MGIC Investment Corporation — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Unaudited consolidated results. MGIC principally provides private mortgage insurance to lenders and government-sponsored entities.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $273.9 million | $269.5 million | $796.0 million | $782.9 million |
| Net premiums earned | $237.4 million | $239.2 million | $690.2 million | $670.0 million |
| Net losses incurred | $60.9 million | $76.5 million | $192.5 million | $248.5 million |
| GAAP net income | $56.6 million | $822.9 million | $235.0 million | $1,069.6 million |
| Diluted GAAP EPS | $0.14 | $1.78 | $0.58 | $2.35 |
| Net operating income, non-GAAP | $102.2 million | $83.1 million | $288.0 million | $229.5 million |
| Net operating income per diluted share, non-GAAP | $0.25 | $0.20 | $0.71 | $0.55 |
- Margins and underwriting: The loss ratio fell to 25.7% in Q3 from 32.0%; nine-month loss ratio was 27.9% versus 37.1%. The underwriting expense ratio was 14.7% in Q3 versus 14.4%, and 15.1% for nine months versus 15.2%.
- Cash flow: Nine-month operating cash flow was $31.6 million, down from $135.0 million; investing cash flow was $46.0 million and financing cash flow $16.0 million. Cash increased $93.6 million to $274.7 million. Management attributed weaker operating cash flow mainly to the prior-year reinsurance commutation settlement and 2016 debt transactions, partly offset by lower claim payments.
- Balance sheet and debt: At September 30, total assets were $5.87 billion, total liabilities $3.29 billion and shareholders’ equity $2.58 billion. Debt carrying value was $1.18 billion ($1.19 billion par). Holding-company cash and investments were about $329 million, versus $1.17 billion of holding-company debt principal; annual debt service was about $71 million, including amounts payable to MGIC.
- Liquidity and capital: MGIC reported $4.7 billion of PMIERs available assets against $4.1 billion required and stated it was compliant and eligible to insure GSE loans. Its statutory risk-to-capital ratio was 11.1:1. Its policyholder position exceeded Wisconsin’s $1.1 billion minimum policyholder position by $1.4 billion. MGIC paid three $16 million dividends to the holding company in 2016, its first since 2008; further dividends require regulatory approval.
Material changes versus prior comparable periods
- Revenue rose 2% in both the quarter and nine-month period. Q3 net premiums earned declined 1%, while nine-month premiums earned increased 3%; higher ceded premiums and the prior-year quota-share commutation affected comparisons.
- Losses incurred declined 20% in Q3 and 23% year to date, supported by fewer new delinquency notices and favorable prior-year reserve development. Primary default inventory was 51,433 at quarter-end, down from 64,642 a year earlier.
- GAAP earnings fell sharply against 2015, chiefly because Q3 and nine-month 2015 included a large tax benefit from reversing the deferred-tax valuation allowance. 2016 also included $75.2 million of Q3 and $90.5 million of nine-month debt-extinguishment losses. Excluding specified items, non-GAAP net operating income increased.
- Debt transactions included issuing $425 million of 5.75% notes due 2023, repurchasing $292.4 million par of 2% convertible notes, repurchasing $188.5 million par of 5% notes, and MGIC’s purchase of $132.7 million par of 9% debentures. These transactions reduced potential dilution and repositioned maturities, but generated extinguishment losses. The company also issued shares as partial consideration for the 2% note purchases and repurchased those shares.
- Net loss reserves fell to $1.49 billion from $1.85 billion at year-end 2015, primarily because claims paid exceeded incurred losses. The investment portfolio was $4.73 billion; net unrealized gains were $116.3 million, versus net unrealized losses of $26.6 million at year-end 2015.
Outlook, management commentary and risks
- No formal earnings or revenue guidance was provided. Management expected insurance in force to increase in 2016 compared with 2015, while effective premium yield was likely to decline. It expected losses paid to continue declining during the remainder of 2016.
- Management cited strong underlying credit characteristics in new insurance written and stable-to-modestly improving housing fundamentals. Primary new insurance written was $14.2 billion in Q3, up from $12.4 billion; nine-month volume was $35.1 billion, up from $33.2 billion. Competitive premium pricing and elevated refinancing activity may pressure pricing or purchase-loan mix.
- The 2015 quota-share reinsurance arrangement covers 30% of eligible business and reduces premiums and losses ceded through commissions. Reinsurance supports capital compliance, but GSE or state regulators could change how much ceded risk receives capital credit; the arrangement’s profit commission also varies with losses.
- Loss reserving is judgmental and sensitive to unemployment, home prices, claim severity, foreclosure timing, cures, rescissions and curtailments. Management noted that older 2005–2008 books remained a meaningful source of risk and represented 27% of primary risk in force at quarter-end.
- Claims-practices disputes had an estimated maximum exposure of approximately $281 million where loss was reasonably possible; the company could not reasonably estimate a likely liability range and believed resolution would be for significantly less, without assurance. This estimate excludes interest and consequential or exemplary damages.
- The IRS tax dispute concerns REMIC investments and prior NOL carrybacks. Notices of deficiency included $197.5 million of taxes and penalties plus approximately $195.9 million of interest, and $261.4 million of additional amounts primarily related to NOL carrybacks; a prior $65.2 million payment would reduce amounts ultimately owed. Potential related state taxes and interest were estimated at $50.2 million. The company contested most adjustments in Tax Court and warned that an adverse resolution could materially affect tax expense, cash flow and statutory capital.
- Mortgage-insurance demand and capital remain exposed to GSE reform, future PMIERs or state-capital changes, and the availability of regulated dividends to support holding-company obligations. Management also noted that additional debt actions could result in further 2016 losses.
Most important facts for investors to verify
- Whether favorable reserve development and declining default inventory persist, especially given the remaining aged defaults and potential changes in claim severity.
- MGIC’s ongoing PMIERs and state-capital compliance, including the capital-credit treatment of ceded reinsurance and any future requirement for holding-company contributions.
- The outcome, timing and potential cash and capital impact of the IRS REMIC/NOL case and claims-practices disputes.
- Holding-company liquidity, debt service and access to insurance-subsidiary dividends, alongside any further debt repurchases or share transactions.
- Whether growth in new insurance and lower claims offset pricing competition, cancellations, reinsurance costs and the expected decline in premium yield.