MGIC INVESTMENT CORP - FORM 10-Q - August 1, 2016

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EX-99 - EXHIBIT 99 - MGIC INVESTMENT CORPexhibit99q2.htm
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FORM 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended
June 30, 2016
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ______ to ______
 
Commission file number 1-10816
MGIC INVESTMENT CORPORATION
(Exact name of registrant as specified in its charter)
WISCONSIN
 
39-1486475
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
250 E. KILBOURN AVENUE
 
53202
MILWAUKEE, WISCONSIN
 
(Zip Code)
(Address of principal executive offices)
 
 
(414) 347-6480
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES x
NO o

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company  o
(Do not check if a smaller reporting company)

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

CLASS OF STOCK
 
PAR VALUE
 
DATE
 
NUMBER OF SHARES
Common stock
 
$1.00
 
July 29, 2016
 
340,641,277
 
 
 
 
 



Forward Looking and Other Statements

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


MGIC INVESTMENT CORPORATION AND SUBSIDIARIES

FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2016
 
TABLE OF CONTENTS
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




3 | MGIC Investment Corporation - Q2 2016

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)
 
June 30,
2016
 
December 31,
2015
ASSETS
 
 
 
 
Investment portfolio (notes 7 and 8):
 
 
 
 
Securities, available-for-sale, at fair value:
 
 
 
 
Fixed maturities (amortized cost, 2016 - $4,421,363; 2015 - $4,684,148)
 
$
4,556,202

 
$
4,657,561

Equity securities
 
9,876

 
5,645

Total investment portfolio
 
4,566,078

 
4,663,206

Cash and cash equivalents
 
300,974

 
181,120

Accrued investment income
 
39,709

 
40,224

Reinsurance recoverable on loss reserves (note 4)
 
45,215

 
44,487

Reinsurance recoverable on paid losses
 
4,773

 
3,319

Premiums receivable
 
46,602

 
48,469

Home office and equipment, net
 
30,800

 
30,095

Deferred insurance policy acquisition costs
 
16,680

 
15,241

Deferred income taxes, net (note 11)
 
617,266

 
762,080

Other assets
 
76,689

 
80,102

Total assets
 
$
5,744,786

 
$
5,868,343

 
 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
Liabilities:
 
 
 
 
Loss reserves (note 12)
 
$
1,632,333

 
$
1,893,402

Unearned premiums
 
308,424

 
279,973

Federal Home Loan Bank advance (note 3)
 
155,000

 
—

Convertible senior notes (note 3)
 
636,324

 
822,301

Convertible junior subordinated debentures (note 3)
 
256,872

 
389,522

Other liabilities
 
244,154

 
247,005

Total liabilities
 
3,233,107

 
3,632,203

Contingencies (note 5)
 


 


Shareholders’ equity (note 13):
 
 
 
 
Common stock (one dollar par value, shares authorized 1,000,000; shares issued 2016 - 341,076; 2015 - 340,097; shares outstanding 2016 - 340,636; 2015 - 339,657)
 
341,076

 
340,097

Paid-in capital
 
1,660,666

 
1,670,238

Treasury stock at cost (shares - 440)
 
(3,362
)
 
(3,362
)
Accumulated other comprehensive income (loss), net of tax (note 9)
 
44,840

 
(60,880
)
Retained earnings
 
468,459

 
290,047

Total shareholders’ equity
 
2,511,679

 
2,236,140

Total liabilities and shareholders’ equity
 
$
5,744,786

 
$
5,868,343

See accompanying notes to consolidated financial statements.


MGIC Investment Corporation - Q2 2016 | 4

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

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands, except per share data)
 
2016
 
2015
 
2016
 
2015
Revenues:
 
 
 
 
 
 
 
 
Premiums written:
 
 
 
 
 
 
 
 
Direct
 
$
282,113

 
$
261,404

 
$
547,404

 
$
526,816

Assumed
 
182

 
308

 
390

 
646

Ceded (note 4)
 
(32,280
)
 
(34,937
)
 
(66,498
)
 
(66,231
)
Net premiums written
 
250,015

 
226,775

 
481,296

 
461,231

Increase in unearned premiums, net
 
(18,559
)
 
(13,267
)
 
(28,499
)
 
(30,435
)
Net premiums earned
 
231,456

 
213,508

 
452,797

 
430,796

Investment income, net of expenses
 
27,248

 
25,756

 
55,057

 
49,876

Net realized investment gains (losses):
 


 


 


 


Total other-than-temporary impairment losses
 
—

 
—

 
—

 
—

Portion of losses recognized in comprehensive income, before taxes
 
—

 
—

 
—

 
—

Net impairment losses recognized in earnings
 
—

 
—

 
—

 
—

Other realized investment gains
 
836

 
166

 
3,892

 
26,493

Net realized investment gains
 
836

 
166

 
3,892

 
26,493

Other revenue
 
3,994

 
3,699

 
10,367

 
6,179

Total revenues
 
263,534

 
243,129

 
522,113

 
513,344

 
 
 
 
 
 
 
 
 
Losses and expenses:
 
 
 
 
 
 
 
 
Losses incurred, net (note 12)
 
46,590

 
90,238

 
131,602

 
172,023

Change in premium deficiency reserve
 
—

 
(17,333
)
 
—

 
(23,751
)
Amortization of deferred policy acquisition costs
 
2,245

 
2,046

 
4,206

 
3,803

Other underwriting and operating expenses, net
 
35,348

 
35,829

 
75,125

 
75,097

Interest expense
 
12,244

 
17,373

 
26,945

 
34,735

Loss on debt extinguishment (note 3)
 
1,868

 
—

 
15,308

 
—

Total losses and expenses
 
98,295

 
128,153

 
253,186

 
261,907

 
 
 
 
 
 
 
 
 
Income before tax
 
165,239

 
114,976

 
268,927

 
251,437

Provision for income taxes (note 11)
 
56,018

 
1,322

 
90,515

 
4,707

 
 
 
 
 
 
 
 
 
Net income
 
$
109,221

 
$
113,654

 
$
178,412

 
$
246,730

 
 
 
 
 
 
 
 
 
Income per share (note 6)
 
 
 
 
 
 
 
 
Basic
 
$
0.32

 
$
0.33

 
$
0.52

 
$
0.73

Diluted
 
$
0.26

 
$
0.28

 
$
0.43

 
$
0.60

 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding - basic (note 6)
 
340,678

 
339,705

 
340,411

 
339,406

Weighted average common shares outstanding - diluted (note 6)
 
446,139

 
439,127

 
450,354

 
439,200


See accompanying notes to consolidated financial statements.


