MGIC Investment Corp (MTG) 2003 Q4 法說會逐字稿

Good day, ladies and gentlemen and welcome to the 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. If anyone should require assistance during the conference, please press star then 0 on your touchtone telephone. It is now my pleasure to introduce your host for today's conference, Mr. Mike Zimmerman. Mr. Zimmerman, you may begin your conference, sir.

Okay, thank you. Good morning and thank you for joining us this morning and for your interest in MGIC Investment Corporation. Joining me this morning to discuss the quarterly results 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 --.

Sorry?

Hello? Our earnings release of this morning includes additional information about the company's quarterly and annual results, which we will refer to during the call and includes certain non-GAAP financial measures. The released and this additional information may be accessed on the MGIC homepage located at www.mgic.com. 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 disclosed and discussed on the call are contained in the quarterly earnings release. If the company makes forward-looking statements we are not undertaking an obligation to update those statements in the future in light of subsequent developments. At this time, I'd like to introduce Curt Culver.

Thanks, Mike and good morning. Net income for the fourth quarter totaled 104 million and 494 million for the year. All in all, the fourth quarter was an encouraging quarter for us with strong revenue growth, an upward tick in persistency and a slowdown in the growth of our delinquency portfolio. New insurance written for the quarter totaled 19 billion and a record 97 billion for the year. While insurance in force fell 4% year or year to 190 billion, our persistency rate has slowly climbed each of the past three months from just under 45% to just over 47% at year-end. Delinquencies continued to increase within the quarter but at a reduced rate from past quarters, adding 1300 items. Claims paid totaled 124 million in the quarter and 434 million for the year. We strengthened reserves by 105 million in the quarter to reflect the increased delinquency inventory as well as higher severities and claim rates on the existing portfolio. As we look at 2004, mortgage origination forecasts look for about a 50% reduction to approximately 1.8 trillion. Our purchase money transactions should remain strong with forecasts of 1.2 to 1.3 trillion, about 3% higher than 2003. Because MI penetration is approximately three times higher on purchase money mortgages than refinances, our volumes should be down considerably less than the general market with flow new insurance written off about 25 to 30%. I believe our bulk volume will also be off a similar amount, although it could be off more or less depending on interest rate spreads in 2004. Persistency should continue to rebound throughout 2004 to the mid-60% level by year-end and again lead to insurance and force growth, even with lower new insurance written volume. And finally in the loss side, paid losses will continue to grow from today's levels, although reserving should slow reflecting the maturation of the portfolio as well as the strengthening of the economy. Obviously what happens on the loss side will be the real beta in earnings for 2004, And with that let's take questions.

At this time, if you have a question, please press the 1 key on your touchtone telephone. Once again, if you have a question at this time, please press the 1 key on our touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. One moment, please. Our first question comes from Mr. Rob Ryan of Merrill Lynch.

Good morning.

Good morning.

Since you have some ability to have good visibility on paid claims going forward, so claim payments, say, in the first quarter and the second quarter of '04, what kind of indication can you give us in terms of the sequential change from the run rate that you're at for the fourth quarter for that particular line item?

Rob, Mike, I think what we're anticipating right now is about a $10 million increase sequentially from this base, so, we're at about 124 and we would increase probably about 10 million in the first quarter and then another 10 to 15, possibly, in the second quarter.

Okay, great. And on the persistency, again, is that a 12-month year-end forecast that's somewhere in the mid-60s.

Yes.

What are some of your assumptions surrounding that? Like say 10 year treasury yield movement up during this year or what are you thinking?

We're thinking rates will be flat to up.

And business volumes down. As Curt said.

I mean, relative to interest rates, we just think they'll be flat or up, either one of those will get to get to that level.

How about the pace of the improvement in persistency during 2004, meaning will it be mostly back-end loaded and we'll see more of the increase to what you're expecting in the second half of the year? Or pretty smooth throughout the year?

I think sequentially, all things being equal, if we stay on this trend it would trend up each month and quarterly. Unless we get changes in rates again.

Okay, great, thank you.

You bet.

Our next question comes from A.J. Grewal of Smith Barney.

Yes, hi. Just in relation to credit picture, what kind of losses incurred levels do you expect over the next couple of quarters? Looking at your cash claims paid, they seem to be flat in your guidance towards plus 15 million over the next couple of quarters, but on a net increase in reserves, is that going to be at the same pace of the fourth quarter?

