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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 June 30, 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 7/31/97 33,267,687
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THE PMI GROUP, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
JUNE 30, 1997
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<CAPTION>
PART I - FINANCIAL INFORMATION PAGE
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Item 1. Interim Consolidated Financial Statements and Notes.
Consolidated Statements of Operations for the Three
Months and Six Months Ended June 30, 1997 and 1996. 3
Consolidated Balance Sheets as of June 30, 1997 and
December 31, 1996. 4
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 1997 and 1996. 5
Notes to Consolidated Financial Statements. 6-7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations. 8-19
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders. 20
Item 5. Other Information. 20
Item 6. Exhibits and Reports on Form 8-K. 21
SIGNATURES 22
INDEX TO EXHIBITS 23
</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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------- --------------
(In thousands except for per share amounts) 1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
REVENUES
Premiums earned $109,906 $ 95,261 $217,997 $188,284
Investment income, less investment expense 20,676 17,727 40,671 33,488
Realized capital gains, net 546 3,761 18,814 9,984
Other income 1,705 2,307 2,897 3,206
-------- -------- -------- --------
TOTAL REVENUES 132,833 119,056 280,379 234,962
-------- -------- -------- --------
LOSSES AND EXPENSES
Losses and loss adjustment expenses 34,235 29,678 73,750 63,503
Underwriting and other expenses 35,883 31,350 70,298 61,889
Interest expense 1,687 -- 3,375 --
Distributions on redeemable capital
securities - minority interest 2,079 -- 3,464 --
-------- -------- -------- --------
TOTAL LOSSES AND EXPENSES 73,884 61,028 150,887 125,392
-------- -------- -------- --------
INCOME BEFORE INCOME TAXES 58,949 58,028 129,492 109,570
INCOME TAX EXPENSE 16,670 16,808 38,041 31,360
-------- -------- -------- --------
NET INCOME $ 42,279 $ 41,220 $ 91,451 $ 78,210
======== ======== ======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING 33,716 35,090 34,026 35,105
======== ======== ======== ========
NET INCOME PER SHARE $ 1.25 $ 1.17 $ 2.69 $ 2.23
======== ======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
3
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THE PMI GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
(Dollars in thousands) 1997 1996
---- ----
<S> <C> <C>
ASSETS
Investments
Available for sale, at market
Fixed income securities
(amortized cost $1,178,967 and $1,042,570) $1,224,661 $1,085,514
Equity securities
Common stock (cost $40,127 and $77,775) 68,502 112,583
Preferred stock (cost $6,067 and $305) 6,069 388
Common stock of affiliate, at underlying book value 14,692 11,385
Short-term investments (at cost, which approximates market) 129,704 81,876
---------- ----------
TOTAL INVESTMENTS 1,443,628 1,291,746
Cash 4,990 6,592
Accrued investment income 20,608 19,439
Reinsurance recoverable and prepaid premiums 23,439 83,379
Receivable from affiliates 10,329 10,525
Receivable from Allstate 16,822 16,822
Deferred policy acquisition costs 33,789 31,633
Property and equipment, net 25,912 22,519
Other assets 35,552 27,264
---------- ----------
TOTAL ASSETS $1,615,069 $1,509,919
========== ==========
LIABILITIES
Reserve for losses and loss adjustment expenses $ 198,289 $ 199,774
Unearned premiums 99,690 116,951
Long-term debt 99,418 99,342
Reinsurance balances payable 10,076 13,295
Deferred income taxes 51,108 50,786
Other liabilities and accrued expenses 42,812 42,909
---------- ----------
TOTAL LIABILITIES 501,393 523,057
---------- ----------
COMPANY-OBLIGATED MANDATORILY REDEEMABLE CAPITAL SECURITIES
OF SUBSIDIARY TRUST HOLDING SOLELY JUNIOR SUBORDINATED
DEFERRABLE INTEREST DEBENTURE OF THE COMPANY (NOTE 2) 99,014 -
SHAREHOLDERS' EQUITY
Preferred stock -- $.01 par value; 5,000,000 shares authorized - -
Common stock -- $.01 par value; 125,000,000 shares
authorized; 35,109,312 and 35,047,619 issued 351 350
Additional paid-in capital 260,137 258,059
Unrealized net gains on investments 48,234 50,709
Retained earnings 795,989 707,885
Treasury stock (1,672,100 and 537,800 shares at cost) (90,049) (30,141)
---------- ----------
TOTAL SHAREHOLDERS' EQUITY 1,014,662 986,862
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,615,069 $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>
SIX MONTHS
ENDED JUNE 30,
--------------
(In thousands) 1997 1996
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 91,451 $ 78,210
Adjustments to reconcile net income to net cash
