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FORM 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2006
     
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
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 þ                    NOo
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ                    Accelerated filer o                    Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES o                    NOþ
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       07/31/06       84,461,238  
 
 

 


Table of Contents

MGIC INVESTMENT CORPORATION
TABLE OF CONTENTS
         
        Page No.
  FINANCIAL INFORMATION    
 
       
  Financial Statements (Unaudited)    
 
       
 
  Consolidated Balance Sheets as of June 30, 2006 (Unaudited) and December 31, 2005   3
 
       
 
  Consolidated Statements of Operations for the Three and Six Month Periods Ended June 30, 2006 and 2005 (Unaudited)   4
 
       
 
  Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2006 and 2005 (Unaudited)   5
 
       
 
  Notes to Consolidated Financial Statements (Unaudited)   6-20
 
       
  Management’s Discussion and Analysis of Financial Condition and Results of Operations   21-41
 
       
  Quantitative and Qualitative Disclosures About Market Risk   41
 
       
  Controls and Procedures   41-42
 
       
  OTHER INFORMATION    
 
       
  Risk Factors   43
 
       
  Unregistered Sale of Equity Securities and Use of Proceeds   43
 
       
  Submission of Matters to a Vote of Security Holders   44
 
       
  Exhibits   44
 
       
SIGNATURES   45
 
       
INDEX TO EXHIBITS    
 Statement Re Computation of Net Income Per Share
 302 Certification of CEO
 302 Certification of CFO
 906 Certification of CEO and CFO
 Risk Factors

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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, 2006 (Unaudited) and December 31, 2005
                 
    June 30,     December 31,  
    2006     2005  
    (In thousands of dollars)  
ASSETS
               
Investment portfolio:
               
Securities, available-for-sale, at market value:
               
Fixed maturities (amortized cost, 2006 — $5,250,223; 2005 — $5,173,091)
  $ 5,270,031     $ 5,292,942  
Equity securities (cost, 2006 — $2,546; 2005 — $2,504)
    2,490       2,488  
 
           
 
               
Total investment portfolio
    5,272,521       5,295,430  
 
               
Cash and cash equivalents
    106,442       195,256  
Accrued investment income
    64,503       66,369  
Reinsurance recoverable on loss reserves
    13,236       14,787  
Prepaid reinsurance premiums
    10,481       9,608  
Premiums receivable
    84,033       91,547  
Home office and equipment, net
    32,261       32,666  
Deferred insurance policy acquisition costs
    15,449       18,416  
Investments in joint ventures
    526,674       481,778  
Other assets
    177,662       151,712  
 
           
 
               
Total assets
  $ 6,303,262     $ 6,357,569  
 
           
 
               
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Liabilities:
               
Loss reserves
  $ 1,087,337     $ 1,124,454  
Unearned premiums
    172,277       159,823  
Short- and long-term debt (note 2)
    631,104       685,163  
Income taxes payable
    41,531       62,006  
Other liabilities
    181,070       161,068  
 
           
 
               
Total liabilities
    2,113,319       2,192,514  
 
           
 
               
Contingencies (note 3)
               
 
               
Shareholders’ equity:
               
Common stock, $1 par value, shares authorized 300,000,000; shares issued, 6/30/06 — 122,964,267 12/31/05 — 122,549,285;
shares outstanding, 6/30/06 — 85,692,378 12/31/05 — 88,046,430
    122,964       122,549  
Paid-in capital
    292,714       280,052  
Treasury stock (shares at cost, 6/30/06 — 37,271,889
12/31/05 — 34,502,855)
    (2,027,959 )     (1,834,434 )
Accumulated other comprehensive income, net of tax (note 5)
    13,259       77,499  
Retained earnings
    5,788,965       5,519,389  
 
           
 
               
Total shareholders’ equity
    4,189,943       4,165,055  
 
           
Total liabilities and shareholders’ equity
  $ 6,303,262     $ 6,357,569  
 
           
See accompanying notes to consolidated financial statements.

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three and Six Month Periods Ended June 30, 2006 and 2005
(Unaudited)
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2006     2005     2006     2005  
    (In thousands of dollars, except per share data)  
Revenues:
                               
Premiums written:
                               
Direct
  $ 340,907     $ 342,000     $ 674,483     $ 684,287  
Assumed
    447       251       844       453  
Ceded
    (36,074 )     (33,031 )     (69,575 )     (63,281 )
 
                       
 
                               
Net premiums written
    305,280       309,220       605,752       621,459  
(Increase) decrease in unearned premiums, net
    (10,777 )     2,413       (11,582 )     6,253  
 
                       
 
                               
Net premiums earned
    294,503       311,633       594,170       627,712  
Investment income, net of expenses
    59,380       57,178       117,344       114,181  
Realized investment (losses) gains, net
    (1,838 )     15,187       (1,751 )     16,752  
Other revenue
    11,459       10,955       22,773       21,216  
 
                       
 
                               
Total revenues
    363,504       394,953       732,536       779,861  
 
                       
 
                               
Losses and expenses:
                               
Losses incurred, net
    146,467       136,915       261,352       235,781  
Underwriting and other expenses, net
    71,492       68,059       145,757       135,954  
Interest expense
    8,843       10,512       18,158       21,234  
 
                       
 
                               
Total losses and expenses
    226,802       215,486       425,267       392,969  
 
                       
 
                               
Income before tax and joint ventures
    136,702       179,467       307,269       386,892  
Provision for income tax
    34,479       49,605       80,645       109,265  
Income from joint ventures, net of tax
    47,616       44,495       86,668       78,743  
 
                       
 
                               
Net income
  $ 149,839     $ 174,357     $ 313,292     $ 356,370  
 
                       
 
                               
Earnings per share (note 4):
                               
Basic
  $ 1.75     $ 1.88     $ 3.64     $ 3.79  
 
                       
Diluted
  $ 1.74     $ 1.87     $ 3.61     $ 3.77  
 
                       
 
                               
Weighted average common shares outstanding — diluted (shares in thousands, note 4)
    86,259       93,182       86,753       94,545  
 
                       
 
                               
Dividends per share
  $ 0.2500     $ 0.1500     $ 0.5000     $ 0.2250  
 
                       
See accompanying notes to consolidated financial statements.

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 2006 and 2005
(Unaudited)
                 
    Six Months Ended  
    June 30,  
    2006     2005  
    (In thousands of dollars)  
Cash flows from operating activities:
               
Net income
  $ 313,292     $ 356,370  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Amortization of deferred insurance policy acquisition costs
    7,040       10,215  
Increase in deferred insurance policy acquisition costs
    (4,073 )     (5,657 )
Depreciation and amortization
    12,588       9,172  
Decrease in accrued investment income
    1,866       2,841  
Decrease in reinsurance recoverable on loss reserves
    1,551       1,842  
Decrease in prepaid reinsurance premiums
    (873 )     (1,408 )
Decrease in premium receivable
    7,514       115  
Decrease in loss reserves
    (37,117 )     (73,308 )
Increase (decrease) in unearned premiums
    12,454       (4,844 )
(Decrease) increase in income taxes payable
    (24,798 )     2,908  
Equity earnings in joint ventures
    (127,746 )     (115,641 )
Distributions from joint ventures
    84,409       69,125  
Other
    44,385       (24,580 )
 
           
 
               
Net cash provided by operating activities
    290,492       227,150  
 
           
 
               
Cash flows from investing activities:
               
Purchase of fixed maturities
    (1,130,845 )     (425,702 )
Additional investment in joint ventures
    (1,503 )     (7,058 )
Proceeds from sale of equity securities
          1,846  
Proceeds from sale of fixed maturities
    935,445       580,831  
Proceeds from maturity of fixed maturities
    109,202       135,089  
 
           
 
               
Net cash (used in) provided by investing activities
    (87,701 )     285,006  
 
           
 
               
Cash flows from financing activities:
               
Dividends paid to shareholders
    (43,716 )     (21,279 )
Net repayment of short-term debt
    (57,722 )     (42,101 )
Reissuance of treasury stock
    3,856       728  
Repurchase of common stock
    (214,258 )     (272,025 )
Common stock issued
    15,912       1,162  
Excess tax benefits from share-based payment arrangements
    4,323        
 
           
 
               
Net cash used in financing activities
    (291,605 )     (333,515 )
 
           
 
               
Net (decrease) increase in cash and cash equivalents
    (88,814 )     178,641  
Cash and cash equivalents at beginning of period
    195,256       166,468  
 
           
 
               
Cash and cash equivalents at end of period
  $ 106,442     $ 345,109  
 
           
See accompanying notes to consolidated financial statements.

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MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2006
(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 accounting principles generally accepted in the United States of America. These statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2005 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 auditors in accordance with the standards of the Public Company Accounting Oversight Board (United States), but in the opinion of management such financial statements include all adjustments, consisting only of normal recurring accruals, necessary to summarize fairly the Company’s financial position and results of operations. The results of operations for the six months ended June 30, 2006 may not be indicative of the results that may be expected for the year ending December 31, 2006.
New Accounting Standards
     In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 155, “Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140” (“SFAS 155”). SFAS 155 permits an entity to measure at fair value any financial instrument that contains an embedded derivative that otherwise would require bifurcation. This Statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company is currently evaluating the provisions of SFAS 155 and believes that adoption will not have a material effect on its financial position or results of operations.
     In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes.” The Interpretation seeks to reduce the significant diversity in practice associated with recognition and measurement in the accounting for income taxes. The Interpretation applies to all tax positions accounted for in accordance with SFAS No. 109, “Accounting for Income Taxes.” When evaluating a tax position for recognition and measurement, an entity shall presume that the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information. The Interpretation adopts a benefit recognition model with a two-step approach, a more-likely-than-not threshold for recognition and derecognition, and a measurement attribute that is the greatest amount of benefit that is cumulatively greater than 50% likely of being realized. This Interpretation is effective for the first annual period beginning after

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December 15, 2006. The Company is currently evaluating the impact, if any, this Interpretation will have on the Company’s results of operations and financial position.
Reclassifications
     Certain reclassifications have been made in the accompanying financial statements to 2005 amounts to conform to 2006 presentation.
Note 2 — Short- and long-term debt
     The Company has a $300 million commercial paper program, which is rated “A-1” by Standard and Poors (“S&P”) and “P-1” by Moody’s. At June 30, 2006 and 2005, the Company had $133.5 and $100.0 million in commercial paper outstanding with a weighted average interest rate of 5.30% and 3.18%, respectively.
     In March of 2005, the Company obtained a $300 million, five year revolving credit facility, expiring in 2010. The facility replaced the previous $285 million facility that was due to expire in 2006. Under the terms of the credit facility, the Company must maintain shareholders’ equity of at least $2.25 billion and Mortgage Guaranty Insurance Corporation (“MGIC”) must maintain a risk-to-capital ratio of not more than 22:1 and maintain policyholders’ position (which includes MGIC’s statutory surplus and its contingency reserve) of not less than the amount required by Wisconsin insurance regulation. At June 30, 2006, these requirements were met. The facility will continue to be used as a liquidity back up facility for the outstanding commercial paper. The remaining credit available under the facility after reduction for the amount necessary to support the commercial paper was $166.5 million and $200.0 million at June 30, 2006 and 2005, respectively.
     The Company had $300 million, 5.375% Senior Notes due in November 2015 and $200 million, 6% Senior Notes due in March 2007 outstanding at June 30, 2006. At June 30, 2005 the Company had $300 million, 7.5% Senior Notes due in October 2005 and $200 million, 6% senior Notes due in March 2007. In October 2005 the Company issued, in a public offering, $300 million, 5.375% Senior Notes due in 2015. Interest on the Notes is payable semiannually in arrears on May 1 and November 1 of each year, beginning on May 1, 2006. The Senior Notes were rated “A-1” by Moody’s, “A” by S&P and “A+” by Fitch. The Company utilized the proceeds from the sale of these Senior Notes, together with available cash, to repay the $300 million, 7.5% Senior Notes that came due October 17, 2005. At June 30, 2006 and 2005, the market value of the outstanding debt was $615.6 million and $609.2 million, respectively.
     Interest payments on all long-term and short-term debt were $19.1 million and $22.1 million for the six months ended June 30, 2006 and 2005, respectively.
     During the first quarter of 2006, an outstanding interest rate swap contract was terminated. This swap was placed into service to coincide with the committed credit facility, used as a backup for the commercial paper program. Under the terms of the swap contract, the Company paid a fixed rate of 5.07% and received a variable interest rate based on the London Inter Bank Offering Rate (“LIBOR”). The swap had an expiration