I would say that the incurred level will be probably less than the third and fourth. We increased the reserves approximately 100 million in each of those quarters. In third and fourth quarter we're looking for something less than that, maybe as much as half of that or slightly up from that relative to the first and second quarter. Generally speaking, the first two quarters of the year we don't see a significant increase in delinquencies and traditionally we even see a decrease, possibly, or flattening in the second quarter. So, there may be some lumps, if you will, relative to level -- changes of notices in the first and second quarter. So, we have to obviously track that, but on an annual basis, we increased the reserves this year approximately 330 million. That had the combination of factors. One was just the increase in paids, obviously the increase in notice level. We also had some increases in claims rates. Going forward, I would anticipate that the reserve change for the year, for '04, would be probably in the area of 175 to 200 for the year, possibly a little bit higher depending what happens primarily in the second half of the year.

Okay. And your expense ratio steams have improved in the fourth quarter. What kind of trend are you expecting there over the next couple of quarters and into the end of '04? It's down almost 200 basis points, it looks like, in the fourth quarter. That seems to be a pretty decent move. Can you give us some color on that, too, please?

Well, we had some relatively significant levels of contract underwriting reductions during the fourth quarter as a result of the decrease in volume. Going forward, the question will be can we reduce further head counts and contract underwriting? That is obviously going to be a kind of a quarter-to-quarter event, if you will. I would anticipate that the first couple of quarters expenses ought to be approximately flat with a slight increase in the second half of the year. That, again, will depend on whether or not we can take further reductions to contract underwriting. Except I would qualify it and say that we've taken the better part of that already, activating if you will, reactions to what's happened to volume in the fourth quarter.

Thank you.

Our next question comes from Josh Shanker of Blaylock.

Hi, there, how you guys doing today?

Good.

I'm calling regarding the other revenue line. You guys had a significant contribution from C-BASS this quarter and yet the other revenue line is still very, very strong. Wondering what's going into that and whether there's trend there?

Well, I think relative to C-BASS, remember, as we stated in other quarters, it's lumpy, if you will, from quarter-to-quarter. They did have a better quarter this quarter than the previous quarter relative to revenues from servicing and an additional security transaction. On an annual basis, we're looking at C-BASS to be approximately flat to slightly up, for the year. Relative to the rest of the other revenue line, contract underwriting revenue was off, not as much as we thought, but going forward it should decline slightly. We did have some other fees that were up and Sherman was a little bit better than last quarter. So, it's kind a combination of not as much reduction and contract underwriting as we thought. Better C-BASS and slightly better Sherman.

Great, thank you.

Our next question comes from David Hochstim of Bear Stearns.

Hi. I wonder if you could talk about the average premium rate and how to think about that over the next few quarters. If there isn't much growth in the bulk business, if resistancy rises on the flow business, you ought to see more growth in flow and less grow in bulk on a percentage basis. And how does that factor into the overall premium rate?

I think, remember that we've just put on a pretty significant book with respect to the premiums this last year, '03, and especially the bulk business. So those will get full year, if you will, 12 months of premium off of that book. So, the average premium rate should hold pretty well, notwithstanding the fact that we've got the lower volume for '04 forecast. So, in other words the renewal side of the book we get the benefit of.

I think you'll also see in the flow side, David, because it will be a purchase money market more so than the past couple years have been, and within those markets we do more higher LTV loans and a lot more 95s within a purchase money market. So on the flow side, that should be slightly higher, also.

So, could this average premium rate of a little over 73 stick for a little while?

I would say yes, close to it.

Okay. And then can you just talk about the -- it's had a little bit of an increase in the average paid claim and with -- I mean is there anything going on geographically? Or what's happening there and how much worse do you think that gets? And what's happening with Cure Aid?

With regard to the severity question, severity is up, the economy is soft and that has impacted some of our loss mitigation opportunities, acquisitions are down. We save money on acquisitions versus the percent option payment and presales activity and those two items, in particular, have caused the severity to go up. And also as we go forward here, year to year to year, the average loan amount continues to increase. So, that will continue to put pressure on severity, but in the short-term it's more the economy's impact on acquisition and pre-sales.

Okay. And what about Cure Aid?

Well, the Cure Aid on the inventory slipped a little bit from prior years, but I guess we're encouraged by recent signs on new notices, cure activity and what's happened with the economy.

Okay. And then could you just remind us on C-BASS, how much of the revenue in this last quarter was kind of recurring from servicing and how much was from gains?

I don't have it in front of me, David. We will have to get a follow-up on it.

Okay, thanks a lot.

Our next question comes from Mikiko Colley of Endeavor Capital.

Hi, good morning.

Good morning, Mikiko

Nice quarter. Most of my questions were asked, but just two quick ones. The tax rate --

Yes.

