<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1997
OR
[_] 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 1-13664
THE PMI GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3199675
(State of Incorporation) (IRS Employer Identification No.)
601 MONTGOMERY STREET,
SAN FRANCISCO, CALIFORNIA 94111
(Address of principal executive offices) (Zip Code)
(415) 788-7878
(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
----- -----
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 $0.01 4/30/97 33,612,651
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THE PMI GROUP, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
MARCH 31, 1997
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION PAGE
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<S> <C>
Item 1. Interim Consolidated Financial Statements and Notes.
Consolidated Statements of Operations for the Three Months Ended
March 31, 1997 and 1996 (Unaudited). 3
Consolidated Balance Sheets as of March 31, 1997 (Unaudited) and
December 31, 1996. 4
Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 1997 and 1996 (Unaudited). 5
Notes to Consolidated Financial Statements (Unaudited). 6-7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations. 8-16
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K. 17
SIGNATURES 18
INDEX TO EXHIBITS 19
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM 1. INTERIM FINANCIAL STATEMENTS
THE PMI GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months
Ended March 31,
---------------
(In thousands except for per share amounts) 1997 1996
----- -----
(Unaudited)
<S> <C> <C>
REVENUES
Premiums earned $108,091 $ 93,023
Investment income, less investment expense 19,995 15,761
Realized capital gains, net 18,268 6,223
Other income 1,192 899
-------- --------
TOTAL REVENUES 147,546 115,906
-------- --------
LOSSES AND EXPENSES
Losses and loss adjustment expenses 39,515 33,825
Underwriting and other expenses 34,415 30,539
Interest expense 1,688 -
Distributions on redeemable capital
securities - minority interest 1,385 -
-------- --------
TOTAL LOSSES AND EXPENSES 77,003 64,364
-------- --------
INCOME BEFORE INCOME TAXES 70,543 51,542
INCOME TAX EXPENSE 21,371 14,552
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NET INCOME $ 49,172 $ 36,990
======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING 34,342 35,126
======== ========
NET INCOME PER SHARE $ 1.43 $ 1.05
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
3
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THE PMI GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
(Dollars in thousands) 1997 1996
---- ----
(Unaudited)
<S> <C> <C>
ASSETS
Investments
Available for sale, at market
Fixed income securities
(amortized cost $1,176,760 and $1,042,570) $1,201,654 $1,085,514
Equity securities
Common stock (cost $43,433 and $77,775) 60,724 112,583
Preferred stock (cost $305 and $305) 387 388
Common stock of affiliate, at underlying book value 11,564 11,385
Short-term investments (at cost, which approximates market) 138,858 81,876
---------- ----------
TOTAL INVESTMENTS 1,413,187 1,291,746
Cash 6,517 6,592
Accrued investment income 21,232 19,439
Reinsurance recoverable and prepaid premiums 22,031 83,379
Receivable from affiliates 13,346 10,525
Receivable from Allstate 16,822 16,822
Deferred policy acquisition costs 32,757 31,633
Property and equipment, net 23,890 22,519
Other assets 30,555 27,264
---------- ----------
TOTAL ASSETS $1,580,337 $1,509,919
========== ==========
LIABILITIES
Reserve for losses and loss adjustment expenses $ 201,196 $ 199,774
Unearned premiums 104,294 116,951
Long-term debt 99,359 99,342
Reinsurance balances payable 9,013 13,295
Deferred income taxes 39,467 50,786
Other liabilities and accrued expenses 48,015 42,909
---------- ----------
TOTAL LIABILITIES 501,344 523,057
---------- ----------
COMPANY-OBLIGATED MANDATORILY REDEEMABLE CAPITAL SECURITIES
OF SUBSIDIARY TRUST HOLDING SOLELY JUNIOR SUBORDINATED
DEFERRABLE INTEREST DEBENTURE OF THE COMPANY (NOTE 2) 99,006 -
SHAREHOLDERS' EQUITY
Preferred stock -- $.01 par value; 5,000,000 shares authorized - -
Common stock -- $.01 par value; 125,000,000 shares
authorized, 35,052,600 and 35,047,619 issued 351 350
Additional paid-in capital 258,225 258,059
Unrealized net gains on investments 26,442 50,709
Retained earnings 755,332 707,885
Treasury stock (1,104,300 and 537,800 shares at cost) (60,363) (30,141)
---------- ----------
TOTAL SHAREHOLDERS' EQUITY 979,987 986,862
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,580,337 $1,509,919
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
4
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THE PMI GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
----------------
(In thousands) 1997 1996
------ ------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 49,172 $ 36,990
Adjustments to reconcile net income to net cash
provided by operating activities
Realized capital gains, net (18,268) (6,223)
Equity in (earnings) loss of affiliate (352) 450
Depreciation and amortization 961 1,092
Changes in:
Reserve for losses and loss adjustment expenses 1,422 5,190
Unearned premiums (12,657) (16,569)
Deferred policy acquisition costs (1,124) 1,520
Accrued investment income (1,793) 2,568
Reinsurance balances payable (4,282) 449
Reinsurance recoverable and prepaid premiums 61,348 (759)
Income taxes 227 (176)
Receivable from affiliates (2,821) (4,325)
Receivable from Allstate - (1,784)
Other 815 6,436
--------- ---------
Net cash provided by operating activities 72,648 24,859
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of equity securities 64,769 38,674
Investment collections of fixed income securities 6,520 54,233
Proceeds from sales of fixed income securities 162,892 50,390
Investment purchases
Fixed income securities (304,168) (199,749)
Equity securities (10,559) (28,425)
Net (increase) decrease in short-term investments (56,982) 63,688
Investment in affiliate - (1,350)
Purchase of property and equipment (2,416) (2,320)
--------- ---------
Net cash used in investing activities (139,944) (24,859)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of redeemable capital securities (Note 2) 99,000 -
Proceeds from exercise of stock options 168 -
Dividends paid to shareholders (1,725) (1,750)
Purchase of The PMI Group, Inc. common stock (30,222) -
--------- ---------
Net cash provided by (used in) financing activities 67,221 (1,750)
--------- ---------
NET DECREASE IN CASH (75) (1,750)
CASH AT BEGINNING OF PERIOD 6,592 3,654
--------- ---------
CASH AT END OF PERIOD $ 6,517 $ 1,904
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
5
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THE PMI GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1997
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include the
accounts of The PMI Group, Inc. ("TPG"), its wholly owned subsidiaries, PMI
Mortgage Insurance Co. ("PMI"), Residential Guaranty Co. ("RGC"), American
Pioneer Title Insurance Company ("APTIC"), PMI Mortgage Guaranty Co. ("PMG") and
PMI Capital I, and PMI's wholly owned subsidiaries, PMI Mortgage Services Co.
