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 SEPTEMBER 30, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-10816
MGIC INVESTMENT CORPORATION
(Exact name of registrant as specified in its charter)
WISCONSIN 39-1486475
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
250 E. KILBOURN AVENUE 53202
MILWAUKEE, WISCONSIN (Zip Code)
(Address of principal executive offices)
(414) 347-6480 (Registrant's
telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OF STOCK PAR VALUE DATE NUMBER OF SHARES
Common stock $1.00 10/31/02 100,477,880
Page 1
MGIC INVESTMENT CORPORATION
TABLE OF CONTENTS
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheet as of
September 30, 2002 (Unaudited) and December 31, 2001 3
Consolidated Statement of Operations for the Three and Nine
Month Periods Ended September 30, 2002 and 2001 (Unaudited) 4
Consolidated Statement of Cash Flows for the Nine Months
Ended September 30, 2002 and 2001 (Unaudited) 5
Notes to Consolidated Financial Statements (Unaudited) 6-12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13-30
Item 3. Quantitative and Qualitative Disclosures About Market Risk 31
Item 4. Controls and Procedures 31
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 31
SIGNATURES 32
CERTIFICATIONS 33-36
INDEX TO EXHIBITS 37
Page 2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
September 30, 2002 (Unaudited) and December 31, 2001
September 30, December 31,
2002 2001
---------------- ----------------
ASSETS (In thousands of dollars)
Investment portfolio:
Securities, available-for-sale, at market value:
Fixed maturities $ 4,428,532 $ 3,888,740
Equity securities 18,882 20,747
Short-term investments 193,998 159,960
---------------- ----------------
Total investment portfolio 4,641,412 4,069,447
Cash 12,874 26,392
Accrued investment income 55,250 59,036
Reinsurance recoverable on loss reserves 22,666 26,888
Reinsurance recoverable on unearned premiums 8,712 8,415
Home office and equipment, net 35,337 34,762
Deferred insurance policy acquisition costs 31,859 32,127
Investments in joint ventures 200,335 161,674
Other assets 149,273 148,271
---------------- ----------------
Total assets $ 5,157,718 $ 4,567,012
================ ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Loss reserves $ 667,177 $ 613,664
Unearned premiums 174,345 174,545
Short-and long-term debt (note 2) 634,852 472,102
Other liabilities 346,256 286,514
---------------- ----------------
Total liabilities 1,822,630 1,546,825
---------------- ----------------
Contingencies (note 4)
Shareholders' equity:
Common stock, $1 par value, shares authorized
300,000,000; shares issued, 9/30/02 - 121,418,637
12/31/01 - 121,110,800; shares outstanding,
9/30/02 - 100,802,880 12/31/01 - 106,086,594 121,419 121,111
Paid-in surplus 232,950 214,040
Members' equity (553) -
Treasury stock (shares at cost, 9/30/02 - 20,615,757
12/31/01 - 15,024,206) (1,009,546) (671,168)
Accumulated other comprehensive income, net of tax 197,409 46,644
Retained earnings 3,793,409 3,309,560
---------------- ----------------
Total shareholders' equity 3,335,088 3,020,187
---------------- ----------------
Total liabilities and shareholders' equity $ 5,157,718 $ 4,567,012
================ ================
See accompanying notes to consolidated financial statements.
Page 3
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
Three and Nine Month Periods Ended September 30, 2002 and 2001
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- ------------------------------
2002 2001 2002 2001
(In thousands of dollars, except per share data)
Revenues:
Premiums written:
Direct $ 336,516 $ 288,288 $ 957,065 $ 803,797
Assumed 105 126 242 353
Ceded (note 3) (35,260) (17,408) (86,234) (46,653)
------------ ------------- ------------- -------------
Net premiums written 301,361 271,006 871,073 757,497
(Increase) decrease in unearned premiums (2,408) (6,226) 498 5,837
------------ ------------- ------------- -------------
Net premiums earned 298,953 264,780 871,571 763,334
Investment income, net of expenses 51,036 51,021 154,640 152,632
Realized investment gains, net 8,891 7,247 21,984 28,822
Other revenue 31,926 16,788 102,014 55,070
------------ ------------- ------------- -------------
Total revenues 390,806 339,836 1,150,209 999,858
------------ ------------- ------------- -------------
Losses and expenses:
Losses incurred, net 101,094 43,468 225,224 109,149
Underwriting and other expenses, net 64,646 58,317 192,163 168,495
Interest expense 10,070 7,604 26,522 23,294
------------ ------------- ------------- -------------
Total losses and expenses 175,810 109,389 443,909 300,938
------------ ------------- ------------- -------------
Income before tax 214,996 230,447 706,300 698,920
Provision for income tax 63,426 71,455 214,607 220,786
------------ ------------- ------------- -------------
Net income $ 151,570 $ 158,992 $ 491,693 $ 478,134
============ ============= ============= =============
Earnings per share (note 5):
Basic $ 1.47 $ 1.48 $ 4.69 $ 4.46
============ ============= ============= =============
Diluted $ 1.47 $ 1.47 $ 4.66 $ 4.43
============ ============= ============= =============
Weighted average common shares
outstanding - diluted (shares in
thousands, note 5) 103,361 108,218 105,511 108,036
============ ============= ============= =============
Dividends per share $ 0.025 $ 0.025 $ 0.075 $ 0.075
============ ============= ============= =============
See accompanying notes to consolidated financial statements.