provided by operating activities
Realized capital gains, net (18,814) (9,984)
Equity in (earnings) loss of affiliate (659) 432
Depreciation and amortization 2,052 920
Changes in:
Reserve for losses and loss adjustment expenses (1,485) 3,004
Unearned premiums (17,261) (23,035)
Deferred policy acquisition costs (2,156) 47
Accrued investment income (1,169) 253
Reinsurance balances payable (3,219) 2,157
Reinsurance recoverable and prepaid premiums 59,940 (4,521)
Income taxes 1,653 3,034
Receivable from affiliates 196 (1,784)
Receivable from Allstate -- (2,354)
Other (9,156) (16,528)
--------- ---------
Net cash provided by operating activities 101,373 29,851
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of equity securities 74,665 53,921
Investment collections of fixed income securities 7,500 40,628
Proceeds from sales of fixed income securities 232,113 113,642
Investment purchases
Fixed income securities (376,785) (256,599)
Equity securities (22,136) (39,698)
Net (increase) decrease in short-term investments (47,828) 68,414
Investment in affiliate (2,700) (1,350)
Purchase of property and equipment (5,576) (5,403)
--------- ---------
Net cash used in investing activities (140,747) (26,445)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of redeemable capital securities (Note 2) 99,000 --
Proceeds from exercise of stock options 2,078 293
Dividends paid to shareholders (3,398) (3,500)
Purchase of The PMI Group, Inc. common stock (59,908) --
--------- ---------
Net cash provided by (used in) financing activities 37,772 (3,207)
--------- ---------
NET INCREASE (DECREASE) IN CASH (1,602) 199
CASH AT BEGINNING OF PERIOD 6,592 3,654
--------- ---------
CASH AT END OF PERIOD $ 4,990 $ 3,853
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
5
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THE PMI GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
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)
considered necessary for a fair presentation of the Company's consolidated
financial condition at June 30, 1997, and its consolidated statements of
operations and cash flows for the periods ended June 30, 1997 and 1996, have
been included. Interim results for the periods ended June 30, 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, were
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 STANDARDS
In February 1997, the Financial Accounting Standards Board ("FASB") 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 $1.26 and $1.18 in the three months ended June 30,
1997 and 1996, respectively, and $2.70 and $2.23 in the six months ended June
30, 1997 and 1996, respectively. Diluted EPS under SFAS No. 128 would not have
been different than the primary EPS currently reported for both periods.
In June 1997, FASB issued SFAS No. 130, Reporting Comprehensive Income, which
requires that the Company report, by major components and a single total, the
change in its net assets during the period from non-owner sources; and SFAS No.
131, Disclosures about Segments of an Enterprise and Related Information, which
establishes annual and interim reporting standards for the Company's operating
segments and related disclosures about its products, services, geographic areas
and major customers. Adoption of these statements will not impact the Company's
consolidated financial position, results of operations or cash flows, and any
effect will be limited to the form and content of its disclosures. Both
statements are effective for fiscal years beginning after December 15, 1997,
with earlier application permitted.
NOTE 4 - RELATED PARTY TRANSACTION
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 $6.3 million of pool premiums to Forestview and collected
$32.5 million of reimbursed pool claims from Forestview in the six months ended
June 30, 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.
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 Item 2, "FACTORS THAT MAY AFFECT
FUTURE RESULTS AND MARKET PRICE OF STOCK - Continuing relationships with
Allstate and Affiliates."
7
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF CONSOLIDATED OPERATIONS
THREE MONTHS ENDED JUNE 30, 1997 AND 1996
Consolidated net income in the three months ended June 30, 1997 was $42.3
million, a 2.7% increase over net income of $41.2 million in the corresponding
period of 1996. The increase was attributable to increases primarily in
premiums earned and secondarily in investment income of 15.4% and 16.6%,
respectively, partially offset by increases primarily in losses and loss
adjustment expenses of 15.4%, secondarily to increases in underwriting and other
expenses of 14.5%, and also to interest and other charges of $3.8 million not
incurred during 1996 and to a $3.2 million reduction in realized capital gains.