("MSC") and PMI Securities Co., collectively referred to as the "Company". All
material intercompany transactions and balances have been eliminated in
consolidation.
The Company's unaudited consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the requirements of Form 10-Q. In the opinion of
management, all adjustments (consisting only of normal recurring adjustments,
except for the redeemable capital securities discussed in Note 2) considered
necessary for a fair presentation of the Company's consolidated financial
condition at March 31, 1997, and its consolidated statements of operations and
cash flows for the periods ended March 31, 1997 and 1996, have been included.
Interim results for the period ended March 31, 1997 are not necessarily
indicative of the results that may be expected for the year ending December 31,
1997. The financial statements should be read in conjunction with the audited
consolidated financial statements and footnotes included in The PMI Group, Inc.
1996 Annual Report to Shareholders.
NOTE 2 - COMPANY-OBLIGATED MANDATORILY REDEEMABLE CAPITAL SECURITIES OF
SUBSIDIARY TRUST HOLDING SOLELY JUNIOR SUBORDINATED DEFERRABLE INTEREST
DEBENTURE OF THE COMPANY
On February 4, 1997 TPG, through a wholly-owned trust, privately issued $100.0
million of 8.309% capital securities, Series A. Such securities are redeemable
after February 1, 2007, at a premium and upon occurrence of certain tax events,
and mature on February 1, 2027. The net proceeds, totaling $99.0 million, will
be used for general corporate purposes, including common stock repurchases,
acquisitions and additions to the investment portfolio. The capital securities
were issued by PMI Capital I (the "Issuer Trust"). The sole assets of the
Issuer Trust consist of $103.1 million principal amount of a junior subordinated
debenture (the "Debenture") issued by TPG to the Issuer Trust. The Debenture
bears interest at the rate of 8.309% per annum and matures on February 1, 2027.
The amounts due to the Issuer Trust under the Debenture and the related income
statement amounts have been eliminated in the Company's consolidated financial
statements. Distributions on the capital securities occur on February 1 and
August 1 of each year. The obligations of TPG under the Debenture and a related
guarantee and expense agreement constitute a full and unconditional guarantee by
TPG of the Issuer Trust's obligations under the capital securities. The capital
securities are subject to mandatory redemption under certain circumstances.
NOTE 3 - RECENTLY ISSUED ACCOUNTING STANDARD
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 128, Earnings per Share. The
Company is required to adopt SFAS No. 128 at December 31, 1997 and will restate
at that time earnings per share ("EPS") data for prior periods to conform with
SFAS No. 128. Earlier application is not permitted.
6
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SFAS No. 128 replaces current EPS reporting requirements and requires a dual
presentation of basic and diluted EPS. Basic EPS excludes dilution and is
computed by dividing net income available to common shareholders by the weighted
average of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock.
If SFAS No. 128 had been in effect during the current and prior year periods,
basic EPS would have been $1.44 and $1.06 for the quarters ended March 31, 1997
and 1996, respectively. Diluted EPS under SFAS No. 128 would not have been
different than the primary EPS currently reported for both periods.
NOTE 4 - RELATED PARTY TRANSACTIONS
In December 1993, PMI entered into an agreement ("Reinsurance Treaty") with
Forestview Mortgage Insurance Co. ("Forestview"), a wholly-owned subsidiary of
Allstate Insurance Company ("Allstate"), whereby Forestview agreed to reinsure
all liabilities (net of amounts collected from third party reinsurers and
indemnitors) in connection with PMI's mortgage pool insurance business in
exchange for premiums received. In 1994, Forestview agreed to assume PMI's
mortgage pool insurance business upon receipt of all required regulatory
approvals. PMI ceded $3.0 million of pool premiums to Forestview and collected
$17.4 million of reimbursed pool claims from Forestview in the three months
ended March 31, 1997 in connection with the Reinsurance Treaty. During 1996, PMI
ceded $13.9 million of pool premiums to Forestview and collected $58.9 million
of reimbursed pool claims from Forestview. It is anticipated that additional
pool claims significantly in excess of pool premiums will be paid in 1997 and
beyond. Forestview has recently advised PMI that it believes it may have
overpaid in reimbursing PMI under the Reinsurance Treaty in connection with
certain claims. PMI's claims practices with respect to the run-off of the
mortgage pool insurance business under the Reinsurance Treaty are the subject of
an audit by Forestview. The ultimate amount and financial impact of any required
repayments, if Forestview were successful in its assertions, cannot be predicted
with any certainty at this time. PMI has disputed that there is a basis for
claiming that any such overpayment has occurred. See "FACTORS THAT MAY AFFECT
FUTURE RESULTS AND MARKET PRICE OF STOCK - Continuing relationships with
Allstate and Affiliates."
