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| MTG > SEC Filings for MTG > Form 10-Q on 10-Aug-2009 | All Recent SEC Filings |
10-Aug-2009
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.
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,
2008. 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 are immaterial. The results of our operations in Australia are
included in the consolidated results disclosed. For additional information about
our Australian operations, see "Overview-Australia" in our 10-K MD&A.
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
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 "Overview - Future of the Domestic Residential Housing Finance System" in our 10-K MD&A.
For additional information about these challenges, see the portions of our
10-K MD&A titled "Overview - Future of the Domestic Housing Finance System,"
"Overview - Debt at our Holding Company and Holding Company Capital Resources"
and "Overview - Private and Public Efforts to Modify Mortgage Loans and Reduce
Foreclosure."
Capital
At June 30, 2009, MGIC's policyholders position exceeded the required minimum
by approximately $1.0 billion, and we exceeded the required minimum by
approximately $1.1 billion on a combined statutory basis. (The combined figures
give effect to reinsurance with subsidiaries of our holding company.) At
June 30, 2009 MGIC's risk-to-capital was 13.8:1 and was 15.8:1 on a combined
statutory basis. Beginning with our June 30, 2009 risk-to-capital calculations
we have deducted risk in force on policies currently in default and for which
loss reserves have been established. For additional information about how we
calculate risk-to-capital, see "Liquidity and Capital Resources - Risk to
Capital" below.
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, 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. Unless loss trends materially mitigate, we
expect that these incurred losses will reduce our policyholders position and
increase our risk-to-capital beyond the levels necessary to meet current
regulatory requirements. This could occur in the first or second quarter of
2010, or earlier; the timing will primarily depend on the level of new loan
default notices and the claim rate associated with loans in default. For
additional information on these regulatory requirements see the portion of our
10-K MD&A titled "Overview - Capital."
We believe that we have claims paying resources at MGIC that exceed our claim
obligations on our insurance in force, even in scenarios in which losses
materially exceed those that would result in not meeting regulatory
requirements. In July 2009, we announced that the Office of the Commissioner of
Insurance of Wisconsin ("OCI") would allow a reactivation plan under which MGIC
would contribute up to $1 billion, to MGIC Indemnity Corporation ("MIC"), a
wholly owned subsidiary of MGIC, to enable MIC to begin writing new mortgage
guaranty insurance. MGIC's contribution was to be made in two $500 million
installments, the first of which was to be made not later than July 31, 2009.
The second contribution was to be made within five business days after
January 1, 2011 if MIC was then writing new business and the contribution was
not disallowed by the OCI. Before we can begin writing new business in MIC, the
OCI must specifically authorize MIC to write new business and MIC must obtain
licenses in the states where it will transact business. In addition, as a
practical matter, MIC must also be approved as an eligible mortgage insurer by
the GSEs.
On August 3, 2009, we announced that in connection with the discussions to
have MIC approved as an eligible mortgage insurer by the GSEs, we delayed the
date on which we would make the first contribution of capital to MIC to a date
to be determined
by us and acceptable to the OCI. We also announced that the amount of the
contribution to MIC will be determined as part of the discussions with the GSEs
and that it was expected to be reduced from what we had anounced in July.
The plan to use MIC to write new business was driven by our concern that in
the future MGIC might not meet regulatory capital requirements to continue to
write new business. These requirements are present in certain states while other
jurisdictions do not have specific capital requirements. It is possible that as
part of obtaining GSE approval of MIC as an eligible mortgage insurer, MIC would
write new business in certain states and MGIC would continue to write new
business in the remaining jurisdictions. If this structure were implemented, the
amount of capital needed by MIC to write new business would be less than it
would need if it wrote business in all jurisdictions. As a result, MGIC would
reduce its contribution of capital to MIC.
The discussions with the GSEs to have MIC approved as an eligible mortgage
insurer are ongoing; in this regard, Fannie Mae's Form 10-Q filing made on
August 6, 2009 says, "As of August 5, 2009, we have not approved MIC as a
qualified mortgage insurer, but we remain in discussions with MGIC. Any capital
contribution by MGIC to a subsidiary would result in less liquidity available to
MGIC to pay claims on its existing book of business, resulting in an increased
risk that MGIC might not pay its claims in full in the future." These
discussions include alternatives other than MIC writing new business in certain
states and MGIC continuing to write new business in the remaining jurisdictions.
In addition, TARP or other governmental funding could be alternatives to MIC.
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 insurance in force, 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 the FHA, other mortgage insurers and alternatives to mortgage insurance.
• Cancellations, which reduce insurance in force. 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. Cancellations also include rescissions, which require us to return any premiums received related to the rescinded policy, and policies canceled due to claim payment.
• 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 or the GSEs. 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 recognized in earnings. 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 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, with higher average loan amounts tending to increase losses incurred.
