Hedge funds led by Paulson & Co. and Maverick Capital are piling into mortgage insurers in a bet that some of the companies worst hit by the U.S. housing crash will be among the biggest winners in the rebound.
Maverick, run by Lee Ainslie, added 23.6 million shares of MGIC Investment Corp. in the first quarter as the stock almost doubled, according to regulatory filings. Billionaire John Paulson’s $18 billion hedge-fund firm acquired 17 million shares of MGIC and 8 million of rival Radian Group Inc.
Perry Capital, George Soros’s family office, and Blue Ridge Capital LLC also added stakes as some of the world’s largest hedge funds wager that companies seen as recently as last year to be on the verge of default, and whose debt is still junk- rated, will benefit from rising home prices and the government’s retreat from insuring home loans. Operating income before taxes for the industry more than doubled in the first quarter from the prior year, according to Moody’s Investors Service, as loan delinquencies declined to the lowest since 2008.
“The mortgage insurance sector is a very good business right now,” said Bose George, an analyst at Keefe Bruyette & Woods in New York. “You’re getting returns in the high teens on new capital and there are barriers to entry.”
Mortgage insurers cover losses when homeowners default and foreclosures fail to recoup costs. The coverage is typically required when homeowners make a down payment of less than 20 percent. Firms such as Philadelphia-based Radian and MGIC, in Milwaukee, received waivers from regulators to continue selling coverage after the housing bubble burst in 2007 and millions of homeowners defaulted. Losses pushed PMI Group Inc., Triad Guaranty Inc. and Old Republic International Corp. from the market.
Survivors Thrive
The survivors are now attracting capital as the housing market rebounds from the worst plunge in eight decades. Home prices jumped 10.5 percent in March from a year earlier, the fastest pace in seven years, according to CoreLogic Inc. Home sales probably rose in April to the highest level in more than three years, according to the median forecast of economists surveyed by Bloomberg ahead of figures from the National Association of Realtors and the Commerce Department. The proportion of home loans at least 90 days late or in foreclosure was 6.39 percent as of March 31, the lowest since the end of 2008, according to Mortgage Bankers Association data.
MGIC rose 86 percent in the first quarter after losing 29 percent in 2012. Radian surged 75 percent, and nearly tripled last year. The companies’ prospects were bolstered when they sold shares and debt in the first quarter to replenish capital that was drained amid the financial crisis, said George.
Recovery Exposure
“People are looking for names that are still very exposed to improvements in home prices and improvements in mortgage credit over the next few years,” he said. “If you believe in a very strong recovery, the insurers remain the best way” to invest.
Sales of private mortgage insurance jumped 78 percent in the first quarter from a year earlier, according to Inside Mortgage Finance, as the U.S. scaled back its role in the market and home sales rose. Radian was the top seller, followed by American International Group Inc.’s United Guaranty, MGIC, and Genworth Financial Inc.
The Federal Housing Administration has raised premiums to back mortgages, and some lawmakers have pressed the U.S. to further reduce its role in the real estate market. FHA and other U.S. programs accounted for 67 percent of the mortgage insurance market in the first three months of this year, down from 74 percent in the same period of 2012, Inside Mortgage Finance figures show.
Regain Share
“Our strengthened financial condition puts us in a position to regain market share,” MGIC Chief Executive Officer Curt Culver said on an April 30 conference call with analysts. “Returns on the new business are very strong and should continue to be so given the outstanding credit quality of the business.”
MGIC rose 12 percent this month to $6.07 and Radian has climbed 15 percent to $13.69.
Some funds are scaling back after the rally. Saba Capital Management LP, run by Boaz Weinstein, cut its MGIC stake by 87 percent from three months earlier to 1.2 million shares as of March 31. Jonathan Gasthalter, a spokesman for the New York- based firm, declined to comment.
The companies also have debt ratings that indicate very high credit risk. MGIC, which lost its investment grade status in 2009, is ranked Caa3 by Moody’s, while Radian is two levels higher at Caa1.
Too Optimistic
Investors may be too optimistic about the prospects for a quick shift of the housing market from government backing to private capital, Jason Stewart, an analyst at Compass Point Research & Trading LLC., wrote in a May 1 note.
“Assigning a value greater than $5 to MTG shares today is akin to making a wager on the government’s propensity and ability to transform the U.S. housing finance market,” he wrote, using the ticker symbol for MGIC. “Historically, this wager has been met with outcomes most private MI common equity holders would classify as massively disappointing.”
Previous mortgage insurer rallies in 2009 and 2010 evaporated as losses from policies sold before the crisis persisted. Radian closed above $18 in 2010 and MGIC above $13.
Leon Cooperman’s Omega Advisors Inc. disclosed a stake of more than 5 percent in mortgage-guarantor PMI Group Inc. that year. At the time, Cooperman said the company was a “survivor.” PMI filed for bankruptcy protection in 2011.
Housing Recovery
This time the housing market’s strength will support the shares. The insurers are operating in a housing recovery that’s strengthening as the job market improves and the Federal Reserve pushes borrowing costs for mortgages to near record lows. The unemployment rate fell to a four-year low of 7.5 percent in April, according to Labor Department data.
“Mortgage insurers are all experiencing improving fundamentals, as their performance is tied to the housing recovery, and should offer considerable upside if recent positive housing trends continue,” Paulson & Co. said in a letter to clients obtained by Bloomberg News in April. “Certain types of insurance companies are currently trading at low relative valuations and should offer considerable upside.”
Paulson said Radian can reach $20 per share by 2015. The fund also has stakes in MGIC and Richmond, Virginia-based Genworth, which backs mortgages and sells life insurance and long-term care coverage.
Soros Buying
Soros Fund Management LLC took a 2.8 million share stake in Radian as of March 31. Perry took a stake of about 9 million shares of MGIC, and Blue Ridge added 5 million, bringing its holding to 14.9 million shares.
Spokespeople for Paulson, Maverick and Blue Ridge, which is run by John Griffin, declined to comment on the share purchases. Blue Ridge, which manages $7 billion, and Maverick, are so- called Tiger Cubs that trace their roots to Julian Robertson, founder of Tiger Management LLC.
Michael Vachon, a Soros spokesman, and Mike Neus, general counsel at Perry, didn’t respond to messages seeking comment.
Investors are “looking at the credit quality of the business, the improved housing market, and the expected return to profitability of the business,” said Emily Riley, a spokeswoman for Radian. Radian has forecast a marginal operating profit for the mortgage insurance business this year, excluding some compensation expenses tied to the rising share price.
Genworth’s mortgage unit reported its first profit since 2007 in the first quarter. At AIG’s United Guaranty, operating profit rose to $41 million from $8 million a year earlier. Excluding some one-time and unusual costs, Radian also posted a profit in the first quarter, according to a May 2 note from Mark DeVries at Barclays Plc.
Improving Profitability
Paulson’s fund also holds debt from Radian and MGIC, according to data compiled by Bloomberg. Improving profitability helps bolster the credit ratings of MGIC and Radian, Moody’s said in a May 15 report. The insurance the companies have sold since the crisis backs higher quality mortgages than the loans they backed before the crisis, Moody’s said.
Radian raised about $689 million selling stock and senior notes in February after commissions and expenses, and MGIC raised about $1.15 billion in debt and equity offerings the following month. The cash helped replenish capital that was drained during the housing crash and showed investor confidence in the firms.
“When you leverage the new capital and cure the older books, there is a turbo-effect to the earnings of these companies,” said Jack Micenko, an analyst at Susquehanna International Group LLP. “These are fairly higher earners in a normalized environment. We are moving from a very difficult environment to an environment that is much more positive for them.”
