Fitch May Drop Some Mortgage Insurer Ratings

Fitch Ratings in New York said it is changing its mortgage insurance rating model to reflect the impact of the U.S. subprime mortgage market collapse and could drop a few company ratings by a notch.

It said a ratings review and updates of mortgage insurance firms could be expected in two weeks.

The rating firm said its mortgage insurance model updates correspond to recent revisions that were made by Fitch's U.S. Residential Mortgage-Backed Securities (RMBS) group in its mortgage default and loss model, known as ResiLogic.

Most of the changes will be centered on increasing the expected default probability used to model the existing mortgage insurance-in-force (IIF) exposure at each company, reflecting changes that have taken place more recently in the U.S. mortgage markets, Fitch said.

Consistent with recent enhancements made to the ResiLogic model, the firm said it will increase the default probability in its mortgage insurance capital model by 20 percent.

Fitch said it believes this higher assumed default rate will better incorporate the risks inherent in the U.S. mortgage market, such as greater deterioration in home prices and significantly poorer performance of loans with certain characteristics.

Fitch also said it will be applying a more significant capital charge to all illiquid equity investments held within the investment portfolios of the mortgage insurance companies.

Going forward, the capital charge for illiquid assets, such as investments in subsidiaries or equity investments in unrelated third party entities, will be increased to 100 percent by Fitch.

Previously, the company had been applying a lower capital charge against these assets. The updated charge, it said, reflects the potential challenges in extracting liquidity from such investments during periods of financial stress. The impact of this change will vary by company, with several of the mortgage insurance companies being relatively unaffected.

Fitch noted that since the updated default rates will produce greater gross capital charges for most mortgage insurance companies, the nature of any reinsurance arrangements will take on greater importance in the overall model results going forward.

To the extent a mortgage insurance company has reinsurance in place to absorb modeled losses; the Fitch model will now be recognizing a greater level of reinsurance credit as a partial offset to the higher level of gross losses.

This reinsurance credit, Fitch said, may be most noteworthy for excess-of-loss captive mortgage reinsurance coverage held in trusts for the benefit of each primary mortgage insurance company.

Fitch views the revisions announced today as an interim step in its development of an updated U.S. mortgage insurance capital model, and believes that the revisions reflect a timely reaction to recent events.

Ultimately, Fitch said it intends to provide further upgrades to its U.S. mortgage insurance capital model, with the expectation of mortgage insurance migrating to a platform that more closely mirrors the dynamic ResiLogic model of the agency's RMBS group.

The company said it is in the process of updating all mortgage insurance companies' capital model results with the revised model enhancements for the period ending Dec. 31, 2006, and will announce results of this analysis shortly.

In the near future, Fitch said it will also be producing capital model results for each rated company's insured portfolio as of the period ending June 30.

There is “a potential that some of the mortgage insurance companies rated by Fitch will no longer maintain the necessary level of capital expected for their given ratings level.”

Fitch said it does not anticipate “a significant number” of rating actions related to these revisions, and where actions are ultimately taken, based on our preliminary analysis it is expected that any downgrades will be limited to only one notch.