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 JUNE 30, 2001
[ ] 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
MGIC INVESTMENT CORPORATION
(Exact name of registrant as specified in its charter)
WISCONSIN 39-1486475
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
250 E. KILBOURN AVENUE 53202
MILWAUKEE, WISCONSIN (Zip Code)
(Address of principal executive offices)
(414) 347-6480
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OF STOCK PAR VALUE DATE NUMBER OF SHARES
- -------------- --------- ---- ----------------
Common stock $1.00 7/31/01 107,327,071
Page 1
MGIC INVESTMENT CORPORATION
TABLE OF CONTENTS
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheet as of
June 30, 2001 (Unaudited) and December 31, 2000 3
Consolidated Statement of Operations for the Three and Six
Month Periods Ended June 30, 2001 and 2000 (Unaudited) 4
Consolidated Statement of Cash Flows for the Six Months
Ended June 30, 2001 and 2000 (Unaudited) 5
Notes to Consolidated Financial Statements (Unaudited) 6-11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-26
Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 27
Item 4. Submission of Matters to a Vote of Security Holders 27-28
Item 6. Exhibits and Reports on Form 8-K 28
SIGNATURES
INDEX TO EXHIBITS
Page 2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
June 30, 2001 (Unaudited) and December 31, 2000
June 30, December 31,
2001 2000
------------ ------------
ASSETS (In thousands of dollars)
Investment portfolio:
Securities, available-for-sale,
at market value:
Fixed maturities $ 3,577,764 $ 3,298,561
Equity securities 19,839 22,042
Short-term investments 147,492 151,592
----------- -----------
Total investment portfolio 3,745,095 3,472,195
Cash 12,320 5,598
Accrued investment income 53,919 51,419
Reinsurance recoverable on loss reserves 28,276 33,226
Reinsurance recoverable on unearned premiums 8,294 8,680
Home office and equipment, net 32,137 31,308
Deferred insurance policy acquisition costs 28,175 25,839
Investments in joint ventures 159,008 138,838
Other assets 103,665 90,678
----------- -----------
Total assets $ 4,170,889 $ 3,857,781
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Loss reserves $ 599,252 $ 609,546
Unearned premiums 168,277 180,724
Notes payable (note 2) 408,426 397,364
Other liabilities 214,603 205,265
----------- -----------
Total liabilities 1,390,558 1,392,899
----------- -----------
Contingencies (note 4) Shareholders' equity:
Common stock, $1 par value, shares
authorized 300,000,000; shares
issued 121,110,800; shares
outstanding, 6/30/01 - 107,218,361
12/31/00 - 106,825,758 121,111 121,111
Paid-in surplus 212,208 207,882
Treasury stock (shares at cost,
6/30/01 - 13,892,439
12/31/00 - 14,285,042 (604,501) (621,033)
Accumulated other comprehensive income,
net of tax 56,609 75,814
Retained earnings 2,994,904 2,681,108
----------- -----------
Total shareholders' equity 2,780,331 2,464,882
----------- -----------
Total liabilities and shareholders'
equity $ 4,170,889 $ 3,857,781
=========== ===========
See accompanying notes to consolidated financial statements.
Page 3
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
Three and Six Month Periods Ended June 30, 2001 and 2000
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- -------------------
2001 2000 2001 2000
(In thousands of dollars, except per share data)
Revenues:
Premiums written:
Direct $271,888 $231,538 $515,509 $440,264
Assumed 122 191 227 417
Ceded (15,107) (10,915) (29,245) (20,547)
-------- -------- -------- --------
Net premiums written 256,903 220,814 486,491 420,134
(Increase) decrease in
unearned premiums 469 (2,380) 12,063 8,404
-------- -------- -------- --------
Net premiums earned 257,372 218,434 498,554 428,538
Investment income, net of
expenses 51,566 42,731 101,611 83,340
Realized investment gains,
net 7,882 159 21,575 163
Other revenue 22,723 12,840 38,282 23,296
-------- -------- -------- --------
Total revenues 339,543 274,164 660,022 535,337
-------- -------- -------- --------
Losses and expenses:
Losses incurred, net 36,304 22,540 65,681 45,155
Underwriting and other
expenses 58,524 46,198 110,178 93,206
Interest expense 7,127 7,052 15,690 13,673
-------- -------- -------- --------
Total losses and expenses 101,955 75,790 191,549 152,034
-------- -------- -------- --------
Income before tax 237,588 198,374 468,473 383,303
Provision for income tax 76,370 62,271 149,331 119,980
-------- -------- -------- --------
Net income $161,218 $136,103 $319,142 $263,323
======== ======== ======== ========
Earnings per share (note 5):
Basic $ 1.51 $ 1.28 $ 2.98 $ 2.49
======== ======== ======== ========
Diluted $ 1.49 $ 1.27 $ 2.96 $ 2.46
======== ======== ======== ========
Weighted average common shares
outstanding - diluted (shares
in thousands, note 5) 108,102 106,845 107,954 106,874
======== ======== ======== ========
Dividends per share $ 0.025 $ 0.025 $ 0.050 $ 0.050
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
Page 4
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Six Months Ended June 30, 2001 and 2000
(Unaudited)
Six Months Ended
June 30,
---------------------------
2001 2000
(In thousands of dollars)
Cash flows from operating activities:
Net income $ 319,142 $ 263,323
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of deferred insurance
policy acquisition costs 8,876 7,514
Increase in deferred insurance policy
acquisition costs (11,212) (6,854)
Depreciation and amortization 3,123 3,671
Increase in accrued investment income (2,500) (710)
Decrease (increase) in reinsurance
recoverable on loss reserves 4,950 (2,211)
Decrease (increase) in reinsurance
recoverable on unearned premiums 386 (2,110)
Decrease in loss reserves (10,294) (16,323)
Decrease in unearned premiums (12,447) (6,294)
Equity earnings in joint ventures (17,931) (14,149)
Other (5,663) 31,009
----------- ----------
Net cash provided by operating activities 276,430 256,866
----------- ----------
Cash flows from investing activities:
