FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended SEPTEMBER 30, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 1-10816
MGIC INVESTMENT CORPORATION
(Exact name of registrant as specified in its charter)
WISCONSIN 39-1486475
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
250 E. KILBOURN AVENUE 53202
MILWAUKEE, WISCONSIN (Zip Code)
(Address of principal executive offices)
(414) 347-6480
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
---------- ----------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OF STOCK PAR VALUE DATE NUMBER OF SHARES
-------------- --------- ---- ----------------
Common stock $1.00 10/31/00 106,752,918
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MGIC INVESTMENT CORPORATION
TABLE OF CONTENTS
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheet as of
September 30, 2000 (Unaudited) and December 31, 1999 3
Consolidated Statement of Operations for the Three and Nine
Month Periods Ended September 30, 2000 and 1999 (Unaudited) 4
Consolidated Statement of Cash Flows for the Nine Months
Ended September 30, 2000 and 1999 (Unaudited) 5
Notes to Consolidated Financial Statements (Unaudited) 6-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-27
Item 3. Quantitative and Qualitative Disclosures About Market Risk 27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 27
Item 6. Exhibits and Reports on Form 8-K 28
SIGNATURES 29
INDEX TO EXHIBITS 30
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
September 30, 2000 (Unaudited) and December 31, 1999
<CAPTION>
September 30, December 31,
2000 1999
----------------- ----------------
ASSETS (In thousands of dollars)
------
<S> <C> <C>
Investment portfolio:
Securities, available-for-sale, at market value:
Fixed maturities $ 3,103,499 $ 2,666,562
Equity securities 16,553 15,426
Short-term investments 115,165 107,746
----------------- ----------------
Total investment portfolio 3,235,217 2,789,734
Cash 4,239 2,322
Accrued investment income 45,042 46,713
Reinsurance recoverable on loss reserves 34,878 35,821
Reinsurance recoverable on unearned premiums 9,096 6,630
Home office and equipment, net 31,255 32,880
Deferred insurance policy acquisition costs 25,970 22,350
Investments in joint ventures 130,932 101,545
Other assets 65,624 66,398
----------------- ----------------
Total assets $ 3,582,253 $ 3,104,393
================= ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Loss reserves $ 614,853 $ 641,978
Unearned premiums 182,440 181,378
Notes payable (note 2) 410,000 425,000
Other liabilities 122,339 80,048
----------------- ----------------
Total liabilities 1,329,632 1,328,404
----------------- ----------------
Contingencies (note 4) Shareholders' equity:
Common stock, $1 par value, shares authorized
300,000,000; shares issued 121,110,800;
shares outstanding, 9/30/00 - 106,486,712
12/31/99 - 105,798,034 121,111 121,111
Paid-in surplus 206,826 211,593
Treasury stock (shares at cost, 9/30/00 - 14,624,088
12/31/99 - 15,312,766) (635,772) (665,707)
Accumulated other comprehensive income - unrealized
appreciation (depreciation) in investments, net of tax 9,002 (40,735)
Retained earnings 2,551,454 2,149,727
----------------- ----------------
Total shareholders' equity 2,252,621 1,775,989
----------------- ----------------
Total liabilities and shareholders' equity $ 3,582,253 $ 3,104,393
================= ================
</TABLE>
See accompanying notes to consolidated financial statements.
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<TABLE>
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
Three and Nine Month Periods Ended September 30,
2000 and 1999
(Unaudited)
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------- -------------------------------
2000 1999 2000 1999
---- ---- ---- ----
(In thousands of dollars, except per share data)
<S> <C> <C> <C> <C>
Revenues:
Premiums written:
Direct $ 250,275 $ 214,997 $ 690,539 $ 604,332
Assumed 245 308 662 1,912
Ceded (14,312) (7,723) (34,859) (18,277)
------------- ----------------- ------------- -------------
Net premiums written 236,208 207,582 656,342 587,967
(Increase) decrease in unearned premiums (7,000) (7,540) 1,404 822
------------- ----------------- ------------- -------------
Net premiums earned 229,208 200,042 657,746 588,789
Investment income, net of expenses 46,125 39,303 129,465 114,845
Realized investment gains, net 422 48 585 3,401
Other revenue 6,963 10,990 30,259 39,946
------------- ----------------- ------------- -------------
Total revenues 282,718 250,383 818,055 746,981
------------- ----------------- ------------- -------------
Losses and expenses:
Losses incurred, net 21,442 19,533 66,597 94,706
Underwriting and other expenses, net 40,055 47,476 133,261 151,732
Interest expense 7,412 4,788 21,085 14,830
------------- ----------------- ------------- -------------
Total losses and expenses 68,909 71,797 220,943 261,268
------------- ----------------- ------------- -------------
Income before tax 213,809 178,586 597,112 485,713
Provision for income tax 67,454 55,677 187,434 149,452
------------- ----------------- ------------- -------------
Net income $ 146,355 $ 122,909 $ 409,678 $ 336,261
============= ================= ============= =============
Earnings per share (note 5):
Basic $ 1.38 $ 1.13 $ 3.86 $ 3.09
============= ================= ============= =============
Diluted $ 1.36 $ 1.11 $ 3.83 $ 3.06
============= ================= ============= =============
Weighted average common shares
outstanding - diluted (shares in
thousands, note 5) 107,339 110,261 107,065 109,993
============= ================= ============= =============
Dividends per share $ 0.025 $ 0.025 $ 0.075 $ 0.075
============= ================= ============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
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<TABLE>
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Nine Months Ended September 30, 2000 and 1999
(Unaudited)
<CAPTION>
Nine Months Ended
September 30,
--------------------------------------
2000 1999
---- ----
(In thousands of dollars)
<S> <C> <C>
Cash flows from operating activities:
Net income $ 409,678 $ 336,261
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of deferred insurance policy
acquisition costs 14,646 12,064
Increase in deferred insurance policy
acquisition costs (18,266) (10,624)
Depreciation and amortization 5,366 8,783
Decrease in accrued investment income 1,671 342
Decrease in reinsurance recoverable on loss reserves 943 6,060
(Increase) decrease in reinsurance recoverable
on unearned premiums (2,466) 1,838
Decrease in loss reserves (27,125) (8,234)
Increase (decrease) in unearned premiums 1,062 (2,658)
Equity earnings in joint ventures (15,892) (10,750)
Other 33,610 15,881
----------------- ----------------
Net cash provided by operating activities 403,227 348,963
----------------- ----------------
Cash flows from investing activities:
Purchase of equity securities (14,629) (13,770)
Purchase of fixed maturities (1,372,238) (928,418)
Additional investment in joint ventures (13,495) (20,587)
Proceeds from sale of equity securities 14,315 -
Proceeds from sale or maturity of fixed maturities 1,010,528 748,264
----------------- ----------------
Net cash used in investing activities (375,519) (214,511)
----------------- ----------------
Cash flows from financing activities:
Dividends paid to shareholders (7,951) (8,180)
Net decrease in notes payable (15,000) (31,000)
Reissuance of treasury stock 10,803 2,929
Repurchase of common stock (6,224) (150,000)
----------------- ----------------
Net cash used in financing activities (18,372) (186,251)
----------------- ----------------
Net increase (decrease) in cash and short-term investments 9,336 (51,799)
Cash and short-term investments at beginning of period 110,068 176,859
----------------- ----------------
Cash and short-term investments at end of period $ 119,404 $ 125,060
================= ================
</TABLE>
See accompanying notes to consolidated financial statements.