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date coinciding with the maturity of the credit facility and was designated as a cash flow hedge. At June 30, 2006 the Company has no interest rate swaps outstanding.
     (Income) expense on the interest rate swaps for the six months ended June 30, 2006 and 2005 of approximately ($0.1) million and $0.5 million, respectively, was included in interest expense. Gains or losses arising from the amendment or termination of interest rate swaps are deferred and amortized to interest expense over the life of the hedged items.
Note 3 — Litigation and contingencies
     The Company is involved in litigation in the ordinary course of business. In the opinion of management, the ultimate resolution of this pending litigation will not have a material adverse effect on the financial position or results of operations of the Company.
     Consumers are bringing a growing number of lawsuits against home mortgage lenders and settlement service providers. In recent years, seven mortgage insurers, including MGIC, have been involved in litigation alleging 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. MGIC’s settlement of class action litigation against it under RESPA became final in October 2003. MGIC settled the named plaintiffs’ claims in litigation against it under FCRA in late December 2004 following denial of class certification in June 2004. There can be no assurance that MGIC will not be subject to material future litigation under RESPA or FCRA.
     In June 2005, in response to a letter from the New York Insurance Department (“NYID”), the Company provided information regarding captive mortgage reinsurance arrangements and other types of arrangements in which lenders receive compensation. In February 2006, the NYID requested MGIC to review its premium rates in New York and to file adjusted rates based on recent years’ experience or to explain why such experience would not alter rates. In March 2006, MGIC advised the NYID that it believes its premium rates are reasonable and that, given the nature of mortgage insurance risk, premium rates should not be determined only by the experience of recent years. In February 2006, in response to an administrative subpoena from the Minnesota Department of Commerce (the “MDC”), which regulates insurance, the Company provided the MDC with information about captive mortgage reinsurance and certain other matters. Insurance departments or other officials in other states may also seek information about or investigate captive mortgage reinsurance or other matters.
     The anti-referral fee provisions of RESPA provide that the Department of Housing and Urban Development as well as the insurance commissioner or attorney general of any state may bring an action to enjoin violations of these provisions 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 the Company believes its captive reinsurance arrangements are in conformity with applicable laws and regulations, it is not possible to predict the outcome of any such reviews or investigations nor is it possible to predict their effect on the Company or the mortgage insurance industry.

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     Under its contract underwriting agreements, the Company may be required to provide certain remedies to its customers if certain standards relating to the quality of the Company’s underwriting work are not met. The cost of remedies provided by the Company to customers for failing to meet these standards has not been material to the Company’s financial position or results of operations for the six months ended June 30, 2006 and 2005.
     The Internal Revenue Service (“IRS”) has been conducting an examination of the federal income tax returns of the Company for taxable years 2000 though 2004. The IRS has indicated that they intend to propose adjustments to taxable income relating to a portfolio of investments in the residual interests of Real Estate Mortgage Investment Conduits (“REMICs”). This portfolio has been managed and maintained during years prior to, during and subsequent to the examination period. The tax returns have included the flow through of income and losses from these investments in the computation of taxable income. The IRS has indicated that they do not believe that the Company has established sufficient tax basis in the REMIC residual interests to deduct some portion of the flow through losses from income. To date, they have not provided a detailed explanation of their position or the calculation of the dollar amount of any potential adjustment. Also, in the second quarter of 2006, the IRS stated that they will no longer seek to enforce a summons which was issued for certain documents containing communications with outside legal counsel. The Company will contest any such proposal to increase taxable income and believes that income taxes related to these years have been properly provided for in the financial statements.
Note 4 — 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 Company’s net income is the same for both basic and diluted EPS. Basic EPS is based on the weighted average number of common shares outstanding. Diluted EPS is based on the weighted average number of common shares outstanding plus common stock equivalents which include stock awards and stock options. 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,  
    2006     2005     2006     2005  
    (Shares in thousands)  
Weighted-average shares — Basic
    85,668       92,594       86,122       93,930  
Common stock equivalents
    591       588       631       615  
 
                       
 
                               
Weighted-average shares — Diluted
    86,259       93,182       86,753       94,545  
 
                       

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Note 5 — 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,  
    2006     2005     2006     2005  
    (In thousands of dollars)  
Net income
  $ 149,839     $ 174,357     $ 313,292     $ 356,370  
Other comprehensive income (loss)
    (32,717 )     62,205       (64,240 )     5,513  
 
                       
 
                               
Total comprehensive income
  $ 117,122     $ 236,562     $ 249,052     $ 361,883  
 
                       
 
                               
Other comprehensive income (loss) (net of tax):
                               
Change in unrealized net derivative gains and losses
  $     $ (5,560 )   $ 777     $ (4,849 )
Amortization of deferred losses on derivatives
          203             406  
Change in unrealized gains and losses on investments
    (32,717 )     67,876       (65,053 )     9,520  
Other
          (314 )     36       436  
 
                       
 
                               
Other comprehensive income (loss)
  $ (32,717 )   $ 62,205     $ (64,240 )   $ 5,513  
 
                       
     At June 30, 2006, accumulated other comprehensive income of $13.3 million included $12.9 million of net unrealized gains on investments and $0.4 million relating to the accumulated other comprehensive gain of the Company’s joint venture investment, all net of tax. At December 31, 2005, accumulated other comprehensive income of $77.5 million included $77.9 million of net unrealized gains on investments, ($0.8) million relating to derivative financial instruments and $0.4 million relating to the accumulated other comprehensive loss of the Company’s joint venture investment.
Note 6 — Benefit Plans
     The following table provides the components of net periodic benefit cost for the pension and other postretirement benefit plans:

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    Three Months Ended  
    June 30,  
                    Other Postretirement  
    Pension Benefits     Benefits  
    2006     2005     2006     2005  
    (In thousands of dollars)  
Service cost
  $ 2,332     $ 2,210     $ 916     $ 788  
Interest cost
    2,586       2,371       1,014       877  
Expected return on plan assets
    (3,739 )     (3,355 )     (648 )     (561 )
Recognized net actuarial loss (gain)
    (27 )           100       24  
Amortization of transition obligation
                71       71  
Amortization of prior service cost
    216       185              
 
                       
 
                               
Net periodic benefit cost
  $ 1,368     $ 1,411     $ 1,453     $ 1,199  
 
                       
                                 
    Six Months Ended  
    June 30,  
                    Other Postretirement  
    Pension Benefits     Benefits  
    2006     2005     2006     2005  
    (In thousands of dollars)  
Service cost
  $ 4,696     $ 4,420     $ 1,814     $ 1,707  
Interest cost
    5,213       4,742       2,038       1,861  
Expected return on plan assets
    (7,448 )     (6,710 )     (1,297 )     (1,121 )
Recognized net actuarial loss (gain)
    71             211       151  
Amortization of transition obligation
                142       142  
Amortization of prior service cost
    432       370              
 
                       
 
                               
Net periodic benefit cost
  $ 2,964     $ 2,822     $ 2,908     $ 2,740  
 
                       
     The Company previously disclosed in its financial statements for the year ended December 31, 2005 that it expected to contribute approximately $10.3 million and $4.6 million, respectively, to its pension and postretirement plans in 2006. As of June 30, 2006, no contributions have been made.
Note 7 — Share-based compensation plans
     The Company has certain share-based compensation plans. Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123R, “Share-Based Payment,” under the modified prospective method, accordingly prior period amounts have not been restated. SFAS No. 123R requires that the compensation cost relating to share-based payment transactions be measured based on the fair value of the equity or liability instrument issued and be recognized in the financial statements of the company. This statement is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”. The fair value recognition provisions of SFAS No. 123 were voluntarily adopted by the Company in 2003 prospectively to all employee awards granted or modified on or after January 1, 2003. The adoption of

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SFAS No. 123R and SFAS No. 123 did not have a material effect on the Company’s results of operations or its financial position. Under the fair value method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period which generally corresponds to the vesting period. Awards under the Company’s plans generally vest over periods ranging from one to five years.
     The cost related to stock-based employee compensation included in the determination of net income for 2005 was less than that which would have been recognized if the fair value based method had been applied to all awards since the original effective date of SFAS No. 123. The following table illustrates the effect on net income and earnings per share if the fair value method had been applied to all outstanding and unvested awards for the three and six months ended June 30, 2005.
                 
    Three Months Ended     Six Months Ended  
    June 30,  
    2005     2005  
    (in thousands of dollars,  
    except per share data)  
Net income, as reported
  $ 174,357     $ 356,370  
 
               
Add stock-based employee compensation expense included in reported net income, net of tax
    3,205       5,727  
 
               
Deduct stock-based employee compensation expense determined under fair value method for all awards, net of tax
    (4,294 )     (7,917 )
 
           
 
               
Pro forma net income
  $ 173,268     $ 354,180  
 
           
 
               
Earnings per share:
               
Basic, as reported
  $ 1.88     $ 3.79  
 
           
 
               
Basic, pro forma
  $ 1.87     $ 3.77  
 
           
 
               
Diluted, as reported
  $ 1.87     $ 3.77  
 
           
 
               
Diluted, pro-forma
  $ 1.86     $ 3.75  
 
           
     The compensation cost that has been charged against income for the share-based plans was $8.7 million and $16.6 million for the three and six months ended June 30, 2006, compared to $4.9 million and $8.8 million for the three and six months ended June 30, 2005. The related income tax benefit recognized for the share-based compensation plans was $5.8 million and $3.1 million for the six months ended June 30, 2006 and 2005, respectively.
     The Company has stock incentive plans that were adopted in 1991 and 2002. When the 2002 plan was adopted, no further awards could be made under the 1991 plan. The

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maximum number of shares covered by awards under the 2002 plan is the total of 7.1 million shares plus the number of shares that must be purchased at a purchase price of not less than the fair market value of the shares as a condition to the award of restricted stock under the 2002 plan. The maximum number of shares of restricted stock that can be awarded under the 2002 plan is 5.9 million shares. Both plans provide for the award of stock options with maximum terms of 10 years and for the grant of restricted stock or restricted stock units, and the 2002 plan also provides for the grant of stock appreciation rights. The exercise price of options is the closing price of the common stock on the New York Stock Exchange on the date of grant. The vesting provisions of options and restricted stock are determined at the time of grant. Newly issued shares are used for exercises under the 1991 plan, and treasury shares are used for exercises under the 2002 plan. Directors may receive awards under the 2002 plan and were eligible for awards of restricted stock under the 1991 plan.
     A summary of option activity in the stock incentive plans during 2006 is as follows:
                 
    Weighted        
    Average     Shares  
    Exercise     Subject  
    Price     to Option  
 
               
Outstanding, December 31, 2005
  $ 54.19       3,274,731  
 
               
Granted
           
Exercised
    39.20       (238,437 )
Forfeited or expired
    54.80       (13,930 )
 
             
 
               
Outstanding, March 31, 2006
  $ 55.37       3,022,364  
 
             
 
               
Granted
  $        
Exercised
    50.68       (255,745 )
Forfeited or expired
    68.50       (2,800 )
 
             
 
               
Outstanding, June 30, 2006
  $ 55.79       2,763,819  
 
             
     During the three and six months ended June 30, 2006, the total intrinsic value of options exercised (i.e., the difference in the market price at exercise and the price paid by the employee to exercise the option) was $3.6 million and $10.0 million, respectively. The total amount of cash received from exercise of options was $8.3 million and $15.0 million and the related net tax benefit realized from the exercise of those stock options was $1.3 million and $3.5 million for the same period.
     The following is a summary of stock options outstanding at June 30, 2006:

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    Options Outstanding     Options Exercisable  
                    Weighted                     Weighted  
Exercise           Remaining     Average             Remaining     Average  
Price           Average     Exercise             Average     Exercise  
Range   Shares     Life (years)     Price     Shares     Life (years)     Price  
$33.81 — 47.31
    1,167,619       4.3     $ 44.17       633,629       4.0     $ 43.70  
 
                                               
$53.70 — 68.63
    1,596,200       5.8     $ 64.28       1,119,300       5.5     $ 63.15  
 
                                           
 
                                               
Total
    2,763,819       5.2     $ 55.79       1,752,929       4.9     $ 56.12  
 
                                           
     The aggregate intrinsic value of options outstanding at June 30, 2006 was $25.5 million. The aggregate intrinsic value of options exercisable was $15.6 million. The aggregate intrinsic value represents the total pre-tax intrinsic value based on the Company’s closing stock price of $65.00 as of June 30, 2006 which would have been received by the option holders had all option holders exercised their options on that date.
     A summary of restricted stock or restricted stock units during 2006 is as follows:
                 
    Weighted        
    Average        
    Grant Date        
    Fair Market        
    Value     Shares  
Restricted stock outstanding at December 31, 2005
  $ 60.50       898,671  
 
               
Granted
    64.66       564,350  
Vested
    56.87       (262,982 )
Forfeited
    61.53       (6,069 )
 
             
 
               
Restricted stock outstanding at March 31, 2006
  $ 63.26       1,193,970  
 
             
 
               
Granted
    69.96       1,000  
Vested
           
Forfeited
    64.26       (240 )
 
             
 
               
Restricted stock outstanding at June 30, 2006
  $ 63.27       1,194,730  
 
             
     At June 30, 2006, 4,523,718 shares were available for future grant under the 2002 stock incentive plan. Of the shares available for future grant, 4,440,398 are available for restricted stock awards.
     As of June 30, 2006, there was $74.5 million of total unrecognized compensation cost related to nonvested share-based compensation agreements granted under the Plan. That cost is expected to be recognized over a weighted-average period of 2.8 years. The total fair value of shares vested during the three and six months ended June 30, 2006 was $0.0 million and $17.1 million, respectively.

