April 29, 2008
Research Associate: Megha Kumar, M.Fin.
Editor: Madhurima Majumdar
Sr. Ed.: Ian Madsen, CFA; ; 1-800-767-3771, x9417
www.zackspro.com 111 N. Canal Street, Suite 1101 l Chicago, IL 60606
MGIC Investment Corp. / (MTG - NYSE) / $12.69*Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report: 1Q08 Earnings Update
Previous Edition: 4Q07 and FY07 Earnings Update, March 7, 2008; (broker material considered till February 27, 2008)
Brokers’ Recommendations: Neutral: 62.5% (5 firms); Negative: 25.0% (2); Positive: 12.5% (1) Prev.: 6; 1; 1
Brokers’ Target Price: $15.00 (↓ $1.00 from last edition; 7 firms) Brokers’ Avg. Expected Return: 18.2%
*NOTE: Though dated April 29, share price is of April 24; broker material is as of April 24.
Flash Update on 1Q08 Earnings Update done on April 17, 2008.
Portfolio Manager Executive Summary
MGIC Investment Corp (MTG or the Company) is the largest provider of mortgage insurance in the U.S., serving all 50 states. Headquartered in Milwaukee, Wisconsin, the company employs over 1,200 people and has offices around the country. Mortgage insurance is required, for most mortgages where home buyers put less than a 20% down payment on the home’s value. This 20% rule is mandated for loans to be purchased by housing government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. Although MGIC is a monocline mortgage insurer, the company has joint ventures C-BASS and Sherman, which invest in and rehabilitate non-performing mortgage and credit card debt.
62.5% of the firms in the Digest group are neutral on the stock, 25.0% are negative, while the rest 12.5% have a positive stance. Seven brokerage firms provided target prices while six provided valuation metrics. The firm with the highest target price did not provide any valuation metric and rated MTG outperform. The firm with the lowest target price valued the shares on 0.5x 2008 estimated book value and rated the stock neutral.
Neutral and Negative outlook - seven firms or 87.5% - Target Price in the $11.00-$15.00 range: According to firms, though the newly written mortgage insurance (MI) business is experiencing generally positive growth trends, helped by the increasing GSE market share and the recognition in the market of the value of credit enhancements, the overhang of credit losses on existing books of business remains a drag on earnings. In particular, rising delinquencies (due to the weakening economy) and rising severity (due to declining home prices) are pushing up paid losses and reserve increases to historically high levels. Unfortunately, analysts expect the situation to persist for the foreseeable future.
Buy or equivalent outlook - one firm or 12.5% - Target Price of $25.00 provided by the firm: According to the firm, MTG is working with the GSEs to address any concerns that they might have regarding capital adequacy and claims paying ability. MTG’s capital base is currently solid, especially with the recent boost from an additional $840 million raised.
April 29, 2008
Recent Events
On April 17, 2008, MTG announced its 1Q08 financial results. Highlights are as follows:
· Net loss in 1Q08 was $34.4 million versus net income of $92.4 million in 1Q07.
· Diluted loss per share was $0.41 in 1Q08 versus diluted earnings per share of $1.12 in 1Q07.
Overview
Analysts have identified the following factors for evaluating the investment merits of MTG.
Key Positive Arguments / Key Negative Arguments· Newly written mortgage insurance (MI) business is experiencing generally positive growth trends.
· MTG has shown strong expense control and growth in market share over the past several years.
· MTG stands to reap the cyclical benefits of rising interest rates via increasing persistency rates, a low expense ratio, and high penetration rates.
· MTG has a strong management team with disciplined credit methods. / · A secular decline in the mortgage insurance business could adversely affect the company’s earnings.
· Lack of diversification weighs down on MTG’s earnings, leading to considerable volatility.
· Overhang of credit losses on existing books of business remains a drag on earnings.
· Rising delinquencies (due to the weakening economy) and rising severity (due to declining home prices) are pushing up paid losses and reserve increases to historically high levels.
Based in Milwaukee, Wisconsin, MGIC Investment Corporation (MTG or the Company) is the nation’s largest provider of private mortgage insurance coverage with $221.4 billion primary insurance in force, covering 1.5 million mortgages as of March 31, 2008. MGIC serves more than 3,300 lenders with locations across the country and in Puerto Rico, Guam, and Australia, helping families to achieve homeownership faster by making affordable low-down-payment mortgages possible.
