Splitsville for MGIC-Radian

The planned merger of the mortgage-insurance giants was scuppered by subprime woes. How will the companmioes weather the storm on their own?

by Ben Steverman

The seven-month engagement of two of the U.S.'s biggest mortgage insurers is over, done in by the spreading subprime mess and credit market disruptions.

The merger between MGIC Investment Corp. (MTG) and Radian Group (RDN) first appeared to be souring a month ago. A legal fight was brewing over whether MGIC could pull out of the merger, already approved by both corporate boards.

But the split, announced Sept. 5, was amicable, at least on the surface. All lawsuits were dropped, and neither company will pay the other for their trouble.

Why end a deal that in February one exec raved made sense "strategically, financially and operationally"? A joint statement read: "Current market conditions have made combining the companies significantly more challenging."

Radian chief executive S.A. Ibrahim told analysts: "We are in a market environment right now that is extremely challenged." He added: "The right thing to do was to focus our resources on navigating this storm in the mortgage business."

That storm is well-known and has been tossing around many other mortgage players. Risky loans were made to homebuyers now having trouble keeping up with payments. Meanwhile, housing prices in many regions are falling, further hurting mortgage holders. Worries about subprime roiled credit markets as the value of mortgage-backed investments has plummeted.

Many of these trends have hurt MGIC and Radian since they announced their planned merger in February. Both could lose their entire investments, more than $500 million, in a jointly owned company known as C-BASS. Credit Based Asset Servicing and Securitization, its full name, buys up distressed loans in the mortgage business.

Radian was also facing other losses in its own portfolio, analysts say. Of the two companies, Radian's mortgage business was focused on some of the "riskier pieces of the business," says Michael Grasher, an analyst at Piper Jaffray & Co. (PJC).

As subprime worries deepened, MGIC executives seemed to reconsider the merger. Analysts speculate that the firms spent the summer re-negotiating the terms of the deal behind the scenes. Keefe, Bruyette & Woods (KBW) analyst Geoffrey Dunn speculated a month ago that they may "have reached an impasse." A further worry was that, as a result of the negotiations, "bad blood has been created between these two companies," he wrote. That would have been troubling, because in the new company MGIC and Radian's top executives were slated to work closely with each other.

(Piper Jaffray and KBW both receive, or expect to receive, investment banking business from MGIC.)

Now that the merger is officially off, how will MGIC and Radian fare as independent companies?

Others in the mortgage industry have seen combinations and buyouts as the best way to keep enough capital to stay afloat. The risks to MGIC and Radian appear less dire. Analysts have the most questions about Radian, which appeared to have more exposure to subprime mortgages and other risks.

"In mortgage, Radian holds a riskier set of cards," Grasher says. However, he points out that Radian has a strong international business and divisions offering other, non-mortgage financial services and insurance.

Because Radian is actually more diversified than MGIC, the two firms' "wherewithal to weather the storm is probably equal," Grasher says.

Radian executives sought to prove that to investors on Sept. 5 in a long conference call. A 42-page presentation was also released with information on Radian's finances.

Radian acknowledged the trouble in the mortgage market, and risks to its portfolio, but touted some positive signs. As the mortgage industry consolidates, the large lenders that are Radian's core customers could benefit. Non-mortgage businesses should provide "stable and profitable results," the firm said. It should have plenty of capital to meet the risks out there.

Radian can "capitalize well on current financial trends," Ibrahim said. The company's strength "positions us much better than most of the other players in the mortgage market," he added.

Investors seemed to like what they heard. Radian's share price spiked almost 20% in the first 30 minutes of the conference call, recovering from a drop earlier in the morning. Radian shares ended the day up 0.88% to 18.27. MGIC shares fell 0.96% to $30.05 on Sept. 5.

Steverman is a reporter for BusinessWeek's Investing channel.