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Thursday, July 22, 2010

Another Look at the Mortgage Bond Insurers

A few months ago, we took a look at MGIC (MTG), PMI (PMI), Radian (RDN), Ambac (ABK) and MBIA (MBI). At the time, I commented that they seemed to be coming back from the dead with the stocks posting very rapid increases in the six weeks prior to that post. Fairly shortly thereafter, they all had a rough go of it and subsequently dropped off a cliff as they, one after the other, posted fairly lousy earnings and the overall market was fairly rotten too.

At the time I commented that I wasn't entirely sold on their recovery as we are still within the wake of the vessel of death that was the mortgage crisis, however I think we can say that at least some of these companies should survive. I'm not too thrilled when I look at any of their balance sheets. They are in fairly weak positions, though debt burdens are not ruinous in any particular case so it is unlikely that even another brief credit shock would force any one of them into receivership in a hurry. Normally, this is not promising ground for starting a discussion on a stock or group of stocks, but when you are talking about companies that 18 months ago traded at fractions of their still low prices today it makes sense to do so.

Let's then turn to their earnings prospects. On the revenues side, it's fairly simple. Mortgage lenders and investors purchase insurance to cover against defaults by borrowers. Historically this was a boring business as default rates were so low that payouts were quite meager. Of course, that changed and these companies hemorrhaged money at unbelievable rates for nearly two and a half years straight. Really, it's actually a fairly simple business at its most fundamental level. There are eccentricities to the contracts I invite a more learned person to chime in on, but the basics are easy to understand.

With that in mind, what is the overall outlook? Home sales, once the plunge following the tax credit is done sorting itself out, really do have to go up. I hate to put it as simply as that, but I think it is fair. Over the next couple years, mortgage originations should increase along with the sales. This year is a little choppy and full of distortions so I don't expect miracles. What I don't know is what has happened to the premiums they are able to collect. Have they reduced them to try to grab a bigger piece of a smaller pie or have they increased them as their perceptions of risk were repriced? I can't find any data on this so I would encourage anyone to take a look at it.

On the expenses side, defaults are slowing and should top out shortly. Already we are seeing the claims paid by almost all of these companies taper off, albeit slowly. Of course, if we have a double-dip, things could get dicey, but then we have other problems. As such, I think on both the revenue and expenditure sides, we have the first true trends toward stability since the second quarter of 2007. Yeah, this mess started that long ago. However, I am speaking broadly of the sector. There is differentiation among the several firms.

As I still am not overly familiar with the companies, I won't try to be cute in what I think of their financial conditions and instead I will keep it simple. The companies that are most rapidly moving toward the break-even line are the best bets. MTG is the one most clearly moving toward profitability with claims dropping rapidly from close to $1 billion a quarter to under $500 million. I would still wait for their next earnings report to see if this trend holds. With this plunge, they are actually within sight of profitability. MBI is a little difficult to divine due to large one time charges, but they seem well on the path as well. RDN confuses me and the outlook appears unclear, even for this sector. PMI is iffy and ABK is trash and both shouldn't be touched, especially ABK for those who are attracted to penny stocks.

If I had to buy one, though I am still not inclined to buy any until I see a truly decent earnings report since the easiest money has already been made in these stocks, I would have to buy MTG. I remember when the announced in about August or September of 2007 that they didn't think they would turn a profit again until 2011 or 2012. I'll give them credit since that was probably one of the most accurate forecasts of this entire crisis and because of it they did the best job of protecting themselves and those efforts are starting to bear fruit. That said, I am still less than enthralled by the entire sector. I like value plays, but this is on the outer limits of my tolerances.


  1. MTG was the preferred option of these when I was just idly skimming their information this morning, as well. Effective as of May, MGIC released a new set of delegated guidelines to all of their mortgage servicing partners. The details are not especially important, but the overall influence is. It's the rare loan that falls outside of their delegated guidelines, meaning they'll approve modification for almost any distressed borrower if the servicer decides to do so and the lender approves. Loans falling outside of the delegated guidelines need only have a few certain other requirements met to be approved, as well. This is causing MGIC to pay out fewer claims and spend much less money and manpower approving modification requests.

    In addition, it turns out that the backlog of modification requests is industry-wide for the servicers, so although the threat of foreclosures remains it's much more likely that lenders will maintain their massive modification operations active through the next 2-3 years and spare the insurers a great deal of payouts. I would imagine MGIC has few places to go but up.

    Radian is a tougher issue. Servicers are completely delegated but they will not modify over original principal balances. Since most of the defaulting loans are very new, there are a lot of Radian loans that go to foreclosure or short sale, forcing them to continue paying lots of claims.

    PMI is the only one I know about, and I don't know much. They're another of the insurer with delegated guidelines, but they just aren't as common as MGIC so it's hard to judge from my experiences so far. Waiting and watching seems a fair plan, at this point.

  2. When this quarter's earnings come out, I'll give them all a good go through. I think there is value to be had here, but we have to be careful.