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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
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Date of Report
(Date of earliest
event reported): March 13, 2002
MGIC Investment Corporation
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(Exact name of registrant as specified in its charter)
Wisconsin 1-10816 39-1486475
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(State or other (Commission File (IRS Employer
jurisdiction of Number) Identification No.)
incorporation)
MGIC Plaza, 250 East Kilbourn Avenue
Milwaukee, Wisconsin 53202
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(Address of principal executive offices including zip code)
(414) 347-6480
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(Registrant's telephone number)
Item 5. Other Events and Regulation FD Disclosure.
The Registrant is filing this Current Report on Form 8-K to file, among
other material, its consolidated financial statements for the three years ended
December 31, 2001 (filed as Exhibit 99.1) and its Management's Discussion and
Analysis (filed as Exhibit 99.2), which discusses its results of operations for
December 31, 2001 compared to December 31, 2000 and December 31, 2000 compared
to December 31, 1999 and its financial condition and liquidity and capital
resources at December 31, 2001. Risk Factors relating to the business of the
Registrant appear at the end of Management's Discussion and Analysis.
Item 7. Financial Statements and Exhibits.
(a) Not applicable.
(b) Not applicable.
(c) Exhibits.
The exhibits listed in the accompanying Exhibit Index
are filed as part of this Current Report on Form 8-K.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
MGIC INVESTMENT CORPORATION
Date: March 13, 2002 By:/s/Patrick Sinks
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Patrick Sinks
Senior Vice President and Chief
Accounting Officer
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MGIC INVESTMENT CORPORATION
EXHIBIT INDEX TO FORM 8-K
Report Dated March 13, 2002
Exhibit Number Description
(23) Consent of PricewaterhouseCoopers LLP
(99.1) Consolidated Financial Statements of the Registrant:
Consolidated statement of operations for each
of the three years in the period ended
December 31, 2001
Consolidated balance sheet at December 31, 2001
and 2000
Consolidated statement of shareholders' equity
for each of the three years in the period
ended December 31, 2001
Consolidated statement of cash flows for each
of the three years in the period ended
December 31, 2001
Notes to consolidated financial statements
Report of independent accountants
(99.2) Management's Discussion and Analysis
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CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statement on Form S-3 (No. 333-39890) of our report dated January 9, 2002 relating to the financial statements of MGIC Investment Corporation, which appears in this Current Report on Form 8-K dated March 13, 2002. PricewaterhouseCoopers LLP Milwaukee, Wisconsin March 13, 2002
Management's Discussion and Analysis
Results of Consolidated Operations
2001 Compared with 2000
Net income for 2001 was $639.1 million, compared with $542.0 million in 2000, an
increase of 18%. Diluted earnings per share was $5.93 for 2001 compared with
$5.05 in 2000. Included in diluted earnings per share for 2001 was $0.23 for
realized gains. The 2000 earnings per share included $0.01 for realized gains
and a $0.14 charge for the RESPA settlement made in the fourth quarter of 2000.
See "Other Matters" below. Earnings per share excluding amounts for realized
gains in 2000 and 2001 and excluding the RESPA settlement in 2000 was $5.70 for
2001, compared to $5.18 for 2000, an increase of 10%. Earnings per share
excluding amounts for realized gains increased 15% during the first half of 2001
compared to 2000, and earnings per share excluding amounts for realized gains
and the RESPA settlement increased 5% during the second half of 2001 compared to
the second half of 2000. 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 2001 were $1,357.8 million, an increase of 22% from the
$1,110.3 million for 2000. This increase was primarily attributable to an
increase in new business writings, which included $25.7 billion of bulk
transactions. Also contributing to the increase in revenues was an increase in
investment income resulting from strong cash flows and increases in realized
gains and other revenue. See below for a further discussion of premiums,
investment income and other revenue.
Losses and expenses for 2001 were $425.9 million, an increase of 32% from $321.5
million for the same period of 2000. The increase from last year can be
attributed to an increase in losses related to an increase in notice inventories
and an increase in expenses related to increases in insured volume and in
contract underwriting. See below for a further discussion of losses incurred and
underwriting expenses.
The amount of new primary insurance written by Mortgage Guaranty Insurance
Corporation ("MGIC") during 2001 was $86.1 billion, compared with $41.5 billion
in 2000. Refinancing activity increased to 42% of new primary insurance written
in 2001 on a flow basis (or $25.1 billion), compared to 13% in 2000 (or $4.6
billion) as a result of the decreasing mortgage interest rate environment in
2001. New primary insurance written in bulk transactions increased to 30% of new
primary insurance written in 2001 compared to 17% in 2000, reflecting the
increasing use of mortgage insurance in certain mortgage securitizations and
MGIC's share of this market. A portion of the loans insured in bulk transactions
are refinance loans.
