Description

MGIC Investment Corp (MTG)

Investment idea- Buy MGIC Investment Corp 5.375 Senior Notes maturing on 11/1/2015

MGIC senior notes trade 67 and offer a 16% yield to a 2015 maturity. In June the senior notes traded at 90 when MTG stock traded at $6.  MTG stock bottomed on October 3rd at a $1.63; MTG senior notes traded down to 67 as the stock hit its lows.  MTG stock has subsequently moved up to over $4 last week ($4.10 as we write this).  MTG senior debt continues to trade at the same level that it did in October.  We believe these levels provide an attractive entry point for the senior notes. 

 "You see the pig has moved through the python in terms of US housing losses."  - Kyle Bass on MGIC from November 7, 2011 WSJ article after reporting a 5% MTG stake

MGIC Investment Corp is the holding company for Mortgage Guaranty Insurance Corp, the largest mortgage insurance company in the US (see prior VIC write-ups for more background).  MGIC has suffered significant losses post the UShousing collapse.  We believe that the worst is behind them, and there is significant value in MGIC holding company debt securities.  While all of MTG debt securities look compelling to us, we recommend the 5.375% 2015 notes for the purposes of this write-up.  MGIC debt outstanding is shown below. 

Marks as 1/9/2012

Why haven't the bonds traded higher?  As our bond salesperson told us today "the bond price is being driven off of perception."   We believe that the bankruptcy of PMI Group has weighed on the prices of MGIC debt.  Also, Republic Mortgage Insurance Company, a subsidiary of Old Republic, recently was forced to halt underwriting new business after its statutory capital levels were breached.  We'd note that subsequent to the PMI and Republic announcements, MGIC senior debt sold off significantly and has not recovered.  PMI Group filed chapter 11 on November 24^th.  MGIC senior notes traded down to 63 at the end of November.  We believe that MGIC will continue to be able underwrite new business and will be a survivor in a less competitive industry.  We would note that if our analysis proves correct that all debt securities and MTG stock will do well. 

Our thesis on MGIC is premised on four important components:  1)MGICdelinquent inventory peaked last year and continues to improve.  2)MGICsenior notes have value even in a stressed/run-off scenario.  3) The surviving private mortgage insurers will benefit as the FHA becomes less competitive and PMI and Republic have exited.  4) The US housing market has troughed.  

1)      MGIC delinquent inventory peaked last year and the remaining book continues to improve. MGIC has underwritten two types of business: primary and pool. MGIC continues to underwrite primary business but halted pool in 2008.  Of the $46B remaining risk in force, only $2B is pool. 

Table 1: SEE SCRIBD LINK ABOVE

As shown in the chart above, after peaking at roughly 250,440 primary delinquent loans at the end of 2009, MGIC's book continues to burn-off.  In its latest monthly disclosure, MTG reported 175,691 primary loans delinquent.    

MGIC also had 33,792 mortgages in default at the pool level at the end of the 3^rd quarter.  Of the $2B in pool risk in force $770mn maintains aggregate loss limits.  The remaining $1,260mn does not have aggregate loss limits but is 2004 vintage and prior and has had minimal losses. MGIC has $379mn of reserves against the $2B pool risk in force.  Pool delinquencies have fallen off similar to primary.

MGIC's current primary insurance in force is highlighted in Table 2:

 Table 2:

MGIC has reserves of $4.4B or $24,340 per delinquent primary mortgage.  The average mortgage size is $157k.  MGIC newer business (post 1H 2008) has been pristine.  As legacy business continues to burn-off, MGIC will look like a much healthier entity.  In the near-term, there is investor concern that MGICis not adequately reserved and at risk of breaching their statutory capital levels in 2012 or early 2013.  MGIC is required to maintain a minimum statutory position of 25 to 1.  After downstreaming cash to the insurance subsidiary at year-end, MGIC pro-forma statutory capital levels are shown below.  MGIC announced that would be moving $200mn down on the 3^rd quarter call.

 Table 3:

While we concede that breaching a 25 to 1 level is possible, we’d note that MGIC will have additional available cash to downstream to the insurance subsidiary.  In fact, we recommend that the company Tender or buy its senior notes in the open market before 2015 as this would provide more cash available to downstream in a stressed scenario.  This would not be unprecedented as the company bought back $55mn face at 94 in Q2 of 2011. 

 Table 4:

 2) MGIC senior notes have value in a run-off scenario.  In the following analysis we attempt to illustrate thatMGIC has significant value even in a scenario where they were unable to underwrite new business.  While we do not believeMGIC will be put in run-off, we believe it important to stress the model in this worst case scenario.  We concede this analysis is anything but perfect, but we do believe that even in conservative scenarios there is ample room to pay the senior notes (and other debt securities).

At the end of the 3^rd quarter,MGIC had $763mn in cash. MGIC has roughly $563 million in cash at the holding company level after moving $200mn from HoldCo to insurance subsidiary post-Q3 excluding losses in Q4. 

The key assumptions in this analysis include the default rate for remaining insurance in force (for loans in the various buckets- current, 45 days to 3 months delinquent, 4-11 months delinquent, 12 months or more delinquent), severity of the claim and (as shown in Table 6), the burn-off trajectory of insurance in force.

Table 5:

Catalyst