“Brace yourself. Winter is coming”
Fans of HBO’s Game of Thrones are no doubt familiar with this statement that seems to also echo the experience of living in Wisconsin, the birthplace of MGIC and the modern private mortgage insurance (MI) industry. I would like to propose a slight modification to this expression that is highly relevant to the mortgage lending community:
Brace yourself. Losses are coming.
Since I’m not able to predict the future, I can’t tell you when these losses are coming, but there’s no real dispute that at some point, loan losses are going to increase. We’re currently experiencing a strong economy, record low unemployment, and the mortgages originated from 2009 forward are of the highest quality in a generation. For those lenders who hold mortgages in portfolios, things have been really good.
As lenders develop the capability to deal with the new CECL (Current Expected Credit Loss) standard, it’s easy to feel like you’re prepared for losses. After all, you have great analytics in place, and you even have reserves set aside against your expected losses. There’s no need to worry. There’s nothing to get stressed about.
Except, there is something to worry about.
There are two things about losses we don’t know: when they are going to happen, and how much they’re going to be. Do you know precisely when the next wave of losses is going to hit, and how severe those losses are going to be? Even if you do know, unless your organization is perfectly aligned with your belief, your ability to prevent the inevitable will be limited.
Now, if you’ve read our blog about CECL, you’ll know that a sound MI strategy can help protect you against the hit of CECL. Not surprisingly, if you’re protected against CECL, you’re protected against those exact “current expected” credit losses that you’ve predicted.
But what if that isn’t enough?
Consider a relatively stable market:
In a scenario with a 25% decrease in the value of the home, losses on a mortgage with 25% MI coverage are less than a third of the losses on an uninsured mortgage.
By increasing the MI coverage percentage slightly, from 25% to 30%, you can cut losses by an additional 50%.
When you start to factor in all the components that go into the claim calculation, such as delinquent interest, property maintenance costs, default servicing expenses, and REO disposition costs, the value of MI is clear.
Even in a relatively mild scenario, MI is delivering real value.
But that’s just one loan. What happens if we look at an entire portfolio, and hit it with a significant decline in home prices?
In this case, deciding to forego MI results in a loss of 8.5%. Move to 25% MI coverage and your loss drops to 4.5%, while going all the way to 45% MI coverage results in a loss of only 1.4%. That 45% coverage has taken a 14% default rate and 40% home price decline and effectively reduced your loss severity by 90%. That’s powerful. That’s the value of MI.
Ultimately, you’ll have to arrive at your own conclusions as to what the next downturn will look like from a mortgage default perspective. If you’ve implemented a sound MI strategy, you’ll likely have significant protection in place, which will help minimize the negative impact to your institution.
Unfortunately, many portfolio lenders haven’t done this. Our internal research indicates that MI penetration rates in portfolio lending are low. Most loans sitting on balance sheets are not insured. We believe this puts portfolio lenders at unnecessary risk.
If you have a mortgage portfolio, ask yourself the following questions:
- Do I know when the next downturn is?
- Do I know what my loss severity will be?
- Am I using MI?
- Have I purchased the right amount of coverage?
These are questions we can’t answer for you, but what we can do is provide you with the mortgage insurance you need to protect against the losses you’ll experience in the next downturn.
The first step is to make sure you’re insuring your current loan production, and that you’re purchasing the right amount of coverage. The next step is to work with MGIC to insure any uninsured loans that are currently in your portfolio. Your MGIC Account Manager can help make sure you’re on the right track.
While it’s tempting to put off thinking about this until a later date, it’s important to remember that the best time to buy insurance is when you don’t need it. Waiting until defaults are imminent may be too late. By acting now, you maximize the insurability of your portfolio and ensure you’ll be protected against a sudden increase in defaults.
Brace yourself. Losses are coming.
This is part of a new blog series from MGIC Connects that highlights the value proposition of mortgage insurance. Check out Reduce the Impact of CECL with Mortgage Insurance for more insights.Tags: CECL, Economy, Mortgage Insurance