EXHIBIT 13
MGIC INVESTMENT CORPORATION & SUBSIDIARIES -- YEARS ENDED DECEMBER 31, 2002, 2001, 2000, 1999 AND 1998
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Five-Year Summary of Financial Information
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2002 2001 2000 1999 1998
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(In thousands of dollars, except per share data)
Summary of Operations
Revenues:
Net premiums written....................... $ 1,177,955 $ 1,036,353 $ 887,388 $ 792,345 $ 749,161
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Net premiums earned........................ $ 1,182,098 $ 1,042,267 $ 890,091 $ 792,581 $ 763,284
Investment income, net..................... 207,516 204,393 178,535 153,071 143,019
Realized investment gains, net............. 29,113 37,352 1,432 3,406 18,288
Other revenue.............................. 147,076 73,829 40,283 47,697 47,075
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Total revenues........................... 1,565,803 1,357,841 1,110,341 996,755 971,666
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Losses and expenses:
Losses incurred, net....................... 365,752 160,814 91,723 97,196 211,354
Underwriting and other expenses............ 265,633 234,494 177,837 198,147 187,103
Interest expense........................... 36,776 30,623 28,759 20,402 18,624
Litigation settlement...................... - - 23,221 - -
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Total losses and expenses................ 668,161 425,931 321,540 315,745 417,081
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Income before tax............................. 897,642 931,910 788,801 681,010 554,585
Provision for income tax...................... 268,451 292,773 246,802 210,809 169,120
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Net income.................................... $ 629,191 $ 639,137 $ 541,999 $ 470,201 $ 385,465
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Weighted average common shares outstanding (in
thousands)................................. 104,214 107,795 107,260 109,258 113,582
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Diluted earnings per share.................... $ 6.04 $ 5.93 $ 5.05 $ 4.30 $ 3.39
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Dividends per share........................... $ .10 $ .10 $ .10 $ .10 $ .10
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Balance sheet data
Total investments.......................... $ 4,726,472 $ 4,069,447 $ 3,472,195 $ 2,789,734 $ 2,779,706
Total assets............................... 5,300,303 4,567,012 3,857,781 3,104,393 3,050,541
Loss reserves.............................. 733,181 613,664 609,546 641,978 681,274
Short- and long-term debt.................. 677,246 472,102 397,364 425,000 442,000
Shareholders' equity....................... 3,395,192 3,020,187 2,464,882 1,775,989 1,640,591
Book value per share....................... 33.87 28.47 23.07 16.79 15.05
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A brief description of the Company's business is contained in Note 1 to the Consolidated Financial Statements of the Company.
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MGIC INVESTMENT CORPORATION & SUBSIDIARIES -- YEARS ENDED DECEMBER 31, 2002, 2001, 2000, 1999 AND 1998
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Five-Year Summary of Financial Information
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2002 2001 2000 1999 1998
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New primary insurance written ($ millions).... $ 92,532 $ 86,122 $ 41,546 $ 46,953 $ 43,697
New primary risk written ($ millions)......... 23,403 21,038 10,353 11,422 10,850
New pool risk written ($ millions) (1)........ 674 412 345 564 618
Insurance in force (at year-end) ($ millions)
Direct primary insurance................... 196,988 183,904 160,192 147,607 137,990
Direct primary risk........................ 47,623 42,678 39,090 35,623 32,891
Direct pool risk (1)....................... 2,568 1,950 1,676 1,557 1,133
Primary loans in default ratios
Policies in force.......................... 1,655,887 1,580,283 1,448,348 1,370,020 1,320,994
Loans in default........................... 73,648 54,653 37,422 29,761 29,253
Percentage of loans in default............. 4.45% 3.46% 2.58% 2.17% 2.21%
Percentage of loans in default-- bulk (2).. 10.09% 8.59% 9.02% 8.04% -
Insurance operating ratios (GAAP)
Loss ratio................................. 30.9% 15.4% 10.3% 12.3% 27.7%
Expense ratio.............................. 14.8% 16.5% 16.4% 19.7% 19.6%
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Combined ratio............................. 45.7% 31.9% 26.7% 32.0% 47.3%
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Risk-to-capital ratio (statutory)
MGIC....................................... 8.7:1 9.1:1 10.6:1 11.9:1 12.9:1
(1) Represents contractual aggregate loss limits and, for the year ended December 31, 2002, for $3.0 billion
of risk without such limits, risk is calculated at $276 million for new risk written and $274 million for
risk in force, the estimated amount that would credit enhance these loans to a `AA' level.
(2) Information relating to bulk defaults in 1998 is not separately presented and is not material.
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Management's Discussion and Analysis
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Results of Consolidated Operations
2002 Compared with 2001
Net income for 2002 was $629.2 million, compared to $639.1 million in 2001, a
decrease of 2%. Diluted earnings per share for 2002 was $6.04 compared with
$5.93 in 2001. Adjusted weighted average diluted shares outstanding for the
years ended December 31, 2002 and 2001 were 104.2 million and 107.8 million,
respectively. As used in this report, the term "Company" means the Company and
its consolidated subsidiaries, which do not include less than majority owned
joint ventures in which the Company has an equity interest.
Total revenues for 2002 were $1,565.8 million, an increase of 15% from the
$1,357.8 million for 2001. This increase was primarily attributed to increases
in net premiums earned and other revenue. See below for a further discussion of
premiums and other revenue.
Losses and expenses for 2002 were $668.2 million, an increase of 57% from $425.9
million for 2001. The increase from last year can be attributed to a 127%
increase in losses incurred, which primarily related to increases in delinquent
loans and paid losses, and an aggregate increase in underwriting and interest
expenses of 14%, which related to increases in insured volume and debt
outstanding. See below for a further discussion of losses incurred and expenses.
The amount of new primary insurance written by MGIC during 2002 was $92.5
billion, compared to $86.1 billion in 2001, an increase of $6.4 billion. New
insurance written in the bulk channel declined $3.2 billion during 2002 compared
to 2001, as further discussed below. New insurance written on a flow basis
increased $9.6 billion during 2002 compared to 2001, with refinance volume
approximately equal in both years (41.6% of new insurance written in 2001 and
42.6% in 2002).
The $92.5 billion of new primary insurance written during 2002 was offset by the
cancellation of $79.4 billion of insurance in force, and resulted in a net
increase of $13.1 billion in primary insurance in force, compared to new primary
insurance written of $86.1 billion, the cancellation of $62.4 billion of
insurance in force and a net increase of $23.7 billion in primary insurance in
force during 2001. Direct primary insurance in force was $197.0 billion at
December 31, 2002 compared to $183.9 billion at December 31, 2001. Direct
primary risk in force, net of aggregate loss limits, was $47.6 billion at
December 31, 2002 compared to $42.7 billion at December 31, 2001.
In addition to providing primary insurance coverage, the Company also insures
pools of mortgage loans. New pool risk written during 2002 and 2001 was $674
million and $412 million, respectively. The Company's direct pool risk in force
was $2.6 billion at December 31, 2002 and $2.0 billion at December 31, 2001. Of
the pool risk written in 2002 and the risk in force, $398 million and $2.3
billion, respectively, represent contractual aggregate loss limits. For $3.0
billion of risk without such limits, risk is calculated at $276 million for new
pool risk written and $274 million for pool risk in force, the estimated amount
that would credit enhance these loans to a `AA' level.
Cancellation activity has historically been affected by the level of mortgage
interest rates, with cancellations generally moving inversely to the change in
the direction of interest rates. The home mortgage interest rate environment
continued to decline in 2002. As a result, cancellations increased during 2002
compared to the cancellation levels during 2001, which resulted in a decrease in
the MGIC persistency rate (percentage of insurance remaining in force from one
year prior) to 56.8% at December 31, 2002 from 61.0% at December 31, 2001. In
view of continued strong refinance activity in 2003, the persistency rate could
decline further during the first quarter of 2003.
New insurance written during 2002 for bulk transactions was $22.5 billion ($6.6
billion, $5.7 billion, $4.4 billion and $5.8 billion for the first through
fourth quarters, respectively) compared to $25.7 billion during 2001. The
Company's writings of bulk insurance are in part sensitive to the volume of
securitization transactions involving non-conforming loans. A securitization
involves the sale of whole loans held by the securitizer. The Company believes
that the relatively high historical spread between the cost of funding mortgages
and mortgage coupon rates during portions of the second half
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of 2002 resulted in increased prices for whole loans which had the effect of
reducing the supply of mortgages available for current securitization. The
Company's writings of bulk insurance are also sensitive to competition from
other methods of providing credit enhancement in a securitization, including the
willingness of investors to purchase tranches of the securitization with a
higher degree of credit risk. The Company expects bulk volume for the first
quarter of 2003 will exceed bulk volume for the fourth quarter of 2002.
The Company expects that the loans included in bulk transactions will have
delinquency and claim rates in excess of those on the Company's flow business
and will have lower persistency than the Company's flow business. While the
Company believes it has priced its bulk business to generate acceptable returns,
there can be no assurance that the assumptions underlying the premium rates
adequately address the risk of this business. In the first quarter of 2002, the
Company entered into a preliminary agreement providing that new insurance
written in 2002 through the bulk channel on Alt A, subprime and certain other
loans would be subject to quota share reinsurance of approximately 15% provided
by a third party reinsurer. The agreement was terminated on a cutoff basis
effective October 1, 2002, relieving both parties of any further obligations.
Net premiums written increased 14% to $1,178.0 million during 2002, from
$1,036.4 million during 2001. Net premiums earned increased 13% to $1,182.1
million for 2002 from $1,042.3 million for 2001. The increases were primarily a
result of the growth in insurance in force and a higher percentage of premiums
on products with higher premium rates, principally on insurance written through
the bulk channel, offset in part by an increase in ceded premiums.
Premiums ceded in captive mortgage reinsurance arrangements and in risk sharing
arrangements with the GSEs were $100.0 million in 2002, compared to $61.0
million in 2001. Through September 30, 2002, approximately 53% of the Company's
new insurance written on a flow basis was subject to such arrangements compared
to 50% for the year ended December 31, 2001. (New insurance written through the
bulk channel is not subject to such arrangements.) The percentage of new
insurance written during a period covered by such arrangements normally
increases after the end of the period because, among other reasons, the transfer
of a loan in the secondary market can result in a mortgage insured during a
period becoming part of such an arrangement in a subsequent period. Therefore,
for 2002, the percentage of new insurance written covered by such arrangements
is shown as of the end of the prior quarter. Premiums ceded in such arrangements
are reported as ceded in the period in which they are ceded regardless of when
the mortgage was insured.
A substantial portion of the Company's captive mortgage reinsurance arrangements
are structured on an excess of loss basis. The Company has decided that,
effective March 31, 2003, it will not participate in excess of loss risk sharing
arrangements with net premium cessions in excess of 25% on terms which are
generally present in the market. The captive mortgage reinsurance programs of
larger lenders generally are not consistent with the Company's position. Hence,
the Company expects its position with respect to such risk sharing arrangements
will result in a reduction in business from such lenders.
Investment income for 2002 was $207.5 million, compared to $204.4 million for
2001. This increase was the result of increases in the amortized cost of average
invested assets to $4.2 billion for 2002 from $3.7 billion for 2001, an increase
of 15%, offset by a decrease in the investment yield. The portfolio's average
pre-tax investment yield was 4.7% for 2002 and 5.4% for 2001. The portfolio's
average after-tax investment yield was 4.2% for 2002 and 4.6% for the same
period in 2001. The Company's net realized gains were $29.1 million for 2002
compared to net realized gains of $37.4 million during 2001, resulting primarily
from the sale of fixed maturities.
Other revenue, which is composed of various components, was $147.1 million for
2002, compared with $73.8 million for 2001. The increase is primarily the result
of increased equity earnings from Credit-Based Asset Servicing and
Securitization LLC and its subsidiaries (collectively, "C-BASS") and Sherman
Financial Group LLC and its subsidiaries (collectively, "Sherman"), joint
ventures with Radian Group Inc. ("Radian"), and from contract underwriting.
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C-BASS, in which the Company and Radian each have an interest of approximately
45.9%, is a mortgage investment and servicing firm specializing in
credit-sensitive single-family residential mortgage assets and residential
mortgage-backed securities. C-BASS principally invests in whole loans (including
subprime loans) and mezzanine and subordinated residential mortgage-backed
securities backed by non-conforming residential mortgage loans. C-BASS's
principal sources of revenues during the last three years were gain on
securitization and liquidation of mortgage-related assets, servicing fees and
net interest income (including accretion on mortgage securities), which revenue
items were offset by unrealized losses. C-BASS's results of operations are
affected by the timing of its securitization transactions. Virtually all of
C-BASS's assets do not have readily ascertainable market values and, as a
result, their value for financial statement purposes is estimated by the
management of C-BASS. These estimates reflect the net present value of the
future cash flows from the assets, which in turn depend on, among other things,
estimates of the level of losses on the underlying mortgages and prepayment
activity by the mortgage borrowers. Market value adjustments could impact
C-BASS's results of operations and the Company's share of those results.
Total consolidated assets of C-BASS at December 31, 2002 and 2001 were
approximately $1.754 billion and $1.288 billion, respectively. Total liabilities
at December 31, 2002 and 2001 were approximately $1.385 billion and $1.006
billion, respectively, of which approximately $1.110 billion and $0.934 billion,
respectively, were funding arrangements, including accrued interest, virtually
all of which mature within one year or less. The remaining liabilities at those
dates were related to interest rate hedging activities or were accrued expenses
and other liabilities. For the years ended December 31, 2002 and 2001, revenues
of approximately $311 million and $224 million, respectively, and expenses of
approximately $173 million and $138 million, respectively, resulted in income
before tax of approximately $138 million and $86 million, respectively. The
Company does not anticipate that C-BASS's income before tax in 2003 will exceed
its income before tax in 2002. The Company is not undertaking any obligation to
provide an update of this expectation should it subsequently change.