5 | MGIC Investment Corporation - Q2 2016

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

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands)
 
2016
 
2015
 
2016
 
2015
Net income
 
$
109,221

 
$
113,654

 
$
178,412

 
$
246,730

Other comprehensive income (loss), net of tax (note 9):
 
 
 
 
 
 
 
 
Change in unrealized investment gains and losses (note 7)
 
56,338

 
(63,646
)
 
107,165

 
(44,083
)
Benefit plan adjustments
 
(173
)
 
(392
)
 
(481
)
 
(1,092
)
Foreign currency translation adjustment
 
11

 
390

 
(964
)
 
(1,624
)
Other comprehensive income (loss), net of tax
 
56,176

 
(63,648
)
 
105,720

 
(46,799
)
Comprehensive income
 
$
165,397

 
$
50,006

 
$
284,132

 
$
199,931


See accompanying notes to consolidated financial statements


MGIC Investment Corporation - Q2 2016 | 6

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

 
 
Six Months Ended June 30,
(In thousands)
 
2016
 
2015
Common stock
 
 
 
 
Balance, beginning of period
 
$
340,097

 
$
340,047

Net common stock issued under share-based compensation plans
 
979

 
32

Balance, end of period
 
341,076

 
340,079

 
 
 
 
 
Paid-in capital
 
 
 
 
Balance, beginning of period
 
1,670,238

 
1,663,592

Net common stock issued under share-based compensation plans
 
(5,954
)
 
(32
)
Reissuance of treasury stock, net
 
—

 
(7,181
)
Tax benefit from share-based compensation
 
115

 
2,568

Equity compensation
 
6,017

 
5,984

Reacquisition of convertible junior subordinated debentures-equity component (note 3)
 
(9,750
)
 
—

Balance, end of period
 
1,660,666

 
1,664,931

 
 
 
 
 
Treasury stock
 
 
 
 
Balance, beginning of period
 
(3,362
)
 
(32,937
)
Reissuance of treasury stock, net
 
—

 
29,575

Balance, end of period
 
(3,362
)
 
(3,362
)
 
 
 
 
 
Accumulated other comprehensive income (loss)
 
 
 
 
Balance, beginning of period
 
(60,880
)
 
(81,341
)
Other comprehensive income (loss), net of tax (note 9)
 
105,720

 
(46,799
)
Balance, end of period
 
44,840

 
(128,140
)
 
 
 
 
 
Retained earnings (deficit)
 
 
 
 
Balance, beginning of period
 
290,047

 
(852,458
)
Net income
 
178,412

 
246,730

Reissuance of treasury stock, net
 
—

 
(29,496
)
Balance, end of period
 
468,459

 
(635,224
)
 
 
 
 
 
Total shareholders’ equity
 
$
2,511,679

 
$
1,238,284


See accompanying notes to consolidated financial statements.


7 | MGIC Investment Corporation - Q2 2016

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
 
Six Months Ended June 30,
(In thousands)
 
2016
 
2015
Cash flows from operating activities:
 
 
 
 
Net income
 
$
178,412

 
$
246,730

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
 
Depreciation and amortization
 
28,477

 
23,938

Deferred tax expense (benefit)
 
88,157

 
(13
)
Realized investment gains, net
 
(3,892
)
 
(26,493
)
Excess tax benefits related to share-based compensation
 
(115
)
 
(2,568
)
Payment of original issue discount-convertible junior subordinated debentures
 
(41,540
)
 
—

Change in certain assets and liabilities:
 
 
 
 
Accrued investment income
 
515

 
(4,043
)
Prepaid insurance premium
 
48

 
(10,462
)
Reinsurance recoverable on loss reserves
 
(728
)
 
4,385

Reinsurance recoverable on paid losses
 
(1,454
)
 
506

Premium receivable
 
1,867

 
4,974

Deferred insurance policy acquisition costs
 
(1,439
)
 
(1,920
)
Profit commission receivable
 
(2,793
)
 
(50,957
)
Loss reserves
 
(261,069
)
 
(286,046
)
Premium deficiency reserve
 
—

 
(23,751
)
Unearned premiums
 
28,451

 
40,874

Return premium accrual
 
(7,300
)
 
(3,500
)
Income taxes payable - current
 
523

 
526

Other
 
(13,063
)
 
27,929

Net cash used in operating activities
 
(6,943
)
 
(59,891
)
 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
Purchases of investments:
 
 
 
 
Fixed maturities
 
(723,409
)
 
(1,499,319
)
Equity securities
 
(3,128
)
 
(39
)
Proceeds from sales of fixed maturities
 
649,776

 
1,218,688

Proceeds from maturity of fixed maturities
 
313,484

 
298,618

Proceeds from sale of equity securities
 
2,525

 
—

Net increase in payable for securities
 
24,519

 
41,762

Net decrease in restricted cash
 
—

 
17,212

Additions to property and equipment
 
(2,724
)
 
(1,711
)
Net cash provided by investing activities
 
261,043

 
75,211

 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
Proceeds from issuance of long-term debt
 
155,000

 
—

Purchase of convertible senior notes
 
(188,501
)
 
—

Purchase of convertible junior subordinated debentures-liability component
 
(91,110
)
 
—

Purchase of convertible junior subordinated debentures-equity component
 
(9,750
)
 
—

Excess tax benefits related to share-based compensation
 
115

 
2,568

Net cash (used in) provided by financing activities
 
(134,246
)
 
2,568

 
 
 
 
 
Net increase in cash and cash equivalents
 
119,854

 
17,888

Cash and cash equivalents at beginning of period
 
181,120

 
197,882

Cash and cash equivalents at end of period
 
$
300,974

 
$
215,770

See accompanying notes to consolidated financial statements.


MGIC Investment Corporation - Q2 2016 | 8

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2016
(Unaudited)

Note 1 – Nature of Business and Basis of Presentation

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

The accompanying unaudited consolidated financial statements of MGIC Investment Corporation and its wholly-owned subsidiaries have been prepared in accordance with the instructions to Form 10-Q as prescribed by the Securities and Exchange Commission (“SEC”) for interim reporting and do not include all of the other information and disclosures required by accounting principles generally accepted in the United States of America (“GAAP”). These statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2015 included in our Annual Report on Form 10-K. As used below, “we,” “our” and “us” refer to MGIC Investment Corporation’s consolidated operations or to MGIC Investment Corporation, as the context requires.