Page 4
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Nine Months Ended September 30, 2002 and 2001
(Unaudited)
Nine Months Ended
September 30,
---------------------------------
2002 2001
(In thousands of dollars)
Cash flows from operating activities:
Net income $ 491,693 $ 478,134
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of deferred insurance policy
acquisition costs 17,900 14,712
Increase in deferred insurance policy
acquisition costs (17,632) (18,409)
Depreciation and amortization 8,730 5,145
Decrease in accrued investment income 3,786 826
Decrease in reinsurance recoverable on loss reserves 4,222 5,398
(Increase) decrease in reinsurance recoverable on unearned premiums (297) 62
Increase (decrease) in loss reserves 53,513 (5,608)
Decrease in unearned premiums (200) (5,899)
Equity earnings in joint ventures (58,951) (23,007)
Other (25,474) 70,698
--------------- ---------------
Net cash provided by operating activities 477,290 522,052
--------------- ---------------
Cash flows from investing activities:
Purchase of fixed maturities (1,985,114) (2,162,273)
Additional investment in joint ventures - (15,000)
Sale of equity securities 3,424 1,585
Proceeds from sale or maturity of fixed maturities 1,695,034 1,700,427
--------------- ---------------
Net cash used in investing activities (286,656) (475,261)
--------------- ---------------
Cash flows from financing activities:
Dividends paid to shareholders (7,845) (8,031)
Proceeds from issuance of long-term debt 199,992 111,499
Repayment of short- and long-term debt (40,446) (133,384)
Reissuance of treasury stock 16,696 15,307
Repurchase of common stock (338,818) (7,821)
Common stock issued 308 -
--------------- ---------------
Net cash used in financing activities (170,113) (22,430)
--------------- ---------------
Net increase in cash and short-term investments 20,520 24,361
Cash and short-term investments at beginning of period 186,352 157,190
--------------- ---------------
Cash and short-term investments at end of period $ 206,872 $ 181,551
=============== ===============
See accompanying notes to consolidated financial statements.
Page 5
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 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 nine months ended September 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 $17.9 million and $14.7 million of deferred
insurance policy acquisition costs during the nine months ended September 30,
2002 and 2001, respectively.
Page 6
Loss reserves
Reserves are established for reported insurance losses and loss
adjustment expenses based on when notices of default on insured mortgage loans
are received. Reserves are also established for estimated losses incurred on
notices of default not yet reported by the lender. Consistent with industry
practices, the Company does not establish loss reserves for future claims on
insured loans which are not currently in default. Reserves are established by
management using estimated claims rates and claims amounts in estimating the
ultimate loss. Amounts for salvage recoverable are considered in the
determination of the reserve estimates. Adjustments to reserve estimates are
reflected in the financial statements in the years in which the adjustments are
made. The liability for reinsurance assumed is based on information provided by
the ceding companies.
The incurred but not reported ("IBNR") reserves result from defaults
occurring prior to the close of an accounting period, but which have not been
reported to the Company. Consistent with reserves for reported defaults, IBNR
reserves are established using estimated claims rates and claims amounts for the
estimated number of defaults not reported.
Reserves also provide for the estimated costs of settling claims,
including legal and other expenses and general expenses of administering the
claims settlement process.
Income recognition
The insurance subsidiaries write policies which are guaranteed renewable
contracts at the insured's option on a single, annual or monthly premium basis.
The insurance subsidiaries have no ability to reunderwrite or reprice these
contracts. Premiums written on a single premium basis and an annual premium
basis are initially deferred as unearned premium reserve and earned over the
policy term. Premiums written on policies covering more than one year are
amortized over the policy life in accordance with the expiration of risk, which
is the anticipated claim payment pattern based on historical experience.
Premiums written on annual policies are earned on a monthly pro rata basis.
Premiums written on monthly policies are earned as coverage is provided.
Fee income of the non-insurance subsidiaries is earned and recognized as
the services are provided and the customer is obligated to pay.
Note 2 - Short- and long-term debt
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 September 30, 2002, the Company had $134.0
million in commercial paper outstanding with a weighted average interest rate of
1.85%.
Page 7
The Company had a $285 million credit facility available at September
30, 2002, expiring in 2006. 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 September 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 $151 million at September 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 September 30, 2002 and $300 million at September
30, 2001.
Interest payments on all long-term debt (commercial paper is classified
as short-term debt) were $17.2 million and $12.8 million for the nine months
ended September 30, 2002 and 2001, respectively. At September 30, 2002, the
market value of the short- and long-term debt is $680 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 May 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 nine
months ended September 30, 2002 and 2001 of approximately $1.0 million and $2.0
million, respectively, were included in interest expense. The cash flow swap
outstanding at September 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
Page 8
credit risk to the extent the counterparty would be unable to discharge its
obligations under the swap agreements.
Note 3 - Reinsurance
The Company cedes a portion of its business to reinsurers and records
assets for reinsurance recoverable on estimated reserves for unpaid losses and
unearned premiums. Business written between 1985 and 1993 is ceded under various
quota share reinsurance agreements with several reinsurers. The Company receives
a ceding commission in connection with this reinsurance. Business ceded to
reinsurers also includes certain business written in 2002 through the bulk
channel as discussed under "Management's Discussion and Analysis--Three Months
Ended September 30, 2002 Compared With Three Months Ended September 30, 2001" in
Item 2 of this Report. 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
Page 9
prohibiting MGIC from receiving future premium payments. If the settlement is
not fully implemented, the litigation will continue. In these circumstances,
there can be no assurance that the ultimate outcome of the litigation will not
materially affect the Company's financial position or results of operations.
