Bankruptcy

The GSEs, PMIs, and the Banks

By Adam Levitin

Yves Smith at Naked Capitalism has a fascinating post about the GSEs and private mortgage insurance. The short of it is that the GSEs don't seem to be making claims on PMI policies despite being the loss payees. The reason why is that if the GSEs made claims on the PMIs, it would quickly render all of the PMIs not just insolvent, but illiquid (which is the real kiss of death). And if the PMIs went under, then the GSEs would have to take huge write-downs on all of the still performing loans with PMI insurance. Chris Whalen estiamtes that in order to avoid perhaps $100B plus in write-downs, the GSEs are forgoing several billion in PMI claims. If this is the case, it shows what a farce GSE regulation by FHFA is.

There's a further twist, however, that Yves post didn't capture. A lot of PMI is reinsured. And guess who does about half of PMI reinsurance? The captive reinsurance affiliates of the large banks.

While most large banks have reinsurance capitves, the captives of the big 4 banks get about 1/3 of all PMI reinsurance premiums, which probably translates to something like 1/3 of the exposure.  Just to list the biggest, that's Balboa Reinsurance (Countrywide/BoA); Bank of America Reinsurance (BoA); Cross Country Insurance (Chase); North Star Mortgage Guaranty Reinsurance (Wells Fargo). I haven't figured out the extent of this exposure, as not all PMI is reinsured, and not all reinsurance is first-loss position, but there is definitely some bank group skin on the line with PMI. 

What this all means is that if the GSEs are forbearing in making claims on their PMI policies, it not only hides the GSEs' losses.  It also means we're seeing another quiet bailout of the banks.

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In case you're interested in why banks' reinsurance captives are reinsuring PMI, it's a kickback game. The lender, not the homeowner picks the PMI carrier because they all charge the same rates and the homeowner is indifferent. The lender selects the PMI carrier based on the amount of business the PMI firm will cede to the lender's captive reinsurance subsidiary. And therein lies a regulatory capital game, as captive reinsurers aren't required to hold much regulatory capital at all, as there is jurisdictional competition for charters.  The biggest US chartering jurisdiction for captive insurance companies in Vermont (!) and looking at Vermont's captive insurance law, I don't see any regulatory capital requirements beyond a de minimis initial capitalization that isn't enough to buy a house in parts of DC.  

Full post as published by Credit Slips on March 23, 2011 (boomark / email).