Two Value Managers Sweat Out the Mortgage Insurance Sector

Two value managers, Marty Whitman and Al Zucaro, have invested heavily in the troubled mortgage insurance sector, Erik Holm reported in Bloomberg, and they are prepared to sweat it out.

MGIC Investment Corp. (MTG), PMI Group Inc. (PMI) and Radian Group Inc., (RDN) the industry's three largest firms, had their worst year in 2007, declining as much as 78 percent. Whitman bought into the slump to become the largest stakeholder in Philadelphia- based Radian. Zucaro became the No. 1 investor in PMI of Walnut Creek, California, and the second-biggest for Milwaukee-based MGIC.

``We're just going to have to sweat it out for the next 18 or 24 months,'' said Zucaro, who runs Old Republic International Corp., parent of the industry's sixth-largest company.

Holm reported that the two took the plunge as the sector's shares took a plunge of their own: Radian shares slumped 78 percent in 2007, with the company reporting 3Q losses of $704 million; PMI dropped 72 percent on a quarterly loss of $86.6 million; and MGIC, the largest U.S. mortgage insurer, saw its stock fall 64 percent on losses of $372.5 million, with no 2008 profits in sight.

The value managers refused to disclose the price they paid for the shares, but using a simple calculation based on average prices during the period of the purchases, Holm concluded that, to date, Whitman may have made 60 percent losses on his PMI holding, and 80 percent on his Radian investment, while Zucaro may have lost a third on his MGIC stake.

``While the near-term situation may seem dire, we are patient, long-term investors willing to ride out short-term volatility,'' Whitman's company said in a December 28 filing.

Furthermore, holdings in financial insurance companies, including Radian, MGIC and bond insurer MBIA Inc. (MBI), were less than 4 percent of Third Avenue Value Fund's $11 billion in assets.

The tide may already be turning for the sector, Holm suggested. This was based on reported higher premiums from new policies, tougher standards on mortgage borrowers which may cut default rates, and Treasury Secretary Henry Paulson's plan to freeze rates on some adjustable loans for five years.

``Value investors are looking ahead and have figured that, by hook or by crook, these companies will get through 2008,'' said David Havens, a credit analyst at UBS AG in Stamford, Connecticut. ``The insurance they are selling now is probably quite a bit better than it has been for a number of years in terms of quality.''

As Third Avenue International Fund's portfolio manager Amit Wadhwaney wrote in the fourth quarter letter to shareholders:

The whiff of panic currently blowing through the financial markets has the potential to present tremendous buying opportunities.

Comments

[helplessobs...:]

It does my heart good to see the smart money guys have to turn their smart trades into long term holdings. So much for big school MBA smarts. The smart guy in the room lives in Omaha, lives in a $500K home, drives an old car and most importantly knows the value of a buck. BRK will cherry pick these companie's holdings while scooping up all the new business it wants. Most importantly BRK will be around in 18 months looking for more attractive deals. The same can't be said for ABK, PMI, MI etc.

2008 Jan 10 10:04 AM

[Straightly put:]

I know very little of MI. When I bought my house, my reaction to MI and Title insurance was: What a rip off.

From the other end: What a sure in business!

Then there is all the reports on the trouble of the monolines. Even now, after a lot of searching and reading, I still do not understand why the MIs are better off than the Monolines.

The borrower (B) borrowed 135K on a 150K house after 10% down. The lender (L) makes him to pay for MI for a 25% coverage (33750). The lender (or Underwriter?) takes the mortgage (packaged it into CBO) and sells it to the Investor (Ir) for whatever price. Ir does not feel comfortable with the mortgage, so it goes to the Monolines and purchased insurance on its investment.

B cannot pay. So the house is foreclosed and eventually sold for 100K. Assuming B did not pay down his mortgage at all, and then the total loss is 50K. B obviously losses his 15K down pay. The MI is on the hook for the 33750. Then the monolines is on for only 1250 and the investor is made whole again: 13500 = 100000 + 33750 + 1250.

What I don't understand are these:

1. MI has to take the hit BEFORE the monolines: only after the MI has paid its full coverage will the investors' monoline policies even affected. Then how can MI be standing if the monolines are falling?

2. The lenders made the borrowers pay MI. If the MI is a good deal, why the lender not just keeps the premium? If the MI is a bad deal, then the MI companies are not safe, then what is there to make the lender fell safer?

3. I know this will sound stupid, but truly I want to know. When B cannot pay his mortgage, obviously he is not paying his MI premium either. Does that mean the MI is therefore canceled? If I don't pay the premium of my life, auto, house, medical insurance, that is what will happen.

4. In the fourth quarter alone its claims reached $1.3 billion. How much did it pay out?

5. When does MTG has to pay? When B did not pay for 90 days? Or when the house is foreclosed?

Thanks a lot if any of you knowledge people would care to provide some answers.

2008 Feb 19 12:55 AM