See the "Glossary of terms and acronyms" for definitions and descriptions of terms used throughout this annual report.
As used below, “we” and “our” refer to MGIC Investment Corporation’s consolidated operations or to MGIC Investment Corporation, as a separate entity, as the context requires. References to "we" and "our" in the context of debt obligations refer to MGIC Investment Corporation.
See "Explanation and Reconciliation of our use of Non-GAAP Financial Measures".
Losses incurred, net were $240.2 million, down 30% as new delinquent notice activity declined and we experienced higher favorable reserve development on prior year delinquencies and on our IBNR when compared to the prior year.
The loss on debt extinguishment recorded during 2016 resulted from debt transactions in which we, or MGIC, repurchased portions of our outstanding long-term debt at amounts that in aggregate were in excess of our carrying values. In addition, we wrote-off unamortized debt issuance costs on the repurchased portions of some of our long-term debt. See Note 7 - "Debt" to our consolidated financial statements for further discussion of the accounting for these transactions. We will continue to assess opportunities to improve our debt profile and / or reduce potential dilution from our remaining outstanding convertible debt, which could result in additional debt extinguishment losses in the future.
The provision for (benefit from) income taxes in our 2016 results reflects a tax provision at the statutory rate while our prior year results reflect the impact of the changes in our valuation allowance against our deferred tax assets, including its reversal in that year.
MGIC's capital position in relation to the PMIERs requirements continued to strengthen as MGIC held over $630 million of Available Assets in excess of the Minimum Required Assets at December 31, 2016. Our current strategy is to maintain an excess of 10%-15% over the Minimum Required Assets. Our ability to manage to this range is primarily subject to OCI approval of dividends from MGIC to our holding company (which would reduce MGIC's Available
Assets), the credit performance of our RIF (which would increase or decrease its Minimum Required Assets), and any changes made to the PMIERs financial requirements (which could increase or decrease Available Assets and/or Minimum Required Assets). During 2016, MGIC distributed $64 million of its excess Available Assets as dividends to our holding company. These dividends were the first dividends from MGIC since 2008.
Our book of IIF is the main driver of our revenues and earnings and its growth is driven by our ability to generate NIW and retain existing policies in force, as measured by our persistency. Interest rates influence both our NIW and persistency. Since the Presidential election, mortgage rates, as reflected in the 30-year fixed rate, have risen. In a rising rate environment, we expect the level of cancellation activity to decelerate, and in turn increase persistency, although the impact generally lags the change in interest rates. Higher interest rates could reduce affordability for borrowers, which could slow housing activity, and of particular importance to our industry, slow first time home buyer purchase activity resulting in less NIW. Historically however, purchase origination volume has not been significantly impacted by interest rate changes of less than 100 bps on a year-over-year basis.
We expect to face challenges growing our earned premium revenues in 2017 from 2016 levels, even with a larger book of IIF, as the impact of changing premium rates on our IIF continues to adversely impact our premium yield. Our premium yield is expected to decline in 2017 from the 2016 level as a greater percentage of our IIF will be from book years 2009 and later, which were generally written at lower premium rates than the earlier books. In addition, premium rates are resetting to lower rates on a substantial portion of our monthly and annual premium policies that have not been refinanced under HARP and remain in force on their ten year anniversary. The initial ten-year period is reset when a loan is refinanced under HARP. As of December 31, 2016, the 2007 book year IIF that is subject to premium rate resets during 2017 was approximately 4% of our total IIF. Counter to this trend, our net premiums earned may continue to benefit from cancellations on single premium policies in 2017, which increases our premium yield when persistency is less than was assumed when the policy was written, as the premium is generally non-refundable and becomes fully earned. Higher persistency on our monthly and annual premium business would also counteract the impact of lower premium rates.
with the PMIERs which are subject to change and the GSEs could make them more onerous in future periods, which could materially affect our Available Assets and/or Minimum Required Assets. We expect the GSEs to perform a comprehensive review of the PMIERs financial requirements and to update them in 2017 as the PMIERs provide that the tables of factors that determine Minimum Required Assets will be updated at least every two years. As part of the GSEs' comprehensive review, changes may also be made to provisions of the PMIERs that determine our Available Assets. As of December 31, 2016, we believe any reasonably foreseeable changes to the PMIERs financial requirements would not result in our failing to be in compliance with those new requirements.
The GSEs could make the PMIERs more onerous in the future; in this regard, the PMIERs provide that the tables of factors that determine Minimum Required Assets will be updated every two years and may be updated more frequently to reflect changes in macroeconomic conditions or loan performance. The GSEs will provide notice 180 days prior to the effective date of table updates. In addition, the GSEs may otherwise amend the PMIERs at any time.
The GSEs may reduce the amount of credit they allow under the PMIERs for the risk ceded under our quota share reinsurance transaction. The GSEs’ ongoing approval of that transaction is subject to several conditions and the transaction will be reviewed under the PMIERs at least annually by the GSEs. For more information about the transaction, see our risk factor titled “The mix of business we write affects our Minimum Required Assets under the PMIERs, our premium yields and the likelihood of losses occurring.”
On an overall basis, the amount of Available Assets MGIC must hold in order to continue to insure GSE loans increased under the PMIERs over what state regulation currently requires.
At December 31, 2016, MGIC’s risk-to-capital ratio was 10.7 to 1, below the maximum allowed by the jurisdictions with State Capital Requirements, and its policyholder position was $1.6 billion above the required MPP of $1.1 billion. In calculating our risk-to-capital ratio and MPP, we are allowed full credit for the risk ceded under our reinsurance transaction with a group of unaffiliated reinsurers. It is possible that under the revised State Capital Requirements discussed below, MGIC will not be allowed full credit for the risk ceded to the reinsurers. If MGIC is not allowed an agreed level of credit under either the State Capital Requirements or the PMIERs, MGIC may terminate the reinsurance transaction, without penalty. At this time, we expect MGIC
to continue to comply with the current State Capital Requirements; however, you should read our risk factors for information about matters that could negatively affect such compliance.
The federal government, including through the U.S. Department of the Treasury and the GSEs, and several lenders have modification and refinance programs to make outstanding loans more affordable to borrowers with the goal of reducing the number of foreclosures. These programs included HAMP and similar modification programs, and HARP. During 2015 and 2016, we were notified of modifications that cured delinquencies that had they become paid claims would have resulted in approximately $0.6 billion and $0.5 billion, respectively, of estimated claim payments. These levels are down from a high of $3.2 billion in 2010.
HAMP expired at the end of 2016 and although HARP has been extended through September 2017, we believe that we have realized the majority of the benefits from that program because the number of loans insured by us that we are aware are entering that program has decreased significantly. The GSEs have introduced the "Flex Modification" program to replace HAMP effective in October 2017. Until it becomes effective, loan servicers must still evaluate borrowers for other GSE modification programs.
NIW, which increases IIF, is the aggregate principal amount of the mortgages that are insured during a period. Many factors affect NIW, including the volume of low down payment home mortgage originations and competition to provide credit enhancement on those mortgages, including competition from the FHA, the VA, other mortgage insurers, GSE programs that may reduce or eliminate the demand for mortgage insurance and other alternatives to mortgage insurance. NIW does not include loans previously insured by us that are modified, such as loans modified under HARP.
Premium rates, which are affected by product type, competitive pressures, the risk characteristics of the insured loans and the percentage of coverage on the insured loans. The substantial majority of our monthly and annual mortgage insurance premiums are under premium plans for which, for the first ten years of the policy, the amount of premium is determined by multiplying the initial premium rate by the original loan balance; thereafter, the premium resets and a lower premium rate is used for the remaining life of the policy. However, for loans that have utilized HARP, the initial ten-year period resets as of the date of the HARP transaction. The remainder of our monthly and annual premiums are under premium plans for which premiums are determined by a fixed percentage of the loan’s amortizing balance over the life of the policy.
Losses incurred are the current expense that reflects estimated payments that will ultimately be made as a result of delinquencies on insured loans. As explained under “Critical Accounting Policies” below, except in the case of a premium deficiency reserve, we recognize an estimate of this expense only for delinquent loans. The level of new delinquencies has historically followed a seasonal pattern, with new delinquencies in the first part of the year lower than new delinquencies in the latter part of the year, though this pattern can be affected by the state of the economy and local housing markets. Losses incurred are generally affected by:
The state of the economy, including unemployment and housing values, each of which affects the likelihood that loans will become delinquent and whether loans that are delinquent cure their delinquency. Changes in housing values also affect our ability to mitigate our losses through sales of properties we acquire after paying a claim as well as borrower willingness to continue to make mortgage payments when the value of the home is below the mortgage balance.
