FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the quarterly period ended JUNE 30, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 1-10816
MGIC INVESTMENT CORPORATION
(Exact name of registrant as specified in its charter)
WISCONSIN 39-1486475
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
250 E. KILBOURN AVENUE 53202
MILWAUKEE, WISCONSIN (Zip Code)
(Address of principal executive offices)
(414) 347-6480
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OF STOCK PAR VALUE DATE NUMBER OF SHARES
- -------------- --------- ------- ----------------
Common stock $1.00 7/31/02 102,685,980
MGIC INVESTMENT CORPORATION
TABLE OF CONTENTS
Page No.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheet as of
June 30, 2002 (Unaudited) and December 31, 2001 3
Consolidated Statement of Operations for the Three and Six
Month Periods Ended June 30, 2002 and 2001 (Unaudited) 4
Consolidated Statement of Cash Flows for the Six Months
Ended June 30, 2002 and 2001 (Unaudited) 5
Notes to Consolidated Financial Statements (Unaudited) 6-11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12-28
Item 3. Quantitative and Qualitative Disclosures About Market Risk 29
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 6. Exhibits and Reports on Form 8-K 30
SIGNATURES 31
INDEX TO EXHIBITS 32
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
June 30, 2002 (Unaudited) and December 31, 2001
June 30, December 31,
2002 2001
------------ ------------
ASSETS (In thousands of dollars)
- ------
Investment portfolio:
Securities, available-for-sale,
at market value:
Fixed maturities $ 4,025,608 $ 3,888,740
Equity securities 22,191 20,747
Short-term investments 417,022 159,960
----------- -----------
Total investment portfolio 4,464,821 4,069,447
Cash 17,109 26,392
Accrued investment income 55,458 59,036
Reinsurance recoverable on loss reserves 22,948 26,888
Reinsurance recoverable on unearned premiums 7,656 8,415
Home office and equipment, net 35,470 34,762
Deferred insurance policy acquisition costs 31,511 32,127
Investments in joint ventures 187,471 161,674
Other assets 141,870 148,271
----------- -----------
Total assets $ 4,964,314 $ 4,567,012
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Loss reserves $ 626,728 $ 613,664
Unearned premiums 170,879 174,545
Short-and long-term debt (note 2) 613,851 472,102
Other liabilities 308,360 286,514
----------- -----------
Total liabilities 1,719,818 1,546,825
----------- -----------
Contingencies (note 4) Shareholders' equity:
Common stock, $1 par value, shares authorized
300,000,000; shares issued, 6/30/02 -
121,411,117 12/31/01 - 121,110,800; shares
outstanding, 6/30/02 - 103,907,047
12/31/01 - 106,086,594 121,411 121,111
Paid-in surplus 232,586 214,040
Members' equity (553) -
Treasury stock (shares at cost, 6/30/02 -
17,504,070 12/31/01 - 15,024,206) (849,944) (671,168)
Accumulated other comprehensive income, net
of tax 96,595 46,644
Retained earnings 3,644,401 3,309,560
----------- -----------
Total shareholders' equity 3,244,496 3,020,187
----------- -----------
Total liabilities and shareholders' equity $ 4,964,314 $ 4,567,012
=========== ===========
See accompanying notes to consolidated financial statements.
3
MGICINVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
Three and Six Month Periods Ended June 30, 2002 and 2001
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
(In thousands of dollars, except per share data)
Revenues:
Premiums written:
Direct $ 314,372 $ 271,888 $ 620,549 $ 515,509
Assumed 51 122 137 227
Ceded (note 3) (27,808) (15,107) (50,974) (29,245)
--------- --------- --------- ---------
Net premiums written 286,615 256,903 569,712 486,491
Decrease in unearned premiums 1,554 469 2,906 12,063
--------- --------- --------- ---------
Net premiums earned 288,169 257,372 572,618 498,554
Investment income, net of expenses 51,654 51,566 103,604 101,611
Realized investment gains, net 4,975 7,882 13,093 21,575
Other revenue 39,037 22,723 70,088 38,282
--------- --------- --------- ---------
Total revenues 383,835 339,543 759,403 660,022
--------- --------- --------- ---------
Losses and expenses:
Losses incurred, net 64,416 36,304 124,130 65,681
Underwriting and other expenses, net 63,049 58,524 127,517 110,178
Interest expense 9,828 7,127 16,452 15,690
--------- --------- --------- ---------
Total losses and expenses 137,293 101,955 268,099 191,549
--------- --------- --------- ---------
Income before tax 246,542 237,588 491,304 468,473
Provision for income tax 75,606 76,370 151,181 149,331
--------- --------- --------- ---------
Net income $ 170,936 $ 161,218 $ 340,123 $ 319,142
========= ========= ========= =========
Earnings per share (note 5):
Basic $ 1.63 $ 1.51 $ 3.22 $ 2.98
========= ========= ========= =========
Diluted $ 1.61 $ 1.49 $ 3.19 $ 2.96
========= ========= ========= =========
Weighted average common shares
outstanding - diluted (shares in
thousands, note 5) 105,921 108,102 106,470 107,954
========= ========= ========= =========
Dividends per share $ 0.025 $ 0.025 $ 0.050 $ 0.050
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
4
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Six Months Ended June 30, 2002 and 2001
(Unaudited)
Six Months Ended
June 30,
----------------------------
2002 2001
----------- ------------
(In thousands of dollars)
Cash flows from operating activities:
Net income $ 340,123 $ 319,142
Adjustments to reconcile net income to net
cash provided by operating activities:
Amortization of deferred insurance
policy acquisition costs 11,005 8,876
Increase in deferred insurance policy
acquisition costs (10,389) (11,212)
Depreciation and amortization 6,018 3,123
Decrease (increase) in accrued investment
income 3,578 (2,500)
Decrease in reinsurance recoverable on
loss reserves 3,940 4,950
Decrease in reinsurance recoverable on
unearned premiums 759 386
Increase (decrease) in loss reserves 13,064 (10,294)
Decrease in unearned premiums (3,666) (12,447)
Equity earnings in joint ventures (43,748) (17,931)
Other (67) (5,663)
----------- -----------
Net cash provided by operating activities 320,617 276,430
----------- -----------
Cash flows from investing activities:
Purchase of equity securities (503) -
Purchase of fixed maturities (1,310,428) (1,514,059)
Additional investment in joint ventures - (15,000)
Sale of equity securities 1,037 1,535
Proceeds from sale or maturity of fixed
maturities 1,255,862 1,238,056
----------- -----------
Net cash used in investing activities (54,032) (289,468)
----------- -----------
Cash flows from financing activities:
Dividends paid to shareholders (5,283) (5,347)
Proceeds from issuance of long-term debt 199,992 108,509
Repayment of short- and long-term debt (60,801) (98,184)
Reissuance of treasury stock 16,369 10,682
Repurchase of common stock (169,383) -
Common stock issued 300 -
----------- -----------
Net cash (used in) provided by financing
activities (18,806) 15,660
----------- -----------
Net increase in cash and short-term investments 247,779 2,622
Cash and short-term investments at beginning of
period 186,352 157,190
----------- -----------
Cash and short-term investments at end of period $ 434,131 $ 159,812
=========== ===========
See accompanying notes to consolidated financial statements.
5
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2002
(Unaudited)
Note 1 - Basis of presentation and summary of certain significant accounting
policies
The accompanying unaudited consolidated financial statements of MGIC
Investment Corporation (the "Company") and its wholly-owned subsidiaries have
been prepared in accordance with the instructions to Form 10-Q and do not
include all of the other information and disclosures required by generally
accepted accounting principles. These statements should be read in conjunction
with the consolidated financial statements and notes thereto for the year ended
December 31, 2001 included in the Company's Annual Report on Form 10-K for that
year.
The accompanying consolidated financial statements have not been audited by
independent accountants in accordance with generally accepted auditing
standards, but in the opinion of management such financial statements include
all adjustments, including normal recurring accruals, necessary to summarize
fairly the Company's financial position and results of operations. The results
of operations for the six months ended June 30, 2002 may not be indicative of
the results that may be expected for the year ending December 31, 2002.
