MGIC Investment's (MTG) CEO Curt Culver on Q2 2014 Results - Earnings Call Transcript

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 |  About: MGIC Investment Corporation (MTG)
by: SA Transcripts

MGIC Investment Corp. (NYSE:MTG)

Q2 2014 Earnings Conference Call

July 16, 2014 10:00 AM ET

Executives

Michael J. Zimmerman – Investor Relations

Curt S. Culver – Chairman and Chief Executive Officer

Timothy Mattke – Senior Vice President and Chief Financial Officer

Lawrence J. Pierzchalski – Executive Vice President of Risk Management

Patrick Sinks – President and Chief Operating Officer

Analysts

Bose George – Keefe, Bruyette & Woods

Mark C. DeVries – Barclays Capital, Inc.

Eric Beardsley – Goldman Sachs & Co.

Jack Micenko – Susquehanna Financial Group LLP

Geoffrey M. Dunn – Dowling & Partners

Seth Glasser – DK Capital

Chris Gamaitoni – Autonomous Research US LP

Jason M. Stewart – Compass Point Research & Trading LLC

Ed G. Groshans – Height Analytics LLC

Scott Frost – Bank of America Merrill Lynch

Douglas Harter – Credit Suisse Group

Sean Dargan – Macquarie Research

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the MGIC Investment Corporation Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today’s presentation, Mr. Mike Zimmerman. Sir, please begin.

Michael J. Zimmerman

Thanks, Howard. Good morning and thank you for joining us this morning and for your interest in MGIC Investment Corporation. Joining me on the call today to discuss the results for the second quarter of 2014 are Chairman and CEO, Curt Culver; President and COO, Pat Sinks; Executive Vice President and CFO, Tim Mattke; and, Executive Vice President of Risk Management, Larry Pierzchalski.

I want to remind all participants that our earnings release of this morning, which maybe accessed on MGIC’s website, which is located at mtg.mgic.com under Investor Information, includes additional information about the Company’s quarterly results that we will refer to during the call and includes certain non-GAAP financial measures. As we have indicated in this morning’s press release, we have posted on our website the supplemental information containing characteristics of our primary risk in force and new insurance written, which we think you’ll find valuable.

During the course of this call, we may make comments about our expectations of the future, which, on this call, also include statements regarding the potential impact of the draft GSE mortgage insurance eligibility requirements, or alternatives MGIC could pursue, or these draft mortgage insurance eligibility requirements implemented in their current form.

Actual results could differ materially from those contained in these forward-looking statements. Additional information about those factors that could cause actual results to differ materially from those discussed on the call are contained in the Form 8-K that was filed earlier this morning. If the Company makes any forward-looking statements, we are not undertaking obligation to update those statements in the future in light of subsequent developments. Further, no interested parties should rely on the fact that such guidance or forward-looking statements are current at any time other than the time of this call or the issuance of the Form 8-K.

Now with that, let me turn the call over to Curt.

Curt S. Culver

Thanks, Mike, and good morning. In the second quarter, we recorded net income of $45 million or $0.12 a share versus net income of $12 million or $0.04 a share for the same period last year. The quarterly financial results were driven primarily by the level of incurred losses, which totaled $141 million, and lower net underwriting expenses, which totaled $34 million, offset by lower net premiums earned.

As usual, there were multiple influences on the incurred losses. First, we received 17% fewer notices than the same period last year. Second, we applied the improved cure rate that has been developing over the last year to these new notices. And third, we increased our accrual by $20 million for probable rescission-related settlements.

We believe that the improvement in the cure rate is a result of the modestly improving housing and employment trends. Further contributing to the positive credit profile is the fact that the in force book written after 2008 and the loans that took advantage of HARP are generating low levels of delinquencies.

The delinquent inventory ended the quarter at 85,416 loans, which is down 27% year-over-year and down 7% sequentially. We expect to see the inventory continue to decline for the remainder of 2014. The overall origination volume is lower year-over-year for our customers, due to a decrease in the refinance market. However, the 30-year mortgage rates remain very affordable. And as a result, the purchase market remains reasonably healthy.

Since purchase transactions, which accounted for 90% of our new writings during the quarter tend to use mortgage insurance more than refinance transactions, our purchase application volume is approximately 25% higher than for the same period last year. As I mentioned last quarter, new business writings are typically slow in the first quarter, and then pick up in the second and a portion of the third before slowing down again. This year was no different. In the second quarter, we wrote $8.3 billion of new business, which was up 60% from the first quarter of this year, and up 4% when compared to the second quarter of last year.

Given the volume we have written to date and the applications in process, we expect to write approximately the same volume of business in 2014 that we did last year. While second quarter numbers are not yet available, we estimate that our industry’s market share in the second quarter was approximately 13% to 14% of the overall market, and we expect the share could grow to 16% during the year. This compares to 11% for 2013. And while only one other company has reported its new business writings to date, we believe that within our industry, MGIC’s second quarter market share is approximately 18.5%.

Insurance in force increased to $159.3 billion at the end of the quarter. In addition to the increased levels of new insurance writings that contributed to insurance in force growth, the annual persistency rate increased to 82.4% from 81.1% last quarter as a result of fewer refinances and claim payments.

At quarter end, approximately 58% of our insurance in force was included in reinsurance transactions, with a substantial majority of that being covered by the transaction we executed last year.

During the quarter, the impact of all reinsurance transactions continued to be in line with our original estimates and had a bottom-line net impact of reducing net income by approximately $8 million.

Paid claims in the second quarter were $300 million, down 31% from the same period last year, and down 12% from last quarter. Claims received in the quarter continue to decline and were down 37% from the same period last year and down 10% quarter-to-quarter. Given the claim filing patterns we are experiencing, we expect – or we continue to expect paid losses to be lower this year than last.

At quarter end, cash and investments totaled $5 billion, including $515 million of cash and investments at the holding company. Our total annual interest expense is approximately $66 million and our next scheduled debt maturity is $62 million due in November 2015.

Let me now take a couple of minutes to discuss the regulatory environment. As most followers of our industry know, the Federal Housing Finance Agency, or FHFA, recently released, for public input, draft private mortgage insurer eligibility requirements, or PMIERs. When finalizing effect of the GSEs will use the eligibility requirements to approve private mortgage insurers. The PMIERs will become effective 180 days after they’re finalized, and an insurer would have up to two years to comply with the financial requirements.

