form10-q.htm


FORM 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549


T
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2010
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from    to ______
Commission file number 1-10816
MGIC INVESTMENT CORPORATION
(Exact name of registrant as specified in its charter)

WISCONSIN
39-1486475
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
   
250 E. KILBOURN AVENUE
53202
MILWAUKEE, WISCONSIN
(Zip Code)
(Address of principal executive offices)
 

(414) 347-6480
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES x
NO o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
YES x
NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
 
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
YES o
NO x

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

CLASS OF STOCK
PAR VALUE
DATE
NUMBER OF SHARES
Common stock
$1.00
07/31/10
200,449,588
 


 
 

 

PART I.  FINANCIAL INFORMATION
           
ITEM 1.  FINANCIAL STATEMENTS
           
             
MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
 
June 30, 2010 (Unaudited) and December 31, 2009
 
   
             
   
June 30,
   
December 31,
 
   
2010
   
2009
 
ASSETS
 
(In thousands of dollars)
 
Investment portfolio (notes 7 and 8):
           
Securities, available-for-sale, at fair value:
           
Fixed maturities (amortized cost, 2010 - $6,885,265; 2009 - $7,091,840)
  $ 7,083,289     $ 7,251,574  
Equity securities
    3,014       2,891  
                 
Total investment portfolio
    7,086,303       7,254,465  
                 
Cash and cash equivalents
    2,395,568       1,185,739  
Accrued investment income
    70,487       79,828  
Reinsurance recoverable on loss reserves (note 4)
    339,542       332,227  
Prepaid reinsurance premiums
    3,125       3,554  
Premium receivable
    91,782       90,139  
Home office and equipment, net
    27,932       29,556  
Deferred insurance policy acquisition costs
    8,206       9,022  
Income taxes recoverable (note 11)
    -       275,187  
Other assets
    162,145       144,702  
                 
Total assets
  $ 10,185,090     $ 9,404,419  
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Liabilities:
               
Loss reserves (note 12)
  $ 6,388,929     $ 6,704,990  
Premium deficiency reserve (note 13)
    169,001       193,186  
Unearned premiums
    249,438       280,738  
Senior notes (note 3)
    377,213       377,098  
Convertible senior notes (note 3)
    345,000       -  
Convertible junior debentures (note 3)
    303,130       291,785  
Other liabilities
    379,646       254,041  
                 
Total liabilities
    8,212,357       8,101,838  
                 
Contingencies (note 5)
               
                 
Shareholders' equity: (note 14)
               
Common stock, $1 par value, shares authorized 460,000,000; shares issued, 2010 - 205,046,780; 2009 - 130,163,060; shares outstanding, 2010 - 200,449,588; 2009 - 125,101,057
    205,047       130,163  
Paid-in capital
    1,132,229       443,294  
Treasury stock (shares at cost, 2010 - 4,597,192; 2009 - 5,062,003)
    (222,632 )     (269,738 )
Accumulated other comprehensive income, net of tax (note 9)
    94,329       74,155  
Retained earnings
    763,760       924,707  
                 
Total shareholders' equity
    1,972,733       1,302,581  
                 
Total liabilities and shareholders' equity
  $ 10,185,090     $ 9,404,419  
                 
See accompanying notes to consolidated financial statements.
               

 
2

 

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF OPERATIONS
 
Three and Six Months Ended June 30, 2010 and 2009
 
(Unaudited)
 
                         
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
   
(In thousands of dollars, except per share data)
 
Revenues:
                       
Premiums written:
                       
Direct
  $ 314,310     $ 359,781     $ 589,444     $ 737,735  
Assumed
    779       844       1,576       2,307  
Ceded
    (19,743 )     (30,242 )     (39,616 )     (62,146 )
                                 
Net premiums written
    295,346       330,383       551,404       677,896  
Decrease in unearned premiums, net
    13,828       16,749       29,722       25,066  
Net premiums earned
    309,174       347,132       581,126       702,962  
                                 
Investment income, net of expenses
    62,868       78,036       131,727       155,209  
Realized investment gains, net
    31,702       23,920       64,656       32,361  
Total other-than-temporary impairment losses
    -       (9,401 )     (6,052 )     (35,103 )
Portion of losses recognized in other comprehensive income, before taxes
    -       -       -       -  
Net impairment losses recognized in earnings
    -       (9,401 )     (6,052 )     (35,103 )
Other revenue
    2,611       14,795       5,668       34,237  
                                 
Total revenues
    406,355       454,482       777,125       889,666  
                                 
Losses and expenses:
                               
Losses incurred, net (note 12)
    320,077       769,631       774,588       1,527,524  
Change in premium deficiency reserve (note 13)
    (10,619 )     (62,386 )     (24,185 )     (227,187 )
Amortization of deferred policy acquisition costs
    1,770       1,888       3,493       3,961  
Other underwriting and operating expenses, net
    52,280       59,833       110,502       120,309  
Reinsurance fee
    -       -       -       26,407  
Interest expense
    25,099       23,930       46,117       47,856  
                                 
Total losses and expenses
    388,607       792,896       910,515       1,498,870  
                                 
Income (loss) before tax
    17,748       (338,414 )     (133,390 )     (609,204 )
(Benefit) provision from income taxes (note 11)
    (6,803 )     1,421       (7,850 )     (84,809 )
                                 
Net income (loss)
  $ 24,551     $ (339,835 )   $ (125,540 )   $ (524,395 )
                                 
Income (loss) per share (note 6):
                               
Basic
  $ 0.14     $ (2.74 )   $ (0.82 )   $ (4.22 )
Diluted
  $ 0.13     $ (2.74 )   $ (0.82 )   $ (4.22 )
                                 
Weighted average common shares outstanding - diluted (shares in thousands, note 6)
    182,156       124,244       152,344       124,122  
                                 
See accompanying notes to consolidated financial statements.
                         

 
3

 

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
 
Year Ended December 31, 2009 and Six Months Ended June 30, 2010 (unaudited)
 
                                     
                                     
                                     
                                     
   
Common stock
   
Paid-in capital
   
Treasury stock
   
Accumulated other comprehensive income (loss)
   
Retained earnings
   
Comprehensive (loss) income
 
   
(In thousands of dollars)
 
                                     
Balance, December 31, 2008
  $ 130,119     $ 440,542     $ (276,873 )   $ (106,789 )   $ 2,247,234        
                                               
Net loss
    -       -       -       -       (1,322,277 )   $ (1,322,277 )
Change in unrealized investment gains and losses, net
    -       -       -       154,358       -       154,358  
Noncredit component of impairment losses, net
    -       -       -       (1,764 )     -       (1,764 )
Common stock shares issued upon debt conversion
    44       263       -       -       -          
Reissuance of treasury stock, net
    -       (11,613 )     7,135       -       (545 )        
Equity compensation
    -       14,102       -       -       -          
Defined benefit plan adjustments, net
    -       -       -       10,704       -       10,704  
Unrealized foreign currency translation adjustment
    -       -       -       17,646       -       17,646  
Other
    -       -       -       -       295          
Comprehensive loss
    -       -       -       -       -     $ (1,141,333 )
                                                 
Balance, December 31, 2009
  $ 130,163     $ 443,294     $ (269,738 )   $ 74,155     $ 924,707          
                                                 
                                                 
Net loss
    -       -       -       -       (125,540 )   $ (125,540 )
Change in unrealized investment gains and losses, net
    -       -       -       27,324       -       27,324  
Common stock shares issued (note 14)
    74,884       697,416       -       -       -          
Reissuance of treasury stock, net
    -       (14,425 )     47,106       -       (35,407 )        
Equity compensation
    -       5,944       -       -       -          
Unrealized foreign currency translation adjustment
    -       -       -       (7,150 )     -       (7,150 )
Comprehensive loss (note 9)
    -       -       -       -       -     $ (105,366 )
                                                 