Purchase of equity securities - (14,629)
Purchase of fixed maturities (1,514,059) (773,734)
Additional investment in joint ventures (15,000) (15,023)
Proceeds from sale of equity securities 1,535 14,285
Proceeds from sale or maturity of
fixed maturities 1,238,056 584,247
----------- ----------
Net cash used in investing activities (289,468) (204,854)
----------- ----------
Cash flows from financing activities:
Dividends paid to shareholders (5,347) (5,290)
Proceeds from issuance of long- and
short-term debt 108,509 -
Repayment of long- and short-term debt (98,184) (5,000)
Reissuance of treasury stock 10,682 3,514
Repurchase of common stock - (6,224)
----------- ----------
Net cash provided by/(used in)
financing activities 15,660 (13,000)
----------- ----------
Net increase in cash and short-term
investments 2,622 39,012
Cash and short-term investments at
beginning of period 157,190 110,068
----------- ----------
Cash and short-term investments at end of period $ 159,812 $ 149,080
=========== ==========
See accompanying notes to consolidated financial statements.
Page 5
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2001
(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, 2000 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 six months ended June 30, 2001 may not be indicative of
the results that may be expected for the year ending December 31, 2001.
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 $7.5 million and $8.9 million of deferred insurance
policy acquisition costs during the six months ended June 30, 2000 and 2001,
respectively.
Page 6
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
In June of 2000, the Company filed a $500 million public debt shelf
registration statement. During the fourth quarter of 2000, the Company issued,
in public offerings, $300 million, 7-1/2% Senior Notes due 2005. The notes are
unsecured and were rated "A1" by Moody's and "A+" by Standard and Poor's
("S&P"). The net proceeds were used to repay borrowings under bank credit
facilities.
Page 7
During the first quarter of 2001, the Company established a $200 million
short term commercial paper program, rated "A-1" by S&P and "P-1" by Moody's. At
June 30, 2001, the Company's outstanding par balance of commercial paper notes
was $109.3 million. The proceeds of the commercial paper were used during the
first quarter to repay all outstanding borrowings under the bank facilities.
There were no borrowings outstanding under the 1998 or 1999 credit facilities at
June 30, 2001. These facilities are 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 back up the commercial
paper, was $90.7 million. The weighted average interest rates on the borrowings
for the quarter were as follows:
Senior notes 7.50%
Commercial paper 4.59%
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 an appeal of a related order denying certain class members the
right to intervene in the case to challenge certain aspects of the settlement,
payments to borrowers in the settlement are delayed pending the outcome of the
appeal. The settlement includes an injunction that prohibits certain practices
and specifies the basis on which
Page 8
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 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 Six Months Ended
June 30 June 30,
------------------ ----------------
2001 2000 2001 2000
---- ---- ---- ----
(Shares in thousands)
Weighted-average shares -
Basic EPS 107,111 105,924 106,997 105,887
Common stock equivalents 991 921 957 987
------- ------- ------- -------
Weighted-average shares -
Diluted EPS 108,102 106,845 107,954 106,874
======= ======= ======= =======
Note 6 - New accounting standards
The Company adopted SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, as amended, on January 1, 2001, in accordance with the
transition provisions of SFAS No. 133.
The Company recorded a net-of-tax cumulative-effect-type adjustment of $1.0
million in accumulated other comprehensive income to recognize at fair value all
derivatives that are designated as cash-flow hedging instruments. Net losses on
derivatives of $7.6 million that had been previously deferred were reclassified
on the balance sheet through a net-of-tax cumulative-effect-type adjustment of
$5.0 million to other comprehensive income.
Page 9
Note 7 - Comprehensive income
The Company's total comprehensive income, as calculated per SFAS No. 130,
Reporting Comprehensive Income, was as follows:
Three Months Ended Six Months Ended
June 30, June 30
------------------ ----------------
2001 2000 2001 2000
---- ---- ---- ----
(In thousands of dollars)
Net income $161,218 $136,103 $319,142 $263,323
Other comprehensive income
(loss) (24,087) 68 (19,205) 30,213
-------- -------- -------- --------
Total comprehensive income $137,131 $136,171 $299,937 $293,536
======== ======== ======== ========
Other comprehensive income (loss)
(net of tax):
Cumulative effect - FAS 133 $ N/A $ N/A $(5,982) $ N/A
Net derivative gains (losses) 645 N/A (1,165) N/A
Amortization of deferred losses
and Ineffectiveness of cash
flow hedge 270 N/A 540 N/A
FAS 115 (25,002) 68 (12,598) 30,213
-------- -------- -------- --------
Comprehensive income (loss) $(24,087) $ 68 $(19,205) $30,213
======== ======== ======== ========
The difference between the Company's net income and total comprehensive
income for the six months ended June 30, 2001 and 2000 is due to the change in
unrealized appreciation/depreciation on investments, the cumulative effect of
the adoption of SFAS No. 133 and the market value adjustment of the hedges, all
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-
Page 10
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.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Consolidated Operations
Three months Ended June 30, 2001 Compared With Three months Ended June 30, 2000
Net income for the three months ended June 30, 2001 was $161.2 million,
compared to $136.1 million for the same period of 2000, an increase of 18%.