With regard to their financial requirement, the draft PMIERs would no longer consider the financial strength rating of a mortgage insurer, and they would not use a risk to capital approach as many expected. Instead, they would require that an insurer have what they refer to as available assets equal to or greater than what they refer to as the minimum required assets. Generally available assets are the most liquid assets of an insurer. The minimum required assets are calculated with regard to risk in force from tables of factors with several risk dimensions and are subject to a floor amount.

The stated goal of the financial requirements of the PMIERs is to ensure that approved insures have adequate liquidity and claims-paying capacity during periods of economic stress. However, in our view, the draft PMIERs would require insurers to mean liquid assets far in excess of the amount required to achieve that goal, and could potentially have adverse effects on creditworthy borrowers and mute the housing recovery.

We believe the primary drivers causing the amount of minimum required assets to be unnecessarily excessive in light of the stated goal or that the future contractual premiums on all policies that are in force are not part of available assets, and that the required asset factors for new business are established to withstand a stress loss scenario at the time the insurance is written, meaning the factors already anticipate that there will be delinquent loans.

However, as loans become delinquent, the draft PMIERs require additional assets to be held for these loans. In addition, there is no mechanism to lower the required asset level for non-delinquent loans as a book of business seasons. Due to the way the PMIERs are constructed and despite MGIC’s risk to capital ratio of 15.2 to 1 as of June 30, and a return to annual profitability that should result from declining losses on our legacy books and the high quality of the business written from 2009 forward, if the draft PMIERs were implemented in the form release for public input, assuming full credit for reinsurance, MGIC would have a short fall in our required assets at both the projected effective date of approximately $600 million and approximately $300 million two years after their publication date.

As I previously mentioned, MGIC investment has approximately $515 million of cash and investments, a portion of which we believe may be available for future contribution to MGIC. Furthermore, there are regulated insurance affiliates of MGIC that have approximately $100 million of assets. We expect that we will be able to use a material portion of these assets to increase the Available Assets of MGIC. Additionally, we would consider seeking additional reinsurance and/or non-dilutive debt capital, both which we expect will be available to us. As a result, I believe we will be able to use a combination of the alternatives I mentioned, such that we would meet the requirements of the draft PMIERs even if they become effective in their current form.

We embrace robust risk-adjusted capital requirements and support the goal of modernizing the GSE’s mortgage insurance eligibility requirements. However, we believe that this modernization should result in a system that reduces taxpayer risk and provides incentives for private capital to play a larger role in ensuring that creditworthy borrowers have access to mortgage credit at a reasonable cost. It is our opinion that the draft PMIERs do not accomplish this, but could with some relatively simple changes. And we will be – provide our reasoning and suggested changes in our public comment letter. It is also important to note that it has not impacted our customer’s perception of MGIC despite the lobbying of some of our shortsighted competitors against the legacy firms.

On a related topic, the review and updating of state capital standards by the NAIC, by which the Wisconsin insurance regulator is leading, continues to move forward, although we are not aware of a timeframe for implementation. We do not expect the revised state capital standards to be more restrictive than the financial requirement of the draft PMIERs.

The debate over the role of FHA and the GSEs in the housing market continues, with seemingly no end in sight. With the partisanship in Washington being what it is, and with elections looming this year, we don’t believe there will be any definitive action by Congress in 2014 and for sometime thereafter.

In closing, during the quarter we continue to make progress on the path towards sustained profitability. We wrote $8.3 billion of high-quality business; the level of delinquencies and claim payments continued to fall; MGIC’s risk-to-capital ratio improved to 15.2 to 1; and we maintained our traditional low expense ratio. As a result, I feel our Company is in the excellent position to take advantage of the housing recovery and the opportunities provided to us and we are committed to maximizing those opportunities. And just as importantly, even if the PMIERs are adopted as proposed with the inconsistencies I previously mentioned, we will have the resources to comply with that.

With that, operator, let’s take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question or comment comes from the line of Bose George from KBW. Your line is open.

Bose George – Keefe, Bruyette & Woods

Hey, guys. Good morning.

Curt S. Culver

Good morning.

Bose George – Keefe, Bruyette & Woods

This is just a question on the net earned premium. We calculate that it went down about a couple of basis points. Can you talk about any drivers of the change in the premium, quarter-over-quarter? Also, can you give us a dollar amount of the ceded premiums that’s flowing through the operating expense line item?

Michael J. Zimmerman

Sure. Bose, this is Mike Zimmerman. Relative to the premium yield, as we talk about when we executed the transaction, we’d expect that that premium yield would continue to drift lower, as more business – the new writings get covered and as it just kind of plays out over time. And that would drift down as we’re ceding the premium. So I’d say it’s directionally heading the right way, because that would be an expectation of the transaction. And that as far as the ceding commission that’s falling through the expense line item, we disclosed the additional information that there’s $9.6 million of ceding commission in the quarter. So that would be the offset to the base of the income statement.

Bose George – Keefe, Bruyette & Woods

Okay, great. Thanks. And then just switching to the PMIERs, you note in your commentary that there would be aside a $300 million benefit to the numbers by the end of 2016 based on operations. And can you just give us the math on that $300 million? Is that earnings and includes assumed growth, et cetera?

Timothy Mattke

Well, I think – this is Tim speaking. There’s a number of factors that come into play there. Some of it’s earnings, but recall we lose credit for the premium on the older books that is in there currently. And so it’s really calculation of the required assets go down, because our delinquency inventory decreased during the time period, but the same time our available assets decreases as we paid claims. But the big drivers is really delinquent notice inventories and the run off of the 2005 through 2008 book that those rundown, that decreases our required asset levels.

Bose George – Keefe, Bruyette & Woods

Okay, great. Then just one more on that. The $515 million of cash you have on the holding company, what’s a good way to think about how much you want to retain of the holding company and how much you can downstream it, if you need?

