Update on MGIC Investment Corp. and PMI Group Inc.

Tomorrow morning, MGIC (NYSE: MTG) will announcement earnings for the first quarter of 2007. This will be the first earning announcement to come out of the mortgage insurance sector since the subprime meltdown began. Although some analysts seem to think that the problems with subprime and Alt-A loans will not carry over into the mortgage insurance sector, the first quarter report from MGIC could give investors their first real look into the potential problems that the subprime mess could cause mortgage insurers.

Investors will key on the quantity of insurance claims paid during the quarter. Wall Street Mayhem believes that any significant increase in claims paid should send this sector down. Last month, National City corp., the nation’s ninth largest bank, said that their $2.2 billion subprime and Alt-A mortgage portfolio was covered by two different carriers. National City went on to say that one of these carriers was paying claims, but the other was “rejecting a meaningful number of claims”. National City will seek contractual or judicial relief against this carrier. Since Radian Group and MGIC are merging, that leaves PMI Group and Triad Guaranty Inc. as the other large mortgage insurers. Although large insurance companies such as AIG also sell mortgage insurance, it is not a stretch to think that PMI Group or MGIC could be the unnamed company refusing to pay claims considering that PMI and MGIC are the largest insurers focusing on mortgage insurance.

If MGIC or PMI Group is refusing to pay claims this could be a signal of major problems related to subprime and Alt-A mortgages. Even if neither MGIC nor PMI group is the nonpaying culprit, it is reasonable to assume that if these companies are paying claims, the increase in claims paid will have a significant negative impact on earnings going forward.

MGIC and PMI Group bulls will argue that many of the subprime loans were securitized and sold in the capital markets instead of being insured. Through this logic mortgage insurers will not have a significant increase in claims paid due to subprime and Alt-A defaults. Although this argument holds some credence, the statement by National City shows that at least some of the large mortgage originators still used insurance for subprime and Alt-A loans.

In PMI Group’s most recent 10-K they state, “In 2006, PMI’s average premium rate increased primarily as a result of its primary portfolio containing higher percentages of high LTV and Alt-A loans. However, there can be no assurance that the premiums earned and the associated investment income will prove adequate to compensate for future losses from these loans.” Although 10-K’s are notorious for sounding like the company is in dire straights due to the legal ramifications of these documents, this statement shows that PMI has significant exposure to Alt-A loans. Apparently, not all of these loans were securitized after all.

Details about MGIC’s questionable acquisition of Fieldstone Investment will also be a key issue surrounding MGIC’s conference call. Although MGIC did manage to lower the offer price from $5.53 per share to $4 a share, Fieldstone’s shares are currently trading at $3.21 implying that the street does not have confidence that the deal will go through. Yesterday, Friedman Billings Ramsey announced that they have sold their entire position in Fieldstone.

We already covered half of our short positions in MGIC and PMI Group for a nice profit. Tomorrow’s earning report for MGIC will set the tone for mortgage insurers going forward. If MGIC has somehow maneuvered through the subprime meltdown unscathed we will cover the rest of our short position, but in our opinion the mortgage insurance sector will continue to under perform.

Full disclosure: Wall Street Mayhem is short MTG and PMI