NOTE TO BOARD:
Just got done reading the post by mewbie RON369. Like Ron, I�m new to this board and I'd like to say how much I appreciate the information contained here.
I felt I should reciprocate.
Because of the huge downturn in the market I started looking at mortgage insurers in late October. I studied hard. I read the conference calls over the past year and tried to make since of the supporting data.
I pulled the trigger on my IRA and some for my Joint account with my wife.
My wife, like many of you, is smart. But she had not studied the market. So I tried to write out what I was learning. The following is a several page overview I prepared for her. If you are a newbie or are trying to convince your spouse or significant other of whether to invest this might be beneficial. I have also tried to honestly lay out why many believe bankruptcy is going to occur. My feeling is that if I fully inform my wife of the risks before investing, I have limited the potential for "I told you so" later on (which my wife, thankfully, is not given to).
I spent days researching it and at least 6 hours writing it. So it is very long and will only fit by multiple postings. (If you wish to comment, please do so at the end, so that others may read the material in order.)
Unfortunately, in cutting and pasting from Word to Yahoo, there are characters (mostly, the apostrophe) that transfer as gibberish. I will try to clean those up before posting (I have also avoided contractions I would otherwise use). But, normally when I post there are a few characters that I don't catch.
Thanks again for your help.
A final note: I liked this stock a lot more at $6-$8.50 where I bought, than at $11.
I hope some of you have the patience to wade thought this and benefit from it, as I have benefited from you.
Dennis, I just read your study and wanted to congratulate you. I wish everyone would do even half as much research and analysis before investing. It is a very tough job to try to balance value, sentiment, risk and market forces and, insofar as it comes down to a personal decision for all of us, your method is something everyone can use to weight all the factors to their needs. Great job, man!
Hola all, Dennis great write up, well done. I am in the investment business and troll the boards looking for any info i might have missed or some new rumor. I rarely post as most of the discussions are not worth it but I thought I would throw in some other info for people to just consider.
As my disclosure I have been short this name since the low 30s. I am no mortgage/lending expert but I just saw things here that couldn't hold up. My position is very small now because I don't want to be a pig but I am not covering yet. Y'all seem rational so I wanted to play the devils advocate.
I would strongly encourage all to pull TGIC's most recent 10Q. The points to consider are that their leverage ratio is 17.8 to 1 (22 to 1, is the magic number because it means debt downgrages/capital calls). Secondly check your #s on loans of LTV of 95% or higher, as of Sept 31, 2007 that number for the previous 9 months had grown from 15.1% ended Sept 2006 to 40.4% Sept 2007. Also they define Alt-A with FICO scores over 619 that have been underwritten with reduced or no documentation. This account for 33% of their business as of Sept 31, 2007. Also note their largest customer for 2007 was American Home Mortgage (35% of their business in 2007). AHM went belly under and was less than a credible lender. I do not think TGIC is consider a conservative underwriter, in fact they are probably the most aggresive.
GOt to run market getting run over now, but please be careful here, a 5% position would be fine, but i would strongly encourage you to not double down, or try and follow this name down if it should go lower. They are in a very tight spot and I have a hard time seeing how they survive. The insider buying is nice and frankly throws me off a little because I don't know if they are brilliant or just being dumb. Please read the 10Q and just notice how their numbers are changing and their credit quality is going down. I ultimatly think the leverage ratio is what gets them in trouble as it climbs and the debt downgrages pile up causing them to liquidate at the wrong time.
Good luck! be careful and happy investing. Also for the record if you are looking for other names if for some reason you change your mind, I like ETFC to survive and ABK to survive. PMI might make it as well but i dont know them well.
Also short HRB, they are going to miss earnings with this Option One still on the books and people aren't paying close attention. :)
Great summary Dennis. I would also say that your analysis makes a good long-term case for the company even at a price of $10.50/share. To me, it isn't the screaming buy it was in the $6-8 range, but it still looks more attractive long-term than most other companies that I've studied. I'll probably invest some of my dividends from other companies in TGIC while it remains under $12 or so - to me, that offers a reasonable margin of safety when looking at the 5+ year term.