Sherman is engaged in the business of purchasing and servicing delinquent
consumer assets such as credit card loans and Chapter 13 bankruptcy debt. A
substantial portion of Sherman's consolidated assets are investments in consumer
receivable portfolios that do not have readily ascertainable market values.
Sherman's results of operations are sensitive to estimates by Sherman's
management of ultimate collections on these portfolios. Effective January 1,
2003, the Company and Radian each sold 4 percentage points of their respective
interest in Sherman to Sherman's management for cash, reducing each company's
interest in Sherman to 41.5%. Because C-BASS and Sherman are accounted for by
the equity method, they are not consolidated with the Company and their assets
and liabilities do not appear in the Company's balance sheet. The "investments
in joint ventures" item in the Company's balance sheet reflects the amount of
capital contributed by the Company to the joint ventures plus the Company's
share of their net income (or minus its share of their net loss) and minus
capital distributed to the Company by the joint ventures. The Company's
investment in C-BASS on an equity basis at December 31, 2002 was $168.7 million.
The Company's investment in Sherman on an equity basis at December 31, 2002 was
$54.4 million.
As discussed in "Note 2 - Loss Reserves" to the Company's consolidated financial
statements, consistent with industry practice, loss reserves for future claims
are established only for loans that are currently delinquent. (The terms
"delinquent" and "default" are used interchangeably by the Company.) Loss
reserves are established by management's estimating the number of loans in the
Company's inventory of delinquent loans that will not cure their delinquency
(historically, a substantial majority of delinquent loans have cured), which is
referred to as the claim rate, and further estimating the amount that the
Company will pay in claims on the loans that do not cure, which is referred to
as claim severity. Estimation of losses that the Company will pay in the future
is inherently judgmental. The conditions that affect the claim rate and claim
severity include the current and future state of the domestic economy and the
current and future strength of local housing markets.
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Net losses incurred increased 127% to $365.8 million in 2002, from $160.8
million in 2001. On a quarterly basis, net losses incurred were $59.7 million,
$64.4 million, $101.1 million and $140.5 million for the first through the
fourth quarters, respectively. The increase in 2002 was due to an increase in
the primary notice inventory related to bulk default activity and defaults
arising from the early development of the 2000 and 2001 flow books of business
as well as an increase in losses paid. The average primary claim paid for 2002
was $20,115 compared to $18,607 for 2001. In 2002, the primary determinant of
incurred losses was the level and composition of the notice inventory, rather
than claim severity. The Company expects that incurred losses in 2003 will
increase over the level of 2002. The Company is not undertaking any obligation
to provide an update of this expectation should it subsequently change.
Information about the composition of the primary insurance default inventory at
December 2002 and 2001 appears in the table below.
December 31, December 31,
2002 2001
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Total loans delinquent......... 73,648 54,653
Percentage of loans delinquent
(default rate)............... 4.45% 3.46%
Flow loans delinquent.......... 43,196 36,193
Percentage of flow loans
delinquent (default rate).... 3.19% 2.65%
Bulk loans delinquent.......... 30,452 18,460
Percentage of bulk loans
delinquent (default rate).... 10.09% 8.59%
A-minus and subprime credit
loans delinquent*............ 25,504 15,649
Percentage of A-minus and
subprime credit loans
delinquent (default rate).... 12.68% 11.60%
* A portion of A-minus and subprime credit loans is included in flow loans
delinquent and the remainder is included in bulk loans delinquent. Most
A-minus and subprime credit loans are written through the bulk channel.
The pool notice inventory increased from 23,623 at December 31, 2001 to 26,676
at December 31, 2002.
Information about losses paid in 2002 and 2001 appears in the table below.
Twelve months ended
Net paid claims ($ millions) December 31,
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2002 2001
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Flow........................... $117 $ 93
Bulk........................... 65 14
Second mortgage................ 24 16
Pool and other................. 35 27
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$241 $150
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The Company stopped writing new second mortgage risk for loans closing after
2001.
At December 31, 2002, 82% of MGIC's insurance in force was written subsequent to
December 31, 1998. Based on the Company's flow business, the highest claim
frequency years have typically been the third through fifth year after the year
of loan origination. However, the pattern of claims frequency for refinance
loans may be different from this historical pattern and the Company expects the
period of highest claims frequency on bulk loans will occur earlier than in this
historical pattern.
For additional information about loss reserves, see Note 6 of the Notes to the
Company's consolidated financial statements.
Underwriting and other expenses increased to $265.6 million in 2002 from $234.5
million in 2001, an increase of 13%. The increase can be attributed to increases
in expenses related to increased volume. In December 2002, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
("SFAS") No. 148, Accounting for Stock-Based Compensation - Transition and
Disclosure, an amendment to SFAS No. 123, Accounting for Stock-Based
Compensation. The Company intends to adopt SFAS No. 148 in the first quarter of
2003. The adoption requires expensing of stock-based employee compensation
costs.
Interest expense increased to $36.8 million in 2002 from $30.6 million during
the same period in 2001 primarily due to an increase in debt outstanding offset
by lower weighted-average interest rates during 2002 compared to 2001.
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The consolidated insurance operations loss ratio was 30.9% for 2002 compared to
15.4% for 2001. The consolidated insurance operations expense and combined
ratios were 14.8% and 45.7%, respectively, for 2002 compared to 16.5% and 31.9%
for 2001.
The effective tax rate was 29.9% in 2002, compared to 31.4% in 2001. During both
periods, the effective tax rate was below the statutory rate of 35%, reflecting
the benefits of tax-preferenced investments. The lower effective tax rate in
2002 resulted from a higher percentage of total income before tax being
generated from the tax-preferenced investments.
2001 Compared with 2000
Net income for 2001 was $639.1 million, compared to $542.0 million in 2000, an
increase of 18%. Net income for 2000 includes a pre-tax charge of $23.2 million
for settlement of the RESPA settlement described in "Other Matters" below.
Diluted earnings per share was $5.93 for 2001 compared with $5.05 in 2000.
Total revenues for 2001 were $1,357.8 million, an increase of 22% from the
$1,110.3 million for 2000. This increase was primarily attributable to an
increase in new business writings, which included $25.7 billion of bulk
transactions. Also contributing to the increase in revenues was an increase in
investment income resulting from strong cash flows and increases in realized
gains and other revenue. See below for a further discussion of premiums,
investment income and other revenue.
Losses and expenses for 2001 were $425.9 million, an increase of 32% from $321.5
million for the same period of 2000. The increase in 2001 can be attributed to
an increase in losses related to an increase in notice inventories and an
increase in expenses related to increases in insured volume and in contract
underwriting. See below for a further discussion of losses incurred and
underwriting expenses.
The amount of new primary insurance written by MGIC during 2001 was $86.1
billion, compared with $41.5 billion in 2000. Refinancing activity increased to
42% of new primary insurance written in 2001 on a flow basis (or $25.1 billion),
compared to 13% in 2000 (or $4.6 billion) as a result of the decreasing mortgage
interest rate environment in 2001. New primary insurance written in the bulk
channel increased to 30% of new primary insurance written in 2001 compared to
17% in 2000, reflecting the increasing use of mortgage insurance in certain
mortgage securitizations and MGIC's share of this market. A portion of the loans
insured in bulk transactions are refinanced loans. New insurance written on a
flow basis increased $25.9 billion from 2000 to 2001.
The $86.1 billion of new primary insurance written during 2001 was offset by the
cancellation of $62.4 billion of insurance in force, and resulted in a net
increase of $23.7 billion in primary insurance in force, compared to new primary
insurance written of $41.5 billion, the cancellation of $28.9 billion of
insurance in force and a net increase of $12.6 billion in primary insurance in
force during 2000.
New pool risk written during 2001 and 2000 was $411.7 million and $345.5
million, respectively. The Company's direct pool risk in force was $2.0 billion
at December 31, 2001 compared to $1.7 billion at December 31, 2000.
Cancellations increased during 2001 compared to the cancellation levels of 2000
principally due to the lower mortgage interest rate environment which resulted
in a decrease in the MGIC persistency rate to 61.0% at December 31, 2001 from
80.4% at December 31, 2000.
Net premiums written increased 17% to $1,036.4 million in 2001, from $887.4
million in 2000. Net premiums earned increased 17% to $1,042.3 million in 2001
from $890.1 million in 2000. The increases were primarily a result of the growth
in insurance in force and a higher percentage of renewal premiums on products
with higher premium rates, principally on insurance written though the bulk
channel, offset in part by an increase in ceded premiums to $65.3 million in
2001, compared to $52.9 million in 2000. Premiums ceded in captive mortgage
reinsurance arrangements and in risk sharing arrangements with the GSEs were
$61.0 million in 2001 compared to $43.2 million in 2000.
Investment income for 2001 was $204.4 million, an increase of 14% over the
$178.5 million in 2000. This increase was primarily the result of an increase in
the amortized cost of average invested assets to $3.7 billion
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for 2001 from $3.1 billion for 2000, an increase of 18%. The portfolio's average
pre-tax investment yield was 5.4% and 6.0% at December 31, 2001 and 2000,
respectively. The portfolio's average after-tax investment yield was 4.6% and
4.9% at December 31, 2001 and 2000, respectively. The Company's net realized
gains of $37.4 million during 2001 compared to $1.4 million in 2000, resulted
primarily from the sale of fixed maturities.
Other revenue was $73.8 million in 2001, compared with $40.3 million in 2000.
The increase is primarily the result of an increase in contract underwriting
revenue and increases in equity earnings from C-BASS and Sherman.
For the years ended December 31, 2001 and 2000, C-BASS had revenues of
approximately $224 million and $154 million, respectively, and expenses of
approximately $138 million and $98 million, respectively, which resulted in
income before tax of approximately $86 million and $56 million, respectively.
Net losses incurred increased 75% to $160.8 million in 2001, from $91.7 million
in 2000. The increase was due to an increase in the primary notice inventory
related to bulk default activity, which in turn was the result of the higher
volume of bulk business; the maturation of the relatively large 1998 and 1999
books of business, which had entered their peak delinquency periods; and
defaults arising from the early development of the 2000 book of business. The
average claim paid for 2001 was $18,607 compared to $18,977 in 2000. For
information about the notice inventory and default rates for 2001, see "2002
Compared with 2001."
Underwriting and other expenses increased to $234.5 million in 2001 from $177.8
million in 2000, an increase of 32%. The increase can be attributed to increases
in both insurance and non-insurance expenses related to increased volume and
contract underwriting.
Interest expense in 2001 increased to $30.6 million from $28.8 million in 2000
due to slightly higher weighted-average interest rates in 2001 compared to 2000,
and higher weighted-average balances.
The consolidated insurance operations loss ratio was 15.4% for 2001 compared to
10.3% for 2000. The consolidated insurance operations expense and combined
ratios were 16.5% and 31.9%, respectively, for 2001 compared to 16.4% and 26.7%,
respectively for 2000.
The effective tax rate was 31.4% in 2001, compared to 31.3% in 2000. During both
years, the effective tax rate was below the statutory rate of 35%, reflecting
the benefits of tax-preferenced investments. The higher effective tax rate in
2001 resulted from a lower percentage of total income before tax being generated
from tax-preferenced investments in 2001.
Other Matters
In June 2001, the Federal District Court for the Southern District of Georgia,
before which Downey et. al. v. MGIC was pending, issued a final order approving
a settlement agreement and certified a nationwide class of borrowers. In the
fourth quarter of 2000, the Company recorded a $23.2 million charge to cover the
estimated costs of the settlement, including payments to borrowers. Due to
appeals by certain class members and members of classes in two related cases,
payments to borrowers in the settlement are delayed pending the outcome of the
appeals. The settlement includes an injunction that prohibits certain practices
and specifies the basis on which agency pool insurance, captive mortgage
reinsurance, contract underwriting and other products may be provided in
compliance with the Real Estate Settlement Procedures Act. There can be no
assurance that the standards established by the injunction will be determinative
of compliance with the Real Estate Settlement Procedures Act were additional
litigation to be brought in the future.
The complaint in the case alleges that MGIC violated the Real Estate Settlement
Procedures Act by providing agency pool insurance, captive mortgage reinsurance,
contract underwriting and other products that were not properly priced, in
return for the referral of mortgage insurance. The complaint seeks damages of
three times the amount of the mortgage insurance premiums that have been paid
and that will be paid at the time of judgment for the mortgage insurance found
to be involved in a violation of the Real Estate Settlement Procedures Act. The
complaint also seeks injunctive
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relief, including prohibiting MGIC from receiving future premium payments. If
the settlement is not fully implemented, the litigation will continue. In these
circumstances, there can be no assurance that the ultimate outcome of the
litigation will not materially affect the Company's financial position or
results of operations.
Under the Office of Federal Housing Enterprise Oversight's ("OFHEO") risk-based
capital stress test for the GSEs, claim payments made by a private mortgage
insurer on GSE loans are reduced below the amount provided by the mortgage
insurance policy to reflect the risk that the insurer will fail to pay. Claim
payments from an insurer whose claims-paying ability rating is `AAA' are subject
to a 3.5% reduction over the 10-year period of the stress test, while claim
payments from a `AA' rated insurer, such as MGIC, are subject to an 8.75%
reduction. The effect of the differentiation among insurers is to require the
GSEs to have additional capital for coverage on loans provided by a private
mortgage insurer whose claims-paying rating is less than `AAA.' As a result,
there is an incentive for the GSEs to use private mortgage insurance provided by
a `AAA' rated insurer.
