PMI - PMI Group

**jmrisley** Wed Aug 22, 2007 8:29 am

PMI - PMI Group
Did you ever run across PMI in your scans for low price to book shares? This stock currently trades at $31.50 and book value is $43. I understand that this is in the mortage / residential business and the current credit cruch could hurt them with excessive losses.

But my experience with insurance companies is that they never loss in the end. They are allowed to raise premiums, diverisfy their risks by buying reinsurance and writing off the losses against earnings.

Wouldn't this be a good buy? Also insiders have been accumulating the shares lately.

**bdcmm** Wed Aug 22, 2007 5:10 pm

I also believe mortgage sector is way oversold. There are risks associated with this sector, but the selling also creates rare investment opportunities. The one I particularly like is RAS (Rait Financial Trust), and I've accumulated quite some RAS shares (with average cost of $8.2 per share) during the past couple of weeks.

Although I'm not an expert in mortgage business, there are a few things about this company which made me decide to invest in this company:

- Deep discount to book value: according to its balance sheet and recent conference call, it has liquidation value of over $16 per share. Now it is sold for half of its liquidation value.

- Huge cash flow and dividend: as a REIT company, it distributes 90% earnings to shareholders. Dividend for the past two quarters is $0.8 and $0.84 per quarter, check out its dividend history:
http://www.raitft.com/invrel/index.asp?link=divs
Next dividend will be announced in the mid-September. Although there is some uncertainty on how much will be announced, but its earning power is well-explained in the recent conference call. I expect earning and dividend will be quite decent.

- Huge insider buying: before the crash, insiders including Chairman/CEO/CFO had been buying the share at around $30. After the crash, many different insiders including Chairmain/CEO/CFO/VP/Trustees have been continuously buying. This gives investors good confidence that the company is in good shape. And I also like the management team from this regard. Overall, I think it is well-managed REIT company with good experience in this industry.

- Buffet is buying bank shares: Banks mainly makes money in Mortgage business. Actually when Buffet bought Wells Fargo in 1990, he bought 10% interest for $290M, when its asset is $56 billion and the share price is about 5 times of before-tax earning. If you calculate the ratio here, RAS is being sold at a similar discount. If RAS is bigger, I think Buffet will be interested in this company as well.

Certainly, there are some risks associated with mortgage business as Buffet pointed out for his Wells Fargo purchase in 1990: 1. Earthquake in California; 2. The financial problem is so severe that few businesses survive. Both are possible but unlikely in Buffet's mind at that time, so he made the investment. People often make mistake when thinking "this time it is different."

In my opinion, this stock RAS is likely to double this year and tripple next year. But this is just my personal opinion, so do you own homework before you invest.

I am very busy now, so I barely have time to post or reply in the forum. I apologize in advance if I cannot answer your questions.

I know Blast and many people don't like high leveraged business, but I'd like to pass on this good opportunity to the board members.

Good luck in value investing!

**lzhang** Wed Aug 22, 2007 5:27 pm

Re: PMI - PMI Group
PE wise, it is not cheap compared to other mortgage insurance companies. Further studies required.

Anyway, nowadays, cheap stocks are not hard to find.

Safe buys might be those companies which are not directly affected by this subprime problem, but get penalized, just because of `credit crunch'. For example, major commercial banks, investment banks, etc. They do not have major stakes in the subprime loans. Other areas like the M&A arbitrages we are actively doing right now. For companies directly linked to the subprime loans or HBs with lots of debts, much more detailed studies are needed.

Disclaimer

This is not an investment recommendation to buy or sell any of the securities mentioned therein. All materials presented here are for information purposes only.

jmrisley wrote: Did you ever run across PMI in your scans for low price to book shares? This stock currently trades at $31.50 and book value is $43. I understand that this is in the mortage / residential business and the current credit cruch could hurt them with excessive losses.

But my experience with insurance companies is that they never loss in the end. They are allowed to raise premiums, diverisfy their risks by buying reinsurance and writing off the losses against earnings.

Wouldn't this be a good buy? Also insiders have been accumulating the shares lately.

**lzhang** Wed Aug 22, 2007 5:46 pm

WFC was much more diversified even at that time. Home mortgage was large part of its operation, but that part, with loan default problems, was still small. It is not a pure mortgage loan company.

bdcmm wrote:
- Buffet is buying bank shares: Banks mainly makes money in Mortgage business. Actually when Buffet bought Wells Fargo in 1990, he bought 10% interest for $290M, when its asset is $56 billion and the share price is about 5 times of before-tax earning. If you calculate the ratio here, RAS is being sold at a similar discount. If RAS is bigger, I think Buffet will be interested in this company as well.

