MGIC Investment Corporation (MTG) Q2 2017 Earnings Report, Transcript and Summary

Good morning. My name is Josephine, and I will be your conference operator today. At this time, I would like to welcome everyone to the MGIC Investment Corporation Second Quarter 2017 Earnings Call. [Operator Instructions] I would now like to turn the conference over to Mike Zimmerman, Senior Vice President, Investor Relations. Please go ahead.

Thanks Josephine. Good morning and thank you for joining us this morning and for your interest in MGIC Investment Corporation. Joining me on the call today to discuss results for the second quarter of 2017 are CEO, Pat Sinks; Executive Vice President and CFO, Tim Mattke; and Executive Vice President of Risk Management, Steve Mackey. I want to remind all participants that our earnings release of this morning, which may be accessed on MGIC's website, which is located at mtg.mgic.com under Newsroom, includes additional information about the Company's quarterly results that we will refer to during the call, and includes certain non-GAAP financial measures. We have posted on our website a presentation that contains information pertaining to our primary risk in force and new insurance written, and other information which we think you will find valuable. During the course of this call, we may make comments about our expectations of the future. Actual results could differ materially from those contained in these forward-looking statements. Additional information about those factors that could cause actual results to differ materially from those discussed on the call, are contained in the Form 8-K that was filed earlier this morning. If the Company makes any forward-looking statements, we are not undertaking obligation to update those statements in the future in light of subsequent developments. Further, no interested parties should rely on the fact that such guidance or forward-looking statements are current any time other than the time of this call or the issuance of the Form 8-K. At this time, I’d like to turn the call over to Pat Sinks.

Thanks, Mike, and good morning. I’m pleased to report that we had another strong quarter and that we continue to build on the momentum of the first quarter. In a few minutes Tim will cover the details of the financial results but before he does let me provide a few highlights. In the quarter we wrote $12.9 billion of new business, up 2.4% from the same period last year. New business combined with a sequentially higher annual persistency resulted in a 5.5% increase in insurance in force. Since insurance in force is the driver of our revenues, this is a key metric that we focus on. The growth of insurance in force reflects the expanding purchase mortgage market. Our company's market share of approximately 18% and the hard work and dedication of my fellow coworkers to deliver stellar customers service. The 2009 in newer books now account for more than 74% of our risk in force and continue to generate a level of losses. The increase in size and quality of our insurance in force, the run-off of the older books and our strong financial performance position us well to provide credit enhancement and low-down payment solutions for lenders, GSEs and borrowers. During the quarter, we saw a low level of refinance transactions accounting for just 9% of our new insurance written compared to 17% both last quarter and the second quarter of 2016. Year-to-date through mid July, refinance applications accounted for just 11% of total applications compared to 17% for the same period last year. Year-to-date purchase application activity through mid-July is 7% higher than the same period last year. This is a net positive for our company and our industry as our industry's market share as a percentage of total originations is 3.5 to 4 times higher purchase loans and refi's. With the current and expected level of mortgage rates, we expect the continued low level of refinance activity and that the annual persistency metric we report each quarter will continue to increase gradually in subsequent periods. Given the actual results to date and expected new business we still expect to write approximately $48 billion of new business for the full year. This level of new business combined with an expected increase in persistency should result in insurance in force continuing to increase. We continue to reposition our balance sheet to take advantage of future business opportunities. During the quarter the 2017 senior notes matured, which eliminated approximately 11 million potentially dilutive shares. We repaid the credit facility, converted most of the outstanding 2020 senior notes to common stock and redeemed those that did not convert. These actions improved our leverage ratios and will decrease our interest expense in future periods. With that, let me turn it over to Tim.