In the opinion of management the accompanying financial statements include all adjustments, consisting primarily of normal recurring accruals, necessary to fairly state our consolidated financial position and consolidated results of operations for the periods indicated. The consolidated results of operations for the interim period may not be indicative of the results that may be expected for the year ending December 31, 2016.

Reclassifications

Certain reclassifications have been made in the accompanying financial statements to 2015 amounts to conform to 2016 presentation. See Note 2 - “New Accounting Pronouncements” for a discussion of our adoption of accounting guidance related to the presentation of debt issuance costs in the first quarter of 2016, with retrospective application to prior periods.

Subsequent events

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

 
Note 2 – New Accounting Pronouncements

Adopted Accounting Standards

Presentation of Debt Issuance Costs

In April 2015, the Financial Accounting Standards Board (“FASB”) issued updated guidance related to the presentation of debt issuance costs. The new standard requires the presentation of debt issuance costs in the balance sheet as a deduction from the carrying amount of the related debt liability instead of a deferred charge, consistent with the treatment of debt discounts. The updated guidance was effective for reporting periods beginning after December 15, 2015. The adoption of this guidance as of March 31, 2016 has been applied retrospectively to prior periods. See Note 3 - “Debt” for the reclassification made to our consolidated balance sheet as of December 31, 2015. The adoption of this guidance had no impact on our statements of operations or retained earnings.

Accounting for Share-Based Compensation When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period

In June 2014, the FASB issued updated guidance to resolve diversity in practice concerning employee share-based compensation that contains performance targets that could be achieved after the requisite service period. No explicit guidance on how to account for these types of performance share-based compensation awards existed prior to this update. The updated guidance requires that a performance target that affects vesting and that can be achieved after the requisite service period be treated as a performance condition. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the periods for which service has been rendered. If the performance target becomes probable of being achieved before the end of the service period, the remaining unrecognized compensation cost for which requisite service has not yet been rendered is recognized prospectively over the remaining service period. The total amount of compensation cost recognized during and after the service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The updated guidance was effective for reporting periods after December 15, 2015. The adoption of this guidance as of March 31, 2016, with application to awards granted in 2016, is not expected to have a material impact on our consolidated financial statements.



9 | MGIC Investment Corporation - Q2 2016

Prospective Accounting Standards

Measurement of Credit Losses on Financial Instruments

In June 2016, the FASB issued updated guidance that requires immediate recognition of estimated credit losses expected to occur over the remaining life of many financial instruments. Entities will be required to utilize a current expected credit losses (“CECL”) methodology that incorporates their forecasts of future economic conditions into its loss estimate unless such forecast is not reasonable and supportable in which case the entity will revert to historical loss experience. Any allowance for CECL reduces the amortized cost basis of the financial instrument to the amount an entity expects to collect. For most financial instruments in scope, recognition of credit losses will generally accelerate as entities will effectively recognize losses when the instruments are originated or purchased. The updated guidance is not prescriptive about certain aspects of estimating expected credit losses, including the specific methodology to use, and therefore will require significant judgment in application. The updated guidance is effective for annual periods beginning after December 15, 2019, including interim periods within those annual periods. Early adoption is permitted for annual and interim periods in fiscal years beginning after December 15, 2018. We are currently evaluating the impacts the adoption of this guidance will have on our consolidated financial statements, but do not expect it to have a material impact on our consolidated financial statements or disclosures.

Improvements to Employee Share-Based Compensation Accounting

In March 2016, the FASB issued updated guidance that simplifies several aspects of the accounting for employee share-based compensation including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification of related amounts within the statement of cash flows. The updated guidance requires that, prospectively, all tax effects related to share-based compensation be made through the statement of operations at the time of settlement as opposed to excess tax benefits being recognized in paid-in capital under the current guidance. The updated guidance also removes the requirement to delay recognition of a tax benefit until it reduces current taxes payable. This change is required to be applied on a modified retrospective basis, with a cumulative effect adjustment to opening retained earnings. Additionally, all tax related cash flows resulting from share-based compensation are to be reported as operating activities on the statement of cash flows, a change from the existing requirement to present tax benefits as an inflow from financing activities and an outflow from operating activities. Finally, for tax withholding purposes, entities will be allowed to withhold an amount of shares up to the employee’s maximum individual tax rate (as opposed to the minimum statutory tax rate) in the relevant jurisdiction without resulting in liability classification of the award. The change in withholding requirements will be applied on a modified retrospective approach. The updated guidance is effective for annual periods beginning after December 15, 2016, and interim periods within those
 
annual periods. Early adoption is permitted in any interim or annual period. We are currently evaluating the impacts the adoption of this guidance will have on our consolidated financial statements.

Recognition and Measurement of Financial Assets and Financial Liabilities

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

Disclosures about Short-Duration Contracts

In May 2015, the FASB issued updated guidance requiring expanded disclosures for insurance entities that issue short-duration contracts. The expanded disclosures are designed to provide additional insight into an insurance entity’s ability to underwrite and anticipate costs associated with claims. The disclosures include information about incurred and paid claims development, on a net of reinsurance basis, for the number of years claims incurred typically remain outstanding, not to exceed ten years. Each period presented in the disclosure about claims development that precedes the current reporting periods is considered supplementary information. The expanded disclosures also include more transparent information about significant changes in methodologies and assumptions used to estimate claims, and the timing, frequency, and severity of claims. The disclosures required by this update are effective for annual periods beginning after December 31, 2015, and interim periods within annual periods beginning after December 31, 2016, and is to be applied retrospectively. We are evaluating the applicability and impact, if any, of the new disclosure requirements.




MGIC Investment Corporation - Q2 2016 | 10

Note 3 – Debt


2016 debt transactions
During the first half of 2016, market conditions allowed us to complete a series of transactions that repositioned the maturity profile of our debt and lowered our interest expense. These transactions, including the amounts and accounting impacts, are discussed below.

5% Convertible Senior Notes
During the first six months of 2016, we purchased $188.5 million in par value of our 5% Convertible Senior Notes (the “5% Notes”) due in 2017 at a purchase price of $195.5 million, plus accrued interest using funds held at our holding company. The excess of the purchase price over par value is reflected as a loss on debt extinguishment and outstanding debt issuance costs on the purchased debt were recognized as interest expense on our consolidated statement of operations for the three and six months ended June 30, 2016. The purchases of the 5% Notes reduced our potentially dilutive shares by approximately 14.0 million shares.