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. The 1996 results
of operations include reinsurance transactions pursuant to the Reinsurance
Treaty with Centre Re in effect during 1996. Earnings per share were $1.25 in
the three months ended June 30, 1997, compared with $1.17 in the corresponding
period of 1996, a 6.8% increase. Excluding capital gains, earnings per share
were $1.24 in the second quarter of 1997 compared with $1.10 in the second
quarter of 1996, a 12.7% increase. Revenues in the second quarter of 1997 were
$132.8 million, an 11.5% increase over revenues of $119.1 million in the second
quarter of 1996.
PMI's new insurance written ("NIW") totaled $3.6 billion in the second quarter
of 1997, compared with $5.0 billion in the second quarter of 1996, a 28.0%
decrease. The decrease in NIW resulted from the number of new mortgage insurance
policies issued decreasing by 30.1%, to 28,401 policies in the three months
ended June 30, 1997 from 40,609 policies in the corresponding period of 1996,
partially offset by an increase in the average loan size to $127,200 from
$123,300.
The primary factor contributing to the decrease in new policies issued was the
decline in the volume of insured loans in the private mortgage insurance
industry in the second quarter of 1997 compared with the corresponding period of
1996. The private mortgage insurance industry experienced a decline in total new
insurance written of 18.2% to $28.7 billion in the second quarter of 1997 from
$35.1 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 to 10.5% in the three months ended June 30,
1997 from 19.5% 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 12.6% in the
three months ended June 30, 1997 from 14.3% in the corresponding period of 1996.
On a combined basis with CMG Mortgage Insurance Company ("CMG"), market share
decreased to 13.7% in the second quarter of 1997 compared with 14.9% 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. 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.
However, PMI's market share of 12.6% in the second quarter represents an
increase from the first quarter 1997 share of 12.2%. Management believes that
market share has stabilized in the second quarter of 1997 after decreases
experienced during the fourth quarter of 1996 and first quarter of 1997, and
further expects that PMI will continue to grow market share in the second
half of the year. See Cautionary Statement.
8
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PMI's cancellations of insurance in force were $3.8 billion in the second
quarter of 1997 compared to $3.4 billion in the corresponding period of 1996.
During the second quarter of 1997, PMI received a policy cancellation request
from one loan servicing customer which represented slightly more than 10% of the
total cancellations during the quarter. Due to this high level of cancellations,
PMI experienced a decrease in insurance in force of $0.2 billion during the
second quarter of 1997. However, the cancellations did not have a significant
impact on second quarter premiums written or premiums earned, primarily because
the loan servicing customer had made no payments on a substantial portion of
these policies during 1997 and no premium receivable relating to these past due
policies was recorded.
PMI's persistency rate (percentage of insurance remaining in force from one year
prior) increased 1.6 percentage points over the twelve month period, and stands
at 83.9% as of June 30, 1997 compared with 82.3% as of June 30, 1996. This
increase is due primarily to the decline in the refinancing activity. Insurance
in force as of June 30, 1997 was $77.5 billion compared with $73.7 billion as of
June 30, 1996.
Mortgage insurance net premiums written were $92.1 million in the second quarter
of 1997 compared with $77.7 million in the corresponding period of 1996, an
increase of 18.5%. The increase is attributable primarily to the growth of
insurance in force from one year prior, secondarily to higher average premium
rates and higher average loan sizes, and also to 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 97.6% of NIW in the three months ended June 30, 1997 compared
with 95.0% in the three months ended June 30, 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
43.4% of NIW in the second quarter of 1997 compared with 40.2% in the second
quarter of 1996. Further, this deep-coverage book of business had a greater
impact on renewal premiums as the percent of 95s with 30% coverage increased to
19.0% of insurance in force as of June 30, 1997 from 12.0% as of June 30, 1996.
ARMs increased to 14.5% of NIW in the second quarter of 1997 compared with 11.6%
in the second quarter of 1996.