The majority of our operating expenses are fixed, with some variability due to contract underwriting volume. Contract underwriting generates fee income included in “Other revenue.” Underwriting and other expenses are net of any ceding commission associated with our reinsurance agreements. See Note 9 - “Reinsurance” to our consolidated financial statements for a discussion of our reinsurance agreements.
Realized gains and losses are a function of the difference between the amount received on the sale of a security and the security’s cost basis, as well as any OTTI recognized in earnings. The amount received on the sale of fixed income securities is affected by the coupon rate of the security compared to the yield of comparable securities at the time of sale.
At times, we may undertake activities to improve our debt profile and/or reduce potential dilution from our outstanding convertible debt. Extinguishing our outstanding debt obligations early through these discretionary activities may result in losses primarily driven by the payment of consideration in excess of our carrying value, and the write off of unamortized debt issuance costs on the extinguished portion of the long-term debt.
Refer to “Explanation and reconciliation of our use of Non-GAAP financial measures” below to understand how these items impact our evaluation of our fundamental financial performance.
In general, the majority of any underwriting profit that a book generates occurs in the early years of the book, with the largest portion of any underwriting profit realized in the first year following the year the book was written. Subsequent years of a book generally result in either underwriting profit or underwriting losses. This pattern of results typically occurs because relatively few of the claims that a book will ultimately experience typically occur in the first few years of the book, when premium revenue is highest, while subsequent years are affected by declining premium revenues, as the number of insured loans decreases (primarily due to loan prepayments) and increasing losses. The typical pattern is also a function of premium rates generally resetting to lower levels after ten years.
Net operating income (loss) per diluted share is calculated by dividing (i) net operating income (loss) adjusted for interest expense on convertible debt, share dilution from convertible debt, and the impact of stock-based compensation arrangements consistent with the accounting standard regarding earnings per share, whenever the impact is dilutive, by (ii) diluted weighted average common shares outstanding.
Although pretax operating income (loss) and net operating income (loss) exclude certain items that have occurred in the past and are expected to occur in the future, the excluded items represent items that are: (1) not viewed as part of the operating performance of our primary activities; or (2) impacted by both discretionary and other economic factors and are not necessarily indicative of operating trends, or both. These adjustments, along with the reasons for their treatment, are described below. Other companies may calculate these measures differently. Therefore, their measures may not be comparable to those used by us.
Trends in the profitability of our fundamental operating activities can be more clearly identified without the fluctuations of these realized investment gains and losses.
Deferred tax asset valuation allowance. The recognition, or reversal, of a valuation allowance against deferred tax assets is subject to significant management judgment and such recognition or reversal may significantly impact the discrete accounting period in which it is recorded.
Source: GSEs and MBA estimates/forecasts as of January 2017. Amounts represent the average of all sources.
THE MORTGAGE INSURANCE INDUSTRY REMAINS INTENSELY COMPETITIVE (see tables 02 and 03)
We compete against five other private mortgage insurers, as well as government mortgage insurance programs such as the FHA and VA. There are various ways in which we compete with other mortgage insurers, including pricing, underwriting requirements, financial strength, customer relationships, reputation, and the strength of our management team and field organization. Competition in 2016 primarily centered on pricing practices in the market and included: (i) reductions in standard filed rates on BPMI policies, (ii) use by certain competitors of a spectrum of filed rates to allow for formulaic, risk-based pricing (commonly referred to as "black-box" pricing); and (iii) use of customized rates (discounted from published rates) on LPMI single premium policies. These pricing practices were driven by both the implementation of PMIERs at the end of 2015, as well as industry competition to maintain or grow market share. The result of the pricing changes, in which we participated, generally decreased filed premium rates on higher-FICO score loans and increased rates on lower-FICO score loans. We also continue to use authority set forth in our rate filings to provide customized LPMI single premium policy rates on a selective basis. We believe our current rates allow us to compete effectively across many FICO scores; however there is no guarantee that pricing competition will not intensify further, which could result in a decrease in our NIW and/or product-based returns.
Even though the PMI industry's pricing changes raised premiums on lower-FICO score loans, the PMI industry captured a greater share of the total PMI and government insured volume in 2016. The increase in PMI share was due in part to new 97% LTV loan offerings from lenders that securitize loans with the GSEs, which provided an alternative to similar FHA loan programs for qualified borrowers, and
While our market share in 2016 declined from 2015 levels due to the overall competitive environment, we believe the decline is principally attributable to our maintaining greater pricing discipline than certain competitors in LPMI single premium policies. We plan to continue to focus on writing new insurance that meets our risk-adjusted return thresholds across the spectrum of loans we insure and provide market-leading customer service. Our market share in 2017 will again primarily be influenced by competitive pricing practices, but is also expected to be influenced by customer service, and changes in ownership of our competitors as lenders prefer to allocate business across a spectrum of mortgage insurers, with limitations on amounts allocated to any individual mortgage insurer.
ESTIMATED PRIMARY MI MARKET SHARE % OF TOTAL PRIMARY MI VOLUME
Source: Inside Mortgage Finance - February 16, 2017 or SEC filings. Excludes HARP NIW.
percentage of NIW from LTVs 95.01 and above, which was largely a function of new 97% LTV loan programs offered by lenders and a shift by lenders from the FHA to PMI. The percentage of NIW from LTVs 80.01% to 85% also increased for a number of reasons: our lowering of premiums in this LTV segment and for borrowers with higher FICO scores, and a higher amount of refinancing originations by borrowers whose home values increased but still were required to have PMI.
The amount of our IIF and RIF is impacted by the amount of NIW and cancellations of primary IIF during the year. Although we wrote $47.9 billion of new insurance in 2016, we experienced an increasing level of cancellation volume, which hindered our IIF growth from the prior year. Cancellation activity is primarily due to refinancing activity, but is also impacted by rescissions, cancellations due to claim payment, and policies cancelled when borrowers achieve the required amount of home equity. Refinancing activity has historically been affected by the level of mortgage interest rates and the level of home price appreciation. Cancellations generally move inversely to the change in the direction of interest rates, although they generally lag a change in direction.
The proportion of our total primary RIF written after 2008 has been steadily increasing in proportion to our total primary RIF. Our 2009 and later books possess significantly improved credit characteristics when compared to our 2005-2008 origination years. The loans we insured beginning in 2009, on average, have substantially higher FICO scores and lower LTVs than those insured in 2005-2008. The credit profile of our RIF has also benefited from programs such as HARP. HARP allows borrowers who are not delinquent, but who may not otherwise be able to refinance their loans under the current GSE underwriting standards due to, for example, the current LTV exceeding 100%, to refinance and lower their note rate. Loans
associated with 97.5% of all of our HARP modifications were current as of December 31, 2016. The following chart shows the composition of our primary RIF as of December 31, 2016. As shown in the chart below, the aggregate of our 2009-2016 books and our HARP modifications accounted for approximately 81% of our total primary RIF at December 31, 2016.
2015 compared to 2014. NPW increased 15.7% from the prior year. The increase reflects higher premiums from new business, as well as a reduction to our premium refund accruals. In addition, ceded premiums were lower in 2015
due to the commutation of our 2013 QSR Transaction in the third quarter.
Premium yield decreased to 51.9 basis points for 2016 (2015: 52.8, 2014: 52.2)
The books we wrote in 2009 and after were 72% of our IIF as of December 31, 2016, compared to 64% as of December 31, 2015 and these book years have a lower average premium rate than prior books due to several factors, including, lower risk characteristics.
Premium refunds upon claim payment or rescission decrease our premium yield. Generally, the level of premiums we refund and our premium refund accrual are highly variable from period to period.
When a policy is cancelled for a reason other than rescission or claim payment, all premium that is non-refundable is immediately earned and any refundable premium from the cancellation date is returned to the servicer or borrower. Non-refundable premium is
primarily associated with our single premium policies, which are discussed below.
The recent decrease in single premium policy persistency has increased our premium yield, with an increasing impact in recent periods as single premium policies have become a larger portion of our IIF and mortgage interest rates have remained low resulting in greater cancellations of policies.
The use of reinsurance lowers our premium yield, however the magnitude of the impact varies from period to period due to the following considerations.
The 2015 QSR Transaction increased the amount of our IIF covered by reinsurance and results in an increase in the amount of premiums and losses ceded. We cede 30% of earned and received premiums and losses incurred. The premiums we cede are reduced by a profit commission, which primarily varies by the level of losses we cede.
Our reinsurance affects premiums, underwriting expenses and losses incurred and should be analyzed by reviewing its total effect on our statements of operations, as discussed below under “Reinsurance agreements.”
