MGIC Investment Corporation (MTG) Q4 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the MGIC Investment Corporation fourth-quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, today's conference is being recorded. I would now like to introduce your host for today's conference call, Mr. Michael Zimmerman. You may begin sir.

Thanks, Kevin. 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 fourth quarter and full year of 2013 are Chairman and CEO, Curt Culver; President and COO, Pat Sinks; Executive Vice President and CFO, Mike Lauer; Executive Vice President of Risk Management, Larry Pierzchalski; and Senior Vice President and Controller, Tim Mattke. I want to remind all participants that our earnings release of this morning, which may be accessed on our website, is located at MGIC.com under Investor Information, includes additional information about the company's quarterly results that we will refer to during the call and include certain non-GAAP financial measures. As we've indicated in this morning's press release, we had posted on our website supplemental information containing characteristics of our primary risk in force and new insurance written, which we think you'll 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 statement, we are not undertaking an obligation to update these 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 at any time other than the time of this call or issuance of the Form 8-K. With that, let me turn the call over to Curt.

Thanks, Mike. Good morning. In the fourth quarter, we recorded a modest net loss of $1.4 million. But perhaps more significantly, I am pleased to report that in 2013 the company made substantial progress on numerous issues that have been challenging us for the last few years. Most importantly, we improved the capital position of the company through the capital raise as well as through the use of external reinsurance. And on an operating basis, new insurance written increased 24%, new delinquent notices declined 20%, the delinquent inventory declined 26%, and claim payments fell 29%. I'll expand on each of these topics during my remarks. Let me first address our improved capital position. In March of 2013, we raised $1.15 billion of new capital, of which $800 million was contributed to MGIC. In April, we closed a reinsurance transaction for new business written between the second quarter of 2013 and year-end 2015. The transaction is a 30% quota share with a 20% ceding commission and a profit commission. In December, we amended that treaty to include business written in the first quarter of 2013 and prior that has never been delinquent, totaling approximately $55 billion of insurance in force and $13.7 billion of risk in force as of December 31, 2013. This portion of the reinsured portfolio will have a 40% quota share, but all other terms remain the same. By implementing this amendment, MGIC's risk to capital ratio on a preliminary basis fell to 15.8 to 1 at the end of 2013. Without the amendment, it would have been 19.2 to 1 at the end of 2013 compared to 20.1 last quarter and 44.7 to 1 one year ago. We view that any reinsurance with strong partners in a cost-effective manner provides us increased flexibility to deal with revisions…

Thank you.

With that, Operator, we will take questions.

(Operator Instructions). Our first question comes from Mark DeVries with Barclays. Mark DeVries – Barclays Capital: Yes, thanks. First question. Curt, is the decision to reinsure so much risk at this point taking your risk to capital down a fair amount? Should we read into that any concern that when the eligibility requirements come out, it will be kind of the – the cap will be materially lower than the 18 to 1 that Radian initially cited, or is it more of a reflection that you are really optimistic about the amount of risk you will be writing over the next several years?

This puts us in a position of maximum flexibility, and one that is nondilutive and another that we have the ability to do it on a short-term basis if we choose. So it's more about the flexibility it offers to the company and the opportunity that it offers the company Mark. It is not reflective of what we think the capital standards are. It just puts us in a position that we think whatever comes out, we can maximize on what comes out. Mark DeVries – Barclays Capital: Okay. And I imagine – I know that the cost to you of the last reinsurance deal was quite attractive. Could you provide any color just on the difference in what you perceive the costs have been from this as opposed to another potential capital raise?

Well, we'd say the cost of this is the exact same. This is [an addendum] [ph] to the original agreement, so the cost to us is effectively the same on this part of the reinsurance agreement as the first part.

Right. Again, I don't know if you are talking about other capital raises that we have done, Mark, or just the first reinsurance transaction. Mark DeVries – Barclays Capital: Yes. So the cost of this reinsurance versus if you were, you know – if you were to have to raise additional equity.

