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 MARCH 31, 2002
[ ] 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
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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 4/30/01 105,693,499
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MGIC INVESTMENT CORPORATION
TABLE OF CONTENTS
Page No.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheet as of
March 31, 2002 (Unaudited) and December 31, 2001 3
Consolidated Statement of Operations for the Three
Months Ended March 31, 2002 and 2001 (Unaudited) 4
Consolidated Statement of Cash Flows for the Three Months
Ended March 31, 2002 and 2001 (Unaudited) 5
Notes to Consolidated Financial Statements (Unaudited) 6-11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12-25
Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 26
SIGNATURES 27
INDEX TO EXHIBITS 28
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
March 31, 2002 (Unaudited) and December 31, 2001
March 31, December 31,
2002 2001
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ASSETS (In thousands of dollars)
------
Investment portfolio:
Securities, available-for-sale, at market value:
Fixed maturities $ 4,072,454 $ 3,888,740
Equity securities 22,839 20,747
Short-term investments 309,417 159,960
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Total investment portfolio 4,404,710 4,069,447
Cash 13,307 26,392
Accrued investment income 53,242 59,036
Reinsurance recoverable on loss reserves 24,324 26,888
Reinsurance recoverable on unearned premiums 7,992 8,415
Home office and equipment, net 35,427 34,762
Deferred insurance policy acquisition costs 31,862 32,127
Investments in joint ventures 169,350 161,674
Other assets 138,630 148,271
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Total assets $ 4,878,844 $ 4,567,012
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Loss reserves $ 620,902 $ 613,664
Unearned premiums 172,770 174,545
Short-and long-term debt (note 2) 613,541 472,102
Other liabilities 323,314 286,514
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Total liabilities 1,730,527 1,546,825
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Contingencies (note 4) Shareholders' equity:
Common stock, $1 par value, shares authorized 300,000,000;
shares issued, 3/31/02 - 121,129,630 12/31/01 - 121,110,800;
shares outstanding, 3/31/02 - 105,900,252
12/31/01 - 106,086,594 121,130 121,111
Paid-in surplus 218,112 214,040
Members' equity (1,829) -
Treasury stock (shares at cost, 3/31/02 - 15,229,378
12/31/01 - 15,024,206) (691,632) (671,168)
Accumulated other comprehensive income, net of tax 26,442 46,644
Retained earnings 3,476,094 3,309,560
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Total shareholders' equity 3,148,317 3,020,187
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Total liabilities and shareholders' equity $ 4,878,844 $ 4,567,012
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See accompanying notes to consolidated financial statements.
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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
Three Months Ended March 31, 2002 and 2001
(Unaudited)
Three Months Ended
March 31,
-----------------------------
2002 2001
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(In thousands of dollars, except per share data)
Revenues:
Premiums written:
Direct $ 306,177 $ 243,621
Assumed 86 105
Ceded (23,166) (14,138)
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Net premiums written 283,097 229,588
Decrease in unearned premiums 1,352 11,594
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Net premiums earned 284,449 241,182
Investment income, net of expenses 51,950 50,045
Realized investment gains, net 8,118 13,693
Other revenue 31,051 15,559
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Total revenues 375,568 320,479
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Losses and expenses:
Losses incurred, net 59,714 29,377
Underwriting and other expenses, net 64,468 51,654
Interest expense 6,624 8,563
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Total losses and expenses 130,806 89,594
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Income before tax 244,762 230,885
Provision for income tax 75,575 72,961
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Net income $ 169,187 $ 157,924
============ ============
Earnings per share (note 5):
Basic $ 1.59 $ 1.48
============ ============
Diluted $ 1.58 $ 1.46
============ ============
Weighted average common shares
outstanding - diluted (shares in
thousands, note 5) 106,931 107,817
============ ============
Dividends per share $ 0.025 $ 0.025
============ ============
See accompanying notes to consolidated financial statements.
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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Three Months Ended March 31, 2002 and 2001
(Unaudited)
Three Months Ended
March 31,
-------------------------------
2002 2001
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(In thousands of dollars)
Cash flows from operating activities:
Net income $ 169,187 $ 157,924
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of deferred insurance policy
acquisition costs 5,145 3,984
Increase in deferred insurance policy
acquisition costs (4,880) (4,397)
Depreciation and amortization 3,083 1,315
Decrease in accrued investment income 5,794 4,200
Decrease (increase) in reinsurance recoverable
on loss reserves 2,564 (1,350)
Decrease (increase) in reinsurance recoverable on
unearned premiums 423 (40)
Increase (decrease) in loss reserves 7,238 (2,574)
Decrease in unearned premiums (1,775) (11,555)
Equity earnings in joint ventures (18,127) (8,175)
Other 64,895 72,804
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Net cash provided by operating activities 233,547 212,136
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Cash flows from investing activities:
Purchase of equity securities (1,201) -
Purchase of fixed maturities (818,127) (772,908)
Additional investment in joint ventures - (5,000)
Sale of equity securities - (315)
Proceeds from sale or maturity of fixed maturities 607,870 597,565
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Net cash used in investing activities (211,458) (180,658)
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Cash flows from financing activities:
Dividends paid to shareholders (2,653) (2,670)
Proceeds from issuance of long-term debt 199,992 87,678
Repayment of short- and long-term debt (59,607) (98,184)
Reissuance of treasury stock 6,630 4,056
Repurchase of common stock (30,098) -
Common stock issued 19 -
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Net cash provided by (used in) financing activities 114,283 (9,120)
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Net increase in cash and short-term investments 136,372 22,358
Cash and short-term investments at beginning of period 186,352 157,190
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Cash and short-term investments at end of period $ 322,724 $ 179,548
============== ==============
See accompanying notes to consolidated financial statements.
