MGIC Investment Corporation — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012; balance-sheet comparisons are to December 31, 2011. MGIC principally provides mortgage insurance to lenders and government-sponsored enterprises. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Total revenue | $321.1 | $367.0 | $700.8 | $720.1 |
| Net premiums earned | $242.6 | $284.5 | $505.0 | $573.0 |
| Investment income, net | $32.2 | $55.5 | $69.6 | $112.0 |
| Net realized investment gains | $26.6 | $21.7 | $104.2 | $27.5 |
| Losses incurred, net | $551.4 | $459.6 | $888.5 | $770.0 |
| Net loss | $(273.9) | $(151.7) | $(293.4) | $(185.4) |
| Loss per share, diluted | $(1.36) | $(0.75) | $(1.45) | $(0.92) |
- Margins: Q2 loss ratio was 227.3% versus 161.6%, and combined ratio was 243.9% versus 178.1%. For the first half, loss ratio was 175.9% versus 134.4%, and combined ratio was 192.5% versus 150.7%. The underwriting expense ratio was 16.6% in both Q2 periods and 16.6% versus 16.3% for the six-month periods.
- Cash flow: Operating cash used was $854.1 million in the first half, compared with $977.5 million used in 2011. Investing activities provided $474.6 million; financing activities used $53.1 million. Cash and cash equivalents declined $432.7 million to $563.1 million.
- Balance sheet: Total assets were $6.319 billion, down from $7.216 billion at year-end; shareholders’ equity was $867.2 million, down from $1.197 billion, and retained deficit was $356.7 million. Loss reserves were $4.109 billion, versus $4.558 billion; premium deficiency reserve was $93.3 million, versus $134.8 million.
- Debt and liquidity: Debt was $834.6 million carrying value and $834.6 million par value at June 30; this included $100.1 million of senior notes, $345 million of convertible senior notes and $389.5 million principal of junior debentures. Holding-company cash and investments were $411 million, compared with $835 million of debt at par. Insurance-subsidiary dividends were restricted. The separate regulatory “Liquid Assets” measure was approximately $5.4 billion.
- Other financial indicators: Direct primary insurance in force was $166.7 billion, down from $182.4 billion a year earlier; direct primary risk in force was $42.9 billion, down from $46.8 billion. Primary delinquency inventory fell to 153,990 loans from 184,452 a year earlier, but 59% had been in default at least 12 months, versus 58% a year earlier.
Material changes versus comparable periods
- Revenue fell year over year in Q2 and the first half, principally as lower average insurance in force and increased premium refunds outweighed reduced premiums ceded to captives. Investment income also declined, reflecting lower average invested assets and yield; portfolio yield was 2.4% at June 30, 2012, versus 3.1% a year earlier.
- Losses incurred increased, worsening the loss and combined ratios. First-half 2012 losses included $674 million of current-year development and $214 million of unfavorable prior-year development; first-half 2011 included $855 million of current-year development offset by $85 million of favorable prior-year development. Higher estimated claim rates on older defaults drove the unfavorable prior-year development.
- Primary new insurance written increased to $5.9 billion in Q2 from $3.1 billion and to $10.1 billion for the first half from $6.1 billion. Refinance business represented 32% of Q2 new insurance written, compared with 16% a year earlier. Cancellations nevertheless exceeded new business, and management expected average insurance in force to keep declining in 2012.
- First-half paid losses and loss-adjustment expenses declined to $1.309 billion from $1.502 billion. Senior-note repurchases reduced par value by $70.9 million and generated a $17.8 million gain in 2012. The six-month net realized investment gain of $104.2 million was substantially above the prior-year amount.
Outlook, risks and unusual items
- Outlook: Management expected 2012 new insurance written to exceed 2011, but expected average insurance in force and investment income to decline. It expected annual net losses to continue, while stating it could not predict when or whether annual profitability would return. Management expected regulatory Liquid Assets to remain above the $1 billion required by the Wisconsin order during its covered period through December 31, 2013, but anticipated a material decline as claims and other cash uses exceed operating cash generation.
- Regulatory capital and new business: MGIC’s preliminary risk-to-capital ratio was 27.8:1, above the commonly applicable 25:1 limit, and its policyholder position was $211 million below Wisconsin’s $1.3 billion requirement. Combined insurance operations were at 30.0:1. Wisconsin had waived its requirements through December 31, 2013; waivers elsewhere remained incomplete. MGIC planned to use subsidiary MIC to write in jurisdictions where MGIC could not, subject to regulatory and GSE approvals and restrictions.
- Freddie Mac conditions: An August 1, 2012 approval for MIC to write in specified jurisdictions was conditioned on a $200 million holding-company contribution to MGIC by September 30, substantial agreement on the pool-policy dispute by October 31, and OCI agreement by December 31 that MIC capital would be available for MGIC claims. Approval could be withdrawn and expired December 31, 2012. A pool-policy settlement could further reduce statutory capital.
- Claims and rescissions: Loss estimates depend on claim rates, severity, economic and housing conditions, and rescission activity. Rescissions had reduced estimated loss reserves by about $0.6 billion at June 30. Management expected the reserve benefit from rescissions to decline; adverse outcomes in rescission disputes or settlements could increase losses. The company had suspended certain Countrywide-related rescissions covering about 1,300 loans and $97 million of potential claims, while assuming those loans would be rescinded for reserve purposes.
- Key disputes and contingencies: Countrywide claimed nearly $700 million in additional damages, plus exemplary damages; MGIC disputed the claims and had not accrued an adverse-outcome reserve because it could not reasonably estimate the exposure. MGIC and Freddie Mac disputed pool-policy aggregate limits; Freddie Mac’s interpretation would have increased incurred losses by $85 million in the first half of 2012 and $192 million for 2011. The IRS declined to finalize a tentative settlement of a tax dispute involving $190.7 million of assessed taxes and penalties, plus potentially substantial interest and state taxes; MGIC had previously paid $65.2 million. A final resolution could materially affect cash flow, results and statutory capital.
- Other risks and items: The CFPB was investigating captive mortgage reinsurance practices, and seven related RESPA class actions remained pending. The filing also cites GSE and QRM policy uncertainty, weak insurer ratings, competition, foreclosure delays, loan-modification redefaults, and potential stock delisting risk. All auction-rate securities remained subject to failed auctions; their fair value was about $121 million, with management expecting liquidity by December 31, 2015. A $0.3 million investment impairment was recognized in the first half.
Most important facts for investors to verify
- Progress on MGIC’s capital shortfall, outstanding state waivers, the Wisconsin order and the required $200 million contribution.
- Whether Freddie Mac’s MIC approval was extended and whether the pool-policy dispute was settled, including the resulting capital and loss effects.
- Changes in delinquency aging, claim-rate assumptions, paid claims and the shrinking reserve benefit attributed to rescissions.
- Outcomes of the Countrywide dispute, other rescission challenges, captive-reinsurance investigations and the IRS tax matter; no clear estimate of potential adverse exposure is provided for several proceedings.
- Holding-company liquidity after the planned capital contribution, restricted access to insurance-subsidiary dividends, and continued cash use for claims and debt obligations.
- Whether new business growth can offset cancellations and declining insurance in force, and whether investment income and losses develop as management anticipated.