MGIC INVESTMENT CORP quarterly report, Q2 FY2017

MGIC Investment Corp. — Q2 2017 Form 10-Q

Reporting period: Three and six months ended June 30, 2017. MGIC, through its subsidiary Mortgage Guaranty Insurance Corporation, provides mortgage insurance primarily on low-down-payment residential loans. Figures below are U.S. dollars; financial statement amounts are consolidated.

Financial performance and position

Metric	Q2 2017	Q2 2016	Six months 2017	Six months 2016
Total revenue	$263.3 million	$263.5 million	$524.2 million	$522.1 million
Net premiums earned	$231.1 million	$231.5 million	$460.2 million	$452.8 million
Net income	$118.6 million	$109.2 million	$208.4 million	$178.4 million
Diluted EPS	$0.31	$0.26	$0.55	$0.43
Net losses incurred	$27.3 million	$46.6 million	$55.0 million	$131.6 million

Pre-tax income was $180.6 million in Q2 and $354.6 million for the first half. First-half tax provision was $146.2 million, including a $27.8 million charge related to the IRS dispute; the resulting effective tax rate was 41.2% versus 33.7% in first-half 2016.
Approximate loss ratios, calculated as net losses incurred divided by net premiums earned, were 11.8% in Q2 2017 versus 20.1% a year earlier, and 11.9% for the first half versus 29.1%.
Net premiums written were $245.8 million in Q2, down 2%; first-half net premiums written were $482.5 million, approximately flat. Premium yield fell to 49.9 basis points in Q2 and 50.0 basis points year to date, from 52.5 and 51.6 basis points, respectively.
Operating cash flow was $125.6 million for the first half, compared with $55.0 million in 2016. Investing activities provided $5.4 million; financing activities used $158.5 million. Cash and cash equivalents ended at $127.9 million, down from $155.4 million at year-end 2016.
Total assets were $5.60 billion and shareholders’ equity was $3.00 billion at June 30, 2017. Total liabilities were $2.61 billion. Loss reserves were $1.19 billion, down from $1.44 billion at year-end.
Long-term debt carrying value was $829.9 million, versus $1.18 billion at year-end; debt-to-equity was approximately 28%, compared with 47%. Holding-company cash and investments were approximately $149 million at quarter-end.
The investment portfolio was $4.71 billion at fair value. MGIC reported $31.8 million in gross unrealized losses and no other-than-temporary impairments. Fixed-income portfolio modified duration was 4.6 years.

Material changes versus the prior comparable period

Net income increased 9% in Q2 and 17% for the first half. Lower incurred losses were the primary driver; first-half results also benefited from substantially lower debt-extinguishment losses than in 2016.
New delinquency notices were 10% lower year over year in both Q2 and the first half. The estimated claim rate on new notices was approximately 11%, compared with approximately 13% in 2016. Favorable prior-year reserve development was $103.9 million in the first half, versus $64.9 million.
Primary default inventory declined to 41,317 loans from 50,282 at year-end 2016 and 52,558 a year earlier. The primary default rate was 4.11%, versus 5.04% at year-end and 5.30% a year earlier.
Net insurance in force grew: primary insurance in force was $187.3 billion, compared with $177.5 billion a year earlier; primary risk in force was $48.5 billion, versus $46.2 billion.
Q2 new insurance written was $12.9 billion, versus $12.6 billion; first-half production was $22.2 billion, versus $20.9 billion. Purchase loans represented 91.3% of Q2 new insurance written, up from 83.1%.
Debt transactions reduced leverage: approximately $202.5 million of 2% notes converted into about 29.1 million common shares, the remaining $5.1 million was redeemed, and $145 million of 5% notes matured and was repaid. A $150 million revolver borrowing was repaid in April.

Outlook, management commentary, risks and unusual items

Management expected persistency to trend higher during 2017 amid low anticipated refinancing activity, and expected the default inventory to continue declining, though at a moderating pace as newer books season. Management also expected paid claims to decline in 2017 versus 2016. These are expectations, not formal earnings guidance; the filing provides no numerical earnings forecast.
MGIC reported approximately $4.7 billion of PMIERs Available Assets, about $815 million above the $3.8 billion Minimum Required Assets, and stated it remained eligible to insure GSE loans. The company’s risk-to-capital ratio was 10.2:1, below the commonly applicable 25:1 maximum; its policyholder position exceeded the required minimum by $1.8 billion.
Reinsurance transactions provide capital credit and reduce exposure, but that benefit depends on GSE and regulatory acceptance of ceded-risk credit. MGIC said the GSEs could revise PMIERs, with no update then expected before Q4 2018, or reduce reinsurance credit. Proposed state capital-rule changes remained under review.
Loss reserves depend on estimates of claim frequency and severity, and actual claims may differ materially. Management estimated that a $1,000 change in average severity would change reserves by about $22 million, and a one-percentage-point change in the average claim-rate assumption by about $23 million. Claims trends can be affected by the economy, housing prices, foreclosure timing, cures, and settlements.
Claims-paying-practice disputes and related proceedings had an estimated maximum reasonably possible exposure of approximately $291 million, excluding interest and consequential or exemplary damages; the company said it expected to resolve matters for significantly less but could not assure that outcome.
The IRS tax dispute remained unresolved. Notices of deficiency reflected $197.5 million of taxes and penalties on REMIC matters, plus approximately $195.7 million of interest, and $261.4 million of additional amounts primarily concerning a NOL carryback. The company had paid $65.2 million previously and recorded a $27.8 million first-half 2017 provision based on settlement discussions. A settlement remained subject to review by the Joint Committee on Taxation and was not assured; state taxes and interest were estimated at approximately $82.4 million, with possible penalties.
MGIC paid a $30 million dividend to the holding company in Q2 and expected quarterly dividends through year-end, subject to regulatory constraints. Holding-company liquidity had fallen by $302 million during Q2, making subsidiary dividends and access to capital markets important funding sources.
Other notable items: 2005–2008 books continued to weigh on results, although they represented approximately 23% of primary risk in force; HARP was scheduled to expire at September 2017, with Flex Modification expected to replace HAMP in October. The filing also identifies competition, alternative credit products, GSE reform, tax-law changes and investment-market risk as material uncertainties.

Important facts for investors to verify

Track whether lower delinquencies and reserve releases persist, and test the sensitivity of reserves to claim-rate and severity assumptions.
Monitor PMIERs headroom, state capital requirements, and continued regulatory and GSE recognition of reinsurance capital credit.
Follow the IRS dispute, potential settlement approval, recorded tax provision, and possible federal and state cash liabilities.
Assess holding-company liquidity, debt service and maturity obligations, and the sustainability and regulatory availability of MGIC dividends.
Compare premium yield, pricing competition, new insurance written, persistency and cancellations, including the effect of mortgage rates and GSE/FHA/VA alternatives.
Review claims-paying-practice litigation exposure and investment portfolio interest-rate and credit-spread sensitivity.