The US housing markets have shown considerable improvement with the help of the government’s stimulus programs. As a result, I believe mortgage insurance giants like Radian Group Inc (NYSE:RDN) and MGIC Investment Corp. (NYSE:MTG) will post strong results in the coming quarters. Bloomberg recently reported that Standard & Poor’s expects these companies to report the return of profits after a long wait.
Fears of insolvency
Analysts at S&P believe that fears about the companies becoming insolvent are long gone. The rebounding housing markets have led to a surge of capital into the mortgage insurance sector. At the same time, private guarantors wrote more than double ($175 billion) as many new policies in 2012 as compared to the prior year.
Since 2006, when MGIC Investment Corp. (NYSE:MTG) last reported an annual profit, the sector was largely written off by many. In this time span, Radian Group Inc (NYSE:RDN) was able to report only one annual profit. However, things are beginning to change amid the housing rebound.
Higher NIW through 2013
The new insurance written (NIW) by both Radian Group Inc (NYSE:RDN) and MGIC Investment Corp. (NYSE:MTG) was higher than expected, leading me to believe that the full year 2013 new insurance written would be higher than previously expected. The sector is now expected to write $219 billion worth of new policies for the year, up 25% over the prior year. These higher volumes are driven by an 8% market share gain from the Federal Housing Authority.
Therefore, higher expected NIW, capital inflows, and the rebounding US housing market will lead the mortgage insurance sector to become profitable once again.
Limitations of reinsurance
Looking at the earnings power expectations of Radian and MGIC Investment Corp. (NYSE:MTG), Credit Suisse Group AG (ADR) (NYSE:CS) has increased its price targets for both companies. After a capital raise in the first quarter, both MGIC Investment and Radian Group Inc (NYSE:RDN) have been using reinsurance to help manage risk to capital ratios. Radian has drastically reduced its reinsurance to 5% (from 20%) of the new insurance written (NIW), while MGIC Investment Corp. (NYSE:MTG) is reinsuring 30% of its NIW.
Higher levels of reinsurance has its limitations. More of the premiums earned are used up for reinsurance purposes. Here, since MGIC Investment Corp. (NYSE:MTG) is using a higher proportion of reinsurance, you should expect the company to report lower earnings by 2014. To become more profitable, it has to scale back on its reinsurance activities.
A look into the future
During the remainder of the current year, Radian Group Inc (NYSE:RDN) is expected to write new insurance worth $51 billion, 37% over the prior year, while its market share will remain stable. However, 2014 will see declines in both its market share and NIW as competition increases from new entrants. MGIC Investments is expected to write $29 billion of new insurance, 22% higher than the prior year. NIW will fall 3% next year, while its market share will shrink 50 bps due to increased competition.
Increasing competition
Over the past two years, the competitive environment within private mortgage insurers has become more favorable, as smaller players like The PMI Group, Inc. (OTCMKTS:PPMIQ) and Old Republic International Corporation (NYSE:ORI) have left the business. This left Radian Group and American International Group Inc (NYSE:AIG) to gain market share. Radian Group Inc (NYSE:RDN) reached the highest share of 28.4%, followed by AIG at 27.5%. MGIC Investments has the third largest share of 17% at the end of the first quarter.
However, the situation will begin to reverse over the remaining half of 2013 given Arch Capital Group Ltd. (NASDAQ:ACGL)’sacquisition of CMG Mortgage Insurance Company and the recent approval of NMI Holdings to begin writing business. By the end of next year, Arch Capital and NMI Holdings can gain a share of 15-20% from the existing mortgage insurers.
American International Group Inc (NYSE:AIG) has recently been named as a non-bank Systemically Important Financial Institution (SIFI) by the Fed. While the implications remain unclear, one thing is sure: They will be tested by the Fed for stress tests and would require approval to repurchase stocks or raise dividends. Although American International Group Inc (NYSE:AIG) appears to be well capitalized under the current rules, it will face major constraints on its future share buyback programs. The company had an established track record of repurchasing its stocks.
Conclusion
The situation is beginning to improve for Radian Group and MGIC Investment after they accumulated losses for years. However, the improving situation is also attracting more smaller players in the industry, which will ultimately snatch some of the old players’ share. Still, with this increased competition, Radian and MGIC are expected to produce some impressive results in the coming quarter. While both Radian and MGIC are expected to write higher insurances during the remaining of the year, MGIC’s future profitability is highly dependent on the level of reinsurance it uses. I believe Radian is better positioned compared to MGIC due to the lower reinsurance it has employed.
Adnan Khan has no position in any stocks mentioned. The Motley Fool recommends American International Group. The Motley Fool owns shares of American International Group and has the following options: Long Jan 2014 $25 Calls on American International Group. Adnan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Profits to Return to These Mortgage Insurers originally appeared on Fool.com is written by Adnan Khan.
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