MGIC Investment Corporation — 2011 Q2 Form 10-Q
Reporting period: Three and six months ended June 30, 2011; balance-sheet comparisons are with December 31, 2010. The unaudited consolidated company primarily provides mortgage insurance to lenders and government-sponsored entities. Dollar figures below are in millions unless otherwise indicated.
Financial performance and condition
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net premiums earned | $284.5 | $309.2 | $573.0 | $581.1 |
| Total revenue | $367.0 | $406.4 | $720.1 | $777.1 |
| Losses incurred, net | $459.6 | $320.1 | $770.0 | $774.6 |
| Net income (loss) | $(151.7) | $24.6 | $(185.4) | $(125.5) |
| Basic and diluted EPS | $(0.75) | $0.14 basic; $0.13 diluted | $(0.92) | $(0.82) |
| Loss ratio | 161.6% | 103.5% | 134.4% | 133.3% |
| Combined ratio | 178.1% | 118.5% | 150.7% | 149.9% |
- Revenue and earnings: Q2 revenue fell year over year, while the company swung from profit to loss. For the first half, revenue declined and the net loss widened. Q2 losses incurred rose sharply; first-half losses incurred were broadly flat year over year.
- Cash flow: Operating cash outflow was $977.5 million in the first half, compared with $183.8 million in the prior-year period. Investing activities provided $763.6 million; financing activities used $51.8 million. Cash and cash equivalents declined by $265.6 million to $1.039 billion.
- Balance sheet and liquidity: Total assets were $8.270 billion, down from $9.334 billion at year-end; shareholders’ equity was $1.513 billion, down from $1.669 billion. The investment portfolio was $6.746 billion. The company reported $823 million of cash and investments at the holding company, subject to the distinction between holding-company and insurance-subsidiary resources.
- Debt: Carrying amounts were $321.6 million of senior notes, $345 million of convertible senior notes, and $329.3 million of convertible junior debentures. The $77.4 million, 5.625% senior notes were due September 2011. The company repurchased $55 million par value of 5.375% senior notes in Q2 and recorded a $3.2 million gain. Debt covenants were reported in compliance at June 30.
- Insurance capital: MGIC’s statutory risk-to-capital ratio was 20.4:1, versus 19.8:1 at December 31, 2010; the combined insurance operations ratio was 23.4:1, versus 23.2:1. The common regulatory maximum is 25:1, but waivers apply in some jurisdictions. Management said the ratio could reach 40:1 or higher under a stress-loss scenario.
Material changes and operating trends
- Primary new insurance written increased to $3.1 billion in Q2 and $6.1 billion in the first half, from $2.7 billion and $4.5 billion, respectively. Management attributed the increase mainly to a modest gain in private mortgage insurance market share. Cancellations still exceeded new insurance: primary insurance in force fell by $4.5 billion in Q2 and $8.9 billion in the first half.
- Primary default inventory declined to 184,452 loans from 214,724 at year-end and 228,455 a year earlier. However, 58% of the June 2011 inventory had been in default for at least 12 months, up from 55% at year-end; management noted older defaults are more likely to result in claims.
- First-half paid losses and loss-adjustment expenses were $1.502 billion, versus $1.099 billion. Management expected 2011 paid claims to exceed 2010, while stating that quarterly paid claims had likely peaked in Q2 if foreclosure patterns continued.
- First-half net investment income declined to $112.0 million from $131.7 million as average invested assets fell while the company liquidated investments to meet claims. The average pre-tax portfolio yield was 2.7%, compared with 2.5% a year earlier; management expected investment income to decline further in 2011.
- The premium deficiency reserve fell to $158.9 million from $179.0 million at year-end. Management attributed the reduction primarily to lower estimated ultimate losses and higher estimated ultimate premiums.
Outlook, risks, contingencies and unusual items
- Management outlook: The company expected 2011 new insurance written to increase modestly from $12 billion in 2010, but expected average insurance in force to keep declining because new business would not offset cancellations. Management said it expected continued annual net losses and could not predict when, or whether, annual profitability would return. No specific earnings guidance was provided.
- Capital and approvals: MGIC’s Wisconsin waiver of risk-to-capital requirements was scheduled to expire December 31, 2011; other waivers have varying terms and outcomes. If waivers are not renewed and capital requirements are exceeded, MGIC could be restricted from writing new business. The subsidiary MIC had conditional GSE approvals through December 2011 (Fannie Mae) and December 2012 (Freddie Mac); management planned to discuss an extension with Fannie Mae. Additional capitalization of MIC is restricted without GSE approval.
- Rescissions and reserves: Rescissions reduced paid losses by an estimated $0.4 billion in the first half. At June 30, management estimated that rescissions reduced loss reserves by about $0.9 billion. The company expected rescission benefits to decline and had not accrued additional reserves for possible adverse outcomes in ongoing rescission disputes, including the Countrywide matter; management said potential liability could not be reasonably estimated.
- Countrywide litigation: Countrywide sought damages “well-exceeding” $150 million in arbitration over disputed rescissions and claims. A related bellwether hearing was postponed to May 2012. MGIC had not reserved for an adverse outcome. Countrywide-related loans represented about 22% of primary delinquency inventory at quarter-end.
- Freddie Mac pool-policy dispute: The parties differed by approximately $535 million on calculation of an aggregate loss limit. MGIC’s interpretation limited losses incurred by $52 million in Q2; absent that limitation, Q2 losses incurred would have been $52 million higher. The company expected the disputed amount to grow absent resolution and warned that the outcome could be materially adverse.
- Other notable uncertainties: A proposed Qualified Residential Mortgage definition could materially affect demand for private mortgage insurance; the final rule and timing were unknown. The company also cited potential impacts from GSE changes, FHA competition, foreclosure and servicing delays, loan modifications, housing values, unemployment, and possible litigation or regulatory actions. A federal housing discrimination complaint and related class action remained pending; MGIC disputed the allegations. The securities class action relating to C-BASS had been dismissed with prejudice, but plaintiffs pursued an appeal and sought relief from the judgment.
- Unusual tax and investment items: A one-time taxable inclusion related to the conclusion of C-BASS bankruptcy proceedings reduced tax net operating loss carryforwards. The company reported a $485 million deferred-tax valuation allowance. The entire $287.2 million auction-rate securities portfolio remained subject to failed auctions; management expected liquidity by December 31, 2014, but principal was not readily accessible.
Most important facts for investors to verify
- Whether state capital waivers and Fannie Mae/Freddie Mac approvals for MGIC and MIC are renewed, and how capital ratios develop relative to regulatory thresholds.
- Whether claim emergence, housing conditions, and rescission rates support the loss-reserve assumptions—particularly the estimated $0.9 billion reserve benefit from rescissions.
- The outcome and potential financial exposure of the Countrywide proceedings and the Freddie Mac aggregate-loss-limit dispute.
- Whether operating cash outflows, claim payments, and declining invested assets leave adequate liquidity at both the holding company and insurance subsidiaries, including refinancing or repayment of the September 2011 notes.
- How final QRM rules, GSE policy changes, and competitive conditions affect new insurance written and the company’s path to profitability.