MGIC INVESTMENT CORP quarterly report, Q2 FY2018

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MGIC Investment Corporation — Q2 2018 Form 10-Q

Business context and period. MGIC provides private mortgage insurance, principally for low-down-payment residential mortgages. This unaudited filing covers the quarter and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods unless noted.

Financial performance and position

  • Q2 revenue and earnings: Total revenue was $282.0 million, up 7%. Net income was $186.8 million, up 57%, and diluted EPS was $0.49 versus $0.31. Adjusted net operating income, a non-GAAP measure, was $189.2 million, or $0.50 per diluted share.
  • First-half performance: Revenue was $547.8 million, up 5%; net income was $330.5 million, up 59%; diluted EPS was $0.87 versus $0.55. Adjusted net operating income was $333.8 million, or $0.88 per diluted share.
  • Premiums and investment income: Q2 net premiums earned were $247.0 million, up 7%; first-half net premiums earned were $479.1 million, up 4%. Investment income was $34.5 million in Q2 and $66.6 million for the first half, up 16% and 13%, respectively. Premium yield declined to 49.6 basis points in Q2 and 48.5 basis points year to date, from 49.9 and 50.0.
  • Losses and expenses: Net losses incurred were a benefit of $13.5 million in Q2, compared with $27.3 million of expense in Q2 2017; first-half losses were $10.4 million versus $55.0 million. Lower new delinquency notices and estimated claim rates, plus favorable prior-year reserve development, drove the improvement. First-half other underwriting and operating expenses rose 11% to $87.9 million. The loss ratio declined; the filing text does not provide a clear numerical ratio. The underwriting expense ratio increased, primarily due to higher compensation costs.
  • Cash flow and liquidity: First-half operating cash flow was $262.6 million versus $125.6 million; investing cash flow was negative $62.4 million and financing cash flow negative $108.1 million. Cash and cash equivalents rose to $191.9 million from $99.9 million at year-end 2017. Holding-company cash and investments were approximately $191 million.
  • Balance sheet and debt: At June 30, total assets were $5.59 billion, liabilities $2.28 billion, and shareholders’ equity $3.31 billion. Loss reserves were $813.0 million, down from $985.6 million at year-end; long-term debt carrying value was approximately $831.0 million, broadly unchanged. Holding-company principal debt was $814.5 million; MGIC also had a $155 million FHLB advance.
  • Capital and portfolio: MGIC reported $4.8 billion of PMIERs Available Assets, approximately $1.0 billion above Minimum Required Assets, and remained eligible to insure GSE loans. Its statutory risk-to-capital ratio was 9.1:1. Primary insurance in force was $200.7 billion, and primary risk in force was $51.7 billion.

Material changes versus the prior period

  • Earnings improved substantially, chiefly reflecting lower incurred losses and a lower income-tax provision. The 2018 statutory tax rate was 21%, versus 35% in 2017; the prior-year first-half tax provision also included $27.8 million related to the IRS dispute.
  • Primary delinquent inventory fell to 36,037 loans from 41,317 a year earlier and 46,556 at year-end 2017. The primary delinquency rate was 3.49%, versus 4.11% a year earlier and 4.55% at year-end.
  • First-half net losses and LAE paid declined to $171 million from $301 million. Approximately $21 million of first-half 2018 payments related to NPL commutations and claims-practices disputes, compared with $45 million in the prior-year period.
  • Unrealized investment losses increased: fixed-income fair value was $4.93 billion versus $4.98 billion at year-end, while accumulated other comprehensive loss reached $117.3 million from $43.8 million.
  • The company repurchased approximately 9.2 million shares for $100.1 million in Q2, at a weighted average price of $10.88. A $200 million repurchase authorization runs through the end of 2019.

Outlook, commentary, risks, and unusual items

  • Management expects at least $50 million in quarterly dividends from MGIC to the holding company for the remainder of 2018. The company expects MGIC to remain PMIERs-compliant under proposed PMIERs 2.0, but anticipates a materially lower capital excess; proposed requirements were expected to be finalized in Q3 2018 and take effect at the end of Q1 2019.
  • Management expected persistency to rise gradually as higher mortgage rates limit refinancing. It also expected losses paid to continue declining as the credit profile improves and delinquent inventory falls. These are expectations, not guarantees.
  • DTI ratios above 45% represented approximately 19% of Q2 NIW and 20% of first-half NIW, up from 6% and 10% in the respective 2017 periods. MGIC tightened underwriting in March 2018 and added risk-based premium adjustments effective July 2018.
  • Revised borrower-paid premium rates were estimated to reduce direct rates on first-quarter 2018 NIW by approximately 8.5%, potentially weighing on premium yield as business mix changes. New GSE credit-risk-transfer pilots and broader GSE or housing-finance reforms could also affect demand for traditional mortgage insurance.
  • The IRS settlement was finalized and approved by the Tax Court in July 2018; its expected impact had already been reflected in the statements. Unrecognized tax benefits of $144.9 million were expected to be reduced in the second half of 2018, with approximately $57 million of net cash tax and interest outflows expected after prior payments and NOL carrybacks.
  • Hurricane-related delinquencies remained elevated in affected areas, though management did not expect a material increase in incurred losses or paid claims. Economic deterioration, home-price declines, delayed foreclosures, or lower cure rates could change that outcome. Loss-reserve estimates are judgmental and sensitive: a $1,000 change in average severity reserve factor would change reserves by about $15 million; a one-percentage-point change in average claim-rate factor by about $20 million.
  • Claims-practices litigation and disputes remain a contingency. The company estimated maximum exposure of approximately $288 million for matters where loss was reasonably possible, excluding interest and consequential or exemplary damages; it could not reasonably estimate a liability range.
  • Other risks include competition and pricing pressure, changing GSE requirements and alternatives to PMI, reinsurer credit or availability, state capital rules, holding-company debt and restricted subsidiary dividends, and possible limits on the use of approximately $344 million of NOL carryforwards following an ownership change. A rights agreement adopted in August 2018 seeks to protect NOL use.

Important facts for investors to verify

  • Final PMIERs 2.0 terms, resulting capital excess, and MGIC’s ability to maintain quarterly dividends.
  • Future delinquency cures, claim severity, hurricane-area performance, reserve development, and actual claims paid.
  • Effects of premium-rate reductions, higher-DTI underwriting and pricing actions, and GSE pilot programs on NIW, premium yield, and margins.
  • Cash outflows and final accounting consequences of the IRS settlement, including the expected approximately $57 million net payment.
  • Claims-practices litigation exposure, reinsurance recoverability and capital credit, and holding-company liquidity relative to debt service and planned repurchases.