Sept 19 As more Americans buy homes, the handful of private insurers that cover their mortgages are attracting heavyweight investors keen to profit from the nascent housing market recovery.
With billionaire John Paulson snapping up their shares, Radian Group Inc and MGIC Investment Corp are at the forefront of a recovery that is wiping out losses sustained when the housing bubble burst five years ago.
"These companies are writing highly profitable new business," said Charles Murphy, partner at hedge fund Paulson & Co.
Though the housing recovery might have slowed, with mortgage rates rising on the expectation that the U.S. Federal Reserve will soon reduce its bond-buying economic stimulus program, most economists think the upward trend will continue.
Once again, there are seven private mortgage insurers in the United States - the same number as before the housing crash, their depleted ranks bolstered by new entrants that have acquired defunct operating platforms.
Private mortgage insurers accounted for 36 percent of U.S. mortgage insurance written in the second quarter, their biggest quarterly share of the market since 2008, according to a Royal Bank of Scotland report published in August.
The proportion will keep rising as home prices appreciate and their main competitor, the Federal Housing Administration (FHA), charges higher premiums, analysts and executives said.
Mortgage insurers cover losses when homeowners default and foreclosures fail to recoup costs. Typically, coverage is required when homeowners make a downpayment of less than 20 percent on a property.
Companies such as Genworth Financial Inc and Old Republic International Corp, as well as Radian and MGIC, were left nursing losses after selling billions of dollars of low-priced policies before the market crashed in 2008.
As a result, the FHA's share of mortgage insurance ballooned to a high of around 70 percent in 2009, according to specialist publication Inside Mortgage Finance.
But the agency's share has been falling as it has reduced its market exposure and raised premiums to replenish dwindling cash reserves.
"Our lender-customers consistently tell us they are moving back toward private MI (mortgage insurance) usage from FHA, and the numbers bear that out," said Rohit Gupta, president and chief executive of Genworth U.S. Mortgage Insurance.
Echoing data quoted by others, MGIC Chief Executive Curt Culver said private companies now accounted for about one-third of the U.S. mortgage insurance market and the FHA two-thirds.
"I would expect that to flip totally over the next few years, back to the traditional two-thirds, one-third in our favor," Culver said at a conference this month.
Macquarie Equities analyst Sean Dargan identified the higher FHA premiums - and thus the agency's reduced ability to compete - as one of two main drivers of the revival in private insurance.
Higher home prices are the other major driver, he said.
"As we see more home price appreciation, it will improve the outlook for claims severity and perhaps will cause a change in borrower behavior - where borrowers are less likely to default."
Investors are betting on the recovery. MGIC's stock has risen sixfold in the last year and Radian's has quadrupled.
Yet both still trade at a fraction of their pre-crisis values, suggesting plenty of room for growth. MGIC's stock price of $7.77 compares with a lifetime high of $75.62 in 2004; Radian peaked in 2007 at nearly five times its current price of $14.06.
"We think there's a good run left in terms of regaining share," Radian Chief Financial Officer Bob Quint said at the same conference this month.
Fund heavyweight John Paulson bought 17 million MGIC shares in the first quarter to become the insurer's No. 3 shareholder, with a 5 percent stake. He also owns about 7 percent of Radian, making him that company's second-largest shareholder.
Paulson & Co's Murphy said losses from the insurers' legacy portfolios had become less severe as home prices have risen and the number and severity of foreclosures has declined.
Other hedge funds, including Maverick Capital and the family office of George Soros, have also built stakes in Radian and MGIC in the first half of the year. Maverick, helmed by veteran stock-picker Lee Ainslie, owns about 4.4 percent of MGIC.
Genworth's Gupta said private mortgage insurers raised about $2 billion in capital in the last year. As more money flows in, they will be better equipped to assume risk and reduce the government's role in the housing market, he said.
The mean price target of eight analysts covering MGIC's stock has risen nearly 28 percent in the last two months to $7.50, according to Thomson Reuters I/B/E/S. On Radian, the mean price target has risen 20 percent to $15.21.
None of the eight analysts covering Radian has a "sell" rating on the stock. Of those covering MGIC, only Credit Suisse analyst Douglas Harter rates the stock a "sell", having said in June that the favorable trends were priced in.
SPACE IS LIMITED
Three of today's seven private mortgage insurers - NMI Holdings, Arch Capital Group Ltd and Essent Guaranty Inc - entered the business by acquiring the operating platform of a company that had stopped writing new insurance.
Essent Group Ltd and NMI, which raised about $510 million in a private placement of its shares in April 2012, have both filed for an initial public offering of their shares. They declined to comment ahead of their respective listings.
With no more such platforms available, any company seeking entry to the market now would have to start from scratch. High entry barriers and tighter regulatory oversight make this a tough task.
To be competitive, any new entrant would need to raise $200 million to $400 million of new capital and maintain such a level for seven to 10 years, Susquehanna analyst Jack Micenko said.
A new insurer would also need approval from individual states to write new business, as well as the endorsement of government-sponsored entities such as Fannie Mae and Freddie Mac - a process that can take more than a year.
All of which bodes well for those already in business. MGIC and Radian, which together account for nearly half of the U.S. private mortgage insurance market, each wrote record business in July.
"You are more likely to see an expansion of market-share opportunities for the existing players," FBR Capital Markets analyst Edward Mills said.