Note 5 - Earnings per share
The Company's basic and diluted earnings per share ("EPS") have been
calculated in accordance with SFAS No. 128, Earnings Per Share. The following is
a reconciliation of the weighted-average number of shares used for basic EPS and
diluted EPS.
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2002 2001 2002 2001
---- ---- ---- ----
(Shares in thousands)
Weighted-average shares - Basic EPS 102,825 107,305 104,793 107,099
Common stock equivalents 536 913 718 937
------- ------- ------- -------
Weighted-average shares - Diluted EPS 103,361 108,218 105,511 108,036
======= ======= ======= =======
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 September
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.
Page 10
Note 7 - Comprehensive income
The Company's total comprehensive income, as calculated per SFAS No.
130, Reporting Comprehensive Income, was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2002 2001 2002 2001
---- ---- ---- ----
(In thousands of dollars)
Net income $151,570 $158,992 $491,693 $478,134
Other comprehensive income 100,814 42,078 150,765 22,873
-------- -------- -------- --------
Total comprehensive income $252,384 $201,070 $642,458 $501,007
======== ======== ======== ========
Other comprehensive income (loss) (net of tax):
Cumulative effect - FAS 133 $ N/A $ N/A $ N/A $ (5,982)
Net derivative gains (losses) (3,079) (2,654) (1,457) (3,819)
Amortization of deferred losses 270 270 810 810
FAS 115 103,623 44,462 151,412 31,864
-------- -------- -------- --------
Comprehensive gain (loss) $100,814 $ 42,078 $150,765 $ 22,873
======== ======== ======== ========
The difference between the Company's net income and total comprehensive
income for the nine months ended September 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
Page 11
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.
Page 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Consolidated Operations
Three Months Ended September 30, 2002 Compared With Three Months Ended September
30, 2001
Net income for the three months ended September 30, 2002 was $151.6
million, compared to $159.0 million for the same period of 2001, a decrease of
5%. Diluted earnings per share for the three months ended September 30, 2002 was
$1.47, which equaled the $1.47 for the same period last year. Included in
diluted earnings per share for the quarter ended September 30, 2002 and 2001
were $0.06 and $0.04, respectively, for realized gains. Adjusted weighted
average diluted shares outstanding for the quarter ended September 30, 2002 and
2001 were 103.4 million and 108.2 million, respectively. 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 third quarter 2002 were $390.8 million, an
increase of 15% from the $339.8 million for the third 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. See
below for a further discussion of premiums and other revenue.
Losses and expenses for the third quarter were $175.8 million, an
increase of 61% from $109.4 million for the same period of 2001. The increase
from last year can be attributed to a 133% increase in losses incurred, which
primarily related to an increase in delinquent loans, and an aggregate increase
in underwriting and interest expenses of 13%, which related to increases in
insured volume and debt outstanding, respectively. See below for a further
discussion of losses incurred and expenses.
The amount of new primary insurance written by MGIC during the three
months ended September 30, 2002 was $21.9 billion, compared to $23.4 billion in
the same period of 2001, a decline of $1.5 billion. New insurance written in the
bulk channel declined $2.2 billion during the three months ended September 30,
2002 compared to the same period of 2001, as further discussed below. New
insurance written on a flow basis increased $700 million during the third
quarter of 2002 compared to the corresponding quarter of 2001, with refinance
volume approximately equal in the two quarters.
The $21.9 billion of new primary insurance written during the third
quarter of 2002 was offset by the cancellation of $19.8 billion of insurance in
force, and resulted in a net increase of $2.1 billion in primary insurance in
force, compared to new primary insurance written of $23.4 billion, the
cancellation of $15.4 billion of insurance in force and a net increase of $8.0
billion in primary insurance in force during the third quarter of 2001.
Page 13
Direct primary insurance in force was $196.6 billion at September 30, 2002
compared to $183.9 billion at December 31, 2001 and $179.6 billion at September
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 September 30, 2002 and September 30, 2001 was $68 million and $133
million, respectively. The Company's direct pool risk in force was $2.2 billion
at September 30, 2002, $2.0 billion at December 31, 2001, and was $1.8 billion
at September 30, 2001.
Cancellation activity has historically been affected by the level of
mortgage interest rates, with cancellations generally moving inversely to the
change in the direction of interest rates. The third quarters of 2001 and 2002
were both affected by a declining home mortgage interest rate environment.
Cancellations increased during the third quarter of 2002 compared to the
cancellation levels during the third quarter of 2001, which resulted in a
decrease in the MGIC persistency rate (percentage of insurance remaining in
force from one year prior) to 58.9% at September 30, 2002 from 61.0% at December
31, 2001 and 67.7% at September 30, 2001. In view of continued strong refinance
activity, the persistency rate at December 31, 2002 could decline from the rate
at September 30, 2002.
New insurance written for bulk transactions was $4.5 billion during the
third quarter of 2002 compared to $6.7 billion for the same period a year ago
and average quarterly writings of $6.1 billion for the three quarters subsequent
to the third 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 during the third
quarter of 2002, as well as other factors present in the whole loan market
during the quarter, resulted in increased prices for whole loans which 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 prevailing in the bond market during the third quarter
of 2002 resulted in more investors purchasing such tranches.
