MGIC INVESTMENT CORP/WI MTG
January 10, 2012 - 5:28pm EST by
Affton1
2012 2013
Price: 4.21 EPS $0.00 $0.00
Shares Out. (in M): 201 P/E 0.0x 0.0x
Market Cap (in $M): 846 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0.0x 0.0x

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  • Undervalued Bond
  • Mortgage Insurance

Description

MGIC Investment Corp (MTG)

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

PLEASE SEE THE FOLLOWING LINK FOR A MUCH CLEANER WRITE-UP.  MANY OF THE CHARTS I WAS UNABLE TO PASTE ONTO VIC.
 
http://www.scribd.com/doc/77818865/MTG-AFFTON1

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. 

 

Face Value

Market Price

Market Value

Senior Notes (5.375%) due 2015

$245

$67

$164

Convertible Senior Notes (5.0%) due 2017

$345

$61

$210

Convertible Junior Subordinated Debt (9.0%) due 2063

$390

$50

$195

Total

$980

 

$569

Marks as 1/9/2012

Disclosure:  We own the senior notes, the 2063 converts and call options on MTG stock.
 

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 24th.  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 3rd 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:

 

 

 

 

 

 

# of Loans

 

Total $ (mns)

Avg Mortgage Size

Insurance in Force

     1,141,442

 

$179,000

$156,819

 

 

 

 

 

Default Inventory

# of Loans

 

 

 

3 months or less

          33,167

 

 

 

4-11 months

          45,110

 

Primary Reserves

12 months or more

        102,617

 

Total $ (mns)

Per Loan

Ending Default Inventory

        180,894

 

$4,403

$24,340

* As ofSept 30, 2011

 

 

 

 

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 3rd quarter call.

 Table 3:

Separate Company   downstream proforma
Statutory Capital        1,479 200        1,679
Risk-in-force       32,779         32,779
Stat Capital Ratio          22.2            19.5
       
Combined      
Statutory Capital        1,580 200        1,780
Risk-in-force       37,979         37,979
Stat Capital Ratio          24.0            21.3

 

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:

  Do Nothing Purchase/Tender
MGIC HoldCo Cash after downstream 563  $      563.0  $      563.0  $      563.0
2015 Debt Outstanding 245  $      245.0  $      245.0  $      245.0
2015 & 2017 Debt Interest due 2012-2015 121.6  $       69.0  $       69.0  $       69.0
Purchase/Tender Price   70 85 100
Cash Used 245  $      171.5  $      208.3  $      245.0
Cash Available to Downstream  $      196.4  $      322.5  $      285.8  $      249.0
*assumes MGIC opts to not pay interest on the 2063 subordinated notes  

 

 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 3rd 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:

 
 
 
$ in mns # Outstanding Default Rate Default #
Current Loans (a)           960,548 4.20%         40,343
Delinquent Loans      
3 months or less            43,312 50.0%         21,656
4-11 months            47,929 75.0%         35,947
Subtotal (b)            91,241 63.1%         57,603
12 months or more            89,653    
       Known HAMP trials (c.)            13,900    
       Re-default rate (d) 50.0%    
       DQ reduction (c x d)             (6,950)    
Net 12 months or more (e)            82,703 95.0%         78,568
= Total (a+b+e)           176,514
       
Total claims               176,514
X Average claim ($000s)     $50.900
= Total claims ($mns)     $8,985
       
Rescission benefit      
Total claim ($mns)     $8,985
X MTG est. benefit     7.0%
= MTG implied rescission     $629
       
Net Primary Claims     $8,356
Less: Reserves     $4,403
Surplus (Deficit)     ($3,953)
       
Pool Risk                 770
Default %     70.0%
Pool Claims     $539
Less: Reserves     $379
Surplus (Deficit)     ($160)
       
Total Claims (net primary claims + pool claims)   $8,895
Less: Reserves     $4,792
Surplus (Deficit)     ($4,103)
Cash & Investments     $7,125
Surplus (Deficit)     ($1,770)
 
Table 6
  4Q2011 2012 2013 2014 2015 2016 2017 2018 Sum 4Q11-2018
Beg Insurance in force (IFF)           179,000        172,288       146,444      124,478      105,806        89,935        71,948        57,558  
Persistency 85.0% 85.0% 85.0% 85.0% 85.0% 80.0% 80.0% 80.0%  
Run-off             (6,713)         (25,843)        (21,967)       (18,672)       (15,871)       (17,987)       (14,390)       (11,512)  
Ending insurance in force (IFF)           172,288        146,444       124,478      105,806        89,935        71,948        57,558        46,047  
Premium rate 0.61% 0.61% 0.61% 0.61% 0.61% 0.61% 0.61% 0.61%  
Ave IIF           175,644        159,366       135,461      115,142        97,871        80,942        64,753        51,803  
Premium earned $267 $971 $825 $701 $596 $493 $394 $315 $4,563
                   