Diluted earnings per share for the three months ended June 30, 2001 was $1.49
compared with $1.27 in the same period last year, an increase of 17%. 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 second quarter 2001 were $339.5 million, an increase
of 24% from the $274.2 million for the second quarter 2000. This increase was
primarily attributed to an increase in new business writings, which included
$18.3 billion in bulk transactions since the second quarter of 2000, of which
$6.3 billion was written in the second quarter of 2001. Also contributing to the
increase in revenues was an increase in investment income resulting from strong
cash flows during the prior twelve months, and increases in realized gains and
other revenue. See below for a further discussion of premiums and investment
income.
Losses and expenses for the second quarter were $102.0 million, an increase
of 35% from $75.8 million for the same period of 2000. The increase from last
year can be attributed to increases in insured volume and in contract
underwriting and an increase in notice inventories. 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 June 30, 2001 was $22.4 billion, compared to $10.6 billion in the same
period of 2000. The increase in new primary insurance written principally
reflected the increase in refinancing activity on the non-bulk business and the
increase in bulk transactions written in the second quarter of 2001 compared to
the second quarter of 2000.
Page 11
The $22.4 billion of new primary insurance written during the second
quarter of 2001 was offset by the cancellation of $15.6 billion of insurance in
force, and resulted in a net increase of $6.8 billion in primary insurance in
force, compared to new primary insurance written of $10.6 billion, the
cancellation of $7.2 billion of insurance in force and a net increase of $3.4
billion in primary insurance in force during the second quarter of 2000. Direct
primary insurance in force was $171.6 billion at June 30, 2001 compared to
$160.2 billion at December 31, 2000 and $151.9 billion at June 30, 2000.
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 June 30, 2001 and June 30, 2000, which was virtually all agency
pool insurance, was $110 million and $100 million, respectively. The Company's
direct pool risk in force was $1.8 billion at June 30, 2001, $1.7 billion at
December 31, 2000, and was $1.6 billion at June 30, 2000.
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
second quarter of 2001 compared to the cancellation levels of 2000 principally
due to the lower mortgage interest rate environment which resulted in a decrease
in the MGIC persistency rate (percentage of insurance remaining in force from
one year prior) to 71.7% at June 30, 2001 from 80.4% at December 31, 2000 and
79.3% at June 30, 2000. Future cancellation activity could be somewhat higher
than it otherwise would have been as a result of legislation that went into
effect in July 1999 regarding cancellation of mortgage insurance. Cancellation
activity could also increase as more of the Company's subprime credit loans
season. The Company anticipates that subprime credit loans will have materially
lower persistency than the Company's prime business. Subprime credit loans are
all loans submitted under MGIC's A- program and loans with FICO credit scores
below 620 submitted as part of bulk transactions.
New insurance written for subprime credit mortgages was 9% of new insurance
written during the second quarter of 2001 compared to 14% for the same period a
year ago. The Company expects that subprime credit loans will have delinquency
and claim rates in excess of those on the Company's prime business. While the
Company believes it has priced its subprime credit business to generate
acceptable returns, there can be no assurance that the assumptions underlying
the premium rates adequately address the risk of this business.
Net premiums written increased 16% to $256.9 million during the second
quarter of 2001, from $220.8 million during the second quarter of 2000. Net
premiums earned increased 18% to $257.4 million for the second quarter of 2001
from $218.4 million for the same period in 2000. 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 $15.1 million in the second quarter of 2001 compared to $10.9
million during the same period a year ago, primarily due to an increase in
captive mortgage reinsurance.
Page 12
Mortgages (newly insured during the six months ended June 30, 2001 or in
previous periods) approximating 25% of MGIC's new insurance written during the
second quarter of 2001 were subject to captive mortgage reinsurance and similar
arrangements compared to 30% during the same period in 2000. 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 June 30, 2001 and at December 31, 2000,
approximately 21% 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.
Investment income for the second quarter of 2001 was $51.6 million, an
increase of 21% over the $42.7 million in the second quarter of 2000. This
increase was the result of increases in the amortized cost of average invested
assets to $3.6 billion for the second quarter of 2001 from $3.0 billion for the
second quarter of 2000, an increase of 18%, and offset by a slight decrease in
the investment yield. The portfolio's average pre-tax investment yield was 5.7%
for the second quarter of 2001 and 5.8% for the same period in 2000. The
portfolio's average after-tax investment yield was 4.7% for the second quarter
of 2001 and 4.9% for the second quarter of 2000. The Company's net realized
gains were $7.9 million for the three months ended June 30, 2001 compared to net
realized gains of $0.2 million during the same period in 2000, resulting
primarily from the sale of corporate and taxable municipal securities.
Other revenue, which is composed of various components, was $22.7 million
for the second quarter of 2001, compared with $12.8 million for the same period
in 2000. The increase is primarily the result of an increase in contract
underwriting revenue, an increase in equity earnings from Credit-Based Asset
Servicing and Securitization LLC ("C-BASS"), a joint venture with Radian Group
Inc. ("Radian"), and equity earnings (compared to a loss in the prior period)
from Sherman Financial Group LLC ("Sherman"), also a joint venture with Radian.
