MTG

Business Context and Reporting Period

Company: MGIC Investment Corporation
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 1998
Business Overview: MGIC is a holding company and the leading provider of private mortgage insurance (PMI) in the United States. Through its subsidiary, Mortgage Guaranty Insurance Corporation (MGIC), it insures residential first and second mortgages, enabling home purchases with less than 20% down payments. The company also provides contract underwriting and other mortgage-related services.

Key Financial Metrics

Revenue and Income (Parent Company Only):

• Total Revenue: $398.1 million (1998) vs. $328.4 million (1997).
• Net Income: $385.5 million (1998) vs. $323.8 million (1997).
• Investment Income: Net pre-tax investment income was $143.0 million for the consolidated company, representing an after-tax yield of 4.9% (down from 5.0% in 1997).

• Total Assets: $2.097 billion (1998) vs. $1.730 billion (1997).
• Total Liabilities: $456.5 million (1998) vs. $243.1 million (1997).
• Notes Payable: $442.0 million (1998) vs. $237.5 million (1997).
• Shareholders' Equity: $1.641 billion (1998) vs. $1.487 billion (1997).
• Cash and Short-term Investments: $22.0 million (1998) vs. $5.4 million (1997).

• Direct Primary Insurance In Force: $137.99 billion (1998) vs. $138.50 billion (1997).
• Direct Primary Risk In Force: $32.89 billion (1998) vs. $32.18 billion (1997).
• Default Rate (Primary): 2.21% (1998) vs. 2.12% (1997).
• Default Rate (Pool): 0.73% (1998) vs. 0.58% (1997).
• Investment Portfolio (Consolidated): Approximately $2.8 billion book value, with 77.3% in municipal securities.

• Dividends Paid (1998): $11.2 million ($0.10 per share).

Material Changes vs. Prior Period

• Profitability Growth: Net income increased by approximately 19% year-over-year, driven largely by higher equity in undistributed net income of subsidiaries ($368.2 million in 1998 vs. $304.4 million in 1997).
• Debt Increase: Notes payable at the parent company level increased by $204.5 million to $442 million, reflecting financing activities.
• Default Rates: The primary loan default rate rose to 2.21% from 2.12%, attributed to the maturation of the insurance book and higher risk profiles in loans insured in 1994-1995.
• Refinancing Activity: Due to historically low interest rates in 1998, 25.6% of primary risk written represented refinances, a significant increase from 12.2% in 1997.
• Investment Yield: The after-tax yield on investments declined slightly to 4.9% from 5.0% due to lower average interest rates.

Guidance, Outlook, Risks, and Contingencies

Regulatory Risks:

• RESPA Compliance: The U.S. Department of Housing and Urban Development (HUD) is reviewing MGIC's agency pool insurance and captive mortgage reinsurance transactions for compliance with the Real Estate Settlement Procedures Act (RESPA). Violations could result in civil liability up to three times the charge paid.
• State Regulation: The New York Department of Insurance (NYID) issued a circular warning that "significantly underpriced" agency pool insurance may violate state law. California is also reviewing similar products.
• Homeowners Protection Act (HPA): Enacted in July 1998, this federal law allows borrowers to cancel PMI when loan-to-value (LTV) ratios reach certain thresholds (80% or 78%), potentially reducing future premium revenue.

• GSE Competition: Fannie Mae and Freddie Mac introduced programs allowing reduced mortgage insurance coverage in exchange for delivery fees, potentially reducing demand for private insurance.
• Credit Ratings: MGIC maintains an "AA+" rating from S&P and "Aa2" from Moody's. Maintaining a rating of at least AA-/Aa3 is critical for writing new business.
• Loss Reserves: Estimating loss reserves is difficult due to changing economic conditions. Reserves are established only for loans currently in default, meaning future losses from current defaults may not be fully recognized until claims are filed.

Management notes that higher coverage percentages (depth of coverage) imposed by GSEs since 1995 have increased premium revenue but also increase potential claim severity. The company targets similar returns on capital regardless of coverage depth but acknowledges uncertainty in pricing adequacy during economic recessions.

Investor Verification Checklist

• Loss Reserve Adequacy: Verify the assumptions used for claim rates and severity in the loss reserve calculations, particularly given the rising default rate (2.21%) and the aging of the 1994-1995 loan book.
• Regulatory Exposure: Monitor the outcome of HUD's RESPA review and NYID's stance on pool insurance pricing, as these could impact revenue models or result in penalties.
• Debt Service: Review the parent company's increased debt load ($442 million) and its impact on liquidity and dividend capacity, noting the regulatory limits on dividends from insurance subsidiaries.
• Investment Portfolio Quality: Confirm the credit quality of the $2.8 billion investment portfolio, noting that 98.9% is rated "A" or better, but yields are declining with interest rates.
• Refinance Impact: Assess the long-term profitability of the high volume of refinanced loans (25.6% of new risk), which may have different claim patterns than original originations.