FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the quarterly period ended SEPTEMBER 30, 2001
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from to Commission file
number 1-10816
MGIC INVESTMENT CORPORATION
(Exact name of registrant as specified in its charter)
WISCONSIN 39-1486475
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
250 E. KILBOURN AVENUE 53202
MILWAUKEE, WISCONSIN (Zip Code)
(Address of principal executive offices)
(414) 347-6480
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OF STOCK PAR VALUE DATE NUMBER OF SHARES
Common stock $1.00 10/31/01 107,185,914
Page 1
MGIC INVESTMENT CORPORATION
TABLE OF CONTENTS
Page
No.
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheet as of
September 30, 2001 (Unaudited) and
December 31, 2000 3
Consolidated Statement of Operations
for the Three and Nine Month Periods
Ended September 30, 2001 and 2000
(Unaudited) 4
Consolidated Statement of Cash Flows
for the Nine Months Ended September 30,
2001 and 2000 (Unaudited) 5
Notes to Consolidated Financial Statements
(Unaudited) 6-11
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations 11-25
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 26
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 27
SIGNATURES
INDEX TO EXHIBITS
Page 2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
September 30, 2001 (Unaudited) and December 31, 2000
September 30, December 31,
2001 2000
------------- ------------
ASSETS (In thousands of dollars)
Investment portfolio:
Securities, available-for-sale,
at market value:
Fixed maturities $ 3,837,447 $ 3,298,561
Equity securities 20,646 22,042
Short-term investments 171,504 151,592
----------- -----------
Total investment portfolio 4,029,597 3,472,195
Cash 10,047 5,598
Accrued investment income 50,593 51,419
Reinsurance recoverable on loss
reserves (note 3) 27,828 33,226
Reinsurance recoverable on unearned
premiums (note 3) 8,618 8,680
Home office and equipment, net 33,253 31,308
Deferred insurance policy acquisition costs 29,536 25,839
Investments in joint ventures 164,084 138,838
Other assets 133,569 90,678
----------- -----------
Total assets $ 4,487,125 $ 3,857,781
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Loss reserves $ 603,938 $ 609,546
Unearned premiums 174,825 180,724
Short- and long-term debt (note 2) 377,264 397,364
Other liabilities 353,422 205,265
----------- -----------
Total liabilities 1,509,449 1,392,899
----------- -----------
Contingencies (note 4) Shareholders' equity:
Common stock, $1 par value, shares
authorized 300,000,000; shares issued
121,110,800; shares outstanding, 9/30/01
- 107,220,914 12/31/00 - 106,825,758 121,111 121,111
Paid-in surplus 213,978 207,882
Treasury stock (shares at cost, 9/30/01
- 13,889,886 12/31/00 - 14,285,042 (607,311) (621,033)
Accumulated other comprehensive income,
net of tax (note 6) 98,687 75,814
Retained earnings 3,151,211 2,681,108
----------- -----------
Total shareholders' equity 2,977,676 2,464,882
----------- -----------
Total liabilities and shareholders' equity $ 4,487,125 $ 3,857,781
=========== ===========
See accompanying notes to consolidated financial statements.
Page 3
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
Three and Nine Month Periods Ended September 30, 2001 and 2000
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- -------------------
2001 2000 2001 2000
(In thousands of dollars,
except per share data)
Revenues:
Premiums written:
Direct $288,288 $250,275 $803,797 $690,539
Assumed 126 245 353 662
Ceded (note 3) (17,408) (14,312) (46,653) (34,859)
-------- -------- -------- --------
Net premiums written 271,006 236,208 757,497 656,342
(Increase) decrease in
unearned premiums (6,226) (7,000) 5,837 1,404
-------- -------- -------- --------
Net premiums earned 264,780 229,208 763,334 657,746
Investment income, net
of expenses 51,021 46,125 152,632 129,465
Realized investment
gains, net 7,247 422 28,822 585
Other revenue 16,788 6,963 55,070 30,259
-------- -------- -------- --------
Total revenues 339,836 282,718 999,858 818,055
-------- -------- -------- --------
Losses and expenses:
Losses incurred, net 43,468 21,442 109,149 66,597
Underwriting and other
expenses 58,317 40,055 168,495 133,261
Interest expense 7,604 7,412 23,294 21,085
-------- -------- -------- --------
Total losses and expenses 109,389 68,909 300,938 220,943
-------- -------- -------- --------
Income before tax 230,447 213,809 698,920 597,112
Provision for income tax 71,455 67,454 220,786 187,434
-------- -------- -------- --------
Net income $158,992 $146,355 $478,134 $409,678
======== ======== ======== ========
Earnings per share (note 5):
Basic $ 1.48 $ 1.38 $ 4.46 $ 3.86
======== ======== ======== ========
Diluted $ 1.47 $ 1.36 $ 4.43 $ 3.83
======== ======== ======== ========
Weighted average common shares
outstanding - diluted
(shares in thousands, note 5) 108,218 107,339 108,036 107,065
======== ======== ======== ========
Dividends per share $ 0.025 $ 0.025 $ 0.075 $ 0.075
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
Page 4
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Nine Months Ended September 30, 2001 and 2000
(Unaudited)
Nine Months Ended
September 30,
----------------------------
2001 2000
(In thousands of dollars)
Cash flows from operating activities:
Net income $ 478,134 $ 409,678
Adjustments to reconcile net income to net
cash provided by operating activities:
Amortization of deferred insurance
policy acquisition costs 14,712 14,646
Increase in deferred insurance policy
acquisition costs (18,409) (18,266)
Depreciation and amortization 5,145 5,366
Decrease in accrued investment income 826 1,671
Decrease in reinsurance recoverable
on loss reserves 5,398 943
Decrease (increase) in reinsurance
recoverable on unearned premiums 62 (2,466)
Decrease in loss reserves (5,608) (27,125)
(Decrease) increase in unearned premiums (5,899) 1,062