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 and will have lower persistency than 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. In the first
quarter of 2002, the Company entered into a preliminary agreement providing that
new insurance written in 2002 through the bulk channel on Alt A, subprime and
certain other loans would be subject to quota share reinsurance of approximately
15% provided by a third party reinsurer. The reinsurance transaction was
contingent on the Company receiving credit for the reinsurance under insurance
regulation. Under the
Page 14
Company's interpretation of the preliminary agreement, confirmation of such
credit was required to be received by September 30, 2002. This deadline was not
met and the Company gave the reinsurer notice that the agreement was terminated.
The reinsurer has disputed the Company's interpretation. Given the dispute,
ceded premiums for the third quarter of 2002 include $5.6 million of premiums
that would have been ceded had this agreement not been terminated.
Net premiums written increased 11% to $301.4 million during the third
quarter of 2002, from $271.0 million during the third quarter of 2001. Net
premiums earned increased 13% to $299.0 million for the third quarter of 2002
from $264.8 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 premiums
on products with higher premium rates, principally on insurance written through
the bulk channel, 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 $27.7 million in the third quarter of
2002, compared to $18.3 million in the same period of 2001. During the second
quarter of 2002, approximately 52% 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.) The percentage of new insurance written during a
quarter covered by such arrangements normally increases after the end of the
quarter because, among other reasons, 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. 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.
A substantial portion of the Company's captive mortgage reinsurance
arrangements are structured on an excess of loss basis, with the remainder
structured on a quota share basis. The Company has advised customers that,
effective March 31, 2003, it will not participate in excess of loss risk sharing
arrangements with net premium cessions in excess of 25% or in quota share
arrangements with net premium cessions in excess of 40%. While the amount of
premium ceded during the third quarter under risk sharing agreements that exceed
these thresholds is not material to direct premiums written during the quarter,
captive mortgage reinsurance programs are competitively important, with larger
lenders generally having programs with higher premium cessions (and
commensurately higher levels of risk sharing). Hence, there can be no assurance
that the Company's position with respect to such risk sharing arrangements will
not result in a reduction in business from such lenders.
Investment income for the third quarter of 2002 was $51.0 million, a
slight increase over the third quarter of 2001. This increase was the result of
increases in the amortized cost of average invested assets to $4.3 billion for
the third quarter of 2002 from $3.8 billion for the third quarter of 2001, an
increase of 15%, offset by a decrease in the
Page 15
investment yield. The portfolio's average pre-tax investment yield was 4.8% for
the third quarter of 2002 and 5.5% for the same period in 2001. The portfolio's
average after-tax investment yield was 4.3% for the third quarter of 2002 and
4.7% for the same period in 2001. The Company's net realized gains were $8.9
million for the three months ended September 30, 2002 compared to net realized
gains of $7.2 million during the same period in 2001, resulting primarily from
the sale of fixed maturities.
Other revenue, which is composed of various components, was $31.9
million for the third quarter of 2002, compared with $16.8 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 and its
subsidiaries (collectively, "C-BASS") and Sherman Financial Group LLC and its
subsidiaries (collectively, "Sherman"), joint ventures with Radian Group Inc.,
and from contract underwriting.
C-BASS is a mortgage investment and servicing firm specializing in
credit-sensitive single-family residential mortgage assets and residential
mortgage-backed securities. C-BASS principally invests in whole loans (including
subprime loans) and mezzanine and subordinated residential mortgage-backed
securities backed by non-conforming residential mortgage loans. C-BASS's
principal sources of revenues during the last three years and through the third
quarter of 2002 were gain on securitization and liquidation of mortgage-related
assets, servicing fees and net interest income (including accretion on mortgage
securities), which revenue items were offset by unrealized losses. C-BASS's
results of operations are affected by the timing of its securitization
transactions. Virtually all of C-BASS's 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. These estimates reflect the net present
value of the future cash flows from the assets, which in turn depend on, among
other things, estimates of the level of losses on the underlying mortgages and
prepayment activity by the mortgage borrowers. Market value adjustments could
impact C-BASS's results of operations and the Company's share of those results.
Total consolidated assets of C-BASS at September 30, 2002 and December
31, 2001 were approximately $2.2 billion and $1.3 billion. Total liabilities at
September 30, 2002 and December 31, 2001 were approximately $1.9 billion and
$1.0 billion, respectively, of which approximately $1.6 billion and $0.9
billion, respectively, were funding arrangements, including accrued interest,
virtually all of which mature within one-year or less. For the three months
ended September 30, 2002 and 2001, revenues of approximately $58 million and $39
million, respectively, and expenses of approximately $38 million and $27
million, respectively, resulted in income before tax of approximately $20
million and $12 million, respectively. C-BASS had income before tax for the
first and second quarters of 2002 of approximately $35 million and $47 million,
respectively.
Sherman is engaged in the business of purchasing and servicing
delinquent consumer assets such as credit card loans and Chapter 13 bankruptcy
debt. A substantial portion of Sherman's consolidated assets are investments in
consumer receivable portfolios that do not have readily ascertainable market
values. Sherman's
Page 16
results of operations are sensitive to estimates by Sherman's management of
future collections on these portfolios.