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. 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 June 30, 2001 and 2000 were
approximately $844 million and $961 million, respectively, of which
approximately $679 million and $841
Page 13
million, respectively, were mortgage-related assets, including open trades.
Total liabilities at June 30, 2001 and 2000 were approximately $572 million and
$730 million, respectively, of which approximately $471 million and $648
million, respectively, were funding arrangements, including accrued interest,
virtually all of which were short-term. For the three months ended June 30, 2001
and 2000, revenues of approximately $66 million and $56 million, respectively,
and expenses of approximately $37 million and $31 million, respectively,
resulted in income before tax of approximately $29 million and $25 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 bankruptcy debt. A substantial portion of Sherman's consolidated
assets are investments in receivable portfolios that do not have readily
ascertainable market values and as a result their value for financial statement
purposes is estimated by the management of Sherman. Market value adjustments
could impact Sherman's results of operations and the Company's share of those
results.
Net losses incurred increased 61% to $36.3 million during the second
quarter of 2001 from $22.5 million during the same period in 2000. The increase
from a year ago was primarily attributable to an increase in new notices and a
decrease in the redundancy of prior year loss reserves. The default rate at June
30, 2001 was 2.75% compared to 2.58% at December 31, 2000, and the primary
notice inventory increased from 37,422 at December 31, 2000 to 41,390 at June
30, 2001. Excluding subprime credit loans, the default rate was 2.22% at June
30, 2001 and at December 31, 2000. The Company expects the primary notice
inventory, the default rate including all loans (which at the end of the third
quarter of 2001 could exceed 3%) and claims paid to increase from current levels
due to, among other factors, the increase in the portion of the insurance in
force consisting of subprime loans. The average primary claim paid during the
second quarter was $19,100 compared to $18,200 in the second quarter of 2000.
The pool notice inventory increased from 18,209 at December 31, 2000 to 18,787
at June 30, 2001.
At June 30, 2001, 74% of MGIC's insurance in force was written subsequent
to December 31, 1997. Based on all of the loans in the Company's insurance in
force, the highest claim frequency years have typically been the third through
fifth year after the year of loan origination. However, the pattern of claims
frequency for refinance loans may be different from this historical pattern and
the Company expects the period of highest claims frequency on subprime credit
loans will occur earlier than in this historical pattern.
Underwriting and other expenses increased to $58.5 million in the second
quarter of 2001 from $46.2 million in the same period of 2000, an increase of
27%. The increase can be attributed to increases in both insurance and
non-insurance expenses related to increased volume and contract underwriting.
Page 14
The consolidated insurance operations loss ratio was 14.1% for the second
quarter of 2001 compared to 10.3% for the second quarter of 2000. The
consolidated insurance operations expense and combined ratios were 16.1% and
30.2%, respectively, for the second quarter of 2001 compared to 17.5% and 27.8%
for the second quarter of 2000.
The effective tax rate was 32.1% in the second quarter of 2001, compared to
31.4% in the second quarter of 2000. During both periods, the effective tax rate
was below the statutory rate of 35%, reflecting the benefits of tax-preferenced
investment income. The higher effective tax rate in 2001 resulted from a lower
percentage of total income before tax being generated from the tax-preferenced
investments.
Six months Ended June 30, 2001 Compared With Six months Ended June 30, 2000
Net income for the six months ended June 30, 2001 was $319.1 million,
compared to $263.3 million for the same period of 2000, an increase of 21%.
Diluted earnings per share for the six months ended June 30, 2001 was $2.96
compared with $2.46 in the same period last year, an increase of 20%. 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 half of 2001 were $660.0 million, an increase
of 23% from the $535.3 million for the first half of 2000. This increase was
primarily attributed to an increase in new business writings, which included
$18.3 billion in bulk transactions since the second quarter of 2000, of which
$13.0 billion was written in the first half of 2001. Also contributing to the
increase in revenues was an increase in investment income resulting from strong
cash flows during the prior twelve months, and increases in realized gains and
other revenue. See below for a further discussion of premiums and investment
income.
Losses and expenses for the first half were $191.5 million, an increase of
26% from $152.0 million for the same period of 2000. The increase from last year
can be attributed to increases in both insurance and non-insurance expenses
relating to increased volume and contract underwriting and increases in notice
inventories. See below for a further discussion of losses incurred and
underwriting expenses.
The amount of new primary insurance written by MGIC during the six months
ended June 30, 2001 was $39.1 billion, compared to $17.9 billion in the same
period of 2000. The increase in new primary insurance written principally
reflected the increase in refinancing activity on the non-bulk business and the
increase in bulk transactions written through the second quarter of 2001,
compared to the same period of 2000.
The $39.1 billion of new primary insurance written during the first six
months of 2001 was offset by the cancellation of $27.7 billion of insurance in
force, and resulted in a net increase of $11.4 billion in primary insurance in
force, compared to new primary insurance written of $17.9 billion, the
cancellation of $13.6 billion of insurance in force and a net
Page 15
increase of $4.3 billion in primary insurance in force during the same period of
2000. Direct primary insurance in force was $171.6 billion at June 30, 2001
compared to $160.2 billion at December 31, 2000 and $151.9 billion at June 30,
2000.
