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Monday, July 24, 2006

The Roof Is On Fire

When the roof is on fire, the whole house collapes. First it was the homebuilders themselves, whose sales will be hit most directly by the slowing down of the housing ATM. The walls are collapsing... who will be next?

We believe that the financial sector which delves in giving consumers abundant access to cash amid the housing boom, despite the inherent risks, will be the next to come down. The signs are ominous.

MTG (MGIC Investments), a mortgage insurance company, saw its stock drop 3.5% last Tuesday and has even fallen further despite reporting stellar Q2 results that trumped analyst estimates by $0.02, saw insurance in-force rebound from the previous quarter and inciting positive analyst comments. It seems that investors are starting to look beyond the numbers and seeing the reality that will be when the housing slowdown bites at these companies. Despite beating estimates profits at MTG are still down 14% yoy. Where's the magic?

Beyond mortgage insurers, also bound to be burned down in the financial sector are the mortgage lenders, whose stocks have still proven resilient but are showing signs of weakness as of late. Mortgage lenders have been able to escape the clutches of the housing slowdown by securitizing their risky mortages, selling them and booking gains and keeping balance sheets clean. They also have some of their mortgage exposure insured, especially the most risky ones which allow downpayments of as low as 20%.

But when the housing slowdown turns for the worse, and it will, defaults will rise, mortgage insurance premium costs will rise, and no one will be stupid enough to buy those securitized mortgages from them anymore. We'll probably see them try to securitize and sell as many mortgages as possible, but eventually it will be too late to save the industry.

Short mortgage insurers (MTG, PMI, RDN) and mortgage lenders (CFC, LEND, NEW, AHM) on breakdown or any rallies.



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