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     For purposes of determining the pro forma net income, the fair value of options granted was estimated at grant date using the binomial option pricing model for the 2004 options and the Black-Scholes model for the 2003 and prior options with the following weighted average assumptions for each year:
                 
    Grants Issued in Year Ended December 31,  
    2004     2003  
Risk free interest rate
    3.27 %     2.91 %
Expected life
  5.50 years   4.87 years
Expected volatility
    30.20 %     29.40 %
Expected dividend yield
    0.25 %     0.25 %
Fair value of each option
  $ 21.68     $ 13.12  

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Note 8 — Condensed consolidating financial statements
     The following condensed financial information sets forth, on a consolidating basis, the balance sheet, statement of operations, and statement of cash flows for MGIC Investment Corporation (“Parent Company”), which represents the Company’s investments in all of its subsidiaries under the equity method, Mortgage Guaranty Insurance Corporation and Subsidiaries (“MGIC Consolidated”), and all other subsidiaries of the Company (“Other”) on a combined basis. The eliminations column represents entries eliminating investments in subsidiaries, intercompany balances, and intercompany revenues and expenses.

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Condensed Consolidating Balance Sheets
At June 30, 2006
(in thousands of dollars)
                                         
    Parent     MGIC                    
    Company     Consolidated     Other     Eliminations     Total  
ASSETS
                                       
Total investments
  $ 2,481     $ 4,989,436     $ 280,604     $     $ 5,272,521  
Cash and cash equivalents
    100       91,396       14,946             106,442  
Reinsurance recoverable on loss reserves
          71,899       27       (58,690 )     13,236  
Prepaid reinsurance premiums
          26,361       3       (15,883 )     10,481  
Deferred insurance policy acquisition costs
          15,449                   15,449  
Investments in subsidiaries/joint ventures
    4,754,305       526,674             (4,754,305 )     526,674  
Other assets
    70,310       367,709       32,992       (112,552 )     358,459  
 
                                       
 
                             
 
                                       
Total assets
  $ 4,827,196     $ 6,088,924     $ 328,572     $ (4,941,430 )   $ 6,303,262  
 
                             
 
                                       
LIABILITIES AND SHAREHOLDERS’ EQUITY
                                       
Liabilities:
                                       
Loss reserves
  $     $ 1,087,337     $ 58,690     $ (58,690 )   $ 1,087,337  
Unearned premiums
          172,278       15,882       (15,883 )     172,277  
Short- and long-term debt
    631,065       9,364             (9,325 )     631,104  
Other liabilities
    6,188       272,052       35,091       (90,730 )     222,601  
 
                             
 
                                       
Total liabilities
    637,253       1,541,031       109,663       (174,628 )     2,113,319  
 
                             
 
                                       
Total shareholders’ equity
    4,189,943       4,547,893       218,909       (4,766,802 )     4,189,943  
 
                             
 
                                       
Total liabilities and shareholders’ equity
  $ 4,827,196     $ 6,088,924     $ 328,572     $ (4,941,430 )   $ 6,303,262  
 
                             
Condensed Consolidating Balance Sheets
At December 31, 2005
(in thousands of dollars)
                                         
    Parent     MGIC                    
    Company     Consolidated     Other     Eliminations     Total  
ASSETS
                                       
Total investments
  $ 2,570     $ 5,047,475     $ 245,385     $     $ 5,295,430  
Cash and cash equivalents
    211       176,370       18,675             195,256  
Reinsurance recoverable on loss reserves
          78,097       36       (63,346 )     14,787  
Prepaid reinsurance premiums
          17,521       3       (7,916 )     9,608  
Deferred insurance policy acquisition costs
          18,416                   18,416  
Investments in subsidiaries/joint ventures
    4,842,932       481,778             (4,842,932 )     481,778  
Other assets
    13,542       356,624       28,274       (56,146 )     342,294  
 
                                       
 
                             
Total assets
  $ 4,859,255     $ 6,176,281     $ 292,373     $ (4,970,340 )   $ 6,357,569  
 
                             
 
                                       
LIABILITIES AND SHAREHOLDERS’ EQUITY
                                       
Liabilities:
                                       
Loss reserves
  $     $ 1,124,454     $ 63,346     $ (63,346 )   $ 1,124,454  
Unearned premiums
          159,823       7,916       (7,916 )     159,823  
Short- and long-term debt
    685,124       9,364             (9,325 )     685,163  
Other liabilities
    9,076       232,109       13,435       (31,546 )     223,074  
 
                             
 
                                       
Total liabilities
    694,200       1,525,750       84,697       (112,133 )     2,192,514  
 
                             
 
                                       
Total shareholders’ equity
    4,165,055       4,650,531       207,676       (4,858,207 )     4,165,055  
 
                             
 
                                       
Total liabilities and shareholders’ equity
  $ 4,859,255     $ 6,176,281     $ 292,373     $ (4,970,340 )   $ 6,357,569  
 
                             

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Condensed Consolidating Statements of Operations
Three months ended June 30, 2006
(in thousands of dollars)
                                         
    Parent     MGIC                    
    Company     Consolidated     Other     Eliminations     Total  
Revenues:
                                       
Net premiums written
  $     $ 281,064     $ 24,256     $ (40 )   $ 305,280  
 
                             
 
                                       
Net premiums earned
          276,900       17,643       (40 )     294,503  
 
                                       
Equity in undistributed net income of subsidiaries
    595                   (595 )      
Dividends received from subsidiaries
    155,000                   (155,000 )      
Investment income, net of expenses
    51       56,328       3,001             59,380  
Realized investment gains (losses), net
          (1,905 )     67             (1,838 )
Other revenue
          2,692       8,767             11,459  
 
                             
 
                                       
Total revenues
    155,646       334,015       29,478       (155,635 )     363,504  
 
                             
 
                                       
Losses and expenses:
                                       
Losses incurred, net
          140,753       5,714             146,467  
Underwriting and other expenses
    63       51,171       20,309       (51 )     71,492  
Interest expense
    8,843                         8,843  
 
                             
 
                                       
Total losses and expenses
    8,906       191,924       26,023       (551 )     226,802  
 
                             
 
                                       
Income before tax and joint ventures
    146,740       142,091       3,455       (155,584 )     136,702  
Provision (credit) for income tax
    (3,099 )     36,958       582       38       34,479  
Income from joint ventures, net of tax
          47,616                   47,616  
 
                             
 
                                       
Net income
  $ 149,839     $ 152,749     $ 2,873     $ (155,622 )   $ 149,839  
 
                             
Condensed Consolidating Statements of Operations
Three months ended June 30, 2005
(in thousands of dollars)
                                         
    Parent     MGIC                    
    Company     Consolidated     Other     Eliminations     Total  
Revenues:
                                       
Net premiums written
  $     $ 292,897     $ 16,401     $ (78 )   $ 309,220  
 
                             
 
                                       
Net premiums earned
          295,192       16,519       (78 )     311,633  
 
                                       
Equity in undistributed net loss of subsidiaries
    (237,996 )                 237,996        
Dividends received from subsidiaries
    419,300                   (419,300 )      
Investment income, net of expenses
    353       54,551       2,492       (218 )     57,178  
Realized investment gains (losses), net
          15,189       (2 )           15,187  
Other revenue
          385       10,570             10,955  
 
                             
 
                                       
Total revenues
    181,657       365,317       29,579       (181,600 )     394,953  
 
                             
 
                                       
Losses and expenses:
                                       
Losses incurred, net
          129,715       7,200             136,915  
Underwriting and other expenses
    62       45,314       22,772       (89 )     68,059  
Interest expense
    10,516       214             (218 )     10,512  
 
                             
 
                                       
Total losses and expenses
    10,578       175,243       29,972       (307 )     215,486  
 
                             
 
                                       
Income (loss) before tax and joint ventures
    171,079       190,074       (393 )     (181,293 )     179,467  
Provision (credit) for income tax
    (3,278 )     53,833       (654 )     (296 )     49,605  
Income from joint ventures, net of tax
          44,495                   44,495  
 
                             
 
                                       
Net income
  $ 174,357     $ 180,736     $ 261     $ (180,997 )   $ 174,357  
 
                             

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Condensed Consolidating Statements of Operations
Six months ended June 30, 2006
(in thousands of dollars)
                                         
    Parent     MGIC                    
    Company     Consolidated     Other     Eliminations     Total  
Revenues:
                                       
Net premiums written
  $     $ 563,717     $ 42,097     $ (62 )   $ 605,752  
 
                             
 
                                       
Net premiums earned
          560,102       34,130       (62 )     594,170  
 
                                       
Equity in undistributed net loss of subsidiaries
    (34,920 )                 34,920        
Dividends received from subsidiaries
    360,000                       (360,000 )      
Investment income, net of expenses
    150       111,400       5,794             117,344  
Realized investment gains (losses), net
          (1,848 )     97             (1,751 )
Other revenue
          5,357       17,416             22,773  
 
                             
 
                                       
Total revenues
    325,230       675,011       57,437       (325,142 )     732,536  
 
                             
 
                                       
Losses and expenses:
                                       
Losses incurred, net
          251,352       10,000             261,352  
Underwriting and other expenses
    127       105,279       40,435       (84 )     145,757  
Interest expense
    18,158                         18,158  
 
                             
 
                                       
Total losses and expenses
    18,285       356,631       50,435       (84 )     425,267  
 
                             
 
                                       
Income before tax and joint ventures
    306,945       318,380       7,002       (325,058 )     307,269  
Provision (credit) for income tax
    (6,347 )     85,696       1,241       55       80,645  
Income from joint ventures, net of tax
          86,668                   86,668  
 
                             
 
                                       
Net income
  $ 313,292     $ 319,352     $ 5,761     $ (325,113 )   $ 313,292  
 
                             
Condensed Consolidating Statements of Operations
Six months ended June 30, 2005
(in thousands of dollars)
                                         
    Parent     MGIC                    
    Company     Consolidated     Other     Eliminations     Total  
Revenues:
                                       
Net premiums written
  $     $ 588,302     $ 33,303     $ (146 )   $ 621,459  
 
                             
 
                                       
Net premiums earned
          594,249       33,609       (146 )     627,712  
 
                                       
Equity in undistributed net loss of subsidiaries
    (93,434 )                 93,434        
Dividends received from subsidiaries
    463,600                   (463,600 )      
Investment income, net of expenses
    603       109,156       4,846       (424 )     114,181  
Realized investment gains, net
          16,738       14             16,752  
Other revenue
          896       20,320             21,216  
 
                             
 
                                       
Total revenues
    370,769       721,039       58,789       (370,736 )     779,861  
 
                             
 
                                       
Losses and expenses:
                                       
