PMI Credit Swaps Signal Mortgage Insurer Risks Default: Corporate Finance

PMI Group Inc. (PMI), the third-largest guarantor of U.S. home loans, may be headed toward default following four years of losses, trading in credit derivatives shows.

Credit-default swaps on PMI at about a 16-month high imply an 85 percent probability of default within five years, according to data-provider CMA. The Walnut Creek, California- based company’s ability to write new business may be frozen if it fails to meet regulatory capital requirements by the end of September, according to CreditSights Inc.

PMI, which pays lenders when homeowners default and foreclosures fail to recoup all of the mortgages, has posted 15 straight quarterly losses amid the worst slump in U.S. housing prices since the Great Depression. Home prices decreased in the year ended in April by the most in 17 months, according to the S&P/Case-Shiller index of property values in 20 cities.

“Eventually this company has to go bankrupt. I just don’t see this company ultimately surviving, but it can survive a long time,” said Jonathan Carmel, founder and money manager at Carmel Asset Management LLC in New York. “People are nervous. They’ll squeak past it for the time being.”

Insurers need to show U.S. regulators they have sufficient capital to back policies, and many states require a risk- capital ratio of less than 25-to-1. The company repatriated $14.5 million from a European business in April to bolster U.S. unit PMI Mortgage Insurance Co., or MIC. MIC’s risk-to-capital ratio was 24.4-to-1 for the first quarter, up from 8.3-to-1 in the comparable period of 2007.

‘Out of Compliance’

“As a result of continuing losses, we expect that MIC will be out of compliance with applicable regulatory requirements in the second quarter of 2011,” and may be prohibited from issuing new policies in 16 states, PMI said in its May 5 earnings statement. PMI said it has received or requested waivers where applicable in the states in which it fails to meet requirements.

Its principal overseer in Arizona, where MIC is domiciled, told the company in March it isn’t required to obtain a waiver to continue writing business if it fails to meet requirements. The insurer may try to sell coverage from a different subsidiary if MIC is prohibited from selling new policies.

Kosta Karmaniolas, a spokesman for the company, declined to comment.

A regulatory seizure of MIC would trigger a cross-default, according to a June 8 CreditSights Inc. note. The cost to protect against a default by PMI, which has been publicly traded since 1995, has held at about a 16-month high, with five-year credit-default swaps tied to the company’s debt diverging from the other so-called monoline mortgage insurers, MGIC Investment Corp. (MTG) and Radian Group Inc. (RDN), by the most on record.

PMI Swaps

Contracts on PMI’s debt climbed to 37.7 percent upfront yesterday, according to CMA. That’s more than six times their level on Dec. 31, and means investors would pay $3.77 million initially and $500,000 annually to protect $10 million of the insurer’s obligations.

Radian’s risk-to-capital ratio was 20.3-to-1 as of March 31, according to its latest quarterly filing, and MGIC’s, excluding combined insurance operations, was 19.7-to-1, its filing shows. PMI is running out of options if its risk levels, already the highest of the three, deteriorate, according to Matthew Howlett, an analyst at Macquarie Group Ltd.

“They’ve already asked for and received waivers from states to continue running their business. At some point, if the capital levels keep eroding, there are not a lot of other things they can do,” he said. “What the market is saying is, how much further will regulators bend the rules for this company that’s honestly in a very weak operating position?”

Default Probability

Howlett, who has a “neutral” rating on the company’s stock, does not expect a default this year.

The swap contract’s implied probability of default is up from 44 percent on Dec. 31, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.

PMI is rated Caa2 with a positive outlook by Moody’s Investors Service and CCC- by Standard & Poor’s. S&P lowered PMI’s counterparty credit and senior debt ratings from CCC+ on June 14, and said it may cut the rankings further, citing “expectations of continued elevated losses in 2011 and 2012” relative to its capital.

‘Significant Pressure’

“Losses in line with or in excess of the current industry trends -- without additional capital contributions or substantial internal capital generating initiatives -- could put significant pressure on PMI’s statutory capital by year-end 2012,” S&P analysts led by Miles Kaschalk wrote in the note.

“Even with various capital raises, we’ve seen PMI statutory capital dwindle over the past couple of years,” New York-based Kaschalk said in an interview. “As losses emerge, the capital continues to decline, so based on our forecast, we’re seeing the statutory capital decreasing to a significantly low level, a point where you start to have concerns about the regulators cutting off new business writings.”