It is significantly less than raising additional equity. I mean that's the key that we talked about. Not only is it less expensive, but it's also there is a timing horizon here that goes away after a number of years, and it also has some cancelability features to it. So it's a much better feature than raising capital and dilutive for a long-term basis.

I mean this is really a – but this is really a bridge that takes us through whatever the capital standards may come. At a point in time when they'd be implemented, it takes us through that period of time, and then after that, if it's not necessary, it's not necessary. So again, it really grants us great flexibility on a nondilutive basis, and a very cost effective – when you figure in the profits, a very cost effective manner. Mark DeVries – Barclays Capital: Understood. I just wanted to clarify one of your comments, Curt. I think you said it equates to about 2 basis points of premium yield. Is that correct?

That's correct. Mark DeVries – Barclays Capital: So, that's on all of your insurance in force. If I think about that, you're ceding about a third of your book in this case, right? Is that the equivalent of basically paying up 6 basis points for the amount that you're ceding?

Well, Mark, this is Mike Zimmerman, because there's two different segments. You have the first part of the transaction which is on the new business [met and] [ph] 30%... Mark DeVries – Barclays Capital: Yes.

…total this year, and this has about a 40% quota share on the legacy. So, on a weighted basis, we're trying to give you – there's some geography, because there's policy, the profit commission which runs through the premium line, the ceding commission that runs through the cost line with it, but on a bottom line basis, the equivalent is about 2 basis points annually. So, the yield itself will be effected more than that, but bottom line it's about a 2 basis point annual impact. Mark DeVries – Barclays Capital: Okay. Is that 55 – sorry, is that $55 billion number – is that the incremental from the latest addendum? Or is that the total between the earlier deal and this addendum?

That's the addendum. In the additional information in the press release, we give you the total amount of insurance in force. It is around 55 – all told about 55% of the insurance in force is covered by risk sharing arrangement. Mark DeVries – Barclays Capital: Okay.

What we're talking about were just for this addendum. Mark DeVries – Barclays Capital: Okay. So…

But the premium application of the quota share [inaudible] before the 40%. Mark DeVries – Barclays Capital: Okay, but bottom line, I guess the amount you're seeing is a much lower percentage of the premium than the amount of risk that your ceding?

Well, right because of the – you’re right because of the profit commission and the way the deal is structured. Mark DeVries – Barclays Capital: Yes, yes.

That's right. Mark DeVries – Barclays Capital: Okay.

And another way to think about it instead of basis points, the combined deals we think will probably cost us about $25 million to $30 million per year. And that’s… Mark DeVries – Barclays Capital: Okay, okay. That's helpful. Great. All right. Let me be the first to, Mike, wish you the best on your future endeavors.

Thank you. Thanks.

Our next question comes from Eric Beardsley with Goldman Sachs. Eric Beardsley – Goldman Sachs: Hi. Thanks. Just to follow-up on the reinsurance. I guess – as you look at the timing – I know you're looking at flexibility, but with the landscape, that you might not have the FHFA eligibility requirements for another few months. Why do you choose to pursue this now? Were there any concerns about competition in terms of reinsurance and others looking for deals?

Clearly. Clearly. Again, we – again, we have relationships with these, reinsurers, but we also are aware that others are in the market. And so it was a case of what we thought getting the preferred reinsurers that we have dealt with in the past and move forward with them at this point in time. Eric Beardsley – Goldman Sachs: Great. And then just to follow-up. Can you comment on any trends you're seeing in severities? It looks like, on our calculations that your average severity for primary claim is down roughly 3% year-over-year, which is a little bit less an improvement than we've seen in prior quarters. Is there any change in terms of geography there, or any seasonality we should be aware of?

No. Nothing significant. We see that bounce around a little bit quarter to quarter, so nothing unexpected with the movement in the quarter. Eric Beardsley – Goldman Sachs: Okay. Great. Thank you.

Our next question comes from Sean Dargan with Macquarie. Sean Dargan – Macquarie Research: Thanks. And to start off by wishing Mike the best of luck in your retirement. Just going back to Mark's question about the - I guess the cost of the reinsurance, did I hear that the cost for the business covered by the addendum is the same as the new business?