Timothy Mattke

Well, I think so we have to consider the $66 million of annual interest that we have at this point and we’ve got the debt maturity, as Curt mentioned, of $62 million in November of 2015 and our next maturity after that is convertible debt in 2017. So I think those factors will come into play when we consider how much we can downstream.

Bose George – Keefe, Bruyette & Woods

Okay, great. Thanks.

Timothy Mattke

Thanks.

Curt S. Culver

Thanks, Bose.

Operator

Thank you. Our next question or comment comes from the line of the Mark DeVries from Barclays. Your line is open.

Mark C. DeVries – Barclays Capital, Inc.

Yes, thanks. My first question is about your existing reinsurance agreements. Can you talk a little bit about what the issues may be that you will have to address to ensure that you get full credit for that under PMIERs, what revisions you may have to make? And what, if any, economics you may have to give up in the course of that?

Lawrence J. Pierzchalski

This is Larry Pierzchalski. Yes, one of the GSEs has an issue with the termination date of the reinsurance contract. The contract runs through the end of 2018 and their feeling is that in a stress scenario, some stress losses would extend beyond that. So they believe some haircut is in order, given the 2018 termination date and the spillover of some stress losses beyond that. And I guess if we left things as is, that haircut would increase each year as we got closer and closer to the 2018 termination date. So we are engaged with the reinsurers and they seem supportive to making appropriate changes to the contract in order to minimize any haircuts.

Mark C. DeVries – Barclays Capital, Inc.

Okay. Obviously, they are very interested in engaging that in the first place. I assume there’s not going to be a lot of pushback on extending it. Would you think you’d have to give up some economics to do that and potentially still maintain an option for early termination?

Lawrence J. Pierzchalski

I would say that the economics would remain the same. I think they are very interested in extending it. And so I think things will play out very much in our favor.

Mark C. DeVries – Barclays Capital, Inc.

Okay, great. Thanks. And then on the possibility of raising some debt to fill the $300 million void, can you help us think through kind of how much incremental leverage you’d be willing to take on at this point?

Michael J. Zimmerman

Mark, this is Mike Zimmerman. I think at this point it’s premature. We outlined several options that we have, a combination of the holding company cash, this reinsurance that we just talked about, the potential contribution of other assets that currently would not be counted and then the possibility of raising using non-dilutive capital or the debt market.

So I think at this stage, those are all things that we’re evaluating. So it’s difficult to give you a really precise answer as to how much more leverage that we would be willing to take on at this point in time. It really depends on what changes, if anything changes with the PMIERs; that could influence it quite a bit. I mean some simple changes could eliminate that shortfall altogether.

Mark C. DeVries – Barclays Capital, Inc.

Is there the theoretical kind of maximum leverage above which you wouldn’t seek to go over?

Curt S. Culver

I don’t think there is a theoretical maximum. Obviously it’s something we need out, consider as rating agencies and their views on it, trying to make sure we don’t take on too much debt. But, as Mike said, I think we have to consider all factors, including changes to the PMIERs, reinsurance capabilities. And we’ll consider all those possibilities that we’ve outlined.

Mark C. DeVries – Barclays Capital, Inc.

Okay. And then just finally, could you talk a little bit about what other kind of incremental reinsurance opportunities you see in your existing book?

Michael J. Zimmerman

Well, we could increase the cede percentage or include some of the loans that are in currently reinsured. So, those are also part of the discussions we are initiating with reinsures.

Mark C. DeVries – Barclays Capital, Inc.

Got it, all right. Thank you.

Michael J. Zimmerman

Thanks Mark.

Operator

Thank you. Our next question or comment comes from the line of Eric Beardsley with Goldman Sachs. Your line is open.

Eric Beardsley – Goldman Sachs & Co.

Hi, thank you. Just on the quarter, I was curious if there are any changes to the claim rate? And just wanted to follow-up on your comment that there was a $20 million increase to the provision due to expected rescission reversals. Is that correct?

Lawrence J. Pierzchalski

Correct.

Eric Beardsley – Goldman Sachs & Co.

Got it.

Lawrence J. Pierzchalski

Yes, so the $20 million was settlement that view as probable at this time and required to accrue for it under GAAP for the $20 million. As far as the trends that we see, we continue to see, obviously, the downward trajectory in new notices. And then cure rate on those new notices, we continue to see improvement on those. If you compare it to the first quarter, the first quarter obviously has a real strong interperiod cure activity. And so it's not always fair to second quarter directly to that. But the fact that we are moving closer to I’d say about, closer to 15% expect the claim rate on new notices, shows the continued improvement in that cure rate on the new notices.

Eric Beardsley – Goldman Sachs & Co.

Got it. Is that where you provisioned this past quarter at that 15%, excluding the rescission settlement?

Lawrence J. Pierzchalski

Very close to it, yes.

Eric Beardsley – Goldman Sachs & Co.

Okay. Great. Thanks. And then just back to the assumptions of the capital shortfall, could you share any color on what your expected risk in force growth is? And also the pace of legacy runoff that you assume?

Curt S. Culver

On the persistency side, we’ve said in the past that we would think that persistency would peak out at probably 85%, thereabouts. You know, maybe a touch lower, depending on things. We saw a little bit of progress there a little north of 82%. So I think that’s going to become a good baseline thinking about as far as runoff goes. And then on the risk in force side, I think it's safe to say we would expect some moderate growth in risk in force from here on out. This year, we expect to be pretty level to last year and our in force has stabilized. So if the market gets any larger we would expect to get our share of that, and have built that in from a projection standpoint.

Eric Beardsley – Goldman Sachs & Co.

Got it. And if the rules were implemented as is, how much do you think the industry would need to raise pricing across the various FICO and LTV buckets?

Michael J. Zimmerman

I think it’s premature to talk about that because we don’t, there’s a number of forces that would be at work there. In particular what competition might do within this sector and then any changes to it. So I think its’ premature to talk about what, if any, changes would require, changes to the PMIERs themselves that might change. I know you asked if they didn’t change. But I think we got to wait and see what the overall market reaction would be to that.

Eric Beardsley – Goldman Sachs & Co.

Now, but if you were just, say, isolated – let's say you were the only player in the industry in a very hypothetical scenario, I mean, what required return would you want to get on those lower FICO, higher LTV buckets? I mean, would you be looking at low-teens? High-teens to account for some of the greater volatility in those buckets?

