MGIC Investment Corp (MTG) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the MGIC Investment Corporation fourth quarter earnings conference call. [OPERATOR INSTRUCTIONS]. I would now like to introduce your host for today's conference, Mr. Mike Zimmerman, Vice President of Investor Relations. Sir, you may begin.

Great, thank you. Good morning, and thank you for joining us today on the call and for your interest in MGIC Investment Corp. Joining me on the call today to discuss the fourth quarter and full-year 2006 results are Chairman and CEO, Curt Culver; Executive Vice President and CFO, Mike Lauer; and Executive Vice President of Risk Management, Larry Pierzchalski.

Before we get started this morning, I wanted to remind all participants that our earnings release of this morning, which may be accessed on MGIC's Web site, which is located at www.MGIC.com, includes additional information about the Company's quarterly results that we will refer to during the call, and includes certain non-GAAP financial measures. 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 quarterly earnings release. If the Company makes any forward-looking statements, we are not undertaking an obligation to update those statements for the future in light of subsequent developments.

To begin this morning's discussion, I would like to turn the call over to Curt.

Thanks, Mike, and good morning.

Net income in the fourth quarter totalled $121.5 million compared with $128 million a year ago. Diluted earnings per share was $1.47 versus $1.44 a year ago. New insurance written in the quarter was $15.5 billion, that was comprised of $10.4 billion of flow business, and $5.1 billion of bulk. Persistency was at 69.6% at year end with flow at 73.5% and bulk at 57%. This compares to 61% a year ago, with flow at 65%, and bulk at 49%. Insurance in force continued to grow in the quarter and ended the year at $176.5 billion, which was up 3.8% from a year ago. Paid claims in the quarter totalled $157 million flat with last quarter, and totalled $611 million for the year. Losses incurred in the fourth quarter were $187 million compared to $172 million last quarter, which reflects the customary seasonal increase in delinquencies, which approximated 2300 in the quarter, as well as the higher loan balance on the delinquent loans.

On a positive note, lost mitigation opportunities remained basically flat with last quarter. Underwriting expenses were $75 million versus $71 million a year ago, with the majority of that increase in expenses was related to our international expansion in Australia and Canada. We expect to be operational in Australia late in this quarter and Canada, hopefully, by year end. Relative to the joint ventures, we had another excellent quarter with income of $47 million, up from $37 million a year ago with full-year contributions totaling $169.5 million versus $147 million last year. My congratulations to the outstanding management teams at C-BASS and Sherman for those results.

Looking at 2007, while we're estimating a smaller origination market at $2.4 trillion, with higher interest rates and tax deductibility for our product now in place, we expect to see flow mortgage insurance penetration increase from 10% today to 12% by year end. In addition, we expect credit spreads to continue to widen, and as a result, we expect to increase new insurance written by at least 10% over 2006. In addition, we expect the flow persistency rate to increase marginally, which when coupled with the higher new insurance writings and the slower property appreciation rate going on across the nation, that will help continue the insurance in force growth that we've experienced this past year. The loss side will be more difficult, as the delinquency makeup and ultimately the claims paid will reflect as we talked about last quarter significantly higher loan balances.

As a result, while we expect a number of claims paid to remain flat with 2006, the severities will be up approximately 10%, leading to a total claims paid number up approximately 10% from 2006. Expenses for 2007 should be up approximately 5% from 2006 with a majority of that expense relating to our international expansion. Finally, regarding our joint venture results, which are an important and growing part of our financials, to those of you who have been with us for some time, you are aware that they have a habit of exceeding our expectations and lessening our credibility with you on this matter, although that has been a very good thing. However, given the outstanding results in 2006, we are again factoring in financial results that overall are flat year to year. With that, let's take questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Geoffrey Dunn from KBW.

Thanks, good morning.

Good morning, Geoff.

I know it's difficult to look out in terms of what the world might bring you for provisioning needs, but when you look at your book of business now, the seasoning of your delinquency portfolio, would you expect a normal seasonal patterns, at least, to materialize again in '07, where we have potentially favorable development in the first half, and then building in the back half?

Yeah, that's exactly right, Geoff.

