Curt Culver - Chairman and CEO
MGIC Investment Corporation (MTG) 2013 Goldman Sachs US Financial Services Conference Call December 11, 2013 1:10 PM ET
Okay. There we go. Well, this would be interesting. I can say anything I want. Well happy holidays. Okay back to, we have been doing this a lot given what we've been through the last five years, so it’s nice to be back with all of you again.
To those of you that are new to us, who we are MGIC, we've been doing this since 1957, when Max Karl, who started the industry started MGIC. And just to show you how the world works. He started the company to compete against FHA because he thought they were too expensive and too slow. And here we are again we’re going to talk about that same thing. But from that point in time, those of you that know us we’ve really at the industry for 50 plus years, throughout it. And it’s a very simple industry. What we do is provide mortgage insurance to those who provide less than 20% down and getting a home loan, it’s required by lenders and the secondary market agencies to have coverage.
And hence our overall business is serving first time home buyers because they are the ones in a position that won’t have 20% down and I guess I [want to] show you that later then.
Unidentified Company Representative
Curt just further [rightsize it], slides are available on our website. So they’re just going forwarded up to here. So they are available on the website what Curt will be referring to.
So what we try to do is provide and write the most business we can maximize the business, we can improve the underwriting standards and doing that in their efficient manner. And I’ll talk about those later.
I’m also, I mean just what I am going to talk about is really what's happened to the company recently as they improve financial performance of the company driven really by two things. One the improved performance or loss performance of the legacy book, the $160 billion, we have in force as well as the quality of the new writings that we’re putting on, the books and the loss ratio are outstanding there. And then looking for the future, the opportunities that we have both as a company and as an industry relative to serving a growing market, household formations would be very positive as well as taking share back, I think from some competitors, but even more so taking sharing back from the FHA. And I’ll talk a little bit about Washington also.
Relative to the company’s performance, this third quarter we’ve posted our second consecutive quarter of operating profits. To those of you that don’t know the business that's really been a big deal for us. We had a long period of time, a very difficult period of time. So that was extremely positive. It was driven really on the loss side of the business, loss has incurred third quarter, over the third quarter we are down 63% and that was reflective of improvement in loss severity, but also improvement in delinquency picture. Delinquencies have dropped now to actually November numbers; a $104,000 unchanged that's down 25% year-over-year.
The other strong impedance to the reserve improvement it was an improvement in the cure ratio. And what we've said at the start of the year about one in four, new delinquency that we ensured we’re going to go to claim, in mid-year we improved that to one out of five and saw 80% [curing] and now it’s probably little bit higher than that, in the neighborhood of 81%, 82% claim rate. In very normal times we are at 90%. So if you get a new delinquency in normal times 90% of those curing. So we are gradually getting up to that point of normal seen that’s very important relative to our business.
The other area obviously is what that leads to and that claims. Claims paids have been declining. I mean a good indicator of that as we look at our books. A year ago, we if you looked at our inventory of claims we had 11,000, I think the 800 claims received but not yet paid today that's like 7,600. So we've drop in that dramatically and we're paying about a 1,000 less a month than we were a year ago. So that improvement has been excellent.
So the loss side has been the real contributor to our operating profits for the last two quarter. But also very positive within that has been the new writings. New business third quarter versus a year ago was up I think 23% quarterly, but up 35% year-to-date, that's very positive. And probably more meaningful for a longer term profitability, we grew the insurance in force in the third quarter which was the first time since 2008 that that happened. So, pretty much all the trends impacting the company are moving in the right direction. And as that impacts our future profitability, it’s just how fast those trends continue to improve.
The other aspect of that is really relates to our book of business and the quality that we've written, if you looked at the book of business today and looked at a FICO score basis. Our average FICO is in the neighborhood of 750 to 760. A numbers of years ago that would have been closer to 700s. So, the quality of the book, I think 71% of the book is in 720 and higher FICOs and as a result of that, that's very good.
