MGIC Investment Corporation — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing also reports fourth-quarter results; this is an annual report, not a standalone Q4 filing. Amounts are U.S. dollars.
Business context
MGIC is a holding company whose subsidiaries provide private mortgage insurance and related mortgage credit-risk and underwriting services. Its business depends heavily on low-down-payment mortgage originations and the rules and practices of Fannie Mae and Freddie Mac (the GSEs). In 2018, MGIC wrote $50.5 billion of primary new insurance and ended the year with $209.7 billion of direct primary insurance in force (IIF) and $54.1 billion of primary risk in force (RIF).
Financial and operating performance
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Total revenue | $1,123.8 million | $1,066.1 million |
| Net premiums earned | $975.2 million | $934.7 million |
| Net investment income | $141.3 million | $120.9 million |
| Losses incurred, net | $36.6 million | $53.7 million |
| Income before tax | $844.2 million | $784.5 million |
| Net income | $670.1 million | $355.8 million |
| Diluted EPS | $1.78 | $0.95 |
| Operating cash flow | $544.5 million | $406.7 million |
| Cash and cash equivalents, year-end | $151.9 million | $99.9 million |
| Total investments, year-end | $5,159.0 million | $4,990.6 million |
| Total assets / shareholders’ equity, year-end | $5,677.8 million / $3,581.9 million | $5,619.5 million / $3,154.5 million |
The loss ratio improved to 3.7% from 5.7%; the underwriting expense ratio increased to 18.2% from 16.0%. Premium yield declined to 48.2 basis points from 49.6 basis points. Primary IIF grew 7.6%, while year-end persistency rose to 81.7% from 80.1%. The primary delinquency rate fell to 3.11% from 4.55%.
Fourth quarter: Net income was $157.7 million and diluted EPS was $0.43. Net premiums earned were $245.7 million, and net losses incurred were $27.7 million. Quarterly loss incurred can be volatile and should be read with reserve development and annual results.
Capital, debt and liquidity
Consolidated long-term debt had a carrying value of $831.6 million, including MGIC’s $155 million FHLB advance, the $419.7 million carrying value of the 5.75% notes, and $256.9 million of convertible junior subordinated debentures. At the holding company, cash and investments were approximately $248 million against about $815 million of debt principal; annual debt service was approximately $60 million. The $175 million revolving facility was undrawn at year-end. MGIC paid $220 million in dividends to the parent in 2018, subject to regulatory constraints.
MGIC had $4.8 billion of PMIERs Available Assets, $1.4 billion above Minimum Required Assets at year-end; management estimated the excess would be approximately $1.0 billion under revised PMIERs effective March 31, 2019. MGIC’s statutory risk-to-capital ratio was 9.0:1, and its policyholder position exceeded the required minimum by $2.6 billion. These measures rely in part on credit for reinsurance arrangements.
Changes versus prior period and unusual items
- Net income rose 88%, primarily reflecting a lower tax provision and lower losses incurred. The 2017 comparison included a $133 million deferred-tax-asset remeasurement under the Tax Act and an additional provision related to IRS litigation; the IRS settlement was finalized in 2018.
- Net losses incurred decreased 32%. New delinquency notices fell 20%, and the estimated claim rate on new notices declined. Favorable prior-year reserve development was $167 million in 2018 versus $231 million in 2017.
- Net losses and loss-adjustment expenses paid declined to $333 million from $505 million. This is a cash-flow measure, distinct from losses incurred.
- Shareholders’ equity rose to $3.58 billion, despite $175 million of share repurchases and an $80.4 million after-tax other comprehensive loss, largely reflecting investment valuation changes. The repurchases covered approximately 16.0 million shares.
- The company entered fully collateralized excess-of-loss reinsurance providing up to $318.6 million of coverage on a defined portfolio, after MGIC retains the first $168.7 million of aggregate losses. Quota-share reinsurance covered approximately 78% of IIF at year-end.
Outlook, management commentary and principal risks
Management expected 2019 new insurance written to be relatively flat with 2018 and IIF to increase. Direct premiums written and net premiums earned were expected to be comparable to 2018, with premium yield continuing to decline. Management expected investment income to increase, losses on 2019 notices to be lower than the comparable 2018 amount, but total 2019 net losses incurred to increase if there were no favorable development on prior-year notices. The expected 2019 effective tax rate was approximately 21%.
- Housing-finance and competition: GSE reform, expanded use of nontraditional credit-risk transfers, government insurance programs, competitors’ pricing and changes in low-down-payment originations could reduce MGIC’s volume or returns.
- Credit and reserves: Results depend on employment, home values, borrower performance, claim severity and cure rates. Reserves are generally established for delinquent loans, not all future claims on performing insured loans; estimates are judgmental. A $1,000 change in the average severity reserve factor was estimated to change reserves by about $12 million, and a one-percentage-point change in claim-rate assumptions by about $19 million.
- Business mix and pricing: The share of new insurance with LTV above 95% increased to 16.0% from 10.7%; DTI above 45% rose to 19.6% from 10.4%. MGIC tightened underwriting and introduced DTI-based pricing adjustments; its MiQ loan-level pricing system launched in Q1 2019. Management identified risk of adverse selection while adoption develops.
- Capital and reinsurance: Revised PMIERs reduce credit for future premiums. Reinsurance credit may change, and reinsurer or collateral performance, future capital rules, or higher required assets could constrain growth or capital returns.
- Legal contingencies: For reasonably possible claims-practices matters, MGIC estimated maximum exposure of approximately $279 million but could not reasonably estimate a liability range; the estimate excludes interest and consequential or exemplary damages. Management stated that ordinary-course proceedings were not expected to materially affect results based on currently known facts.
- Investment and other risks: The investment portfolio is exposed to interest-rate and credit-spread movements; a parallel 100-basis-point rate increase was estimated to reduce fixed-income fair value by about 4.1%. Natural disasters, servicing disruptions, technology implementation, and policy or regulatory changes are also identified risks.
Most important facts for investors to verify
- Whether revised PMIERs, subsequent updates and reinsurance-credit treatment preserve MGIC’s capital cushion and GSE eligibility.
- Whether claim rates, cure activity and severity assumptions support the $674 million year-end GAAP loss reserve and the favorable $167 million prior-year development.
- Whether the 2018 increases in high-LTV and high-DTI new business affect future claims, capital requirements or premium yield.
- How premium yield, MiQ adoption, competition and the 2019 volume outlook develop against management’s expectations.
- Holding-company liquidity, regulated dividend capacity, debt-service needs and remaining share-repurchase authorization.
- Developments in the approximately $279 million maximum reasonably possible claims-practices exposure and in GSE reform or alternative risk-transfer programs.