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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2002
(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, 2001 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, including normal recurring accruals, necessary to summarize
fairly the Company's financial position and results of operations. The results
of operations for the three months ended March 31, 2002 may not be indicative of
the results that may be expected for the year ending December 31, 2002.
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 Statement of Financial Accounting Standards ("SFAS") No. 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 No. 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 $4.0 million and $5.1 million of deferred insurance
policy acquisition costs during the three months ended March 31, 2001 and 2002,
respectively.
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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.
Note 2 - Short- and long-term debt
During the first quarter of 2001, the Company established a $200 million
commercial paper program, which was rated "A-1" by Standard and Poors ("S&P")
and "P-1" by Moody's. At March 31, 2002, the Company had $113.7 million in
commercial paper outstanding with a weighted average interest rate of 1.81%.
The Company had a $200 million credit facility available at March 31,
2002, with $100 million expiring in 2003 and $100 million expiring in 2004.
Under the terms of the
Page 7
credit facilities, the Company must maintain shareholders' equity of at least
$2.25 billion and MGIC must maintain a claims paying ability rating of AA- or
better with S&P. At March 31, 2002, the Company had shareholders' equity of
$3.15 billion and MGIC had a claims paying ability rating of AA+ from S&P. These
facilities are currently being used as liquidity back up facilities for the
outstanding commercial paper. The remaining credit available under these
facilities after reduction for the amount necessary to support the commercial
paper was $86.3 million at March 31, 2002. In May, 2002, the Company entered
into a new four-year $285 million credit facility and terminated the two $100
million facilities. The covenants in the new facility regarding shareholders'
equity and the claims paying ability rating are the same as in the terminated
facilities.
In March of 2002, the Company issued, in a public offering, $200 million
6% Senior Notes due in 2007. The notes are unsecured and were rated "A1" by
Moody's and "A+" by S&P. The Company had Senior Notes outstanding of $500
million at March 31, 2002 and $300 million at March 31, 2001.
Interest payments on all long-term debt (commercial paper is classified
as short-term debt) were $1.5 million, and $1.9 million for the quarters ended
March 31, 2002 and 2001 respectively. At March 31, 2002, the market value of the
long-term debt is $628.0 million.
The Company uses interest rate swaps to hedge interest rate exposure
associated with its short- and long-term debt. During 1999, 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. The notional amount of $100 million represents the
stated principal balance used for calculating payments. The Company received and
paid amounts based on rates that were both fixed and variable.
In 2000, two of the swaps were amended and designated as fair-value
hedges which qualified for short cut accounting. The Company paid an interest
rate based on LIBOR and received a fixed rate of 7.5% to hedge the 5 year Senior
Notes issued in the fourth quarter of 2000. These swaps were terminated in
September 2001. In January 2002, the Company initiated a new swap which was
designated as a fair value hedge of the 7.5% Senior Notes. The gain on
termination is being amortized over the remaining life of the underlying debt.
The remaining swap was also amended during 2000 and designated as a cash flow
hedge. Under the terms of the swap contract, the Company pays a fixed rate of
6.79% and receives an interest rate based on LIBOR. The swap has an expiration
date coinciding with the maturity of the credit facilities and is designated as
a hedge. Gains or losses arising from the amendment or termination of interest
rate swaps are deferred and amortized to interest expense over the life of the
hedged items. Earnings on the swaps through March 31, 2002 of approximately $0.2
million were netted against interest expense. Expenses on the swaps through
March 31, 2001, of approximately $0.8 million, were included in interest
expense. The cash flow swap outstanding at December 31, 2001 is evaluated
quarterly using regression analysis with any ineffectiveness being recorded as
an expense. To date this evaluation has not resulted in any hedge
ineffectiveness. The swaps are subject to
Page 8
credit risk to the extent the counterparty would be unable to discharge its
obligations under the swap agreements.