And on the delinquency inventory as I mentioned which is at a five year low at $104,000. The makeup of that we are seeing the troublesome 2005 to 2008 vintages running off or being much less impact, in fact by year end they should be above 50% of our insurance in force. So that’s very positive a year from now it would probably be 40% or lower. So as a legacy business runs off it’s very positive for us, interesting. While our new business 2009 and above we call the new business is about, I don’t know 37%, 38% of our insurance in force, that’s only 1% of our delinquency inventory which speaks to the quality of that business also interesting. And I think this points to the economy is that about 30% of the new delinquencies we received are from warrants we insured in 2004 and prior. Now you think people that have tenures of seasoning on their loans wouldn’t be 30% of our new delinquencies, but the reality is it speaks to I think what’s going on in employment in this country. And so if you get any boost in employment it really helps our legacy book of business.
The aspect relative to the profitability of the book of business, I think as indicated and you can’t see it obviously, but if we compare it to older vintages that we had that were very profitable business in fact the 1999 book of business was one of our best at 17% loss ratio. And if you compare that ‘99 book to the ‘09, ‘10, ‘11 and ’12, everyone of those books is a better vintage than the 1999. If you look today at the 2009 book of business and the loss on it is 13%, the ‘10 book of business is 6%, the ‘11 book is 4%, the ‘12 book is 1% and the ‘13 book is under 1%. Those all performed less than 20%, all performed better than ‘99 book of business.
So you can see the quality of the business that we're writing and the strong impact that that will have relative to delivering capital to the company longer-term, when you write $10 billion of that type of quality of business you’re going to generate capital of $180 to $200 million to the company and that’s how you will grow capital long-term. This business really grows organically quite well and profitable times and in a few years that’s what you’ll see in the industry and our company in particular.
And the reason that will grow that business really reflects couple of things. One, the FHA as I mentioned back, the Max Karl starting our company the main reason to compete against the FHA while we're still knocking heads over the last number of years. Traditionally we've been two thirds of the industry or the no down-payment market our industry and the FHA has been one third. Over the last four years they've been about 80% of the market and really been 20% of the market, so a huge flip-flop.
Now we're turning that around. FHA is having to deal with its financial problems on its own goodness. As tax payers we should all appreciate that. And as a result of that has increased premium rates three times over the past year, also have put in a provision that their insurance is non-cancelable or as private insurance is on the books until the borrower gets below 80% LTV which generally a normal appreciation cycles is above four years, four to five years a little probably on these newer books of business or maybe in the six years.
So the cost aspect of the FHA is much more expensive than the private mortgage insurance. Even we have some private meetings today where they've asked about the recent GP increases from the FHFA which will add about 14 basis points of cost on the private mortgage insurance industry MGIC, is still more cost effective on all loans above 660 FICO score and 90% loan to value and then 95-680 and above were more cost effective on a monthly basis. If you are add-in the effect and that that’s non-cancellable to FHA and every FICO, private mortgage insurance is a better deal.
So it’s just a matter of that share reversing back to our industry. This third quarter was a milestone for us and that the industry captured 41% of the business versus FHA at 39% and [NIW] is doing the remainder. So we have gradually now gotten above and I would think ultimately that will be three quarters at the industry relative to FHA and FHA being at corner, so 75-25 given the class changes as they deal with their financial situation.
So a very good outlook there. The other aspect that is very positive to our industry is household formations. If you look at the demographics of this country. And I have been talking about this since 2000, I guess since we went public, since I have been in this role, household formations were slated for this decade. They average around $1 million annually and did up until 2006, and then they tailed off to $500,000 and they have done. So the last four years, last year they were back up towards normalize $1.2 million, and that’s what’s projected by the Joint Center of Housing, $1.2 million household formations annually over the next 10 years and we have been running at half of that.
So we’ve got a lot of people, a lot of people renting that want to own, we have a lot of kids living with their parents, frankly because they can't get jobs. And so as employment increases I think you will see a dramatic increase in household formations of people wanting to buy. And first time home buyers are what we do, 30% if you look a transaction across a country, about 30% are first time home buyers. They virtually all require mortgage insurance. In fact, if you look, more recently, last year 45% of all transactions with mortgages had less than 20% down. So as the big pie growth, we’re at the forefront of capturing end market through demographics. And that's very, very positive for the business obviously. And I’ll talk in a second about originations and how that impacts that. But the next question then as well, how do you do in your industry? MGIC’s market share is around 17%; five years ago, we were probably 24%, 25% and then we got into some litigation with (inaudible) who was a major presence at that time, because they had countrywide origination. And we lost that business, because of that and that was about 3 percentage points of share. And then we've had our own financial issues until the capital raised by Goldman Sachs and working in court consulate with them, which has put those to rest. But during that time, our share decreased and also the problems of the single premium product, which was about a third of the market; and we didn’t participate in that. We thought the returns will vary under, while we’re very low, relative to what was available in the monthly market.