Equity earnings in joint ventures (23,007) (15,892)
Other 70,698 35,138
----------- -----------
Net cash provided by operating activities 522,052 404,755
----------- -----------
Cash flows from investing activities:
Purchase of equity securities - (14,629)
Purchase of fixed maturities (2,162,273) (1,372,238)
Additional investment in joint ventures (15,000) (15,023)
Proceeds from sale of equity securities 1,585 14,315
Proceeds from sale or maturity of fixed
maturities 1,700,427 1,010,528
----------- -----------
Net cash used in investing activities (475,261) (377,047)
----------- -----------
Cash flows from financing activities:
Dividends paid to shareholders (8,031) (7,951)
Proceeds from issuance of long- and
short-term debt 111,499 10,000
Repayment of long- and short-term debt (133,384) (25,000)
Reissuance of treasury stock 15,307 10,803
Repurchase of common stock (7,821) (6,224)
----------- -----------
Net cash used in financing activities (22,430) (18,372)
----------- -----------
Net increase in cash and short-term
investments 24,361 9,336
Cash and short-term investments at
beginning of period 157,190 110,068
----------- -----------
Cash and short-term investments at
end of period $ 181,551 $ 119,404
=========== ===========
See accompanying notes to consolidated financial statements.
Page 5
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2001
(Unaudited)
Note 1 - Basis of presentation and summary of certain significant accounting
policies
The accompanying unaudited consolidated financial statements of MGIC
Investment Corporation (the "Company") and its wholly-owned subsidiaries have
been prepared in accordance with the instructions to Form 10-Q and do not
include all of the other information and disclosures required by generally
accepted accounting principles. These statements should be read in conjunction
with the consolidated financial statements and notes thereto for the year ended
December 31, 2000 included in the Company's Annual Report on Form 10-K for that
year.
The accompanying consolidated financial statements have not been audited by
independent accountants in accordance with auditing standards generally accepted
in the United States of America, but in the opinion of management such financial
statements include all adjustments, including normal recurring accruals,
necessary to summarize fairly the Company's financial position and results of
operations. The results of operations for the nine months ended September 30,
2001 may not be indicative of the results that may be expected for the year
ending December 31, 2001.
Deferred insurance policy acquisition costs
Costs associated with the acquisition of mortgage insurance business,
consisting of employee compensation and other policy issuance and underwriting
expenses, are initially deferred and reported as deferred acquisition costs
(DAC). Because Statement of Financial Accounting Standards ("SFAS") No. 60
specifically excludes mortgage guaranty insurance from its guidance relating to
the amortization of DAC, amortization of these costs for each underwriting year
book of business are charged against revenue in proportion to estimated gross
profits over the life of the policies using the guidance of SFAS No. 97,
Accounting and Reporting by Insurance Enterprises For Certain Long Duration
Contracts and Realized Gains and Losses From the Sale of Investments. This
includes accruing interest on the unamortized balance of DAC. The estimates for
each underwriting year are updated annually to reflect actual experience and any
changes to key assumptions such as persistency or loss development.
The Company amortized $14.6 million and $14.7 million of deferred insurance
policy acquisition costs during the nine months ended September 30, 2000 and
2001, respectively.
Page 6
Loss reserves
Reserves are established for reported insurance losses and loss adjustment
expenses based on when notices of default on insured mortgage loans are
received. Reserves are also established for estimated losses incurred on notices
of default not yet reported by the lender. Consistent with industry practices,
the Company does not establish loss reserves for future claims on insured loans
which are not currently in default. Reserves are established by management using
estimated claims rates and claims amounts in estimating the ultimate loss.
Amounts for salvage recoverable are considered in the determination of the
reserve estimates. Adjustments to reserve estimates are reflected in the
financial statements in the periods in which the adjustments are made. The
liability for reinsurance assumed is based on information provided by the ceding
companies.
The incurred but not reported ("IBNR") reserves result from defaults
occurring prior to the close of an accounting period, but which have not been
reported to the Company. Consistent with reserves for reported defaults, IBNR
reserves are established using estimated claims rates and claims amounts for the
estimated number of defaults not reported.
Reserves also provide for the estimated costs of settling claims, including
legal and other expenses and general expenses of administering the claims
settlement process.
Income recognition
The insurance subsidiaries write policies which are guaranteed renewable
contracts at the insured's option on a single, annual or monthly premium basis.
The insurance subsidiaries have no ability to reunderwrite or reprice these
contracts. Premiums written on a single premium basis and an annual premium
basis are initially deferred as unearned premium reserve and earned over the
policy term. Premiums written on policies covering more than one year are
amortized over the policy life in accordance with the expiration of risk, which
is the anticipated claim payment pattern based on historical experience.
Premiums written on annual policies are earned on a monthly pro rata basis.