Michael J. Zimmerman

I mean, I think all things being equal you were the only player in the market and you want to keep the returns that we would be checking earning today, then that would say prices would have to go up.

Curt S. Culver

Yes, but I, on your question, I think for the lower FICO you need a mid-teens minimum return, given the variability on that business and how quickly things can change. So, certainly it demands a higher return. The returns on the other business will be, I think low-to-mid teens so that certainly would require in my opinion, a high-teens return.

Eric Beardsley – Goldman Sachs & Co.

Okay, great. Thank you.

Operator

Thank you. Our next question or comment comes from the line of Jack Micenko from SIG. Your line is open.

Jack Micenko – Susquehanna Financial Group LLP

Hi, good morning. Given the strong NIW build in June, and understanding you had a draft of the – or a sense of the draft, did you change any of your business approach in the new writings for the month of June?

Curt S. Culver

No.

Jack Micenko – Susquehanna Financial Group LLP

Okay. And then reading the draft, it suggests that the MI can use or count reinsurer's liquid assets toward your own calculation. Is that your interpretation, I’m wondering? And if you factor that into your projections, if I'm reading that correctly?

Timothy Mattke

I think you are referring to affiliate reinsures, so within the holding company system. And yes that is our read and that is we are including that in our calculation.

Jack Micenko – Susquehanna Financial Group LLP

Okay, great. And then I guess just lastly, what do you think the rationale was for the unearned premium exclusion in the draft?

Timothy Mattke

One more time Jack.

Michael J. Zimmerman

The premium exclusion in the draft.

Timothy Mattke

Well, it’s hard for us to figure out. I mean it’s a contractual premium. They want to have liquid assets available to the case that they liquid assets that comes available when, if the premiums aren’t paid, there is no insurance, and therefore, no losses with it. Once the rational is and I think that they’re concerned maybe in some part about the unearned premium being excluded there because of the non – or the refundability of it and some concerns about discounted pricing in that segment. But on the monthly premiums, it’s public, and I guess that would be the best way that I could describe that because it is a real asset. And claims don’t get paid the day, when the loan goes delinquent, as we all know, it takes on this environment it takes almost two years for a claim, for a delinquency to mature to a claim payment. So, to exclude a real asset, albeit our balance sheet, it’s real it’s contractual.

Jack Micenko – Susquehanna Financial Group LLP

Okay. Okay. And then just wondering bigger picture, with the loan level price adjustment still pre-crisis levels, I mean, is that – is it reasonable to think that that should become part of the discussion around MI pricing or higher potential pricing as we go through the draft period?

Timothy Mattke

Well, based on a conversation FHFA had yesterday, they said that they would certainly look at the interplay of those types of things. But if they lowered the LLPAs, but MI prices have to go up, I don’t know there is a net positive that comes from that?

Jack Micenko – Susquehanna Financial Group LLP

Okay, all right.

Curt S. Culver

And there is a discussion that both should be considered as part of the discussion.

Jack Micenko – Susquehanna Financial Group LLP

Right, right. All right, thanks, guys.

Curt S. Culver

Thank you.

Operator

Thank you. Our next question or comment comes from the line of Geoffrey Dunn from Dowling & Partners. Your line open.

Geoffrey M. Dunn – Dowling & Partners

Thank you. Good morning. Could you comment as to the unit returns on your first half business under the current capital requirements, and how you think that would be impacted if the PMIERs went through as suggested?

Lawrence J. Pierzchalski

Sure. This is Lawrence Pierzchalski. Under the proposed eligibility requirements, the mix in the first half of the year seems to require a risk to capital of about 14-to-1 at time of origination, i.e. they are all current. But as we know, even with the high-quality profile, some will go delinquent. So, if you factored that in and probably goes to 13-to-1. And then if you want to add some room away from the capital requirement just to give yourself some margin you probably talking 11.5-to-12-to-1.

And by our calculations, on a direct basis before any reinsurance and whatnot, we think that delivers a return in the lower double-digits. On the current or prior to eligibility requirements that we are issued here, we were think and closer to 18-to-1. And if you give yourself a little room and whatnot operate around 16-to-1. We think those returns are kind of back as Curt said where they probably should be for the overall risk of the business in the mid-teens.

Geoffrey M. Dunn – Dowling & Partners

Okay, great. And then, Curt, curious as to your thoughts. It's a small industry. You've expressed your views on this. Why are we getting such a divided response from new versus legacy players when it seems like the long-term impact to returns, as you are suggesting, is something everybody needs to be concerned about?

Curt S. Culver

Yes, I mean, I made a special point, as you noticed of me mentioning that, I think it's very shortsighted. Now, Jeff one of the things that was wonderful, I’ve got about 33 years here and was part of MICA for many, many years, whereby we competed very, very hard against each other. In fact, at some points, we had 14 companies pointing at each other. But I can tell you when I dealt with things that were franchise issues, which were DC-oriented, there was a united front from all companies. And I’m very disappointed with some of our newer entrants on a very shortsighted point of view lobbying the way they have. And it is to the long-term interest of all of us to have returns that are long-term acceptable and that attract private capital to the marketplace. And we have some companies I just don’t think that long-term. Very disappointing to me.

Geoffrey M. Dunn – Dowling & Partners

Okay, great. Thank you.

Curt S. Culver

Thanks Jeff.

Operator

Thank you. Our next question or comment comes from the line of Seth Glasser from DK Capital. Your line is open.

Seth Glasser – DK Capital

Hi guys, Thanks for taking the questions. I think it was Mike mentioned earlier in the call that some fairly minor changes to the potential proposal could result in actually eliminating the entire deficiency in liquid assets. Could you walk through or at least give some sort of an idea of the sensitivities that we are looking at there? You know, because that’s obviously a – I mean, we are obviously dealing with a situation where there is a bid and an offer here with regard to this proposal. And what we are seeing now is the full offered side. So, I guess what I’m trying to understand is, what – how small can the changes really be to this proposal and actually have a significant impact on the liquid asset efficiency that you have?