The $86.1 billion of new primary insurance written during 2001 was offset by the
cancellation of $62.4 billion of insurance in force, and resulted in a net
increase of $23.7 billion in primary insurance in force, compared to new primary
insurance written of $41.5 billion, cancellation of $28.9 billion, and a net
increase of $12.6 billion in insurance in force during 2000. Direct primary
insurance in force was $183.9 billion at December 31, 2001, compared to $160.2
billion at December 31, 2000.
In addition to providing direct primary insurance coverage, the Company also
insures pools of mortgage loans. New pool risk written during 2001 and 2000,
which was virtually all agency pool insurance, was $411.7 million and $345.5
million, respectively. The Company's direct pool risk in force at December 31,
2001 was $2.0 billion compared to $1.7 billion at December 31, 2000.
Cancellation activity has historically been affected by the level of mortgage
interest rates, with cancellations generally moving inversely to the change in
the direction of interest rates. Cancellations increased during 2001 compared to
the cancellation levels of 2000 principally due to the lower mortgage interest
rate environment which resulted in a decrease in the MGIC persistency rate
(percentage of insurance remaining in force from one year prior) to 61.0% at
December 31, 2001, from 80.4% at December 31, 2000. Future cancellation activity
could also be somewhat higher than it otherwise would have been as a result of
legislation that went into effect in July 1999 regarding cancellation of
mortgage insurance. Cancellation activity could also increase as more of the
Company's bulk loans season. The Company anticipates that the bulk loans will
have
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materially lower persistency than the Company's flow business.
New insurance written for bulk transactions was $25.7 billion during 2001
compared to $7.0 billion for 2000 and $2.2 billion for 1999. The Company does
not anticipate that the level of growth in the bulk business during the last
three years will continue in 2002. The Company expects that the loans that are
included in bulk transactions will have delinquency and claim rates in excess of
those on the Company's flow business. While the Company believes it has priced
its bulk business to generate acceptable returns, there can be no assurance that
the assumptions underlying the premium rates adequately address the risk and
persistency of this business.
Net premiums written increased 17% to $1,036.4 million in 2001, from $887.4
million in 2000. Net premiums earned increased 17% to $1,042.3 million in 2001,
from $890.1 million in 2000. The increases were primarily a result of the growth
in insurance in force and a higher percentage of renewal premiums on products
with higher premium rates offset in part by an increase in ceded premiums to
$65.3 million in 2001, compared to $52.9 million in 2000, primarily due to an
increase in captive mortgage reinsurance.
Mortgages (newly insured during 2001 or 2000) equal to approximately 27% of
MGIC's new insurance written during 2001 were subject to captive mortgage
reinsurance and similar arrangements compared to 33% during 2000. Such
arrangements entered into during a reporting period customarily include loans
newly insured in a prior reporting period. As a result, the percentages cited
above would be lower if only the current reporting period's newly insured
mortgages subject to such arrangements were included. At December 31, 2001
approximately 24% of MGIC's risk in force was subject to captive reinsurance and
similar arrangements compared to 21% at December 31, 2000. The amount of
premiums ceded under captive mortgage reinsurance arrangements and the amount of
risk in force subject to such arrangements are expected to continue to increase.
Investment income for 2001 was $204.4 million, an increase of 14% over the
$178.5 million in 2000. This increase was primarily the result of an increase in
the amortized cost of average investment assets to $3.7 billion for 2001, from
$3.1 billion for 2000, an increase of 18%. The portfolio's average pre-tax
investment yield was 5.4% and 6.0% at December 31, 2001 and 2000, respectively.
The portfolio's average after-tax investment yield was 4.6% and 4.9% at December
31, 2001 and 2000, respectively. The Company realized gains of $37.4 million
during 2001 compared to $1.4 million in 2000, resulting primarily from the sale
of corporate and taxable municipal securities.
Other revenue, which is composed of various components, was $73.8 million in
2001, compared with $40.3 million in 2000. The increase is primarily the result
of an increase in contract underwriting revenue and increases in equity earnings
from Credit-Based Asset Servicing and Securitization LLC ("C-BASS") and Sherman
Financial Group LLC, ("Sherman"), joint ventures with Radian Group Inc.
("Radian").
C-BASS engages in the acquisition and resolution of delinquent single-family
residential mortgage loans ("mortgage loans"). C-BASS also purchases and sells
mortgage-backed securities ("mortgage securities"), interests in real estate
mortgage investment conduit residuals and performs mortgage loan servicing. In
addition, C-BASS issues mortgage-backed debt securities collateralized by
mortgage loans and mortgage securities. C-BASS's results of operations are
affected by the timing of these securitization transactions. Substantially all
of C-BASS's mortgage-related assets do not have readily ascertainable market
values and as a result their value for financial statement purposes is estimated
by the management of C-BASS. This valuation is made by C-BASS management in
connection with each release of financial statements. In the case of assets that
are residual interests in securitizations, these estimates reflect the net
present value of the future cash flows from these assets, which in turn depend
on, among other things, estimates of the level of losses on the underlying
mortgages and prepayment activity by the mortgage borrowers. Market value
adjustments could impact C-BASS's results of operations and the Company's share
of those results.
