PMI Pmi Grp. (The) Common Stock

We are downgrading our recommendation on the shares of MGIC Investment Corp. (MTG) to Neutral from Outperform, following the company’s first quarter 2011 results, which missed the earnings guidance due to higher paid losses, lower rescission and increased claims.

For the past couple of years, MGIC has been hit hard by the deterioration in mortgage and housing markets. However, the gradual improvement in residential mortgage markets is expected to lead the company to profitability.

MGIC attempted to narrow mortgage-related losses by reviewing more claims for rescissions. Historically, these have not accounted for a material portion of the company’s resolved claims. But, with the detection of fraudulence in 2006 and 2007 books of business, the rescission activity in 2008 substantially mitigated the company’s paid and incurred losses. However, the rescission benefit declined in 2010 and will likely decrease further in 2011, as the benefit has already been realized almost up to its full extent.

MGIC’s net investment income has been under pressure for the past couple of years due to a drop in the average investment yield, offset by an increase in the average amortized cost of invested assets. The decrease in investment yield was driven by lower prevailing interest rates and a fall in the average maturity of investments. We expect the same trend to continue in 2011 as well.

Moreover, owing to stiff competition from the Federal Housing Authority (FHA), MGIC’s market share has been declining. Also, FHA has received the regulatory approval to increase its monthly premium since October 2010. However, this rate hike is being viewed positively by MGIC. Management expects that the rate hike by its competitor, along with MGIC’s new credit tiered pricing, would make MGIC’s products more competitive and enhance its market share as well. This was also evident from the company’s fourth quarter results, wherein new insurance written improved 20% sequentially to $4.2 billion. 

Delinquency rates declined 113 basis points sequentially and 179 basis points year over year to 16.4% in the first quarter. We expect delinquencies to improve further and reserve per delinquency to trend down going forward.

However, MGIC is also experiencing a setback with respect to credit ratings. The mortgage insurance industry has historically viewed a financial strength rating of “Aa3/AA-” as critical to writing new business. The company is currently rated “Ba3” by Moody’s Investors Service and “B+” by Standard & Poor’s Rating Services; the outlook for both the ratings is negative. Therefore, MGIC’s below-par rating renders it incapable of writing considerable new business.

Based in Milwaukee, Wisconsin, MGIC competes closely with other mortgage providers such as PMI Group Inc. (PMI) and Radian group Inc. (RDN). The stock of MGIC carries a Zacks Rank # 4, which translates into a Sell rating over the short term (1-3 months). However, over the longer time horizon (6+ months), as the mortgage market slowly recovers, we expect the company’s business to improve and therefore, we rate the shares Neutral.

 
MGIC INVSTMT CP (MTG): Free Stock Analysis Report
 
PMI GROUP (PMI): Free Stock Analysis Report
 
RADIAN GRP INC (RDN): Free Stock Analysis Report
 
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