Balance, June 30, 2010
  $ 205,047     $ 1,132,229     $ (222,632 )   $ 94,329     $ 763,760          
                                                 
                                                 
 See accompanying notes to consolidated financial statements
                             

 
4

 

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Six Months Ended June 30, 2010 and 2009
 
(Unaudited)
 
   
Six Months Ended
 
   
June 30,
 
             
   
2010
   
2009
 
   
(In thousands of dollars)
 
Cash flows from operating activities:
           
Net loss
  $ (125,540 )   $ (524,395 )
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
               
Amortization of deferred insurance policy acquisition costs
    3,493       3,961  
Capitalized deferred insurance policy acquisition costs
    (2,677 )     (2,430 )
Depreciation and amortization
    27,825       32,201  
Decrease in accrued investment income
    9,341       1,452  
Increase in reinsurance recoverable on loss reserves
    (7,315 )     (130,532 )
Decrease in prepaid reinsurance premiums
    429       559  
(Increase) decrease in premium receivable
    (1,643 )     1,767  
(Increase) decrease in real estate acquired
    (1,841 )     25,000  
(Decrease) increase in loss reserves
    (316,061 )     923,086  
Decrease in premium deficiency reserve
    (24,185 )     (227,187 )
Decrease in unearned premiums
    (31,300 )     (23,014 )
Deferred tax (benefit) provision
    (12,588 )     221,857  
Decrease in income taxes recoverable (current)
    294,095       127,572  
Realized investment gains, excluding impairment losses
    (64,656 )     (32,361 )
Net investment impairment losses
    6,052       35,103  
Other
    62,780       (2,578 )
Net cash (used in) provided by operating activities
    (183,791 )     430,061  
                 
Cash flows from investing activities:
               
Purchase of fixed maturities
    (2,593,435 )     (2,260,868 )
Purchase of equity securities
    (56 )     (48 )
Proceeds from sale of fixed maturities
    2,483,172       1,641,643  
Proceeds from maturity of fixed maturities
    352,525       318,961  
Net increase in payable for securities
    44,664       32,867  
Net cash provided by (used in) investing activities
    286,870       (267,445 )
                 
Cash flows from financing activities:
               
Net proceeds from convertible senior notes
    334,450       -  
Common stock shares issued
    772,300       -  
Repayment of note payable
    -       (200,000 )
Repayment of long-term debt
    -       (51,760 )
                 
Net cash provided by (used in) financing activities
    1,106,750       (251,760 )
                 
Net increase (decrease) in cash and cash equivalents
    1,209,829       (89,144 )
Cash and cash equivalents at beginning of period
    1,185,739       1,097,334  
Cash and cash equivalents at end of period
  $ 2,395,568     $ 1,008,190  
                 
See accompanying notes to consolidated financial statements.
               

 
5

 

MGIC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010
(Unaudited)

Note 1 - Basis of presentation

The accompanying unaudited consolidated financial statements of MGIC Investment Corporation and its wholly-owned subsidiaries have been prepared in accordance with the instructions to Form 10-Q as prescribed by the Securities and Exchange Commission (“SEC”) for interim reporting and do not include all of the other information and disclosures required by accounting principles generally accepted in the United States of America. These statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2009 included in our Annual Report on Form 10-K. As used below, “we”, “our” and “us” refer to MGIC Investment Corporation’s consolidated operations or to MGIC Investment Corporation, as the context requires.

In the opinion of management the accompanying financial statements include all adjustments, consisting primarily of normal recurring accruals, necessary to fairly state our financial position and results of operations for the periods indicated. The results of operations for the interim periods may not be indicative of the results that may be expected for the year ending December 31, 2010.


Capital

At June 30, 2010, Mortgage Guaranty Insurance Corporation’s (“MGIC”) policyholders position exceeded the required regulatory minimum by approximately $383 million, and we exceeded the required minimum by approximately $452 million on a combined statutory basis. (The combined figures give effect to reinsurance with subsidiaries of our holding company.) At June 30, 2010 MGIC’s risk-to-capital ratio was 17.8:1 and was 20.6:1 on a combined statutory basis. MGIC’s policyholders position and risk-to-capital ratio were affected by our contribution of $200 million to MGIC in the second quarter of 2010. This contribution was made from part of the proceeds from our April 2010 common stock offering discussed in Note 14.

The insurance laws or regulations of 17 states, including Wisconsin, require a mortgage insurer to maintain a minimum amount of statutory capital relative to the risk in force (or a similar measure) in order for the mortgage insurer to continue to write new business. We refer to these requirements as the risk-to-capital requirement. While formulations of minimum capital may vary in certain states, the most common measure applied allows for a maximum permitted risk-to-capital ratio of 25 to 1.  Based upon internal company estimates, MGIC’s risk-to-capital ratio over the next few years, after giving effect to any additional contribution to MGIC of the proceeds from our April 2010 common stock and convertible note offerings, could reach 40 to 1 or even higher.

 
6

 

In December 2009, the Office of the Commissioner of Insurance for the State of Wisconsin (“OCI”) issued an order waiving, until December 31, 2011, the risk-to-capital requirement. MGIC has also applied for waivers in all other jurisdictions that have risk-to-capital requirements. MGIC has received waivers from some of these jurisdictions. These waivers expire at various times, with the earliest expiration being December 31, 2010. Some jurisdictions have denied the request and others may deny the request. The OCI and other state insurance departments, in their sole discretion, may modify, terminate or extend their waivers. If the OCI or other state insurance department modifies or terminates its waiver, or if it fails to renew its waiver after expiration, MGIC would be prevented from writing new business anywhere, in the case of the waiver from the OCI, or in the particular jurisdiction, in the case of the other waivers, if MGIC’s risk-to-capital ratio exceeds 25 to 1 unless MGIC raised additional capital to enable it to comply with the risk-to-capital requirement. New insurance written in the jurisdictions that have risk-to-capital requirements represented approximately 50% of new insurance written in 2009 and the first half of 2010. If we were prevented from writing new business in all states, our insurance operations would be in run-off, meaning no new loans would be insured but loans previously insured would continue to be covered, with premiums continuing to be received and losses continuing to be paid, on those loans, until we either met the applicable risk-to-capital requirement or obtained a necessary waiver to allow us to once again write new business.

We cannot assure you that the OCI or any other jurisdiction that has granted a waiver of its risk-to-capital requirements will not modify or revoke the waiver, that it will renew the waiver when it expires or that we could raise additional capital to comply with the risk-to-capital requirement.

We have implemented a plan to write new mortgage insurance in MGIC Indemnity Corporation (“MIC”), a subsidiary of MGIC, in selected jurisdictions in order to address the likelihood that in the future MGIC will not meet the minimum regulatory capital requirements discussed above and may not be able to obtain appropriate waivers of these requirements in all jurisdictions in which minimum requirements are present. MIC has received the necessary approvals, including from the OCI, to write business in all of the jurisdictions in which MGIC would be prohibited from continuing to write new business in the event of MGIC’s failure to meet applicable regulatory capital requirements and obtain waivers of those requirements.

In October 2009, we, MGIC and MIC entered into an agreement with Fannie Mae (the “Fannie Mae Agreement”) under which MGIC agreed to contribute $200 million to MIC (which MGIC has done) and Fannie Mae approved MIC as an eligible mortgage insurer through December 31, 2011 subject to the terms of the Fannie Mae Agreement. Under the Fannie Mae Agreement, MIC will be eligible to write mortgage insurance only in those jurisdictions (other than Wisconsin) in which MGIC cannot write new insurance due to MGIC’s failure to meet regulatory capital requirements and if MGIC fails to obtain relief from those requirements or a specified waiver of them.