2015 compared to 2014. Our 2015 full-year premium yield increased when compared to full-year 2014 (see table 10). As shown in the chart the increase in our premium yield was due to lower premium refunds, higher earned premiums
The effects described above result in a net cost of the reinsurance, with respect to a covered loan, of 6% (but can be lower if losses are materially higher than we expect). This cost is derived by dividing the reduction in our pre-tax net income from such loans with reinsurance by our direct (that is, without reinsurance) premiums from such loans. Although the net cost of the reinsurance is generally constant at 6%, the effect of the reinsurance on the various components of pre-tax income discussed above will vary from period to period, depending on the level of ceded
The following table provides additional information related to our premiums written and earned and RIF subject to reinsurance agreements for 2016, 2015, and 2014.
See "Balance Sheet Analysis" in this MD&A for further discussion regarding our investment portfolio.
NET REALIZED INVESTMENT GAINS LOWER IN 2016; 2015 GAINS REFLECT OPPORTUNISTIC SALES ACTIVITY
The net unrealized (losses) gains position of our investment portfolio (see chart 12) as of December 31, 2016, 2015, and 2014 is as follows.
Estimation of losses is inherently judgmental. The conditions that affect the claim rate and claim severity include the current and future state of the domestic economy, including unemployment and the current and future strength of local housing markets. The actual amount of the claim payments may be substantially different than our loss reserve estimates. Our estimates could be adversely affected by several factors, including a deterioration of regional or national economic conditions, including unemployment, leading to a reduction in borrower income and thus their ability to make mortgage payments, and a drop in housing values, that could result in, among other things, greater losses on loans, and may affect borrower willingness to continue to make mortgage payments when the value of the home is below the mortgage balance. Historically, losses incurred have followed a seasonal trend in which the second half of the year has weaker credit performance than the first half, with higher new notice activity and a lower cure rate. Our estimates are also affected by any agreements we enter into regarding our claims paying practices, such as the settlement agreements discussed in Note 17 - “Litigation and Contingencies” to our consolidated financial statements. Changes to our estimates could
2016 compared to 2015. Losses incurred, net decreased 30% to $240 million compared to $344 million in 2015. The decrease was primarily due to a decrease in losses and LAE incurred in respect to defaults reported in the current year and favorable development on defaults that occurred in prior years. Current year losses declined due to a 9% reduction in new notices received and a lower claim rate applied to the new notices. The claim rate applied to new notices in each quarter of 2016 and 2015 generally ranged from 12% to 13% with the full-year 2016 claim rate on new notices declining by approximately 0.5 percentage points compared to the full-year 2015 claim rate. Favorable development on prior year defaults occurred in 2016 and 2015 due to a lower claim rate on previously reported defaults. In 2015, the amount of development was also favorably impacted by $21 million due to re-estimation of previously recorded reserves related to disputes on our claims paying practices and IBNR. The favorable development recognized in both 2016 and 2015 due to lower claim rates on prior year defaults was partially offset by increases in our expected severity assumption on prior year defaults. The increases in our severity assumption reflected a rising trend, following periods of relative stability, in our average claim paid, expressed as a percentage of our exposure (the unpaid principal balance of the loan times our insurance coverage percentage), from the first quarter of 2015 through the first quarter of 2016 (see table 17). Our loss reserves estimates take into consideration trends over time, because the development of the delinquencies may vary from period to period without establishing a meaningful trend.
In 2014, the favorable development reflected a lower claim rate and a lower severity assumption on prior years defaults.
The loss ratio is the ratio, expressed as a percentage, of the sum of incurred losses and LAE, net to net premiums earned. The decline in the loss ratio in 2016 when compared to 2015, and in 2015 when compared to 2014 was primarily due to a lower level of losses incurred, net.
prior represented approximately 96% of new notices received and 86% of those notices related to loans that were previously delinquent (see chart 16). As a result of this cycle (in which loans default, cure, and re-default, along with the duration that defaults may ultimately remain in our notice inventory), significant judgment is required in establishing the claim rate.
Net losses and LAE paid decreased 16% in 2016 compared to 2015 driven by lower claim activity on our primary business as the credit profile of our RIF continued to improve and our delinquent inventory declined. This is a continuation of the trend experienced in 2015 as net losses and LAE paid decreased 28% compared to 2014. During 2016, there was an increase in loss payments from settlements of disputes for claims paying practices and NPL settlements increased, primarily due to NPL settlements with the GSEs to resolve legacy defaults. Pool losses paid included our 2011 settlement with Freddie Mac; our final payment under this settlement was made on December 1, 2016. We believe paid claims will continue to decline in 2017.
See Note 8 - "Loss Reserves" for additional information on our settlements of disputes for claims paying practices and NPL settlements.
Our primary default rate at December 31, 2016 was 5.04% (2015: 6.31%, 2014: 8.25%). Our primary default inventory was 50,282 loans at December 31, 2016, representing a decrease of 20% from 2015 and 37% from 2014. The reduction in our primary default inventory is the result of the total number of defaulted loans: (1) that have cured; (2) for which claim payments have been made; or (3) that have resulted in rescission, claim denial, or removal from inventory due to NPL settlements, collectively exceeding the total number of new defaults on insured loans. In recent periods we have experienced improved cure rates and the overall mix of our default inventory, as represented by the number of missed payments, has improved compared to the prior years. As of December 31, 2016, the percentage of our default inventory that has 12 or more missed payments was 38% (2015: 43%, 2014: 47%). Generally, the fewer missed payments a defaulted loan has the lower the likelihood it will result in a claim. The NPL settlements were each completed at amounts approximating the loss reserves previously established on the defaulted loans. We expect our default inventory to continue to decline in 2017 from 2016 levels; however, the pace of decline is expected to moderate as our more recent book years naturally season.
See our Form 8-K filed with the Securities and Exchange Commission on November 30, 2012 for a discussion of our settlement with Freddie Mac regarding a pool policy. As of December 31, 2016 we had completed our obligation under this settlement agreement.
Note: Jurisdictions in italics in the table above are those that predominately use a judicial foreclosure process, which generally increases the amount of time it takes for a foreclosure to be completed.
Our results of operations continue to be negatively impacted by the mortgage insurance we wrote during 2005 through 2008 (see chart 18). Although uncertainty remains with respect to the ultimate losses we will experience on these books of business, as we continue to write new insurance on mortgages, those books have become a smaller percentage of our total mortgage insurance portfolio. Our 2005 through 2008 books of business represented approximately 25% and 32% of our total primary RIF at December 31, 2016 and 2015, respectively. Approximately 38% of the remaining primary RIF on our 2005-2008 books of business benefited from HARP as of December 31, 2016, compared to 36% as of December 31, 2015.
2016 compared to 2015. Underwriting and other expenses includes items such as employee compensation costs, fees for professional services, and premium taxes, and are reported net of ceding commissions. Underwriting and other expenses for 2016 decreased when compared to 2015 due to an increase in ceding commissions from reinsurers, offset by increases in employee costs and professional services.
2016 compared to 2015. Interest expense for 2016 decreased when compared to 2015 reflecting the following activities.
purchase by MGIC of $132.7 million in par value of our 9% Debentures, which are eliminated in consolidation, in the first quarter of 2016;
MGIC borrowed $155 million in the form of a 1.91% fixed rate advance from the FHLB in the first quarter of 2016; and
Loss on debt extinguishment in 2016 reflects our repurchases of a portion of our 2% Notes, 5% Notes, and MGIC's purchase of a portion of our 9% Debentures, which were all completed at amounts that were in excess of the purchased debt's carrying value. The loss also includes the
write-off of debt issuance costs on the extinguished portion of the outstanding 2% Notes. The 9% Debentures held by MGIC are eliminated in consolidation.
INCOME TAX EXPENSE (BENEFIT) REFLECTS THE CHANGE IN OUR TAX STATUS AND VALUATION ALLOWANCE REVERSAL
The return we generate on our investment portfolio, which primarily consists of investment income, is an important component of our consolidated financial results and the protection of principal is an important component of our portfolio objectives. Our investment portfolio primarily consists of a diverse mix of highly rated fixed income securities (see chart 20) and targets an intermediate 4 to 6 year duration that is designed to achieve the following main portfolio objectives:
The credit risk of specific securities is evaluated through analysis of the underlying fundamentals that includes consideration of the issuer's sector, scale, profitability, debt coverage, and ratings. The investment policy guidelines limit the amount of our credit exposure to any one issue, issuer and type of instrument.
Deferred income taxes primarily consist of net operating loss carryforwards from operating losses experienced in prior years that we expect to realize in future periods. During 2015, we reversed the valuation allowance that had been recorded against our deferred tax assets since 2009. The reversal of the valuation allowance was based on analysis that it was more likely than not that our deferred tax assets would be fully realizable.