And so, our share on the monthlies was about 22%; on the singles was about 7%. And so we dropped down into the world of 17% or 18%, but on very positive business, as I have shown. I don’t think going forward single premiums will be nearly what they are. Dodd-Frank imposes a 3% limit on fees that lenders can charge and that single premium is considered as part of that. And so that will have an impact in those going away. Also the single premium product that was underpriced for our industry, I think also goes away as refis die. It was a great product for refis in getting those done. And those are going to be a much smaller part that I'll talk about in a second, to the market going forward. And also, it makes a little sense to write a single premium product that has 2.5 years premium attached to it, when you're looking at interest rates that will keep these books of business on probably five or six years.
So, to the extent you're right that you're getting 2.5 years of premium for six years of coverage is not a good trade off. And so single premiums will be much less I think of the future writings. I think also importantly and a lot of people have asked us where we've got a lot of new in competition. But the reality is as new competitors don't have sales in underwriting organization. MGIC has 250 people dedicated across the country that have worked for us on average 18 years, representing our company and going forward, market share is going to be earned on what do you do from me as it always has been. The way some of the new companies got into business is a couple of went out of business are MIC and PMI. And that allowed some to capture share just from that. But also I would tell you the legacy companies had financial issues that caused us a lot of pressure and a lot of customers.
And those are all going now with a capital raise we did earlier this year that what Radian did and that what Genworth has been doing. So the legacy companies I think have a tremendous advantage going forward relative so they have existing sales and underwriting organizations. And that's really what the competition is if you don't have financial concerns with those companies.
And so, I think the legacy companies are in a great position and no one better than MGIC. We have 3,000 customers and our real strength is in smaller lenders. And I think that is really going to be important as you analyze the mortgage market. I think you are going to see the bigs lose some share to the smaller community banks because of the implementation of the qualified mortgage definition. And the qualified mortgage definition sets a bright line relative to legal liability on ability to pay if you stay within I would say relatively tight guidelines. And a lot of the banks given the lawsuits they have been in the mortgage sector, don’t want to step outside that ability to pay bright line by 43% DVI limit they won’t do a 44 no matter what your FICO is.
And at the community banks I think, well I know will step into that space because they have been doing it to begin with. And that is a real good thing for MGIC because our real strength is in the smaller lender sector. If you looked at our company a couple of years ago, our market share was a top 100 was 19, so a top 100 lenders was 19%. Our market share with everyone below the top 100 goes 29%, and that speaks to the force of that sales and underwriting organization that they know so well. And I think that’s where the real growth in the industry is because the bigs again want to stand in QM space and the others will compete outside that on very quality mortgages.
So, I feel real good relative to our ability to compete and get share regardless of how many entrants we have in the business. And if you look at our expense ratio, we are about I think 40% under the others in the industry. So we do everything in a very efficient manner; there is a real good thing being based in market Milwaukee, Wisconsin. I think it helps you compete on a cost basis.
So on both, an increase in the whole pie that’s going to impact the industry, both from gaining share from the FHA as well as the growth that’s going to happen with household formations. And then I think we will increase our own share and not meaningfully but we will continue to increase our share going forward. I think those are all great growth aspects for the company.
When you look at the other I guess concern being expressed as well; we're looking at a origination market next year of down from 1.7 trillion this year probably to 1.4 trillion next year, and maybe 1.2 trillion the year after. But the reality of that is that the purchase transactions in both 2014 and 2015 will be higher than 2013. That’s really good for our industry because our penetration, our industry’s penetration on purchase transaction is multiples higher; some say four times, I don’t think it’s quite that but it’s certainly higher than on refinances. So the aspect of the market that’s falling is the one that we participate least in and it’s also the one we have lot of single premium business and we're insured, so that’s really a good thing. I think as you look at the mortgage origination market for MGIC over the next two years, the market we really plan to purchase transactions will be larger, right, about 15% next year and probably another 15% year after and our ability to compete within it because singles will be a less of a factor and be better.
