Business context and reporting period
MGIC Investment Corporation’s fiscal year ended December 31, 2016; this is a full-year Form 10-K, not a standalone fourth-quarter filing. The company provides private mortgage insurance and related services. Its primary insurance in force (IIF) was $182.0 billion and direct primary risk in force (RIF) was $47.2 billion at year-end.
Key financial and operating metrics
| Metric | 2016 | 2015 |
|---|---|---|
| Total revenue | $1,062.5 million | $1,041.3 million |
| Net premiums written | $975.1 million | $1,020.3 million |
| Net premiums earned | $925.2 million | $896.2 million |
| Net income | $342.5 million | $1,172.0 million |
| Diluted EPS | $0.86 | $2.60 |
| Losses incurred, net | $240.2 million | $343.5 million |
| Loss ratio | 26.0% | 38.3% |
| Expense ratio | 15.3% | 14.9% |
| Operating cash flow | $219.7 million | $152.0 million |
| Total assets / shareholders’ equity | $5,734.5 million / $2,548.8 million | $5,868.3 million / $2,236.1 million |
Net operating income, a non-GAAP measure, was $395.6 million, or $0.99 per diluted share, up 29% and 32%, respectively. Fourth-quarter 2016 net income was $107.5 million; net premiums earned were $235.1 million and net losses incurred were $47.7 million.
Year-end cash and cash equivalents were $155.4 million. Cash flows were $(93.4) million from investing activities and $(152.0) million from financing activities. The investment portfolio was $4.69 billion, with a 2.6% pretax yield. Consolidated debt carrying value was $1.18 billion. At the holding company, cash and investments were approximately $283 million against $1.17 billion of debt principal; 2017 debt service was expected to include approximately $68 million of interest and repayment of the remaining $145 million of 5% notes due May 2017.
Mortgage insurance indicators improved: primary IIF grew 4.3% to $182.0 billion, new primary insurance written rose to $47.9 billion from $43.0 billion, and the primary default rate fell to 5.04% from 6.31%. MGIC’s PMIERs Available Assets exceeded Minimum Required Assets by more than $630 million (approximately $4.7 billion versus $4.1 billion); its statutory risk-to-capital ratio was 10.7:1.
Material changes versus the prior comparable period
- Revenue increased 2%, while net premiums earned rose 3.2%; net premiums written declined 4.4%, in part because 2015 included the non-recurring effects of commuting an earlier quota-share reinsurance agreement.
- Net income fell 71%, principally because 2015 included $847.8 million of deferred-tax valuation-allowance benefits. The 2016 result also included a $90.5 million debt-extinguishment loss. In contrast, non-GAAP net operating income improved as incurred losses declined.
- Losses incurred fell 30%, reflecting fewer new delinquent notices and favorable development on prior-year defaults. Year-end primary default inventory declined 20% to 50,282 loans.
- The company issued $425 million of 5.75% senior notes, repurchased portions of its 2% and 5% convertible notes, and MGIC purchased a portion of the 9% debentures. Management said these transactions reduced potential dilution by approximately 66 million shares and lowered annual consolidated interest expense; the transactions produced the debt-extinguishment loss.
- MGIC paid $64 million in dividends to the holding company, its first such dividends since 2008. MGIC’s estimated private-MI market share declined to 17.8% from 19.9%, despite industry-wide growth.
Outlook, commentary, risks and unusual items
- Management expected 2017 new insurance written to be comparable to 2016. Forecast lower refinancing originations were expected to be partly offset by higher purchase activity’s greater PMI penetration; actual results depend on originations, pricing competition and MGIC’s market share.
- Management expected premium yield and earned-premium growth to face pressure in 2017 as newer, lower-rate books make up more of IIF and some older policies reset to lower rates. Rising interest rates could support persistency but could also reduce housing affordability and purchase activity.
- Management expected credit trends and paid claims to continue improving, but cautioned that favorable reserve development might not continue. Loss reserves are estimated for delinquent loans, not all insured loans; changes in claim frequency or severity can materially affect earnings. The filing estimates that a $1,000 change in the average severity reserve factor would change reserves by about $27 million, and a one-percentage-point change in the claim-rate factor by about $28 million.
- PMIERs compliance, reinsurance credit, and possible GSE revisions are key capital risks. A 2017 quota-share agreement was expected to cover much of 2017 new business, subject to execution and continuing GSE approval. A reduction in credit for ceded risk or stricter capital rules could constrain business or returns. State capital rules may also change.
- Competition from other private insurers, the FHA, the VA and alternative risk-transfer products could pressure pricing, market share and underwriting returns. The future role or structure of Fannie Mae and Freddie Mac remains uncertain.
- Claims-paying-practice disputes carried estimated maximum reasonably possible exposure of approximately $295 million, excluding interest and consequential or exemplary damages; management could not reasonably estimate a range and expected eventual resolutions to be substantially lower, without assurance.
- The IRS dispute over 2000–2007 REMIC tax treatment remained unresolved at year-end. In January 2017 the parties reported a basis for settlement of major issues, subject to Joint Committee on Taxation review and not assured. The company expected a $15–$25 million tax-and-interest provision in first-quarter 2017; under the described settlement basis, estimated net cash outflow could be about $52 million. The filing also reports $1.5 billion of federal NOL carryforwards and warns an ownership change could limit their use.
- Other notable risks include the holding company’s reliance on regulated subsidiary dividends for liquidity, potential dilution from remaining convertible debt, and the uncertainty of re-defaults on modified loans. HAMP expired at year-end 2016; HARP was extended through September 2017.
Important facts for investors to verify
- Whether the anticipated 2017 NIW level, premium-yield trend and credit-performance assumptions were realized, and how market share and pricing changed.
- Whether PMIERs and state-capital cushions remained adequate after regulatory updates, reinsurance-credit decisions and any changes in the portfolio’s risk profile.
- Actual claims, reserve development and severity compared with management’s estimates, particularly for legacy 2005–2008 business and modified loans.
- Final IRS settlement terms, related tax provision and cash payment, and any effects on NOLs, statutory capital or liquidity.
- Holding-company liquidity after repayment or conversion of the 5% notes due May 2017, debt service, and any further subsidiary dividends or capital contributions.
- Resolution and financial effect of claims-paying-practice disputes, including whether actual exposure differs materially from the stated $295 million estimate.