Michael J. Zimmerman

Seth, this is Mike. Let me follow-up, but the question is easily answered if you just look at where our premium, earned premium, is at just this quarter, that some of it is being counted. But, effectively, that’s $800 million or $900 million. So to count one year of premium, the shortfall goes away. So, overtime. Now, obviously, currently, we are counting to 2008 and prior that’s a fairly open – that's going to shrink overtime. But so if you run it forward several years, so, pass the implementation curve, the effective date in the transition period, it’s simply you could say one year premium would do it.

Seth Glasser – DK Capital

Right. And so, I mean is it – I guess it’s possible that that could be a potential solution to the issue that the industry has, is to say, look, we’re not asking for credit for premiums going out 10 years, but at least give us next year’s premium, right, which seems close enough at-hand that it shouldn’t need to be haircut or discounted that significantly.

Curt S. Culver

I would have to say though, Seth, as common sense, as what Mike described, should happen, that, certainly, one of the GSEs has really dug their heels in on that issue. So, I – the reality of it happening, as it should happen, is a little more difficult, because that’s been a source of a lot of conversation already with the mortgage insurers.

Seth Glasser – DK Capital

Right, right.

Timothy Mattke

As we said, too, I mean, there are ways that – I mean, they have – the goal is not unreasonable what they want. Right? They don’t want deferred payment obligations. They want their claims paid on time. That’s not an unreasonable request of an insurance company. And we think that there's a number of ways that, as we’ve talked about, that can be achieved and we’re going to articulate those in our comment letter. But something as simple as what we just described there or other ways that to ensure statutory solvency as well as liquidity to avoid the DPOs, there are a number of ways that that can be accomplished and achieve the goal that they want, which is, again, a reasonable goal.

Seth Glasser – DK Capital

Right, right. So, I mean, really, it sounds like – I mean to sort of summarize what’s going on here, it sounds like we have the offered side of the proposal. We know – or at least, I mean, there is significant reason to believe that additional dilutive capital would not be needed under the worst-case scenario. And as we sit here and wait for the finalized version of this, and you think about how QRM went, and how significant the changes were between the proposal and the finalized version there, it seems like the levers now are kind of to the upside. It seems like this proposal won't get worse as we sit here and wait for the finalization. Would that – would you agree with that characterization?

Michael J. Zimmerman

I think it's hard to imagine getting it worse.

Seth Glasser – DK Capital

Okay, okay. Mike, if either you or Tim would like to give me a call at some point after the call, we'd like to put in an order for the bond deal that you may or may not need to do. And I'm actually serious about that. So, we'll speak.

Michael J. Zimmerman

Newly notice.

Seth Glasser – DK Capital

Thank you.

Operator

Thank you. Our next question or comment comes from the line of Chris Gamaitoni from Autonomous. Your line is open.

Chris Gamaitoni – Autonomous Research US LP

Thanks for taking my call, guys. Could you give me the updated IBNR with the additional $20 million contribution that you mentioned that’s in the primary reserve?

Timothy Mattke

The total amount that's in IBNR right now, you're asking

Chris Gamaitoni – Autonomous Research US LP

Yes, the total IBNR that’s in primary.

Timothy Mattke

I think if you look at the – I guess it's not including additional information. We disclosed it in the Q. I don’t have the number handy right now.

Michael J. Zimmerman

And maybe as we can apprise it during the call, we’ll certainly put it out there. But it definitely will be included into the Q, Curt. We just don't have that.

Chris Gamaitoni – Autonomous Research US LP

Okay. I guess on what I'm getting at is I’m trying to figure out the reserve per delinquency excluding IBNR, and look where it went quarter-over-quarter. It still looked like it increased a little bit, which kind of goes against the commentary that you mentioned. I’m trying to figure out why.

Timothy Mattke

It would’ve increased a little bit quarter-over-quarter. If you look from a – it has to do with a mix of the inventory. If you look at the statistics, there’s not much difference quarter-over-quarter as far as the actual age of the inventory, but it is a little bit older and that created a little bit of upward movement. And so that I would say is the biggest part of that. I mean, it’s not a significant movement on the average reserve, but with the $20 million settlement as well, that obviously increases the average per delinquent.

Chris Gamaitoni – Autonomous Research US LP

Right. That’s what I was trying to back out the IBNR part, just to kind of get a true number. Moving past that, the ROE that you described on new business, does that include – I’m just trying to figure out calculated. So, is the ROE – is the E in that calculated.

Timothy Mattke

Okay. You cut out on us, Chris.

Chris Gamaitoni – Autonomous Research US LP

In your ROE calculation, I'm trying to figure out the denominator. Is the E the available assets under this new calculation that you're using?

Curt S. Culver

On the new business, the calc that tried to walk you through was, as written, of the proposed eligibility requirements we think require about 14-to-1 risk to capital before any delinquencies happen. With some…

Chris Gamaitoni – Autonomous Research US LP

Right, great. I’m just trying to find out what capital is. Is that available assets? Or is that equity under the old definition?

Timothy Mattke

That’s a required assets.

Chris Gamaitoni – Autonomous Research US LP

Okay, that's required assets. And are you including any Holdco leverage in that calculation or any change in the business mix, if you were to be pushed to more prime?

Timothy Mattke

No, no, no.

Chris Gamaitoni – Autonomous Research US LP

Okay.

Timothy Mattke

That’s reflective of the first half business mix.

Chris Gamaitoni – Autonomous Research US LP

Okay, perfect. All right.

Timothy Mattke

And then just circling back on your IBNR question. The IBNR in total was flat from quarter-to-quarter. It’s – about $230 million in total. So we had the increase related to the settlements, but the IBNR related to other items that have not been reported to us was decreased in the quarter.

Chris Gamaitoni – Autonomous Research US LP

Okay, perfect. And then just on any types of business changes or capital actions, should we be assuming that we are going to wait until the final rule comes out before there is any reinsurance agreements or debt raising that would have maybe more permanent implications, in front of a rule that may change?

Timothy Mattke

I think we are fluid on that, Chris. I mean, if there's market opportunities – you know we've got debt down the line also. We’ve got other uses. So, I mean, we are looking at things on a more fluid basis than saying we won't do anything until a certain date.

Chris Gamaitoni – Autonomous Research US LP

Okay. Well, thank you so much for answering my questions.