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF CONSOLIDATED OPERATIONS
THREE MONTHS ENDED MARCH 31, 1997 AND 1996
Consolidated net income in the three months ended March 31, 1997 was $49.2
million, a 33.0% increase over net income of $37.0 million in the corresponding
period of 1996. The increase was primarily attributable to increases in
investment income (including capital gains) and secondarily in premiums earned
of 74.0% and 16.2%, respectively, partially offset primarily by increases in
losses and loss adjustment expenses and secondarily in underwriting and other
expenses of 16.8% and 12.7%, respectively. Investment income increased
primarily from capital gains on the sales of equity securities while premiums
earned increased primarily from the ongoing mortgage insurance operations and
secondarily from the effect of a termination and commutation of a reinsurance
treaty with Centre Re effective December 31, 1996. Earnings per share were $1.43
in the three months ended March 31, 1997, compared with $1.05 in the
corresponding period of 1996, a 36.2% increase. Excluding capital gains,
earnings per share were $1.09 in the first quarter of 1997 compared with $0.94
in the first quarter of 1996, a 16.0% increase. Revenues in the first quarter of
1997 were $147.5 million, a 27.3% increase over revenues of $115.9 million in
the first quarter of 1996.
PMI's new insurance written ("NIW") totaled $3.1 billion in the first quarter of
1997, compared with $3.9 billion in the first quarter of 1996, a 20.5% decrease.
The decrease in NIW resulted from the number of new mortgage insurance policies
issued decreasing by 21.2%, to 24,100 policies in the three months ended March
31, 1997 from 30,600 policies in the corresponding period of 1996, partially
offset by an increase in the average loan size to $127,200 from $126,400.
The primary factor contributing to the decrease in new policies issued was the
decline in the total number of loan originations in the private mortgage
insurance industry in the first quarter of 1997 compared with the corresponding
period of 1996. The private mortgage insurance industry experienced a decline in
total new insurance written of 13.1% to $25.1 billion in the first quarter of
1997 from $28.9 billion in the corresponding period of 1996, which was caused by
decreases in both the new home purchase market and refinancing activity.
Refinancing as a percentage of PMI's NIW decreased by 11.5 percentage points, to
16.7% in the three months ended March 31, 1997 from 28.2% in the corresponding
period of 1996.
A secondary factor contributing to the decrease in new policies issued was a
decline in market share. PMI's market share of NIW decreased to 12.2% in the
three months ended March 31, 1997 from 13.4% in the corresponding period of
1996. On a combined basis with CMG Mortgage Insurance Company ("CMG"), market
share decreased to 13.0% in the first quarter of 1997 compared with 13.8% in the
corresponding period of 1996. CMG is a 45% owned affiliate of PMI and is
accounted for on the equity method in the Company's consolidated financial
statements. PMI's (excluding CMG) market share of NIW in the third quarter and
fourth quarter of 1996 was 14.7% and 13.7%, respectively. These declines in
market share were primarily due to the availability of a pool insurance product
not offered by PMI and secondarily to increases in product and underwriting
competition in the California market. Management believes that the recent
decreases in quarterly market share will stabilize in the second quarter, and
management continues to expect that PMI will attain market share growth in the
second half of the year. See Cautionary Statement.
8
<PAGE>
PMI's persistency rate (percentage of insurance remaining in force from one year
prior) decreased 0.3 percentage points over the twelve month period, and stands
at 84.2% as of March 31, 1997 compared with 84.5% as of March 31, 1996. The
persistency rate leveled off in the second quarter of 1996 and experienced
slight but consistent improvements since the third quarter of 1996. Insurance
in force as of March 31, 1997 was $77.7 billion compared with $72.1 billion as
of March 31, 1996. The annualized increase of insurance in force was 1.9% in
the first quarter of 1997 compared with 3.5% in the corresponding period of
1996, due primarily to the decrease in NIW from the 1996 level. The first
quarter annualized growth rates are historically lower than the full year actual
growth rates due to seasonality.
Mortgage insurance net premiums written were $83.4 million in the first quarter
of 1997 compared with $66.9 in the corresponding period of 1996, an increase of
24.7%. The increase is attributable primarily to the growth of insurance in
force, secondarily to higher average premium rates and higher average loan
sizes, and also the effect of the Centre Re cessions in 1996, offset by a
decrease in new premiums written resulting from the decrease in NIW from the
1996 level. The monthly premium plan as a percent of NIW represented 96.9% of
NIW in the three months ended March 31, 1997 compared with 95.1% in the three
months ended March 31, 1996.
The increase in average premium rates was caused by a continuing shift to
mortgages with loan-to-value ratios ("LTVs") greater than 90% and equal to or
less than 95% ("95s") with increased insurance coverage, and an increase in the
use of adjustable rate mortgages (ARMs). 95s with 30% coverage increased to
41.6% of NIW in the first quarter of 1997 compared with 36.9% in the first
quarter of 1996. Further, the deep coverage policies had a greater impact on
renewal premiums as the percent of 95s with 30% coverage increased to 17.5% of
insurance in force as of March 31, 1997 from 9.6% as of March 31, 1996. ARMs
increased to 13.1% of NIW in the first quarter of 1997 compared with 7.5% in the
first quarter of 1996.
