MTG

MGIC Investment Corp. 10-Q Summary: Period Ended June 30, 2008

Business Context and Reporting Period

This report covers the quarterly period ended June 30, 2008. MGIC Investment Corporation is the leading provider of private mortgage insurance in the United States. The company operates primarily through its subsidiary, Mortgage Guaranty Insurance Corporation (MGIC). The reporting period reflects a challenging environment characterized by rising delinquencies, particularly in the 2006 and 2007 books of business, and a significant deterioration in the housing market.

Key Financial Metrics

Material Changes vs. Prior Period

• Significant Losses: The company reported a net loss of $132.3 million for the six months ended June 30, 2008, compared to net income of $169.1 million in the prior year period. This reversal was driven primarily by a massive increase in losses incurred ($1.38 billion vs. $417 million).
• Loss Drivers: Losses increased due to a significant rise in the default inventory (up ~21,100 delinquencies in the first half of 2008 vs. ~2,000 in 2007) and higher claim severity. Delinquencies in California and Florida rose sharply.
• Premium Deficiency Reserve: The premium deficiency reserve on Wall Street bulk transactions decreased by $423 million to $788 million, providing a benefit to the income statement, though the underlying business remains loss-generating.
• Capital Raising: In the first half of 2008, the company raised approximately $815 million through a common stock offering and the issuance of $390 million in 9% Convertible Junior Subordinated Debentures. This significantly increased cash reserves and shareholders' equity.
• Investment Income: Investment income increased to $149.5 million (vs. $124.9 million) due to a larger portfolio size, despite a decline in yield.

Guidance, Outlook, and Risks

• Outlook: Management expects the 2006 and 2007 books of business to continue generating material incurred and paid losses for several years. The view on potential losses has trended upward due to a lack of improvement in cure rates.
• Risk-to-Capital: The company's risk-to-capital ratio increased to 12.7:1 (from 11.9:1). Management believes a ratio around 20:1 is more appropriate given the current loss environment. They expect the ratio to increase throughout 2008 as risk in force grows and statutory policyholders' position declines.
• Underwriting Changes: The company has implemented stricter underwriting guidelines to improve the credit risk profile of new business, reducing exposure to high loan-to-value (LTV) loans and reduced documentation loans. New insurance written for the full year 2008 is expected to be significantly below 2007 levels.
• Reinsurance: A new reinsurance agreement with an affiliate of HCC Insurance Holdings was entered into in June 2008 to provide claims-paying resources for catastrophic losses on new business.
• Legal and Regulatory Risks:
  • SEC Investigation: The SEC is investigating C-BASS, the terminated merger with Radian, and subprime mortgage assets.
  • Class Action Lawsuits: Four stockholder class action lawsuits have been filed alleging misrepresentations regarding C-BASS liquidity, loss reserves, and capitalization.
  • Tax Dispute: An ongoing dispute with the IRS regarding REMIC residual interests involves an assessment of $189.5 million in taxes and penalties; the company has appealed.
  • Regulatory Scrutiny: HUD and state insurance departments are investigating captive mortgage reinsurance arrangements.
• Debt Covenants: The company must maintain a Consolidated Net Worth of at least $2.00 billion under its credit facility. As of June 30, 2008, Consolidated Net Worth was approximately $3.25 billion.

Investor Verification Checklist

• Loss Reserve Adequacy: Verify the assumptions used for claim rates and severity, particularly for the 2006 and 2007 books, given the volatility in housing markets.
• Premium Deficiency Reserve: Monitor the $788 million reserve on Wall Street bulk transactions and the sensitivity of this figure to changes in persistency and claim assumptions.
• Debt Covenant Compliance: Track Consolidated Net Worth to ensure it remains above the $2.00 billion threshold required by the credit facility.
• Legal Exposure: Assess the potential financial impact of the SEC investigation, stockholder class actions, and the IRS tax dispute.
• Underwriting Quality: Confirm that the new, stricter underwriting guidelines are effectively reducing the volume of high-risk loans (LTV > 95%, reduced doc) in the new insurance written.
• Cash Flow: Monitor the ability to fund claim payments, as the company anticipates claim payments will exceed premiums received in 2008.