Deferred insurance policy acquisition costs
Costs associated with the acquisition of mortgage insurance business,
consisting of employee compensation and other policy issuance and underwriting
expenses, are initially deferred and reported as deferred acquisition costs
("DAC"). Because Statement of Financial Accounting Standards ("SFAS") No. 60
specifically excludes mortgage guaranty insurance from its guidance relating to
the amortization of DAC, amortization of these costs for each underwriting year
book of business are charged against revenue in proportion to estimated gross
profits over the life of the policies using the guidance of SFAS No. 97,
Accounting and Reporting by Insurance Enterprises For Certain Long Duration
Contracts and Realized Gains and Losses From the Sale of Investments. This
includes accruing interest on the unamortized balance of DAC. The estimates for
each underwriting year are updated annually to reflect actual experience and any
changes to key assumptions such as persistency or loss development.
The Company amortized $11.0 million and $8.9 million of deferred insurance
policy acquisition costs during the six months ended June 30, 2002 and 2001,
respectively.
6
Loss reserves
Reserves are established for reported insurance losses and loss adjustment
expenses based on when notices of default on insured mortgage loans are
received. Reserves are also established for estimated losses incurred on notices
of default not yet reported by the lender. Consistent with industry practices,
the Company does not establish loss reserves for future claims on insured loans
which are not currently in default. Reserves are established by management using
estimated claims rates and claims amounts in estimating the ultimate loss.
Amounts for salvage recoverable are considered in the determination of the
reserve estimates. Adjustments to reserve estimates are reflected in the
financial statements in the years in which the adjustments are made. The
liability for reinsurance assumed is based on information provided by the ceding
companies.
The incurred but not reported ("IBNR") reserves result from defaults
occurring prior to the close of an accounting period, but which have not been
reported to the Company. Consistent with reserves for reported defaults, IBNR
reserves are established using estimated claims rates and claims amounts for the
estimated number of defaults not reported.
Reserves also provide for the estimated costs of settling claims, including
legal and other expenses and general expenses of administering the claims
settlement process.
Income recognition
The insurance subsidiaries write policies which are guaranteed renewable
contracts at the insured's option on a single, annual or monthly premium basis.
The insurance subsidiaries have no ability to reunderwrite or reprice these
contracts. Premiums written on a single premium basis and an annual premium
basis are initially deferred as unearned premium reserve and earned over the
policy term. Premiums written on policies covering more than one year are
amortized over the policy life in accordance with the expiration of risk, which
is the anticipated claim payment pattern based on historical experience.
Premiums written on annual policies are earned on a monthly pro rata basis.
Premiums written on monthly policies are earned as coverage is provided.
Fee income of the non-insurance subsidiaries is earned and recognized as
the services are provided and the customer is obligated to pay.
Note 2 - Short- and long-term debt
During the second quarter of 2001, the Company established a $200 million
commercial paper program, which was rated "A-1" by Standard and Poors ("S&P")
and "P-1" by Moody's. At June 30, 2002, the Company had $113.0 million in
commercial paper outstanding with a weighted average interest rate of 1.87%.
The Company had a $285 million credit facility available at June 30, 2002,
expiring in 2006. This facility was entered into during the second quarter of
2002 and
7
replaced two separate $100 million facilities. Under the terms of the credit
facility, as amended in July 2002, 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 surplus and its
contingency reserve) of not less than the amount required by Wisconsin insurance
regulation. At June 30, 2002, the Company met these tests. The facility is
currently being 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 $172
million at June 30, 2002.
In March of 2002, the Company issued, in a public offering, $200 million 6%
Senior Notes due in 2007. The notes are unsecured and were rated "A1" by
Moody's, "A+" by S&P and "AA-" by Fitch. The Company had Senior Notes
outstanding of $500 million at June 30, 2002 and $300 million at June 30, 2001.
Interest payments on all long-term debt (commercial paper is classified as
short-term debt) were $11.3 million and $12.8 million for the six months ended
June 30, 2002 and 2001, respectively. At June 30, 2002, the market value of the
short- and long-term debt is $643 million.
The Company uses interest rate swaps to hedge interest rate exposure
associated with its short- and long-term debt. During 1999, the Company utilized
three interest rate swaps, each with a notional amount of $100 million, to
reduce and manage interest rate risk on a portion of the variable rate debt
under the credit facilities. The notional amount of $100 million represents the
stated principal balance used for calculating payments. The Company received and
paid amounts based on rates that were both fixed and variable.
In 2000, two of the swaps were amended and designated as fair-value hedges
which qualified for short cut accounting. The Company paid an interest rate
based on LIBOR and received a fixed rate of 7.5% to hedge the 5 year Senior
Notes issued in the fourth quarter of 2000. These swaps were terminated in
September 2001. In January 2002, the Company initiated a new swap which was
designated as a fair value hedge of the 7.5% Senior Notes. This swap was
terminated in June 2002. The remaining swap was also amended during 2000 and
designated as a cash flow hedge. In June 2002, this swap was amended to coincide
with the new credit facility. Under the terms of the swap contract, the Company
pays a fixed rate of 5.43% and receives an interest rate based on LIBOR. The
swap has an expiration date coinciding with the maturity of the credit facility
and is designated as a hedge. Gains or losses arising from the amendment or
termination of interest rate swaps are deferred and amortized to interest
expense over the life of the hedged items. Expenses on the swaps for the six
months ended June 30, 2002 and 2001 of approximately $0.3 million and $2.0
million, respectively, were included in interest expense. The cash flow swap
outstanding at June 30, 2002 and December 31, 2001 is evaluated quarterly using
regression analysis with any ineffectiveness being recorded as an expense. To
date this evaluation has not resulted in any hedge ineffectiveness. The swaps
are subject to credit risk to the extent the counterparty would be unable to
discharge its obligations under the swap agreements.
8
Note 3 - Reinsurance
The Company cedes a portion of its business to reinsurers and records
assets for reinsurance recoverable on estimated reserves for unpaid losses and
unearned premiums. Business written between 1985 and 1993 is ceded under various
quota share reinsurance agreements with several reinsurers. The Company receives
a ceding commission in connection with this reinsurance. Beginning in 1997, the
Company has ceded business to captive reinsurance subsidiaries of certain
mortgage lenders primarily under excess of loss reinsurance agreements.
The reinsurance recoverable on loss reserves and the reinsurance
recoverable on unearned premiums primarily represent amounts recoverable from
large international reinsurers. The Company monitors the financial strength of
its reinsurers, including their claims paying ability rating, and does not
currently anticipate any collection problems. Generally, reinsurance
recoverables on loss reserves and unearned premiums are backed by trust funds or
letters of credit. No reinsurer represents more than $10 million of the
aggregate amount recoverable.
Note 4 - Contingencies and litigation settlement
The Company is involved in litigation in the ordinary course of business.
In the opinion of management, the ultimate resolution of this pending litigation
will not have a material adverse effect on the financial position or results of
operations of the Company.
In addition, in June 2001, the Federal District Court for the Southern
District of Georgia, before which Downey et. al. v. MGIC was pending, issued a
final order approving a settlement agreement and certified a nationwide class of
borrowers. In the fourth quarter of 2000, the Company recorded a $23.2 million
charge to cover the estimated costs of the settlement, including payments to
borrowers. Due to appeals by certain class members and members of classes in two
related cases, payments to borrowers in the settlement are delayed pending the
outcome of the appeals. The settlement includes an injunction that prohibits
certain practices and specifies the basis on which agency pool insurance,
captive mortgage reinsurance, contract underwriting and other products may be
provided in compliance with the Real Estate Settlement Procedures Act.
The complaint in the case alleges that MGIC violated the Real Estate
Settlement Procedures Act by providing agency pool insurance, captive mortgage
reinsurance, contract underwriting and other products that were not properly
priced, in return for the referral of mortgage insurance. The complaint seeks
damages of three times the amount of the mortgage insurance premiums that have
been paid and that will be paid at the time of judgment for the mortgage
insurance found to be involved in a violation of the Real Estate Settlement
Procedures Act. The complaint also seeks injunctive relief, including
prohibiting MGIC from receiving future premium payments. If the settlement is
not fully implemented, the litigation will continue. In these circumstances,
there can be no
9
assurance that the ultimate outcome of the litigation will not materially affect
the Company's financial position or results of operations.