Because C-BASS and Sherman are accounted for by the equity method, they
are not consolidated with the Company and their assets and liabilities do not
appear in the Company's balance sheet. The "investments in joint ventures" item
in the Company's balance sheet reflects the amount of capital contributed by the
Company to the joint ventures plus the Company's share of their net income (or
minus its share of their net loss) and minus capital distributed to the Company
by the joint ventures.
As discussed in "Note 1 - Loss Reserves" to the Company's consolidated
financial statements, consistent with industry practice, loss reserves for
future claims are established only for loans that are currently delinquent. (The
terms "delinquent" and "default" are used interchangeably by the Company.) Loss
reserves are established by management's estimating the number of loans in the
Company's inventory of delinquent loans that will not cure their delinquency
(historically, a substantial majority of delinquent loans have cured), which is
referred to as the claim rate, and further estimating the amount that the
Company will pay in claims on the loans that do not cure, which is referred to
as claim severity. Estimation of losses that the Company will pay in the future
is inherently judgmental. The conditions that affect the claim rate and claim
severity include the current and future state of the domestic economy and the
current and future strength of local housing markets.
Net losses incurred increased 133% to $101.1 million in the third
quarter of 2002, from $43.5 million in the same period of 2001. Net losses
incurred in the first and second quarters of 2002 were $59.7 million and $64.4
million, respectively. The increase in the third quarter was due to an increase
in the primary notice inventory related to bulk default activity and defaults
arising from the early development of the 2000 and 2001 flow books of business
as well as a modest increase in losses paid. The average claim paid for the
quarter ended September 30, 2002 was $19,737 compared to $17,700 for the same
period in 2001. In recent quarters, the primary determinant of incurred losses
has been the level and composition of the notice inventory, rather than claim
severity. Depending on the level and composition of the notice inventory at
December 31, 2002, incurred losses in the fourth quarter of 2002 could be higher
than in the third quarter.
Page 17
Information about the composition of the primary insurance default
inventory at September 30, 2002, December 31, 2001 and September 30, 2001
appears in the table below.
September 30, December 31, September 30,
2002 2001 2001
---- ---- ----
Total loans delinquent 67,114 54,653 48,820
Percentage of loans delinquent
(default rate) 4.04% 3.46% 3.14%
Flow loans delinquent 39,292 36,193 33,109
Percentage of flow loans delinquent
(default rate) 2.85% 2.65% 2.41%
Bulk loans delinquent 27,822 18,460 15,711
Percentage of bulk loans delinquent
(default rate) 9.97% 8.59% 8.73%
Subprime credit loans delinquent* 23,086 15,649 13,595
Percentage of subprime credit loans
delinquent (default rate) 12.38% 11.60% 11.78%
* A portion of subprime credit loans is included in flow loans delinquent and
the remainder is included in bulk loans delinquent. Most subprime credit loans
are written through the bulk channel.
The pool notice inventory increased from 23,623 at December 31, 2001 to
25,592 at September 30, 2002; the pool notice inventory was 20,760 at September
30, 2001.
At September 30, 2002, 79% 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 $64.6 million in the third
quarter of 2002 from $58.3 million in the same period of 2001, an increase of
11%. 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 fourth quarter of 2002 will
increase over the level of the third quarter of 2002. The Company is not
undertaking any obligation to provide an update of this expectation should it
subsequently change.
Interest expense increased to $10.1 million in the third quarter of 2002
from $7.6 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 September 30, 2002 compared to the comparable period in 2001.
The consolidated insurance operations loss ratio was 33.8% for the third
quarter of 2002 compared to 16.4% for the third quarter of 2001. The
consolidated insurance operations expense and combined ratios were 14.1% and
47.9%, respectively, for the third quarter of 2002 compared to 16.0% and 32.4%
for the third quarter of 2001.
The effective tax rate was 29.5% in the third quarter of 2002, compared
to 31.0% in the third 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
Page 18
effective tax rate in 2002 resulted from a higher percentage of total income
before tax being generated from the tax-preferenced investments.
Nine months Ended September 30, 2002 Compared With Nine months Ended September
30, 2001
Net income for the nine months ended September 30, 2002 was $491.7
million, compared to $478.1 million for the same period of 2001, an increase of
3%. Diluted earnings per share for the nine months ended September 30, 2002 was
$4.66 compared with $4.43 in the same period last year, an increase of 5%.
Included in diluted earnings per share for the nine months ended September 30,
2002 and 2001 were $0.14 and $0.17, respectively, for realized gains. Adjusted
weighted average diluted shares outstanding for the nine months ended September
30, 2002 and 2001 were 105.5 million and 108.0 million, respectively.
Total revenues for the first nine months of 2002 were $1,150.2 million,
an increase of 15% from the $999.9 million through the same period in 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 through September 30, 2002 were $443.9 million, an
increase of 48% from $300.9 million for the same period of 2001. The increase
from last year can be attributed to an increase in losses of 106%, which
primarily related to an increase in notice inventories, and an aggregate
increase in underwriting and interest expenses of 14%, which related to
increases in insured volume, in debt outstanding and in contract underwriting,
respectively. See below for a further discussion of losses incurred and
expenses.
The amount of new primary insurance written by MGIC during the nine
months ended September 30, 2002 was $67.3 billion, compared to $62.5 billion in
the same period of 2001, an increase of $4.8 billion. New insurance written in
the bulk channel decreased $3.0 billion during the first nine months of 2002
compared to the same period a year ago. New insurance written on a flow basis
increased $7.8 billion during the nine months ended September 30, 2002 compared
to the same period in 2001, with refinance volume approximately equal in the two
periods.
