MGIC Investment Corporation — Q1 2016 Form 10-Q
Business and period: MGIC Investment Corporation is a holding company principally engaged in U.S. mortgage insurance through Mortgage Guaranty Insurance Corporation. This unaudited report covers the three months ended March 31, 2016; comparisons are with Q1 2015 unless otherwise stated. Dollar amounts below are in millions unless noted.
Key financial results
| Metric | Q1 2016 | Q1 2015 / prior date | Change / context |
|---|---|---|---|
| Total revenue | $258.6 | $270.2 | Down 4% |
| Net premiums earned | $221.3 | $217.3 | Up 2% |
| Investment income, net | $27.8 | $24.1 | Up 15% |
| Net realized investment gains | $3.1 | $26.3 | Down substantially; Q1 2015 included higher security-sale gains |
| Losses incurred, net | $85.0 | $81.8 | Up 4%; current-year losses fell, but favorable prior-year development was smaller |
| Income before tax | $103.7 | $136.5 | Down 24% |
| Income tax expense / effective rate | $34.5 / 33.3% | $3.4 / 2.5% | 2016 reflects a full tax provision after reversal of the deferred-tax valuation allowance in 2015 |
| Net income / diluted EPS | $69.2 / $0.17 | $133.1 / $0.32 | Net income down 48%; EPS down 47% |
| Net cash from operating activities | $(56.5) | $(32.7) | Greater cash use, including debt-transaction-related outflows |
| Cash and cash equivalents | $249.9 | $181.1 at Dec. 31, 2015 | Increased $68.8 during the quarter |
| Total assets / shareholders’ equity | $5,773.4 / $2,343.4 | $5,868.3 / $2,236.1 at Dec. 31, 2015 | Investment portfolio declined; equity increased |
| Loss reserves | $1,753.4 gross; $1,712.3 net of recoverables | $1,893.4 gross at Dec. 31, 2015 | Net reserves declined as claims paid exceeded losses incurred |
| Debt carrying value | $1,097.5 | $1,211.8 at Dec. 31, 2015 | Net reduction of about $115.8 from debt transactions |
Material changes and operating trends
- Primary new insurance written was $8.3 billion versus $9.0 billion. Cancellations were $7.8 billion in both periods, so primary insurance in force increased by $0.5 billion in Q1 2016. Direct primary insurance in force was $175.0 billion, up from $166.1 billion a year earlier.
- Primary default inventory fell to 55,590 from 62,633 at year-end 2015 and 72,236 a year earlier. The default rate was 5.62%, compared with 6.31% at year-end and 7.44% a year earlier. New default notices also declined year over year.
- Current-year incurred losses were $92.5 million, versus $109.4 million. Favorable prior-year reserve development was $7.5 million, compared with $27.6 million in Q1 2015. Management attributed the reduced favorable development partly to higher severity assumptions.
- Average primary claim paid, excluding material settlements, was $49,281 versus $47,366. The ratio of average claim paid to exposure rose to 111.8% from 106.7% a year earlier, an adverse severity trend noted by management.
- The 2015 quota-share reinsurance agreement covered 74% of insurance in force, versus 57% under quota-share reinsurance a year earlier. It increases ceded premiums and losses and is expected to reduce premium yield; the company described its typical net cost as about 6% of direct premiums on covered loans.
- Investment portfolio fair value was $4.56 billion, down from $4.66 billion at year-end. Net unrealized gains were $51.8 million versus net unrealized losses of $26.6 million at year-end. No other-than-temporary impairments were recorded.
Debt, liquidity, and capital
- During the quarter, the company repurchased $138.3 million par value of 5% convertible senior notes and MGIC purchased $132.7 million par value of 9% junior subordinated debentures. A $155 million FHLB advance, bearing fixed interest at 1.91% and maturing in 2023, funded the debenture purchase. These actions lowered consolidated annual interest cost but generated a $13.4 million extinguishment loss.
- At March 31, holding-company cash and investments were about $265 million. The holding company’s debt obligations were $1.085 billion par value. MGIC’s purchase of debentures remains a use of holding-company liquidity, although the purchased debt is eliminated in consolidated GAAP reporting.
- MGIC reported PMIERs Available Assets of $4.8 billion against Minimum Required Assets of $4.3 billion and stated it remained eligible to insure GSE loans. MGIC’s risk-to-capital ratio was 12.3:1; its policyholder position exceeded Wisconsin’s required minimum policyholder position by $1.1 billion. These measures depend on regulatory and reinsurance credit treatment.
- MGIC received approval for a $16 million dividend to the holding company, paid in April; additional dividends require regulatory approval. The FHLB advance is secured by investment collateral maintained at 102% of principal.
Outlook, commentary, and material risks
- Management expected insurance in force to increase in 2016, while net premiums and premium yield were likely to decline from 2015 levels, largely because of expanded reinsurance coverage and changing portfolio mix. It expected the 2016 claim rate on new notices to range from 12% to 13%, and believed paid claims would continue to decline for the remainder of 2016 compared with 2015.
- Premium-rate revisions effective April 2016 generally lowered filed rates for some higher-FICO loans and raised them for some lower-FICO loans. The company expected a modest reduction in new insurance written, especially on lower-FICO loans, amid continued pricing competition.
- Management said it would continue assessing debt transactions to improve the debt profile, liquidity, or potential dilution; additional 2016 transactions could result in further losses. The filing gives no formal earnings or EPS guidance.
- Claims and reserves are sensitive to economic conditions, unemployment, home prices, foreclosure timelines, claim severity, and estimates of rescissions and curtailments. Loss reserves are established for delinquent loans; expected future losses on loans not yet delinquent are not reflected in those reserves.
- For claims-paying-practice disputes where losses were reasonably possible, the company estimated maximum exposure at approximately $193 million, while believing eventual resolution would be significantly lower. The estimate excludes interest and consequential or exemplary damages.
- The IRS dispute involves proposed assessments for 2000–2007, including $197.5 million of taxes and penalties on REMIC matters plus approximately $187.4 million of interest at March 31, 2016; notices also cited $261.4 million of additional amounts, primarily involving a NOL carryback. MGIC contests most adjustments. It reported $107.4 million of unrecognized tax benefits, including related interest, and approximately $49.3 million of potential state taxes and interest. Resolution could materially affect taxes, results, cash flows, assets, and statutory capital.
- Other risks include possible changes to GSE eligibility and capital requirements, reduced credit for quota-share reinsurance, uncertainty around GSE reform, intensified competition, and potential effects of mortgage-insurance ratings. The company cited stable outlooks at Moody’s Baa3 and S&P BBB.
Important facts for investors to verify
- Whether the falling default inventory and lower current-year losses persist, and whether rising claim severity offsets those improvements.
- How the 2015 quota-share agreement affects premium yield, earnings, and PMIERs or state-capital credit as it covers additional business.
- The outcome, timing, and potential cash and capital consequences of the IRS REMIC dispute and claims-paying-practice matters.
- Holding-company liquidity and debt maturities after the repurchases, including the cash impact of debentures held by MGIC and any further debt transactions.
- Whether MGIC continues to meet PMIERs and state capital requirements as rules, reinsurance treatment, and statutory capital change.
- Whether April 2016 pricing changes and competitive conditions affect new insurance written, market share, and expected premium yield.