In addition to providing direct primary insurance coverage, the Company
also insures pools of mortgage loans. New pool risk written during the six
months ended June 30, 2001 and June 30, 2000, which was virtually all agency
pool insurance, was $158 million and $183 million, respectively. The Company's
direct pool risk in force was $1.8 billion at June 30, 2001 and $1.7 billion at
December 31, 2000 and at June 30, 2000.
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 half of 2001 compared to the cancellation levels of 2000 principally due
to the lower mortgage interest rate environment which resulted in a decrease in
the MGIC persistency rate (percentage of insurance remaining in force from one
year prior) to 71.7% at June 30, 2001 from 80.4% at December 31, 2000 and 79.3%
at June 30, 2000. Future cancellation activity could be somewhat higher than it
otherwise would have been as a result of legislation that went into effect in
July 1999 regarding cancellation of mortgage insurance. Cancellation activity
could also increase as more of the Company's subprime credit loans season. The
Company anticipates that subprime credit loans will have materially lower
persistency than the Company's prime business. Subprime credit loans are all
loans submitted under MGIC's A- program and loans with FICO credit scores below
620 submitted as part of bulk transactions.
New insurance written for subprime credit mortgages was 14% of new
insurance written during the first half of 2001 compared to 11% for the same
period a year ago. The Company expects that subprime credit loans will have
delinquency and claim rates in excess of those on the Company's prime business.
While the Company believes it has priced its subprime credit business to
generate acceptable returns, there can be no assurance that the assumptions
underlying the premium rates adequately address the risk of this business.
Net premiums written increased 16% to $486.5 million during the first half
of 2001, from $420.1 million during the first half of 2000. Net premiums earned
increased 16% to $498.6 million for the first six months of 2001 from $428.5
million for the same period in 2000. 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 $29.2 million in the first half of 2001 compared to $20.5 million
during the same period a year ago, primarily due to an increase in captive
mortgage reinsurance.
Mortgages (newly insured during the six months ended June 30, 2001 or in
previous periods) approximating 24% of MGIC's new insurance written during the
first half of 2001 were subject to captive mortgage reinsurance and similar
arrangements compared to 32% during the same period in 2000. Such arrangements
entered into during a reporting period customarily include loans newly insured
in a prior reporting period. As a result, the
Page 16
percentages cited above would be lower if only the current reporting period's
newly insured mortgages subject to such arrangements were included. At June 30,
2001 and at December 31, 2000, approximately 21% 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.
Investment income for the first six months of 2001 was $101.6 million, an
increase of 22% over the $83.3 million in the first six months of 2000. This
increase was the result of increases in the amortized cost of average invested
assets to $3.5 billion for the first half of 2001 from $3.0 billion for the same
period in 2000, an increase of 18%, and offset by a slight decrease in the
investment yield. The portfolio's average pre-tax investment yield was 5.7% for
the first half of 2001 and 5.8% for the same period in 2000. The portfolio's
average after-tax investment yield was 4.8% for the first half of 2001 and 4.9%
for the first half of 2000. The Company's net realized gains were $21.6 million
for the six months ended June 30, 2001 compared to net realized gains of $0.2
million during the same period in 2000, resulting primarily from the sale of
corporate and taxable municipal securities.
Other revenue, which is composed of various components, was $38.3 million
for the first half of 2001, compared with $23.3 million for the same period in
2000. The increase is primarily the result of an increase in contract
underwriting revenue, an increase in equity earnings from Credit-Based Asset
Servicing and Securitization LLC ("C-BASS"), a joint venture with Radian Group
Inc. ("Radian"), and equity earnings (compared to a loss in the prior period)
from Sherman Financial Group LLC ("Sherman"), also a joint venture with Radian.
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. 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 June 30, 2001 and 2000 were
approximately $844 million and $961 million, respectively, of which
approximately $679 million and $841 million, respectively, were mortgage-related
assets, including open trades. Total liabilities at June 30, 2001 and 2000 were
approximately $572 million and $730 million, respectively, of which
approximately $471 million and $648 million, respectively, were funding
arrangements, including accrued interest, virtually all of which were
short-term. For the six months ended June 30, 2001 and 2000, revenues of
approximately $121 million and $95 million, respectively, and expenses of
approximately $63 million and $52 million,
Page 17
respectively, resulted in income before tax of approximately $58 million and $43
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 bankruptcy debt. A substantial portion of Sherman's consolidated
assets are investments in receivable portfolios that do not have readily
ascertainable market values and as a result their value for financial statement
purposes is estimated by the management of Sherman. Market value adjustments
could impact Sherman's results of operations and the Company's share of those
results.
Net losses incurred increased 45% to $65.7 million during the first half of
2001 from $45.2 million during the same period in 2000. The increase from a year
ago was primarily attributable to an increase in new notices and a decrease in
the redundancy of prior year loss reserves. The default rate at June 30, 2001
was 2.75% compared to 2.58% at December 31, 2000, and the primary notice
inventory increased from 37,422 at December 31, 2000 to 41,390 at June 30, 2001.
Excluding subprime credit loans, the default rate was 2.22% at June 30, 2001 and
at December 31, 2000. The average primary claim paid through the second quarter
was $18,600 compared to $18,900 through the second quarter of 2000. The Company
expects the primary notice inventory, the default rate including all loans
(which at the end of the third quarter of 2001 could exceed 3%) and claims paid
to increase from current levels due to, among other factors, the increase in the
portion of the insurance in force consisting of subprime loans. The pool notice
inventory increased from 18,209 at December 31, 2000 to 18,787 at June 30, 2001.
