MGIC INVESTMENT CORP quarterly report, Q2 FY2019

Business context and reporting period

MGIC Investment Corporation’s unaudited Form 10-Q covers the quarter and six months ended June 30, 2019. Through its subsidiaries, the company provides mortgage insurance on low-down-payment residential loans and participates in GSE credit-risk-transfer programs. Amounts below are in U.S. dollars; financial-statement amounts are generally in millions unless stated otherwise.

Financial performance and position

Quarterly net income fell 10%, principally because favorable reserve development was lower than a year earlier; higher investment income and lower taxes partly offset the increase in losses. First-half net income declined 3%, as higher premiums and investment income partly offset higher losses. Management reported adjusted net operating income of $167.6 million for Q2 and $320.0 million for the first half; these are non-GAAP measures.

• Operating cash flow was $281.6 million for the first half, versus $262.6 million in 2018. Investing cash flow was negative $169.2 million and financing cash flow negative $42.2 million; cash and restricted cash increased $70.1 million to $225.2 million.
• At June 30, total assets were $6.06 billion, liabilities $2.02 billion and shareholders’ equity $4.04 billion. The investment portfolio was $5.51 billion; loss reserves were $621.9 million.
• Consolidated debt carrying value was $832.2 million: $155 million of FHLB advances, $420.3 million of senior notes and $256.9 million of convertible debentures. Holding-company debt principal was approximately $814.5 million, compared with $333 million of holding-company cash and investments.
• MGIC reported $4.4 billion of PMIERs Available Assets, approximately $1.1 billion above Minimum Required Assets. Its risk-to-capital ratio was 10.1:1; policyholder position exceeded the required minimum by $2.7 billion.

Material changes and operating trends

• Net premiums earned were essentially flat in Q2 and rose 4% year to date. Premium yield declined, reflecting lower average rates on newer business and ceded reinsurance premiums, including a one-time $6.8 million fee tied to an amendment of the 2015 quota-share agreement.
• Investment income rose 23% in Q2 and 25% year to date, attributed to a larger average portfolio and higher yields. The portfolio’s embedded pre-tax yield was 3.2%, with a 4.0-year duration.
• Net losses incurred increased materially from the prior-year periods, when Q2 included $13.5 million of favorable reserve development. In the first half of 2019, prior-year reserve development was favorable by $33 million, versus $98 million in 2018; 2019 included a $23.5 million probable litigation loss.
• Primary delinquent inventory declined to 29,795 loans from 32,898 at year-end 2018 and 36,037 a year earlier. Primary delinquency rate was 2.80%, versus 3.11% and 3.49%, respectively. New-insurance written was $14.9 billion in Q2 and $25.0 billion year to date.
• Shareholders’ equity rose from $3.58 billion at year-end, supported by earnings and higher unrealized investment gains, partly offset by share repurchases. The company repurchased 1.8 million shares for $25 million in Q2 and authorized a new program of up to $200 million through 2020.

Outlook, risks and unusual items

• Management expects premium yield to decline in 2019, primarily because average premium rates on insurance in force are lower. It also said it may pursue further excess-of-loss reinsurance if capital-market conditions remain favorable. No quantified earnings or revenue guidance is provided.
• MGIC said it remained eligible to insure GSE loans and compliant with PMIERs and current state capital requirements. Reinsurance transactions provided approximately $1.3 billion of PMIERs capital credit. Changes to GSE requirements, state capital rules, or the amount of credit allowed for ceded risk could affect capital needs and business eligibility.
• Housing-finance reform and the possible expiration of the GSE Patch by January 2021 pose uncertainty. Loans with DTI above 43% represented 24% of Q2 new insurance written; effects on lender demand and private mortgage insurance are uncertain.
• Claims-paying-practices disputes remain a key contingency. The company estimated maximum exposure on matters where loss is reasonably possible at approximately $289 million above the probable loss recorded; this estimate is judgmental and excludes interest and consequential or exemplary damages. An August 2, 2019 settlement agreement for a previously reserved dispute required no additional loss recognition and remained subject to GSE approval.
• Loss reserves depend on estimated claim frequency and severity and could change materially with economic conditions, home prices, cure rates, foreclosure timing, or litigation outcomes. Management estimated that a $1,000 change in average severity would change reserves by about $11 million, and a one-percentage-point change in average claim rate by about $17 million.
• The board declared a $0.06-per-share quarterly dividend payable September 20, 2019. Management expected MGIC to continue paying quarterly dividends of at least $70 million to the holding company, subject to board approval and regulatory non-disapproval.

Important facts for investors to verify

• Whether the claims-paying-practices settlement receives GSE approval and how remaining disputes affect reserves and the stated potential exposure.
• Whether PMIERs and state-capital rules, including the treatment of reinsurance credit, change and affect MGIC’s capital surplus or eligibility to write GSE business.
• Whether lower premium yields, reinsurance costs and loan mix are offset by new business, investment income and claims experience.
• Whether delinquency cures and reserve development continue, and whether actual claim severity and payment timing differ from assumptions.
• Holding-company liquidity relative to debt service, dividends from the regulated insurer, and planned share repurchases.