Total combined assets of C-BASS at December 31, 2001 and 2000 were approximately
$1.3 billion and
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$1.0 billion, respectively, of which approximately $1,071 million and $867
million, respectively, were mortgage-related assets, including open trades.
Total liabilities at December 31, 2001 and 2000 were approximately $981 million
and $765 million, respectively, of which approximately $938 million and $746
million, respectively, were funding arrangements, including accrued interest,
virtually all of which were short-term. For the years ended December 31, 2001
and 2000, revenues of approximately $216 million and $153 million, respectively,
and expenses of approximately $130 million and $97 million, respectively,
resulted in income before tax of approximately $86 million and $56 million,
respectively.
Sherman is engaged in the business of purchasing, servicing and securitizing
delinquent unsecured consumer assets such as credit card loans and Chapter 13
bankruptcy debt. A substantial portion of Sherman's consolidated assets are
investments in receivable portfolios that do not have readily ascertainable
market values. Initially the portfolios are valued at cost. Subsequently their
value for financial statement purposes is estimated by the management of Sherman
based on the estimated future cash flow from the portfolios. The assets are
valued by Sherman's management each time financial statements are released.
Market value adjustments could impact Sherman's results of operations and the
Company's share of those results.
Because C-BASS and Sherman are accounted for by the equity method, they are not
consolidated with the Company and their assets and liabilities do not appear in
the Company's balance sheet. The "investments in joint ventures" item in the
Company's balance sheet reflects the amount of capital contributed by the
Company to the joint ventures plus the Company's share of their net income (or
minus its share of their net loss) and minus capital distributed to the Company
by the joint ventures.
As discussed in "Note 2 -- 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 75% to $160.8 million in 2001, from $91.7 million
in 2000. The increase was due to an increase in the primary notice inventory
related to bulk default activity, which in turn was the result of the higher
volume of bulk business; the maturation of the relatively large 1998 and 1999
books of business which had entered their peak delinquency periods; and defaults
arising from the early development of the 2000 book of business. The primary
insurance notice inventory increased from 37,422 at December 31, 2000 to 54,653
at December 31, 2001 and pool notice inventory increased from 18,209 at December
31, 2000 to 23,623 at December 31, 2001. Included in the notice inventory was
the bulk notice inventory of 18,460 at December 31, 2001 and 7,533 at December
31, 2000. The default rate at December 31, 2001 was 3.46% compared to 2.58% at
December 31, 2000. Excluding bulk defaults, the default rates were 2.65% and
2.19% at December 31, 2001 and 2000, respectively. The default rate on bulk
loans were 8.59% and 9.02% at December 31, 2001 and 2000, respectively. The
Company does not view the decline in the bulk loan default rate as meaningful
and expects that each of the default rates reported above will increase in the
future. The average claim paid for 2001 was $18,607 compared to $18,977 in 2000.
The redundancy in loss reserves in 2001 of $212.1 million was relatively
consistent with 2000's redundancy of $229.0 million. Loss reserves are redundant
when the estimate of the losses that would be paid in the future on loans in the
default inventory at the end of the prior year exceeds the losses that were paid
on those loans during the subsequent year, and are deficient when the losses
paid during the subsequent year exceed the estimate. See "Note 6 -- Loss
six
Reserves" to the Company's consolidated financial statements.
At December 31, 2001, 69% of the primary insurance in force was written during
the last three years, compared to 67% at December 31, 2000. Based on all of the
loans in the Company's insurance in force, the highest claim frequency years
have typically been the third through fifth years 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 transaction loans will occur earlier than in
this historical pattern.
Underwriting and other expenses increased to $234.5 million in 2001 from $177.8
million in 2000, an increase of 32%. The increase can be attributed to increases
in both insurance and non-insurance expenses related to increased volume and
contract underwriting.
Interest expense in 2001 increased to $30.6 million from $28.8 million in 2000
due to slightly higher weighted average interest rates in 2001 compared to 2000,
and higher weighted average balances.
The consolidated insurance operations loss ratio was 15.4% for 2001 compared to
10.3% for 2000. The consolidated insurance operations expense and combined
ratios were 16.5% and 31.9%, respectively, for 2001 compared to 16.4% and 26.7%,
respectively, for 2000.
The effective tax rate was 31.4% in 2001, compared with 31.3% in 2000. During
both years, the effective tax rate was below the statutory rate of 35%,
reflecting the benefits of tax-preferenced investment income. The higher
effective tax rate in 2001 resulted from a lower percentage of total income
before tax being generated from tax-preferenced investments in 2001.
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 of related orders denying certain class members the right to intervene
to challenge certain aspects of the settlement in Downey and 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, which is known as
RESPA. There can be no assurance that the standards established by the
injunction will be determinative of compliance with RESPA were additional
litigation to be brought in the future.
