RDN

Business Context and Reporting Period

This Form 10-Q covers CMAC Investment Corporation (the registrant) and its principal operating subsidiary, Commonwealth Mortgage Assurance Company (CMAC), for the quarterly and nine-month periods ended September 30, 1998. The Company operates in the private mortgage insurance industry, providing insurance for mortgage loans. As of November 10, 1998, there were 22,703,958 shares of common stock outstanding.

Key Financial Metrics

Liquidity and Capital: Cash and short-term investments totaled $18.5 million as of September 30, 1998. The Company reported positive operating cash flows of $89.2 million for the nine-month period. Stockholders' equity increased to $538.6 million, driven by net income and unrealized investment gains.

Material Changes vs. Prior Period

• Revenue Growth: Net income increased 21.4% in Q3 and 21.0% for the nine-month period compared to 1997, driven by a 16.9% (Q3) and 20.2% (9mo) increase in premiums earned and a 14.8% (Q3) and 14.1% (9mo) increase in net investment income.
• Volume Expansion: New primary insurance written surged 59.0% in Q3 and 61.1% for the nine months ended September 30, 1998, compared to the prior year. Market share increased to 11.6% for the nine-month period.
• Expense Increases: Other operating expenses rose 45.6% in Q3 and 42.5% for the nine months, primarily due to an 81.7% (Q3) and 84.4% (9mo) increase in contract underwriting expenses.
• Loss Reserves: The provision for losses increased 9.2% in Q3 and 16.2% for the nine months, reflecting business growth and maturation, as well as adverse experience in California and specific "affordable housing" loans.

Outlook, Risks, and Management Commentary

• Market Trends: Lower interest rates have driven refinancing activity, though the rate of growth in the private mortgage industry has lagged the broader mortgage market due to strong housing prices allowing borrowers to refinance without insurance. The persistency rate declined to 71.9% (from 88.1% in 1997) due to refinancing but is expected to stabilize.
• Product Mix: The Company increased exposure to "pool insurance" (stop-loss coverage) and sub-prime loans (Alternative A and A-minus). While pool insurance premiums are lower, they limit aggregate risk exposure. Sub-prime loans carry higher default risks but are priced with higher premiums.
• Investment Strategy: The Company modified its investment policy in Q2 1998 to include common equities (target 5% of portfolio) and convertible securities (target 10%), which may cause a short-term decline in investment income but is expected to have no material long-term impact.
• Year 2000 Compliance: The Company has completed its Year 2000 project, with all systems expected to be compliant by the end of 1998. No material costs were incurred.
• Risks: Key risks include the performance of "affordable housing" loans from 1994-1995, the maturation of the book of business leading to higher defaults, and the potential for third-party non-compliance with Year 2000 standards.

Investor Verification Checklist

• Verify the sustainability of the 61.1% growth in new primary insurance written given the slowing refinancing boom.
• Monitor the loss development trends for "affordable housing" loans and sub-prime (Alternative A/A-minus) portfolios, which have shown higher default rates.
• Assess the impact of rising contract underwriting expenses (up 84.4% YTD) on future operating margins.
• Review the Company's capital adequacy relative to the stricter capital requirements for pool insurance imposed by rating agencies.
• Confirm the timeline for the integration of contract underwriting with Fannie Mae and Freddie Mac systems to realize cost efficiencies.