Refunded premiums decreased in the second quarter of 1997 to $3.8 million from
$4.7 million in the second quarter of 1996, due primarily to the increase in
persistency related to the decrease in mortgage refinancing volume during the
second quarter of 1997. PMI's ceded premiums written as a percentage of net new,
renewal and refunded premiums decreased to 3.0% in the second quarter of 1997
compared with 8.2% in the corresponding period of 1996. The reduction of ceding
percentages in 1997 was due to the Centre Re termination and commutation which
allows a larger portion of premiums to remain with the Company.
Mortgage insurance premiums earned increased 15.9% to $96.3 million in the
second quarter of 1997 from $83.1 million in the second 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 the decrease in
NIW from the 1996 level.
The Company's net investment income in the second quarter of 1997 was $20.7
million compared with $17.7 million in the second quarter of 1996, an increase
of 16.9%. 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 $198.3 million of combined proceeds from the November 1996
debt offering and the February 1997 redeemable capital securities offering,
coupled with a slight increase in the average investment yield (pretax) to 6.2%
in the
9
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second quarter of 1997 from 6.1% in the second quarter of 1996. Investment
income in the second quarter of 1996 includes $1.4 million in call premiums on
pre-refunded tax-exempt securities. Realized capital gains (net of losses)
experienced a decrease from 1996, down $3.3 million to $0.5 million in the
second quarter of 1997 from $3.8 million in the second quarter of 1996.
Mortgage insurance losses and loss adjustment expenses increased to $33.9
million in the second quarter of 1997 from $29.3 million in the second quarter
of 1996, an increase of 15.7%. 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, 1992 through December 31, 1995 represents
62.2% of PMI's insurance in force at June 30, 1997, with the 1993 book of
business representing 20.5%. Consistent with increasing coverage percentages
and increasing mortgage principal amounts in those years, claim amounts have
risen in recent years. Primary claims paid in the second quarter of 1997 were
approximately $36 million compared with approximately $35 million for the second
quarter of 1996.
In addition to claim increases, PMI's default rate has increased to 2.20% at
June 30, 1997 from the June 30, 1996 rate of 1.96%. This increase was 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 continue to improve, decreasing to
3.65% (representing 4,041 loans in default) at June 30, 1997, from 3.91%
(representing 4,207 loans in default) at June 30, 1996. This decline represents
the fourth consecutive quarter of year over year improvements. Policies written
in California accounted for approximately 65% and 73% of the total dollar amount
of claims paid in the second quarter of 1997 and second quarter of 1996,
respectively. In addition, the 1997 share of 65% is approximately 11 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 Company average claim size will continue to decrease for the
foreseeable future. See Cautionary Statement.
Mortgage insurance underwriting and other expenses increased 28.0% to $20.6
million in the second quarter of 1997 from $16.1 million in the second quarter
of 1996. This increase was primarily attributable to the effect of Centre Re
cessions on 1996 expenses and secondarily to an increase in contract
underwriting expenses. Contract underwriting is generally more expensive on a
per application basis than underwriting a loan in-house, and is becoming an
increasingly popular method among mortgage lenders for originating loans.
Contract underwriting services have generated a significant percentage of PMI's
NIW in the second quarter of 1997, and are expected to do so in the foreseeable
future. See Cautionary Statement.
The mortgage insurance loss ratio improved slightly to 35.2% in the second
quarter of 1997 compared to 35.3% in the second quarter of 1996 due primarily to
the growth in premiums earned, partially offset by the increase in losses and
loss adjustment expenses. The expense ratio increased over 1996 to 22.4% in the
second quarter of 1997 from 20.7% in the second quarter of 1996, resulting in a
combined ratio of 57.6% in 1997, 1.6 percentage points higher than the 1996
ratio of 56.0%.
10
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Interest expense of $1.7 million was incurred in the second quarter of 1997
related to the long-term debt issued by the Company in November 1996. The
Company incurred an additional $2.1 million of expenses in the quarter related
to distributions on the redeemable capital securities (see Note 2 of Notes to
Consolidated Financial Statements above).
Title insurance premiums earned increased 11.5% to $13.6 million in the second
quarter of 1997 compared with $12.2 million in the second quarter of 1996. This
improvement was due to the ongoing expansion efforts of the title business.