Operator

Thank you. Our next question or comment comes from the line of Jason Stewart from Compass Point. Your line is open.

Jason M. Stewart – Compass Point Research & Trading LLC

Hi good morning thank you. There’s been a lot of discussion about the required assets. And I’m just wondering if you could give us what your estimate for required or some asset bases of 1Q or 2Q would be under the new proposed regulations?

Timothy Mattke

As far as the required assets you’re saying now versus what we've given? I think we gave at the end of this year what we thought they would be. Is that what the question is?

Jason M. Stewart – Compass Point Research & Trading LLC

Right. So you give us two things. You give us year-end required assets and you give us what your estimated risk to cap would be on risk in 1H 2014. So I don’t – we don’t have a starting point, and I’m just wondering if we could – if you could give us that, I mean, we could obviously try to calculate it ourselves too.

Timothy Mattke

Yes, I say that’s $200 million from now until the end of the year, the required asset component.

Jason M. Stewart – Compass Point Research & Trading LLC

Okay. And then when you look at the risk side, what bucket of risk that you write that you have written is the most constraining or limiting factor? Under the….

Timothy Mattke

Well, the tables on the 2005 through 2008 on the performing loans have higher factors associated with them. So those are obviously the highest required assets. And then on the non-performing loans are a separate grid and those charges are even higher.

Jason M. Stewart – Compass Point Research & Trading LLC

Right. I can see all that, but I’m talking about just the risks you’ve written in 1H 2014. I mean, when you look at LTV FICO, you give us averages and you break down some pretty broad buckets. But when you break it down into all of these tables and grids for risk written in 1H, what becomes the most limiting factor in terms of your ROE or risk to cap, as you’ve given us?

Timothy Mattke

Well, you’ve got the table there. You can see, obviously the lower cycles and the higher LTVs to require more capital that 14-to-1 return on equity exercise that we went through. I think that’s, what about 7% capital. And so anything that requires more than 7% in that capital grid obviously weighs on that equation.

Jason M. Stewart – Compass Point Research & Trading LLC

Okay. So I can do that, the inverse of that. I mean, are there overlays when we’re talking about things over 43 DTI? I mean, those are those factors being included today?

Curt S. Culver

Yes, most everything – that only applies if it’s not ready GSE-eligible. And basically everything we are booking today is GSE. So, that table I think is, what, 3A? By and large, you can ignore at this point.

Jason M. Stewart – Compass Point Research & Trading LLC

Okay. That’s good. That’s helpful. Thank you. And then when we talk about holding company cash, are there any covenants or restrictions or rating agency targets that you have to be – that you have to limit yourself to?

Timothy Mattke

I think that from a rating agency perspective, like I mentioned earlier, I think we need to be cognizant of their views on it. But the ratings haven’t been is important recently. But I think will obviously consider all those things when we look at options. But no specific covenants that we have to be worried about on the current debt, if that was a concern of yours.

Jason M. Stewart – Compass Point Research & Trading LLC

Okay, great. Thanks for taking the questions.

Operator

Thank you. Our next question or comment comes from the line of Edward Groshans from Height. Your line is open.

Ed G. Groshans – Height Analytics LLC

Good morning, everybody, and thank you for taking my questions. I guess I’ll start off with the strangest question, is the industry is operated under a risk-to-capital constraint for a long time. And my read of the proposed rule is, other than the $400 million to $500 million requirement, there doesn’t appear to be any other capital constraints or requirements that are in there. Is that a fair statement?

Michael J. Zimmerman

Ed if you’re talking about from a statutory perspective?

Ed G. Groshans – Height Analytics LLC

Well, just in the FHFA PMIERs proposal. Just – we’re focused on available assets, required assets, and the $400 million if you are a legacy company, and $500 million if you are a new company, you got – in capital, but other than that, I don’t see anything else regarding capital, right?

Michael J. Zimmerman

Right. That’s your ante to the game and then it's some combination of stat, GAAP and cash.

Ed G. Groshans – Height Analytics LLC

Well, so let me ask a sort of odd question. What prevents any MI company from just levering itself to the hilt in order to ensure it has the appropriate amount of assets to meet the FHFA’s proposal?

Michael J. Zimmerman

Based on a comment FHFA made yesterday, they said, well that may require a conversation Right? That’s all they said.

Ed G. Groshans – Height Analytics LLC

Right. So basically, an estimate it’s not. So that leads me to my next point is, and correct me if I’m wrong here, but I thought that FHFA and the GSEs were working with the NAIC in developing this proposal. And so I guess I find it a little odd that when the proposal comes out, the capital doesn’t seem to be a constraining item here.

Michael J. Zimmerman

Yes, I think you need to dial a different phone number to get those answers now, to be perfectly frank about it. We don't know all the thinking that went into how the FHFA developed these standards, what they drafted, what information that the states may have provided to them. We were under nondisclosure agreements where we were prohibited from talking to anybody other than other MIs and officers within the Company about these proposals until they were made public. So, we’re not in a position to be able to answer that question. But we would agree with you that a uniform standard that conforms to both states and their issues and the FHFA’s that the issues make sense. But we’re in no position to answer that very logical question.

Ed G. Groshans – Height Analytics LLC

Okay. So let me ask another question. On your unearned premiums, when those policies are canceled, is there any portion of that that MTG keeps?

Michael J. Zimmerman

Yes.

Curt S. Culver

Yes.

Ed G. Groshans – Height Analytics LLC

And can you give us some estimate of do you get to keep 15% of it? Do you get to keep all of it? Or how does that kind of split work?

Michael J. Zimmerman

It depends on the type of the premium plan. A single nonrefundable, if it’s canceled or goes to claim, all that would come to us, none would be returned. And then we’ve got a fully refundable single premium. So a good portion of that is refunded dependent upon the age of the policy. The monthlies, by and large, they are – I mean, that’s on a month-by-month basis.

Ed G. Groshans – Height Analytics LLC

Right. I'm talking more about the upfront annual. Right? You're talking about the single premium product?

Michael J. Zimmerman

Single, yes.