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 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 and litigation settlement
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, in June 2001, the Federal District Court for the Southern
District of Georgia, before which Downey et. al. v. MGIC is pending, issued a
final order approving a settlement agreement and certified a nationwide class of
borrowers. In the fourth quarter of 2000, the Company recorded a $23.2 million
charge to cover the estimated costs of the settlement, including payments to
borrowers. Due to appeals of related orders denying certain class members the
right to intervene to challenge certain aspects of the settlement in Downey and
two related cases, payments to borrowers in the settlement are delayed pending
the outcome of the appeals. The settlement includes an injunction that prohibits
certain practices and specifies the basis on which agency pool insurance,
captive mortgage reinsurance, contract underwriting and other products may be
provided in compliance with the Real Estate Settlement Procedures Act.
The complaint in the case alleges that MGIC violated the Real Estate
Settlement Procedures Act by providing agency pool insurance, captive mortgage
reinsurance, contract underwriting and other products 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. If the settlement is
not fully
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implemented, the litigation will continue. In these circumstances, there can be
no assurance 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 SFAS No. 128, Earnings Per Share. The following is
a reconciliation of the weighted-average number of shares used for basic EPS and
diluted EPS.
Three Months Ended
March 31,
2002 2001
---- ----
(Shares in thousands)
Weighted-average shares - Basic EPS 106,194 106,883
Common stock equivalents 737 934
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Weighted-average shares - Diluted EPS 106,931 107,817
======= =======
Note 6 - New accounting standards
The Company adopted Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"),
effective January 1, 2001. The statement establishes accounting and reporting
standards for derivative instruments and for hedging activities. The adoption of
SFAS 133 did not have a significant effect on the Company's results of
operations or its financial position due to its limited use of derivative
instruments.
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141 ("SFAS 141"), Business
Combinations, and No. 142 ("SFAS 142"), Goodwill and Other Intangible Assets.
SFAS 141 is effective for all business combinations initiated after June 30,
2001 and SFAS 142 is effective for fiscal years beginning after December 15,
2001. In August 2001, the FASB issued statement of Accounting Standards No. 144,
Accounting for the Impairment or Disposal of Long-lived Assets, which is
effective for fiscal years beginning after December 15, 2001.
The adoption of these pronouncements did not have a significant effect on
the Company's result of operations or its financial position.
Note 7 - Comprehensive income
The Company's total comprehensive income, as calculated per SFAS No. 130,
Reporting Comprehensive Income, was as follows:
Page 10
Three Months Ended
March 31,
2002 2001
---- ----
(In thousands of dollars)
Net income $169,187 $ 157,924
Other comprehensive income (20,202) 4,882
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Total comprehensive income $148,985 $ 162,806
========= =========
Other comprehensive income (loss) (net of tax):
Cumulative effect - FAS 133 $ N/A $ (5,982)
Net derivative gains (losses) 672 (1,810)
Amortization of deferred losses 270 270
FAS 115 (21,144) 12,404
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Comprehensive (loss) gain $(20,202) $ 4,882
======== =========
The difference between the Company's net income and total comprehensive
income for the three months ended March 31, 2002 and 2001 is due to the change
in unrealized appreciation/depreciation on investments, and the market value
adjustment of the hedges, both net of tax.
Note 8 - Accounting for Derivatives and Hedging Activities
Generally, the Company's use of derivatives is limited to entering into
interest rate swap agreements intended to hedge its debt financing terms. All
derivatives are recognized on the balance sheet at their fair value. On the date
the derivative contract is entered into, the Company designates the derivative
as a hedge of the fair value of a recognized asset or liability ("fair value"
hedge), or as a hedge of a forecasted transaction or of the variability of cash
flows to be received or paid related to a recognized asset or liability ("cash
flow" hedge). Changes in the fair value of a derivative that is highly effective
as, and that is designated and qualifies as, a fair-value hedge, along with the
loss or gain on the hedged asset or liability that is attributable to the hedged
risk, are recorded in current-period earnings. Changes in the fair value of a
derivative that is highly effective as, and that is designated and qualifies as,
a cash-flow hedge are recorded in other comprehensive income, until earnings are
affected by the variability of cash flows (e.g. when periodic settlements on a
variable-rate asset or liability are recorded in earnings).
The Company formally documents all relationships between hedging
instruments and hedged items, as well as its risk-management objective and
strategy for undertaking various hedge transactions. This process includes
linking all derivatives that are designated as fair-value or cash-flow hedges to
specific assets and liabilities on the balance sheet or forecasted transactions.
The Company also formally assesses, both at the hedge's inception and on an
ongoing basis, whether the derivatives that are used in hedging transactions are
highly effective in offsetting changes in fair values or cash flows of hedged
items. When it is determined that a derivative is not highly effective as a
hedge or that it has ceased to be a highly effective hedge, the Company
discontinues hedge accounting prospectively.
Page 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Results of Consolidated Operations
Three Months Ended March 31, 2002 Compared With Three Months Ended March 31,
2001
Net income for the three months ended March 31, 2002 was $169.2 million,
compared to $157.9 million for the same period of 2001, an increase of 7%.