Effectively, it’s [inaudible] weighted in effectively, yes. I mean – I think the way you want to think about the reinsurance transaction though is in its entirety, you know relative to the treaty is one. So that all the [inaudible] ratios, the ceding commission, the profit commission et cetera all work in combination, and that's [inaudible], Sean, that it's equivalent to about a 2 basis point bottom-line impact. Sean Dargan – Macquarie Research: Okay, because I would just think that, because the risk characteristics are different, that the counterparty would want to charge more to assume that risk.

The terms are the same other than the quota share, so the ceding commission, profit commission, they are all the same. Sean Dargan – Macquarie Research: Yes.

So net-net, aside from the quota share, they get the same amount. Sean Dargan – Macquarie Research: Okay. And then another way to ask a question about the timing of your transaction, it came in December, during which time we saw a change in leadership at the FHFA. Now, I know you didn't get affirmative approval from either of the GSEs, but is this something that you cleared with – or discussed at least with the new leadership at the FHFA before you entered into the addendum?

We’ve been – they are aware. Freddie and Fannie are aware, as is the FHFA, and we expect them to approve it, which is why it was recorded. Sean Dargan – Macquarie Research: Okay. Thank you very much.

And really, again, the timing – yes, I think, as Curt mentioned, one thing on the timing was the known parties, but also, like any other transaction, windows open and close and you want to make sure that you have the advantage of the counterparties when they're also in the market [inaudible]. Sean Dargan – Macquarie Research: Okay, thank you.

Our next question comes from Jack Micenko with SIG. Jack Micenko – Susquehanna Financial Group/SIG: Thanks for taking the question., and Mike, wishing you warm weather and wide-open fairways. On the quota share, the new incremental – you said term is the same. Does that mean you can reverse this at points in time if we get further clarity on risk to capital in the future?

Well – this is Larry. Let me just check a couple of things. Early some – earlier, somebody mentioned, “Geez. What if it – the 18 to 2, if it was 18 to 1 risk to capital, we would want to operate right at the line, so operating around 16 to 1 is probably where you want to be. This transaction kind of takes us there.” And the provisions in the contract, one, if we don't get full credit from the state or the GSEs, we have the ability to terminate. Aside from that, we have an early termination provision before the contract termination date of 2018. And so, as Curt said, others in the marketplace, terms are attractive. The cost of capital on this transaction we believe is single digit. So the returns on the business are in the upper teens. By having part of your capital supplied by reinsurance with a cost below, it enhances the returns of the shareholders.

This is Mike again. Another thing to think about is that in the sequence of running the business long-term, what we have added again that we used to have in part of the capital structure was some very good reinsurance relationships. Going back 25 years ago, we had a significant amount of reinsurance that we used, and it proved to us to be very well. We moved out of that for a lot of different reasons during the 1990s, and we are now back looking at that again as another couple structure. And as you will see longer-term, it's financially advantageous to have these relationships. It's less costly than the dilution in various other capital structures, and it will serve, I think, long-term to be another very good capital alternative vehicle for the company moving forward. That's another way to think about this, as opposed to just this unique risk to capital issue that we are talking about. Jack Micenko – Susquehanna Financial Group/SIG: Okay, great. And then late last summer competitor entered a deal with Freddie capping losses pretty close to reserve levels and I think, over the last several months, talking about that. And I think there sounded to be an inclination to look at something similar on your part. Is that still something you're looking at where we could think about a potential announcement on a go-forward?

Yes. It’s Mike. The reserve sometimes – I was like –we thought we had – I don't know how much room there is on the plates of Freddie and Fannie at the FHFA to undertake that, what the capital guidelines and other issues they have, but certainly that's something that we would entertain. Jack Micenko – Susquehanna Financial Group/SIG: Okay, great. And then bigger picture, final question. I guess 15 years until this summer, I guess mortgage rates have sort of come down somewhat consistently over time with volatility in between. With rates coming sort of off the bottom, I'm just curious as to what your thoughts are on persistency going forward. Saw a nice pickup in 3Q to 4Q. Where do you sort of think that number can get to if rates sort of stay on the sort of glide path they are on now?