The complaint in the case alleges that MGIC violated the Real Estate Settlement
Procedures Act by providing agency pool insurance, captive mortgage reinsurance,
contract underwriting and other products that were not properly priced, in
return for the referral of mortgage insurance. The complaint seeks damages of
three times the amount of the mortgage insurance premiums that have been paid
and that will be paid at the time of judgment for the mortgage insurance found
to be involved in a violation of the Real Estate Settlement Procedures Act. The
complaint also seeks injunctive relief, including prohibiting MGIC from
receiving future premium payments. If the settlement is not fully implemented,
the litigation will continue. In these circumstances, there can be no assurance
that the ultimate outcome of the litigation will not materially affect the
Company's financial position or results of operations.
In the third quarter of 2001, the Office of Federal Housing Enterprise Oversight
("OFHEO") adopted a risk-based capital stress test for the GSEs. One of the
elements of the stress test is that future 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' were
subject to a 5% reduction over the 10-year period of the stress test, while
claim payments from a `AA' rated insurer, such as
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MGIC, were subject to a 15% reduction. In February 2002, OFHEO adopted
amendments to the stress test that reduced the differential between `AAA' and
`AA' rated mortgage insurers to 5.25%. 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.
2000 Compared with 1999
Net income for 2000 was $542.0 million, compared with $470.2 million in 1999, an
increase of 15%. Diluted earnings per share was $5.05 for 2000 compared with
$4.30 in 1999. Included in diluted earnings per share for 2000 were a $0.14
charge for the RESPA settlement agreement and $0.01 for realized gains. The 1999
earnings per share included $0.02 for realized gains and $0.10 for loss reserve
reductions made in the fourth quarter of 1999. Excluding the aforementioned
amounts, earnings per share was $5.18 for 2000, compared to $4.18 for 1999, an
increase of 24%.
Total revenues for 2000 were $1,110.3 million, an increase of 11% from the
$996.8 million for 1999. This increase was primarily attributed to an
improvement in persistency, which generated an increase in renewal premiums.
Also contributing to the increase in revenues was an increase in investment
income resulting from strong cash flows. See below for a further discussion of
premiums and investment income.
Losses and expenses for 2000 were $321.5 million, an increase of 2% from $315.7
million for the same period of 1999. The increase was primarily attributed to
the RESPA settlement, offset by a decline in underwriting expenses resulting
from a decline in contract underwriting activity and an increase in deferred
insurance policy acquisition costs.
The amount of new primary insurance written by MGIC during 2000 was $41.5
billion, compared with $47.0 billion in 1999. Refinancing activity decreased to
13% of new primary insurance written in 2000, compared to 25% in 1999 as a
result of the increasing mortgage interest rate environment of the second half
of 1999 and in 2000. New insurance written for bulk transactions was 17% of new
insurance written during 2000 compared to 5% for 1999.
The $41.5 billion of new primary insurance written during 2000 was offset by the
cancellation of $28.9 billion of insurance in force, and resulted in a net
increase of $12.6 billion in primary insurance in force, compared to new primary
insurance written of $47.0 billion, cancellation of $37.4 billion, and a net
increase of $9.6 billion in insurance in force during 1999. Direct primary
insurance in force was $160.2 billion at December 31, 2000, compared to $147.6
billion at December 31, 1999.
New pool risk written during 2000 and 1999, which was virtually all agency pool
insurance, was $345.5 million and $563.8 million, respectively. The Company's
direct pool risk in force at December 31, 2000 was $1.7 billion compared to $1.6
billion at December 31, 1999.
Cancellations decreased during 2000 due to increasing mortgage interest rates
which resulted in an increase in the MGIC persistency rate (percentage of
insurance remaining in force from one year prior) to 80.4% at December 31, 2000,
from 72.9% at December 31, 1999.
Net premiums written increased 12% to $887.4 million in 2000, from $792.3
million in 1999. Net premiums earned increased 12% to $890.1 million in 2000,
from $792.6 million in 1999. The increases were primarily a result of a higher
percentage of renewal premiums on products with higher premium rates and the
growth in insurance in force offset by an increase in ceded premiums to $52.9
million in 2000, compared to $26.2 million in 1999, primarily due to an increase
in captive mortgage reinsurance and similar arrangements.
Mortgages (newly insured during 2000 or 1999) equal to approximately 33% of
MGIC's new insurance written during 2000 were subject to captive mortgage
reinsurance and similar arrangements compared to 32% during 1999. At December
31, 2000 approximately 21% of MGIC's risk in force was subject to captive
reinsurance and similar arrangements compared to 15% at December 31, 1999.
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Investment income for 2000 was $178.5 million, an increase of 17% over the
$153.1 million in 1999. This increase was primarily the result of an increase in
the amortized cost of average investment assets to $3.1 billion for 2000, from
$2.7 billion for 1999, an increase of 13%. The portfolio's average pre-tax
investment yield was 6.0% and 5.6% at December 31, 2000 and 1999, respectively.