At June 30, 2001, 74% of MGIC's insurance in force was written subsequent
to December 31, 1997. Based on all of the loans in the Company's insurance in
force, the highest claim frequency years have typically been the third through
fifth year after the year of loan origination. However, the pattern of claims
frequency for refinance loans may be different from this historical pattern and
the Company expects the period of highest claims frequency on subprime credit
loans will occur earlier than in this historical pattern.
Underwriting and other expenses increased to $110.2 million in the first
half of 2001 from $93.2 million in the same period of 2000, an increase of 18%.
The increase can be attributed to increases in both insurance and non-insurance
expenses related to increased volume and contract underwriting.
Interest expense increased to $15.7 million in the first half of 2001 from
$13.7 million during the same period in 2000 primarily due to higher
weighted-average interest rates during the six months ended June 30, 2001
compared to the comparable period in 2000.
The consolidated insurance operations loss ratio was 13.2% for the first
six months of 2001 compared to 10.5% for the same period in 2000. The
consolidated insurance operations expense and combined ratios were 16.6% and
29.8%, respectively, for the first half of 2001 compared to 18.7% and 29.2% for
the first half of 2000.
Page 18
The effective tax rate was 31.9% in the first half of 2001, compared to
31.3% in the same period of 2000. During both periods, the effective tax rate
was below the statutory rate of 35%, reflecting the benefits of tax-preferenced
investment income. The higher effective tax rate in 2001 resulted from a lower
percentage of total income before tax being generated from the tax-preferenced
investments.
Other Matters
In December 2000, MGIC entered into an agreement to settle Downey et. al.
v. MGIC, which is pending in Federal District Court for the Southern District of
Georgia. As described in Item 1, in June 2001, the District Court entered a
final order approving the settlement.
During the second quarter of 1999, Fannie Mae and Freddie Mac changed their
mortgage insurance requirements for certain mortgages approved by their
automated underwriting services. The changes permit lower coverage percentages
on these loans than the deeper coverage percentages that went into effect in
1995. MGIC's premium rates vary with the depth of coverage. While lower coverage
percentages result in lower premium revenue, lower coverage percentages should
also result in lower incurred losses at the same level of claim incidence.
MGIC's results could also be affected to the extent Fannie Mae and Freddie Mac
are compensated for assuming default risk that would otherwise be insured by the
private mortgage insurance industry. Fannie Mae and Freddie Mac have programs
under which a delivery fee is paid to them, with mortgage insurance coverage
reduced below the coverage that would be required in the absence of the delivery
fee.
In partnership with mortgage insurers, Fannie Mae and Freddie Mac are also
offering programs under which, on delivery of an insured loan to them, the
primary coverage is converted to an initial shallow tier of coverage followed by
a second tier that is subject to an overall loss limit and, depending on the
program, compensation may be paid to them for services or other benefits
realized by the mortgage insurer from the coverage conversion. Because lenders
receive guaranty fee relief from Fannie Mae and Freddie Mac on mortgages
delivered with these restructured coverages, participation in these programs is
competitively significant to mortgage insurers.
In July 2001, the Office of Federal Housing Enterprise Oversight ("OFHEO")
released a risk-based capital stress test for Fannie Mae and Freddie Mac. One of
the elements of the stress test is that future claim payments made by a private
mortgage insurer on Fannie Mae and Freddie Mac loans are reduced below the
amount provided by the mortgage insurance policy to reflect the risk that the
insurer will fail to pay. When fully phased in, claim payments from an insurer
whose claims-paying ability rating is "AAA" are 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, are subject to a 15% reduction. The effect of the
differentiation among insurers is to require Fannie Mae and Freddie Mac to have
additional capital for coverage on loans provided by a private mortgage insurer
whose
Page 19
claims-paying rating is less than "AAA." As a result, if the final rule is the
same as the rule released in July 2001, there is an incentive for Fannie Mae and
Freddie Mac to use private mortgage insurance provided by a "AAA" rated insurer.
If the stress test ultimately gives Fannie Mae and Freddie Mac an incentive to
use "AAA" mortgage insurance, MGIC may need "AAA" capacity, which in turn would
entail using capital to support such a facility as well as additional expenses
or MGIC may need to make other changes to provide Fannie Mae or Freddie Mac with
the equivalent of "AAA" coverage.
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 $263.7 million and $255.3 million for the six months
ended June 30, 2001 and 2000, 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.
Consolidated total investments and cash balances increased approximately
$280 million to $3.8 billion at June 30, 2001 from $3.5 billion at December 31,
2000, primarily due to positive net cash flow, offset by decreases in unrealized
gains on securities marked to market of $19 million. The Company generated
consolidated cash flows from operating activities of $263.7 million through June
30, 2001, compared to $255.3 million generated during the same period in 2000.
The increase in operating cash flows through the first half of 2001 compared to
2000 is due primarily to increases in renewal premiums and investment income. As
of June 30, 2001, the Company had $147.5 million of short-term investments with
maturities of 90 days or less, and 67% of the portfolio was invested in
tax-preferenced securities. In addition, at June 30, 2001, based on book value,
the Company's fixed income securities were approximately 97% invested in 'A'
rated and above, readily marketable securities, concentrated in maturities of
less than 15 years.
