MGIC Investment Corporation — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011. Unless noted, financial amounts below are in millions. Comparisons are with Q1 2010 for operating results and December 31, 2010 for balance-sheet amounts.
Business context
MGIC is a leading U.S. private mortgage insurer. Its results are driven by premiums on insured loans, mortgage defaults and claims, investment income, and the capital and eligibility requirements of state regulators and Fannie Mae and Freddie Mac.
Financial results and key metrics
| Metric | Q1 2011 | Q1 2010 / comparison |
|---|---|---|
| Total revenues | $353.1 | $370.8 |
| Net premiums earned | $288.5 | $272.0 |
| Investment income, net | $56.5 | $68.9 |
| Net realized investment gains and impairment losses | $5.8 net gain; no impairment losses | $26.9 net gain, including $6.1 of impairment losses |
| Losses incurred, net | $310.4 | $454.5 |
| Loss before tax | $(31.9) | $(151.1) |
| Income tax provision (benefit) | $1.8 | $(1.0) |
| Net loss and diluted loss per share | $(33.7); $(0.17) | $(150.1); $(1.20) |
| Combined insurance operations ratios | Loss 107.6%; expense 16.2%; combined 123.8% | Loss 167.1%; expense 18.4%; combined 185.5% |
Operating cash flow was negative $420.9, compared with negative $197.0 in Q1 2010. Investing activities provided $229.1, versus using $170.6; financing activities were zero. Cash and cash equivalents fell $191.8 during the quarter to $1,112.3.
At March 31, total assets were $8,848.0 and shareholders’ equity was $1,608.3. The investment portfolio was $7,203.4 at fair value. Loss reserves were $5,471.5, down from $5,884.2 at year-end. Premium deficiency reserves were $169.9, versus $179.0.
Debt principal totaled approximately $1.112 billion: $77.4 of senior notes due September 2011, $300 of senior notes due 2015, $345 of convertible senior notes due 2017, and $389.5 of convertible junior debentures due 2063. The balance-sheet carrying values differ from principal, particularly for the junior debentures. The company reported compliance with senior-note covenants.
MGIC’s separate-company risk-to-capital ratio was 19.7:1 and its combined insurance operations ratio was 23.0:1. MGIC reported statutory policyholders’ position approximately $237 million above its domiciliary-state minimum; the combined margin was approximately $306 million.
Material changes versus prior periods
- Net loss narrowed substantially year over year, mainly as losses incurred fell by $144.1. Current-year losses incurred were $347.4, compared with $512.5; favorable prior-year development was $37.0, compared with $58.0.
- Primary new insurance written rose to $3.0 billion from $1.8 billion, while cancellations were $7.4 billion versus $6.9 billion. Direct primary insurance in force was $186.9 billion, down from $207.1 billion a year earlier.
- Primary default inventory fell to 195,885 loans from 241,244 a year earlier. However, 57% of the inventory had been in default for at least 12 months, compared with 47% a year earlier.
- Net losses and loss-adjustment expenses paid increased to $686 million from $519 million. Management expected paid claims in 2011 to exceed 2010, reflecting the aged delinquency inventory and claims awaiting payment.
- Net investment income declined, and average pre-tax portfolio yield fell to 2.7% from 3.2%. Net realized investment gains were also lower than in the prior-year quarter.
- Shareholders’ equity declined by approximately $60.7 million from year-end, including the quarterly net loss and a $24.7 million other comprehensive loss.
Outlook, management commentary, risks and contingencies
- Management expected 2011 new insurance written to increase modestly over the $12 billion written in 2010. Average insurance in force was expected to continue declining because new business was not expected to exceed cancellations. Investment income was expected to decline during 2011.
- Management expected rescissions to mitigate losses less than in recent years. Rescissions reduced paid losses by approximately $0.2 billion in Q1 2011; estimated ending loss reserves included about $1.1 billion of benefit from rescissions. The company cautioned that actual rescission outcomes could materially affect losses.
- Regulatory capital and insurer eligibility remain key risks. Wisconsin’s risk-to-capital waiver was scheduled to expire December 31, 2011; other waivers had varying expiration dates, and some jurisdictions had denied or could deny waivers. In a stress-loss scenario, MGIC’s risk-to-capital ratio could reach 40:1 or higher, according to company estimates. MGIC Indemnity Corporation had conditional GSE approvals to write in certain jurisdictions, but those approvals were time-limited and subject to conditions.
- Countrywide disputes MGIC’s rescissions and sought damages described as “well-exceeding” $150 million. The bellwether arbitration hearing was postponed to May 2012. MGIC had not accrued a reserve for a possible adverse outcome and said it could not reasonably estimate potential liability. An adverse outcome could also affect rescissions involving other lenders.
- Other significant uncertainties include the proposed Qualified Residential Mortgage definition and possible GSE reform, Bank of America’s stated plan to enable replacement of MGIC coverage on certain correspondent loans, economic and housing-market conditions, foreclosure and servicing delays, and the uncertain re-default rate on modified loans. MGIC assumed approximately 50% of modified loans would ultimately re-default for internal reporting purposes.
- All 32 auction-rate securities, with fair value of $334.3 million, remained subject to failed auctions. Substantially all underlying student loans had a federal guarantee, and MGIC had continued to receive interest; nevertheless, principal liquidity remained uncertain. Management expected liquidity by December 31, 2014.
- A $77.4 million senior-note maturity was due in September 2011. The holding company reported $887 million in cash and investments, while insurance-subsidiary dividends to the parent were restricted and required Wisconsin regulatory approval through 2011.
- The company had a $440.5 million deferred-tax valuation allowance and $1.331 billion of regular-tax net operating loss carryforwards. A tentative IRS settlement remained subject to congressional review; the company expected approximately $22 million of net cash outflow in 2011 related to the settlement.
Most important facts for investors to verify
- Whether MGIC maintains regulatory waivers and GSE eligibility, and the effect of any change on its ability to write new business.
- Whether loss reserves remain adequate as claims develop, delinquencies age, and rescission benefits decline.
- The outcome and potential financial impact of the Countrywide litigation and arbitration, including any effects on other rescissions.
- Actual 2011 new insurance written, cancellations, paid claims, investment income, and parent-company liquidity relative to management’s expectations.
- Liquidity and valuation developments for failed-auction securities, and repayment or refinancing of the September 2011 senior-note maturity.
- Final QRM and GSE policy changes, and their effects on private mortgage insurance demand and MGIC’s customer relationships.