9% Convertible Junior Subordinated Debentures
In February 2016, MGIC purchased $132.7 million of par value of our 9% Convertible Junior Subordinated Debentures (the “9% Debentures”) due in 2063 at a purchase price of $150.7 million, plus accrued interest. The 9% Debentures include a conversion feature that allows us, at our option, to make a cash payment to converting holders in lieu of issuing shares of common stock upon conversion of the 9% Debentures. The accounting standards applicable to extinguishment of debt with a cash conversion feature require the consideration paid to be allocated between the extinguishment of the liability component and reacquisition of the equity component. The purchase of the 9% Debentures resulted in an $8.3 million loss on debt extinguishment on the consolidated statement of operations for the six months ended June 30, 2016, which represents the difference between the fair value and the carrying value of the liability component on the purchase date. In addition, our shareholders’ equity was separately reduced by $9.8 million related to the reacquisition of the equity component. For GAAP accounting purposes, the 9% Debentures owned by MGIC are considered retired and are eliminated in our consolidated financial statements and the underlying common stock equivalents, approximately 9.8 million shares, are not included in the computation of diluted shares.

Federal Home Loan Bank Advance
In February 2016, MGIC borrowed $155.0 million in the form of a fixed rate advance from the Federal Home Loan Bank (“FHLB”) (the “Advance”) to provide funds used to purchase the 9% Debentures. Interest on the Advance is payable monthly at an annual rate, fixed for the term of the Advance, of 1.91%. The principal of the Advance matures
 
on February 10, 2023. MGIC may prepay the Advance at any time. Such prepayment would be below par if interest rates have risen after the Advance was originated, or above par if interest rates have declined. The Advance is secured by eligible collateral whose market value must be maintained at 102% of the principal balance of the Advance. MGIC provided eligible collateral from its investment portfolio.

Accounting standard update
As of March 31, 2016 we adopted the accounting update related to the presentation of debt issuance costs in the financial statements. The change in accounting guidance has been applied retrospectively to prior periods. As a result, a reclassification of approximately $11.2 million of debt issuance costs was made on our December 31, 2015 balance sheet, resulting in a reduction to other assets and a reduction to long-term debt; there was no impact on our consolidated statement of operations or retained earnings.

The impact of the reclassification of debt issuance costs on our outstanding debt obligations as of December 31, 2015 is as follows.
 
 
December 31, 2015
(In millions)
 
As previously reported
 
Adjustment
 
As Adjusted
Convertible Senior Notes, interest at 5% per annum, due May 2017
 
$
333.5

 
$
(2.0
)
 
$
331.5

Convertible Senior Notes, interest at 2% per annum, due April 2020
 
500.0

 
(9.2
)
 
490.8

Convertible Junior Subordinated Debentures, interest at 9% per annum, due April 2063
 
389.5

 
—

 
389.5

Total long-term debt
 
$
1,223.0

 
$
(11.2
)
 
$
1,211.8




11 | MGIC Investment Corporation - Q2 2016

The principal amounts of our debt obligations and their aggregate carrying value as of June 30, 2016 and December 31, 2015 were as follows.
(In millions)
 
June 30,
2016
 
December 31,
2015
FHLB Advance, interest at 1.91% per annum, due February 2023
 
$
155.0

 
$
—

Convertible Senior Notes, interest at 5% per annum, due May 2017 (1)
 
145.0

 
333.5

Convertible Senior Notes, interest at 2% per annum, due April 2020 (2) (3)
 
500.0

 
500.0

Convertible Junior Subordinated Debentures, interest at 9% per annum, due April 2063 (4)
 
256.9

 
389.5

Long-term debt, par value
 
1,056.9

 
1,223.0

Less: Debt issuance costs on convertible senior notes
 
(8.7
)
 
(11.2
)
Long-term debt, carrying value
 
$
1,048.2

 
$
1,211.8

(1) 
Convertible at any time prior to maturity at the holder’s option, at an initial conversion rate, which is subject to adjustment, of 74.4186 shares per $1,000 principal amount, representing an initial conversion price of approximately $13.44 per share.

(2) 
Prior to January 1, 2020, the 2% Convertible Senior Notes are convertible only upon satisfaction of one or more conditions. One such condition is that during any calendar quarter commencing after March 31, 2014, the last reported sale price of our common stock for each of at least 20 trading days during the 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter be greater than or equal to 130% of the applicable conversion price on each applicable trading day. The 2% Notes are convertible at an initial conversion rate, which is subject to adjustment, of 143.8332 shares per $1,000 principal amount, representing an initial conversion price of approximately $6.95 per share. 130% of such conversion price is $9.03. On or after January 1, 2020, holders may convert their notes irrespective of satisfaction of the conditions.

(3) 
Prior to April 10, 2017, the notes will not be redeemable. On any business day on or after April 10, 2017 we may redeem for cash all or part of the notes, at our option, at a redemption rate equal to 100% of the principal amount of the notes being redeemed, plus any accrued and unpaid interest, if the closing sale price of our
 
common stock exceeds 130% of the then prevailing conversion price of the notes for each of at least 20 of the 30 consecutive trading days preceding notice of the redemption.

(4) 
Convertible at any time prior to maturity at the holder’s option, at an initial conversion rate, which is subject to adjustment, of 74.0741 shares per $1,000 principal amount, representing an initial conversion price of approximately $13.50 per share. If a holder elects to convert their debentures, deferred interest owed on the debentures being converted is also converted into shares of our common stock. The conversion rate for any deferred interest is based on the average price that our shares traded at during a 5-day period immediately prior to the election to convert. In lieu of issuing shares of common stock upon conversion of the debentures, we may, at our option, make a cash payment to converting holders for all or some of the shares of our common stock otherwise issuable upon conversion.

The Convertible Senior Notes and Convertible Junior Subordinated Debentures are obligations of our holding company, MGIC Investment Corporation, and not of its subsidiaries. As of June 30, 2016, we had approximately $217 million in cash and investments at our holding company. The net unrealized gains on our holding company investment portfolio were approximately $0.5 million as of June 30, 2016. The modified duration of the holding company investment portfolio, excluding cash and cash equivalents, was 1.4 years at June 30, 2016.
Interest payments on our debt obligations appear below.
 