And then turning to the international side, obviously you have a little bit higher run rate expense as you build that out. How quickly do you think the revenue offset could materialize from Australia, and then in turn, Canada, to bring the profitability back to the green?

We have pro formas, which are basically break even in Australia for this year. So that will come back. Canada, we're not going to start writing until the end of the year. So that's as good of guidance as I can give you.

Okay. The last question. You didn't buy much stock this quarter, so it looked like you didn't chase the rally into year end. What are your current resources for stock repurchase; and what's your appetite here, just above '07 book?

It's Mike. We didn't have any excess cash available at the holding company in the fourth quarter. We did have cash from the proceeds of the debt offering. However, recall, that's due in March, so we pulled that financing ahead. So we need to go through another round, if you will, of discussions with the rating -- or with the insurance commissioner just after the first of the year here and talk about dividends again, excess transfers of operating capital. We're getting into that as soon as we close up '06 financials.

Okay, great. Thank you.

Thanks, Geoff.

Our next question comes from Ed Groshans.

Good morning. Thanks for taking my question.

Yes.

On the joint venture side I if we look at your investment in Sherman, that was up $264 million, and that appears to be the driver of the results there. Can you address that?

I'm not sure what you want addressed?

My understanding, Sherman's a debt collector. I'm just surprised -- it looks like they had some significant outperformance. I'm having trouble getting my arms around that.

The outperformance was not on the debt collection side. They did have a one-time gain in the fourth quarter with respect to sale of some assets, but the driver has been the growth of their credit bank business.

The issuance of credit cards.

Doing the credit card issuance, that's what's driving that?

Right.

Well, both.

Okay. And then, you talked about the loss mitigation efforts staying fairly stable.

Right.

Do you expect that trend to continue through '07?

I think marginally, it will weaken in '07 relative to both their opportunities on presales and acquisitions, but not significant. I think we've experienced most of that, so I think we may be down a tick or two throughout '07, but all in all, relatively flat to where we are now.

Okay. And my last question really stems around severity. Severity was relatively flat quarter over quarter, but when you're looking at the two pieces of the puzzle, the flow dropped pretty nicely, yet the bulk continued to rise. What's going on between the two different books there?

The one side is gross and the flow versus the bulk. Just to give you an example, on flow, if you looked at our average unpaid balance in 2003, it was $144,000 and in 2006, there was $161,000. The growth there has not been that significant. On the bulk side, if you go back to 2003, the average loan was $147,000. 2006, it's $244,000. So you can see why the severity growth has been much more significant on the bulk side of the business. It's reflective of the loan balances we're insuring, just being larger. Which is a good thing, because we're getting bigger premiums on those larger balances also.

I believe you talked about this last quarter, a little bit of an update. The subprime book represents about 10 to 12% of your total insurance in force. Can you give us a feel for how much of that is really '06? I think that's where the concern stems around. How bad the subprime book for '06 could be.

Do we have that, Mike? '06 -- while they're looking for a specific number, I would have to say just a generalization from my standpoint, we didn't do nearly as much because on the bulk side, many of the transactions that we did were agency GSE-related transactions, where there were deductibles involved within it which were prime-type credit risks. So we didn't do a lot of subprime. A great deal of that business was involved with second liens. So you had a first and second that was taken away -- we didn't have an opportunity to insure it.

Right.

Maybe that was a very good -- in retrospect, that was probably a very good thing. It wasn't a big part of our writings.

I don't have the exact number with me, but if you look at the average in force in subprime again, we define it less than 575 credit scores, we get a disclosure on the last page, we're at 12.8%, same time this fourth quarter '05 was at 15.1. So, if anything, that would suggest that the subprime writings are down on a year-over-year basis.

Which clearly we saw on the business that we booked within the bulk channel.

11% of the bulk in '06 was 575 and under. I don't have handy the flow number.

Thank you very much.

You bet. Thanks, Ed.

Our next question comes from David Hochstim.

Can you give us a sense, the 10% growth in new insurance written you're anticipating in '07, how does that break out between flow and bulk, and then Australia? And I have two other questions.

