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Mortgage Insight From the Trenches


In the past eight months, Fannie and Freddie bought, and Radian and MGIC insured, some of the worst loans ever originated.

Editors Note: This article was written by Andrew Jeffery of the Minyanville Editorial Staff. Andrew worked in the mortgage finance business during the boom and bust of the past five years.

I had dinner with some old colleagues last night who are still alive and kicking in the mortgage business, and as expected there was not a lot of good news to report. Television doesn't do justice to how brutal it is out there, and the precipitous drop in housing related stocks may just be a harbinger of activity for clerks in the Delaware Bankruptcy courts.

Here is a bit of insight into the implications of the structural shifts of the last eight months and who may be left without a chair the next time the music stops.

When news broke in March that there was a chink in the armor of the mortgage-repackaging machine, investors in whole loans quickly scaled back their appetite for Alt-A and Subprime product to brace for the coming storm. Many originators had already shuttered their doors (Ownit, Acoustic, MLN, etc) and the survivors quickly rotated to Agency-eligible loans to sell to Fannie Mae (FNM) and Freddie Mac (FRE).

Demand for high loan to value (LTV) loans in bubble areas like California, Florida, Las Vegas and Phoenix was still strong, but the market for the second liens that enabled cash-strapped borrowers to buy or refinance was quickly evaporating. Originators turned to companies like Radian Group (RDN) and MCIG Investment (MTG) for mortgage insurance to keep the production gates (and front doors) open. The second lien and home equity loan had seriously crimped the mortgage insurance business for years, so these companies jumped at the renewed demand for their product.

Maybe they should have looked before they leaped.

Mortgage Insurance allows borrowers to borrow more than 80% of the value of the house and originators to dress up Alt-A and Subprime loans to look Conventional. These products have always been available, but have recently been exploited by originators stopped out of other markets. Since automated underwriting engines perform most decisioning on loan eligibility for Fannie and Freddie, originators tweak loans to get the engines to approve loans that maybe should not be approved. Furthermore, since insurance protects the investor, an originator's incentive to prudently underwrite goes completely out the window. With many of these shops on their last legs and struggling to make payroll each month, any deal they could sell became a deal good enough to close.

In short, in the past eight months, Fannie and Freddie bought, and Radian and MGIC insured, some of the worst loans ever originated. A statement like that on the back of the toxic 2006 vintage should be cause for pause. While mortgage industry woes are beyond well documented, there is no reason these insurers of whole loans are in any less a precarious state than bond insurers like Ambac (ABK) and MBIA (MBI) as home prices continue to drop and delinquencies continue to soar.

One needs look no further than Wells Fargo's (WFC) recent announcement of losses on Prime Home Equity loans as evidence of more pain to come. If Mortgage Insurance replaced the second lien, and there is currently no bid for second liens – who will miss the last seat this time around?
Position in MTG

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