MTG’s principal products are primary mortgage insurance and pool mortgage insurance. Primary mortgage insurance may be written on a flow basis in which loans are insured in individual, loan-by-loan transactions, or written on a bulk basis in which a portfolio of loans is individually insured in a single, bulk transaction. Pool mortgage insurance is generally used as an additional credit enhancement for certain secondary market mortgage transactions and covers the loss on defaulted mortgage loans that exceed the claim payment under the primary coverage, if primary insurance is required on that mortgage loan, as well as the total loss on a defaulted mortgage loan that does not require primary insurance. MTG is licensed in all 50 states, the District of Columbia, and Puerto Rico. In addition to mortgage insurance on first liens, the Company provides lenders with various underwriting and other services and products related to home mortgage lending through other subsidiaries. The Company also owns joint venture with the Radian Group called C-BASS (Credit-Based Asset Servicing and Securitization), which services and securitizes high-risk loans.
NOTE: The Company’s fiscal year references coincide with the calendar year.
April 29, 2008
Revenue
Total revenue, as compiled by Zacks Digest, is shown in the table below:
Total Revenue ($M) / 1Q07A / 4Q07A / 2007A / 1Q08A / 2Q08E / 2008E / 2009E / 2010EDigest High / $372.7 / $409.0 / $1,551.0 / $425.1 / $440.8↓ / $1,777.7↓ / $1,958.2↓ / $1,861.1↓
Digest Low / $361.7 / $399.0 / $1,530.3 / $424.0 / $421.2↑ / $1,730.7↑ / $1,756.4↑ / $1,861.1↓
Digest Average / $371.1 / $406.5 / $1,546.9 / $424.9 / $433.9↓ / $1,745.3↓ / $1,831.3↓ / $1,861.1↓
YOY Growth / 0.6% / 10.8% / 5.4% / 14.5% / 15.3% / 12.8% / 4.9% / 1.6%
Sequential Growth / 1.2% / 4.0% / 4.5% / 2.1%
Zacks Consensus / $458.0↑ / $1,814.0↓ / $1,948.0↓
The Company reported total revenue of $423.9 million in 1Q08 versus $369.6 million in 1Q07. As per Zacks Digest model, total revenue in 1Q08 was $424.9 million, up 14.5% y-o-y from $371.1 million in 1Q07.
As of March 31, 2008, MTG's primary insurance in force was $221.4 billion versus $211.7 billion at December 31, 2007, and $178.3 billion at March 31, 2007. The book value of MTG’s investment portfolio, cash, and cash equivalents was $7.3 billion at March 31, 2008, versus $6.2 billion at December 31, 2007, and $5.6 billion at March 31, 2007.
Revenue components, as compiled by Zacks Digest, are shown in the table below:
($ Million) / 1Q07A / 4Q07A / 2007A / 1Q08A / 2Q08E / 2008E / 2009E / 2010ENet Premiums Earned / $299.0 / $336.0 / $1,262.2 / $345.4 / $350.7↓ / $1,425.5↓ / $1,524.4↓ / $1,737.8↓
Investment Income / $63.0 / $70.1 / $259.9 / $72.4 / $77.1↑ / $305.1↑ / $312.7↑ / $295.3↑
Other Income / $10.7 / $3.0 / $28.9 / $7.1 / $6.2↓ / $26.0↑ / $26.9↑ / $22.0↓
Total Revenue / $371.1 / $406.5 / $1,546.9 / $424.9 / $433.9↓ / $1,745.3↓ / $1,831.3↓ / $1,861.1↓
Net premiums earned, as per Zacks Digest model, in 1Q08 were $345.4 million versus $299.0 million in 1Q07 and $336.0 million in 4Q07.
Investment income, as per Zacks Digest model, in 1Q08 was $72.4 million versus $63.0 million in 1Q07 and $70.1 million in 4Q07.
Other income, as per Zacks Digest model, in 1Q08 was $7.1 million versus $10.7 million in 1Q07 and $3.0 million in 4Q07.
Net premiums written in 1Q08 were $368.5 million versus $304.0 million in 1Q07.
New Insurance Written (NIW) in 1Q08 was $19.1 billion versus $12.7 billion in 1Q07. New insurance written in the quarter included $1.0 billion of non-Wall Street bulk transactions compared to $2.3 billion, including $0.2 billion of non-Wall Street transactions in 1Q07.
Outlook
Management expects NIW to slow down to roughly $50 billion (prior guidance was $60-64 billion). Premium deficiency reserve run-off is expected to be close to 700 million (prior guidance was $500-$700 million). Premium deficiency reserve run-off for 2Q08 is expected to be somewhat less than 1Q08, and lower amounts forecasted for 3Q08 and 4Q08 to achieve the annual amount of $700 million. Average premium earned rate is expected to be lower throughout the 2008, with a full year average around 60 basis points.
One firm (Bear Stearns) expects slower growth of insurance in force for 2008, but estimates that earned premiums will continue to grow in the coming years.
Please refer to the Zacks Research Digest spreadsheet on MTG for specific revenue estimates.
