MGIC Investment Corporation — Q3 2012 Form 10-Q
Business and period. MGIC Investment Corporation is a holding company principally engaged, through MGIC and MIC, in U.S. private mortgage insurance. This unaudited filing covers the quarter and nine months ended September 30, 2012; comparisons are with the corresponding 2011 periods unless indicated. Dollar amounts below are in millions except per-share data and ratios.
Financial performance and position
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Total revenue | $306.2 | $337.2 | $1,007.0 | $1,057.3 |
| Net premiums earned | $266.4 | $275.1 | $771.5 | $848.1 |
| Investment income, net | $30.4 | $48.9 | $100.0 | $160.9 |
| Losses incurred, net | $490.1 | $462.7 | $1,378.6 | $1,232.6 |
| Net loss | $(246.9) | $(165.2) | $(540.4) | $(350.6) |
| Loss per diluted share | $(1.22) | $(0.82) | $(2.68) | $(1.74) |
| Net cash used in operating activities | — | $(1,172.5) | $(1,416.0) | |
| Net losses and LAE paid | — | — | $1,896 | $2,217 |
Margins and claims. Combined insurance operations’ loss ratio was 184.0% in Q3 and 178.7% year to date, versus 168.2% and 145.3%, respectively, in 2011. The combined ratio was 197.6% for Q3 and 194.3% year to date, versus 184.6% and 161.6%. The company attributed the higher loss ratios to higher incurred losses and lower earned premiums. Primary default inventory fell to 148,885 loans from 180,894 a year earlier, but 59% of defaults had been delinquent for at least 12 months, a group management said is more likely to produce claims.
Balance sheet and liquidity. At September 30, total assets were $6,008.9, including an investment portfolio of $4,926.8 and cash and cash equivalents of $730.4. Total liabilities were $5,340.9 and shareholders’ equity was $668.0, down from $1,196.8 at December 31, 2011; retained deficit was $603.6. Cash decreased $265.4 during the first nine months. The company reported approximately $5.1 billion of regulatory-defined “Liquid Assets” at MGIC and certain subsidiaries; this is a different measure from consolidated cash and investments. Management said claims and other cash uses exceed operating cash generation and expects liquid assets to decline materially, while not expecting them to fall below the $1 billion keepwell threshold during the applicable period.
Debt. Holding-company debt was approximately $834.6 par value: $100.1 of 5.375% senior notes due 2015, $345 of 5% convertible senior notes due 2017, and $389.5 of 9% convertible junior debentures due 2063. The company repurchased $70.9 par value of senior notes in 2012 and recorded a $17.8 gain. It deferred the $17.5 interest payment on the junior debentures due October 1, 2012; deferred interest compounds at 9%, and the company said it expects to defer additional interest. The filing reports compliance with senior-note covenants at September 30.
Material changes versus comparable periods
- Q3 and year-to-date net losses worsened, as higher losses incurred more than offset reduced operating expenses and other revenue. Nine-month losses incurred rose to $1,378.6 from $1,232.6, including $287.3 of unfavorable prior-year development in 2012 versus $96.3 of favorable development in 2011. The 2012 prior-year deterioration primarily reflected a higher estimated claim rate on older primary defaults.
- Net premiums earned and investment income declined year over year, reflecting lower average insurance in force, reduced invested assets and a lower average investment yield. The portfolio’s average pre-tax yield was 2.4% at September 30, 2012, versus 3.1% a year earlier.
- Primary new insurance written increased to $7.0 billion in Q3 from $3.9 billion and to $17.1 billion year to date from $10.0 billion. However, cancellations exceeded new business: primary insurance in force was $164.9 billion, down from $179.0 billion a year earlier. Management attributed the NIW increase partly to higher originations and improved private-industry market share.
- Investment gains lifted nine-month results: realized investment gains were $110.4 versus $38.9 in 2011. The filing also reports a $17.8 gain on senior-note repurchases. These gains did not prevent a larger net loss.
