Charter creep concerns resurface in Freddie's new risk-sharing pilot

Freddie Mac and Arch Capital are testing a new form of risk-sharing deal to boost investor appetite for low down payment mortgages. But the pilot is raising concerns about "charter creep" because it dictates private mortgage insurance decisions typically made by lenders.

With IMAGIN — short for Integrated Mortgage Insurance — lenders will sell low down payment mortgages to Freddie Mac. At the time the government-sponsored enterprise purchases the loan, private mortgage insurance will be attached using a panel of insurers and reinsurers managed by a newly created subsidiary of Arch Capital, named Arch MRT (short for Mortgage Risk Transfer).

"IMAGIN is an alternative structure for lenders to obtain charter-compliant credit enhancement solutions and to bring additional sources of private capital to support low down payment lending," Freddie Mac spokesman Chad Wandler said in an emailed statement.

"This arrangement encourages additional participants and capital to support first-loss exposure in mortgages," Arch Capital said in a March 13 press release. "The high quality panel of (re)insurers will competitively bid, through a transparent process, to provide, over the long term, lower cost mortgage insurance for borrowers."

The GSE maintains the pilot doesn't exceed the boundaries of its federal charter.

"We believe IMAGIN will provide numerous benefits — to borrowers, lenders and the U.S. taxpayer. However, it's important to note that the traditional MI structure remains an important tool for Freddie Mac and the industry to provide access to credit for qualified borrowers with low down payments," Wandler said.

But others are not so sure.

IMAGIN "totally violates the spirit of the charter. There is not any public information about what the capital requirements are going to be and what the standards are," Lindsey Johnson, president and executive director of USMI, said in an interview. The trade group represents all of the industry's private mortgage insurers, except Arch.

Those five PMI firms have all seen their stock prices drop by 7% to 14.5% since March 12, when analysts first caught wind of the Freddie pilot. Arch's stock is also down about 3%, but that is due to the closing of a second stock offering related to Arch's acquisition of United Guaranty from AIG.

The USMI members and their shareholders are concerned the pilot gives preferential treatment to reinsurers by not holding them to the same Private Mortgage Insurer Eligibility Standards that PMI carriers must follow in order to do business with the GSEs.

"We've had to adhere to capital and operational requirements and there are unknown standards for IMAGIN, even though those reinsurers that are selected by Freddie Mac are taking the exact same risk that we would take and have to hold PMIERs capital against," Johnson said.

Part of the concern may be due to the lack of available details about the pilot. Freddie and Arch's plans to announce the program may have been pre-empted by Freedom Mortgage, which was promoting its role as one of the 12 participating lenders last week.

Freedom Mortgage declined to comment, and Arch and Freddie Mac both declined requests for interviews. Freddie Mac's conservator and regulator, the Federal Housing Finance Agency, also declined to comment.

USMI's Johnson said the lack of information created uncertainty about IMAGIN's impact. "If this had gone through a public and open process we would know and understand a lot more."

IMAGIN has been compared to lender-paid mortgage insurance, which made up 19% of the 2017 industry new insurance written, according to estimates by research firm Compass Point.

Like LPMI, the PMI premium for IMAGIN loans is rolled into the interest rate. That differs from borrower-paid MI, where the premium is a separate charge that's paid upfront or as part of the borrower's monthly payments.

One key difference is the length of coverage. LPMI is typically paid in one upfront premium and the policy remains in effect for the life of the loan. With IMAGIN loans, the coverage sunsets after 10 years, a feature similar to the cancellability of borrower-paid mortgage insurance when the loan reaches a 78% loan-to-value ratio.

But any competitive threat to LPMI is mitigated since many lenders already receive discounted rates for those policies. "The prices offered by Freedom might not end up being meaningfully lower than prices being offered by the MIs," Keefe, Bruyette & Woods analyst Bose George said in a March 12 research note.

The actual impact of the program is not expected to be huge; Compass Point puts the volume at around 3% of new insurance written over the next 12 months.

While Compass Point analyst Isaac Boltansky is not convinced the program crosses the line between primary and secondary markets, he said it comes close.

"While the IMAGIN construct is not a direct foray into the primary mortgage market, it surely blurs the Congressionally-mandated line of demarcation. In this transaction, Freddie Mac selects insurance at the loan level and appears to effectively control both pricing and coverage determinations," Boltansky wrote in a March 13 research note.

In the short term, IMAGIN is not an immediate threat to PMI carriers, Cowen analyst Jaret Seiberg wrote in a March 12 research note. "Yet it does represent a long-term risk if the savings prove greater than expected or if the enterprises see this as a safer way to obtain congressionally required mortgage insurance on loans with less than 20% borrower equity."

But by market share, Radian does the most LPMI and may be most vulnerable competitively.

"In addition to our existing mortgage insurance products, which have responsibly helped millions become homeowners in an affordable and sustainable way, we remain committed to continuing to deliver permanent capital solutions that address the needs of the residential mortgage market — solutions that are reliable through the credit cycles, without additional taxpayer cost or risk, and in compliance with regulatory capital requirements," Radian spokeswoman Emily Riley said in an email.

With only limited information available about the program, mortgage groups remain cautious.

"We absolutely encourage creative approaches and innovative solutions that can lower costs for homeowners while promoting a level playing field for all lenders," Mortgage Bankers Association President and CEO David Stevens said in an email. "We have long advocated for more up-front credit risk transfer programs and when the details of IMAGIN are released, we will be studying them closely to better understand how it would work and to ensure it is consistent with the GSE charters and does not cross the bright line that separates the GSEs' secondary market functions from the primary mortgage market."

The lack of public details about IMAGIN was vexing to Community Home Lenders Association Executive Director Scott Olson.

"CHLA continues to believe that more transparency about these pilots would be helpful, and more broadly believes that the GSEs should be subject to the Freedom of Information Act," he said in an interview.

"That said, based on preliminary information about the pilot, CHLA generally supports efforts like this which appear to provide more insurance options for lower down payment loans, which we assume will involve competitive pricing for smaller independent mortgage bankers," Olson added.

Arch Capital was a mortgage reinsurance provider prior to its acquisition of CMG Mortgage Insurance, now known as Arch Mortgage Insurance, in January 2014. Following its acquisition of United Guaranty in late 2016, Arch became the industry's largest PMI carrier. Its size and past experience with reinsurance likely helped it secure the pilot with Freddie. But the GSEs have been known to open up programs to additional participants following a successful test run.

Both Fannie and Freddie have previously done risk-sharing pilots with PMI carriers, and insurers have been advocating for more participation, especially deeper coverage, which is considered 50% of losses, as opposed to the standard 18% to 37%.