Thursday, March 15, 2007

Subprime Bad and Ugly

Subprime mortgage default insurers such as PMI Group (NYSE:PMI) and MGIG Investment Corp (NASDAQGM:MGIC) will scratch back very soon. Insurers do not just write out checks. They will want to ensure that underwriting and documentation standards have been properly adhered to.

There is increasing anecdotal evidence that subprime mortgages were given to anyone; even in some circumstances individuals whose income was left off the application/underwriting form. Claims of this nature will most likely be declined. The lender will be declared reckless and the insurer could keep the premium. The battle will be trench warfare mortgage file by mortgage file. If the insurer cannot keep the premium watch for earnings restatements and decreased cash positions.

The insurers are fighting for their lives and will say and do almost anything. Remember the real estate and mortgage scandals from Savings and Loan days. Lots of documentation wars went on for years creating work for lawyers, accountants and associated fee sucking bottom feeders.

But we should have seen this coming. How blind were we all? In the just recently filed 10K PMI Group (NYSE:PMI) reports an increase in loss and loss adjustment (That’s the money they actually lose as an insurance company) in 06 over 05 of 17.5%. This is double the comparable 05 over 04 increase which was 8.6%. So the year over year trend was like a fast bullet train leaving the station.

The real indicator was PMI’s 10Q filed Nov 07, 2006, which showed a Q3 06 over Q3 05 increase of 29% in loss and loss adjustments. That was probably the real tip off of the coming storm.

In both the 10Q and 10K management took great pains to explain that NIW (New Insurance Written) had been dropping dramatically due to increased amounts of securitization.

Lots of foolish red ink around for all categories.

But if that was not enough Mr. L. Stephen Smith, 57 CEO, Pres, COO, Director, Member of Financial Guaranty Oversight Committee and Chief Exec. Officer of PMI Mortgage Insurance Co has been selling shares like a maniac and cashing in his chips. (As late as March 1 he exercised options and sold 10,000 shares into the market immediately; as well as Feb 6, Feb 2, Jan 3, all of 2007 and Dec 7, 2006.)

Oh and Mr. Victor J. Bacigalupi, 63 Chief Admin. Officer, EVP, Gen. Counsel, Sec., Chief Admin. Officer of PMI Mortgage Insurance Co and EVP of PMI Mortgage Insurance Co has also been bailing out.

While the CEO and key officers were running for the hills the stock surged approximately from $42 on Nov 1, 2006 to $50 in early Feb to almost back down to $42 in recent trading.

Methinks some SEC and DOJ scrutiny will be coming shortly. The ISS (Institutional Shareholders Services) Corporate Governance Quotient (CGQ®) for PMI as of 1-Mar-07 was better than 86.4% of S&P 400 companies and 97.8% of Banks companies. ISS will be reviewing their files and perhaps explaining why this company looked so good.