So all-in-all, even though you look at total originations being down, I am excited about the possibilities of what will be up as the market we actually participate in. So for those reasons, I think the company is really in a good position relative to our industry and the market we serve and the size of the market we serve, which gets us to Washington. We have a lot going on there but nothing going on there. Certainly lots of conversations; our industry is going to be subject to doing capital standards which should be released sometime in the next two weeks that -- we’re not quite sure to what that will be, we heard a lot, and you all have asked lots of question regarding it. But they’re probably a little more stringent than the existing ones. Again, we are very interested as they all lie, so we are looking for that definition. But I think that will be caught out. And the thing that we try to do with MGIC is just position us on whatever may happen, or have the flexibility to deal with it. And to that end, we’ve got $594 million of money at the parents that we’ve got about $85 at debt in 2015, I think about $60 million of annual interest costs, so that’s our cost at the parent. So we can move some of that capital obviously to the writing company if need be.
We have implemented reinsurance arrangements on new business going forward that helps us on the risk to capital ratio. We have that same group for reinsurers very interested in doing legacy insurance that would help on risk to capital significantly also. So I think we have a lot of flexibility at the company relative to whatever may come out from Washington. And the implementation of those standards, I think the more stringent they might be, as they are stringent would be further out in time implementation.
So I think the company is well positioned relative to whatever may come out that we’ll be in a position to move forward with those on a cost effective manner. So all-in-all I think the company as you look at us today and having gone year-over-year, it’s just unbelievable how things have changed to positive relative to the industry and to the business itself. And I think we are really in a good position. I look at I have been doing this nearly 40 years now, and I look at this period of time, I just talk to our, all our co-workers in our company meeting and said -- for many years I was concern you weren’t going to have the same opportunities I have to grow up in this industry. And now I am convinced they have even better opportunities than I have.
I think we’re in for a housing nirvana in the next number of years as the economy recovers. That's the key; we got to get the economy recovered, get jobs to our young people, so they can buy houses. And they’ve shown on survey after survey that 70% plus of them want to buy a home.
So I think we’re really in a good position in the future relative to demand. And quite honestly while I don’t agree with lot of Dodd-Frank, not much at all, was helpful, was that they did put standards in through the qualified mortgage that I think will serve this industry well in keeping some of the dumpings that we did as an industry, out of the business in the years ahead. That was a role I asked how Fannie and Freddie could have served and didn’t, because of the public (inaudible) their companies in competing, but that will be an issue.
So I think credit quality going forward also is very important. And the legislation part, will it keep the industry. When those of us that remember what we just went through are gone, will keep it under check. So I think it’s a wonderful future for all our young people in this business and obviously for U.S. investors.
So with that, take questions?
Yeah. Just to touch on the single premium business that you addressed, I think over the last few years it’s only been 9% to 10% of your NIW? Now that your pricing is in line with the rest of the industry as we’ve gone through the price changes, have you seen that percentage tick up at all over the past two months?
Well first of all, we just did that. So that won’t impact any of the business we've written. I too, I don’t think singles will be nearly as significant as I talked about as part of the business. Although as we probably wouldn’t have done that if I thought was going to be a meaningful part of the business. So, I don't think it's going to have a meaningful impact. I don't think singles will be a meaningful part of the business.
Okay. And then just on the holding company liquidity of roughly 600 million, what's a minimum amount that you would be comfortable running with moving forward?
Well, I think and I'll -- I think Mike is anxious to pop in here. But I mean I talked about what our debt is that we've got outstanding and our annual interest. So, we're in a good position and some of that’s deferrable also if need be. So we're in a good position that we can move substance there, if need be. But we need to see the standards. It's hard, I don't want to mislead anyone, we need to see those standards and how they address subsidiaries and how they address new business versus old business, how those deal with reinsurance? I think there will be aspects of it.
We’ve really had worked hard with frankly the GSEs prior to all this about new capital standards that were risk based, meaning that the risk that you insured, if you insured 800 FICO and a 600, there should be a lot of capital against this and not much against this. I mean it just makes sense we're going to have a much higher claim rate with a lower FICO and some of the instruments we insured. And so capital standard should be based on risk insured and the premium we receive for that.
And so I'm hopeful that, this and make sure I want to take some of that into effect, because I think it will also help keep premium rates regulated. And then longer term I think the NAIC has put and capital standards and the FHFA will work with them longer term to implement standards that we think are better.