The $67.3 billion of new primary insurance written during the first nine
months of 2002 was offset by the cancellation of $54.6 billion of insurance in
force, and resulted in a net increase of $12.7 billion in primary insurance in
force, compared to new primary insurance written of $62.5 billion, the
cancellation of $43.1 billion of insurance in force and a net increase of $19.4
billion in primary insurance in force through the same period in 2001.
Page 19
New pool risk written during the first nine months ended September 30,
2002 and September 30, 2001 was $258 million and $291 million, respectively. The
Company's direct pool risk in force was $2.2 billion at September 30, 2002, $2.0
billion at December 31, 2001, and was $1.8 billion at September 30, 2001.
Cancellations increased during the first nine months of 2002 compared to
the cancellation levels of 2001 which resulted in a decrease in the MGIC
persistency rate to 58.9% at September 30, 2002 from 61.0% at December 31, 2001
and 67.7% at September 30, 2001.
Net premiums written increased 15% to $871.1 million during the nine
months ended September 30, 2002, from $757.5 million during the first nine
months of 2001. Net premiums earned increased 14% to $871.6 million for the
first nine months of 2002 from $763.3 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 premiums on products with higher premium rates, principally
on insurance written though the bulk channel, 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 $72.7 million through September
30, 2002 compared to $47.7 in the same period of 2001. Premiums ceded during the
nine months ended September 30, 2002 under the disputed bulk reinsurance
transaction referred to under "Three Months Ended September 30, 2002 Compared
With Three Months Ended September 30, 2001" were $10.4 million.
Investment income for the first nine months of 2002 was $154.6 million,
a slight increase over the $152.6 million for the same period of 2001. This
increase was the result of increases in the amortized cost of average invested
assets to $4.2 billion for the first nine months of 2002 from $3.6 billion for
the same period in 2001, an increase of 15% offset by a decrease in the
investment yield. The portfolio's average pre-tax investment yield was 4.9% for
the first nine months of 2002 and 5.6% for the same period in 2001. The
portfolio's average after-tax investment yield was 4.4% through September 30,
2002 and 4.7% for the same period in 2001. The Company's net realized gains were
$22.0 million for the nine months ended September 30, 2002 compared to net
realized gains of $28.8 million during the same period in 2001, resulting
primarily from the sale of fixed maturities.
Other revenue was $102.0 million for the first nine months of 2002,
compared with $55.1 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 nine months ended September 30, 2002 and 2001, C-BASS had
revenues of approximately $218 million and $160 million, respectively, and
expenses of approximately $116 million and $90 million, respectively, which
resulted in income before tax of approximately $102 million and $70 million,
respectively.
Net losses incurred increased 106% to $225.2 million in the first nine
months of 2002, from $109.1 million in the same period of 2001. The increase was
due to an increase in the primary notice inventory related to bulk default
activity and defaults arising from the early development of the 2000 and 2001
flow books of business, as well as a
Page 20
modest increase in losses paid. The average claim paid for the nine months ended
September 30, 2002 was $19,731 compared to $18,286 for the same period in 2001.
For information about the notice inventory and default rates, see "Three Months
Ended September 30, 2002 Compared With Three Months Ended September 30, 2001".
Underwriting and other expenses increased to $192.2 million in the first
nine months of 2002 from $168.5 million in the same period of 2001, an increase
of 14%. 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 $26.5 million through September 30, 2002
from $23.3 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 nine months ended September 30, 2002 compared to the comparable period in
2001.
The consolidated insurance operations loss ratio was 25.8% for the first
nine months of 2002 compared to 14.3% for the first nine months of 2001. The
consolidated insurance operations expense and combined ratios were 14.7% and
40.5%, respectively, for the first nine months of 2002 compared to 16.4% and
30.7% for the first nine months of 2001.
The effective tax rate was 30.4% through September 30, 2002, compared to
31.6% 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 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
Page 21
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.
Financial Condition
Consolidated total investments and cash balances increased approximately
$558 million to $4.7 billion at September 30, 2002 from $4.1 billion at December
31, 2001, primarily due to net cash provided by operating activities, unrealized
gains on securities marked to market of $233 million and the proceeds of the
sale of the 6% Senior Notes discussed under "Liquidity and Capital Resources"
below, offset by funds used to repurchase Common Stock discussed under
"Liquidity and Capital Resources" below. The Company generated net cash from
operating activities of $477.3 million for the first nine months of 2002,
compared to $522.1 million generated during the same period in 2001. The
decrease in operating cash flows during the first nine months of 2002 compared
to 2001 is due primarily to increases in losses paid, offset by increases in
renewal premiums, investment income and other revenue as discussed above.
As of September 30, 2002, the Company had $194.0 million of short-term
investments with maturities of 90 days or less, and 83% of the portfolio was
invested in tax-preferenced securities. In addition, at September 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 September 30, 2002, the Company had
$18.9 million of investments in equity securities compared to $20.7 million at
December 31, 2001.