Thanks Pat. In the quarter, we earned $118.6 million of net income or $0.31 per diluted share versus $109.2 million or $0.26 per diluted share for the same period last year. The year-over-year comparisons to the financial results more meaningful, we disclose adjusted net operating income a non-GAAP measure. While there are only immaterial impacts in the quarter, a reconciliation of GAAP net income to adjusted non net operating income is included in the body of the press release. The primary driver of the improvement in our financial performance was lower losses incurred. Losses incurred were $27.3 million versus $46.6 million for the same period last year, due primarily to fewer new notices received and a lower claim rate and to new notices received compared to the same quarter last year. Each quarter we review the performance of the existing delinquent inventory to determine what if any changes should be made to the estimated claim rates and severity factors. As a result of this review, we updated our assumption for previously received delinquent notices because the actual experience has outperformed our previous estimate. This resulted in a benefit of approximately $52 million to our primary loss reserves, principally due to lower estimated claim rate. In the second quarter we received 10% fewer new notices versus the same period last year and reflecting a current economic environment and anticipated cures, we use a claim rate of approximately 11% on these new notices. While this rate is modestly higher than the first quarter due to the seasonal factors, it is lower than the 13% rates used in the same period last year. The new delinquent activity from the larger, more recently written books remains quite low, reflecting their high credit quality and new delinquent notices from the legacy book continue to decline at a steady pace. We expect that the legacy books will continue to be the primary source of new notice activity for the foreseeable future. During the quarter, the legacy books generated nearly 83% of the new delinquent notices received, while accounting for just over 25% of the risk in force. Reflecting a smaller delinquent inventory, the number of claims received in the quarter declined 13% from the same period last year. Net day claims in the second quarter were $173 million. Included in that amount was $45 million that was associated with the loans that were removed from inventory to the agreement demining coverage that have been previously disclosed in our monthly operating statistic. Excluding this impact, primary day claims were $126 million down 18% from the same period last year. The effective average premium yield for the second quarter of 2017 was approximately 50 basis points which was effectively flat from the first quarter level. As I have discussed in the past, for a variety of reasons we expect to be effective premium yields will trend lower in future pier. However the exact amount and timing is difficult to predict. At the end of the second quarter, MGIC’s available assets for PMIERs purposes totaled approximately $4.7 billion, resulting in $800 million excess over the required assets. MGIC's statutory capital is $1.8 billion in excess of the state requirements. Reflecting the profitability and quality of the new books of business, as well as the improved performance and runoff of the legacy books, the excess over the PMIERs required asset continues to grow. In addition to writing new business and exploring new opportunities as they arise, we will try to manage the amount of excess by continually reviewing our use of reinsurance, as well as continuing to seek and pay dividends out of the writing company. Regarding MGIC's ability to pay quarterly dividends, we previously disclosed that the Wisconsin insurance regulator approved the $30 million dividend that was paid to the holding company in the second quarter. We continue to be optimistic that these quarterly dividends will continue and are planning to ask for and receive a higher dividend in the third quarter. We are hopeful that the dividends can grow in the future, especially if the difference between available assets and required assets under PMIERs growth as we expect. As a reminder, OCI authorization is sought before MGIC pays any dividend. In March, we issued a irrevocable notice of redemption of our 2% convertible senior notes due in 2020. As expected in April, virtually all of the holders elected to convert their notes to shares of our common stock. The conversion had no material impact to diluted earnings per share during the quarter as the event previously included a net calculation. We also repaid $150 million that was previously drawn on the line of credit as those resources were not needed to settle the redemption. These transactions combined with the retirement of the 5% senior notes results in a debt to capital ratio declining to approximately 22% at the end of the second quarter from approximately 30% at the end of the second quarter of 2016. At quarter-end, our consolidated cash and investments totaled $4.8 billion including $149 million of cash and investments at the holding company. The investment portfolio had a mix of 68% taxable and 32% tax exempt securities, a pre-tax yield of 2.7% and a duration of 4.6 years. The holding company has resources for approximately 2 and 1.5 year of ongoing debt service. As of June 30, the holding company's annual debt service on their remaining outstanding debt is approximately $60 million. This includes approximately $12 million that the holding company pays MGIC which owns $133 million of a 9% junior subordinated debt. When we analyze various options to deploy our capital resources, we need to take into account that the holding company's primary source of capital is the writing company. So, while capital is being traded at the writing company level, its ability to pay dividends at holding company is subject to OCI review and approval. We also consider the resulting leverage ratio, the ability to continue our positive ratings trajectory and the debt service ability at the holding company. With that, let me turn it back to Pat.