I can tell you on the flow side, I expect that we'll be up at least 10%. All of it, at least, is showing on the bulk side. I think we did at least, is showing on the bulk side. I think we did 18-something -- I mean, on the flow side. I misstated. So at least -- let's use 100% of the increase will be on the flow side.

Okay.

I think the bulk will be up a little bit more than that, too, David, but just -- might be 90/10, if you will.

Okay. Just in terms of Sherman, how big was that gain that you both have mentioned now?

They had a gain on portfolio of about 5 to $6 million, I believe difference between the quarters, about 9 million for the quarter, but a difference of about 5, I think. And they had some other one-time transactions. But I think generally the question that they had earlier was the year to year improvement and was it coming out of the portfolio business, and I said, no, that was probably flat. They did have in the portfolio business some one-time gains. But the generator -- the predominant generator of the earnings year to year was earnings from the bank.

But to have earnings flat at these elevated levels, as Curt pointed out, you keep saying it's going to be flat, and it keeps going up. I guess you're assuming they're going to find some other gains in '07 as well?

I think they're limited. Because the portfolio business, as the caller mentioned before, is getting softer and they recognized that. The question is, can they offset that with something else, and we're saying no at this point in time.

But you're saying earnings will be --

We're saying they can offset to the extent that they have the gains. They should be -- don't count on anything more than flat from them.

I guess I'm thinking flat's pretty good, because we're flat at an elevated level.

We have too for the last three or four years and continue to exceed it, but this time we're really serious.

Okay, good. I wonder if Larry can talk about regional credit trends? Give us a sense of how bad things are in the Midwest this quarter, and if you're starting to see any deterioration in California or Florida?

In the auto sector, Michigan, Ohio, Indiana, quarter to quarter, we think things are pretty stable, pretty flat. Not that they've recovered any, but things haven't gotten any worse. They're still weaker than national, but things seem to be holding in there. Where things are starting to change would be California and Florida, if you look at the housing statistics, a month's supply in California now about seven months versus a year or so ago about four.

Supply is up also in Florida, and as a result of that and some of the prices being flat to down slightly, we're starting to see the beginnings of that housing picture carry over into our delinquency activity. We're seeing a start of an uptick in California and Florida, and as well as a change in what percent of those delinquencies from California and Florida cure versus claim. Up until now, virtually all the activity from California and Florida pretty much cured out not only the claim, but very few went to claim on the strength of the housing market, but now we're seeing that move upwards towards national numbers in terms of the curing and claiming activity. So in our forecast, we're assuming that California and Florida transition from where they've been to more national numbers in terms of curing and claiming.

And hence the higher loan balances that we're using for reserving and paids.

Okay. And how much higher is California balance for you than national average?

I don't know if we have that offhand. We don't have a huge -- I think 8% of our risk is in California, so we're not overly exposed to that market. But on a loan balance, we don't have that number, David. We can come back to you. Mike can get back to you on that.

But even for you, it's higher than the national average?

Sure. But a lot of the bulk business is California-oriented. The basis of that number is pretty close to what our California number is.

Okay. Thanks a lot.

You bet.

Our next question comes from Eric Wasserstrom.

Thanks. A couple of questions, please. The first one is, the premium margin looks like it eroded a little bit, and I'm trying to reconcile that with the commentary you made about the bulk premium still being very good, and the fact that it looks like the amount of business that had a deductible associated with it was basically flat. Can you help me understand that trend?

I'll ask for help here, but a couple things that are going on. One, the growth of SingleFile, which is at a 50% reduction because of the credits that are insured under it, for the year it was 9% versus 6.3 a year ago. On the flow side, you have premiums coming in that are at a lower level. On the bulk, actually, this quarter, the premiums were up from the third quarter because we did more routine or more securitization-type transactions versus GSE, which is a very good thing for us. But we also lost some of the higher premium from the '03 book in particular that canceled, and some of the '04, and even though the premiums were up this quarter, we were not replacing at the level that the '03, '04 loss was. So I would say on the flow side, it's SingleFile, which is a growing part of what we do. And on the bulk side, even though the premiums were up this quarter, and again, a very good thing for us, and a very good thing for us, they weren't replacing what we loss from the early '03 and '04 books.

