Document
 

FORM 10-Q
UNITED STATES 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
June 30, 2017
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the transition period from ______ to ______
 
 
Commission file number 1-10816
 
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=11733141&doc=13
(Exact name of registrant as specified in its charter)
WISCONSIN
 
39-1486475
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer 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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES x
NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company  o
(Do not check if a smaller reporting company)
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES o
NO x

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
 
July 31, 2017
 
370,561,601
 



Forward Looking and Other Statements

All statements in this report that address events, developments or results that we expect or anticipate may occur in the future are “forward looking statements.” Forward looking statements consist of statements that relate to matters other than historical fact. In most cases, forward looking statements may be identified by words such as “believe,” “anticipate” or “expect,” or words of similar import. The risk factors referred to in “Forward Looking Statements and Risk Factors – Location of Risk Factors” in Management’s Discussion and Analysis of Financial Condition and Results of Operations below, may cause our actual results to differ materially from the results contemplated by forward looking statements that we may make. We are not undertaking any obligation to update any forward looking statements or other statements we may make in this document even though these statements may be affected by events or circumstances occurring after the forward looking statements or other statements were made. Therefore no reader of this document should rely on these statements being current as of any time other than the time at which this document was filed with the Securities and Exchange Commission.


Table of contents

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2017
 
TABLE OF CONTENTS
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




Table of contents

GLOSSARY OF TERMS AND ACRONYMS
/ A
ARMs
Adjustable rate mortgages

ABS
Asset-backed securities

ASC
Accounting Standards Codification

Available Assets
Assets, as designated under the PMIERs, that are readily available to pay claims, and include the most liquid investments

/ B
Book or book year
A group of loans insured in a particular calendar year

BPMI
Borrower-paid mortgage insurance

/ C
CFPB
Consumer Financial Protection Bureau

CLO
Collateralized loan obligations

CMBS
Commercial mortgage-backed securities

/ D
DAC
Deferred insurance policy acquisition costs

/ F
Fannie Mae
Federal National Mortgage Association

FCRA
Fair Credit Reporting Act

FHA
Federal Housing Administration

FHFA
Federal Housing Finance Agency
 

FHLB
Federal Home Loan Bank of Chicago, of which MGIC is a member

FICO score
A measure of consumer credit risk provided by credit bureaus, typically produced from statistical models by Fair Isaac Corporation utilizing data collected by the credit bureaus

Freddie Mac
Federal Home Loan Mortgage Corporation

/ G
GAAP
Generally Accepted Accounting Principles in the United States

GSEs
Collectively, Fannie Mae and Freddie Mac

/ H
HAMP
Home Affordable Modification Program

HARP
Home Affordable Refinance Program

HOPA
Homeowners Protection Act

/ I
IBNR
Losses incurred but not reported

IIF
Insurance in force, which for loans insured by us, is equal to the unpaid principal balance, as reported to us

/ J
JCT
Joint Committee on Taxation

/ L
LAE
Loss adjustment expenses




MGIC Investment Corporation - Q2 2017 | 4

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Legacy book
Mortgage insurance policies written prior to 2009

Loan-to-value ("LTV") ratio
The ratio, expressed as a percentage, of the dollar amount of the first mortgage loan to the value of the property at the time the loan became insured and does not reflect subsequent housing price appreciation or depreciation. Subordinate mortgages may also be present.

Long-term debt:
5% Notes
5% Convertible Senior Notes due on May 1, 2017, with interest payable semi-annually on May 1 and November 1 of each year

2% Notes
2% Convertible Senior Notes due on April 1, 2020, with interest payable semi-annually on April 1 and October 1 of each year

5.75% Notes
5.75% Senior Notes due on August 15, 2023, with interest payable semi-annually on February 15 and August 15 of each year

9% Debentures
9% Convertible Junior Subordinated Debentures due on April 1, 2063, with interest payable semi-annually on April 1 and October 1 of each year

FHLB Advance or the Advance
1.91% Fixed rate advance from the FHLB due on February 10, 2023, with interest payable monthly

Loss ratio
The ratio, expressed as a percentage, of the sum of incurred losses and LAE to NPE

Low down payment loans or mortgages
Loans with less than 20% down payments

LPMI
Lender-paid mortgage insurance

/ M
MBS
Mortgage-backed securities

MD&A
Management's discussion and analysis of financial condition and results of operations

 
MGIC
Mortgage Guaranty Insurance Corporation, a subsidiary of MGIC Investment Corporation

MIC
MGIC Indemnity Corporation, a subsidiary of MGIC

Minimum Required Assets
The minimum amount of Available Assets that must be held under the PMIERs, which is generally the greater of $400 million or an amount based upon a percentage of RIF weighted by certain risk attributes

MPP
Minimum Policyholder Position, as required under certain state requirements. The “policyholder position” of a mortgage insurer is its net worth or surplus, contingency reserve and a portion of the reserves for unearned premiums

/ N
N/A
Not applicable for the period presented

NAIC
The National Association of Insurance Commissioners

NIW
New Insurance Written

N/M
Data, or calculation, deemed not meaningful for the period presented

NPE
The amount of premiums earned, net of premiums assumed and ceded under reinsurance agreements

NPL
Non-performing loan, which is a delinquent loan, at any stage in its delinquency

NPW
The amount of premiums written, net of premiums assumed and ceded under reinsurance agreements

/ O
OCI
Office of the Commissioner of Insurance of the State of Wisconsin




5 | MGIC Investment Corporation - Q2 2017

Table of contents

/ P
Persistency
The percentage of our insurance remaining in force from one year prior

PMI
Private Mortgage Insurance (as an industry or product type)

PMIERs
Private Mortgage Insurer Eligibility Requirements issued by the GSEs

Premium Yield
The ratio of NPE divided by the average IIF outstanding for the period measured

/ Q
QSR Transaction
Quota share reinsurance transaction

/ R
REMIC
Real Estate Mortgage Investment Conduit

RESPA
Real Estate Settlement Procedures Act

RIF
Risk in force, which for an individual loan insured by us, is equal to the unpaid loan principal balance, as reported to us, multiplied by the insurance coverage percentage. RIF is sometimes referred to as exposure

Risk-to-capital
The ratio of RIF, net of reinsurance and exposure on policies currently in default and for which loss reserves have been established, to the level of statutory capital

RMBS
Residential mortgage-backed securities

 
/ U
Underwriting Expense ratio
The ratio, expressed as a percentage, of the underwriting and operating expenses, net and amortization of DAC of our combined insurance operations (which excludes underwriting and operating expenses of our non-insurance operations) to NPW

Underwriting profit
NPE minus incurred losses

/ V
VA
U.S. Department of Veterans Affairs




MGIC Investment Corporation - Q2 2017 | 6

Table of contents

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)
 
Note
 
June 30,
2017
 
December 31,
2016
ASSETS
 
 
 
 
 
 
Investment portfolio:
 
7 / 8
 
 
 
 
Securities, available-for-sale, at fair value:
 
 
 
 
 
 
Fixed income (amortized cost, 2017 - $4,674,965; 2016 - $4,717,211)
 
 
 
$
4,701,211

 
$
4,685,222

Equity securities
 
 
 
7,209

 
7,128

Total investment portfolio
 
 
 