Claims paid $700 $2,200 $2,000 $1,850 $1,375 $320 $285 $165 $8,895
Opex expenses $50 $50 $50 $50 $50 $50 $50 $50 $400
                   
Beg Investment $7,125 $6,669 $5,476 $4,308 $3,155 $2,121 $2,279 $2,058  
+ Net econ profit ($456) ($1,193) ($1,168) ($1,152) ($789) $158 $124 $171  
- Debt repayment $0 $0 $0 $0 ($245) $0 ($345) $0  
- Annual tax payment $0 $0 $0 $0 $0 $0 $0 $0  
= End Investment $6,669 $5,476 $4,308 $3,155 $2,121 $2,279 $2,058 $2,229  
Average Investment $6,897 $6,073 $4,892 $3,732 $2,638 $2,200 $2,169 $2,144  
Investment rate 2.50% 2.50% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00%  
Interest income $43 $152 $122 $112 $92 $87 $97 $106 $811
                   
Average debt $980 $980 $980 $980 $735 $735 $390 $390  
Debt rate 6.68% 6.68% 6.68% 6.68% 7.12% 7.12% 8.09% 9.00%  
Interest expense $16 $65 $65 $65 $52 $52 $32 $35 $384
 
Table 7:
 
4Q2011-2018
Total premiums earned $4,563
+ Investment income $811
Premium & investment income $5,373
- Interest expense $384
- Operating expenses $400
Net cash inflow/(outflow) $4,589
 
To give credit where credit is due, Tables 5, 6, and 7 were piggybacked off the work of Compass Point Research analyst Chris Gamaitoni (we encourage anyone doing further diligence to reach out to him). 
 
In what we consider as a relatively bearish scenario, shown in Table 5, there may be a deficit of $1.8B given the current potential claims.  However, even in this bearish scenario, we believe that the significant (undiscounted) cash flows generated from premiums and investment income after interest and operating expenses would far exceed this potential deficit as shown in Table 7.  Again, this analysis assumes a run-off scenario and no new business is generated; in our opinion this is the worst case scenario.  We believe the senior notes will be repaid in this scenario.

3) The share of the mortgage insurance market underwritten by the private players will grow significantly in 2013 and beyond.  This is more relevant to our longer-term view of MGIC (if private players were not to pick up share it would not change our view on the senior notes).

After the housing collapse the FHA became the main provider of insurance on low-down payment mortgages.  Given increased pricing (in April 2010) from the FHA, the private players have captured additional share.  As shown in the chart below in the 4th quarter of 2009 and 1st quarter of 2010, the private market maintained only 12% share.  As of the 3rd quarter of 2011, that share has doubled to 24%.

Table 8 - See SCRIBD LINK ABOVE

While it is unclear when this share will swing significantly back in favor to private mortgage insurers, we believe it will eventually.  We concede that given the spreads on Ginnie Mae securities versus Fannie and Freddie securities, the current share mix will probably remain static in the nearer-term.  If the FHA were to increase pricing again, additional share to the private players would result and could be a potent catalyst for additional revenues and cash flows for MGIC.

Notably, the surviving players will benefit from poorly reserved peers exiting.  As mentioned earlier PMI and Republic (subsidiary of Old Republic) are no longer underwriting business after breaching statutory capital levels.  We believe this is a positive for MGIC as two large competitors representing 20% of the market are no longer competing for business.  Five mortgage insurers remain.

Table 9

Private Mortgage Insurance Market Share
  3Q10 4Q10 1Q11 2Q11 3Q11 2011 YTD
United Guaranty 15.8% 16.5% 16.0% 18.6% 25.4% 20.0%
Radian 20.7% 20.5% 19.9% 17.9% 22.2% 20.0%
MGIC 22.5% 22.9% 22.9% 23.0% 20.3% 22.1%
Genworth 16.8% 16.8% 17.4% 15.6% 15.0% 16.0%
PMI 16.4% 15.7% 15.2% 14.5% 8.6% 12.8%
Old Republic 7.9% 7.5% 6.6% 6.9% 4.3% 5.9%
Essent 0.0% 0.0% 2.0% 3.5% 4.0% 3.2%
Other 0.0% 0.1% 0.0% 0.0% 0.2% 0.1%
Total 100% 100% 100% 100% 100% 100%

In the last three months, MGIC new insurance written has picked up.  On MGIC’s 3rd quarter conference call, management stated they expected $2.5-$3.5B of new insurance written in Q4, a typically slow time for originations.  As shown in the table below, MGIC already has written $2.8B in October and November alone.  We believe this to be directly a function of peers exiting.