 
Six Months Ended June 30,
(In millions)
 
2016
 
2015
FHLB Advance, interest at 1.91% per annum, due February 2023
 
$
0.9

 
$
—

Senior Notes, interest at 5.375% per annum, due November 2015
 
—

 
1.7

Convertible Senior Notes, interest at 5% per annum, due May 2017
 
6.9

 
8.6

Convertible Senior Notes, interest at 2% per annum, due April 2020
 
5.0

 
5.0

Convertible Junior Subordinated Debentures, interest at 9% per annum, due April 2063
 
15.9

 
17.5

Total interest payments
 
$
28.7

 
$
32.8





MGIC Investment Corporation - Q2 2016 | 12

Note 4 – Reinsurance

The effect of all reinsurance agreements on premiums earned and losses incurred is as follows:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands)
 
2016
 
2015
 
2016
 
2015
Premiums earned:
 
 
 
 
 
 
 
 
Direct
 
$
263,566

 
$
240,171

 
$
518,953

 
$
485,919

Assumed
 
182

 
308

 
390

 
646

Ceded
 
(32,292
)
 
(26,971
)
 
(66,546
)
 
(55,769
)
Net premiums earned
 
$
231,456

 
$
213,508

 
$
452,797

 
$
430,796

 
 
 
 
 
 
 
 
 
Losses incurred:
 
 
 
 
 
 
 
 
Direct
 
$
54,863

 
$
95,710

 
$
147,295

 
$
183,746

Assumed
 
339

 
198

 
440

 
766

Ceded
 
(8,612
)
 
(5,670
)
 
(16,133
)
 
(12,489
)
Net losses incurred
 
$
46,590

 
$
90,238

 
$
131,602

 
$
172,023


Quota share reinsurance
Effective July 1, 2015, we entered into a quota share reinsurance agreement (“2015 QSR Transaction”) and commuted our prior 2013 quota share reinsurance agreement (“2013 QSR Transaction”). The group of unaffiliated reinsurers are the same under our 2015 QSR Transaction as our prior 2013 QSR Transaction and each has an insurer financial strength rating of A- or better by Standard and Poor’s Rating Services, A.M. Best or both. The 2015 QSR Transaction provides coverage on policies that were in the 2013 QSR Transaction; additional qualifying in force policies as of the agreement effective date which either had no history of defaults, or where a single default had been cured for twelve or more months at the agreement effective date; and all qualifying new insurance written through December 31, 2016. The agreement cedes losses incurred and premiums on or after the effective date through December 31, 2024, at which time the agreement expires.

The 2015 QSR Transaction increased the amount of our insurance in force covered by reinsurance and will result in an increase in the amount of premiums and losses ceded. A higher level of losses ceded will reduce our profit commission and in turn will reduce our premium yield. Early termination of the agreement can be elected by us effective December 31, 2018 for a fee, or under specified scenarios for no fee upon prior written notice, including if we will receive less than 90% of the full credit amount under
 
the private mortgage insurer eligibility requirements (“PMIERs”) of Fannie Mae and Freddie Mac (collectively, the “GSEs”) for the risk ceded in any required calculation period. The structure of the 2015 QSR Transaction is a 30% quota share for all policies covered, with a 20% ceding commission as well as a profit commission. Generally, under the 2015 QSR Transaction, we will receive a profit commission provided that the loss ratio on the loans covered under the agreement remains below 60%.

A summary of our quota share reinsurance agreements, excluding captive agreements, for the three and six months ended June 30, 2016 and 2015 appears as follows.
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands)
 
2016
 
2015
 
2016
 
2015
2013 QSR Transaction
 
 
 
 
 
 
 
 
Ceded premiums written, net of profit commission
 
n/a

 
$
30,919

 
n/a

 
$
58,055

Ceded premiums earned, net of profit commission
 
n/a

 
22,954

 
n/a

 
47,567

Ceded losses incurred
 
n/a

 
1,187

 
n/a

 
6,060

Ceding commissions (1)
 
n/a

 
11,681

 
n/a

 
21,803

Profit commission
 
n/a

 
27,483

 
n/a

 
50,957

 
 
 
 
 
 
 
 
 
2015 QSR Transaction (Effective July 1, 2015)
Ceded premiums written, net of profit commission (2)
 
$
29,961

 
n/a

 
$
61,627

 
n/a

Ceded premiums earned, net of profit commission (2)
 
29,961

 
n/a

 
61,627

 
n/a

Ceded losses incurred
 
6,070

 
n/a

 
14,583

 
n/a

Ceding commissions (1)
 
11,946

 
n/a

 
23,522

 
n/a

Profit commission
 
29,767

 
n/a

 
55,982

 
n/a

(1) 
Ceding commissions are reported within Other underwriting and operating expenses, net on the consolidated statements of operations.
(2) 
Effective July 1, 2015 premiums are ceded on an earned and received basis as defined in our 2015 QSR Transaction.

Under the terms of the 2015 QSR Transaction, reinsurance premiums, ceding commission and profit commission are settled net on a quarterly basis. The reinsurance premium due after deducting the related ceding commission and profit commission is reported within “Other liabilities” on the consolidated balance sheets.



13 | MGIC Investment Corporation - Q2 2016


The reinsurance recoverable on loss reserves related to our 2015 QSR Transaction was $22 million as of June 30, 2016 and $11 million as of December 31, 2015. The reinsurance recoverable balance is secured by funds on deposit from the reinsurers which are based on the funding requirements of PMIERs that address ceded risk.

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

Captive agreements were generally written on an annual book of business and each captive reinsurer is required to maintain a separate trust account to support its combined reinsured risk on all annual books. MGIC is the sole beneficiary of the trusts, and the trust accounts are made up of capital deposits by the captive reinsurers, premium deposits by MGIC, and investment income earned. The reinsurance recoverable on loss reserves related to captive agreements was $23 million as of June 30, 2016, which was supported by $109 million of trust assets, while as of December 31, 2015, the reinsurance recoverable on loss reserves related to captive agreements was $34 million, which was supported by $137 million of trust assets.

Note 5 – Litigation and Contingencies

Before paying a claim, we review the loan and servicing files to determine the appropriateness of the claim amount. All of our insurance policies provide that we can reduce or deny a claim if the servicer did not comply with its obligations under our insurance policy. We call such reduction of claims “curtailments.” In 2015 and the first half of 2016, curtailments reduced our average claim paid by approximately 6.7% and 5.5%, respectively.

When reviewing the loan file associated with a claim, we may determine that we have the right to rescind coverage on the loan. (In our SEC reports, we refer to insurance rescissions and denials of claims collectively as “rescissions” and variations of that term.) In recent quarters, approximately 5% of claims received in a quarter have been resolved by rescissions, down from the peak of approximately 28% in the first half of 2009. Our loss reserving methodology incorporates our estimates of future rescissions,
 
curtailments, and reversals of rescissions and curtailments. A variance between ultimate actual rescission, curtailment and reversal rates and our estimates, as a result of the outcome of litigation, settlements or other factors, could materially affect our losses.