4,708,420

 
4,692,350

Cash and cash equivalents
 
 
 
127,908

 
155,410

Accrued investment income
 
 
 
44,030

 
44,073

Reinsurance recoverable on loss reserves
 
 
44,783

 
50,493

Reinsurance recoverable on paid losses
 
 
 
6,151

 
4,964

Premiums receivable
 
 
 
51,344

 
52,392

Home office and equipment, net
 
 
 
42,212

 
36,088

Deferred insurance policy acquisition costs
 
 
 
18,677

 
17,759

Deferred income taxes, net
 
 
481,389

 
607,655

Other assets
 
 
 
75,254

 
73,345

Total assets
 
 
 
$
5,600,168

 
$
5,734,529

 
 
 
 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
Loss reserves
 
 
$
1,187,089

 
$
1,438,813

Unearned premiums
 
 
 
352,010

 
329,737

Federal Home Loan Bank advance
 
 
155,000

 
155,000

Senior notes
 
 
417,983

 
417,406

Convertible senior notes
 
 

 
349,461

Convertible junior subordinated debentures
 
 
256,872

 
256,872

Other liabilities
 
 
 
236,153

 
238,398

Total liabilities
 
 
 
2,605,107

 
3,185,687

Contingencies
 
 


 


Shareholders’ equity:
 
 
 
 
 
Common stock (one dollar par value, shares authorized 1,000,000; shares issued 2017 - 370,557; 2016 - 359,400; shares outstanding 2017 - 370,557; 2016 - 340,663)
 
 
 
370,557

 
359,400

Paid-in capital
 
 
 
1,842,601

 
1,782,337

Treasury stock at cost (shares 2016 - 18,737)
 
 
 

 
(150,359
)
Accumulated other comprehensive loss, net of tax
 
 
 
(37,494
)
 
(75,100
)
Retained earnings
 
 
 
819,397

 
632,564

Total shareholders’ equity
 
 
 
2,995,061

 
2,548,842

Total liabilities and shareholders’ equity
 
 
 
$
5,600,168

 
$
5,734,529

See accompanying notes to consolidated financial statements.



7 | MGIC Investment Corporation - Q2 2017

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

 
 
 
 
Three Months Ended June 30,
 
Six Months Ended
June 30,
(In thousands, except per share data)
 
Note
 
2017
 
2016
 
2017
 
2016
Revenues:
 
 
 
 
 
 
 
 
 
 
Premiums written:
 
 
 
 
 
 
 
 
 
 
Direct
 
 
 
$
275,245

 
$
282,113

 
$
541,068

 
$
547,404

Assumed
 
 
 
685

 
182

 
1,973

 
390

Ceded
 
 
(30,096
)
 
(32,280
)
 
(60,505
)
 
(66,498
)
Net premiums written
 
 
 
245,834

 
250,015

 
482,536

 
481,296

Increase in unearned premiums, net
 
 
 
(14,698
)
 
(18,559
)
 
(22,297
)
 
(28,499
)
Net premiums earned
 
 
 
231,136

 
231,456

 
460,239

 
452,797

Investment income, net of expenses
 
 
 
29,716

 
27,248

 
59,193

 
55,057

Net realized investment (losses) gains
 
 
(42
)
 
836

 
(164
)
 
3,892

Other revenue
 
 
 
2,502

 
3,994

 
4,924

 
10,367

Total revenues
 
 
 
263,312

 
263,534

 
524,192

 
522,113

 
 
 
 
 
 
 
 
 
 
 
Losses and expenses:
 
 
 
 
 
 
 
 
 
 
Losses incurred, net
 
 
27,339

 
46,590

 
54,958

 
131,602

Amortization of deferred policy acquisition costs
 
 
 
2,584

 
2,245

 
4,814

 
4,206

Other underwriting and operating expenses, net
 
 
 
38,511

 
35,348

 
79,276

 
75,125

Interest expense
 
 
 
14,197

 
12,244

 
30,506

 
26,945

Loss on debt extinguishment
 
 
 
65

 
1,868

 
65

 
15,308

Total losses and expenses
 
 
 
82,696

 
98,295

 
169,619

 
253,186

Income before tax
 
 
 
180,616

 
165,239

 
354,573

 
268,927

Provision for income taxes
 
 
61,994

 
56,018

 
146,153

 
90,515

Net income
 
 
 
$
118,622

 
$
109,221

 
$
208,420

 
$
178,412

 
 
 
 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
 
 
 
Basic
 
 
$
0.32

 
$
0.32

 
$
0.59

 
$
0.52

Diluted
 
 
$
0.31

 
$
0.26

 
$
0.55

 
$
0.43

 
 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding - basic
 
 
366,918

 
340,678

 
354,035

 
340,411

Weighted average common shares outstanding - diluted
 
 
394,470

 
446,139

 
398,302

 
450,354

See accompanying notes to consolidated financial statements.



MGIC Investment Corporation - Q2 2017 | 8

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)

 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands)
 
Note
 
2017
 
2016
 
2017
 
2016
Net income
 
 
 
$
118,622

 
$
109,221

 
$
208,420

 
$
178,412

Other comprehensive (loss) income, net of tax:
 
 
 
 
 
 
 
 
 
Change in unrealized investment gains and losses
 
 
25,749

 
56,338

 
37,870

 
107,165

Benefit plan adjustments
 
 
 
(142
)
 
(173
)
 
(295
)
 
(481
)
Foreign currency translation adjustment
 
 
 

 
11

 
31

 
(964
)
Other comprehensive income, net of tax
 
 
 
25,607

 
56,176

 
37,606

 
105,720

Comprehensive income
 
 
 
$
144,229

 
$
165,397

 
$
246,026

 
$
284,132


See accompanying notes to consolidated financial statements



9 | MGIC Investment Corporation - Q2 2017

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Unaudited)

 
 
 
 
Six Months Ended June 30,
(In thousands)
 
Note
 
2017
 
2016
Common stock
 
 
 
 
 
 
Balance, beginning of period
 
 
 
$
359,400

 
$
340,097

Net common stock issued under share-based compensation plans
 
 
 
771

 
979

Issuance of common stock
 
 
10,386

 

Balance, end of period
 
 
 
370,557

 
341,076

 
 
 
 
 
 
 
Paid-in capital
 
 
 
 
 
 
Balance, beginning of period
 
 
 
1,782,337

 
1,670,238

Net common stock issued under share-based compensation plans
 
 
 
(7,494
)
 
(5,954
)
Issuance of common stock
 
 
60,903

 

Tax benefit from share-based compensation
 
 
 

 
115

Equity compensation
 
 
 
6,855

 
6,017

Reacquisition of convertible junior subordinated debentures-equity component
 
 
 

 
(6,337
)
Balance, end of period
 
 
 
1,842,601

 
1,664,079

 
 
 
 
 
 
 
Treasury stock
 
 
 
 
 
 
Balance, beginning of period
 
 
 
(150,359
)
 
(3,362
)
Reissuance of treasury stock, net
 
 
 
150,359

 

Balance, end of period
 
 
 

 
(3,362
)
 
 
 
 
 
 
 
Accumulated other comprehensive loss
 
 
 
 
 
 
Balance, beginning of period
 
 
 
(75,100
)
 
(60,880
)
Other comprehensive income, net of tax
 
 
37,606

 
105,720

Balance, end of period
 
 
 
(37,494
)
 
44,840

 
 
 
 
 
 
 
Retained earnings
 
 
 
 
 
 
Balance, beginning of period
 
2 / 13
 
632,717

 
290,047

Net income
 
 
 
208,420

 
178,412

Reissuance of treasury stock, net
 
 
 
(21,740
)
 

Balance, end of period
 
 
 
819,397

 
468,459

 
 
 
 
 
 
 
Total shareholders’ equity
 
 
 
$
2,995,061

 
$
2,515,092


See accompanying notes to consolidated financial statements.