Diluted earnings per share for the three months ended March 31, 2002 was $1.58
compared with $1.46 in the same period last year, an increase of 8%. Included in
diluted earnings per share for the quarter ended March 31, 2002 and 2001 were
$0.05 and $0.08, respectively, for realized gains. 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 first quarter 2002 were $375.6 million, an
increase of 17% from the $320.5 million for the first quarter 2001. This
increase was primarily attributed to an increase in insurance in force. Also
contributing to the increase in revenues was an increase in investment income
resulting from the strong cash flows during the prior twelve months which were
invested in the investment portfolio, and an increase in other revenue offset by
a decrease in realized gains. See below for a further discussion of premiums,
investment income and other revenue.
Losses and expenses for the first quarter were $130.8 million, an
increase of 46% from $89.6 million for the same period of 2001. The increase
from last year can be attributed to an increase in losses related to an increase
in notice inventories and an increase in expenses related to increases in
insured volume and in contract underwriting. 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 March 31, 2002 was $23.6 billion, compared to $16.7 billion in the
same period of 2001. Refinancing activity increased to 49% of new primary
insurance written in 2002 on a flow basis (or $8.4 billion), compared to 38% in
2001 (or $3.8 billion).
The $23.6 billion of new primary insurance written during the first
quarter of 2002 was offset by the cancellation of $16.9 billion of insurance in
force, and resulted in a net increase of $6.7 billion in primary insurance in
force, compared to new primary insurance written of $16.7 billion, the
cancellation of $12.1 billion of insurance in force and a net increase of $4.6
billion in primary insurance in force during the first quarter of 2001. Direct
primary insurance in force was $190.6 billion at March 31, 2002 compared to
$183.9 billion at December 31, 2001 and $164.8 billion at March 31, 2001.
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 March 31, 2002 and March 31, 2001 was $107 million and $48 million,
respectively. The
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Company's direct pool risk in force was $2.1 billion at March 31, 2002, $2.0
billion at December 31, 2001, and was $1.7 billion at March 31, 2001.
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 increased during the
first quarter of 2002 compared to the cancellation levels of 2001 which resulted
in a decrease in the MGIC persistency rate (percentage of insurance remaining in
force from one year prior) to 59.2% at March 31, 2002 from 61.0% at December 31,
2001 and 76.7% at March 31, 2001Cancellation activity could also increase as
more of the Company's bulk loans season. The Company anticipates that the bulk
loans will have materially lower persistency than the Company's flow business.
New insurance written for bulk transactions was $6.6 billion during the
first quarter of 2002 compared to $6.7 billion for the same period a year ago.
The Company expects that the loans that are included in bulk transactions will
have delinquency and claim rates in excess of those on the Company's flow
business. While the Company believes it has priced its bulk business to generate
acceptable returns, there can be no assurance that the assumptions underlying
the premium rates adequately address the risk of this business. Beginning in
2002, new insurance written through the bulk channel on Alt A, subprime and
certain other loans will be subject to quota share reinsurance of approximately
15% provided by a third party reinsurer. The reinsurance transaction is
contingent on the Company receiving credit for the reinsurance under insurance
regulation. The amount of premiums ceded under this reinsurance during the first
quarter of 2002 was immaterial.
Net premiums written increased 23% to $283.1 million during the first
quarter of 2002, from $229.6 million during the first quarter of 2001. Net
premiums earned increased 18% to $284.4 million for the first quarter of 2002
from $241.2 million for the same period in 2001. 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 $23.2 million in the first quarter of 2002 compared to $14.1
million during the same period a year ago, primarily due to an increase in
captive mortgage reinsurance.
Mortgages (newly insured during the three months ended March 31, 2002 or
in previous periods) approximating 29% of MGIC's new insurance written during
the first quarter of 2002 were subject to captive mortgage reinsurance and
similar arrangements compared to 23% during the same period in 2001. 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 March 31, 2002 and at
December 31, 2001, approximately 24% of MGIC's risk in force was subject to
captive reinsurance and similar arrangements. The amount of premiums ceded under
captive mortgage reinsurance arrangements and the amount of risk in force
subject to such arrangements are expected to continue to increase.
Page 13
Investment income for the first quarter of 2002 was $52.0 million, an
increase of 4% over the $50.0 million in the first quarter of 2001. This
increase was the result of increases in the amortized cost of average invested
assets to $4.2 billion for the first quarter of 2002 from $3.5 billion for the
first quarter of 2001, an increase of 21%. The portfolio's average pre-tax
investment yield was 4.9% for the first quarter of 2002 and 5.9% for the same
period in 2001. The portfolio's average after-tax investment yield was 4.2% for
the first quarter of 2002 and 4.9% for the same period in 2001. The Company's
net realized gains were $8.1 million for the three months ended March 31, 2002
compared to net realized gains of $13.7 million during the same period in 2001,
resulting primarily from the sale of fixed maturities.