The portfolio's average after-tax investment yield was 4.9% in 2000 and 1999.
The Company realized gains of $1.4 million during 2000 compared to $3.4 million
in 1999.
Other revenue was $40.3 million in 2000, compared with $47.7 million in 1999.
The change is primarily the result of decreases in contract underwriting and FHA
fee revenue (a contract with the FHA was completed in 1999) and an increase in
equity losses for Customers Forever LLC, a joint venture with Marshall & Ilsley
Corporation, which were offset by increases in equity earnings from C-BASS and
Sherman.
Total combined assets of C-BASS at December 31, 2000 and 1999 were approximately
$1.0 billion and $934 million, respectively, of which approximately $867 million
and $773 million, respectively, were mortgage-related assets, including open
trades. Total liabilities at December 31, 2000 and 1999 were approximately $765
million and $744 million, respectively, of which approximately $746 million and
$617 million, respectively, were funding arrangements, including accrued
interest, virtually all of which were short-term. For the years ended December
31, 2000 and 1999, revenues of approximately $153 million and $112 million,
respectively, and expenses of approximately $97 million and $72 million,
respectively, resulted in income before tax of approximately $56 million and $40
million, respectively.
Net losses incurred decreased 6% to $91.7 million in 2000, from $97.2 million in
1999. Such decrease was primarily due to generally strong economic conditions,
including in California, and a related decline in losses paid which led the
Company to reduce its estimate of the claim rate and the severity (the "reserve
factors") for loans in the primary and pool notices inventory. Partially
offsetting the reduction in reserve factors was an increase in the primary
insurance notice inventory from 29,761 at December 31, 1999 to 37,422 at
December 31, 2000, primarily reflecting an increase in notices related to bulk
transactions, and an increase in pool insurance notice inventory from 11,638 at
December 31, 1999 to 18,209 at December 31, 2000. Included in the notice
inventory was the bulk notice inventory of 7,533 at December 31, 2000 and 2,699
at December 31, 1999. The default rate at December 31, 2000 was 2.58% compared
to 2.17% at December 31, 1999. Excluding bulk defaults, the default rates were
2.19% and 2.02% for 2000 and 1999, respectively. The default rate on bulk loans
were 9.02% and 8.04% at December 31, 2000 and 1999, respectively. The average
claim paid for 2000 was $18,977 compared to $19,444 in 1999. The redundancy in
loss reserves for 2000 was relatively consistent with that experienced in 1999.
At December 31, 2000, 67% of the primary insurance in force was written during
the last three years, compared to 65% at December 31, 1999.
Underwriting and other expenses decreased to $177.8 million in 2000 from $198.1
million in 1999, a decrease of 10%. This decrease was primarily due to decreases
in contract underwriting and an increase in deferred insurance policy
acquisition costs.
Interest expense in 2000 increased to $28.8 million from $20.4 million in 1999
due to higher weighted average interest rates in 2000 compared to 1999.
The consolidated insurance operations loss ratio was 10.3% for 2000 compared to
12.3% for 1999. The consolidated insurance operations expense and combined
ratios were 16.4% and 26.7%, respectively, for 2000 compared to 19.7% and 32.0%,
respectively, for 1999.
The effective tax rate was 31.3% in 2000, compared with 31.0% in 1999. During
both years, the effective tax rate was below the statutory rate of 35%,
reflecting the benefits of tax-preferenced investment income. The higher
effective tax rate in 2000 resulted from a lower percentage of total income
before tax being generated from tax-preferenced investments in 2000.
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Financial Condition
Consolidated total investments increased approximately $597 million to $4.1
billion at December 31, 2001 from $3.5 billion at December 31, 2000, primarily
due to positive net cash flow offset by unrealized losses on securities marked
to market of $33 million. The Company generated consolidated cash flows from
operating activities of $626.1 million during 2001, compared to $551.0 million
generated during 2000. The increase in operating cash flows during 2001 compared
to 2000 is due primarily to increases in new business renewal premiums,
investment income and other revenue (which includes contract underwriting
revenue).
As of December 31, 2001, the Company had $160.0 million of short-term
investments with maturities of 90 days or less, and 72% of the portfolio was
invested in tax-preferenced securities. In addition, at December 31, 2001, based
on book value, the Company's fixed income securities were approximately 98%
invested in `A' rated and above, readily marketable securities, concentrated in
maturities of less than 15 years. At December 31, 2001 the Company had $20.7
million of investments in equity securities compared to $22.0 million at
December 31, 2000.
