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3 Reasons to Be Cautious on MGIC Investment Stock

Tom Taulli

MGIC Investment (NYSE:MTG), which insures about one million mortgages, has continued to find ways to crank out profits. In the latest quarter, its net income came to $186.8 million, or 49 cents a share, up from $118.6 million, or 31 cents a share. On a year-over-year basis, there was a 7.2% increase in the amount of insurance in force, to $200.7 billion.

The second quarter also saw other important trends. MTG reported improvements in new primary delinquent notices and delinquent inventory.

But despite all this, Wall Street has been a bit skeptical. For the year so far, MTG stock is off about 11%.  This has also been the case with other publicly traded mortgage insurance operators.

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OK so what now? Well, for the most part, I think Wall Street is on target, and here are three reasons why.

MTG Stock Issue: Competition

The private mortgage insurance market is intensely competitive. Just some of the players include: Arch Mortgage Insurance Company, Genworth Mortgage Insurance Corporation, Radian Group (NYSE:RDN), Essent Group (NYSE:ESNT) and NMI Holdings (NASDAQ:NMIH).

True, competition is common for most large markets. But in the case of private mortgage insurance, one of the main differentiators is price. That is, the market is fairly mature and commoditized. So this makes it tough to gin up growth on the top line.

According to MTG’s latest 10-K filing: “There can be no assurance that pricing competition will not intensify further, which could result in a decrease in our new insurance written and/or returns.”

But there are other competitive issues. For example, some of MTG’s competitors have access to lower-cost capital sources, which allows for creating other forms of credit enhancement. Note that the company’s rating from Moody’s (NASDAQ:MCO) is Baa2, and BBB+ from Standard & Poor’s.

MTG Stock Issue: Mortgage Volume

Another headwind for MTG stock is the rise in interest rates. Of course, this puts pressure on mortgage originations.

With the U.S. economy growing at a rapid clip and with unemployment at low levels, the Federal Reserve has indicated that it will continue to pursue a tighter monetary policy. The plan is to raise short-term rates two more times this year and three more times next year.

Keep in mind that there could be even more pressure on rates, though. After all, the budget deficit is likely to be over $1 trillion. This could make it tougher for the federal government to fund the debt.

In the meantime, housing prices have escalated during the past few years, making it tough to buy new homes. There has also been a lag in new and existing housing availability, as well as a slowdown in household formations because of demographics and changes in immigration.

MTG Stock Issue: Alternatives Entering Market

For the long haul, perhaps the biggest threat to MTG stock is the potential for disruption in the market. Consider that there are a variety of alternatives to private mortgage insurance, and they are likely to take a growing share of the market.

They include non-mortgage firms that use FHA, VA and other government programs; sophisticated investors that leverage risk-mitigation systems; and piggyback structures (such as by having different loan-to-value ratios on first and second mortgages).

These approaches are still in the early stages. However, it does look like GSEs (Government-Sponsored Enterprises) like Fannie Mae and Freddie Mac are getting serious about all this. All in all, there could be erosion for business for MTG if these initiatives gain traction.

Tom Taulli is the author of High-Profit IPO StrategiesAll About Commodities and All About Short SellingFollow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.

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