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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
 
Six Months Ended June 30,
(In thousands)
 
2017
 
2016
Cash flows from operating activities:
 
 
 
 
Net income
 
$
208,420

 
$
178,412

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
33,191

 
28,477

Deferred tax expense
 
106,163

 
88,157

Net realized investment losses (gains)
 
164

 
(3,892
)
Loss on debt extinguishment
 
65

 
15,308

Change in certain assets and liabilities:
 
 
 
 
Accrued investment income
 
43

 
515

Prepaid insurance premium
 
25

 
48

Reinsurance recoverable on loss reserves
 
5,710

 
(728
)
Reinsurance recoverable on paid losses
 
(1,187
)
 
(1,454
)
Premium receivable
 
1,048

 
1,867

Deferred insurance policy acquisition costs
 
(918
)
 
(1,439
)
Profit commission receivable
 
(4,603
)
 
(2,793
)
Loss reserves
 
(251,724
)
 
(261,069
)
Unearned premiums
 
22,273

 
28,451

Return premium accrual
 
(11,900
)
 
(7,300
)
Income taxes payable - current
 
32,991

 
523

Other, net
 
(14,205
)
 
(8,090
)
Net cash provided by operating activities
 
125,556

 
54,993

 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
Purchases of investments:
 
 
 
 
Fixed income
 
(545,281
)
 
(723,409
)
Equity securities
 
(38
)
 
(3,128
)
Proceeds from sales of fixed income
 
166,606

 
649,776

Proceeds from maturity of fixed income
 
390,344

 
313,484

Proceeds from sale of equity securities
 

 
2,525

Net increase in payable for securities
 
3,447

 
24,519

Additions to property and equipment
 
(9,659
)
 
(2,724
)
Net cash provided by investing activities
 
5,419

 
261,043

 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
Proceeds from revolving credit facility
 
150,000

 

Repayment of revolving credit facility
 
(150,000
)
 

Proceeds from issuance of long-term debt
 

 
155,000

Purchase or repayment of convertible senior notes
 
(145,620
)
 
(182,846
)
Payment of original issue discount - convertible senior notes
 
(4,504
)
 
(5,655
)
Purchase of convertible junior subordinated debentures
 

 
(100,860
)
Payment of original issue discount - convertible junior subordinated debentures
 

 
(41,540
)
Cash portion of loss on debt extinguishment
 

 
(15,308
)
Payment of debt issuance costs
 
(1,630
)
 

Payment of withholding taxes related to share-based compensation net share settlement
 
(6,723
)
 
(4,973
)
Net cash used in financing activities
 
(158,477
)
 
(196,182
)
 
 
 
 
 
Net (decrease) increase in cash and cash equivalents
 
(27,502
)
 
119,854

Cash and cash equivalents at beginning of period
 
155,410

 
181,120

Cash and cash equivalents at end of period
 
$
127,908

 
$
300,974

See accompanying notes to consolidated financial statements.



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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2017
(Unaudited)

Note 1. Nature of Business and Basis of Presentation
MGIC Investment Corporation is a holding company which, through Mortgage Guaranty Insurance Corporation (“MGIC”) is principally engaged in the mortgage insurance business.  We provide mortgage insurance to lenders throughout the United States and to government sponsored entities (“GSEs”) to protect against loss from defaults on low down payment residential mortgage loans.

The accompanying unaudited consolidated financial statements of MGIC Investment Corporation and its wholly-owned subsidiaries have been prepared in accordance with the instructions to Form 10-Q as prescribed by the Securities and Exchange Commission (“SEC”) for interim reporting and do not include all of the other information and disclosures required by accounting principles generally accepted in the United States of America (“GAAP”). These statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2016 included in our Annual Report on Form 10-K. As used below, “we,” “our” and “us” refer to MGIC Investment Corporation’s consolidated operations or to MGIC Investment Corporation, as the context requires.

In the opinion of management the accompanying financial statements include all adjustments, consisting primarily of normal recurring accruals, necessary to fairly state our consolidated financial position and consolidated results of operations for the periods indicated. The consolidated results of operations for the interim period may not be indicative of the results that may be expected for the year ending December 31, 2017.

Substantially all of our insurance written since 2008 has been for loans purchased by the GSEs. We operate under the Private Mortgage Insurer Eligibility Requirements ("PMIERs") of the GSEs that became effective December 31, 2015 and have been amended from time to time. The financial requirements of the PMIERs require a mortgage insurer’s "Available Assets" (generally only the most liquid assets of an insurer) to equal or exceed its "Minimum Required Assets" (which are based on an insurer's book and are calculated from tables of factors with several risk dimensions and are subject to a floor amount). Based on our interpretation of the PMIERs, as of June 30, 2017, MGIC’s Available Assets are in excess of its Minimum Required Assets; and MGIC is in compliance with the financial requirements of the PMIERs and eligible to insure loans purchased by the GSEs.

 
Reclassifications
Certain reclassifications to 2016 amounts have been made in the accompanying financial statements to conform to the 2017 presentation.

Subsequent events
We have considered subsequent events through the date of this filing.

Note 2. New Accounting Pronouncements
Adopted Accounting Standards
Improvements to Employee Share-Based Compensation Accounting
In March 2016, the Financial Accounting Standards Board (“FASB”) issued updated guidance that simplifies several aspects of the accounting for employee share-based compensation including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification of related amounts within the statement of cash flows. The updated guidance requires that, prospectively, all tax effects related to share-based compensation be made through the statement of operations at the time of settlement. In contrast, the previous guidance required excess tax benefits to be recognized in paid-in capital. The updated guidance also removes the requirement to delay recognition of a tax benefit until it reduces current taxes payable. This change is required to be applied on a modified retrospective basis, with a cumulative effect adjustment to opening retained earnings. Additionally, all tax related cash flows resulting from share-based compensation are to be reported as operating activities on the statement of cash flows, a change from the existing requirement to present tax benefits as an inflow from financing activities and an outflow from operating activities. Finally, for tax withholding purposes, entities will be allowed to withhold an amount of shares up to the employee’s maximum individual tax rate (as opposed to the minimum statutory tax rate) in the relevant jurisdiction without resulting in liability classification of the award. The change in tax withholding is to be applied on a modified retrospective approach. This updated guidance became effective January 1, 2017. We adopted this guidance in the first quarter of 2017 and as a result of the adoption:
We recognized discrete tax benefits of $1.5 million in the provision for income taxes on our statement of operations for the six months ended June 30, 2017 related to excess tax benefits upon vesting of share-based awards during the period.
We recognized a cumulative effect adjustment related to the recognition of a deferred tax asset related to



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suspended tax benefits from vesting transactions occurring in prior years and from the elimination of our forfeiture estimate on share-based awards, which was previously applied only to awards with service conditions.
Prior to adoption, cash flows related to excess tax benefits from share-based compensation were included in financing activities. We have reclassified excess tax benefits related to share-based compensation for the prior year period to operating activities.
Prior to adoption, cash flows related to employee taxes paid for withheld shares were included in operating activities. We have reclassified employee taxes paid for withheld shares for the prior year period to financing activities.

