MGIC Investment Corporation — Q2 2010 Form 10-Q
Business and period. MGIC is a U.S. private mortgage insurer. This unaudited filing covers the three and six months ended June 30, 2010; balance-sheet comparisons are to December 31, 2009. Amounts below are in U.S. dollars.
Financial performance and position
- Second-quarter results: Total revenue was $406.4 million, down from $454.5 million a year earlier. Net premiums earned were $309.2 million versus $347.1 million. Net income was $24.6 million, or $0.14 basic and $0.13 diluted per share, compared with a net loss of $339.8 million, or $2.74 per share. The quarter’s $6.8 million tax benefit contributed to reported net income.
- First-half results: Revenue was $777.1 million versus $889.7 million; net premiums earned were $581.1 million versus $703.0 million. Net loss narrowed to $125.5 million from $524.4 million, or $0.82 versus $4.22 loss per share.
- Losses and ratios: Net losses incurred were $320.1 million in Q2 versus $769.6 million, and $774.6 million for the first half versus $1.53 billion. The combined ratio improved to 118.5% from 236.9% in Q2 and to 149.9% from 232.2% for the half; both remained above 100%. Loss reserve estimates incorporate expected rescission effects.
- Cash flow and liquidity: Operating cash flow was negative $183.8 million for the first half, versus positive $430.1 million in 2009. Cash and equivalents rose to $2.40 billion from $1.19 billion, principally reflecting financing proceeds. Investing activities provided $286.9 million; financing activities provided $1.11 billion.
- Balance sheet: Total assets were $10.19 billion and shareholders’ equity $1.97 billion at June 30, compared with $9.40 billion and $1.30 billion at year-end. Loss reserves were $6.39 billion, down from $6.70 billion; the premium deficiency reserve was $169.0 million, down from $193.2 million.
- Investments: The portfolio was $7.09 billion at fair value. About 95% of fixed-income investments were rated A or better. The company held $407 million in auction-rate securities; all were subject to failed auctions and principal was not readily accessible, although interest had been collected.
- Debt: The balance sheet included $377.2 million of senior notes, $345.0 million of 5% convertible senior notes issued in April, and $303.1 million carrying value of junior convertible debentures. The junior debentures have $55.0 million of deferred interest; interest payments have been deferred for ten years from April 2009, while interest continues to accrue and compound.
Material changes and operating trends
- Primary new insurance written fell to $2.7 billion in Q2 from $5.9 billion and to $4.5 billion for the first half from $12.3 billion. Management attributed the decline to FHA competition, lower originations and lost business from a major lender following disputes over rescissions. Full-year 2010 new insurance written was projected at $10–$12 billion, below 2009.
- Primary insurance in force declined to $202.4 billion from $212.2 billion at year-end. The primary default inventory fell to 228,455 loans from 250,440 at year-end, but remained above the 212,237 a year earlier. Defaults aged materially: 53% had been in the inventory for at least 12 months, versus 42% at year-end.
- Paid claims rose despite lower incurred losses: net losses and loss-adjustment expenses paid were $1.10 billion in the first half versus $736 million. Management expected second-half paid claims to exceed first-half payments, and expected second-half losses incurred to materially exceed first-half reported losses.
- April capital raising produced $772.3 million net proceeds from a common-stock offering of 74.9 million shares and $334.5 million net proceeds from $345 million of convertible notes. MGIC received a $200 million capital contribution. The share issuance increased outstanding shares substantially.
Outlook, risks and contingencies
- MGIC’s risk-to-capital ratio was 17.8:1, or 20.6:1 combined statutory, at June 30. Although both were below the commonly applied 25:1 limit, management estimated MGIC’s ratio could reach 40:1 or higher in coming years. State waivers are not assured; some jurisdictions had denied requests, and the earliest granted waivers expired December 31, 2010. Losing required waivers could restrict new business. MIC is approved to write limited business in certain jurisdictions, subject to GSE terms and time limits.
- Management warned that rescissions may not continue to mitigate paid and incurred losses at recent levels. Rescissions mitigated paid losses by $640 million in the first half and were estimated to have mitigated incurred losses by about $600 million. Disputes, litigation or settlements affecting rescission practices could materially change claim costs and reserves.
- Countrywide sought at least $150 million, plus interest, costs and potentially other damages, in litigation and arbitration concerning claims and rescissions. Outcomes were uncertain. The company also disclosed an ongoing SEC investigation related to C-BASS and a proposed amended securities class-action complaint; it could not estimate potential losses.
- The IRS disputed the company’s tax treatment of REMIC investments, assessing $197.1 million in taxes and accuracy-related penalties, plus interest. The appeal was ongoing. The company reported $91.4 million of unrecognized tax benefits and $23.1 million accrued for interest, and said a materially different resolution could affect earnings and cash flow.
- Other significant uncertainties include housing prices, unemployment, claim severity and cure rates; GSE eligibility and changes in mortgage-insurance requirements; FHA competition; loan-modification redefaults; regulatory actions; and contract-underwriting remedy claims. Management stated it could not assure when, or whether, annual profitability would resume.
Important facts for investors to verify
- Whether state capital waivers remain in force or are renewed, and whether MGIC or MIC can continue writing new business under applicable regulatory and GSE requirements.
- How actual claim payments, default aging, loss reserves and rescission outcomes compare with management’s assumptions, including the expected decline in rescission benefits.
- Whether second-half losses and paid claims exceed first-half levels, and whether the $10–$12 billion full-year new-insurance outlook remains achievable.
- Developments in the Countrywide dispute, SEC investigation, securities litigation and IRS appeal, including any changes to estimated exposure or reserves.
- Holding-company liquidity and debt service capacity, including the use of offering proceeds, deferred junior-debenture interest and the 2011 senior-note maturity.