MGIC Investment Corp (MTG) 2002 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to MGIC Investment Corporation's quarterly 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.

If anyone should require assistance during the conference, please press star then zero on your touch tone telephone. I would now like to introduce your host for today's conference, Mr. Jim McGinnus. Mr. McGinnus, You may begin your conference.

Thank you. Good morning, and welcome to the call. With me on the call here this morning are Curt Culver, president and CEO, Mike Lauer, Executive Vice President and CFO, Larry Pierzchalski, Executive Vice President of Risk Management, and John Fisk, Executive Vice President of Strategic Planning.

During the course of this call, we may make comments about our expectations for the future. Actual results could differ materially from those contained in these forward looking statements. Additional information about the factors that can cause actual results to differ materially is in our 1st quarter 10-Q, filed with the SCC, and this quarter's earnings release. If the company makes forward-looking statements, by making those statements we are not undertaking an obligation to update those statements in the future in light of subsequent developments.

With that, I'll turn it over to Curt.

Thanks Jim, and welcome. We had another excellent quarter, with record earnings of $171 million, and a 10% increase in earnings per share excluding realized gains. Revenues increased a strong 13% in the quarter, primarily due to a 12% increase in earned premiums.

New insurance written volume also was strong at $21.8 billion, consisting of $16.1 billion of our traditional flow business, and $5.7 billion of bulk business.

Insurance and force increased 13% year over year despite high refinance and cancellation activity, and now stands just under $195 billion.

Persistency was 59.5% in the 2nd quarter, up slightly from 59.2 in the 1st quarter and 71.7% a year ago.

The quarterly run rate however was 63% flat, with the 1st quarter. And our quarterly run rate would have been higher, but we we had a significant portion of a jumble arm bulk deal that we booked last year canceled as borrowers took advantage of lower interest rates in the quarter, and refinanced out of the arms and into fixed rate instruments.

Claims paid in the quarter totalled $57 million, up from $50 million in the 1st quarter, with a $7 million quarterly increase, virtually all in our bulk business, as well as the second mortgage business. And if you might remember, we discontinued insuring second mortgages six months ago.

Losses incurred were also up, reflecting the increase in paids, as well as the expected increase in the delinquency inventory. And I say expected, as all traditional flow [INAUDIBLE] books as well as our bulk business continued to perform within our pricing expectations.

Expenses totalled $64.8 million, up 8% from a year ago, but down 2% from last quarter and 4% from the 4th quarter. As a result, our expense ratio fell to 14.5% down from 59.4% last quarter and 16.1 a year ago.

Return on equity continued to be strong at 21.4%, and during the second quarter we repurchased approximately 2.3 million shares at a cost of $157 million. That brings our year to date purchases 2.7 million shares at a cost of $187 million.

The outlook for the remainder of the year continues to be good, reflecting the slowly improving economy and continued strong mortgage originations. As a result we should continue to write high levels of new insurance. And while I don't believe we will exceed last year's record total of $86 billion, our total will be closer to that $86 billion than I expected three months ago. Those same portions, however, are holding down our persistency rate. And where we expected it to reach the high 60s to low 70s three months ago, today we are looking at a mid-to high 60s persistency rate by year end.

Regarding loss development, it should continue in line with with recent trends, reflecting the huge writings of insurance in recent years, as well as the growth of our bulk business. As a result we anticipate that our delinquency inventory will continue to grow, and that there will be continued growth in paid claims and loss reserves. However, despite the increase in delinquencies, we expect that healthy real estate markets will continue to mitigate the growth of paid claims.

Finally, as I've stated earlier, we also expect underwriting expenses to follow recent quarterly trends and continue to ratchet down in the second half of the year, reflecting slightly lower levels of contract underwrite and insurance volume. And with that, let's take questions.

Thank you. Ladies and gentlemen, if you have a question at this time, please press the 1 key on your touch tone telephone. If your question has been answered, or you wish to remove yourself from the queue, please press the pound key. If you are using a speaker phone, please lift the handset before asking your question. One moment please for the first question. The first question comes from David [Hobsten] of Bear Stearns and Company. Please proceed with your question.

