Monoline Insurance - Hedge Funds Increasingly Active

The profits of doom are foregathering in the blogosphere to tell us that “nothing has really changed since 2008” regarding US mortgage foreclosures. There are too many defaults and banks are hiding their exposure – goes the refrain. We have heard the major US banks say they are re-examining their foreclosure decisions after the “robo signing” revelations. If this theme is echoed by real money investors, we would expect to see short positions being re-established in the monoline companies who insure residential mortgages. We find a mixed bag of fairly high short interest in MBIA - NYSE:MBI, Ambac - ABK, PMI Group - PMI, MGIC - MTG and Ocwen - OCN. There is also some interesting short selling in a firm who thrive on real estate turnover - Stewart Information Group - STC and this could be the real worry.

If they have learned the lessons of the past, those monolines that were most publicly damaged in the credit crunch would be the ones in the best health now so we would expect to see low short interest now and a strong recent price performance. MBIA Inc (MBI) which took a battering at the height of the credit crunch seems to be better off for the experience. It’s projections have been consistently in line with mortgage market performance over the year, with adequate reserves and impairments accurately budgeted for. Therefore, it is no surprise to see MBI’s shares hitting a new 52-week high last week and short interest close to breaking its 52-week low. Short interest peaked in May at 15%, after which we have since seen consistent short covering to 7%.

Ambac Financial Group Inc (ABK) ran into trouble when the financial crisis hit but investors are showing more confidence in the company, which has recently sued Bank of America over the lending practices of acquired Countrywide Financial. Generally, investors have also been covering their short positions in Ambac since July, reducing levels from 18% to 13% recorded at the end of September. Short interest has since risen slightly to 15%.

Firms that were less high profile casualties of the credit crunch are more in vogue for the short sellers. Shadowed by the likes of Ambac and MBIA, PMI Group Inc (PMI) has lost 91% of its market value since mid-2007 but there are recent reports that some large hedge funds have been recently buying into PMI predicting a turnaround. They are joined by institutional funds who have doubled their ownership to 40% of the company. However, the last time they held this much PMI we were pre credit crunch and the shares five times higher than they are today! On the flip side, short sellers are still active in this stock as we see short interest double to 20% of the float in the past three weeks. Similarly, MGIC Investment Corp (MTG) has also seen a spike in short interest from 16% to 21% over the past three weeks.

Ocwen Financial Corp (OCN) has seen a tumble in its share price, hitting a new 52-week low on Monday as the foreclosure crisis gains momentum. Short interest has been building up in Ocwen rising from 3% to 4% over the past month.

We are hearing that US property transactions have sunk to an all time low in August – and that this key metric is ignored by the classic barometer of real estate confidence a.k.a the Case Shiller index. People are not selling or buying which is a very worrying sign since the US economy must not seize up, as occurred in Japan. Stewart Information Group (STC) needs real estate transaction flow since it provides title insurance and related information services required for settlement by the real estate and mortgage industries. It has seen recent short covering as the price has rebounded, which could be due to profit taking, but the short interest is still at a high of 18% of total shares outstanding on loan. But, could there be a flurry of activity if the banks release all these properties they have taken on due to defaulting mortgages?

The situation is delicately poised regarding these monoline insurers. Short selling is far higher in most of them than the Russell 2000 weighted average short interest (5.8%) but it is far from one way traffic.