MGIC INVESTMENT CORP quarterly report, Q2 FY2013

MGIC Investment Corporation — Q2 2013 Form 10-Q

Reporting period: Three and six months ended June 30, 2013; balance-sheet comparisons are with December 31, 2012. MGIC primarily provides private mortgage insurance to lenders and government-sponsored entities.

Financial results and condition

Amounts below are in millions except per-share data, ratios and where noted.

Metric	Q2 2013	Q2 2012	Six months 2013	Six months 2012
Total revenue	$263.9	$321.1	$533.0	$700.8
Net premiums earned	$237.8	$242.6	$484.8	$505.0
Investment income, net	$20.9	$32.2	$39.2	$69.6
Losses incurred, net	$196.3	$551.4	$462.5	$888.5
Net income (loss)	$12.4	$(273.9)	$(60.6)	$(293.4)
Diluted EPS	$0.04	$(1.36)	$(0.21)	$(1.45)

• Q2 pre-tax income was $13.4 million; six-month pre-tax loss was $58.4 million. Q2 2013 included $2.5 million of realized investment gains, versus $26.6 million a year earlier. The six-month comparison was $3.7 million versus $104.2 million.
• Combined insurance-operations ratios: Q2 loss ratio 82.5% and combined ratio 100.2%, versus 227.3% and 243.9% in Q2 2012. For the first six months, loss and combined ratios were 95.4% and 113.3%, versus 175.9% and 192.5%. The filing says the loss-ratio improvement reflected lower incurred losses, partly offset by lower earned premiums.
• At June 30, total assets were $6.04 billion, total liabilities $5.36 billion and shareholders’ equity $680.7 million, compared with $5.57 billion, $5.38 billion and $196.9 million at year-end. Equity benefited from the March stock offering; accumulated other comprehensive loss increased to $168.4 million from $48.2 million.
• Investments at fair value were $5.00 billion; cash and cash equivalents were $571.5 million, with another $60.3 million restricted in escrow. Gross unrealized investment losses were $90.3 million, partly offset by $22.2 million of gains; management attributed the losses primarily to interest-rate changes. All fixed-income holdings were rated investment grade. The portfolio’s average pre-tax yield was 1.6%, versus 2.4% at June 30, 2012.
• Six-month operating cash flow was negative $508.6 million, investing cash flow negative $1.08 billion and financing cash flow positive $1.13 billion. Cash and cash equivalents declined $456.2 million to $571.5 million. Claim payments continued to exceed premiums received.
• Debt at par was $1.32 billion at June 30, versus $834.6 million at year-end. March financing included $500 million of 2% convertible senior notes, generating $484.7 million net proceeds, and a $663.4 million net common-stock offering. The company contributed $800 million to MGIC’s insurance capital. Holding-company cash and investments were approximately $592 million; insurance-subsidiary dividends to the holding company are restricted.

Material changes and operating trends

• Primary new insurance written rose to $8.0 billion in Q2 from $5.9 billion and to $14.5 billion for six months from $10.1 billion. However, cancellations exceeded new business: primary insurance in force declined by $0.9 billion in Q2 and $3.5 billion in the first half. Management expected average insurance in force to continue declining in 2013.
• Primary default inventory fell to 117,105 loans from 139,845 at year-end and 153,990 a year earlier. Nevertheless, 61% of the June inventory had been in default for at least 12 months, up from 58% at year-end. The six-month loss-reserve rollforward included $5.9 million of favorable prior-year development, versus $214.4 million of unfavorable development in 2012.
• Net losses and LAE paid were $899 million in the first half, down from $1.31 billion. Investment income fell as average invested assets and yields declined. Interest expense also decreased, principally because the discount on junior debentures was fully amortized by March 31, partly offset by interest on the new 2020 notes.
• The premium deficiency reserve declined to $60.8 million from $73.8 million at year-end. Management attributed the Q2 reduction principally to higher estimated ultimate premiums and lower estimated ultimate losses.

Outlook, risks and contingencies

• Management expected MGIC to comply with current capital requirements. Its June 30 risk-to-capital ratio was 20.2:1, below the commonly applicable 25:1 limit, and its policyholder position was $175 million above Wisconsin’s $1.2 billion minimum. Combined insurance operations were at 23.0:1. Wisconsin’s waiver was effective through December 31, 2013; waivers and approvals remain subject to regulatory discretion.
• New mortgage-insurer capital standards from the GSEs and regulatory changes were pending. Management identified potential capital contributions, external reinsurance, use of subsidiary MIC and additional capital raising as possible responses if new standards threatened eligibility. MIC’s ability to write business is subject to approvals and conditions.
• Management expected investment income to decline in 2013, average insurance in force to fall, and premium yields for the rest of 2013 to decline slightly, partly due to the new reinsurance agreement. It expected paid claims to continue declining, excluding the expected effect of the Countrywide settlement. Results remain sensitive to housing prices, unemployment, foreclosure and servicing delays, claim timing, rescissions and loan-modification re-defaults.
• Two April agreements to resolve Countrywide rescission disputes were considered probable but still required approvals and consents for implementation. The company had recorded an aggregate approximately $100 million increase in loss reserves for the two probable customer settlements in Q4 2012. Countrywide’s separate curtailment dispute was approximately $40 million; MGIC did not consider a loss probable and recorded no reserve for an adverse outcome. Implementation of the settlements could also encourage other customers to seek remedies.
• The CFPB investigation of captive reinsurance concluded in April without findings of wrongdoing. MGIC paid a $2.65 million civil penalty and agreed not to enter new captive reinsurance arrangements or reinsure new loans under existing captive arrangements for ten years. Other state inquiries and RESPA class-action litigation remained, including appeals.
• The IRS disputed the company’s tax treatment of REMIC residual interests, assessing $190.7 million in taxes and penalties, plus substantial interest; the company had previously paid $65.2 million. A statutory notice of deficiency was expected in the second half of 2013, potentially leading to litigation. Management said recorded tax provisions and liabilities remained appropriate, but a changed assessment could materially affect results, cash flows and statutory capital. The company also maintained a substantial deferred-tax valuation allowance.
• The company’s convertible junior debentures carry a 9% coupon and permit interest deferral, with deferred interest compounding; deferred interest was paid in April 2013. Debt maturities, interest obligations and limited holding-company cash inflows are relevant liquidity considerations. Management noted that actual loss payments and their timing could differ materially from estimates.

Investor verification priorities

• Track regulatory waivers, MGIC and combined risk-to-capital ratios, policyholder position, and GSE capital and insurer-eligibility requirements.
• Confirm whether the Countrywide and other customer settlements obtain required approvals, their final financial effects, and developments in the separate curtailment dispute.
• Monitor default-inventory aging, paid claims, loss-reserve assumptions and development, including rescission outcomes and modification re-defaults.
• Review holding-company liquidity, restricted subsidiary dividends, debt service and the effects of continued claims exceeding premium receipts.
• Follow the IRS REMIC dispute and any changes to the deferred-tax valuation allowance or tax liabilities.
• Assess the effect of GSE, FHA, QRM/QM and mortgage-insurer capital changes on new business, pricing and demand for private mortgage insurance.