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| MTG > SEC Filings for MTG > Form 10-K on 2-Mar-2009 | All Recent SEC Filings |
2-Mar-2009
Annual 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 product is primary 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. Prior to 2008, we wrote
significant volume through the bulk channel, substantially all of which was Wall
Street bulk business, which we discontinued writing in 2007. We expect any
future business written through the bulk channel will be insignificant to us.
Prior to 2009, we also wrote pool mortgage insurance. We do not expect we will
write any significant pool mortgage insurance in the future.
As used below, "we" and "our" refer to MGIC Investment Corporation's
consolidated operations. 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 Australian operations which are
immaterial. The results of our operations in Australia are included in the
consolidated results disclosed. For additional information about our Australian
operations, see "-Australia" below.
Forward Looking Statements
As discussed under "Forward Looking Statements and Risk Factors" in Item 1A
of Part 1 of this annual report to which readers of this annual report should
refer because such risk factors are an integral part of the discussion 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 annual report 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 annual report 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
At this time, we are facing two particularly significant challenges, which we
believe are shared by the other participants in our industry:
• Whether we will have access to sufficient capital to continue to write new
business. This challenge is discussed under "Capital" below.
• Whether private mortgage insurance will remain a significant credit enhancement alternative for low down payment single family mortgages. This challenge is discussed under "Future of the Domestic Residential Housing Finance System" below.
Capital
The mortgage insurance industry is experiencing material losses, especially
on the 2006 and 2007 books. The ultimate amount of these losses will depend in
part on general economic conditions, including unemployment, and 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, there is significant uncertainty surrounding 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 Quarterly Report on Form 10-Q for the third quarter of 2008.
The Office of the Commissioner of Insurance of Wisconsin ("OCI") 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 prescribed 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 policyholders position
(MPP) required by the formula 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.
In February 2009, we received clarification from the OCI regarding the
methodology used in calculating the excess of our policyholders position over
the MPP. The clarification effectively reduces the required MPP by our reserves
established for delinquent loans, beginning with our December 31, 2008
calculations. At December 31, 2008, MGIC's policyholders position exceeded the
required minimum by more than $1.5 billion, and we exceeded the required minimum
by $1.6 billion on a combined statutory basis. (The combined figures give effect
to reinsurance with subsidiaries of our holding company.)
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. It is also our understanding that certain states have clarified their
calculation of risk-to-capital to reduce risk in force for established loss
reserves. We have used this methodology beginning with our December 31, 2008
calculations. At December 31, 2008 MGIC's risk-to-capital was 12.9:1 and was
14.7:1 on a combined statutory basis.
In addition to the uncertainties that could result in increased losses, there
are other items that could favorably impact our future losses. For example, 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 and our perception that books of
insurance we wrote before 2008 contain a significant number of loans involving
fraud, we expect our rescission rate during future periods to increase. The
insured can dispute our right to rescind coverage, and whether the requirements
to rescind are met ultimately would be determined by arbitration or judicial
proceedings. Also, our estimated loss reserves do not take account of the effect
of potential benefits that might be realized from third party and governmental
loan modification programs.
Because these and other factors that will affect our future losses are
subject to significant uncertainty, there is significant uncertainty regarding
the level of our future losses. However, unless recent loss trends materially
mitigate, MGIC's policyholders position could decline and its risk-to-capital
could increase beyond the levels necessary to meet regulatory requirements and
this could occur before the end of 2009.
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.
We are considering options to obtain capital to write new business, which
could occur through the sale of equity or debt securities, from reinsurance
and/or through the use of claims paying resources that should not be needed to
cover obligations on our existing insurance in force. While we have not pursued
raising capital from private sources, we initiated discussions with the US
Treasury late in October 2008 to seek a capital investment and/or reinsurance
under the Troubled Assets Relief Program ("TARP"). We understand there is
intense competition for TARP and other government assistance. We cannot predict
whether we will be successful in obtaining capital from any source but any sale
of additional securities could dilute substantially the interest of existing
shareholders and other forms of capital relief could also result in additional
costs.