Hi guys. Could you talk about a couple of things. One would be the kind of trend in claims paid for the bulk business and the traditional business. And then, I wonder if you can talk about what happened with Sherman, and kind of what else is in the other revenue line, besides Seabass and Sherman earnings.

Dave, this is Mike. Let me talk a little bit about the claims paid. As Curt mentioned, $57 million for the quarter versus 50. Most of that increase, again, was bulk and second. The trends that we see really would show that the primary business was up just a bit quarter to quarter. So, no significant increase. As a matter of a fact, on an overall basis, average severity for the quarter was down about three ticks, about 19.3 I think versus 19.6 in the 1st quarter. So, we saw a little bit of a break, if you will, on average severity, but we do see an increase in bulk paid quarter to quarter as well as second mortgage. And I think that's where we will see -- the balance of the year we'll see the same trend. I think primary will trend up slightly, but we will see the increases on bulk and second mortgage.

With respect to other revenue, we talked about $39 million versus $23 quarter to quarter, for a $16 million increase. Eight of that came from Seabass. If you'll recall, they did have some releases during the quarter, where they had a couple executions, securitizations during the quarter. And we see an improvement, if you will, in other fee revenue based items.

We had a strong contract underwriting revenue again for the quarter. It's trending down now, I think, late in the quarter. But it was a good quarter.

Sherman had a good quarter, and we saw other fee revenues too. So, for the most part, I think that when you look at this line, you have to remember that Seabass did have two securitizations this quarter.

Last year in the second half of the year, their contribution trended down. We see the same type of trend, if you will. So I would think that relative to Seabass in the second half of the year, we look at something comparable to what they delivered last quarter -- I mean last year in the second half. And that was about 5 cents in the third and 3 cents in the fourth. And barring any extraordinary securitizations, that's kind of the trend line we see.

Is there much of a difference in claims paid between bulk and traditional now?

When you say --

You mean as far as severity, David?

Yeah.

Larry?

They are close. Bulk is a tad higher than the traditional business.

Okay.

That's because of the deeper coverage on that bulk business, David. But they run pretty much similar relative to severity.

Okay. And just again, on the other revenue. The things other than contract underwriting, are they largely recurring, the other revenues? Should we expect similar level as Seabass earnings decline in the 3rd and 4th quarter, should we see the others about the same or down a bit?

I think down a bit from this quarter.

Okay. Mainly because of contract underwriting?

Right, yes.

And should there be some pick up though in that, if we see much of an increase in refinancings ?

If refinancings continue to increase, you would expect them to hold at the levels that we're, you know, near today.

Okay.

As far as contract underwriting revenues.

Okay, thank you.

You bet.

Thank you. The next question comes from Jonathan Gray of Sanford Bernstein and Company.

yes. You indicated that the increase in paid claims was entirely in the nontraditional, bulk and second sector of your portfolio. I believe you had told us on the 1st quarter conference call that the paid claims expense on bulk, I assume that includes the seconds as well, was $9 million. Is that correct? In other words, were the claims, the claims expense -- Did it go from 9 to 16 between the first and second quarters?

I think, Jonathan, we might have been talking about deltas with respect to that 9. Let's go back and talk about the 1st quarter. I guess we -- I don't have the 1st quarter comparison, but I think what we were talking about in the 1st quarter was that we had an increase and we saw the increase, if you will, in bulk and second mortgage. In fact, the bulk was about $9 million, as a matter of fact. And it increased to about 13 in the quarter.

I see. What did you mean then when you referred to the $7 million increase? Did that include seconds, which are not --

Yes, the seconds went up a couple also.

Six out of the seven, 4 was from bulk and two from second mortgages.

I see, okay. Thank you very much.

Okay, good to hear your voice.

Yeah, welcome back.

Good to be here.

Thank you. The next question comes from Gary Gordon of UBS.

Thanks. Two questions. Roughly, what is the bulk share of your outstanding transports --

About 18?

Yeah. You're fading out, Gary.

You're fading out Gary. If you said what's the share of our bulk business to the [INAUDIBLE], it's about 18%.

Okay. And do you have any self-imposed limit or [INAUDIBLE]

We are trying to run in the area of 20-25% of our writings, Gary. And I -- that's what I expect the flows to be.

