MGIC Investment Corporation — Q1 2012 Form 10-Q
Business context and reporting period. MGIC Investment Corporation is a holding company principally engaged in U.S. private mortgage insurance through MGIC and subsidiaries. This unaudited filing covers the three months ended March 31, 2012; balance-sheet comparisons are with December 31, 2011. Dollar amounts below are in millions unless stated otherwise.
Key financial results and position
| Metric | Q1 2012 | Q1 2011 / prior date |
|---|---|---|
| Net premiums earned | $262.4 | $288.5 |
| Investment income, net | $37.4 | $56.5 |
| Net realized investment gains | $77.6 | $5.8 |
| Total revenues | $379.7 | $353.1 |
| Losses incurred, net | $337.1 | $310.4 |
| Pre-tax loss | $(18.2) | $(31.9) |
| Net loss; diluted loss per share | $(19.6); $(0.10) | $(33.7); $(0.17) |
| Operating cash flow | $(423.6) | $(420.9) |
| Cash and cash equivalents, March 31 | $902.6 | $995.8 at Dec. 31, 2011 |
| Total assets; shareholders’ equity, March 31 | $6,812.1; $1,131.6 | $7,216.2; $1,196.8 at Dec. 31, 2011 |
Q1 2012’s loss ratio was 128.5%, underwriting expense ratio 16.7%, and combined ratio 145.2%, versus 107.6%, 16.2%, and 123.8%, respectively, in Q1 2011. Investment gains materially supported reported revenue; without them, the underlying revenue comparison would be weaker. The company reported no other-than-temporary investment impairments in either quarter.
Loss reserves were $4,209.2, down from $4,557.5 at year-end. The premium deficiency reserve was $120.6, down from $134.8. Gross primary risk in force was $43.5 billion and direct primary insurance in force was $169.0 billion, both lower than a year earlier. Primary delinquency inventory declined to 160,473 loans from 195,885 a year earlier, but 58% of the inventory had been in default for at least 12 months.
Investing activities provided $330.4; financing activities were zero. Net cash decreased $93.2 during the quarter. The company held a $5.5 billion investment portfolio, all reported as investment grade; its average pre-tax portfolio yield was 2.4%, down from 3.2% a year earlier. Its $142 million auction-rate securities portfolio remained subject to failed auctions and was not readily liquid. Management expected liquidity for those securities by December 31, 2014.
Debt included $171 million of 5.375% senior notes due 2015, $345 million of 5% convertible senior notes due 2017, and $389.5 million principal of 9% convertible junior debentures due 2063. The debentures’ carrying amount was $352.6 million. Q1 interest expense was $24.6 million. The holding company had $490 million of cash and investments; insurance-subsidiary dividends to the holding company were restricted.
Material changes versus comparable periods
- Net loss improved to $19.6 million from $33.7 million, but included $77.6 million of realized gains on investment sales versus $5.8 million a year earlier.
- Net premiums earned fell about 9% year over year, primarily reflecting lower average insurance in force and higher premium refunds on paid claims. Investment income also declined, due to lower average invested assets and yield.
- Losses incurred rose to $337.1 million from $310.4 million. Q1 2012 included $56.5 million of unfavorable prior-year development, principally from higher estimated claim rates on older primary defaults; Q1 2011 had $37.0 million of favorable prior-year development.
- Primary new insurance written increased to $4.2 billion from $3.0 billion, while cancellations also increased, to $8.1 billion from $7.4 billion. Insurance in force therefore continued to shrink.
- Shareholders’ equity declined to $1,131.6 million, including a $44.8 million other comprehensive loss, partly offset by net reissuance of treasury shares.
Outlook, risks, contingencies, and unusual items
- Capital and ability to write new business: MGIC’s statutory risk-to-capital ratio was 20.3:1; the combined insurance operations ratio was 22.2:1. Management expected MGIC’s ratio to exceed 25:1 in the second half of 2012. Wisconsin’s capital requirements were waived through December 31, 2013 subject to regulatory conditions, including a $1 billion liquid-assets requirement. Defined liquid assets were approximately $5.9 billion at March 31; management expected them to decline materially as claims and other cash uses exceeded operating cash generation, though it did not expect them to fall below $1 billion during the covered period.
- MGIC contributed $200 million to subsidiary MIC in January; MIC reported $437 million of statutory capital at March 31. MIC’s ability to write business depends on regulatory and GSE approvals, several of which are conditional or time-limited. Waiver denials or changes could restrict new business or cause run-off.
- Claims and rescissions: Rescissions reduced paid losses by about $80 million in Q1 2012, and expected rescissions reduced ending loss reserves by an estimated $0.6 billion. Management expected rescissions to continue declining. It suspended rescissions on approximately 1,110 loans across Countrywide and other customer matters, representing about $81 million of potential claims; reserves assume those coverages will be rescinded.
- Countrywide dispute: MGIC was in mediation and had not accrued for a possible adverse outcome because it could not reasonably estimate the loss. Countrywide asserted other damages of almost $700 million, in addition to disputed claim amounts and possible exemplary damages. The arbitration hearing on selected “bellwether” loans was scheduled for March 2013. An adverse result or settlement could increase losses and reduce capital.
- Freddie Mac pool-limit disagreement: Freddie Mac’s interpretation would produce an aggregate loss limit about $535 million higher than MGIC’s interpretation. MGIC reported that Q1 2012 incurred losses would have been $49 million higher under Freddie Mac’s view, and expected the difference to grow.
- Regulatory and legal exposure: The CFPB opened an investigation into captive mortgage reinsurance practices; MGIC also faced RESPA class-action complaints and other regulatory inquiries. On April 30, 2012, after quarter-end, MGIC agreed to a DOJ consent order involving a $511,250 settlement fund and a $38,750 civil penalty. A separate proposed class settlement was not binding and required court approval.
- Tax contingency: The IRS’s REMIC assessment was $190.7 million in taxes and penalties, plus potentially substantial interest and state taxes. The IRS was reconsidering a tentative settlement; the ultimate outcome could materially affect earnings, cash flow, and statutory capital. A $65.2 million payment had previously been made.
- Management outlook: MGIC expected 2012 new insurance written to exceed the $14 billion written in 2011, but expected insurance in force to continue declining, investment income to fall, and annual net losses to continue. Management expected paid claims to decline if recent foreclosure patterns persisted. Q1 changes included lower premiums for loans with FICO scores of 760 or higher; the net effect on future premiums was uncertain.
- Business risks also include potential changes to GSE roles, mortgage-insurance eligibility, and the proposed qualified residential mortgage definition; housing prices, unemployment, servicing delays, loan modifications, and re-default rates; and the possibility that lower-than-assumed rescission benefits increase claims.
Important facts for investors to verify
- Whether capital ratios, regulatory waivers, MIC approvals, and the $1 billion liquid-assets requirement remain sufficient to support ongoing new business.
- How loss reserves develop as delinquency inventory ages, rescissions decline, and actual claim rates and severities compare with management assumptions.
- Developments and financial effects of the Countrywide mediation/arbitration, other rescission disputes, and Freddie Mac’s pool-policy interpretation.
- The outcome of the IRS REMIC matter and captive-reinsurance investigations, and whether any resulting liabilities affect statutory capital or liquidity.
- Whether investment-sale gains recur, and the pace at which operating cash use, claims payments, and investment income affect liquidity.