Losses incurred, net
          224,244       11,537             235,781  
Underwriting and other expenses
    130       94,615       41,377       (168 )     135,954  
Interest expense
    21,235       424             (425 )     21,234  
 
                             
 
                                       
Total losses and expenses
    21,365       319,283       52,914       (593 )     392,969  
 
                             
 
                                       
Income before tax and joint ventures
    349,404       401,756       5,875       (370,143 )     386,892  
Provision (credit) for income tax
    (6,966 )     115,660       864       (293 )     109,265  
Income from joint ventures, net of tax
          78,743                   78,743  
 
                             
 
                                       
Net income
  $ 356,370     $ 364,839     $ 5,011     $ (369,850 )   $ 356,370  
 
                             

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Condensed Consolidating Statements of Cash Flows
For the Six Months Ended June 30, 2006
(in thousands of dollars)
                                         
    Parent     MGIC                    
    Company     Consolidated     Other     Eliminations     Total  
Net cash provided by operating activities
  $ 304,228 (1)   $ 317,995     $ 36,769     $ (368,500 )   $ 290,492  
Net cash used in investing activities
    (8,411 )     (47,292 )     (40,498 )     8,500       (87,701 )
Net cash used in financing activities
    (295,928 )     (355,677 )           360,000       (291,605 )
 
                             
Net decrease in cash
  $ (111 )   $ (84,974 )   $ (3,729 )   $     $ (88,814 )
 
                             
 
(1)   Includes dividends received from subsidiaries of $360,000.
Condensed Consolidating Statements of Cash Flows
For the Six Months Ended June 30, 2005
(in thousands of dollars)
                                         
    Parent     MGIC                    
    Company     Consolidated     Other     Eliminations     Total  
Net cash provided by operating activities
  $ 403,254 (1)   $ 283,598     $ 3,314     $ (463,600 )   $ 226,566  
Net cash provided by (used in) investing activities
    106       298,636       (13,736 )           285,006  
Net cash used in financing activities
    (333,515 )     (463,016 )           463,600       (332,931 )
 
                             
Net increase (decrease) in cash
  $ 69,845     $ 119,218     $ (10,422 )   $     $ 178,641  
 
                             
 
(1)   Includes dividends received from subsidiaries of $463,600.

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ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Business and General Environment
     We, through our subsidiary Mortgage Guaranty Insurance Corporation (“MGIC”), are the leading provider of private mortgage insurance in the United States to the home mortgage lending industry. Our principal products are primary mortgage insurance and pool mortgage insurance. Primary mortgage insurance may be written through the flow market channel, in which loans are insured in individual, loan-by-loan transactions. Primary mortgage insurance may also be written through the bulk market channel, in which portfolios of loans are individually insured in single, bulk transactions.
     As used below, “we” refers to our consolidated operations. The discussion below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2005. We refer to this Discussion as the “10-K MD&A.”
Our results of operations are affected by:
  Premiums written and earned
     Premiums written and earned in a year are influenced by:
    New insurance written, which increases the size of the in force book of insurance. New insurance written is the aggregate principal amount of the mortgages that are insured during a period and is referred to as “NIW”. NIW is affected by many factors, including the volume of low down payment home mortgage originations and competition to provide credit enhancement on those mortgages, including competition from other mortgage insurers and alternatives to mortgage insurance, such as piggyback loans.
 
    Cancellations, which reduce the size of the in force book of insurance that generates premiums. Cancellations due to refinancings are affected by the level of current mortgage interest rates compared to the mortgage coupon rates throughout the in force book, as well as by home price appreciation.
 
    Premium rates, which are affected by the risk characteristics of the loans insured and the percentage of coverage on the loans.
 
    Premiums ceded to reinsurance subsidiaries of certain mortgage lenders and risk sharing arrangements with the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation (government sponsored entities or “GSEs”).
Premiums are generated by the insurance that is in force during all or a portion of the period. Hence, lower average insurance in force in one period compared to another is a

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factor that will reduce premiums written and earned, although this effect may be mitigated (or enhanced) by differences in the average premium rate between the two periods as well as by premium that is ceded. Also, NIW and cancellations during a period will generally have a greater effect on premiums written and earned in subsequent periods than in the period in which these events occur.
  Investment income and realized gains and losses
     The investment portfolio is comprised almost entirely of highly rated, fixed income securities. The principal factors that influence investment income are the size of the portfolio and its yield. As measured by amortized cost (which excludes changes in fair market value, such as from changes in interest rates), the size of the investment portfolio is mainly a function of cash generated from operations, including investment earnings, less cash used for non-investment purposes, such as share repurchases. Realized gains and losses are a function of the difference between the amount received on sale of a security and the security’s amortized cost. The amount received on sale is affected by the coupon rate of the security compared to the yield of comparable securities.
  Losses incurred
     Losses incurred are the expense that results from a payment delinquency on an insured loan. As explained under “Critical Accounting Policies” in the 10-K MD&A, this expense is recognized only when a loan is delinquent. Losses incurred are generally affected by:
    The state of the economy, which affects the likelihood that loans will become delinquent and whether loans that are delinquent cure their delinquency. The level of delinquencies has historically followed a seasonal pattern, with a reduction in delinquencies in the first part of the year, followed by an increase in the latter part of the year.
 
    The product mix of the in force book, with loans having higher risk characteristics generally resulting in higher delinquencies and claims.
 
    The average claim payment, which is affected by the size of loans insured (higher average loan amounts tend to increase losses incurred), the percentage coverage on insured loans (deeper average coverage tends to increase incurred losses), and housing values, which affect our ability to mitigate our losses through sales of properties with delinquent mortgages.
 
    The distribution of claims over the life of a book. Historically, the first two years after a loan is originated are a period of relatively low claims, with claims increasing substantially for several years subsequent and then declining, although persistency and the condition of the economy can affect this pattern.
  Underwriting and other expenses

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     Our operating expenses generally vary primarily due to contract underwriting volume, which in turn generally varies with the level of mortgage origination activity. Contract underwriting generates fee income included in “Other revenue.”
  Income from joint ventures
     Our results of operations are also affected by income from joint ventures. Joint venture income principally consists of the aggregate results of our investment in two less than majority owned joint ventures, Credit-Based Asset Servicing and Securitization LLC (“C-BASS”) and Sherman Financial Group LLC (“Sherman”).
     C-BASS: C-BASS is primarily an investor in the credit risk of credit-sensitive single-family residential mortgages. It finances these activities through borrowings included on its balance sheet and by securitization activities generally conducted through off-balance sheet entities. C-BASS generally retains the first-loss and other subordinate securities created in the securitization. The mortgage loans owned by C-BASS and underlying C-BASS’s mortgage securities investments are generally serviced by Litton Loan Servicing LP, a subsidiary of C-BASS (“Litton”). Litton’s servicing operations primarily support C-BASS’s investment in credit risk, and investments made by funds managed or co-managed by C-BASS, rather than generating fees for servicing loans owned by third-parties.
     C-BASS’s consolidated results of operations are affected by:
    Portfolio revenue, which in turn is primarily affected by net interest income, gain on sale and liquidation and hedging gains and losses related to portfolio assets, net of mark-to-market and whole loan reserve changes.
    Net interest income
 
      Net interest income is principally a function of the size of C-BASS’s portfolio of whole loans and mortgages and other securities, and the spread between the interest income generated by these assets and the interest expense of funding them. Interest income from a particular security is recognized based on the expected yield for the security.
 
    Gain on sale and liquidation
 
      Gain on sale and liquidation results from sales of mortgage and other securities, and liquidation of mortgage loans. Securities may be sold in the normal course of business or because of the exercise of call rights by third parties. Mortgage loan liquidations result from loan payoffs, from foreclosure or from sales of real estate acquired through foreclosure.
    Servicing revenue
 
      Servicing revenue is a function of the unpaid principal balance of mortgage loans serviced and servicing fees and charges. The unpaid principal balance of mortgage loans serviced by Litton is affected by mortgages acquired by C-BASS

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      because servicing on subprime and other mortgages acquired is generally transferred to Litton. Litton also services or provides special servicing on loans in mortgage securities owned by funds managed or co-managed by C-BASS. Litton also may obtain servicing on loans in third party mortgage securities acquired by C-BASS or when the loans become delinquent by a specified number of payments (known as “special servicing”).
 
    Revenues from money management activities
 
      These revenues include management fees from C-BASS issued collateralized bond obligations (“CBOs”), equity in earnings from C-BASS investments in investment funds managed or co-managed by C-BASS and management fees and incentive income from investment funds managed or co-managed by C-BASS.
 
    Transaction revenue, which in turn is affected by gain on securitization and hedging gains and losses related to securitization
    Gain on securitization
 
      Gain on securitization is a function of the face amount of the collateral in the securitization and the margin realized in the securitization. This margin depends on the difference between the proceeds realized in the securitization and the purchase price paid by C-BASS for the collateral. The proceeds realized in a securitization include the value of securities created in the securitization that are retained by C-BASS.
    Hedging gains and losses, net of mark-to-market and whole loan reserve changes
 
      Hedging gains and losses primarily consist of changes in the value of derivative instruments (including interest rate swaps, interest rate caps and futures) and short positions, as well as realized gains and losses from the closing of hedging positions. C-BASS uses derivative instruments and short sales in a strategy to reduce the impact of changes in interest rates on the value of its mortgage loans and securities. Changes in value of derivative instruments are subject to current recognition because C-BASS does not account for the derivatives as “hedges” under SFAS No. 133.
 
      Mortgage and other securities are classified by C-BASS as trading securities and are carried at fair value, as estimated by C-BASS. Changes in fair value between period ends (a “mark-to-market”) are reflected in C-BASS’s statement of operations as unrealized gains or losses. Changes in fair value of mortgage and other securities may relate to changes in credit spreads or to changes in the level of interest rates or the slope of the yield curve. Mortgage loans are not marked-to-market and are carried at the lower of cost or fair value on a portfolio basis, as estimated by C-BASS.
 
      During a period in which short-term interest rates decline, in general, C-BASS’s hedging positions will decline in value and the change in value, to the extent that

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      the hedges related to whole loans, will be reflected in C-BASS’s earnings for the period as an unrealized loss. The related increase, if any, in the value of mortgage loans will not be reflected in earnings but, absent any countervailing factors, when mortgage loans owned during the period are securitized, the proceeds realized in the securitization should increase to reflect the increased value of the collateral.
     Sherman: Sherman is principally engaged in purchasing and collecting for its own account delinquent consumer receivables, which are primarily unsecured, and in originating and servicing subprime credit card receivables. The borrowings used to finance these activities are included in Sherman’s balance sheet.
     Sherman’s consolidated results of operations are affected by:
  Revenues from delinquent receivable portfolios
 
    These revenues are the cash collections on such portfolios, and depend on the aggregate amount of delinquent receivables owned by Sherman, the type of receivable and the length of time that the receivable has been owned by Sherman.
 
  Amortization of delinquent receivable portfolios
 
    Amortization is the recovery of the cost to purchase the receivable portfolios. Amortization expense is a function of estimated collections from the portfolios over their estimated lives. If estimated collections cannot be reasonably predicted, cost is fully recovered before any net revenue (the difference between revenues from a receivable portfolio and that portfolio’s amortization) is recognized.
 
  Credit card interest and fees, along with the coincident provision for losses for uncollectible amounts.
 
  Costs of collection, which include servicing fees paid to third parties to collect receivables.
   2006 Second Quarter Results
     Our results of operations in the second quarter of 2006 were principally affected by:
  Losses incurred
     Losses incurred for the second quarter of 2006 increased compared to the same period in 2005 primarily due to a larger increase in the estimates regarding how much will be paid on claims, offset by a larger decrease in the estimates regarding how many delinquencies will result in a claim, when both are compared to the same period in 2005. The increase in estimates regarding how much will be paid on claims is primarily the result of the default inventory containing higher loan exposures with expected higher average claim payments, while the decrease in estimates regarding how many delinquencies will result in a claim is the result of improvements in the claim rate in

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certain geographical regions, with the exception of the Midwest where claims rates have not improved.
  Premiums written and earned
     During the second quarter of 2006, our written and earned premiums were lower than in the second quarter of 2005 due to a decline in the average insurance in force.
  Underwriting expenses
     Underwriting expenses increased in the second quarter of 2006 compared to the second quarter of 2005 primarily due to additional amounts related to Myers Internet (acquired in January 2006) and equity based compensation.
  Investment income
     Investment income in the second quarter of 2006 was higher than in the second quarter of 2005 due to a slight increase in the pre-tax yield, offset by a decrease in the average amortized cost of invested assets.
  Income from joint ventures
     Income from joint ventures increased in the second quarter of 2006 compared to the same period in 2005 due to higher income from C-BASS.