Other revenue, which is composed of various components, was $31.1 million
for the first quarter of 2002, compared with $15.6 million for the same period
in 2001. The increase is primarily the result of an increase in contract
underwriting revenue and increases in equity earnings from Credit-Based Asset
Servicing and Securitization LLC ("C-BASS") and Sherman Financial Group LLC
("Sherman"), joint ventures with Radian Group Inc.
C-BASS engages in the acquisition and resolution of delinquent
single-family residential mortgage loans ("mortgage loans"). C-BASS also
purchases and sells mortgage-backed securities ("mortgage securities"),
interests in real estate mortgage investment conduit residuals and performs
mortgage loan servicing. In addition, C-BASS issues mortgage-backed debt
securities collateralized by mortgage loans and mortgage securities. C-BASS's
results of operations are affected by the timing of these securitization
transactions. 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. This valuation is
made by C-BASS management in connection with each release of financial
statements. In the case of assets that are residual interests in
securitizations, these estimates reflect the net present value of the future
cash flows from the assets, which in turn depend on, among other things,
estimates of the level of losses on the underlying mortgages and prepayment
activity by the mortgage borrowers. Market value adjustments could impact
C-BASS's results of operations and the Company's share of those results.
Total combined assets of C-BASS at March 31, 2002 and December 31, 2001
were approximately $1.5 billion and $1.3 billion, respectively, of which
approximately $1.2 billion and $0.9 billion, respectively, were mortgage-related
assets, including open trades. Total liabilities at March 31, 2002 and December
31, 2001 were approximately $1.2 billion and $1.0 billion, respectively, of
which approximately $1.0 billion and $0.9 billion, respectively, were funding
arrangements, including accrued interest, virtually all of which were
short-term. For the three months ended March 31, 2002 and 2001, revenues of
approximately $72 million and $55 million, respectively, and expenses of
approximately $37 million and $26 million, respectively, resulted in income
before tax of approximately $35 million and $29 million, respectively.
Sherman is engaged in the business of purchasing, servicing and
securitizing delinquent unsecured consumer assets such as credit card loans and
Chapter 13
Page 14
bankruptcy debt. A substantial portion of Sherman's consolidated assets are
investments in receivable portfolios that do not have readily ascertainable
market values. Initially the portfolios are valued at cost. Subsequently their
value for financial statement purposes is estimated by the management of Sherman
based on the estimated future cash flow from the portfolios. The assets are
valued by Sherman's management each time financial statements are released.
Market value adjustments could impact Sherman's results of operations and the
Company's share of those results.
Because C-BASS and Sherman are accounted for by the equity method, they
are not consolidated with the Company and their assets and liabilities do not
appear in the Company's balance sheet. The "investments in joint ventures" item
in the Company's balance sheet reflects the amount of capital contributed by the
Company to the joint ventures plus the Company's share of their net income (or
minus its share of their net loss) and minus capital distributed to the Company
by the joint ventures.
As discussed in "Note 1 - Loss Reserves" to the Company's consolidated
financial statements, consistent with industry practice, loss reserves for
future claims are established only for loans that are currently delinquent. (The
terms "delinquent" and "default" are used interchangeably by the Company.) Loss
reserves are established by management's estimating the number of loans in the
Company's inventory of delinquent loans that will not cure their delinquency
(historically, a substantial majority of delinquent loans have cured), which is
referred to as the claim rate, and further estimating the amount that the
Company will pay in claims on the loans that do not cure, which is referred to
as claim severity. Estimation of losses that the Company will pay in the future
is inherently judgmental. The conditions that affect the claim rate and claim
severity include the current and future state of the domestic economy and the
current and future strength of local housing markets.
Net losses incurred increased 103% to $59.7 million in the first quarter
of 2002, from $29.4 million in the same period of 2001. The increase was due to
an increase in losses paid, an increase in the primary notice inventory related
to bulk default activity, the maturation of the 1998 and 1999 books of business
and defaults arising from the early development of the 2000 book of business.
The primary insurance notice inventory increased from 54,653 at December 31,
2001 to 56,455 at March 31, 2002 and the pool notice inventory increased from
23,623 at December 31, 2001 to 23,716 at March 31, 2002. Included in the primary
notice inventory was the bulk notice inventory of 21,726 at March 31, 2002 and
18,460 at December 31, 2001. The primary default rate at March 31, 2002 was
3.48% compared to 3.46% at December 31, 2001. Excluding bulk defaults, the
default rates were 2.53% and 2.65% at March 31, 2002 and December 31, 2001,
respectively. The default rate on bulk loans were 8.66% and 8.59% at March 31,
2002 and December 31, 2001, respectively. The Company expects the primary
default rate and the default rate on bulk loans to increase. The average claim
paid through March 31, 2002 was $19,858 compared to $18,113 for the same period
in 2001.
At March 31, 2002, 73% of MGIC's insurance in force was written
subsequent to December 31, 1998. Based on the Company's flow business, the
highest claim frequency years have typically been the third through fifth year
after the year of loan origination.