Our senior management believes that one of the capital generating options
referred to above will be feasible or that the uncertainties described above
will develop in a manner such that we will be able to continue to write new
business through the end of 2009. We can, however, give no assurance in this
regard, and higher losses, adverse changes in our relationship with the GSEs, or
reduced benefits from loss mitigation, among other factors, could result in
senior management's belief not being realized. In addition, to the extent this
belief of senior management is a "forward-looking statement" under
Section 21E(c) of the Securities Exchange Act of 1934, as amended (and without
thereby suggesting that other forward-looking statements we make in this annual
report are not accompanied by meaningful cautionary statements because the
reference to such cautionary statements does not appear in immediate proximity
to such other forward-looking statements), the statements under Item 1.A. "Risk
Factors" are intended to provide additional meaningful cautionary statements
that identify additional material factors that could cause actual results to
differ materially from those in this forward-looking statement of senior
management.
Future of the Domestic Housing Finance System
For decades, Fannie Mae and Freddie Mac have been the principal factor in
determining the availability of single-family mortgages in the United States for
conforming loans. From the summer of 2007 to the summer of 2008, the combined
common and preferred equity market capitalization of the GSEs declined on the
order of $140 billion, the FHFA was appointed conservator of each GSE and their
most senior management was replaced by executives designated by the federal
government. As their conservator, FHFA controls and directs the operations of
Fannie Mae and Freddie Mac. In connection with the conservatorship, the United
States Treasury has committed a $200 billion facility to each GSE to support its
capital, which is a $100 billion increase from the original facility established
for each GSE at the time the conservatorship began. Both GSEs have either drawn
or announced their intention to draw material amounts under their respective
facilities to cure deficiencies in their regulatory capital as of September 30,
2008, which is the last period end reported on prior to finalization of this
annual report.
Under the charters of the GSEs, which are contained in federal statutes
subject to amendment by legislation, the GSEs must obtain credit enhancement on
single-family mortgages that they purchase when the LTV ratio exceeds 80%. Such
low down payment mortgages form the foundation of our business. For decades
private mortgage insurance has been the mortgage market's preferred form of
credit enhancement for conforming loans. (For a few years that ended in 2007,
piggyback loans, which are loans comprised of both a first and second mortgage,
with the LTV ratio of the first mortgage below what investors require for
mortgage insurance, took substantial market share from private mortgage
insurance. As shown by their recent performance in declining housing markets, we
believe piggybacks cannot be fairly viewed as credit enhancements.)
As a result of the conservatorship of the GSEs and the mortgage insurance
programs of the FHA and other federal agencies, the federal government has
assumed the leading role in the residential mortgage market. These circumstances
could lead Congress to undertake a wide ranging review of the system of
residential mortgage finance in the United States, including what role the
government should play. We believe there are strong policy reasons that
favor the continuation of private mortgage insurance as the preferred credit
enhancement for conforming loans. We cannot predict, however, the scope of any
changes that may be made to the housing finance system as a result of such
review or the effect such changes would have on our industry.
Debt at our Holding Company and Holding Company Capital Resources
At December 31, 2008, we had approximately $394 million in short-term
investments at our holding company. These investments were virtually all of our
holding company's liquid assets. Our holding company's obligations include
$1.090 billion in indebtedness, $400 million of which is scheduled to mature
before the end of 2011 and must be serviced pending scheduled maturity. See
Notes 6 and 7 to our consolidated financial statements contained in Item 8 for
additional information about this indebtedness. See "Liquidity and Capital
Resources - Debt at our Holding Company and Holding Company Capital Resources"
for information about restrictions on MGIC's payment of dividends to our holding
company and our expectation that we will not be seeking additional dividends
that would increase our holding company's cash resources in 2009. Historically,
dividends from MGIC have been the principal source of our holding company's cash
inflow.
Private and Public Efforts to Modify Mortgage Loans and Reduce Foreclosure
In September the Emergency Economic Stabilization Act of 2008 was enacted.