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RESULTS OF CONSOLIDATED OPERATIONS
     As discussed under “Forward Looking Statements and Risk Factors” below, actual results may differ materially from the results contemplated by forward looking statements. We are not undertaking any obligation to update any forward looking statements we may make in the following discussion or elsewhere in this document even though these statements may be affected by events or circumstances occurring after the forward looking statements were made.
NIW
     The amount of MGIC’s NIW (this term is defined in the “Overview-Business and General Environment” section) during the three and six months ended June 30, 2006 and 2005 was as follows:
                                 
    Three months ended     Six months ended  
    June 30,     June 30,  
    ($ billions)     ($ billions)  
    2006     2005     2006     2005  
Flow
  $ 10.1     $ 10.4     $ 18.0     $ 19.3  
Bulk
    6.0       6.2       8.1       8.7  
 
                       
 
                               
Total NIW
  $ 16.1     $ 16.6     $ 26.1     $ 28.0  
 
                       
 
                               
Refinance volume as a % of primary flow NIW
    22 %     26 %     25 %     29 %
     NIW on a flow basis for the second quarter and first six months of 2006 was less than the volume during the comparable periods in 2005. This decrease in NIW on a flow basis was primarily the result of a decrease in refinance volume. Refinance volume in turn is driven by changes in interest rates as discussed with respect to cancellations below. For a discussion of NIW written through the bulk channel, see “Bulk transactions” below.

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Cancellations and insurance in force
     NIW and cancellations of primary insurance in force during the three and six months ended June 30, 2006 and 2005 were as follows:
                                 
    Three months ended     Six months ended  
    June 30,     June 30,  
    2006     2005     2006     2005  
    ($ billions)     ($ billions)  
NIW
  $ 16.1     $ 16.6     $ 26.1     $ 28.0  
Cancellations
    (13.2 )     (16.9 )     (26.3 )     (33.3 )
 
                       
 
                               
Change in primary insurance in force
  $ 2.9     $ (0.3 )   $ (0.2 )   $ (5.3 )
 
                       
     Direct primary insurance in force was $169.8 billion at June 30, 2006 compared to $170.0 billion at December 31, 2005 and $171.8 billion at June 30, 2005. The $2.9 billion increase in insurance in force in the second quarter of 2006 was the first quarter of growth in the in force book since the fourth quarter of 2002.
     Cancellation activity has historically been affected by the level of mortgage interest rates and the level of home price appreciation. Cancellations generally move inversely to the change in the direction of interest rates, although they generally lag a change in direction. MGIC’s persistency rate (percentage of insurance remaining in force from one year prior) was 64.1% at June 30, 2006, an increase from 61.3% at December 31, 2005 and 60.9% at June 30, 2005. We expect modest improvement in the persistency rate for the remainder of 2006, although this expectation assumes the absence of significant declines in the level of mortgage interest rates from their level in late July 2006.
Bulk transactions
     NIW from bulk transactions during the second quarter and first six months of 2006 was slightly less than the volume during the comparable periods in 2005.
     Our writings of bulk insurance are in part sensitive to the volume of securitization transactions involving non-conforming loans. Our writings of bulk insurance are also sensitive to competition from other methods of providing credit enhancement in a securitization, including an execution in which the subordinate tranches in the securitization rather than mortgage insurance bear the first loss from mortgage defaults. Competition from such an execution in turn depends on, among other factors, the yield at which investors are willing to purchase tranches of the securitization that involve a higher degree of credit risk compared to the yield for tranches involving the lowest credit risk (the difference in such yields is referred to as the spread) and the amount of credit for losses that a rating agency will give to mortgage insurance. As the spread narrows, competition from an execution in which the subordinate tranches bear the first loss increases. The competitiveness of the mortgage insurance execution in the bulk

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channel may also be impacted by changes in our view of the risk of the business, which is affected by the historical performance of previously insured pools and our expectations for regional and local real estate values. As a result of the sensitivities discussed above, bulk volume can vary materially from period to period.
Pool insurance
     In addition to providing primary insurance coverage, we also insure pools of mortgage loans. New pool risk written during the three months ended June 30, 2006 and 2005 was $89 million and $58 million, respectively. Our direct pool risk in force was $3.2 billion, $2.9 billion and $2.8 billion at June 30, 2006, December 31, 2005 and June 30, 2005, respectively. These risk amounts represent pools of loans with contractual aggregate loss limits and those without such limits. For pools of loans without such limits, risk is estimated based on the amount that would credit enhance the loans in the pool to a ‘AA’ level based on a rating agency model. Under this model, at June 30, 2006 and 2005, for $4.7 billion and $5.3 billion, respectively, of risk without such limits, risk in force was calculated at $471 million and $462 million, respectively. New risk written under this model, for the three months ended June 30, 2006 and 2005, was $1 million and $24 million, respectively.
     New pool risk written during the six months ended June 30, 2006 and 2005 was $157 million and $106 million, respectively. Under the model described above, for risk without contractual aggregate loss limits, new risk written during the six months ended June 30, 2006 and 2005 was calculated at $2 million and $44 million, respectively.
Net premiums written and earned
     Net premiums written and earned during the second quarter and first six months of 2006 decreased due to a decline in the average insurance in force, when compared to the same periods in 2005. We anticipate that net premiums written and earned in the second half of 2006 will be lower than the comparable period in 2005, due to lower premium rates, offset by slight growth in the average insurance in force.
Risk sharing arrangements
     For the quarter ended March 31, 2006, approximately 48.0% of our new insurance written on a flow basis was subject to arrangements with reinsurance subsidiaries of certain mortgage lenders or risk sharing arrangements with the GSEs compared to 46.7% for the quarter ended June 30, 2005. The percentage of new insurance written during a period covered by such arrangements normally increases after the end of the period because, among other reasons, the transfer of a loan in the secondary market can result in a mortgage insured during a period becoming part of such an arrangement in a subsequent period. Therefore, the percentage of new insurance written covered by such arrangements is not shown for the current quarter. Premiums ceded in such arrangements are reported in the period in which they are ceded regardless of when the mortgage was insured.

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      Continuing a program begun in 2005 to reduce exposure to certain geographical areas and categories of risk, during the second quarter of 2006, we entered into an excess of loss reinsurance agreement under which we ceded approximately $45 million of risk in force in to a special purpose reinsurance company. The structure of this reinsurance transaction was similar to two reinsurance transactions entered into in 2005. See the 10-K MD&A under “Results of Consolidated Operations - Risk-sharing arrangements”. Premiums ceded under these three reinsurance agreements have not been material and are included in “ceded premiums”. We may enter into similar transactions in the future.
Investment income
     Investment income for the second quarter of 2006 increased due a slight increase in the average investment yield, offset by a decrease in the average amortized cost of invested assets. Investment income for the first six months of 2006 increased due to a slight increase in the average investment yield. The portfolio’s average pre-tax investment yield was 4.45% at June 30, 2006 and 4.32% at June 30, 2005. The portfolio’s average after-tax investment yield was 3.96% at June 30, 2006 and 3.88% at June 30, 2005. Our net realized losses in the second quarter and first six months of 2006 were immaterial. Our net realized gains in the second quarter and first six months of 2005 resulted primarily from the sale of fixed maturities.
Other revenue
     The increase in other revenue is primarily the result of additional revenue from the operation of Myers Internet, offset by somewhat lower revenues from other non-insurance operations.
Losses
     As discussed in “Critical Accounting Policies” in the 10-K MD&A, consistent with industry practices, loss reserves for future claims are established only for loans that are currently delinquent. (The terms “delinquent” and “default” are used interchangeably by the Company and are defined as an insured loan with a mortgage payment that is 45 days or more past due.) Loss reserves are established by management’s estimating the number of loans in our inventory of delinquent loans that will not cure their delinquency (historically, a substantial majority of delinquent loans have cured), which is referred to as the claim rate, and further estimating the amount that we will pay in claims on the loans that do not cure, which is referred to as claim severity.
     The estimated claims rates and claims amounts represent what management believes best reflect the estimate of what will actually be paid on the loans in default as of the reserve date. These estimates are based on management’s review of historical trends in default inventory, such as defaults that have resulted in a claim, the amount of the claim, the change in the level of defaults by geography and the change in average loan exposure. The process does not encompass management projecting any correlation to projected economic conditions such as changes in unemployment rate, interest rate or housing value. As a result, management’s process to determine reserves does not include quantitative ranges of outcomes that are reasonably likely to occur.

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     In considering the potential sensitivity of the factors underlying management’s best estimate of loss reserves, it is possible that even a relatively small change in estimated claim rate or a relatively small percentage change in estimated claim amount could have a significant impact on reserves and, correspondingly, on results of operations. For example, as of the reserve date a $1,000 change in the average severity reserve factor combined with a 1% change in the average claim rate reserve factor could change the reserve amount by approximately $50 million. Historically, it has not been uncommon for us to experience variability in the development of the reserves at this level or higher.
     The establishment of loss reserves is subject to inherent uncertainty and requires judgment by management. The actual amount of the claim payments may vary significantly from the loss reserve estimates. Changes to our estimates could result in material changes to our operations, even in a stable economic environment. Adjustments to reserve estimates are reflected in the financial statements in the periods in which the adjustments are made.
     Net losses incurred increased in the second quarter of 2006 compared to the same period in 2005 due to a larger increase in the estimates regarding how much will be paid on claims, offset by a slightly larger decrease in the estimates regarding how many delinquencies will eventually result in a claim, when compared to the same period in 2005. The increase in estimates regarding how much will be paid on claims is primarily the result of the default inventory containing higher loan exposures with expected higher average claim payments, while the decrease in estimates regarding how many delinquencies will result in a claim is the result of improvements in the claim rate in certain geographical regions, with the exception of the Midwest where claim rates have not improved. The average primary claim paid for the three months ended June 30, 2006 was $27,153 compared to $25,708 for the same period in 2005.
     Net losses incurred increased in the first six months of 2006 compared to the same period in 2005 due to a larger increase in the estimates regarding how many delinquencies will eventually result in a claim, when compared to the same period in 2005. The increase in estimates regarding how much will be paid on claims is primarily the result of the default inventory containing higher loan exposures with expected higher average claim payments. The average primary claim paid for the six months ended June 30, 2006 was $27,016 compared to $25,894 for the same period in 2005.
     We anticipate that losses incurred in the second half of 2006 will be above the level in the first half of 2006.
     Information about the composition of the primary insurance default inventory at June 30, 2006, December 31, 2005 and June 30, 2005 appears in the table below.

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    June 30,     December 31,     June 30,  
    2006     2005     2005  
Total loans delinquent
    73,354       85,788       76,081  
Percentage of loans delinquent (default rate)
    5.77 %     6.58 %     5.62 %
 
                       
Flow loans delinquent
    39,049       47,051       39,958  
Percentage of flow loans delinquent (default rate)
    3.82 %     4.52 %     3.70 %
 
                       
Bulk loans delinquent
    34,305       38,737       36,123  
Percentage of bulk loans delinquent (default rate)
    13.84 %     14.72 %     13.13 %
 
                       
A-minus and subprime credit loans delinquent*
    32,508       36,485       32,613  
Percentage of A-minus and subprime credit loans delinquent (default rate)
    17.35 %     18.30 %     15.47 %
*A portion of A-minus and subprime credit loans is included in flow loans delinquent and the remainder is included in bulk loans delinquent. Most A-minus and subprime credit loans are written through the bulk channel. A-minus loans have FICO credit scores of 575-619, as reported to MGIC at the time a commitment to insure is issued, and subprime loans have FICO credit scores of less than 575.
     The pool notice inventory decreased from 23,772 at December 31, 2005 to 19,630 at June 30, 2006; the pool notice inventory was 22,702 at June 30, 2005.
     At June 30, 2006, we estimate that the default inventory included 1,650 mortgages on properties in areas within Alabama, Florida, Louisiana, Mississippi and Texas that have been declared eligible for individual and public assistance by the Federal Emergency Management Agency as a result of Hurricanes Katrina, Rita and Wilma. For additional information on the potential effect of these hurricanes, see “Deterioration in the domestic economy or changes in the mix of business may result in more homeowners defaulting and the Company’s losses increasing” under “Risk Factors”, included in our Form 10-K, filed for the year ended December 31, 2005.
Information about net losses paid in 2006 and 2005 appears in the table below.
                                 
