MGIC Investment has been the victim of negative headlines since writing down its joint venture, mortgage securitization and servicing company C-Bass. The company followed it up by calling off a potential merger with fellow mortgage insurer Radian Group, and it most recently announced $602.3 million in third-quarter losses. But mortgage resets and delinquencies are not all bad news for the company, whose lending model may benefit from the subprime mess as borrowers face decreased financing alternatives.
"Mortgage insurers refer to right now as the onset of the golden age, which is interesting because it looks a lot like the apocalypse," said James Brender, a director at Standard and Poor's. However, currently there is tremendous demand for mortgage insurance with the majority of loans being done through the GSE channel, Brender said. "There are still a lot of borrowers out there who are credit worthy and want to buy a house but do not have 20% to put down. So since banks do not want to do second liens, and GSEs do not want to take a loan that does not have 20% down without mortgage insurance, mortgage insurance becomes a valued product." At the same time, the current market environment is also supporting better pricing, better persistency and fewer mortgage insurance avoidance products than have previously been seen, said Ralph Aurora senior director at Fitch Ratings.
Indeed, insured persistency is on the rise, market participants say. Prior to the subprime defaults, persistency - the rate at which performing loans stay on the books - had been declining because loans were being quickly refinanced. Good loans were going away and that was a loss of revenue for MGIC, Aurora noted. Currently, persistency, which bottomed out at 46% back in 2003, is at 74%, said S&P's Brender, who predicted that it could grow to 80%. In its third quarter results announced last week, PMI Group reported that its primary persistency rate increased to 73.3% compared with 67.3% in the third quarter of 2006.
At the same time, the prevalence of mortgage insurance avoidance products like piggyback loans, which had previously put a lot of pressure on MGIC business, is declining. Some market participants expect that [piggyback] loans will probably not be issued for the next decade.
More Bad News
However, the worst is far from over for mortgage insurers. There is a significant credit crisis going on in the overall market, and mortgage insurers are in a risky position, Moody's Aurora said. And with expected losses to continue well into next year, MGIC faces a steep upward climb to profitability. "The news was a disaster; it was way worse than expected and it looks like they are deteriorating far faster than anyone had anticipated," said Rob Haines, senior insurance analyst at CreditSights, citing MGIC's admission that it is not going to be earning money until 2009. "You literally throw a year's worth of earnings out, which is a major blow to the company." In the fourth quarter the company said it is expecting paid losses somewhere in the $270 to $290 million range. And in 2008 it is expecting paid losses in the $1.2 to $1.5 billion range.
Further, management's view of mortgages really improved only in the third quarter of 2007, S&P's Brender said. "We had thought that when the problems occurred at New Century Financial Corp., the lenders should have cleaned up their act. It is reasonable to think that there would be some loans stuck in the pipeline, but the idea that this has gone on since February?" Bender said. Indeed, PMI Group announced a net loss for the third quarter 2007 of $86.8 million. This includes a net loss of $65.2 million in its U.S. mortgage insurance operations.
Ratings Still Intact
The insurers have not seen their ratings cut as a result of the bad news. "I think the rating agencies are a little bit overly optimistic," Haines said, noting that they generate huge revenues from the mortgage insurers like MGIC. "[Mortgage insurers] cannot fall below AA'; [they] would get cut off from being able to do business with the GSEs Fannie Mae and Freddie Mac, and that is a death sentence," he said, adding that rating agencies have also not adjusted the ratings on Radian Group, whose numbers, at press time, were expected to be similar if not worse. In addition, [Radian] has a big financial guarantee business, which is expected to suffer a huge mark-to-market loss. "It will be a big headline number," Haines predicted.
The impact of all the resets, the amount of borrowers simply walking away from their homes and the decline in volume of home sales will all factor into the outlook for the company, which some market players feel is too optimistic. While Haines expects that MGIC will most likely muddle through the bad times ahead, he predicts that the company could experience two to three years of some rough times. "They look like they are pretty well protected," he said. "Their annual debt service is about $40 million dollars at the operating company, and let's say you add in $10 million dollars for more operating expenses. If [MGIC has] to cut their dividends totally, they have a cash run rate of about $50 million dollars a year." And after the most recent additions from some of their operating subsidiaries, they are going to end the year with holding company liquidity of $300 million plus $200 million under their credit facility, Haines noted.
S&P's prediction on when the company would bottom out was a bit rosier, expecting it could take a final hit as early as the second quarter of 2008 but with a greater possibility of hitting bottom in the third quarter of 2008, or even more likely the fourth quarter of 2008 or later. "There is more downside risk of the problems being protracted rather than cleaning up early," Bender said.
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