Business Context and Reporting Period
Company: MGIC Investment Corp.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2006
Business Overview: MGIC is the leading provider of private mortgage insurance (PMI) in the United States, operating primarily through its subsidiary Mortgage Guaranty Insurance Corporation (MGIC). The company insures residential first mortgage loans, protecting lenders against borrower defaults. It also holds significant ownership interests in two joint ventures: Credit-Based Asset Servicing and Securitization LLC (C-BASS) and Sherman Financial Group LLC (Sherman).
Recent Developments: On February 6, 2007, MGIC announced a definitive agreement to merge with competitor Radian Group Inc., expected to close in the fourth quarter of 2007.
Key Financial Metrics
| Metric | 2006 | 2005 | 2004 |
|---|---|---|---|
| Net Premiums Written | $1,217.2 million | $1,252.3 million | $1,305.4 million |
| Net Premiums Earned | $1,187.4 million | $1,238.7 million | $1,329.4 million |
| Investment Income (Net) | $240.6 million | $228.9 million | $215.1 million |
| Losses Incurred (Net) | $613.6 million | $553.5 million | $701.0 million |
| Net Income | $564.7 million | $626.9 million | $553.2 million |
| Diluted EPS | $6.65 | $6.78 | $5.63 |
| Total Assets | $6,621.7 million | $6,357.6 million | $6,380.7 million |
| Shareholders' Equity | $4,295.9 million | $4,165.1 million | $4,143.6 million |
| Debt (Short & Long-term) | $781.3 million | $685.2 million | $639.3 million |
| Loss Reserves | $1,125.7 million | $1,124.5 million | $1,185.6 million |
Insurance Ratios (GAAP):
- Loss Ratio: 51.7% (2006) vs. 44.7% (2005)
- Expense Ratio: 17.0% (2006) vs. 15.9% (2005)
- Combined Ratio: 68.7% (2006) vs. 60.6% (2005)
Material Changes vs. Prior Period
- Revenue Decline: Net premiums written and earned decreased in 2006 compared to 2005, primarily due to lower average premium rates, partially offset by a slight increase in average insurance in force.
- Increased Losses: Net losses incurred rose by approximately $60 million (10.9%) year-over-year. This was driven by a larger increase in estimated claim severity (average claim paid rose to $28,228 from $26,361) and a smaller decrease in estimated claim rates.
- Default Rates: The overall primary loan default rate improved slightly to 6.13% in 2006 from 6.58% in 2005. However, the default rate for bulk loans remained high at 14.87%.
- Joint Venture Income: Income from joint ventures increased to $169.5 million in 2006 from $147.3 million in 2005, driven by higher earnings from both C-BASS (increased net interest and servicing revenue) and Sherman (increased credit card income).
- Stock Repurchases: The company repurchased 6.1 million shares of common stock in 2006 at a cost of $385.6 million.
Guidance, Outlook, and Risks
- 2007 Outlook: Management expects New Insurance Written (NIW) to be above 2006 levels due to increased market penetration and regulatory scrutiny of non-traditional mortgages. However, losses incurred in 2007 are expected to exceed 2006 levels due to higher average insured loan sizes and potential deterioration in housing markets (specifically California and Florida).
- Merger with Radian: The proposed merger is expected to double the company's size. Completion is subject to regulatory and shareholder approvals. There is a risk that rating agencies may downgrade MGIC's financial strength rating to match Radian's (Aa3/AA) upon completion, though management does not expect this to materially affect business.
- Subprime Market Volatility: Significant dislocation occurred in the subprime mortgage market in February 2007. C-BASS estimated an expense of approximately $30 million due to negative mark-to-market revaluations of assets during this period. Management views this as a risk to achieving 2007 forecasts.
- Regulatory Risks: The company faces ongoing scrutiny regarding captive mortgage reinsurance arrangements and premium rates from state regulators (e.g., New York, Minnesota) and potential litigation under RESPA and FCRA.
- Interest Rate Sensitivity: The company's investment portfolio has an effective duration of 4.6 years. A 100 basis point parallel shift in the yield curve would result in an approximate 4.6% change in the market value of the fixed income portfolio.
Key Facts for Investor Verification
- Loss Reserve Adequacy: Verify the assumptions regarding claim severity and claim rates, particularly for the Midwest region (Michigan, Ohio, Indiana) where economic conditions have been weak, and for California/Florida where housing markets showed signs of deterioration in late 2006.
- Merger Completion: Monitor the status of regulatory and shareholder approvals for the Radian merger, as failure to close could negatively impact stock price and result in unrecoverable transaction costs.
- Joint Venture Exposure: Assess the impact of the subprime market dislocation on C-BASS's liquidity and earnings, specifically regarding margin calls and mark-to-market losses on mortgage securities.
- Persistency Rates: Track the persistency rate (percentage of insurance remaining in force), which was 69.6% at year-end 2006. A decline in persistency due to refinancing could reduce future premium revenue.
- Regulatory Actions: Watch for outcomes of investigations by the New York Insurance Department and Minnesota Department of Commerce regarding captive reinsurance and premium pricing.