Ed G. Groshans – Height Analytics LLC

And I guess, Mike, in your response, what you're really talking about is the single premium nonrefundable. Can you give us any – because to me, it seems like if it's single premium nonrefundable, then it's not going away. And if FHFA and the GSEs want to take a haircut for pending future claims on that, okay, I'm all right with that; but the rest of that does appear to be available assets. And then I guess my next question is, is do they consider that – the reason they excluded that is because are they already saying, well, that asset is invested in the balance sheet elsewhere, i.e., in your bonds and whatnot?

Curt S. Culver

They’re not doing that because they’re subtracting it off of the available assets. So I think they’re taking into account that we the cash and they include it in the cash and investments in the available assets. And then they take back off all of the unearned premiums. So I think they're consciously deducting all of the unearned premiums.

Michael J. Zimmerman

This is Mike. I mean when you’re talking about is really a subset of what we’re talking earlier of accounting all contractual premium, I mean whether unearned premium is a subset of that, but it really needs to, in our view, kind of be considered in the full context considering all premiums or some portion of all premiums. But you’re right, I mean it’s cash that's on the balance sheet. That is nonrefundable.

Ed G. Groshans – Height Analytics LLC

And then, hopefully, my last question for you and I do appreciate your time. And I'm not trying to put this out there in any bad way, but if Wisconsin was to take MGIC into conservatorship or receivership, then it's my understanding that the payments go to $0.50 on the dollar for paid claims. Is that correct?

Curt S. Culver

I don't think you can – I mean, that theory of what happens in a conservatorship or a receivership, that's up to the commissioner to determine what are the sources and uses, what’s the residual value on a runoff basis of how much is there before they would make that determination. So I don't think you can set in stone any percentage of what would happen in that type of scenario.

Ed G. Groshans – Height Analytics LLC

But, well, Curt, how about this? Is it fair to say that in a scenario like that, the paid claims are not 100 cents on the dollar?

Curt S. Culver

I don’t think you can predetermine the answer percent. I mean obviously other states when that has happened has discounted the claim payments, but we clearly can’t speak for what the State of Wisconsin would do. They’d have to look at the resources. Again the expected claim payments and the timing of those before that determination was made. So, again, we’re not in a position to really give you as much guidance there.

Ed G. Groshans – Height Analytics LLC

No, no. And that's fair enough. I think your comment there, Mike, that some states have discounted the payments to the GSEs. So I guess, to some degree, that brings me back to my initial question of, if we are looking at a standard where capital – which is, in my 20 years of doing financial services, is one of the key barometers of solvency and we’re not really focusing on that element here in the PMIERs proposal, this whole focus on the available assets to make paid claims can immediately go out the window if an MI company fails. Because they know when the state Commissioner steps in and pays them $0.50 on the dollar regardless of available assets.

Michael J. Zimmerman

This is Mike. FHFA has said they welcome comments to the proposed PMIERs, and I would encourage you to express your opinion.

Ed G. Groshans – Height Analytics LLC

Okay. I appreciate that, Mike. I appreciate all your time and your comments. Thank you so much.

Michael J. Zimmerman

Thanks, Ed.

Curt S. Culver

Thanks, Ed.

Operator

Thank you. Our next question or comment comes from the line of Scott Frost from Bank of America. Your line is open.

Scott Frost – Bank of America Merrill Lynch

Thanks for taking my call. Just some follow-ups on the reinsurance contract and ratings. It kind of sounds like – I appreciate the color on the reinsurance. That was good. Is it right to think about this as any reinsurance contract that comes within five years is kind of like bank capital? You get declining credit as you approach the maturity or termination dates with anything outside of five years, you would get full credit on; and as it comes inside, that declines. Is that the right way to think about it?

Timothy Mattke

Certainly, given what we’ve heard, there’s a haircut at the five-year mark. It would grow as you approached it. The question is to totally remove the haircut, how far do you have to go out? I guess we think if we went out to seven by and large the haircut would be minimal.

Scott Frost – Bank of America Merrill Lynch

Okay. And do those contracts typically, in the reinsurance market that you’re seeing, do they include repricing mechanisms? If so, how often would they reprice versus sort of a fixed premium regardless of loss? I mean, can you maybe give us a little bit of color on that?

Timothy Mattke

The terms of the contract are fixed for the life of the contract. And then our contract has a profit commission in it. So, to the degree the book is profitable, we get a lot more profit back then in a true quota share arrangement.

Scott Frost – Bank of America Merrill Lynch

Okay. And switching to ratings and this is a little bit of a tangent to the leverage questions that you were talking about, which that was a helpful discussion. Thanks. Given that it sounds like what you’d said is the GSEs aren’t going to be using external ratings to establish eligibility requirements. The PMIERs are going to set it. But you talked about ratings considerations when you raise debt capital potentially. What relevance do external ratings from NRSROs have on your business any more? Is it for private-label or for what reason? And what would be kind of a targeted rating that you’d like and why? Mainly a holdco.

Curt S. Culver

I don’t know what to say on the target. I mean, just improving and that takes…

Scott Frost – Bank of America Merrill Lynch

Yes, why, though? Why, though?

Timothy Mattke

I think for opportunities outside the [PMIERs] (ph) space, it’s going to be the rationale. I mean, within the draft PMIERs, there is a requirement to have a rating from one rating agency. But you are right in, I think, in your read that it’s not obviously as critical as it was before what that rating is. But our view is, from a rating, and this is longer-term thinking, for business that’s done outside the GSEs, we think that ratings could become more important as time advances. And so we want to be cognizant of that.

Michael J. Zimmerman

I think the market outside the GSEs will continue to grow. So this Company needs to be in a position to serve that market when it becomes really significant. And so that’s why we’re going to keep improving.

Scott Frost – Bank of America Merrill Lynch

So then, it’s fair to say that you believe that other business opportunities will look to counterparty ratings to assess your risk, and not just how you qualify under whatever form the PMIERs take? And that’s going to be the operational relevance of NRSRO ratings?

Michael J. Zimmerman

I think the answer to that is, yes, Scott. Obviously, we’ve got to wait and see how things play out relative to the final PMIERs and they’re adjusted to levels that we’ve talked about – not levels but the fixes, if you will. Then maybe the ratings aren’t as important for portfolio lenders, private labels, HFAs et cetera. We just don’t know at this time. So that’s why we made the comments we made about the longer- term things where it could be applicable.

