The escalating crisis surrounding Equity Programs Investment Corp. (EPIC) has sent shock waves through the mortgage finance industry, and the most immediate result could be a shake-out of private mortgage insurance companies.
Although analysts believe the majority of the industry will weather the storm, some major players are expected to take substantive, and even fatal, hits because of the collapse of the real estate investment group.
The company with the most to lose because of the crisis is Ticor Mortgage Insurance Co. of Los Angeles, which has estimated its exposure at EPIC at $165 million. The company announced a major restructuring this week in which it said it would stop accepting new mortgage insurance business, raising fears among analysts as to its long-term viability.
"The industry has never seen anything like this. This is like the San Francisco fire," said one insurance executive, discussing the fallout from EPIC.
Private mortgage insurance is a crucial component to the mortgage-finance industry. Among other roles it plays, it makes it easier for financial service companies to sell mortgages or mortgage-backed securities to investors, because those investors know they usually can recoup their initial investment even in the case of a default.
This is precisely the tool used by EPIC, which set up limited partnerships to buy new houses as tax shelters. EPIC Mortgage Inc., its mortgage-banking affiliate, sold mortgage loans directly or pooled the loans and sold securities based on them in order to finance the purchases of these houses.
Mortgage insurance made instiutions more willing to buy these loans and securities, but with EPIC's apparent default on the payments due, the insurance companies are now exposed to potential claims estimated at $300 million to $400 million.
Besides Ticor, two other major firms, the Mortgage Guaranty Insurance Co. (MGIC) and the Republic Mortgage Insurance Co., face heavy losses at EPIC. But industry analysts said these companies are owned by healthy parent companies, which should be able to advance them capital to meet any shortage caused by big claims from EPIC.
However, a fourth firm, the U.S. Mortgage Insurance Co., may be in trouble, despite a relatively small exposure at EPIC, because of its small capital base, Wall Street sources said. One source put its exposure at about $19 million, although company officials could not be reached to confirm this figure.
Beyond the immediate risk to the companies most heavily involved with EPIC, industry executives and analysts said the dramatic losses will have a ripple effect in a business that has been flooded by red ink lately because of the stagnating real estate market. Losses incurred and loss-adjustment expenses totaled $470 million in 1984 and are expected to be double that for 1985, according to an analysis by Moody's Investor Services.
With Ticor, until now the fourth-largest mortgage insurer, effectively out of the market, other companies will have the chance to grab their business, said one insurance executive, who asked not to be identified. That, however, could be difficult given that, according to analysts, many of the companies are writing policies at the limits of their capacity.
Under the rules of the industry, the maximum limit of what a mortgage company has at risk is about 25 times its equity capital and contingency reserves -- a figure which many companies are approaching, said analysts. Thus, the ultimate effect of Ticor's removal from the market is that the entire capacity of the industry will shrink, causing premiums -- and ultimately the cost of mortgages -- to rise.
A second major result of the EPIC situation will be to frighten off foreign reinsurers to whom many of the mortgage insurance companies have increasingly turned to spread some of their risk, analysts said.
"You're probably going to see a certain review of the foreign reinsurers' commitment to this business," said Douglas Watson, an official at Moody's. Other analysts said that the renegotiation of a number of reinsurance treaties have been tabled since the EPIC problems came to light, causing further reductions of new capital into the cash-starved industry.
Insurance executives said the EPIC situation will make companies much more careful about the risks they underwrite. EPIC was an unusually risky endeavor, and as more of the facts spill out, analysts said it is becoming clear that the insurance companies did not do their homework in becoming so heavily involved.
Although the companies saw that EPIC had a good track record in paying off its obligations before the crisis, they did not look at some of the underlying facts that made it risky, such as the interlocking nature of the partnerships. "Had we known that, we would have come up with a different rating for some of the insurance companies," said another Moody's analyst, Michael Moleski.
"This type of relationship goes beyond the normal mortgage insurance coverage," said Stephen Doehler, executive vice president of the Mortgage Insurance Companies of America, a trade association. "It will make everybody more aware of their business dealings."