Premiums written on monthly policies are earned as coverage is provided.
Fee income of the non-insurance subsidiaries is earned and recognized as
the services are provided and the customer is obligated to pay.
Note 2 - Short- and long-term debt
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, 7-1/2% Senior Notes due 2005. The notes are
unsecured and were rated "A1" by Moody's and "A+" by Standard and Poor's
("S&P"). The net proceeds were used to repay borrowings under bank credit
facilities.
Page 7
During the first quarter of 2001, the Company established a $200 million
short term commercial paper program, rated "A-1" by S&P and "P-1" by Moody's. At
September 30, 2001, the Company's outstanding par balance of commercial paper
notes was $78.0 million. The proceeds of the commercial paper were used during
the first quarter to repay all outstanding borrowings under the bank facilities.
There were no borrowings outstanding under the bank facilities at September 30,
2001. These facilities are 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 back the commercial
paper, was $122.0 million at September 30, 2001. The weighted average interest
rates on the borrowings for the quarter were as follows:
Senior notes 7.50%
Commercial paper 3.90%
Note 3 - Reinsurance
The Company cedes a portion of its business to reinsurers and records
assets for reinsurance recoverable on estimated reserves for unpaid losses and
unearned premiums. Business written between 1985 and 1993 is ceded under various
quota share reinsurance agreements with several reinsurers. The Company receives
a ceding commission in connection with this reinsurance. Beginning in 1997, the
Company has ceded business to captive reinsurance subsidiaries of certain
mortgage lenders primarily under excess of loss reinsurance agreements.
The reinsurance recoverable on loss reserves and the reinsurance
recoverable on unearned premiums primarily represent amounts recoverable from
large international reinsurers. The Company monitors the financial strength of
its reinsurers, including their claims paying ability rating, and does not
currently anticipate any collection problems. Generally, reinsurance
recoverables on loss reserves and unearned premiums are backed by trust funds or
letters of credit. No reinsurer represents more than $10 million of the
aggregate amount recoverable.
Note 4 - Contingencies and litigation settlement
The Company is involved in litigation in the ordinary course of business.
In the opinion of management, the ultimate resolution of this pending litigation
will not have a material adverse effect on the financial position or results of
operations of the Company.
In addition, in June 2001, the Federal District Court for the Southern
District of Georgia before which Downey et. al. v. MGIC is 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
Page 8
are delayed pending the outcome of the appeals. The settlement includes an
injunction that prohibits certain practices and specifies the basis on which
agency pool insurance, captive mortgage reinsurance, contract underwriting and
other products may be provided in compliance with the Real Estate Settlement
Procedures Act.
The complaint in the case alleges that MGIC violated the Real Estate
Settlement Procedures Act by providing agency pool insurance, captive mortgage
reinsurance, contract underwriting and other products that were not properly
priced, in return for the referral of mortgage insurance. The complaint seeks
damages of three times the amount of the mortgage insurance premiums that have
been paid and that will be paid at the time of judgment for the mortgage
insurance found to be involved in a violation of the Real Estate Settlement
Procedures Act. The complaint also seeks injunctive relief, including
prohibiting MGIC from receiving future premium payments. If the settlement is
not fully implemented, the litigation will continue. In these circumstances,
there can be no assurance that the ultimate outcome of the litigation will not
materially affect the Company's financial position or results of operations.
Note 5 - Earnings per share
The Company's basic and diluted earnings per share ("EPS") have been
calculated in accordance with SFAS No. 128, Earnings Per Share. The following is
a reconciliation of the weighted-average number of shares used for basic EPS and
diluted EPS.
Three Months Ended Nine Months Ended
September 30 September 30,
------------------ ------------------
2001 2000 2001 2000
------- ------- ------- -------
(Shares in thousands)
Weighted-average shares -
Basic EPS 107,305 106,334 107,099 106,036
Common stock equivalents 913 1,005 937 1,029
------- ------- ------- -------
Weighted-average shares -
Diluted EPS 108,218 107,339 108,036 107,065
======= ======= ======= =======
Note 6 - New accounting standards
The Company adopted SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, as amended, on January 1, 2001, in accordance with the
transition provisions of SFAS No. 133.
The Company recorded a net-of-tax cumulative-effect-type adjustment of $1.0
million in accumulated other comprehensive income to recognize at fair value all
derivatives that are designated as cash-flow hedging instruments. Net losses on
derivatives of $7.6 million that had been previously deferred were reclassified
on the balance sheet through a net-of-tax cumulative-effect-type adjustment of
$5.0 million to other comprehensive income.
Page 9
In 2001, The Financial Accounting Standards Board issued SFAS No. 141
"Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets", which are effective for the Company on January 1, 2002. SFAS No. 141
requires business combinations initiated after June 30, 2001 be accounted for
using the purchase method of accounting. It also specifies the types of acquired
intangible assets that are required to be recognized and reported separately
from goodwill. SFAS No. 142 requires goodwill and certain intangibles no longer
be amortized, but instead be tested for impairment at least annually. The
Company does not have any material amounts of goodwill and therefore, does not
expect any significant impairment of goodwill upon adoption.
