MGIC Investment Corporation: Strong Buy At 84% Of Book Value (NYSE:MTG)

MGIC Investment Corporation (NYSE:MTG) is one of the leading mortgage insurance companies in the United States. As the Federal Reserve has aggressively raised interest rates to combat rampant inflation, housing prices have started to decline in many formerly buoyant markets. Fear of a recession in 2023 has caused the stock to drop, as mortgage defaults are typically driven by rising unemployment. Despite the fear, MTG’s business is performing extremely well and is generating very robust profits. At a material discount to book value and 6x forward earnings, MTG offers tremendous value for the long-term investor.

Mortgage insurance companies are paid premiums to insure mortgage payments on homes purchased with lower down payments. They play an essential role in assisting families with the ability to buy a home without having to put the full 20% down on it. The industry basically blew up during the Great Recession, as fraudulent lending, and a massive housing crash, caused bankruptcies, dilution, and large losses. Post-crisis, the industry has transformed itself to be materially less risky, due to far more stringent underwriting, and an aggressive reinsurance program. The idea behind the reinsurance or risk transfers is to protect capital under extremely stressed scenarios. A major recession like 2008 might wipe out earnings in a given year, but the companies should survive and maintain enough capital to be able to continue writing new business. Pricing and underwriting standards tend to improve in periods of market stress, so often that business written at those junctures of time tend to be some of the safest and most profitable. Insurance-linked note transactions cover most of MTG’s 2016 through 2021 books of business, and then in April, the company completed its first excess-to-loss transaction in the traditional reinsurance market, which covers most of the policies written in 2022. These transactions reduce the capital required to run the business and, as mentioned before, dramatically reduce the risk during stressful times.

On November 3^rd, MTG reported a very strong 3^rd quarter, earning $250MM of GAAP net income, or $.81 per diluted share, up from $158MM, or $.46 at the same time last year. Total revenues were $293MM in the quarter, down slightly from $296MM YoY. The company generated an annualized return on equity of 21.8%, highlighting the strong profitability of the business. Insurance in-force grew 9.4% YoY to $293B, up 2.4% sequentially. While higher rates have certainly had a negative impact on mortgage origination and refinancing, it also has had a positive impact on the persistency rate for mortgage insurers, which should lead to stable revenues. Persistency increased to 76% at the end of the quarter, up from 72% on June 30^th, and 59.5% YoY. Persistency and the size and rate of the insurance book are what drives revenues for MTG. The loss ratio was negative 41.7%, or negative $105MM, as the number of new delinquencies was more than offset by a re-estimation of ultimate losses on delinquencies in prior quarters. New delinquency notices added roughly $36MM to loss incurred in Q3 of 2022, but the re-estimation of loss reserves resulted in favorable development of approximately $141MM related to a decrease in the estimated claim rate on delinquencies.

In the quarter, the delinquent inventory decreased by 3.6% to 25,900 loans, marking the 9^th consecutive quarter of decrease from the pandemic peak of 69,300 in Q2 of 2020. While Covid-19 and the associated lockdowns created an enormous number of defaults, the cure rate has exceeded expectations quite dramatically. Rising home prices also created a nice tailwind to credit performance, however the tide is changing now on that front. Roughly 60% of the insurance in-force book stems from business written in 2020 and 201, which is performing well. New insurance written was $19.6B, down from $24.3B in Q2, and $28.7B YoY, reflecting that major decrease in mortgage origination.

MTG is very well-capitalized and has been deploying capital relatively conservatively, redeeming notes and buying back some stock. MGIC’s PMIERs Available Assets totaled $5.9B, which is $2.6B above its Minimum Required Assets, as of the end of Q3. Buybacks are highly accretive at the recent price of $12.73, which is just 84% of the $15.16 book value as of the end of Q3. In Q3, the company repurchased 6.1MM outstanding shares for $84MM. Book value declined by 2 pennies in the 3^rd quarter, due to mark to market losses on the investment portfolio. Ultimately, higher rates should be a nice driver of higher earnings as premiums taken in by the company can now be invested at much higher yields. The company also pays a $.10 per share quarterly dividend. The company repurchased $14MM in aggregate principal of its convertible debentures due in 2063, reducing potentially dilutive shares by 1.1MM. MTG also redeemed $242.3MM of aggregate principal outstanding on its 2023 Senior Notes for $248.4MM, plus accrued interest. Consolidated debt declined to $663MM, down from $1.2B a year ago. In October, the company bought back another 2.6MM shares of stocks at an average cost of $12.96. MGIC paid a $400MM dividend to its holding company in the 4^th quarter, given the excess capital position at the subsidiary.

Mortgage insurance isn’t a sexy business, but it is a pretty good one. Over the last 6 years, MTG has averaged net income of $520MM, and its current market cap is around $4.8B. Even in 2020, the company was solidly profitable with net income of $446MM. With recent reserve releases, the company has made $848MM over the last 12 months and is in the best financial condition in over a decade, if not ever. Clearly, the market is concerned that a potential recession will lead to increased unemployment and mortgage defaults, generating losses for MTG. We know credit is cyclical so that is a rational view, but this is not a normal economy going into a recession. The latest unemployment rate was 3.5%, and while we are seeing white collar layoffs in areas such as Technology and Finance, blue collar jobs are holding pretty tight because companies know it is tough to find employees right now. Even areas such as travel, restaurants, and leisure are holding up strong as consumer spending is still way up since pre-pandemic levels. One area to watch is construction, but builders still have big order books, which is going to delay the major reckoning there. Mortgages originated over the last decade have far lower rates than what is available currently, so most homeowners are incentivized to do everything they can to keep their homes. I also think that companies acquired substantial knowledge in payment deferment programs during the lockdown/pandemic, which could prove helpful in reducing losses during the next crisis.

At 84% of book value, MTG is a strong buy given its consistent ability to generate returns on equity in the teens. Earnings will probably be a bit lower in 2023, but it still should be a solid year given the durability of the revenues and the stubborn strength in the employment market, despite the obvious headwinds. It’s not the same industry that buckled under the massive tsunami of 2008. The company has prudently reduced its capital risk with an aggressive reinsurance program, but the market doesn’t seem to be giving any credit to this lower risk business profile. With a 3.14% dividend yield, a valuation of only 6x forward earnings and 4.8x trailing earnings, the stock is indeed prices for severe losses to come in its insured portfolio. MTG has made major progress reducing its debt and is well positioned to strategically buy back stock on weakness, enhancing key financial metrics such as book value per share and earnings per share. I believe MTG could be a $20 stock with 2-3 years, as the economy recovers from whatever we are going into in 2023, and as the strengthened business model once again proves itself as it did in 2020.