PMI- The private mortgage insurance company
by Matthew C. Slaney, a security analyst with FinArc, LLC.
If you know what it is, you don't want to pay it. The acronym stands for private mortgage insurance and is also the name of the third largest player in that industry. What you may not realize is that PMI's service gives an enormous number of people access to homeownership when they could not otherwise afford it. For many, it is impossible to put 20% of the property value down when buying a home. With private mortgage insurance in place, lenders will take on the extra risk of a smaller down payment because PMI will cover any shortfall that might occur.
Mortgage insurance plays a critical role in the U.S. housing market. That is because it reduces default risk and adds market liquidity so that lenders can trade mortgages amongst themselves. Liquidity works like this: a mortgage lender, such as a bank, originates a loan when someone buys a house. This loan must meet certain risk requirements so that it can be packaged with similar loans and be sold to an agency such as Fannie Mae. Fannie Mae then keeps the mortgage and earns money from the interest, or it sells a mortgage-backed security to other investors. Mortgage insurance can satisfy one of Fannie Mae's requirements for purchasing loans. By making the loan available to a much larger group of investors and making the trading of the loan relatively easy, the mortgage rate will be lower and the homeowner receives a net benefit.
Industry analysis shows that loans to homeowners are among the safest credit risks and this takes on greater importance as the economy slows. History suggests that mortgage payments should remain a high priority for most homeowners even if other bills go unpaid.
PMI distinguishes itself from its larger competitors, MGIC and Radian, in three ways that we feel make it a superior investment: First, PMI has international operations and is expanding them even further. In 1999, the company began its foreign expansion by providing residential mortgage reinsurance in Hong Kong. That same year, PMI acquired Australian-based MGICA, becoming the second largest mortgage insurer in Australia and largest mortgage insurer in New Zealand. And in February 2001, PMI entered the European market and began working to develop its nascent mortgage credit enhancement industry. Second, PMI operates a title insurance business that helps to buffer earnings in periods of high refinancing. Consider this, when interest rates fall significantly, borrowers may refinance their mortgages to realize the cost savings. The affect on PMI is that the company must process a new mortgage insurance application, incurring origination costs and squeezing margins.
More significantly, however, is the fact that home value appreciation may mean that the insurance is no longer required at all and PMI loses some business. The title insurance business should do well in a falling rate environment because the premium is paid entirely at the time of closing and more closings should occur when rates are lower. Bear in mind that this business is relatively small for PMI and generated less than 3% of net income in 2000. Third, PMI's relative valuation is more attractive than MGIC and Radian. As of June 4, 2001, the price to earnings ratio based on 2002 consensus earnings estimates was 9.2x for PMI, 10.0x for Radian and 10.9x for MGIC. (Source: Zacks)
One of the risks of investing in PMI is that rates will fall and homeowners will refinance without needing private mortgage insurance. We are comforted by the fact that approximately 65% of the mortgages outstanding have been made since 1998 and are at fairly low interest rates. (18% of loans are at a rate of 6.9%, 23% are at 7.4%, and 24% are at 8.1% (Source: Freddie Mac). Rates must drop further before it makes economic sense to incur the closing costs associated with refinancing.
We feel that PMI is an excellent example of an investment that allows people to pursue their financial goals and ethical values mutually. While this is not a recommendation to buy the stock, we applaud the company's overall efforts and achievement.
Matthew C. Slaney is a security analyst with FinArc, LLC. FinArc manages portfolios for individuals, foundations, and companies, with a specialty in socially responsible investing. Account types include retirement accounts, trusts, and employee benefit plans for businesses. For more information, contact (877) 734-6272, email@example.com, or visit our web site at www.finarc.com.