At June 30, 2001, the Company had an immaterial amount of derivative
financial instruments in its investment portfolio. 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.
The Company's investments in joint ventures increased $20.2 million from
$138.8 million at December 31, 2000 to $159.0 million at June 30, 2001 as a
result of additional investments of $15.0 million and equity earnings of $17.9
million offset by $12.8 million of dividends received.
Page 20
Consolidated unearned premiums decreased $12.4 million from $180.7 million
at December 31, 2000, to $168.3 million at June 30, 2001, primarily reflecting
the continued high level of monthly premium policies written.
During the first quarter of 2001, the Company established a $200 million
short term commercial paper program, rated "A-1" by S&P and "P-1" by Moody's. At
June 30, 2001, the Company's outstanding par balance of commercial paper notes
was $109.3 million. The proceeds of the commercial paper were used to repay all
outstanding borrowings under the bank facilities. At June 30, 2001, the
Company's outstanding debt was $408.4 million.
Consolidated shareholders' equity increased to $2.8 billion at June 30,
2001, from $2.5 billion at December 31, 2000, an increase of 13%. This increase
consisted of $319.1 million of net income through the second quarter of 2001,
$20.9 million from the reissuance of treasury stock offset by dividends declared
of $5.3 million and other comprehensive losses, net of tax, of $19.2 million.
MGIC is the principal insurance subsidiary of the Company. MGIC's
risk-to-capital ratio was 9.9:1 at June 30, 2001 compared to 10.6:1 at December
31, 2000. The decrease was due to MGIC's increased policyholders' reserves,
partially offset by the net additional risk in force of $2.2 billion, net of
reinsurance, during the first half of 2001.
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.
In April 2001, the Staff of the Congressional Joint Committee on Taxation
proposed the elimination of the federal income tax deduction for amounts added
to contingency reserves that are required to be established under state
insurance regulation of mortgage guaranty and certain other classes of credit
insurance. Insurers taking the deduction must purchase from the Treasury
non-interest bearing tax and loss bonds equal to the tax benefit of the
deduction. The bonds are recognized as assets in computing capital and the
elimination of the deduction could affect MGIC's risk-to-capital ratio. The
income tax legislation enacted in June 2001 did not include any change to the
contingency reserve provisions.
Page 21
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 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.
For the second quarter of 2001, our new insurance written volume increased
112% compared to the same period in 2000. One of the reasons our volume was
higher in 2001 was because many borrowers refinanced their mortgages during the
first six months of 2001 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.
Page 22
If lenders and investors select alternatives to private mortgage insurance,
the amount of insurance that we write could decline, which could result in
declines in our future revenues.
These alternatives to private mortgage insurance include:
o lenders using government mortgage insurance programs, including those
of the Federal Housing Administration and the Veterans Administration,
o investors holding mortgages in portfolio and self-insuring,
o investors using credit enhancements other than private mortgage
insurance or using other credit enhancements in conjunction with
reduced levels of private mortgage insurance coverage, and
o lenders structuring mortgage originations to avoid private mortgage
insurance, such as a first mortgage with an 80% loan-to-value ratio
and a second mortgage with a 10% loan-to-value ratio (referred to as
an 80-10-10 loan) rather than a first mortgage with a 90% loan-
to-value ratio.
We believe that during 2000 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 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. In the last quarter of 2000, the Federal Housing
Administration reduced its mortgages insurance premiums. Investors are using
reduced mortgage insurance coverage on a somewhat higher percentage of loans
that we insure than they had over the last several years.
Because most of the loans MGIC insures are sold to Fannie Mae and Freddie
Mac, changes in their business practices could reduce our revenues or increase
our losses.
The business practices of Fannie Mae and Freddie Mac affect the entire
relationship between them and mortgage insurers and include:
o the level of private mortgage insurance coverage, subject to the
limitations of Fannie Mae and Freddie Mac's charters, when private
mortgage insurance is used as the required credit enhancement on low
down payment mortgages,
o whether Fannie Mae or Freddie Mac influence the mortgage lender's
selection of the mortgage insurer providing coverage and, if so, any
transactions that are related to that selection,
Page 23
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
o the circumstances in which mortgage servicers must perform activities
intended to avoid or mitigate loss on insured mortgages that are
delinquent.
We do not have a "AAA" rating. If the recently released capital rules of
the Office of Federal Housing Enterprise Oversight are adopted in the form in
which they were released, private mortgage insurers with "AAA" ratings, would be
given greater capital credit than we would receive. As a result, we may need to
obtain a "AAA" capacity for mortgages delivered to Fannie Mae or Freddie Mac or
may need to make other changes to provide Fannie Mae or Freddie Mac with the
equivalent of "AAA" coverage. While we believe we can obtain this rating, we
would need to dedicate capital to the mortgage insurance business that we might
use in other ways and we would also have additional costs that we would not
otherwise incur.
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 June 30, 2001, about
21% 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 in 1997 compared to 36.2% in 2000.
Page 24
Our private mortgage insurance competitors include:
o PMI Mortgage Insurance Company
o GE Capital Mortgage Insurance Corporation
o United Guaranty Residential Insurance Company
o Radian Guaranty Inc.
o Republic Mortgage Insurance Company
o Triad Guaranty Insurance Corporation
o CMG Mortgage Insurance Company
If interest rates decline, house prices appreciate or mortgage insurance
cancellation requirements change, the length of time that our policies remain in
force could decline and result in declines in our revenue.