Financial Condition
Consolidated total investments and cash balances increased approximately $642
million to $4.7 billion at December 31, 2002 from $4.1 billion at December 31,
2001, primarily due to net cash provided by operating activities, the change in
unrealized gains on securities marked to market of $176 million and the proceeds
of the sale of the 6% Senior Notes discussed under "Liquidity and Capital
Resources" below, offset by funds used to repurchase Common Stock discussed
under "Liquidity and Capital Resources" below. The Company generated net cash
from operating activities of $613.3 million for 2002, compared to $626.1 million
generated during 2001. The decrease in operating cash flows during 2002 compared
to 2001 is due primarily to increases in losses paid, offset by increases in
renewal premiums, investment income and other revenue as discussed above.
As of December 31, 2002, the Company had $102.2 million of short-term
investments with maturities of 90 days or less, and 82% of the portfolio was
invested in tax-preferenced securities. In addition, at December 31, 2002, based
on book value, the Company's fixed income securities were approximately 99%
invested in `A' rated and above, readily marketable securities, concentrated in
maturities of less than 15 years. At December 31, 2002, the Company had $10.8
million of investments in equity securities compared to $20.7 million at
December 31, 2001.
At December 31, 2002, the Company's derivative financial instruments in its
investment portfolio were immaterial. The Company places its investments in
instruments that meet high credit quality standards, as specified in the
Company's investment policy guidelines; the policy also limits the amount of
credit exposure to any one issue, issuer and type of instrument. At December 31,
2002, the effective duration of the Company's fixed income investment portfolio
was 5.7 years. This means that for an instantaneous parallel shift in the yield
curve of 100 basis points there would be an approximate 5.7% change in the
market value of the Company's fixed income portfolio.
The Company's investments in unconsolidated joint ventures increased $78.4
million from $161.7 million at December 31, 2001 to $240.1 million at December
31, 2002 primarily as a result of equity earnings of $81.8 million and a $17.5
million contribution to affordable housing tax credit ventures, offset by $20.1
million of dividends received. The unconsolidated joint ventures are reported on
the equity method. Only the Company's investment in the unconsolidated joint
ventures appears on the Company's balance sheet.
Consolidated loss reserves increased to $733.2 million at December 31, 2002 from
$613.7 million at December 31, 2001, reflecting increases in the primary and
pool insurance notice inventories, as discussed earlier. Consistent with
industry practices, the Company does not establish loss reserves for future
claims on insured loans which are not currently in default.
Consolidated unearned premiums decreased $4.3 million from $174.5 million at
December 31, 2001, to $170.2 million at December 31, 2002, primarily reflecting
the continued high level of monthly premium policies written for which there is
no unearned premium.
-------------
nine
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Consolidated shareholders' equity increased to $3.4 billion at December 31,
2002, from $3.0 billion at December 31, 2001, an increase of 12%. This increase
consisted of $629.2 million of net income during 2002, other comprehensive
income, net of tax, of $101.3 million and $0.4 million from the consolidation of
a previously unconsolidated joint venture that is now majority owned, offset by
$345.5 million from the repurchase of treasury stock (net of reissuances) and
dividends declared of $10.4 million.
Liquidity and Capital Resources
The Company's consolidated sources of funds consist primarily of premiums
written and investment income. The Company generated positive cash flows from
operating activities of approximately $613.3 million and $626.1 million for the
years ended December 31, 2002 and 2001, respectively, as shown on the
Consolidated Statement of Cash Flows. Positive cash flows are invested pending
future payments of claims and other expenses. Substantially all of the
investment portfolio securities are held by the Company's insurance
subsidiaries.
The Company has a $285 million commercial paper program, which is rated `A-1' by
Standard and Poors ("S&P") and `P-1' by Moody's. At December 31, 2002 and 2001,
the Company had $177.3 million and $172.1 million in commercial paper
outstanding with a weighted average interest rate of 1.46% and 1.91% at December
31, 2002 and 2001, respectively.
The Company had a $285 million credit facility available at December 31, 2002
expiring in 2006. Under the terms of the credit facility, as amended in July
2002, the Company must maintain shareholders' equity of at least $2.25 billion
and MGIC must maintain a risk-to-capital ratio of not more than 22:1 and
maintain policyholders position (which includes MGIC's surplus and its
contingency reserve) of not less than the amount required by Wisconsin insurance
regulation. At December 31, 2002, the Company met these requirements. The
facility is currently being used as a liquidity back up facility for the
outstanding commercial paper. The remaining credit available under the facility
after reduction for the amount necessary to support the commercial paper was
$107.7 million at December 31, 2002.
In March of 2002, the Company issued, in a public offering, $200 million, 6%
Senior Notes due in 2007. The notes are unsecured and were rated `A1' by
Moody's, `A+' by S&P and `AA-' by Fitch. The Company had $300 million, 7.5%
Senior Notes due in 2005 outstanding at December 31, 2002 and 2001.
In October 2002, the Company announced a new share repurchase program covering
up to 5 million shares. During 2002, the Company repurchased 6.4 million shares
at a cost of $373.3 million. Of these shares, 0.1 million were purchased under
the new program and the remainder under a predecessor program which was
completed. (The number of shares and the cost of the repurchases described in
this paragraph include trades effected on or prior to December 31, 2002 but
which settled thereafter.) From mid-1997 through December 31, 2002, the Company
repurchased 21.4 million shares of Common Stock at a cost of $1.1 billion. Funds
for the shares repurchased by the Company since mid-1997 have been provided
through a combination of debt, including the Senior Notes and the commercial
paper, and internally generated funds.
The commercial paper, back-up credit facility and the Senior Notes are
obligations of the Company and not of its subsidiaries. The Company is a holding
company and the payment of dividends from its insurance subsidiaries is
restricted by insurance regulation. MGIC is the principal source of
dividend-paying capacity. As a result of a $138 million dividend scheduled to be
paid to the Company by MGIC in late March 2003, as of the date of the payment of
such dividend, MGIC may not pay more than $1.7 million of additional dividends
without the approval of the Office of the Commissioner of Insurance of the State
of Wisconsin (the "OCI"). The first paragraph of Note 11 of the Notes to the
Company's consolidated financial statements discusses the regulations of the OCI
governing the payment of dividends without approval of the OCI.
Interest payments on all long-term and short-term debt (commercial paper is
classified as short-term debt) were $36.2 million and $22.6 million for the
years ended December 31, 2002 and 2001, respectively. At December 31, 2002, the
market value of the short- and long-term debt is $721.9 million.
-------------
ten
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The Company uses interest rate swaps to hedge interest rate exposure associated
with its short- and long-term debt. In 2000, the Company paid an interest rate
based on LIBOR and received a fixed rate of 7.5% to hedge the 5-year Senior
Notes issued in the fourth quarter of 2000. These swaps were terminated in
September 2001. In January 2002, the Company initiated a new swap which was
designated as a fair value hedge of the 7.5% Senior Notes. This swap was
terminated in June 2002. In May 2002, a swap designated as a cash flow hedge was
amended to coincide with the new credit facility. Under the terms of the swap
contract, the Company pays a fixed rate of 5.43% and receives an interest rate
based on LIBOR. The swap has an expiration date coinciding with the maturity of
the credit facility and is designated as a cash flow hedge. Gains or losses
arising from the amendment or termination of interest rate swaps are deferred
and amortized to interest expense over the life of the hedged items. Expenses on
the swaps during 2002 and 2001 of approximately $1.8 million and $3.7 million,
respectively, were included in interest expense. The cash flow swap outstanding
at December 31, 2002 and 2001 is evaluated quarterly using regression analysis
with any ineffectiveness being recorded as an expense. To date this evaluation
has not resulted in any hedge ineffectiveness. The swaps are subject to credit
risk to the extent the counterparty would be unable to discharge its obligations
under the swap agreements.
The Company's principal category of contingent liabilities is its obligation to
pay claims under MGIC's mortgage guaranty insurance policies. At December 31,
2002, MGIC's direct (before any reinsurance) primary and pool risk in force
(which is the unpaid principal balance of insured loans as reflected in the
Company's records multiplied by the coverage percentage, and taking account of
any contractual loss limit) was approximately $52.9 billion. In addition, as
part of its contract underwriting activities, the Company is responsible for the
quality of its underwriting decisions in accordance with the terms of the
contract underwriting agreements with customers. Through December 31, 2002, the
cost of remedies provided by the Company to customers for failing to meet the
standards of the contracts has not been material. However, the decreasing trend
of home mortgage interest rates over the last several years may have mitigated
the effect of some of these costs since the general effect of lower interest
rates can be to increase the value of certain loans on which remedies are
provided. There can be no assurance that contract underwriting remedies will not
be material in the future.
MGIC is the principal insurance subsidiary of the Company. MGIC's
risk-to-capital ratio was 8.7:1 at December 31, 2002 (determined using $42.4
billion of risk, which includes calculated risk of $274 million on $3.0 billion
of contractual pool risk, and $4.9 billion of capital) compared to 9.1:1 at
December 31, 2001. The decrease was due to MGIC's increased policyholders'
reserves, partially offset by the net additional risk in force of $3.2 billion,
net of reinsurance, during 2002.
The risk-to-capital ratios set forth above have been computed on a statutory
basis. However, the methodology used by the rating agencies to assign
claims-paying ability ratings permits less leverage than under statutory
requirements. As a result, the amount of capital required under statutory
regulations may be lower than the capital required for rating agency purposes.
In addition to capital adequacy, the rating agencies consider other factors in
determining a mortgage insurer's claims-paying rating, including its competitive
position, business outlook, management, corporate strategy, and historical and
projected operating performance.
For certain material risks of the Company's business, see "Risk Factors" below.
Risk Factors
Our revenues and losses could be affected by the risk factors discussed below.
These factors may also cause actual results to differ materially from the
results contemplated by forward looking statements that the Company may make.
Forward looking statements consist of statements which relate to matters other
than historical fact. Among others, statements that include words such as the
Company "believes," "anticipates" or "expects," or words of similar import, are
forward looking statements.
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eleven
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As the domestic economy deteriorates, more homeowners may default and the
Company's losses may increase.
Losses result from events that reduce a borrower's ability to continue to make
mortgage payments, such as unemployment, and whether the home of a borrower who
defaults on his mortgage can be sold for an amount that will cover unpaid
principal and interest and the expenses of the sale. Favorable economic
conditions generally reduce the likelihood that borrowers will lack sufficient
income to pay their mortgages and also favorably affect the value of homes,
thereby reducing and in some cases even eliminating a loss from a mortgage
default. A deterioration in economic conditions generally increases the
likelihood that borrowers will not have sufficient income to pay their mortgages
and can also adversely affect housing values.
Competition or changes in the Company's relationships with its customers could
reduce the Company's revenues or increase its losses.
Competition for private mortgage insurance premiums occurs not only among
private mortgage insurers but increasingly with mortgage lenders through captive
mortgage reinsurance transactions. In these transactions, a lender's affiliate
reinsures a portion of the insurance written by a private mortgage insurer on
mortgages originated by the lender. In 1996, the Company shared risk under risk
sharing arrangements with respect to virtually none of its new insurance
written. During the nine months ended September 30, 2002, about 53% of the
Company's new insurance written on a flow basis was subject to risk sharing
arrangements. A substantial portion of the Company's captive mortgage
reinsurance arrangements are structured on an excess of loss basis. The Company
has decided that, effective March 31, 2003, it will not participate in excess of
loss risk sharing arrangements with net premium cessions in excess of 25% on
terms which are generally present in the market. The captive mortgage
reinsurance programs of larger lenders generally are not consistent with the
Company's position. Hence, the Company expects its position with respect to such
risk sharing arrangements will result in a reduction of business from such
lenders.
The level of competition within the private mortgage insurance industry has also
increased as many large mortgage lenders have reduced the number of private
mortgage insurers with whom they do business. At the same time, consolidation
among mortgage lenders has increased the share of the mortgage lending market
held by large lenders. The Company's top ten customers generated 27.0% of the
new primary insurance that it wrote on a flow basis in 1997 compared to 39.5% in
2002.
Our private mortgage insurance competitors include:
o PMI Mortgage Insurance Company
o GE Capital Mortgage Insurance Corporation
o United Guaranty Residential Insurance Company
o Radian Guaranty Inc.
o Republic Mortgage Insurance Company
o Triad Guaranty Insurance Corporation
o CMG Mortgage Insurance Company
If interest rates decline, house prices appreciate or mortgage insurance
cancellation requirements change, the length of time that our policies remain in
force could decline and result in declines in our revenue.
In each year, most of the Company's premiums are from insurance that has been
written in prior years. As a result, the length of time insurance remains in
force (which is also generally referred to as persistency) is an important
determinant of revenues. The factors affecting the length of time the Company's
insurance remains in force include:
o the level of current mortgage interest rates compared to the mortgage
coupon rates on the insurance in force, which affects the vulnerability of
the insurance in force to refinancings, and
o mortgage insurance cancellation policies of mortgage investors along with
the rate of home price appreciation experienced by the homes underlying the
mortgages in the insurance in force.
In recent years, the length of time that our policies remain in force has
declined. Due to this decline, our premium revenues were lower than they would
have been if the length had not declined.
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twelve
-------------
- --------------------------------------------------------------------------------
If the volume of low down payment home mortgage originations declines, the
amount of insurance that the Company writes could decline which would reduce our
revenues.
The factors that affect the volume of low down payment mortgage originations
include:
o the level of home mortgage interest rates,
o the health of the domestic economy as well as conditions in regional and
local economies, o housing affordability,
o population trends, including the rate of household formation,
o the rate of home price appreciation, which in times of heavy refinancing
can affect whether refinance loans have loan-to-value ratios that require
private mortgage insurance, and
o government housing policy encouraging loans to first-time homebuyers.
While we have not experienced lower volume in recent years other than as a
result of declining refinancing activity, one of the risks we face is that
higher interest rates will substantially reduce purchase activity by first-time
homebuyers and that the decline in cancellations of insurance that in the past
have accompanied higher interest rates will not be sufficient to offset the
decline in premiums from loans that are not made.
