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| MTG > SEC Filings for MTG > Form 10-Q on 9-Nov-2009 | All Recent SEC Filings |
9-Nov-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 "Fannie Mae and Freddie Mac" below.
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 September 30, 2009, MGIC's policyholders position exceeded the required
regulatory minimum by approximately $456 million, and we exceeded the required
minimum by approximately $543 million on a combined statutory basis. (The
combined figures give effect to reinsurance with subsidiaries of our holding
company.) At September 30, 2009 MGIC's risk-to-capital was 17.3:1 and was 19.7:1
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.
For some time, we have been working to implement a plan to write new mortgage
insurance in MGIC Indemnity Corporation ("MIC"), a wholly owned subsidiary of
MGIC. This plan is driven by our belief that MGIC will not meet regulatory
capital requirements in Wisconsin (which would prevent MGIC from writing new
business anywhere) or in certain jurisdictions (which would prevent MGIC from
writing business in the particular jurisdiction) and may not be able to obtain
appropriate waivers of these requirements. This could occur in the first 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. In addition
to Wisconsin, these capital requirements are present in 16 jurisdictions while
the remaining jurisdictions in which MGIC does business do not have specific
capital requirements applicable to mortgage insurers. Before MIC can begin
writing new business, the Office of the Commissioner of Insurance for the State
of Wisconsin ("OCI") must specifically authorize MIC to do so and MIC must
obtain or reactivate licenses in the jurisdictions where it will transact
business. In addition, as a practical matter, MIC's ability to write mortgage
insurance depends on being approved as an eligible mortgage insurer by Fannie
Mae and/or Freddie Mac (together, the "GSEs").
On October 14, 2009, we, MGIC and MIC entered into an agreement (the
"Agreement") with Fannie Mae under which MGIC agreed to contribute $200 million
to MIC and Fannie Mae approved MIC as an eligible mortgage insurer through
December 31, 2011 subject to the terms of the Agreement. The contribution to MIC
was made on October 21, 2009. Under the Agreement, MIC will be eligible to write
mortgage insurance only if the OCI grants MGIC a waiver from Wisconsin's capital
requirements and only in those 16 jurisdictions in which MGIC cannot write new
insurance due to MGIC's failure to meet regulatory capital requirements
applicable to mortgage insurers and if MGIC fails to obtain relief from those
requirements or a specified waiver of them. We expect MGIC will be able to
obtain waivers in a number of these jurisdictions such that MGIC, rather than
MIC, will write new business there. The Agreement, including certain
restrictions imposed on us, MGIC and MIC, is summarized more fully in, and
included as an exhibit to, our Form 8-K filed with the Securities and Exchange
Commission on October 16, 2009.
Under the Agreement, MIC has been approved as an eligible mortgage insurer by
Fannie Mae only though December 31, 2011. Whether MIC will continue as an
eligible mortgage insurer after that date will be determined by Fannie Mae's
mortgage insurer eligibility requirements then in effect. Further, under the
Agreement we cannot capitalize MIC with more than a $200 million contribution,
without prior approval from Fannie Mae, which limits the amount of business MIC
can write. We believe that the amount of capital that we have contributed to MIC
will be more than sufficient to write business for the term of the Agreement in
the jurisdictions in which, giving effect to our expectation that MGIC will
obtain waivers of regulatory capital requirements in certain jurisdictions as
referred to above, MIC is eligible to do so under the Agreement. There can be no
assurance, however, that in fact MIC's capital will be sufficient to permit this
level of writings.
We have been working closely with Freddie Mac to approve MIC as an eligible
mortgage insurer. Freddie Mac has informed us that they will need additional
analysis prior to approving MIC as an eligible mortgage insurer. This analysis
could take some time to complete. There can be no assurance that Freddie Mac
will approve MIC as an eligible mortgage insurer.
We are also working closely with the OCI to receive the approvals that MIC
requires to begin writing new insurance. While in July 2009 the OCI approved a
transaction under which we would have contributed more than $200 million to MIC
and MIC would have written mortgage insurance in all jurisdictions in place of
MGIC, the OCI has not approved the plan to write mortgage insurance through MIC
contemplated by the Agreement nor has it yet granted MGIC a waiver from the
regulatory capital requirements in Wisconsin. There can be no assurance that we
will be able to obtain, in a timely fashion or at all, the approvals from OCI
necessary to allow MGIC to continue to write new insurance or the approvals
necessary for MIC to write new insurance in any jurisdiction. Similarly, there
can be no assurances that MIC will receive the necessary approvals from any or
all of the jurisdictions in which MGIC would be prohibited from doing so due to
MGIC's failure to meet applicable regulatory capital requirements.
Depending on the level of losses that MGIC experiences in the future, it is
possible that regulatory action by one or more jurisdictions, including those
that do not have specific regulatory capital requirements applicable to mortgage
insurers, may prevent MGIC from continuing to write new insurance in some or all
of the jurisdictions in which MIC will not write business. It is also possible
that the OCI could take actions that would prohibit MGIC and/or MIC from writing
new business in any jurisdiction.
A failure to meet regulatory capital requirements does not mean that MGIC
does not have sufficient resources to pay claims on its insurance. Even in
scenarios in which losses materially exceed those that would result in not
meeting regulatory requirements, we believe that we have claims paying resources
at MGIC that exceed our claim obligations on our insurance in force. Our
estimates of our claims paying resources and claim obligations are based on
various assumptions, including our anticipated rescission activity.