Thanks, Tim. Before moving to questions, let me give a quick update on the regulatory and political fronts. The review and updating of state capital standards by the NAIC, continues to move forward albeit slowly. At this time, we do not expect the revised state capital standards to be more restrictive than the financial requirements of the PMIERs. Regarding PMIERs, the GSEs have committed to us that they would provide at least 180 days written notice prior to the effective date of new requirements. Recently they informed us that they currently anticipate that new PMIER financial requirements would not become effective until the fourth quarter of 2018. In regards to the housing reform, we remain optimistic but it continues to be very difficult to gauge what actions may be taken and the timing of any such actions. But the message that private capital could play a greater role in housing policy is being heard, is a positive for MGIC and our industry. As an individual company and through various trade associations including USMI, we are actively engaged in Washington, hoping to shape a greater role for private mortgage insurance. We are encouraged that the discussions about housing reform are now beginning to be more inclusive about the role of each of the GSEs, FHA and private capital versus treating them as separate topics. Regarding the FHA specifically, our new director has not yet been named but based on our discussion with various parties in the administration, we do not expect FHA to cut it's premium rates in the foreseeable future. In closing, we continue to build off of the great start we have in the first quarter. Our insurance in force continue to grow. Annual persistency is increasing, new delinquent notices declined as the newer books of business continue to generate low-levels of new delinquent notices and the legacy portfolio continues to run off. Further the anticipated claim rate on existing delinquency has declined. We maintained our traditionally lower expense ratio and the holding company received a $30 million governing from MGIC. I'm very excited and confident about the opportunities MGIC has to continue to serve the housing market. And as I said in previous quarters, I firmly believe that there is a greater role for us to play in providing increased access to credit for consumers and reducing GSE credit risk while generating good returns for shareholders and we are committed to pursuing those opportunities. With that operator, let's take questions.

[Operator Instructions] Your first question comes from Bose George with KBW.

Just first on PMIERs 2.0 you guys noted, you have $800 million, excess capital under PMIERs just longer term, once you have clarity on PMIERs 2.0. What do you think is a good run rate for in terms of the capital cushion for PMIERs?

Bose, this is Tim, we talked that we like to be in the 10% to 15% right now, but I think that includes some of our not knowing what PMIERs 2.0 would be. So I think it's safe to say that in general we think it could be lower than that, but I think it will depend upon the conditions that exist at the time and once we see sort of what PMIERs 2.0 looks like, we'll have a -- we'll be able to have a better response as to what we think the right range would be at that point.

Okay. And then you noticed that you've heard from FHFA or GSEs that it won't be effective until the end of 2018. Is there any other indication of how PMIERs 2.0 might be different from 1.0?

This is Mike. So to clarify, it's the fourth quarter of '18. So not necessarily yearend '18, just to be technical on it, but to answer your question directly, no, we haven’t really heard any directional comments from the GSEs about what -- or the FHFA about how, what they're thinking about as far as changing the tables, what factors and those types of things.

Okay. Great. And then just one more on the premium, your average premium on NIW went up again this quarter, I am just curious what is driving the improvement there? Is there a sort of seasonality purchase versus refi mix or anything else moving that number?

This is Tim, I think it's mostly mix. I don't think it's seasonality per se, but slight increase in the 97 LP business and marginally lower FICO scores probably contribute to those numbers.

Okay. Thank you.

Your next question comes from Jack Micenko with SIG.

Hi. Good morning. What was the quarterly persistency rate? I know you guys reported portfolio level, but on a quarterly number for us?

Jake, this is Mike. It's just a tad over 80% as refi picked up just a little bit and the cancellation rate I should say picked up a little bit. But again as I did last quarter, I don't want anybody to overemphasize the quarterly trend, the annual persistency keeps ticking up.

Okay. That's fair and then Tim, as we kind of see some proposal out accounting for credit losses and realizing more of those over-the-life losses upfront, I'm curious if you looked at that and how you think about it? It's certainly going to be something for the banks to deal with. It does apply the loans and you're not a lender, but it does carve out financial instruments and debt investments too. So do you guys have any thoughts around whether that's going to apply to MI policies or any forward thought there?

Yes Jake, it's a good question. I think our current thinking right now is that it does not apply to MIs from an insurance accounting standpoint when you think about the loss reserving process, but that's something that we obviously keep close eye on and make sure we understand what the guidance is if there is an authoritative guidance that would come out that would scope in the MI industry.

Okay. And just real quick, was there any tie at all between the larger recessions and the development -- positive development that you saw in the quarter.

Jake, do you want to clarify the larger you said recession.