The amount of insurance the Company writes could be adversely affected if
lenders and investors select alternatives to private mortgage insurance.
These alternatives to private mortgage insurance include:
o lenders structuring mortgage originations to avoid private mortgage
insurance, such as a first mortgage with an 80% loan-to-value ratio and a
second mortgage with a 10% loan-to-value ratio (referred to as an 80-10-10
loan) rather than a first mortgage with a 90% loan-to-value ratio,
o investors holding mortgages in portfolio and self-insuring,
o investors using credit enhancements other than private mortgage insurance
or using other credit enhancements in conjunction with reduced levels of
private mortgage insurance coverage, and
o lenders using government mortgage insurance programs, including those of
the Federal Housing Administration and the Veterans Administration.
While no data is publicly available, the Company believes that due to the
current low interest rate environment and favorable economic conditions,
80-10-10 loans are a significant percentage of mortgage originations. Investors
are using reduced mortgage insurance coverage on a higher percentage of loans
that the Company insures than they had over the last several years.
Changes in the business practices of Fannie Mae and Freddie Mac could reduce the
Company's revenues or increase its losses.
The business practices of Fannie Mae and Freddie Mac affect the entire
relationship between them and mortgage insurers and include:
o the level of private mortgage insurance coverage, subject to the
limitations of Fannie Mae and Freddie Mac's charters, when private mortgage
insurance is used as the required credit enhancement on low down payment
mortgages,
o whether Fannie Mae or Freddie Mac influence the mortgage lender's selection
of the mortgage insurer providing coverage and, if so, any transactions
that are related to that selection,
o whether Fannie Mae or Freddie Mac will give mortgage lenders an incentive,
such as a reduced guaranty fee, to select a mortgage insurer that has a
`AAA' claims-paying ability rating to benefit from
-------------
thirteen
-------------
- --------------------------------------------------------------------------------
the lower capital requirements for Fannie Mae and Freddie Mac when a
mortgage is insured by a company with that rating,
o the underwriting standards that determine what loans are eligible for
purchase by Fannie Mae or Freddie Mac, which thereby affect the quality of
the risk insured by the mortgage insurer and the availability of mortgage
loans,
o the terms on which mortgage insurance coverage can be canceled before
reaching the cancellation thresholds established by law, and
o the circumstances in which mortgage servicers must perform activities
intended to avoid or mitigate loss on insured mortgages that are
delinquent.
Net premiums written could be adversely affected if a proposed regulation by the
Department of Housing and Urban Development under the Real Estate Settlement
Procedures Act is adopted.
The regulations of the Department of Housing and Urban Development under the
Real Estate Settlement Procedures Act prohibit paying lenders for the referral
of settlement services, including mortgage insurance, and prohibit lenders from
receiving such payments. In July 2002, the Department of Housing and Urban
Development proposed a regulation that would exclude from these anti-referral
fee provisions settlement services included in a package of settlement services
offered to a borrower at a guaranteed price. If mortgage insurance is required
on a loan, the package must include any mortgage insurance premium paid at
settlement. Although certain state insurance regulations prohibit an insurer's
payment of referral fees, adoption of this regulation by the Department of
Housing and Urban Development could adversely affect the Company's revenues to
the extent that lenders offered such packages and received value from the
Company in excess of what they could have received were the anti-referral fee
provisions of the Real Estate Settlement Procedures Act to apply and if such
state regulations were not applied to prohibit such payments.
The mortgage insurance industry is subject to litigation risk.
In recent years, consumers have brought a growing number of lawsuits against
home mortgage lenders and settlement service providers. As of the end of
December 2002, seven mortgage insurers, including the Company's MGIC subsidiary,
were involved in litigation alleging violations of the Real Estate Settlement
Procedures Act. MGIC and two other mortgage insurers entered into an agreement
to settle the cases against them in December 2000, and another mortgage insurer
entered into a comparable settlement agreement in February 2002. In June 2001,
the Court entered a final order approving the settlement to which MGIC and the
other two insurers are parties, although due to appeals challenging certain
aspects of this settlement, the final implementation of the settlement will not
occur until the appeals are resolved. The Company took a $23.2 million pre-tax
charge in 2000 to cover MGIC's share of the estimated costs of the settlement.
While MGIC's settlement includes an injunction that prohibits certain practices
and specifies the basis on which other practices may be done in compliance with
the Real Estate Settlement Procedures Act, MGIC may still be subject to future
litigation under the Real Estate Settlement Procedures Act.
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fourteen
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MGIC INVESTMENT CORPORATION & SUBSIDIARIES
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
------------------------------------------------------------------------------------
Consolidated Statement of Operations
------------------------------------------------------------------------------------
2002 2001 2000
-------------- --------------- ---------------
REVENUES: (In thousands of dollars, except per share data)
Premiums written:
Direct.................................................... $ 1,292,283 $ 1,101,160 $ 939,482
Assumed................................................... 336 516 847
Ceded (note 7)............................................ (114,664) (65,323) (52,941)
-------------- --------------- ---------------
Net premiums written........................................ 1,177,955 1,036,353 887,388
Decrease in unearned premiums............................... 4,143 5,914 2,703
-------------- --------------- ---------------
Net premiums earned (note 7)................................ 1,182,098 1,042,267 890,091
Investment income, net of expenses (note 4)................. 207,516 204,393 178,535
Realized investment gains, net (note 4)..................... 29,113 37,352 1,432
Other revenue............................................... 147,076 73,829 40,283
-------------- --------------- ---------------
Total revenues............................................ 1,565,803 1,357,841 1,110,341
-------------- --------------- ---------------
LOSSES AND EXPENSES:
Losses incurred, net (notes 6 and 7)........................ 365,752 160,814 91,723
Underwriting and other expenses............................. 265,633 234,494 177,837
Interest expense............................................ 36,776 30,623 28,759
Litigation settlement (note 13)............................. - - 23,221
-------------- --------------- ---------------
Total losses and expenses................................. 668,161 425,931 321,540
-------------- --------------- ---------------
Income before tax.............................................. 897,642 931,910 788,801
Provision for income tax (note 10)............................. 268,451 292,773 246,802
-------------- --------------- ---------------
Net income..................................................... $ 629,191 $ 639,137 $ 541,999
============== =============== ===============
Earnings per share (note 11):
Basic....................................................... $ 6.07 $ 5.98 $ 5.10
============== =============== ===============
Diluted..................................................... $ 6.04 $ 5.93 $ 5.05
============== =============== ===============
See accompanying notes to consolidated financial statements.
-------------
fifteen
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MGIC INVESTMENT CORPORATION & SUBSIDIARIES
December 31, 2002 and 2001
------------------------------------------------------------------------------------
Consolidated Balance Sheet
------------------------------------------------------------------------------------
2002 2001
---------------- -----------------
ASSETS (In thousands of dollars) Investment portfolio (note 4):
Securities, available-for-sale, at fair value:
Fixed maturities........................................................ $ 4,613,462 $ 3,888,740
Equity securities....................................................... 10,780 20,747
Short-term investments.................................................. 102,230 159,960
---------------- -----------------
Total investment portfolio (amortized cost, 2002 - $4,466,183;
2001 - $3,985,656).................................................. 4,726,472 4,069,447
Cash ........................................................................ 11,041 26,392
Accrued investment income.................................................... 58,432 59,036
Reinsurance recoverable on loss reserves (note 7)............................ 21,045 26,888
Reinsurance recoverable on unearned premiums (note 7)........................ 8,180 8,415
Premiums receivable.......................................................... 97,751 78,853
Home office and equipment, net............................................... 35,962 34,762
Deferred insurance policy acquisition costs.................................. 31,871 32,127
Investments in joint ventures (note 8)....................................... 240,085 161,674
Other assets................................................................. 69,464 69,418
---------------- -----------------
Total assets.......................................................... $ 5,300,303 $ 4,567,012
================ =================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Loss reserves (notes 6 and 7)............................................. $ 733,181 $ 613,664
Unearned premiums (note 7)................................................ 170,167 174,545
Short- and long-term debt (note 5)........................................ 677,246 472,102
Income taxes payable...................................................... 133,843 80,937
Other liabilities......................................................... 190,674 205,577
---------------- -----------------
Total liabilities..................................................... 1,905,111 1,546,825
---------------- -----------------
Contingencies (note 13)
Shareholders' equity (note 11):
Common stock, $1 par value, shares authorized
300,000,000; shares issued 2002 - 121,418,637; 2001 - 121,110,800
outstanding 2002 - 100,251,444; 2001 - 106,086,594...................... 121,419 121,111
Paid-in surplus........................................................... 232,950 214,040
Members' equity........................................................... 380 -
Treasury stock (shares at cost 2002 - 21,167,193; 2001 - 15,024,206)...... (1,035,858) (671,168)
Accumulated other comprehensive income - net of tax (note 2).............. 147,908 46,644
Retained earnings (note 11)............................................... 3,928,393 3,309,560
---------------- -----------------
Total shareholders' equity.............................................. 3,395,192 3,020,187
---------------- -----------------
Total liabilities and shareholders' equity.............................. $ 5,300,303 $ 4,567,012
================ =================
See accompanying notes to consolidated financial statements.
-------------
sixteen
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MGIC INVESTMENT CORPORATION & SUBSIDIARIES
Years Ended December 31, 2002, 2001 and 2000
------------------------------------------------------------------------------------------------
Consolidated Statement of Shareholders' Equity
------------------------------------------------------------------------------------------------
Accumulated
other
comprehensive
Common Paid-in Members' Treasury income Retained Comprehensive
stock surplus equity stock (note 2) earnings income
-------------- ------------ ----------- ------------ --------------- ------------ ------------
(In thousands of dollars)
Balance, December 31, 1999...... $ 121,111 $ 211,593 $ - $ (665,707) $ (40,735) $ 2,149,727
Net income...................... - - - - - 541,999 $ 541,999
Unrealized investment gains - - - - 116,549 - 116,549
(losses), net
--------------
Comprehensive income............ - - - - - - $ 658,548
==============
Dividends declared.............. - - - - - (10,618)
Repurchase of outstanding
common shares................. - - - (6,224) - -
Reissuance of treasury stock.... - (3,711) - 50,898 - -
------------ ----------- ------------ -------------- ------------ -------------
Balance, December 31, 2000...... 121,111 207,882 - (621,033) 75,814 2,681,108
Net income...................... - - - - - 639,137 $ 639,137
Unrealized investment gains - - - - (21,351) - (21,351)
(losses), net
Unrealized loss on derivatives, - - - - (7,819) - (7,819)
net
--------------
Comprehensive income............ - - - - - - $ 609,967
==============
Dividends declared.............. - - - - - (10,685)
Repurchase of outstanding
common shares................. - - - (73,488) - -
Reissuance of treasury stock.... - 6,158 - 23,353 - -
------------ ----------- ------------ -------------- ------------ -------------
Balance, December 31, 2001...... 121,111 214,040 - (671,168) 46,644 3,309,560
Net income...................... - - - - - 629,191 $ 629,191
Unrealized investment gains
(losses), - - - - 114,724 - 114,724
net (note 4)..................
Unrealized loss on derivatives,
net (note 5).................. - - - - (442) - (442)
Minimum pension liability
adjustment, - - - - (13,018) - (13,018)
net (note 9)..................
--------------
Comprehensive income............ - - - - - - $ 730,455
==============
Change in members' equity....... - - 380 - - -
Dividends declared.............. - - - - - (10,358)
Common stock shares issued...... 308 16,101 - - - -
Repurchase of outstanding
common shares................. - - - (373,281) - -
Reissuance of treasury stock.... - 2,809 - 8,591 - -
------------ ----------- ------------ -------------- ------------ -----------
Balance, December 31, 2002...... $ 121,419 $ 232,950 $ 380 $ (1,035,858) $ 147,908 $ 3,928,393
=============
============ =========== ============ ============== ============
See accompanying notes to consolidated financial statements.
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seventeen
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MGIC INVESTMENT CORPORATION & SUBSIDIARIES
Years Ended December 31, 2002, 2001 and 2000
------------------------------------------------------------------------------------------------
Consolidated Statement of Cash Flows
------------------------------------------------------------------------------------------------
2002 2001 2000
---------------- --------------- ----------------
(In thousands of dollars)
Cash flows from operating activities:
Net income....................................................... $ 629,191 $ 639,137 $ 541,999
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization of deferred insurance policy
acquisition costs.......................................... 25,862 22,233 20,597
Increase in deferred insurance policy acquisition costs...... (25,606) (28,521) (24,086)
Depreciation and other amortization.......................... 12,292 8,281 6,860
Decrease (increase) in accrued investment income............. 604 (7,617) (4,706)
Decrease in reinsurance recoverable on loss reserves......... 5,843 6,338 2,595
Decrease (increase) in reinsurance recoverable on
unearned premiums.......................................... 235 265 (2,050)
Increase (decrease) in loss reserves......................... 119,517 4,118 (32,432)
Decrease in unearned premiums................................ (4,378) (6,179) (654)
Equity earnings in joint ventures............................ (81,240) (28,097) (18,113)
Other........................................................ (68,990) 16,161 61,027
---------------- --------------- ----------------
Net cash provided by operating activities........................... 613,330 626,119 551,037
---------------- --------------- ----------------
Cash flows from investing activities:
Purchase of equity securities.................................... - (71) (14,629)
Purchase of fixed maturities..................................... (2,804,029) (2,801,654) (1,807,718)
Investments in joint ventures.................................... (17,528) (15,000) (19,180)
Proceeds from sale of equity securities.......................... 12,465 1,685 14,029
Proceeds from sale or maturity of fixed maturities............... 2,287,018 2,213,289 1,349,398
---------------- --------------- ----------------
Net cash used in investing activities............................... (522,074) (601,751) (478,100)
---------------- --------------- ----------------
Cash flows from financing activities:
Dividends paid to shareholders................................... (10,358) (10,685) (10,618)
Proceeds from issuance of short- and long-term debt.............. 202,087 205,521 309,079
Repayment of short- and long-term debt........................... - (133,384) (336,751)
Reissuance of treasury stock..................................... 6,179 16,830 18,699
Repurchase of common stock....................................... (373,070) (73,488) (6,224)
Common stock shares issued....................................... 10,825 - -
---------------- --------------- ----------------
Net cash (used in) provided by financing activities................. (164,337) 4,794 (25,815)
---------------- --------------- ----------------
Net (decrease) increase in cash and cash equivalents................ (73,081) 29,162 47,122
Cash and cash equivalents at beginning of year...................... 186,352 157,190 110,068
---------------- --------------- ----------------
Cash and cash equivalents at end of year............................ $ 113,271 $ 186,352 $ 157,190
================ =============== ================
See accompanying notes to consolidated financial statements.
