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| MTG > SEC Filings for MTG > Form 10-Q on 10-Nov-2008 | All Recent SEC Filings |
10-Nov-2008
Quarterly Report
Overview
Through our subsidiary MGIC, we are the leading provider of private mortgage
insurance in the United States to the home mortgage lending industry. Our
principal products are primary mortgage insurance and pool mortgage insurance.
Primary mortgage insurance may be written through the flow market channel, in
which loans are insured in individual, loan-by-loan transactions. Primary
mortgage insurance may also be written through the bulk market channel, in which
portfolios of loans are individually insured in single, bulk transactions.
As used below, "we" and "our" refer to MGIC Investment Corporation's
consolidated operations. The discussion below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in our Annual Report on Form 10-K for the year ended December 31,
2007. We refer to this Discussion as the "10-K MD&A." In the discussion below,
we classify, in accordance with industry practice, as "full documentation" loans
approved by GSE and other automated underwriting systems under "doc waiver"
programs that do not require verification of borrower income. For additional
information about such loans, see footnote (3) to the delinquency table under
"Results of Consolidated Operations-Losses-Losses Incurred". The discussion of
our business in this document generally does not apply to our international
operations which began in 2007, are conducted only in Australia and are
immaterial. The results of our operations in Australia are included in the
consolidated results disclosed. For additional information about our Australian
operations, see "We may not be able to realize benefits from our international
initiative" in Exhibit 99 to this Report.
Forward Looking Statements
As discussed under "Forward Looking Statements and Risk Factors" below,
actual results may differ materially from the results contemplated by forward
looking statements. We are not undertaking any obligation to update any forward
looking statements or other statements we may make in the following discussion
or elsewhere in this document even though these statements may be affected by
events or circumstances occurring after the forward looking statements or other
statements were made. Therefore no reader of this document should rely on these
statements being accurate as of any time other than the time at which this
document was filed with the Securities and Exchange Commission.
Outlook
We believe the mortgage insurance industry will experience material losses on
the 2006 and 2007 books. The ultimate amount of these losses will depend in part
on the direction of home prices in California, Florida and other distressed
markets, which in turn will be influenced by general economic conditions and
other factors. Because we cannot predict future home prices or general economic
conditions with confidence, we cannot predict with confidence what our ultimate
losses will be on our 2006 and 2007 books. Our current expectation, however, is
that these books will continue to generate material incurred and paid losses for
a number of years. Our view of potential losses on these books has trended
upward since the first quarter of 2008, including since the time at which we
finalized our Form 10-Q for the second quarter of this year.
The Office of the Commissioner of Insurance of Wisconsin is MGIC's principal
insurance regulator. To assess a mortgage guaranty insurer's capital adequacy,
Wisconsin's insurance regulations require that a mortgage guaranty insurance
company maintain "policyholders position" of not less than a minimum computed
under a formula. Policyholders position is the insurer's net worth, contingency
reserve and a portion of the reserves for unearned premiums, with credit given
for authorized reinsurance. The minimum required by the formula ("MPP") depends
on the insurance in force and whether the loans insured are primary insurance or
pool insurance and further depends on the LTV ratio of the individual loans and
their coverage percentage (and in the case of pool insurance, the amount of any
deductible). If a mortgage guaranty insurer does not meet MPP it cannot write
new business until its policyholders position meets the minimum.
Some states that regulate us have provisions that limit the risk-to-capital
ratio (see "Liquidity and Capital Resources-Risk to Capital") of a mortgage
guaranty insurance company to 25:1. If an insurance company's risk-to-capital
ratio exceeds the limit applicable in a state, it may be prohibited from writing
new business in that state until its risk-to-capital ratio falls below the
limit.
At September 30, 2008, MGIC exceeded MPP by more than $1.6 billion, and we
exceeded MPP by $1.8 billion on a combined basis. At September 30, 2008 MGIC's
risk-to-capital was 12.3:1 and our risk-to-capital was 13.9:1 on a combined
basis. (The combined figures give effect to reinsurance with subsidiaries of our
holding company.)
Because the factors that will affect our future losses are subject to
significant uncertainty, we cannot predict with confidence the level of our
future losses. However, if recent loss trends continue MGIC's policyholders
position would decline and its risk-to-capital would increase beyond the levels
necessary to meet regulatory requirements. Depending on the level of future
losses, this could occur before the end of 2009.
