Business context and reporting period
MGIC Investment Corporation is a holding company whose principal business, through Mortgage Guaranty Insurance Corporation (MGIC), is U.S. private mortgage insurance. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2016; comparisons are with the corresponding 2015 periods unless otherwise noted. Amounts below are consolidated unless identified as insurer-specific.
Financial performance and condition
- Revenue: Q2 total revenue was $263.5 million, up 8%; first-half revenue was $522.1 million, up 2%. Q2 net premiums earned rose 8% to $231.5 million; first-half rose 5% to $452.8 million. Investment income increased 5% in Q2 to $27.2 million and 10% in the first half to $55.1 million.
- Profit: Q2 net income was $109.2 million ($0.32 basic and $0.26 diluted per share), down 4%; first-half net income was $178.4 million ($0.52 basic and $0.43 diluted), down 28%. Income before tax rose 44% in Q2 to $165.2 million and 7% in the first half to $268.9 million. Effective tax rates were 33.9% and 33.7% in 2016, versus 1.1% and 1.9% in 2015, mainly because the prior-year periods benefited from valuation-allowance changes.
- Losses: Net losses incurred fell 48% in Q2 to $46.6 million and 23% in the first half to $131.6 million. First-half results included $64.9 million of favorable prior-year reserve development, compared with $51.5 million in 2015. The filing’s extracted text does not provide a clear numeric GAAP loss-ratio value.
- Cash flow: First-half operating cash flow was negative $6.9 million, compared with negative $59.9 million in 2015. Investing activities provided $261.0 million and financing activities used $134.2 million. Cash and cash equivalents increased $119.9 million to $301.0 million.
- Balance sheet and liquidity: At June 30, total assets were $5.745 billion, total liabilities $3.233 billion, and shareholders’ equity $2.512 billion. Investments totaled $4.566 billion. The holding company had approximately $217 million in cash and investments. MGIC reported $4.7 billion of PMIERs Available Assets against $4.2 billion of Minimum Required Assets.
- Debt: Debt carrying value was $1.048 billion at June 30, versus $1.212 billion at year-end 2015. First-half transactions repurchased $188.5 million par value of 5% notes and $132.7 million par value of 9% debentures, funded in part by a $155 million FHLB advance at 1.91%, due 2023. These actions reduced consolidated debt by about $166 million and lowered interest expense, but generated $15.3 million in first-half extinguishment losses. Interest expense declined 22% in the first half to $26.9 million.
- Capital and business: MGIC’s statutory risk-to-capital ratio was 11.6:1, below the commonly applicable 25:1 maximum; its policyholder position exceeded the $1.1 billion required minimum by $1.3 billion. Primary insurance in force was $177.5 billion, and the primary default inventory was 52,558, down from 66,357 a year earlier.
Material changes and management outlook
- Revenue growth reflected higher earned premiums, including premium refunds and single-premium policy cancellations, and higher investment income. First-half realized investment gains fell to $3.9 million from $26.5 million in 2015, when favorable markets supported securities sales.
- Lower losses reflected fewer new default notices and more favorable prior-year reserve development. Management said first-half claim rates on new notices were approximately 13%, broadly consistent with the prior year. The company cautioned that losses have historically tended to be higher in the second half of the year.
- Management expected insurance in force to increase in 2016 versus 2015, but expected premium yield to decline, principally because more business was covered by the 2015 quota-share reinsurance arrangement and because older, higher-rate books were shrinking and reaching premium resets. The company also said it expected losses paid to decline over the remainder of 2016 compared with the prior year.
- The 2015 quota-share arrangement covers 30% of qualifying business and generally entails a stated net cost of 6% of direct premiums on covered loans. It increases ceded premiums and losses; lower losses can also mean a higher profit commission. Reinsurance credit and terms remain relevant to capital compliance.
- Management described a favorable housing and employment backdrop and strong credit characteristics in new business, while noting persistent private mortgage insurance price competition. Filed rates were revised effective April 2016; certain higher-FICO rates decreased and certain lower-FICO rates increased. In July 2016, an insurance regulator advised that customized lender-paid rates did not comply with its jurisdiction’s law; the company was evaluating its response and noted potential effects on competitiveness and returns.
Risks, contingencies, and unusual items
- Loss estimates: Reserves depend on judgment about claim frequency, severity, cures, rescissions, curtailments, housing values, employment, and claim timing. Actual claims could differ materially. The $1.632 billion gross loss reserve was partly offset by $45.2 million of reinsurance recoverables.
- Claims disputes: The company estimated maximum exposure of approximately $193 million for reasonably possible claims-practices matters, excluding interest and consequential or exemplary damages; it expected to resolve them for significantly less but could not provide a reliable estimate of potential liability.
- Tax litigation: The IRS notices for 2000–2007 included $197.5 million of taxes and penalties related to REMIC matters, plus approximately $191.2 million of interest at June 30, 2016. Notices also included $261.4 million of additional amounts, primarily tied to a disputed NOL carryback. The company contests most adjustments. It reported $107.6 million of unrecognized tax benefits, including related interest, and estimated related state taxes and interest of $49.7 million. Resolution could materially affect taxes, earnings, cash flows, available assets, and statutory capital.
- Regulatory and capital risks: MGIC was compliant with PMIERs and state requirements at quarter-end, but GSE rule changes, treatment of ceded risk, or proposed NAIC risk-based capital rules could raise capital needs or restrict new business. MGIC paid two $16 million dividends to the holding company in 2016 with regulatory approval; further dividends require approval.
- Market and portfolio: The investment portfolio had $138.5 million of net unrealized gains, compared with $26.6 million of net unrealized losses at year-end. Fixed-income portfolio modified duration was 4.9 years; an instantaneous 100-basis-point parallel yield-curve move was estimated to change fair value by 4.9% in the opposite direction. No other-than-temporary investment impairments were recorded.
- Unusual items: The company substantially liquidated its Australian operations in the first quarter and recorded about $4 million of foreign-exchange gains. First-half claim payments included $51 million associated with claims-practices settlements and nonperforming-loan sales; these reduced default inventory by 1,273 notices and had no material impact on losses incurred.
Most important facts for investors to verify
- Whether favorable reserve development and the decline in defaults persist, given uncertainty in claim severity and the typical seasonal pattern of losses.
- Whether PMIERs and state-capital compliance remain adequate after any GSE or NAIC changes, and whether reinsurance continues to receive sufficient regulatory credit.
- The outcome and potential cash, tax, and capital effects of the IRS REMIC dispute and claims-practices matters.
- Whether debt maturities, holding-company liquidity, and any further debt transactions remain manageable; debt repurchases reduced interest expense but required above-carrying-value payments.
- How premium-yield trends, reinsurance costs, pricing competition, and the regulator’s view of customized rates affect future profitability.