10/21/2017

MGIC Investment Corporation: Focus Intrinsic Value Buy Idea

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Overview: MGIC Investment Corp is a provider of private mortgage insurance and ancillary services. The company provides mortgage insurance to lenders throughout the United States and to government sponsored entities to protect against loss from defaults on low down payment residential mortgage loans. Its principal product is primary mortgage insurance. Primary insurance provides mortgage default protection on individual loans and covers unpaid loan principal, delinquent interest and certain expenses associated with the default and subsequent foreclosure or sale approved by the company. The company also provides various services for the mortgage finance industry, such as contract underwriting, analysis of loan originations and portfolios, and mortgage lead generation.

MTG operates in the US across many states. The firm’s top five jurisdictions, representing roughly 30% of its overall business, are California, Florida, Texas, Pennsylvania, and Ohio. The company’s current portfolio of insured loans can be divided into two parts based on the insured date of the underlying mortgage:

1) Pre 2009 Legacy Book: MTG faced large hurdles during the 2007-08 financial crisis. Lax lending standards and the collapse of housing prices from 2005 to 2008 led to an overexposure of risky loans insured by the firm. Rapid rises in mortgage delinquencies and subsequent defaults left the company with large losses during those years. Although MTG was able to survive, they still faced losses through the recovery. Since a significant portion of the riskiest loans were written at or near the height of the housing bubble, the ensuing losses continued for a number of years. The Legacy portion of MTG’s business represents the largest amount of risk, as this book contains a portion of loans that are subprime, as well as loans with little or no income and employment verification at origination. However, this fraction of the business has been diminishing in recent years.

2) 2009-Present Book: With the collapse of the housing market, MTG aggressively altered its existing lending standards. As the economy recovered and the quality of loans improved, the firm gradually returned to profitability years later. Loan level data show that the company’s new business from 2009 forward has improved significantly over the Legacy Book. In fact, in 2015, the company’s loans that were insured between 2009-2014 had a total of 2,710 defaults, compared to 20,000 defaults from loans originally insured in 2007 alone.

Catalyst: MTG’s catalyst in the near term is a combination of its continued business turnaround from the financial crisis, as well as current mortgage industry trends:

Business Turnaround: As the years have gone by, MTG’s exposure to its older Legacy Book has consistently shrunk year over year. This trend has led to a number of economic improvements in the business including fewer loans in default, lower default percentages, and higher profitability. Total loans in default have gone from over 175,000 in 2011, down to around 62,000 in 2015. The default rate for all insured loans was 16.1% in 2011, 13.9% in 2012, 10.8% in 2013, 8.2% in 2014 and 6.3% in 2015. Additionally, in each of the company’s categories of loans (prime, A-minus and subprime), default rates have fallen over the past five years. As the company continues to reduce its exposure to the older Legacy Book, profitability should continue to improve.

Industry Trends: At the beginning of 2016, new legislation called the Private Mortgage Eligibility Requirements (the “PMIERs”) was passed, giving certain requirements to entities that insure mortgages purchased by Fannie Mae and Freddie Mac. Since a majority of loans insured by MTG are sold to the government sponsored entities, the firm is subject to the new legislation. During 2015, there was some uncertainty around the specific requirements for mortgage insurers surrounding this law. However, MTG was able to adopt the standards immediately and faces no immediate issues with compliance. As of June 30, 2016, and based on MTG’s interpretation of PMIERs, the firm’s Available Assets were $4.7 billion while the Minimum Required Assets were $4.2 billion, giving them a surplus of ~$500 million in capital. With a significant cushion over the required amount, and two quarters of performance under compliance (Q1 and Q2 of the current year), it appears that MTG’s business should not be negatively impacted by the new standards.

MTG should also benefit from broad positive housing trends in the US. Default rates have fallen in the last two years in all ten of MTG’s major jurisdictions, which account for nearly 50% of the company’s business. Furthermore, across the entire US, mortgage delinquencies on single family homes have fallen substantially, going from 10.68% in Q3 of 2012 to 4.55% in Q2 of 2016. Although delinquencies are still at a higher rate than pre crisis levels of around 2%, the downward trend appears to be continuing into 2016, with rates going from 5.17% at the end of 2015, to 4.84% in Q1 2016, to the 16Q2 level of 4.55%. As the housing market gradually recovers, and MTG progresses with phasing out its Legacy Book, the firm’s profitability should continue to improve.

About John Holt 5 Articles

Research Analyst at The Applied Finance Group

Focus areas: Equity Analysis, Portfolio Consulting, Quantitative Research.
Joined AFG in 2015

About John Holt 5 Articles

Research Analyst at The Applied Finance Group

Focus areas: Equity Analysis, Portfolio Consulting, Quantitative Research.
Joined AFG in 2015