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eighteen
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MGIC Investment Corporation & Subsidiaries-- December 31, 2002, 2001 and 2000
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Nature of business
MGIC Investment Corporation ("Company") is a holding company which, through
Mortgage Guaranty Insurance Corporation ("MGIC") and several other subsidiaries,
is principally engaged in the mortgage insurance business. The Company provides
mortgage insurance to lenders throughout the United States to protect against
loss from defaults on low down payment residential mortgage loans. Through
certain other non-insurance subsidiaries, the Company also provides various
services for the mortgage finance industry, such as contract underwriting and
portfolio analysis and retention.
At December 31, 2002, the Company's direct primary insurance in force
(representing the principal balance in the Company's records of all mortgage
loans that it insures) and direct primary risk in force (representing the
insurance in force multiplied by the insurance coverage percentage), excluding
MGIC Indemnity Corporation ("MIC") was approximately $197.0 billion and $49.2
billion, respectively. In addition to providing direct primary insurance
coverage, the Company also insures pools of mortgage loans. The Company's direct
pool risk in force at December 31, 2002 was approximately $2.6 billion. MIC's
direct primary insurance in force, direct primary risk in force and direct pool
risk in force was approximately $0.4 billion, $0.3 billion and $0.2 billion,
respectively, at December 31, 2002.
2. Basis of presentation and summary of significant accounting policies
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America ("GAAP") requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting periods. Actual results could differ from those
estimates.
Principles of consolidation
The consolidated financial statements include the accounts of MGIC
Investment Corporation and its wholly-owned subsidiaries. All intercompany
transactions have been eliminated. The Company's 45.9% investment in
Credit-Based Asset Servicing and Securitization LLC ("C-BASS") and 45.5%
investment in Sherman Financial Group LLC, ("Sherman"), which are joint ventures
with Radian Group Inc., are accounted for using the equity method of accounting
and recorded on the balance sheet as investments in joint ventures. The
Company's equity earnings from these joint ventures are included in other
revenue. (See note 8.)
The Company has certain other joint ventures and investments, accounted for
in accordance with the equity method of accounting, of an immaterial amount.
Investments
The Company categorizes its investment portfolio according to its ability
and intent to hold the investments to maturity. Investments which the Company
does not have the ability and intent to hold to maturity are considered to be
available-for-sale and are reported at fair value and the related unrealized
gains or losses are, after considering the related tax expense or benefit,
recognized as a component of accumulated other comprehensive income in
shareholders' equity in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 115, Accounting for Certain Investments in Debt and
Equity Securities. The Company's entire investment portfolio is classified as
available-for-sale. Realized investment gains and losses are reported in income
based upon specific identification of securities sold. (See note 4.)
Home office and equipment
Home office and equipment is carried at cost net of depreciation. For
financial statement reporting purposes, depreciation is determined on a
straight-line basis for the home office, equipment and data processing hardware
over estimated lives of 45, 5 and 3 years, respectively. For income tax
purposes, the Company uses accelerated depreciation methods.
Home office and equipment is shown net of accumulated depreciation of $38.6
million and
-------------
nineteen
-------------
- --------------------------------------------------------------------------------
$34.9 million at December 31, 2002 and 2001, respectively. Depreciation expense
for the years ended December 31, 2002, 2001 and 2000 was $5.5 million, $4.9
million and $4.7 million, respectively.
Deferred insurance policy acquisition costs
Costs associated with the acquisition of mortgage insurance business,
consisting of employee compensation and other policy issuance and underwriting
expenses, are initially deferred and reported as deferred insurance policy
acquisition costs ("DAC"). Because SFAS No. 60, Accounting and Reporting by
Insurance Enterprises, specifically excludes mortgage guaranty insurance from
its guidance relating to the amortization of DAC, amortization of these costs
for each underwriting year book of business is charged against revenue in
proportion to estimated gross profits over the estimated life of the policies
using the guidance of SFAS No. 97, Accounting and Reporting by Insurance
Enterprises For Certain Long Duration Contracts and Realized Gains and Losses
From the Sale of Investments. This includes accruing interest on the unamortized
balance of DAC. The estimates for each underwriting year are updated annually to
reflect actual experience and any changes to key assumptions such as persistency
or loss development.
During 2002, 2001 and 2000, the Company amortized $25.9 million, $22.2
million and $20.6 million, respectively, of deferred insurance policy
acquisition costs.
Loss reserves
Reserves are established for reported insurance losses and loss adjustment
expenses based on when notices of default on insured mortgage loans are
received. Reserves are also established for estimated losses incurred on notices
of default not yet reported by the lender. Consistent with industry practices,
the Company does not establish loss reserves for future claims on insured loans
which are not currently in default. Reserves are established by management using
estimated claims rates and claims amounts in estimating the ultimate loss.
Amounts for salvage recoverable are considered in the determination of the
reserve estimates. Adjustments to reserve estimates are reflected in the
financial statements in the years in which the adjustments are made. The
liability for reinsurance assumed is based on information provided by the ceding
companies.
The incurred but not reported ("IBNR") reserves result from defaults
occurring prior to the close of an accounting period, but which have not been
reported to the Company. Consistent with reserves for reported defaults, IBNR
reserves are established using estimated claims rates and claims amounts for the
estimated number of defaults not reported.
Reserves also provide for the estimated costs of settling claims, including
legal and other expenses and general expenses of administering the claims
settlement process. (See note 6.)
Revenue recognition
The insurance subsidiaries write policies which are guaranteed renewable
contracts at the insured's option on a single, annual or monthly premium basis.
The insurance subsidiaries have no ability to reunderwrite or reprice these
contracts. Premiums written on a single premium basis and an annual premium
basis are initially deferred as unearned premium reserve and earned over the
policy term. Premiums written on policies covering more than one year are
amortized over the policy life in accordance with the expiration of risk which
is the anticipated claim payment pattern based on historical experience.
Premiums written on annual policies are earned on a monthly pro rata basis.
Premiums written on monthly policies are earned as coverage is provided.
Fee income of the non-insurance subsidiaries is earned and recognized as
the services are provided and the customer is obligated to pay.
Income taxes
The Company and its subsidiaries file a consolidated federal income tax
return. A formal tax sharing agreement exists between the Company and its
subsidiaries. Each subsidiary determines income taxes based upon the utilization
of all tax deferral elections available. This assumes tax and loss bonds are
purchased and held to the extent they would have been purchased and held on a
separate company basis since the tax sharing agreement provides that the
redemption
-------------
twenty
-------------
----------------------------------
Notes (continued)
----------------------------------
or non-purchase of such bonds shall not increase such member's separate taxable
income and tax liability on a separate company basis.
Federal tax law permits mortgage guaranty insurance companies to deduct
from taxable income, subject to certain limitations, the amounts added to
contingency loss reserves. Generally, the amounts so deducted must be included
in taxable income in the tenth subsequent year. The deduction is allowed only to
the extent that U.S. government non-interest bearing tax and loss bonds are
purchased and held in an amount equal to the tax benefit attributable to such
deduction. The Company accounts for these purchases as a payment of current
federal income taxes.
Deferred income taxes are provided under the liability method, in
accordance with SFAS No. 109, Accounting for Income Taxes, which recognizes the
future tax effects of temporary differences between amounts reported in the
financial statements and the tax bases of these items. The expected tax effects
are computed at the current federal tax rate. (See note 10.)
Benefit plans
The Company has a non-contributory defined benefit pension plan covering
substantially all employees. Retirement benefits are based on compensation and
years of service. The Company's policy is to fund pension cost as required under
the Employee Retirement Income Security Act of 1974. (See note 9.)
The Company accrues the estimated costs of retiree medical and life
benefits over the period during which employees render the service that
qualifies them for benefits. The Company offers both medical and dental benefits
for retired employees and their spouses. Benefits are generally funded on a
pay-as-you-go basis. The cost to the Company was not significant in 2002, 2001
and 2000. (See note 9.)
Stock-based compensation
The Company has certain stock-based compensation plans, as more fully
discussed in Note 11. The Company accounts for these plans under the expense and
measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations. The following table illustrates the
effect on net income and earnings per share if the fair value based method under
SFAS No. 123, Accounting for Stock-Based Compensation, had been applied to all
outstanding and unvested awards in each period (in thousands, except per share
amounts).
Years Ended December 31,
-----------------------------------
2002 2001 2000
---------- ---------- -----------
Net income, as reported... $ 629,191 $ 639,137 $ 541,999
Add stock-based employee
compensation expense
included in reported
earning, net of tax..... 2,610 2,038 1,840
Deduct stock-based
employee compensation
expense, determined
under the fair value
method, net of tax...... (12,425) (13,483) (11,374)
---------- ---------- -----------
Pro forma net income...... $ 619,376 $ 627,692 $ 532,465
========== ========== ===========
Earnings per share:
Basic, as reported...... $ 6.07 $ 5.98 $ 5.10
Basic, pro forma........ $ 5.97 $ 5.87 $ 5.01
Diluted, as reported.... $ 6.04 $ 5.93 $ 5.05
Diluted, pro forma...... $ 5.94 $ 5.82 $ 4.96
Reinsurance
Loss reserves and unearned premiums are reported before taking credit for
amounts ceded under reinsurance treaties. Ceded loss reserves are reflected as
"Reinsurance recoverable on loss reserves." Ceded unearned premiums are
reflected as "Reinsurance recoverable on unearned premiums." The Company remains
contingently liable for all reinsurance ceded. (See note 7.)
Earnings per share
The Company's basic and diluted earnings per share ("EPS") have been
calculated in accordance with SFAS No. 128, Earnings Per Share. The Company's
net income is the same for both basic and diluted EPS. Basic EPS is based on the
weighted-average number of common shares outstanding. Diluted EPS is based on
the weighted-average number of common shares outstanding and common stock
equivalents which would arise from the exercise of stock options. The following
is a reconciliation of the weighted-average number of shares used for basic EPS
and diluted EPS. (See note 11.)
-------------
twenty-one
-------------
- --------------------------------------------------------------------------------
Years Ended December 31,
-----------------------------------
2002 2001 2000
---------- ---------- -----------
(shares in thousands)
Weighted-average shares - 103,725 106,941 106,202
Basic
Common stock equivalents 489 854 1,058
---------- ---------- -----------
Weighted-average shares -
Diluted 104,214 107,795 107,260
========== ========== ===========
Statement of cash flows
For purposes of the consolidated statement of cash flows, the Company
considers short-term investments with original maturities of three months or
less to be cash equivalents.
Comprehensive income
The Company's total comprehensive income, as calculated per SFAS No. 130,
Reporting Comprehensive Income, was as follows:
Years Ended December 31,
-----------------------------------
2002 2001 2000
---------- ---------- -----------
(in thousands of dollars)
Net income................... $ 629,191 $ 639,137 $ 541,999
Other comprehensive
income (loss).............. 101,264 (29,170) 116,549
---------- ---------- -----------
Total comprehensive $ 730,455 $ 609,967 $ 658,548
income
========== ========== ===========
Other comprehensive
income (loss) (net of tax):
Cumulative effect - SFAS
No. 133.................. $ N/A $ (5,982) $ N/A
Net derivative losses...... (1,524) (2,919) N/A
Amortization of deferred
losses 1,082 1,082 N/A
Unrealized gain (loss) on
investments.............. 114,724 (21,351) 116,549
Minimum pension liability
adjustment............... (13,018) - -
---------- ---------- -----------
Other comprehensive
income (loss).............. $ 101,264 $ (29,170) $ 116,549
========== ========== ===========
The difference between the Company's net income and total comprehensive
income for the years ended December 31, 2002, 2001 and 2000 is due to the change
in unrealized appreciation/ depreciation on investments, the cumulative effect
of the adoption of SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, the fair value adjustment and amortization of deferred
losses relating to derivative financial instruments and a minimum pension
liability adjustment, all net of tax. At December 31, 2002, accumulated other
comprehensive income of $147.9 million includes $169.2 million of net unrealized
gains on investments, ($13.0) million relating to the minimum pension liability
and ($8.3) million relating to derivative financial instruments. (See notes 4, 5
and 9.)
Recent accounting pronouncements
The Company adopted SFAS No. 133 effective January 1, 2001. The statement
establishes accounting and reporting standards for derivative instruments and
for hedging activities. The adoption of SFAS No. 133 did not have a significant
effect on the Company's results of operations or its financial position due to
its limited use of derivative instruments. (See note 5.)
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible
Assets. Under SFAS No. 142, goodwill and intangible assets with indefinite
useful lives are no longer amortized, but rather, are subject to review for
impairment. The Company adopted SFAS No. 142, effective January 1, 2002. The
adoption had an immaterial impact on the Company's financial statements.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets, which is effective for fiscal years beginning
after December 15, 2001. Adoption of SFAS No. 144 in 2002 had no effect on the
Company's financial statements.