Yes.

Maybe try to get it nothing about the determination of the coverage or.

Just recession kind was higher and I am wondering if that had anything to do with the - I know you said it claim rate change but I think bulk settlement something like that okay.

I think from our reaction no it didn’t have a correlation.

Okay, thanks.

Your next question comes from Phil Stefano with Deutsche Bank.

Thanks and good morning. A quick point of clarification so the few master point it will be fourth quarter effective is that apply second quarter will get the draft wording and such and think about 180 day like?

Well based on the information - this might give us 180 day written notice before the fact of it and that in the tighter in the fourth quarter so it could be as early as second quarter depending on if it’s later in the fourth quarter it will be later into the year but that’s the best information that we have at this time.

Got it, got it okay. And thinking about the expenses in the expense ratio, so if we look in expenses excluding the CD commission, it feels like it’s been growing mid-single digits. To what extent is that the right way to think about expense growth in light of the potential to earn premium growth pressure that you've been guiding with lower premiums yields? How can I think about this translating to the expense ratio I guess ultimately what I'm trying to get to is how can I think about the scalability of the business and what that implies moving forward?

Yes, I think Phil this is Tim. I think from a scalability I think we feel very good about it. That being said, I think I would say if you’re talking about the expense ratio the run rate we had this quarter was pretty consistent with what we seen over the last couple quarter there is probably a pretty good range to think about that over the rest of the year. That being said, if you’re looking just as the growth expenses, I think we talked at the end of last year coming to this year from a growth base this will probably going to be up somewhere it just less than 5% and I think those things sort of all - sort of come together. We found a little bit more from the expense standpoint on growth basis but we don’t think that means that the expense ratios got a whack with where they have been over the last year so.

Okay. Is there a feel for quote unquote right expense ratio is for the long-term. I guess how do you think about being comfortable it was operating efficiently, but also making investments for the future. And what are the conversations generally that happen there around that balance?

Yes I think we’ve always in general talked about from a pricing standpoint that we think about a 20% expense ratio that seems to be sort of the standard measure in the industry. I think we’ve always taken a great pride and that we’ve been able to operate underneath that for the most part. So I think you know if we trend higher towards that 20% we have some tough questions but at the same time we feel like we continuously invest in our IT infrastructure and don't have any sort of significant one type items that are delayed on that. And so I think we feel pretty good about where expenses are right now.

Okay that’s all I have thanks and best of luck.

Your next question comes from Geoffrey Dunn with Dowling & Partners.

Thanks good morning. Tim just first can you quantity refunded premiums in the quarter please?

The refunded premiums from a accelerated premium amount that what’s you’re talking about Geoff.

Yes exactly.

If you’re talking about accelerate singles in the quarter it was about 7.5 million that compared to probably about 5 million in Q1 the balance from what we got in the second half of last year.

Right. And then with team mayors obviously not a surprise I guess I didn’t hit the deadline but what do you guys read into the fact as would pass that kind of June 30 implied to your maximum review deadline. And as you think about what could come at you is there any posturing from the GSE that suggest that they wouldn't just kind of arbitrarily tightness up on it?

This is Tim. I think it’s tough to answer I think you to what they might do I think it will be all speculation from our part and we don't have any knowledge about that as far as what they could do they spot us and others having in excess tough I mean I’ll take to comfort hoping that they will do what they think is the appropriate thing for the amount of capital that the industry needs to hold. So I don’t know of the delay to me is the delay is just a timing issue as oppose to anything else.

Okay, great. Thanks.

Your next question comes from Douglas Harter with Credit Suisse.

Thanks. As the dividends are getting from the writing company up to the hold co start to exceed your cash needs there, can you talk about what the potential uses are and how you're prioritizing those?

I think we're very happy that the dividends are increasing and they're outpacing sort of the hold co in the East from an interest service standpoint right now, but the same is I think we've talked in the past, we like to have somewhere around two to three years of interest coverage there and right now we're not up to three years. So we don't view us as having a lot of excess firepower up there at this point. Let's say from a debt leverage perspective, we're very happy that we've gotten into the lower 20s, but I don't think we're looking to take on additional leverage at this time to do anything else from a capital perspective. So I think it's something that hopefully we continue to get the dividend increase over time, but I think it will be something that we think we'll take even closer look at, but right now with where we are, we feel pretty comfortable with the cash at the holding company to cover the interest carry that's there right now.