High-yield insurers bonds have lost 3.46 percent this month, while overall junk debt dropped 1.68 percent, according to Bank of America Merrill Lynch index data.

Mortgage insurers are resolving “very problematic legacy portfolios” while facing relatively low demand on better- quality new business, said Guy LeBas, chief fixed-income strategist and economist at Janney Montgomery Scott LLC.

Triad Guaranty

“I suspect that will someday change, and given the administration’s proposals for mortgage market reform, there’s good long-term potential for the industry,” Philadelphia-based LeBas said in an e-mail. “But the light on the horizon is many years off, whereas the problems are very much immediate.”

Triad Guaranty Inc. was forced to stop selling mortgage insurance in June 2008 when government-backed Freddie Mac disqualified it as a guarantor of new home loans.

PMI’s $250 million of 6 percent notes due in September 2016 plummeted to 59.5 cents on the dollar with a yield of 18.3 percent yesterday from as high as 81 cents with a 10.6 percent yield in February, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The notes were issued in September 2006 to yield 6.01 percent, or 1.25 percentage points more than similar-maturity Treasuries, Bloomberg data show. At the time, the mortgage insurer was graded A by S&P and its senior unsecured debt was assigned an A1, a step higher, by Moody’s. The current spread is 16.74 percentage points, Trace data show.

Spreads Widen

Average spreads on PMI’s debt have expanded to 1,475 basis points, or 14.75 percentage points, as of June 27 from 726 basis points at the start of the year, Bank of America Merrill Lynch index data show.

PMI ended at $1.15, down 1 cent, in New York Stock Exchange composite trading yesterday. The shares have fallen 65 percent in the past 12 months as the housing market remains an obstacle for the U.S. recovery. MGIC has declined 26 percent and no. 2 Radian has fallen 53 percent.

“In an industry that’s still trying to turn itself around, PMI has the lowest cushion and lowest margin of error among the three monoline mortgage insurers, and that’s weighing on the stock and bond prices,” said New York-based Howlett. “If losses do accelerate in the mortgage insurance industry, they’re clearly in the worst position.”

‘Positive Catalyst’

PMI agreed to sell its Australian and Asian units to QBE Insurance Group Ltd. for about $896 million in August 2008. Assuming full payout, the parent company will get about $208 million in September and MIC received $25 million from QBE, adding 94 cents per share, the company said in a May 5 earnings call.

“That may be a positive catalyst for the CDS and the bonds,” Jeff Peskind, founder of Phoenix Investment Adviser LLC, which oversees $300 million in New York, including some PMI debt. “That’s really kind of a short-term issue. What really needs to happen is the homebuilding cycle needs to gain a little traction.”

PMI will use those proceeds to pay off a $48 million short- term lending facility maturing in October, Macquarie’s Howlett said. After that payment, the company’s next major debt maturity is in 2016 with the $250 million of 6 percent notes, Bloomberg data show.

Housing Falls

The S&P/Case-Shiller index fell 4 percent from April 2010, the biggest drop since November 2009, a report yesterday showed. Robert Shiller, an economist who created the index with Karl Case, told a conference in New York this month that a further decline in property values of 10 percent to 25 percent in the next five years “wouldn’t surprise me at all.”

“There’s no precedent for this statistically, so no way to predict,” Shiller said June 9 at the conference hosted by S&P.

PMI’s new business writings have been “limited” over the past two years by competition from the Federal Housing Administration, and this year by “lower than expected residential mortgage originations,” according to its latest quarterly filing.

“This one is not for the faint of heart but we think there’s decent liquidity and a decent chance for the company to have enough time for the market to recover,” Peskind said. “If this thing turns, people will make a lot of money in this space.”

German finance minister, banks to discuss French plan

BERLIN(Reuters) - Germany's finance minister will meet the chiefs of the country's top insurers and banks on Thursday to discuss a French proposal detailing private sector involvement in a second Greek bailout package.
French banks, the most exposed to the Greek debt crisis, have reached an outline agreement to roll over holdings of maturing Greek bonds as part of a wider European plan to avoid sovereign default.
"We think this French proposal serves as a good basis," Deputy Finance Minister Joerg Asmussen said in a speech he to a real estate conference in Berlin.
"On this basis, the German finance minister will hold talks with the chief executives of the major German banks and insurers on Thursday, June 30, in Berlin," he said.
Under the French proposal, banks would reinvest 70 percent of the proceeds when Greek bonds fall due in 2011-14 and cash out the rest. Of the amount reinvested, 50 percent would go into the new 30-year bonds and 20 percent would go into zero-coupon AAA bonds with deferred interest.
They would pay annual interest of between 5.5 percent and 8 percent, tied to Greek GDP growth.
In a Sunday interview with a German weekly newspaper, Finance Minister Wolfgang Schaeuble said protecting their Greek investments should be reason enough for German banks and insurers to participate voluntarily in an aid deal, so there was no need for additional incentives.
German private sector banks, which quantify their exposure to Greece at some 10-20 billion euros, have called for the state to guarantee their risk if they allow a debt rollover.
German insurers estimate their holdings are substantially less than 6 billion euros, or 0.5 percent of the 1.2 trillion euros in insurers' invested assets.