Reclassifications
Certain reclassifications have been made in the accompanying financial
statements to 2001 and 2000 amounts to allow for consistent financial reporting.
3. Related party transactions
The Company provided certain services to C-BASS in 2002, 2001 and 2000 in
exchange for an immaterial amount of fees. In addition, C-BASS provided certain
services to the Company during 2002, 2001 and 2000 in exchange for an immaterial
amount of fees.
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twenty-two
-------------
----------------------------------
Notes (continued)
----------------------------------
4. Investments
The following table summarizes the Company's investments at December 31,
2002 and 2001:
Financial
Amortized Fair Statement
Cost Value Value
--------------- --------------- ---------------
(In thousands of dollars)
At December 31, 2002:
Securities, available-for-sale:
Fixed maturities........................................................ $ 4,353,174 $ 4,613,462 $ 4,613,462
Equity securities....................................................... 10,779 10,780 10,780
Short-term investments.................................................. 102,230 102,230 102,230
--------------- --------------- --------------
Total investment portfolio................................................ $ 4,466,183 $ 4,726,472 $ 4,726,472
=============== =============== ==============
At December 31, 2001:
Securities, available-for-sale:
Fixed maturities........................................................ $ 3,804,274 $ 3,888,740 $ 3,888,740
Equity securities....................................................... 21,481 20,747 20,747
Short-term investments.................................................. 159,901 159,960 159,960
--------------- --------------- --------------
Total investment portfolio................................................ $ 3,985,656 $ 4,069,447 $ 4,069,447
=============== =============== ===============
The amortized cost and fair value of investments at December 31, 2002 are as
follows:
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2002: Cost Gains Losses Value
--------------- --------------- --------------- ---------------
(In thousands of dollars)
U.S. Treasury securities and obligations of U.S. government
corporations and agencies................................ $ 392,346 $ 11,929 $ (3) $ 404,272
Obligations of states and political subdivisions............ 3,725,062 232,487 (1,267) 3,956,282
Corporate securities........................................ 247,828 12,586 (100) 260,314
Mortgage-backed securities.................................. 76,154 2,971 (5) 79,120
Debt securities issued by foreign sovereign governments..... 14,014 1,690 - 15,704
--------------- --------------- --------------- ---------------
Total debt securities.................................... 4,455,404 261,663 (1,375) 4,715,692
Equity securities........................................... 10,779 1 - 10,780
--------------- --------------- --------------- ---------------
Total investment portfolio............................... $ 4,466,183 $ 261,664 $ (1,375) $ 4,726,472
=============== =============== =============== ===============
The amortized cost and fair value of investments at December 31, 2001 are as
follows:
Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2001: Cost Gains Losses Value
--------------- --------------- --------------- ---------------
(In thousands of dollars)
U.S. Treasury securities and obligations of U.S. government
corporations and agencies................................ $ 307,761 $ 3,486 $ (5,799) $ 305,448
Obligations of states and political subdivisions............ 2,998,688 85,336 (14,513) 3,069,511
Corporate securities........................................ 564,659 15,201 (1,497) 578,363
Mortgage-backed securities.................................. 79,082 1,089 - 80,171
Debt securities issued by foreign sovereign governments..... 13,985 1,222 - 15,207
--------------- --------------- --------------- ---------------
Total debt securities.................................... 3,964,175 106,334 (21,809) 4,048,700
Equity securities........................................... 21,481 - (734) 20,747
--------------- --------------- --------------- ---------------
Total investment portfolio............................... $ 3,985,656 $ 106,334 $ (22,543) $ 4,069,447
=============== =============== =============== ===============
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twenty-three
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The amortized cost and fair values of debt securities at December 31, 2002,
by contractual maturity, are shown below. Debt securities consist of fixed
maturities and short-term investments. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
Amortized Fair
Cost Value
------------- ------------
(In thousands of dollars)
Due in one year or less........ $ 174,754 $ 175,766
Due after one year through
five years................... 738,608 774,812
Due after five years through
ten years.................... 1,039,705 1,108,558
Due after ten years............ 2,426,183 2,577,436
------------- ------------
4,379,250 4,636,572
Mortgage-backed securities..... 76,154 79,120
------------- ------------
Total at December 31, 2002..... $ 4,455,404 $ 4,715,692
============= ============
Net investment income is comprised of the following:
2002 2001 2000
----------- ----------- ----------
(In thousands of dollars)
Fixed maturities....... $ 199,472 $ 195,821 $ 167,810
Equity securities...... 3,707 2,953 1,279
Short-term investments. 5,611 6,863 10,673
Other ................. 832 495 341
----------- ----------- ----------
Investment income...... 209,622 206,132 180,103
Investment expenses.... (2,106) (1,739) (1,568)
----------- ----------- ----------
Net investment income.. $ 207,516 $ 204,393 $ 178,535
=========== =========== ==========
The net realized investment gains (losses) and change in net unrealized
appreciation (depreciation) of investments are as follows:
2002 2001 2000
---------- ---------- ----------
(In thousands of dollars)
Net realized investment
gains (losses), on sale
of investments:
Fixed maturities........ $ 38,357 $ 38,199 $ 1,440
Equity securities....... (9,283) (876) -
Short-term investments.. 39 29 (8)
---------- ---------- ----------
29,113 37,352 1,432
---------- ---------- ----------
Change in net unrealized
appreciation
(depreciation):
Fixed maturities........ 175,822 (32,032) 182,387
Equity securities....... 735 (873) (3,084)
Short-term investments.. (59) 59 -
---------- ---------- ----------
176,498 (32,846) 179,303
---------- ---------- ----------
Net realized investment
gains (losses) and change
in net unrealized $ 205,611 $ 4,506 $ 180,735
appreciation (depreciation) ========== ========== ==========
The gross realized gains and the gross realized losses on sales of
securities were $47.2 million and $18.1 million, respectively, in 2002, $50.8
million and $13.4 million, respectively, in 2001 and $18.2 million and $16.8
million, respectively, in 2000.
The tax (benefit) expense of the changes in net unrealized (depreciation)
appreciation was $61.8 million, ($11.5) million and $62.8 million for 2002, 2001
and 2000, respectively.
5. Short- and long-term debt
During the first quarter of 2001, the Company established a $200 million
commercial paper program, which was rated `A-1' by Standard and Poors ("S&P")
and `P-1' by Moody's. At December 31, 2002 and 2001, the Company had $177.3
million and $172.1 million in commercial paper outstanding with a weighted
average interest rate of 1.46% and 1.91% at December 31, 2002 and 2001,
respectively.
The Company had a $285 million credit facility available at December 31,
2002, expiring in 2006. Under the terms of the credit facility, as amended in
July 2002, the Company must maintain shareholders' equity of at least $2.25
billion and MGIC must maintain a risk-to-capital ratio of not more than 22:1 and
maintain policyholders' position (which includes MGIC's surplus and its
contingency reserve) of not less than the amount required by Wisconsin insurance
regulation. At December 31, 2002, the Company met these requirements. The
facility is currently being used as a liquidity back-up facility for the
outstanding commercial paper. The remaining credit available under the facility
after reduction for the amount necessary to support the commercial paper was
$107.7 million at December 31, 2002.
In March of 2002, the Company issued, in a public offering, $200 million,
6% Senior Notes due in 2007. The notes are unsecured and were rated `A1' by
Moody's, `A+' by S&P and `AA-' by Fitch. The Company had $300 million, 7.5%
Senior Notes due in 2005 outstanding at December 31, 2002 and 2001.
-------------
twenty-four
-------------
----------------------------------
Notes (continued)
----------------------------------
Interest payments on all long-term and short-term debt were $36.2 million,
$22.6 million and $27.1 million for the years ended December 31, 2002, 2001 and
2000, respectively. At December 31, 2002, the market value of the outstanding
debt is $721.9 million.
The Company uses interest rate swaps to hedge interest rate exposure
associated with its short- and long-term debt. In 2000, the Company paid an
interest rate based on LIBOR and received a fixed rate of 7.5% to hedge the
5-year Senior Notes issued in the fourth quarter of 2000. These swaps were
terminated in September 2001. In January 2002, the Company initiated a new swap
which was designated as a fair value hedge of the 7.5% Senior Notes. This swap
was terminated in June 2002. In May 2002, a swap designated as a cash flow hedge
was amended to coincide with the new credit facility. Under the terms of the
swap contract, the Company pays a fixed rate of 5.43% and receives an interest
rate based on LIBOR. The swap has an expiration date coinciding with the
maturity of the credit facility and is designated as a cash flow hedge. Gains or
losses arising from the amendment or termination of interest rate swaps are
deferred and amortized to interest expense over the life of the hedged items.
Expenses on the swaps during 2002 and 2001, of approximately $1.8 million and
$3.7 million, respectively, were included in interest expense. The cash flow
swap outstanding at December 31, 2002 and 2001 is evaluated quarterly using
regression analysis with any ineffectiveness being recorded as an expense. To
date this evaluation has not resulted in any hedge ineffectiveness. The swaps
are subject to credit risk to the extent the counterparty would be unable to
discharge its obligations under the swap agreements.
6. Loss reserves
Loss reserve activity was as follows:
2002 2001 2000
----------- ----------- ------------
(In thousands of dollars)
Reserve at beginning
of year $ 613,664 $ 609,546 $ 641,978
Less reinsurance
recoverable............. 26,888 33,226 35,821
----------- ----------- ------------
Net reserve at beginning
of year................. 586,776 576,320 606,157
Reserve transfer (1)...... - - 85
----------- ----------- ------------
Adjusted reserve at
beginning of year....... 586,776 576,320 606,242
Losses incurred:
Losses and LAE incurred
in respect of default
notices received in:
Current year........ 440,004 372,940 320,769
Prior years (2)..... (74,252) (212,126) (229,046)
----------- ----------- ------------
Subtotal.......... 365,752 160,814 91,723
----------- ----------- ------------
Losses paid:
Losses and LAE paid in
respect of default
notices received in:
Current year........ 19,546 14,047 9,044
Prior years......... 220,846 136,311 112,601
----------- ----------- ------------
Subtotal.......... 240,392 150,358 121,645
----------- ----------- ------------
Net reserve at end of year 712,136 586,776 576,320
Plus reinsurance
recoverables.............. 21,045 26,888 33,226
----------- ----------- ------------
Reserve at end of year.... $ 733,181 $ 613,664 $ 609,546
=========== =========== ============
(1) Received in conjunction with the cancellation of certain reinsurance
treaties. (See note 7.)
(2) A negative number for a prior year indicates a redundancy of loss reserves,
and a positive number for a prior year indicates a deficiency of loss
reserves.
The top portion of the table above shows losses incurred on default notices
received in the current year and in prior years, respectively. The amount of
losses incurred relating to default notices received in the current year
represents the estimated amount to be ultimately paid on such default notices.
The amount of losses incurred relating to default notices received in prior
years represents an adjustment made in the current year for defaults which were
included in the loss reserve at the end of the prior year.
Current year losses incurred increased from 2001 to 2002 primarily due to
an increase in the primary notice inventory related to bulk default activity and
defaults arising from the early development of the 2000 and 2001 flow books of
business as well as a modest increase in losses paid. The primary insurance
notice inventory increased from 54,653 at December 31, 2001 to 73,648 at
December 31, 2002 and pool insurance notice
-------------
twenty-five
-------------
- --------------------------------------------------------------------------------
inventory increased from 23,623 at December 31, 2001 to 26,676 at December 31,
2002. The average claim paid for 2002 was $20,115 compared to $18,607 in 2001.
In 2002, the primary determinant of incurred losses has been the level and
composition of the notice inventory, rather than claim severity.
The favorable development of the reserves in 2002, 2001 and 2000 is
reflected in the prior year line, and results from the actual claim rates and
actual claim amounts being lower than those estimated by the Company when
originally establishing the reserve at December 31, 2001, 2000 and 1999,
respectively.
The lower portion of the table above shows the breakdown between claims
paid on default notices received in the current year and default notices
received in prior years. Since it takes, on average, about twelve months for a
default which is not cured to develop into a paid claim, most losses paid relate
to default notices received in prior years.
Information about the composition of the primary insurance default
inventory at December 2002 and 2001 appears in the table below.
December 31, December 31,
2002 2001
------------- ------------
Total loans delinquent......... 73,648 54,653
Percentage of loans delinquent
(default rate)............... 4.45% 3.46%
Flow loans delinquent.......... 43,196 36,193
Percentage of flow loans
delinquent (default rate).... 3.19% 2.65%
Bulk loans delinquent.......... 30,452 18,460
Percentage of bulk loans
delinquent (default rate).... 10.09% 8.59%
A-minus and subprime credit
loans delinquent (1)......... 25,504 15,649
Percentage of A-minus and
subprime credit loans
delinquent (default rate).... 12.68% 11.60%
(1) A portion of A-minus and subprime credit loans is included in flow loans
delinquent and the remainder is included in bulk loans delinquent. Most
A-minus and subprime credit loans are written through the bulk channel.
7. Reinsurance
The Company cedes a portion of its business to reinsurers and records
assets for reinsurance recoverable on estimated reserves for unpaid losses and
unearned premiums. Business written between 1985 and 1993 is ceded under various
quota share reinsurance agreements with several reinsurers. The Company receives
a ceding commission in connection with this reinsurance. Beginning in 1997, the
Company has ceded business to captive reinsurance subsidiaries of certain
mortgage lenders primarily under excess of loss agreements.
The reinsurance recoverable on loss reserves and the reinsurance
recoverable on unearned premiums primarily represent amounts recoverable from
large international reinsurers. The Company monitors the financial strength of
its reinsurers including their claims paying ability rating and does not
currently anticipate any collection problems. Generally, reinsurance
recoverables on loss reserves and unearned premiums are backed by trust funds or
letters of credit. No reinsurer represents more than $10 million of the
aggregate amount recoverable.