Prospective Accounting Standards
Stock Compensation - Scope of Modification Accounting
In May 2017, the FASB issued updated guidance related to a change in the terms or conditions (modification) of a share-based award. The updated guidance provides that an entity should account for the effects of a modification unless the fair value and vesting conditions of the modified award and the classification of the award (equity or liability instrument) are the same as the original award immediately before the modification. The updated guidance addresses the current diversity in practice on applying modification accounting, as some entities evaluate whether changes to awards are substantive, which is not prescribed within the current accounting guidance. The updated guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. Early adoption is permitted, including adoption in any interim period. We are currently evaluating the impacts the adoption of this guidance will have on our consolidated financial statements, but do not expect it to have a material impact on our consolidated financial statements or disclosures.

Premium Amortization on Purchased Callable Debt Securities
In March 2017, the FASB issued updated guidance to amend the amortization period for certain purchased callable debt securities held at a premium shortening the amortization period to the earliest call date. Under current GAAP, there is diversity in practice in the amortization period for premiums of callable debt securities and in how the potential for exercise of a call is factored into current impairment assessments. This updated guidance aligns with how callable debt securities, in the United States, are generally quoted, priced, and traded assuming a model that incorporates consideration of calls (also referred to as “yield-to-worst” pricing). The updated guidance is effective for annual periods beginning after December 15, 2018, including interim periods within those annual periods. We are currently evaluating the impacts the adoption of this
 
guidance will have on our consolidated financial statements, but do not expect it to have a material impact on our consolidated financial statements or disclosures. We currently account for premium amortization on our purchased callable debt securities on a yield-to-worst basis, which generally aligns with the earliest call date.

Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost
In March 2017, the FASB issued updated guidance that improves the reporting of net benefit cost in the financial statements. The updated guidance requires that an employer report the service cost component in the same financial statement caption as other compensation costs arising from services rendered by employees during the period. The other components of net benefit cost are required to be presented in the statement of operations separately from the service cost component and outside a subtotal of income from operations, if one is presented. Current guidance does not prescribe where the amount of net benefit cost should be presented in an employer’s statement of operations and does not require entities to disclose by line item the amount of net benefit cost that is included in the statement of operations. The updated guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. We are currently evaluating the impacts the adoption of this guidance will have on our consolidated financial statements, but do not expect it to have a material impact on our consolidated financial statements or disclosures.

Measurement of Credit Losses on Financial Instruments
In June 2016, the FASB issued updated guidance that requires immediate recognition of estimated credit losses expected to occur over the remaining life of many financial instruments. Entities will be required to utilize a current expected credit losses (“CECL”) methodology that incorporates their forecasts of future economic conditions into their loss estimate unless such forecast is not reasonable and supportable, in which case the entity will revert to historical loss experience. Any allowance for CECL reduces the amortized cost basis of the financial instrument to the amount an entity expects to collect. Credit losses relating to available-for-sale fixed maturity securities are to be recorded through an allowance for credit losses, rather than a write-down of the asset, with the amount of the allowance limited to the amount by which fair value is less than amortized cost. In addition, the length of time a security has been in an unrealized loss position will no longer impact the determination of whether a credit loss exists. The updated guidance is not prescriptive about certain aspects of estimating expected credit losses, including the specific methodology to use, and therefore will require significant judgment in application. The updated guidance is effective for annual periods beginning after December 15, 2019, including interim periods within those annual periods. Early



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adoption is permitted for annual and interim periods in fiscal years beginning after December 15, 2018. We are currently evaluating the impacts the adoption of this guidance will have on our consolidated financial statements, but do not expect it to have a material impact on our consolidated financial statements or disclosures.

Recognition and Measurement of Financial Assets and Financial Liabilities
In January 2016, the FASB issued updated guidance to address the recognition, measurement, presentation, and disclosure of certain financial instruments. The updated guidance requires equity investments, except those accounted for under the equity method of accounting, that have a readily determinable fair value to be measured at fair value with changes in fair value recognized in net income. Equity investments that do not have readily determinable fair values may be remeasured at fair value either upon the occurrence of an observable price change or upon identification of an impairment. A qualitative assessment for impairment is required for equity investments without readily determinable fair values. The updated guidance also eliminates the requirement to disclose the method and significant assumptions used to estimate the fair value of financial instruments measured at amortized cost on the balance sheet. Further, the updated guidance clarifies that entities should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entities other deferred tax assets. The updated guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods and will require recognition of a cumulative effect adjustment at adoption. We do not currently expect the adoption of this guidance to impact our consolidated financial position or liquidity.

Note 3. Debt
2017 debt transactions
2% Notes
On March 21, 2017, we issued an irrevocable notice of redemption in respect of our outstanding 2% Notes, with a redemption date of April 21, 2017. In April, holders of approximately $202.5 million of the outstanding principal exercised their rights to convert their notes into shares of our common stock. The remaining $5.1 million of outstanding principal was redeemed for cash. The conversions of the 2% Notes at a rate of 143.8332 shares per $1,000 principal amount resulted in the issuance of approximately 29.1 million shares of our common stock in April. The conversions and cash redemption eliminated our debt obligation. A loss on debt extinguishment of $0.07 million was recognized on the redemption of the $5.1 million of 2% Notes. No gain or loss was recognized from the conversions as the outstanding debt issuance costs associated with the conversions are included in the debt
 
carrying value, which was credited to shareholders’ equity at the time of conversion.

Credit Facility
On March 21, 2017, we entered into a Credit Agreement with various lenders which provides for a $175 million unsecured revolving credit facility maturing on March 21, 2020. Revolving credit borrowings bear interest at a floating rate, which will be, at our option, either a eurocurrency rate or a base rate, in each case plus an applicable margin. The applicable margins are subject to adjustment based on our senior unsecured long-term debt rating, or if we do not have such a rating, our corporate or issuer rating. Amounts under the facility may be borrowed, repaid and reborrowed from time to time until the maturity of the revolving credit facility. Voluntary prepayments and commitment reductions are permitted at any time without fee subject to a minimum dollar requirement and, for outstanding eurocurrency loans, customary breakage costs.

We are required under the Credit Agreement to pay commitment fees on the average daily amount of the unused revolving commitments of the lenders, and an annual administrative fee to the administrative agent. The Credit Agreement contains affirmative, negative and financial covenants which are customary for financings of this type, including, among other things, limits on the creation of liens, limits on the incurrence of indebtedness, restrictions on dispositions, maximum debt-to-capital ratio, minimum consolidated stockholders' equity, minimum policyholder's position of MGIC, and compliance with the financial requirements of the PMIERs. The Credit Agreement includes customary events of default for facilities of this type (with customary grace periods, as applicable) and provides that, upon the occurrence of an event of default, payments of all outstanding loans may be accelerated and/or the lenders' commitments may be terminated. Upon the occurrence of certain insolvency or bankruptcy related events of default, all amounts payable under the Credit Agreements shall automatically become immediately due and payable, and the lenders' commitments will automatically terminate. In addition, upon the occurrence of certain insolvency or bankruptcy related events of default, or the failure to pay interest, principal or fees, the interest rates on all outstanding obligations will be increased.