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

Until a liability associated with settlement discussions or legal proceedings becomes probable and can be reasonably estimated, we consider our claim payment or rescission resolved for financial reporting purposes. Under ASC 450-20, an estimated loss from such discussions and proceedings is accrued for only if we determine that the loss is probable and can be reasonably estimated. In such cases, we have recorded our best estimate of our probable loss. If we are not able to implement settlements we consider probable, we intend to defend MGIC vigorously against any related legal proceedings.

In addition to matters for which we have recorded a probable loss, we are involved in other discussions and/or proceedings with insureds with respect to our claims paying practices. Although it is reasonably possible that when these matters are resolved we will not prevail in all cases, we are unable to make a reasonable estimate or range of estimates of the potential liability. We estimate the maximum exposure associated with matters where a loss is reasonably possible to be approximately $193 million, although we believe (but can give no assurance that) we will ultimately resolve these matters for significantly less than this amount. This estimate of our maximum exposure does not include interest or consequential or exemplary damages.

Mortgage insurers, including MGIC, have been involved in litigation and regulatory actions related to alleged violations of the anti-referral fee provisions of the Real Estate Settlement Procedures Act, which is commonly known as RESPA, and the notice provisions of the Fair Credit Reporting Act, which is commonly known as FCRA.

For MGIC, while these proceedings in the aggregate have not resulted in material liability, were there to be future proceedings under these laws, there can be no assurance that the outcome would not have a material adverse affect on us. In addition, various regulators, including the CFPB, state insurance commissioners and state attorneys general may bring other actions seeking various forms of relief in connection with alleged violations of RESPA. The insurance law provisions of many states prohibit paying for the referral of insurance business and provide various mechanisms to enforce this prohibition. While we believe our practices are in conformity with applicable laws and regulations, it is not possible to predict the eventual scope, duration or outcome of any such reviews or investigations nor is it possible to predict their effect on us or the mortgage insurance industry.



MGIC Investment Corporation - Q2 2016 | 14

Through a non-insurance subsidiary, we utilize our underwriting skills to provide an outsourced underwriting service to our customers known as contract underwriting. As part of the contract underwriting activities, that subsidiary is responsible for the quality of the underwriting decisions in accordance with the terms of the contract underwriting agreements with customers. That subsidiary may be required to provide certain remedies to its customers if certain standards relating to the quality of our underwriting work are not met, and we have an established reserve for such future obligations. Claims for remedies may be made a number of years after the underwriting work was performed. Beginning in the second half of 2009, our subsidiary experienced an increase in claims for contract underwriting remedies, which continued throughout 2012. The underwriting remedy expense for 2015 was approximately $1 million, but may increase in the future.

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

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

Note 6 – Earnings per Share
Basic earnings per share (“EPS”) is calculated by dividing net income by the weighted average number of common shares outstanding during the reporting period. Diluted EPS includes the components of basic EPS and also gives effect to dilutive common equivalent shares outstanding during the reporting period. We calculate diluted EPS using the treasury stock method for unvested restricted stock, and the if-converted method for convertible debt instruments. For unvested restricted stock, assumed proceeds under the treasury stock method would include unamortized compensation expense and windfall tax benefits or shortfalls. The determination of potentially issuable shares from our convertible debt instruments does not consider satisfaction of the conversion requirements and the shares are included in the determination of diluted EPS as of the beginning of the period, if dilutive. In addition, interest expense, net of tax, related to dilutive convertible debt instruments is added back to earnings in calculating diluted EPS.
 
The following table reconciles the numerators and denominators used to calculate basic and diluted EPS and also indicates the number of antidilutive securities.
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands, except per share data)
 
2016
 
2015
 
2016
 
2015
Basic earnings per share:
 
 
 
 
 
 
 
 
Net income
 
$
109,221

 
$
113,654

 
$
178,412

 
$
246,730

Weighted average common shares outstanding
 
340,678

 
339,705

 
340,411

 
339,406

Basic income per share
 
$
0.32

 
$
0.33

 
$
0.52

 
$
0.73

 
 
 
 
 
 
 
 
 
Diluted earnings per share:
 
 
 
 
 
 
 
 
Net income
 
$
109,221

 
$
113,654

 
$
178,412

 
$
246,730

Interest expense, net of tax (1):
 
 
 
 
 
 
 
 
2% Convertible Senior Notes due 2020
 
1,982

 
3,049

 
3,964

 
6,098

5% Convertible Senior Notes due 2017
 
1,728

 
4,692

 
4,406

 
9,384

9% Convertible Junior Subordinated Debentures due 2063
 
3,757

 
—

 
8,379

 
—

Diluted income available to common shareholders
 
$
116,688

 
$
121,395

 
$
195,161

 
$
262,212

 
 
 
 
 
 
 
 
 
Weighted average shares - basic
 
340,678

 
339,705

 
340,411

 
339,406

Effect of dilutive securities:
 
 
 
 
 
 
 
 
Unvested restricted stock units
 
1,209

 
1,831

 
1,444

 
2,203

2% Convertible Senior Notes due 2020
 
71,917

 
71,917

 
71,917

 
71,917

5% Convertible Senior Notes due 2017
 
13,307

 
25,674

 
15,449

 
25,674

9% Convertible Junior Subordinated Debentures due 2063
 
19,028

 
—

 
21,133

 
—

Weighted average shares - diluted
 
446,139

 
439,127

 
450,354

 
439,200

Diluted income per share
 
$
0.26

 
$
0.28

 
$
0.43

 
$
0.60

 
 
 
 
 
 
 
 
 
Antidilutive securities (in millions)
 
—

 
28.9

 
—

 
28.9

(1) 
Due to the valuation allowance recorded against deferred tax assets, the three and six months ended June 30, 2015 were not tax effected. The three and six months ended June 30, 2016 have been tax effected at a rate of 35%.



