The Cycles in Mortgage Insurance
So long as home prices are rising, mortgage insurers take in premiums and pay out virtually nothing in claims. But when the tides change, and home prices decline, this corner of the insurance industry can suffer outsize losses.
One listener asked if Essent Group's (NYSE: ESNT) sky-high profitability is sustainable in the long run, and the answer is: probably not.
In this Industry Focus: Financials segment, host Gaby Lapera and contributor Jordan Wathen discuss the long cycles in mortgage insurance, and why the industry can be profitable for decades before facing insolvency and bankruptcy when home prices fall.
A full transcript follows the video.
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This video was recorded on May 22, 2017.
Gaby Lapera: Are Essent's 68% net margins too good to be true?Some background for listeners,Essentis a mortgage insurer. That's theprivate mortgage insurance you need to buy if you put down less than 20% on down payment for a house.
Jordan Wathen:Yeah. This is a billion-dollarquestion. The answer is,it's hard to say. I guess,come back when home values aregoing down rather than up. Mortgage insurance is just tough. On a long timeline, it seems like allmortgage insurers eventually go to zero,because the industrybasically went extinct during the Great Depression. Half of them blew upin the 1980s,many of them blew up, or almost blew up, in2008. So you have these long, generational cycles of profits, and then house values go down and they lose a fortune,because they're basically taking the first loss on houses. Personally,I don't spend too much timefollowing it because the cycles are so long, andbecause it's one of those industries where the government playsa really big role.So if the government comes out andwants to promote homeownership,they could really ruin the mortgage insurance industry if they want to. Or they could make it obscenely profitable bymaking it harder. It's just an industry that,truthfully, I don't understand too well. AndI think you would really have to haveyour finger on the pulse of Washington politics to really understand it.
Lapera:Yeah,and not just Washington politics, but,like you mentioned, the housing cycletends to be very boom and bust, and the problem isprivate mortgage insurers arenot the oneswriting the loans for the houses. In that case, it's two steps ofunderwriting. It's the bank's underwriting plusthe insurer's underwriting that iscreating this policy for this person. So if the bank did a really bad job underwriting that house, then the insurers aredefinitely going to lose out. So it's just something that has a lot of variables and is hard to control. So just think about that before youconsider investing in private mortgage insurance.
Wathen:That'sa good point. Because these cycles are so long,someone could theoretically join amortgage insurance company out of college,become an executive, andthrough that whole timeline where theymove up thecompany, basically, theyoperate in an industry during the time whenthey experience almost no losses. So all they've been rewarded for is underwriting more and more and more insurance. Psychologically, it's something that'sreally difficult to grasp,because eventually, the losses do come -- it'sjust a matter of time. But someone could easily see 10-30 years of excess profits, and thenall of a sudden, it's just complete wipeout in one year when house values go down.
Gaby Lapera has no position in any stocks mentioned. Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.