Outlook, management commentary, risks and contingencies
- Regulatory capital is a central risk. At September 30, MGIC’s preliminary risk-to-capital ratio was 31.5:1, versus 20.3:1 at December 31, 2011; combined insurance operations were at 34.1:1. MGIC’s policyholder position was $344 million below Wisconsin’s $1.3 billion minimum. Management expected MGIC’s ratio to rise and remain above 25:1. Wisconsin had waived its requirements through December 31, 2013, subject to conditions; waivers elsewhere were incomplete, and some existing waivers could be exceeded in Q4.
- MIC and Freddie Mac conditions. MIC wrote $587 million of new insurance in Q3 and had $443 million of statutory capital. Freddie Mac’s expanded MIC approval was subject to conditions including a $100 million holding-company contribution by December 1, 2012, an agreement with Wisconsin’s insurance regulator about MIC capital availability by December 31, and a pool-policy settlement process. The settlement condition was reported as met, but the proposed $267.5 million settlement—$100 million at effectiveness and $167.5 million in 48 monthly installments—still required approvals and resolution of other conditions. MGIC said it would not sign unless further MIC approvals and a satisfactory resolution of the regulator condition were obtained. No settlement loss was accrued; management warned that effectiveness could materially worsen statutory capital compliance.
- Claims, rescissions and reserves. Loss estimates depend on uncertain claim rates, severities, housing values, unemployment, foreclosure timing and rescission outcomes. Rescissions reduced paid losses by an estimated $0.2 billion in the first nine months of 2012; estimated reserves at September 30 were reduced by approximately $0.5 billion for anticipated rescissions. Management expects this reserve benefit to decline as newer defaults have a lower likelihood of rescission. Adverse outcomes in rescission disputes could materially increase losses; the filing says no additional reserve was recorded for proceedings where losses were not considered both probable and reasonably estimable.
- Countrywide and pool-policy disputes. Countrywide contended it could seek almost $700 million in other damages, in addition to disputed claims, plus exemplary damages. MGIC estimated past Countrywide rescissions had mitigated paid losses by about $440 million and suspended certain rescissions affecting approximately 1,700 loans with potential claims of $125 million. No adverse-outcome reserve was recorded; a bellwether arbitration hearing was scheduled for March 2013. Separately, Freddie Mac’s interpretation of pool-policy limits was about $535 million higher than MGIC’s; MGIC exhausted the limit under its interpretation in Q3 and removed approximately 15,600 pool notices from inventory. The proposed settlement terms are described above.
- Tax contingency. The IRS assessment on REMIC tax treatment was $190.7 million in taxes and penalties, plus substantial interest and potentially state taxes. In July 2012 the IRS declined to finalize a tentative settlement. MGIC had previously paid $65.2 million and said a new settlement could cost more; a changed assessment of its prospects could materially affect taxes, cash flow and statutory capital.
- Other risks and outlook. Management expected average insurance in force and investment income to continue declining in 2012, and premium yields for the remainder of the year to remain near the first-nine-month level. It expected paid claims to continue declining if foreclosure patterns persisted, but emphasized uncertainty in the timing and amount of claims. Other risks include CFPB and other regulatory inquiries into captive mortgage reinsurance, RESPA litigation, GSE eligibility and policy changes, potential QRM and GSE reforms, and possible dilution from capital raising or conversion of debt. No earnings guidance or quantified profitability timetable is provided.
Important facts for investors to verify
- Progress and final terms of the Freddie Mac settlement, the $100 million capital contribution, the OCI condition, and continuing Fannie Mae/Freddie Mac approvals for MIC.
- MGIC’s statutory capital, risk-to-capital ratios, state waiver status, liquid assets and ability to maintain new-business eligibility as claims consume cash.
- Developments in Countrywide arbitration/mediation and other rescission disputes, and whether changes in rescission assumptions require higher loss reserves.
- Loss emergence in the aging delinquency inventory, especially the 12-month-plus segment, and the adequacy of reserves under changing foreclosure and housing conditions.
- Resolution and cash consequences of the IRS REMIC dispute, including interest and possible state-tax exposure.
- Liquidity and financing implications of deferred junior-debenture interest, potential future deferrals, debt maturities and any additional capital needs.