Despite all of the turmoil caused by the pandemic and its lingering aftermath, the U.S. consumer is in pretty good shape. Incomes are rising, and lenders are reporting that loan delinquencies remain below pre-pandemic levels. That said, as the Federal Reserve has hiked interest rates over the past year in order to combat inflation, many strategists and economists are beginning to worry about a potential recession in 2023. And some are already describing the current state of affairs in real estate as a "housing recession."
If the U.S. economy does go into a recession this year, how will this affect MGIC (MTG -0.39%)?
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Private mortgage insurance protects the government-sponsored enterprises
MGIC is a private mortgage insurer, and also provides mortgage credit risk management solutions. Private mortgage insurance (PMI) is typically required when someone purchases a home with a down payment of less than 20% of the purchase value. The government-sponsored enterprises Fannie Mae and Freddie Mac are not permitted to purchase low down-payment loans without some sort of private credit enhancement. This is where MGIC comes in. Private mortgage insurance covers losses to the insured entity if a borrower defaults on their mortgage.
Not all low down-payment loans require PMI. Those made under programs run by the Federal Housing Administration, the Department of Agriculture, and the Veterans Administration are insured by the government with an up-front payment that can be rolled into the loan balance. And if a loan does require PMI, the borrower can get it canceled once the loan-to-value ratio is below 80%. Typically, the insurance will be canceled when the loan-to-value ratio has fallen to 78%, according to the Consumer Financial Protection Bureau.
The U.S. labor market is exceptionally strong
The U.S. labor market has been exceptionally strong recently, with unemployment at its lowest levels in 50 years, elevated job openings, and weekly initial jobless claims of around 200,000. In fact, the Fed is worried that the labor market is too strong, and would like to cool it down. The strength of the labor market is evident in the unusually low mortgage delinquency rate, which is still below pre-pandemic levels.
US Mortgage Transition Rate: Current to Over 90 Days Delinquent data by YCharts.
Forbearance has helped MGIC
When the COVID-19 pandemic struck, the government instituted a mortgage forbearance program that allowed borrowers to stop paying their mortgages for a while. In addition, the government imposed a foreclosure moratorium. These measures helped support MGIC's earnings as it pushed off delinquencies into the future. If a borrower skips a mortgage payment, the servicer covers the delinquent principal and interest payments, not MGIC.
Home prices are another issue in that they can be a double-edged sword for MGIC. On the one hand, rising home prices reduce the likelihood that MGIC will have to pay out claims -- after all, if a home's price rises enough for a sale of the property to cover what's owed on the mortgage, then there would be no loss to Fannie Mae or Freddie Mac in a default. On the other hand, rising home prices reduce persistency -- the length of time that mortgage insurance policies remain in effect. Since a borrower can cancel their private mortgage insurance once their home equity is high enough, they generally will so that they can stop paying extra money alongside their mortgage.
MGIC is trading at a cheap valuation
The big question for MGIC is how next year will shape up if we get a recession. First, it is important to note that delinquencies overall are still below pre-pandemic levels -- even for auto lenders. Even if delinquencies tick up, they will still be at historical averages. MGIC is trading at a forward price-to-earnings ratio of 6.3, which is reasonable and well below its historical average. Given the strength of the labor market, delinquencies may remain low.
The stock also pays a dividend of $0.40 annually, which is well below its expected earnings per share of $2.79 in 2023. MGIC stock has outperformed the mortgage lenders during the past year, as well as the mortgage REITs. It's not a company that is going to grow like a weed, but it is a stable real estate play that is trading on the cheap side.
