Mortgage Insurance Part 4: The Dangers of Number Blindness

Since I already purchased both RDN and MTG based on some of the analysis I've written about in previous posts on mortgage insurance, I'm soon going to turn my attention to other opportunities.  Before I do, however, I wanted to write a final piece on mortgage insurance because it illustrates the divide between two approaches to investing.  Namely, the tension between a numbers-based approach and an approach based on a realpolitick assessment of the state of the world and a particular industry.

Oliver Davies has done some nice analysis on Seeking Alpha, which concludes that RDN is at risk of insolvency and is certainly a much riskier investment than MTG, due to slow-paying claims and inadequate reserving (among other factors).  See here for Mr. Davies' summary of his thoughtful research:

http://seekingalpha.com/article/1003411-radian-responds-to-barron-s

A comment to this article illustrates the divide of perspectives that I mentioned, however:

"So right. Radian has made it through the housing crisis and out the other side. Now that real estate and all tangential markets are improving, the Fed will definitely question their reserve assumptions and try to close them down. What better way to usher in the housing recovery everyone is waiting for than taking down one of the premier MI issuers. Sheer genius.

P.S. I'm sure Fannie Mae almost hired S.A. Ibrahim a couple of months ago because they detested his MI practice. You are definitely onto something here. Have you proposed this to Fox News yet?"

This comment's tone is unfortunately typical of  many comments on Seeking Alpha but, I must say, despite its tone and lack of deep numerical analysis, I side with the commenter and not Mr. Davies.  The federal government wants to keep private mortgage insurers in business and the fact that Radian has survived this long suggests to me that they are going to survive longer.  Mr. Ibrahim's apparently cordial relationship with the Fed is just icing here.

Thus, an investor must be careful about being blinded by the numbers, particularly in certain industries.  Let me put it another way:  if you've lived through the last 4 years in this country, do you still believe that a company's reported numbers can reliably determine that company's chances of survival -- particularly when that company is a financial institution or insurer?    

Mortgage Insurance: Part 3

One issue I did not mention in my prior pieces on mortgage insurance was that MGIC had sued Freddie Mac over capital requirements that Freddie had imposed on MGIC which, if implemented, would have precluded MGIC from writing policies.  That suit is apparently in the process of being settled:  

http://www.rttnews.com/1995110/mgic-in-preliminary-deal-with-freddie-mac-to-settle-pool-insurance-dispute.aspx

There are some possible stumbling blocks to this resolution, however.  Namely, Freddie (and the Wisconsin insurance commissioner, which oversees Milwaukee-based MGIC), want assurance that MGIC is sufficiently capitalized to cover its risks in certain states.  As a result, MGIC's holding company will have to make a capital infusion into the MGIC unit -- although a significantly lower one than originally required by Freddie. 

In the type of shell game we have come to expect in the financial and insurance sectors of our economy, MGIC has gotten Freddie's approval for an end-run around its overly high risk ratio in other states:  it will simply have a new unit, MIC, which has a lower risk ratio than MGIC, write policies in these other states.

My take:  state and federal regulators, Fannie, and Freddie all want MGIC to survive -- although it is possible that MGIC will be unable to meet even the reduced requirements set forth by these entities.  So MGIC undeniably presents some investment risk.  Putting aside the moral implications of yet another example of rules being changed to allow failed institutions to survive -- this blog is about investing, not philosophy -- MGIC looks like a pretty good junk bond equivalent.  

Follow Up on Mortgage Insurer Stocks As Junk Bonds

I've done some further reading on the mortgage insurance situation and it is interesting enough to merit a second post.  The below article is a good overview of the competing interests trying to stake claims in the mortgage insurance arena after 3 of the main players were shut down by regulators in the last few years (one of them, PMI).

http://www.bloomberg.com/news/2012-08-22/arizona-regulator-sues-nmi-showing-watchdog-influence-mortgages.html

Let me give you what I believe are the most salient points:

• The Arizona Department of Insurance, acting as the receiver of the defunct PMI, has sued upstart would-be mortgage insurer NMI Holdings from improperly appropriating PMI assets. The suit could hinder NMI from selling mortgage insurance;

My thought:  former PMI employees are anxious to get back in the business

• Private mortgage insurers, which have lost more than $18 billion since mid-2007, wrote $40.1 billion of coverage last quarter, or almost 10 percent of the $405 billion of new loans.

My thought:  I'm absolutely astounded that the industry wrote more coverage last quarter than the amount of losses suffered during the housing crash

• MGIC’s preliminary ratio of risk relative to capital breached the level some regulators require to write new policies as of June 30, the insurer said Aug. 2.

My thoughts:  MGIC should probably be shut down but is being allowed to continue to operate

• Goldman Sachs Group Inc. (GS), JPMorgan Chase & Co (JPM), private-equity firm Pine Brook and reinsurer PartnerRe Ltd. are among backers of the industry’s other startup, Essent Guaranty Inc. The Radnor, Pennsylvania-based firm raised $600 million in 2009 and 2010 and began writing policies last year, providing 5.3 percent of coverage in the first half of this year.

My thoughts:  Goldman and JP Morgan see an opportunity in mortgage insurance.  The management team at Essent looks like it's been poached from other major mortgage insurers. 

One more thought, not from the article.  There was significant insider buying of shares in August of this year.  See http://seekingalpha.com/article/789171-why-i-bought-mgic-investment-corp-for-a-trade.
 
This is starting to look even more interesting.  I will continue to follow this industry.

Mortgage Insurer Stocks: Like Junk Bonds?

I recently ran across an article which mentioned the private mortgage insurer, MGIC.  I hadn't thought about the company in years.  Not since shorting it in the wake of the financial crisis and watching it pleasantly sink from about $38 to $24 before bailing out.  Only to regret my impatience later when it went nearly to zero.  At the time, although I was a major doomsayer, I did not foresee the complete collapse of the housing market.

Later, when the full scale of the disaster became evident, I was given to making pronouncements like:  "There is no way the mortgage insurers can survive.  Their liabilities are insurmountable."  And then just the other day, I was reminded of these thoughts after not thinking about the private mortgage insurance industry for several years.  My first reaction was "how are these mortgage insurers still in business?"  Some quick research revealed that not all of them are.  PMI, one of the major players, was seized and is now apparently a historical note.  But MGIC and Radian, two other big insurers, have survived.  The following article attempts to detail how this miracle could be:

http://seekingalpha.com/article/862831-radian-group-management-is-misleading-investors

I'm still not convinced but, that being said, if MGIC and Radian have survived the last four years, then it seems to me there are two possibilities.  One, they are getting ready to die, as PMI did last year.  Or two, they can survive anything and may very well run up if the housing market recovers to some degree.  In no way shape or form do I believe the housing market will make a significant recovery any time soon (I'll save my reasons supporting this assertion for another day).  However, the mortgage insurers would benefit from even a minor recovery in the housing market.  The article above details how MGIC is in much better position than Radian.  Some of the commenters believe otherwise.  In any event, if these two are still around, they may survive until the sun shines again...