On February 11, 2010, Freddie Mac notified MGIC (the “Freddie Mac Notification”) that it may utilize MIC to write new business in states in which MGIC does not meet minimum regulatory capital requirements to write new business and does not obtain appropriate waivers of those requirements. This conditional approval to use MIC as a “Limited Insurer” will expire December 31, 2012. This conditional approval includes terms substantially similar to those in the Fannie Mae Agreement.

 
7

 

Under the Fannie Mae Agreement, Fannie Mae approved MIC as an eligible mortgage insurer only through December 31, 2011 and Freddie Mac (together with Fannie Mae, referred to as “GSEs”) has approved MIC as a “Limited Insurer” only through December 31, 2012. Whether MIC will continue as an eligible mortgage insurer after these dates will be determined by the applicable GSE’s mortgage insurer eligibility requirements then in effect. Further, under the Fannie Mae Agreement and the Freddie Mac Notification, MGIC cannot capitalize MIC with more than the $200 million contribution already made without prior approval from each GSE, which limits the amount of business MIC can write. We believe that the amount of capital that MGIC has contributed to MIC will be sufficient to write business for the term of the Fannie Mae Agreement in the jurisdictions in which MIC is eligible to do so. Depending on the level of losses that MGIC experiences in the future, however, it is possible that regulatory action by one or more jurisdictions, including those that do not have specific regulatory capital requirements applicable to mortgage insurers, may prevent MGIC from continuing to write new insurance in some or all of the jurisdictions in which MIC is not eligible to write business.

A failure to meet the specific minimum regulatory capital requirements to insure new business does not necessarily mean that MGIC does not have sufficient resources to pay claims on its insurance liabilities. While we believe that MGIC has sufficient claims paying resources to meet its claim obligations on its insurance in force, even in scenarios in which it fails to meet regulatory capital requirements, we cannot assure you that the events that lead to MGIC failing to meet regulatory capital requirements would not also result in it not having sufficient claims paying resources. Furthermore, our estimates of MGIC’s claims paying resources and claim obligations are based on various assumptions. These assumptions include our anticipated rescission activity, future housing values and future unemployment rates. These assumptions are subject to inherent uncertainty and require judgment by management. Current conditions in the domestic economy make the assumptions about housing values and unemployment rates highly volatile in the sense that there is a wide range of reasonably possible outcomes. Our anticipated rescission activity is also subject to inherent uncertainty due to the difficulty of predicting the amount of claims that will be rescinded and the outcome of any dispute resolution proceedings related to rescissions that we make.

Historically, rescissions of policies for which claims have been submitted to us were not a material portion of our claims resolved during a year. However, beginning in 2008, our rescissions of policies have materially mitigated our paid and incurred losses. In 2009, rescissions mitigated our paid losses by $1.2 billion and in the first half of 2010, rescissions mitigated our paid losses by $640 million (both of these figures include amounts that would have resulted in either a claim payment or been charged to a deductible under a bulk or pool policy, and may have been charged to a captive reinsurer). While we have a substantial pipeline of claims investigations that we expect will eventually result in future rescissions, we expect that rescissions will not continue to mitigate paid losses at the same level we have recently experienced.

Our loss reserving methodology incorporates the effects rescission activity is expected to have on the losses we will pay on our delinquent inventory. A variance between ultimate actual rescission rates and these estimates, as a result of the outcome of claims investigations, litigation, settlements or other factors, could materially affect our losses. We estimate rescissions mitigated our incurred losses by approximately $2.5 billion in 2009, compared to $0.6 billion in the first half of 2010, substantially all of which was experienced in the first quarter of 2010. Both of these figures include the benefit of claims not paid in the period as well as the impact of changes in our estimated expected rescission activity on our loss reserves in the period. Our loss reserves continue to be significantly mititgated by expected recession activity. In recent quarters, between 25% and 30% of claims received in a quarter have been resolved by rescissions. At June 30, 2010, we had 228,455 loans in our primary delinquency inventory; the resolution of a significant portion of these loans will not involve paid claims.

 
8

 

In addition, if MGIC’s right to rescind coverage is disputed, the outcome of the dispute ultimately would be determined by legal proceedings. Objections to rescission may be made several years after we have rescinded an insurance policy.  Countrywide Home Loans, Inc. and an affiliate (“Countrywide”) have filed a lawsuit against MGIC alleging that MGIC has denied, and continues to deny, valid mortgage insurance claims. MGIC has filed an arbitration case against Countrywide regarding rescissions and Countrywide has responded seeking damages of at least $150 million, exclusive of interest and costs. For more information about this lawsuit and arbitration case, see Note 5.

In the second quarter of 2010, we entered into a settlement agreement with a lender-customer regarding our rescission practices. Loans covered by this settlement agreement represent fewer than 10% of our policies in force as well as our delinquent inventory. Under this agreement, we are waiving certain of our rescission rights on loans subject to the agreement and the customer is contributing to the cost of claims that we pay on these loans. The rescission rights we are waiving are for matters related to loan origination, which historically have been the basis of substantially all of our rescissions. In addition, under the agreement we reversed certain rescissions and the customer waived claims regarding certain other past rescissions.  We considered the terms of this agreement when establishing our loss reserves at June 30, 2010, however this agreement did not have a significant impact. In addition, we continue to discuss with other lenders their objections to material rescissions and are involved in other arbitration proceedings with respect to rescissions that are not collectively material in amount.

 
Reclassifications

Certain reclassifications have been made in the accompanying financial statements to 2009 amounts to conform to 2010 presentation.


Note 2 - New Accounting Guidance

In January 2010 new accounting guidance was issued that expanded the required disclosures on fair value measurements. The guidance will require the disclosure of transfers in and out of Levels 1 and 2 of the fair value hierarchy and the reasons for those transfers and separate presentation of purchases, sales, issuances and settlements for Level 3 securities, on a gross basis rather than as one net number. The new guidance also clarifies the level of disaggregation required to be disclosed for each class of assets and liabilities and provides clarification on the appropriate disclosures of inputs and valuation techniques used to measure fair value for both recurring and non recurring measurements in Levels 2 and 3. This guidance is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements for the Level 3 securities. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. We have evaluated the provisions of this guidance and there is no significant impact on our financial statement disclosures.

 
9

 

Note 3 - Debt

Senior Notes

At June 30, 2010 and December 31, 2009 we had outstanding approximately $78.4 million, 5.625% Senior Notes due in September 2011 and $300 million, 5.375% Senior Notes due in November 2015. Covenants in the Senior Notes include the requirement that there be no liens on the stock of the designated subsidiaries unless the Senior Notes are equally and ratably secured; that there be no disposition of the stock of designated subsidiaries unless all of the stock is disposed of for consideration equal to the fair market value of the stock; and that we and the designated subsidiaries preserve our corporate existence, rights and franchises unless we or such subsidiary determines that such preservation is no longer necessary in the conduct of its business and that the loss thereof is not disadvantageous to the Senior Notes.  A designated subsidiary is any of our consolidated subsidiaries which has shareholder’s equity of at least 15% of our consolidated shareholders equity. We were in compliance with all covenants at June 30, 2010.

If we fail to meet any of the covenants of the Senior Notes discussed above; there is a failure to pay when due at maturity, or a default results in the acceleration of maturity of, any of our other debt in an aggregate amount of $40 million or more; or we fail to make a payment of principal of the Senior Notes when due or a payment of interest on the Senior Notes within thirty days after due and we are not successful in obtaining an agreement from holders of a majority of the applicable series of Senior Notes to change (or waive) the applicable requirement or payment default, then the holders of 25% or more of either series of our Senior Notes each would have the right to accelerate the maturity of that series.  In addition, the Trustee of these two issues of Senior Notes could, independent of any action by holders of Senior Notes, accelerate the maturity of the Senior Notes.

At June 30, 2010 and December 31, 2009, the fair value of the amount outstanding under our Senior Notes was $325.5 million and $293.2 million, respectively. The fair value was determined using publicly available trade information.