Women Break Down Barriers in Mideast Finance

Hoda Abou-Jamra still remembers the meeting when potential investors for herprivate equity fund thought she was the secretary.

“I would ask a question, and they would answer to the man next to me. I would answer their question, and they would look at him,” she said, laughing. “I didn’t let it bother me. I just stood up straighter and talked louder.”

Women deal makers, financiers and entrepreneurs are a rare breed in the Middle East. As a founding partner of a $40 million health care fund in Dubai, Ms. Abou-Jamra operates in a male-dominated industry globally and a male-dominated work force locally.

In private equity, women account for roughly 9 percent of the senior management positions worldwide, with the share varying from 9.1 percent in Europe to 8.7 percent in the United States, according to a study this year by the industry research firm Preqin. The gender imbalance is even more extreme in the Middle East, market participants say. While few statistics are available on the region’s nascent industry, only 25 percent of women enter the job market at all, compared with nearly 60 percent in the United States

Ms. Abou-Jamra and other women financial professionals in the Middle East are trying improve the mix. It is a slow process, but they are making headway by creating their own investment vehicles, forging ties with influential players, and generally raising awareness.

“For the gulf states, in the last decade, women have become a lot more entrepreneurial,” said Dina Kawar, the ambassador to France from Jordan, where women account for about 13 percent of all private-sector workers.

Like Ms. Abou-Jamra, Maha Al-Ghunaim found a place at the top by creating a new financial firm, rather than working inside an existing one. At the investment arm of Kuwait’s sovereign wealth fund, Mrs. Al-Ghunaim steadily rose through the ranks, reaching the position an assistant general manager. But competition was intense, and she felt her best opportunity for advancement was elsewhere.

“When you are climbing the ladder, you have to balance between speed and safety,” Mrs. Al-Ghunaim said.

So 13 years ago she founded Global Investment House, a Kuwait-based financial firm that began as a brokerage firm and investment bank. She has since expanded into private equity, with four funds overseeing about $1.5 billion.

The barriers for women are both cultural and structural.

“The guys have so much testosterone, I’ve had to learn to be more aggressive to be heard,” Ms. Abou-Jamra said. “I’ve found that unless I participate in boys’ club activities, I’m put aside. You have to be one of the boys to really fit.”

But some Mideast countries ban women from driving or mixing in public spaces with the opposite sex. Strict dress codes are also enforced in places like Saudi Arabia and Iran.

“There are buildings where I walk in, and I’m the only woman there,” said Ms. Abou-Jamra. “Even the secretaries are male.”

Such restrictions made it difficult for Muna AbuSulayman, an entrepreneur and former television personality, to develop her latest ventures, a fashion line and a Facebook application for new parents. Simply registering the businesses with the government took a year, instead of the usual three days, she said.

“Each time, they would ask for something else, another piece of information, but they wouldn’t ask for all of it at the same time,” she said.

One item that held up the process: an address. The country’s law forbids people from using their home for commercial purposes. Ms. AbuSulayman could not use her father’s office either, since it was not licensed to have women employees under Saudi Arabia’s gender segregation rules. She obtained a business address through a brother.

It can be difficult to find capital, too.

Despite the region’s wealth and deep-pocketed investors, women are often reliant on conservative lenders, which are reluctant to give loans to small, women-led firms. When Ms. AbuSulayman and a male counterpart submitted similar applications to the same Saudi Arabian bank, she received a loan roughly a third of the size of the man.

“Applying for a loan, a woman will not get as much as a man,” she said. “My sister decided to sell her catering business when she could not raise the money she needed to expand it.”

Ms. Abou-Jamra went outside of the Mideast to find money for her firm. After meeting with four international private equity firms, she won the backing of the TVM Capital, a German private equity firm focused on the life sciences, to start a health care fund. She has since raised capital from investors like the World Bank’s private-sector arm, the International Finance Corporation, and the health care unit of General Electric.