We continue to have unresolved tax matters primarily related to reviews of our 2000-2007 federal income tax returns by the IRS. In January 2017, we and the IRS informed the Tax Court that we had reached a basis for settlement of the major unresolved tax matters. Any agreed settlement terms will ultimately be subject to review by the Joint Committee on Taxation before a settlement can be completed and there is no assurance that a settlement will be completed. Our consolidated financial statements reflect our estimates of the tax contingencies discussed more fully
Total equity increased 14% to $2,549 million as of December 31, 2016 from $2,236 million as of December 31, 2015. This increase from the prior year was driven by net income generated during 2016.
We have a non-contributory defined benefit pension plan covering substantially all domestic employees, as well as a supplemental executive retirement plan. Retirement benefits are based on compensation and years of service. We maintain plan assets to fund our benefit obligations. As of December 31, 2016 and 2015 our pension and post-retirement benefit plans have plan assets in excess of their projected obligations. The supplemental executive retirement plan benefits are paid from MGIC assets following employee retirements. Our projected benefit obligations under these plans are subject to numerous actuarial assumptions that may change in the future and as a result could substantially increase or decrease our obligations. Plan assets held to pay our obligations are primarily invested in a portfolio of debt securities to preserve capital and to provide monthly cash flows aligned with the liability component of our obligations, with a lesser allocation to a mix of equity securities. If the performance of our invested plan assets differs from our expectations, the funded status of the benefit plans may decline, even with no significant change in the obligations. See Note 11 - "Benefit Plans" to our consolidated financial statements for a complete discussion of these plans and their effect on the consolidated financial statements.
cash back when losses subject to our reinsurance coverage are paid.
The increase in net cash from operating activities in 2015 compared to 2014 was primarily due to a lower level of losses paid and the result of commuting our 2013 QSR Transaction. Cash flows from operations in 2015 also increased compared to 2014 due to an increase in premiums collected as our mix of single premium policies written and our IIF increased, and also from a higher level of investment income.
We maintain an investment portfolio that is primarily invested in a diverse mix of fixed income securities. As of December 31, 2016, our portfolio had a fair value of $4.7 billion. As of December 31, 2016 the value of our investment portfolio increased by $29.1 million, or 0.6% from December 31, 2015. In addition to investment portfolio activities, our investing activities included additions to property and equipment. In 2016, we began an initiative to update our corporate headquarters building and continued to invest in our technology infrastructure to enhance our ability to conduct business and execute our strategies.
Net cash flows used in investing activities in 2015 primarily reflect purchasing investment securities in an amount that exceeded our proceeds from sales and maturities of fixed income securities during the year. This outflow was offset in part by a reduction of cash restricted in its use.
Net cash flows used in financing activities for 2016 primarily reflect the transactions in which we repurchased a portion of the outstanding principal on our 5% Notes and 2% Notes, and in which MGIC purchased a portion of the outstanding principal on our 9% Debentures. MGIC's ownership of our 9% Debentures by MGIC is eliminated in consolidation. These transactions were completed at amounts in excess of the carrying value of the debt obligations and the excess amount settled in cash is reflected in our financing activities. These transactions were offset in part by the issuance of long-term debt that included an FHLB borrowing and our 5.75% Notes offering, net of related issuance fees.
Net cash flows used in financing activities for 2015 reflect the repayment of our Senior Notes that matured on November 1, 2015 and repurchases of $11.5 million par value of our Convertible Senior Notes due in May 2017, offset in part by tax benefits related to share-based compensation.
Capital risk is the risk that we have an insufficient level and composition of capital to comply with applicable requirements and to support our business activities and associated risks during normal economic environments and stressed conditions.
Maintain compliance with the financial requirements of PMIERs, and regulatory capital, and sizing the level of capital to balance competitive needs, handle contingencies, and create shareholder value;
As of December 31, 2016, we had approximately $283 million in cash and investments at our holding company. These resources are maintained primarily to service our debt interest expense, pay debt maturities, repurchase outstanding debt obligations as opportunities arise, and to settle intercompany obligations. We may also use available holding company cash to repurchase shares of our common stock. While these assets are held, we generate investment income that serves to offset a portion of our interest expense. In addition to investment income, the payment of dividends from our insurance subsidiaries and/or raising capital in the public markets are the principal sources of holding company cash inflow. MGIC is the principal source of dividend-paying capacity, which is restricted by insurance regulation. The ability to raise capital in the public markets is subject to prevailing market conditions, investor demand for the securities to be issued, and our deemed creditworthiness.
company included an aggregate of $64 million of dividends received from MGIC, and we dissolved other insurance subsidiaries resulting in a net cash infusion to the holding company of approximately $16 million. Investment income was approximately $7 million and other net cash inflows were approximately $5 million.
The dividends paid by MGIC to our holding company were the first since 2008. We expect MGIC to continue to pay quarterly dividends. OCI authorization is sought before MGIC pays dividends and MGIC will pay a dividend of $20 million to our holding company in the first quarter of 2017.
See Note 7 - “Debt” to our consolidated financial statements for additional information about the conversion terms of these issuances and the terms of our indebtedness, including our option to defer interest on our 9% Debentures. Any deferred interest compounds at the stated rate of 9%. The description in Note 7 - “Debt" to our consolidated financial statements is qualified in its entirety by the terms of the notes and debentures. The terms of our 5% Notes are contained in a Supplemental Indenture, dated as of April 26, 2010, between us and U.S. Bank National Association, as trustee, which is included as an exhibit to our 8-K filed with the SEC on April 30, 2010, and in the Indenture dated as of October 15, 2000, between us and the trustee ("2000 Indenture"). The terms of our 2% Notes are contained in a Second Supplemental Indenture, dated as of March 12, 2013, between us and U.S. Bank National Association, as trustee, which is included as an exhibit to our 8-K filed with the SEC on March 15, 2013, and the 2000 Indenture. The terms of our 9% Debentures are contained in the Indenture dated as of March 28, 2008, between us and U.S. Bank National Association filed as an exhibit to our Form 10-Q filed with the SEC on May 12, 2008.
As of December 31, 2016, MGIC’s Available Assets under PMIERs totaled approximately $4.7 billion, an in excess of approximately $630 million over its Minimum Required Assets of approximately $4.1 billion; and MGIC is in compliance with the requirements of the PMIERs and eligible to insure loans purchased by the GSEs. Maintaining a sufficient level of excess Available Assets will allow MGIC to remain in compliance with the PMIERs financial requirements, including , we believe, to the extent they are modified further in the next scheduled review; and will also allow us flexibility to participate in additional business opportunities as they may arise. The 2015 QSR Transaction provided an aggregate of approximately $730 million of PMIERs capital credit as of December 31, 2016. Our 2017 QSR transaction terms are similar to our 2015 QSR transaction and will also provide PMIERs capital credit.
RIF - net, as shown in the table above, is net of reinsurance and exposure on policies currently in default ($2.6 billion at December 31, 2016 and $3.2 billion at December 31, 2015) and for which loss reserves have been established.
The reductions in MGIC's and our combined insurance companies risk-to-capital in 2016 were primarily due to an increase in statutory policyholders' position due to an increase in statutory contingency reserves, partially offset by an increase in net RIF in both calculations. Our RIF, net of reinsurance, increased in 2016, due to an increase in our IIF. Our risk-to-capital ratio will decrease if the percentage increase in capital exceeds the percentage increase in insured risk.
Our other long-term liabilities represent the loss reserves established to recognize the liability for losses and LAE related to existing defaults on insured mortgage loans. The timing of the future claim payments associated with the established loss reserves was determined primarily based on two key assumptions: the length of time it takes for a notice of default to develop into a received claim and the length of time it takes for a received claim to be ultimately paid. The future claim payment periods are estimated based on historical experience, and could emerge significantly different than this estimate. Due to the uncertainty regarding how certain factors, such as loss mitigation protocols established by servicers and changes in some state foreclosure laws that may include, for example, a requirement for additional review and/or mediation process, will affect our future paid claims it is difficult to estimate the amount and timing of future claim payments. See Note 8 - “Loss Reserves” to our consolidated financial statements and “Critical Accounting
Policies” below. In accordance with GAAP for the mortgage insurance industry, we establish loss reserves only for loans in default. Because our reserving method does not take account of the impact of future losses that could occur from loans that are not delinquent, our obligation for ultimate losses that we expect to occur under our policies in force at any period end is not reflected in our consolidated financial statements or in the table above.
Reserves are established for reported insurance losses and LAE based on when notices of default on insured mortgage loans are received. For reporting purposes, we consider a loan in default when it is two or more payments past due. Even though the accounting standard, ASC 944, regarding accounting and reporting by insurance entities specifically excluded mortgage insurance from its guidance relating to loss reserves, we establish loss reserves using the general principles contained in the insurance standard. However, consistent with industry standards for mortgage insurers, we do not establish loss reserves for future claims on insured loans which are not currently in default.