Is it going to stay around here or as your (inaudible) goes up, it goes up.

I think, Mikko, it will trend down slightly '04. We ended the quarter at about 24 and I think what we're forecasting for '04 with that rate on an annual basis to be down maybe a tick or a tick and a half.

From 24?

Yes.

Okay. And that's all the mix issue?

Yes.

In your revenue?

Yes, that's correct.

Okay. And the share repurchase, I was expecting a little bit more in the fourth quarter and you seemed to be kind of keeping it a little bit on the fold?

No, I think we did repurchase 94,000 shares, you probably remember that. As I discussed on the last quarter, we did have a special dividend early in the year for over $130 million and we have been in the process of getting approval to increase the quarterly dividends through our Wisconsin insurance commissioner. We've been doing that on a quarterly basis and so at this point in time, throughout '03, we were effectively negotiating, if you will, with the commissioner to increase the quarterly dividend. We've done that three times and as recently as late in the fourth quarter we got approval for a $30 million dividend and we're hopeful that we can continue to do that and increase, if you will, a standard quarterly dividend that we would not have to get pre-approved, do you follow? And going into '04 we believe we'll be successful in doing that. Raising the quarterly standard dividend from the writing company to the holding company.

So, you're waiting for the authorization to do the repurchasing?

Well, what I'm saying is the way the stats work, because we had a special dividend earlier in the year, we needed to get approval for any additional increases in normal quarterly dividends. So, we've been doing that on a quarterly basis. And we need to do that one more quarter. In the first quarter of '04 we will need to get approval for increasing the standard quarterly dividend.

So, basically we have to wait another quarter before you can repurchase a significant amount of shares?

Well, a significant amount of shares would require additional capital. So, I think the share repurchase will depend on a number of things, albeit cash available at the holding company, dividend authorizations and other issues, obviously.

Great, thank you very much.

Okay.

Our next question comes from Paul Miller of FBR.

Yes, thank you very much. Insurance and force growth, which was down, what are you kind of looking for growth and for '04? I know some of your competitors are saying that they think they can see insurance force growth grow in the 10 to 20% range. I just want to know your thoughts on that?

I would tell you our thoughts are not nearly at those levels. It's single digit in growth from our expectations.

And would most of it come in the bulk business with you? I know you guys are playing on the lower FICO score range for your new insurance written. Would that continue to be the case in '04?

No, I would think it would be more in the flow side of the business.

Probably just the opposite.

Yeah, I would say because the bulk is going to be very lumpy, I think, with interest rate spreads and I think the flow is a real growth side in this year.

So, even with lower bulk business you still think on that average premium yield of 73, 74 basis point, you can maintain that, mainly to the higher LTVs on the flow?

Well that will be part of it and, again, on the new writings, we may not be at that level on bulk business, but as Mike said, we're going to get 12 months of that on deals we've done this past year.

Okay. And on the credit side, you guys are more exposed in the midwest than a lot of your competitors. Is like the Michigans and the highers in Indianas, I guess that's where a lot of your credit problems are coming from. Do you see any improvement in those areas at all? Did this latest employment report change your opinion of what's going on in those areas?

We haven't seen improvement yet and that's reflected, I guess, in the reserving relative to -- I mean the midwest makes up about 1/3 of our delinquencies. So, I guess what's more optimistic about -- not in the numbers we've seen, yet, but what's happening in the general economy and as we've talked to people in the manufacturing sector, the strength that they're seeing locally. So, it's more of a big picture, it hasn't been reflected in our numbers yet. Other than the falling of the delinquencies.

So, over the quarter - Curt, you've been a little bit on the negative side of the economy, but over the quarter it sounds like your opinion has changed a little bit on the positive side?

In the manufacturing sector it has, yes.

Okay, thank you very much.

Thank you.

Our next question comes from Richard Diamond of Inwood Capital.

Yes, good morning, gentlemen. At current 30 year conventional rates of 5.5%, what percentage of your portfolio is subject to refinancing?

I know, Mike, you have those numbers.

Yeah, 64% of the portfolio and (inaudible) of the portfolio is below 7% coupon rate.

And if interest rates drop another 25 basis points, which is possible in this environment, how would that change your view on directions of refinancing?

It might add a couple hundred billion to the total market. The reality is it's going to be a very strong purchase money market with record volumes within that. Again, we have about a 20% penetration rate on purchase money transactions versus about a 7% on refinances. So, we'll add a couple hundred billion of refinances, maybe, if it drops a quarter.