Our estimated loss reserves reflect loss mitigation from rescissions using
only the rate at which we have rescinded claims during recent periods, as
discussed under "Results of Consolidated Operations-Losses-Losses Incurred". In
light of the number of claims investigations we are pursuing, we expect our
current rescission rate to increase materially, although if the insured disputes
our right to rescind a claim, whether the requirements to rescind are met
ultimately would be determined by arbitration or judicial proceedings. Our
estimated loss reserves also do not take account of the effect of potential
benefits that might be realized from loan modification programs. Our MPP and
risk-to-capital have historically been computed based on risk in force that is
not reduced for loss reserves established for known delinquencies even though
our policyholders position is reduced for those delinquencies. See "Liquidity
and Capital Resources-Risk to Capital." To the extent our risk in force could be
reduced for such loss reserves and the reduction were consistent with regulatory
requirements, we may be able to defer the time at which we would not meet
regulatory levels of MPP or risk-to-capital. While these items, if they in fact
occur, would reduce the amount by which MPP and risk-to-capital would not meet
regulatory requirements, we have not quantified their effect and cannot
determine the amount of any such reduction.
We are considering options to obtain additional capital, which could occur
through the sale of equity or debt securities and/or reinsurance. We cannot
predict whether we will be successful in raising additional capital from any
source but any sale of additional securities could dilute substantially the
interest of existing shareholders.
An inability to write new business does not mean that we do not have
sufficient resources to pay claims. We believe we have more than adequate
resources to pay claims on our insurance in force, even in scenarios in which
losses materially exceed those that would result in not meeting MPP and
risk-to-capital requirements. Our claims paying resources principally consist of
our investment portfolio, captive reinsurance trust funds and future premiums on
our insurance in force, net of premiums ceded to captive and other reinsurers.
At October 31, 2008, we had approximately $391 million in short-term
investments at our holding company. Our holding company's obligations include
$1.090 billion in indebtedness. See Notes 2 and 3 of the Notes to the
Consolidated Financial Statements contained elsewhere in this Form 10-Q for
additional information about this indebtedness. See "Liquidity and Capital
Resources - Holding Company Capital Resources" for information about
restrictions on MGIC's payment of dividends to our holding company.
Historically, these dividends have been the principal source of our holding
company's cash inflow.
Housing Legislation
In late July the Housing and Economic Recovery Act of 2008 was enacted.
Included in this legislation is the HOPE for Homeowners Act of 2008 which
creates a new, temporary, voluntary program within FHA to back FHA-insured
mortgages to distressed borrowers. The new mortgages offered by FHA-approved
lenders will refinance the loans of distressed owner-occupants at risk of losing
their homes to foreclosure at significant discounts to the original value of the
home. Also included in the Act is the Federal Housing Finance Regulatory Reform
Act of 2008 which establishes a new, independent, "world class" regulator for
Fannie Mae, Freddie Mac and the Federal Home Loan Banks. This regulator has been
given broad authority to ensure the safety and soundness of these entities,
including the ability to establish new capital standards, restrict asset growth,
establish standards for portfolio risk management, and review and approve new
product offerings. There can be no assurance that any changes resulting from the
implementation of this new regulatory regime will not alter our relationship or
ability to conduct business with the GSEs in a materially adverse manner.
In September the Emergency Economic Stabilization Act of 2008 ("EESA") was
enacted. Included in this legislation is the Troubled Assets Relief Program
("TARP") which, among other provisions, allows mortgage assets to be purchased
by the federal government from financial institutions. To the extent assets are
acquired or controlled by a government agency such agency must implement a plan
that seeks to maximize assistance to homeowners to minimize foreclosures. Some
lenders have agreed to modify certain loans that are currently delinquent or are
at risk to become delinquent. There can be no assurance that current, or future,
legislation or agreements to modify loans, should they occur, will materially
reduce the level of delinquencies and claims we are currently experiencing or
could experience in the future.
Factors Affecting Our Results
Our results of operations are affected by:
• Premiums written and earned
Premiums written and earned in a year are influenced by:
• New insurance written, which increases the size of the in force book of insurance, is the aggregate principal amount of the mortgages that are insured during a period. Many factors affect new insurance written, including the volume of low down payment home mortgage originations and competition to provide credit enhancement on those mortgages, including competition from other mortgage insurers and alternatives to mortgage insurance.
• Cancellations, which reduce the size of the in force book of insurance that generates premiums. Cancellations due to refinancings are affected by the level of current mortgage interest rates compared to the mortgage coupon rates throughout the in force book, as well as by current home values compared to values when the loans in the in force book became insured.
• Premium rates, which are affected by the risk characteristics of the loans insured and the percentage of coverage on the loans.
• Premiums ceded to reinsurance subsidiaries of certain mortgage lenders ("captives") and risk sharing arrangements with the GSEs.
