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Managing risk in a changing world: being in the mortgage insurance business is all about being good at risk management. PMI Mortgage Insurance Co. has created a variety of tools to help monitor the multiple risks of residential real estate.

Article Excerpt
Danish scientist and Nobel Prize-winner Niels Bohr once commented, "Prediction is very difficult, especially about the future." He was right--but as risk managers, that's our job. From FICO[R] scores to automated underwriting engines, all of us in the mortgage finance industry have systems in place to assess the potential that a borrower will be able to meet his or her obligations, [??] These predictors generally work well, but in today's fiercely competitive and ever-changing environment, risk management means going beyond the individual to assess the larger environment, looking at a variety of risks and the relationships among them, as well as their relationship with credit risk. [??] As "chief worry officer" for PMI Mortgage insurance Co., Walnut Creek, California--one of the nation's largest mortgage insurance companies--I spend a lot of time thinking about how to measure, assess and manage risk. In this article, I'll take you through some examples of the kinds of things we watch, as well as some of the ways we're expanding our ability to predict risk.

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Geographic risk

As a mortgage insurer that insures lenders against the possibility of borrower default, geographic risk is one of our key risks. The PMI U.S. Market Risk Index[SM], which we publish quarterly, predicts the likelihood of home-price declines in the 50 largest metropolitan statistical areas (MSAs) and metropolitan statistical area divisions (MSADs) in the United States. The Risk Index is based on Office of Federal Housing Enterprise Oversight (OFHEO) data, employment numbers from the Department of Labor's Bureau of Labor Statistics (BLS) and the proprietary PMI Affordability Index[SM]. We also publish an appendix that gives data for all metropolitan areas that OFHEO tracks.

The advantage to using the OFHEO index is that it is a repeat-transaction index, so there's less price volatility than with median home prices, because the index measures price changes in repeat sales and financings on the same properties. (Especially in the case of smaller regions, changes in the characteristics of homes for sale in a particular month or quarter can cause median prices to be more volatile.)

The disadvantage is the OFHEO index is constructed using data derived from the government-sponsored enterprises (GSEs), so our analysis is most applicable to properties financed by conventional and conforming mortgages.

We use the Risk Index to help manage our portfolio, tracking our concentrations in areas at high risk of price declines. We also track trends...

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