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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2000
(Unaudited)
Note 1 - Basis of presentation and summary of certain significant accounting
policies
The accompanying unaudited consolidated financial statements of MGIC
Investment Corporation (the "Company") and its wholly-owned subsidiaries have
been prepared in accordance with the instructions to Form 10-Q and do not
include all of the other information and disclosures required by generally
accepted accounting principles. These statements should be read in conjunction
with the consolidated financial statements and notes thereto for the year ended
December 31, 1999 included in the Company's Annual Report on Form 10-K for that
year.
The accompanying consolidated financial statements have not been audited
by independent accountants in accordance with generally accepted auditing
standards, but in the opinion of management such financial statements include
all adjustments, consisting only of normal recurring accruals, necessary to
summarize fairly the Company's financial position and results of operations. The
results of operations for the nine months ended September 30, 2000 may not be
indicative of the results that may be expected for the year ending December 31,
2000.
Deferred insurance policy acquisition costs
Costs associated with the acquisition of mortgage insurance business,
consisting of employee compensation and other policy issuance and underwriting
expenses, are initially deferred and reported as deferred acquisition costs
(DAC). Because SFAS 60 specifically excludes mortgage guaranty insurance from
its guidance relating to the amortization of DAC, amortization of these costs
for each underwriting year book of business are charged against revenue in
proportion to estimated gross profits over the life of the policies using the
guidance of SFAS 97, Accounting and Reporting by Insurance Enterprises For
Certain Long Duration Contracts and Realized Gains and Losses From the Sale of
Investments. This includes accruing interest on the unamortized balance of DAC.
The estimates for each underwriting year are updated annually to reflect actual
experience and any changes to key assumptions such as persistency or loss
development.
The Company amortized $3.9 million and $7.1 million of deferred
insurance policy acquisition costs during the three months ended September 30,
1999 and 2000, respectively, and amortized $12.1 million and $14.6 million
during the nine months ended September 30, 1999 and 2000, respectively. During
1997, 1998 and 1999, the Company
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amortized $21.4 million, $20.7 million and $16.8 million, respectively, of
deferred insurance policy acquisition costs.
Loss reserves
Reserves are established for reported insurance losses and loss
adjustment expenses based on when notices of default on insured mortgage loans
are received. Reserves are also established for estimated losses incurred on
notices of default not yet reported by the lender. Consistent with industry
practices, the Company does not establish loss reserves for future claims on
insured loans which are not currently in default. Reserves are established by
management using estimated claims rates and claims amounts in estimating the
ultimate loss. Amounts for salvage recoverable are considered in the
determination of the reserve estimates. Adjustments to reserve estimates are
reflected in the financial statements in the years in which the adjustments are
made. The liability for reinsurance assumed is based on information provided by
the ceding companies.
The incurred but not reported ("IBNR") reserves result from defaults
occurring prior to the close of an accounting period, but which have not been
reported to the Company. Consistent with reserves for reported defaults, IBNR
reserves are established using estimated claims rates and claims amounts for the
estimated number of defaults not reported.
Reserves also provide for the estimated costs of settling claims,
including legal and other expenses and general expenses of administering the
claims settlement process.
Income recognition
The insurance subsidiaries write policies which are guaranteed renewable
contracts at the insured's option on a single, annual or monthly premium basis.
The insurance subsidiaries have no ability to reunderwrite or reprice these
contracts. Premiums written on a single premium basis and an annual premium
basis are initially deferred as unearned premium reserve and earned over the
policy term. Premiums written on policies covering more than one year are
amortized over the policy life in accordance with the expiration of risk, which
is the anticipated claim payment pattern based on historical experience.
Premiums written on annual policies are earned on a monthly pro rata basis.
Premiums written on monthly policies are earned as coverage is provided.
Fee income of the non-insurance subsidiaries is earned and recognized as
the services are provided and the customer is obligated to pay.
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Note 2 - Notes payable
At September 30, 2000, the Company's outstanding balance of the notes
payable on the 1997, 1998 and 1999 credit facilities were $175 million, $200
million and $35 million, respectively, which approximated market value. The
remaining credit available under these facilities was $0, $0, and $65 million,
respectively. The interest rate on the notes payable varies based on LIBOR and
at September 30, 2000 and December 31, 1999 the weighted-average interest rate
was 6.82% and 6.17%, respectively. The weighted-average interest rate on the
notes payable for borrowings under the 1997, 1998 and 1999 credit agreements was
6.65% per annum for the nine months ended September 30, 2000.
During the nine months ended September 2000, the Company utilized three
interest rate swaps each with a notional amount of $100 million to reduce and
manage interest rate risk on a portion of the variable rate debt under the
credit facilities. With respect to all such transactions, the notional amount of
$100 million represents the stated principal balance used as a basis for
calculating payments. On the swaps, the Company receives and pays amounts based
on rates that can be fixed or variable depending on the terms negotiated. Two of
the swaps renew monthly and one renews quarterly, beginning in October 2000,
unless in each case the counterparty elects not to renew. Earnings during the
nine months ended September 2000 on the swaps of approximately $0.3 million are
netted against interest expense in the Consolidated Statement of Operations.
Any gain or loss arising from termination of an interest rate swap would
be deferred and amortized over the remaining life of the hedged item. The
Company did not terminate any interest rate swaps in the nine months ended
September 30, 2000 or in 1999, 1998 or 1997.
In June 2000, the Company filed a registration statement with the
Securities and Exchange Commission covering $500 million of senior debt
securities to be offered from time to time. Unless otherwise specified for a
particular offering, the net proceeds from the sale of these securities would be
used for general corporate purposes, including repayment of a portion of the
notes payable. See footnote 8.
Note 3 - Reinsurance
The Company cedes a portion of its business to reinsurers and records
assets for reinsurance recoverable on estimated reserves for unpaid losses and
unearned premiums. Business written between 1985 and 1993 is ceded under various
quota share reinsurance agreements with several reinsurers. The Company receives
a ceding commission in connection with this reinsurance. Beginning in 1997, the
Company has ceded business to captive reinsurance subsidiaries of certain
mortgage lenders primarily under excess of loss reinsurance agreements.
The reinsurance recoverable on loss reserves and the reinsurance
recoverable on unearned premiums primarily represent amounts recoverable from
large international
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reinsurers. The Company monitors the financial strength of its reinsurers
including their claims paying ability rating and does not currently anticipate
any collection problems. Generally, reinsurance recoverables on loss reserves
and unearned premiums are backed by trust funds or letters of credit. No
reinsurer represents more than $10 million of the aggregate amount recoverable.
Note 4 - Contingencies
The Company is involved in litigation in the ordinary course of
business. In the opinion of management, the ultimate resolution of this pending
litigation will not have a material adverse effect on the financial position or
results of operations of the Company.
In addition, the Company's Mortgage Guaranty Insurance Corporation
subsidiary ("MGIC") is a defendant in Downey et. al. v. MGIC, which is pending
in Federal District Court for the Southern District of Georgia and seeks class
action status on behalf of a nationwide class of home mortgage borrowers. The
complaint alleges that MGIC violated the Real Estate Settlement Procedures Act
by providing agency pool insurance and entering into other transactions with
lenders (including captive mortgage reinsurance and contract underwriting) that
were not properly priced, in return for the referral of mortgage insurance. The
complaint seeks damages of three times the amount of the mortgage insurance
premiums that have been paid and that will be paid at the time of judgment for
the mortgage insurance found to be involved in a violation of the Real Estate
Settlement Procedures Act. The complaint also seeks injunctive relief, including
prohibiting MGIC from receiving future premium payments. MGIC has answered the
complaint and denied liability. In August 2000, the Court granted a motion for
summary judgment and dismissed three similar cases brought against other private
mortgage insurers on the ground that the McCarran-Ferguson Act barred the Real
Estate Settlement Procedures Act claims brought by the individual plaintiffs in
those actions. On November 3, 2000, MGIC filed a motion for judgment on the
pleadings on McCarran-Ferguson Act grounds in the case pending against MGIC.