Page 15
However, the pattern of claims frequency for refinance loans may be different
from this historical pattern and the Company expects the period of highest
claims frequency on bulk loans will occur earlier than in this historical
pattern.
Underwriting and other expenses increased to $64.5 million in the first
quarter of 2002 from $51.7 million in the same period of 2001, an increase of
25%. The increase can be attributed to increases in both insurance and
non-insurance expenses related to increased volume and contract underwriting.
Interest expense decreased to $6.6 million in the first quarter of 2002
from $8.6 million during the same period in 2001 primarily due to lower
weighted-average interest rates during the three months ended March 31, 2002
compared to the comparable period in 2001.
The consolidated insurance operations loss ratio was 21.0% for the first
quarter of 2002 compared to 12.2% for the first quarter of 2001. The
consolidated insurance operations expense and combined ratios were 15.4% and
36.4%, respectively, for the first quarter of 2002 compared to 17.2% and 29.4%
for the first quarter of 2001.
The effective tax rate was 30.9% in the first quarter of 2002, compared
to 31.6% in the first quarter of 2001. During both periods, the effective tax
rate was below the statutory rate of 35%, reflecting the benefits of
tax-preferenced investment income. The lower effective tax rate in 2002 resulted
from a higher percentage of total income before tax being generated from the
tax-preferenced investments.
Other Matters
In June 2001, the Federal District Court for the Southern District of
Georgia, before which Downey et. al. v. MGIC was pending, issued a final order
approving a settlement agreement and certified a nationwide class of borrowers.
In the fourth quarter of 2000, the Company recorded a $23.2 million charge to
cover the estimated costs of the settlement, including payments to borrowers.
Due to appeals of related orders denying certain class members the right to
intervene to challenge certain aspects of the settlement in Downey and two
related cases, payments to borrowers in the settlement are delayed pending the
outcome of the appeals. The settlement includes an injunction that prohibits
certain practices and specifies the basis on which agency pool insurance,
captive mortgage reinsurance, contract underwriting and other products may be
provided in compliance with the Real Estate Settlement Procedures Act, which is
known as RESPA. There can be no assurance that the standards established by the
injunction will be determinative of compliance with RESPA were additional
litigation to be brought in the future.
The complaint in the case alleges that MGIC violated the Real Estate
Settlement Procedures Act by providing agency pool insurance, captive mortgage
reinsurance, contract underwriting and other products 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
Page 16
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. If the settlement is not fully implemented, the litigation will
continue. In these circumstances, there can be no assurance that the ultimate
outcome of the litigation will not materially affect the Company's financial
position or results of operations.
In the third quarter of 2001, the Office of Federal Housing Enterprise
Oversight ("OFHEO") adopted a risk-based capital stress test for the GSEs. One
of the elements of the stress test is that future claim payments made by a
private mortgage insurer on GSE 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'
were subject to a 5% reduction over the 10-year period of the stress test, while
claim payments from a `AA' rated insurer, such as MGIC, were subject to a 15%
reduction. In February 2002, OFHEO adopted amendments to the stress test that
reduced the differential between `AAA' and `AA' rated mortgage insurers to
5.25%. The effect of the differentiation among insurers is to require the GSEs
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, there is an
incentive for the GSEs to use private mortgage insurance provided by a `AAA'
rated insurer.
Financial Condition
Consolidated total investments and cash balances increased approximately
$322 million to $4.4 billion at March 31, 2002 from $4.1 billion at December 31,
2001, primarily due to positive net cash flow, including the proceeds of the
sale of the 6% Senior Notes discussed under "Liquidity and Capital Resources"
below, offset by unrealized losses on securities marked to market of $33 million
and a $33 million decrease in payables for securities. The Company generated
consolidated cash flows from operating activities of $233.6 million through
March 31, 2002, compared to $212.1 million generated during the same period in
2001. The increase in operating cash flows during the first quarter of 2002
compared to 2001 is due primarily to increases in renewal premiums, investment
income and other revenue (which includes contract underwriting revenue).
As of March 31, 2002, the Company had $309.4 million of short-term
investments with maturities of 90 days or less, and 71% of the portfolio was
invested in tax-preferenced securities. In addition, at March 31, 2002, based on
book value, 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 March 31, 2002, the Company had $22.8
million of investments in equity securities compared to $20.7 million at
December 31, 2001.
At March 31, 2002, the Company had no derivative financial instruments in
its investment portfolio. 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 March 31, 2002, the average
duration of the Company's investment
Page 17
portfolio was 5.3 years. The effect of a 1% increase/decrease in market interest
rates would result in a 5.3% decrease/increase in the value of the Company's
fixed income portfolio.
