MTG

Business Context and Reporting Period

Company: MGIC Investment Corp.
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Three months ended March 31, 2006
Business Overview: MGIC is the leading provider of private mortgage insurance in the United States. Its principal products include primary mortgage insurance (flow and bulk channels) and pool mortgage insurance. The Company also holds significant investments in joint ventures, specifically Credit-Based Asset Servicing and Securitization LLC (C-BASS) and Sherman Financial Group LLC.

Key Financial Metrics

Insurance Ratios (Q1 2006 vs Q1 2005)

• Loss Ratio: 38.3% (vs 31.3%)
• Expense Ratio: 17.5% (vs 15.9%)
• Combined Ratio: 55.8% (vs 47.2%)

Material Changes vs. Prior Period

• Revenue Decline: Net premiums earned decreased by approximately 5.2% due to a decline in average insurance in force. New Insurance Written (NIW) dropped to $10.0 billion from $11.4 billion, driven primarily by lower refinance volumes.
• Profitability Decrease: Net income fell 10.2% to $163.5 million. This was primarily driven by higher losses incurred and increased underwriting expenses.
• Losses Incurred: Net losses incurred rose to $114.9 million (from $98.9 million) due to increased estimates regarding claim frequency and severity. The loss ratio increased to 38.3%.
• Expense Increase: Underwriting and other expenses increased to $74.3 million (from $67.9 million), largely due to the acquisition of Myers Internet and higher equity-based compensation costs.
• Joint Venture Income: Income from joint ventures increased to $39.1 million (from $34.2 million), driven by higher earnings from both C-BASS and Sherman.
• Debt Reduction: Total debt decreased by approximately $87.5 million, reflecting the repayment of $300 million in senior notes due in October 2005 (refinanced in late 2005) and net repayments of commercial paper.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Premiums: Management expects average insurance in force for the remainder of 2006 to be slightly lower than in 2005, anticipating lower net premiums written and earned for the full year.
• Losses: The Company anticipates losses incurred in the second quarter of 2006 will be above the level recorded in the first quarter.
• Persistency: The persistency rate improved to 62.0% at March 31, 2006. Management expects modest improvement for the remainder of 2006, assuming no significant decline in mortgage interest rates.
• Dividends: Following regulatory approvals, the subsidiary MGIC paid a quarterly dividend of $55 million and an extraordinary dividend of $150 million in February 2006. Further dividends require additional regulatory approval.

Risks and Contingencies

• Regulatory Investigations: The Company is responding to inquiries from the New York Insurance Department (NYID) regarding premium rates and captive mortgage reinsurance arrangements. The Minnesota Department of Commerce (MDC) has also issued a subpoena regarding similar matters.
• Litigation: Ongoing exposure to litigation regarding RESPA (anti-referral fees) and FCRA (notice provisions). A recent Ninth Circuit decision may increase the likelihood of future FCRA litigation.
• Tax Examination: The IRS is examining tax returns for 2000–2004, specifically challenging the tax basis of investments in REMIC residual interests. The Company intends to contest any proposed adjustments.
• Market Risk: The investment portfolio has an effective duration of 4.9 years. A 100 basis point parallel shift in the yield curve would result in an approximate 4.9% change in the market value of the fixed income portfolio.

Investor Verification Checklist

• Loss Reserve Adequacy: Verify the assumptions used for claim frequency and severity, given the 38.3% loss ratio and management's expectation of higher Q2 losses.
• Regulatory Impact: Monitor the outcome of the NYID and MDC investigations into captive reinsurance and premium rates, as these could materially affect future pricing and profitability.
• IRS Tax Dispute: Track the status of the IRS examination regarding REMIC residual interests, as a disallowance of tax basis could significantly increase tax liabilities.
• Joint Venture Performance: Review the specific drivers of the increased income from C-BASS and Sherman to ensure sustainability, particularly regarding securitization spreads and credit card portfolio performance.
• Capital Constraints: Note that the subsidiary MGIC cannot currently pay further dividends without new regulatory approval, which may impact the parent company's liquidity strategy.