A Mortgage Marriage Made in Heaven?

Investors bid up shares of MGIC Investment and Radian Group Tuesday after the two companies agreed to merge

The clubby world of U.S. mortgage insurers received a jolt on Feb. 6 from news that the industry's No. 1 player, MGIC Investment (MTG), agreed to acquire rival Radian Group (RDN) in a stock deal valued at around $4.9 billion. Shares of both outfits shot higher after the deal was announced.

Through subsidiaries, both companies provide private mortgage insurance (PMI), which protects mortgage investors in the event of default. Homebuyers are often required to purchase PMI when taking out low downpayment mortgages. Through a subsidiary, Radian also offers financial guaranty insurance in certain niche market sectors and reinsurance capacity.

Terms of the deal call for Radian holders to receive 0.9658 MGIC shares per Radian share. The deal is expected to close in the fourth quarter of 2007, pending approvals by regulators and shareholders. The combined company, to be known as MGIC Radian Financial Group, will have nearly $15 billion in assets with more than $290 billion of primary mortgage insurance in force.

MGIC CEO Curt S. Culver will serve as chairman and CEO of the combined company. S.A. Ibrahim, current CEO of Radian, will be president and COO of the combined company, and will succeed Culver as CEO in 2009 and as chairman in 2010. The combined company’s headquarters will be located in MGIC's hometown of Milwaukee.

"Our companies have similar goals and shared values regarding increasing shareholder value. We will take a deliberate, methodical approach to integrating our companies, making certain that customers continue to receive high quality service and that our shareholders realize the potential benefits of this merger," said Culver in a Feb. 6 press release.

"The appeal of this merger is compelling by any measure – strategically, financially and operationally," said Ibrahim in the press release.

The combined company expects to realize aggregate cost savings of $128 million, pre-tax. It expects to incur restructuring costs of approximately $125–$150 million, after tax. The companies figure that the planned cost reductions could add 2.8% to EPS in 2008 and 6.3% in 2009.

In a Feb. 6 note, Standard & Poor's Ratings Services said its 'A' ratings on MGIC and Radian are not affected by the merger deal. S&P Ratings believes there is "a good strategic fit" between the two companies in the mortgage insurance sector. "When the transaction is complete, the combined entity will be the largest industry player by far, significantly changing the playing field for all U.S. mortgage insurers" said the ratings agency.

Meanwhile, Standard & Poor's Equity Research, which operates separately from S&P Ratings, was bullish on the deal. Analyst Stuart Plesser said he expects cost savings of roughly $130 million, with 75% likely to be realized in 2008. He also said the two companies make "a good fit", since Radian would add more international exposure to MGIC's heavily domestic book of business.

Plesser boosted his target price for MGIC by $6 to $77 and maintained his buy rating on the stock. He also boosted his target price for Radian by $8 to $77. (Standard & Poor's, like BusinessWeek.com, is a unit of The McGraw-Hill Cos.)

Investors liked the combination as well. Shares of MGIC jumped 11.4% to $70.09, while Radian climbed 9.3% to $66.51, in NYSE trading Feb. 6.

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