Thanks. And on to the buy back. You had a fairly active buy back. The risk to capital ratio [INAUDIBLE] 9.0 for the quarter. [INAUDIBLE] Two things. One, is there anything else that [INAUDIBLE] has to do with that [INAUDIBLE] capital. And two, [INAUDIBLE]

Hey Gary? We couldn't hear either question, Gary. Could you, I don't know --

Is this any better?

Yes, that's better.

Alright, sorry. Okay, on the buy backs. One, the GSD -- is that issue behind you, or is there anything else [INAUDIBLE] so you don't need to worry about the [INAUDIBLE] effort. And then two, are you in a position now to start [INAUDIBLE]

We lost the second question again. But the first had to do with the buy back. We still are involved in the original repurchase that we announced in the 1st quarter. Whether or not we extend that again is a time to time thing based on a number of issues, including whether or not there is any issue with respect to ratings, etc.. So I think for now, we are on the program we announced, and we will continue down that line and report accordingly. There is no decision, if you will, with respect to the regulatory issue.

Yeah, and on the sale risked based capitol rules. As you see, they are still running numbers, and they've given some results out. I think that that's pretty much behind us, but frankly there's no final decision yet by either agency. But I'm fairly certain where it will all end up, and not have an impact on us. But that still has not been finalized.

Did we answer both questions Gary?

Yes, you did. Thank you.

Thank you. The next question comes from Richard Diamond of Enwood Partners.

Yes, good morning. There seems to be a prevalence of loosening lending standards for housing, such as 100% or 103% loans in California. While you don't participate in this market, in the event of a double dip recession, how do you model for the impact on MTG for the potential defaults of high LTV loans?

The agencies Freddy Mac and Fanny May do have some affordable housing programs in the 100% LTV area, and as well as some banks for CRA purposes. And we do have some writings in the 100 and even 103% LTV category, but percentagewise, loans at 100 or 103 are maybe a percent or two of our business.

In modeling those, first off, a lot of the programs require better credit scores. Our standard guidelines when you get into the higher LTV's generally are at 660 or better. Some even at 700 or better. But in any case, we are comfortable with that risk.

[INAUDIBLE] data we have on not only 95, but 97 LTV loans that we've done over the years. We've shared that information with the rating agencies a couple of years ago when we started writing this business. So, do we have extensive data on exactly 100, 103? No, but we do have a good base of information on 95s and 97s to at least get comfortable. And we closely monitor the performance of that business month in, month out.

A couple other thoughts too. One, on those programs, when they get to those higher levels of LTV. In addition to the higher credit score requirement, also in many cases they require counseling, home buyer counseling for -- that potential home buyers have to complete after they can get a mortgage loan.

And then, relative to what we can do about it in the underwriting process, obviously collateral is very, very important. The value there. So that gets back to our analysis of local real estate markets and what's happening in values. And to the extent, we see issues implementing special market underwritinging guidelines that would in some cases preclude doing loans of higher LTV's if markets are troubled.

Well, I'm not really that concerned about MTG, because I know you have, you know, very strong underwriting criteria. I'm interested more in your thoughts on the market place in general. From talking to mortgage brokers, it seems that there has been a loosening of lending standards in the last couple of months. Have you noticed it? And secondly, do you model for that at any point?

The loosening -- I'm not sure it just happened over the last few months. I would say over the past couple of years there has been a tendency towards things like higher debt to income ratios, which we've mentioned a number of times. And there is more of that being done in part to try to get people into homes. We do price for that as best we can.

Some of that business, because of not necessarily lets say the credit score, but because of the debt to income ratios, may get insured, but at an A minus premium rate -- higher premium rates. to try and offset that. But you know, to the degree that mortgage interest rates move up, that certainly takes away some of the affordability that's currently out there. You know, you can't really push debt to income ratios much farther than they already are.

Thank you very much.

Thank you. The next question comes from Howard Shapiro of Goldman Sachs.

Good morning. Two quick questions. Can you tell us the percentage of subprime loans in the bulk business you did in the quarter? And I was also wondering if it's possible, and whether or not you would consider, giving us any kind of static pool development on your bulk business.