In March, we borrowed $150 million under the revolving credit facility, to fund a portion of the redemption price of the 2% Notes if holders did not elect to convert their 2% Notes. In April, we repaid the amount borrowed under the revolving credit facility because most holders elected to convert their notes. Costs incurred to enter into the Credit Agreement have been deferred and recorded as Other



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assets and will be amortized over the term of the Credit Agreement.

5% Notes
On May 1, 2017, our 5% Notes due in 2017 (“5% Notes”) matured and we repaid the outstanding $145 million in aggregate par value, plus accrued interest with cash at our holding company.

First half 2016 debt transactions
5% Notes
During the first six months of 2016, we purchased $188.5 million in aggregate par value of our 5% Notes at an aggregate purchase price of $195.5 million for which we recognized losses on debt extinguishment on our consolidated statements of operations for the three and six months ended June 30, 2016.

9% Debentures
In February 2016, MGIC purchased $132.7 million in aggregate par value of our 9% Debentures at a purchase price of $150.7 million. The purchase of the 9% Debentures resulted in an $8.3 million loss on debt extinguishment on the consolidated statement of operations for the six months ended June 30, 2016, which represents the difference between the fair value and the carrying value of the liability component on the purchase date. Our shareholders’ equity was separately reduced by $6.3 million related to the reacquisition of the equity component. For GAAP accounting purposes, the 9% Debentures owned by MGIC are considered retired and are eliminated in our consolidated financial statements and the underlying common stock equivalents, approximately 9.8 million shares, are not included in the computation of diluted shares.

Debt obligations
The par value of our long-term debt obligations and their aggregate carrying values as of June 30, 2017 and December 31, 2016 were as follows.
(In millions)
 
June 30,
2017
 
December 31,
2016
FHLB Advance
 
$
155.0

 
$
155.0

5% Notes
 

 
145.0

2% Notes
 

 
207.6

5.75% Notes
 
425.0

 
425.0

9% Debentures(1)
 
256.9

 
256.9

Long-term debt, par value
 
836.9

 
1,189.5

Debt issuance costs
 
(7.0
)
 
(10.8
)
Long-term debt, carrying value
 
$
829.9

 
$
1,178.7

(1) 
Convertible at any time prior to maturity at the holder’s option, at an initial conversion rate, which is subject to adjustment, of 74.0741 shares per $1,000 principal amount, representing an initial conversion price of approximately $13.50 per share.
 
If a holder elects to convert their debentures, deferred interest owed on the debentures being converted is also converted into shares of our common stock. The conversion rate for any deferred interest is based on the average price that our shares traded at during a 5-day period immediately prior to the election to convert. In lieu of issuing shares of common stock upon conversion of the debentures, we may, at our option, make a cash payment to converting holders for all or some of the shares of our common stock otherwise issuable upon conversion.

The 5.75% Senior Notes due 2023 (“5.75% Notes”) and 9% Convertible Junior Subordinated Debentures due in 2063 (“9% Debentures”) are obligations of our holding company, MGIC Investment Corporation, and not of its subsidiaries. The Federal Home Loan Bank Advance (the “FHLB Advance”) is an obligation of MGIC.

Interest payments on our debt obligations appear below.
 
 
Six Months Ended June 30,
(In millions)
 
2017
 
2016
Revolving credit facility
 
$
0.5

 
$

FHLB Advance
 
1.5

 
0.9

5% Notes
 
3.6

 
6.9

2% Notes
 
2.1

 
5.0

5.75% Notes
 
12.9

 

9% Debentures
 
11.6

 
15.9

Total interest payments
 
$
32.2

 
$
28.7


Note 4. Reinsurance
The reinsurance agreements we have entered into are discussed below. The effect of all of our reinsurance agreements on premiums earned and losses incurred is as follows:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands)
 
2017
 
2016
 
2017
 
2016
Premiums earned:
 
 
 
 
 
 
 
 
Direct
 
$
261,180

 
$
263,566

 
$
520,608

 
$
518,953

Assumed
 
62

 
182

 
160

 
390

Ceded
 
(30,106
)
 
(32,292
)
 
(60,529
)
 
(66,546
)
Net premiums earned
$
231,136

 
$
231,456

 
$
460,239

 
$
452,797

 
 
 
 
 
 
 
 
 
Losses incurred:
 
 
 
 
 
 
 
 
Direct
 
$
31,396

 
$
54,863

 
$
63,809

 
$
147,295

Assumed
 
61

 
339

 
166

 
440

Ceded
 
(4,118
)
 
(8,612
)
 
(9,017
)
 
(16,133
)
Losses incurred, net
 
$
27,339

 
$
46,590

 
$
54,958

 
$
131,602





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Quota share reinsurance
In March 2017, we entered into a quota share reinsurance agreement (“2017 QSR Transaction”) with an effective date of January 1, 2017 with a group of unaffiliated reinsurers, each with a financial strength rating of A- or better by Standard and Poor’s, A.M. Best or both. We utilize quota share reinsurance to manage our exposure to losses resulting from our mortgage guaranty insurance policies and to provide reinsurance capital credit under the PMIERs. Our 2017 QSR Transaction provides coverage on new business written January 1, 2017 through December 29, 2017 that meets certain eligibility requirements. Under the agreement we cede losses incurred and premiums on or after the effective date through December 31, 2028, at which time the agreement expires. Early termination of the agreement can be elected by us effective December 31, 2021 for a fee, or under specified scenarios for no fee upon prior written notice including if we will receive less than 90% of the full credit amount under the PMIERs for the risk ceded in any required calculation period.

Our 2015 quota share reinsurance agreement (“2015 QSR Transaction”), which became effective on July 1, 2015, covers eligible risk in force written before 2017. The group of unaffiliated reinsurers under our 2015 QSR Transaction each has an insurer financial strength rating of A- or better by Standard and Poor’s Rating Services, A.M. Best or both. The 2015 QSR Transaction cedes losses incurred and premiums through December 31, 2024, at which time the agreement expires. Early termination of the agreement can be elected by us effective December 31, 2018 for a fee, or under specified scenarios for no fee upon prior written notice, including if we will receive less than 90% of the full credit amount under the PMIERs for the risk ceded in any required calculation period.

The structure of both the 2017 QSR Transaction and 2015 QSR Transaction is a 30% quota share for all policies covered, with a 20% ceding commission as well as a profit commission. Generally, under the QSR Transactions, we will receive a profit commission provided that the loss ratio on the loans covered under the agreement remains below 60%.

Following is a summary of our quota share reinsurance agreements, excluding captive agreements discussed below, for the three and six months ended June 30, 2017 and 2016.
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands)
 
2017
 
2016
 
2017
 
2016
Ceded premiums written and earned, net of profit commission (1)
 
$
28,917

 
$
29,961

 
$
57,812

 
$
61,627

Ceded losses incurred
 
4,424

 
6,070

 
9,111

 
14,583

Ceding commissions (2)
 
12,248

 
11,946

 
24,251

 
23,522

Profit commission
 
32,325

 
29,767

 
63,442

 
55,982

 
(1) 
Under our QSR Transactions, premiums are ceded on an earned and received basis as defined in the agreements.
(2) 
Ceding commissions are reported within Other underwriting and operating expenses, net on the consolidated statements of operations.

