MGIC INVESTMENT CORP annual report, FY2010

Business context and reporting period

MGIC Investment Corporation filed this Form 10-K for the fiscal year ended December 31, 2010. The company is a holding company whose principal business is private mortgage insurance, primarily through Mortgage Guaranty Insurance Corporation (MGIC). The filing also presents unaudited quarterly results for 2010, including the fourth quarter.

Financial performance and key metrics

Metric	2010	2009
Total revenue	$1.521 billion	$1.709 billion
Net premiums written	$1.102 billion	$1.243 billion
Net premiums earned	$1.169 billion	$1.302 billion
Net investment income	$247.3 million	$304.7 million
Net losses incurred	$1.608 billion	$3.379 billion
Net loss	$363.7 million	$1.322 billion
Loss per diluted share	$2.06	$10.65
Operating cash flow	$(875.4) million	$330.0 million

Fourth-quarter 2010 net loss was $186.7 million, or $0.93 per diluted share, compared with a $280.1 million net loss in fourth-quarter 2009. Fourth-quarter 2010 net premiums earned were $291.1 million and net losses incurred were $448.4 million.

The 2010 GAAP loss ratio was 137.5%, expense ratio 16.3%, and combined ratio 153.8%. The ratios improved substantially from 2009 but remained above 100%, indicating underwriting losses. The filing does not present a clear consolidated free-cash-flow measure.

Financial position, liquidity and capital

At December 31, 2010, total assets were $9.334 billion, shareholders’ equity $1.669 billion, loss reserves $5.884 billion, and premium deficiency reserves $179.0 million.
Cash and cash equivalents were $1.304 billion; the investment portfolio was $7.458 billion. The combined fair value of investments and cash was approximately $8.8 billion.
Consolidated long-term debt included $77.4 million of 5.625% senior notes due September 2011, $300 million of 5.375% senior notes due 2015, $345 million of 5% convertible senior notes due 2017, and $389.5 million principal amount of 9% convertible junior debentures due 2063. The junior debentures’ balance-sheet carrying amount was $315.6 million.
The parent company reported $891 million in cash and investments. MGIC paid no dividends to the parent in 2009 or 2010; dividends from insurance subsidiaries were restricted and required Wisconsin regulatory approval through 2011.
April 2010 financing raised approximately $772.4 million net from common stock and $334.4 million net from convertible senior notes. The share issuance materially increased the share count. No cash dividend was paid in 2010.
MGIC’s statutory risk-to-capital ratio was 19.8:1; the combined insurance companies’ ratio was 23.2:1, near the commonly applied 25:1 limit. Regulatory waivers and the ability of subsidiary MIC to write business are important to continued operations.

Material changes versus the prior comparable period

Net loss narrowed by about $959 million from 2009, mainly as net losses incurred fell by about $1.772 billion. The 2010 loss remained the company’s fourth consecutive annual net loss.
Net premiums written fell 11% and net premiums earned fell 10%, reflecting lower average insurance in force and higher premium refunds, partly offset by reduced ceded premiums. Investment income also declined.
Primary new insurance written decreased to $12.3 billion from $19.9 billion; primary insurance in force fell to $191.3 billion from $212.2 billion.
Primary defaults declined to 214,724 from 250,440, and the default rate eased to 17.48% from 18.41%. However, 55% of the remaining primary default inventory had been delinquent for at least 12 months, versus 42% a year earlier.
Net paid losses and loss-adjustment expenses increased to $2.280 billion from $1.549 billion. Average primary claim paid declined to $50,173 from $52,627.
The premium deficiency reserve for Wall Street bulk transactions declined to $179 million from $193 million. MGIC had ceased writing Wall Street bulk business in 2007 and wrote no bulk business in 2009 or 2010.

Outlook, management commentary and principal risks

Management expected 2011 new insurance written to increase modestly from approximately $12 billion in 2010, but expected average insurance in force to continue declining and investment income to fall. Management expected claim payments in 2011 to exceed 2010 and stated that annual losses were still expected; the timing of a return to annual profitability was uncertain.
Loss estimates depend on uncertain claim rates, claim severity, housing prices, employment, loan cures, modifications and rescissions. A stated sensitivity example: a $1,000 change in average severity combined with a 1% change in average claim-rate factor could change loss reserves by approximately $254 million.
Rescissions materially reduced losses, but management expected their future benefit to decline. Rescissions reduced paid losses by approximately $1.2 billion in each of 2009 and 2010; the company estimated $1.3 billion of reserve benefit remained at year-end 2010. Adverse outcomes in disputes could weaken capital; no additional reserve was recorded for the Countrywide proceedings because the potential loss could not be reasonably estimated.
Countrywide sought damages “well-exceeding” $150 million in litigation and arbitration over claims and rescissions. The parties selected 24 bellwether loans, with a hearing scheduled for October 2011. Countrywide-related loans represented approximately 21% of MGIC’s primary delinquency inventory at year-end.
MGIC operated under GSE remediation plans with below-investment-grade financial strength ratings: Ba3 with a positive Moody’s outlook and B+ with a negative S&P outlook. Loss of GSE eligibility could sharply reduce new business.
Capital requirements, potential waiver changes, and GSE approval of MIC create a risk that MGIC could be restricted from writing new insurance. MIC’s approvals were time-limited, and additional capitalization required GSE consent.
Other risks include GSE and housing-finance reform, the still-undefined Qualified Residential Mortgage rules, FHA competition, foreclosure and servicing delays, loan-modification re-defaults, regional housing weakness, premium adequacy, regulatory scrutiny, captive-reinsurance litigation, and potential contract-underwriting remedies.
Approximately $358 million of auction-rate securities had failed auctions and were not readily liquid. Management expected liquidity by December 31, 2014; this depended on market access, refinancing or repayment assumptions.
The IRS tax examination had a tentative settlement pending congressional review. Management expected approximately $22 million of net cash outflows in 2011 under that agreement.

Important facts for investors to verify

Whether 2011 claim payments, loss development and reserve assumptions—particularly the expected effect of rescissions and loan modifications—match management’s outlook.
Updates on MGIC’s statutory capital ratios, regulatory waivers, MIC’s writing capacity and GSE eligibility requirements.
Developments in the Countrywide litigation and arbitration, including any impact on reserves, capital or rescission practices across other lenders.
Whether new insurance written, premium yield and persistency stabilize enough to offset continued runoff of insurance in force and lower investment yields.
The parent company’s debt-service capacity given restrictions on subsidiary dividends, the September 2011 note maturity, and potential dilution from convertible securities or further capital raising.
Liquidity and valuation of failed-auction securities, and any material changes in the IRS settlement or other contingencies.

PricewaterhouseCoopers LLP gave an unqualified opinion on the consolidated financial statements and concluded that internal control over financial reporting was effective as of December 31, 2010.