MGIC INVESTMENT CORP annual report, FY2017

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MGIC Investment Corporation — 2017 Form 10-K

Business context and reporting period. This annual report covers the fiscal year ended December 31, 2017; it is not a standalone fourth-quarter filing. MGIC Investment Corporation is a holding company whose primary business is private mortgage insurance, principally through MGIC. The company reported $49.1 billion of new primary insurance written (NIW) in 2017 and $194.9 billion of direct primary insurance in force (IIF) at year-end.

Financial and operating performance

  • Revenue: Total revenue was $1.066 billion, up slightly from $1.062 billion in 2016. Net premiums earned were $934.7 million and net premiums written were $998.0 million. Net investment income was $120.9 million, up from $110.7 million.
  • Profit: Income before tax was $784.5 million versus $514.7 million in 2016. Net income was $355.8 million, up 4%; diluted EPS was $0.95 versus $0.86. Adjusted net operating income, a non-GAAP measure, was $517.7 million, or $1.36 per diluted share, compared with $396.3 million, or $0.99, in 2016.
  • Losses and margins: Net losses incurred fell 78% to $53.7 million, including $231.2 million of favorable prior-year reserve development. The GAAP loss ratio declined to 5.7% from 26.0%; the expense ratio rose to 16.0% from 15.3%. Premium yield declined to 49.6 basis points from 51.9 basis points.
  • Cash flow: Operating cash flow was $406.7 million, compared with $224.8 million in 2016. Investing cash outflow was $303.6 million and financing cash outflow was $158.6 million. Cash and cash equivalents ended the year at $99.9 million, down from $155.4 million.
  • Balance sheet and capital: Total assets were $5.619 billion, shareholders’ equity was $3.155 billion, and total liabilities were $2.465 billion. Consolidated loss reserves were $985.6 million gross of reinsurance recoverables; net reserves were $937.2 million. MGIC reported $4.8 billion of PMIERs Available Assets, $0.8 billion above Minimum Required Assets. Its statutory risk-to-capital ratio was 9.5:1, and its policyholder position exceeded the required minimum by $2.1 billion.
  • Debt and liquidity: Consolidated debt carrying value was $830.4 million, down from $1.179 billion, reflecting the 2017 maturity of $145 million of 5% Notes and conversion/redemption of the 2% Notes. The long-term debt-to-equity ratio fell to 26.5% from 46.7%. The holding company had approximately $216 million in cash and investments, $815 million of outstanding debt principal, and an undrawn $175 million revolving credit facility. MGIC paid $140 million in dividends to the parent in 2017.
  • Insurance portfolio: Direct primary IIF increased to $194.9 billion from $182.0 billion; direct primary risk in force (RIF) rose to $50.3 billion from $47.2 billion. Persistency increased to 80.1% from 76.9%. Primary delinquency rate improved to 4.55% from 5.04%, though hurricane-related delinquencies rose in affected areas.

Material changes versus 2016

  • Net income increased modestly despite a substantial rise in the income-tax provision. The 2017 effective tax rate was 54.7%, versus 33.5% in 2016, mainly reflecting a $133 million deferred-tax-asset remeasurement under the Tax Act and a $29 million provision for the expected IRS settlement.
  • Losses incurred declined sharply, driven by lower estimated claim rates and stronger favorable development on prior-year delinquencies. The delinquent inventory fell to 46,556 loans from 50,282.
  • NIW increased to $49.1 billion from $47.9 billion; purchase business made up 88.6% of 2017 NIW, versus 80.4% in 2016. The share of NIW with LTV above 95% rose to 10.7% from 5.8%.
  • Equity increased 24% to $3.155 billion, supported by net income and conversion of approximately $202.5 million of 2% Notes into about 29.1 million common shares. Debt and the debt-to-equity ratio declined.
  • Operating cash flow increased, primarily due to lower claim payments and higher net premiums written. Investment portfolio fair value grew 6.4% to approximately $5.0 billion.

Outlook, risks, contingencies, and unusual items

  • 2018 outlook: Management expected NIW to increase slightly from 2017, IIF to continue growing, and persistency to remain comparable to 2017. Earned-premium growth was expected to be comparable to 2017, with lower premium yield partly offset by higher IIF. Management expected higher investment income, fewer new delinquencies and lower losses on 2018 notices, while noting that prior-year loss development could not be predicted. The expected 2018 effective tax rate was approximately 21%.
  • PMIERs: Proposed GSE-recommended PMIERs changes were expected to take effect no earlier than Q4 2018. Management expected MGIC to retain excess Available Assets, but said the cushion would be materially lower; it expected to continue paying quarterly $50 million dividends to the parent, subject to the final requirements and other conditions.
  • Market and credit risks: Results depend on housing prices, employment, mortgage originations, interest rates, loan quality, persistency and claims experience. Competition from other mortgage insurers, government programs and alternative credit-transfer structures could reduce business or pricing. Changes to GSE practices, eligibility rules, capital requirements or housing-finance policy could materially affect operations.
  • Hurricanes: Hurricane-related notices increased in Texas, Florida and Puerto Rico. Management did not expect a material increase in incurred losses or paid claims, but acknowledged uncertainty around property damage, home values, borrower defaults, claims disputes and PMIERs capital requirements.
  • Tax and legal contingencies: The IRS dispute concerns 2000–2007 tax years. The parties reached agreement on all issues, but the proposed settlement remained subject to Joint Committee on Taxation review. The filing describes IRS assessments, interest and possible state tax exposure; it recorded an additional $29 million provision in 2017. If settled on the disclosed basis, estimated net cash outflows were approximately $55 million after prior payments and tax-loss carrybacks. Separately, the company estimated maximum reasonably possible exposure of approximately $285 million for claims-paying-practice disputes, excluding interest and consequential or exemplary damages; it could not reasonably estimate the likely liability range.
  • Other notable items: The 2017 fourth quarter included a $31.0 million benefit from negative net losses incurred and net income of $27.3 million. The annual results also reflect the Tax Act deferred-tax remeasurement. No cash dividends have been paid to common shareholders since July 2008. The auditor reported that the financial statements were fairly presented and internal control over financial reporting was effective.

Important facts for investors to verify

  • Final PMIERs revisions, the resulting Available Assets cushion, and MGIC’s capacity to maintain parent-company dividends.
  • Resolution and cash cost of the IRS settlement, including any effects on taxes, liquidity and statutory capital.
  • Whether favorable loss-reserve development and low claim rates persist, especially as newer, higher-LTV vintages season; assess the sensitivity of reserves to claim-rate and severity assumptions.
  • Actual hurricane-related claims, cures and delinquency trends, particularly in Puerto Rico, Florida and Texas.
  • Premium yield, persistency, pricing competition and NIW mix, including the rising proportion of loans with LTV above 95% and higher debt-to-income ratios.
  • Parent-company liquidity and debt-service capacity, given restricted subsidiary dividends, outstanding debt and potential capital needs at MGIC.
  • Potential exposure from claims-paying disputes and changes in GSE, state-capital or housing-finance requirements.