So as we think about what occurs over '07, how do we think about it? Is there that much exposure left to '03 and '04, versus what are the pricing trends in the bulk business right now?

I would say flat. I don't think there's much left on '03 right now at all. Maybe 9, 10%?

I'd say in the first quarter, too, certainly in '04, we probably on a bulk premium rate side, on an in force basis be relatively flat, but as we add newer writings that equal to or higher than the average premium rate, we're kind of turning the corner here as the spreads widen now.

These bulk premiums should be higher than last year's now. So that will be a good thing for us. I'd say flat at worst.

Okay. And just to get back to the reserving in the period, I understand the severity issue, but obviously, the delinquency inventory build was pretty modest and the delinquency rate was pretty modest. Can you help me understand those trends relative to the magnitude of the reserve build in the period?

Well, it's a combination of things. Granted, there was only about 2300 change in the delinquencies, but where the agent changed, I would say probably in the six to nine month area, as well as Curt mentioned the higher severities too. It's a combination of both of those. The numerical change, one of the things being where it was in the aging, and then secondly, the higher loan balances. So it's not out of the norm with respect to the aggregate change in reserves at this time of the year.

How do we -- how should we think about the paid claims outlook versus the reserving outlook for '07?

Well, I think David touched on that a little earlier. And, of course, the issue is, what we do have in is seasonal changes that happen, and that is generally speaking, in the first two quarters, we have a reduction, if you will, in delinquencies. Traditionally, the higher delinquencies at year end cure out in the first two quarters for economic reasons, all things being equal, if the economy doesn't change, obviously. So you generally see a reduction in delinquencies, and heretofore, nothing -- everything else being equal, that generated usually lower incurreds and paids, a reduction in the reserve. In the second half of the year, you have the opposite. You have the aging of the existing delinquencies that start to get to six to nine-month curtailments, and then also, an increase in the number of new delinquencies, and heretofore, we've had increases then of incurreds over paid. So that's generally what happens, that can change subject to economic conditions, but historically, that's been the trend.

Would that suggest on a year-over-year basis, the two would be equal in magnitude, but the timing might be different?

The difference would be in changing environments. If you go back a number of years, there are times when the paids are in aggregate more than the incurreds. And then correspondingly, less than incurreds. It depends on the change. All things being equal, if we had a year like this last year, it would be similar. If, in fact, the delinquencies rise faster and there's an increase if you will, in severity, it's possible for incurreds to be greater than the paids.

Thanks very much.

Our next question comes from Michael Grasher.

Good morning.

Good morning.

The question on persistency, just to follow-up with you, mention it being stronger, going higher. Do we look for that to be above 70%? Could it get to 75? Just a little more reflection on that.

On the flow, it should get above 75, but I think on a combined basis, it won't next year.

Okay. Understood. And since the tax deductibility on MI went through, are you able to gauge the impact on the book or on your new insurance written since it went through?

Not really. I just use that as one of the factors along with the higher interest rates that's going to help push flow penetration from 10 to 12% this year. It's meaningful from a perception and publicity standpoint, certainly, and I'm hearing advertising on the radio now about mortgage insurance, which is a good thing. So it's going to help move that MI penetration as part of that movement that we see, but I don't know what part of that it plays.

Any sense of what the impact might be to the lender-paid product?

SingleFile?

Yes, SingleFile, sorry.

Yes, I don't know if it will have an impact, frankly. I really don't.

Mike, this is Mike Lauer. That SingleFile is a product -- piggybacks are still a prevalent part of the market out there, and it appeals to a certain segment of the consumer base who would prefer to not to pay mortgage insurance, whether it's tax-deductible or not.

We don't care how we get them, just so we get them.

Understood. A question for Mike. Any sense of what the delinquencies were in the quarter out of the Michigan, Ohio, Indiana states as a percent of the total?

They stay about the same, about a tick lower. I think there was 36, 37 in the third --

Paids or delinquencies?

Delinquencies, yeah. Was it like 35% of total last quarter?