There can be no assurance, however, that the ultimate outcome of the litigation
will not materially affect the Company's financial position or results of
operations.
Note 5 - Earnings per share
The Company's basic and diluted earnings per share ("EPS") have been
calculated in accordance with Statement of Financial Accounting Standards No.
128, Earnings Per Share ("SFAS 128"). The following is a reconciliation of the
weighted-average number of shares used for basic EPS and diluted EPS.
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<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------- --------------
2000 1999 2000 1999
---- ---- ---- ----
(Shares in thousands)
<S> <C> <C> <C> <C>
Weighted-average shares - Basic EPS 106,334 108,533 106,036 108,863
Common stock equivalents 1,005 1,728 1,029 1,130
---------- -------- ------- --------
Weighted-average shares - Diluted EPS 107,339 110,261 107,065 109,993
======= ======= ======= =======
</TABLE>
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Note 6 - Comprehensive income
The Company's total comprehensive income, as calculated per Statement of
Financial Accounting Standards No. 130, Reporting Comprehensive Income, was as
follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- --------------------
2000 1999 2000 1999
---- ---- ---- ----
(In thousands of dollars)
<S> <C> <C> <C> <C>
Net income $146,355 $122,909 $409,678 $336,261
Other comprehensive gain (loss) 19,524 (27,666) 49,737 (102,476)
---------- ---------- ---------- --------
Total comprehensive income $165,879 $ 95,243 $459,415 $233,785
======== ========= ======== ========
</TABLE>
The difference between the Company's net income and total comprehensive
income for the three and nine months ended September 30, 2000 and 1999 is due to
the change in unrealized appreciation/depreciation on investments, net of tax.
Note 7 - New accounting standards
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities ("SFAS 133"), which will be effective for all fiscal
quarters of all fiscal years beginning after June 15, 2000. The statement
establishes accounting and reporting standards for derivative instruments and
for hedging activities. Management does not anticipate the adoption of SFAS 133
will have a significant effect on the Company's results of operations or its
financial position due to its limited use of derivative instruments. (See note
2.)
Note 8 - Subsequent events
On October 20, 2000, the Company issued $200 million principal amount of 7-1/2%
Senior Notes due 2005 under its $500 million SEC shelf registration statement.
The Notes are senior unsecured and were rated A1 by Moody's and A+ by S&P. The
Company received net proceeds before expenses of approximately $198,018,000. The
net proceeds will be used to pay off all the 1997 bank revolving credit facility
with the balance used to partially pay down the 1998 bank revolving credit
facility.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Consolidated Operations
Three Months Ended September 30, 2000 Compared With Three Months Ended September
30, 1999
Net income for the three months ended September 30, 2000 was $146.4
million, compared to $122.9 million for the same period of 1999, an increase of
19%. Diluted earnings per share for the three months ended September 30, 2000
was $1.36 compared with $1.11 in the same period last year, an increase of 23%.
As used in this report, the term "Company" means the Company and its
consolidated subsidiaries, which do not include joint ventures in which the
Company has an equity interest.
Total revenues for the third quarter 2000 were $282.7 million, an
increase of 13% from the $250.4 million for the third quarter 1999. This
increase was primarily attributed to an improvement in persistency, which
generated an increase in renewal premiums. Also contributing to the increase in
revenues was an increase in investment income resulting from strong cash flows.
See below for a further discussion of premiums and investment income.
Losses and expenses for the third quarter were $68.9 million, a decrease
of 4% from $71.8 million for the same period of 1999. The decrease was primarily
attributed to a decline in underwriting expenses resulting from a decline in
contract underwriting activity and an increase in deferred insurance policy
acquisition costs. See below for a further discussion of losses incurred and
underwriting expenses.
The amount of new primary insurance written by MGIC during the three
months ended September 30, 2000 was $12.7 billion, which included a one-time
$2.6 billion bulk transaction referred to below, compared to $13.1 billion in
the same period of 1999. The decline in new primary insurance written
principally reflected the decline in refinancing activity, which accounted for
11% of new primary insurance written in the third quarter of 2000, compared to
16% in the third quarter of 1999.
The $12.7 billion of new primary insurance written during the third
quarter of 2000 was offset by the cancellation of $7.6 billion of insurance in
force, and resulted in a net increase of $5.1 billion in primary insurance in
force, compared to new primary insurance written of $13.1 billion, the
cancellation of $8.2 billion of insurance in force and a net increase of $4.9
billion in primary insurance in force during the third quarter of 1999. Direct
primary insurance in force was $157.0 billion at September 30, 2000 compared to
$147.6 billion at December 31, 1999 and $145.1 billion at September 30, 1999. In
addition to providing direct primary insurance coverage, the Company also
insures pools of mortgage loans. New pool risk written during the three months
ended September 30, 2000 and September 30, 1999, which was virtually all agency
pool insurance, was $87
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million and $125 million, respectively. The Company's direct pool risk in force
was $1.8 billion at September 30, 2000 and $1.6 billion at December 31, 1999.
Cancellation activity has historically been affected by the level of
mortgage interest rates, with cancellations generally moving inversely to the
change in the direction of interest rates. Cancellations continued to decrease
during the third quarter of 2000 compared to the cancellation levels of 1999 due
to the higher mortgage interest rate environment which resulted in an increase
in the MGIC persistency rate (percentage of insurance remaining in force from
one year prior) to 80.3% at September 30, 2000 from 72.9% at December 31, 1999
and 69.1% at September 30, 1999. Future cancellation activity could be somewhat
higher than it otherwise would have been as a result of legislation that went
into effect in July 1999 regarding cancellation of mortgage insurance.
Cancellation activity could also increase as more of the Company's insurance in
force is represented by subprime loans, which the Company anticipates will have
materially lower persistency than the Company's prime business.
New insurance written for adjustable rate mortgages ("ARMs") was 9% of
new insurance written for both the third quarter of 2000 and for the same period
in 1999. New insurance written for mortgages with loan-to-value ("LTV") ratios
in excess of 90% but not more than 95% ("95s") was 43% of new insurance written
during the third quarter of 2000 compared to 42% in the third quarter a year
ago.
Principally as a result of changes in coverage requirements by Fannie
Mae and Freddie Mac (described below), new insurance written for mortgages with
reduced coverage (coverage of 17% for 90s (mortgages with LTV ratios in excess
of 85% but not more than 90%) and coverage of 25% for 95s) increased to 16% of
new insurance written in the third quarter of 2000 compared to 10% a year ago.
New insurance written for mortgages with deep coverage (coverage of 25% for 90s
and coverage of 30% for 95s) declined to 61% of new insurance written in the
third quarter of 2000 compared to 66% a year ago.
New insurance written for subprime mortgages (in general, mortgages that
would not meet the standard underwriting guidelines of Fannie Mae and Freddie
Mac for prime mortgages due to credit quality, documentation, or other factors,
such as in a refinance transaction exceeding a specified increase in the amount
of the mortgage debt due to cash being paid to the borrower) was 28% of new
insurance written during the third quarter of 2000 compared to 17% for the same
period a year ago. The subprime new insurance written for the third quarter of
2000 included $2.9 billion in bulk transactions. The Company expects that
subprime loans will have delinquency and default rates in excess of those on the
Company's prime business. While the Company believes it has priced its subprime
business to generate acceptable returns, there can be no assurance that the
assumptions underlying the premium rates adequately address the risk of this
business.