Convertible Senior Notes

In April 2010 we completed the sale of $345 million principal amount of 5% Convertible Senior Notes due in 2017.  We received net proceeds of approximately $334.5 million after deducting underwriting discount and offering expenses. Interest on the Convertible Senior Notes will be payable semi-annually in arrears on May 1 and November 1 of each year, beginning on November 1, 2010. We do not have the right to defer interest payments on the Convertible Senior Notes. The Convertible Senior Notes will mature on May 1, 2017, unless earlier converted by the holders or repurchased by us. Covenants in the Convertible Senior Notes include a requirement to notify holders in advance of certain events and that we and the designated subsidiaries (defined above) preserve our corporate existence, rights and franchises unless we or such subsidiary determines that such preservation is no longer necessary in the conduct of its business and that the loss thereof is not disadvantageous to the Convertible Senior Notes.
 
If we fail to meet any of the covenants of the Convertible Senior Notes; there is a failure to pay when due at maturity, or a default results in the acceleration of maturity of, any of our other debt in an aggregate amount of $40 million or more; a final judgment for the payment of $40 million or more (excluding any amounts covered by insurance) is rendered against us or any of our subsidiaries which judgment is not discharged or stayed within certain time limits; or we fail to make a payment of principal of the Convertible Senior Notes when due or a payment of interest on the Convertible Senior Notes within thirty days after due and we are not successful in obtaining an agreement from holders of a majority of the Convertible Senior Notes to change (or waive) the applicable requirement or payment default, then the holders of 25% or more of the Convertible Senior Notes would have the right to accelerate the maturity of those notes. In addition, the Trustee of the Convertible Senior Notes could, independent of any action by holders, accelerate the maturity of the Convertible Senior Notes.
 
The Convertible Senior Notes are convertible, at the holder's option, at an initial conversion rate, which is subject to adjustment, of 74.4186 shares per $1,000 principal amount at any time prior to the maturity date. This represents an initial conversion price of approximately $13.44 per share. The initial conversion price represents a 25% conversion premium based on the $10.75 per share price to the public in our concurrent common stock offering as discussed in Note 14. These Convertible Senior Notes will be equal in right of payment to our existing Senior Notes, discussed above, and will be senior in right of payment to our existing Convertible Junior Debentures, discussed below. Debt issuance costs will be amortized to interest expense over the contractual life of the Convertible Senior Notes. The provisions of the Convertible Senior Notes are complex. The description above is not intended to be complete in all respects. Moreover, that description is qualified in its entirety by the terms of the notes, which are contained in the Supplemental Indenture, dated as of April 26, 2010, between us and U.S. Bank National Association, as Trustee (the “Trustee”), and the Indenture dated as of October 15, 2000, between us and the Trustee.

 
10

 

We intend to use the net proceeds from the offering to provide funds to repay at maturity or repurchase prior to maturity the $78.4 million outstanding principal amount of our 5.625% Senior Notes due in September 2011 and for our general corporate purposes, which may include improving liquidity by providing funds for debt service and increasing the capital of MGIC and other subsidiaries.

At June 30, 2010, the fair value of the amount outstanding under our Convertible Senior Notes was $302.7 million. The fair value was determined using publicly available trade information.


Convertible Junior Subordinated Debentures

At June 30, 2010 and December 31, 2009 we had outstanding $389.5 million principal amount of 9% Convertible Junior Subordinated Debentures due in 2063 (the “debentures”). The debentures have an effective interest rate of 19% that reflects our non-convertible debt borrowing rate at the time of issuance. At June 30, 2010 and December 31, 2009 the amortized value of the principal amount of the debentures is reflected as a liability on our consolidated balance sheet of $303.1 million and $291.8 million, respectively, with the unamortized discount reflected in equity. At June 30, 2010 and December 31, 2009 we also had $55.0 million and $35.8 million, respectively, of deferred interest outstanding on the debentures which is included in other liabilities on the consolidated balance sheet. The debentures rank junior to all of our existing and future senior indebtedness.

Interest on the debentures is payable semi-annually in arrears on April 1 and October 1 of each year. As long as no event of default with respect to the debentures has occurred and is continuing, we may defer interest, under an optional deferral provision, for one or more consecutive interest periods up to ten years without giving rise to an event of default. Deferred interest will accrue additional interest at the rate then applicable to the debentures. Violations of the covenants under the Indenture governing the debentures, including covenants to provide certain documents to the trustee, are not events of default under the Indenture and would not allow the acceleration of amounts that we owe under the debentures.  Similarly, events of default under, or acceleration of, any of our other obligations, including those described above, would not allow the acceleration of amounts that we owe under the debentures.  However, violations of the events of default under the Indenture, including a failure to pay principal when due under the debentures and certain events of bankruptcy, insolvency or receivership involving our holding company would allow acceleration of amounts that we owe under the debentures.

 
11

 

Interest on the debentures that would have been payable on the scheduled interest payment dates beginning with April 1, 2009 has been deferred for 10 years past the scheduled payment date. During this 10-year deferral period the deferred interest will continue to accrue and compound semi-annually to the extent permitted by applicable law at an annual rate of 9%. We also have the right to defer interest that is payable on subsequent scheduled interest payment dates if we give the required 15 day notice. Any deferral of such interest would be on terms equivalent to those described above.

When interest on the debentures is deferred, we are required, not later than a specified time, to use reasonable commercial efforts to begin selling qualifying securities to persons who are not our affiliates. The specified time is one business day after we pay interest on the debentures that was not deferred, or if earlier, the fifth anniversary of the scheduled interest payment date on which the deferral started. Qualifying securities are common stock, certain warrants and certain non-cumulative perpetual preferred stock. The requirement to use such efforts to sell such securities is called the Alternative Payment Mechanism. Although there is no current requirement to begin the Alternative Payment Mechanism, the common shares issued in April 2010, discussed in Note 14, are qualifying securities. We have 180 days from the date of issuance of those shares to use the proceeds to pay deferred interest if we elect to do so with such proceeds.

The net proceeds of Alternative Payment Mechanism sales are to be applied to the payment of deferred interest, including the compound portion. We cannot pay deferred interest other than from the net proceeds of Alternative Payment Mechanism sales, except at the final maturity of the debentures or at the tenth anniversary of the start of the interest deferral. The Alternative Payment Mechanism does not require us to sell common stock or warrants before the fifth anniversary of the interest payment date on which that deferral started if the net proceeds (counting any net proceeds of those securities previously sold under the Alternative Payment Mechanism) would exceed the 2% cap. The 2% cap is 2% of the average closing price of our common stock times the number of our outstanding shares of common stock. The average price is determined over a specified period ending before the issuance of the common stock or warrants being sold, and the number of outstanding shares is determined as of the date of our most recent publicly released financial statements.

We are not required to issue under the Alternative Payment Mechanism a total of more than 10 million shares of common stock, including shares underlying qualifying warrants. In addition, we may not issue under the Alternative Payment Mechanism qualifying preferred stock if the total net proceeds of all issuances would exceed 25% of the aggregate principal amount of the debentures.

The Alternative Payment Mechanism does not apply during any period between scheduled interest payment dates if there is a “market disruption event” that occurs over a specified portion of such period. Market disruption events include any material adverse change in domestic or international economic or financial conditions.

The provisions of the Alternative Payment Mechanism are complex. The description above is not intended to be complete in all respects. Moreover, that description is qualified in its entirety by the terms of the debentures, which are contained in the Indenture, dated as of March 28, 2008, between us and U.S. Bank National Association, as trustee.