I will share with you the thoughts of one web poster (I've cleaned up some of the typos) concerning Radian:
Outlook seems positive, and price is the key:
1) Rate cut [by Fed] will give it a boost
2) Yes, this quarter might be bad and they might lose 2-3$ a share ..guess what.... the stock is down over $40+ a share..think its priced in lol... even if all of 2008 turns out to be a loser put those future losses to present value terms...present stock price still makes no sense. Oh and imagine if it isn't...
3) Assets might take a writedown, well the stock is off by 80%+ i think the writedown of what even a billion [on RDN]...well then the stock should be worth more than double its current price.
4) What about bankruptcy..did u read the S&P report?.. so much for that.
5) Earnings, if earnings aren't a total mess stock will shoot up and if management thinks its outlook is like Countrywide's, then were lookin' at a 40% one shot boost.
6) Shorts will get squeezed another boost.
7) Think the CEO [of RND] bought 250K worth of the stock @17$ cause his bank account was full? Or cause he knows the situation ain't that bad compared to the price the stock is at? and that was @17.
Time to rob people and take their shares that they are giving away.
Its like the story yes the outlook ain't rosy but at what price does that factor out. Price is the key.
Mercedes is a good car but not at $400,000 it ain't.
Fords aren't as good and are built cheap etc..etc.. Kinda like our situation here ( future is not bright, might be a loss etc..) but if you can get a new Ford for 1000$ well...
I believe the market overreacted. I believe many of these companies are going to bankruptcy court. Triad and probably Radian will not. The upside is a 300%-400% profit. The downside is a loss of everything invested. I believe a purchase of 5% of our portfolio is warranted.
Several months ago I did an extensive amount of due diligence on this company (see previous posts) in an effort to explain to my wife why I wanted to invest in it. (Sorry, I didn’t edit myself very well; it’s way too long.)
A few of you decided to invest based upon my analysis. I was right on a number of areas: when bad stuff happened the fed was willing to lower interest rates to bring liquidity and reinflate the market for homes. However, I have now substantially reduced my position in TGIC. Since some people listened to me then, I think I have a duty to inform them of my decision to exit.
My leaving is largely because of the following:
(1) The large decline in China has offered investment opportunities that I believe may create 300% returns over 3-5 years. These stocks offer the upside I sought with TGIC but with far less downside (assuming some diversification). The companies are making money in a country with incredible growth and an undervalued currency. (If you would like to see which stocks in that market I like, go to the Yahoo SUTR board, where I have outlined my recent investments on a 31 March ’08 post.)
(2) Instead of scaling back their business, TGIC has sought additional equity in order to grow, which will result in substantial shareholder delusion. This dramatically reduces the upside on this stock.
(3) It appears the Feds efforts are not significantly holding back the decline in home prices. They are trying to stop the tide of reduced prices. (Or, put another way, they want to fight the laws of supply and demand. A difficult thing to do.)
(4) The combination of the housing crisis and higher prices for oil, food, etc., is leading us into a recession (if we aren’t in one already). A recession will put increased pressure on housing prices, especially in the problem states.
TGIC now requires down payments of 10% to issue business in the problem states (CA, NV, FL). I believe they should not be issuing insurance in any area where less than half of the population can afford a home. (Guys, why not just close down the shop in San Diego and LA?) In some areas of California only 20% of the population can afford a home even at today’s lower prices.
It seems to me that the housing crisis is a Katrina type event in America – at least financially. TGIC is selling policies as the hurricane is hitting land. While they are getting better rates, a financial hurricane is a financial hurricane. It’s never good for the insurer.
I suggest we put Kenny Rogers on the board of TGIC. He knows that: “You gott’a know when to hold ‘em, and know when to fold ‘em, know when to walk away, and know when to run.”
I think the California, Florida, and Nevada markets are ones that you should run away from. TGIC management believes they have adequately priced their policies to accept the risk. At least as to 80% of my TGIC investment, I’m walking away from the table.
For those of you who are still bulls, my leaving and Philby’s leaving may be a great contrarian indicator. The best time to invest is when there is blood in the streets. If bulls like us have bailed, there is blood in the streets.
I would like to personally thank Shifty591 for his constructive criticism of my October/November analysis. I indicated in my report that I intended to invest 5% of my and my wife’s portfolio in this segment. I got as high as 15% (oops). After reviewing Shifty’s post, I cut back to 8% and then 5% when the price hit $10. That cut my overall loses in the segment down to manageable levels. Thanks.
