Despite all the turmoil caused by the pandemic and its lingering aftermath, the American consumer is in great shape. Revenues are rising and lenders report that loan delinquencies remain below pre-pandemic levels. That said, with the Federal Reserve raising interest rates over the past year to combat inflation, many strategists and economists are beginning to worry about a possible recession in 2023. And some already describe the current state of affairs in real estate as a “real estate recession”.

If the US economy goes into recession this year, how will this affect MAGIC (MTG) -0.30%)?

private mortgage insurance image

Image source: Getty Images.

Private Mortgage Insurance Protects Government-Sponsored Businesses

MGIC is a private mortgage insurer and also offers mortgage credit risk management solutions. Private Mortgage Insurance (PMI) is generally required when someone buys a home with a down payment of less than 20% of the purchase value. Government sponsored companies fanny mae Y freddy mac they are not allowed to buy low down payment loans without some form of private credit enhancement. This is where MGIC comes into play. Private mortgage insurance covers the insured entity’s losses if a borrower defaults on their mortgage.

Not all low down payment loans require PMI. Those made under programs administered by the Federal Housing Administration, the Department of Agriculture, and the Veterans Administration are government-insured with a down payment that can be rolled over to the loan balance. And if a loan requires PMI, the borrower can cancel it once the loan-to-value ratio falls below 80%. Insurance will typically be canceled when the loan-to-value ratio has dropped to 78%, according to the Consumer Financial Protection Bureau.

The US job market is exceptionally strong

The US job market has been exceptionally strong recently, with unemployment at its lowest levels in 50 years, job openings high, and weekly initial jobless claims of around 200,000. In fact, the Fed is concerned 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 Table 90+ Days Past Due

US Mortgage Transition Rate – current to 90+ days delinquent data by YCharts.

Indulgence has helped MGIC

When the COVID-19 pandemic struck, the government instituted a mortgage forbearance program that allowed borrowers to temporarily stop paying their mortgages. In addition, the government imposed a foreclosure moratorium. These moves helped support MGIC’s earnings as future delinquencies eased. If a borrower misses a mortgage payment, the servicer covers late principal and interest payments, not MGIC.

Home prices are another issue, as 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 claims; after all, if the price of a home increases enough that the sale of the property covers what is owed on the mortgage, then there would be no loss. to Fannie Mae or Freddie Mac by default. On the other hand, the increase in housing prices reduces persistence, that is, the period of validity of mortgage insurance policies. Since a borrower can cancel their private mortgage insurance once their home equity is high enough, they will usually do so in order to stop paying extra money along with their mortgage.

MGIC is trading at a cheap valuation

The big question for MGIC is what next year will be like if we have a recession. First, it’s important to note that delinquencies overall are still below pre-pandemic levels, even for auto lenders. Even if delinquencies increase, they will still be at historical averages. MGIC is trading at a forward price-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 shares also pay a dividend of $0.40 a year, which is well below its expected earnings per share of $2.79 in 2023. MGIC shares have outperformed mortgage lenders over the past year, as well as mortgage REITs. It’s not a company that’s going to grow like weeds, but it’s a stable real estate game that trades on the cheap side.