Premiums are generated by the insurance that is in force during all or a
portion of the period. Hence, changes in the average insurance in force in the
current period compared to an earlier period is a factor that will increase
(when the average in force is higher) or reduce (when it is lower) premiums
written and earned in the current period, although this effect may be enhanced
(or mitigated) by differences in the average premium rate between the two
periods as well as by premiums that are ceded to captives. Also, new insurance
written and cancellations during a period will generally have a greater effect
on premiums written and earned in subsequent periods than in the period in which
these events occur.
• Investment income
Our investment portfolio is comprised almost entirely of fixed income
securities rated "A" or higher. The principal factors that influence investment
income are the size of the portfolio and its yield. As measured by amortized
cost (which excludes changes in fair market value, such as from changes in
interest rates), the size of the investment portfolio is mainly a function of
cash generated from (or used in) operations, such as investment earnings and
claim payments, less cash used for non-operating activities, such as share
repurchases. Realized gains and losses are a function of the difference between
the amount received on sale of a security and the security's amortized cost. The
amount received on sale of fixed income securities is affected by the coupon
rate of the security compared to the yield of comparable securities at the time
of sale.
• Losses incurred
Losses incurred are the current expense that reflects estimated payments that will ultimately be made as a result of delinquencies on insured loans. As explained under "Critical Accounting Policies," in the 10-K MD&A, except in the case of premium deficiency reserves, we recognize an estimate of this expense only for delinquent loans. Losses incurred are generally affected by:
• The state of the economy and housing values, each of which affects the likelihood that loans will become delinquent and whether loans that are delinquent cure their delinquency. The level of delinquencies has historically followed a seasonal pattern, with a reduction in delinquencies in the first part of the year, followed by an increase in the latter part of the year. However, although this pattern has continued, the default inventory has increased each quarter since the second quarter of 2007 because the seasonal pattern has been more than offset by the development of the 2006 and 2007 books of business.
• The product mix of the in force book, with loans having higher risk characteristics generally resulting in higher delinquencies and claims.
• The size of loans insured. Higher average loan amounts tend to increase losses incurred.
• The percentage of coverage on insured loans. Deeper average coverage tends to increase incurred losses.
• Changes in housing values, which affect our ability to mitigate our losses through sales of properties with delinquent mortgages as well as borrower willingness to continue to make mortgage payments when the value of the home is below the mortgage balance.
• The distribution of claims over the life of a book. Historically, the first two years after a loan is originated are a period of relatively low claims, with claims increasing substantially for several years subsequent and then declining, although persistency, the condition of the economy and other factors can affect this pattern.
• Changes in premium deficiency reserves
Each quarter, we re-estimate the premium deficiency reserve on the remaining
Wall Street bulk insurance in force. The premium deficiency reserve primarily
changes from quarter to quarter as a result of two factors. First, it changes as
the actual premiums, losses and expenses that were previously estimated are
recognized. Each period such items are reflected in our financial statements as
earned premium, losses incurred and expenses. The difference between the amount
and timing of actual earned premiums, losses incurred and expenses and our
previous estimates used to establish the premium deficiency reserves has an
effect (either positive or negative) on that period's results. Second, the
premium deficiency reserve changes as our assumptions relating to the present
value of expected future premiums, losses and expenses on the remaining Wall
Street bulk insurance in force change. Changes to these assumptions also have an
effect on that period's results.
• Underwriting and other expenses
The majority of our operating expenses are fixed, with some variability due
to contract underwriting volume. Contract underwriting generates fee income
included in "Other revenue."
• Interest expense
Interest expense reflects the interest associated with our debt obligations.
Our long-term debt obligations at September 30, 2008 include our $300 million of
5.375% Senior Notes due in November 2015, $200 million of 5.625% Senior Notes
due in September 2011, $200 million outstanding under a credit facility expiring
in March 2010 and $390 million in convertible debentures due in 2063, as
discussed in "Note 2. Short- and long-term debt" and "Note 3. Convertible
debentures and related derivatives" to our consolidated financial statements and
under "Liquidity and Capital Resources" below.
• Income (loss) from joint ventures
Our results of operations are also affected by the results of our joint
ventures, which are accounted for under the equity method. Historically, joint
venture income principally consisted of the aggregate results of our investment
in two less than majority owned joint ventures, Credit-Based Asset Servicing and
Securitization LLC, C-BASS, and Sherman Financial Group LLC. In 2007, joint
venture losses included an impairment charge equal to our entire equity interest
in C-BASS, as well as equity losses incurred by C-BASS in the fourth quarter
that reduced the carrying value of our $50 million note from C-BASS to zero. As
a result, beginning in the first quarter of 2008, our joint venture income
principally consisted of income from Sherman. In the third quarter of 2008, we
sold our entire interest in Sherman to Sherman. As a result, beginning in the
fourth quarter of 2008, we expect that our joint venture income will be less
material to our results of operations. Our income (loss) from joint ventures
also includes certain tax credit investments, accounted for in accordance with
the equity method of accounting, of an immaterial amount.