To those of you who listened to me and lost: I am sorry. I put my money where my mouth was. For now, I was wrong. If TGIC had decided to trim their sails and weather the storm, I'd still be here. Instead, they appear to want to run into the storm and throw the passengers (you and me) overboard with a delusive offering.
I also concur that this is one of the best written discussions I have ever seen on Yahoo. I was also pleasantly surprised to see that I was cited as a source regarding Triad's conservative underwriting standards.
They have always been more conservative and that is one of the reasons we send only our delegated business to them. Delegated refers to our cookie-cutter loans that fit their guidelines perfectly. They are very by the book when it comes to underwriting and do not make exceptions.
This company is not going anywhere, but I also expect that the next 12-18 months will be difficult for them. The patient long term investor will be rewarded. For the short term, I expect a great deal of volatility.
Still long and happy to be part of an excellent message board.
Thank you Dennis for the best analysis I have ever come across on Yahoo.
Your analysis has convinced me to go ahead and add to my position a conclusion I had partially reached by looking at the long term stock chart.
I was looking to see if their price spiked upwards sharply during the bubble years of 2005 and 2006 ( As is the case with CFC and others ), the fact that it does not lends credence to your asertion that they are conservative underwriters with high standards. That might not seem much to go on , but knowing the Wall St heard mentality and the fact that no whiz kid will now have a mortgage insurer in his portfolio , is enough to explain why this stock is on sale .
(5) THE POSITITVES
I've sprinkled the positive throughout this report, so here I'll just add a few more:
(a) Executives at both companies are buying their stock. The head of Radiant paid $250,000 for stock at $17. Triad executives have purchased at $20 and purchased more at $8 within two days of the release of their third quarter loss. (Since this was first written, on 10/31/07, 9 insiders have purchased shares, an unusually large number over two weeks.)
(b) Listening to the conference call, the Triad executives did not seem to be in a "we're in deep-do-do" mode. More of a "can't you guys figure out that we're going to live?" mode. That's an attitude executives frequently have before stocks go up -- it was typical of executives in 1974. Part of their attitude was reflected in their desire to get the information
out to the public -- transparency is normally done by people with nothing to hide.
(c) Once again -- these stocks are selling at 20% of book. And book is not worthless old factories in the rust belt. In the case of Triad, it's a book of 80% AAA bonds that can be liquidated, as needed.
(d) I have a bias that California real estate is hugely overpriced. But I also have a bias that there is world-wide inflation. This was caused (in large part) by the Fed's 1% interest rates under Greenspan. If oil has doubled (and more), food is doubling, and health care is doubling, why won't inflation come back to real estate too? (And foreigners will be buying a lot of houses in CA and FL with cheap dollars.)
As inflation hits real estate, even if real estate would otherwise go down, it may only go down 10% in dollars -- at some point there is a cross-over point where the value gets back to what it once was. And with inflation, wages go up making it easier for people to afford their payments.
(e) I have indicated that default rates would have to exceed 25% to endanger the companies (according to Triad management). That means a lot of 700+ credit ratings (50% of their customers) defaulting. Unlikely. The most likely way that happens if there is a BIG recession.
But in case of recession, the Fed breaks the glass. It cuts interest rates. If interest rates go back down to 3% on CDs and 5% on home loans (they were that for a while), then real estate prices are likely to go back up. That would bail out these companies.
I do not believe, as some do, that Congress will bail out all of the idiots who got 100% mortgages on 800 sq. ft. 1 bedroom houses that cost $600,000 in San Diego. But, then again, these people vote and there may be an election next year.
(4) WHAT THEY DID TO PROTECT THEMSELVES
Radian capped its Alt-A (that's one step from subprime) exposure at 14%. It sold a unit to generate cash. They improved their capital adequacy ratio.
Triad refused to write any sub-prime loans in the first place (although they have some that appear to be close to that level).
On the web, one writer (Kingwk01) with industry experience states that Triad has always been conservative. He states as follows:
"I have been in the mortgage industry for 20 years and have had the chance to work directly with Triad in obtaining mortgage insurance for our loans and know many individuals that currently work for Triad.
"For what it's worth, I have always found Triad to be on the more conservative side when it comes to underwriting loans for mortgage insurance. They also rarely make exceptions outside of their guidelines. I don't believe that they have the exposure that some of the other mortgage insurers may have.