And I guess it looks like and obviously we're dealing with rounded numbers, but the PMIERs excess went from $700-ish million to $800-ish million. I guess any thoughts as to how quickly the dividend could increase such that that excess cushion stops growing?

That's tough to speculate exactly how much. I think as far as how much the dividend will increase, but I do think there is a hopefully a correlation and we alluded for that as the excess continues to grow and the PMIERs requirement and we hope that that bolsters the case for being able to get dividends out but the relationship exactly I think that's difficult to forecast.

Okay. Thank you.

Your next question comes from Mark DeVries of Barclays.

Yeah thanks. First I just wanted to clarify your comments around your cash position. Sounds like Tim you said, you don't only view the company's having much excess at this point, but if I have the numbers right I think you indicated current cash investments are around 150, the debt service requirements annually are 60 and your dividends up from the writing company are annualized almost two extra debt service. So what am I missing? Why aren't you in an excess cash position where you are now?

The numbers are right. $149 million or cash to Holdco right now. $60 million a year as far as the interest coverage goes and so we really look at that compared to the $149 million so about 2.5 years of interest coverage there because we have to request approval from the state right now. I think that's how we sort of look at it as far as the dividends go, even though we again from a looking-forward perspective, we were very hopeful that we will get the dividend, but from coming out where we come from, I think our view is comparing that cash that's sitting there right now compared to the interest carrier is how we're looking at it versus the additional net increase in the dividend on the comp potentially.

Okay. Got it. And I think you indicated you're hoping to get more increase in the dividend in 3Q. You didn't indicate how much I don't think that's something you can comment on.

We did not indicate and it's not something that's we're going to comment on.

Okay. Fair enough. And then finally, I was hoping you should have seen through when we might start to see some revenue growth here because you've got insurance in force accelerating here I think North of 5%. I was trying NIW, their positive trends in terms of the average premium with the mix of higher altitude business increasing obviously partially offset by just the impact of these reinsurance. Interested in your thoughts on the trajectory going forward on revenue growth?

Yes, this is Tim again. I think in the quarter again the average premium yield was pretty flat quarter-over-quarter, but we do still view that as a headwind from a revenue standpoint that we still expect when you look over to the longer term that the average premium yield will continue to trend down like it has over the last couple of years. And so right now, we're expecting mid single-digit increase in end quarter that helps to keep the premium relatively steady right now but as far as growth in the short-term I think with the average premium yield continue to decline. We don't see that in the short term absent changes in persistency and no additional volume over what we expect etcetera.

Okay. And when you expect that premium pressure to abate?

The timing of that really difficult to know especially as you look at this most recent quarter and we do see this we are writing a little bit higher average premium rate in our new business. So the mix of the business is plays a lot in that so we try to figure out exactly when that might sort stabilize return I think it’s very difficult.

Okay, fair enough, thanks.

Your next question comes from Randy Binner with FBR.

Hi, I have one more on 2.0 the 180 day written notice period does that give you the opportunity to come back to go back to the GSEs with alternatives of their proposal or is that basically just 180 days of warning that they have issued a final rule?

Yes Randy this is Mike. We didn’t expect there will be some back and forth for the 180 days think of that as of the final so the final updates would be made and then what we have a 180 days industry level 180 days is the further fact of. So we would expect the total will have some back and forth I would actually see them before then. So, it's not just - that it's going to show up in mail and the fact there will be some conversation about it.

And you all mentioned that tables and factors could be changed which I think was about the same but is there I mean do you expect any haircuts around these reinsurance or other average assets is there any kind of sense you have of where to land and the follow-up of this just going to be should we expect you have to carry this significant PMIERs buffer until I guess mid 2018 year?

Yes, Randy this is Mike again. There is very little visibility and to what changes it could be including the topics that you talked about. So we’re - I will say like the rest of the market waiting to see what the GSE and FHFA will face will propose as far as change is to the factors. And just to clarify to the GSEs FHFA over the last year have made some subtle changes relative to different requirements in Q3 and things we are clarifying things but not in the financial factors so that’s really where the 180 days, they could change other subtle things along the way but the 180 days window is really about the financial tables.

