MGIC Investment Corporation — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015; comparisons are with the corresponding 2014 periods unless stated otherwise. MGIC principally provides U.S. mortgage insurance protecting lenders against defaults on low-down-payment residential mortgages. Substantially all recent insurance writings support loans sold to Fannie Mae and Freddie Mac (the GSEs).
Financial performance and position
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Total revenue | $269.5 million | $235.1 million | $782.9 million | $701.4 million |
| Net premiums earned | $239.2 million | $209.0 million | $670.0 million | $630.8 million |
| Losses incurred, net | $76.5 million | $115.3 million | $248.5 million | $379.0 million |
| Income before tax | $127.2 million | $72.3 million | $378.7 million | $179.6 million |
| Net income | $822.9 million | $72.0 million | $1,069.6 million | $177.5 million |
| Diluted EPS | $1.78 | $0.18 | $2.35 | $0.45 |
Q3 net income includes a $695.6 million income tax benefit, principally from releasing the deferred-tax-asset valuation allowance. The nine-month tax benefit was $690.9 million. These discrete tax effects make reported net income and EPS much higher than pre-tax operating performance alone would indicate.
Underwriting and operating measures: The combined ratio was 46.4% in Q3 2015 versus 70.0% in Q3 2014, and 52.3% for the first nine months versus 75.1%. The loss ratio improved to 32.0% for Q3 and 37.1% year to date. Nine-month favorable prior-year reserve development was $90 million, compared with $75 million in 2014. Net investment income was $25.9 million in Q3 and $75.8 million year to date. Nine-month realized investment gains were $27.1 million, mainly from securities sales in Q1; Q3 gains were $0.6 million.
Cash flow and liquidity: Nine-month operating cash flow was $135.0 million, compared with cash used of $337.7 million in 2014. Investing activities provided $49.5 million; financing activities provided $2.1 million. Cash and cash equivalents increased by $186.7 million to $384.5 million. Management attributed the operating cash inflow principally to settling the prior quota-share reinsurance agreement and receiving premiums and profit commission. At the holding company, cash and investments were approximately $469 million.
Balance sheet and debt: At September 30, 2015, total assets were $6.01 billion, total liabilities $3.86 billion, and shareholders’ equity $2.15 billion, compared with $5.27 billion, $4.23 billion, and $1.04 billion, respectively, at December 31, 2014. Loss reserves were $1.98 billion, down from $2.40 billion; no premium deficiency reserve was recorded, versus $23.8 million at year-end 2014. Debt totaled approximately $1.30 billion at par, including $61.9 million of 5.375% senior notes, $845 million of convertible senior notes, and $389.5 million of 9% convertible junior debentures. The $61.9 million senior notes were repaid on November 2, 2015, after quarter-end, from holding-company cash.
Material changes and operating trends
- Primary new insurance written rose to $12.4 billion in Q3 from $10.4 billion, and to $33.2 billion for the first nine months from $23.9 billion. Management expected 2015 writings to be the highest since 2008.
- Primary insurance in force was $172.7 billion, up 6% year over year; direct primary risk in force was $45.0 billion. Primary default inventory declined to 64,642 loans from 83,154 a year earlier, and the default rate fell to 6.54% from 8.65%.
- Losses incurred fell as new default notices declined and claim rates improved. Q3 notices were 19,509, versus 22,927 in 2014. Claims paid were also lower year to date.
- Effective July 1, MGIC commuted its 2013 quota-share reinsurance agreement and entered a replacement 2015 agreement. The commutation added $69.4 million to Q3 net premiums written and $11.6 million to net premiums earned, and included receipt of a $142.5 million profit commission. The new agreement generally cedes 30% of covered premiums and losses, with a 20% ceding commission and a profit commission. Management described the recurring net cost as generally about 6% of direct premiums on covered loans.
- Investment yield increased to 2.5% at September 30, from 2.1% a year earlier. The investment portfolio was $4.6 billion, and all fixed-maturity securities were investment grade.
Outlook, risks, and contingencies
- Outlook: Management expected insurance in force and net premiums earned to increase in 2015, and believed the newer, higher-quality post-2008 books would support positive operating results. It also expected premium yield to decline into 2016, in part because the replacement reinsurance agreement covers more business and because older, higher-rate books continue to shrink. Management said paid claims were expected to continue declining for the remainder of 2015, while noting that losses historically can be seasonally higher in the second half.
- GSE capital rules: Revised PMIERs requirements were due to take effect December 31, 2015. Management expected MGIC to comply, relying in part on full GSE credit for the new reinsurance transaction and anticipated transfers of assets from subsidiary MIC. GSE approval is conditional and subject to at least annual review; reduced reinsurance credit, limits on asset transfers, increased capital factors, or adverse results could threaten compliance. Losing GSE eligibility could materially reduce new business.
- Statutory capital: MGIC’s risk-to-capital ratio was 12.3:1, below the commonly applicable 25:1 maximum; its policyholder position was $1.1 billion above the required minimum. Revised state requirements and treatment of reinsurance credit remain potential risks.
- Competition and pricing: Management cited intense competition, discounted lender-paid single-premium pricing, and the FHA’s 2015 premium reduction. A higher share of discounted or single-premium business could reduce average premium rates. New GSE requirements may also require more assets for certain lender-paid policies.
- Tax dispute: The IRS issued proposed assessments concerning REMIC tax treatment. Notices of deficiency included $197.5 million of taxes and penalties plus approximately $179.2 million of interest as of September 30, 2015; additional proposed adjustments of $261.4 million were primarily related to a disputed NOL carryback. MGIC contests most adjustments in Tax Court. The filing reports $106.9 million of unrecognized tax benefits, including related interest, and estimates possible state taxes and interest of approximately $48.4 million. The outcome could materially affect taxes, cash flows, available assets, and statutory capital.
- Litigation and reserving: Countrywide settlement-related probable losses were recorded; maximum exposure above the recorded best estimate was estimated at $124.9 million. Other claims-practices matters had estimated maximum exposure of approximately $202.5 million, but the company could not reasonably estimate a potential liability and believed ultimate resolution would be significantly lower. Loss estimates depend on claim frequency and severity, economic conditions, home values, servicing and foreclosure timing, and outcomes of disputes. Actual results could differ materially.
- Other items: A ten-year prohibition on new captive reinsurance business followed the CFPB and Minnesota settlements. Management stated disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Separate recurring underwriting earnings from the $695.6 million Q3 tax benefit and the $27.1 million year-to-date realized investment gain.
- Track PMIERs compliance after the December 31, 2015 effective date, including the GSEs’ continuing credit for ceded risk and the planned transfer of MIC assets.
- Review the economics and reported premium-yield effects of the replacement quota-share agreement as it reaches a full operating period.
- Monitor reserve development, default inventory, claim severity, and litigation exposure, especially for older 2005–2008 books.
- Follow the Tax Court dispute and compare potential tax liabilities with the valuation-allowance release and the company’s available capital and liquidity.