At December 31, 2001, the Company had no derivative financial instruments in its
investment portfolio. The Company places its investments in instruments that
meet high credit quality standards, as specified in the Company's investment
policy guidelines; the policy also limits the amount of credit exposure to any
one issue, issuer and type of instrument. At December 31, 2001, the average
duration of the Company's investment portfolio was 5.5 years. The effect of a 1%
increase/ decrease in market interest rates would result in a 5.5% decrease/
increase in the value of the Company's fixed income portfolio.
The Company's investments in joint ventures increased $22.9 million from $138.8
million at December 31, 2000 to $161.7 million at December 31, 2001 as a result
of equity earnings of $28.1 million and additional investments of $15.0 million
offset by dividends received of $20.2 million. As discussed under "Results of
Consolidated Operations -- 2001 Compared with 2000," 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 $613.7 million at December 31, 2001 from
$609.5 million at December 31, 2000, reflecting increases in the primary and
pool insurance notice inventories. Consistent with industry practices, the
Company does not establish loss reserves for future claims on insured loans
which are not currently in default. For additional discussion of loss reserves,
see "Results of Consolidated Operations -- 2001 Compared with 2000."
Consolidated unearned premiums decreased $6.2 million from $180.7 million at
December 31, 2000, to $174.5 million at December 31, 2001, primarily reflecting
the continued high level of monthly premium policies written for which there is
no unearned premium.
Consolidated shareholders' equity increased to $3.0 billion at December 31,
2001, from $2.5 billion at December 31, 2000, an increase of 23%. This increase
consisted of $639.1 million of net income during 2001 and $29.5 million from the
reissuance of treasury stock offset by unrealized losses on investments, net of
tax, of $21.3 million, unrealized losses on derivatives, net of tax, of $7.8
million, the repurchase of $73.5 million of outstanding common shares and
dividends declared of $10.7 million.
Liquidity and Capital Resources
The Company's consolidated sources of funds consist primarily of premiums
written and investment income. Funds are applied primarily to the payment of
claims and expenses. Approximately 70% of underwriting expenses are
personnel-related costs, most of which are considered by the Company to be fixed
costs over the short term. Approximately 5% of operating expenses relate to
occupancy costs, which are fixed costs. Substantially all of the remaining
operating expenses are considered by the Company to be variable in nature, with
data processing costs and taxes, licenses and fees representing approximately 3%
and 9%, respectively, of total operating expenses. The Company generated
positive operating cash flows of approximately $626.1 million, $551.0 million
and $455.0 million in
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2001, 2000 and 1999, 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, at the Company's insurance
subsidiaries 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 first 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 December 31, 2001, the Company had $172.1 million in
commercial paper outstanding with a weighted average interest rate of 1.91%. S&P
affirmed the `A-1' rating in February 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 has credit facilities under which $200 million was available at
December 31, 2001, with $100 million expiring in 2003 and $100 million expiring
in 2004. Under the terms of the credit facilities, the Company must maintain
shareholders' equity of at least $1 billion and MGIC must maintain a claims
paying ability rating of `AA-` or better with S&P. At December 31, 2001, the
Company had shareholders' equity of $3.02 billion and MGIC had a claims paying
ability rating of `AA+' from S&P. (S&P affirmed the `AA+' rating in February
2002.) These facilities are currently being used as liquidity back up facilities
for the outstanding commercial paper. The remaining credit available under these
facilities after reduction for the amount necessary to support the commercial
paper was $27.9 million at December 31, 2001. The Company had $98 million
outstanding under the credit facility at December 31, 2000.
In June of 2000, the Company filed a $500 million public debt shelf registration
statement. During the fourth quarter of 2000, the Company issued, in public
offerings, $300 million, 71/2% Senior Notes due in 2005. The notes are unsecured
and were rated `A1' by Moody's and `A+' by S&P. The Company had Senior Notes
outstanding of $300 million at December 31, 2001 and 2000.
The proceeds of the commercial paper and the Senior Notes were used to fund the
repurchase of Common Stock. In January 2002, the Company announced a new share
repurchase program covering up to 5.5 million shares in addition to the 800,000
shares remaining from the prior repurchase program. Funds for shares to be
purchased in the future are expected to be provided from a combination of
internally generated funds and borrowings. From mid-1997 until the end of 2001,
the Company repurchased 15.0 million shares of Common Stock at a cost of $775.5
million.
The commercial paper, back-up credit facilities and the Senior Notes are
obligations of the Company and not of its subsidiaries. The Company is a holding
company and the payment of dividends from its insurance subsidiaries is
restricted by insurance regulation. MGIC is the principal source of
dividend-paying capacity. As a result of a $150 million dividend paid to the
Company by MGIC in February 2002, MGIC may not pay additional dividends until
February 2003 without the approval of the Office of the Commissioner of
Insurance of the State of Wisconsin.
Interest payments on all long-term debt were $26.9 million, $25.5 million and
$22.0 million for the years ended December 31, 2001, 2000 and 1999,
respectively. At December 31, 2001, the market value of the long-term debt is
$492.6 million. The commercial paper is classified as short-term debt.