And secondly, as I look at the delinquency rates among the various classes, especially A-minus and subprime at over 14%, do I hear you saying that these losses have peaked and we should expect them to decline or as we model going forward should we expect A-minus and subprime delinquency to rise till we see a recovery in the economy?

This is Mike Lauer, I will let Larry talk about the categories of delinquencies, but relative to just lost development for the year, as I stated before, we are looking for an increase incurreds somewhere in the area of 175 to 200 to 225 over a year-to-year increase, depending on what happens to loss development. So, all things being equal, we are looking for an increase in incurred losses year-to-year. The reason for that, obviously, is not only the economy, but also the size of the books and where they are in maturation and an increase in paids that we talked about earlier. So, although it's slowing, we're still looking for a year-to-year increase in incurred losses. Larry, you may want to talk about the FICO changes?

Yes. Well the bulk business, what I was going to say with regard to the delinquencies, which in part drives Mike's incurreds and that, the bulk business, we've written some pretty strong volumes for years now such that the portfolio is seasoned and is reaching, let's say, a steady state in terms of seasoning and the amounts at the various points. So as we go forward here, if the new writings are less and we're close to steady state on the existing, we will probably short order here, reach a point where delinquencies rise a little bit from here but maybe sometime in '04 we peak out in terms of absolute numbers. The same, I think, on the flow side. We had some pretty big books here that came out at a higher delinquency rate than prior books but now with, hopefully, the economy approving and a smaller book being written, that, too, will cause the flow delinquencies to, I think, increase modestly in '04 and potentially peak once again dependent upon the economy.

Last question. What is the time lag, generally speaking, between strong job creation and improvements in books? I know there is usually a two quarter delta, but let's say we don't get strong job creation until the second half of '04, would that change your forecast at all?

No, I don't think so. I mean we weren't looking for stock strong job creation.

You are really just looking at less job loss? Right. Thank you very much.

Our next question comes from Bruce Harting of Lehman Brothers.

Good morning.

Good morning.

So, just so I can understand exactly, you're saying that the timing on the bulk, which you've been talking about for a while, needs to get steady state and you're saying that that should occur this year and delinquencies there may peak as well as on the flow business. How do you factor into that the fact that typically on the flow, I think you said that typically bulk deteriorates or hits delinquency after about 16 to 18 months, whereas the flow is more like three to four or five years. At what point do you think the big -- do we need to worry about the three to five year timing factor on the big 2000, late 2002-2003 re-fi years starts to impact delinquencies, is that obviously a couple of years out? And if you have reached the steady state on the bulk, is there any implication there that you might actually start looking to increase the writings there? Thanks. And then finally, Mike, I don't know -- do you have the one month December number, and if I missed it, I'm sorry, for persistency. And will you guys be providing that as the, hopefully, the one month number rises over the course of...

The quarterly rate was 57. The one-month rate, I don't know if it means anything.

Quarterly was 57?

Yeah.

Okay.

The delinquency questions... Yeah, bulk, we've, like I said, wrote some pretty strong years now and, yeah, it takes a couple years to peak and some of those '01, '02 books are going to be there in '04. And we're going to get, if we write much less volume both in the flow and the bulk, this new book coming online, climbing up that delinquency curve, being smaller, is not going to add as much. So, all that kind of leads me to think that '04 will be maybe a year of delinquency peak especially given the fact if the economy is flat to up. Now paids, that three to five question, the three to five year point you made, that's paids. So, typically once delinquencies peak, it's probably close to another three to four quarters before paids peak because the delinquencies go through the delinquency, then the foreclosure and some of the redemption periods in a number of states can be quite long. So, paids will take a while after delinquencies peak.

And on the bulk, Bruce, you know, I think as the economy recovers, I think you've got less opportunity to do bulk because the spread's generally narrow in that kind of environment in which we compete against. And so would we write more -- well, we would on a - volume comes in on a lumpy basis, but still, I think this year may be under 25% as I look at it right now. Again, we will see how the year plays out.

(Sounds)

We didn't hear that question? Operator?

I'm sorry, we lost Mr. Bruce.

Okay.

Our next question is from Jeff Dunn of KBW.

Hi, good morning. Most of my questions have been answered. I just want to clarify on the reserving guidance, you're saying that could drop in half immediately? The net provision?

The change in the reserve are you saying?

Yes.

Yeah, this quarter we were reserving at about -- incurreds were about 230 and the increase was about 105 and I'm saying going into the first quarter, the increase may be somewhere in a range to 50 to 70, depending on what happens. Traditionally we don't see as much notice build up in the first quarter.

Right.

All right.

With that in mind and with the delinquency trends maybe starting to show some slowing in their deterioration, do you think you could return to what I would consider maybe a more normalized paid to incurred in '05 and you will be back to the reserve position you need to be at?