Refunded premiums decreased in the first quarter of 1997 to $3.2 million from
$4.1 million in the first quarter of 1996. This was due primarily to a decrease
in policy cancellations related to the decrease in mortgage refinancing volume
during the first quarter of 1997. Mortgage insurance ceded premiums were $1.9
million in the first quarter of 1997 compared with $6.3 million in the
corresponding period of 1996, while PMI's ceded premiums written as a percentage
of net new, renewal and refunded premiums decreased to 2.2% in the first quarter
of 1997 compared with 9.5% in the corresponding period of 1996. The reduction of
ceding percentages in 1997 was due to the Centre Re commutation which allows a
larger portion of premiums to remain with the Company through the use of RGC as
a reinsurer.
Mortgage insurance premiums earned increased 18.0% to $95.7 million in the first
quarter of 1997 from $81.1 million in the first quarter of 1996. This increase
is due primarily to the growth in insurance in force from one year prior,
secondarily to higher premium rates and higher average loan sizes, and also to
the effect of the Centre Re cessions in 1996, offset by a decrease in NIW from
the 1996 level.
The Company's net investment income in the first quarter of 1997 was $20.0
million compared with $15.8 million in the first quarter of 1996, an increase of
26.6%. The increase was primarily attributable to the growth in the average
amount of invested assets, which resulted from cash flows generated by operating
activities and the unused portion of the $198.3 million of proceeds from the
November 1996 debt offering and the February 1997 redeemable capital securities
offering, partially offset by a decrease in the average investment yield
(pretax) to 6.0% in the first quarter of 1997 from 6.1% in the first quarter of
1996. Realized capital gains (net of losses) experienced a significant increase
over 1996, up $12.1 million to $18.3 million in the first quarter of 1997 from
$6.2 million in the first quarter of 1996. This was caused by the sale of
approximately $50.0 million of equity securities which were reinvested in fixed
income securities.
9
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Mortgage insurance losses and loss adjustment expenses increased to $39.2
million in the first quarter of 1997 from $33.3 million in the first quarter of
1996, an increase of 17.7%. This increase was due primarily to the growth and
maturation of insurance in force and a related increase in the default rate,
secondarily to the effect of the Centre Re cessions in 1996, and also to
increased claim amounts associated with the higher coverage percentages and
higher loan sizes.
The majority of claims under PMI policies have historically occurred during the
third through the sixth years after issuance of the policies. Insurance written
by PMI from the period January 1, 1991 through December 31, 1994 represents
52.9% of PMI's insurance in force at March 31, 1997, with the 1993 book of
business alone representing 21.5%. Consistent with increasing coverage
percentages and increasing mortgage principal amounts, claim amounts have risen
in recent years. Primary claims paid in the first quarter of 1997 were
approximately $37 million compared with approximately $29 million for the first
quarter of 1996. Also, PMI has been experiencing an acceleration in its claim
payment process. This acceleration is a result of Fannie Mae's and Freddie
Mac's continuing loss mitigation efforts to make earlier determinations
regarding delinquent loans and to accelerate the loan foreclosure and claim
process. Management believes that this is only an acceleration of the timing of
payments, and will not increase the expected number of claims ultimately paid by
PMI. See Cautionary Statement.
In addition to claim increases, PMI's default rate has increased to 2.22% at
March 31, 1997 from the March 31, 1996 rate of 2.07%. This increase was caused
by a growth in the inventory level of notices of delinquency to 15,601 at March
31, 1997 compared with 13,730 at March 31, 1996 due primarily to the maturation
of PMI's 1992 and 1993 books of business. Management expects the default rate
to increase slightly during the remainder of 1997. See Cautionary Statement.
Default rates on PMI's California policies decreased to 3.89% (representing
4,338 loans in default) at March 31, 1997, from 4.15% (representing 4,391 loans
in default) at March 31, 1996. This decline represents the third consecutive
quarter of year over year improvements, which supports California's economic
strengthening. Policies written in California accounted for approximately 71%
and 72% of the total dollar amount of claims paid in the first quarter of 1997
and first quarter of 1996, respectively. In addition, the 1997 share of 71% is
approximately 5 percentage points lower than the third quarter 1996 peak of 76%.
Although management expects that during 1997 California will continue to account
for the majority of total claims paid, management also anticipates that
California claims paid as a percentage of total claims paid will continue to
decline consistent with the decline in default rates on PMI's California
policies. Accordingly, management anticipates the average claim size to
decrease for the foreseeable future. See Cautionary Statement.
Mortgage insurance underwriting and other expenses increased 17.0% to $20.0
million in the first quarter of 1997 from $17.1 million in the first quarter of
1996. This increase was primarily attributable to the effect of Centre Re
cessions on 1996 expenses and secondarily to an increase in the allocation of a
portion of MSC's underwriting expenses to PMI due to increased contract
underwriting.
Interest expense of $1.7 million was incurred in the first quarter of 1997
related to interest payable on the debt offering in November 1996, and the
Company accrued an additional $1.4 million related to distributions on the
redeemable capital securities (see Note 2 of Notes to Consolidated Financial
Statements above).
The increase in losses and loss adjustment expenses discussed above did not
increase the mortgage insurance loss ratio in the first quarter of 1997, which
stood at 41.0% in both the first quarters of 1997 and 1996. The expense ratio
improved over 1996, dropping to 24.0% in the first quarter of 1997 from 25.5% in
the first quarter of 1996, resulting in a combined ratio of 65.0% in 1997, 1.5
percentage points better than the 1996 ratio of 66.5%. The combined ratio
decreased due to the increases in premiums written and premiums earned,
partially offset by the increases in losses and loss adjustment expenses and
underwriting and other expenses.
