House Financial Services Subcommittee on Housing and Insurance Hearing
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Introduction
Chairman Neugebauer, Ranking Member Capuano and members of the Subcommittee, I am
Let me briefly introduce myself and Essent.
I was born in
Essent was formed in 2008, founded by private investors with a fundamental belief that private capital would be needed to support a well-functioning U.S. housing finance system in the wake of the financial and mortgage crisis. In Essent's early days, with no end in sight to the crisis, many questioned the wisdom of starting a new private MI company. Essent continued to believe that a private mortgage insurer with the financial strength to pay claims backed by a strong contract that treats policyholders with fairness and transparency would be a valued partner to lenders, mortgage investors and taxpayers (through their ownership and backstop of the GSEs).
Essent not only initiated a new wave of private capital into the MI industry, but also contributed to the renewal of the MI product by addressing market concerns related to representation and warranties in the mortgage transaction. Our introduction of Clarity of Coverage[TM], a binding endorsement to the company's insurance contract, commits us to the highest standards of transparent, reliable and fair practices in MI protection, and gives insured lenders and policy beneficiaries a renewed confidence that their claims will be evaluated fairly and valid claims will be timely paid. The clarity we've brought to the MI contract has been complemented by clarification of representation and warranty obligations by the GSEs and in recent contract changes by other MI companies. Clarity of Coverage shows how private sector competition can lead a broad response to market needs.
Essent's business approach has been validated by the market. Since writing our first policy in the second quarter of 2010, we have insured
We recognize the contributions of FHA to getting the nation through the recent crisis, given the contraction of private credit that occurred in the wake of the crisis, and support a future role for FHA that returns to a more focused mission of providing access to homeownership to creditworthy borrowers that cannot be adequately served in the conventional market with private MI. Accordingly, this requires private capital to play a larger role to ensure that creditworthy borrowers continue to be well served in the U.S. mortgage market, and private capital has firmly demonstrated its willingness to invest in the U.S. MI industry. The demonstrated ability to attract capital allows firms such as ours to support the U.S. mortgage market with increasing capacity to write more, deeper and broader MI coverage.
Reform of the housing finance system, including FHA, should move forward, guided by shared objectives which should include reducing taxpayer credit risk and expanding the role of private capital, while preserving access to homeownership for creditworthy borrowers. This can best be achieved, in our view, by (i) addressing the solvency of FHA within a mission-focused footprint (ii) leveling the playing field between private MI and FHA, including encouraging regulators to establish rules such as QM (for FHA), QRM and Basel III that do not distort the market in favor of FHA (and the associated taxpayer risk) and (iii) implementing other reforms that encourage the expanded use of private capital, including MI, without adverse impacts on credit availability and liquidity in the mortgage market. For example, credit risk-sharing by both the GSEs and the FHA with private MI can play a significant role toward accomplishing these objectives efficiently and reliably.
The Role of the U.S. MI Industry
The role of private MI is important because the potential for severe credit losses is inherent in the mortgage market at all times. Protecting policyholders by absorbing insured losses, especially when economic conditions are bad, is our fundamental role. Over the past four years, private MIs have paid approximately
In the crisis, the role of the industry contracted, bottoming around 2010 when new MI written fell to 4-5% of the total mortgage originations market. Since that time, new insurance volumes have grown, rising to
Our industry has shown resilience, importantly demonstrating the ability to attract capital, both through new entrants and recapitalization of incumbent companies. Companies in the MI industry raised over
MI coverage significantly reduces the credit risk to taxpayers on loans securitized through the GSE TBA market. For example, on the typical 5% down payment loan (i.e., a 95% LTV), first-loss MI coverage insures 30% of the loan balance, transforming the risk exposure for taxpayers to an effective LTV of approximately 67%. There is a tremendous difference in loss exposure between a mortgage that defaults at 95% LTV without MI, versus the same loan with MI. That risk reduction comes from the private capital of the MI company standing in front of the U.S. taxpayer.