It's kind of hard to tell as the business is developing how it's truly going. Because I'm assuming when you're giving us delinquency information on the bulk business, you are giving us both the business that's somewhat seasoned as well as the new business. So, it's kind of hard to tell how it's truly developing. I was wondering if there was a way to give us static pool data on that. Thank you.

The subprime piece. In the quarter, 17.4% of the writings were subprime. That compares with about 18% last quarter. And as a percent of the enforce, I think subprime is about 10.8% of the enforce.

With regard to delinquency on bulk, it is the same way -- reported the same way as our flow business. It's all the books.

So the older writings versus the newer writings. Our delinquency rate on bulk did increased this quarter. It was driven more by the slowing in the growth of the enforce due to some cancellation activity that Curt mentioned before, rather than an increase in the delinquency count themselves. The counts were up, but the quarter to quarter increase was less than prior quarters. And the reason the delinquency rate went up, was the enforce.

So the delinquency rate is a mixed bag, if you will, of varying books, and it's also driven by changes in delinquency count as well as changes in the enforce count. We don't have a static pool here to give you at the moment, but maybe we will think on that and at a later date provide something.

Thanks very much.

Thank you. The next question comes from Kenneth [Posna] of Morgan Stanley.

Hi Curt.

Hi Ken.

I was wondering if you could talk a little bit about capital allocation for your bulk business versus your core business. Do you have to hold different amounts of capital for the different kinds of products?

We do have to hold more capital, but that is offset by the lower LTV's of the bulk business. As you remember, it averages about 83% versus 93% on our traditional business. And because of that fact, you are getting to fairly close capital requirements.

When we look at the risk to capital of about 9.0, I guess what you are suggesting is that the bulk business, it's not going to put any pressure on that ratio up or downwards?

No. I'm agreeing with that. It's not going to put pressure on it.

Okay, thank you.

You bet.

Thank you. The next question comes from Bob Ryan of Bank of America.

Good morning.

Good morning.

I'm interested in the two transactions that did you during the quarter that also had [INAUDIBLE] back wraps, whether this is some kind of trend or some kind of partnership. Or just a one off strange circumstance.

One off strange circumstance. I think that has been the case off and on since we've insured bulk business --

Okay.

-- where those have happened, Rob.

In at least one of the circumstances, the transaction was described by Asset Securitizations Report as second liens. I thought you stopped doing second liens six months ago. Is this a -- What's the explanation?

Well, when we insure pools of mortgages in the bulk arena which sometimes get securitized, we don't necessarily insure all the loans in the pool. We do exclude second liens as well as some other high risk segments. So, you may see seconds being a part of securitizations, but that does not necessarily mean we have insured those loans.

Okay, got it. On a different topic, could you list any local or regional real estate markets where there are conditions of concern?

We have two that we are keeping a close eye on at the moment. One is Seattle, the other is Denver. Both markets have seen substantial home price appreciation through the years, and now the employment picture is soft because of Boeing primarily in Seattle, and some of the telecoms -- Qwest in Denver.

Okay, but those are areas that you've looked at for a while now, in that nothing really changed in the 2nd quarter?

Well, in the 2nd quarter here I guess our concerns are a little stronger than in prior quarters. They are heightened in those two markets. But relative to the rest of the country, Rob, no.

Okay, very good. Thank you.

Thank you. Again, ladies and gentlemen if you have a question at this time, please press the 1 key on your touch tone telephone. One moment please. The next question comes from Gordon [Himulwitz] of Cypress Fund. Please proceed with your question.

Hi, how do you do?

Good,

I'm fairly new to the story so maybe you can help me out of two things, please. One is, on the bulk. Do you break out on a subprime delinquency rate as well as a bulk delinquency rate?

Yes we do. Or, I don't know if we do it on the earnings release itself.

It's not on the release, but we do give out the information.

The subprime this quarter was 11% delinquent versus 11.29 last quarter. Bulk, this quarter 8.97 versus 8.66 last quarter.

Which includes that subprime sector.

Which is inclusive of subprime.

Do you give the denominator on those numbers? In other words, the balance of loan bulk that are subprime?

Bulk is about 18% of the enforce and subprime is 10.8% of the enforce.