10
<PAGE>
Title insurance premiums earned increased 4.2% to $12.4 million in the first
quarter of 1997 compared with $11.9 million in the first quarter of 1996. This
improvement was due to the ongoing expansion efforts of the title business.
Underwriting and other expenses increased 4.6% to $11.4 million in the first
quarter of 1997 compared to $10.9 million in the first quarter of 1996. This
increase is directly attributable to the increase in premiums earned. The title
insurance combined ratio decreased to 94.4% in the first quarter of 1997 from
95.7% in the first quarter of 1996.
Other income, primarily revenues generated by MSC, increased to $1.2 million in
the first quarter of 1997 from $0.9 million in the first quarter of 1996. This
growth is primarily due to increased mortgage services operations resulting from
the expansion of its contract underwriting services, partially offset by a
decrease in refinancing activity.
The Company's effective tax rate increased to 30.3% in the first quarter of
1997, compared to 28.2% in the first quarter of 1996. The benefits of tax-
preference investment income and other permanent differences reduced the
effective rates below the statutory rate of 35% during both periods. The
increase in the effective rate in 1997 over 1996 was due primarily to the
capital gains on the sale of equity securities.
LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION
Liquidity and capital resource considerations are different for TPG and PMI, its
principal insurance operating subsidiary, as discussed below.
TPG's principal sources of funds are dividends from PMI and APTIC, cash and
investment income thereon and funds that may be raised from time to time in the
capital markets. There are various restrictions on PMI's ability to pay
dividends which are discussed in Note 11 of Notes to Consolidated Financial
Statements contained in The PMI Group, Inc. 1996 Annual Report to Shareholders.
Under the most restrictive of such dividend limitations, the maximum amount of
dividends PMI can distribute to TPG cannot exceed $30.7 million during 1997
without prior regulatory approval. TPG has two available bank credit lines
totaling $50.0 million. At March 31, 1997, there were no outstanding borrowings
under the credit lines. In February 1997, TPG privately issued $100 million
8.309% redeemable capital securities (see Note 2 of Notes to Consolidated
Financial Statements above).
TPG's principal uses of funds are common stock repurchases, the payment of
dividends to shareholders, payment of operating expenses, funding of
acquisitions, additions to its investment portfolio and investments in
subsidiaries. Under the stock buy-back program authorized by the TPG Board of
Directors, the Company may repurchase an additional $89.6 million of common
stock as of March 31, 1997.
As of March 31, 1997, TPG had approximately $184.4 million of available funds.
This amount has increased substantially from the December 31, 1996 amount due to
the unused portion of the proceeds from the February redeemable capital
securities issue, less common stock repurchases of $30.2 million in the first
quarter of 1997.
The principal sources of funds for PMI are premiums received on new and renewal
business, commissions on ceded business and reimbursement of losses from
reinsurers (including approximately $17 million from Forestview in the first
quarter of 1997), and amounts earned from the investment of this cash flow. The
principal uses of funds by PMI are the payment of claims and related expenses,
reinsurance premiums, other operating expenses and dividends to TPG.
In the mortgage guaranty insurance industry, liquidity refers to the ability of
an enterprise to generate adequate amounts of cash from its normal operations,
including premiums received and investment income, in order to
11
<PAGE>
meet its financial commitments, which are principally obligations under the
insurance policies it has written. Liquidity requirements are significantly
influenced by the level and severity of claims. PMI's claims-paying ability is
currently rated "AA+" (Very High) by Duff & Phelps Credit Rating Co., "AA+"
(Very Strong) by Fitch Investors Service, Inc., "Aa2" (Excellent) by Moody's
Investors Service, Inc. and "AA+" (Excellent) by Standard and Poor's Rating
Services. These ratings are subject to revisions or withdrawal at any time by
the assigning rating organization. The ratings by the organizations are based
upon factors relevant to PMI's policyholders and are not applicable to the
Company's common stock or outstanding debt.
PMI generates substantial cash flows from operations as a result of premiums
being received in advance of the time when claim payments are required. Cash
flows generated from PMI's operating activities totaled $73.0 million and $20.4
million for the three months ended March 31, 1997 and 1996, respectively. This
increase is due primarily to the collection of $53.6 million as a result of the
Centre Re commutation.
Consolidated reserve for losses and loss adjustment expenses increased from
$199.8 million at December 31, 1996, to $201.2 million at March 31, 1997, an
increase of $1.4 million, or 0.7%. The change in consolidated reserve for
losses and loss adjustment expense is due primarily to an increase resulting
from the maturation of PMI's book of business, offset by a decrease due to the
acceleration of claim payments, which are both discussed above.
Consolidated shareholders' equity decreased from $986.9 million at December 31,
1996, to $980.0 million at March 31, 1997, a decrease of $6.9 million, or 0.7%.
The change in shareholders' equity consisted of increases of $49.2 million from
net income and $0.2 million from stock option activity, offset by common stock
repurchases of $30.2 million, dividends declared of $1.8 million and a decrease
of $24.3 million in net unrealized gains on investments available for sale (net
of tax).
PMI's risk-to-capital ratio at March 31, 1997 was 15.8:1, compared to 15.9:1 at
December 31, 1996.