 
12

 

We may redeem the debentures prior to April 6, 2013, in whole but not in part, only in the event of a specified tax or rating agency event, as defined in the Indenture. In any such event, the redemption price will be equal to the greater of (1) 100% of the principal amount of the debentures being redeemed and (2) the applicable make-whole amount, as defined in the Indenture, in each case plus any accrued but unpaid interest. On or after April 6, 2013, we may redeem the debentures in whole or in part from time to time, at our option, at a redemption price equal to 100% of the principal amount of the debentures being redeemed plus any accrued and unpaid interest if the closing sale price of our common stock exceeds 130% of the then prevailing conversion price of the debentures for at least 20 of the 30 trading days preceding notice of the redemption. We will not be able to redeem the debentures, other than in the event of a specified tax event or rating agency event, during an optional deferral period.

The debentures are currently convertible, at the holder's option, at an initial conversion rate, which is subject to adjustment, of 74.0741 common shares per $1,000 principal amount of debentures at any time prior to the maturity date. This represents an initial conversion price of approximately $13.50 per share. If a holder elects to convert their debentures, deferred interest owed on the debentures being converted is also converted into shares of our common stock. The conversion rate for the deferred interest is based on the average price that our shares traded at during a 5-day period immediately prior to the election to convert. In 2009, we issued 44,316 shares of our common stock on conversion of $478,000 principal amount of our convertible debentures and related deferred interest. In lieu of issuing shares of common stock upon conversion of the debentures occurring after April 6, 2013, we may, at our option, make a cash payment to converting holders equal to the value of all or some of the shares of our common stock otherwise issuable upon conversion.

The fair value of the debentures was approximately $333.0 million and $254.3 million, respectively, at June 30, 2010 and December 31, 2009, as determined using available pricing for these debentures or similar instruments.

Interest payments on all outstanding debt were $10.3 million and $20.1 million for the six months ended June 30, 2010 and 2009, respectively.


Note 4 – Reinsurance
 
Of the total reinsurance recoverable on loss reserves, the reinsurance recoverable on loss reserves related to captive agreements was approximately $303 million at June 30, 2010 and $297 million at December 31, 2009. The total fair value of the trust fund assets under our captive agreements at June 30, 2010 was $568 million, compared to $547 million at December 31, 2009. During 2009, $119 million of trust fund assets were transferred to us as a result of captive terminations. There were no significant captive terminations during the first six months of 2010.
 
 
Note 5 – Litigation and contingencies

 
13

 

In addition to the matters described below, we are involved in other litigation in the ordinary course of business. In our opinion, the ultimate resolution of this ordinary course litigation will not have a material adverse effect on our financial position or results of operations.

Consumers are bringing a growing number of lawsuits against home mortgage lenders and settlement service providers. Seven mortgage insurers, including MGIC, have been involved in litigation alleging violations of the anti-referral fee provisions of the Real Estate Settlement Procedures Act, which is commonly known as RESPA, and the notice provisions of the Fair Credit Reporting Act, which is commonly known as FCRA. MGIC’s settlement of class action litigation against it under RESPA became final in October 2003. MGIC settled the named plaintiffs’ claims in litigation against it under FCRA in late December 2004 following denial of class certification in June 2004. Since December 2006, class action litigation was separately brought against a number of large lenders alleging that their captive mortgage reinsurance arrangements violated RESPA. While we are not a defendant in any of these cases, there can be no assurance that we will not be subject to future litigation under RESPA or FCRA or that the outcome of any such litigation would not have a material adverse effect on us.

We are subject to comprehensive, detailed regulation by state insurance departments. These regulations are principally designed for the protection of our insured policyholders, rather than for the benefit of investors. Although their scope varies, state insurance laws generally grant broad supervisory powers to agencies or officials to examine insurance companies and enforce rules or exercise discretion affecting almost every significant aspect of the insurance business. Given the recent significant losses incurred by many insurers in the mortgage and financial guaranty industries, our insurance subsidiaries have been subject to heightened scrutiny by insurance regulators. State insurance regulatory authorities could take actions, including changes in capital requirements or termination of waivers of capital requirements, that could have a material adverse effect on us. In addition, the Dodd-Frank Act, which was passed in July 2010, establishes the Bureau of Consumer Financial Protection to regulate the offering and provision of consumer financial products or services under federal law.  We are uncertain whether this Bureau will issue any rules or regulations that affect our business.  Such rules and regulations could have a material adverse effect on us.

In June 2005, in response to a letter from the New York Insurance Department, we provided information regarding captive mortgage reinsurance arrangements and other types of arrangements in which lenders receive compensation. In February 2006, the New York Insurance Department requested MGIC to review its premium rates in New York and to file adjusted rates based on recent years’ experience or to explain why such experience would not alter rates. In March 2006, MGIC advised the New York Insurance Department that it believes its premium rates are reasonable and that, given the nature of mortgage insurance risk, premium rates should not be determined only by the experience of recent years. In February 2006, in response to an administrative subpoena from the Minnesota Department of Commerce (the “MN Department”), which regulates insurance, we provided the Department with information about captive mortgage reinsurance and certain other matters. We subsequently provided additional information to the MN Department, and beginning in March 2008 the MN Department has sought additional information as well as answers to questions regarding captive mortgage reinsurance on several occasions. In addition, beginning in June 2008, we have received subpoenas from the Department of Housing and Urban Development, commonly referred to as HUD, seeking information about captive mortgage reinsurance similar to that requested by the MN Department, but not limited in scope to the state of Minnesota. Other insurance departments or other officials, including attorneys general, may also seek information about or investigate captive mortgage reinsurance.

 
14

 

The anti-referral fee provisions of RESPA provide that HUD as well as the insurance commissioner or attorney general of any state may bring an action to enjoin violations of these provisions of RESPA. The insurance law provisions of many states prohibit paying for the referral of insurance business and provide various mechanisms to enforce this prohibition. While we believe our captive reinsurance arrangements are in conformity with applicable laws and regulations, it is not possible to predict the outcome of any such reviews or investigations nor is it possible to predict their effect on us or the mortgage insurance industry.

Since October 2007 we have been involved in an investigation conducted by the Division of Enforcement of the SEC. The investigation appears to involve disclosure and financial reporting by us and by a co-investor regarding our respective investments in our C-BASS joint venture. We have provided documents to the SEC and a number of our executive officers, as well as other employees, have testified. This matter is ongoing and no assurance can be given that the SEC staff will not recommend an enforcement action against our company or one or more of our executive officers or other employees.

Five previously-filed purported class action complaints filed against us and several of our executive officers were consolidated in March 2009 in the United States District Court for the Eastern District of Wisconsin and Fulton County Employees’ Retirement System was appointed as the lead plaintiff. The lead plaintiff filed a Consolidated Class Action Complaint (the “Complaint”) on June 22, 2009. Due in part to its length and structure, it is difficult to summarize briefly the allegations in the Complaint but it appears the allegations are that we and our officers named in the Complaint violated the federal securities laws by misrepresenting or failing to disclose material information about (i) loss development in our insurance in force, and (ii) C-BASS, including its liquidity. Our motion to dismiss the Complaint was granted on February 18, 2010. On March 18, 2010, plaintiffs filed a motion for leave to file an amended complaint. Attached to this motion was a proposed Amended Complaint (the “Amended Complaint”). The Amended Complaint alleges that we and two of our officers named in the Amended Complaint violated the federal securities laws by misrepresenting or failing to disclose material information about C-BASS, including its liquidity, and by failing to properly account for our investment in C-BASS. The Amended Complaint also names two officers of C-BASS with respect to the Amended Complaint’s allegations regarding C-BASS. The purported class period covered by the Complaint begins on February 6, 2007 and ends on August 13, 2007. The Amended Complaint seeks damages based on purchases of our stock during this time period at prices that were allegedly inflated as a result of the purported violations of federal securities laws. On April 12, 2010, we filed a motion in opposition to Plaintiff’s motion for leave to amend its complaint. With limited exceptions, our bylaws provide that our officers are entitled to indemnification from us for claims against them of the type alleged in the Amended Complaint. We are unable to predict the outcome of these consolidated cases or estimate our associated expenses or possible losses. Other lawsuits alleging violations of the securities laws could be brought against us.