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. Earnings on the swaps
during 1999, of approximately $3.8 million, were netted against interest
expense.
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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.
The gain on termination is being amortized over the remaining life of the
underlying debt. The remaining swap was also amended during 2000 and designated
as a cash flow hedge. Under the terms of the swap contract, the Company pays a
fixed rate of 6.79% 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. Earnings on the swaps during 2000 of approximately
$0.3 million were netted against interest expense. Expenses on the swaps during
2001, of approximately $3.7 million, were included in interest expense. The swap
outstanding at December 31, 2001 is evaluated quarterly using regression
analysis with any ineffectiveness being recorded as an expense. To date this
evaluation has not resulted in any hedge ineffectiveness. The swaps are subject
to credit risk to the extent the counterparty would be unable to discharge its
obligations under the swap agreements.
MGIC is the principal insurance subsidiary of the Company. MGIC's
risk-to-capital ratio was 9.1:1 at December 31, 2001 compared to 10.6:1 at
December 31, 2000. The decrease was due to MGIC's increased policyholders'
reserves, partially offset by the net additional risk in force of $2.8 billion,
net of reinsurance, during 2001.
The risk-to-capital ratios set forth above have been computed on a statutory
basis. However, the methodology used by the rating agencies to assign
claims-paying ability ratings permits less leverage than under statutory
requirements. As a result, the amount of capital required under statutory
regulations may be lower than the capital required for rating agency purposes.
In addition to capital adequacy, the rating agencies consider other factors in
determining a mortgage insurer's claims-paying rating, including its competitive
position, business outlook, management, corporate strategy, and historical and
projected operating performance.
For certain material risks of the Company's business, see "Risk Factors" below.
Risk Factors
Our revenues and losses could be affected by the risk factors discussed below.
These factors may also cause actual results to differ materially from the
results contemplated by forward looking statements that the Company may make.
Forward looking statements consist of statements which relate to matters other
than historical fact. Among others, statements that include words such as the
Company "believes," "anticipates" or "expects," or words of similar import, are
forward looking statements.
If the volume of low down payment home mortgage originations declines, the
amount of insurance that we write could also decline which could result in
declines in our future revenues.
The factors that affect the volume of low down payment mortgage originations
include:
o the level of home mortgage interest rates,
o the health of the domestic economy as well as conditions in regional and
local economies,
o housing affordability,
o population trends, including the rate of household formation,
o the rate of home price appreciation, which in times of heavy refinancing
affects whether refinance loans have loan-to-value ratios that require
private mortgage insurance, and
o government housing policy encouraging loans to first-time homebuyers.
Our new insurance written volume increased 107% in 2001 compared to the same
period in 2000. One of the reasons our volume was higher in 2001 was because
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many borrowers refinanced their mortgages during 2001 due to a lower interest
rate environment, which also led to lenders canceling insurance that we wrote in
the past. While we have not experienced lower volume in recent years other than
as a result of declining refinancing activity, one of the risks we face is that
substantially higher interests rates will substantially reduce purchase activity
by first-time homebuyers and that the decline in cancellations of insurance that
in the past have accompanied higher interest rates will not be sufficient to
offset the decline in premiums from loans that are not made.
If lenders and investors select alternatives to private mortgage insurance, the
amount of insurance that we write could decline, which could result in declines
in our future revenues.
These alternatives to private mortgage insurance include:
o lenders using government mortgage insurance programs, including those of
the Federal Housing Administration and the Veterans Administration,
o investors holding mortgages in portfolio and self-insuring,
o investors using credit enhancements other than private mortgage insurance
or using other credit enhancements in conjunction with reduced levels of
private mortgage insurance coverage, and
o lenders structuring mortgage originations to avoid private mortgage
insurance, such as a first mortgage with an 80% loan-to-value ratio and a
second mortgage with a 10% loan-to-value ratio (referred to as an 80-10-10
loan) rather than a first mortgage with a 90% loan-to-value ratio.
We believe, that during 2001, lenders and investors were self-insuring and
making 80-10-10 loans at about the same percentage as they did over the last
several years. Although during 2001 and 2000, the share of the low down payment
market held by loans with Federal Housing Administration and Veterans
Administration mortgage insurance was lower than in 1999, during three of the
prior four years, the Federal Housing Administration and Veterans
Administration's collective share of this market increased. Investors are using
reduced mortgage insurance coverage on a higher percentage of loans that we
insure than they had over the last several years.
Because most of the loans MGIC insures are sold to Fannie Mae and Freddie Mac,
changes in their business practices could reduce our revenues or increase our
losses.