I mean if you look at our industry MGIC prior to the problems was at 7 to 1 risk to capital ratio, that’s 2007. So for capital sake, it doesn’t matter. How that capital is adjusted against the risk you’re ensuring and I think we’ve proven that. So we are in a good position to give reinsurance I think and capital at the parent -- money at the parent to deal with it.
And just with regard to the upcoming FHFA decision, it’s surprising I think to all of us that you don’t have more clarity yet. So actually given that we’re all expecting that thing to come out in the next two weeks. But just your general sense based on all of the discussions that you have been in and the whole process has played out. I mean there seems to be a consensus in the market that’s formed around 15 times on legacy business, 18 times on new business and potentially year of implementation period. I mean is that something that seems reasonable to you or is the market just totally off on what the thinking is at this point?
Well, I mean that’s certainly been bannered about, I don’t know how those all started, but we’ve heard the same rumors. I mean we haven’t heard it from the [horse]. So I don’t know, but there has been so many conjecturing there, but I’m starting to believe it. The question that I ask and some of you have brought this up with us also is what’s the point? The FHFA needs to define why if it’s 18 to 1 and 15 to 1 on why, I mean I get back to that 7 to 1 point that I just mentioned. So it’s just -- capital going to -- it didn’t deal with it last time. So I am -- and once I’m [cheerful] things are being done just to get them done, but I think what’s -- everything we've heard done is things that are manageable or that are being talked about, but again we've not heard that from them. We've heard the same rumors you’re hearing.
And so when it actually comes out, what’s your understanding of the process? I mean is there a common period at that point or is it something where it’s just put out there and that’s what it is and an implementation date and discussion over?
Yeah. Even that hasn’t been shared with us, but I would say from conversations with the GSEs who want the finalization FHFA is that the thought was that we might get the standards a couple days before you see them then there would be general common period of few months and that implementation will happen in January of 2015. But that is pure conjecture and that is nothing that’s -- just to respond I am hearing the same rumors you’re hearing.
I had a couple quick questions if I could. The first is, am I correct that there don’t appear to be any other management teams out there available to start up a new competitor, one of the requirements as you have experienced management team. I am not aware of there being any on the beach right now, am I correct about that?
I have a doubt about that. I think issue with some of them already said up. So it’s not a very high standard I guess, but the value is good. It is on the internet I think.…
My other question a lot of us were disappointed when we saw the price cut -- it just seems as if it’s just at the margin lower the returns we set the plays I mean you could respond to that?
Totally it was the case of one of our competitors I think that has -- well whatever. One of our competitors reacting and dropping prices five basis points on all business. And as Mike knows, we step down and I met with our board, so at least we got some action because we are getting some signal here, if we got prices -- we will get the best expense ratio in the business. So it’s really everyone else more than us and we are not going to let this be basis of competition.
And generally fall right behind line, you look at the filings and see the one company and then a week later us and then day after that generally and day after that else. So I think our message has been sent in the industry -- it makes no sense, because you just dropped everyone’s returns five basis points and you’re getting no share for that.
In fact, if anything you will take more flat from this community and even some of our customers. And as you have seen, they want us to make sure we’re in here long-term. And so I think the message has been sent. I don’t -- I’m not worried about pricing perse going forward. I think -- and the returns are so high right now because of the [distinct] -- if your loss has been so good, there is margin there. I mean we are still even at that at 17.5 plus to capital ratio, we will still get a return with insurance 20% in dropping it.
But now our deal and our industry need to do more and more of the FHFA business, our loss ratio needs to rise some, we need to expand overall profitability with a little lower returns on what we are getting and that’s where the business is going.
And that the FHFA is selling new insurance, non-cancellable?
So when you get over the 20%, you can’t go and get an appraisal and say over and out?
So the other way to get out of it is to sell the house?
The only way out is to pay off your mortgage, however we may do that.
And the FHFA’s problem is they raised premiums three times, what if they increase the equity to 5% or 7% or 10% rather than 3.5%?
Yeah. You are hitting the real points on why we’re not getting more of that shares only 41%, 39% for them 41% for us is the 3% down mortgage Fannie and Freddie don’t buy that mortgage any longer. So FHFA is the only outlet of that mortgage and so that's the business we’re losing as our industry that's good FICO stuff we’d like to insure some 3% down versus 5% down. I mean you would wish Congress would step in or something would have stepped in and said 3% down is crazy. But that hasn’t happened yet, but that's the business we’re losing. And if that would change that be monumental shift in share to our industry.