Certainly, there are some risks associated with mortgage business as Buffet pointed out for his Wells Fargo purchase in 1990: 1. Earthquake in California; 2. The financial problem is so severe that few businesses survive. Both are possible but unlikely in Buffet's mind at that time, so he made the investment. People often make mistake when thinking "this time it is different."

**bdcmm** Wed Aug 22, 2007 6:59 pm

I agree what WFC was a bit more diversified and bigger, therefore more attrative with the same valuation. However, banks mainly makes money from mortgages and commercial loans. At today's price, banks are not so attrative as today's depressed mortgage REIT business. Good mortgage REIT businesses are the true bargain currently.

Both banks and mortgage REIT business make money by the interest rate difference. RAS uses matching-funds and swaps to hedge interest rates to ensure stable cash flow. Rising mortgage rates will make current RAS customers stay (i.e., not pre-pay their mortgage), so cash flow is stable in the next few years I believe. Also most RAS loans have good credit profile, so little exposure to subprime risks.

**lzhang** Wed Aug 22, 2007 7:13 pm

bdcmm wrote:
Although I'm not an expert in mortgage business, there are a few things about this company which made me decide to invest in this company:

That being said (not an expert in mortgage business), how could you have the following claims on RAS?

bdcmm wrote:
RAS uses matching-funds and swaps to hedge interest rates to ensure stable cash flow. Rising mortgage rates will make current RAS customers stay (i.e., not pre-pay their mortgage), so cash flow is stable in the new few years I believe. Also most RAS loans has good credit profile, so little exposure to subprime risks.

How do you know its exposure to subprime loans? Its investment in AHM was gone. It has other holdings in other mortgage companies and HB companies. How much more does it need to write off? Unless you have those numbers and reasonable estimation, how could you say it is good investment?

**goog** Wed Aug 22, 2007 7:33 pm

RAS refused to disclose the mortgage/homebuilder holdings except the $95M of AHM write off. Though a very possible big upside here, the risk of losing all investment is still not ignorable without enough detail information.

AHM had huge insider buying in last two years. I would say bet the economy (especially housing market) on the insiders may be dangerous.

Anyway, very interesting idea and thank for sharing.

**bdcmm** Wed Aug 22, 2007 8:18 pm

Listen to the conference call and read 10-k, you'll get the answers. The total exposure is about $290M, less than 3% of it portfolio. Again this is assuming zero-recovery of its Trust Preferred Securities (TruPS) with AHM and other HB builders. Not a big deal to RAS.

RAS also has a good portion of commercial real estate mortgage, which has been growing very well. Sorry I could not provide very detailed analysis here, but I recommend you to listen to the conference call and look at its financial reports to get the whole picture.

lzhang wrote:
That being said (not an expert in mortgage business), how could you have the following claims on RAS?

bdcmm wrote:
RAS uses matching-funds and swaps to hedge interest rates to ensure stable cash flow. Rising mortgage rates will make current RAS customers stay (i.e., not pre-pay their mortgage), so cash flow is stable in the new few years I believe. Also most RAS loans has good credit profile, so little exposure to subprime risks.

How do you know its exposure to subprime loans? Its investment in AHM was gone. It has other holdings in other mortgage companies and HB companies. How much more does it need to write off? Unless you have those numbers and reasonable estimation, how could you say it is good investment?

**bdcmm** Wed Aug 22, 2007 8:24 pm

RAS did not disclose it in the conference call because it contained insider/confidential information for those HB builders. So it was right to do so. But they did disclose the total exposure, which is less than 3% of its whole portfolio, assuming zero-recovery (you should expect to recover some.)

I based my decision not only on insider buying, but also on its financial condition. It certainly has risk, but I'm personally comfortable with its risk/reward.

goog wrote: RAS refused to disclose the mortgage/homebuilder holdings except the $95M of AHM write off. Though a very possible big upside here, the risk of losing all investment is still not ignorable without enough detail information.

AHM had huge insider buying in last two years. I would say bet the economy (especially housing market) on the insiders may be dangerous.

Anyway, very interesting idea and thank for sharing.

**blast_investor** Wed Aug 22, 2007 9:39 pm

I would be very cautious on mortgage insurance company such as PMI.

Mortgage insurance typically insurace that last 20% of equity for banks and lenders.