That was the paids we gave out last quarter, and it's just a tick below that, marginally below. No significant change.

Okay, great. Thank you.

You bet.

Our next question comes from David Chamberlain.

My questions have been answered. Thanks.

Okay, David.

Our next question comes from Andrew Brill.

Just a few quick questions. First question, can you just talk to the trends you're seeing on the subprime side with regards to incurred losses versus the trends you're seeing on the prime side, and I have one follow-up question.

No significant difference. Higher severity, as we talked about, and you can see, I think we have that on the disclosure sheet on the back. The paids' higher, the average severity is higher, but no significant change in any direction.

Just to clarify, there's no change, either, as I think about the impact to reserve? So on the incurreds side, not necessarily just on the paids claim side, but as we think about the impact to the increase in the reserves on the quarter?

Andrew, just to clarify, when you're talking about subprime, you're referring to our bulk business -- or just a segment of the bulk business?

Just the subprime piece of the bulk business.

What was the question?

I just want to make sure I'm thinking about this correctly. I know you talked about it on the paid claims side, there's no stark difference. But as I think about the additions to the reserves, not on the claims side, but on the additions to reserves in the quarter, was there any noticeable difference on the subprime side versus the prime side?

No, not at all. The composition of the inventory didn't change. Subprime didn't increase, if that's your question.

Yes, it is. Okay. And secondly, my follow-up question, just with regards to your expectations next year for incurred losses, what do you think the impact will be next year if we see California and Florida normalize?

If they normalize?

Yes.

I would say, then, that incurreds probably add about the paid level or slightly higher depending on what happens to total delinquencies, as I mentioned earlier. Higher delinquency levels will change -- could change incurreds in the second half of the year, and then any new development with respect to California would have an impact, because materially they would be significantly higher delinquencies, if you will, in severity.

Have you quantified the potential impact at all?

No.

Thank you. That's it.

Our next question comes from Rob Ryan.

Good morning.

Hi, Rob.

I'm wondering how you're thinking about the rollout of eventual defaults on the significant amount of bulk writings in '06 that had deductibles? How you're going to report them to us, how you're going to reserve for them, or not reserve for them until a certain threshold is met? What are your thoughts?

We'll have to break that out, we think, in '07. We've talked about it and as we get into '07, it will become more of a material item. So we'll have to start discussing in the delinquencies, how many had coverage, and what percentage, and we'll have to do more disclosures.

More transparency.

We already talked about that internally.

And what type of average attachment points are we talking about? Or how big are the deductibles on average?

Relative to expecteds, or --?

Yeah. I'd say they're probably in the area of 100 basis points of the original -- size of the original transaction, if that helps. Mostly on the bulk side -- I doubt we have anything on the flow side, and I think maybe about a third of the '06 bulk business had a deductible, and I'd say probably the average size was about 100 basis points of the original insured of those deals that had deductibles.

You'd think in virtually every case that would handle expected losses at a minimum, and higher than that normally, although for us to quantify is too much detail for this call.

Okay. Just going to be something we're going to have to look for. As you said, you'll have additional disclosures.

Yes, we'll break them out so you can make a adjustment on them, more transparency.

Okay. And what have you seen recently on the bulk side in terms of conditions? Obviously there's been some spread widening, and you're optimistic for 2007, but with what happened in the fourth quarter and the kinds of submissions you're getting now, how would you characterize the market?

It's coming back our way. I think now going forward some of these players -- I mean, first off, our competition was really the non-MI execution. 90% of the transactions, the securitizations probably went no MI. So that's really the competition that we're eyeing up. And as spreads widen here, that makes that execution more costly. While that's going on and in our favor, we continue to evaluate the markets, particularly California and Florida, and we see more risk in those markets today than we did a year ago. What wins out, we'll have to see. Whether its spreads widen and surpass our increased view of the risk or not, but all in all, I think it's a favorable development.

Okay, great. Thank you.

You bet.

Our next question comes from Brad Ball.

Thanks. In terms of the SingleFile product, what percentage was that of new insurance written in the quarter? And what does that represent in terms of your total insurance in force right now?

