Mortgage Insurance Firms Due for a Comeback

Mike Breen: You have a name you were adding to your buying recently that wouldn't strike me as an obvious growth target. It was Radian, which I think is mortgage lender-related.

Frank Sustersic: Right.

Breen: Maybe you can explain the appeal of that whole thing in this tough environment.

Sustersic: Sure. This is a controversial industry right now--mortgage insurance. Many of the companies, though, are trading at really depressed multiples compared to book value.

You have a disconnect right now between delinquencies and foreclosures. The companies themselves in the mortgage insurance industry we believe are going to be survivors here.

Several different issues, but there's a disconnect between delinquencies, which are still rising, and actual foreclosure activity--and there are several reasons. The banks have realized that once you foreclose on a property the entire value of the property takes major hits, and they don't have the capital cushion to do that.

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Then also there are very political activities that are trying to prevent that from happening. A lot of mortgage modification programs are kicking in. That's one thing I think a lot of investors don't realize is that not only is this a moratorium on foreclosure, but these new adjustment programs, modification programs, the banks are working with the homeowners to lower the monthly payment.

Again, the focus here is to prevent foreclosures, keep individuals in the home, because that is the worst-case scenario for everyone involved.

Thirdly, the mortgage insurers have looked at their claims that are coming through and are using the rescission clause. This is something where they analyze the individual claim, and they've massively staffed up to look at each individual claim and say, OK, was this mortgage insurance policy issued under a fraudulent basis, be it the issuer was rushing out to create more mortgages during the boom period, or was there just outright deception used by the individual to qualify?

They're looking was there proper documentation behind each mortgage? The banks and the GSEs Fannie and Freddie, when faced with these rescission claims, are realizing you're right. It was fraudulently based, and these mortgage insurers are not paying those claims.

That activity just started three to six months ago. Again, all the mortgage insurers are starting to look at each individual claim and are withholding payment because of that basis.

We think that's going to continue, and so these companies are going to, over time, trade closer to book value because they're going to lap--the really bad vintage is '05, '06, and '07, and that's going to become a smaller and smaller part of the overall portfolio.