 
15

 

Several law firms have issued press releases to the effect that they are investigating us, including whether the fiduciaries of our 401(k) plan breached their fiduciary duties regarding the plan’s investment in or holding of our common stock or whether we breached other legal or fiduciary obligations to our shareholders. With limited exceptions, our bylaws provide that our officers and 401(k) plan fiduciaries are entitled to indemnification from us for claims against them. We intend to defend vigorously any proceedings that may result from these investigations.

As we previously disclosed, for some time we have had discussions with lenders regarding their objections to rescissions that in the aggregate are material. On December 17, 2009, Countrywide filed a complaint for declaratory relief in the Superior Court of the State of California in San Francisco (the “California State Court”) against MGIC. This complaint alleges that MGIC has denied, and continues to deny, valid mortgage insurance claims submitted by Countrywide and says it seeks declaratory relief regarding the proper interpretation of the flow insurance policies at issue. On January 19, 2010, we removed this case to the United States District Court for the Northern District of California (the “District Court”). On March 30, 2010, the District Court ordered the case remanded to the California State Court. We have appealed this decision to the United States Court of Appeals for the Ninth Circuit (the “Court of Appeals”) and asked the Court of Appeals to vacate the remand and stay proceedings in the District Court. On May 17, 2010, the Court of Appeals denied a stay of the District Court’s remand order. On May 28, 2010, Countrywide filed an amended complaint substantially similar to the original complaint in the California State Court. On July 2, 2010, we filed a petition in the California State Court to compel arbitration and stay the litigation in that court.

In connection with the Countrywide dispute discussed above, on February 24, 2010, we commenced an arbitration action against Countrywide seeking a determination that MGIC was entitled to deny and/or rescind coverage on the loans involved in the arbitration action, which numbered more than 1,400 loans as of the filing of the action. On March 16, 2010, Countrywide filed a response to our arbitration action objecting to the arbitrator’s jurisdiction in view of the case initiated by Countrywide in the California State Court and asserting various defenses to the relief sought by MGIC in the arbitration. The response also seeks damages of at least $150 million, exclusive of interest and costs, as a result of purported breaches of flow insurance policies issued by MGIC and additional damages, including exemplary damages, on account of MGIC’s purported breach of an implied covenant of good faith and fair dealing. We intend to defend MGIC against Countrywide’s complaint and arbitration response, and to pursue MGIC’s claims in the arbitration, vigorously. However, we are unable to predict the outcome of these proceedings or their effect on us.

In addition to the rescissions at issue with Countrywide, we have a substantial pipeline of claims investigations (including investigations involving loans related to Countrywide) that we expect will eventually result in future rescissions. In the second quarter of 2010, we entered into a settlement agreement with a lender-customer regarding our rescission practices. Loans covered by this settlement agreement represent fewer than 10% of our policies in force as well as our delinquent inventory. Under this agreement, we are waiving certain of our rescission rights on loans subject to the agreement and the customer is contributing to the cost of claims that we pay on these loans. The rescission rights we are waiving are for matters related to loan origination, which historically have been the basis of substantially all of our rescissions. In addition, under the agreement we reversed certain rescissions and the customer waived claims regarding certain other past rescissions.  We considered the terms of this agreement when establishing our loss reserves at June 30, 2010, however this agreement did not have a significant impact.

 
16

 

We provide an outsourced underwriting service to our customers known as contract underwriting. Under our contract underwriting agreements, we may be required to provide certain remedies to our customers if certain standards relating to the quality of our underwriting work are not met. We have an established reserve for such obligations. The cost of remedies provided by us to customers for failing to meet these standards has not been material to our financial position or results of operations for the six months ended June 30, 2010 and 2009. A generally positive economic environment for residential real estate that continued until approximately 2007 may have mitigated the effect of some of these costs, and claims for remedies may be submitted a number of years after the underwriting work was performed. A material portion of our new insurance written through the flow channel in recent years, including for 2006 and 2007, involved loans for which we provided contract underwriting services. We believe the rescission of mortgage insurance coverage on loans for which we provided contract underwriting services may make a claim for a contract underwriting remedy more likely to occur. Beginning in the second half 2009, we experienced an increase in claims for contract underwriting remedies, which may continue. Hence, there can be no assurance that contract underwriting remedies will not be material in the future.

See note 11 – “Income taxes” for a description of federal income tax contingencies.


Note 6 – Earnings (loss) per share

Our basic EPS is based on the weighted average number of common shares outstanding, which for the three months ended June 30, 2010 includes participating securities of 1.8 million with non-forfeitable rights to dividends. For the three months ended June 30, 2009 and the six months ended June 30, 2010 and 2009 the participating securities of 1.9 million, 1.8 million and 1.9 million, respectively, are excluded because they were anti-dilutive due to our reported net loss.  Typically, diluted EPS is based on the weighted average number of common shares outstanding plus common stock equivalents which include certain stock awards, stock options and the dilutive effect of our convertible debt. In accordance with accounting guidance, if we report a net loss from continuing operations then our diluted EPS is computed in the same manner as the basic EPS. In addition if any common stock equivalents are anti-dilutive they are always excluded from the calculation. The following includes a reconciliation of the weighted average number of shares; however for the three months ended June 30, 2010 and 2009 common stock equivalents of 53.3 million and 35.0 million, respectively, and for the six months ended June 30, 2010 and 2009 common stock equivalents of 45.8 million and 35.3 million, respectively, were not included because they were anti-dilutive.

 
17

 

 
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
                         
   
2010
   
2009
   
2010
   
2009
 
 
(in thousands, except per share data)
 
Basic earnings per share:
                       
Average common shares outstanding
    181,267       124,244       152,344       124,122  
Net Income (loss)
  $ 24,551     $ (339,835 )   $ (125,540 )   $ (524,395 )
Basic earnings (loss) per share
  $ 0.14     $ (2.74 )   $ (0.82 )   $ (4.22 )
                                 
                                 
Diluted earnings per share:
                               
                                 
Weighted-average shares - Basic
    181,267       124,244       152,344       124,122  
Common stock equivalents
    889       -       -       -  
                                 
Weighted-average shares - Diluted
    182,156       124,244       152,344       124,122  
                                 
Net Income (loss)
  $ 24,551     $ (339,835 )   $ (125,540 )   $ (524,395 )
Diluted earnings (loss) per share
  $ 0.13     $ (2.74 )   $ (0.82 )   $ (4.22 )


See Note 14 for information related to our sale of common stock and Note 3 for information related to our issuance of convertible senior notes, both in April 2010.


Note 7 – Investments

The amortized cost, gross unrealized gains and losses and fair value of the investment portfolio at June 30, 2010 and December 31, 2009 are shown below. Debt securities consist of fixed maturities and short-term investments.

 
18

 

         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
June 30, 2010
 
Cost
   
Gains
   
Losses (1)
   
Value
 
   
(In thousands of dollars)
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ 986,348     $ 21,637     $ (29 )   $ 1,007,956  
Obligations of U.S. states and political subdivisions
    3,728,931       146,040       (31,445 )     3,843,526  
Corporate debt securities
    2,008,855       63,177       (8,561 )     2,063,471  
Residential mortgage-backed securities
    57,371       3,967       -       61,338  
Debt securities issued by foreign sovereign governments
    103,760       3,453       (215 )     106,998  
Total debt securities
    6,885,265       238,274       (40,250 )     7,083,289  
Equity securities
    2,948       66       -       3,014  
                                 
Total investment portfolio
  $ 6,888,213     $ 238,340     $ (40,250 )   $ 7,086,303  


         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
December 31, 2009
 
Cost
   
Gains
   
Losses (1)
   
Value
 
   
(In thousands of dollars)
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ 736,668     $ 4,877     $ (6,357 )   $ 735,188  
Obligations of U.S. states and political subdivisions
    4,607,936       187,540       (59,875 )     4,735,601  
Corporate debt securities
    1,532,571       40,328       (9,158 )     1,563,741  
Residential mortgage-backed securities
    102,062       3,976       (1,986 )     104,052  
Debt securities issued by foreign sovereign governments
    112,603       1,447       (1,058 )     112,992  
Total debt securities
    7,091,840       238,168       (78,434 )     7,251,574  
Equity securities
    2,892       3       (4 )     2,891  
                                 
Total investment portfolio
  $ 7,094,732     $ 238,171     $ (78,438 )   $ 7,254,465  

(1) At June 30, 2010 and December 31, 2009, gross unrealized losses for residential mortgage-backed securities include $0 million and $1.8 million, respectively, in other-than-temporary impairment losses recorded in other comprehensive income, since the adoption of new guidance on other-than-temporary impairments.