CAUTIONARY STATEMENT
Cautionary Statement for purposes of the Safe Harbor Provisions of the Private
Securities Litigation Reform Act of 1995. The statements contained in this
document, including statements which are incorporated by reference, that are not
historical facts, and that relate to future plans, events or performance are
forward-looking statements. Such forward-looking statements in this document
include the following: (i) Management believes that the recent decreases in
quarterly market share will stabilize in the second quarter, and management
continues to expect that PMI will attain market share growth in the second half
of the year; (ii) management believes the increase in the claims payment process
is only an acceleration of the timing of payments and will not increase the
expected number of claims ultimately paid by PMI; (iii) management expects the
default rate to increase slightly during the remainder of 1997; (iv)
management anticipates the average claim size to decrease for the foreseeable
future; and (v) it is anticipated that additional pool claims significantly in
excess of pool premiums will be paid in 1997 and beyond. The Company's actual
results may differ materially from those expressed in any forward-looking
statements made by the Company. These forward-looking statements involve a
number of risks or uncertainties including, but not limited to, the factors set
forth below and in the next section.
Several factors such as economic recessions, falling housing values, rising
unemployment rates, deteriorating borrower credit, interest rate volatility,
legislation impacting borrowers' rights, or combinations of such factors might
affect the mortgage insurance industry in general and could materially and
adversely affect the Company's financial condition and results of operations.
Such economic events could materially and adversely impact the demand for
mortgage insurance, cause claims on policies issued by PMI to increase, and/or
cause a similar adverse increase in PMI's loss experience.
12
<PAGE>
In addition to nationwide economic conditions, PMI could be particularly
affected by economic downturns in specific regions where a large portion of its
business is concentrated, particularly California, where PMI has 22.0% of its
risk in force concentrated and where the default rate on all PMI policies in
force is 3.89% compared to 2.22% nationwide as of March 31, 1997.
Several other factors that may influence the amount of NIW by PMI include
mortgage insurance industry volumes of new business, the impact of competitive
underwriting criteria and products including mortgage pool insurance, the
effect of risk-sharing structured transactions, changes in the performance of
the financial markets, general economic conditions that affect the demand for or
acceptance of the Company's products, changes in government housing policy,
changes in the statutory charters, regulations and coverage requirements of
government sponsored enterprises ("GSEs"), banks and savings institutions,
customer consolidation and other risk factors listed from time to time in TPG's
Securities and Exchange Commission filings.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
POTENTIAL INCREASE IN CLAIMS
Mortgage insurance coverage generally cannot be canceled by PMI and remains
renewable at the option of the insured for the life of the loan. As a result,
the impact of increased claims from policies originated in a particular year
generally cannot be offset by premium increases on policies in force or
mitigated by nonrenewal of insurance coverage. There can be no assurance,
however, that the premiums charged will be adequate to compensate PMI for the
risks and costs associated with the coverage provided to its customers.
RECENT GROWTH; CHANGES IN COMPOSITION OF INSURANCE WRITTEN
The mortgage insurance industry has experienced a significant increase in NIW
since 1990, primarily as a result of historically low interest rates. Policies
written by PMI from January 1, 1991 through December 31, 1994 represent 52.9% of
PMI's insurance in force as of March 31, 1997. The majority of claims under
PMI policies have historically occurred during the third through the sixth years
after issuance of the policies. Thus, this substantial volume of PMI's business
is in its expected peak claims period, and management expects that the default
rate will rise in the future as such business continues through its expected
peak claims period. If actual claim frequency on such business significantly
exceeds expected claim frequency, the Company's financial condition and results
of operations could be materially and adversely affected.
The composition of PMI's NIW has included an increasing percentage of mortgages
with LTVs in excess of 90% and less than or equal to 95% ("95s"). At March 31,
1997, approximately 44% of PMI's risk in force consisted of 95s, which, in PMI's
experience, have had a claims frequency approximately twice that of mortgages
with LTVs equal to or less than 90% and over 85% ("90s"). PMI also offers
coverage for mortgages with LTVs in excess of 95% and up to 97% ("97s"), which
have even higher risk characteristics than 95s and greater uncertainty as to
pricing adequacy. PMI's NIW also includes adjustable rate mortgages ("ARMs"),
which, although priced higher, have risk characteristics that exceed the risk
characteristics associated with PMI's book of business as a whole. Although PMI
charges higher premium rates for loans which are ARMs and/or 95s and even higher
rates for 97s, the premiums earned on such products, and the associated
investment income, may ultimately prove to be inadequate to compensate for
future losses from such products. Such net losses could materially and
adversely affect the Company's financial condition and results of operations.
LOSS RESERVES
13
<PAGE>
PMI establishes loss reserves based upon estimates of the claim rate and average
claim amount, as well as the estimated costs, including legal and other fees, of
settling claims. Such reserves are based on estimates, which are regularly
reviewed and updated. There can be no assurance that PMI's reserves will prove
to be adequate to cover ultimate loss development on incurred defaults. The
Company's financial condition and results of operations could be materially and
adversely affected if PMI's reserve estimates are insufficient to cover the
actual related claims paid and expenses incurred.
MARKET SHARE; COMPETITION
PMI's market share, as measured by NIW, declined in the first quarter of 1997
compared to the fourth quarter of 1996, and in the fourth quarter of 1996
compared to the third quarter of 1996. These declines are due primarily to PMI's
decision not to offer mortgage pool insurance and secondarily to increases in
product and underwriting competition in the California market. Management
believes that the recent decreases in quarterly market share will stabilize in
the second quarter, and management continues to expect that PMI will attain
market share growth in the second half of the year. The Company's financial
condition and results of operation could be materially and adversely affected by
a continuing decline in its market share. Numerous factors bear on the relative
position of the private mortgage insurance industry versus government and quasi-
governmental competition as well as the competition of lending institutions
which choose to remain uninsured. PMI competes directly with federal and state
governmental and quasi-governmental agencies; principally the FHA and, to a
lesser degree, the VA. PMI and other private mortgage insurers also compete
indirectly with Fannie Mae and Freddie Mac. These GSEs are permitted by statute
to purchase conventional high LTV mortgages from lenders who obtain mortgage
insurance on those loans. Any legislative or statutory change that would
eliminate the requirement of mortgage insurance for high LTV loans purchased by
Fannie Mae or Freddie Mac could adversely affect the demand for private mortgage
insurance and have a material and adverse effect on the Company's financial
condition and results of operations.
