A large FHA premium cut could tilt market away from private insurers

If Federal Housing Administration premiums are cut in excess of 25 basis points, private mortgage insurers could lose some of their market share, Keefe, Bruyette & Woods said.

The Biden administration has not announced any cuts, but the Obama Administration in its final days rolled out a 25 basis point reduction in the FHA premium, which was quickly tabled by President Trump when he took office.

At that time, some analysts felt the cut could make the FHA product more attractive to eligible borrowers, taking business from private insurers. On the other hand, mortgage lenders welcomed the cut as a stimulus for their own business.

Now there is talk that President Biden could put that cut back on the table, said Bose George, an analyst at KBW. For some investors, the fear of that, combined with a possible first-time home buyer tax credit, helped to drive down stock prices for the four standalone mortgage insurers on Jan. 21 and 22 and in early trading on Jan 25.

Starting with federal fiscal year 2010, FHA garnered a larger market share than the private MIs, who were suffering in the early part of the decade due to the large numbers of defaults that put three companies out of business. But that gap has been narrowing and in FY 2019, the split between PMI and FHA was almost even.

"We had assumed the FHA would wait until there is some slowdown in housing before initiating a cut. The FHA capital level at the end of fiscal year 2020 was 6.1%, well ahead of the 2% minimum capital requirement," George wrote in a report. "So, from a capital standpoint, the FHA appears well positioned to cut."

But, the FHA's capital levels are very sensitive to home price appreciation because they take into account the present value of future earnings. Thus keeping a cushion to the minimum capital level would be prudent, George added.

Also, things have changed for the private MIs since the start of 2017. All six firms price most of their business through their respective "black boxes," rather than using a rate card (although for those customers that desire it, the rate cards still exist).

So, the impact of an FHA premium cut is harder to ascertain at first glance. But George drew a comparison with MGIC's rate card.

Insurance for the higher credit quality loans was cheaper with MGIC than the FHA, he found. There is a small competitive overlap area, which is between a 700 and 720 FICO score.

But if the Biden administration goes with a larger cut, to 50 bps, the private companies' market share will take more of a hit. "The mix of new insurance written at the MIs suggests that a 50 bp rate cut would impact another roughly 10-15% of the MI market (versus a 25 bp cut)," George forecasted.

While the Biden Administration is said to be pushing for a $15,000 tax credit for first-time home buyers, no details have been disclosed. But George pointed to reports on CNBC that indicated the credit could be offered up-front as a form of down payment assistance.

Any tax credit would likely be temporary and not have any longer-term effect on the mortgage insurance business, George said.

"Further, $15,000 would equate to roughly [a] 5% loan-to-value (given an average MI loan size of around $275,000). This suggests that the main impact would be on the 80-85% LTV bucket, which is a relatively small part of production," he continued.