Curt S. Culver

Yes, I mean we have to plan for the future and be ready for it. It takes a long time to raise your ratings. And so we got to keep making incremental steps in doing that, so when that market is significant, we can be a significant part of it.

Scott Frost – Bank of America Merrill Lynch

Okay, great. Thanks.

Curt S. Culver

Thanks, Scott.

Operator

Thank you. Our next question or comment comes from the line of Douglas Harter from Credit Suisse. Your line is open.

Douglas Harter – Credit Suisse Group

Thanks. I know this is a bit of a long-term question, but did the PMIERs spell out what their policies or practice would be for ultimately getting cash through a dividend from the MI sub to the parent company, just sort of in terms of how you're thinking about long-term, how much capital – cash you have to hold up at the holdco?

Michael J. Zimmerman

That could be a function of the minimum required assets to the available assets would be that’s how we read it.

Douglas Harter – Credit Suisse Group

I mean, would that be like a formal – you have to ask for a formal request from the FHFA? And do you have to have a certain buffer? Or is it still sort of that level of detail isn't set yet?

Michael J. Zimmerman

I mean that’s state insurance department.

Curt S. Culver

Yes, I think it’s still – well, the request is the State Insurance Department but obviously keeping in mind you need to certify, you need the required asset requirement of the GSEs.

Douglas Harter – Credit Suisse Group

Got it. All right. I appreciate the time. Thank you.

Operator

Thank you. Our next question or comment comes from the line of Sean Dargan from Macquarie. Your line is open.

Sean Dargan – Macquarie Research

Yes, thanks. I guess from the sound of Curt's comments that this U.S. mortgage insurance organization is not going to put up a unified front during the comment period. Is that a fair way to think about it?

Patrick Sinks

This is Pat Sinks. That's still being discussed. I mean, each company has to address this individually, because obviously, there is individual company impacts. So to the extent USMI can move forward in the united way is still to be determined.

Sean Dargan – Macquarie Research

All right. And I guess as each company thinks about how this impacts them, for the next couple of years at least, newer companies would not have to raise pricing as much as the legacy companies to achieve mid-teen ROE's, if that was their desire. If – I guess, would you be content with the trade-off of a lower enterprise level return, if it meant that's what you had to do to be competitive? Or are you committed to earning the kind of returns that you were talking about before that these draft PMIERs came out?

Curt S. Culver

I mean, that is so speculative. There are so many different moving parts within that it’s hard to comment. I mean, we will be competitive relative to the marketplace and earn double-digit returns. The reinsurance that we utilize helps those returns in fact, so we can achieve good returns even in this world, but reality is given the risk of some of the products within it, it should be price tighter if these are indeed the capital requirements, and they want the private market to serve that. And that’s why I was disappointed I think in some of our competition that responding accordingly, we want to be there for all segments of the marketplace and in some of those returns aren't commensurate with the risks.

So, we will be competitive, trust me.

Sean Dargan – Macquarie Research

Okay, thank you.

Operator

Thank you. Our next question or comment comes from the line of Eric Beardsley from Goldman Sachs. Your line is open.

Eric Beardsley – Goldman, Sachs & Co.

Hi, thanks. Just a really quick follow-up. I guess there's been a lot of talk on the credit you don't get on the unearned premiums and the future contractual premiums. What are your thoughts on the delinquencies? I know you don't like that it's almost double-counting, but if we were to look at the three miss payments or less bucket and the 55% required assets against that, compared to your expected claim rate of 15% and a base case, I mean, how should – I guess, is that a big area of focus for you, as you provide comments?

Lawrence J. Pierzchalski

This is Larry. As the numbers in the table 5 speaking to the delinquencies, I would say are higher than what we've experienced during this downturn.

Eric Beardsley – Goldman, Sachs & Co.

Okay. What was the actual experience if you were to look at your new notices ultimately going to claim in the worst of it?

Curt S. Culver

I don’t have that in front of me right now. But once again, we’ll provide comments on these but they seem higher than what we’ve experienced historically during this downturn.

Eric Beardsley – Goldman, Sachs & Co.

Okay.

Curt S. Culver

Eric, there is some past presentations in our Web site that when we have shared our cumulative cure rates that are out and available, you can take a look at which – talk about but you can take a look at what the cumulative for given months notices how those played out during those cycles.

Eric Beardsley – Goldman, Sachs & Co.

Okay, great. And then just secondly, in terms of the expense ratio, is that sustainable at this level with the reinsurance deal and the ceding commission?

Curt S. Culver

I would say that we are probably in the range or run rate, I know it’s a little bit below 15 this quarter, it’s probably a little bit later than what the expected run rate is. I’d say 15 is how we feel sort of the good target of where we expect to be long-term.

Eric Beardsley – Goldman, Sachs & Co.

Okay, great. Thank you.

Michael J. Zimmerman

Thank you.

Operator

Thank you. Our next question or comment comes from the line of Chris Gamaitoni from Autonomous. Your line is open.

Chris Gamaitoni – Autonomous Research US LP

Hi, just a follow-up. Under the assumption that the lower end of the market would be uncompetitive from a return basis for FHFA, if these were to go into effect. Do you have any type of – can you quantify what your normalized loss ratio would be if you were forced to shift to the higher FICO 740-plus type vintage or type borrower? We know, historically, you kind of say 35%, but that's across the whole book. So, I'm just trying to get a sense of how the different stratas are priced.

Curt S. Culver

If you think about the performance of our business in 2009, 2010, 2011 and 2012 and it was pretty much at the higher end of the spectrum and given the environment that we went through, it wasn’t a real robust economy either, and I think from time to time we disclose loss ratio of those books basically 15% or thereabouts maybe 20%.

Chris Gamaitoni – Autonomous Research US LP

That’s perfect, thank you so much.

Curt S. Culver

Yes, thank you, Chris.

Operator

I’m showing no additional audio questions at this time. I will turn the conference back over to you, sir.

Curt S. Culver

Thank you. Seeing no additional questions, thanks for a wonderful discussion of our business, have a great day, thank you.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program. You may now disconnect, everyone have a wonderful day.

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