MGIC Investment Corporation — 2010 Q3 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010; comparisons are with the corresponding 2009 periods. MGIC provides private mortgage insurance, principally through its subsidiary Mortgage Guaranty Insurance Corporation (MGIC).
Financial performance and position
| Metric | Q3 2010 | Q3 2009 | 9M 2010 | 9M 2009 |
|---|---|---|---|---|
| Total revenue | $382.3 million | $413.3 million | $1,159.5 million | $1,303.0 million |
| Net premiums earned | $296.5 million | $293.5 million | $877.6 million | $996.5 million |
| Losses incurred, net | $384.6 million | $971.0 million | $1,159.2 million | $2,498.6 million |
| Net loss | $51.5 million | $517.8 million | $177.1 million | $1,042.2 million |
| Loss per diluted share | $0.26 | $4.17 | $1.05 | $8.39 |
| Combined insurance ratio | 146.3% | 347.2% | 148.7% | 266.1% |
Amounts in parentheses in the filing denote losses. The combined ratio remained above 100%, indicating insurance losses and expenses exceeded net premiums written under the company’s stated ratio definition.
- Cash flow and liquidity: Operating cash flow was a use of $453.4 million in the first nine months, versus a source of $417.2 million in 2009. Cash and cash equivalents were $2.166 billion at September 30, up from $1.186 billion at year-end 2009. The company also reported approximately $1.0 billion of cash and investments at the holding company.
- Balance sheet: Total assets were $9.987 billion; loss reserves were $6.179 billion; and shareholders’ equity was $1.983 billion. The premium deficiency reserve was $160.1 million, down from $193.2 million at year-end.
- Debt: Carrying amounts included $377.3 million of senior notes, $345 million of convertible senior notes, and $309.2 million of convertible junior debentures. The junior debentures had $57.5 million of deferred interest outstanding at quarter-end; that interest was paid October 1, 2010. The company issued $345 million principal amount of 5% convertible senior notes in April.
- Capital raised: April offerings generated net proceeds of about $772.4 million from common stock and $334.4 million from convertible notes. MGIC received a $200 million capital contribution. The stock offering increased shares outstanding substantially.
- Regulatory capital: At September 30, MGIC’s risk-to-capital ratio was 17.7:1 and the combined statutory ratio was 20.6:1. Management said stress scenarios could push MGIC’s ratio to 40:1 or higher in coming years. Regulatory waivers and approvals for subsidiary MIC are important to continued new-business writing.
Material changes versus the prior comparable period
- Net losses were substantially smaller than in 2009, principally because incurred losses fell as the primary default inventory declined, compared with growth in 2009. Nine-month primary defaults decreased by 27,067, versus an increase of 53,422 in 2009.
- Despite the decline in defaults, the inventory remained aged: 55% of primary defaults had been in default for at least 12 months, compared with 36% in Q3 2009. Management noted that older defaults are historically more likely to produce claims.
- Net paid losses and loss-adjustment expenses increased to $1.652 billion for nine months, from $1.112 billion in 2009. Rescissions mitigated paid losses by $903 million, but management said rescission benefits to incurred losses were lower than in 2009 and are expected to decline further.
- Nine-month net premiums earned fell to $877.6 million from $996.5 million. Primary new insurance written declined to $8.0 billion from $17.0 billion; direct primary insurance in force was $196.9 billion, down from $212.2 billion at year-end 2009.
- Investment income declined to $190.2 million for nine months from $230.7 million, reflecting lower yields. The portfolio’s average pre-tax yield was 2.41% at quarter-end versus 3.76% a year earlier.
- Operating cash flow turned negative, while cash increased largely alongside the equity and convertible-note offerings. Unrealized investment losses narrowed to $21.5 million from $78.4 million at year-end 2009.
Outlook, commentary, and principal risks
- Management expected full-year 2010 new insurance written of $10–$12 billion and said Q4 2010 losses were expected to exceed Q3 losses. It also expected insurance in force to continue declining into 2011 as cancellations could exceed new business.
- Management stated it expected annual losses to continue, while noting it could not predict when, or whether, the company would return to annual profitability. Its forecasts depend on uncertain assumptions about defaults, cures, housing prices, unemployment, rescissions, and foreclosure timing.
- Capital and eligibility are significant risks. Waivers have varying expiration dates, some requests were denied, and termination or nonrenewal could restrict MGIC’s ability to write new insurance. MIC’s approvals are limited in duration and its capital cannot be increased beyond the $200 million contribution without GSE approval.
- Countrywide litigation and arbitration concern claims and rescissions; Countrywide sought at least $150 million in damages, potentially subject to increase. Countrywide loans represented about 24% of MGIC’s primary delinquency inventory. Outcomes and any additional exposure were not predictable.
- Rescissions have materially reduced paid and incurred losses, but the company cautioned that future benefits may be lower and disputes may lead to litigation. A lender settlement waived certain rescission rights on loans representing fewer than 10% of policies in force and delinquent inventory.
- All $383.9 million of auction-rate securities were subject to failed auctions, limiting access to principal. The securities were student-loan-backed and substantially guaranteed by the U.S. Department of Education; the company reported that interest had been collected to date.
- Other uncertainties include GSE policy changes, FHA competition, foreclosure moratoriums and servicing delays, possible contract-underwriting remedy claims, regulatory reviews of captive reinsurance, and an ongoing SEC investigation related to C-BASS disclosures.
- The company reached a tentative IRS settlement concerning tax years 2000–2007. It expected a final agreement in Q4 2010, a $103.1 million reduction in unrecognized tax benefits, and approximately $22 million of net cash outflows after prior payments and available carrybacks.
Investor verification priorities
- Track regulatory capital ratios, waiver renewals, MIC’s ability to write business, and MGIC’s access to additional capital.
- Assess whether loss-reserve assumptions remain supportable as defaults age and rescission benefits diminish; compare incurred losses with paid claims and delinquency trends.
- Verify progress and potential exposure from Countrywide proceedings, other rescission disputes, and contract-underwriting remedy claims.
- Monitor new insurance written, cancellations, premium levels, FHA and GSE policy changes, and management’s $10–$12 billion full-year 2010 NIW outlook.
- Review holding-company liquidity and debt-service needs, including the October 2010 deferred-interest payment, 2011 note maturity, and remaining offering proceeds.
- Confirm the final IRS settlement terms and resulting cash, tax-benefit, and unrecognized-tax-benefit effects.