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During the third quarter of 2000, the Company began to insure mortgages
with LTVs of up to 103%.
Net premiums written increased 14% to $236.2 million during the third
quarter of 2000, from $207.6 million during the third quarter of 1999. Net
premiums earned increased 15% to $229.2 million for the third quarter of 2000
from $200.0 million for the same period in 1999. The increases were primarily a
result of the growth in insurance in force and a higher percentage of renewal
premiums on products with higher premium rates offset in part by an increase in
ceded premiums to $14.3 million in the third quarter of 2000 compared to $7.7
million during the same period a year ago, primarily due to an increase in
captive mortgage reinsurance.
During the first quarter of 1999, Fannie Mae and Freddie Mac changed
their mortgage insurance requirements for certain mortgages approved by their
automated underwriting services. The changes permit lower coverage percentages
on these loans than the deeper coverage percentages that went into effect in
1995. MGIC's premium rates vary with the depth of coverage. While lower coverage
percentages result in lower premium revenue, lower coverage percentages should
also result in lower incurred losses at the same level of claim incidence.
MGIC's results could also be affected to the extent Fannie Mae and Freddie Mac
are compensated for assuming default risk that would otherwise be insured by
MGIC. Fannie Mae and Freddie Mac have programs under which a delivery fee is
paid to them, with mortgage insurance coverage reduced below the coverage that
would be required in the absence of the delivery fee.
In partnership with mortgage insurers, Fannie Mae and Freddie Mac are
also beginning to offer programs under which, on delivery of an insured loan to
Fannie Mae or Freddie Mac, the primary coverage is restructured to an initial
shallow tier of coverage followed by a second tier that is subject to an overall
loss limit and, depending on the program, some compensation may be paid for
services. Because lenders receive guaranty fee relief from Fannie Mae and
Freddie Mac on mortgages delivered with these restructured coverages,
participation in these programs is competitively significant to mortgage
insurers.
In March 1999, the Office of Federal Housing Enterprise Oversight
("OFHEO") released a proposed risk-based capital stress test for Fannie Mae and
Freddie Mac. One of the elements of the proposed stress test is that future
claim payments made by a private mortgage insurer on Fannie Mae or Freddie Mac
loans are reduced below the amount provided by the mortgage insurance policy to
reflect the risk that the insurer will fail to pay. Claim payments from an
insurer whose claims-paying ability rating is "AAA" are subject to a 10%
reduction over the 10-year period of the stress test, while claim payments from
a "AA" rated insurer, such as MGIC, are subject to a 20% reduction. The effect
of the differentiation among insurers is to require Fannie Mae and Freddie Mac
to have additional capital for coverage on loans provided by a private mortgage
insurer whose claims-paying rating is less than "AAA." As a result, if adopted
as proposed, there is an incentive for Fannie Mae and Freddie Mac to use private
mortgage
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insurance provided by a "AAA" rated insurer. The Company does not believe there
should be a reduction in claim payments from private mortgage insurance nor
should there be a distinction between "AAA" and "AA" rated private mortgage
insurers. The proposed stress test covers many topics in addition to capital
credit for private mortgage insurance and is not expected to become final for
some time. If the stress test ultimately gives Fannie Mae and Freddie Mac an
incentive to use "AAA" mortgage insurance, MGIC may need "AAA" capacity, which
in turn would entail using capital to support such a facility as well as
additional expenses. The Company cannot predict whether the portion of the
stress test discussed above will be adopted in its present form.
Mortgages (newly insured during the nine months ended September 30,
2000 or in previous periods) approximating 35% of MGIC's new insurance written
(excluding bulk transactions) during the third quarter of 2000 were subject to
captive mortgage reinsurance and similar arrangements compared to 44% during the
same period in 1999. Captive mortgage reinsurance arrangements entered into
during a reporting period customarily include loans newly insured in a prior
reporting period. As a result, the percentages cited above would be lower if
only the current reporting period's newly insured mortgages subject to such
arrangements were included. The percentage of new insurance written subject to
captive mortgage reinsurance for the third quarter of 2000 was lower than the
same period in 1999 because the volume of loans insured in a prior reporting
period included in captive reinsurance arrangements during the third quarter of
1999 was greater than such volume in the third quarter of 2000. At September 30,
2000, approximately 19% of MGIC's risk in force was subject to captive
reinsurance and similar arrangements compared to 15% at December 31, 1999. The
Company expects that in 2001 the percentage of new insurance written, after
adjusting for loans insured in a prior reporting period, and the percentage of
risk in force subject to captive reinsurance arrangement, will increase. The
complaint in the litigation regarding the Real Estate Settlement Procedure Act
referred to in note 4 of the notes to the consolidated financial statements
alleges that MGIC pays "inflated" captive mortgage reinsurance premiums in
violation of the Real Estate Settlement Procedure Act .
Investment income for the third quarter of 2000 was $46.1 million, an
increase of 17% over the $39.3 million in the third quarter of 1999. This
increase was the result of increases in the amortized cost of average invested
assets to $3.1 billion for the third quarter of 2000 from $2.8 billion for the
third quarter of 1999, an increase of 13%, and an increase in the investment
yield. The portfolio's average pre-tax investment yield was 6.0% for the third
quarter of 2000 and 5.5% for the same period in 1999. The portfolio's average
after-tax investment yield was 5.0% for the third quarter of 2000 and 4.7% for
the same period in 1999. The Company's net realized gains were $0.4 million for
the three months ended September 30, 2000 compared to net realized gains of $48
thousand during the same period in 1999 resulting primarily from the sale of
fixed maturities.
Other revenue, which is composed of various components, was $7.0 million
for the third quarter of 2000, compared with $11.0 million for the same period
in 1999. The
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decrease is primarily the result of a decrease in contract underwriting revenue,
the expiration in December 1999 of a contract with a government agency for
premium reconciliation services and a decrease in equity earnings from
Credit-Based Asset Servicing and Securitization LLC ("C-BASS"), a joint venture
with Enhance Financial Services Group Inc. ("Enhance"), partially offset by a
decrease in equity losses from Customers Forever LLC ("Customers Forever"), a
joint venture with Marshall & Ilsley Corporation consummated in the third
quarter of 1999, and equity earnings (compared to a loss in the prior period)
from Sherman Financial Group LLC ("Sherman"), also a joint venture with Enhance.
On September 28, 2000, Enhance announced that it had entered into a definitive
agreement to sell its interest in C-BASS to Residential Funding Corporation.
In accordance with generally accepted accounting principles, each
quarter C-BASS is required to estimate the value of its mortgage-related assets
and recognize in earnings the resulting net unrealized gains and losses.
Including open trades, C-BASS's mortgage-related assets were $955 million at
September 30, 2000 and are expected to increase in the future. Substantially all
of C-BASS's mortgage-related assets do not have readily ascertainable market
values and, as a result, their value for financial statement purposes is
estimated by the management of C-BASS. Market value adjustments could impact the
Company's share of C-BASS's results of operations.
A substantial portion of Sherman's consolidated assets are investments
in receivable portfolios that do not have readily ascertainable market values
and, as a result, their value for financial statements purposes is estimated by
the management of Sherman. Market value adjustments could impact the Company's
share of Sherman's results of operations.