Fund-raising in the Middle East was a central topic at a conference in Paris this month. The one-day event, attended by dozens of business people, diplomats and policy analysts, covered how mentorships and social media could play a transformative role in helping women financiers succeed in the region.

“As a woman in the Middle East, as an Arab woman, I found some men were very supportive,” Ms. Abou-Jamra said. “They helped me to not give up.”

Anu Bhardwaj, organizer of the conference, said “like-minded people invest in one another.”

Ms. Bhardwaj’s efforts are tied to a wider campaign by the Women’s Business Forum. Backed by the Organization for Economic Cooperation and Development, Jordan and the United States, the group is trying to educate women entrepreneurs and executives across the globe.

The group wants to tap into the vast resources of the region’s wealthy women. In the Middle East, women are thought to control billions.

“Widows and divorcées have that kind of money,” Ms. Bhardwaj said, “and they don’t spend it all on eye shadow.”

High Court Strikes Down Ariz. Campaign Finance Law

The U.S. Supreme Court delivered a blow, but not a fatal one, to public campaign financing, with a 5-4 decision striking down a central provision of an Arizona law.

The Arizona law offers public funds to state legislative and executive-branch candidates who abide by tight contribution and spending limits. Another provision gives additional dollars when publicly funded candidates face big-spending opponents or outside money groups — and that's what was rejected by Chief Justice John Roberts, writing for the majority.

Roberts said this type of public financing — called "fair fight" money, or funds "triggered" by other spending, or funds meant to "level the playing field" — unfairly burdens the free-speech rights of the other candidates or groups, because it balances out their political spending.

Three years ago, the Supreme Court ruled in another case that the government can justify campaign finance laws intended to fight corruption, but not those to level the playing field.

Reaction To Decision

Lawyers for the plaintiffs were jubilant.

"From our perspective, it is great that the court finally ended Arizona's Frankenstein's experiment with government-manipulated elections," said Nick Dranias of the Goldwater Institute, representing John McComish and two other former legislative candidates.

Dranias said the Goldwater Institute aimed this lawsuit at the leveling funds, but its larger target is Arizona's overall public financing system.

"Future lawsuits will undoubtedly determine whether the entire system can withstand the striking down of the matching funds component," he said.

Still, Roberts stopped short of throwing out the entire law, writing, "That is not our business." Some advocates of tighter campaign finance laws took comfort in that.

Arizona Assistant Attorney General James Barton said the law has been challenged repeatedly, and this is the first major loss. But he added, "Justice Roberts' opinion took the time to say that this isn't an attack on public financing in general. It's only related to these triggered matching funds."

Dissenting View

After Roberts delivered the ruling Monday, Justice Elena Kagan, an Obama appointee, read a fierce dissent.

Writing for the three more liberal members of the court, she said anyone "familiar with our country's core values — our devotion to democratic self-governance," and to a robust political debate, "might expect this court to celebrate, or at least not interfere with" a public financing system.

Kagan's dissent could open a new chapter in the campaign finance debate, and proponents of campaign finance regulation were cheered by it.

"To the majority, it looks like the mere mention of a leveling interest is enough to doom the law," said Rick Hasen, a law professor at the University of California, Irvine. "Justice Kagan in her dissent says, 'So what if some of this is motivated to level the playing field? It was also motivated on anti-corruption grounds, and it is justified on anti-corruption grounds.' "

Still, Kagan is in a four-justice minority on the Roberts court. Monica Youn, who was an attorney for the Brennan Center for Justice on an amicus brief in the case, said, "This is the fifth campaign finance case that the Roberts court has heard, and the fifth that it has struck down, in a mere five years."

Future Lawsuits Possible

One of those other cases, of course, is the controversial Citizens United ruling of 2010, which was cited 10 times by Roberts in Monday's decision. The Citizens United decision lets corporations and unions spend unlimited amounts to support or attack candidates.

The Goldwater Institute's Dranias pointed to a footnote in Monday's decision as a possible seed for future lawsuits.

The footnote seems to cast doubt on the anti-corruption basis for public financing laws. Roberts wrote, "Public financing does nothing to prevent politicians from accepting bribes in exchange for their votes."

Dranias said, "Now that, to me, is a substantial finding that cuts out one of the three legs that has traditionally upheld public financing, that it's a means of preventing bribery to politicians."

So the legal foundations of campaign finance laws will continue to shift.