Note 7 - Comprehensive income
The Company's total comprehensive income, as calculated per SFAS No. 130,
Reporting Comprehensive Income, was as follows:
Three Months Ended Nine Months Ended
September 30 September 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
(Shares in thousands)
Net income $158,992 $146,355 $478,134 $409,678
Other comprehensive income 42,078 19,524 22,873 49,737
-------- -------- -------- --------
Total comprehensive income $201,070 $165,879 $501,007 $459,415
======== ======== ======== ========
Other comprehensive income (loss)
(net of tax):
Cumulative effect - FAS 133 $ N/A $ N/A $ (5,982) $ N/A
Net derivative losses (2,654) N/A (3,819) N/A
Amortization of deferred losses
and Ineffectiveness of cash
flow hedge 270 N/A 810 N/A
FAS 115 44,462 19,524 31,864 49,737
-------- -------- -------- --------
Comprehensive income $ 42,078 $ 19,524 $ 22,873 $ 49,737
======== ======== ======== ========
The difference between the Company's net income and total comprehensive
income for the nine months ended September 30, 2001 and 2000 is due to the
change in unrealized appreciation/depreciation on investments, the cumulative
effect of the adoption of SFAS No. 133 and the market value adjustment of the
hedges, all net of tax.
Note 8 - Accounting for derivatives and hedging activities
Generally, the Company's use of derivatives is limited to entering into
interest rate swap agreements intended to hedge its debt financing terms. All
derivatives are recognized on the balance sheet at their fair value. On the date
the derivative contract is entered into, the Company designates the derivative
as a hedge of the fair value of a recognized asset or liability ("fair value"
hedge), or as a hedge of a forecasted transaction or of the variability of cash
flows to be received or paid related to a recognized asset or liability ("cash
flow" hedge). Changes in the fair value of a derivative that is highly effective
as, and that is designated and qualifies as, a fair-value hedge, along with the
loss or gain on the hedged
Page 10
asset or liability that is attributable to the hedged risk, are recorded in
current-period earnings. Changes in the fair value of a derivative that is
highly effective as, and that is designated and qualifies as, a cash-flow hedge
are recorded in other comprehensive income, until earnings are affected by the
variability of cash flows (e.g. when periodic settlements on a variable-rate
asset or liability are recorded in earnings).
The Company formally documents all relationships between hedging
instruments and hedged items, as well as its risk-management objective and
strategy for undertaking various hedge transactions. This process includes
linking all derivatives that are designated as fair-value or cash-flow hedges to
specific assets and liabilities on the balance sheet or forecasted transactions.
The Company also formally assesses, both at the hedge's inception and on an
ongoing basis, whether the derivatives that are used in hedging transactions are
highly effective in offsetting changes in fair values or cash flows of hedged
items. When it is determined that a derivative is not highly effective as a
hedge or that it has ceased to be a highly effective hedge, the Company
discontinues hedge accounting prospectively.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Consolidated Operations
Three months Ended September 30, 2001 Compared With Three months Ended September
30, 2000
Net income for the three months ended September 30, 2001 was $159.0
million, compared to $146.4 million for the same period of 2000, an increase of
9%. Diluted earnings per share for the three months ended September 30, 2001 was
$1.47 compared with $1.36 in the same period last year, an increase of 8%. As
used in this report, the term "Company" means the Company and its consolidated
subsidiaries, which do not include joint ventures in which the Company has an
equity interest.
Total revenues for the third quarter 2001 were $339.8 million, an increase
of 20% from the $282.7 million for the third quarter 2000. This increase was
primarily attributed to an increase in new business writings, which included
$19.7 billion in bulk transactions year-to-date, of which $6.7 billion was
written in the third quarter of 2001. Also contributing to the increase in
revenues was an increase in investment income resulting from strong cash flows
during the prior twelve months, 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 the third quarter were $109.4 million, an increase
of 59% from $68.9 million for the same period of 2000. The increase from last
year can be attributed to an increase in notice inventories and increases in
insured volume and in
Page 11
contract underwriting. See below for a further discussion of losses incurred and
underwriting expenses.
The amount of new primary insurance written by MGIC during the three months
ended September 30, 2001 was $23.4 billion, compared to $12.7 billion in the
same period of 2000. The increase in new primary insurance written principally
reflected the increase in refinancing activity on the non-bulk business and the
increase in bulk transactions written in the third quarter of 2001 compared to
the third quarter of 2000. The Company does not expect comparable increases in
the volume of bulk transactions after the fourth quarter of 2001.
The $23.4 billion of new primary insurance written during the third quarter
of 2001 was offset by the cancellation of $15.4 billion of insurance in force,
and resulted in a net increase of $8.0 billion in primary insurance in force,
compared to new primary insurance written of $12.7 billion, the cancellation of
$7.6 billion of insurance in force and a net increase of $5.1 billion in primary
insurance in force during the third quarter of 2000. Direct primary insurance in
force was $179.6 billion at September 30, 2001 compared to $160.2 billion at
December 31, 2000 and $157.0 billion at September 30, 2000.
In addition to providing primary insurance coverage, the Company also
insures pools of mortgage loans. New pool risk written during the three months
ended September 30, 2001 and September 30, 2000, which was virtually all agency
pool insurance, was $133 million and $87 million, respectively. The Company's
direct pool risk in force was $1.8 billion at September 30, 2001, $1.7 billion
at December 31, 2000, and was $1.8 billion at September 30, 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 the
third quarter of 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 67.7% at September 30, 2001 from 80.4% at December 31, 2000
and 80.3% at September 30, 2000. Future cancellation activity could 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 materially lower
persistency than the Company's flow business.
