While the economy is finally starting to show signs of a recovery, opportunity within the finance sector can possibly still be found within an unconventional, niche industry. The majority of the financial sector, everything from the credit to the small regionals, have performed exceptionally well of late.
Why?
Rising interest rates, improving credit quality, and a recovering housing market have created a near-perfect storm for this industry. Financial companies, which have taken themselves to the highest level of operating efficiency, are now ready to benefit from this environment. The institutions can afford to lend greater amounts due to improving credit quality at higher interest rates, thus leaving the potential for great growth in net interest income.
A niche industry you may have never heard of, mortgage insurance, may benefit greatly during this time of recovery. Companies within this sector write insurance policies that protect mortgage lenders or title holders in the event that the borrower defaults on payments, dies, or is otherwise unable to to pay mortgage. I would like to highlight three stocks positioned to benefit from the major tailwind that I just mentioned.
Paulson’s picks
Radian Group Inc (NYSE:RDN) provides investors direct exposure to the mortgage insurance industry through its subsidiaries. Over the last few months, the company has witnessed its delinquency rates fall 7%, a bullish indicator of momentum to come. Analysts are expecting just over $1.00 per share in earnings next year, giving the company a forward earnings multiple of 13 times, which is not bad considering the housing recovery is just getting underway.
Next Up, MGIC Investment Corp. (NYSE:MTG), another favorite of the hedge fund legend Paulson. While shares have moved up by over 100% this year, some believe the run is far from over. The company itself has predicted quarterly losses for the foreseeable quarters, however, analysts covering the company have taken a slightly more bullish stance on it of late.
By 2014, the Street believes the company will register a small, $0.19 per share profit for the fiscal year. More recently, the company has improved its profitability situation with help from the recovering economy. A combination of new issuance and declining delinquencies has helped it over the last few months. Delinquency loans dropped 6% while new issuance rose 17%. Looking forward, I would expect to see delinquency rates remain stable around these levels, improving credit quality, and declining debit balances have put people in a great position financially. For example, delinquency rates on credit cards for the largest issuers sit at roughly half of the typical levels.
Diversified exposure
When writing about companies with high risks, I always like to include an alternative investment vehicle for the more risk adverse investor. In this case, I want to highlight an exchanged traded fund, the SPDR S&P Mortgage Finance ETF provides investors diversified exposure within the broader mortgage finance industry. Below, I have created a chart showing the current breakdown of the fund.
Investors will receive diversification and exposure to both the housing recovery and insurance sectors. The housing recovery portion of this portfolio will benefit from greater housing demand and credit quality as mentioned previously. Additionally, the insurance portion of this portfolio will benefit from increasing interest rates as these firms can generate higher return on the lumps of cash they currently have parked in low yielding products.
Summary
The mortgage finance industry stands to benefit from a number of tailwinds, including higher credit quality, lower delinquencies, and rising interest rates. Investors might consider the options above to benefit from these drivers.
Nathaniel Matherson has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
The article Why You Should Consider Mortgage Finance originally appeared on Fool.com.
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