The amortized cost and fair values of debt securities at June 30, 2010, by contractual maturity, are shown below. 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.  Because most auction rate and mortgage-backed securities provide for periodic payments throughout their lives, they are listed below in separate categories.

 
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Amortized
   
Fair
 
June 30, 2010
 
Cost
   
Value
 
   
(In thousands of dollars)
 
             
Due in one year or less
  $ 281,144     $ 282,000  
Due after one year through five years
    3,124,119       3,204,905  
Due after five years through ten years
    1,220,919       1,275,528  
Due after ten years
    1,771,037       1,852,624  
      6,397,219       6,615,057  
                 
Residential mortgage-backed securities
    57,371       61,338  
Auction rate securities (1)
    430,675       406,894  
                 
Total at June 30, 2010
  $ 6,885,265     $ 7,083,289  

(1) At June 30, 2010, approximately 98% of auction rate securities had a contractual maturity greater than 10 years.

 
20

 

At June 30, 2010 and December 31, 2009, the investment portfolio had gross unrealized losses of $40.3 million and $78.4 million, respectively.  For those securities in an unrealized loss position, the length of time the securities were in such a position, as measured by their month-end fair values, is as follows:

 
 
Less Than 12 Months
 
12 Months or Greater
 
Total
 
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
June 30, 2010
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
 
 
(In thousands of dollars)
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ 31,032     $ 29     $ -     $ -     $ 31,032     $ 29  
Obligations of U.S. states and political subdivisions
    376,717       3,308       561,579       28,137       938,296       31,445  
Corporate debt securities
    230,332       2,601       80,790       5,960       311,122       8,561  
Residential mortgage-backed securities
    -       -       -       -       -       -  
Debt issued by foreign sovereign governments
    705       1       4,620       214       5,325       215  
Equity securities
    6       -       -       -       6       -  
Total investment portfolio
  $ 638,792     $ 5,939     $ 646,989     $ 34,311     $ 1,285,781     $ 40,250  
                                                 
                                                 
 
Less Than 12 Months
 
12 Months or Greater
 
Total
 
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
December 31, 2009
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
 
 
(In thousands of dollars)
 
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ 434,362     $ 6,357     $ -     $ -     $ 434,362     $ 6,357  
Obligations of U.S. states and political subdivisions
    926,860       29,390       398,859       30,485       1,325,719       59,875  
Corporate debt securities
    453,804       9,158       -       -       453,804       9,158  
Residential mortgage-backed securities
    8,743       1,764       870       222       9,613       1,986  
Debt issued by foreign sovereign governments
    56,122       1,058       -       -       56,122       1,058  
Equity securities
    2,398       4       -       -       2,398       4  
Total investment portfolio
  $ 1,882,289     $ 47,731     $ 399,729     $ 30,707     $ 2,282,018     $ 78,438  

 
There were 222 securities in an unrealized loss position at June 30, 2010. The unrealized losses in all categories of our investments were primarily caused by the difference in interest rates at June 30, 2010 and December 31, 2009, compared to the interest rates at the time of purchase as well as the illiquidity premium applied in our auction rate securities discounted cash flow model. All of the securities in an unrealized loss position greater than 12 months at June 30, 2010 had a fair value greater than 80% of amortized cost.

 
21

 

Under the current guidance a debt security impairment is deemed other than temporary if we either intend to sell the security, or it is more likely than not that we will be required to sell the security before recovery or we do not expect to collect cash flows sufficient to recover the amortized cost basis of the security. During the second quarter and first six months of 2010 we recognized other-than-temporary impairments (“OTTI”) in earnings of $0 and $6.1 million, respectively, compared to $9.4 million and $35.1 million, respectively, during the second quarter and first six months of 2009. Our OTTI during these periods in 2010 and 2009 was primarily related to securities for which we had the intent to sell.

The following table provides a rollforward of the amount related to credit losses recognized in earnings for which a portion of an OTTI was recognized in accumulated other comprehensive income (loss) for the three and six months ended June 30, 2010.

 
   
Three months ended
   
Six months ended
 
   
June 30, 2010
 
   
(In thousands of dollars)
 
             
Beginning balance
  $ 1,021     $ 1,021  
Addition for the amount related to the credit loss for which an OTTI was not previously recognized
    -       -  
Additional increases to the amount related to the credit loss for which an OTTI was previously recognized
    -       -  
Reductions for securities sold during the period (realized)
    (1,021 )     (1,021 )
Ending balance
  $ -     $ -  
 
 
We held approximately $407 million in auction rate securities (ARS) backed by student loans at June 30, 2010.  ARS are intended to behave like short-term debt instruments because their interest rates are reset periodically through an auction process, most commonly at intervals of 7, 28 and 35 days. The same auction process has historically provided a means by which we may rollover the investment or sell these securities at par in order to provide us with liquidity as needed.  The ARS we hold are collateralized by portfolios of student loans, all of which are ultimately 97% guaranteed by the United States Department of Education.  At June 30, 2010, approximately 85% of our ARS portfolio was AAA/Aaa-rated by one or more of the following major rating agencies: Moody’s, Standard & Poor’s and Fitch Ratings.

In mid-February 2008, auctions began to fail due to insufficient buyers, as the amount of securities submitted for sale in auctions exceeded the aggregate amount of the bids.  For each failed auction, the interest rate on the security moves to a maximum rate specified for each security, and generally resets at a level higher than specified short-term interest rate benchmarks.  At June 30, 2010, our entire ARS portfolio, consisting of 39 investments, was subject to failed auctions, however, from the period when the auctions began to fail through June 30, 2010, $108.5 million in ARS was either sold or called, with the average amount we received being 99% of par. To date, we have collected all interest due on our ARS.

 
22

 

As a result of the persistent failed auctions, and the uncertainty of when these investments could be liquidated at par, the investment principal associated with failed auctions will not be accessible until successful auctions occur, a buyer is found outside of the auction process, the issuers establish a different form of financing to replace these securities, or final payments come due according to the contractual maturities of the debt issues.

The net realized investment gains (losses) and OTTI on the investment portfolio are as follows:


   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
 
(In thousands of dollars)
 
Net realized investment gains (losses) and OTTI on investments:
                       
Fixed maturities
  $ 31,680     $ 14,375     $ 58,316     $ (3,034 )
Equity securities
    19       12       57       136  
Other
    3       132       231       156  
                                 
    $ 31,702     $ 14,519     $ 58,604     $ (2,742 )


   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
 
(In thousands of dollars)
 
Net realized investment gains (losses) and OTTI on investments:
                       
Gains on sales
  $ 36,608     $ 36,001     $ 72,588     $ 53,931  
Losses on sales
    (4,906 )     (12,081 )     (7,932 )     (21,570 )
Impairment losses
    -       (9,401 )     (6,052 )     (35,103 )
                                 
    $ 31,702     $ 14,519     $ 58,604     $ (2,742 )


The net realized gains on investments during 2010 and 2009 primarily resulted from sales of tax-exempt municipal securities. Such sales were made in connection with our decision to reduce the proportion of our investment portfolio held in tax-exempt municipal securities and to increase the proportion held in taxable securities principally since the tax benefits of holding tax exempt municipal securities are no longer available based on our recent net operating losses.


