Business Context and Reporting Period
Company: MGIC Investment Corporation (MGIC)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2003
Business Overview: MGIC is the leading provider of private mortgage insurance (PMI) in the United States. Through its subsidiary Mortgage Guaranty Insurance Corporation, it insures residential first mortgage loans, primarily for borrowers with down payments of less than 20%. The company operates through two main channels: "flow" (individual loans) and "bulk" (portfolios of loans, often non-conforming or subprime). MGIC also provides contract underwriting services and holds interests in joint ventures (C-BASS and Sherman Financial Group).
Key Financial Metrics
| Metric | 2003 | 2002 | Change |
|---|---|---|---|
| Net Premiums Earned | $1,366.0 million | $1,182.1 million | +15.6% |
| Total Revenues | $1,685.4 million | $1,484.6 million | +13.5% |
| Net Income | $493.9 million | $629.2 million | -21.5% |
| Diluted EPS | $4.99 | $6.04 | -17.4% |
| Losses Incurred (Net) | $766.0 million | $365.8 million | +109.4% |
| Combined Ratio | 70.2% | 45.7% | +24.5 pts |
| Total Assets | $5,917.4 million | $5,300.3 million | +11.6% |
| Shareholders' Equity | $3,796.9 million | $3,395.2 million | +11.8% |
| Debt (Short & Long Term) | $599.7 million | $677.2 million | -11.4% |
Operational Metrics:
- Primary Insurance in Force: $189.6 billion (down from $197.0 billion in 2002 due to high cancellations).
- Default Rate (Primary): 5.57% (up from 4.45% in 2002).
- Bulk Loan Default Rate: 11.80% (up from 10.09% in 2002).
- Persistency Rate: 47.1% (down significantly from 56.8% in 2002).
Material Changes vs. Prior Period
- Surge in Losses: Net losses incurred more than doubled to $766 million. This was driven by a higher number of delinquencies, increased estimates for claim rates and severity, and a $193 million increase in net losses paid. The average claim paid rose to $22,925 from $20,115.
- Profitability Decline: Despite a 15.6% increase in net premiums earned, net income fell 21.5% due to the sharp rise in losses and increased underwriting expenses.
- High Cancellation Rates: Unprecedented levels of refinancing led to $104.2 billion in cancellations, offsetting $96.8 billion in new insurance written. This resulted in a net decrease in primary insurance in force.
- Market Share Impact: MGIC's flow market share declined to 21.9% (from 24.8% in 2002) after the company stopped participating in certain excess-of-loss captive reinsurance arrangements with large lenders in Q2 2003.
- Investment Income: Net investment income decreased slightly to $202.9 million (from $207.5 million) as a decline in pre-tax yield (4.3% vs 4.7%) offset the growth in the investment portfolio.
Guidance, Outlook, and Risks
- Outlook for 2004: Management expects new insurance written to decline materially in 2004, consistent with industry forecasts of lower mortgage originations. Persistency is expected to improve if refinancing activity declines. However, incurred losses are expected to increase over 2003 levels.
- Rating Action: In December 2003, Standard & Poor's lowered MGIC's financial strength rating from "AA+" to "AA" and the company's counterparty credit rating from "A+" to "A," citing weakening operating performance and rising delinquencies. Moody's and Fitch reaffirmed their ratings.
- Key Risks:
- Economic Deterioration: A downturn could increase defaults and reduce home values, increasing claim severity.
- Interest Rate Environment: Declining rates fuel refinancing, reducing persistency and premium revenue.
- Bulk Loan Risk: The bulk book (approx. 25% of in-force) has higher default rates and is expected to peak in claims earlier than flow business.
- Competition: Competition from government programs (FHA/VA) and alternative credit enhancement structures.
- Legal Contingencies: A nationwide class action regarding the Fair Credit Reporting Act (FCRA) remains pending; the court denied MGIC's motion to dismiss the damages portion in December 2003. A previous RESPA litigation settlement became final in October 2003.
Investor Verification Checklist
- Loss Reserve Adequacy: Verify the assumptions used for claim rates and severity, particularly for the bulk and subprime loan segments where default rates are significantly higher than flow loans.
- Persistency Trends: Monitor refinancing activity and interest rate trends to assess the sustainability of premium revenue given the 47.1% persistency rate.
- Rating Agency Impact: Assess the potential impact of the S&P rating downgrade on the company's ability to compete for business with GSEs (Fannie Mae/Freddie Mac), which favor "AAA" rated insurers.
- Legal Exposure: Track the status of the FCRA class action lawsuit and potential liability exposure.
- Dividend Restrictions: Note that MGIC cannot pay dividends without regulatory approval until March 27, 2004, following an extraordinary dividend paid in March 2003.