We've got mic ready.
Just going back to pricing, outside of the actual mortgage insurance you talked about there is a lot of interest in taking mortgage risk both directly and like the reinsurers that you guys have right now doing it, willing to do it at a level that's a lot lower return than the 20% ROEs that you guys have talked about. At what point does that start to put pressure on returns for the industry?
Well, they are not in the business of writing the risk and I think there is limited capacity there. I mean I can tell you that right now relative to some of them that are out there they don’t want to do transactions with others, but I don’t see how that impacts. I mean a lot of what we’re doing won’t be done if weren’t done for capital reasons. So I mean as the profitability improves, the less you want to use reinsurance. So I mean I think that becomes a lesser part of the business.
I guess I mean if FHFA and GSEs are open two alternative structures, if you have traditional mortgage insurers that are earning 20% ROEs, but you have PNC insurers that are willing to take the same risk and write it at 10% ROE, why wouldn't -- we're at other books…
They got to become license, they got to stick 500 million plus in this thing, keep it in your long-term.
Unidentified Company Representative
And in fact, you’re kind of about like the stacker transactions and those securities are other part. Those are point in time execution they have been tremendously attractive return and variable of no losses. The question will be in a normalized cycle if losses are to increase from 10% or 15% loss ratios to the normal 35%, 40% are those buyers of those going to be there.
And the point we make in testimony to said it to our another conversation with regulators, if point in time cycle is not a reliable credit enhancement, you need reliable credit enhancement [dipping some] you have maybe some people will pull back tightening the underwriting standards when appropriate widened them when it's better marketplaces. But to have the mortgage market rely upon fleeting capital, when it's -- update will be extremely strong, when the market is extremely strong and non-existence when the market is even just weak, not necessarily terrible. We don't think it’s enviable mechanism long-term.
And I think the regulators view that as well too you can see they [cancel] their testament that's the downside of those transactions. And the fact that matters still they are playing at below 80% in those transactions. So they are not playing. We think a better execution for tax payers is to deepen the cover of MI down to lower LTVs, deeper cover, make sure there is real dipped capital standard for those counterparties in front of it, but that's a much better execution, because it will be a reliable execution.
So is it a threat, is it something that's out there and you chose that it had to be monitor, absolutely, but it's really, I mean it's proven time-to-time again to be fleeting bids and that it will be really good when it's strong and non-existence when it's weak. So that's a --people love it playing, so make sure you have reliable counter parties.
Yeah. The deal with the [PDA] market and stuff that you need the loan-by-loan level providing quite an enhancement and that just doesn’t fit any other business model. And I would say the other aspect is one we really haven’t talked much about is the business opportunities provide the deeper coverage which the MBA is really selling now because they feel the cost of deeper mortgage insurance would be less. When the GDP increases, their customers are holding. And that would be the best way to lower risk to the government rather than government charging more premium rates for it. And there is quite an active debate on that right now.
Can you talk about your intensity to rise the interest rates in very broad terms I mean I can take bunch of different moving parts, how you think about that?
Interest rate movements, yeah going up -- if it goes up slowly it’s really beneficial to our industry. One, again single premiums go away. So I mean we all write a policy just to write a monthly rather than a single less positive. But I think importantly we keep the loan on the book much longer. And as I say, if you looked at these books of business we are writing now, the individual books will probably have a persistency rate of 90% when you look at other books that are 80 or less.
So rates going up help us keep the policies and the premiums much longer, I think it makes the monthly premium much better competitive and obviously it helps our investment portfolio significantly and given how low they are. I mean I remind our coworkers when I came to MGIC in 1982, my mortgage was 13.5%.
So the movement and we are still at affordability numbers where more values are that are extremely positive for people any movement in employment and housing numbers jump. So interest rates up are actually a good thing for MGIC.
Yeah. You get a 200 basis point jump or something like that, that’s a little different. And probably the other thing that the reason why rates drive upward is the economy, that’s employment, that’s very, very good for a company that has a legacy book of business.
I think we’re probably out of time right now. But thank you very much, Curt.
Yeah. Thank you.
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