The effect of these agreements on premiums earned and losses incurred is as
follows:
2002 2001 2000
------------ ------------ ------------
(In thousands of dollars)
Premiums earned:
Direct.............. $ 1,296,548 $ 1,107,168 $ 939,981
Assumed............. 448 686 999
Ceded .............. (114,898) (65,587) (50,889)
------------ ------------ ------------
Net premiums earned. $ 1,182,098 $ 1,042,267 $ 890,091
============ ============ ============
Losses incurred:
Direct.............. $ 367,149 $ 157,360 $ 93,218
Assumed............. (208) (123) 35
Ceded .............. (1,189) 3,577 (1,530)
------------ ------------ ------------
Net losses incurred. $ 365,752 $ 160,814 $ 91,723
============ ============ ============
8. Investments in joint ventures
C-BASS is a mortgage investment and servicing firm specializing in
credit-sensitive single-family residential mortgage assets and residential
mortgage-backed securities. C-BASS principally invests in whole loans (including
subprime loans) and mezzanine and subordinated residential mortgage-backed
securities backed by non-conforming residential mortgage loans. C-BASS's
principal sources of revenues during the last three years were gains on
securitization and liquidation of mortgage-related assets, servicing fees and
net interest income (including accretion on mortgage securities),
-------------
twenty-six
-------------
----------------------------------
Notes (continued)
----------------------------------
which revenue items were offset by unrealized losses. C-BASS's results of
operations are affected by the timing of its securitization transactions.
Virtually all of C-BASS's assets do not have readily ascertainable market values
and, as a result, their value for financial statement purposes is estimated by
the management of C-BASS. These estimates reflect the net present value of the
future expected cash flows from the assets, which in turn depend on, among other
things, estimates of the level of losses on the underlying mortgages and
prepayment activity by the mortgage borrowers. Market value adjustments could
impact C-BASS's results of operations and the Company's share of those results.
Total consolidated assets of C-BASS at December 31, 2002 and 2001 were
approximately $1.8 billion and $1.3 billion, respectively. Total liabilities at
December 31, 2002 and 2001 were approximately $1.4 billion and $1.0 billion,
respectively, of which approximately $1.1 billion and $0.9 billion,
respectively, were funding arrangements, including accrued interest, virtually
all of which mature within one year or less. For the years ended December 31,
2002 and 2001, revenues of approximately $311 million and $216 million,
respectively, and expenses of approximately $173 million and $130 million,
respectively, resulted in income before tax of approximately $138 million and
$86 million, respectively. The Company's investment in C-BASS on an equity basis
at December 31, 2002 was $168.7 million.
Sherman is engaged in the business of purchasing and servicing delinquent
consumer assets such as credit card loans and Chapter 13 bankruptcy debt. A
substantial portion of Sherman's consolidated assets are investments in consumer
receivable portfolios that do not have readily ascertainable market values.
Sherman's results of operations are sensitive to estimates by Sherman's
management of ultimate collections on these portfolios. The Company's investment
in Sherman on an equity basis at December 31, 2002 was $54.4 million.
Because C-BASS and Sherman are accounted for by the equity method, they are
not consolidated with the Company and their assets and liabilities do not appear
in the Company's balance sheet. The "investments in joint ventures" item in the
Company's balance sheet reflects the amount of capital contributed by the
Company to the joint ventures plus the Company's share of their net income (or
minus its share of their net loss) and minus capital distributed to the Company
by the joint ventures. (See note 2.)
-------------
twenty-seven
-------------
- --------------------------------------------------------------------------------
9. Benefit plans
The following tables provide reconciliations of the changes in the benefit
obligation, fair value of plan assets and funded status of the pension and other
postretirement benefit plans:
Other Postretirement
Pension Benefits Benefits
-------------------------- --------------------------
2002 2001 2002 2001
------------ ----------- ------------ ------------
(In thousands of dollars)
Reconciliation of benefit obligation:
Benefit obligation at beginning of year................................. $ 91,629 $ 74,182 $ 36,732 $ 27,924
Service cost......................................................... 6,580 5,113 3,136 2,065
Interest cost........................................................ 6,585 5,518 2,711 2,056
Plan amendment (1)................................................... 2,092 1,202 - -
Actuarial loss (gain)................................................ 5,708 6,838 4,361 5,336
Benefits paid........................................................ (1,409) (1,224) (630) (649)
------------ ----------- ------------ ------------
Benefit obligation at end of year....................................... $ 111,185 $ 91,629 $ 46,310 $ 36,732
============ =========== ============ ============
Reconciliation of fair value of plan assets:
Fair value of plan assets at beginning of year.......................... $ 90,159 $ 86,285 $ 14,102 $ 13,556
Actual return on plan assets......................................... (17,288) (4,385) (3,004) (1,095)
Employer contributions............................................... 19,703 9,483 2,088 1,641
Benefits paid........................................................ (1,409) (1,224) - -
------------ ----------- ------------ ------------
Fair value of plan assets at end of year................................ $ 91,165 $ 90,159 $ 13,186 $ 14,102
============ =========== ============ ============
Reconciliation of funded status:
Benefit obligation at end of year....................................... $ (111,185) $ (91,629) $ (46,310) $ (36,732)
Fair value of plan assets at end of year................................ 91,165 90,159 13,186 14,102
------------ ----------- ------------ ------------
Funded status at end of year............................................ (20,020) (1,470) (33,124) (22,630)
Unrecognized net actuarial loss (gain)............................... 38,506 8,935 12,346 4,075
Unrecognized net transition obligation............................... - - 5,299 5,829
Unrecognized prior service cost...................................... 4,448 2,864 - -
------------ ----------- ------------ ------------
Net amount recognized................................................... $ 22,934 $ 10,329 $ (15,479) $ (12,726)
============ =========== ============ ============
(1) The plan has been amended to provide additional benefits for certain participants as listed in the plan
documents and for the increased benefit and salary limits on the projected benefit obligation.
The following table provides the components of net periodic benefit cost
for the pension and other postretirement benefit plans:
Other Postretirement
Pension Benefits Benefits
----------------------------------------- -----------------------------------------
2002 2001 2000 2002 2001 2000
------------ ------------ ------------ ------------ ------------ ------------
(In thousands of dollars)
Service cost................................. $ 6,580 $ 5,113 $ 4,734 $ 3,137 $ 2,065 $ 1,943
Interest cost................................ 6,585 5,518 4,885 2,711 2,056 1,831
Expected return on plan assets............... (6,712) (6,350) (6,496) (1,058) (1,016) (1,009)
Recognized net actuarial loss (gain)......... 32 (27) (520) 152 (54) (146)
Amortization of transition obligation........ - - 32 530 530 530
Amortization of prior service cost........... 507 232 183 - - -
------------ ------------ ------------ ------------ ------------ ------------
Net periodic benefit cost.................... $ 6,992 $ 4,486 $ 2,818 $ 5,472 $ 3,581 $ 3,149
============ ============ ============ ============ ============ ============
The assumptions used in the measurement of the Company's pension and other
postretirement benefit obligations are shown in the following table:
-------------
twenty-eight
-------------
----------------------------------
Notes (continued)
----------------------------------
Other Postretirement
Pension Benefits Benefits
---------------------------------------- ---------------------------------------
2002 2001 2000 2002 2001 2000
------------ ------------ ----------- ---------- ------------ ------------
Weighted-average interest rate assumptions as
of December 31:
Discount rate............................. 6.75% 7.00% 7.50% 6.75% 7.00% 7.50%
Expected return on plan assets............ 7.50% 7.50% 7.50% 7.50% 7.50% 7.50%
Rate of compensation increase............. 4.50% 6.00% 6.00% N/A N/A N/A
Plan assets consist of fixed maturities and equity securities. The Company
is amortizing the unrecognized transition obligation for other postretirement
benefits over 20 years.
The assumed health care cost trend rates used in measuring the accumulated
postretirement benefit obligation are:
Medical.......... 8.5% for 2002 graded down by 0.5% per year to 6.0% in 2007
and remaining level thereafter.
Dental........... 6.0% per year.
A 1% change in the health care trend rate assumption would have the
following effects on other postretirement benefits:
1-Percentage 1-Percentage
Point Point
Increase Decrease
-------------- -------------
(In thousands of dollars)
Effect on total service and
interest cost components.... $ 1,382 $ (1,103)
Effect on postretirement
benefit obligation.......... 9,895 (7,932)
The Company has a profit sharing and 401(k) savings plan for employees. At
the discretion of the Board of Directors, the Company may make a profit sharing
contribution of up to 5% of each participant's compensation. The Company
provides a matching 401(k) savings contribution on employees' before-tax
contributions at a rate of 80% of the first $1,000 contributed and 40% of the
next $2,000 contributed. Profit sharing costs and the Company's matching
contributions to the 401(k) savings plan were $6.3 million, $5.8 million and
$4.7 million in 2002, 2001 and 2000, respectively.
10. Income taxes
The components of the net deferred tax liability as of December 31, 2002 and
2001 are as follows:
2002 2001
----------- -----------
(In thousands of dollars)
Unearned premium reserves............ $ (14,470) $ (11,269)
Deferred policy acquisition costs.... 11,155 11,244
Loss reserves........................ (6,163) (4,009)
Unrealized appreciation 86,653 25,116
in investments.....................
Contingency loss reserves............ 43,268 50,018
Mortgage investments................. 57,829 45,966
Litigation settlement................ (7,918) (7,918)
Investments in joint ventures........ (9,804) 3,074
Other, net........................... (12,145) (5,772)
----------- -----------
Net deferred tax liability........... $ 148,405 $ 106,450
=========== ===========
At December 31, 2002, gross deferred tax assets and liabilities amount to
$87.0 million and $235.4 million, respectively. Management believes that all
gross deferred tax assets at December 31, 2002 are fully realizable and no
valuation reserve is established.
The following summarizes the components of the provision for income tax:
2002 2001 2000
----------- ----------- -----------
(In thousands of dollars)
Federal:
Current.............. $ 277,536 $ 248,679 $ 208,949
Deferred............. (12,572) 40,376 34,476
State.................. 3,487 3,718 3,377
----------- ----------- -----------
Provision for income $ 268,451 $ 292,773 $ 246,802
tax
=========== =========== ===========
The Company paid $261.3 million, $271.3 million and $199.9 million in
federal income tax in 2002, 2001 and 2000, respectively. At December 31, 2002
and 2001, the Company owned $1,181.9 million and $1,004.3 million, respectively,
of tax and loss bonds.
-------------
twenty-nine
-------------
- --------------------------------------------------------------------------------
The reconciliation of the tax provision computed at the federal tax rate of
35% to the reported provision for income tax is as follows:
2002 2001 2000
----------- ----------- -----------
(In thousands of dollars)
Tax provision computed
at federal tax rate.. $ 314,175 $ 326,169 $ 276,080
(Decrease) increase in
tax provision resulting
from:
Tax exempt
municipal bond (46,381) (35,715) (32,350)
interest.........
Other, net......... 657 2,319 3,072
----------- ----------- -----------
Provision for income $ 268,451 $ 292,773 $ 246,802
tax
=========== =========== ===========
11. Shareholders' equity and dividend restrictions
The Company's insurance subsidiaries are subject to statutory regulations
as to maintenance of policyholders' surplus and payment of dividends. The
maximum amount of dividends that the insurance subsidiaries may pay in any
twelve-month period without regulatory approval by the Office of the
Commissioner of Insurance of the State of Wisconsin ("OCI") is the lesser of
adjusted statutory net income or 10% of statutory policyholders' surplus as of
the preceding calendar year end. Adjusted statutory net income is defined for
this purpose to be the greater of statutory net income, net of realized
investment gains, for the calendar year preceding the date of the dividend or
statutory net income, net of realized investment gains, for the three calendar
years preceding the date of the dividend less dividends paid within the first
two of the preceding three calendar years. As the result of an extraordinary
dividend paid by MGIC in February 2002, MGIC cannot pay any dividends without
regulatory approval until February 16, 2003. Thereafter, MGIC can pay $154.8
million of dividends. The other insurance subsidiaries of the Company can pay
$8.7 million of dividends without such regulatory approval.
Certain of the Company's non-insurance subsidiaries also have requirements
as to maintenance of net worth. These restrictions could also affect the
Company's ability to pay dividends.
In 2002, 2001 and 2000, the Company paid dividends of $10.4 million, $10.7
million and $10.6 million, respectively, or $0.10 per share in 2002, 2001 and
2000.
The principles used in determining statutory financial amounts differ from
GAAP, primarily for the following reasons:
Under statutory accounting practices, mortgage guaranty insurance companies
are required to maintain contingency loss reserves equal to 50% of premiums
earned. Such amounts cannot be withdrawn for a period of ten years except
as permitted by insurance regulations. Contingency loss reserves are not
reflected as liabilities under GAAP.
Under statutory accounting practices, insurance policy acquisition costs
are charged against operations in the year incurred. Under GAAP, these
costs are deferred and amortized as the related premiums are earned
commensurate with the expiration of risk.
Under statutory accounting practices, purchases of tax and loss bonds are
accounted for as investments. Under GAAP, purchases of tax and loss bonds
are recorded as payments of current income taxes.
Under statutory accounting practices, fixed maturity investments are
generally valued at amortized cost. Under GAAP, those investments which the
Company does not have the ability and intent to hold to maturity are
considered to be available-for-sale and are recorded at market, with the
unrealized gain or loss recognized, net of tax, as an increase or decrease
to shareholders' equity.
Under statutory accounting practices, certain assets, designated as
non-admitted assets, are charged directly against statutory surplus. Such
assets are reflected on the GAAP financial statements.