15 | MGIC Investment Corporation - Q2 2016

Note 7 – Investments
 



The amortized cost, gross unrealized gains and losses and fair value of the investment portfolio at June 30, 2016 and December 31, 2015 are shown below.
June 30, 2016
(In thousands)
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses (1)
 
Fair Value
U.S. Treasury securities and obligations of U.S. government corporations and agencies
 
$
59,860

 
$
2,276

 
$
(806
)
 
$
61,330

Obligations of U.S. states and political subdivisions
 
1,968,194

 
109,789

 
(531
)
 
2,077,452

Corporate debt securities
 
1,704,917

 
31,769

 
(6,721
)
 
1,729,965

Asset-backed securities
 
104,221

 
236

 
(50
)
 
104,407

Residential mortgage-backed securities
 
241,314

 
600

 
(3,574
)
 
238,340

Commercial mortgage-backed securities
 
281,502

 
3,547

 
(891
)
 
284,158

Collateralized loan obligations
 
61,355

 
44

 
(849
)
 
60,550

Total debt securities
 
4,421,363

 
148,261

 
(13,422
)
 
4,556,202

Equity securities
 
6,228

 
3,651

 
(3
)
 
9,876

Total investment portfolio
 
$
4,427,591

 
$
151,912

 
$
(13,425
)
 
$
4,566,078





 
December 31, 2015
(In thousands)
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses (1)
 
Fair Value
U.S. Treasury securities and obligations of U.S. government corporations and agencies
 
$
160,393

 
$
2,133

 
$
(1,942
)
 
$
160,584

Obligations of U.S. states and political subdivisions
 
1,766,407

 
33,410

 
(7,290
)
 
1,792,527

Corporate debt securities
 
2,046,697

 
2,836

 
(44,770
)
 
2,004,763

Asset-backed securities
 
116,764

 
56

 
(203
)
 
116,617

Residential mortgage-backed securities
 
265,879

 
161

 
(8,392
)
 
257,648

Commercial mortgage-backed securities
 
237,304

 
162

 
(3,975
)
 
233,491

Collateralized loan obligations
 
61,345

 
3

 
(1,148
)
 
60,200

Debt securities issued by foreign sovereign governments
 
29,359

 
2,474

 
(102
)
 
31,731

Total debt securities
 
4,684,148

 
41,235

 
(67,822
)
 
4,657,561

Equity securities
 
5,625

 
38

 
(18
)
 
5,645

Total investment portfolio
 
$
4,689,773

 
$
41,273

 
$
(67,840
)
 
$
4,663,206

(1) 
At June 30, 2016 and December 31, 2015, there were no other-than-temporary impairment losses recorded in other comprehensive income.

During the first quarter of 2016, we substantially liquidated our Australian entities and repatriated most assets, including proceeds from the monetization of our Australian investment portfolio. As of June 30, 2016 we held no investments in foreign sovereign governments.

As discussed in Note 3 - “Debt” we are required to maintain collateral of at least 102% of the outstanding principal balance of the Advance. As of June 30, 2016 we pledged eligible collateral with a total fair value of $166.6 million.



MGIC Investment Corporation - Q2 2016 | 16

The amortized cost and fair values of debt securities at June 30, 2016, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Because most asset-backed and mortgage-backed securities and collateralized loan obligations provide for periodic payments throughout their lives, they are listed below in separate categories.
June 30, 2016
 
 
 
 
(In thousands)
 
Amortized Cost
 
Fair Value
Due in one year or less
 
$
272,706

 
$
273,365

Due after one year through five years
 
1,143,174

 
1,163,590

Due after five years through ten years
 
1,128,998

 
1,156,648

Due after ten years
 
1,188,093

 
1,275,144

 
 
$
3,732,971

 
$
3,868,747

 
 
 
 
 
Asset-backed securities
 
104,221

 
104,407

Residential mortgage-backed securities
 
241,314

 
238,340

Commercial mortgage-backed securities
 
281,502

 
284,158

Collateralized loan obligations
 
61,355

 
60,550

Total as of June 30, 2016
 
$
4,421,363

 
$
4,556,202



At June 30, 2016 and December 31, 2015, the investment portfolio had gross unrealized losses of $13.4 million and $67.8 million, respectively.  For those securities in an unrealized loss position, the length of time the securities were in such a position, as measured by their month-end fair values, is as follows:
June 30, 2016
 
Less Than 12 Months
 
12 Months or Greater
 
Total
(In thousands)
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
U.S. Treasury securities and obligations of U.S. government corporations and  agencies
 
$
8,996

 
$
(806
)
 
$
—

 
$
—

 
$
8,996

 
$
(806
)
Obligations of U.S. states and political subdivisions
 
30,347

 
(303
)
 
15,842

 
(228
)
 
46,189

 
(531
)
Corporate debt securities
 
110,610

 
(2,341
)
 
167,209

 
(4,381
)
 
277,819

 
(6,722
)
Asset-backed securities
 
13,440

 
(45
)
 
8,047

 
(5
)
 
21,487

 
(50
)
Residential mortgage-backed securities
 
2,383

 
(68
)
 
203,939

 
(3,505
)
 
206,322

 
(3,573
)
Commercial mortgage-backed securities
 
33,169

 
(553
)
 
38,382

 
(338
)
 
71,551

 
(891
)
Collateralized loan obligations
 
—

 
—

 
52,050

 
(849
)
 
52,050

 
(849
)
Equity securities
 
—

 
—

 
154

 
(3
)
 
154

 
(3
)
Total
 
$
198,945

 
$
(4,116
)
 
$
485,623

 
$
(9,309
)
 
$
684,568

 
$
(13,425
)




17 | MGIC Investment Corporation - Q2 2016

December 31, 2015
 
Less Than 12 Months
 
12 Months or Greater
 
Total
(In thousands)
 
Fair Value
 
Unrealized
 Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
 Losses
U.S. Treasury securities and obligations of U.S. government corporations and agencies
 
$
60,548

 
$
(1,467
)
 
$
1,923

 
$
(475
)
 
$
62,471

 
$
(1,942
)
Obligations of U.S. states and political   subdivisions
 
417,615

 
(6,404
)
 
37,014

 
(886
)
 
454,629

 
(7,290
)
Corporate debt securities
 
1,470,628

 
(38,519
)
 
114,982

 
(6,251
)
 
1,585,610

 
(44,770
)
Asset-backed securities
 
86,604

 
(173
)
 
5,546

 
(30
)
 
92,150

 
(203
)
Residential mortgage-backed securities
 
35,064

 
(312
)
 
209,882

 
(8,080
)
 
244,946

 
(8,392
)
Commercial mortgage-backed securities
 
134,488

 
(2,361
)
 
69,927

 
(1,614
)
 
204,415

 
(3,975
)
Collateralized loan obligations
 
—

 
—

 
51,750

 
(1,148
)
 
51,750

 
(1,148
)
Debt securities issued by foreign sovereign governments
 
4,463

 
(102
)
 
—

 
—

 
4,463

 
(102
)
Equity securities
 
355

 
(8
)
 
171

 
(10
)
 
526

 
(18
)
Total
 
$
2,209,765

 
$
(49,346
)
 
$
491,195

 
$
(18,494
)
 
$
2,700,960

 
$
(67,840
)
The unrealized losses in all categories of our investments at June 30, 2016 and December 31, 2015 were primarily caused by the difference in interest rates at each respective period, compared to interest rates at the time of purchase. There were 211 and 303 securities in an unrealized loss position at June 30, 2016 and December 31, 2015, respectively.