But with the current books, you're going to be in the mid-80s% I think, and maybe a little higher. That's the run rate that you see 78% or whatever, they way that really works, but if you looked at the individual vintages, I think probably, in 2011, 2012 and this year, you're going to see very high persistency, almost a return to the days of old when I started in the business. So, who knows what 2014 will hold, but I think the last three books of business still have significant increases in persistency. Jack Micenko – Susquehanna Financial Group/SIG: All right. Thank you.

Our next question comes from Douglas Harter with Credit Suisse. Douglas Harter – Credit Suisse: Thanks. Just talking about the capital structure and sort of cash usage, can you talk long-term what your plans would be for how much cash you feel that you need to hold at the parent company level?

You know the only thing – right now, we are still waiting for capital rates to come up. We understand longer-term where we are. Then, the only thing we've got to cover obviously is interest payments and debt issues. They – we don't have any other capital needs up at the holding company, and there aren't any other significant expenses out of the operating company. So the idea would be that, longer-term, other sources of cash would come out of the rating company in this – as it gets profitable and there's a source of cash there. But I think the relative to our debt structure, we are in a good position right now for the next three years. The first debt payment we've got coming up in 2015 is well covered interest payments were covered. We've got some conversion feature on the next debt coming up. And I think we are structured right now at some higher interest rates. We could do something with some of the debt and restructure it, but before we do that, we need to know a little bit better about where the capital rates are going to be and what the interpretation of capital will be and if there's any longer-term capital structure coming up. So I think, where we are today, we are well-positioned for the intermediate next two to three years, and the first call would be to understand what the capital requirements are going to be. Douglas Harter – Credit Suisse: Okay. Yes. I mean that would be my sense is that you have plenty of cash. I was just wondering why not use some of that cash as opposed to a reinsurance transaction as an even cheaper source of capital.

Yes. I think part of that is the understanding of where the capital requirements are going to be and have a little bit of leverage, if you will. Remember, we want to be – whatever comes out, we want to be significantly available not only to operate but also to capitalize on what we think will be increasing volumes. Douglas Harter – Credit Suisse: Got it. Thank you.

Our next question comes from Jason Stewart with Compass Point. Jason Stewart – Compass Point Research & Trading: Hi. Thanks. Given the seasonally slow time of the year that we are in the fourth quarter and the first quarter, are you seeing any building price pressure in the market?

No. You mean competitive pressure? Jason Stewart – Compass Point Research & Trading: Yes.

No. Not at all. Jason Stewart – Compass Point Research & Trading: Okay. And then will you – just to follow-up on Jack's question. When you were talking about persistency, you called out 2011 and beyond. And I know 2009 through 2011 perhaps saw higher-than-expected persistency. Could you give us some color on how those vintages are trending in terms of persistency?

I didn’t – I mean I think those are done at a lower rate. That is the only reason I don't think deficits should be as high as 2011 and after. But…

Yes. I mean, if you go back, if memory serves me right, a lot of those books were upper 4%, maybe around 5%. The market is now around 4.5%. So the persistency on the 2009, 2010, 2011 books are improving because of the 100 basis point rise. Maybe there's a little room for refinancing activity at a 4%.5 market if they are around 5%, but a lot of that has been – if they haven't acted already, the probability of them going forward and acting has probably diminished. Jason Stewart – Compass Point Research & Trading: Okay. And one last question. Have you seen any change in penetration of the use of mortgage insurance in the purchase market or has it been consistent from the third quarter to the fourth quarter?

We target that back that the penetration in FHA, what, from 10% to 13%. So…

This is Mike. There is not a lot of visibility yet into the fourth quarter…

Yes.

And now relative to the FHA. But – so the minimum is how it's almost relative to our share and I probably do expect it to be growing. We expect growth from third quarter the fourth quarter, we just don't know to what level yet.