We establish reserves using estimated claim rates and claim severities in estimating the ultimate loss. The liability for reinsurance assumed is based on information provided by the ceding companies.
The claim rates and claim severities are likely to be affected by external events, including actual economic conditions such as changes in unemployment rate, interest rate or
The actual amount of the claim payments may be substantially different than our loss reserve estimates. Our estimates could be adversely affected by several factors, including a deterioration of regional or national economic conditions, including unemployment, leading to a reduction in borrower income and thus their ability to make mortgage payments, and a drop in housing values, that could result in, among other things, greater losses on loans, and may affect borrower willingness to continue to make mortgage payments when the value of the home is below the mortgage balance. Our estimates are also affected by any agreements we enter into regarding our claims paying practices, such as the settlement agreements discussed in Note 17 - “Litigation and Contingencies” to our consolidated financial statements.
Because our insurance premiums are earned over time, changes in persistency result in DAC being amortized against revenue over a comparable period of time. At December 31, 2016, the persistency rate of our primary mortgage insurance was 76.9%, compared to 79.7% at December 31, 2015. This change did not significantly affect the amortization of deferred insurance policy acquisition costs for the period ended December 31, 2016. A 10% change in persistency would not have a material effect on the amortization of DAC in the subsequent year.
At December 31, 2016, our direct domestic primary insurance in force ("IIF") was $182.0 billion, which represents the principal balance in our records of all mortgage loans that we insure, and our direct domestic primary risk in force ("RIF") was $47.2 billion, which represents the insurance in force multiplied by the insurance coverage percentage.
Substantially all of our insurance written since 2008 has been for loans purchased by the GSEs. We operate under the Private Mortgage Insurer Eligibility Requirements ("PMIERs") of the GSEs that became effective December 31, 2015, and were most recently revised in December 2016. The financial requirements of the PMIERs require a mortgage insurer’s "Available Assets" (generally only the most liquid assets of an insurer) to equal or exceed its "Minimum Required Assets" (which are based on an insurer's book and are calculated from tables of factors with several risk dimensions and are subject to a floor amount). Based on our interpretation of the PMIERs, as of December 31, 2016, MGIC’s Available Assets are in excess of its Minimum Required Assets; and MGIC is in compliance with the requirements of the PMIERs and eligible to insure loans purchased by the GSEs. The revisions to the PMIERs in December 2016 had no impact on our calculation of Available Assets or Minimum Required Assets, and did not impact our operations.
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"), as codified in the Accounting Standards Codification ("ASC"). Our consolidated financial statements include the accounts of MGIC Investment Corporation and its majority-owned subsidiaries. Intercompany transactions and balances have been eliminated. In accordance with GAAP, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. We have considered subsequent events through the date of this filing.
independent pricing sources and believe that their policies adequately consider market activity, either based on specific transactions for the issue valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. A variety of inputs are utilized by the independent pricing sources including benchmark yields, reported trades, non-binding broker/dealer quotes, issuer spreads, two sided markets, benchmark securities, bids, offers and reference data including data published in market research publications. Inputs may be weighted differently for any security, and not all inputs are used for each security evaluation.
The independent pricing sources utilize these approaches to determine the fair value of the instruments in Level 2 of the fair value hierarchy based on type of instrument:
Corporate Debt & U.S. Government and Agency Bonds are evaluated by surveying the dealer community, obtaining
Level 3 - Valuations derived from valuation techniques in which one or more significant inputs or value drivers are unobservable or from par values for equity securities restricted in their ability to be redeemed or sold. The inputs used to derive the fair value of Level 3 securities reflect our own assumptions about the assumptions a market participant would use in pricing an asset or liability. Financial assets utilizing Level 3 inputs primarily include equity
portion that is due to other factors. The credit loss portion is recognized as a loss in the statement of operations, while the loss due to other factors is recognized in accumulated other comprehensive loss, net of taxes. A credit loss is determined to exist if the present value of the discounted cash flows, using the security’s original yield, expected to be collected from the security is less than the cost basis of the security.
Home office and equipment is shown net of accumulated depreciation of $30.6 million, $26.1 million and $54.9 million as of December 31, 2016, 2015 and 2014, respectively. Depreciation expense for the years ended December 31, 2016, 2015 and 2014 was $4.6 million, $3.2 million and $2.2 million, respectively.
The calculation of premium deficiency reserves requires the use of significant judgments and estimates to determine the present value of future premium and present value of expected losses and expenses on our business. The calculation of future premium depends on, among other things, assumptions about persistency and repayment patterns on underlying loans. The calculation of expected losses and expenses depends on assumptions relating to severity of claims and claim rates on current defaults, and expected defaults in future periods. These assumptions also include an estimate of expected rescission activity.
Similar to our loss reserve estimates, our estimates for premium deficiency reserves could be adversely affected by several factors, including a deterioration of regional or economic conditions leading to a reduction in borrowers' income and thus their ability to make mortgage payments, and a drop in housing values can influence the willingness of borrowers with sufficient resources to make mortgage payments to do so when the mortgage balance exceeds the value of the home, which could expose us to greater losses. Assumptions used in calculating the deficiency reserves can also be affected by volatility in the current housing and mortgage lending industries. To the extent premium patterns and actual loss experience differ from the assumptions used in calculating the premium deficiency reserves, the differences between the actual results and our estimate will affect future period earnings and could be material.
We previously established a premium deficiency reserve in 2007 on our Wall Street Bulk business, which we also ceased writing in that year. As of December 31, 2015 a premium deficiency reserve was no longer required. Changes in the premium deficiency reserve from period to period were primarily due to the recognition of previously estimated premiums, losses, and expenses, and changes in our assumptions relating to the present value of expected future premiums, losses, and expenses on the remaining Wall Street Bulk IIF. Our consolidated statements of operations for the years ended December 31, 2015 and 2014 were affected by decreases in our premium deficiency reserves of $24 million and $25 million, respectively. The decreases represented the net result of actual premiums, losses and expenses as well as a net change in assumptions for these periods.
Fee income of our non-insurance subsidiaries is earned and recognized as the services are provided and the customer is obligated to pay. Fee income consists primarily of contract underwriting and related fee-based services provided to lenders and is included in “Other revenue” on the consolidated statements of operations.
Deferred income taxes are provided under the liability method, which recognizes the future tax effects of temporary differences between amounts reported in the consolidated financial statements and the tax bases of these items. The expected tax effects are computed at the enacted regular federal statutory tax rate. Using this method, we have recorded a net deferred tax asset primarily due to net operating losses incurred in prior years. On a quarterly basis, we review the need to maintain a deferred tax asset valuation allowance as an offset to the net deferred tax asset, before valuation allowance. We analyze several factors, among which are the severity and frequency of operating losses, our capacity for the carryback or carryforward of any losses, the existence and current level of taxable operating income, operating results on a three year cumulative basis, the expected occurrence of future income or loss, the expiration dates of the carryforwards, the cyclical nature of our operating results, and available tax planning strategies. Based on our analysis, we reduced our benefit from income tax through the recognition of a valuation allowance from the first quarter of 2009 through the second quarter of 2015. In the third quarter of 2015, as discussed in Note 12 -“Income Taxes,” we concluded that it was more likely than not that our deferred tax assets would be fully realizable and we reversed the valuation allowance.
We have certain share-based compensation plans. Under the fair value method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period which generally corresponds to the vesting period. The fair value of awards classified as liabilities is remeasured at each reporting period until the award is settled. Awards under our plans generally vest over periods ranging from one to three years. (See Note 15 - “Share-based Compensation Plans.”)
Basic earnings per share ("EPS") is calculated by dividing net income by the weighted average number of shares of common stock outstanding. Diluted EPS includes the components of basic EPS and also gives effect to dilutive common stock equivalents. We calculate diluted EPS using the treasury stock method and if-converted method. Under the treasury stock method, diluted EPS reflects the potential dilution that could occur if our unvested restricted stock units result in the issuance of common stock. Under the if-converted method, diluted EPS reflects the potential dilution that could occur if our convertible debt instruments result in the issuance of common stock. The determination of potentially issuable shares does not consider the satisfaction of the conversion requirements and the shares are included in the determination of diluted EPS as of the
Requires the presentation of debt issuance costs in the balance sheet as a deduction from the carrying amount of the related debt liability instead of as a deferred charge.
There was no material impact on the consolidated balance sheets, and no impact on our statements of operations.
Adopted March 31, 2016 with application to performance based awards granted in 2016.
Compensation cost should be recognized in the period in which it become probable that the performance target will be achieved and should represent the compensation cost attributable to the periods for which service has been rendered.
This standard is not considered applicable to our business and therefore we have not adopted these disclosure requirements.