When borrowers default, the first % loss goes to mortgage insurance company.

Insurance company book value and earnings are not that meaningful because huge loss can wipe out book value easily if the company does not book enough loss reserve on it.

If PMI does not use leverage, then it might be good business. If it leverages up, then the risk is very high. Unfortunately in insurance industry, most companies leverage up to get to earnings, and get high risk too along the way.

**jmrisley** Wed Aug 22, 2007 9:49 pm

PMI
If you reference

http://finance.yahoo.com/q/ks?s=PMI

PMI only has 497 million of outstanding debt and last years net earnings were 390 million with 565 million of cash on the books. Plus the company just announced they are increasing their current stock buyback prgram, management has been buying the stock reference.

http://finance.yahoo.com/q/it?s=PMI

You might give this a second look.

JMR

**goog** Wed Aug 22, 2007 11:19 pm

Re: PMI
In fact, all other companies in the same sector are trading at the same valuation if not lower. So what is the reason (except insider buying) that you favor PMI against other companies? Thanks
jmrisley wrote: If you reference

http://finance.yahoo.com/q/ks?s=PMI

PMI only has 497 million of outstanding debt and last years net earnings were 390 million with 565 million of cash on the books. Plus the company just announced they are increasing their current stock buyback prgram, management has been buying the stock reference.

http://finance.yahoo.com/q/it?s=PMI

You might give this a second look.

JMR

**lzhang** Wed Aug 22, 2007 11:31 pm

Re: PMI
As I said, PE wise, it is not cheap compared to other mortgage insurance companies. Actually, you can find many other major financial companies, IBs, etc., at the same PE level. That is just simply amazing right now, but people seemed get scared with low PE ratio.

Bargains are everywhere. I prefer larger financial companies with no direct link to subprime mortgage or HBs.

goog wrote: In fact, all other companies in the same sector are trading at the same valuation if not lower. So what is the reason (except insider buying) that you favor PMI against other companies? Thanks
jmrisley wrote: If you reference

http://finance.yahoo.com/q/ks?s=PMI

PMI only has 497 million of outstanding debt and last years net earnings were 390 million with 565 million of cash on the books. Plus the company just announced they are increasing their current stock buyback prgram, management has been buying the stock reference.

http://finance.yahoo.com/q/it?s=PMI

You might give this a second look.

JMR

**lzhang** Thu Aug 23, 2007 1:56 am

Re: PMI - PMI Group
Hi jmrisley,

As blast has said, book value and current earnings are not very relative in evaluating its business.

To my understanding after reading its 10-K and 10-Q, PMI is primarily underwriting private mortgage insurance. So its major customers are families with low credit scores and/or low income documentation, and/or low down payment. Those combinations may sound scary already, not mentioning current situation. But those scary things might not be bad to insurance business, because their business is to translate risks into its own profits.

What matters here is if they can properly calculate the insurance premiums for different risk profiles, if they can properly project the future interest rates and housing markets, etc., which sound quite challenging to me.

In car insurance, you may be able to calculate the insurance premium relatively easy based on several simple factors. It is hard to calculate here. Another very important difference here between the two kinds of insurances is that you are almost sure that customer A's car insurance policy is independent of customer B's. If A will have any car accident has nothing to do with B, almost. But if, due to macroeconomic environment change, etc., family A default their home loan, it is more likely than not family B with similar profile are going to default as well. With hundreds of billions dollars' net worth to cover with its policies, it does sound very scary.

Unless you have profound insights into the industry and know the company is going to do it right, I think it is better to avoid this kind of insurance company.

jmrisley wrote: Did you ever run across PMI in your scans for low price to book shares? This stock currently trades at $31.50 and book value is $43. I understand that this is in the mortage / residential business and the current credit cruch could hurt them with excessive losses.

But my experience with insurance companies is that they never loss in the end. They are allowed to raise premiums, diverisfy their risks by buying reinsurance and writing off the losses against earnings.

Wouldn't this be a good buy? Also insiders have been accumulating the shares lately.

**fuzzac** Thu Aug 23, 2007 1:18 pm

It's is very difficult to come to any definitive conclusions on many of these financial companies. Many of them look very cheap at current valuations - if they survive.

A good way to invest in these is probably not to bet big on any one of them, but rather buy a diversified list of them, and have them together represent a normal full size position, Ben Graham style.

Also, it's worth to take a look at preferred shares, since these companies are often forced to raise capital though convertible debt/preferred and thereby diluting the common shares (like CFC yesterday).