Table 10:  See SCRIBD LINK ABOVE

What is interesting to us is the revenue opportunity available to MGIC assuming more business trends back to the private players versus FHA/VA.  In Table 11 we have run an analysis of the percentage of all mortgages originated that have required mortgage insurance.

 Table 11:

  Mortgage Origination Total MI   % Private $ Private % MTG of Private MTG NIW
1998 $1,656   20%   56% $187      
1999 $1,379   26%   52% $189      
2000 $1,139   24%   59% $163      
2001 $2,243   20%   63% $283      
2002 $2,854   18%   64% $337      
2003 $3,812   17%   64% $405      
2004 $2,773   14%   67% $264      
2005 $3,027   12%   76% $268      
2006 $2,726   13%   77% $266 22%   $58
2007 $2,306   20%   77% $357 22%   $77
2008 $1,509   32%   40% $193 25%   $48
2009 $1,995   27%   15% $82 24%   $20
2010 $1,572   28%   16% $70 17%   $12
2011E $1,000   27%   21% $57 25%   $14
2012E $1,100   23%   25% $63 25%   $16
2013E $1,250   22%   30% $83 25%   $21

This table above shows that in 2011 approximately $1T in mortgages were originated.  Of the $1T, more than 27% had a mortgage insurance policy ($269.7B worth had mortgage insurance through October 2011).  The breakout between private and government insurance is shown in Table 12 below.

Table 12 

Primary Mortgage Insurance Activity              
                   
  New Primary Private MI   Gov't Insured Lending   Total
  Traditional Bulk Total   FHA VA Total   Primary MI
1998 n/a n/a $187,450   $103,164 $42,569 $145,733   $333,183
1999 n/a n/a $188,910   $122,284 $49,553 $171,837   $360,747
2000 n/a n/a $163,160   $93,110 $22,210 $115,320   $278,480
2001 n/a n/a $282,970   $131,240 $35,430 $166,670   $449,640
2002 $282,230 $54,820 $337,050   $145,055 $41,947 $187,002   $524,053
2003 $330,790 $73,780 $404,570   $165,330 $66,147 $231,477   $636,048
2004 $216,000 $47,830 $263,830   $93,662 $35,313 $128,975   $392,806
2005 $183,640 $83,900 $267,540   $57,527 $24,884 $82,411   $349,951
2006 $174,452 $91,621 $266,073   $53,730 $24,461 $78,191   $344,264
2007 $285,698 $71,445 $357,143   $79,543 $25,158 $104,701   $461,844
2008 $190,663 $2,604 $193,267   $254,173 $40,585 $294,758   $487,992
2009 $81,568 $132 $81,700   $375,791 $74,030 $449,821   $531,521
2010 $69,797 $383 $70,180   $298,136 $68,921 $367,057   $437,237
2011 YTD $54,910 $1,897 $56,807   $157,909 $55,022 $212,931   $269,738
                   
* YTD = Oct                  

We estimate MTG will write $13.5-$14.2B in new insurance total for 2011 ($12.8 through November 30).  If one believes that FHA will continue to rein in their mortgage insurance efforts, the remaining private mortgage insurers would see a spike in new business in 2012 and 2013.  See Table 11 bottom right corner for an estimate on the impact to MGIC. 

4) We believe the US housing market has troughed and is beginning to rebound.  We refer readers to the write-up by cnm3d www.scribd.com/doc/64974231/Anon-Housing-Thesis-09-12-2011 as we feel it is well-done and in the interest of this audience find it unnecessary to reiterate what the analysis underscores. 

Other key points:

  • MGIC investment portfolio appears clean with no exotic/illiquid investments.

 

Table 13:

Investment portfolio at September 30, 2011 Fair Value
US treasury securities & US govt securities         776,254
Obligations of US States       2,999,632
Corporate Debt Securities       2,293,106
Commercial mortgage backed securities         195,033
Residential mortgage backed securities           49,835
Debt securities issued by foreign sovereign govts         141,661
Total debt securities       6,455,521
Equity securities             2,699
Total Investment Portfolio       6,458,220
 
 
  • MGIC currently has $1.32bn in NOLs.
  • MGIC has already funded a stacked subsidiary with $200mn (MIC) in the event MGIC were to breach the 25 to 1 stat capital threshold.

 

Risks:

  • A significant jump in employment causes higher default rates than our assumptions
  • Severity rates are much higher than we anticipate
  • Housing prices

 

 

Conclusion

In an environment of zero interest rates, we believe MGIC senior notes yielding 16% over the next 4 years are a compelling investment idea. With MTG market capitalization growing from $326mn on October 3rd to $840mn today, it seems like a dislocation to us that the company’s $245mn in senior notes continue to be priced below 70.    

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