New insurance written for bulk transactions was 29% of new insurance
written during the third quarter of 2001 compared to 23% for the same period a
year ago. The Company expects that the loans that are included in these 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
transactions 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.
Page 12
Net premiums written increased 15% to $271.0 million during the third
quarter of 2001, from $236.2 million during the third quarter of 2000. Net
premiums earned increased 16% to $264.8 million for the third quarter of 2001
from $229.2 million for the same period 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 $17.4 million in the third quarter of 2001 compared to $14.3
million during the same period a year ago, primarily due to an increase in
captive mortgage reinsurance.
Mortgages (newly insured during the nine months ended September 30, 2001 or
in previous periods) approximating 27% of MGIC's new insurance written during
both the third quarter of 2001 and 2000 were subject to captive mortgage
reinsurance and similar arrangements. 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 September 30, 2001, approximately 23% 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 the third quarter of 2001 was $51.0 million, an
increase of 11% over the $46.1 million in the third quarter of 2000. This
increase was the result of increases in the amortized cost of average invested
assets to $3.8 billion for the third quarter of 2001 from $3.1 billion for the
third quarter of 2000, an increase of 19%, and offset by a slight decrease in
the investment yield. The portfolio's average pre-tax investment yield was 5.5%
for the third quarter of 2001 and 6.0% for the same period in 2000. The
portfolio's average after-tax investment yield was 4.7% for the third quarter of
2001 and 5.0% for the third quarter of 2000. The Company's net realized gains
were $7.2 million for the three months ended September 30, 2001 compared to net
realized gains of $0.4 million during the same period in 2000, resulting
primarily from the sale of corporate and taxable municipal securities.
Other revenue, which is composed of various components, was $16.8 million
for the third quarter of 2001, compared with $7.0 million for the same period in
2000. The increase is primarily the result of an increase in contract
underwriting revenue, an increase in equity earnings from Credit-Based Asset
Servicing and Securitization LLC ("C-BASS"), a joint venture with Radian Group
Inc. ("Radian"), and equity earnings from Sherman Financial Group LLC
("Sherman"), also a joint venture with 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
Page 13
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.
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 September 30, 2001 and 2000 were
approximately $960 million and $955 million, respectively, of which
approximately $764 million and $826 million, respectively, were mortgage-related
assets, including open trades. Total liabilities at September 30, 2001 and 2000
were approximately $676 million and $716 million, respectively, of which
approximately $591 million and $627 million, respectively, were funding
arrangements, including accrued interest, virtually all of which were
short-term. For the three months ended September 30, 2001 and 2000, revenues of
approximately $39 million and $25 million, respectively, and expenses of
approximately $27 million and $18 million, respectively, resulted in income
before tax of approximately $12 million and $7 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 and as a result their value for financial statement
purposes is estimated by the management of Sherman. Market value adjustments
could impact Sherman's results of operations and the Company's share of those
results.
Net losses incurred increased 103% to $43.5 million during the third
quarter of 2001 from $21.4 million during the same period in 2000. The increase
from a year ago was due to an increase in the primary notice inventory related
to bulk delinquency activity, the maturation of the 1998 and 1999 books of
business which were larger than books written in years preceding 1998 that have
passed through their historical peak delinquency years, and increased
delinquencies on the 2000 and 2001 books of business which are likely due to the
higher risk profile of these books compared to prior books. The delinquency rate
at September 30, 2001 was 3.14% compared to 2.58% at December 31, 2000, and the
primary notice inventory increased from 37,422 at December 31, 2000 to 48,820 at
September 30, 2001. Excluding bulk transaction loans, the delinquency rate was
2.41% at September 30, 2001 and 2.19% at December 31, 2000. The Company expects
the primary notice inventory, the delinquency rate, incurred losses and claims
paid, to increase from current levels due to the factors discussed above
relating to the increase in incurred losses. The average primary claim paid
during the third quarter was $17,700 compared to $19,500 in the third quarter of
2000. The pool notice inventory increased from 18,209 at December 31, 2000 to
20,760 at September 30, 2001.
At September 30, 2001, 64% of MGIC's insurance in force was written
subsequent to December 31, 1998. Based on all of the loans in the Company's
insurance in force, the
Page 14
highest claim frequency years have typically been the third through fifth year
after the year of loan origination. However, the pattern of claims frequency for
refinance loans may be different from this historical pattern and the Company
expects the period of highest claims frequency on bulk transaction loans will
occur earlier than in this historical pattern.
Underwriting and other expenses increased to $58.3 million in the third
quarter of 2001 from $40.1 million in the same period of 2000, an increase of
46%. The increase can be attributed to increases in both insurance and
non-insurance expenses related to increased volume and contract underwriting.
The consolidated insurance operations loss ratio was 16.4% for the third
quarter of 2001 compared to 9.4% for the third quarter of 2000. The consolidated
insurance operations expense and combined ratios were 16.0% and 32.4%,
respectively, for the third quarter of 2001 compared to 13.8% and 23.2% for the
third quarter of 2000.
The effective tax rate was 31.0% in the third quarter of 2001, compared to
31.5% in the third quarter of 2000. During both periods, the effective tax rate
was below the statutory rate of 35%, reflecting the benefits of tax-preferenced
investment income. The lower effective tax rate in 2001 resulted from a higher
percentage of total income before tax being generated from the tax-preferenced
investments.