PMI, through MSC, provides contract underwriting services that enable customers
to improve the efficiency and quality of their operations by outsourcing all or
part of their mortgage loan underwriting. Contract underwriting services have
become increasingly important to mortgage lenders as they seek to reduce costs.
Due to the limited number of underwriting customers, underwriting personnel
availability, and heavy price competition among mortgage insurance companies,
PMI's inability to recruit and maintain a sufficient number of qualified
underwriters could materially and adversely affect its market share and
materially and adversely affect the Company's financial condition and results of
operation.
TPG and PMI from time to time introduce new mortgage insurance products or
programs. The Company's financial condition and results of operations could be
materially adversely affected if PMI or the Company experience delays in
introducing competitive new products and programs. In addition, for any
introduced product, there can be no assurance that such products or programs
will be as profitable as the Company's existing products and programs.
FANNIE MAE, FREDDIE MAC AND FHA; STATE AND FEDERAL LEGISLATION
Fannie Mae and Freddie Mac impose requirements on private mortgage insurers for
such insurers to be eligible to insure loans sold to such agencies. Any change
in PMI's existing eligibility status could have a material and adverse effect on
the Company's financial condition and results of operations.
Effective February 1997, the maximum principle balance of loans eligible for
purchase by Fannie Mae and Freddie Mac increased to $214,600. In addition,
proposals have been advanced which would allow Fannie Mae and Freddie Mac
greater flexibility in utilizing substitutes for private mortgage insurance. The
Company cannot
14
<PAGE>
predict whether the higher loan principal balance eligible for purchase by these
GSEs or whether such proposals, if adopted by these GSEs, would materially and
adversely affect the Company's financial condition and results of operations.
Although PMI cannot generally cancel its mortgage insurance policies once
issued, PMI must cancel mortgage insurance for a mortgage loan upon the request
of the insured. Fannie Mae and Freddie Mac have guidelines which give borrowers
the right to request cancellation of mortgage insurance when specified
conditions are met. In addition, federal legislation and legislation in
approximately a dozen states has been introduced that also addresses these
issues. Proposals concerning borrower notification of their cancellation rights,
cancellation criteria, or the point at which mortgage insurance premiums may no
longer be charged to borrowers, are still being formulated and remain uncertain.
PMI believes it is too early to ascertain the impact of enactment of the
mortgage cancellation proposals.
Legislation and regulatory changes affecting the FHA and certain commercial
banks that forego insurance have affected demand for private mortgage insurance.
For example, the maximum individual loan amount that the FHA can insure was
recently increased to $160,950. Also, the maximum individual loan amount that
the VA can insure is $203,150. Legislation, increases in the maximum insurable
loan amount, or other expansion of eligibility for the FHA and VA would likely
have a material and adverse effect on the Company's financial position and
results of operations. Various proposals are being discussed by Congress and
certain federal agencies to reform or modify the FHA. Since PMI competes
principally with the FHA, any increase in the FHA's maximum individual loan
amount could make the FHA more competitive with PMI. In addition, the Office of
the Comptroller of the Currency granted permission in 1996 to national banks to
have a reinsurance company as a wholly-owned operating subsidiary for the
purpose of reinsuring mortgage insurance written on loans originated by such
bank. The Office of Thrift Supervision is in the process of considering whether
similar activities are permitted for savings institutions. The reinsurance
subsidiaries of national banks or savings institutions would become significant
competitors of the Company in the future and could materially and adversely
effect the Company's financial condition and results of operations.
NEW YORK DEPARTMENT OF INSURANCE
TPG has offered a risk-sharing product (a performance note) that is designed to
encourage quality originations and loss mitigation by lenders. To date, this
risk-sharing product has not represented a significant portion of the Company's
revenues. In March 1997, the New York Department of Insurance stated in a letter
addressed to all private mortgage insurers that both captive reinsurance
structures and the use of variable rate notes to a lender by an affiliate of a
mortgage guarantee insurer where the rate of interest to the noteholder is based
upon the underwriting experience of the mortgage guarantee insurer on the
mortgages originated by the noteholder would be considered to be illegal under
New York law. The Company is currently discussing with the New York Department
of Insurance the structure of its performance note product, and disagrees with
the statements in the letter. Management is unable to predict at this time the
results of these discussions. It is presently anticipated that additional
clarification regarding the Company's performance note product will be received
in the next 60 to 90 days.
RISK-TO-CAPITAL RATIO
Regulators specifically limit the amount of insurance risk that may be written
by PMI to a multiple of 25 times PMI's statutory capital (which includes the
contingency reserve). Other factors affecting PMI's risk-to-capital ratio
include: (i) regulatory review and oversight by the State of Arizona, PMI's
state of domicile for insurance regulatory purposes; (ii) limitations under the
Runoff Support Agreement discussed below, which prohibit PMI from paying any
dividends if, after the payment of any such dividend, PMI's risk-to-capital
ratio would equal or
15
<PAGE>
exceed 23 to 1, (iii) TPG's credit agreements, and (iv) TPG's and PMI's credit
or claims-paying ability ratings which require that the risk-to-capital ratio
not exceed 20 to 1.