Net losses incurred increased 10% to $21.4 million during the third
quarter of 2000 from $19.5 million during the same period in 1999. The increase
from a year ago was primarily attributable to an increase in new notices offset
by generally strong economic conditions, including in California, and a related
decline in losses paid. The default rate at September 30, 2000 was 1.94%
(excluding subprime), compared to 2.03% at December 31, 1999, and the primary
notice inventory increased from 29,761 at December 31, 1999 to 31,095 at
September 30, 2000. The average primary claim paid during the third quarter was
$19,500 compared to $19,200 in the third quarter of 1999. The pool notice
inventory increased from 11,638 at December 31, 1999 to 14,883 at September 30,
2000. The redundancy in loss reserves in the third quarter of 2000 was
relatively consistent with that experienced in the third quarter of 1999.
At September 30, 2000, 73% of MGIC's insurance in force was written
subsequent to December 31, 1996. The highest claim frequency years have
typically been the third through fifth year after the year of loan origination.
However, the pattern of claims frequency for refinance loans (which accounted
for 25% and 31% of total new insurance written for the years ended December 31,
1999 and 1998, respectively) may be different from the historical pattern of
other loans.
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Underwriting and other expenses decreased to $40.1 million in the third
quarter of 2000 from $47.5 million in the same period of 1999, a decrease of
16%. This decrease was primarily due to decreases in contract underwriting and
an increase in deferred insurance policy acquisition costs.
Interest expense increased to $7.4 million in the third quarter of 2000
from $4.8 million during the same period in 1999 primarily due to a higher
weighted-average interest rate on the notes payable balance and lower earnings
on interest rate swap transactions (discussed below) during the three months
ended September 30, 2000 compared to the comparable period in 1999.
The Company utilized financial derivative transactions during the third
quarter of 2000 and 1999 consisting of interest rate swaps to reduce and manage
interest rate risk on its notes payable. During the third quarter of 2000,
earnings on such transactions aggregated approximately a $0.1 million loss
compared to a $1.2 million gain a year ago and were netted against interest
expense. See note 2 to the consolidated financial statements.
The consolidated insurance operations loss ratio was 9.4% for the third
quarter of 2000 compared to 9.8% for the third quarter of 1999. The consolidated
insurance operations expense and combined ratios were 13.8% and 23.2%,
respectively, for the third quarter of 2000 compared to 17.9% and 27.7% for the
third quarter of 1999.
The effective tax rate was 31.5% in the third quarter of 2000, compared
to 31.2% in the third quarter of 1999. During both periods, the effective tax
rate was below the statutory rate of 35%, reflecting the benefits of
tax-preferenced investment income. The higher effective tax rate in 2000
resulted from a lower percentage of total income before tax being generated from
the tax-preferenced investments.
Nine Months Ended September 30, 2000 Compared With Nine Months Ended September
30, 1999
Net income for the nine months ended September 30, 2000 was $409.7
million, compared to $336.3 million for the same period of 1999, an increase of
22%. Diluted earnings per share for the nine months ended September 30, 2000 was
$3.83 compared with $3.06 in the same period last year, an increase of 25%. The
1999 diluted earnings per share included $0.02 for realized gains.
Total revenues through September 30, 2000 were $818.1 million, an
increase of 10% from the $747.0 million for the same period in 1999. This
increase was primarily attributed to an improvement in persistency, which
generated an increase in renewal premiums. Also contributing to the increase in
revenues was an increase in investment income resulting from strong cash flows.
See below for a further discussion of premiums and investment income.
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Losses and expenses through September 30, 2000 were $220.9 million, a
decrease of 15% from $261.3 million for the same period of 1999. This decrease
was primarily attributed to a decrease in losses incurred resulting from
generally strong economic conditions and a decline in underwriting expenses
resulting from a decline in contract underwriting activity and an increase in
deferred insurance policy acquisition costs. See below for a further discussion
of losses incurred and underwriting expenses.
The amount of new primary insurance written by MGIC during the nine
months ended September 30, 2000 was $30.7 billion, which included $4.8 billion
in bulk transactions referred to below, compared to $37.2 billion in the same
period in 1999. The decline in new primary insurance written principally
reflected the decline in refinancing activity, which accounted for 13% of new
primary insurance written during the nine months ended September 30, 2000,
compared to 28% during the comparable period of 1999.
The $30.7 billion of new primary insurance written during the nine
months ended September 30, 2000 was offset by the cancellation of $21.3 billion
of insurance in force, and resulted in a net increase of $9.4 billion in primary
insurance in force, compared to new primary insurance written of $37.2 billion,
the cancellation of $30.1 billion of insurance in force and a net increase of
$7.1 billion in primary insurance in force during the same period in 1999.
Direct primary insurance in force was $157.0 billion at September 30, 2000
compared to $147.6 billion at December 31, 1999 and $145.1 billion at September
30, 1999. In addition to providing direct primary insurance coverage, the
Company also insures pools of mortgage loans. New pool risk written during the
nine months ended September 30, 2000 and September 30, 1999, which was virtually
all agency pool insurance, was $270 million and $499 million, respectively. The
Company's direct pool risk in force was $1.8 billion at September 30, 2000 and
$1.6 billion at December 31, 1999.
Cancellation activity has historically been affected by the level of
mortgage interest rates, with cancellations generally moving inversely to the
change in the direction of interest rates. Cancellations continued to decrease
during the third quarter of 2000 compared to the cancellation levels of 1999 due
to the higher mortgage interest rate environment which resulted in an increase
in the MGIC persistency rate (percentage of insurance remaining in force from
one year prior) to 80.3% at September 30, 2000 from 72.9% at December 31, 1999
and 69.1% at September 30, 1999. Future cancellation activity could be somewhat
higher than it otherwise would have been as a result of legislation that went
into effect in July 1999 regarding cancellation of mortgage insurance.
Cancellation activity could also increase as more of the Company's insurance in
force is represented by subprime loans, which the Company anticipates will have
materially lower persistency than the Company's prime business.
New insurance written for ARMs increased to 11% of new insurance written
during the first nine months of 2000 from 6% of new insurance written during the
same period in
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1999 as a result of higher mortgage interest rates on fixed rate mortgage loans.
New insurance written for mortgages with LTV ratios in excess of 90% but not
more than 95% (95s) were 42% of new insurance written during the first nine
months of 2000 compared to 37% in the same period a year ago, as a result of
declining refinancing activity during 2000.
Principally as a result of changes in coverage requirements by Fannie
Mae and Freddie Mac new insurance written for mortgages with reduced coverage
(coverage of 17% for 90s (mortgages with LTV ratios in excess of 85% but not
more than 90%) and coverage of 25% for 95s) increased to 14% of new insurance
written through September 30, 2000 compared to 7% a year ago. New insurance
written for mortgages with deep coverage (coverage of 25% for 90s and coverage
of 30% for 95s) declined to 62% of new insurance written in the first nine
months of 2000 compared to 68% a year ago.
New insurance written for subprime mortgages (in general, mortgages that
would not meet the standard underwriting guidelines of Fannie Mae and Freddie
Mac for prime mortgages due to credit quality, documentation, or other factors,
such as in a refinance transaction exceeding a specified increase in the amount
of the mortgage debt due to cash being paid to the borrower) was 21% of new
insurance written during the first nine months of 2000 compared to 8% for the
same period a year ago. The subprime new insurance written through September
included $4.8 billion in bulk transactions. The Company expects that subprime
loans will have delinquency and default rates in excess of those on the
Company's prime business. While the Company believes it has priced its subprime
business to generate acceptable returns, there can be no assurance that the
assumptions underlying the premium rates adequately address the risk of this
business.
During the third quarter of 2000, the Company began to insure mortgages
with LTVs of up to 103%.