Well, here's a couple of questions there. The normalized, I guess, you're talking about a normalized loss ratio... Or...

I think you guys have said your normalized loss ratio is maybe 35 to 45%, do you think you can achieve that --

I think you need to remember we've got two different businesses fundamentally with respect to loss ratios. One is the flow business, that we talked about 35 to 40. But then secondly, remember we've written this bulk business with an expectation of being 60, 65. So, you've got a combination of the two. Remember the bulk business is priced significantly higher. We also don't have any captives associated with it. So, notwithstanding the fact that it has a higher loss ratio, projected loss ratio, it's got higher return margin to us because of very little net expense associated with it. So, you've got, if you will, as Larry talked about, these books going through the cycles they're going through now, we will be incurring a combination of higher loss ratios with respect to the bulk business as well as lower on the flow side. So, kind of a melding of those two, if you will. That's where we currently are and I think you see that again in '04.

Okay. And last question. This last run through with delinquencies and the resulting ramp-up in reserves, has that changed maybe your approach going forward? That if we went into a very positive economy, would you still release reserves on a net basis in the future? Or maybe have you softened that approach at all?

No, I think exactly. We'd have to because the reserve formula, and we work with outside third party actuaries, work off of existing inventory and what rates are and if, in your case --

Claim rates.

Claim rates and notice levels improve, reserves have to be released. Within a formula.

As well as claim rates improving.

Yeah, if you got to that environment -- in other words, in our philosophy and accounting principles, you can't hold the reserve if you don't have substantiation for it. You can't cookie jar accounting reserves anymore. And specifically if you have got reserves established for notices and claims rates and the developments aren't there, they must be released in the current period.

Okay, thank you.

You bet.

We have Mr. Bruce Harting back on the line from Lehman Brothers. Mr. Bruce Harting, you may go ahead, sir. Our next question comes from Brad Ball of Prudential.

Thanks. Just as a follow-up, Mike, I think you mentioned paid claims up 10 and then 10 to 15 million in the first and second quarters respectively. Is that going to be largely driven by increases in bulk paid claims? Or should we expect to continue to see an increase on the flow side, as well?

I think the better part of that increase will be on the bulk side with some increase on the flow, but most of it will be bulk. I think as you saw this quarter, the flow is relatively flat, bulk is up and I think we will see that same trend continue in the first couple of quarters.

But we're not at the point of seeing flow related paid claims on the decline yet?

Well, I think, remember, we're only into a quarter. I think we will know more in the first and second quarter and we will report that out.

Okay. And separately, Curt, I think you've mentioned in the past some optimism about the potential for tax deductability of MI. I wondered if you could comment on what you're hearing from Washington lately and what your thoughts are for '04?

Well, to put a quantification on it, the people we work with in Washington have given it a high probability of passage by Easter and so I'm very encouraged by that. I think we have 148 co-sponsors in the house and a number in the Senate. We've got no opposition to it. The difficulty is finding a tax bill to attach it to. So, if there's tax legislation, we have outstanding opportunity to have it attached to that and so it all depends on the country's priorities relative to legislation, early this year. But a high probability of passage, I think, by April.

I'm sorry, just to clarify, that's a high probability of passage if there's a tax bill to attach it to? But would you say there's a high probability of a tax bill?

Yes.

Okay.

Our next question comes from Jonathan Gray of Bernstein.

At the end of 1998, five years ago, the company's capital rose at about 120 basis points as a percentage of insurance enforce. Were you severely undercapitalized at that time? I don't recall the company ever having indicating that it was?

No.

Well, today you're at 200 basis points. You've practically got half the leverage you used to. Are you then overcapitalized today? I don't remember the company building capital, along with your competitors out of concern for the discrimination that was potentially going to risk based capital for Fannie and Freddie, where preference would be given to AAA versus AA insurers, but that, in affect, never really came about with any force and yet your capital levels seemed to be very substantial. Risk enforce, which was 20 times capital five years ago is 13 times today. I must say your competitors all show the same profile, though. Your capital position is somewhat higher than theirs. How should we react to this? How should investors think about this?