Note 5 - Earnings per share
The Company's basic and diluted earnings per share ("EPS") have been
calculated in accordance with SFAS No. 128, Earnings Per Share. The following is
a reconciliation of the weighted-average number of shares used for basic EPS and
diluted EPS.
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -----------------
2002 2001 2002 2001
---- ---- ---- ----
(Shares in thousands)
Weighted-average shares - Basic EPS 105,181 107,111 105,733 106,997
Common stock equivalents 740 991 737 957
------- ------- ------- -------
Weighted-average shares - Diluted EPS 105,921 108,102 106,470 107,954
======= ======= ======= =======
Note 6 - New accounting standards
The Company adopted Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"),
effective January 1, 2001. The statement establishes accounting and reporting
standards for derivative instruments and for hedging activities. The adoption of
SFAS 133 did not have a significant effect on the Company's results of
operations or its financial position due to its limited use of derivative
instruments.
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141 ("SFAS 141"), Business
Combinations, and No. 142 ("SFAS 142"), Goodwill and Other Intangible Assets.
SFAS 141 is effective for all business combinations initiated after June 30,
2001 and SFAS 142 is effective for fiscal years beginning after December 15,
2001. In August 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of Long-lived
Assets, which is effective for fiscal years beginning after December 15, 2001.
The adoption of these pronouncements did not have a significant effect on
the Company's results of operations or its financial position. The Company has
an immaterial amount of goodwill.
Note 7 - Comprehensive income
The Company's total comprehensive income, as calculated per SFAS No. 130,
Reporting Comprehensive Income, was as follows:
10
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
2002 2001 2002 2001
---- ---- ---- ----
(In thousands of dollars)
Net income $170,936 $161,218 $340,123 $319,142
Other comprehensive income 70,153 (24,087) 49,951 (19,205)
-------- -------- -------- --------
Total comprehensive income $241,089 $137,131 $390,074 $299,937
======== ======== ======== ========
Other comprehensive income
(loss) (net of tax):
Cumulative effect - FAS 133 $ N/A $ N/A $ N/A $ (5,982)
Net derivative gains (losses) 950 645 1,622 (1,165)
Amortization of deferred losses 270 270 540 540
FAS 115 68,933 (25,002) 47,789 (12,598)
-------- -------- -------- --------
Comprehensive gain (loss) $ 70,153 $(24,087) $ 49,951 $(19,205)
======== ======== ======== ========
The difference between the Company's net income and total comprehensive
income for the six months ended June 30, 2002 and 2001 is due to the change in
unrealized appreciation/depreciation on investments, and the market value
adjustment of the hedges, both net of tax.
Note 8 - Accounting for Derivatives and Hedging Activities
Generally, the Company's use of derivatives is limited to entering into
interest rate swap agreements intended to hedge its debt financing terms. All
derivatives subject to SFAS 133 are recognized on the balance sheet at their
fair value. On the date the derivative contract is entered into, the Company
designates the derivative as a hedge of the fair value of a recognized asset or
liability ("fair value" hedge), or as a hedge of a forecasted transaction or of
the variability of cash flows to be received or paid related to a recognized
asset or liability ("cash flow" hedge). Changes in the fair value of a
derivative that is highly effective as, and that is designated and qualifies as,
a fair-value hedge, along with the loss or gain on the hedged asset or liability
that is attributable to the hedged risk, are recorded in current-period
earnings. Changes in the fair value of a derivative that is highly effective as,
and that is designated and qualifies as, a cash-flow hedge are recorded in other
comprehensive income, until earnings are affected by the variability of cash
flows (e.g. when periodic settlements on a variable-rate asset or liability are
recorded in earnings).
The Company formally documents all relationships between hedging
instruments and hedged items, as well as its risk-management objective and
strategy for undertaking various hedge transactions. This process includes
linking all derivatives that are designated as fair-value or cash-flow hedges to
specific assets and liabilities on the balance sheet or forecasted transactions.
The Company also formally assesses, both at the hedge's inception and on an
ongoing basis, whether the derivatives that are used in hedging transactions are
highly effective in offsetting changes in fair values or cash flows of hedged
items. If and when it is determined that a derivative is not highly effective as
a hedge or that it has ceased to be a highly effective hedge, the Company
discontinues hedge accounting prospectively.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Consolidated Operations
Three Months Ended June 30, 2002 Compared With Three Months Ended June 30, 2001
Net income for the three months ended June 30, 2002 was $170.9 million,
compared to $161.2 million for the same period of 2001, an increase of 6%.
Diluted earnings per share for the three months ended June 30, 2002 was $1.61
compared with $1.49 in the same period last year, an increase of 8%. Included in
diluted earnings per share for the quarter ended June 30, 2002 and 2001 were
$0.03 and $0.05, respectively, for realized gains. As used in this report, the
term "Company" means the Company and its consolidated subsidiaries, which do not
include joint ventures in which the Company has an equity interest.
Total revenues for the second quarter 2002 were $383.8 million, an increase
of 13% from the $339.5 million for the second quarter 2001. This increase was
primarily attributed to an increase in insurance in force. Also contributing to
the increase in revenues was an increase in other revenue offset by a decrease
in realized gains. See below for a further discussion of premiums and other
revenue.
Losses and expenses for the second quarter were $137.3 million, an increase
of 35% from $102.0 million for the same period of 2001. The increase from last
year can be attributed to an increase in losses related to an increase in notice
inventories and an increase in expenses related to increases in insured volume.
See below for a further discussion of losses incurred and underwriting expenses.
The amount of new primary insurance written by MGIC during the three months
ended June 30, 2002 was $21.8 billion, compared to $22.4 billion in the same
period of 2001. Refinancing activity decreased to 35% of new primary insurance
written in 2002 on a flow basis (or $5.6 billion), compared to 43% in 2001 (or
$3.1 billion).
The $21.8 billion of new primary insurance written during the second
quarter of 2002 was offset by the cancellation of $17.9 billion of insurance in
force, and resulted in a net increase of $3.9 billion in primary insurance in
force, compared to new primary insurance written of $22.4 billion, the
cancellation of $15.6 billion of insurance in force and a net increase of $6.8
billion in primary insurance in force during the second quarter of 2001. Direct
primary insurance in force was $194.5 billion at June 30, 2002 compared to
$183.9 billion at December 31, 2001 and $171.6 billion at June 30, 2001.
In addition to providing primary insurance coverage, the Company also
insures pools of mortgage loans. New pool risk written during the three months
ended June 30, 2002 and June 30, 2001 was $83 million and $110 million,
respectively. The Company's direct pool risk in force was $2.1 billion at June
30, 2002, $2.0 billion at December 31, 2001, and was $1.8 billion at June 30,
2001.
12
Cancellation activity has historically been affected by the level of
mortgage interest rates, with cancellations generally moving inversely to the
change in the direction of interest rates. Cancellations increased during the
second quarter of 2002 compared to the cancellation levels of 2001 which
resulted in a decrease in the MGIC persistency rate (percentage of insurance
remaining in force from one year prior) to 59.5% at June 30, 2002 from 61.0% at
December 31, 2001 and 71.7% at June 30, 2001. In view of continued strong
refinance activity, the persistency rate at September 30, 2002 could decline
from the rate at June 30, 2002. Cancellation activity could also increase as
more of the Company's bulk loans season. The Company anticipates that the bulk
loans in general will have lower persistency than the Company's flow business.
