Please ensure Javascript is enabled for purposes of website accessibility

Are These Former Heroes Going to Zero?

By Cindy Johnson - Updated Apr 6, 2017 at 8:31PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

These all-or-nothing bets worked, until they didn't.

Some would call it justice. Mortgage insurers -- the companies that made it possible to put less than 20% down to buy a home -- have become victims of the housing bust. Companies that specialize in private mortgage insurance may not survive, according to a lengthy article by Jonathan R. Laing in Barron's -- but after reading the article, my question is not whether they'll survive but rather when they'll fail.   

Think you're not affected? Guess again.
You're probably exposed to these stocks even if you don't own them. That's because private mortgage insurers owe Fannie Mae and Freddie Mac an estimated $30 billion of insurance recoveries on mortgages that have already defaulted. And the bill is likely to rise, a lot. With the U.S. government supporting these two agencies, taxpayers will wind up footing the bill for any money not collected from private mortgage insurers. 

Mortgage insurance is essentially an all-or-nothing bet in which the insurer pays the first 25% of a mortgage's value and accrued interest if a mortgage lender takes title to a home. In the decade-plus before the housing bust, stocks of monoline private mortgage insurers -- MGIC Investment (NYSE: MTG), Radian Group (NYSE: RDN), PMI Group (NYSE: PMI) and Triad Guaranty -- significantly outperformed the market. It was no wonder, considering the growth in mortgages issued with down payments of less than 20%.  

Risky business
Back in the days when home prices never declined, mortgage insurance was a predictable business. But it has become risky business now that about 28% of mortgages are underwater, strategic defaults are the new norm, and the outlook for housing prices and jobs is uncertain.

Triad's fate already appears to be sealed. It is operating under the supervision of the Illinois Department of Insurance and paying only 60% of claims in cash. The remaining 40% are being paid in IOUs that probably have value only as tax-loss writeoffs. Triad's stock has gone from more than $60 in 2004 to $0.21.

PMI Group, MGIC, and Radian -- which account for about 60% of the private mortgage insurance industry -- may not be far off from state supervision or runoff status, in which an insurer is prohibited from writing new business that might cushion losses from current obligations. That happens if a company's risk-to-capital ratio exceeds 25-to-1. PMI's ratio is approaching 25. MGIC's and Radian's are near 20. All three are at risk of having their shareholder equity eliminated, with limited prospects for rescue through a fresh capital infusion.

The walking wounded
Genworth Financial
(NYSE: GNW), AIG (NYSE: AIG), and Old Republic International (NYSE: ORI) are also important participants in the mortgage insurance industry, with exposure to the same market conditions. However, they're part of larger, more diversified businesses with financial resources that should mitigate the damage from the foreclosure tsunami. Although their stocks are likely to be wounded, it's less likely that their wounds will be fatal.

What could save PMI Group, MGIC, and Radian from such a fate? A sharp abatement in foreclosures should have a significant positive impact on their outlook. It would also be a big help if more insurance claims on fraudulent and otherwise irregular loans are successfully denied. Neither outcome seems likely, though, given the foreclosure tsunami and reports of sloppy loan paperwork. Indeed, many people believe the pace of foreclosures will pick up once the robo-signing scandal settles down. An unemployment rate that refuses to drop, coupled with the huge number of underemployed workers, does not bode well, either.

Even if these companies are allowed to continue writing new insurance, which could theoretically contribute new revenue and profits, there seems to be little opportunity in an environment of low mortgage demand and mortgage lenders that insist on 20% down.

Foolish takeaway
Without a dramatic and surprising turn in the economy and foreclosure crisis, it may be only a matter of time until the monoline private mortgage insurers fail. If you own one of these stocks, the best time to get out may be now.

What do you think: Are the stocks of PMI Group, MGIC, and Radian heading for the Pink Sheets on their way to zero? An easy way to stay on top of market developments is The Motley Fool's free new My Watchlist feature. You can get up-to-date news and analysis by adding these stocks to your Watchlist now:

Fool contributor Cindy Johnson owns no shares of any stock mentioned in this story. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

American International Group, Inc. Stock Quote
American International Group, Inc.
AIG
$52.90 (1.21%) $0.63
Radian Group Inc. Stock Quote
Radian Group Inc.
RDN
$22.21 (-0.76%) $0.17
Genworth Financial, Inc. Stock Quote
Genworth Financial, Inc.
GNW
$4.33 (1.64%) $0.07
MGIC Investment Corporation Stock Quote
MGIC Investment Corporation
MTG
$14.39 (-0.86%) $0.12
Old Republic International Corporation Stock Quote
Old Republic International Corporation
ORI
$22.62 (0.69%) $0.15

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
379%
 
S&P 500 Returns
123%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/09/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.