During each of the three and six months ended June 30, 2016 and 2015 there were no other-than-temporary impairments (“OTTI”) recognized.   The net realized investment gains on the investment portfolio are as follows:
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
(In thousands)
 
2016
 
2015
 
2016
 
2015
Realized investment gains (losses) on investments:
 
 
 
 
 
 
 
 
Fixed maturities
 
$
831

 
$
161

 
$
3,886

 
$
26,485

Equity securities
 
5

 
5

 
6

 
8

Net realized investment gains
 
$
836

 
$
166

 
$
3,892

 
$
26,493

 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
(In thousands)
 
2016
 
2015
 
2016
 
2015
Realized investment gains (losses) on investments:
 
 
 
 
 
 
 
 
Gains on sales
 
$
1,404

 
$
785

 
$
5,509

 
$
27,991

Losses on sales
 
(568
)
 
(619
)
 
(1,617
)
 
(1,498
)
Net realized investment gains
 
$
836

 
$
166

 
$
3,892

 
$
26,493


 
Note 8 – Fair Value Measurements

Our estimates of fair value for financial assets and financial liabilities are based on the framework established in the fair value accounting guidance.  The framework is based on the inputs used in valuation, gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuations when available.

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




MGIC Investment Corporation - Q2 2016 | 18

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

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

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

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

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

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

Obligations of U.S. States & Political Subdivisions are evaluated by tracking, capturing, and analyzing quotes for active issues and trades reported via the Municipal Securities Rulemaking Board records. Daily briefings and reviews of current economic conditions, trading levels, spread relationships, and the slope of the yield curve provide further data for evaluation.

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

Commercial Mortgage-Backed Securities are evaluated using valuation techniques that reflect market participants’ assumptions and maximize the use of relevant observable inputs including quoted prices for similar assets, benchmark yield curves and market corroborated inputs. Evaluation utilizes regular reviews of the inputs for securities covered, including executed trades, broker quotes, credit information, collateral attributes and/or cash flow waterfall as applicable.

Asset-Backed Securities are evaluated using spreads and other information solicited from market buy- and sell-side sources, including primary and secondary dealers, portfolio managers, and research analysts. Cash flows are generated for each tranche, benchmark yields are determined, and deal collateral performance and tranche level attributes including market color as available are used, resulting in tranche-specific spreads.

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





19 | MGIC Investment Corporation - Q2 2016

Fair value measurements for assets measured at fair value included the following as of June 30, 2016 and December 31, 2015:
June 30, 2016
(In thousands)
 
Total Fair Value
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
U.S. Treasury securities and obligations of U.S. government corporations and  agencies
 
$
61,330

 
$
14,678

 
$
46,652

 
$
—

Obligations of U.S. states and political subdivisions
 
2,077,452

 
—

 
2,076,396

 
1,056

Corporate debt securities
 
1,729,965

 
—

 
1,729,965

 
—

Asset-backed securities
 
104,407

 
—

 
104,407

 
—

Residential mortgage-backed securities
 
238,340

 
—

 
238,340

 
—

Commercial mortgage-backed securities
 
284,158

 
—

 
284,158

 
—

Collateralized loan obligations
 
60,550

 
—

 
60,550

 
—

Total debt securities
 
4,556,202

 
14,678

 
4,540,468

 
1,056

Equity securities (1)
 
9,876

 
2,936

 
—

 
6,940

Total investment portfolio
 
$
4,566,078

 
$
17,614

 
$
4,540,468

 
$
7,996

Real estate acquired (2)
 
$
9,642

 
$
—

 
$
—

 
$
9,642

 
December 31, 2015
(In thousands)
 
Total Fair Value
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
U.S. Treasury securities and obligations  of U.S. government corporations and   agencies
 
$
160,584

 
$
46,197

 
$
114,387

 
$
—

Obligations of U.S. states and political  subdivisions
 
1,792,527

 
—

 
1,791,299

 
1,228

Corporate debt securities
 
2,004,763

 
—

 
2,004,763

 
—

Asset-backed securities
 
116,617

 
—

 
116,617

 
—

Residential mortgage-backed securities
 
257,648

 
—

 
257,648

 
—

Commercial mortgage-backed securities
 
233,491

 
—

 
233,491

 
—

Collateralized loan obligations
 
60,200

 
—

 
60,200

 
—

Debt securities issued by foreign  sovereign governments
 
31,731

 
31,731

 
—

 
—

Total debt securities
 
4,657,561

 
77,928

 
4,578,405

 
1,228

Equity securities (1)
 
5,645

 
2,790

 
—

 
2,855

Total investment portfolio
 
$
4,663,206

 
$
80,718

 
$
4,578,405

 
$
4,083

Real estate acquired (2)
 
$
12,149

 
$
—

 
$
—

 
$
12,149

(1) 
Certain equity securities in Level 3 are carried at cost, which approximates fair value.
(2) 
Real estate acquired through claim settlement, which is held for sale, is reported in Other assets on the consolidated balance sheets.
There were no transfers of securities between Level 1 and Level 2 during the first six months of 2016.





MGIC Investment Corporation - Q2 2016 | 20

For assets measured at fair value using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances for the three and six months ended June 30, 2016 and 2015 is shown in the following tables. There were no transfers into or out of Level 3 in those periods and there were no losses included in earnings for those periods attributable to the change in unrealized losses on assets still held at the end of the applicable period.
Three Months Ended June 30, 2016
(In thousands)
 
Debt Securities
 
Equity Securities
 
Total Investments
 
Real Estate Acquired
Balance at March 31, 2016
 
$
1,192

 
$
3,421

 
$
4,613

 
$
12,849

Total realized/unrealized gains (losses):
 
 

 
 

 
 

 
 

Included in other comprehensive income
 
—

 
3,519

 
3,519

 
—

Included in earnings and reported as losses incurred, net
 
—

 
—

 
—

 
651

Purchases
 
—

 
—

 
—

 
6,748

Sales
 
(136
)
 
—

 
(136
)
 
(10,606
)
Balance at June 30, 2016
 
$
1,056

 
$
6,940

 
$
7,996

 
$
9,642

Three Months Ended June 30, 2015
(In thousands)
 
Debt
Securities
 
Equity
Securities
 
Total
Investments
 
Real Estate
Acquired
Balance at March 31, 2015
 
$
1,791

 
$
321

 
$
2,112

 
$
10,897