MGIC Investment Corporation — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. MGIC provides private mortgage insurance, primarily on low-down-payment residential mortgages sold to Fannie Mae and Freddie Mac. Figures below are in millions of dollars unless noted.
Financial results and position
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $231.2 | $263.9 | $466.3 | $533.0 |
| Net premiums earned | $207.5 | $237.8 | $421.7 | $484.8 |
| Losses incurred, net | $141.1 | $196.3 | $263.7 | $462.5 |
| Income (loss) before tax | $46.6 | $13.4 | $107.3 | ($58.4) |
| Net income (loss) | $45.5 | $12.4 | $105.5 | ($60.6) |
| Diluted EPS | $0.12 | $0.04 | $0.27 | ($0.21) |
- Q2 revenue fell about 12% year over year, while net income rose to $45.5 million, principally as incurred losses and operating expenses declined. Six-month revenue fell about 13%, but results turned to profit from a prior-year loss.
- For combined insurance operations, Q2 loss, underwriting expense and combined ratios were 68.0%, 14.4% and 82.4%, respectively, versus 82.5%, 17.7% and 100.2%. Six-month ratios were 62.5%, 15.0% and 77.5%, versus 95.4%, 17.9% and 113.3%.
- Six-month operating cash flow was negative $282.4 million, improved from negative $508.6 million. Investing activities provided $314.0 million; financing used $21.8 million. Cash and cash equivalents ended at $342.6 million, with a further $17.2 million restricted.
- At June 30, total assets were $5.38 billion, total liabilities $4.45 billion and shareholders’ equity $931.6 million. Loss reserves were $2.68 billion, down from $3.06 billion at year-end 2013.
- Debt principal was approximately $1.30 billion: $62 million senior notes due 2015, $345 million convertible notes due 2017, $500 million convertible notes due 2020, and $389.5 million junior debentures due 2063. Holding-company cash and investments were approximately $515 million; subsidiary dividends to the holding company were restricted and MGIC had paid none since 2008.
- MGIC’s standalone statutory risk-to-capital ratio was 15.2:1, below the usual 25:1 state limit; its policyholder position exceeded Wisconsin’s required minimum by $555 million. Combined insurance operations’ ratio was 17.3:1.
Changes and operating trends
- New primary insurance written was $8.3 billion in Q2, compared with $8.0 billion; for the first half it was $13.5 billion, versus $14.5 billion. The first-half decline reflected lower refinance volume, partly offset by higher purchase volume.
- Net premiums written and earned declined, reflecting lower average insurance in force and increased ceded premiums under reinsurance. Average insurance in force was expected to rise slightly in the remainder of 2014, while premium yields were expected to decline.
- Primary default inventory fell to 85,416 loans from 117,105 a year earlier; the reported default rate declined to 8.98% from 12.00%. Six-month net paid claims and loss-adjustment expenses fell to $643 million from $899 million.
- Prior-year loss development was favorable by $43 million in the first half, compared with $6 million in the prior-year period. The decrease in new default notices and a lower estimated claim rate reduced current-period losses.
- The premium deficiency reserve declined to $35 million from $48 million at year-end, mainly reflecting revised assumptions for higher ultimate premiums and lower ultimate losses.
- Investment income increased to $21.2 million for Q2 and $41.3 million for the first half. The portfolio’s average pre-tax yield was 2.0% at June 30, versus 1.6% a year earlier. Net realized investment gains were lower year over year; no other-than-temporary impairments were recorded.
Outlook, risks and unusual items
- Draft GSE capital rules: FHFA issued draft PMIERs on July 10, 2014. Under the draft as modeled, MGIC estimated an Available Assets shortfall of about $600 million at December 31, 2014, declining to about $300 million by December 31, 2016. These estimates assume repatriation of MIC capital and full credit for existing reinsurance, which MGIC did not expect to receive. Management cited holding-company resources, possible transfers from regulated affiliates, modified or additional reinsurance, and non-dilutive debt as potential remedies; compliance was not assured. Loss of GSE eligibility could materially reduce new business.
- Management outlook: The company expected 2014 new insurance written to be similar to 2013, average insurance in force to increase slightly through year-end, and paid claims to continue declining in the remainder of 2014, excluding the expected Countrywide settlement impact. Management cautioned that second-half credit performance is historically weaker and claim estimates remain sensitive to economic and housing conditions.
- Countrywide and other claims disputes: The CHL settlement for non-GSE loans remained subject to investor consent, which management considered probable. Estimated maximum exposure above the recorded best-estimate provision was $510 million, including about 45% related to the CHL agreement. Separate claims-paying disputes had estimated maximum exposure of about $220 million, which management expected to resolve for significantly less. These estimates exclude interest and consequential or exemplary damages.
- Tax contingency: The IRS disputed MGIC’s tax treatment of REMIC investment losses. Proposed federal taxes and penalties were $197.5 million, with estimated interest of $161.3 million; potential state taxes and interest were approximately $46.7 million, before possible state penalties. The company reported $105.8 million in unrecognized tax benefits and had paid $65.2 million in 2007. The matter could materially affect taxes, cash flow, statutory capital and PMIER compliance.
- Other risks: Mortgage-insurance demand depends on GSE and FHA policy, housing and mortgage originations, competition, pricing and regulatory capital rules. New underwriting policies and draft PMIERs may increase expenses or capital needs. Loan modifications may re-default; the company used an internal planning assumption of roughly 50% re-defaults but said the ultimate rate could not be predicted confidently. Loss-reserve estimates are judgmental and actual claims may differ materially.
- MGIC remained below GSE financial-strength rating requirements and operated under GSE remediation plans. Moody’s rated it Ba3 (stable outlook) and S&P rated it BB (positive outlook). The company also noted ongoing regulatory inquiries and litigation involving captive reinsurance and other matters.
Important facts for investors to verify
- Final PMIERs requirements, the actual Available Assets shortfall, and whether reinsurance, asset transfers or financing close that gap within the transition period.
- Implementation and financial effects of the CHL settlement, and developments in other claims-paying disputes and related contingencies.
- Outcome and potential cash, tax and capital effects of the IRS REMIC dispute.
- Whether lower defaults and claims persist, including second-half seasonality, cure rates, claim severity and possible re-defaults of modified loans.
- Trends in new insurance written, premium yield, reinsurance costs and GSE/FHA competition, including the effect of capital requirements on returns.
- Holding-company liquidity and debt-service capacity given restricted subsidiary dividends, ongoing claim payments and potential capital contributions.