Net premiums written increased 12% to $656.3 million during the first
nine months of 2000, from $588.0 million during the same period in 1999. Net
premiums earned increased 12% to $657.7 million for the first nine months of
2000 from $588.8 million for the same period in 1999. The increases were
primarily a result of the growth in insurance in force and a higher percentage
of renewal premiums on products with higher premium rates offset in part by an
increase in ceded premiums to $34.9 million through September 30, 2000 compared
to $18.3 million during the same period a year ago, primarily due to an increase
in captive mortgage reinsurance.
For a discussion of certain programs with Fannie Mae and Freddie Mac
regarding reduced mortgage insurance requirements and for a discussion of
proposed capital regulations for Fannie Mae and Freddie Mac, see third quarter
discussion.
Mortgages (newly insured during the nine months ended September 30, 2000
or in previous periods) equal to approximately 35% of MGIC's new insurance
written (excluding bulk transactions) during the first nine months of 2000 were
subject to captive
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mortgage reinsurance and similar arrangements compared to 33% during the same
period in 1999. Such arrangements entered into during a reporting period
customarily include loans newly insured in a prior reporting period. As a
result, the percentages cited above would be lower if only the current reporting
period's newly insured mortgages subject to such arrangements were included. At
September 30, 2000, approximately 19% of MGIC's risk in force was subject to
captive reinsurance and similar arrangements compared to 15% at December 31,
1999. In a February 1999 circular letter, the New York Department of Insurance
said it was in the process of developing guidelines that would articulate the
parameters under which captive mortgage reinsurance is permissible under New
York insurance law. The complaint in the Real Estate Settlement Procedures Act
litigation referred to in note 4 of the notes to the consolidated financial
statements alleges that MGIC pays "inflated" captive mortgage reinsurance
premiums in violation of Real Estate Settlement Procedures Act.
Investment income for the first nine months of 2000 was $129.5 million,
an increase of 13% over the $114.8 million in the same period of 1999. This
increase was the result of increases in the amortized cost of average invested
assets to $3.0 billion at September 30, 2000 from $2.7 billion at September 30,
1999, an increase of 12%, and an increase in the investment yield. The
portfolio's average pre-tax investment yield was 6.0% through September 30, 2000
and 5.5% for the same period in 1999. The portfolio's average after-tax
investment yield was 4.9% through September 30, 2000 and 4.7% for the same
period in 1999. The Company's net realized gains were $0.6 million during the
nine months ended September 30, 2000 compared to net realized gains of $3.4
million during the same period in 1999 resulting primarily from the sale of
fixed maturities.
Other revenue, which is composed of various components, was $30.3
million for the nine months ended September 30, 2000, compared with $39.9
million for the same period in 1999. The decrease is primarily the result of a
decrease in contract underwriting revenue, the expiration in December 1999 of a
contract with a government agency for premium reconciliation services and an
increase in equity losses from Customers Forever, a joint venture with Marshall
& Ilsley Corporation consummated in the third quarter of 1999, partially offset
by an increase in equity earnings from C-BASS and a decrease in equity losses
from Sherman, both joint ventures with Enhance. On September 28, 2000, Enhance
announced that it had entered into a definitive agreement to sell its interest
in C-BASS to Residential Funding Corporation.
In accordance with generally accepted accounting principles, each
quarter C-BASS is required to estimate the value of its mortgage-related assets
and recognize in earnings the resulting net unrealized gains and losses.
Including open trades, C-BASS's mortgage-related assets were $955 million at
September 30, 2000 and are expected to increase in the future. Substantially all
of C-BASS's mortgage-related assets do not have readily ascertainable market
values and, as a result, their value for financial statement purposes is
estimated by the management of C-BASS. Market value adjustments could impact the
Company's share of C-BASS's results of operations.
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A substantial portion of Sherman's consolidated assets are investments
in receivable portfolios that do not have readily ascertainable market values
and, as a result, their value for financial statements purposes is estimated by
the management of Sherman. Market value adjustments could impact the Company's
share of Sherman's results of operations.
Net losses incurred decreased 30% to $66.6 million during the nine
months ended September 30, 2000 from $94.7 million during the same period in
1999. The decline from a year ago was primarily attributed to generally strong
economic conditions, including California, and a related decline in losses paid
which was offset by an increase in the notice inventory. The default rate at
September 30, 2000 was 1.94% (excluding subprime), compared to 2.03% at December
31, 1999, and the primary notice inventory increased from 29,761 at December 31,
1999 to 31,095 at September 30, 2000. The average primary claim paid through
September 30, 2000 was $19,100, compared to the $19,600 for the same period in
1999. The pool notice inventory increased from 11,638 at December 31, 1999 to
14,883 at September 30, 2000. The redundancy in loss reserves in 2000 was
relatively consistent with the same period in 1999.
At September 30, 2000, 73% of MGIC's insurance in force was written
subsequent to December 31, 1996. The highest claim frequency years have
typically been the third through fifth year after the year of loan origination.
However, the pattern of claims frequency for refinance loans (which accounted
for 25% and 31% of total new insurance written for the years ended December 31,
1999 and 1998, respectively) may be different from the historical pattern of
other loans.
Underwriting and other expenses decreased to $133.3 million in the first
nine months of 2000 from $151.7 million in the same period of 1999, a decrease
of 12%. This decrease was primarily due to decreases in contract underwriting
and an increase in deferred insurance policy acquisition costs.
Interest expense increased to $21.1 million through September 30, 2000
from $14.8 million during the same period in 1999 primarily due to a higher
weighted-average interest rate on the notes payable balance and lower earnings
on interest rate swap transactions (discussed below) during the nine months
ended September 30, 2000 compared to the comparable period in 1999.
The Company utilized financial derivative transactions during the first
nine months of 2000 and 1999 consisting of interest rate swaps to reduce and
manage interest rate risk on its notes payable. During the first half of 2000,
earnings on such transactions aggregated approximately $0.3 million compared to
$3.0 million a year ago and were netted against interest expense. See note 2 to
the consolidated financial statements.
The consolidated insurance operations loss ratio was 10.1% for the first
nine months of 2000 compared to 16.1% for the same period in 1999. The
consolidated insurance operations expense and combined ratios were 17.0% and
27.1%, respectively,
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for the nine months ended September 30, 2000 compared to 20.3% and 36.4% for the
same period in 1999.
The effective tax rate was 31.4% for the nine months ended September 30,
2000, compared to 30.8% for the same period in 1999. During both periods, the
effective tax rate was below the statutory rate of 35%, reflecting the benefits
of tax-preferenced investment income. The higher effective tax rate in 2000
resulted from a lower percentage of total income before tax being generated from
the tax-preferenced investments.
Liquidity and Capital Resources
The Company's consolidated sources of funds consist primarily of
premiums written and investment income. The Company generated positive cash
flows from operating activities of $403.2 million for the nine months ended
September 30, 2000. Funds are applied primarily to the payment of claims and
expenses. The Company's business does not require significant capital
expenditures on an ongoing basis. Positive cash flows are invested pending
future payments of claims and other expenses; cash flow shortfalls, if any,
could be funded through sales of short-term investments and other investment
portfolio securities.
Consolidated total investments were $3.2 billion at September 30, 2000,
compared to $2.8 billion at December 31, 1999, an increase of 16%. The increase
was due to additional funds invested in the portfolio and an increase in market
values. The investment portfolio includes an unrealized gain on securities
marked to market of $13.8 million at September 30, 2000 and an unrealized loss
of $62.7 million at December 31, 1999. As of September 30, 2000, the Company had
$115.2 million of short-term investments with maturities of 90 days or less. In
addition, at September 30, 2000, based on amortized cost, the Company's fixed
income securities, were approximately 98% invested in "A" rated and above,
readily marketable securities, concentrated in maturities of less than 15 years.