-------------
thirty
-------------
----------------------------------
Notes (continued)
----------------------------------
The statutory net income, equity and the contingency reserve liability of the
insurance subsidiaries (excluding the non-insurance companies) are as follows:
Year Ended Net Contingency
December 31, Income Equity Reserve
- -------------- ----------- ------------ ------------
(In thousands of dollars)
2002 $ 296,595 $ 1,634,707 $ 3,521,100
2001 426,294 1,451,808 3,039,332
2000 348,137 991,343 2,616,653
Effective January 1, 2001, the OCI required that insurance companies
domiciled in the State of Wisconsin prepare their statutory basis financial
statements in accordance with new guidance contained in the National Association
of Insurance Commissioners' "Accounting Practices and Procedures Manual" version
effective on that date. The effect of the adoption in 2001 did not have a
material impact on the Company's insurance subsidiaries' statutory surplus. The
most significant change affecting surplus is the requirement to record deferred
income taxes.
The Company has 1991 and 2002 stock incentive plans. When the 2002 plan was
adopted in 2002, no further awards could be made under the 1991 plan. The number
of shares covered by awards under the 2002 plan is the total of 10 million
shares plus the number of shares covered by awards under the 1991 plan that were
outstanding on March 1, 2002 that are subsequently forfeited and the number of
shares that must be purchased at a purchase price of not less than the fair
market value of the shares as a condition to the award of restricted stock under
the 2002 plan. The maximum number of shares of restricted stock that can be
awarded under the 2002 plan is 1 million shares. Both plans provide for the
award of stock options with maximum terms of 10 years and for the grant of
restricted stock, and the 2002 plan also provides for the grant of stock
appreciation rights. The exercise price of options is the closing price of the
common stock on the New York Stock Exchange on the date of grant. The vesting
provisions of options and restricted stock are determined at the time of grant.
Directors may receive awards under the 2002 plan and were eligible for awards of
restricted stock under the 1991 plan.
No awards under the 2002 plan were made in 2002. A summary of activity in
the 1991 stock option plans during 2000, 2001 and 2002 is as follows:
Weighted
Average Shares
Exercise Subject to
Price Option
----------- -------------
Outstanding, December 31, 1999... $ 30.52 3,546,264
Granted....................... 45.40 954,000
Exercised..................... 16.91 (1,080,208)
Canceled...................... 37.96 (35,060)
-----------
Outstanding, December 31, 2000... 38.96 3,384,996
-----------
Granted....................... 57.90 533,750
Exercised..................... 29.28 (555,952)
Canceled...................... 44.15 (25,107)
-----------
Outstanding, December 31, 2001... 43.56 3,337,687
-----------
Granted....................... 63.86 818,000
Exercised..................... 34.46 (516,828)
Canceled...................... 49.32 (51,300)
-----------
Outstanding, December 31, 2002... 49.42 3,587,559
===========
The exercise price of the options granted in 2000, 2001 and 2002 was equal
to the market value of the stock on the date of grant. The options are
exercisable between one and ten years after the date of grant. At December 31,
2002, 10,052,621 shares were available for future grant under the stock option
plan.
Information about restricted stock granted during 2002, 2001 and 2000 is as
follows:
Year Ended December 31,
--------------------------------------
2002 2001 2000
----------- ---------- -----------
Shares granted........ 95,638 58,180 78,598
Weighted average grant
date fair market
value.............. $ 64.33 $ 57.93 $ 42.57
For purposes of determining the pro forma net income disclosure in Note 2,
as if compensation expense were determined using the fair value method described
in SFAS No. 123, the fair value of these options was estimated at grant date
using the Black-Scholes option pricing model with the following weighted average
assumptions for each year:
Grants Issued in Year Ended December 31,
-------------------------------------
2002 2001 2000
----------- ----------- -----------
Risk free interest rate 4.51% 5.10% 6.75%
Expected life.......... 5.0 years 5.0 years 6.8 years
Expected volatility.... 41.96% 39.64% 33.62%
Expected dividend yield 0.24% 0.16% 0.15%
Fair value of each $27.15 $24.43 $21.96
option.................
The following is a summary of stock options outstanding at December 31,
2002:
-------------
thirty-one
-------------
- --------------------------------------------------------------------------------
Options Outstanding Options Exercisable
----------------------------- -------------------
Remaining Weighted Weighted
Average Average Average
Exercise Life Exercise Exercise
Price Range Shares (yrs.) Price Shares Price
- --------------- --------- --------- -------- --------- ---------
$9.63-$20.88 67,600 1.1 $15.69 67,600 $ 15.69
$26.69-$47.31 2,073,609 5.8 41.86 1,263,809 39.77
$53.70-$68.63 1,446,350 8.4 61.83 208,150 61.32
--------- ---------
Total 3,587,559 6.8 49.42 1,539,559 41.62
========= =========
At December 31, 2001 and 2000, option shares of 1,486,768 and 1,229,038 were
exercisable at an average exercise price of $37.55 and $31.93, respectively. The
Company also granted an immaterial amount of equity instruments other than
options and restricted stock during 2000, 2001 and 2002.
Under terms of the Company's Shareholder Rights Agreement each outstanding
share of the Company's Common Stock is accompanied by one Right. The
"Distribution Date" occurs ten days after an announcement that a person has
become the beneficial owner (as defined in the Agreement) of the Designated
Percentage of the Company's Common Stock (the date on which such an acquisition
occurs is the "Shares Acquisition Date" and a person who makes such an
acquisition is an "Acquiring Person"), or ten business days after a person
announces or begins a tender offer in which consummation of such offer would
result in ownership by a person of 15 percent or more of the Common Stock. The
Designated Percentage is 15% or more, except that for certain investment
advisers and investment companies advised by such advisers, the Designated
Percentage is 17.5% or more if certain conditions are met. The Rights are not
exercisable until the Distribution Date. Each Right will initially entitle
shareholders to buy one-half of one share of the Company's Common Stock at a
Purchase Price of $225 per full share (equivalent to $112.50 for each one-half
share), subject to adjustment. If there is an Acquiring Person, then each Right
(subject to certain limitations) will entitle its holder to purchase, at the
Rights' then-current Purchase Price, a number of shares of Common Stock of the
Company (or if after the Shares Acquisition Date, the Company is acquired in a
business combination, common shares of the acquiror) having a market value at
the time equal to twice the Purchase Price. The Rights will expire on July 22,
2009, subject to extension. The Rights are redeemable at a price of $0.001 per
Right at any time prior to the time a person becomes an Acquiring Person. Other
than certain amendments, the Board of Directors may amend the Rights in any
respect without the consent of the holders of the Rights.
12. Leases
The Company leases certain office space as well as data processing equipment
and autos under operating leases that expire during the next seven years.
Generally, all rental payments are fixed.
Total rental expense under operating leases was $7.4 million, $6.7 million
and $5.3 million in 2002, 2001 and 2000, respectively.
At December 31, 2002, minimum future operating lease payments are as follows
(in thousands of dollars):
2003 $ 6,234
2004 4,953
2005 2,724
2006 940
2007 570
2008 and thereafter............ 40
-------------
Total....................... $ 15,461
=============
13. Contingencies and litigation settlement
The Company is involved in litigation in the ordinary course of business.
In the opinion of management, the ultimate resolution of this pending litigation
will not have a material adverse effect on the financial position or results of
operations of the Company.
In addition, in June 2001, the Federal District Court for the Southern
District of Georgia, before which Downey et. al. v. MGIC was pending, issued a
final order approving a settlement agreement and certified a nationwide class of
borrowers. In the fourth quarter of 2000, the Company recorded a $23.2 million
charge to cover the estimated costs of the settlement, including payments to
borrowers. Due to appeals by certain class members and members of classes in two
related cases, payments to borrowers in the settlement are delayed pending the
outcome of the appeals. The settlement
-------------
thirty-two
-------------
----------------------------------
Notes (continued)
----------------------------------
includes an injunction that prohibits certain practices and specifies the basis
on which agency pool insurance, captive mortgage reinsurance, contract
underwriting and other products may be provided in compliance with the Real
Estate Settlement Procedures Act. There can be no assurance that the standards
established by the injunction will be determinative of compliance with the Real
Estate Settlement Procedures Act were additional litigation to be brought in the
future.
The complaint in the case alleges that MGIC violated the Real Estate
Settlement Procedures Act by providing agency pool insurance, captive mortgage
reinsurance, contract underwriting and other products that were not properly
priced, in return for the referral of mortgage insurance. The complaint seeks
damages of three times the amount of the mortgage insurance premiums that have
been paid and that will be paid at the time of judgment for the mortgage
insurance found to be involved in a violation of the Real Estate Settlement
Procedures Act. The complaint also seeks injunctive relief, including
prohibiting MGIC from receiving future premium payments. If the settlement is
not fully implemented, the litigation will continue. In these circumstances,
there can be no assurance that the ultimate outcome of the litigation will not
materially affect the Company's financial position or results of operations.
-------------
thirty-three
-------------
- --------------------------------------------------------------------------------
Report of Independent Accountants
- --------------------------------------------------------------------------------
To the Board of Directors & Shareholders of
MGIC Investment Corporation
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of MGIC
Investment Corporation and Subsidiaries (the "Company") at December 31, 2002 and
2001, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Milwaukee, Wisconsin January 8, 2003
-------------
thirty-four
-------------
- --------------------------------------------------------------------------------
Unaudited quarterly financial data
- --------------------------------------------------------------------------------
Quarter
--------------------------------------------------------------- 2002
2002 First Second Third Fourth Year
- ------------------------------------------------ ------------- ------------- ------------- ------------- -------------
(In thousands of dollars, except per share data)
Net premiums written............................. $ 283,097 $ 286,615 $ 301,361 $ 306,882 $ 1,177,955
Net premiums earned.............................. 284,449 288,169 298,953 310,527 1,182,098
Investment income, net of expenses............... 51,950 51,654 51,036 52,876 207,516
Losses incurred, net............................. 59,714 64,416 101,094 140,528 365,752
Underwriting and other expenses, net............. 64,468 63,049 64,646 73,470 265,633
Net income....................................... 169,187 170,936 151,570 137,498 629,191
Earnings per share (a):
Basic......................................... 1.59 1.63 1.47 1.37 6.07
Diluted....................................... 1.58 1.61 1.47 1.37 6.04
Quarter
--------------------------------------------------------------- 2001
2001 First Second Third Fourth Year
- ------------------------------------------------ ------------- ------------- ------------- ------------- -------------
(In thousands of dollars, except per share data)
Net premiums written............................. $ 229,588 $ 256,903 $ 271,006 $ 278,856 $ 1,036,353
Net premiums earned.............................. 241,182 257,372 264,780 278,933 1,042,267
Investment income, net of expenses............... 50,045 51,566 51,021 51,761 204,393
Losses incurred, net............................. 29,377 36,304 43,468 51,665 160,814
Underwriting and other expenses, net............. 51,654 58,524 58,317 65,999 234,494
Net income....................................... 157,924 161,218 158,992 161,003 639,137
Earnings per share (a):
Basic......................................... 1.48 1.51 1.48 1.51 5.98
Diluted....................................... 1.46 1.49 1.47 1.50 5.93
(a) Due to the use of weighted average shares outstanding when calculating
earnings per share, the sum of the quarterly per share data may not equal
the per share data for the year.
-------------
thirty-five
-------------
-----------------------------------------------------------------------
Shareholder Information
-----------------------------------------------------------------------
The Annual Meeting
- ------------------
The Annual Meeting of Shareholders of MGIC Investment Corporation will convene
at 9 a.m. Central Time on May 8, 2003 at the Marcus Center for the Performing
Arts, 929 North Water Street, Milwaukee, Wisconsin.
10-K Report
- -----------
Copies of the Annual Report on Form 10-K, filed with the Securities and Exchange
Commission, will be available without charge after March 31, 2003, to
shareholders on request from:
Secretary
MGIC Investment Corporation
P. O. Box 488
Milwaukee, WI 53201
Transfer Agent and Registrar
- ----------------------------
Wells Fargo Bank Minnesota, N.A.
Shareowner Services
P. O. Box 64854 St. Paul, Minnesota 55164
(800) 468-9716
Corporate Headquarters
- ----------------------
MGIC Plaza
250 East Kilbourn Avenue
Milwaukee, Wisconsin 53202
Mailing Address
P. O. Box 488
Milwaukee, Wisconsin 53201
Shareholder Services
(414) 347-6596
MGIC Stock
- ----------
MGIC Investment Corporation Common Stock is listed on the New York Stock
Exchange under the symbol MTG. At December 31, 2002, 100,251,444 shares were
outstanding. The following table sets forth for 2001 and 2002 by quarter the
high and low sales prices of the Common Stock on the New York Stock Exchange
Composite Tape.
2001 2002
------------------------- ------------------------
Quarters High Low High Low
1st $ 69.36 $ 51.00 $ 71.85 $ 59.03
2nd 77.31 61.00 74.40 65.40
3rd 76.50 54.00 68.95 38.60
4th 66.20 50.56 48.52 33.60
In 2001 and 2002 the Company declared and paid the following cash dividends:
2001 2002
----------------- ------------------
Quarters
1st $ .025 $ .025
2nd .025 .025
3rd .025 .025
4th .025 .025
------------- ------------
$ .100 $ .100
============= ============
The Company is a holding company and the payment of dividends from its insurance
subsidiaries is restricted by insurance regulation. For a discussion of these
restrictions, see the sixth paragraph under "Management's Discussion and
Analysis -- Liquidity and Capital Resources" and Note 11 of the Notes to the
Consolidated Financial Statements.
As of March 12, 2003, the number of shareholders of record was 207. In addition,
there were approximately 139,000 beneficial owners of shares held by brokers and
fiduciaries.
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thirty-six
-------------