Under the terms of QSR Transactions, ceded premiums, ceding commission and profit commission are settled net on a quarterly basis. The ceded premium due after deducting the related ceding commission and profit commission is reported within “Other liabilities” on the consolidated balance sheets.

The reinsurance recoverable on loss reserves related to our QSR Transactions was $33.1 million as of June 30, 2017 and $31.8 million as of December 31, 2016. The reinsurance recoverable balance is secured by funds on deposit from the reinsurers which are based on the funding requirements of PMIERs that address ceded risk.

Captive reinsurance
In the past, MGIC also obtained captive reinsurance. In a captive reinsurance arrangement, the reinsurer is affiliated with the lender for whom MGIC provides mortgage insurance. As part of our settlement with the Consumer Financial Protection Bureau (“CFPB”) in 2013 and with the Minnesota Department of Commerce in 2015, MGIC has agreed to not enter into any new captive reinsurance agreement or reinsure any new loans under any existing captive reinsurance agreement for a period of ten years subsequent to the respective settlements. In accordance with the CFPB settlement, all of our active captive arrangements were placed into run-off. In addition, the GSEs will not approve any future reinsurance or risk sharing transaction with a mortgage enterprise or an affiliate of a mortgage enterprise.

The reinsurance recoverable on loss reserves related to captive agreements was $12.0 million as of June 30, 2017, which was supported by $86.0 million of trust assets, while as of December 31, 2016, the reinsurance recoverable on loss reserves related to captive agreements was $19.0 million, which was supported by $91.0 million of trust assets. Each captive reinsurer is required to maintain a separate trust account to support its combined reinsured risk on all annual books. MGIC is the sole beneficiary of the trusts.

Note 5. Litigation and Contingencies
Before paying an insurance claim, we review the loan and servicing files to determine the appropriateness of the claim amount. When reviewing the files, we may determine that we have the right to rescind coverage on the loan. In our SEC reports, we refer to insurance rescissions and denials of claims collectively as “rescissions” and variations of that term. In addition, all of our insurance policies provide that we can reduce or deny a claim if the servicer did not comply



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with its obligations under our insurance policy. We call such reduction of claims “curtailments.” In recent quarters, an immaterial percentage of claims received in a quarter have been resolved by rescissions. In each of 2016 and the first half of 2017, curtailments reduced our average claim paid by approximately 5.5%.

Our loss reserving methodology incorporates our estimates of future rescissions, curtailments, and reversals of rescissions and curtailments. A variance between ultimate actual rescission, curtailment and reversal rates and our estimates, as a result of the outcome of litigation, settlements or other factors, could materially affect our losses.

When the insured disputes our right to rescind coverage or curtail claims, we generally engage in discussions in an attempt to settle the dispute. If we are unable to reach a settlement, the outcome of a dispute ultimately would be determined by legal proceedings.

Under ASC 450-20, until a liability associated with settlement discussions or legal proceedings becomes probable and can be reasonably estimated, we consider our claim payment or rescission resolved for financial reporting purposes and do not accrue an estimated loss. Where we have determined that a loss is probable and can be reasonably estimated, we have recorded our best estimate of our probable loss. If we are not able to implement settlements we consider probable, we intend to defend MGIC vigorously against any related legal proceedings.

In addition to matters for which we have recorded a probable loss, we are involved in other discussions and/or proceedings with insureds with respect to our claims paying practices. Although it is reasonably possible that when these matters are resolved we will not prevail in all cases, we are unable to make a reasonable estimate or range of estimates of the potential liability. We estimate the maximum exposure associated with matters where a loss is reasonably possible to be approximately $291 million, although we believe (but can give no assurance that) we will ultimately resolve these matters for significantly less than this amount. This estimate of our maximum exposure does not include interest or consequential or exemplary damages.
Mortgage insurers, including MGIC, have been involved in litigation and regulatory actions related to alleged violations of the anti-referral fee provisions of the Real Estate Settlement Procedures Act, which is commonly known as RESPA, and the notice provisions of the Fair Credit Reporting Act, which is commonly known as FCRA. While these proceedings in the aggregate have not resulted in material liability for MGIC, there can be no assurance that the outcome of future proceedings, if any, under these laws would not have a material adverse affect on us. In addition, various regulators, including the CFPB, state insurance
 
commissioners and state attorneys general may bring other actions seeking various forms of relief in connection with alleged violations of RESPA. The insurance law provisions of many states prohibit paying for the referral of insurance business and provide various mechanisms to enforce this prohibition. While we believe our practices are in conformity with applicable laws and regulations, it is not possible to predict the eventual scope, duration or outcome of any such reviews or investigations nor is it possible to predict their effect on us or the mortgage insurance industry.

Through a non-insurance subsidiary, we utilize our underwriting skills to provide an outsourced underwriting service to our customers known as contract underwriting. As part of the contract underwriting activities, that subsidiary is responsible for the quality of the underwriting decisions in accordance with the terms of the contract underwriting agreements with customers. That subsidiary may be required to provide certain remedies to its customers if certain standards relating to the quality of our underwriting work are not met, and we have an established reserve for such future obligations. Claims for remedies may be made a number of years after the underwriting work was performed. The underwriting remedy expense for 2016 and the first half of 2017 was immaterial to our consolidated financial statements.

In addition to the matters described above, we are involved in other legal proceedings in the ordinary course of business. In our opinion, based on the facts known at this time, the ultimate resolution of these ordinary course legal proceedings will not have a material adverse effect on our financial position or results of operations.

See Note 11 – “Income Taxes” for a description of federal income tax contingencies.

Note 6. Earnings per Share
Basic earnings per share (“EPS”) is calculated by dividing net income by the weighted average number of shares of common stock outstanding. Diluted EPS includes the components of basic EPS and also gives effect to dilutive common stock equivalents. We calculate diluted EPS using the treasury stock method and if-converted method. Under the if-converted method, diluted EPS reflects the potential dilution that could occur if our convertible debt instruments result in the issuance of common stock. The determination of potentially issuable shares does not consider the satisfaction of the conversion requirements and the shares are included in the determination of diluted EPS as of the beginning of the period, if dilutive. During the quarter ended June 30, 2017, we had several debt issuances that could result in contingently issuable shares and consider each potential issuance of shares separately to reflect the maximum potential dilution. Nonetheless, our dilutive common stock equivalents may not reflect all of the contingently issuable shares that could be required to be



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issued upon any debt conversion. For purposes of calculating basic and diluted EPS, vested restricted stock and restricted stock units ("RSUs") are considered outstanding.

