to improve their overall risk profiles."

Fannie and Freddie have already stopped using one mortgage insurer, Triad Guaranty Insurance Corp., because it could not raise the capital needed to maintain its ratings (see story). Several other mortgage insurers have been required to submit remediation plans following rating agency downgrades to maintain their "tier one" status with the GSEs (see story).


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