MTG

Business Context and Reporting Period

Company: MGIC Investment Corp.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2009
Business Overview: MGIC is the leading provider of private mortgage insurance in the United States. The company operates primarily through its subsidiary, Mortgage Guaranty Insurance Corporation (MGIC). The reporting period reflects significant challenges in the mortgage insurance industry, including material losses on 2006 and 2007 books of business, declining new insurance written, and increased delinquencies.

Key Financial Metrics

Key Ratios:
- Loss Ratio: 213.0% (vs. 200.2% in Q1 2008)
- Expense Ratio: 14.7% (vs. 16.0% in Q1 2008)
- Combined Ratio: 227.7% (vs. 216.2% in Q1 2008)
- Risk-to-Capital Ratio: 16.1:1 (Combined Statutory)

Material Changes vs. Prior Period

• Net Loss Expansion: Net loss increased significantly to $184.6 million from $34.5 million in the prior year quarter. This was driven primarily by a $66.2 million increase in losses incurred and a $12.2 million increase in interest expense.
• Losses Incurred: Increased to $757.9 million due to a larger increase in the default inventory (13,530 new delinquencies vs. 6,469 in Q1 2008) and higher estimated claim severity.
• Premium Deficiency Reserve: The reserve decreased by $164.8 million (a benefit to earnings) due to a $119 million change in assumptions related to lower estimated ultimate losses, partially offset by lower estimated premiums.
• Investment Income: Increased to $77.2 million from $72.5 million due to a larger portfolio size, despite a lower pre-tax yield (3.70% vs. 4.28%).
• Realized Investment Losses: Increased to $17.3 million, including $25.7 million in "other-than-temporary" impairments, offset by $8.4 million in net realized gains on sales.
• Reinsurance Fee: A one-time fee of $26.4 million was recorded due to the termination of a reinsurance agreement effective March 20, 2009.
• Income Tax: The effective tax rate credit decreased to 31.8% from 51.7% due to the establishment of a $31 million valuation allowance after redeeming tax and loss bonds.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• Capital Adequacy: Management faces significant challenges regarding access to capital to write new business. While MGIC currently exceeds regulatory minimums (Policyholders' Position exceeds minimum by ~$1.2 billion), losses on 2006 and 2007 books are expected to continue for several years. Management is exploring options to obtain additional capital, including discussions with the Wisconsin Office of the Commissioner of Insurance regarding a new subsidiary structure to write new business.
• New Insurance Written (NIW): Flow NIW decreased to $6.4 billion from $18.1 billion in Q1 2008. Management anticipates 2009 flow NIW will remain significantly below 2008 levels due to tighter underwriting guidelines, premium rate increases, and increased usage of FHA insurance programs.
• Loss Trends: Delinquencies continue to rise, particularly in California and Florida. The average claim paid is expected to increase throughout 2009. Paid claims in 2009 are expected to exceed the $1.4 billion paid in 2008.
• Debt Management: The company deferred the April 1, 2009 interest payment on its $390 million Convertible Junior Subordinated Debentures for 10 years. Interest will accrue and compound at 9% annually.

Risks and Contingencies

• Litigation: Five consolidated stockholder class action lawsuits allege violations of federal securities laws regarding C-BASS liquidity, loss reserves, and capitalization. A consolidated complaint is due by June 15, 2009. Additionally, the company faces ongoing IRS examinations regarding REMIC residual interests and potential liability for unrecognized tax benefits of $90.4 million.
• Regulatory Risk: If the risk-to-capital ratio exceeds state limits (e.g., 25:1), the company may be prohibited from writing new business in those states. The company is monitoring its risk-to-capital ratio closely as it is expected to increase.
• Rescissions: While rescissions have mitigated paid losses (over 20% of claims in Q1 2009), there is no assurance this trend will continue. Disputes over rescissions may lead to arbitration or litigation.
• Market Risk: The company holds approximately $521 million in auction rate securities (ARS) backed by student loans, which are currently illiquid and classified as Level 3 assets.

Investor Verification Checklist

• Capital Structure: Verify the status of discussions with the Wisconsin Office of the Commissioner of Insurance regarding the proposed subsidiary structure to write new business.
• Loss Reserves: Monitor the development of loss reserves for the 2006 and 2007 books of business, as these are expected to generate material losses for several years.
• Debt Covenants: Confirm continued compliance with the $2.0 billion Consolidated Net Worth covenant under the credit facility, which could increase to $2.25 billion if net worth exceeds $2.75 billion by June 30, 2009.
• Convertible Debentures: Track the impact of the deferred interest on the $390 million debentures and the potential for future dilution via the Alternative Payment Mechanism or conversion.
• IRS Dispute: Assess the potential financial impact of the ongoing IRS examination regarding REMIC residual interests and the $90.4 million in unrecognized tax benefits.
• Delinquency Trends: Review quarterly updates on delinquency rates, particularly in high-risk states like California and Florida, and the effectiveness of rescissions in mitigating paid losses.