• The percentage of coverage on insured loans, with deeper average coverage tending 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 rates at which we rescind policies. Our estimated loss reserves reflect mitigation from rescissions and denials, which we collectively refer to as rescissions, of coverage using the rate at which we have rescinded claims during recent periods.
• The distribution of claims over the life of a book. Historically, the first two years after loans are 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. See "- Mortgage Insurance Earnings and Cash Flow Cycle" below.
• 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 outstanding debt obligations. Our long-term debt obligations at June 30, 2009 include our approximately $128.4 million of 5.625% Senior Notes due in September 2011, $300 million of 5.375% Senior Notes due in November 2015, and $390 million in convertible debentures due in 2063 (interest on these debentures accrues even if we defer the payment of interest and compounds), as discussed in Notes 2 and 3 of our Notes to Consolidated Financial Statements and under "Liquidity and Capital Resources" below. Also as discussed in
Note 1 of the Consolidated Financial Statements, we adopted FSP APB 14-1,
"Accounting for Convertible Debt Instruments That May Be Settled in Cash upon
Conversion (Including Partial Cash Settlement)", on a retrospective basis, and
our interest expense now reflects our non-convertible debt borrowing rate on the
convertible debentures of approximately 19% at the time of issuance. At June 30,
2009, the convertible debentures are reflected as a liability on our
consolidated balance sheet at the current amortized value of $281 million, with
the unamortized discount reflected in equity.
• Income from joint ventures
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 insured 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.
2009 Second Quarter Results
Our results of operations in the second quarter of 2009 were principally
affected by:
• Net premiums written and earned
Net premiums written and earned during the second quarter of 2009 decreased when compared to the second quarter of 2008 due to lower average premium yields which are a result of the shift in the mix of newer writings to loans with lower loan-to-value ratios,
higher FICO scores and full documentation, which carry lower premium rates and a
lower average insurance in force, offset by lower ceded premiums due to captive
terminations and run-offs.
• Investment income
Investment income in the second quarter of 2009 was higher when compared to
the second quarter of 2008 due to an increase in the average amortized cost of
invested assets, offset by a decrease in the pre-tax yield.
• Realized gains (losses)
Realized gains for the second quarter of 2009 included $23.9 million in net
realized gains on the sale of fixed income investments, offset by $9.4 million
in "other than temporary" impairment losses. Realized losses for the second
quarter of 2008 included $1.8 million in net realized losses on the sale of
fixed income investments, as well as $8.5 million in "other than temporary"
impairment losses.
• Losses incurred
Losses incurred for the second quarter of 2009 increased compared to the
second quarter of 2008 primarily due to a larger increase in the default
inventory. The default inventory increased by 16,519 delinquencies in the second
quarter of 2009, compared to an increase of 14,642 in the second quarter of
2008. The estimated severity remained relatively stable in the second quarter of
2009, but was higher than the comparable period in 2008. The estimated claim
rate remained flat in the second quarter of 2009 and 2008.
• Premium deficiency
During the second quarter of 2009 the premium deficiency reserve on Wall
Street bulk transactions declined by $62 million from $289 million, as of
March 31, 2009, to $227 million as of June 30, 2009. The decrease in the premium
deficiency represents the net result of actual premiums, losses and expenses as
well as a net change of $120 million in assumptions primarily related to lower
estimated ultimate losses, offset by lower estimated ultimate premiums. The
$227 million premium deficiency reserve as of June 30, 2009 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 second quarter of 2009 decreased when
compared to the same period in 2008. The decrease reflects our lower contract
underwriting volume as well as a reduction in headcount and a focus on expenses
in difficult market conditions.
• Interest expense
Interest expense for the second quarter of 2009 increased when compared to
the second quarter of 2008. The increase is primarily the result of interest on
our convertible debentures (interest on these debentures accrues even if we
defer the payment of interest). As discussed in Note 1 of the Consolidated
Financial Statements, we adopted FSP APB 14-1, "Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement)", on a retrospective basis, and our interest expense now reflects
our non-convertible debt borrowing rate on the convertible debentures of
approximately 19%. The increase in interest expense was partially offset by
reductions in interest expense due to the repurchase of some of our Senior Notes
due in 2011.
• Income from joint ventures
We had no income from joint ventures in the second quarter of 2009. Income
from joint ventures, net of tax, was $11.2 million in the second quarter of
2008. The income from joint ventures in 2008 was related to our interest in
Sherman that was sold in the third quarter of 2008.
• Provision (credit) for income tax
We provided income taxes of $1.4 million in the second quarter of 2009, compared to a credit for income taxes of $85.2 million in the second quarter of 2008. The income tax credit in the second quarter of 2009 was decreased due to the establishment of a valuation allowance for deferred taxes of $133.1 million.
Results of Consolidated Operations
New insurance written
The amount of our primary new insurance written during the three and six
months ended June 30, 2009 and 2008 was as follows:
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