    Three months ended     Six months ended  
    June 30,     June 30,  
Net paid claims ($ millions)                        
    2006     2005     2006     2005  
Flow
  $ 72     $ 74     $ 134     $ 145  
Bulk
    65       64       118       122  
Other
    25       20       45       40  
 
                       
 
  $ 162     $ 158     $ 297     $ 307  
 
                       
      Net paid claims increased in the second quarter of 2006 from $135 million in the first quarter of 2006. The increase in paid claims was primarily the result of an acceleration in bankruptcy filings in October 2005 prior to the change in the bankruptcy laws. The effect of this acceleration was that we paid claims in the second quarter of 2006 that we would have paid after the second quarter. To a lesser extent, the increase was also the result of the GSE’s lifting of the moratorium on pursuing delinquencies in certain areas of the hurricane impacted states and the beginning of the clearance of a foreclosure backlog in Ohio. The effect of these factors was that claims that would have been paid before the second quarter were paid in the second quarter.

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     As of June 30, 2006, 81% of our primary insurance in force was written subsequent to December 31, 2002. On our flow business, the highest claim frequency years have typically been the third and fourth year after the year of loan origination. However, the pattern of claims frequency can be affected by many factors, including low persistency (which can have the effect of accelerating the period in the life of a book during which the highest claim frequency occurs) and deteriorating economic conditions (which can result in increasing claims following a period of declining claims). On our bulk business, the period of highest claims frequency has generally occurred earlier than in the historical pattern on our flow business.
Underwriting and other expenses
     Underwriting and other expenses in the second quarter and first six months of 2006 were more than the comparable periods in 2005. The increase was primarily due to additional expenses from Myers Internet and equity based compensation. (In the first six months of 2006, $2.9 million of equity based compensation expenses related to the adoption of FAS 123R.) The effect of these expense increases was partially offset by lower insurance and non-insurance expenses.
Consolidated ratios
     The table below presents our consolidated loss, expense and combined ratios for the periods indicated.
                                 
    Three months ended     Six months ended  
    June 30,     June 30,  
Consolidated Insurance Operations:                        
    2006     2005     2006     2005  
Loss ratio
    49.7 %     43.9 %     44.0 %     37.6 %
Expense ratio
    16.7 %     15.1 %     17.1 %     15.5 %
 
                       
Combined ratio
    66.4 %     59.0 %     61.1 %     53.1 %
 
                       
     The loss ratio (expressed as a percentage) is the ratio of the sum of incurred losses and loss adjustment expenses to net premiums earned. The increase in the loss ratio in 2006, compared to 2005, is due to an increase in losses incurred and a decrease in premiums earned compared to the prior year. The expense ratio (expressed as a percentage) is the ratio of underwriting expenses to net premiums written. The increase in the expense ratio in 2006, compared to 2005, is due to an increase in underwriting expenses and a decrease in premiums written compared to the prior year. The combined ratio is the sum of the loss ratio and the expense ratio.
Income taxes
     The effective tax rate was 25.2% in the second quarter of 2006, compared to 27.6% in the second quarter of 2005. During those periods, the effective tax rate was below the statutory rate of 35%, reflecting the benefits recognized from tax preferenced

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investments. Our tax preferenced investments include tax-exempt municipal bonds, interests in mortgage related securities with flow through characteristics and investments in real estate ventures which generate low income housing credits. The lower effective tax rate in 2006 resulted from a higher percentage of total income before tax being generated from tax preferenced investments, which resulted from lower levels of underwriting income.
     The effective tax rate was 26.2% in the first six months of 2006, compared to 28.2% in the first six months of 2005. The lower effective tax rate in 2006 resulted from a higher percentage of total income before tax being generated from tax preferenced investments, which resulted from lower levels of underwriting income.
Joint ventures
     Our equity in the earnings from the C-BASS and Sherman joint ventures with Radian Group Inc. (“Radian”) and certain other joint ventures and investments, accounted for in accordance with the equity method of accounting, is shown separately, net of tax, on our consolidated statement of operations. The increase in income from joint ventures from the second quarter and first six months of 2005 to the second quarter and first six months of 2006 is primarily the result of increased equity earnings from each of C-BASS and Sherman.
C-BASS
     Summary C-BASS balance sheets and income statements at the dates and for the periods indicated appear below.
Summary Balance Sheet:
                 
    June 30,     December 31,  
    2006     2005  
    ($ millions)  
Assets
               
Whole loans
  $ 3,336     $ 4,638  
Securities
    1,886       2,054  
Servicing
    540       468  
Other
    527       534  
 
           
Total Assets
  $ 6,289     $ 7,694  
 
           
 
               
Total Liabilities
  $ 5,417     $ 6,931  
 
               
Debt*
    4,813       6,434  
 
               
Owners’ Equity
    872       763  
 
*   Most of which is scheduled to mature within one year or less.

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     The amounts of Total Assets, Whole loans and Debt each decreased during the first half of 2006 primarily as a result of the securitization of whole loans acquired in the fourth quarter of 2005 as well as the issuance of new CBOs.
                                 
Summary Income Statement            
    Three months ended     Six months ended  
    June 30,     June 30,  
    2006     2005     2006     2005  
    ($ millions)  
Portfolio
  $ 100.8     $ 72.8     $ 178.3     $ 139.6  
Servicing
    82.3       64.8       158.8       126.1  
Money management
    9.4       7.6       16.2       14.3  
Transaction
    19.0       29.0       29.3       41.5  
 
                       
Total revenue
    211.5       174.2       382.6       321.5  
 
                               
Total expense
    114.1       99.0       219.8       185.7  
 
                       
 
                               
Income before tax
  $ 97.4     $ 75.2     $ 162.8     $ 135.8  
 
                       
 
                               
Company’s share of pretax income
  $ 45.0     $ 34.6     $ 75.1     $ 62.6  
 
                       
     See “Overview—Business and General Environment—Income from Joint Ventures—C-BASS” for a description of the components of the revenue lines.
     The increased contribution for the second quarter of 2006, compared to the same period in 2005, was primarily due to increased net interest income and servicing revenue. Higher net interest income was the result of a higher average investment portfolio and higher earnings on trust deposits for securities serviced by Litton as well as the overall interest rate movement. The increased servicing revenue was due primarily to Litton’s higher average servicing portfolio.
     In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets (“SFAS 156”), an amendment to SFAS No.140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities. SFAS 156 provides standards for the recognition and measurement of separately recognized servicing assets and liabilities and provides an approach to simplify efforts to obtain hedge-like (offset) accounting. It is effective for fiscal years beginning after September 15, 2006. C-BASS is currently evaluating the effect, if any, the new standard will have on its results of operations and financial position.
     Our investment in C-BASS on an equity basis at June 30, 2006 was $413.9 million. We received $23.9 million in distributions from C-BASS during the first half of 2006. We anticipate that C-BASS’s income before tax in the second half of 2006 will be below its income before tax in first half of 2006.

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Sherman
     Summary Sherman balance sheets and income statements at the dates and for the periods indicated appear below.
                 
Summary Balance Sheet:            
    June 30,     December 31,  
    2006     2005  
    ($ millions)  
Total Assets
  $ 1,056     $ 979  
 
               
Total Liabilities
    833       743  
 
               
Debt
    687       597  
 
               
Members’ Equity
    223       236  
      During 2006, the changes in debt and members equity were primarily related to a capital distribution paid in the first quarter. We received $60.5 million in distributions in the first half of 2006. Our investment in Sherman on an equity basis at June 30, 2006 was $74.4 million and was $39.8 million at July 31, 2006, subsequent to a $43.2 million distribution received in July.

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Summary Income Statement            
    Three months ended     Six months ended  
    June 30,     June 30,  
    2006     2005     2006     2005  
    ($ millions)     ($ millions)  
Revenues from receivable portfolios
  $ 265.1     $ 224.8     $ 547.5     $ 427.8  
Portfolio amortization
    103.6       79.9       204.8       149.4  
 
                       
Revenues, net of amortization
    161.5       144.9       342.7       278.4  
 
                       
 
                               
Credit card interest income and fees
    88.6       56.9       160.9       62.2  
Other revenue
    19.1       30.7       26.7       42.8  
 
                       
Total revenues
    269.2       232.5       530.3       383.4  
 
                               
Expenses
    190.6       154.3       369.8       249.4  
 
                       
 
                               
Income before tax
  $ 78.6     $ 78.2     $ 160.5     $ 134.0  
 
                       
 
                               
Company’s share of pretax income
  $ 27.2     $ 32.4     $ 55.5     $ 55.6  
 
                       
     The decreased contribution from Sherman for the second quarter of 2006, compared to the same period in 2005, was primarily due to a decrease in our interest in Sherman resulting from a third quarter 2005 sale of a portion of our interest to Sherman management. The contribution from Sherman for the first six months of 2006 was comparable to the contribution from the same period in 2005. Sherman experienced increased net revenues in 2006 from portfolios owned and from the operations of the Credit One Bank, acquired in March 2005. The increase in expenses in 2006 relates to the Credit One acquisition.
     We anticipate that Sherman’s income before tax in the second half of 2006 will be below its income before tax in first half of 2006.
     The period to exercise our option to purchase a 6.92% additional interest in Sherman from Sherman management (see the 10-K MD&A under “Results of Consolidated Operations — Sherman”) has been extended through mid-August 2006.
Other Matters
     Under the Office of Federal Housing Enterprise Oversight’s (“OFHEO”) risk-based capital stress test for the GSEs, claim payments made by a private mortgage insurer on GSE loans are reduced below the amount provided by the mortgage insurance policy to reflect the risk that the insurer will fail to pay. Claim payments from an insurer whose claims-paying ability rating is ‘AAA’ are subject to a 3.5% reduction over the 10-year period of the stress test, while claim payments from a ‘AA’ rated insurer, such as MGIC, are subject to an 8.75% reduction. The effect of the differentiation among insurers is to require the GSEs to have additional capital for coverage on loans provided by a private mortgage insurer whose claims-paying rating is less than ‘AAA.’ As a result, there is an

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incentive for the GSEs to use private mortgage insurance provided by a ‘AAA’ rated insurer.
Financial Condition
     We had $300 million, 5.375% Senior Notes due in November 2015 and $200 million, 6% Senior Notes due in March 2007 outstanding at June 30, 2006. At June 30, 2006 and 2005, the market value of the outstanding debt (which also includes commercial paper) was $615.6 million and $609.2 million, respectively.
     See “Results of Operations—Joint ventures” above for information about the financial condition of C-BASS and Sherman.
     As of June 30, 2006, 82% of the investment portfolio was invested in tax-preferenced securities. In addition, at June 30, 2006, based on book value, approximately 98% of our fixed income securities were invested in ‘A’ rated and above, readily marketable securities, concentrated in maturities of less than 15 years.
     At June 30, 2006, our derivative financial instruments in our investment portfolio were immaterial. We place our investments in instruments that meet high credit quality standards, as specified in our investment policy guidelines; the policy also limits the amount of credit exposure to any one issue, issuer and type of instrument. At June 30, 2006, the effective duration of our fixed income investment portfolio was 4.9 years. This means that for an instantaneous parallel shift in the yield curve of 100 basis points there would be an approximate 4.9% change in the market value of our fixed income portfolio.
Liquidity and Capital Resources
     Our consolidated sources of funds consist primarily of premiums written and investment income. Positive cash flows are invested pending future payments of claims and other expenses. Management believes that future cash inflows from premiums will be sufficient to meet future claim payments. Cash flow shortfalls, if any, could be funded through sales of short-term investments and other investment portfolio securities subject to insurance regulatory requirements regarding the payment of dividends to the extent funds were required by other than the seller. Substantially all of the investment portfolio securities are held by our insurance subsidiaries.
     We have a $300 million commercial paper program, which is rated “A-1” by S&P and “P-1” by Moody’s. At June 30, 2006 and 2005, we had $133.5 and $100.0 million in commercial paper outstanding with a weighted average interest rate of 5.30% and 3.18%, respectively. We have a $300 million, five year revolving credit facility expiring in 2010 which will continue to be used as a liquidity back up facility for the outstanding commercial paper. The remaining credit available under the facility after reduction for the amount necessary to support the commercial paper was $166.5 million and $200.0 million at June 30, 2006 and 2005, respectively.