Nine months Ended September 30, 2001 Compared With Nine months Ended September
30, 2000
Net income for the nine months ended September 30, 2001 was $478.1 million,
compared to $409.7 million for the same period of 2000, an increase of 17%.
Diluted earnings per share for the nine months ended September 30, 2001 was
$4.43 compared with $3.83 in the same period last year, an increase of 16%. 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 through September 30, 2001 were $1.0 billion, an increase of
22% from the $818.1 million for the same period in 2000. This increase was
primarily attributed to an increase in new business writings, which included
$19.7 billion in bulk transactions for the nine months ended September 30, 2001.
Also contributing to the increase in revenues was an increase in investment
income resulting from strong cash flows during the prior twelve months, and
increases in realized gains and other revenue. See below for a further
discussion of premiums, investment income and other revenue.
Losses and expenses through September 30, 2001 were $300.9 million, an
increase of 36% from $220.9 million for the same period of 2000. The increase
from last year can be attributed to an increase in notice inventories and
increases in both insurance and non-insurance expenses relating to increased
volume and contract underwriting. See below for a further discussion of losses
incurred and underwriting expenses.
Page 15
The amount of new primary insurance written by MGIC during the nine months
ended September 30, 2001 was $62.5 billion, compared to $30.7 billion in the
same period of 2000. The increase in new primary insurance written principally
reflected the increase in refinancing activity on the non-bulk business and the
increase in bulk transactions written through the third quarter of 2001,
compared to the same period of 2000. The Company does not expect comparable
increases in the volume of bulk transactions after the fourth quarter of 2001.
The $62.5 billion of new primary insurance written during the first nine
months of 2001 was offset by the cancellation of $43.1 billion of insurance in
force, and resulted in a net increase of $19.4 billion in primary insurance in
force, compared to new primary insurance written of $30.7 billion, the
cancellation of $21.3 billion of insurance in force and a net increase of $9.4
billion in primary insurance in force during the same period of 2000. Direct
primary insurance in force was $179.6 billion at September 30, 2001 compared to
$160.2 billion at December 31, 2000 and $157.0 billion at September 30, 2000.
In addition to providing primary insurance coverage, the Company also
insures pools of mortgage loans. New pool risk written during the nine months
ended September 30, 2001 and 2000, which was virtually all agency pool
insurance, was $291 million and $270 million, respectively. The Company's direct
pool risk in force was $1.8 billion at September 30, 2001 and at September 30,
2000 and $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 the
first nine months of 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 67.7% at September 30, 2001 from 80.4% at December
31, 2000 and 80.3% at September 30, 2000. Future cancellation activity could 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 materially lower
persistency than the Company's flow business.
New insurance written for bulk transactions was 31% of new insurance
written during the first nine months of 2001 compared to 16% for the same period
a year ago. The Company expects that the loans that are included in these 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
transactions 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.
Page 16
Net premiums written increased 15% to $757.5 million during the first nine
months of 2001, from $656.3 million during the same period in 2000. Net premiums
earned increased 16% to $763.3 million for the first nine months of 2001 from
$657.7 million for the same period 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 $46.7 million through September 30, 2001 compared to $34.9
million during the same period a year ago, primarily due to an increase in
captive mortgage reinsurance.
Mortgages (newly insured during the nine months ended September 30, 2001 or
in previous periods) approximating 25% of MGIC's new insurance written during
the first nine months of 2001 were subject to captive mortgage reinsurance and
similar arrangements compared to 30% during the same period in 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 September 30, 2001,
approximately 23% 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 the first nine months of 2001 was $152.6 million, an
increase of 18% over the $129.5 million in the first nine months of 2000. This
increase was the result of increases in the amortized cost of average invested
assets to $3.6 billion for the first nine months of 2001 from $3.0 billion for
the same period in 2000, an increase of 19%, and offset by a slight decrease in
the investment yield. The portfolio's average pre-tax investment yield was 5.6%
for the nine months ending September 30, 2001 and 6.0% for the same period in
2000. The portfolio's average after-tax investment yield was 4.7% for the first
nine months of 2001 and 4.9% for the same period in 2000. The Company's net
realized gains were $28.8 million for the nine months ended September 30, 2001
compared to net realized gains of $0.6 million during the same period in 2000,
resulting primarily from the sale of corporate and taxable municipal securities.
Other revenue, which is composed of various components, was $55.1 million
for the first nine months of 2001, compared with $30.3 million for the same
period in 2000. The increase is primarily the result of an increase in contract
underwriting revenue, an increase in equity earnings from Credit-Based Asset
Servicing and Securitization LLC ("C-BASS"), a joint venture with Radian Group
Inc. ("Radian"), and equity earnings (compared to a loss in the prior period)
from Sherman Financial Group LLC ("Sherman"), also a joint venture with 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
Page 17
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.