Cash flows related to debt prepayment and debt issuance transactions have been reclassified as financing activities from operating activities.
Requires equity investments, except those accounted for under the equity method of accounting that have a readily determinable fair value to be measured at fair value with changes in fair value recognized in earnings.
The potential impact from the adoption of this guidance is not expected to have a material impact our consolidated balance sheets, consolidated statements of operations, or liquidity.
Requires recognition of a cumulative effect adjustment to retained earnings as of the beginning of the reporting period of adoption.
Requires that, prospectively, all tax effects related to share-based compensation be made through the statement of operations at the time of settlement, rather than recognizing excess tax benefits within paid-in capital.
We are currently evaluating the impacts the adoption of this guidance will have on our consolidated financial statements.
Requires immediate recognition of estimated credit losses expected to occur over the remaining life of many financial instruments. Entities are required to use a current expected credit loss ("CECL") methodology that incorporates their forecasts of future economic conditions, unless such forecast is not reasonable or supportable, in which case the entity will revert to historical loss experience.
Amends existing guidance for available-for-sale fixed income securities to incorporate an allowance, rather than a write-down of the asset, with the amount of the allowance limited to the amount by which the fair value is less than amortized cost. The guidance will allow for reversals of impairment losses in the event that the credit of an issuer improves. The length of time a security has been in an unrealized loss position will no longer impact the determination of whether a credit loss exists.
The computation of basic EPS includes as "participating securities" unvested share-based compensation awards that contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, under the "two-class" method. Our participating securities are composed of vested restricted stock and restricted stock units with non-forfeitable rights to dividends (of which none have been declared since the issuance of these participating securities). For each of the years ended December 31, 2016, 2015, and 2014, participating securities of 0.1 million have been included in basic EPS.
The computation of diluted EPS for the years ended December 31, 2016, 2015, and 2014 includes weighted average unvested restricted stock units outstanding of 1.5 million, 2.1 million, and 3.1 million, respectively.
There were no OTTI losses recorded in other comprehensive (loss) income as of December 31, 2016 and 2015.
During the first quarter of 2016 we substantially liquidated our Australian entities and repatriated most assets, including proceeds from the monetization of our Australian investment portfolio. As of December 31, 2016 we held no investments in foreign sovereign governments. As of December 31, 2015 our foreign investments primarily consisted of Australian government and semi government securities.
As discussed in Note 7 - "Debt" we are required to maintain collateral of at least 102% of the outstanding principal balance of the FHLB Advance. As of December 31, 2016 that
The amortized cost and fair values of debt securities as of December 31, 2016, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Because most asset-backed and mortgage-backed securities and collateralized loan obligations provide for periodic payments throughout their lives, they are listed below in separate categories.
At December 31, 2016 and 2015, the investment portfolio had gross unrealized losses of $61 million and $68 million, respectively. For those securities in an unrealized loss position, the length of time the securities were in such a position, as measured by their month-end fair values, is as follows:
We had $13.6 million and $18.9 million of investments at fair value on deposit with various states as of December 31, 2016 and 2015, respectively, due to regulatory requirements of those state insurance departments.
Assets measured at fair value included those listed, by hierarchy level, in the following tables as of December 31, 2016 and 2015:
For assets and liabilities measured at fair value using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances for the years ended December 31, 2016, 2015, and 2014 is shown in the following tables. There were no transfers into or out of Level 3 in those years and there we no losses included in earnings for those years attributable to the change in unrealized losses on assets still held at the end of each applicable year.
2014 the majority of our Level 3 securities were state premium tax credit investments.
The 5% Notes, 2% Notes, 5.75% Notes, and 9% Debentures are obligations of our holding company, MGIC Investment Corporation, and not of its subsidiaries.
The impact of the reclassification of debt issuance costs on our outstanding debt obligations as of December 31, 2015 is as follows.
Long-term debt as of December 31, 2016 and 2015 consisted of the following obligations.
Interest payments, on a consolidated basis, for our debt obligations existing during 2016 and 2015 appear below.
The net proceeds from the 5.75% Notes issuance were primarily used as (i) cash consideration to repurchase a portion of our 2% Notes, and (ii) to repurchase the shares issued as partial consideration in the repurchases of our 2% Notes, as further described below. The remaining proceeds are being held for general corporate purposes.
We repaid the outstanding 5.375% Notes with cash at the holding company on November 2, 2015. Interest on these notes was payable semi-annually in arrears on May 1 and November 1 each year. The repayment of our Senior Notes had no material impact on our financial position or liquidity.
As of December 31, 2016 and 2015 we had outstanding $145.0 million and $333.5 million, respectively, principal amount of 5% Notes due in 2017 ("5% Notes"). In 2016, we repurchased $188.5 million in aggregate principal of our 5% Notes at a purchase price of $195.5 million, plus accrued interest using funds held at our holding company. In 2015, we purchased $11.5 million in aggregate principal of our 5% Notes at a purchase price of $12.0 million, plus accrued interest, using funds held at our holding company. In each of 2016 and 2015, the excess of the purchase price over carrying value, plus the write-off of unamortized issuance costs on the par value repurchased, is reflected as a loss on debt extinguishment on our consolidated statements of operations. Our 5% Notes repurchase in 2015 reduced our potentially dilutive shares by approximately 0.9 million shares, and our 2016 5% Notes repurchases reduced our potentially dilutive shares by approximately 14.0 million shares.
Interest on the 5% Notes is payable semi-annually in arrears on May 1 and November 1 of each year. The 5% Notes will mature on May 1, 2017. The 5% Notes are convertible, at the holder's option, at an initial conversion rate, which is subject to adjustment, of 74.4186 shares per $1,000 principal amount at any time prior to the maturity date. This represents an initial conversion price of approximately $13.44 per share. These 5% Notes will be equal in right of payment to our other senior debt and will be senior in right of payment to our 9% Debentures. Debt issuance costs are being amortized to interest expense over the contractual life of the 5% Notes. We have 10.8 million authorized shares reserved for conversion under our 5% Notes.
As of December 31, 2016 and 2015, we had outstanding $207.6 million and $500.0 million, respectively, principal amount of our 2% Notes due in 2020 ("2% Notes"). In the third quarter of 2016, we entered into privately negotiated agreements to repurchase $292.4 million in aggregate principal of our outstanding 2% Notes at a purchase price of $362.1 million, plus accrued interest. We funded the purchases with $230.7 million in cash, using proceeds from the issuance of our 5.75% Notes, and by issuing to certain sellers approximately 18.3 million shares of our common stock. The excess of the purchase price over carrying value, plus the write-off of unamortized issuance costs on the par value repurchased, is reflected as a loss on debt extinguishment on our consolidated statements of operations for the year ended December 31, 2016. The shares issued as consideration for the notes repurchases have been repurchased as of December 31, 2016 using cash from our 5.75% Notes issuance. The repurchases of the 2% Notes reduced potentially dilutive shares by approximately 42.1 million shares, without considering the shares issued as partial consideration in the purchases of the 2% Notes or the repurchase of shares to offset such shares issued.
Prior to January 1, 2020, the 2% Convertible Senior Notes are convertible only upon satisfaction of one or more conditions. One such condition is that during any calendar quarter commencing after March 31, 2014, the last reported sale price of our common stock for each of at least 20 trading days during the 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter be greater than or equal to 130% of the applicable conversion price on each applicable trading day. This condition was met for the quarter ended December 31, 2016. The 2% Notes are convertible at an initial conversion rate, which is subject to adjustment, of 143.8332 shares per $1,000 principal amount. This represents an initial conversion price of approximately $6.95 per share. 130% of such conversion price is approximately $9.04. On or after January 1, 2020, holders may convert their notes irrespective of satisfaction of the conditions.
20 of the 30 trading days preceding notice of the redemption. We have 29.9 million authorized shares reserved for conversion under our 2% Notes.
The provisions of the 2% Notes are complex. Covenants in the 2% Notes include a requirement to notify holders in advance of certain events and that we and the designated subsidiaries (defined above) preserve our corporate existence, rights and franchises unless we or any such subsidiary determines that such preservation is no longer necessary in the conduct of its business and that the loss thereof is not disadvantageous to holders of the 2% Notes. Further, the notes are subject to the indenture between us and the trustee that, among other terms, includes provisions that would constitute an event of default under the indenture. Upon such a default, the trustee could accelerate the maturity of the notes independent of any action by holders of the 2% Notes. This description is not intended to be complete in all respect and is qualified in its entirety by the terms of the 2% Notes, including their covenants and events of default. We were in compliance with all covenants at December 31, 2016. These 2% Notes will be equal in right of payment to our other senior debt and will be senior in right of payment to our 9% Debentures.