In each year, most of MGIC's premiums are from insurance that has been
written in prior years. As a result, the length of time insurance remains in
force is an important determinant of revenues. The factors affecting the length
of time our insurance remains in force include:
o the level of current mortgage interest rates compared to the mortgage
coupon rates on the insurance in force, which affects the
vulnerability of the insurance in force to refinancings, and
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.
As 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. While our losses could increase for
other reasons, a significant deterioration in economic conditions would probably
increase our losses. Also, we expect that the subprime credit loans we insure
will generate higher losses. We believe the premiums we charge on these loans
will generate acceptable return but we cannot guaranty this result.
Page 25
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
June 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. The Court entered a final order
approving this settlement in June 2001, although due to an appeal of an order
denying certain class members the right to intervene in the case to challenge
certain aspects of the settlement, the final implementation of the settlement
will not occur until the appeal is resolved. We took a $23.2 million pretax
charge in 2000 to cover our share of the estimated costs of the settlement.
While the 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.
Because we expect the pace of change in our industry and in home mortgage
lending to remain high, we will be disadvantaged unless we are able to respond
to new ways of doing business.
We expect the processes involved in home mortgage lending will continue to
evolve through greater use of technology. This evolution could effect
fundamental changes in the way home mortgages are distributed. Affiliates of
lenders who are regulated depositary institutions gained expanded insurance
powers under financial modernization legislation and the capital markets may
emerge as providers of insurance in competition with traditional insurance
companies. These trends and others increase the level of uncertainty in our
business, demand rapid response to change and place a premium on innovation.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At June 30, 2001, 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 June 30,
2001, the effective duration of the Company's investment portfolio was 5.7
years. The effect of a 1% increase/decrease in market interest rates would
result in a 5.7% 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.
Page 26
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
With respect to the Downey litigation referred to in Item 3 of the
Company's Annual Report on Form 10-K for the year ended December 31, 2000, the
Federal District Court for the Southern District of Georgia entered a final
order on June 25, 2001 approving the settlement contemplated by the settlement
agreement and certifying the settlement class contemplated by the agreement. An
appeal has been filed to overturn a related decision of the District Court not
to allow certain individuals to intervene in the action. If the appeal is
successful, these individuals could have standing to challenge the terms of the
final approval order. The Company's obligation to pay claims and expenses under
the settlement is delayed pending the outcome of the appeal.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of Shareholders of the Company was held on May 10,
2001.
(b) At the Annual Meeting, the following Directors were elected to the
Board of Directors, for a term expiring at the Annual Meeting of
Shareholders to be held in 2004 or until a successor is duly elected
and qualified:
James A. Abbott
Thomas M. Hagerty
Sheldon B. Lubar
Immediately after the Annual Meeting, Directors with continuing terms of
office were:
Term expiring 2002:
Mary K. Bush
Daniel S. Engleman
Kenneth M. Jastrow, II
Daniel P. Kearney
Term expiring 2003:
Karl E. Case
Curt S. Culver
William A. McIntosh
Leslie M. Muma
Page 27
On July 26, 2001, the Board of Directors elected Michael E. Lehman as a
Director for a term expiring at the Annual Meeting of Shareholders to be
held in 2004 or until a successor is duly elected and qualified.
(c) Matters voted upon at the Annual Meeting and the number of shares
voted for, against, withheld, abstaining from voting and broker
non-votes were as follows:
(1) Election of three Directors for a term expiring in 2004:
FOR WITHHELD
James A. Abbott 92,836,542 530,733
Thomas M. Hagerty 92,838,395 528,880
Sheldon B. Lubar 92,838,018 529,257
(2) Ratification of the appointment of PricewaterhouseCoopers LLP as
independent accounts for the Company for 2001.
For: 93,021,395
Against: 18,584
Abstaining from Voting 327,296
There were no broker non-votes on any matter.
(d) Not applicable
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 - No reports were filed on Form 8-K during the
quarter ended June 30, 2001.
Page 28
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 August 13, 2001.
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 29
INDEX TO EXHIBITS
(Item 6)
Exhibit
Number Description of Exhibit
- ------- ----------------------
11 Statement Re Computation of Net Income
Per Share
Page 30
EXHIBIT 11
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
STATEMENT RE COMPUTATION OF NET INCOME PER SHARE
Three and Six Month Periods Ended June 30, 2001 and 2000
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2001 2000 2001 2000
(In thousands of dollars, except per share data)
BASIC EARNINGS PER SHARE
Average common shares
outstanding 107,111 105,924 106,997 105,887
========= ========= ========= =========
Net income $ 161,128 $ 136,103 $ 319,142 $ 263,323
========= ========= ========= =========
Basic earnings per share $ 1.51 $ 1.28 $ 2.98 $ 2.49
========= ========= ========= =========
DILUTED EARNINGS PER SHARE
Adjusted shares outstanding:
Average common shares
outstanding 107,111 105,924 106,997 105,887
Net shares to be issued
upon exercise of dilutive
stock options after
applying treasury stock
method 991 921 957 987
--------- --------- --------- ---------
Adjusted shares outstanding 108,102 106,845 107,954 106,874
========= ========= ========= =========
Net income $ 161,128 $ 136,103 $ 319,142 $ 263,323
========= ========= ========= =========
Diluted earnings per share $ 1.49 $ 1.27 $ 2.96 $ 2.46
========= ========= ========= =========