MGIC Investment Corporation — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; balance-sheet comparisons are to December 31, 2012. MGIC provides mortgage insurance to lenders and government-sponsored enterprises for low-down-payment residential mortgages.
Financial performance and position
| Metric | Q1 2013 | Q1 2012 / comparison |
|---|---|---|
| Total revenue | $269.2 million | $379.7 million |
| Net premiums earned | $247.1 million | $262.4 million |
| Investment income, net | $18.3 million | $37.4 million |
| Realized investment gains, net | $1.3 million | $77.6 million |
| Losses incurred, net | $266.2 million | $337.1 million |
| Net loss | $72.9 million; $0.31 per share | $19.6 million; $0.10 per share |
| Combined insurance operations ratios | Loss 107.8%; expense 18.0%; combined 125.8% | Loss 128.5%; expense 16.7%; combined 145.2% |
- Cash flow: Operating activities used $251.7 million, versus $423.6 million used in Q1 2012. Investing activities used $288.3 million; financing provided $1.148 billion. Cash and cash equivalents increased $608.2 million to $1.636 billion.
- Balance sheet: Total assets were $6.508 billion and shareholders’ equity $777.7 million at March 31, compared with $5.574 billion and $196.9 million, respectively, at year-end.
- Debt and liquidity: Holding-company debt was $1.335 billion in principal value, versus $834.6 million at year-end, following issuance of $500 million of 2% convertible senior notes. Holding-company cash and investments were approximately $671 million; annual debt service was approximately $68 million. Insurance-subsidiary dividends are restricted, and MGIC had not paid dividends to the holding company since 2008.
- Loss exposure: Loss reserves declined to $3.848 billion from $4.057 billion. Net losses and loss adjustment expenses paid were $466 million. Primary default inventory fell to 126,610 loans from 160,473 a year earlier; 60% of the March 2013 inventory had been in default for at least 12 months.
- Mortgage insurance activity: Primary new insurance written was $6.5 billion, up from $4.2 billion. Cancellations were $9.1 billion, leaving primary insurance in force at $159.5 billion, versus $169.0 billion a year earlier. Persistency was 78.7%.
- Tax: The company recorded a $1.1 million tax provision despite a pretax loss, reflecting a valuation allowance. The allowance was $991.7 million at March 31.
Material changes and notable items
- Revenue and net income comparisons were heavily affected by Q1 2012’s $77.6 million of realized investment gains; Q1 2013 gains were $1.3 million. Investment income also declined, which management attributed to lower average invested assets and yield.
- Losses incurred improved year over year, primarily from favorable development on loans delinquent less than 12 months. Prior-year loss development was favorable by $3 million in Q1 2013 versus unfavorable by $56 million in Q1 2012. The company reported a $20 million increase in estimated severity on primary defaults, partly offset by a $15 million decrease in estimated claim rates.
- In March, MGIC Investment raised approximately $663.5 million net through a 135 million-share common-stock offering and approximately $484.7 million net through the 2% convertible-note offering. It contributed $800 million to MGIC to strengthen statutory capital.
- MGIC’s risk-to-capital ratio improved to 20.4:1 from 44.7:1 at year-end; the combined insurance operations ratio was 23.1:1. MGIC’s policyholder position was $168 million above the $1.2 billion required minimum. The Wisconsin regulator’s waiver remained effective through December 31, 2013.
- After quarter-end, MGIC entered into a 30% quota-share reinsurance agreement with unaffiliated reinsurers, covering specified new insurance written from April 1, 2013 through December 31, 2015. It includes a 20% ceding commission and a profit commission. Management expects premium yields to decline slightly as a result.
- After quarter-end, MGIC settled its CFPB investigation without a finding of wrongdoing, paid a $2.65 million civil penalty, and agreed not to enter into or reinsure new captive arrangements for ten years. Existing captive arrangements are in run-off.
- Also after quarter-end, MGIC reached Countrywide-related rescission settlements, subject to required approvals and consents. Management considered implementation probable. The estimated $100 million aggregate reserve increase for two probable customer settlements had already been recorded in Q4 2012; no additional Q1 charge was recorded for the agreements.
Outlook, risks and contingencies
- Management expected average insurance in force to continue declining in 2013 because expected new business would not exceed cancellations. It also expected investment income to decline compared with 2012 and said quarterly paid claims were expected to continue declining. These are expectations, not guaranteed outcomes.
- Capital compliance remains exposed to loss experience, regulatory action, waiver renewal, and forthcoming NAIC and GSE capital standards. MGIC’s ratings were below GSE published minimums; it operated under GSE remediation plans. Loss of eligibility could materially reduce new business.
- Loss estimates depend on uncertain claim frequency and severity, housing values, unemployment, claim timing, and rescission outcomes. Rescissions were estimated to benefit loss reserves by approximately $200 million at March 31. Adverse legal outcomes or lower-than-expected rescission activity could increase losses.
- Countrywide settlement implementation requires approvals and consents. A separate disputed curtailment matter involved approximately $40 million of asserted amounts; the company said a loss was not probable and had not accrued an adverse outcome. Eight RESPA class-action cases remained active, and two MERS-related lawsuits remained pending.
- The IRS assessed $190.7 million in taxes and penalties over the company’s treatment of REMIC investment losses, plus substantial interest and potentially state taxes. MGIC had paid $65.2 million toward the assessment and expected a statutory notice of deficiency in Q2 2013. Management said existing tax provisions and liabilities were appropriate, but a change in its assessment could have a material effect.
- MGIC’s $389.5 million 9% convertible junior debentures carry an effective interest rate of 19%; interest had been deferred and was paid April 1, 2013, along with the scheduled payment. The company retains the right to defer future interest, which would compound and restrict common-stock dividends.
- Since 2009, claim payments had exceeded premiums received. Management expected this trend to continue and noted that cash shortfalls may require investment sales, subject to regulatory restrictions. Consolidated cash should not be confused with cash available at the holding company.
Important facts for investors to verify
- Progress and conditions for implementing the Countrywide settlements, and any resulting effects on claims, reserves, and rescission practices.
- MGIC’s ongoing statutory capital position, waiver status, GSE eligibility, and final implementation of revised mortgage-insurer capital standards.
- Loss-reserve development, the aging of delinquencies, paid-claim trends, and the sensitivity of reserves to rescissions and housing or employment conditions.
- Holding-company liquidity and debt-service capacity, including the restrictions on subsidiary dividends and any future capital contributions.
- Resolution of the IRS REMIC dispute and any related tax, interest, or state-tax exposure.
- Performance and cost of the new quota-share reinsurance agreement and its effect on premium yields and retained losses.