Fannie Mae and Freddie Mac
In September 2008, the Federal Housing Finance Agency ("FHFA") was appointed
as the conservator of the GSEs. As their conservator, FHFA controls and directs
the operations of the GSEs. The appointment of FHFA as conservator, the
increasing role that the federal government has assumed in the residential
mortgage market, our industry's inability, due to capital constraints, to write
sufficient business to meet the needs of the GSEs or other factors may increase
the likelihood that the business practices of the GSEs change in ways that may
have a material adverse effect on us. In addition, these factors may increase
the likelihood that the charters of the GSEs are changed by new federal
legislation. Such changes may allow the GSEs to reduce or eliminate the level of
private mortgage insurance coverage that they use as credit enhancement. The
Obama administration has announced that it will announce its plans regarding the
future of the GSEs in early 2010.
For a number of years, the GSEs have had programs under which on certain
loans lenders could choose a mortgage insurance coverage percentage that was
only the minimum required by their charters, with the GSEs paying a lower price
for these loans ("charter coverage"). The GSEs have also had programs under
which on certain loans they would accept a level of mortgage insurance above the
requirements of their charters but below their standard coverage without any
decrease in the purchase price they would pay for these loans ("reduced
coverage"). In September 2009, Fannie Mae announced that, effective January 1,
2010, it would expand broadly the types of loans eligible for charter coverage.
Fannie Mae's announcement also said it would eliminate its reduced coverage
program in the second quarter of 2010. During the third quarter of 2009, a
majority of our volume has been on loans with GSE standard coverage, a
substantial portion of our volume has been on loans with reduced coverage, and a
minor portion of our volume has been on loans with charter coverage. We charge
higher premium rates for higher coverages. To the extent lenders selling loans
to Fannie Mae chose charter coverage for loans that we insure, our revenues
would be reduced and we could experience other adverse effects.
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, GSE programs that may reduce or eliminate the demand for mortgage insurance and other alternatives to mortgage insurance. New insurance written does not include loans previously insured by us which are modified, such as loans modified under the Home Affordable Refinance Program.
• 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 returned or expected to be returned in
connection with rescissions and premiums 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, including unemployment, 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, including unemployment, and other factors can affect this pattern. For example, a weak economy can lead to claims from older books increasing, 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" and "-Losses Incurred" 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 September 30, 2009 include
approximately $86.1 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 new guidance regarding the 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 September 30, 2009,
the convertible debentures are reflected as a liability on our consolidated
balance sheet at the current amortized value of $286.5 million, with the
unamortized discount reflected in equity.
• Income from joint ventures
During the period in which we held an equity interest in Sherman Financial
Group, 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 Third Quarter Results
Our results of operations in the third quarter of 2009 were principally
affected by:
• Net premiums written and earned
Net premiums written and earned during the third quarter of 2009 decreased
when compared to the third quarter of 2008 due to a lower average insurance in
force, due to reduced levels of new insurance written, and 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, offset by lower ceded premiums due to captive
terminations and run-offs. Our net premiums written and earned during the third
quarter of 2009 were also negatively impacted as a result of higher levels of
rescissions in the quarter as well as an increase in our estimate for expected
premium refunds due to an increase in our expected rescission levels.
• Investment income
Investment income in the third quarter of 2009 was lower when compared to the
third quarter of 2008 due to a decrease in the pre-tax yield, offset by an
increase in the average amortized cost of invested assets.
• Realized gains (losses) and other-than-temporary impairments
Realized gains for the third quarter of 2009 included $33.5 million in net
realized gains on the sale of fixed income investments. Realized gains for the
third quarter of 2008 included $62.8 million from the sale of our interest in
Sherman, which was offset by realized losses on sales of investments of
$3.2 million and other-than-temporary impairments on our investment portfolio of
$31.7 million.
• Losses incurred
Losses incurred for the third quarter of 2009 increased compared to the third quarter of 2008. The default inventory increased by 23,373 delinquencies in the third quarter of 2009, compared to an increase of 23,677 in the third quarter of 2008. The estimated severity remained relatively stable in the third quarter of 2009, but was higher than the comparable period in 2008. The estimated claim rate remained flat in the third quarter of 2009 and decreased in the third quarter of 2008.
• Premium deficiency
During the third quarter of 2009 the premium deficiency reserve on Wall
Street bulk transactions declined by $19 million from $227 million, as of
June 30, 2009, to $208 million as of September 30, 2009. The decrease in the
premium deficiency represents the net result of actual premiums, losses and
expenses as well as a net change in assumptions primarily related to lower
estimated premiums. The $208 million premium deficiency reserve as of
September 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 third 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 third quarter of 2009 decreased when compared to the
third quarter of 2008. The decrease is primarily the result of repaying the
$200 million credit facility in the second quarter of 2009 as well as the
repurchase, during 2009, of approximately $113.9 million of our Senior Notes due
in September 2011. These reductions were somewhat offset by an increase in
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 new guidance regarding accounting
for convertible debt instruments, on a retrospective basis, and our interest
expense now reflects our non-convertible debt borrowing rate on the convertible
debentures of approximately 19%.
• Income from joint ventures
We had no income from joint ventures in the third quarter of 2009. Income
from joint ventures, net of tax, was $3.3 million in the third 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 for (benefit) from income tax
We had a benefit from income taxes of $100.3 million in the third quarter of 2009, compared to a benefit from income taxes of $90.1 million in the third quarter of 2008. In the third quarter of 2009, our deferred tax asset valuation allowance decreased by the deferred tax liability related to $279.7 million of unrealized gains that were recorded to equity. This decrease in the valuation allowance resulted in a tax benefit of $100.3 million in the third quarter of 2009. Any tax credit on our operating losses is reduced due to the establishment of a valuation allowance for deferred taxes of $133.5 million.
Results of Consolidated Operations
New insurance written
The amount of our primary new insurance written during the three and nine
months ended September 30, 2009 and 2008 was as follows:
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