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Freddie Mac pilot shakes up mortgage insurance

Freddie Mac wants to change how borrowers without large down payments pay for mortgage insurance, a move that could pave the way for broader housing finance reform but one that is likely to attract a fight from the private mortgage insurance industry.

Borrowers interested in conventional mortgages — loans that meet Freddie Mac or Fannie Mae requirements — who cannot afford a down payment equal to 20% of the purchase price must pay for private mortgage insurance. Borrowers can obtain coverage from one of several private mortgage insurers such as MGIC Investment Corp. and Essent Group Ltd., or lenders can pay for the insurance and recoup the cost by charging borrowers a higher rate.

On March 12, the stocks of MGIC Investment, Essent, Radian Group Inc. and NMI Holdings Inc. declined as much as 10% or more on news of the pilot amid fears it could be the first step toward eliminating the need for private mortgage insurers. Freddie Mac's pilot program, which pushes mortgage risk out to reinsurers through a partnership with mortgage insurer Arch Capital Group Ltd., could upend the lender-paid model. But it may also trigger broader reform of Fannie Mae and Freddie Mac, massive government-sponsored enterprises, or GSEs, that have been in conservatorship since the financial crisis.

Freddie Mac's pilot will be run through a new subsidiary known as Arch MRT, established by Arch Capital and based in Washington, D.C. Fannie Mae is expected to unveil its own pilot as well, Wells Fargo Securities analysts wrote in a March 15 note.

"Arch's position appears to be attempting to create a 'proof of concept' on a replacement structure for [Fannie Mae and Freddie Mac] themselves in any reform effort," wrote analysts from Compass Point Research & Trading the same day.

Freddie Mac's pilot, known as Integrated Mortgage Insurance, or IMAGIN, launched March 1 and will target roughly $2.5 billion worth of mortgages by unpaid principal balance, according to a person familiar with the program. Under the pilot, lenders send the risk through the new Arch subsidiary, which will then hold an auction process with reinsurers to insure the risk.

In a newsletter for mortgage brokers, Freedom Mortgage Corp. advertised that it was one of roughly a dozen lenders involved in the pilot program. Freedom Mortgage wrote that the pilot program would streamline mortgage insurance for borrowers by having them pay for it upfront through loan-level price adjustments, which are charges based on the borrower's down payment and credit score. Arch Capital released a white paper on the pilot, indicating that the program should ease the process for borrowers, deliver better pricing and reduce risk for Freddie Mac and, by extension, risk for taxpayers.

But U.S. Mortgage Insurers, an industry group that represents private mortgage insurers, does not believe the program will benefit taxpayers. Lindsey Johnson, president and executive director of the industry group, said the pilot program would bypass higher capital and regulatory requirements implemented after the financial crisis. The pilot would also increase Freddie Mac's role in the mortgage market, raising "bright line" concerns, she added. Lenders have argued that Fannie Mae and Freddie Mac need to abide a "bright line" between the primary mortgage market and the secondary mortgage market so the GSEs do not take business from lenders.

"This is more than 50 years of precedence that they're upending," Johnson said in an interview. "We don't think that it's appropriate that Freddie Mac ingrains itself more into the housing system."

The Mortgage Bankers Association, an industry group that represents bank and nonbank mortgage originators, said in a statement it supports creative solutions but has reservations about the pilot.

"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," said David Stevens, president and CEO of MBA, in the statement.

Freddie Mac issued a statement March 14 indicating that it believed the pilot program fit its mandate from the Federal Housing Finance Agency to pursue more credit risk transfer solutions and claiming the pilot should provide benefits to borrowers, lenders and taxpayers. At the same time, Freddie Mac downplayed the idea that it would upend private mortgage insurance altogether. "It's important to note that the traditional [mortgage insurance] structure remains an important tool for Freddie Mac and the industry to provide access to credit for qualified borrowers with low down payments," a Freddie Mac spokesman said in the statement.

Analysts are skeptical that the pilot program could lead to a crowding out of private mortgage insurance entirely. Sean Dargan, an analyst for Wells Fargo Securities, called the most bearish interpretations of the pilot program "overly negative" considering it was focused on the relatively small lender-paid market, not the borrower-paid market.