MGIC Investment Corp (NYSE: MTG) and Radian Group Inc (NYSE: RDN), the two mortgage insurance companies that are set to merge, announced last night that one of the cash cow partnerships that was to be used to give a boat load of cash to shareholders is not much of a cash cow anymore.

C-Bass, a partnership owned by both MGIC and Radian, "has been materially impaired," MGIC announced last night. Back in the Spring, when MGIC and Radian announced they were going to merge, management said the massive amount of cash in C-Bass, along with a second co-owned partnership called Sherman, was to be given back to shareholders. Total consideration was estimated between $1.75 to $2.0 billion. Well, I guess that is not going to happen.

MGIC said the $516 million in book value as of the end of June could be completely wiped out. I have not seen any news on the Sherman partnership as of yet. C-BASS is principally engaged in the business of investing in the credit risk of subprime single-family residential mortgages.

The MGIC and the Radian transaction is a classic example that investors should always be skeptical of management in any company, even when they are generally as well-respected as MGICs.

However, when companies merge in an industry where the fundamentals are rolling over, as is the case in the mortgage business, it is often best to stay away. Do not bottom fish in this sector yet, there is likely much more bad news to come.