New insurance written for bulk transactions was $5.7 billion during the
second quarter of 2002 compared to $6.3 billion for the same period a year ago
and average quarterly writings of $6.4 billion for the three quarters subsequent
to the second quarter of 2001. The Company's writings of bulk insurance are in
part sensitive to the volume of securitization transactions involving
non-conforming loans. A securitization involves the sale of whole loans held by
the securitizer. The Company believes that the relatively high historical spread
between the cost of funding mortgages and mortgage coupon rates, as well as
other factors currently present in the whole loan market, have resulted in
increased prices for whole loans which have had the effect of reducing the
supply of mortgages available for current securitization. The Company's writings
of bulk insurance are also sensitive to competition from other methods of
providing credit enhancement in a securitization, including the willingness of
investors to purchase tranches of the securitization that involve a higher
degree of credit risk. The Company believes that the relatively low historical
yield levels currently prevailing in the bond market have resulted in more
investors purchasing such tranches. As a result of these factors, the Company
expects the volume of insurance written on bulk transactions during the third
quarter of 2002 will decline materially from the volume in the second quarter.
The Company is not undertaking any obligation to provide an update of this
expectation should it subsequently change.
The Company expects that the loans that are included in bulk transactions
will have delinquency and claim rates in excess of those on the Company's flow
business. While the Company believes it has priced its bulk business to generate
acceptable returns, there can be no assurance that the assumptions underlying
the premium rates adequately address the risk of this business. New insurance
written in 2002 through the bulk channel on Alt A, subprime and certain other
loans will be subject to quota share reinsurance of approximately 15% provided
by a third party reinsurer. The reinsurance transaction is contingent on the
Company receiving credit for the reinsurance under insurance regulation.
Net premiums written increased 12% to $286.6 million during the second
quarter of 2002, from $256.9 million during the second quarter of 2001. Net
premiums earned increased 12% to $288.2 million for the second quarter of 2002
from $257.4 million for the same period in 2001. The increases were primarily a
result of the growth in insurance
13
in force and a higher percentage of renewal premiums on products with higher
premium rates offset in part by an increase in ceded premiums.
Premiums ceded in captive mortgage reinsurance arrangements and in risk
sharing arrangements with the GSEs were $23.5 million in the second quarter of
2002, compared to $15.5 million in the same period of 2001. The amount of
premiums ceded under such arrangements is expected to continue to increase due
in part to increases in the rate at which premiums are ceded. During the first
quarter of 2002, approximately 51% of the Company's new insurance written on a
flow basis was subject to such arrangements compared to 50% for the year ended
December 31, 2001. (New insurance written through the bulk channel is not
subject to such arrangements.) Because the transfer of a loan in the secondary
market can result in a mortgage insured during a quarter becoming part of such
an arrangement in a subsequent quarter, the percentage of new insurance written
during a quarter covered by such arrangements normally increases after the end
of the quarter. 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 as ceded in the quarter in which they are ceded
regardless of when the mortgage was insured.
Investment income for the second quarter of 2002 was $51.7 million, a
slight increase over the $51.6 million in the second quarter of 2001. This
increase was the result of increases in the amortized cost of average invested
assets to $4.3 billion for the second quarter of 2002 from $3.6 billion for the
second quarter of 2001, an increase of 20%, offset by a decrease in the
investment yield. The portfolio's average pre-tax investment yield was 4.9% for
the second quarter of 2002 and 5.7% for the same period in 2001. The portfolio's
average after-tax investment yield was 4.3% for the second quarter of 2002 and
4.7% for the same period in 2001. The Company's net realized gains were $5.0
million for the three months ended June 30, 2002 compared to net realized gains
of $7.9 million during the same period in 2001, resulting primarily from the
sale of fixed maturities.
Other revenue, which is composed of various components, was $39.0 million
for the second quarter of 2002, compared with $22.7 million for the same period
in 2001. The increase is primarily the result of increased equity earnings from
Credit-Based Asset Servicing and Securitization LLC ("C-BASS") and Sherman
Financial Group LLC ("Sherman"), joint ventures with Radian Group Inc.
C-BASS engages in the acquisition and resolution of delinquent
single-family residential mortgage loans ("mortgage loans"). C-BASS also
purchases and sells mortgage-backed securities ("mortgage securities"),
interests in real estate mortgage investment conduit residuals and performs
mortgage loan servicing. In addition, C-BASS issues mortgage-backed debt
securities collateralized by mortgage loans and mortgage securities. C-BASS's
results of operations are affected by the timing of these securitization
transactions. Substantially all of C-BASS's mortgage-related assets do not have
readily ascertainable market values and, as a result, their value for financial
statement purposes is estimated by the management of C-BASS. This valuation is
made by C-BASS management in connection with each release of financial
statements. In the case of assets that are residual interests in
securitizations, these estimates reflect the net
14
present value of the future cash flows from the assets, which in turn depend on,
among other things, estimates of the level of losses on the underlying mortgages
and prepayment activity by the mortgage borrowers. Market value adjustments
could impact C-BASS's results of operations and the Company's share of those
results.
Total combined assets of C-BASS at June 30, 2002 and December 31, 2001 were
approximately $1.6 billion and $1.3 billion, respectively, of which
approximately $1.3 billion and $0.9 billion, respectively, were mortgage-related
assets, including open trades. Total liabilities at June 30, 2002 and December
31, 2001 were approximately $1.3 billion and $1.0 billion, respectively, of
which approximately $1.1 billion and $0.9 billion, respectively, were funding
arrangements, including accrued interest, virtually all of which were
short-term. For the three months ended June 30, 2002 and 2001, revenues of
approximately $88 million and $66 million, respectively, and expenses of
approximately $41 million and $37 million, respectively, resulted in income
before tax of approximately $47 million and $29 million, respectively. C-BASS
had income before tax for the first six months of 2002 of approximately $82
million. C-BASS has advised the Company that due in part to higher prices
prevailing in the market for subprime whole loans, it expects its income before
tax for the third quarter and second six months of 2002 will be lower than its
income before tax for the second quarter and the first six months of 2002,
respectively. The Company is not undertaking any obligation to provide an update
of this expectation should it subsequently change.
Sherman is engaged in the business of purchasing, servicing and
securitizing delinquent unsecured consumer assets such as credit card loans and
Chapter 13 bankruptcy debt. A substantial portion of Sherman's consolidated
assets are investments in receivable portfolios that do not have readily
ascertainable market values. Initially the portfolios are valued at cost.
Subsequently their value for financial statement purposes is estimated by the
management of Sherman based on the estimated future cash flow from the
portfolios. The assets are valued by Sherman's management each time financial
statements are released. Market value adjustments could impact Sherman's results
of operations and the Company's share of those results.
Because C-BASS and Sherman are accounted for by the equity method, they are
not consolidated with the Company and their assets and liabilities do not appear
in the Company's balance sheet. The "investments in joint ventures" item in the
Company's balance sheet reflects the amount of capital contributed by the
Company to the joint ventures plus the Company's share of their net income (or
minus its share of their net loss) and minus capital distributed to the Company
by the joint ventures.
As discussed in "Note 1 - Loss Reserves" to the Company's consolidated
financial statements, consistent with industry practice, loss reserves for
future claims are established only for loans that are currently delinquent. (The
terms "delinquent" and "default" are used interchangeably by the Company.) Loss
reserves are established by management's estimating the number of loans in the
Company's inventory of delinquent loans that will not cure their delinquency
(historically, a substantial majority of delinquent loans have cured), which is
referred to as the claim rate, and further estimating the amount that the
Company will pay in claims on the loans that do not cure, which is
15
referred to as claim severity. Estimation of losses that the Company will pay in
the future is inherently judgmental. The conditions that affect the claim rate
and claim severity include the current and future state of the domestic economy
and the current and future strength of local housing markets.
Net losses incurred increased 77% to $64.4 million in the second quarter of
2002, from $36.3 million in the same period of 2001. The increase was due to an
increase in losses paid, an increase in the primary notice inventory related to
bulk default activity, defaults arising from the early development of the 2000
book of business and defaults arising from the seasoning of other books. The
average claim paid for the quarter ended June 30, 2002 was $19,603 compared to
$19,100 for the same period in 2001.