At September 30, 2000, the Company's investment in preferred stock, which is
classified as fixed maturities, was $73.5 million. The Company had no preferred
stock at December 31, 1999.
The Company's investments in C-BASS, Sherman and Customers Forever
("joint ventures") increased $29.4 million from $101.5 million at December 31,
1999 to $130.9 million at September 30, 2000 as a result of additional net
investments of $13.5 million and equity earnings of $15.9 million. MGIC is
guaranteeing one half of a $50 million credit facility for Sherman that is
scheduled to expire in December 2000. The Company expects that it will provide
additional funding to the joint ventures.
Consolidated loss reserves decreased to $614.9 million at September 30,
2000 from $642.0 million at December 31, 1999 primarily due to generally strong
economic conditions, including California and a related decline in losses paid.
Consistent with
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industry practices, the Company does not establish loss reserves for future
claims on insured loans which are not currently in default.
Consolidated unearned premiums were $182.4 million at September 30,
2000, which approximates the balance at December 31, 1999. Reinsurance
recoverable on unearned premiums increased $2.5 million to $9.1 million at
September 30, 2000 from $6.6 million at December 31, 1999, primarily reflecting
the increase in captive mortgage reinsurance.
Consolidated shareholders' equity increased to $2.3 billion at September
30, 2000, from $1.8 billion at December 31, 1999, an increase of 27%. This
increase consisted of $409.7 million of net income during the first nine months
of 2000, net unrealized gains on investments of $49.7 million, net of tax, and
$31.4 million from the reissuance of treasury stock offset in part by
approximately $6.2 million expended for the repurchase of the Company's common
stock and dividends declared of $8.0 million.
During the first quarter of 2000, the Company repurchased approximately
143,000 shares of its common stock at a total cost of approximately $6.2
million. Funds to repurchase the shares were primarily provided by cash flow and
bank borrowings. The Company cannot predict whether it will repurchase
additional shares in the future.
For information about the Company's sale of $200 million principal
amount of 7-1/2% Senior Notes due 2005, see Note 8--Subsequent Events of the
Notes to the Consolidated Financial Statements.
MGIC is the principal insurance subsidiary of the Company. MGIC's
risk-to-capital ratio was 10.8:1 at September 30, 2000 compared to 11.9:1 at
December 31, 1999. The decrease was due to MGIC's increased policyholders'
reserves, partially offset by the net additional risk in force of $2.2 billion,
net of reinsurance, during the first nine months of 2000.
The Company's combined insurance risk-to-capital ratio was 11.6:1 at
September 30, 2000, compared to 12.9:1 at December 31, 1999. The decrease was
due to the same reasons as described above.
The risk-to-capital ratios set forth above have been computed on a
statutory basis. However, the methodology used by the rating agencies to assign
claims-paying ability ratings permits less leverage than under statutory
requirements. As a result, the amount of capital required under statutory
regulations may be lower than the capital required for rating agency purposes.
In addition to capital adequacy, the rating agencies consider other factors in
determining a mortgage insurer's claims-paying rating, including its competitive
position, business outlook, management, corporate strategy, and historical and
projected operating performance.
For certain material risks of the Company's business, see "Risk Factors"
below.
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Risk Factors
Our revenues and losses could be affected by the risk factors discussed
below. These factors may also cause actual results to differ materially from the
results contemplated by forward looking statements that the Company may make.
Forward looking statements consist of statements which relate to matters other
than historical fact. Among others, statements that include words such as the
Company "believes", "anticipates" or "expects", or words of similar import, are
forward looking statements.
If the volume of low down payment home mortgage originations declines,
the amount of insurance that we write could also decline which could result in
declines in our future revenues.
The factors that affect the volume of low down payment mortgage
originations include:
o the level of home mortgage interest rates,
o the health of the domestic economy as well as conditions in
regional and local economies,
o housing affordability,
o population trends, including the rate of household formation,
o the rate of home price appreciation, which in times of heavy
refinancing affects whether refinance loans have loan-to-value
ratios that require private mortgage insurance, and
o government housing policy encouraging loans to first-time
homebuyers.
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For the first nine months of 2000, our volume declined 18% compared to
the same period in 1999 and we expect our volume for all of 2000 to be lower
than it was in 1999. Our volume was lower in 2000 because many borrowers
refinanced their mortgages during the first nine months of 1999 due to a lower
interest rate environment. While our volume was higher in 1999, lenders
cancelled insurance on loans due to borrowers refinancing. There has been
substantially less refinancing activity in 2000. As a result, lenders have
cancelled our insurance at a lower rate than in 1999. Also, due to generally
favorable home mortgage interest rates in 2000, home purchase activity by first
time homebuyers, who are more likely to need private mortgage insurance,
continued to be strong. As a result of these factors, our premium revenues
increased during the first nine months of 2000 compared to 1999. While we have
not experienced lower volume in recent years other than as a result of
refinancing activity, one of the risks we face is that substantially higher
interests rates will substantially reduce purchase activity by first time
homebuyers and that the decline in cancellations of insurance that in the past
have accompanied higher interest rates will not be sufficient to offset the
decline in premiums from loans that are not made.
If lenders and investors select alternatives to private mortgage
insurance, the amount of insurance that we write could decline, which could
result in declines in our future revenues.
These alternatives to private mortgage insurance include:
o lenders using government mortgage insurance programs, including
those of the Federal Housing Administration and the Veterans
Administration,
o investors holding mortgages in portfolio and self-insuring,
o investors using credit enhancements other than private mortgage
insurance or using other credit enhancements in conjunction with
reduced levels of private mortgage insurance coverage, and
o lenders structuring mortgage originations to avoid private
mortgage insurance, such as a first mortgage with an 80%
loan-to-value ratio and a second mortgage with a 10% loan-to-value
ratio (referred to as an 80-10-10 loan) rather than a first
mortgage with a 90% loan- to-value ratio.
We believe lenders and investors are self-insuring and making 80-10-10
loans at about the same percentage as they did over the last several years.
During 1999, the last year for which information is available, lenders made
loans with Federal Housing Administration and Veterans Administration mortgage
insurance with somewhat more
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frequency than they did in 1997. Investors are using reduced mortgage insurance
coverage on a somewhat higher percentage of loans that we insure than they had
over the last several years.
Because most of the loans MGIC insures are sold to Fannie Mae and Freddie
Mac, changes in their business practices could reduce our revenues or increase
our losses.
The business practices of Fannie Mae and Freddie Mac affect the entire
relationship between them and mortgage insurers and include:
o the level of private mortgage insurance coverage, subject to the
limitations of Fannie Mae and Freddie Mac's charters, when private
mortgage insurance is used as the required credit enhancement on
low down payment mortgages,
o whether Fannie Mae or Freddie Mac influence the mortgage lender's
selection of the mortgage insurer providing coverage and, if so,
any transactions that are related to that selection,
o whether Fannie Mae or Freddie Mac will give mortgage lenders an
incentive, such as a reduced guaranty fee, to select a mortgage
insurer that has a "AAA" claims-paying ability rating to benefit
from the proposed lower capital requirements for Fannie Mae and
Freddie Mac when a mortgage is insured by a company with that
rating,
o the underwriting standards that determine what loans are eligible
for purchase by Fannie Mae or Freddie Mac, which thereby affect
the quality of the risk insured by the mortgage insurer and the
availability of mortgage loans,
o the terms on which mortgage insurance coverage can be canceled
before reaching the cancellation thresholds established by law,
and
o the circumstances in which mortgage servicers must perform
activities intended to avoid or mitigate loss on insured mortgages
that are delinquent.