Included in this legislation is the 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. In February 2009, the Obama Administration
announced the Homeowner Affordability and Stability Plan that has the intent of
helping millions of homeowners receive more favorable mortgage terms. Full
details of the plan were not available at the time this annual report was
finalized.
In the fourth quarter of 2008, the Federal Deposit Insurance Corporation, in
its capacity as a receiver for troubled banks, the GSEs and several lenders
adopted programs to modify loans to make them more affordable to borrowers with
the goal of reducing the number of foreclosures. Similarly, various state and
local governments have enacted foreclosure moratoriums, many with the stated
goal of reducing foreclosures by giving lenders and borrowers additional time to
modify loans to make them more affordable to borrowers.
There can be no assurance that foreclosure avoidance or modification plans
will materially reduce the level of delinquencies and claims we are currently
experiencing or could experience in the future. For additional information about
the potential impact that any plans and programs enacted by legislation may have
on us, see the risk factor titled "Loan modification and other similar programs
may not provide material benefits to us" in Item 1A.
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. Refinancings are also affected by current home values compared to values when the loans in the in force book became insured and the terms on which mortgage credit is available.
• Rescissions, which require us to return any premiums received related to the rescinded policy.
• 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 net premiums received,
investment earnings, net claim payments and expenses, less cash provided by (or
used for) non-operating activities, such as debt or stock issuance or dividend
payments. 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, as well
as any "other than temporary" impairments. 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," 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 new delinquencies has
historically followed a seasonal pattern, with new delinquencies in the
first part of the year lower than new delinquencies in the latter part of
the year.
• 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.
• Rescission rates. Our estimated loss reserves reflect mitigation from rescissions of coverage using only the rate at which we have rescinded claims during recent periods. As we continue to investigate more claims for misrepresentation, we expect the number of rescissions to increase. The rate of rescissions may also continue to increase as fraud may be more prevalent in our insurance in force, which could ultimately decrease our losses incurred from what they would have been had our rescission rate been lower.
• 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. For example, a weak economy can lead to claims from older books continuing at stable levels or experiencing a lower rate of decline. We are currently seeing such performance as it relates to delinquencies from our older books and, to the extent we were notified of such delinquencies as of December 31, 2008, such performance is reflected in our loss reserves.
• 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 December 31, 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 Notes 6 and 7 to our consolidated financial statements in Item 8
and under "Liquidity and Capital Resources" below.
• Income (loss) from joint ventures
Our results of operations have also been 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 (Sherman).
C-BASS
C-BASS, a limited liability company, is an unconsolidated, less than
50%-owned joint venture investment of ours that is not controlled by us.
Historically, C-BASS was principally engaged in the business of investing in the
credit risk of subprime single-family residential mortgages. In the third
quarter of 2007, as a result of margin calls from lenders that C-BASS was unable
to meet, C-BASS's purchases of mortgages and mortgage securities and its
securitization activities ceased. C-BASS 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.
In 2007, joint venture losses included an impairment charge equal to our
entire equity interest in C-BASS, as well as the reduction of the carrying value
of our $50 million note from C-BASS to zero, which was due to equity losses
incurred by C-BASS in the fourth quarter of 2007.
Sherman
During the period in which we held an equity interest in Sherman, Sherman was
principally engaged in purchasing and collecting for its own account delinquent
consumer receivables, which are primarily unsecured, and in originating and
servicing subprime credit card receivables. The factors that affect Sherman's
consolidated results of operations are discussed in our Quarterly Report on Form
10-Q for the Quarter Ended June 30, 2008, to which you should refer.
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, our results of operations are no longer affected by any joint
venture results. See "Results of Consolidated Operations - Joint Ventures -
Sherman" for discussion of our sale of interest in Sherman and related note
receivable.
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.
Australia
In 2007, we began providing mortgage insurance to lenders in Australia. At
December 31, 2008 the equity value of our Australian operations was
approximately $100 million and our risk in force in Australia was approximately
$1.0 billion. In Australia, mortgage insurance is a single premium product that
covers the entire loan balance. As a result, our Australian risk in force
. . .
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