The primary insurance notice inventory increased from 54,653 at December
31, 2001 to 59,314 at June 30, 2002 and the pool notice inventory decreased from
23,623 at December 31, 2001 to 23,542 at June 30, 2002. Included in the primary
notice inventory was the bulk notice inventory of 24,063 at June 30, 2002 and
18,460 at December 31, 2001. The primary default rate at June 30, 2002 was 3.60%
compared to 3.46% at December 31, 2001. Excluding bulk defaults, the default
rate was 2.55% and 2.65% at June 30, 2002 and December 31, 2001, respectively,
and is expected to increase. The default rate on bulk loans was 8.97% and 8.59%
at June 30, 2002 and December 31, 2001, respectively, and the default rate on
subprime loans, most of which are written through the bulk channel, was 11.11%
and 11.60% at June 30, 2002 and December 31, 2001, respectively. Because the
default rate is the number of loans in default divided by the number of policies
in force, and there are relatively few defaults in a book during the year in
which the book was written, lower volume in a quarter has the effect of
increasing the default rate. As discussed above, the Company expects that it
will write materially less bulk business in the third quarter of 2002 than in
the second quarter of 2002. As a result of this anticipated bulk volume decline
and also due to anticipated cancellations of bulk insurance and continued
seasoning of this business, the Company expects the default rate on bulk loans
and subprime loans to increase materially.
At June 30, 2002, 76% of MGIC's insurance in force was written subsequent
to December 31, 1998. Based on the Company's flow business, the highest claim
frequency years have typically been the third through fifth year after the year
of loan origination. However, the pattern of claims frequency for refinance
loans may be different from this historical pattern and the Company expects the
period of highest claims frequency on bulk loans will occur earlier than in this
historical pattern.
Underwriting and other expenses increased to $63.0 million in the second
quarter of 2002 from $58.5 million in the same period of 2001, an increase of
8%. The increase can be attributed to increases in expenses related to increased
volume. In view of continued strong refinance activity, the Company expects
underwriting and other expenses in the third quarter of 2002 will increase over
the level of the second quarter of 2002. The Company is not undertaking any
obligation to provide an update of this expectation should it subsequently
change.
16
Interest expense increased to $9.8 million in the second quarter of 2002
from $7.1 million during the same period in 2001 primarily due to an increase in
debt outstanding offset by lower weighted-average interest rates during the
three months ended June 30, 2002 compared to the comparable period in 2001.
The consolidated insurance operations loss ratio was 22.3% for the second
quarter of 2002 compared to 14.1% for the second quarter of 2001. The
consolidated insurance operations expense and combined ratios were 14.5% and
36.8%, respectively, for the second quarter of 2002 compared to 16.1% and 30.2%
for the second quarter of 2001.
The effective tax rate was 30.7% in the second quarter of 2002, compared to
32.1% in the second quarter of 2001. During both periods, the effective tax rate
was below the statutory rate of 35%, reflecting the benefits of tax-preferenced
investments. The lower effective tax rate in 2002 resulted from a higher
percentage of total income before tax being generated from the tax-preferenced
investments.
Six Months Ended June 30, 2002 Compared With Six Months Ended June 30, 2001
Net income for the six months ended June 30, 2002 was $340.1 million,
compared to $319.1 million for the same period of 2001, an increase of 7%.
Diluted earnings per share for the six months ended June 30, 2002 was $3.19
compared with $2.96 in the same period last year, an increase of 8%. Included in
diluted earnings per share for the six months ended June 30, 2002 and 2001 were
$0.08 and $0.13, respectively, for realized gains.
Total revenues for the first half of 2002 were $759.4 million, an increase
of 15% from the $660.0 million through the second quarter of 2001. This increase
was primarily attributed to an increase in insurance in force. Also contributing
to the increase in revenues was an increase in other revenue offset by a
decrease in realized gains. See below for a further discussion of premiums and
other revenue.
Losses and expenses for the first half of 2002 were $268.1 million, an
increase of 40% from $191.5 million for the same period of 2001. The increase
from last year can be attributed to an increase in losses related to an increase
in notice inventories and an increase in expenses related to increases in
insured volume and in contract underwriting. See below for a further discussion
of losses incurred and underwriting expenses.
The amount of new primary insurance written by MGIC during the six months
ended June 30, 2002 was $45.4 billion, compared to $39.1 billion in the same
period of 2001. Refinancing activity increased to 42% of new primary insurance
written in 2002 on a flow basis (or $14.0 billion), compared to 41% in 2001 (or
$6.9 billion). New insurance written for bulk transactions was $12.3 billion
during the first half of 2002 compared to $13.0 billion for the same period a
year ago. See "Three Months Ended June 30, 2002 compared with Three Months Ended
June 30, 2001" for a discussion of the Company's expectation for bulk
transactions volume in the third quarter of 2002.
17
The $45.4 billion of new primary insurance written during the second half
of 2002 was offset by the cancellation of $34.8 billion of insurance in force,
and resulted in a net increase of $10.6 billion in primary insurance in force,
compared to new primary insurance written of $39.1 billion, the cancellation of
$27.7 billion of insurance in force and a net increase of $11.4 billion in
primary insurance in force through the second quarter of 2001.
New pool risk written during the six months ended June 30, 2002 and June
30, 2001 was $190 million and $158 million, respectively. The Company's direct
pool risk in force was $2.1 billion at June 30, 2002, $2.0 billion at December
31, 2001, and was $1.8 billion at June 30, 2001.
Cancellations increased during the first half of 2002 compared to the
cancellation levels of 2001 which resulted in a decrease in the MGIC persistency
rate to 59.5% at June 30, 2002 from 61.0% at December 31, 2001 and 71.7% at June
30, 2001.
Net premiums written increased 17% to $569.7 million during the first half
of 2002, from $486.5 million during the first half of 2001. Net premiums earned
increased 15% to $572.6 million for the first half of 2002 from $498.6 million
for the same period in 2001. The increases were primarily a result of the growth
in insurance in force and a higher percentage of renewal premiums on products
with higher premium rates offset in part by an increase in ceded premiums.
Premiums ceded in captive mortgage reinsurance arrangements and in risk sharing
arrangements with the GSEs were $45.0 million in the first half of 2002 compared
to $29.4 in the same period of 2001.
Investment income for the first half of 2002 was $103.6 million, an
increase of 2% over the $101.6 million in the first half of 2001. This increase
was the result of increases in the amortized cost of average invested assets to
$4.1 billion for the first half of 2002 from $3.5 billion for the first half of
2001, an increase of 18% offset by a decrease in the investment yield. The
portfolio's average pre-tax investment yield was 4.9% for the first half of 2002
and 5.7% for the same period in 2001. The portfolio's average after-tax
investment yield was 4.3% for the first half of 2002 and 4.8% for the same
period in 2001. The Company's net realized gains were $13.1 million for the six
months ended June 30, 2002 compared to net realized gains of $21.6 million
during the same period in 2001, resulting primarily from the sale of fixed
maturities.
Other revenue was $70.1 million for the first half of 2002, compared with
$38.3 million for the same period in 2001. The increase is primarily the result
of increases in equity earnings from C-BASS and Sherman and an increase in
contract underwriting revenue.
For the six months ended June 30, 2002 and 2001, C-BASS had revenues of
approximately $160 million and $121 million, respectively, and expenses of
approximately $78 million and $63 million, respectively, which resulted in
income before tax of approximately $82 million and $58 million, respectively.
See "Three Months Ended June
18
30, 2002 Compared With Three Months Ended June 30, 2001" for a discussion of
C-BASS's expectation of their results for the remainder of 2002.
Net losses incurred increased 89% to $124.1 million in the first half of
2002, from $65.7 million in the same period of 2001. The increase was due to an
increase in losses paid, an increase in the primary notice inventory related to
bulk default activity, defaults arising from the early development of the 2000
book of business and defaults arising from the seasoning of other books. The
average claim paid for the six months ended June 30, 2002 was $19,727 compared
to $18,629 for the same period in 2001. For information about the notice
inventory and default rates, see "Three Months Ended June 30, 2002 Compared With
Three Months Ended June 30, 2001".
Underwriting and other expenses increased to $127.5 million in the first
half of 2002 from $110.2 million in the same period of 2001, an increase of 16%.
The increase can be attributed to increases in both insurance and non-insurance
expenses related to increased volume and contract underwriting.
Interest expense increased to $16.5 million in the second quarter of 2002
from $15.7 million during the same period in 2001 primarily due to an increase
in the debt outstanding offset by lower weighted-average interest rates during
the six months ended June 30, 2002 compared to the comparable period in 2001.