At September 30, 2002, the Company's derivative financial instruments in
its investment portfolio were immaterial. The Company places its investments in
instruments that meet high credit quality standards, as specified in the
Company's investment policy
Page 22
guidelines; the policy also limits the amount of credit exposure to any one
issue, issuer and type of instrument. At September 30, 2002, the average
duration of the Company's fixed income investment portfolio was 5.7 years. This
means that for each instantaneous parallel shift in the yield curve of 100 basis
points there would be an approximate 5.7% change in the market value of the
Company's fixed income portfolio.
The Company's investments in joint ventures increased $38.6 million
from $161.7 million at December 31, 2001 to $200.3 million at September 30, 2002
primarily as a result of equity earnings of $59.0 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 $667.2 million at September 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 $0.2 million from $174.5
million at December 31, 2001, to $174.3 million at September 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 $3.3 billion at
September 30, 2002, from $3.0 billion at December 31, 2001, an increase of 10%.
This increase consisted of $491.7 million of net income during the first nine
months of 2002 and other comprehensive income, net of tax, of $150.8 million,
offset by $319.2 million from the repurchase of treasury stock (net of
reissuances), dividends declared of $7.8 million and $0.6 million from the
consolidation of a previously unconsolidated joint venture.
Liquidity and Capital Resources
The Company's consolidated sources of funds consist primarily of
premiums written and investment income. The Company generated positive cash
flows from operating activities of approximately $477.3 million and $522.1
million for the nine months ended September 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 third 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 September 30, 2002, the Company had $134.0 million in
commercial paper outstanding with a weighted average interest rate of 1.85%. S&P
Page 23
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-1", 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 September
30, 2002 expiring in 2006. 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 September 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 $151
million at September 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 September 30, 2002 and $300 million at September
30, 2001.
In January 2002, the Company announced a share repurchase program
covering up to 5.5 million shares in addition to the 800,000 shares remaining
from the prior repurchase program. During the first nine months of 2002, the
Company repurchased 5.8 million shares at a cost of $347.0 million. (The number
of shares and the cost of the repurchases described in this paragraph include
trades effected on or prior to September 30, 2002 but which settled thereafter.)
In October 2002, the Company announced a new share repurchase program covering
up to 5 million shares in addition to 300,000 shares remaining from the January
2002 program. The Company's announcement with respect to the new program said it
reserves the right not to purchase any shares, or if shares are purchased, to
discontinue further purchases. From mid-1997 through September 2002, the Company
has repurchased 20.8 million shares of Common Stock at a cost of $1.1 billion.
Funds for the shares repurchased by the Company since mid-1997 have been
provided through a combination of debt, including the Senior Notes and the
commercial paper, and internally generated funds.
The commercial paper, back-up credit 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.
Page 24
Interest payments on all long-term debt (commercial paper is classified
as short-term debt) were $17.2 million and $12.8 million for the nine months
ended September 30, 2002 and 2001, respectively. At September 30, 2002, the
market value of the short- and long-term debt is $680 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 nine months ended September 30, 2002 and 2001 of approximately $1.0 million
and $2.0 million, respectively, were included in interest expense. The cash flow
swap outstanding at September 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.
The Company's principal category of contingent liabilities is its
obligation to pay claims under MGIC's mortgage guaranty insurance policies. At
September 30, 2002, MGIC's direct (before any reinsurance) primary and pool risk
in force (which is the unpaid principal balance of insured loans as reflected in
the Company's records multiplied by the coverage percentage, and taking account
of any loss limit) was approximately $49.2 billion. In addition, as part of its
contract underwriting activities, the Company is responsible for the quality of
its underwriting decisions in accordance with the terms of the contract
underwriting agreements with customers. Through September 30, 2002, the cost of
remedies provided by the Company 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
Page 25
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.
MGIC is the principal insurance subsidiary of the Company. MGIC's
risk-to-capital ratio was 8.8:1 at September 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 $2.1 billion,
net of reinsurance, during the first nine months of 2002.
The risk-to-capital ratios set forth above have been computed on a
statutory basis. However, the methodology used by the rating agencies to assign
claims-paying ability ratings permits less leverage than under statutory
requirements. As a result, the amount of capital required under statutory
regulations may be lower than the capital required for rating agency purposes.
In addition to capital adequacy, the rating agencies consider other factors in
determining a mortgage insurer's claims-paying rating, including its competitive
position, business outlook, management, corporate strategy, and historical and
projected operating performance.
For certain material risks of the Company's business, see "Risk Factors"
below.
Risk Factors
Our revenues and losses could be affected by the risk factors discussed
below. These factors may also cause actual results to differ materially from the
results contemplated by forward looking statements that the Company may make.
Forward looking statements consist of statements which relate to matters other
than historical fact. Among others, statements that include words such as the
Company "believes", "anticipates" or "expects", or words of similar import, are
forward looking statements.
As the domestic economy deteriorates, more homeowners may default and
---------------------------------------------------------------------
the Company's losses may increase by a greater amount than assumed.
- -------------------------------------------------------------------
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.
Competition or changes in the Company's relationships with its customers
------------------------------------------------------------------------
could reduce the Company's revenues or increase its losses.
- -----------------------------------------------------------
Page 26
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. In 1996, the Company shared risk
under risk sharing arrangements with respect to virtually none of its new
insurance written. During the three months ended June 30, 2002, about 52% of the
Company's new insurance written on a flow basis was subject to 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 share of the
mortgage lending market held by large lenders. The Company's top ten customers
generated 27.0% of the new primary insurance that it wrote on a flow basis in
1997 compared to 38.4% in 2001.