John, that's a good question. What's happened, obviously, is because the business still is profitable, notwithstanding the fact that we're going through some interesting periods here with respect to margins, the company still generates profit and strong cash flow and we've been, if you will, building excess capital. Now, others have elected to use that capital for some other diversification efforts, we have not. The rating agency's position on capital has changed in the past years, I would say that prior to maybe five years ago, capital seemed to be king with respect to ratings. It's clearly, now, not the case as much, they seem to be looking at other things. But we're down on a writing company at 8 to 1 and on a consolidated basis of about 9.5 to 1. And you're right, eight years ago we might have been 20 to 1 and we're AA+ rated and now we're AA rated except for one rating agency. So, the company has built up substantial capital, notwithstanding the fact that over the course of the last four years, we repurchased almost 24 million shares of stock and I guess it's a function of the business. We are generating excess capital, notwithstanding the fact we're putting on more risk, we're building more surplus than we are. As I mentioned earlier, we are in discussions with trying to increase quarterly dividends out of the writing company but understand that that's a process that takes some time and for the most part we've elected to build capital and repurchase shares. That's been the use of our capital. But it has been profitable and cash flow positive and we built excess capital relative to the risk we're putting on.

I'd like to does ask a second question. But before I do I think I have a thought as to what kind of an acquisition MGIC might make with the excess capital. How about a rating agency? [ Laughter ]

Well, that's a real sensitive subject, Jonathan. I don't want to get on that.

Obviously I'm not being serious! [ Laughter ] Question regarding your cancellation rate in the quarter, your persistency, 1 minus in persistency. For example, in the third quarter, Fannie Mae's loan liquidation rate was 73% and yours was 63 at an annual rate, your cancellation rate. You were running about 9 or 10 points below them. You ran below them in the second quarter and in the first quarter, as well. And now here in the fourth quarter their liquidation rate, I believe, has fallen precipitously from about 73% at an annual rate to about 30. And yet your liquidation rate has fallen substantially less, your cancellations from 63 to 43. In other words, in the third quarter, cancellations ran 10 points slower than loan liquidations in the market and in the most recent quarter, your cancellations are running 13 points above. My question is in trying to hypothesize why that disparity would be so wide and swing so abruptly.

Let me ask a question first, Jonathan.

Okay.

Are you talking now just flow or the total book of business?

I'm talking the total book of business.

I think we need to do that same analysis on flow only.

Yeah. We've done that. Let me take a quick look at it and see what we find. Well, no, you're -- it looks as though the cancellation rate in the traditional business was also -- actually, you were 6 points below Fannie in the traditional book in the third and you were substantially, oh, no, and you're above them in the fourth, yes, you are, once again. But it's the same pattern, it's just a little less pronounced if you eliminate bulk.

This is Mike, there are probably any number of factors, but one of them -

Well, my question is does it have to do with the delayed reporting of cancellations? In other words, the re-fi's process leaves people to discover that they no longer need mortgage insurance. Perhaps there's a purported delay of some kind between your cancellation rates or change in persistency versus the primary market?

Again, I think that's part of it and also keep in mind that one of the differences in the cancellation rate between MBS's and BMI is borrows can cancel MI without prepaying the loan. And with strong home price appreciation that we've seen in different sectors, that can influence our cancellation activity more so than it would a prepayment. So, there's a lot of different moving parts. John, as we probably have to take a closer look at that to see some different trends more than just the last couple of quarters.

I would say the servicers lag the market by about 2 months, though, Jonathan. And I think that sums up a lot of what you say.

That would add a substantial impact, then, in a bid like this.

Yeah.

I wonder if I could just ask you, I'm sorry too keep going on like this, I wonder if I could ask you to clarify something you'd said earlier. If I'm not mistaken, did you not give some indication of management expectations with regard to claims paid in dollar terms rising? Did you say 10 million was the expectation from the fourth quarter to the first and another 10 to 15 from the first to the second?

Yes, I said 10 in the first, 10 to 15 in the second and probably another 10 in the third and maybe 10 to 15 in the fourth. Those are all sequential.

That's extraordinary. Thank you.

Our next question comes from Chris Buonafede of Fox-Pitt Kelton.

Good morning.

Good morning.

One thing on the expense side of the equation here, total underwriting and other expenses, I guess, were down 3, $4 million link quarter. But the DAK asset was also down a million dollars. So my question is is the expenses being down, I guess 3 or $4 million, that would include an additional $1 million of DAK amortization?

Yes.

So, we could get some leverage from that going into the first and second quarters?

It's not a big item for us.

All right, fair enough. Okay, thanks.

You bet.

Our next question comes from N.W. Montgomery of Rocko Partners.

Thanks for taking my question. Last month you thought the increase in delinquencies were going to be quite a bit more than what they came in.

Right.

What were the reasons for that?