The consolidated insurance operations loss ratio was 21.7% for the first
half of 2002 compared to 13.2% for the first half of 2001. The consolidated
insurance operations expense and combined ratios were 15.0% and 36.7%,
respectively, for the first half of 2002 compared to 16.6% and 29.8% for the
first half of 2001.
The effective tax rate was 30.8% for the first half of 2002, compared to
31.9% in the same period of 2001. During both periods, the effective tax rate
was below the statutory rate of 35%, reflecting the benefits of tax-preferenced
investments. The lower effective tax rate in 2002 resulted from a higher
percentage of total income before tax being generated from the tax-preferenced
investments.
Other Matters
In June 2001, the Federal District Court for the Southern District of
Georgia, before which Downey et. al. v. MGIC was pending, issued a final order
approving a settlement agreement and certified a nationwide class of borrowers.
In the fourth quarter of 2000, the Company recorded a $23.2 million charge to
cover the estimated costs of the settlement, including payments to borrowers.
Due to appeals by certain class members and members of classes in two related
cases, payments to borrowers in the settlement are delayed pending the outcome
of the appeals. The settlement includes an injunction that prohibits certain
practices and specifies the basis on which agency pool insurance, captive
mortgage reinsurance, contract underwriting and other products may be provided
in compliance with the Real Estate Settlement Procedures Act. There can be no
assurance that the standards established by the injunction will be
19
determinative of compliance with the Real Estate Settlement Procedures Act were
additional litigation to be brought in the future.
The complaint in the case alleges that MGIC violated the Real Estate
Settlement Procedures Act by providing agency pool insurance, captive mortgage
reinsurance, contract underwriting and other products that were not properly
priced, in return for the referral of mortgage insurance. The complaint seeks
damages of three times the amount of the mortgage insurance premiums that have
been paid and that will be paid at the time of judgment for the mortgage
insurance found to be involved in a violation of the Real Estate Settlement
Procedures Act. The complaint also seeks injunctive relief, including
prohibiting MGIC from receiving future premium payments. If the settlement is
not fully implemented, the litigation will continue. In these circumstances,
there can be no assurance that the ultimate outcome of the litigation will not
materially affect the Company's financial position or results of operations.
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 incentive for the GSEs to use private mortgage insurance provided by
a `AAA' rated insurer.
The regulations of the Department of Housing and Urban Development under
the Real Estate Settlement Procedures Act prohibit paying lenders for the
referral of settlement services, including mortgage insurance, and prohibit
lenders from receiving such payments. In July 2002, the Department of Housing
and Urban Development 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. If mortgage
insurance is required on the 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, adoption of this
regulation by the Department of Housing and Urban Development could adversely
affect the Company's revenues 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 the Real Estate Settlement Procedures
Act to apply and if such state regulations were not applied to prohibit such
payments.
Financial Condition
Consolidated total investments and cash balances increased approximately
$386 million to $4.5 billion at June 30, 2002 from $4.1 billion at December 31,
2001, primarily due to positive net cash flow, including the proceeds of the
sale of the 6% Senior Notes
20
discussed under "Liquidity and Capital Resources" below, unrealized gains on
securities marked to market of $73 million and offset by a $23 million decrease
in payables for securities. The Company generated consolidated cash flows from
operating activities of $320.6 million through June 30, 2002, compared to $276.4
million generated during the same period in 2001. The increase in operating cash
flows during the first half of 2002 compared to 2001 is due primarily to
increases in renewal premiums, investment income and other revenue as discussed
above.
As of June 30, 2002, the Company had $417.0 million of short-term
investments with maturities of 90 days or less, and 77% of the portfolio was
invested in tax-preferenced securities. In addition, at June 30, 2002, based on
book value, the Company's fixed income securities were approximately 99%
invested in 'A' rated and above, readily marketable securities, concentrated in
maturities of less than 15 years. At June 30, 2002, the Company had $22.2
million of investments in equity securities compared to $20.7 million at
December 31, 2001.
At June 30, 2002, the Company had no derivative financial instruments in
its investment portfolio. The Company places its investments in instruments that
meet high credit quality standards, as specified in the Company's investment
policy guidelines; the policy also limits the amount of credit exposure to any
one issue, issuer and type of instrument. At June 30, 2002, the average duration
of the Company's investment portfolio was 5.3 years. The effect of a 1%
increase/decrease in market interest rates would result in a 5.3%
decrease/increase in the value of the Company's fixed income portfolio.
The Company's investments in joint ventures increased $25.8 million from
$161.7 million at December 31, 2001 to $187.5 million at June 30, 2002 primarily
as a result of equity earnings of $43.7 million, offset by $20.1 million of
dividends received. The joint ventures are reported on the equity method. Only
the Company's investment in the joint ventures appears on the Company's balance
sheet.
Consolidated loss reserves increased to $626.7 million at June 30, 2002
from $613.7 million at December 31, 2001, reflecting increases in the primary
and pool insurance notice inventories, as discussed earlier. Consistent with
industry practices, the Company does not establish loss reserves for future
claims on insured loans which are not currently in default.
Consolidated unearned premiums decreased $3.6 million from $174.5 million
at December 31, 2001, to $170.9 million at June 30, 2002, primarily reflecting
the continued high level of monthly premium policies written for which there is
no unearned premium.
Consolidated shareholders' equity increased to $3.2 billion at June 30,
2002, from $3.0 billion at December 31, 2001, an increase of 7%. This increase
consisted of $340.1 million of net income during the first half of 2002 and
other comprehensive income, net of tax, of $50.0 million, offset by $159.9
million from the repurchase of treasury stock (net of reissuances), dividends
declared of $5.3 million and $0.6 million from the consolidation of a previously
unconsolidated joint venture.
21
Liquidity and Capital Resources
The Company's consolidated sources of funds consist primarily of premiums
written and investment income. The Company generated positive cash flows from
operating activities of approximately $320.6 million and $276.4 million for the
six months ended June 30, 2002 and 2001, respectively, as shown on the
Consolidated Statement of Cash Flows. Positive cash flows are invested pending
future payments of claims and other expenses. Cash-flow shortfalls, if any,
could be funded through sales of short-term investments and other investment
portfolio securities. Substantially all of the investment portfolio securities
are held by the Company's insurance subsidiaries.
During the second quarter of 2001, the Company established a $200 million
commercial paper program, which was rated "A-1" by Standard and Poors ("S&P")
and "P-1" by Moody's. At June 30, 2002, the Company had $113.0 million in
commercial paper outstanding with a weighted average interest rate of 1.87%. S&P
affirmed the "A-1" rating in February 2002 and Moody's affirmed the "P-1" rating
in March 2002. If the Company's commercial paper rating were to fall below "A-1"
or "P-2", the Company would likely have difficulty selling commercial paper and
any commercial paper that could be sold would require an interest rate in excess
of the "A-1/P-1" rating.
The Company had a $285 million credit facility available at June 30, 2002
expiring in 2006. This facility was entered into during the second quarter of
2002 and replaced two separate $100 million facilities. Under the terms of the
credit facility as amended in July 2002, the Company must maintain shareholders'
equity of at least $2.25 billion and MGIC must maintain a risk-to-capital ratio
of not more than 22:1 and maintain policyholders position (which includes MGIC's
surplus and its contingency reserve) of not less than the amount required by
Wisconsin insurance regulation. At June 30, 2002, the Company met these tests.
The facility is currently being 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
$172 million at June 30, 2002.
In March of 2002, the Company issued, in a public offering, $200 million 6%
Senior Notes due in 2007. The notes are unsecured and were rated "A1" by
Moody's, "A+" by S&P and "AA-" by Fitch. The Company had Senior Notes
outstanding of $500 million at June 30, 2002 and $300 million at June 30, 2001.
In January 2002, the Company announced a new share repurchase program
covering up to 5.5 million shares in addition to the 800,000 shares remaining
from the prior repurchase program. From mid-1997 through June 2002, the Company
repurchased 17.7 million shares of Common Stock at a cost of $962.9 million.
