Mortgage Servicing Fraud
occurs post loan origination when mortgage servicers use false statements and book-keeping entries, fabricated assignments, forged signatures and utter counterfeit intangible Notes to take a homeowner's property and equity.
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Nye Lavalle
Mortgage Land's Latest Peril: a Value Trap
By Jonathan R. Laing
1324 words
17 September 2007
(c) 2007 Dow Jones & Company, Inc.
With $4.1 billion in net worth as of June 30, the mortgage-insurance company Radian Group might have seemed cushioned from the mayhem unleashed by the unfolding deterioration in the U.S. residential mortgage market.

But it hasn't turned out that way. In July, the company (ticker: RDN) announced that it had likely suffered a complete impairment of its 46% stake, worth around $518 million, in a joint venture called C-BASS. That concern, which specializes in buying at a discount distressed subprime mortgages and securitizing the paper, was laid low by margin calls it was unable to meet because of the deterioration in the value of its holdings of scratch-and-dent subprime paper.

Then Radian's $128 billion mortgage insurance portfolio was shredded by other subprime bombs. The company fessed up at an investor conference on Sept. 5 that its insurance policies covering $742 million worth of NIMS -- "net interest margin securities" -- the highest-risk portion of subprime-mortgage securitizations, were projected to generate some $340 million in loss claims over the next several years.

Likewise, Radian said it had bet and lost on its insurance of $1.1 billion of second-lien, or "piggy-back," mortgages that were projected to lose more than $300 million over the next three and half years. Such mortgages are being devastated by their first-loss position in front of first-lien mortgages in a market of weakening home prices.

As if this weren't enough, all of these contretemps resulted in rival mortgage insurer MGIC Investment scotching its plans to acquire Radian. Most market observers deemed the offer by the larger, better-capitalized MGIC (MTG) as something of a lifeline for Radian. But MGIC, a joint owner of C-BASS, sued to get out of the Radian deal just weeks after C-BASS hit the wall, expressing concern over Radian's prospects in a weakening credit market. Both companies then agreed to call off the merger on Sept. 5.

The aborted transaction initially involved a stock swap worth $5 billion when announced in February but had dwindled to less than half that value earlier this month in the wake of a more than 60% decline in value of the stocks of both companies.

Radian tried to put the best face on the canceled nuptials during a telephone investor-conference held the same day as the termination announcement. While the company owned up to the projected losses faced at C-BASS and its NIMS and second-lien exposures, as well as a heavy $2.2 billion in likely claims losses in its traditional mortgage-insurance portfolio, Radian claimed that expected earnings in its various lines of business would still boost its net worth or book value from $4.1 billion, or $51.53 a share, as of June 30 to $4.8 billion, or $59.96 a share, by the end of 2010.

The presentation appeared to bolster confidence in the company, with the stock jumping more than 10% over the succeeding week and reaching a closing price of around 20 by last Friday. After all, what's not to like about a stock trading at less than half its latest book value and a third of its projected 2010 net worth?

Among those recent buyers of the stock were several Radian executives and Third Avenue Fund, managed by renowned value investor Marty Whitman. Whitman seemed to be doubling down by boosting his stake to 10.7% from about 2% as of April 30, when the stock was trading around 60.

Yet Radian's future is by no means assured, despite its upbeat forecast. Incurred losses over the next two years could pummel its earnings. Perplexed analysts are forecasting 2007 results all over the map, from a Bear Stearns estimate of a loss of $3.30 a share to a UBS profit estimate of $3.03 a share.

Moreover, a flurry of credit-rating downgrades in the wake of the MGIC jilting call into question the ongoing profitability and value of Radian. As Moody's dryly asserted in its news release of the rating cuts, "Radian will likely experience a contraction in market share and reductions in business volumes." Such downward spirals in business can perpetuate a vicious cycle for insurance companies in which claim losses and shrinking market share feed malignantly on each other.

Plenty could happen, for example, to short-circuit Radian's projection of $59.96 a share in book value by the end of 2010. For one thing, claim losses in its traditional mortgage-insurance business could exceed the $2.2 billion projection given at their investment conference.

Radian's forecast assumes that U.S. home prices over the next three-and-a-half years will remain essentially flat, with areas of price strength compensating for areas of weakness. Such optimism, however, is fast leaching out of the housing markets with the relentless rise in foreclosures and unsold home inventories. The S&P/Case-Shiller composite index of home values showed a shocking 3.2% year-over-year price decline in the second quarter. Based on "repeat sales" of properties in 20 metropolitan areas, the index is a more reliable reflection of reality than the median sales prices favored by the real-estate-broker community.

Radian's projections about possible claim-losses don't inspire much confidence, either. The company has said such losses would balloon by $730 million if one were to assume a worst-case scenario of a 20% decline in home prices in the Midwest auto-industry states and "bubble" areas like California. Still, this test would cover only 43% of the mortgages in the company's portfolio.

Likewise, Radian's base-case loss estimate assumes that only 8.1% of its $41 billion in "Alt-A" mortgages will go to claim, compared with 18.2% of its $13.3 billion in insured subprime loans. The Alt-A category resides in a netherworld between prime and subprime, an area where fraud abounded because borrowers didn't need to furnish proof of income or net worth. Boost the assumed frequency of Alt-A loan problems made in the past two years to around 20%, and Radian would be looking at nearly a $500 million jump in claim losses.

Radian's mortgage-insurance business certainly could be imperiled by falling credit ratings. While its mortgage operations still have a double-A rating from S&P, Moody's has those units just one notch away from single-A. And Radian is under a "Creditwatch with negative implications" at S&P and under review for a possible downgrade at Moody's. A cut to single-A by either would likely reduce materially the volume of business that Radian does with government sponsored enterprises Fannie Mae and Freddie Mac. "If we get downgraded, we'd certainly have to enter into another round of active discussion with the GSEs," Chief Financial Officer Robert Quint told Barron's.

Nor are the prospects unblemished for Radian's financial-guaranty operations, where the company insures against default some $110 billion of municipal bonds and various structured products. A recent rating reduction by Fitch of the business to A-plus from double-A has caused Radian-insured municipal bonds to trade at yields two full percentage points higher than their levels a month ago. "We're hopeful that we can change the market's perceptions in guaranty," Quint says. "Among other things we've asked Fitch to withdraw all their ratings."

Radian, it must be said, is making a few wise moves. It is exiting the businesses like second-lien mortgage insurance that have cost it dearly. But MGIC knew that and still took a pass. Perhaps investors should too.
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