MGIC Investment Corporation — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are with December 31, 2016. MGIC is principally a U.S. mortgage insurer, protecting lenders against losses on low-down-payment residential mortgages. Results are unaudited.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change / context |
|---|---|---|---|
| Total revenue | $260.9 million | $258.6 million | Up 1% |
| Net premiums written | $236.7 million | $231.3 million | Up 2% |
| Net premiums earned | $229.1 million | $221.3 million | Up 4% |
| Investment income, net | $29.5 million | $27.8 million | Up 6% |
| Net losses incurred | $27.6 million | $85.0 million | Down 68% |
| Income before tax | $174.0 million | $103.7 million | Up 68% |
| Net income | $89.8 million | $69.2 million | Up 30% |
| Diluted EPS | $0.24 | $0.17 | Up 41% |
| Net operating income (non-GAAP) | $117.1 million; $0.31 per diluted share | $76.1 million; $0.19 per diluted share | Up 54% in income |
The loss ratio, calculated as losses incurred divided by net premiums earned, was approximately 12% versus 38% in the prior-year quarter. The reported effective tax rate rose to 48.4% from 33.3%, principally because of a $27.2 million provision related to the expected settlement of IRS litigation. Excluding that provision, management reported an effective rate of approximately 32.7%, versus 33.3%.
Net cash provided by operating activities was $77.5 million, compared with $3.5 million. Investing activities provided $52.4 million, versus $209.3 million; financing activities provided $141.8 million, versus $144.1 million used. Cash and cash equivalents increased $271.7 million to $427.1 million. The filing attributes the operating cash-flow improvement mainly to lower net claim payments.
Balance sheet, debt and capital
- At March 31, total assets were $5.90 billion, total liabilities $3.26 billion, and shareholders’ equity $2.65 billion. The investment portfolio was $4.65 billion at fair value.
- Gross loss reserves were $1.34 billion, down from $1.44 billion at year-end; net reserves after reinsurance were $1.29 billion, down 7%. The reserve decline principally reflected $127.6 million of losses paid compared with $27.6 million of losses incurred.
- Carrying-value debt was $1.33 billion at March 31, including $150 million drawn on a new $175 million unsecured revolving facility. In April, the facility borrowing was repaid after holders converted most of the 2% Notes. Approximately $202.5 million principal converted into about 29.1 million shares; the remaining $5.1 million was redeemed for cash. The 5% Notes, with $145 million principal, matured and were repaid on May 1. The company reported these subsequent transactions reduced debt by approximately $502.6 million from the March 31 level.
- Holding-company cash and investments were approximately $451 million at March 31, compared with holding-company debt of approximately $1.32 billion in aggregate principal. After the subsequent debt-related payments, cash and investments fell by about $300 million; the filing also reports approximately $24 million of subsequent interest payments.
- MGIC reported $4.7 billion of PMIERs Available Assets against $4.0 billion of Minimum Required Assets, an excess of approximately $740 million, and said it remained eligible to insure GSE loans. Its statutory risk-to-capital ratio was 10.4:1; policyholder position exceeded the required minimum by $1.7 billion.
Material changes, outlook and risks
- Lower losses drove the earnings improvement: prior-year reserve development was favorable by $52.8 million, compared with $7.5 million in Q1 2016. New-notice claim rate was approximately 10.5%, versus 12.0%; new notices declined 11%. Primary default inventory fell to 45,349 loans, down 10% from year-end and 18% year over year. Management expected defaults and paid claims to continue declining in 2017, while noting the decline in default inventory could moderate as newer books season.
- Primary new insurance written increased approximately 12% to $9.3 billion. Primary insurance in force was $183.5 billion, and risk in force was $47.5 billion. Persistency was 76.9%, unchanged from year-end but below 79.9% a year earlier. Premium yield eased to 50.1 basis points from 50.6 basis points.
- Management expected to continue quarterly subsidiary dividends during 2017. MGIC paid $20 million to the holding company in Q1; the company reported a proposed $30 million Q2 dividend and said it understood the regulator would not object. No specific earnings or revenue guidance was provided.
- Reserve estimates are judgmental and sensitive to claim rates and severity. MGIC estimated that a $1,000 change in its average severity reserve factor would change reserves by approximately $24 million, and a one-percentage-point claim-rate-factor change by approximately $25 million.
- Legal matters involving claims practices had an estimated maximum reasonably possible exposure of approximately $306 million, excluding interest and consequential or exemplary damages; the company said it could not reasonably estimate a liability range and expected to resolve matters for significantly less, without assurance.
- The IRS dispute concerns historic REMIC tax issues. In January 2017, the parties reported a basis for settlement of major issues, subject to Joint Committee on Taxation review and with no assurance of completion. MGIC recorded a $27.2 million Q1 provision; the ultimate resolution could materially affect taxes, earnings, cash flow and statutory capital. It reported $139.9 million of unrecognized tax benefits, including related interest.
- Capital and business risks include possible changes to PMIERs or state capital rules, reduced reinsurance capital credit, GSE reform, housing and employment conditions, and the concentration of older delinquent loans. The company also identified model accuracy and potential share dilution as risks. The 2% Note conversions increased shares outstanding; approximately 370.6 million common shares were outstanding on April 28, 2017.
Most important facts for investors to verify
- Whether favorable reserve development and lower claim rates persist, and how actual claim severity compares with assumptions.
- Final cash, debt and share-count effects of the April 2% Note conversions, facility repayment and May 5% Note maturity repayment.
- Progress and final terms, if any, of the IRS settlement, including related tax, interest and statutory-capital impacts.
- Continued PMIERs compliance and the treatment of quota-share reinsurance under any GSE or state capital-rule changes.
- Developments in claims-practices litigation and regulatory matters, including exposure relative to the company’s estimate.
- Whether expected quarterly dividends can be maintained given insurance-subsidiary dividend restrictions and holding-company liquidity needs.