The business practices of Fannie Mae and Freddie Mac affect the entire
relationship between them and mortgage insurers and include:
o the level of private mortgage insurance coverage, subject to the
limitations of Fannie Mae and Freddie Mac's charters, when private mortgage
insurance is used as the required credit enhancement on low down payment
mortgages,
o whether Fannie Mae or Freddie Mac influence the mortgage lender's selection
of the mortgage insurer providing coverage and, if so, any transactions
that are related to that selection,
o whether Fannie Mae or Freddie Mac will give mortgage lenders an incentive,
such as a reduced guaranty fee, to select a mortgage insurer that has a
`AAA' claims-paying ability rating to benefit from the lower capital
requirements for Fannie Mae and Freddie Mac when a mortgage is insured by a
company with that rating,
o the underwriting standards that determine what loans are eligible for
purchase by Fannie Mae or Freddie Mac, which thereby affect the quality of
the risk insured by the mortgage insurer and the availability of mortgage
loans,
o the terms on which mortgage insurance coverage can be canceled before
reaching the cancellation thresholds established by law, and
o the circumstances in which mortgage servicers must perform activities
intended to avoid or mitigate loss on insured mortgages that are
delinquent.
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Because we participate in an industry that is intensely competitive, changes in
our competitors' business practices could reduce our revenues or increase our
losses.
Competition for private mortgage insurance premiums occurs not only among
private mortgage insurers but increasingly with mortgage lenders through captive
mortgage reinsurance transactions. In these transactions, a lender's affiliate
reinsures a portion of the insurance written by a private mortgage insurer on
mortgages originated by the lender. The low level of losses that has recently
prevailed in the private mortgage insurance industry has encouraged competition
to assume default risk through captive reinsurance arrangements, self-insurance,
80-10-10 loans and other means. In 1996, we reinsured under captive reinsurance
arrangements virtually none of our primary insurance. At the end of 2001, about
24% of our risk in force was subject to captive reinsurance arrangements. The
level of competition within the private mortgage insurance industry has also
increased as many large mortgage lenders have reduced the number of private
mortgage insurers with whom they do business. At the same time, consolidation
among mortgage lenders has increased the share of the mortgage lending market
held by large lenders. Our top ten customers generated 27.0% of the new primary
insurance that we wrote 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 MGIC's premiums are from insurance that has been written
in prior years. As a result, the length of time insurance remains in force is an
important determinant of revenues. The factors affecting the length of time our
insurance remains in force include:
o the level of current mortgage interest rates compared to the mortgage
coupon rates on the insurance in force, which affects the vulnerability of
the insurance in force to refinancings, and
o mortgage insurance cancellation policies of mortgage investors along with
the rate of home price appreciation experienced by the homes underlying the
mortgages in the insurance in force.
While it is difficult to measure the extent of the decline, in recent years, the
length of time that our policies remain in force has declined somewhat. Due to
this decline, our premium revenues were lower than they would have been if the
length had not declined.
If the domestic economy deteriorates, more homeowners may default and our losses
may increase.
Losses result from events that reduce a borrower's ability to continue to make
mortgage payments, such as unemployment, and whether the home of a borrower who
defaults on his mortgage can be sold for an amount that will cover unpaid
principal and interest and the expenses of the sale. Favorable economic
conditions generally reduce the likelihood that borrowers will lack sufficient
income to pay their mortgages and also favorably affect the value of homes,
thereby reducing and in some cases even eliminating a loss from a mortgage
default. In recent years, due in part to the strength of the economy, we have
had low losses by historical standards. A significant deterioration in economic
conditions would probably increase our losses.
Our industry is subject to litigation risk.
In recent years, consumers have brought a growing number of lawsuits against
home mortgage lenders and settlement service providers. As of February 2002,
seven mortgage insurers, including our MGIC subsidiary, were involved in
litigation alleging violations of the Real Estate Settlement Procedures Act. Our
MGIC subsidiary and two other mortgage insurers entered into an agreement to
settle the cases against them
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in December 2000, and another mortgage insurer entered into a comparable
settlement agreement in February 2002. In June 2001, the Court entered a final
order approving the settlement to which we and the other two insurers are
parties, although due to appeals of orders denying certain class members the
right to intervene to challenge certain aspects of this settlement, the final
implementation of the settlement will not occur until the appeals are resolved.
We took a $23.2 million pre-tax charge in 2000 to cover our share of the
estimated costs of our settlement. While our settlement includes an injunction
that prohibits certain practices and specifies the basis on which other
practices may be done in compliance with the Real Estate Settlement Procedures
Act, we may still be subject to future litigation under the Real Estate
Settlement Procedures Act.
Because we expect the pace of change in our industry and in home mortgage
lending to remain high, we will be disadvantaged unless we are able to respond
to new ways of doing business.
We expect the processes involved in home mortgage lending will continue to
evolve through greater use of technology. This evolution could effect
fundamental changes in the way home mortgages are distributed. Affiliates of
lenders who are regulated depositary institutions gained expanded insurance
powers under financial modernization legislation and the capital markets may
emerge as providers of insurance in competition with traditional insurance
companies. These trends and others increase the level of uncertainty in our
business, demand rapid response to change and place a premium on innovation.
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