I think the other thing I’d say to the buffer is one function of how much we line up all but obviously we’re above that and the other part of it is how much we can dividend out based higher regulator. So that’s the other constraint that apart from the PMIERs that comes into place for objective for holding and MGIC.

Right but a lot of binding constraint I guess?

Less binding constraints but in general that’s part of the reason why we’re holding more than we think we need to hold versus PMIERs as how much dividend capacity does the state regulator view is right now you know we do have to seek their approval so even though a 25 to 1 is the requirement that is requirement as far as dividend capacity goes.

And then just jumping over to the reserve activity, so the scores are of reserve releases there is there kind of timing or process that we would expect to continue or not continue meaning what is your methodology around this reserve releases and how should we think about the likelihood of those happening on a quarterly basis going forward?

We go through the process each quarter of updating our assumption over the delinquent inventory, they come up with a new estimate and really the reserve releases we refer to is more of output of that as opposed to decision making on that. So each quarter we go through the process we estimate and that gives us they finance us to whether we are over reserved or under reversed to prior period based on how things went over last couple quarters it’s been favorable development but to predict what will happen in the future is obviously difficult.

All right great thank you.

Your next question comes from Mihir Bhatia with Bank of America.

Good morning, thank you for taking my questions. One quick questions just wanted to talk about market share a little bit. I think you mentioned in your prepared remarks that you all estimated at 18% market share for the quarter I think that's consistent with last quarter and really the last few quarters and I guess my question is just I think our expectation was that your market share would increase a little bit potentially given the thought you view and some of just the other noise in the marketplace? Are you seeing any impacts of that or is that not yet coming through and maybe later in the year you'll start seeing that?

This is Pat. We did see our market share grow from the fourth quarter to the first quarter. I think it was in the high 17 to the low 18. We don't know yet what market share is in the second quarter. We probably won't know that for a month, but our instincts tell us we're still in 18% range. So I can't say with any certainty if we've been able to grow it with any great degree in the second quarter. We feel good about where we're at. We're as much focused on returns on capital and we don't want to grow market share for the sake of growing and now specific to March and the transaction they reported I think over the course of last couple quarters, even prior to the acquisition last year and in the first quarter this year, they had lost I think about a point of share. And then I think my thought is they'll continue to lose some. They said that publicly, but that happens over a period of time and in that regard, we're dependent upon the lenders looking at their MI relationships and deciding to reallocate it and there's no set pattern to that. So I think any share that we may pick up will be very gradual.

Got it. And just one other question really quickly on your premium yield, it was a nice bump up this quarter I think both on monthly and singles even more so and I was just wondering is that just mix shift from the types of policies they're writing or was there also some other things going on there?

I think that's mostly just mix shift and little bit maybe higher LTV and maybe marginally lower FICO creating that.

Got it. And any expectations from I think there's been a little bit of loosening of the credit box from Fannie and from the GSEs a little bit where I think the BDI range and stuff increased, do you all expect that to have any kind of material impact on your NIW expectations for the year?

Yeah we're not expecting, this is Steve, no we're not expecting that to have a material impact.

Okay. Great. That's all the questions I have. Thank you.

Your next question comes from Mackenzie Aron with Zelman & Associates.

Thanks. Good morning. Just two quick ones on the model. Was there any change in the IBNR and then also what should we be looking forward for the tax rate for the full year?

Yeah, Mackenzie it's Tim, IBNR no change. Tax rate for the full year, I think we're in that range now. Part of it depends upon the mix of the investment income we get versus the underwriting income. So I think it was it can trend a little bit higher if we have reserve releases for example that create more underwriting income. But in that 33%, 32%, 33% 34% area I think where you should expect us to be then.

Okay. Great. I guess just one last one on maybe any update on your conversation with the GSEs around potentially continuing to do the pilot program to the front end risk transfers? Do you think that's something that we can look forward to this year?

Well, they're continuing to pursue different types of structures. So we have ongoing dialogues with them. We stuck our toe in the water last year a little bit, but it all comes down to returns on capital, how much capital we need to hold. Different things of that nature. So I expect the discussions to continue but I can't point to anything definitive that will find it's way into a natural transaction.

Okay. Great. Thanks a lot.

And there are no further questions at this time.

Okay. Well, this is Pat and I want to thank everybody for your interest in our company and in joining us this morning and have a great day.