MGIC Investment Displays Market Magic

There are one-hit wonders, and then there are those stocks for which the initial big move is only a preview for even bigger and better gains to come.

Mortgage insurer MGIC Investment (MTG 0.05%) jumped 31% over the past month far surpassing a flat broad market index as federal housing regulators reduced the amount of money it is required to contribute to underwriting subsidiary. With the ability to write new policies eased, MGIC can try to expand once again.

MGIC Investment snapshot

Source: FinViz.com. N/A = not applicable; MTG does not pay a dividend.

A mighty temblor
Bending the rules has long been standard operating procedure in the mortgage industry, which is why it's operating in crisis mode now. So the fact that Freddie Mac is once again allowing MGIC Investment to skirt statutory requirements isn't much of a surprise.

Both Freddie Mac and Fannie Mae granted waivers to MGIC to allow it to operate with financial strength ratings lower than what's called for. MGIC and Genworth Financial (GNW 0.17%) have risk-to-capital ratios above the 25-to-1 maximum limits established by most states, and Radian Group (RDN -1.04%), which has a ratio that dropped to 21-to-1, recently said in its quarterly filings that it expected to exceed the cap later this year. MGIC has said its ratios could go to 40-to-1 or even higher!

MGIC comes up short on the minimum amount needed to pay off claims that's used by its home state Wisconsin regulator to gauge the health of an insurer. No matter, the government is letting it continue to operate and, in fact, cut in half (to $100 million) the amount it needs to temporarily write mortgage insurance in more states. Deadlines that it was required to meet by the end of the year have also been pushed back to the end of 2013.

A shaky foundation
The insurer's losses widened to $274 million in the second quarter, rising 80% from the year-ago period. Revenues were also down, even though the value of newly originated policies nearly doubled. It says it will use its newly granted insurance writing power to expand into states that hadn't granted it waivers.

MGIC also saw a drop in the number of delinquencies, down less than 2% from the month before, but the number of cures, or when a loan returns to on-time payment status, jumped 13%. As positive as that sounds, cures through loan modifications have a horrible track record, with many -- if not most -- defaulting once again. MGIC says 15% of its cures come from loan modifications, and it estimates half of them will default once again.

Era of Big Brother
After the government's takeover of the insurance market through Fannie and Freddie, private insurers like MGIC and PMI have seen their market share wither away. While once the private sector controlled 80% of the industry, that number has dwindled to just 16%.

Investors should be wary of MGIC and the other private insurers despite the enabling actions of government regulators. They've been known to pull away the punch bowl from the party. Just ask Old Republic (ORI -0.92%), which had the waivers granted to its Republic Mortgage Insurance subsidiary suspended

In the end, this bit of market magic by MGIC Investment will amount to little more than smoke and mirrors. While I don't short stocks since market mania can outlast my solvency, I have rated the mortgage insurer to underperform the market indexes on Motley Fool CAPS, the 180,000-plus member-driven investor community that translates informed opinion into ratings from one to five stars.

MGIC's low two-star rating suggests many others in the investment community share my skepticism. Although the stock has gained 15% when I weighed in on it compared to a 1% gain in the index causing me to be the one with an underperforming score, I still believe MGIC will be done in by the excesses of Fannie Mae and Freddie Mac. Feel free to weigh in yourself in the comments box below if you think the mortgage insurer can still pull a rabbit out of the hat.