10.8?

10.8 Of the enforce.

How would that compare with last year?

I don't have that readily available. Follow-up call?

Okay, then. And last question. Your claim expense is going up much faster than your loss provision. In other words, your reserve to annualize losses is down to 2.7, and it was 3.9 last year. Now admittedly, you were more reserved than your peers, but how low do you feel comfortable taking that number before we have to maintain that reserve level at a certain point?

I think what we tried to say in the last two or three quarters is that that mix of business has been changing. Significantly over the last four quarters. And in fact, we have been strengthening factors relative to the lost provisions. I think what you have seen in the past four quarters is an increase in encouraged overpaids, and a strengthening of reserves.

So that's exactly what we have done over the past four quarters. And we are monitoring, as I said, this last quarter we saw a slight change in severity, but significant, it's down slightly . And looking at the claims rates, mix of notices, etc.. And for the most part, we have been increasing reserves for the past five quarters because of that.

I would agree that that you have been increasing reserves in the absolute sense, but the coverage ratio of charge offs is declining, and I'm wondering -- and admittedly it is still a very high. But is there a point in time where you say we're not going to go below 2.5 or two times coverage of --

Well, I have to admit, we don't look at the coverage ratio. The issue in this industry is the mix of notices you have and what is the mix of those. Mixed being geography, claims rate, and severity. And that's what's changing dynamically every month.

So you can't look at it from a standpoint of dollars, if you will, with paids versus incurred. But rather what's happening, if you will, with the book of business, run off of business, cancellation, notices, the claims rate on notices, etc..

What we have been involved in for the last five quarters was a significantly changing environment with respect to notices. Where in the past we had notices of a lower number with a much higher severity and higher claims rate, now we have more of a churning if you will for multiple delinquencies. Where notices come in and they are cured and made delinquent again several months later. So all of that changes the factors we are using.

So I think we are -- We continue to be in a changing environment where we're seeing a higher level of notices, if you will, but a much higher perpensity for multiple delinquencies.

Got it. I appreciate your helping me to understand that.

You bet.

Thank you. The next question is from Chris [Boddifen]of Fox [INAUDIBLE].

Hi guys, how are you doing?

Good.

Can you tell me, of the jumbo arm bulk deal that cancelled, number one the size of it, and number two, was it -- were there any components of that that were subprime?

On the jumbo bulk deal, there is no subprime within those. Those were all 700 plus credit score types. And this is what happens when you do arm deals. You know, we haven't done a lot of them. When fixed rates drop to a level, you see [INAUDIBLE] finance out early. As far as the size of it, actually there were a couple of transactions. Larry, do you have the --

I would say there's probably out of -- the prime jumbo transactions probably cost about a billion, billion five worth of abnormal cancellation activity in the bulk arena in the quarter.

Alright. The second question I have, have you seen an increase in cancellations out of the 19 -- with rates that have dropped so far, have you seen a cancellation rate increase out of the 1998 [INAUDIBLE] book?

Ah, I don't --

I mean, part of the issue, most of the cancellations that have taken place in 2001, I presume were on 2000's book and late 99's book., when rates dropped. And now, what I'm trying to get a feel for is whether rates have fallen low enough where you're seeing an increase in cancellations on the '98 book.

No. Most of the activity is the 2000 as you thought. I would say that once a book of business gets to four or more years old, for whatever reason, they become somewhat insensitive to interest rates. People are in there and they stay in there, and I guess lose sight of the refinance opportunity.

Generally we have the books gone by now anyway, from the '98 book anyway, given your -- just the normal prepayments.

Do you have an idea of what the, let's say what the average coupon is on the '98 book?

I would say on the 98 book, about, I would say three quarters of it at least is below 7.5%.

Okay.

Just to give you an idea, maybe this will help clear it up quicker. Out of the of the $46.5 billion we did that year in insurance, $18.5 remains out of that book. So, there's not a whole lot of exposure left within that book of business.

Okay. Okay, thank you.

You bet.

Thank you. The next question comes from Jim Bissault of Delphi Management Company.

Good morning.

Good morning.

Just, earlier in the call you mentioned about the delinquency inventory would continue to grow. You can give an idea as to how much or, you know, what's that going do?