During the first half of 2002, the Company repurchased 2.7 million shares at a
cost of $187.4 million. Funds for the shares repurchased by the Company since
mid-1997 have been provided through a combination of debt, including the Senior
Notes and the commercial paper, and internally generated funds.
22
The commercial paper, back-up credit facility and the Senior Notes are
obligations of the Company and not of its subsidiaries. The Company is a holding
company and the payment of dividends from its insurance subsidiaries is
restricted by insurance regulation. MGIC is the principal source of
dividend-paying capacity. As a result of a $150 million dividend paid to the
Company by MGIC in February 2002, MGIC may not pay additional dividends until
February 2003 without the approval of the Office of the Commissioner of
Insurance of the State of Wisconsin.
Interest payments on all long-term debt (commercial paper is classified as
short-term debt) were $11.3 million and $12.8 million for the six months ended
June 30, 2002 and 2001, respectively. At June 30, 2002, the market value of the
short- and long-term debt is $643 million.
The Company uses interest rate swaps to hedge interest rate exposure
associated with its short- and long-term debt. During 1999, the Company utilized
three interest rate swaps, each with a notional amount of $100 million, to
reduce and manage interest rate risk on a portion of the variable rate debt
under the credit facilities. The notional amount of $100 million represents the
stated principal balance used for calculating payments. The Company received and
paid amounts based on rates that were both fixed and variable.
In 2000, two of the swaps were amended and designated as fair-value hedges
which qualified for short cut accounting. The Company paid an interest rate
based on LIBOR and received a fixed rate of 7.5% to hedge the 5 year Senior
Notes issued in the fourth quarter of 2000. These swaps were terminated in
September 2001. In January 2002, the Company initiated a new swap which was
designated as a fair value hedge of the 7.5% Senior Notes. This swap was
terminated in June 2002. The remaining swap was also amended during 2000 and
designated as a cash flow hedge. In June 2002, this swap was amended to coincide
with the new credit facilities. Under the terms of the swap contract, the
Company pays a fixed rate of 5.43% and receives an interest rate based on LIBOR.
The swap has an expiration date coinciding with the maturity of the credit
facilities and is designated as a hedge. Gains or losses arising from the
amendment or termination of interest rate swaps are deferred and amortized to
interest expense over the life of the hedged items. Expenses on the swaps for
the six months ended June 30, 2002 and 2001 of approximately $0.3 million and
$2.0 million, respectively, were included in interest expense. The cash flow
swap outstanding at June 30, 2002 and December 31, 2001 is evaluated quarterly
using regression analysis with any ineffectiveness being recorded as an expense.
To date this evaluation has not resulted in any hedge ineffectiveness. The swaps
are subject to credit risk to the extent the counterparty would be unable to
discharge its obligations under the swap agreements.
MGIC is the principal insurance subsidiary of the Company. MGIC's
risk-to-capital ratio was 9.0:1 at June 30, 2002 compared to 9.1:1 at December
31, 2001. The decrease was due to MGIC's increased policyholders' reserves,
partially offset by the net additional risk in force of $1.7 billion, net of
reinsurance, during the first half of 2002.
23
The risk-to-capital ratios set forth above have been computed on a
statutory basis. However, the methodology used by the rating agencies to assign
claims-paying ability ratings permits less leverage than under statutory
requirements. As a result, the amount of capital required under statutory
regulations may be lower than the capital required for rating agency purposes.
In addition to capital adequacy, the rating agencies consider other factors in
determining a mortgage insurer's claims-paying rating, including its competitive
position, business outlook, management, corporate strategy, and historical and
projected operating performance.
For certain material risks of the Company's business, see "Risk Factors"
below.
Risk Factors
Our revenues and losses could be affected by the risk factors discussed
below. These factors may also cause actual results to differ materially from the
results contemplated by forward looking statements that the Company may make.
Forward looking statements consist of statements which relate to matters other
than historical fact. Among others, statements that include words such as the
Company "believes", "anticipates" or "expects", or words of similar import, are
forward looking statements.
If the volume of low down payment home mortgage originations declines, the
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amount of insurance that we write could also decline which could result in
- -------------------------------------------------------------------------------
declines in our future revenues.
- --------------------------------
The factors that affect the volume of low down payment mortgage
originations include:
o the level of home mortgage interest rates,
o the health of the domestic economy as well as conditions in regional
and local economies,
o housing affordability,
o population trends, including the rate of household formation,
o the rate of home price appreciation, which in times of heavy
refinancing can affect whether refinance loans have loan-to-value
ratios that require private mortgage insurance, and
o government housing policy encouraging loans to first-time homebuyers.
24
Our new insurance written volume increased 16% for the first six months of
2002, compared to the same period in 2001. One of the reasons our volume was
higher in 2002 was because many borrowers refinanced their mortgages during the
first six months of 2002 due to a lower interest rate environment, which also
led to lenders canceling insurance that we wrote in the past. While we have not
experienced lower volume in recent years other than as a result of declining
refinancing activity, one of the risks we face is that substantially higher
interest rates will substantially reduce purchase activity by first time
homebuyers and that the decline in cancellations of insurance that in the past
have accompanied higher interest rates will not be sufficient to offset the
decline in premiums from loans that are not made.
If lenders and investors select alternatives to private mortgage insurance,
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the amount of insurance that we write could decline, which could result in
- -------------------------------------------------------------------------------
declines in our future revenues.
- --------------------------------
These alternatives to private mortgage insurance include:
o lenders using government mortgage insurance programs, including those
of the Federal Housing Administration and the Veterans Administration,
o investors holding mortgages in portfolio and self-insuring,
o investors using credit enhancements other than private mortgage
insurance or using other credit enhancements in conjunction with
reduced levels of private mortgage insurance coverage, and
o lenders structuring mortgage originations to avoid private mortgage
insurance, such as a first mortgage with an 80% loan-to-value ratio
and a second mortgage with a 10% loan-to-value ratio (referred to as
an 80-10-10 loan) rather than a first mortgage with a 90% loan-
to-value ratio.
While no data is publicly available, we believe that due to the current low
interest rate environment and favorable economic conditions, lenders and
investors are making 80-10-10 loans at a somewhat higher percentage than they
did during the past year. Although during 2001 and 2000, the share of the low
down payment market held by loans with Federal Housing Administration and
Veterans Administration mortgage insurance was lower than in 1999, during three
of the prior four years, the Federal Housing Administration and Veterans
Administration's collective share of this market increased. Investors are using
reduced mortgage insurance coverage on a higher percentage of loans that we
insure than they had over the last several years.
Because most of the loans MGIC insures are sold to Fannie Mae and Freddie
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Mac, changes in their business practices could reduce our revenues or increase
- -------------------------------------------------------------------------------
our losses.
- -----------
25
The business practices of Fannie Mae and Freddie Mac affect the entire
relationship between them and mortgage insurers and include:
o the level of private mortgage insurance coverage, subject to the
limitations of Fannie Mae and Freddie Mac's charters, when private
mortgage insurance is used as the required credit enhancement on low
down payment mortgages,
o whether Fannie Mae or Freddie Mac influence the mortgage lender's
selection of the mortgage insurer providing coverage and, if so, any
transactions that are related to that selection,
o whether Fannie Mae or Freddie Mac will give mortgage lenders an
incentive, such as a reduced guaranty fee, to select a mortgage
insurer that has a "AAA" claims-paying ability rating to benefit from
the lower capital requirements for Fannie Mae and Freddie Mac when a
mortgage is insured by a company with that rating,
o the underwriting standards that determine what loans are eligible for
purchase by Fannie Mae or Freddie Mac, which thereby affect the
quality of the risk insured by the mortgage insurer and the
availability of mortgage loans,
o the terms on which mortgage insurance coverage can be canceled before
reaching the cancellation thresholds established by law, and
o the circumstances in which mortgage servicers must perform activities
intended to avoid or mitigate loss on insured mortgages that are
delinquent.
Because we participate in an industry that is intensely competitive,
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changes in our competitors' business practices could reduce our revenues or
- -------------------------------------------------------------------------------
increase our losses.