Well, I think traditionally what we've said in the third quarter was that we might see 5,000 increase in notices and notwithstanding the fact it went up about 7 or 8 or 9 the year before. So, based on where we were at the end of October, we anticipated a normal sequential trend. We didn't see that, we saw lower notices than we anticipated in November and December. A little bit higher cures in November. So, whether or not that trend continues, as we said earlier, we'll have to look at. Normally, the first quarter notices increase is not as significant and we'll wait to see the first quarter to see if this trend continues.

Understood. Thanks.

Our next question comes from Robert Hottenson of Goldman Sachs.

Yes, hi, Curt. At the risk of beating this credit quality thing to death it would just seem to me that looking at it in a broad overview that obviously the tone has strengthened. The trajectory has slowed. You seem to have more visibility and more precision on kind of the trajectory of paid claims. Clearly, two or three things are going on. You have an overlay of the vintage analysis on a book by book basis. You're looking at the economic impact and then you're looking at mixed changes in terms of tightening and credit standards that have taken place as the economy was weaker than it is now. My question is in terms of - now that you've given us an outlook in term of credit we've all begun to adjust our models accordingly. If we think of those three things, the vintage, the economy and mix changes and so forth, where is it that the delta from here is likely to be reflected in the actual numbers to the extent that there is. Going forward is the economy more important? Is the the vintage sort of work that you've done with the analysis there or is it a mix issue? How would you really look at the delta from here?

Well, this is Mike Lauer. I guess what you're saying is -- as Curt said earlier in his opening comments, the beta, obviously, to what you're all looking for, relative to performance, is incurred losses. As it was this year, it would continue to be next year. That will be a function of a combination of things. Number one, the maturing of the books as Larry talked about. So, we normally would look for an increase in paids and an increase in incurreds with respect to notices and claims rates. To get back to your comment about the economy improving, if the economy begins to improve and we see it in notice development as we saw something here in the fourth quarter, and that continues, that could be an improving element. We would not need to build reserves as much as we did last year. We would look for claim rates to flatten out. And possibly even better mitigation. Larry talked about mitigation had been off slightly this year relative to loss paid claims. That would start to improve, also. And if you will, reduce incurred losses. So, we're looking for not much improvement and if the improvement comes in the economy, that's a plus for us. We will have to track that quarterly. And as I said earlier, the notice development was a positive for us in the fourth quarter. We will have to see that continue to be more believers, if you will.

Yeah, the economy, Bob, is very important for us and twofold as Mike said in slowing the delinquency, but also in improving the claim rate, which has been a huge impact relative to our reserving over the past year, as well as the severity as Larry mentioned. I mean we mitigated 25% of our claims this year versus three years ago, 38%. So, those are tremendous dollars with the portfolio that we have and to the extent the economy strengthens, we'll improve not only on the delinquency side, but the claim rates within, which are big dollars for us on the reserving. I'm also encouraged as we look at the first quarter by the size of tax refunds. I mean they're going to be 30, 35% higher than in the past and again, that will help many of our borrowers where that's a significant sum for them in their lives relative to making their payments.

One other consideration, too, an earlier question was, geez, we're expecting more delinquencies in the quarter than we got. Now, hopefully that continues and it's not just a one-quarter blip, but with the runoff that we've seen on the flow side with the persistency rates being in the 40s as they've been, so much of the books that we've written and have enforced have burned off, gone away, that out in the tails or even in mid-life, where you'd expect still a lot of delinquencies, because of the runoff, these books have gotten so small that they've, in effect, burn out of producing new delinquencies from some of the time periods when we put these projections together. So, the runoff certainly takes pressure off a delinquency growth, as well.

So, in other words, that last point that you make is it's more adverse selection, that you have less adverse selection, so to speak.

High quality --

Absolute numbers, Bob, there are just fewer of them that can possibly go delinquent.

Yeah, okay.

Our next question comes from Peter Manaco of Tudor Investment.

I, too, apologize for beating the credit debt dead horse, I just want to make sure I understood things correctly. In the next couple of few quarters you do expect a 10 to 15 million per quarter increase in paids but at the same time, you are developing a level of confidence with respect to the trajectory of paids such that incurreds may have, from recent levels in reasonably short order, implying little or no reserve build from here?

Well, I didn't say little. I said $50 million, that's not little. What I was saying is that looking at a normal forecast, all things being equal, we don't see the notice inventory buildup in the first quarter, nor any significant changes in rates. So the reserve change, if you will, where it had been approximately $100 million in the third and fourth quarter, would be less, maybe by as much as $50 million. So...

I see, I misunderstood you. It is not a having of incurreds but a having of the difference between incurreds and paids.

That's correct.

Got it. Thanks.

Thanks for making that point.

We have a follow-up question from A.J. Grewal of Smith Barney.