Well, just generally, what we see usually in the second half of the year is somewhat of a moderate increase in notice activity. So mathematically speaking, barring nothing changing in the economy, you see an increase of the magnitude of anywhere from 2 to 4 to 5,000 notices a quarter possibly in the second half of the year in notices.

Now, all of that is subject obviously to changing economic conditions. But remember, we've got a very large book, and it's coming into that cycle. That's why we have seen this increase over the last three quarters. Generally, it's the size of the books of business.

What is it that causes it to be the second half of the year that is most volatile?

It's not the most volatile. It's just the cycle, if you will, of notices. We generally see a decline in the first half of the year and an increase in the second. It's a seasoning of the books.

Okay, all right. Thank you.

Thank you. We have a follow-up question from Kenneth [Posna]from Morgan Stanley.

yeah, I just wanted to go back to this reserve question again. I guess I'm struggling a little bit conceptually with the directions and the ratios. I recognize that you guys run models that outsiders, you know, don't have access to. But at the end of the day, I'm hoping to get a better conceptual feeling for the variables. And, if I understood you guys correctly, you said that while delinquencies are up, severities are down. If I look at the cash loss payment which should net those two trends, and cash loss payments are up at a pretty smart clip year over year, at least relative to the portfolio. So I see that fast growth in the cash loss payments, and I see the reserve ratio -- reserves to [INAUDIBLE, or however you want to look at it, trending downwards, I guess in my own mind I feel there's a point where that reserve ratio's gonna have to start going back up again. Umm --

Well, help me with your reserve ratio. I'm just looking at paids versus incurred and saying that on a net charge off basis, the reserve is increasing for the last four quarters.

For example, the ratio of the reserve to risk enforce --

Okay.

-- which is 1.3% in this quarter, down from --.

It's meaningless. I mean, the reserve --

It may be meaningless to you guys, because you have models, but us outsiders, we don't. Conceptually whether it's a credit card company or a mortgage company, a lender or insurance company, I think an outsider's always going to look at the reserves relative to the portfolio compared to the trend of cash losses.

Well I think -- Ken, this is Jim. I think, you know, we can explore that in more detail offline.

I think again, what we've tried to convey is that the function of that adjustment, if you will, is a function of what we're seeing in severity with respect to the level of notices we are seeing. So the [INAUDIBLE] has gone up with respect to the change in notice activity and the mix of notices, as well as the severity. And, if you will, the increase in paids, as you pointed out.

I know you are trying to make it more simplistic than it is, but it isn't is the reality of the situation, Ken. Those numbers are dependent as Mike said on the number, the severity, the geography and the multiple number of times the loan goes delinquent, and also remember we have about 18 months from when a loan goes delinquent to when the claims paid. There aren't surprises in that area. I don't know how we can make it easier because that's the reality of what that is. It's dependent on many, many factors. And a --

Let me -- maybe I will follow-up with you guys afterwards. But if I can just end with one more technical question. Given the seasonality of the business, would you recommend looking at delinquencies sequentially or year over year? In other words, is there a typical seasonal pattern to delinquencies?

Well, there is a typical seasonal pattern. That's what I said earlier. They generally trend to go down in the first half, and tend up in the 3rd and 4th quarter. That obviously can be adjusted by the mix of business too. I mean, it depends on where we book the business.

Remember last year, we booked a significant amount of business in the second half of the year. And as we get out a couple of years on that, that's going to have a function, if you will, not with standing whatever happens to refund activity and cancellations on the number of loans in force. So, [INAUDIBLE] the size of the books, obviously, and where they were booked, and in what periods of time. But generally speaking, I think you need to look at it sequentially. That's how we look at it, sequentially. Because, -- I mean monthly, really. Because year to year, it really is not as significant because of when the books were put on and what interest rate environment they were.

Thank you.

Thank you. This concludes the question and answer session, Mr. McGinnis. I'd like to turn the program back to you, sir.

This is Curt. Again, as always, thanks for your interest. And any questions to follow-up, let us know. Thank you.

Ladies and gentlemen, thank you for participation in today's conference. This concludes the program. You may now disconnect. Good day.