Earnings are the “catalyst” for my beloved mortgage insurance stocks. And Radian delivers.
[Publisher’s note: I never send out two posts in the same week. But the news was too good to pass up.]
“Yes, the stock seems cheap, Gordon. But what’s the catalyst?”
That is a constant refrain when I pitch someone a stock. Some magic event – which I am supposed to time! – is supposed to occur on the day of my choosing that will convince doubters that I am right.
The investment real world rarely works like that. A magical catalytic moment doesn’t happen. Rather, a web of data pointing mostly in one direction is what moves stocks over time. I believe that is especially so for “PTSD” stocks that have to overcome a traumatic past event. In the case of the mortgage insurers, that event was of course the 2008 bursting of a huge housing bubble. A decade later, the trauma continues, as indicated by the tone of this article from The Wall Street Journal yesterday:
“Home Prices Continue to Lose Momentum. Gains fell below 6% in August as slowdown in housing market becomes more widespread.”
Yes, the valuations of mortgage insurance companies MGIC and Radian are just silly cheap. As of last night, MGIC was selling at a 13% earnings yield (its third quarter earnings divided by its stock price), while Radian was at 14%. Could there be a catalyst to bring their earnings yields to a more logical 8%-10%?
My best guess is that a relentless stream of earnings that over time will convince more and more investors that the housing market is far healthier than they fear and the mortgage insurers, rather than in imminent danger of earnings hits, will grow their earnings consistently over the next five years. In my last blog post I noted MGIC’s strong Q3 earnings, and said that Radian and National Mortgage Insurance’s earnings this week would do the same.
I was right. This morning, Radian reported operating earnings per share of $2.68 annualized, compared to a Wall Street forecast of $2.52. And last night, National Mortgage delivered $1.84 annualized versus a $1.64 forecast.
Radian’s Q3 highlights:
Growth! Companies with 14% earnings yields should be shrinking, not growing. But Radian grew revenues by 6% over the past year. And it has 10% more insurance in force.
Strong returns on investors’ capital. Radian’s return on equity capital was a terrific 19%. National Mortgage was a hair better, at 20%. Radian’s book value per share now stands at $15.69 per share, up 13% over the past year.
Growing “free cash flow”. Free cash flow is the Holy Grail for investors. These are earnings that are not needed to be reinvested in the business and therefore can be paid to investors in the form of dividends and/or share repurchases. For a mortgage insurer, a good way to calculate free cash is the amount of capital it has relative to the capital regulators require it to hold. That cushion was $237 million a year ago. Today it is $530 million. In addition, Radian gave $50 million back to investors this year with a share repurchase and announced another $100 million buyback plan.
Credit quality is awesome. Claims paid due to mortgage defaults should total about $200 million this year, down from $414 million two years ago. Nearly all of the current losses are due to Radian’s pre-2008 insurance policies. For example, National Mortgage, which started up after 2008, had nearly no claims paid this past quarter.
Credit quality remains excellent on Radian’s new business written:
Source: Company reports
The only possibly troubling statistic is the 17% of new insurance on loans with less than a 5% downpayment. I checked into it, and I believe the reason is that the government’s FHA mortgage insurance program, the primary low downpayment insurer, has been restrained by regulators, so Radian and its peers have taken market share. And I am certain that these low downpayment loans have very high credit scores.
Higher interest rates are not a material risk. Higher interest rates theoretically can hurt Radian by slowing refinancing activity and home sales. But Radian grew its insurance book by 10% over the past year, while interest rates were rising! Refinanced loans were only 4% of Radian’s new business during Q3.
Mortgage insurer earnings during Q3 were a beautiful sight to behold. I look forward to the next round of earnings reports. And the next round…
If so, MGIC should reasonably trade at $20 a share, up 60% from its current price. And Radian should be at $32, or up 70%. When? In the future.