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     During the first quarter of 2006, an outstanding interest rate swap contract was terminated. This swap was placed into service to coincide with the committed credit facility, used as a backup for the commercial paper program. Under the terms of the swap contract, we paid a fixed rate of 5.07% and received a variable interest rate based on LIBOR. The swap had an expiration date coinciding with the maturity of the credit facility and was designated as a cash flow hedge. At June 30, 2006 we has no interest rate swaps outstanding.
     (Income) expense on the interest rate swaps for the three months ended June 30, 2006 and 2005 of approximately ($0.1) million and $0.5 million, respectively, was included in interest expense. Gains or losses arising from the amendment or termination of interest rate swaps are deferred and amortized to interest expense over the life of the hedged items.
     The commercial paper, back-up credit facility and the Senior Notes are obligations of the Company and not of its subsidiaries. We are a holding company and the payment of dividends from our insurance subsidiaries is restricted by insurance regulation. MGIC is the principal source of dividend-paying capacity. Through July MGIC paid dividends of $360 million in 2006. In July 2006 MGIC received regulatory approval to pay dividends totaling $155 million, which are scheduled to be paid in the third quarter of 2006. MGIC cannot currently pay any additional dividends without further regulatory approval.
     During the first six months of 2006, we repurchased 3.2 million shares of Common Stock under publicly announced programs at a cost of $214.3 million. At June 30, 2006, we had authority covering the purchase of an additional 7.6 million shares under these programs. For additional information regarding stock repurchases, see Item 2(c) of Part II of this Quarterly Report on Form 10-Q. From mid-1997 through June 30, 2006, we repurchased 38.7 million shares under publicly announced programs at a cost of $2.2 billion. Funds for the shares repurchased by us since mid-1997 have been provided through a combination of debt, including the Senior Notes and the commercial paper, and internally generated funds.
     Our principal exposure to loss is our obligation to pay claims under MGIC’s mortgage guaranty insurance policies. At June 30, 2006, MGIC’s direct (before any reinsurance) primary and pool risk in force (which is the unpaid principal balance of insured loans as reflected in our records multiplied by the coverage percentage, and taking account of any loss limit) was approximately $52.4 billion. In addition, as part of its contract underwriting activities, we are responsible for the quality of its underwriting decisions in accordance with the terms of the contract underwriting agreements with customers. Through June 30, 2006, the cost of remedies provided by us to customers for failing to meet the standards of the contracts has not been material. However, the decreasing trend of home mortgage interest rates over the last several years may have mitigated the effect of some of these costs since the general effect of lower interest rates can be to increase the value of certain loans on which remedies are provided. There can be no assurance that contract underwriting remedies will not be material in the future.

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     Our consolidated risk-to-capital ratio was 7.4:1 at both June 30, 2006 and December 31, 2005.
     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 historical and projected operating performance, business outlook, competitive position, management and corporate strategy.

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Forward-Looking Statements and Risk Factors
     General: Our revenues and losses could be affected by the risk factors referred to under “Location of Risk Factors” below that are applicable to the Company, and our income from joint ventures could be affected by the risk factors referred to under “Location of Risk Factors” that are applicable to C-BASS and Sherman. These risk factors are an integral part of Management’s Discussion and Analysis.
     These factors may also cause actual results to differ materially from the results contemplated by forward looking statements that we may make. Forward looking statements consist of statements which relate to matters other than historical fact. Among others, statements that include words such as we “believe”, “anticipate” or “expect”, or words of similar import, are forward looking statements. We are not undertaking any obligation to update any forward looking statements we may make even though these statements may be affected by events or circumstances occurring after the forward looking statements were made.
     Location of Risk Factors: The risk factors are in Part II, Item 1 A of our Quarterly Report on Form 10-Q for the Quarter Ended March 31, 2006 and in Item 1 A of our Annual Report on Form 10-K for the year ended December 31, 2005. The risk factors in the 10-K, as supplemented by that 10-Q, are reproduced in Exhibit 99 to this Quarterly Report on Form 10-Q.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     At June 30, 2006, our derivative financial instruments in its investment portfolio were immaterial. We place our investments in instruments that meet investment grade credit quality standards, as specified in our investment policy guidelines; the policy also limits the amount of credit exposure to any one issue, issuer and type of instrument. At June 30, 2006, the effective duration of our fixed income investment portfolio was 4.9 years. This means that for each instantaneous parallel shift in the yield curve of 100 basis points there would be an approximate 4.9% change in the market value of our fixed income investment portfolio.
     Our borrowings under our commercial paper program are subject to interest rates that are variable. See the fourth and fifth paragraphs under “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources” for a discussion of our interest rate swaps.
ITEM 4. CONTROLS AND PROCEDURES
     Our management, with the participation of our principal executive officer and principal financial officer, has evaluated our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our principal executive officer and principal financial officer concluded that

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such controls and procedures were effective as of the end of such period. There was no change in our internal control over financial reporting that occurred during the second quarter of 2006 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION
Item 1 A. Risk Factors
     There have been no material changes in our risk factors from the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2005, as supplemented by Part II, Item 1 A of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2006. The risk factors in that 10-K, as supplemented by that item in the March 31, 2006 10-Q are included in Exhibit 99 to this 10-Q.
ITEM 2. UNREGISTERED SALE OF EQUITY SECURITIES AND USE OF PROCEEDS
(c)   Repurchase of common stock:
Information about shares of Common Stock repurchased during the second quarter of 2006 appears in the table below.
                                 
                            (d)  
                    (c)     Maximum  
                    Total Number of     Number of  
                    Shares     Shares that  
                    Purchased as     May Yet Be  
    (a)     (b)     Part of Publicly     Purchased  
    Total Number of     Average Price     Announced     Under the Plans  
    Shares     Paid per Share     Plans or     or Programs  
Period   Purchased           Programs     (A)  
April 1, 2006 through April 30, 2006
    94,400     $ 69.63 (B)     94,400       9,347,941  
May 1, 2006 through May 31, 2006
    604,222     $ 67.11       604,222       8,743,719  
June 1, 2006 through June 30, 2006
    1,126,197     $ 65.64       1,126,197       7,617,522  
Total
    1,824,819     $ 67.25       1,824,819       7,617,522  
 
(A)   On January 26, 2006 the Company announced that its Board of Directors authorized the repurchase of up to ten million shares of our Common Stock in the open market or in private transactions.
 
(B)   Does not include $1.7 million representing a price adjustment on the final settlement of an accelerated repurchase program initiated in 2005. All shares repurchased under this program were deemed to be purchased at the initiation of the program.

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a)   Our Annual Meeting of Shareholders was held on May 11, 2006.
 
(b)   Not applicable.
 
(c)   Matters voted upon at the Annual Meeting and the number of shares voted for, against and abstaining from voting were as follows. There were no broker non-votes.
  (1)   Election of four Directors for a term expiring in 2009.
                 
    FOR     WITHHELD  
Karl E. Case
    77,567,889       2,370,752  
Curt S. Culver
    76,966,315       2,970,426  
William A. McIntosh
    78,458,328       1,480,313  
Leslie M. Muma
    77,215,186       2,723,455  
  (2)   Ratification of the appointment of PricewaterhouseCoopers LLP as our independent accountants for 2006.
         
For:
    79,306,755  
Against:
    38,166  
Abstaining from Voting:
    593,720  
ITEM 6. EXHIBITS
     The accompanying Index to Exhibits is incorporated by reference in answer to this portion of this Item, and except as otherwise indicated in the next sentence, the Exhibits listed in such Index are filed as part of this Form 10-Q. Exhibit 32 is not filed as part of this Form 10-Q but accompanies this Form 10-Q.

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, on August 9, 2006.
     
 
  MGIC INVESTMENT CORPORATION
 
   
 
  \s\ J. Michael Lauer
 
   
 
  J. Michael Lauer
Executive Vice President and
Chief Financial Officer
 
   
 
  \s\ Joseph J. Komanecki
 
   
 
  Joseph J. Komanecki
Senior Vice President, Controller and
Chief Accounting Officer

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INDEX TO EXHIBITS
(Part II, Item 6)
     
Exhibit    
Number   Description of Exhibit
11
  Statement Re Computation of Net Income Per Share
31.1
  Certification of CEO under Section 302 of Sarbanes-Oxley Act of 2002
31.2
  Certification of CFO under Section 302 of Sarbanes-Oxley Act of 2002
32
  Certification of CEO and CFO under Section 906 of Sarbanes-Oxley Act of 2002 (as indicated in Item 6 of Part II, this Exhibit is not being “filed”)
99
  Risk Factors included in Item 1 A of our Annual Report on Form 10-K for the year ended December 31, 2005, as supplemented by Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2006

exv11
 

EXHIBIT 11
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
STATEMENT RE COMPUTATION OF NET INCOME PER SHARE
Three and Six Month Periods Ended June 30, 2006 and 2005
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2006     2005     2006     2005  
    (In thousands of dollars, except per share data)  
 
                               
BASIC EARNINGS PER SHARE
                               
 
                               
Average common shares outstanding
    85,668       92,594       86,122       93,930  
 
                       
 
                               
Net income
  $ 149,839     $ 174,357     $ 313,292     $ 356,370  
 
                       
 
                               
Basic earnings per share
  $ 1.75     $ 1.88     $ 3.64     $ 3.79  
 
                       
 
                               
DILUTED EARNINGS PER SHARE
                               
 
                               
Adjusted weighted average shares outstanding:
                               
Average common shares outstanding
    85,668       92,594       86,122       93,930  
Common stock equivalents
    591       588       631       615  
 
                       
 
                               
Adjusted weighted average diluted shares outstanding
    86,259       93,182       86,753       94,545  
 
                       
 
                               
Net income
  $ 149,839     $ 174,357     $ 313,292     $ 356,370  
 
                       
 
                               
Diluted earnings per share
  $ 1.74     $ 1.87     $ 3.61     $ 3.77  
 
                       

 

exv31w1
 

Exhibit 31.1
I, Curt S. Culver, certify that:
1.   I have reviewed this quarterly report on Form 10-Q of MGIC Investment Corporation;
 
2.   Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
 
3.   Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
 
4.   The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have:
  a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
  b)   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
  c)   Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
  d)   Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.   The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s

 


 

    auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
  a)   all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
  b)   any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: August 9, 2006
\s\ Curt S. Culver
Curt S. Culver
Chief Executive Officer

 

exv31w2
 

Exhibit 31.2
CERTIFICATIONS
I, J. Michael Lauer, certify that:
1.   I have reviewed this quarterly report on Form 10-Q of MGIC Investment Corporation;
 
2.   Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
 
3.   Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
 
4.   The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and we have:
  (a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
  (b)   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
  (c)   Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
  (d)   Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 


 

5.   The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
  (a)   all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
  (b)   any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: August 9, 2006
\s\ J. Michael Lauer
J. Michael Lauer
Chief Financial Officer

 

exv32
 

Exhibit 32
SECTION 1350 CERTIFICATIONS
The undersigned, Curt S. Culver, Chief Executive Officer of MGIC Investment Corporation (the “Company”), and J. Michael Lauer, Chief Financial Officer of the Company, certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S. C. Section 1350, that to our knowledge:
(1)   the Quarterly Report on Form 10-Q of the Company for the quarter ended June 30, 2006 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
 
(2)   the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Date: August 9, 2006
       
   
/s/ Curt S. Culver    
Curt S. Culver   
Chief Executive Officer   
 
       
   
/s/ J. Michael Lauer    
J. Michael Lauer   
Chief Financial Officer   
 

 

exv99
 

Exhibit 99
Risk Factors included in Item 1 A of our Annual Report on Form 10-K for the year ended December 31, 2005, as supplemented by Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2006
     The amount of insurance the Company writes could be adversely affected if lenders and investors select alternatives to private mortgage insurance.
These alternatives to private mortgage insurance include:
    lenders originating mortgages using piggyback structures to avoid private mortgage insurance, such as a first mortgage with an 80% loan-to-value ratio and a second mortgage with a 10%, 15% or 20% loan-to-value ratio (referred to as 80-10-10, 80-15-5 or 80-20 loans, respectively) rather than a first mortgage with a 90%, 95% or 100% loan-to-value ratio,
 
    investors holding mortgages in portfolio and self-insuring,
 
    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
 
    lenders using government mortgage insurance programs, including those of the Federal Housing Administration and the Veterans Administration.
     While no data is publicly available, the Company believes that piggyback loans are a significant percentage of mortgage originations in which borrowers make down payments of less than 20% and that their use is primarily by borrowers with higher credit scores. During the fourth quarter of 2004, the Company introduced on a national basis a program designed to recapture business lost to these mortgage insurance avoidance products. This program accounted for 5.7% of flow new insurance written in the fourth quarter of 2005 and 6.5% of flow new insurance written for all of 2005.
     Deterioration in the domestic economy or changes in the mix of business may result in more homeowners defaulting and the Company’s losses increasing.
     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. A deterioration in economic conditions generally increases the likelihood that borrowers will not have sufficient income to pay their mortgages and can also adversely affect housing values.
     Approximately 8.5% of the Company’s primary risk in force is located in areas within Alabama (0.3%), Florida (4.5%), Louisiana (1.0%), Mississippi (0.6%) and Texas (2.2%) that have been declared eligible for individual and public assistance by the Federal Emergency Management Agency as a result of Hurricanes Katrina, Rita and Wilma.