Margins
As per Zacks Digest model, pre-tax margin in 1Q08 was (21.6%) versus 27.6% in 1Q07 and net margin was (8.1%) versus 24.9% in 1Q07.
Margins, as compiled by Zacks Digest, are shown in the table below:
Margins / 1Q07A / 4Q07A / 2007A / 1Q08A / 2Q08E / 2008E / 2009E / 2010EPre-Tax Margin / 27.6% / -551.3% / -145.5% / -21.6% / -31.1%↑ / -42.1%↓ / -7.1%↓ / 19.9%↓
Net Margin / 24.9% / -359.6% / -106.9% / -8.1% / -16.0%↑ / -24.3%↑ / -3.3%↓ / 7.2%↓
Losses incurred in 1Q08 were $691.6 million, up from $181.8 million reported in 1Q07. Higher losses incurred were driven by an increase in delinquencies and severity, particularly in high loan balance states of California and Florida.
Underwriting expenses were $79.0 million in 1Q08, including $3.3 million of one-time consulting fees associated with the common stock offering and private placement of the junior subordinated convertible debenture as compared to $76.0 million in 1Q07.
Paid Losses in 1Q08 were $371 million, up $87 million from 4Q07. Total paid losses reflected increases in prime (up $34 million), A-minus (up $20 million), subprime (up $6 million), and reduced documentation (up $29 million), mitigated by a decline in Other (down $2 million).
Outlook
Management expects paid losses to be in the range $1.8 million to $2.0 billion for 2008. Delinquencies are also expected to rise throughout the year and build reserves over paid claims.
Please refer to the Zacks Research Digest spreadsheet on MTG for more details.
Earnings per Share
MTG reported a net loss of $34.4 million in 1Q08 versus net income of $92.4 million in 1Q07. Diluted loss per share was $0.41 in 1Q08 versus diluted earnings per share of $1.12 in 1Q07.
EPS, as compiled by Zacks Digest, is shown in the table below:
EPS / 1Q07A / 4Q07A / 2007A / 1Q08A / 2Q08E / 2008E / 2009E / 2010EDigest High / $1.15 / ($18.02) / ($18.02) / ($0.37) / ($0.34)↓ / ($2.15)↑ / $0.70↓ / $2.47↓
Digest Low / $1.12 / ($18.09) / ($18.12) / ($1.37) / ($1.00)↑ / ($4.82)↑ / ($2.00)↑ / ($0.20)
Digest Average / $1.15 / ($18.08) / ($18.07) / ($0.52) / ($0.76)↑ / ($3.80)↑ / ($0.45)↓ / $1.62↓
YoY growth / -38.7% / -1319.2% / -371.0% / -145.2% / -175.5% / 79.0% / 88.2% / 462.5%
Sequential Growth / -22.7% / -744.4% / 97.1% / -47.6%
Zacks Consensus / ($0.85)↑ / ($3.61)↑ / $0.07↑
As per Zacks Digest model, operating EPS in 1Q08 was ($0.52) versus $1.15 in 1Q07 and ($18.07) in 4Q07.
Highlights from the EPS chart are as follows:
· 2008 forecasts (total 8) range from ($4.82) to ($2.15); the average is ($3.80).
· 2009 forecasts (total 8) range from ($2.00) to $0.70; the average is ($0.45).
· 2010 forecasts (total 4) range from ($0.20) to $2.47; the average is $1.62.
Outlook
As per Zacks Digest model, analysts expect the share count to increase by 48.5% y-o-y to 120.9 million by the end of FY08, by 8.2% y-o-y to 130.8 million by the end of FY09, and decline by -3.7% y-o-y to 125.9 million by the end of FY10. This represents a three- year CAGR of 15.6% on FY07 share outstanding.
As per the Zacks Digest model, for FY08 and FY09, analysts expect loss per share to show an improvement driven by decrease in net loss and increase in shares outstanding. However for FY10, analysts expect the trend to reverse and MTG to post net income of $134.9 million and consequently EPS of $1.62.
Please refer to the Zacks Research Digest spreadsheet on MTG for more extensive EPS figures.
Target Price/Valuation
The average Zacks Digest target price is $15.00 (↓ $1.00 from the previous Digest report; 18.2% upside from the current price). The target prices range from $11.00 (13.3% downside from the current price) (UnionBankSwitz.) to $25.00 (97.0% upside from the current price) (Bear Stearns). The firm with the highest target price rated the stock Positive and did not provide any valuation metric. The firm with the lowest target prices rated the stock Neutral and valued the shares based on 0.5x 2008 estimated book value.
Following the 1Q08 earnings release, two firms (Keefe Bruyette; Piper Jaffray) increased their target prices on the stock. One firm (Bear Stearns) upgraded its rating from Peer Perform to Outperform.