MGIC Investment Corporation — Q3 2014 Form 10-Q
Business and period: MGIC Investment Corporation provides U.S. mortgage insurance through subsidiaries, principally protecting lenders against defaults on low-down-payment residential mortgages. This unaudited filing covers the quarter and nine months ended September 30, 2014; balance-sheet comparisons are with December 31, 2013. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net premiums earned | $209.0 million | $231.9 million | $630.8 million | $716.7 million |
| Total revenue | $235.1 million | $254.4 million | $701.4 million | $787.5 million |
| Losses incurred, net | $115.3 million | $180.2 million | $379.0 million | $642.7 million |
| Net income (loss) | $72.0 million | $12.1 million | $177.5 million | $(48.4) million |
| Diluted earnings (loss) per share | $0.18 | $0.04 | $0.45 | $(0.16) |
| Combined insurance operations combined ratio | 70.0% | 95.8% | 75.1% | 107.6% |
Q3 net premiums written were $222.9 million, down from $234.3 million; nine-month net premiums written were $654.3 million, down from $719.4 million. Management attributed lower premiums primarily to increased ceded premiums under reinsurance. Q3 investment income rose to $22.4 million from $20.3 million; nine-month investment income was $63.7 million versus $59.5 million. The average portfolio yield was 2.1% at September 30, 2014, compared with 1.7% a year earlier.
For the first nine months, operating cash flow was negative $341.7 million, versus negative $692.6 million in 2013. Investing activities provided $274.7 million, while financing used $21.8 million. Cash and cash equivalents were $243.9 million at period-end, down $88.8 million since year-end; including restricted cash, the balance was approximately $261.1 million.
Financial position and capital
- Total assets were $5.34 billion, compared with $5.60 billion at December 31, 2013. Shareholders’ equity increased to $984.5 million from $744.5 million, and accumulated deficit narrowed to $926.9 million.
- Loss reserves were $2.53 billion, down from $3.06 billion; the premium deficiency reserve fell to $28.7 million from $48.5 million. Management cautions that loss estimates are judgmental and sensitive to economic and housing-market conditions.
- Debt at par was approximately $1.30 billion, versus $1.32 billion at year-end. The company repurchased $20.9 million par value of its 5.375% senior notes in February 2014. Holding-company cash and investments were approximately $517 million; insurance-subsidiary dividends to the holding company are restricted.
- MGIC’s statutory risk-to-capital ratio was 15.0:1, below the cited state maximum of 25:1, and its policyholder position exceeded Wisconsin’s minimum requirement by $605 million. Combined insurance operations had a 17.0:1 ratio.
Material changes and operating trends
- Losses incurred fell substantially year over year: nine-month losses were $379.0 million, including $75 million of favorable prior-year development, compared with $642.7 million and $44 million of favorable development in 2013. Management cited fewer new defaults and lower estimated claim rates. Primary default inventory declined to 83,154 loans from 111,587 a year earlier.
- Primary new insurance written was $10.4 billion in Q3 versus $8.6 billion, and $23.9 billion for nine months versus $23.1 billion. Lower refinance volume was offset by purchase business. Primary insurance in force was $162.4 billion, compared with $159.2 billion a year earlier.
- Net paid losses and loss-adjustment expenses were $906 million for the first nine months, down from $1.31 billion. Cash claims continue to exceed premiums received, and the company expects investment assets to decline while that pattern persists.
- Net unrealized investment losses were $17.5 million at September 30, 2014, versus $84.6 million at year-end before tax; the filing reports $44.5 million of gross unrealized losses and $27.0 million of gross unrealized gains. No other-than-temporary impairment losses were recorded in 2014.
Outlook, risks, and unusual items
- PMIERs and GSE eligibility: MGIC was operating under GSE remediation plans and had below-required financial strength ratings. Under the draft PMIERs, management’s July estimate projected an Available Assets shortfall of about $600 million at December 31, 2014, narrowing to about $300 million by December 31, 2016. These estimates assumed transfer of MIC risk and capital and full credit for existing reinsurance; the company did not expect to receive full reinsurance credit. Management expected to address the gap through a combination of holding-company or affiliate assets, reinsurance, and potentially non-dilutive debt, subject to approvals and market availability. Failure to meet GSE requirements could materially reduce new business.
- Business outlook: Management expected 2014 new insurance written to be similar to 2013 or slightly higher, fourth-quarter average insurance in force to increase slightly, and premium yield to decline due to reinsurance and premium-rate reductions. Management noted competition from the FHA and private insurers, pricing pressure, and expectations that recently written business may have somewhat higher claim incidence than recent prior books.
- Tax dispute: The IRS issued deficiency notices for 2000–2007. Notices included $197.5 million of taxes and penalties on the REMIC issue, approximately $164.8 million of related interest, and a further $261.4 million primarily concerning a 2009 NOL carryback. A prior $65.2 million payment would reduce amounts ultimately owed; the filing states the carryback adjustment may have been included to preserve the collection statute. MGIC intended to petition Tax Court by December 8, 2014. The company reported $106 million of unrecognized tax benefits and warned that resolution could materially affect earnings, cash flows, available assets, and statutory capital.
- Litigation: The Countrywide agreement covering non-GSE loans depended on consent by or for other investors, though management considered implementation probable. Maximum exposure above the recorded best-estimate provision for Countrywide-related matters was estimated at $670 million; approximately 58% related to the CHL agreement and curtailment dispute. Other claims-paying-practice proceedings had estimated maximum exposure of about $38 million, with management expecting resolution for significantly less. Other legal and regulatory matters include RESPA-related suits, a Minnesota draft consent order, and a MERS-related appeal.
- Other risks: Mortgage-insurance claims and reserves are exposed to unemployment, home prices, foreclosure timing, loan modifications and re-defaults, and changing GSE and state capital rules. The company estimated that roughly 50% of modified loans could ultimately re-default for internal planning purposes, while stating the ultimate rate is uncertain. The CFPB settlement bars new captive reinsurance business for ten years.
Key investor verification points
- Track final PMIERs, the actual Available Assets calculation, reinsurance credit, and the feasibility and approvals for planned capital sources.
- Monitor the IRS Tax Court process, the potential tax exposure and recorded reserves, including the distinction between the REMIC assessment and NOL-carryback notices.
- Verify progress and consent requirements for the CHL settlement, and changes in the estimated exposure for Countrywide and other claims-practice disputes.
- Assess whether falling defaults and favorable prior-year reserve development continue, alongside paid claims, cure rates, and the aging of remaining defaults.
- Monitor premium yield, reinsurance costs and recoveries, competitive pricing, new insurance written, and capital needs as GSE and state requirements evolve.