 


 

The effect on the Company from these hurricanes, however, will not be limited to these areas to the extent that the borrowers in areas that have not experienced wind or water damage are adversely affected due to deteriorating economic conditions attributable to these hurricanes.
     The mix of business the Company writes also affects the likelihood of losses occurring. In recent years, the percentage of the Company’s volume written on a flow basis that includes segments the Company views as having a higher probability of claim has continued to increase. These segments include loans with loan-to-value (“LTV”) ratios over 95% (including loans with 100% LTV ratios), “FICO” credit scores below 620, limited underwriting, including limited borrower documentation, or total debt-to-income ratios of 38% or higher, as well as loans having combinations of higher risk factors.
     Approximately 9% of the Company’s primary risk in force written through the flow channel, and 72% of the Company’s primary risk in force written through the bulk channel, consists of adjustable rate mortgages (“ARMs”). The Company believes that during a prolonged period of rising interest rates, claims on ARMs would be substantially higher than for fixed rate loans, although the performance of ARMs has not been tested in such an environment. In addition, the Company believes the volume of “interest-only” loans (which may also be ARMs) and other loans with negative amortization features, such as pay option ARMs, increased in 2004 and 2005. Because interest-only loans and pay option ARMs are a relatively recent development, the Company has no data on their historical performance. The Company believes claim rates on certain of these loans will be substantially higher than on comparable loans that do not have negative amortization.
     Competition or changes in the Company’s relationships with its customers could reduce the Company’s revenues or increase its losses.
     Competition for private mortgage insurance premiums occurs not only among private mortgage insurers but also 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 or serviced by the lender. As discussed under “The mortgage insurance industry is subject to risk from private litigation and regulatory proceedings” below, the Company provided information to the New York Insurance Department and the Minnesota Department of Commerce about captive mortgage reinsurance arrangements. It has been publicly reported that certain other insurance departments may review or investigate such 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.
     The Company’s private mortgage insurance competitors include:
  PMI Mortgage Insurance Company,

 


 

  Genworth Mortgage Insurance Corporation,
 
  United Guaranty Residential Insurance Company,
 
  Radian Guaranty Inc.,
 
  Republic Mortgage Insurance Company,
 
  Triad Guaranty Insurance Corporation, and
 
  CMG Mortgage Insurance Company.
     If interest rates decline, house prices appreciate or mortgage insurance cancellation requirements change, the length of time that the Company’s policies remain in force could decline and result in declines in the Company’s revenue.
     In each year, most of the Company’s premiums are from insurance that has been written in prior years. As a result, the length of time insurance remains in force (which is also generally referred to as persistency) is an important determinant of revenues. The factors affecting the length of time the Company’s insurance remains in force include:
    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
 
    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.
     During the 1990s, the Company’s year-end persistency ranged from a high of 87.4% at December 31, 1990 to a low of 68.1% at December 31, 1998. At December 31, 2005 persistency was at 61.3%, compared to the record low of 44.9% at September 30, 2003. Over the past several years, refinancing has become easier to accomplish and less costly for many consumers. Hence, even in an interest rate environment favorable to persistency improvement, the Company does not expect persistency will approach its December 31, 1990 level.
     If the volume of low down payment home mortgage originations declines, the amount of insurance that the Company writes could decline which would reduce the Company’s revenues.
The factors that affect the volume of low-down-payment mortgage originations include:
    The level of home mortgage interest rates,
 
    the health of the domestic economy as well as conditions in regional and local economies,
 
    housing affordability,

 


 

    population trends, including the rate of household formation,
 
    the rate of home price appreciation, which in times of heavy refinancing can affect whether refinance loans have loan-to-value ratios that require private mortgage insurance, and
 
    government housing policy encouraging loans to first-time homebuyers.
     In general, the majority of the underwriting profit (premium revenue minus losses) that a book of mortgage insurance generates occurs in the early years of the book, with the largest portion of the underwriting profit realized in the first year. Subsequent years of a book generally result in modest underwriting profit or underwriting losses. This pattern of results occurs because relatively few of the claims that a book will ultimately experience occur in the first few years of the book, when premium revenue is highest, while subsequent years are affected by declining premium revenues, as persistency decreases due to loan prepayments, and higher losses.
     If all other things were equal, a decline in new insurance written in a year that followed a number of years of higher volume could result in a lower contribution to the mortgage insurer’s overall results. This effect may occur because the older books will be experiencing declines in revenue and increases in losses with a lower amount of underwriting profit on the new book available to offset these results.
     Whether such a lower contribution would in fact occur depends in part on the extent of the volume decline. Even with a substantial decline in volume, there may be offsetting factors that could increase the contribution in the current year. These offsetting factors include higher persistency and a mix of business with higher average premiums, which could have the effect of increasing revenues, and improvements in the economy, which could have the effect of reducing losses. In addition, the effect on the insurer’s overall results from such a lower contribution may be offset by decreases in the mortgage insurer’s expenses that are unrelated to claim or default activity, including those related to lower volume.
     Changes in the business practices of Fannie Mae and Freddie Mac could reduce the Company’s revenues or increase its losses.
     The business practices of the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”), each of which is a government sponsored entity (“GSE”), affect the entire relationship between them and mortgage insurers and include:
    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,
 
    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,
 
    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,
 
    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,
 
    the terms on which mortgage insurance coverage can be canceled before reaching the cancellation thresholds established by law, and
 
    the circumstances in which mortgage servicers must perform activities intended to avoid or mitigate loss on insured mortgages that are delinquent.
The mortgage insurance industry is subject to the risk of private litigation and regulatory proceedings.
     Consumers are bringing a growing number of lawsuits against home mortgage lenders and settlement service providers. In recent years, seven mortgage insurers, including MGIC, have been involved in litigation alleging 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. MGIC’s settlement of class action litigation against it under RESPA became final in October 2003. MGIC settled the named plaintiffs’ claims in litigation against it under FCRA in late December 2004 following denial of class certification in June 2004. There can be no assurance that MGIC will not be subject to future litigation under RESPA or FCRA or that the outcome of any such litigation would not have a material adverse effect on the Company. In August 2005, the United States Court of Appeals for the Ninth Circuit decided a case under FCRA to which the Company was not a party that may make it more likely that the Company will be subject to litigation regarding when notices to borrowers are required by FCRA.
     In June 2005, in response to a letter from the New York Insurance Department (“NYID”), the Company provided information regarding captive mortgage reinsurance arrangements and other types of arrangements in which lenders receive compensation. In February 2006, the NYID requested MGIC to review its premium rates in New York and to file adjusted rates based on recent years’ experience or to explain why such experience would not alter rates. In March 2006, MGIC advised the NYID that it believes its premium rates are reasonable and that, given the nature of mortgage insurance risk, premium rates should not be determined only by the experience of recent years.In February 2006, in response to an administrative subpoena from the Minnesota Department of Commerce (the “MDC”), which regulates insurance, the Company provided the MDC with information about captive mortgage reinsurance and certain other matters. Insurance departments or other officials in other states may also seek information about or investigate captive mortgage reinsurance.
     The anti-referral fee provisions of RESPA provide that the Department of Housing and Urban Development (“HUD”) as well as the insurance commissioner or attorney general of any state may bring an action to enjoin violations of these provisions 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 the Company believes its captive reinsurance arrangements are in conformity with applicable laws and regulations, it is not possible to predict the outcome of any such reviews or investigations nor is it possible to predict their effect on the Company or the mortgage insurance industry.
     Net premiums written could be adversely affected if the Department of Housing and Urban Development reproposes and adopts a regulation under the Real Estate Settlement Procedures Act that is equivalent to a proposed regulation that was withdrawn in 2004.
     HUD regulations under RESPA prohibit paying lenders for the referral of settlement services, including mortgage insurance, and prohibit lenders from receiving such payments. In July 2002, HUD proposed a regulation that would exclude from these anti-referral fee provisions settlement services included in a package of settlement services offered to a borrower at a guaranteed price. HUD withdrew this proposed regulation in March 2004. Under the proposed regulation, if mortgage insurance were required on a loan, the package must include any mortgage insurance premium paid at settlement. Although certain state insurance regulations prohibit an insurer’s payment of referral fees, had this regulation been adopted in this form, the Company’s revenues could have been adversely affected to the extent that lenders offered such packages and received value from the Company in excess of what they could have received were the anti-referral fee provisions of RESPA to apply and if such state regulations were not applied to prohibit such payments.
     The Company could be adversely affected if personal information on consumers that it maintains is improperly disclosed.
     As part of its business, the Company maintains large amounts of personal information on consumers. While the Company believes it has appropriate information security policies and systems to prevent unauthorized disclosure, there can be no assurance that unauthorized disclosure, either through the actions of third parties or employees, will not occur. Unauthorized disclosure could aversely affect the Company’s reputation and expose it to material claims for damages.
     The Company’s income from joint ventures could be adversely affected by credit losses, insufficient liquidity or competition affecting those businesses.
     C-BASS: Credit-Based Asset Servicing and Securitization LLC (“C-BASS”) is particularly exposed to credit risk and funding risk. In addition, C-BASS’s results are sensitive to its ability to purchase mortgage loans and securities on terms that it projects will meet its return targets. With respect to credit risk, a higher proportion of non-conforming mortgage originations (the types of mortgages C-BASS principally purchases) in 2005 compared to 2004 were products, such as interest only loans to subprime borrowers, that are viewed by C-BASS as having greater credit risk. In addition, credit losses are a function of housing prices, which in certain regions have experienced rates of increase greater than historical norms and greater than growth in median incomes.

 


 

     With respect to liquidity, the substantial majority of C-BASS’s on-balance sheet financing for its mortgage and securities portfolio is short-term and dependent on the value of the collateral that secures this debt. While C-BASS’s policies governing the management of capital at risk are intended to provide sufficient liquidity to cover an instantaneous and substantial decline in value, such policies cannot guaranty that all liquidity required will in fact be available.
     Although there has been growth in the volume of non-conforming mortgage originations in recent years, volume is expected to decline in 2006. There is an increasing amount of competition to purchase non-conforming mortgages, including from real estate investment trusts and from firms that in the past acted as mortgage securities intermediaries but which are now establishing their own captive origination capacity. Decreasing credit spreads also heighten competition in the purchase of non-conforming mortgages and other securities.
     Sherman: The results of Sherman Financial Group LLC (“Sherman”) are sensitive to its ability to purchase receivable portfolios on terms that it projects will meet its return targets. While the volume of charged-off consumer receivables and the portion of these receivables that have been sold to third parties such as Sherman has grown in recent years, there is an increasing amount of competition to purchase such portfolios, including from new entrants to the industry, which has resulted in increases in the prices at which portfolios can be purchased.