Please refer to our Quarterly Report on Form 10-Q for the Quarter Ended
June 30, 2008 for a description of the historical business activities of
Sherman.
In 2007, C-BASS ceased its operations and is managing its portfolio pursuant
to a consensual, non-bankruptcy restructuring, under which its assets are to be
paid out over time to its secured and unsecured creditors.
Mortgage Insurance Earnings and Cash Flow Cycle
In our industry, a "book" is the group of loans that a mortgage insurer
insures in a particular calendar year. In general, the majority of any
underwriting profit (premium revenue minus losses) that a book generates occurs
in the early years of the book, with the largest portion of any underwriting
profit realized in the first year. Subsequent years of a book generally result
in modest underwriting profit or underwriting losses. This pattern of results
typically occurs because relatively few of the claims that a book will
ultimately experience typically occur in the first few years of the book, when
premium revenue is highest, while subsequent years are affected by declining
premium revenues, as the number of insured loans decreases (primarily due to
loan prepayments), and losses increase.
2008 Third Quarter Results
Our results of operations in the third quarter of 2008 were principally
affected by:
• Premiums written and earned
Premiums written and earned during the third quarter of 2008 increased
compared to the same period in 2007. The increase in premiums resulted from the
continued increase in the average insurance in force; however the effect of the
higher in force has been somewhat offset by lower average premium yields due to
a shift in the mix of new writings to loans with lower loan-to-value ratios,
higher FICO scores and full documentation, which carry lower premium rates.
• Investment income
Investment income in the third quarter of 2008 was higher when compared to
the same period in 2007 due to an increase in the average amortized cost of
invested assets, offset by a decrease in the pre-tax yield.
• Realized gains
Realized gains for the third quarter of 2008 included $62.8 million from the
sale of our remaining interest in Sherman, which was offset by "other than
temporary" impairments on our investment portfolio of approximately
$31.7 million and realized losses on sales of investments of $3.2 million.
Realized gains in the third quarter of 2007 included a $162.9 million pre-tax
gain on the sale of a portion our interest in Sherman.
• Losses incurred
Losses incurred for the third quarter of 2008 significantly increased
compared to the same period in 2007 primarily due to a significant increase in
the default inventory, offset by a smaller increase in the estimates regarding
how much will be paid on claims, or severity, and a decrease in the estimates
regarding how many delinquencies will result in a claim, or claim rate, when
compared to the same period in 2007. The default inventory increased by
approximately 23,700 delinquencies in the third quarter of 2008, compared to an
increase of approximately 10,200 in the third quarter of 2007. The continued
increase in estimated severity was primarily the result of the default inventory
containing higher loan exposures with expected higher average claim payments as
well as our inability to mitigate losses through the sale of properties due to
slowing home price appreciation or home price declines in some areas. The
decrease in estimated claim rate for the quarter was primarily due to an
increase in mitigation from rescissions and denials for misrepresentation,
ineligibility and policy exclusions.
• Premium deficiency
During the third quarter of 2008 the premium deficiency reserve on Wall
Street bulk transactions declined by $204 million from $788 million, as of
June 30, 2008, to $584 million as of September 30, 2008. The $584 million
premium deficiency reserve as of September 30, 2008 reflects the present value
of expected future losses and expenses that exceeded the present value of
expected future premium and already established loss reserves.
• Underwriting and other expenses
Underwriting and other expenses for the third quarter of 2008 decreased when
compared to the same period in 2007. The decrease reflects our lower volumes of
new insurance written as well as a focus on expenses in difficult market
conditions. Also, the third quarter of 2007 included $11.3 million in one-time
expenses associated with a terminated merger.
• Interest expense
Interest expense for the third quarter of 2008 increased when compared to the
same period in 2007. The increase reflects the issuance of our convertible
debentures in March and April of 2008.
• Income from joint ventures
Income from joint ventures, net of tax, was $3.3 million compared to a loss from joint ventures, net of tax, of $290.6 million for the same period last year. The loss from joint venture in the third quarter of 2007 was due primarily to the impairment of our investment in C-BASS. In the third quarter of 2008 we sold our remaining interest in Sherman. The gain on the sale of our interest is included in realized gains on our statements of operations.
Results of Consolidated Operations
New insurance written
The amount of our primary new insurance written during the three and nine
months ended September 30, 2008 and 2007 was as follows:
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