You know the market – definitely yes.

The penetration of overall MI. Jason Stewart – Compass Point Research & Trading: I guess I was thinking of it…

But then it didn’t turn out well, right? Jason Stewart – Compass Point Research & Trading: Yes, it seems like the market, the purchase market, is deconsolidating a little bit. Have you noticed any subtle changes in your customer mix, whether it was more regional or community bank versus large national accounts?

No. Not today. But I would echo Mike's. I think we've seen both an increase relative to penetration in FHA as an industry in our own company, as I mentioned earlier, and increased market share within the fourth quarter. So those trends are very positive. Jason Stewart – Compass Point Research & Trading: Okay. Appreciate it. Thanks.

Our next question comes from Geoffrey Dunn with Dowling and Partners. Geoffrey Dunn – Dowling & Partners Securities: Thanks, good morning.

Hi. Geoffrey Dunn – Dowling & Partners Securities: First, could you comment on development on the incident side for new notices versus third quarter?

Well, from a development standpoint, I guess the new notices coming in the fourth quarter we're looking at them very similar to when we looked at them in the third quarter, which I think we said was just slightly better than a one-in-five ultimate claim rate on those items, and really no change in severity as I mentioned earlier. And then development of the already existing notices based upon incurreds, no significant changes on those, maybe a little bit of positive development but very subtle. Geoffrey Dunn – Dowling & Partners Securities: Okay. And then I'm not sure if I missed this, but did you disclose specifically the termination duration on the new reinsurance?

We have early termination at our option at the end of 2016, and the contract terminates at the end of 2018. Geoffrey Dunn – Dowling & Partners Securities: And that's the same as the…

You know as the… Geoffrey Dunn – Dowling & Partners Securities: Right?

Right. That's in addition to the – if we don't get full capital treatment, we have a right to terminate as well. Geoffrey Dunn – Dowling & Partners Securities: Right.

Those are pretty different, if you will, triggers, one at the end of 2016, one if we don't get the full capital treatment and then the opposite at the end of the contract as well. Geoffrey Dunn – Dowling & Partners Securities: Okay. And then I'm trying to get a little bit better idea on the profit commission. If I assume about 58 BPS on the ceded risk, it looks like it's about $125 million annual of gross premium cede. And I think, Mike, you indicated this might be a 25%, 30% net cost. So, is there a tax factor when you get to that 25%, 30%, or should we be basically looking at that starting premium less ceding commission and the delta is the profit commission?

And the other component I guess would be the ceded losses that we have in there, but effectively that would be the way I'd look at it, is what you think ceded premium is, plus the ceded commission of 20% plus your loss assumption, and then the delta would get you back to that $25 million, $30 million that we say the bottom line impact us. Geoffrey Dunn – Dowling & Partners Securities: Okay. So it is – it’s fair to say, at the end of the day, that your net cede is less than 50% totally?

Yes. Geoffrey Dunn – Dowling & Partners Securities: Great, thank you.

Thank you.

Our next question comes from Bose George with KBW. Bose George – Keefe, Bruyette, & Woods : Hey there. Good morning. On the losses incurred number for the quarter, was that entirely driven by new notices, or were there any adjustments for existing delinquent inventory?

Primarily driven by new notices. There was probably some slight favorable development on existing delinquencies, but nothing material. Bose George – Keefe, Bruyette, & Woods : Great. And just in terms of the default decline rate that you're assuming, what was that for the quarter and could you see that trending down in 2014?

As I said, I think was slightly better than one in five ultimate claim rates. As far as trending down, we whole sell in good time. It is probably closer to one in ten that ultimately goes to claim. How quickly we get back to that point I guess depends upon the economy and how that recovers. Bose George – Keefe, Bruyette, & Woods : Okay, great. Thanks a lot.

I'm not showing any further questions at this time.

Okay. If not, then it concludes our call. And again, thank you for your interest. And again, thanks to Mike for all he did for our company.

Thank you.

Have a good day.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.