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 September 30, 2001 and 2000 were
approximately $960 million and $955 million, respectively, of which
approximately $764 million and $826 million, respectively, were mortgage-related
assets, including open trades. Total liabilities at September 30, 2001 and 2000
were approximately $676 million and $716 million, respectively, of which
approximately $591 million and $627 million, respectively, were funding
arrangements, including accrued interest, virtually all of which were
short-term. For the nine months ended September 30, 2001 and 2000, revenues of
approximately $160 million and $121 million, respectively, and expenses of
approximately $90 million and $71 million, respectively, resulted in income
before tax of approximately $70 million and $50 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 and as a result their value for financial statement
purposes is estimated by the management of Sherman. Market value adjustments
could impact Sherman's results of operations and the Company's share of those
results.
Net losses incurred increased 64% to $109.1 million during the first nine
months of 2001 from $66.6 million during the same period in 2000. The increase
from a year ago was due to an increase in the primary notice inventory related
to bulk delinquency activity, the maturation of the 1998 and 1999 books of
business which were larger than books written in years preceding 1998 that have
passed through their historical peak delinquency years, and increased
delinquencies on the 2000 and 2001 books of business which are likely due to the
higher risk profile of these books compared to prior books. The delinquency rate
at September 30, 2001 was 3.14% compared to 2.58% at December 31, 2000, and the
primary notice inventory increased from 37,422 at December 31, 2000 to 48,820 at
September 30, 2001. Excluding bulk transaction loans, the delinquency rate was
2.41% at September 30, 2001 and 2.19% at December 31, 2000. The average primary
claim paid through the third quarter was $18,300 compared to $19,100 through the
third quarter of 2000. The Company expects the primary notice inventory, the
delinquency rate, incurred losses and claims paid, to increase from current
levels due to the factors discussed above relating to the increase in incurred
losses. The pool notice inventory increased from 18,209 at December 31, 2000 to
20,760 at September 30, 2001. The redundancy in loss reserves in 2001 was
relatively consistent with the same period in 2000.
Page 18
At September 30, 2001, 64% of MGIC's insurance in force was written
subsequent to December 31, 1998. 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 year after the year of loan origination. However, the
pattern of claims frequency for refinance loans may be different from this
historical pattern and the Company expects the period of highest claims
frequency on bulk transaction loans will occur earlier than in this historical
pattern.
Underwriting and other expenses increased to $168.5 million in the first
nine months of 2001 from $133.3 million in the same period of 2000, an increase
of 26%. The increase can be attributed to increases in both insurance and
non-insurance expenses related to increased volume and contract underwriting.
Interest expense increased to $23.3 million in the first nine months of
2001 from $21.1 million during the same period in 2000 primarily due to higher
weighted-average interest rates during the nine months ended September 30, 2001
compared to the comparable period in 2000.
The consolidated insurance operations loss ratio was 14.3% for the first
nine months of 2001 compared to 10.1% for the same period in 2000. The
consolidated insurance operations expense and combined ratios were 16.4% and
30.7%, respectively, for the first nine months of 2001 compared to 17.0% and
27.1% for the first nine months of 2000.
The effective tax rate was 31.6% through September 30, 2001, compared to
31.4% in the same period of 2000. During both periods, 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 the tax-preferenced
investments.
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. The Company generated positive cash flows from operating
activities of approximately $522.1 million and $404.8 million for the nine
months ended September 30, 2001 and 2000, respectively, as shown on the
Consolidated Statement of Cash Flows. Positive cash flows are invested pending
future payments of claims and other expenses. Cash-flow shortfalls, if any,
could be funded through sales of short-term investments and other investment
portfolio securities.
Consolidated total investments and cash balances increased approximately
$562 million to $4.0 billion at September 30, 2001 from $3.5 billion at December
31, 2000, primarily due to positive net cash flow, and by increases in
unrealized gains on securities marked to market of $49 million. The Company
generated consolidated cash flows from operating activities of $522.1 million
through September 30, 2001, compared to $404.8
Page 19
million generated during the same period in 2000. The increase in operating cash
flows through the first nine months of 2001 compared to 2000 is due primarily to
increases in renewal premiums and investment income. As of September 30, 2001,
the Company had $171.5 million of short-term investments with maturities of 90
days or less, and 70% of the portfolio was invested in tax-preferenced
securities. In addition, at September 30, 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 September 30, 2001, the Company had an immaterial amount of derivative
financial instruments in its investment portfolio. The Company's philosophy is
to invest in instruments that meet high credit quality standards as specified in
the Company's investment policy guidelines; the policy also limits the amount of
credit exposure to any one issue, issuer and type of instrument.
The Company's investments in joint ventures increased $25.3 million from
$138.8 million at December 31, 2000 to $164.1 million at September 30, 2001 as a
result of additional investments of $15.0 million and equity earnings of $23.0
million offset by $12.8 million of dividends received.
Consolidated loss reserves at September 30, 2001, net of reinsurance
recoverable of $27.8 million, decreased slightly to $576.1 million from $576.3
million, net of reinsurance recoverable of $33.2 million, at December 31, 2000,
reflecting a reduction in the primary and pool reserve factors partially offset
by increases in the primary and pool insurance notice inventories, as discussed
earlier. The Company currently expects that consolidated loss reserves will
increase in the fourth quarter of 2001 and throughout 2002 due to higher levels
of incurred losses as discussed above. Consistent with industry practices, the
Company does not establish loss reserves for future claims on insured loans
which are not currently in default.
Consolidated unearned premiums decreased $5.8 million from $172.0 million,
net of reinsurance recoverable of $8.7 million, at December 31, 2000, to $166.2
million, net of reinsurance recoverable of $8.6 million, at September 30, 2001,
primarily reflecting the continued high level of monthly premium policies
written.