Brad, it's Mike. It was 9.5% of flow in the quarter, and for the full year, it was 9.1.

Okay. And with respect to the outlook, your guidance in terms of penetration going from 10 to 12%. I know you noted the higher interest rates, I know you noted the tax deductibility factor, but how do you get -- you're being kind of precise saying 10 to 12. How do you get that extra couple hundred basis points of penetration? What really drives that?

Higher interest rates and MI tax deductibility. As you look at the market, and we've all been here a long time, and you hear what's going on relative to our customers and their offerings, you know that penetration is going up. And then you couple that, I think, with what's going on even with the bank guidance relative to second mortgage liens, that is very, very helpful in the process also. So we're trying to give you guidance on with a we think based on the market that we know and have worked with for a long time.

Got you. So your expectations for 10% growth in NIW in '07 reflects your expectations for the industry increase penetration from 10 to 12?

Right, right.

It's all consistent. And I know this question was asked at least partially earlier about SingleFile. Would you expect SingleFile to be an increasing proportion of your flow in '07, and therefore an increasing proportion in your overall AIF?

I think it will be up maybe marginally, because the opportunities of tax deductibility will make our other products just as important, and so I don't think it will grow significantly this year.

Okay. So it won't grow as much as it did during '06?

Right.

Got you.

Right.

Okay. Thanks very much.

You bet.

Our next question comes from Ed Groshans.

Good. Thank you for taking my follow-up. This is probably a little bit offtopic here, but Bank of America has a new product that they've been marketing or piloting in Washington State, and I think in that product, they're offering up to 100% LTV, depending on a borrower's FICO with no MI. Have you guys looked into that at all, and if Bank of America decided to roll that out nationwide, do you have some commentary on what you think that would do for the SingleFile business?

Well, it may be a lender-paid product.

There's a lot of -- that's primarily they're more focused -- I've seen the offering and I'm not completely fluent on it -- it's a no-cost program, meaning no closing costs, no appraisal costs, you have to be an existing customer of B of A as well. Whether it goes up to 100% LTV then they'll have their banking regulators from capital consideration they can become as well.

I expect they'll be doing that with lender-paid mortgage insurance. One of those programs, which there are many in the marketplace that offers no MI to the consumer, but they're insuring it through our lender-paid programs through the back end.

They've said they don't expect to increase the rate on the mortgage product, despite offering, right, so means they're going to eat the cost of the lender-paid MI, then?

To the customers?

I can't speak for what they're going to do and how they're going to charge, but I'm very familiar with those type products.

Okay. I just had one follow-up on -- you talked about the paids being up approximately 10% next year, and then there was a conversation on California or Florida, and I guess the increase in paids includes your expectations for increased claims from both of those states? Is that correct?

That's why I mentioned the higher loan balances, both on the paids and the reserving was to reflect that.

I think someone touched on it briefly, but the Midwest, still a thirds of paids. Looking forward, any change there? Is it status quo, or there an expectation that maybe the cure rates will pick up there?

We start paying more in California and Florida, I guess the auto states will come down.

They're not improving, they're not deteriorating.

We really haven't had an increase in delinquencies for four quarters, which is positive. That's really positive, because for the three years prior, they were changing quarterly. The only positive aspect there is that it hasn't changed much for the last four quarters.

So holding steady, but not seeing anymore deterioration in there?

Holding steady at high claim rates and high severities -- not high severities, steady severities.

But the corner for the Midwest states still in the future?

Right.

Right.

Okay. Thank you very much, gentleman.

Thank you.

[OPERATOR INSTRUCTIONS] we have a question from James Shanahan.

Thank you, I was furiously trying to keep up with your guidance items, and I thought that maybe I missed something here. Did you provide some guidance for where you thought EPS would be in '07 versus '06? Did you say something like flattish?

We don't do that.

Okay. I must have confused that --

Wrong call.

I must have confused that with your joint venture guidance.

There you go.

Okay, thank you very much.

Thanks, Jim.

[OPERATOR INSTRUCTIONS]. I'm showing no further questions, sir.

Okay, with that, let's wrap it up. As always, I thank you all for your interest in our company. Have a good day.

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