Significant losses could cause a material reduction in statutory capital,
causing an increase in the risk-to-capital ratio and thereby limit PMI's
ability to write new business. The inability to write new business could
materially and adversely affect the Company's financial condition and results
of operations.
CONTINUING RELATIONSHIPS WITH ALLSTATE AND AFFILIATES
Historically, Allstate provided capital and other business support services to
PMI pursuant to a variety of contractual arrangements with PMI and TPG.
Pursuant to the Runoff Support Agreement with Allstate, if PMI's risk-to capital
ratio exceeds 23 to 1, Allstate will have certain limited rights and obligations
to pay amounts with respect to claims under PMI policies in effect prior to the
effective date of the Runoff Support Agreement (or to contribute capital to TPG
or to PMI for such purpose). In December 1993, PMI entered into an agreement
("Reinsurance Treaty") with Forestview whereby Forestview agreed to reinsure all
liabilities (net of amounts collected from third party reinsurers and
indemnitors) in connection with PMI's mortgage pool insurance business in
exchange for premiums received. In 1994, Forestview also agreed that as soon as
practicable after November 1, 1994, Forestview and PMI would seek regulatory
approval for the Reinsurance Treaty to be deemed to be an assumption agreement
and that, upon receipt of the requisite approvals, Forestview would assume such
liabilities. PMI understood that the assumption of the PMI mortgage
pool insurance policies would occur over the two year period following the
initial public offering of PMI's Common Stock in April of 1995. The parties
have recently commenced the process of seeking regulatory approval to complete
the assumption of the mortgage pool insurance policies. Until Forestview has
assumed directly such mortgage pool insurance policies, PMI will remain
primarily liable on the unassumed policies. Forestview has also recently
advised PMI that it believes it may have overpaid in reimbursing PMI under the
Reinsurance Treaty in connection with certain claims. PMI's claims practices
with respect to the run-off of the mortgage pool insurance business under the
Reinsurance Treaty are the subject of an audit by Forestview. The ultimate
amount and financial impact of any required repayments, if Forestview were
successful in its assertions, cannot be predicted with any certainty at this
time. PMI has disputed that there is a basis for claiming that any such
overpayment has occurred. PMI ceded $3.0 million of pool premiums to Forestview
and collected $17.4 million of reimbursed pool claims from Forestview in the
three months ended March 31, 1997 in connection with the Reinsurance Treaty.
During 1996, PMI ceded $13.9 million of pool premiums to Forestview and
collected $58.9 million of reimbursed pool claims from Forestview. It is
anticipated that additional claims significantly in excess of premiums will be
paid in 1997 and beyond. See Note 4 - Related Party Transactions of Notes to
Consolidated Financial Statements above.
16
<PAGE>
THE PMI GROUP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
March 31, 1997
(UNAUDITED)
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - The exhibits listed in the accompanying Index to
Exhibits are filed as part of this Form 10-Q
(b) Reports on Form 8-K
On February 21, 1997, the Company filed a Current Report
on Form 8-K to file a news release dated January 31, 1997
in connection with the agreement to sell $100 million
8.309% capital securities, Series A.
17
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, on May 15, 1997.
THE PMI GROUP, INC.
/s/ John M. Lorenzen, Jr.
------------------------------------
John M. Lorenzen, Jr.
Executive Vice President and
Chief Financial Officer
/s/ William A. Seymore
------------------------------------
William A. Seymore
Vice President and Chief
Accounting Officer
18
<PAGE>
INDEX TO EXHIBITS
(PART II, ITEM 6)
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------ ----------------------
11.1 Computation of Net Income Per Share
27.1 Financial Data Schedule
<PAGE>
EXHIBIT 11.1
THE PMI GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF NET INCOME PER SHARE
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
----------------
(In thousands, except per share data) 1997 1996
---- ----
<S> <C> <C>
PRIMARY NET INCOME PER SHARE
Adjusted shares outstanding:
Average common shares outstanding 34,232 35,010
Net shares to be issued upon exercise of
dilutive stock options after applying
treasury stock method 110 116
------- -------
Average shares outstanding 34,342 35,126
======= =======
Net income $49,172 $36,990
======= =======
Primary net income per share $ 1.43 $ 1.05
======= =======
FULLY DILUTED NET INCOME PER SHARE
Adjusted shares outstanding:
Average common shares outstanding 34,232 35,010
Net shares to be issued upon exercise of
dilutive stock options after applying
treasury stock method 110 116
------- -------
Average shares outstanding 34,342 35,126
======= =======
Net income $49,172 $36,990
======= =======
Fully diluted net income per share $ 1.43 $ 1.05
======= =======
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<DEBT-HELD-FOR-SALE> 1,201,654
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 72,675
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 1,413,187
<CASH> 6,517
<RECOVER-REINSURE> 22,031
<DEFERRED-ACQUISITION> 32,757
<TOTAL-ASSETS> 1,580,337
<POLICY-LOSSES> 201,196
<UNEARNED-PREMIUMS> 104,294
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 351
<OTHER-SE> 979,636
<TOTAL-LIABILITY-AND-EQUITY> 1,580,337
108,091
<INVESTMENT-INCOME> 19,995
<INVESTMENT-GAINS> 18,268
<OTHER-INCOME> 1,192
<BENEFITS> 39,515
<UNDERWRITING-AMORTIZATION> 0
<UNDERWRITING-OTHER> 34,415
<INCOME-PRETAX> 70,543
<INCOME-TAX> 21,371
<INCOME-CONTINUING> 49,172
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 49,172
<EPS-PRIMARY> 1.43
<EPS-DILUTED> 1.43
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