One of the powerful features of private MI is its effective integration in the routine functioning of the mortgage market, including TBA-securitization. Lenders of all sizes and types can access private MI and secure the coverage at loan origination, reducing the credit risk on the loans before taxpayers backstop the risk. MI also works effectively with lenders and GSEs in the servicing of mortgage loans, including significant delegation of authority to servicers and GSEs to undertake modifications to keep families in homes or to benefit from foreclosure alternatives, such as short sales.
Expanded Role of Private MI In Housing Finance Reform
As
Many discussions of reducing the role of government rest on the premise that the choice is one of no taxpayer credit risk or all taxpayer credit risk. Framed in this context, reform discussions have paid great attention to the return of the fully private securitization market without an explicit or implicit government backstop. These markets are, in fact, slowly re-emerging after being moribund since closing for newly originated loans late in 2007. The return of a purely private securitization market should enjoy bipartisan support because, at a minimum, these markets will be needed to play an important role in serving jumbo borrowers.
However, a robust return of private capital and reduction of taxpayer risk need not wait for the return to vitality of purely private securitization markets. In those sectors where government provides a backstop, the expanded use of private MI and similarly well-capitalized and regulated private credit enhancements provide a powerful tool to significantly reduce taxpayer risk.
Use of private MI and other private credit enhancements to place private capital ahead of taxpayer risk is being implemented on an expanded basis by FHFA in the conservatorship of the GSEs. The 2013 FHFA Scorecard for the GSEs established a goal of transferring credit risk to private markets on
In addition, expanding the role of MI can be done gradually through a known process that works. Reforms that require sudden, "big bang" change to the roles of FHA and the GSEs are risky for borrowers and mortgage market participants alike and present
In sum, the expanded risk-sharing initiatives at the GSEs represent the most direct and efficient path to increasing private capital and reducing taxpayer risk in the housing finance system. The lessons learned from expanded credit risk-sharing by the GSEs should provide very useful insights to this Subcommittee as it considers ways to reduce government's credit risk-bearing role at both FHA and the GSEs. We encourage
Addressing FHA Solvency
Addressing the solvency of FHA is an important element of FHA reform. The FY2012 actuarial report analyzed the economic value of the
First, the actual economic contribution of new business is unknown, subject to future economic conditions that may not prove to be benign. Inherent in writing mortgage insurance is the possibility that significant economic stress will occur resulting in large losses. This concern is validated directly within the FY2012 actuarial review, which provided the economic value of the
Second, when new business outside of the mission of FHA contributes immediately to the solvency of the
The issue of FHA solvency has been a focus of
. Enacting provisions similar to those adopted by the House last
. Additional authorities HUD has requested to address solvency; and,
. Prudential changes to seller concessions, a policy change HUD has proposed but not implemented.
The Future of FHA and Private MI: A Partnership to Serve the Market
The current structure of the mortgage market often pits private MI and FHA against each other as competitors. The structure results in borrowers who could become home owners by qualifying for private MI to end up in FHA. The FY2012 Actuarial Review reported that over 95% of 2012 FHA loans had LTV's below 97% and 57.5% of all loans had credit scores of 680 or higher. n4 Essent's credit guidelines, and MI industry guidelines generally, extend to LTVs of 97% and credit scores of 680 and above. This data suggests that a meaningful portion of FHA borrowers may qualify for private MI, a conclusion supported by an observed shift in market share for insured loans toward private MI since FHA implemented additional premium increases in April of 2012. In the first quarter of 2012, prior to the FHA premium increases, the private MI share of the insured market was approximately 26%, and rose during the remainder of 2012 to 34.5% in the fourth quarter. n5
These recent shifts in the market represent progress in returning to a more normal balance of public and private. To sustain the progress, it is important to do more to create a level playing field for private MI. At prior hearings, factors which advantage FHA over private MI were the subject of detailed testimony, including that FHA offers credit terms to all borrowers beyond those allowable in conventional markets (e.g., 6% seller concessions) and that FHA enjoys access to full faith and credit securitization of
As opposed to competition between FHA and private MI, a better approach is greater partnership between private MI and FHA. In a partnership model, the two types of insurance, private and public, would work together to ensure coverage of the market built on the principle that private should be preferred to public when private can serve borrowers well. In such an approach, the future role of FHA would more naturally expand or contract based on the robustness of the risk tolerance and capacity of private mortgage insurance providers.
