MGIC Investment: Living on Borrowed Time -- Barron's

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No MGIC Solution by Jonathan R. Laing

Highlighted companies: MGIC Investment Corp. (MTG), AmeriCredit Corp. (ACF), Conseco Inc. (CNO)
Summary: MGIC Investment Corp. (MTG) shares, at $61.50 (8.5x earnings) look cheap -- as long as Street earnings forecasts of $6.70 and $7.20 a share pan out. The U.S.'s largest mortgage insurer currently insures $173b. But with home sales and prices falling, foreclosures and loan-default claims may rise. The bullish case: (1) Rising short-term interest rates have made personal mortgage insurance an attractive alternative to secondary loans to home buyers who can't afford down payments of up to 20% (piggyback mortgages). (2) MGIC's persistency (the length of time insurance policies stay on the company's books) is improving. (3) In the past 18 months the company shrunk its share base by almost 15%. (4) Loan delinquencies fell in Q3 to 5.98% from 6.58%. The bearish case: (1) The deflating housing bubble, which was built, to a large extent, on loose lending practices. Until now, property-price appreciation enabled borrowers in trouble to sell and pay off their mortgages. (2) Two-year "teaser" loans with low-interest rates are coming due next year ($800b worth), which could see borrowers facing 50%+ monthly payment increases. (3) MGIC's portfolio is increasingly heavy with "pay option" adjustable-rate mortgages (5.2% up from 0.8% at the end of 2004), which allow borrowers to pay less than required, the unpaid portion added to the principal. (4) Alt-A mortgages, a.k.a. liar loans given to almost-qualified borrowers without significant due-diligence are up to 17.2% from half that in 1999. (5) Loans of 100% property value are up to 16% from 4.5% over the same period. (6) Average paid claims, known as "severity," are up to $29,600 from $26,700. Bill Ryan of Portales Partners, who predicted the downfall of AmeriCredit Corp. (ACF) and Conseco Inc. (CNO) in the early 2000s: Assuming a 5% decline in home prices and a modest rise in MGIC's frequency rate, the company's 2007 earnings could fall 50% from analysts' current forecasts, to around $3.50 a share. Barron's: "With home prices up nearly 60% in five years, and speculative construction widespread, the current downturn in the U.S. housing market promises to be no ordinary correction, least of all one that "Magic," with its insured loan portfolio of $173.4 billion, will escape unscathed."
Related: Housing Bubble and Real Estate Market Tracker • Housing: What Does "Return to Mean" Really Mean? • MGIC Investment's Book Value Growth Better Than I Predicted • MGIC Investment Corp.: An Undervalued, Minimal Risk Long Pick • Weak Housing Will Bring This Market Down -- Barron's

Comments

[FIG trader_:]

Barrons is scratching the surface, and they don't know how to value financials. The long/short of this, as I indicated in different posts, is that the market has compressed the valuation substantially over the last five years (as ROE's dropped from mid twenties to teens) and currently is discounting the worst for MTG, as reflected in its 1.26 price/book. If market (or Barrons) is correct in assuming much higher credit defaults, you can hedge the long with short on some other credit (ACF). the reality is the market assumes hard landing for MTG, and soft landing for major US credits. Look at MTG's shareholder equity/assets and "liabilities" (i.e. reserves) and compare it with "banks and credits". The robustness of this ratio suggests substantial capital backing up "un identified future losses). I think it is reporting close to "trough ROE's, and it is the one of few subsesctors (mortgage insurance) offering an upside trade if there is even a partial reversion to mean ROE (perhaps mid to high teens). In worst case, company will be trading at book value in a year and a half, at current earnings rate. The company has been reporting flattish revenues reflecting a contraction of business "levels and changes in the way GSE's do business), but the mortgage insurance model still works (see TGIC, and PMI, as two other alternatives)

2006 Nov 20 02:13 PM