Note 8 – Fair value measurements

Fair value measurements for items measured at fair value included the following as of June 30, 2010 and December 31, 2009:

 
23

 

   
Fair Value
   
Quoted Prices in Active Markets for Identical Assets (Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
   
(in thousands of dollars)
 
June 30, 2010
                       
Assets
                       
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ 1,007,956     $ 1,007,956     $ -     $ -  
Obligations of U.S. states and political subdivisions
    3,843,526       -       3,522,476       321,050  
Corporate debt securities
    2,063,471       2,530       1,966,377       94,564  
Residential mortgage-backed securities
    61,338       -       61,338       -  
Debt securities issued by foreign sovereign governments
    106,998       97,777       9,221       -  
Total debt securities
    7,083,289       1,108,263       5,559,412       415,614  
Equity securities
    3,014       2,693       -       321  
Total investments
  $ 7,086,303     $ 1,110,956     $ 5,559,412     $ 415,935  
                                 
Real estate acquired (1)
    5,671       -       -       5,671  
                                 
                                 
December 31, 2009
                               
Assets
                               
U.S. Treasury securities and obligations of U.S. government corporations and agencies
  $ 735,188     $ 735,188     $ -     $ -  
Obligations of U.S. states and political subdivisions
    4,735,601       -       4,365,260       370,341  
Corporate debt securities
    1,563,741       2,559       1,431,844       129,338  
Residential mortgage-backed securities
    104,052       23,613       80,439       -  
Debt securities issued by foreign sovereign governments
    112,992       101,983       11,009       -  
Total debt securities
    7,251,574       863,343       5,888,552       499,679  
Equity securities
    2,891       2,570       -       321  
Total investments
  $ 7,254,465     $ 865,913     $ 5,888,552     $ 500,000  
                                 
Real estate acquired (1)
    3,830       -       -       3,830  

(1)
Real estate acquired through claim settlement, which is held for sale, is reported in Other Assets on the consolidated balance sheet.

 
24

 

There were no transfers of securities between Level 1 and Level 2 during the first six months of 2010.

For assets and liabilities measured at fair value using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances for the three and six months ended June 30, 2010 and 2009 is as follows:

   
Obligations of U.S. States and Political Subdivisions
   
Corporate Debt Securities
   
Equity Securities
   
Total Investments
   
Real Estate Acquired
 
   
(in thousands of dollars)
 
Balance at March 31, 2010
  $ 367,916     $ 130,066     $ 321     $ 498,303     $ 4,753  
Total realized/unrealized losses:
                                       
Included in earnings and reported as realized investment losses, net
    -       (1,398 )     -       (1,398 )     -  
Included in earnings and reported as losses incurred, net
    -       -       -       -       (557 )
Included in other comprehensive income
    (864 )     (402 )     -       (1,266 )     -  
Purchases, issuances and settlements
    (46,002 )     (33,702 )     -       (79,704 )     1,475  
Transfers in and/or out of Level 3
    -       -       -       -       -  
Balance at June 30, 2010
  $ 321,050     $ 94,564     $ 321     $ 415,935     $ 5,671  
                                         
Amount of total losses included in earnings for the three months ended June 30, 2010 attributable to the change in unrealized losses on assets still held at June 30, 2010
  $ -     $ -     $ -     $ -     $ -  

 
25

 

   
Obligations of U.S. States and Political Subdivisions
   
Corporate Debt Securities
   
Equity Securities
   
Total Investments
   
Real Estate Acquired
 
   
(in thousands of dollars)
 
Balance at December 31, 2009
  $ 370,341     $ 129,338     $ 321     $ 500,000     $ 3,830  
Total realized/unrealized losses:
                                       
Included in earnings and reported as realized investment losses, net
    -       (1,398 )     -       (1,398 )     -  
Included in earnings and reported as losses incurred, net
    -       -       -       -       (933 )
Included in other comprehensive income
    43       326       -       369       -  
Purchases, issuances and settlements
    (49,334 )     (33,702 )     -       (83,036 )     2,774  
Transfers in and/or out of Level 3
    -       -       -       -       -  
Balance at June 30, 2010
  $ 321,050     $ 94,564     $ 321     $ 415,935     $ 5,671  
                                         
Amount of total losses included in earnings for the six months ended June 30, 2010 attributable to the change in unrealized losses on assets still held at June 30, 2010
  $ -     $ -     $ -     $ -     $ -  
 
 
   
Obligations of U.S. States and Political Subdivisions
   
Corporate Debt Securities
   
Equity Securities
   
Total Investments
   
Real Estate Acquired
 
   
(in thousands of dollars)
 
Balance at March 31, 2009
  $ 393,512     $ 138,450     $ 321     $ 532,283     $ 19,301  
Total realized/unrealized losses:
                                       
Included in earnings and reported as losses incurred, net
    -       -       -       -       (1,736 )
Included in other comprehensive income
    (6,103 )     (2,180 )     -       (8,283 )     -  
Purchases, issuances and settlements
    (1,071 )     (2,200 )     -       (3,271 )     (9,707 )
Transfers in and/or out of Level 3
    -       -       -       -       -  
Balance at June 30, 2009
  $ 386,338     $ 134,070     $ 321     $ 520,729     $ 7,858  
                                         
Amount of total losses included in earnings for the three months ended June 30, 2009 attributable to the change in unrealized losses on assets still held at June 30, 2009
  $ -     $ -     $ -     $ -     $ -  

 
26

 

   
Obligations of U.S. States and Political Subdivisions
   
Corporate Debt Securities
   
Equity Securities
   
Total Investments
   
Real Estate Acquired
 
   
(in thousands of dollars)
 
Balance at December 31, 2008
  $ 395,388     $ 150,241     $ 321     $ 545,950     $ 32,858  
Total realized/unrealized losses:
                                       
Included in earnings and reported as realized investment losses, net
    -       (10,107 )     -       (10,107 )     -  
Included in earnings and reported as losses incurred, net
    -       -       -       -       (1,889 )
Included in other comprehensive income
    (6,103 )     (1,429 )     -       (7,532 )     -  
Purchases, issuances and settlements
    (2,947 )     (4,635 )     -       (7,582 )     (23,111 )
Transfers in and/or out of Level 3
    -       -       -       -       -  
Balance at June 30, 2009
  $ 386,338     $ 134,070     $ 321     $ 520,729     $ 7,858  
                                         
Amount of total losses included in earnings for the six months ended June 30, 2009 attributable to the change in unrealized losses on assets still held at June 30, 2009
  $ -     $ -     $ -     $ -     $ -  

Additional fair value disclosures related to our investment portfolio are included in Note 7. Fair value disclosures related to our debt are included in Note 3.


Note 9 - Comprehensive income

Our total comprehensive income was as follows:

 
27

 

   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
 
                         
   
2010
   
2009
   
2010
   
2009
 
   
(In thousands of dollars)
 
                         
Net income (loss)
  $ 24,551     $ (339,835 )   $ (125,540 )   $ (524,395 )
Other comprehensive income
    14,384       28,869       20,174       105,330  
                                 
Total comprehensive income (loss)
  $ 38,935     $ (310,966 )   $ (105,366 )   $ (419,065 )
                                 
Other comprehensive income (loss) (net of tax):
                               
Change in unrealized gains and losses on investments
  $ 21,118     $ 13,443     $ 27,324     $ 90,677  
Noncredit component of impairment loss
    -       -       -       -  
Unrealized foreign currency translation adjustment
    (6,734 )     15,426       (7,150 )     14,653  
                                 
Other comprehensive income