The ultimate goal should be a well-functioning market that dynamically adjusts so private risk bearing is as large as possible and public risk bearing is as small as possible, without gaps in the credit access of mortgage-ready borrowers. FHA Commissioner Galante in her testimony to the
FHA Risk-Sharing with Private MI
If the partnership approach is one
1) Reinsurance - One approach to risk-sharing would be direct risk-sharing between FHA and private MI, analogous to how the GSEs are moving forward in their expanded risk-sharing initiative. This approach has the benefit of minimizing impacts on primary market participants and has the potential to be implemented more quickly.
2) Coinsurance - A second approach to risk-sharing would combine MI and FHA risk-sharing with the objective of deploying the risk management capabilities of MI companies in loan underwriting and claims management. This is analogous to how private MIs work today with the GSEs for new loans with LTVs above 80% that require MI, where borrowers must meet underwriting and eligibility criteria acceptable to both the GSEs and private MI.
The necessary details of the risk-sharing approaches above should be developed and tested through risk-sharing pilots. Much could be learned from pursuit of such pilots, including: (1) which FHA loans are, in fact, privately insurable risks, (2) more robust identification of the reasons FHA loans are not eligible for private coverage, (3) differences between FHA practices from those acceptable in the private market, (4) private versus FHA pricing for risk, and (5) any unintended adverse impacts on borrowers or lenders. This learning could inform more permanent reforms, in conjunction with an assessment of the risk-reducing benefits for taxpayers, appropriately evaluated under the assumption of stressful economic conditions including a material decline in home prices.
To move forward in this direction requires
Conclusion
Private investors have demonstrated their interest in investing capital to support the U.S. mortgage market through the private MI industry, enabling the industry to continue to serve low down payment borrowers to achieve homeownership and play a broader risk-bearing role. Accordingly, we support a continued future role for FHA which transitions to a more focused mission of providing access to homeownership to creditworthy borrowers who cannot be adequately served in the conventional market with private MI. In addition, the expanded use of MI by the GSEs in the risk-sharing initiatives announced by FHFA shows that the industry can play an even broader role in bearing credit risk and reducing taxpayer exposure to credit risk.
Reform of the housing finance system should be implemented, including reform of FHA. Changes should be implemented gradually so as not to disrupt a large and vital market. We should find common cause in sound objectives for reform - to reduce taxpayer credit risk, and expand the role of private capital but preserve access to homeownership for creditworthy borrowers. In this regard, we urge the
. Changes aimed at addressing the solvency of FHA within a mission-focused footprint;
. Creating a level playing field between private MI and FHA so that risk does not go needlessly to taxpayers when credit risks are privately insurable. This includes encouraging regulators to establish rules such as QM (for FHA), QRM and Basel III that do not distort the market in favor of taxpayer-backed risk;
. Expanding use of private MI to gradually broaden the role of private capital without adverse impacts on liquidity in the mortgage market. In this context, we specifically encourage consideration of working toward a new, partnership approach between private MI and FHA that moves the market toward that largest role possible for private risk bearing without loss of mortgage access by creditworthy borrowers.
. Testing the potential to expand the role of private capital through risk-sharing pilots by FHA using private MI for privately insurable risk.
n1 Inside Mortgage Finance (
n2
n3 Ibid (forward loans only).
n4 Actuarial Review of the Federal Housing Administration Mutual Mortgage Insurance Fund Forward Loans for Fiscal Year 2012,
n5 "Primary Mortgage Insurance Activity" Inside Mortgage Finance (
Read this original document at: http://financialservices.house.gov/UploadedFiles/HHRG-113-BA04-WState-AMarzol-20130410.pdf
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