Losses incurred on default notices received in the current year decreased in 2016 compared to 2015, and in 2015 compared to 2014, primarily due to a decrease in the number of new defaults, net of cures, as well as a decrease in the estimated claim rate on recently reported defaults.
A negative number for prior year losses incurred indicates a redundancy of prior year loss reserves. See table below for more information about prior year loss development.
The prior year development of the reserves in 2016, 2015 and 2014 is reflected in the table below.
Approximately 47%, 50% and 53% of the primary default inventory in default for 12 consecutive months or more has been in default for at least 36 consecutive months as of December 31, 2016, 2015 and 2014, respectively.
Pool insurance default inventory decreased to 1,883 at December 31, 2016 from 2,739 at December 31, 2015 and 3,797 at December 31, 2014.
For information about discussions and legal proceedings with customers with respect to our claims paying practices, including settlements that we believe are probable, as defined in ASC 450-20, see Note 17 - “Litigation and Contingencies.”
Our consolidated financial statements reflect the effects of assumed and ceded reinsurance transactions. Assumed reinsurance refers to the acceptance of certain insurance risks that other insurance companies have underwritten. Ceded reinsurance involves transferring certain insurance risks (along with the related earned premiums) we have underwritten to other insurance companies who agree to share these risks. The primary purpose of ceded reinsurance is to protect us, at a cost, against a fixed percentage of losses arising from policies covered by the agreement;
We utilize a quota-share reinsurance agreement with a group of unaffiliated reinsurers, each with an insurer financial strength rating of A- or better by Standard and Poor's Rating Services, A.M. Best, or both, to manage our exposure to losses resulting from our mortgage guaranty policies and to provide reinsurance capital credit under the PMIERs. Our 2015 quota share reinsurance agreement("2015 QSR Transaction"), which became effective July 1, 2015 provides coverage on policies that were in the 2013 quota share reinsurance agreement ("2013 QSR Transaction"); additional qualifying in force policies as of the agreement effective date which either had no history of defaults, or where a single default had been cured for twelve or more months at the agreement effective date; and all qualifying new insurance written through December 31, 2016. The agreement cedes losses incurred and premiums on or after the effective date through December 31, 2024, at which time the agreement expires. Early termination of the agreement can be elected by us effective December 31, 2018 for a fee, or under specified scenarios for no fee upon prior written notice, including if we will receive less than 90% of the full credit amount under the PMIERs for the risk ceded in any required calculation period.
We have agreed to terms on a quota-share reinsurance agreement for 2017 ("2017 QSR Transaction") with a group of unaffiliated reinsurers, each with an insurer financial strength rating of A- or better by Standard and Poor's, A.M. Best or both, to manage our exposure to losses resulting from our mortgage guaranty policies and to provide reinsurance capital credit under the PMIERs. The GSEs have approved the terms of our proposed 2017 QSR Transaction. The 2017 QSR Transaction is expected to be executed during the first quarter of 2017 with an effective date retroactive to January 1, 2017, and will provide coverage on new business written January 1, 2017 through December 29, 2017 that meets certain eligibility requirements. Under the agreed upon terms, the 2017 QSR Transaction will cede losses incurred and premiums on or after the effective date through December 31, 2028, at which time the agreement expires. Early termination of the agreement can be elected by us effective December 31, 2021 for a fee, or under specified scenarios for no fee upon prior written notice, including if we will receive less than 90% of the full credit amount under the PMIERs for the risk ceded in any required calculation period.
The agreed upon structure of the 2017 QSR Transaction is a 30% quota share for all policies covered, with a 20% ceding commission as well as a profit commission. Generally, under the 2017 QSR Transaction, we will receive a profit commission provided that the loss ratio on the loans covered under the agreement remains below 60%.
The year ended December 31, 2015 includes the non-recurring impact of commuting our 2013 QSR Transaction. The commutation had no impact on ceded losses incurred.
Under the terms of 2015 QSR Transaction, reinsurance premiums, ceding commission and profit commission are settled net on a quarterly basis. The reinsurance premium due after deducting the related ceding commission and profit commission is reported within "Other liabilities" on the consolidated balance sheets.
In the past, MGIC also obtained captive reinsurance. In a captive reinsurance arrangement, the reinsurer is affiliated with the lender for whom MGIC provides mortgage insurance. As part of our settlement with the CFPB in 2013 and with the Minnesota Department of Commerce in 2015, MGIC has agreed to not enter into any new captive reinsurance agreement or reinsure any new loans under any existing captive reinsurance agreement for a period of ten years subsequent to the respective settlements. In accordance with the CFPB settlement, all of our active captive arrangements were placed into run-off. In addition, the GSEs will not approve any future reinsurance or risk sharing transaction with a mortgage enterprise or an affiliate of a mortgage enterprise.
The reinsurance recoverable on loss reserves related to captive agreements was $19 million at December 31, 2016 which was supported by $91 million of trust assets, while at December 31, 2015 the reinsurance recoverable on loss reserves related to captive agreements was $34 million which was supported by $137 million of trust assets. Each captive reinsurer is required to maintain a separate trust account to support its combined reinsured risk on all annual books. MGIC is the sole beneficiary of the trusts.
Increases (decreases) Net realized investment gains on the consolidated statements of operations.
See Note 12 - “Income Taxes” for a discussion of the valuation allowance recorded against deferred tax assets.
The amortization of gains and losses resulting from actual experience different from assumed experience or changes in assumptions including discount rates is included as a component of Net Periodic Benefit Cost/(Income) for the year. The gain or loss in excess of a 10% corridor is amortized by the average remaining service period of participating employees expected to receive benefits under the plan.
Includes lump sum payments of $11.2 million and $22.4 million in 2016 and 2015, respectively, from our pension plan to eligible participants, which were former employees with vested benefits.
To determine the fair value of securities in Level 1 and Level 2 of the fair value hierarchy, independent pricing sources have been utilized. One price is provided per security based on observable market data. To ensure securities are appropriately classified in the fair value hierarchy, we review the pricing techniques and methodologies of the independent pricing sources and believe that their policies adequately consider market activity, either based on
specific transactions for the issue valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. A variety of inputs are utilized by the independent pricing sources including benchmark yields, reported trades, non-binding broker/dealer quotes, issuer spreads, two sided markets, benchmark securities, bids, offers and reference data including market research publications. Inputs may be weighted differently for any security, and not all inputs are used for each security evaluation. Market indicators, industry and economic events are also considered. This information is evaluated using a multidimensional pricing model. In addition, on a quarterly basis, we perform quality controls over values received from the pricing source (the “Trustee”) which include comparing values to other independent pricing sources. In addition, we review annually the Trustee’s auditor’s report on internal controls in order to determine that their controls around valuing securities are operating effectively. We have not made any adjustments to the prices obtained from the independent sources.
The pension plan has implemented a strategy to reduce risk through the use of a targeted funded ratio. The liability driven component is key to the asset allocation. The liability driven component seeks to align the duration of the fixed income asset allocation with the expected duration of the plan liabilities or benefit payments. Overall asset allocation is dynamic and specifies target allocation weights and ranges based on the funded status.
Net deferred tax assets and liabilities as of December 31, 2016 and 2015 are as follows:
The components of the net deferred tax asset as of December 31, 2016 and 2015 are as follows:
In the third quarter of 2015, we concluded that it was more likely than not that our deferred tax assets would be fully realizable and that the valuation allowance was no longer necessary and we reversed the valuation allowance. For the year ended December 31, 2015, we reversed $161.1 million of our valuation allowance based on income from 2015. The portion of the valuation allowance reversed related to deferred tax assets that are expected to be realized in future years, totaling $747.5 million, is treated as a discrete period item and is recognized as a component of the tax provision in continuing operations in the period of release. Furthermore, in determining the discrete period impact from the reversal, we removed the prior period disproportionate tax effects that had arisen in other comprehensive income because of the valuation allowance. This reduced the amount of tax benefit included in net income and resulted
Amounts recorded in other comprehensive income to be realized in future years
Giving full effect to the carryback of net operating losses for federal income tax purposes, we have approximately $1,489 million of net operating loss ("NOL") carryforwards on a regular tax basis and $589 million of net operating loss carryforwards for computing the alternative minimum tax as of December 31, 2016. Any unutilized carryforwards are scheduled to expire at the end of tax years 2030 through 2033.
We paid $4.5 million, $5.4 million, and $1.3 million in federal income tax in 2016, 2015 and 2014, respectively.