The following table reconciles the numerators and denominators used to calculate basic and diluted EPS.
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands, except per share data)
 
2017
 
2016
 
2017
 
2016
Basic earnings per share:
 
 
 
 
 
 
 
 
Net income
 
$
118,622

 
$
109,221

 
$
208,420

 
$
178,412

Weighted average common shares outstanding - basic
 
366,918

 
340,678

 
354,035

 
340,411

Basic earnings per share
 
$
0.32

 
$
0.32

 
$
0.59

 
$
0.52

 
 
 
 
 
 
 
 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
Net income
 
$
118,622

 
$
109,221

 
$
208,420

 
$
178,412

Interest expense, net of tax (1):
 
 
 
 
 
 
 
 
2% Notes
 
84

 
1,982

 
907

 
3,964

5% Notes
 
427

 
1,728

 
1,709

 
4,406

9% Debentures
 
3,757

 
3,757

 
7,514

 
8,379

Diluted income available to common shareholders
 
$
122,890

 
$
116,688

 
$
218,550

 
$
195,161

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding - basic
 
366,918

 
340,678

 
354,035

 
340,411

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Unvested RSUs
 
1,140

 
1,209

 
1,314

 
1,444

2% Notes
 
3,827

 
71,917

 
16,771

 
71,917

5% Notes
 
3,557

 
13,307

 
7,154

 
15,449

9% Debentures
 
19,028

 
19,028

 
19,028

 
21,133

Weighted average common shares outstanding - diluted
 
394,470

 
446,139

 
398,302

 
450,354

Diluted earnings per share
$
0.31

 
$
0.26

 
$
0.55

 
$
0.43

(1) 
Tax effected at a rate of 35%.

 
Note 7. Investments
The amortized cost, gross unrealized gains and losses and fair value of the investment portfolio at June 30, 2017 and December 31, 2016 are shown below.
June 30, 2017
(In thousands)
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses (1)
 
Fair Value
U.S. Treasury securities and obligations of U.S. government corporations and agencies
 
$
64,043

 
$
364

 
$
(478
)
 
$
63,929

Obligations of U.S. states and political subdivisions
 
2,131,471

 
42,983

 
(9,165
)
 
2,165,289

Corporate debt securities
 
1,823,823

 
12,699

 
(8,897
)
 
1,827,625

ABS
 
21,988

 
10

 
(11
)
 
21,987

RMBS
 
209,874

 
78

 
(7,612
)
 
202,340

CMBS
 
310,997

 
1,548

 
(5,467
)
 
307,078

CLOs
 
112,769

 
332

 
(138
)
 
112,963

Total debt securities
 
4,674,965

 
58,014

 
(31,768
)
 
4,701,211

Equity securities
 
7,183

 
41

 
(15
)
 
7,209

Total investment portfolio
 
$
4,682,148

 
$
58,055

 
$
(31,783
)
 
$
4,708,420

December 31, 2016
(In thousands)
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses (1)
 
Fair Value
U.S. Treasury securities and obligations of U.S. government corporations and agencies
 
$
73,847

 
$
407

 
$
(724
)
 
$
73,530

Obligations of U.S. states and political subdivisions
 
2,147,458

 
20,983

 
(25,425
)
 
2,143,016

Corporate debt securities
 
1,756,461

 
6,059

 
(18,610
)
 
1,743,910

ABS
 
59,519

 
74

 
(28
)
 
59,565

RMBS
 
231,733

 
102

 
(7,626
)
 
224,209

CMBS
 
327,042

 
769

 
(7,994
)
 
319,817

CLOs
 
121,151

 
226

 
(202
)
 
121,175

Total debt securities
 
4,717,211

 
28,620

 
(60,609
)
 
4,685,222

Equity securities
 
7,144

 
8

 
(24
)
 
7,128

Total investment portfolio
 
$
4,724,355

 
$
28,628

 
$
(60,633
)
 
$
4,692,350

(1) 
At June 30, 2017 and December 31, 2016, there were no other-than-temporary impairment losses recorded in other comprehensive income.




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The FHLB Advance is secured by eligible collateral whose fair value must be maintained at 102% of the outstanding principal balance. As of June 30, 2017 that collateral is included in our total investment portfolio amount shown above with a total fair value of $165.9 million.

The amortized cost and fair values of debt securities at June 30, 2017, by contractual maturity, are shown in the following table. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Because most asset-backed and mortgage-backed securities and collateralized loan obligations provide for periodic payments throughout their lives, they are listed in separate categories.
June 30, 2017
 
 
 
 
(In thousands)
 
Amortized Cost
 
Fair Value
Due in one year or less
 
$
341,831

 
$
342,028

Due after one year through five years
 
1,356,023

 
1,362,799

Due after five years through ten years
 
1,026,851

 
1,030,223

Due after ten years
 
1,294,632

 
1,321,793

 
 
$
4,019,337

 
$
4,056,843

 
 
 
 
 
ABS
 
21,988

 
21,987

RMBS
 
209,874

 
202,340

CMBS
 
310,997

 
307,078

CLOs
 
112,769

 
112,963

Total as of June 30, 2017
 
$
4,674,965

 
$
4,701,211


At June 30, 2017 and December 31, 2016, the investment portfolio had gross unrealized losses of $31.8 million and $60.6 million, respectively.  For those securities in an unrealized loss position, the length of time the securities were in such a position, as measured by their month-end fair values, is as follows:
June 30, 2017
 
Less Than 12 Months
 
12 Months or Greater
 
Total
(In thousands)
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
U.S. Treasury securities and obligations of U.S. government corporations and  agencies
 
$
52,769

 
$
(471
)
 
$
993

 
$
(7
)
 
$
53,762

 
$
(478
)
Obligations of U.S. states and political subdivisions
 
622,767

 
(8,595
)
 
17,400

 
(570
)
 
640,167

 
(9,165
)
Corporate debt securities
 
649,134

 
(7,664
)
 
27,241

 
(1,233
)
 
676,375

 
(8,897
)
ABS
 
3,362

 
(11
)
 

 

 
3,362

 
(11
)
RMBS
 
43,815

 
(885
)
 
155,030

 
(6,727
)
 
198,845

 
(7,612
)
CMBS
 
172,505

 
(5,439
)
 
7,237

 
(28
)
 
179,742

 
(5,467
)
CLOs
 
7,275

 
(138
)
 

 

 
7,275

 
(138
)
Equity securities
 
455

 
(7
)
 
139

 
(8
)
 
594

 
(15
)
Total
 
$
1,552,082

 
$
(23,210
)
 
$
208,040

 
$
(8,573
)
 
$
1,760,122

 
$
(31,783
)
December 31, 2016
 
Less Than 12 Months
 
12 Months or Greater
 
Total
(In thousands)
 
Fair Value
 
Unrealized
 Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
 Losses
U.S. Treasury securities and obligations of U.S. government corporations and agencies
 
$
48,642

 
$
(724
)
 
$

 
$

 
$
48,642

 
$
(724
)
Obligations of U.S. states and political subdivisions
 
1,136,676

 
(24,918
)
 
13,681

 
(507
)
 
1,150,357

 
(25,425
)
Corporate debt securities
 
915,777

 
(16,771
)
 
35,769

 
(1,839
)
 
951,546

 
(18,610
)
ABS
 
3,366

 
(28
)
 
656

 

 
4,022

 
(28
)
RMBS
 
46,493

 
(857
)
 
171,326

 
(6,769
)
 
217,819

 
(7,626
)
CMBS
 
205,545

 
(7,529
)
 
38,587

 
(465
)
 
244,132

 
(7,994
)
CLOs
 
13,278

 
(73
)
 
34,760

 
(129
)
 
48,038

 
(202
)
Equity securities
 
568

 
(15
)
 
137

 
(9
)
 
705

 
(24
)
Total
 
$
2,370,345

 
$
(50,915
)
 
$
294,916

 
$
(9,718
)
 
$
2,665,261

 
$
(60,633
)



19 | MGIC Investment Corporation - Q2 2017

Table of contents

The unrealized losses in all categories of our investments at June 30, 2017 and December 31, 2016 were primarily caused by the difference in interest rates at each respective period, compared to interest rates at the time of purchase. There were 404 and 607 securities in an unrealized loss position at June 30, 2017 and December 31, 2016, respectively.