I think I missed it, what are you expecting for your tax rate again? And how much of an increase do you expect in your average premium rate? And just those two questions. As well --

Oh, go ahead.

My view is that as the loans refinance, they're in essence, the loans that are refinancing in '03 are maybe about three to four years old, maybe on a three year side and so they may be actually four years by this '04, maybe in the peak delinquency period. And given that and given that the amount of refinancings that we've had could the delinquency rate be at the peak, bulk excluded, right now and we could see an improvement because of the seasoning of those loans?

Well, the delinquency rate has a numerator and a denominator. Writing the smaller book and having a lot of burn-off, what's been out there, would take pressure off that numerator. And if persistency improves, we could add to the denominator so both factors would, if they work that way, would bring the delinquency down or at least keep it flat.

But on those -- the cumulative curve is the question I'm getting at, for the loans that refinancing is still on your book from '03, could that cumulative curve already be near it's peak?

On the '03 book?

That's right.

No.

No.

No.

Again, you have to think our loans are not -- you're thinking in terms of general market but if a mortgage insured loan just doesn't have that kind of seasoning on a refinance or they wouldn't need mortgage insurance. So, while you talked they may be in their third or fourth year with a mortgage insured it's probably the first or second year.

You had an earlier questions on the tax rate. We finished up the year for the quarter at -- or the fourth quarter was about 24.2 and we're anticipating that rate to be about 22 to 23. With respect to average basis points, we said earlier that we thought that at the current level next year we might be able to hold that relative to how mix of business changes because we'd get some benefit from the existing bulk business, but we'll have to monitor that as we go into the year and see what the mix of business is. But for now we think we could possibly hold that rate.

Thank you.

Our next question comes from Andrew Bridge of Cherry One Capital.

My question has been answered, thank you very much.

Thank you.

Our next question comes from Jay Leopeld of Legg Mason.

Good morning. Can you give us an update on the captive situation and how your discussions are going? Whether any of your customers are starting to come back and secondarily, just give us an update on the 80-10-10 competitiveness of that product versus traditional MI.

Yes, on the captives, it's been reported, at least General Electric and United Guaranty have taken a position more similar to ours than where they were, anyway, probably General Electric more strongly than United Guaranty. So, that's encouraging relative to our business. Also, I think it's come out in a number of sources that the returns, on the high dollar excessive loss seeds are not sustainable. Independent analysis. So, I think ultimately all have to get there. Competitively with certain of our customers, we're in those discussions right now, Jay, so I don't know how it will break out. Obviously it's more positive than it was a year ago. So, other than saying that, I don't want to break out competitively by customer what that might be. But it's more positive than it was a year ago.

80-10-10 --

The 80-10-10s. Again, a big part of that relates back to the tax deductability and strength in the economy. And what I mean by that is on the tax deductability, probably half of those borrowers choose 80-10-10s because they can deduct the second mortgage interest and they can't mortgage insurance. So, I think you're looking at 40 to 50% of the 80-10-10 business that could come back to our industry if MI tax deductability indeed was put in place. So, a big part of that is dependent on the tax deductability. Another large part is that many commercial banks have made consumer -- or the consumer has been their only source of business relative to the past couple of years because of the lack of commercial business. And as a result, they've been very aggressive in pricing second mortgages. And again, if there is strength within the economy, I think you see those rates being less attractive because banks will be more interested in getting that commercial business and less than that area. So, the strength of the economy would also play a role, I think, in lessening the attractiveness of an 80-10-10 transaction to a consumer.

Is MI superior to 80-10-10 if it was deductible or are they more on an even footing?

Very even footing so it relates them back to where the second mortgage is being offered. But at worst case we're basically even up with them.

Thank you.

Our next question comes from Geoffrey Dunn of KBW.

Just a quick follow-up. Did I hear correctly? You think your persistency rates going to the mid-60s by the end of '04?

Yes.

Given the new mix of business, where do you think your persistency level peaks out compared to past cycles?

Once again, you have to differentiate between bulk and flow.

Yeah, again, 25% of it will be --

Basis, that's why I'm asking, cause I know that the bulk stuff runs off more quickly.

I'd say high 70s.

Okay. Thank you.

We have a follow-up question from Richard Diamond of Inwood Capital.

Hello? Operator?

I'm sorry. We have a follow-up question from Anel Stevens at this time.

I guess we're answering all their questions.

Operator?

Yes, sir.

No question, I guess.

There are no further questions at this time, sir.

With no further questions, I'd like to thank all of you for your interest in MGIC. Good day.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect. Have a great day.