MGIC Investment Corporation — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; balance-sheet comparisons are with December 31, 2013 unless otherwise noted. Amounts are in U.S. dollars. MGIC Investment is a holding company principally engaged in U.S. mortgage insurance through its subsidiaries.
Financial performance and position
| Metric | Q1 2014 | Q1 2013 / comparison |
|---|---|---|
| Net premiums written | $218.0 million | $248.5 million |
| Net premiums earned | $214.3 million | $247.1 million |
| Total revenue | $235.1 million | $269.2 million |
| Losses incurred, net | $122.6 million | $266.2 million |
| Income (loss) before tax | $60.7 million | $(71.8) million |
| Net income (loss) | $60.0 million | $(72.9) million |
| Basic / diluted EPS | $0.18 / $0.15 | $(0.31) / $(0.31) |
| Net investment income | $20.2 million | $18.3 million |
| Interest expense | $17.5 million | $26.4 million |
| Combined insurance ratio | 72.9% | 125.8% |
Net income improved primarily with lower incurred losses and operating expenses, plus lower interest expense. Premiums fell as average insurance in force declined and ceded premiums rose under reinsurance. The loss ratio was 57.2%, versus 107.8%; the underwriting expense ratio was 15.7%, versus 18.0%. Net realized investment losses were $0.2 million, compared with $1.3 million of gains; no other-than-temporary impairment losses were recognized in either period.
- Cash flow: Operating cash outflow was $158.9 million, compared with $251.7 million outflow. Investing activities provided $144.9 million, versus using $288.3 million. Financing activities used $21.8 million, including repurchases of senior notes. Cash and cash equivalents ended at $296.9 million, down from $332.7 million; restricted cash was a further $17.4 million.
- Balance sheet and liquidity: Total assets were $5.465 billion and shareholders’ equity $840.7 million. The investment portfolio was $4.761 billion at fair value. Management reported about $542 million of cash and investments at the holding company; insurance-subsidiary dividends to the parent are restricted and MGIC had paid no dividends to the parent since 2008.
- Reserves and claims: Loss reserves were $2.835 billion, down from $3.061 billion at year-end and $3.848 billion at March 31, 2013. Primary defaults declined to 91,842 from 103,328 at year-end and 126,610 a year earlier. However, 59% of primary defaults had been in default for at least 12 months. Q1 net paid losses and loss-adjustment expenses were $343 million, versus $466 million.
- Debt: Debt principal totaled approximately $1.297 billion: $62 million of 5.375% senior notes, $345 million of 5% convertible senior notes, $500 million of 2% convertible senior notes and $389.5 million of 9% convertible junior debentures. The notes’ aggregate fair value was reported at about $1.630 billion. MGIC repurchased $20.9 million par value of senior notes during the quarter.
- Statutory capital: MGIC’s risk-to-capital ratio improved to 15.3:1 from 15.8:1 at year-end; combined insurance operations were at 17.6:1. MGIC’s policyholder position was reported $519 million above Wisconsin’s $1.0 billion minimum requirement.
Material changes and operating trends
- Primary new insurance written was $5.2 billion, down from $6.5 billion. Refinancing was 15% of primary new insurance written, versus 46%; purchase volume increased and partly offset the refinancing decline. Primary insurance in force decreased by $0.8 billion in the quarter to $157.9 billion.
- New default notices fell to 23,346 from 27,864. Management attributed lower losses to fewer new notices and lower estimated claim rates; prior-year reserve development was favorable by $33 million, versus $3 million in Q1 2013.
- The unaffiliated quota-share reinsurance agreement materially expanded: 56% of insurance in force was subject to reinsurance at quarter-end, versus 10% a year earlier. Approximately 93% of Q1 new insurance written was covered. The arrangement reduces premium yield but also cedes losses and provides ceding commissions.
- Unrealized investment losses improved: gross unrealized losses were $67.8 million versus $101.4 million at year-end; net unrealized losses were $45.0 million at March 31. The portfolio was entirely investment grade, with 14% rated BBB.
Outlook, risks and contingencies
- Management outlook: The company expects 2014 new insurance written to be similar to 2013 levels, average insurance in force to increase slightly over the rest of 2014, and premium yields to decline from Q1 levels due to reinsurance and rate reductions. It expects paid claims to continue declining through the rest of 2014, excluding the expected effect of the remaining Countrywide settlement. Management cautions that mortgage-insurance losses have historically tended to be worse in the second half of the year. No full-year earnings guidance is provided in the supplied filing text.
- GSE eligibility and capital: MGIC’s Moody’s rating was Ba3 (stable) and S&P rating BB (positive), below the existing GSE rating standard; it continued operating as an eligible insurer under remediation plans. New GSE counterparty requirements were expected to be proposed as early as Q2 2014, but their content and effective dates were unknown. Failure to maintain eligibility could significantly reduce new business. Revised state or NAIC capital rules could also constrain writing.
- Claims and reserves: Loss estimates depend on claim frequency, severity, economic conditions and housing values and may differ materially from ultimate payments. The reserve estimate included about $70 million of benefit from anticipated rescissions. Approximately 26% of post-2008 rescissions not subject to settlement remained within the period for potential disputes. Modified loans also pose re-default risk; management used an approximate 50% re-default assumption for internal planning, not as a reported outcome.
- Litigation: The BANA portion of the Countrywide settlement was implemented; the CHL agreement for non-GSE loans remained subject to investor consent, with implementation considered probable but not assured. The company estimated maximum exposure above its recorded best estimate at $484 million, about half related to the CHL agreement. Separate claims-paying discussions and proceedings had estimated maximum exposure of about $266 million; management said it expected resolution for significantly less but could not reasonably estimate a range of liability. These figures exclude interest and consequential or exemplary damages.
- Tax contingency: The IRS proposed $197.5 million of taxes and penalties over the company’s treatment of REMIC investment losses, with about $157.9 million of interest and approximately $46.3 million of potential state taxes and interest also identified. The company reported $105.6 million of unrecognized tax benefits, continued to consider its recorded provisions appropriate, and expected litigation in 2014. Its deferred-tax valuation allowance was $968.6 million.
- Other regulatory and legal matters: A CFPB settlement barred new captive reinsurance for ten years and included a $2.65 million civil penalty, without findings of wrongdoing. A Minnesota regulator’s draft consent order remained under discussion. RESPA-related litigation and investigations, and a remaining MERS-related case that could be appealed, were additional disclosed risks.
- Liquidity and cash demands: Management said claims had exceeded premiums received since 2009 and expected the trend to continue, with significant investment-portfolio declines possible. Holding-company debt service relies principally on investment income and regulated subsidiary dividends; the 9% junior debentures permit interest deferral, but deferred interest compounds and common-stock dividends are prohibited during deferral.
Most important facts for investors to verify
- Whether MGIC maintains GSE eligibility under remediation plans and meets forthcoming GSE and state capital requirements.
- How the CHL settlement is implemented, what the recorded settlement provision covers, and how actual legal outcomes compare with the disclosed maximum exposures.
- Whether falling defaults and favorable prior-year development persist, particularly given the aged default inventory, second-half seasonality and uncertainty in claim severity.
- How much reinsurance profit commission is ultimately realized, whether recoverables remain adequately collateralized, and the effect of ceded premiums on future yields and earnings.
- Whether operating cash outflows, claims exceeding premiums, and holding-company debt obligations affect liquidity or require additional capital support to insurance subsidiaries.
- The outcome and financial effects of the IRS REMIC dispute and other regulatory investigations or litigation.