MGIC Investment Corporation; MTG Feb 10, 2006

Current Price: $63.00
Current PE: 9.3
Current Market Cap: $5.7B
Current Price/ Book: 1.33

History of MGIC Investment Corporation:

In the late 1950s, the national population was growing with the Baby Boom, and everyone expected to have a chicken in every pot and a car in every garage. But before the garage and the car came a home. The average cost of a home at that time was $20,000 and average yearly income was $4,545. Putting the required 20% down payment on a home was difficult.

In 1957, Max Karl, a real estate attorney in Milwaukee, Wisconsin, observed the struggles that people had with saving for a down payment on a home. He also understood the risks that mortgage originators faced in lending the money to potential home buyers. He was frustrated with the process of closing loans with 100% government guarantees, which he believed was rife with red tape and bureaucracy. Why not create a private company that insured only the top portion of a mortgage, rather than 100% of the mortgage? This could be a less costly and easier way to provide low-down payment financing to borrowers with less than a 20% down payment.

Mr. Karl took his idea to a group of investors, many of whom were Savings & Loan executives. This group, along with his family and friends (even his barber!) contributed $250,000 in capital, and he founded the Mortgage Guaranty Insurance Corporation or MGIC.

Today, as average home prices rise across the country, saving for a down payment is still difficult. But nearly 50 years since MGIC was founded, we’re still here, working with mortgage lenders and helping people afford homes with low down payment loans. [Obtained from MGIC Investment Corp's website]

What I like about MTG:

• Superior Net Margin. Improving margin over last 2 years.
  
  Year Net Profit Margin (%)
  12/05 41.1
  12/04 31.9
  12/03 28.2
  12/02 40.2
  12/01 47.1
  12/00 48.8
  12/99 47.2
  12/98 39.7
  12/97 37.3
  12/96 34.6

• Good ROE and ROA. Improving ROE and ROA over last 3 years.
  
  Year ROE ROA
  12/05 15.0 9.8
  12/04 13.4 8.7
  12/03 13.0 8.3
  12/02 18.5 11.9
  12/01 21.2 14.0
  12/00 22.0 14.0
  12/99 26.5 15.1
  12/98 23.5 12.6
  12/97 21.8 12.4
  12/96 18.9 11.6

• Book value/ Share compounds at 15.4% over the last 5 years; and 11.8% over the last 3 years; and 9.9% over last year.
  
  Year Book Value/ Share
  12/05 $47.31
  12/04 $43.05
  12/03 $38.58
  12/02 $33.87
  12/01 $28.47
  12/00 $23.07
  12/99 $16.79
  12/98 $15.05
  12/97 $13.96
  12/96 $11.59

• Current Price/ Book Value = 1.33. This is the 2nd lowest price/ book value in the last 10 years.
  
  Year Price/ Book
  12/05 NA
  12/04 1.60
  12/03 1.48
  12/02 1.22
  12/01 2.17
  12/00 2.92
  12/99 3.58
  12/98 2.65
  12/97 4.76
  12/96 3.28

• Improving persistency (percentage of insurance remaining in force from one year prior).
  
  Year Persistency (%)
  12/05 61.3
  12/04 60.2
  12/03 47.1

• Significant shares repurchase. Outstanding shares are reduced by 23% over last 9 years.
  
  Year Shares Outstanding
  12/05 90.7 Mil
  12/04 96.3 Mil
  12/03 98.4 Mil
  12/02 100.3 Mil
  12/01 106.1 Mil
  12/00 106.8 Mil
  12/99 105.8 Mil
  12/98 109.0 Mil
  12/97 106.5 Mil
  12/96 117.9 Mil

• The most efficient PMI Company with the lowest expense ratio.
• MGIC has one of the largest market shares in the very concentrated private mortgage insurance industry--consistently 20%-25%.
• MGIC has the oldest and most detailed mortgage-history database, which adds a considerable advantage in underwriting skill.
• Compounding housing prices support ongoing premium revenue increases. U.S. house prices haven't fallen nationally since 1952, although there have been several temporary regional declines.
• Collectively, directors and officers own about 1.85% of MGIC.
• Holdings of superinvestors: Bill Miller (Legg Mason Value Fund; 2.34% of assets); Bill Nygren (Oakmark I Fund; 1.71% of assets).

What I dislike about MTG:

• MGIC's moat is shrinking as lenders flex their increasingly powerful muscles to recapture part of MGIC's premiums.
• Unlike mortgage interest, private mortgage insurance isn't tax-deductible. This makes competing products like 80-10-10 (80% first mortgage, 10% second mortgage, and 10% down payment) loans more attractive.
• Alternatives to private mortgage insurance include:
• lenders structuring mortgage originations to avoid private mortgage insurance, such as a first mortgage with an 80% loan-to-value ratio and a second mortgage with a 10%, 15% or 20% loan-to-value ratio (referred to as 80-10-10, 80-15-5 or 80-20 loans, respectively) rather than a first mortgage with a 90%, 95% or 100% loan-to-value ratio,
• investors holding mortgages in portfolio and self-insuring,
• investors using credit enhancements other than private mortgage insurance or using other credit enhancements in conjunction with reduced levels of private mortgage insurance coverage, and
• lenders using government mortgage insurance programs, including those of the Federal Housing Administration and the Veterans Administration.
• Government-sponsored entities (GSEs) Fannie Mae FNM and Freddie Mac FRE control more than 40% of the mortgage market, which lets them dictate terms to mortgage insurers.
• GSEs need more capital to back loans insured by AA-rated insurers like MGIC than loans insured by AAA-insurers like United Guaranty Corporation AIG. This permanently disadvantages MGIC.
• Increasing default rate, year after year.
  
  Year Percentage of default (%)
  12/05 6.58
  12/04 6.05
  12/03 5.57
  12/02 4.45
  12/01 3.46
  12/00 2.58
  12/99 2.17

• Significant insiders selling. CEO (Culver Curt) sold shares worth $2.4M on Feb3, 2006.
  

Feel free to email me if you have any comments, thoughts, criticisms, etc....

All the best,

Dah Hui Lau (David)

dahhuilaudavid@gmail.com