We do not have a "AAA" rating. If the proposed capital rules of the
Office of Federal Housing Enterprise Oversight are adopted in a form that gives
greater capital credit to private mortgage insurers with "AAA" ratings, we may
need to obtain a "AAA" rating. While we believe we can obtain this rating, we
would need to dedicate capital to the mortgage insurance business that we might
use in other ways and we would also have additional costs that we would not
otherwise incur.
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Because we participate in an industry that is intensely competitive,
changes in our competitors' business practices could reduce our revenues or
increase our losses.
Competition for private mortgage insurance premiums occurs not only
among private mortgage insurers but increasingly with mortgage lenders through
captive mortgage reinsurance transactions. In these transactions, a lender's
affiliate reinsures a portion of the insurance written by a private mortgage
insurer on mortgages originated by the lender. The low level of losses that has
recently prevailed in the private mortgage insurance industry has encouraged
competition to assume default risk through captive reinsurance arrangements,
self insurance, 80-10-10 loans and other means. In 1996, we reinsured under
captive reinsurance arrangements virtually none of our primary insurance. We
reinsured 32% of the new primary insurance that we wrote in 1999. The level of
competition within the private mortgage insurance industry has also increased as
many large mortgage lenders have reduced the number of private mortgage insurers
with whom they do business. At the same time, consolidation among mortgage
lenders has increased the share of the mortgage lending market held by large
lenders. Our top ten customers generated 27.0% of the new primary insurance that
we wrote in 1997 compared to 32.5% in 1999.
Our private mortgage insurance competitors include:
o PMI Mortgage Insurance Company
o GE Capital Mortgage Insurance Corporation
o United Guaranty Residential Insurance Company
o Radian Guaranty Inc.
o Republic Mortgage Insurance Company
o Triad Guaranty Insurance Corporation
o CMG Mortgage Insurance Company
If interest rates decline, house prices appreciate or mortgage insurance
cancellation requirements change, the length of time that our policies remain in
force could decline and result in declines in our revenue.
In each year, most of MGIC's premiums are from insurance that has been
written in prior years. As a result, the length of time insurance remains in
force is an important determinant of revenues. The factors affecting the length
of time our insurance remains in force include:
o the level of current mortgage interest rates compared to the
mortgage coupon rates on the insurance in force, which affects the
vulnerability of the insurance in force to refinancings, and
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o mortgage insurance cancellation policies of mortgage investors
along with the rate of home price appreciation experienced by the
homes underlying the mortgages in the insurance in force.
While it is difficult to measure the extent of the decline, in recent
years, the length of time that our policies remain in force has declined
somewhat. Due to this decline, our premium revenues were lower than they would
have been if the length had not declined.
If the domestic economy deteriorates, more homeowners may default and our
losses may increase.
Losses result from events that reduce a borrower's ability to continue to
make mortgage payments, such as unemployment, and whether the home of a borrower
who defaults on his mortgage can be sold for an amount that will cover unpaid
principal and interest and the expenses of the sale. Favorable economic
conditions generally reduce the likelihood that borrowers will lack sufficient
income to pay their mortgages and also favorably affect the value of homes,
thereby reducing and in some cases even eliminating a loss from a mortgage
default. In recent years, due in part to the strength of the economy, we have
had low losses by historical standards. A significant deterioration in economic
conditions would probably increase our losses.
We are subject to litigation that could result in a large damage award
against us.
Our MGIC subsidiary is a defendant in a lawsuit alleging that MGIC
violated the Real Estate Settlement Procedures Act by entering into transactions
with lenders that were not properly priced, in return for the referral of
mortgage insurance. The complaint seeks damages of three times the amount of the
mortgage insurance premiums that have been paid and that will be paid at the
time of judgment for the mortgage insurance found to be involved in a violation
of the Real Estate Settlement Procedures Act. The complaint also seeks
injunctive relief, including prohibiting MGIC from receiving future premium
payments. MGIC has answered the complaint and denied liability. In August 2000,
the Court granted a motion for summary judgment and dismissed three similar
cases brought against other private mortgage insurers on the ground that the
McCarran-Ferguson Act barred the Real Estate Settlement Procedures Act claims
brought by the individual plaintiffs in those cases. On November 3, 2000, MGIC
filed a motion for judgment on the pleadings on McCarran-Ferguson Act grounds in
the case pending against MGIC. However, we cannot predict the ultimate outcome
of litigation. It is possible there could be a large damage award against us or
other adverse outcome.
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Because we expect the pace of change in our industry and in home
mortgage lending to remain high, we will be disadvantaged unless we are able to
respond to new ways of doing business.
We expect the processes involved in home mortgage lending will continue
to evolve through greater use of technology. This evolution could effect
fundamental changes in the way home mortgages are distributed. Affiliates of
lenders who are regulated depositary institutions gained expanded insurance
powers under financial modernization legislation and the capital markets may
emerge as providers of insurance in competition with traditional insurance
companies. These trends and others increase the level of uncertainty in our
business, demand rapid response to change and place a premium on innovation.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At September 30, 2000, the Company's derivative financial instruments in
its investment portfolio were immaterial. The Company places its investments in
instruments that meet high credit quality standards, as specified in the
Company's investment policy guidelines; the policy also limits the amount of
credit exposure to any one issue, issuer and type of instrument. At September
30, 2000, the effective duration of the Company's investment portfolio was 6.6
years. The effect of a 1% increase/decrease in market interest rates would
result in a 6.6% decrease/increase in the value of the Company's investment
portfolio.
The Company's borrowings under the credit facilities are subject to
interest rates that are variable. Changes in market interest rates would have
minimal impact on the value of the notes payable. See note 2 to the consolidated
financial statements.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company's Current Report on Form 8-K, dated May 25, 2000, reported
that MGIC was a defendant in Downey et. al. v. MGIC pending in Federal District
Court for the Southern District of Georgia.
On August 14, 2000, the Court granted motions for summary judgment and
dismissed three similar cases against other private mortgage insurers on the
ground that the McCarran-Ferguson Act barred the RESPA claims brought by the
individual plaintiffs in those actions. The rulings in those cases, which had
been brought in December 1999, in effect, mooted plaintiffs' efforts to have the
cases certified as class actions. The Company understands that the plaintiffs
have appealed the dismissals to the Court of Appeals for the Eleventh Circuit.
On November 3, 2000, MGIC filed a motion for judgment on the pleadings on
McCarran-Ferguson Act grounds in the case
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pending against MGIC, which was filed in May, 2000. The Company cannot predict
the ultimate outcome of the litigation against MGIC. It is possible there could
be a large damage award against MGIC or other adverse outcome.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - The exhibits listed in the accompanying Index to
Exhibits are filed as part of this Form 10-Q.
(b) Reports on Form 8-K - During the quarter ended September 30,
2000, Current Reports on Form 8-K were filed to report
information under Item 5, Other Information, on October 10,
2000 and on October 18, 2000.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, on November 13, 2000.
MGIC INVESTMENT CORPORATION
\s\ J. Michael Lauer
----------------------------------
J. Michael Lauer
Executive Vice President and
Chief Financial Officer
\s\ Patrick Sinks
----------------------------------
Patrick Sinks
Senior Vice President, Controller and
Chief Accounting Officer
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INDEX TO EXHIBITS
(Item 6)
Exhibit
Number Description of Exhibit
11 Statement Re Computation of Net Income
Per Share
27 Financial Data Schedule
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