During each of the three and six months ended June 30, 2017 and 2016 there were no other-than-temporary impairments (“OTTI”) recognized.   The net realized investment gains (losses) on the investment portfolio are as follows:
 
 
Three Months Ended
June 30,
 
Six Months Ended June 30,
(In thousands)
 
2017
 
2016
 
2017
 
2016
Realized investment gains (losses) on investments:
 
 
 
 
 
 
 
 
Fixed maturities
 
$
(52
)
 
$
831

 
$
(177
)
 
$
3,886

Equity securities
 
10

 
5

 
13

 
6

Net realized investments (losses) gains
 
$
(42
)
 
$
836

 
$
(164
)
 
$
3,892

 
 
Three Months Ended
June 30,
 
Six Months Ended June 30,
(In thousands)
 
2017
 
2016
 
2017
 
2016
Realized investment gains (losses) on investments:
 
 
 
 
 
 
 
 
Gains on sales
 
$
644

 
$
1,404

 
$
829

 
$
5,509

Losses on sales
 
(686
)
 
(568
)
 
(993
)
 
(1,617
)
Net realized investments (losses) gains
 
$
(42
)
 
$
836

 
$
(164
)
 
$
3,892


Note 8. Fair Value Measurements
Under the authoritative guidance, fair value is disclosed using a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value and categorizes assets and liabilities into Levels 1, 2, and 3 based on inputs available to determine their fair values. To determine the fair value of securities available-for-sale in Level 1 and Level 2 of the fair value hierarchy, independent pricing sources have been utilized. One price is provided per security based on observable market data. To ensure securities are appropriately classified in the fair value hierarchy, we review the pricing techniques and methodologies of the independent pricing sources and believe that their policies adequately consider market activity, either based on specific transactions for the issue valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. A variety of inputs are utilized by the independent pricing sources including benchmark yields, reported
 
trades, non-binding broker/dealer quotes, issuer spreads, two sided markets, benchmark securities, bids, offers and reference data including data published in market research publications. Inputs may be weighted differently for any security, and not all inputs are used for each security evaluation.

Market indicators, industry and economic events are also considered. This information is evaluated using a multidimensional pricing model. This model combines all inputs to arrive at a value assigned to each security. Quality controls are performed by the independent pricing sources throughout this process, which include reviewing tolerance reports, trading information, data changes, and directional moves compared to market moves. In addition, on a quarterly basis, we perform quality controls over values received from the pricing sources which also includes reviewing tolerance reports, trading information, data changes, and directional moves compared to market moves. We have not made any adjustments to the prices obtained from the independent pricing sources.

In accordance with fair value accounting guidance, we applied the following fair value hierarchy in order to measure fair value for assets and liabilities:

Level 1 - Quoted prices for identical instruments in active markets that we can access. Financial assets utilizing Level 1 inputs primarily include U.S. Treasury securities and equity securities.

Level 2 - Quoted prices for similar instruments in active markets that we can access; quoted prices for identical or similar instruments in markets that are not active; and inputs, other than quoted prices, that are observable in the marketplace for the instrument. The observable inputs are used in valuation models to calculate the fair value of the instruments. Financial assets utilizing Level 2 inputs primarily include obligations of U.S. government corporations and agencies, corporate bonds, mortgage-backed securities, asset-backed securities, and most municipal bonds.

The independent pricing sources utilize these approaches to determine the fair value of the instruments in Level 2 of the fair value hierarchy based on type of instrument:

Corporate Debt & U.S. Government and Agency Bonds are evaluated by surveying the dealer community, obtaining relevant trade data, benchmark quotes and spreads and incorporating this information into the evaluation process.

Obligations of U.S. States & Political Subdivisions are evaluated by tracking, capturing, and analyzing quotes for active issues and trades reported via the Municipal Securities Rulemaking Board records. Daily briefings and reviews of current economic conditions, trading



MGIC Investment Corporation - Q2 2017 | 20

Table of contents

levels, spread relationships, and the slope of the yield curve provide further data for evaluation.

Residential Mortgage-Backed Securities (“RMBS”) are evaluated by monitoring interest rate movements, and other pertinent data daily. Incoming market data is enriched to derive spread, yield and/or price data as appropriate, enabling known data points to be extrapolated for valuation application across a range of related securities.

Commercial Mortgage-Backed Securities (“CMBS”) are evaluated using valuation techniques that reflect market participants’ assumptions and maximize the use of relevant observable inputs including quoted prices for similar assets, benchmark yield curves and market corroborated inputs. The inputs for securities covered, including executed trades, broker quotes, credit information, collateral attributes and/or cash flow waterfall as applicable, are regularly reviewed as part of the evaluation.

Asset-Backed Securities (“ABS”) are evaluated using spreads and other information solicited from market buy- and sell-side sources, including primary and secondary dealers, portfolio managers, and research analysts. Cash flows are generated for each tranche, benchmark yields are determined, and deal collateral performance and tranche level attributes including trade activity, bids, and offer are applied, resulting in tranche-specific prices.

 
Collateralized loan obligations ("CLO") are evaluated by manager rating, seniority in the capital structure, assumptions about prepayment, default and recovery and their impact on cash flow generation. Loan level net asset values are determined and aggregated for tranches and as a final step, prices are checked against available recent trade activity.

Level 3 - Valuations derived from valuation techniques in which one or more significant inputs or value drivers are unobservable or from par values for equity securities restricted in their ability to be redeemed or sold. The inputs used to derive the fair value of Level 3 securities reflect our own assumptions about the assumptions a market participant would use in pricing an asset or liability. Financial assets utilizing Level 3 inputs primarily include equity securities that can only be redeemed or sold at their par value and only to the security issuer and a state premium tax credit investment. The state premium tax credit investment has a maturity of less than 2 years, a credit rating of AAA, and its balance reflects its remaining scheduled payments discounted at an average annual rate of 7.1%. Our non-financial assets that are classified as Level 3 securities consist of real estate acquired through claim settlement. The fair value of real estate acquired is the lower of our acquisition cost or a percentage of the appraised value. The percentage applied to the appraised value is based upon our historical sales experience adjusted for current trends.


_________________________________
Fair value measurements for assets measured at fair value included the following as of June 30, 2017 and December 31, 2016:
June 30, 2017
(In thousands)
 
Total Fair Value
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
U.S. Treasury securities and obligations of U.S. government corporations and agencies
 
$
63,929

 
$
13,342

 
$
50,587

 
$

Obligations of U.S. states and political subdivisions
 
2,165,289

 

 
2,164,712

 
577

Corporate debt securities
 
1,827,625

 

 
1,827,625

 

ABS
 
21,987

 

 
21,987

 

RMBS
 
202,340