During the first quarter of 2001, the Company established a $200 million
short term commercial paper program, rated "A-1" by S&P and "P-1" by Moody's. At
September 30, 2001, the Company's outstanding par balance of commercial paper
notes was $78.0 million. The proceeds of the commercial paper were used to repay
all outstanding borrowings under the bank facilities. At September 30, 2001, the
Company's outstanding debt was $377.3 million.
Consolidated shareholders' equity increased to $3.0 billion at September
30, 2001, from $2.5 billion at December 31, 2000, an increase of 21%. This
increase consisted of $478.1 million of net income through the third quarter of
2001, $19.8 million from the
Page 20
reissuance of treasury stock and other comprehensive gains, net of tax, of $22.9
million, offset by dividends declared of $8.0 million.
MGIC is the principal insurance subsidiary of the Company. MGIC's
risk-to-capital ratio was 9.5:1 at September 30, 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 $2.1 billion,
net of reinsurance, during the first nine months of 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,
Page 21
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.
For the third quarter of 2001, our new insurance written volume increased
84% compared to the same period in 2000. One of the reasons our volume was
higher in 2001 was because many borrowers refinanced their mortgages during the
first nine months of 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
interest rates will substantially reduce purchase activity by first time
homebuyers and that the decline in cancellations of insurance that in the past
have accompanied higher interest rates will not be sufficient to offset the
decline in premiums from loans that are not made.
If lenders and investors select alternatives to private mortgage insurance,
---------------------------------------------------------------------------
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 2000 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 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. In the last quarter of 2000, the Federal Housing
Administration reduced its mortgage insurance premiums.
Page 22
Investors are using reduced mortgage insurance coverage on a somewhat 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.
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
Page 23
under captive reinsurance arrangements virtually none of our primary insurance.
At September 30, 2001, about 23% 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 in 1997 compared to
36.2% in 2000.
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.
Page 24
As 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. While our losses could increase for
other reasons, we expect the weaker economic conditions prevalent today will
probably increase our losses. Also, we expect that the bulk loans we insure will
generate higher losses. We believe the premiums we charge on these loans will
generate acceptable returns but we cannot guaranty this result.
Our industry is subject to litigation risk.
-------------------------------------------
In recent years, consumers have brought a growing number of lawsuits
against home mortgage lenders and settlement service providers. As of the end of
September 2001, 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 have entered
into an agreement to settle the cases against them. The Court entered a final
order approving this settlement in June 2001, although due to appeals of orders
denying certain class members the right to intervene to challenge certain
aspects of the settlement, the final implementation of the settlement will not
occur until the appeals are resolved. We took a $23.2 million pretax charge in
2000 to cover our share of the estimated costs of the settlement. While the
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.
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.
Page 25
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At September 30, 2001, the Company's derivative financial instruments in
its investment portfolio were immaterial. The Company's philosophy is to invest
in instruments that meet high credit quality standards, as specified in the
Company's investment policy guidelines; the policy also limits the amount of
credit exposure to any one issue, issuer and type of instrument. At September
30, 2001, the effective duration of the Company's investment portfolio was 5.7
years. The effect of a 1% increase/decrease in market interest rates would
result in a 5.7% decrease/increase in the value of the Company's investment
portfolio. The Company's borrowings under the commercial paper program are
subject to interest rates that are variable. See note 2 to the consolidated
financial statements.
Page 26
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - The exhibits listed in the accompanying Index to
Exhibits are filed as part of this Form 10-Q.
(b) Reports on Form 8-K - No reports were filed on Form 8-K during
the quarter ended September 30, 2001.
Page 27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, on November 13, 2001.
MGIC INVESTMENT CORPORATION
\s\ J. Michael Lauer
------------------------------------
J. Michael Lauer
Executive Vice President and
Chief Financial Officer
\s\ Patrick Sinks
------------------------------------
Patrick Sinks
Senior Vice President, Controller
and Chief Accounting Officer
Page 28
INDEX TO EXHIBITS
(Item 6)
Exhibit
Number Description of Exhibit
- ------- ----------------------
11 Statement Re Computation of Net Income
Per Share
Page 29
EXHIBIT 11
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
STATEMENT RE COMPUTATION OF NET INCOME PER SHARE
Three and Nine Month Periods Ended September 30, 2001 and 2000
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
(In thousands of dollars,
except per share data)
BASIC EARNINGS PER SHARE
Average common shares outstanding 107,305 106,334 107,099 106,036
======== ======== ======== ========
Net income $158,992 $146,355 $478,134 $409,678
======== ======== ======== ========
Basic earnings per share $ 1.48 $ 1.38 $ 4.46 $ 3.86
======== ======== ======== ========
DILUTED EARNINGS PER SHARE
Adjusted shares outstanding:
Average common shares outstanding 107,305 106,334 107,099 106,036
Net shares to be issued upon
exercise of dilutive stock
options after applying treasury
stock method 913 1,005 937 1,029
-------- -------- -------- --------
Adjusted shares outstanding 108,218 107,339 108,036 107,065
======== ======== ======== ========
Net income $158,992 $146,355 $478,134 $409,678
======== ======== ======== ========
Diluted earnings per share $ 1.47 $ 1.36 $ 4.43 $ 3.83
======== ======== ======== ========