"I believe that the current stock price does present a buying opportunity. They do have a strong management team and I can personally vouch for the strength of their line underwriters and managers. I fully expect to see more insider buying than the 7000 shares that were reflected for 10/30/07.
"I'm currently in for 2500 shares and $5.76 and plan to hold for the long term."
Another web writer (from Portland) stated that he ran into a mortgage broker at a party and, when asked, the guy told him he rarely used Triad because their underwriting was tight.
Triad did a lot of disclosure in it's last earnings conference call, so I can give more details related to it. Here are some highlights:
(a) 1/3 of its portfolio has been subject to reinsurance through "captive" insurance. This means that if default rates go above 4% then someone else pays, until defaults exceed approximately 13% (default rates are currently at 2.7%).
(b) Another 25-30% of the portfolio has other types of limits on losses through "stop-loss" provisions.
(c) Percentage of portfolio in CA, FL, and NV: approx. 32%. (Note, too: Not all of California is super-overpriced. There are some areas, such as
Sacramento, where houses are only expensive, rather than outrageously expensive.)
(d) Percentage of portfolio to people with 700+ credit scores -- 50-55%; 660-699 credit score -- 25%; 620-659 -- 18%; 620 or lower -- 5%.
(e) Percentage with loan to value above 95% -- 20%. (This means that 80% of the people put up some serious cash when they purchased the home that they WILL NOT want to walk away from. And, if they are conservative, they required real income for the 20% of the people they issued policies to with limited down-payments.)
In their conference call, Triad indicated that they still get reasonable returns with up to about a 13% default rate (I assume that means over the life of the business, the current rate is 2.7%). They implied they think it will go up to at least 4% or 5%.
They also were asked what would have to happen for book value to decline 75% (to the current share price). Management answered that for that to happen default rates must go up to amounts that have never been seen before -- 25%, or so. The only time that has happened, so far, was in the limited market of the Rocky Mountains in the early 80s.
As an overview, management believes that the market will have to tank in huge areas of the country for them to have write downs of over $10 per share on book value. That would still get you to a $30 book value and if the stock got back to book, that is a 350% profit.
(3) THE NUMBERS.
Radian earned $5 per share last year. It has a book value of $46. Stockholder equity of $4 billion.
It is selling for $13 ($1 billion for the entire company).
Triad earned $3.80 per share last year. It has a book value of $40. Stockholder equity of $571 million. Very little debt.
It is selling for $8 ($118 million for the entire company).
They are both selling for 20% of their book value. Most companies sell for at least 2 times book. Most financial services companies sell for 1-2 times book.
It is likely that both companies will continue to write down their equity as losses pile up. They will increase reserves. But even if defaults double (to 5%), Triad estimates that they will still have a nice profit. (Recognize that a default can be cured -- not all defaults lead to foreclosure.)
The only time I have seen companies trading at 20% of book value is when the market believes they are going broke. This happened to me last year with a company called Wolverine. I lost 60% before I bailed. (The steamroller.) The difference is that Wolverine had high union contracts and faced Chinese competition -- bad news long-term. Here, the businesses have historically been profitable.
S&P and Fitch have done updated reports on both companies. Although the rating services downgraded the shares, according to the agencies: BOTH Companies have strong financial strength.
The market is saying something different.
If these companies survive, it is likely that their stocks will go up 200-400% from their current level. So there is the potential for high returns for high risk.
(2) MARKET AND PERSONAL PSYCOLOGY
When markets tank sometimes it is real; sometimes it is just perception; and most of the time it is a combination of something real and perception.
One of the greatest examples of this was the Russian stock melt down about six or seven years ago. Russia defaulted on its debt. The market was down something like 80%.
Was there a very real and horrible event? Yes. But those who bought right after the crash got 20 to 1 returns.
Markets often over react. Both up and down. The tech bubble was a real bubble. The NASDAQ went from 500 to 5,000. It went up too far. It then went down 60%, 80% in many cases. It still hasn't recovered. (The NASDAQ is now about 2,800.)
My point is that when the market drops a lot, sometimes it's wise to buy (Russia) and sometimes it's wise to get out of the way of a steamroller (NASDAQ 1999). And you only know which is which in hindsight.