The Company's investments in joint ventures increased $7.7 million from
$161.7 million at December 31, 2001 to $169.4 million at March 31, 2002
primarily as a result of equity earnings of $18.1 million, offset by $12.6
million of dividends received. The joint ventures are reported on the equity
method. Only the Company's investment in the joint ventures appears on the
Company's balance sheet.
Consolidated loss reserves increased slightly to $620.9 million at March
31, 2002 from $613.7 million at December 31, 2001, reflecting increases in the
primary and pool insurance notice inventories, as discussed earlier. Consistent
with industry practices, the Company does not establish loss reserves for future
claims on insured loans which are not currently in default.
Consolidated unearned premiums decreased $1.7 million from $174.5 million
at December 31, 2001, to $172.8 million at March 31, 2002, primarily reflecting
the continued high level of monthly premium policies written for which there is
no unearned premium.
Consolidated shareholders' equity increased to $3.1 billion at March 31,
2002, from $3.0 billion at December 31, 2001, an increase of 4%. This increase
consisted of $169.2 million of net income during the first quarter of 2002
offset by $16.4 million from the repurchase of treasury stock (net of
reissuances) and other comprehensive losses, net of tax, of $20.2 million,
dividends declared of $2.7 million and $1.8 million from the consolidation of a
previously unconsolidated joint venture.
Liquidity and Capital Resources
The Company's consolidated sources of funds consist primarily of premiums
written and investment income. Funds are applied primarily to the payment of
claims and expenses. The Company generated positive cash flows from operating
activities of approximately $233.6 million and $212.1 million for the quarters
ended March 31, 2002 and 2001, respectively, as shown on the Consolidated
Statement of Cash Flows. 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. Substantially all of the investment portfolio securities are held by
the Company's insurance subsidiaries.
During the first quarter of 2001, the Company established a $200 million
commercial paper program, which was rated "A-1" by Standard and Poors ("S&P")
and "P-1" by Moody's. At March 31, 2002, the Company had $113.7 million in
commercial paper outstanding with a weighted average interest rate of 1.81%. S&P
affirmed the 'A-1' rating in February 2002. If the Company's commercial paper
rating were to fall below 'A-1' or 'P-2', the Company would likely have
difficulty selling commercial paper and any
Page 18
commercial paper that could be sold would require an interest rate in excess of
the 'A-1/P-1' rating.
The Company had a $200 million credit facility available at March 31,
2002, with $100 million expiring in 2003 and $100 million expiring in 2004.
Under the terms of the credit facilities, the Company must maintain
shareholders' equity of at least $2.25 billion and MGIC must maintain a claims
paying ability rating of AA- or better with S&P. At March 31, 2002, the Company
had shareholders' equity of $3.15 billion and MGIC had a claims paying ability
rating of AA+ from S&P. These facilities are currently being used as liquidity
back up facilities for the outstanding commercial paper. The remaining credit
available under these facilities after reduction for the amount necessary to
support the commercial paper was $86.3 million at March 31, 2002. In May, 2002,
the Company entered into a new four-year, $285 million credit facility and
terminated the two $100 million facilities. The covenants in the new facility
regarding shareholders' equity and the claims paying ability rating are the same
as in the terminated facilities.
In March of 2002, the Company issued, in a public offering, $200 million
6% Senior Notes due in 2007. The notes are unsecured and were rated "A1" by
Moody's and "A+" by S&P. The Company had Senior Notes outstanding of $500
million at March 31, 2002 and $300 million at March 31, 2001.
In January 2002, the Company announced a new share repurchase program
covering up to 5.5 million shares in addition to the 800,000 shares remaining
from the prior repurchase program. From mid-1997 until the end of 2001, the
Company repurchased 15.0 million shares of Common Stock at a cost of $775.5
million. During the first quarter of 2002, the Company repurchased 451 thousand
shares at a cost of $30.1 million. Funds for the shares repurchased by the
Company since mid-1997 have been provided through a combination of debt,
including the Senior Notes and the commercial paper, and internally generated
funds.
The commercial paper, back-up credit facilities and the Senior Notes are
obligations of the Company and not of its subsidiaries. The Company is a holding
company and the payment of dividends from its insurance subsidiaries is
restricted by insurance regulation. MGIC is the principal source of
dividend-paying capacity. As a result of a $150 million dividend paid to the
Company by MGIC in February 2002, MGIC may not pay additional dividends until
February 2003 without the approval of the Office of the Commissioner of
Insurance of the State of Wisconsin.
Interest payments on all long-term debt were $1.5 million, and $1.9
million for the quarters ended March 31, 2002 and 2001 respectively. At March
31, 2002, the market value of the long-term debt is $628.0 million.
The Company uses interest rate swaps to hedge interest rate exposure
associated with its short- and long-term debt. During 1999, 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. The notional amount of $100 million represents the
stated principal balance used for
Page 19
calculating payments. The Company received and paid amounts based on rates that
were both fixed and variable.
