See the end of the post for Portfolio Composition and weekly trades.
A week of Significant Gains from RDN, MTG, MBIA
The last seven days have been extremely good ones for my portfolio. This has been primarily due to the price appreciation of MGIC, Radian Group and MBIA. As regards MGIC and Radian, I have written so much about these two names, done so much work trying to understand the business (and trying to understand how other people were trying to understand the business), that it is quite rewarding to see it play out the way that it has.
It is amazing to me that MGIC has more than doubled (from a $2.40 low to a $6.10 high) during 5 days when the only notable disclosure was that the company had the ability to raise capital. Someone with an interest in market psychology should really write a piece on MGIC – you could call it the Existential Security.
I reduced my position in both Radian and MGIC by a little more than half during the early part of this week. My sales of MGIC occurred around $5.20 while those with Radian were at a little over $10. I don’t have plans on selling any more of either.
I sold the positions down because they were getting very large (particularly in the case of MGIC) and because my thesis, that these companies would be able to survive, has now played out. What is going to drive the stocks going forward is the long-term potential of the mortgage insurance business and how well each company can capitalize on it. Read more
Over the last couple of weeks I have been reading “Ideas have Consequences” by Richard Weaver, a somewhat well known and from what I understand quite well respected philosopher of conservative thought. The book, in which Weaver critiques the ills of our age and conveys the forgotten values of conservatism that have led to them, was written in 1948, and thus in retrospect it can be seen to have been quite prescient, having anticipated the spirit, if not an eerie amount of the details, that have come to characterize our culture. I would recommend it to any one interested in the subject of how we (as a society) have come to do as we do.
What I wanted to touch on here was a particular passage that I found striking, and also quite right.
In addition, the disappearance of the heroic ideal is always accompanied by the growth of commercialism. There is a cause-and-effect relation here, for the man of commerce is by the nature of things a relativist; his mind is constantly on the fluctuating values of the market place, and there is no surer way for him to fail than to dogmatize and moralize about things. Read more
Over the last couple of days I lightened up on my position in Radian Group and added to my position in MGIC. While I am nervous that this runs contrary to the claims of analysts (which have been getting on board the Radian train lately) I can’t find a hole in my work and cannot ignore the value I see at MGIC.
A few weeks ago I worked through a “blue sky” estimate for both Radian and MGIC. I was pretty surprised by the results. The following is not intended to be 2013 estimate or really an any-particular-time-period estimate. It is simply a look at what earnings might be once defaults “normalize” and each company’s reserve additions revert back to being those on new delinquencies only.
MGIC has really taken it on the chin over the last couple of days. While I can’t speak to the cause of the move down on Thursday, the fall on Friday, which was followed by further pressure in after hours trading, was precipitated by a note from Macquarie analyst jasper Burch.
Burch called MGIC’s valuation “out of whack”, cited earnings and book value pressure, and suggested that there was “an outside chance” that the regulators might “pull the plug”.
I found the comments surprising.
First, I don’t think his regulator comment is consistent with MGIC’s disclosure (from the SeekingAlpha transcript).
We regularly provide updates to both the GSEs and the OCI of our expectations regarding our capital position and as a result this quarter’s results including the risk to capital ratio are not a surprise to them. The GSEs and the OCI understand that our forecast calls for the risk to capital ratio of Magic to continue to rise for some time to come. The exact timing of when it will begin to decline is subject to among other things, the level of new notices and cures, the amount of new insurance written to Magic and the outcome of dispute resolutions.
The turn in housing
– Michael Burry – Scion Capital
The housing market has turned.
Being that it is a huge, lumbering tanker, it takes a long time to slow down and redirect. The changes happen slowly enough that you can miss them if you are focused on the wrong details (price increases and to a lessor degree sales increases) and not enough on the right one’s (inventory). All that matters is that prices are cheap, rates are low, and inventory has come down to levels that leave many cities firmly entrenched as sellers markets. Once buyers stop seeing themselves in the drivers seat, their attitude changes from one of waiting for a better buy to that of getting in before its too late. The vicious circle is replaced by a virtuous one, and sales and price increases will follow. Nothing lasts forever, and the US housing collapse didn’t either.
Falling inventories had to lead the housing turnaround, and that is what we are seeing now. Nationwide in August housing inventories fell from 8.2 months of supply a year ago to 6.1 last month.
A couple of weeks ago a Seeking Alpha article was published that highlighted some problems on the horizon for Radian Group (RDN). The article was excellent and it introduced me to the idea of liquidity risk at a mortgage insurance subsidiary. That led me into a much more detailed investigation of the Radian Guaranty insurance subsidiary, which I will discuss below.
The liquidity of an insurance sub
Before getting into the issues specific to Radian, let’s talk a bit about liquidity risk. For some reason liquidity is not at the forefront of discussion during conference calls and in brokerage reports on mortgage insurance companies. Questions and comments focus on risk to capital ratios and loan loss reserve methodologies, which, while providing important clues, do not in themselves allow you to conclude whether a company will have the cash available to pay the claims. The author of the SeekingAlpha article, Darren Oliver, suggested that this was because the mortgage insurance industry is not very well understood. This could be the case, I don’t know. I just find it surprising.
As a mortgage insurer, the bottom line is that you have the cash available to pay claims and that the regulator who watches over you believes that this is the case. Over time, the cash and short term investments on hand plus the premiums paid need to be enough to pay out claims made as well as operating expenses incurred. If there is a concern that the cash and future premiums will not be enough to cover the expected claims, the insurer will either be taken over by the regulator or put into run off.
I took some of my position in Radian Group and MGIC off the table yesterday. I sold half of my position in MGIC and about 30% of my position in Radian.
The stocks have moved quite a lot in a short period of time. I was buying MGIC at under 80 cents a month ago. I bought Radian in the mid-$2’s in July. These are pretty big moves.
The fundamentals behind the stocks are improving. My thesis that the housing market is bottoming is showing more evidence of playing out. Delinquencies are falling, foreclosure rates are falling.
Yet while I remain optimistic that they can outrun their legacy book, the possibility remains that they won’t.
There were a couple of events today that outlined that uncertainty.
MGIC Conserves Cash Read more