When stocks go down, some people have the guts to add to their holdings. An old saying on Wall Street is: "Buy when there is blood on the streets." Easier said then done. Most of us, follow the thundering herd. If we buy and it goes down, we say: "Hey, I was wrong when it was at 30 and I was wrong at 20, why should I think I'm right at 10?" And we either throw in the towel or we just sit tight hoping it will go up.
Most Institutions are no different. A portfolio manager of a mutual fund may not want to have any mortgage insurance company in his portfolio. People look at anyone stupid enough to have bought a loser and they pull their money out. Better to have a high tech stock go down by 80%, since shareholders understand that high tech is risky. (In contrast, since everyone knows that houses are going down, if a mortgage insurance company fails, they think you are an idiot.)
Sometimes, everyone bails at the same time. This is what is called an "over-sold" stock. Eventually, the stock will reach an equilibrium point: higher than the Low; but much lower than the High. (I believe this occurred with Triad last week right after the earnings release. Millions of shares changed hands. It dropped under $6 per share. I bought.)
Another part of this is personal psychology. Just because a house will sell for less than you paid for it, doesn't mean that a homeowner will walk away.
First, the homeowner will try to convince himself that it will turn around. Second, the homeowner usually loves his house. And, even if he doesn't love his house, his wife and kids do. If a person walks away from a home loan, buying another house becomes impossible for 5 or 10 years -- their credit is shot. Third, if Triad was conservative in selling the policies, the mortgage is less than 28-35% of the person's income -- meaning they can still afford it.
So, a lot of people keep paying when they are underwater on their loan. The only question is if they have the income to keep paying. (If they keep working, they usually can.) Imagine if our first house (price $125,000) had gone down in value to $80,000. Would we have kept making the payments? Yep. Because we liked the house, could afford it, we keep our commitments, and we would trash our credit rating if we left.
My point is that although I firmly believe house prices in FL, CA, DC, and NV will drop a lot (probably more than 20% from the peak), not all of the homeowners will just walk away. Many will keep making that payment, muttering all the way, waiting for the day it comes back. The mortgage insurers will not lose on those houses.
October 31, 2007
RE: Mortgage Insurance Industry (RND and TGIC, only)
I believe that you should consider putting a small portion of your IRA into the mortgage insurance stocks. I already have some of our joint account in one (TGIC).
I want to preface this by saying that you are not expected to pull the trigger on one of these stocks. Sometimes I can be too easily sold or look at opportunities with rose colored glasses. So, if your gut says "stay away", that's fine.
I will present this in five sections: (1) the negatives; (2) market and personal psychology; (3) the numbers; (4) what they did to protect themselves; (5) the positives.
(1) THE NEGATIVES
The stock market is saying that these companies have a substantial (over 50%) chance of going bankrupt with no payout to shareholders.
Earnings are now negative and are likely to be so for at least the next year -- most likely for 18 months.
Mortgage insurance covers the banks if the debtor fails to pay his mortgage payment. It involves the last 20% of home equity, as the banks will loan up to 80% of the appraised value. For a fee, the insurance company is assuming about 90% of the risk of default.
Thus, in markets that are falling 10% a year, like California and Florida, the insurance company will likely be on the hook for 20% of the home's purchase price when a home owner quits paying. The cost is huge. Claims cost at TGIC went from $31,000 in January to $37,000 per claim in the third quarter (with the average default being on a $55,000 loan, note that all claims are not a 100% loss).
House prices are expected to fall another 8% next year. In many inflated markets, such as California (already down 5-10%), Nevada, and Florida, the fall off could accelerate. The greater the decline, the more people will decide to walk away from their homes.
In that event the write downs are huge. It is possible a further S&P rating decrease could be in the works. As Fannie Mae only allows insurance from investment grade companies, this could limit any additional business for both companies.
Further, it could be worse. I believe California real estate is 40-50% overpriced. Buying a 800 sq. ft. house in San Diego -- without a view -- for $600,000 seems crazy to me. But we saw one for sale when we visited. If there is a fall in prices of over 30% (which happened in the early 80s) default rates in the most over priced markets are likely to skyrocket, with huge losses. However, in doing this research, I revised CA real estate web sites and found
(to my surprise) that many properties are available at high but not outlandish prices ($300,000).
Triad has $11.6 B of home loans at risk and $571 of equity (a 5% ratio of capital to risk). They get additional premiums of about $300 million each year. But they have protected themselves through the use of reinsurance, which will be discussed later.