- --------------------
Competition for private mortgage insurance premiums occurs not only among
private mortgage insurers but increasingly with mortgage lenders through captive
mortgage reinsurance transactions. In these transactions, a lender's affiliate
reinsures a portion of the insurance written by a private mortgage insurer on
mortgages originated by the lender. The low level of losses that has recently
prevailed in the private mortgage insurance industry has encouraged competition
to assume default risk through captive reinsurance arrangements, self insurance,
80-10-10 loans and other means. In 1996, we shared risk under captive
reinsurance and GSE risk sharing arrangements with respect to virtually none of
our new insurance written. During the three months ended March 31, 2002, about
51% of our new insurance written on a flow basis was subject to captive
reinsurance and GSE risk sharing 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
26
share of the mortgage lending market held by large lenders. Our top ten
customers generated 27.0% of the new primary insurance that we wrote on a flow
basis in 1997 compared to 38.4% in 2001.
Our private mortgage insurance competitors include:
o PMI Mortgage Insurance Company
o GE Capital Mortgage Insurance Corporation
o United Guaranty Residential Insurance Company
o Radian Guaranty Inc.
o Republic Mortgage Insurance Company
o Triad Guaranty Insurance Corporation
o CMG Mortgage Insurance Company
If interest rates decline, house prices appreciate or mortgage insurance
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cancellation requirements change, the length of time that our policies remain in
- -------------------------------------------------------------------------------
force could decline and result in declines in our revenue.
- ----------------------------------------------------------
In each year, most of MGIC's premiums are from insurance that has been
written in prior years. As a result, the length of time insurance remains in
force is an important determinant of revenues. The factors affecting the length
of time our insurance remains in force include:
o the level of current mortgage interest rates compared to the mortgage
coupon rates on the insurance in force, which affects the
vulnerability of the insurance in force to refinancings, and
o mortgage insurance cancellation policies of mortgage investors along
with the rate of home price appreciation experienced by the homes
underlying the mortgages in the insurance in force.
While it is difficult to measure the extent of the decline, in recent
years, the length of time that our policies remain in force has declined
somewhat. Due to this decline, our premium revenues were lower than they would
have been if the length had not declined.
If the domestic economy deteriorates, more homeowners may default and our
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losses may increase.
- --------------------
Losses result from events that reduce a borrower's ability to continue to
make mortgage payments, such as unemployment, and whether the home of a borrower
who defaults on his mortgage can be sold for an amount that will cover unpaid
principal and interest and the expenses of the sale. Favorable economic
conditions generally reduce the likelihood that borrowers will lack sufficient
income to pay their mortgages and also favorably affect the value of homes,
thereby reducing and in some cases even eliminating a loss from a mortgage
default. In recent years, due in part to the strength
27
of the economy, we have had low losses by historical standards. A significant
deterioration in economic conditions would probably increase our losses.
Our industry is subject to litigation risk.
-------------------------------------------
In recent years, consumers have brought a growing number of lawsuits
against home mortgage lenders and settlement service providers. As of the end of
June 2002, seven mortgage insurers, including our MGIC subsidiary, were involved
in litigation alleging violations of the Real Estate Settlement Procedures Act.
Our MGIC subsidiary and two other mortgage insurers entered into an agreement to
settle the cases against them in December 2000, and another mortgage insurer
entered into a comparable settlement agreement in February 2002. In June 2001,
the Court entered a final order approving the settlement to which we and the
other two insurers are parties, although due to appeals challenging certain
aspects of this settlement, the final implementation of the settlement will not
occur until the appeals are resolved. We took a $23.2 million pretax charge in
2000 to cover our share of the estimated costs of the settlement. While our
settlement includes an injunction that prohibits certain practices and specifies
the basis on which other practices may be done in compliance with the Real
Estate Settlement Procedures Act, we may still be subject to future litigation
under the Real Estate Settlement Procedures Act.
Because we expect the pace of change in our industry and in home mortgage
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lending to remain high, we will be disadvantaged unless we are able to respond
- -------------------------------------------------------------------------------
to new ways of doing business.
- ------------------------------
We expect the processes involved in home mortgage lending will continue to
evolve through greater use of technology. This evolution could effect
fundamental changes in the way home mortgages are distributed. Affiliates of
lenders who are regulated depositary institutions gained expanded insurance
powers under financial modernization legislation and the capital markets may
emerge as providers of insurance in competition with traditional insurance
companies. These trends and others increase the level of uncertainty in our
business, demand rapid response to change and place a premium on innovation.
28
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At June 30, 2002, the Company's derivative financial instruments in its
investment portfolio were immaterial. The Company's philosophy is to invest in
instruments that meet high credit quality standards, as specified in the
Company's investment policy guidelines; the policy also limits the amount of
credit exposure to any one issue, issuer and type of instrument. At June 30,
2002, the effective duration of the Company's investment portfolio was 5.3
years. The effect of a 1% increase/decrease in market interest rates would
result in a 5.3% decrease/increase in the value of the Company's investment
portfolio. The Company's borrowings under the commercial paper program are
subject to interest rates that are variable. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations-Liquidity and Capital
Resources" for a discussion of the Company's interest rate swaps.
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of Shareholders of the Company was held on May 2,
2002.
(b) Not applicable
(c) Matters voted upon at the Annual Meeting and the number of shares
voted for, against, withheld, abstaining from voting and broker
non-votes were as follows:
(1) Election of four Directors for a term expiring in 2005:
FOR WITHHELD
--- --------
Mary K. Bush 96,645,028 482,923
David S. Engelman 96,641,986 485,965
Kenneth M. Jastrow, II 96,649,158 478,793
Daniel P. Kearney 96,646,193 481,758
(2) Approval of the 2002 Stock Incentive Plan:
For: 82,261,156
Against: 5,848,822
Abstaining from voting 472,510
Broker non-votes: 8,545,463
29
(3) Ratification of the appointment of PricewaterhouseCoopers LLP
("PwC") as independent accountants for the Company for 2002.
For: 94,846,964
Against: 1,940,382
Abstaining from vote: 340,605
There were no broker non-votes in the Election of Directors or the
ratification of the appointment of PwC.
(d) Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - The exhibits listed in the accompanying Index to Exhibits
are filed as part of this Form 10-Q. The Company is a party to various
agreements regarding long-term debt that are not filed as exhibits
pursuant to Reg. S-K Item 602 (b)(4)(iii)(A). The Company hereby
agrees to furnish a copy of such agreements to the Commission upon its
request.
(b) Reports on Form 8-K - No reports were filed on Form 8-K during the
quarter ended June 30, 2002.
30
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 14, 2002.
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
31
INDEX TO EXHIBITS
(Item 6)
Exhibit
Number Description of Exhibit
- ------- ----------------------
10 2002 Stock Incentive Plan (incorporated by reference to Exhibit A
to the Company's Proxy Statement for its May 2, 2002 Annual
Meetings of Shareholders)
11 Statement Re Computation of Net Income Per Share
32
EXHIBIT 11
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
STATEMENT RE COMPUTATION OF NET INCOME PER SHARE
Three and Six Month Periods Ended June 30, 2002 and 2001
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
2002 2001 2002 2001
--------- --------- --------- ---------
(In thousands of dollars, except per share data)
BASIC EARNINGS PER SHARE
Average common shares
outstanding 105,181 107,111 105,733 106,997
========= ========= ========= =========
Net income $ 170,936 $ 161,218 $ 340,123 $ 319,142
========= ========= ========= =========
Basic earnings per share $ 1.63 $ 1.51 $ 3.22 $ 2.98
========= ========= ========= =========
DILUTED EARNINGS PER SHARE
Adjusted shares outstanding:
Average common shares
outstanding 105,181 107,111 105,733 106,997
Net shares to be issued upon
exercise of dilutive stock
options after applying
treasury stock method 740 991 737 957
--------- --------- --------- ---------
Adjusted shares outstanding 105,921 108,102 106,470 107,954
========= ========= ========= =========
Net income $ 170,936 $ 161,218 $ 340,123 $ 319,142
========= ========= ========= =========
Diluted earnings per share $ 1.61 $ 1.49 $ 3.19 $ 2.96
========= ========= ========= =========