The reconciliation of the federal statutory income tax rate to the effective tax provision (benefit) rate is as follows:
We filed a petition with the U.S. Tax Court contesting most of the IRS’ proposed adjustments reflected in the Notices of Deficiency and the IRS filed an answer to our petition which continued to assert their claim. The case has twice been scheduled for trial and in each instance, the parties jointly filed, and the U.S. Tax Court approved (most recently in February 2016), motions for continuance to postpone the trial date. Also in February 2016, the U.S. Tax Court approved a joint motion to consolidate for trial, briefing, and opinion, our case with similar cases of Radian Group, Inc., as successor to Enhance Financial Services Group, Inc., et al. In January 2017, the parties informed the Tax Court that they had reached a basis for settlement of the major issues in the case. Any agreed settlement terms will ultimately be subject to review by the Joint Committee on Taxation ("JCT") before a settlement can be completed and there is no assurance that a settlement will be completed. Based on information that we currently have regarding the status of our ongoing dispute, we expect to record a provision for additional taxes and interest of $15 to $25 million in the first quarter of 2017.
In October 2014, we received a Revenue Agent’s Report from the IRS related to the examination of our federal income tax returns for the years 2011 and 2012. The result of this examination had no material effect on the financial statements.
Under current guidance, when evaluating a tax position for recognition and measurement, an entity shall presume that the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information. The interpretation adopts a benefit recognition model with
a two-step approach, a more-likely-than-not threshold for recognition and derecognition, and a measurement attribute that is the greatest amount of benefit that is cumulatively greater than 50% likely of being realized. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
The total amount of the unrecognized tax benefits, related to our aforementioned REMIC issue, which would affect our effective tax rate, is $94.6 million. We recognize interest accrued and penalties related to unrecognized tax benefits in income taxes. During 2016, we recognized $1.1 million in interest. As of December 31, 2016 and 2015, we had $28.9 million and $27.8 million of accrued interest related to uncertain tax positions, respectively. The statute of limitations related to the consolidated federal income tax return is closed for all years prior to 2000. It is reasonably possible that our 2000-2007 federal tax case will be resolved, other than through litigation. If it is resolved under the basis of settlement as disclosed above, our total unrecognized tax benefits would be reduced by $108.2 million during 2017. After taking into account prior payments and the effect of available net operating loss carrybacks, any net cash outflows would approximate $52 million.
As described in Note 7 - "Debt", we entered into privately negotiated agreements to repurchase, for cash, together with, in certain cases, shares of our common stock, $292.4 million aggregate principal amount of our outstanding 2% Notes. We issued approximately 18.3 million shares of our common stock as partial consideration under these agreements. As of December 31, 2016 we have repurchased all of the shares issued as partial consideration for our 2% Notes repurchases. The weighted average price paid for the share repurchases was $8.03, which includes commissions, and the aggregate purchase amount was $147.1 million.
The statutory financial statements of our insurance companies are presented on the basis of accounting practices prescribed or permitted by the Office of the Commissioner of Insurance of the State of Wisconsin (the "OCI"), which has adopted the National Association of
Insurance Commissioners ("NAIC") statutory accounting practices as the basis of its statutory accounting practices ("SSAP"). In converting from statutory to GAAP, typical adjustments include deferral of policy acquisition costs, the inclusion of net unrealized holding gains or losses in shareholders' equity relating to fixed maturities and the inclusion of statutory non-admitted assets.
The statutory net income (loss), policyholders' surplus and contingency reserve liability of the insurance subsidiaries of our holding company are show in the following table. The statutory net loss in 2015 was driven by the dissolution of an MGIC non-insurance subsidiary. The surplus amounts included in the following table are the combined policyholders' surplus of our insurance operations as utilized in our risk-to-capital calculations.
of the investment was fully reflected in surplus as an unrealized loss prior to 2015.
The surplus contributions made to MGIC and dividends paid by MGIC and distributions from other insurance subsidiaries to us, are shown in the table below.
At December 31, 2016, the risk-to-capital ratio of our combined insurance operations (which includes a reinsurance affiliate) was 12.0 to 1. Reinsurance transactions with our affiliate permit MGIC to write insurance with a higher coverage percentage than it could on its own under certain state-specific requirements. A higher risk-to-capital ratio on a combined basis may indicate that, in order for MGIC to continue to utilize reinsurance arrangements with its reinsurance affiliate, additional capital contributions to the affiliate could be needed.
The NAIC previously announced that it plans to revise the minimum capital and surplus requirements for mortgage insurers that are provided for in its Mortgage Guaranty Insurance Model Act. In May 2016, a working group of state regulators released an exposure draft of a risk-based capital framework to establish capital requirements for mortgage insurers, although no date has been established by which the NAIC must propose revisions to the capital requirements. We continue to evaluate the impact of the framework contained in the exposure draft, including the potential impact of certain items that have not yet been completely addressed by the framework which include: the treatment of ceded risk, minimum capital floors, and action level triggers. Currently we believe that the PMIERs contain the more restrictive capital requirements in most circumstances.
While MGIC currently meets the State Capital Requirements of Wisconsin and all other jurisdictions, it could be prevented from writing new business in the future in all jurisdictions if it fails to meet the State Capital Requirements of Wisconsin, or it could be prevented from writing new business in a particular jurisdiction if it fails to meet the State Capital Requirements of that jurisdiction and in each case MGIC does not obtain a waiver of such requirements. It is possible that regulatory action by one or more jurisdictions, including those that do not have specific State Capital Requirements, may prevent MGIC from continuing to write new insurance in such jurisdictions. If we are unable to write business in all jurisdictions, lenders may be unwilling to procure insurance from us anywhere. In addition, a lender’s assessment of the future ability of our insurance operations to meet the State Capital Requirements or the PMIERs may affect its willingness to procure insurance from us. A possible future failure by MGIC to meet the State Capital Requirements or the PMIERs will not necessarily mean that MGIC lacks sufficient resources to pay claims on its insurance liabilities. While we believe MGIC has sufficient claims paying resources to meet its claim obligations on its IIF on a timely basis, you should read the rest of these financial statement footnotes for information about matters that could negatively affect MGIC’s claims paying resources.
In 2016, MGIC paid a total of $64 million in dividends to our holding company, its first dividends since 2008, and we expect MGIC to continue to pay quarterly dividends. During 2016, distributions of $52 million were paid to our holding company from other insurance subsidiaries. These distributions were completed in conjunction with the transfer of risk and the final dissolution of those insurance entities during 2016. Our holding company subsequently contributed the majority of the funds to MGIC in relation to the transfer of risk. During 2015, distributions of $38.5 million were paid to our holding company from other insurance subsidiaries.
MGIC is subject to statutory regulations as to payment of dividends. The maximum amount of dividends that MGIC may pay in any twelve-month period without regulatory approval by the OCI is the lesser of adjusted statutory net income or 10% of statutory policyholders' surplus as of the preceding calendar year end. Adjusted statutory net income is defined for this purpose to be the greater of statutory net income, net of realized investment gains, for the calendar year preceding the date of the dividend or statutory net income, net of realized investment gains, for the three calendar years preceding the date of the dividend less dividends paid within the first two of the preceding three calendar years. The OCI recognizes only statutory accounting practices prescribed or permitted by the State of Wisconsin for determining and reporting the financial condition and results of operations of an insurance company. The OCI has adopted certain prescribed accounting practices that differ from those found in other states. Specifically, Wisconsin domiciled companies record changes in the contingency reserves through the income statement as a change in underwriting deduction. As a result, in periods in which MGIC is increasing contingency reserves, statutory net income is lowered. For the year ended December 31, 2016, MGIC’s statutory net income was reduced by $490 million to account for the increase in contingency reserves.
We have an omnibus incentive plan that was adopted on April 23, 2015. When the 2015 plan was adopted, no further awards could be made under our previous 2011 plan. The purpose of the 2015 plan is to motivate and incent performance by, and to retain the services of, key employees
At December 31, 2016, 8.3 million shares were available for future grant under the 2015 omnibus incentive plan.
We lease certain office space as well as data processing equipment and autos under operating leases that expire during the next five years. Generally, rental payments are fixed.
Under ASC 450-20, until a liability associated with settlement discussions or legal proceedings becomes probable and can be reasonably estimated, we consider our claim payment or rescission resolved for financial reporting purposes and do not accrue an estimated loss. Where we determine that a loss is probable and can be reasonably estimated we have recorded our best estimate of our probable loss. If we are not able to implement settlements we consider probable, we intend to defend MGIC vigorously against any related legal proceedings.
Mortgage insurers, including MGIC, have been involved in litigation and regulatory actions related to alleged violations of the anti-referral fee provisions of RESPA, and the notice provisions of the FCRA.
See Note 12 - “Income Taxes” for a description of federal income tax contingencies.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, comprehensive income, shareholders’ equity and of cash flows present fairly, in all material respects, the financial position of MGIC Investment Corporation and its subsidiaries (the “Company”) at December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure, Controls and Procedures, Other information