In 2000, two of the swaps were amended and designated as fair-value
hedges which qualified for short cut accounting. The Company paid an interest
rate based on LIBOR and received a fixed rate of 7.5% to hedge the 5 year Senior
Notes issued in the fourth quarter of 2000. These swaps were terminated in
September 2001. In January 2002, the Company initiated a new swap which was
designated as a fair value hedge of the 7.5% Senior Notes. The gain on
termination is being amortized over the remaining life of the underlying debt.
The remaining swap was also amended during 2000 and designated as a cash flow
hedge. Under the terms of the swap contract, the Company pays a fixed rate of
6.79% and receives an interest rate based on LIBOR. The swap has an expiration
date coinciding with the maturity of the credit facilities and is designated as
a hedge. Gains or losses arising from the amendment or termination of interest
rate swaps are deferred and amortized to interest expense over the life of the
hedged items. Earnings on the swaps through March 31, 2002 of approximately $0.2
million were netted against interest expense. Expenses on the swaps through
March 31, 2001, of approximately $0.8 million, were included in interest
expense. The cash flow swap outstanding at December 31, 2001 is evaluated
quarterly using regression analysis with any ineffectiveness being recorded as
an expense. To date this evaluation has not resulted in any hedge
ineffectiveness. The swaps are subject to credit risk to the extent the
counterparty would be unable to discharge its obligations under the swap
agreements.
MGIC is the principal insurance subsidiary of the Company. MGIC's
risk-to-capital ratio was 9.3:1 at March 31, 2002 compared to 10.1:1 at December
31, 2001. The decrease was due to MGIC's increased policyholders' reserves,
partially offset by the net additional risk in force of $0.9 billion, net of
reinsurance, during the first quarter of 2002.
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.
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
Page 20
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.
Our new insurance written volume increased 41% through March 31, 2002,
compared to the same period in 2001. One of the reasons our volume was higher in
2002 was because many borrowers refinanced their mortgages during the first
three months of 2002 due to a lower interest rate environment, which also led to
lenders canceling insurance that we wrote in the past. While we have not
experienced lower volume in recent years other than as a result of declining
refinancing activity, one of the risks we face is that substantially higher
interest 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,
Page 21
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, that during 2001, lenders and investors were self-insuring
and making 80-10-10 loans at about the same percentage as they did over the last
several years. Although during 2001 and 2000, the share of the low down payment
market held by loans with Federal Housing Administration and Veterans
Administration mortgage insurance was lower than in 1999, during three of the
prior four years, the Federal Housing Administration and Veterans
Administration's collective share of this market increased. Investors are using
reduced mortgage insurance coverage on a 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 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
Page 22
o the circumstances in which mortgage servicers must perform
activities intended to avoid or mitigate loss on insured mortgages
that are delinquent.
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. At March 31, 2002, about
24% of our risk in force was subject to captive reinsurance arrangements. 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 on a flow basis in 1997 compared to 38.4% in 2001.
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:
Page 23
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
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.
Our industry is subject to litigation risk.
-------------------------------------------
In recent years, consumers have brought a growing number of lawsuits
against home mortgage lenders and settlement service providers. As of the end of
April 2001, seven mortgage insurers, including our MGIC subsidiary, were
involved in litigation alleging violations of the Real Estate Settlement
Procedures Act. Our MGIC subsidiary and two other mortgage insurers have entered
into an agreement to settle the cases against them in December 2000, and another
mortgage insurer entered into a comparable settlement agreement in February
2002. In June 2001, the Court entered a final order approving the settlement to
which we and the other two insurers are parties, although due to appeals of
others denying certain class members the right to intervene to challenge certain
aspects of this settlement, the final implementation of the settlement will not
occur until the appeals are resolved. We took a $23.2 million pretax charge in
2000 to cover our share of the estimated costs of the settlement. While our
settlement includes an injunction that prohibits certain practices and specifies
the basis on which other practices may be done in compliance with the Real
Estate Settlement Procedures Act, we may still be subject to future litigation
under the Real Estate Settlement Procedures Act.
Page 24
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.
Page 25
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At March 31, 2002, the Company's derivative financial instruments in its
investment portfolio were immaterial. The Company's philosophy is to invest 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 March 31,
2002, the effective duration of the Company's investment portfolio was 5.3
years. The effect of a 1% increase/decrease in market interest rates would
result in a 5.3% decrease/increase in the value of the Company's investment
portfolio. The Company's borrowings under the commercial paper program are
subject to interest rates that are variable. See note 2 to the consolidated
financial statements.
PART II. OTHER INFORMATION
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 - A report on Form 8-K dated March 13,
2002 was filed under Item 5 Other Events and Regulation FD
Disclosure. A report on Form 8-K dated March 15, 2002 was
filed under Item 5 Other Events and Regulation FD
Disclosure.
Page 26
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 May 13, 2002.
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
Page 27
INDEX TO EXHIBITS
(Item 6)
Exhibit
Number Description of Exhibit
11 Statement Re Computation of Net Income
Per Share
Page 28