Our private mortgage insurance competitors include:
o PMI Mortgage Insurance Company
o GE Capital Mortgage Insurance Corporation
o United Guaranty Residential Insurance Company
o Radian Guaranty Inc.
o Republic Mortgage Insurance Company
o Triad Guaranty Insurance Corporation
o CMG Mortgage Insurance Company
If interest rates decline, house prices appreciate or mortgage insurance
------------------------------------------------------------------------
cancellation requirements change, the length of time that our policies remain in
- --------------------------------------------------------------------------------
force could decline and result in declines in our revenue.
- ----------------------------------------------------------
In each year, most of 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:
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.
Page 27
In recent years, the length of time that our policies remain in force
has declined. Due to this decline, our premium revenues were lower than they
would have been if the length had not declined.
If the volume of low down payment home mortgage originations declines,
----------------------------------------------------------------------
the amount of insurance that the Company writes could decline which would reduce
- --------------------------------------------------------------------------------
our 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.
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
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.
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:
o lenders using government mortgage insurance programs, including
those of the Federal Housing Administration and the Veterans
Administration,
o investors holding mortgages in portfolio and self-insuring,
Page 28
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, the Company believes 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.
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 Fannie Mae and Freddie Mac affect the entire
relationship between them and mortgage insurers and include:
o the level of private mortgage insurance coverage, subject to the
limitations of Fannie Mae and Freddie Mac's charters, when
private mortgage insurance is used as the required credit
enhancement on low down payment mortgages,
o whether Fannie Mae or Freddie Mac influence the mortgage
lender's selection of the mortgage insurer providing coverage
and, if so, any transactions that are related to that selection,
o whether Fannie Mae or Freddie Mac will give mortgage lenders an
incentive, such as a reduced guaranty fee, to select a mortgage
insurer that has a "AAA" claims-paying ability rating to benefit
from the lower capital requirements for Fannie Mae and Freddie
Mac when a mortgage is insured by a company with that rating,
o the underwriting standards that determine what loans are
eligible for purchase by Fannie Mae or Freddie Mac, which
thereby affect the quality of the risk insured by the mortgage
insurer and the availability of mortgage loans,
o the terms on which mortgage insurance coverage can be canceled
before reaching the cancellation thresholds established by law,
and
Page 29
o the circumstances in which mortgage servicers must perform
activities intended to avoid or mitigate loss on insured
mortgages that are delinquent.
Net premiums written could be adversely affected if a proposed
--------------------------------------------------------------
regulation by the Department of Housing and Urban Development under the Real
- ----------------------------------------------------------------------------
Estate Settlement Procedures Act is adopted.
- --------------------------------------------
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 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, 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.
The mortgage insurance 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
September 2002, seven mortgage insurers, including the Company's MGIC
subsidiary, were involved in litigation alleging violations of the Real Estate
Settlement Procedures Act. MGIC 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 MGIC 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. The Company took a
$23.2 million pretax charge in 2000 to cover MGIC's share of the estimated costs
of the settlement. While MGIC's 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, MGIC may still be
subject to future litigation under the Real Estate Settlement Procedures Act.
Page 30
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At September 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 September
30, 2002, the effective duration of the Company's fixed income investment
portfolio was 5.7 years. This means that for each instantaneous parallel shift
in the yield curve of 100 basis points there would be an approximate 5.7% change
in the market value of the Company's fixed income 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.
ITEM 4. CONTROLS AND PROCEDURES
(a) The Company's principal executive officer and principal financial
officer have each concluded that, based on his evaluation of the Company's
disclosure controls and procedures (as defined in Rule 13a-14(c) under the
Securities Exchange Act of 1934, as amended), as of a date within 90 days of the
filing of this Quarterly Report on Form 10-Q, such controls and procedures were
effective to ensure that material information relating to the Company and its
consolidated subsidiaries would be made known to them by others within those
entities.
(b) There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect these controls
subsequent to the last evaluation of these controls, which was made in
connection with the preparation of the Company's financial statements for the
year ended December 31, 2001.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - The exhibits listed in the accompanying Index to Exhibits are
filed as part of this Form 10-Q. 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 - A report on Form 8-K dated August 12, 2002 was
filed under Item 5 Other Events and Regulation FD Disclosure. A report
on Form 8-K dated August 14, 2002 was filed under Item 9 Regulation FD
Disclosure.
Page 31
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 November 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
Page 32
I, Curt S. Culver, certify that:
1. I have reviewed this quarterly report on Form 10-Q of MGIC Investment
Corporation ("the registrant").
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 officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d -14) for the registrant and we have:
a) designed such disclosure controls and procedures 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) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most
Page 33
recent evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 14, 2002
\s\Curt S. Culver
-------------------------------
Curt S. Culver
Chief Executive Officer
Page 34
I, J. Michael Lauer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of MGIC Investment
Corporation ("the registrant").
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 officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d -14) for the registrant and we have:
a) designed such disclosure controls and procedures 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) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most
Page 35
recent evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 14, 2002
\s\ J. Michael Lauer
-------------------------------
J. Michael Lauer
Chief Executive Officer
Page 36
INDEX TO EXHIBITS
(Item 6)
Exhibit
Number Description of Exhibit
10 MGIC Investment Corporation Deferred Compensation Plan for
Non-Employee Directors, as amended
11 Statement Re Computation of Net Income Per Share
Page 37