Underwriting and other expenses increased 11.0% to $12.1 million in the second
quarter of 1997 compared to $10.9 million in the second quarter of 1996. This
increase is directly attributable to the increase in premiums earned. The title
insurance combined ratio decreased to 91.7% in the second quarter of 1997 from
92.2% in the second quarter of 1996.
Other income, primarily contract underwriting revenues generated by MSC,
decreased to $1.7 million in the second quarter of 1997 from $2.3 million in the
second quarter of 1996. This decrease is representative of the volume decreases
in mortgage loan originations.
The Company's effective tax rate decreased slightly to 28.3% in the second
quarter of 1997 compared to 29.0% in the second 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 year
over year decrease in the effective rate was caused primarily by the decrease in
realized capital gains.
SIX MONTHS ENDED JUNE 30, 1997 AND 1996
Consolidated net income in the six months ended June 30, 1997 was $91.5 million,
a 17.0% increase over net income of $78.2 million in the corresponding period of
1996. The increase was attributable to increases primarily in premiums earned of
15.8%, secondarily in realized capital gains of 88.4%, and also to increases in
investment income of 21.4%, partially offset by increases primarily in losses
and loss adjustment expenses of 16.1%, secondarily in underwriting and other
expenses of 13.6% and also to interest and other charges of $6.8 million not
incurred during 1996. Premiums earned increased primarily from the ongoing
mortgage insurance operations and secondarily from the effect of the Centre Re
termination. Earnings per share were $2.69 in the six months ended June 30,
1997, compared with $2.23 in the corresponding period of 1996, a 20.6% increase.
Excluding capital gains, earnings per share were $2.33 in the six months ended
June 30, 1997 compared with $2.04 in the six months ended June 30, 1996, a 14.2%
increase. Revenues in the six months ended June 30, 1997 were $280.4 million, a
19.3% increase over revenues of $235.0 million in the six months ended June 30,
1996.
PMI's NIW totaled $6.7 billion in the six months ended June 30, 1997, compared
with $8.9 billion in the six months ended June 30, 1996, a 24.7% decrease. The
decrease in NIW resulted from the number of new mortgage insurance policies
issued decreasing by 26.2%, to 52,535 policies in the six months ended June 30,
1997 from 71,231 policies in the corresponding period of 1996, partially offset
by an increase in the average loan size to $127,200 from $124,700.
The primary factor contributing to the decrease in new policies issued was the
decline in the total volume of insured loans in the private mortgage insurance
industry in the six months ended June 30, 1997 compared with the corresponding
period of 1996. The private mortgage insurance industry experienced a decline in
total NIW of 15.9% to $53.9 billion in the six months ended June 30, 1997 from
$64.1 billion in the corresponding period of 1996. The secondary factor
contributing to the decrease in new policies issued was a decline in market
share. PMI's market share of NIW decreased to 12.4% in the six months ended June
30, 1997 from 13.9% in the corresponding period of 1996. Including CMG,
combined market share was 13.4% in the six months ended June
11
<PAGE>
30, 1997 compared with 14.4% in the corresponding period of 1996. 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.
Mortgage insurance net premiums written were $175.5 million in the six months
ended June 30, 1997 compared with $144.6 million in the corresponding period of
1996, an increase of 21.4%. The increase is attributable primarily to the
growth of insurance in force from one year prior, 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 increase in average premium rates was caused by a continuing shift to 95s
with increased insurance coverage, and an increase in the use of ARMs. 95s with
30% coverage increased to 42.6% of NIW in the six months ended June 30, 1997
compared with 38.8% in the six months ended June 30, 1996. ARMs increased to
13.8% of NIW in the six months ended June 30, 1997 compared with 9.9% in the six
months ended June 30, 1996.
Refunded premiums decreased in the six months ended June 30, 1997 to $7.0
million from $8.8 million in the six months ended June 30, 1996. This was due
primarily to the decrease in mortgage refinancing volume during the six months
ended June 30, 1997. PMI's ceded premiums written as a percentage of net new,
renewal and refunded premiums decreased to 2.7% in the six months ended June 30,
1997 compared with 8.8% in the corresponding period of 1996. The reduction of
ceding percentages in 1997 was due to the Centre Re termination and commutation.
Mortgage insurance premiums earned increased 17.0% to $192.0 million in the six
months ended June 30, 1997 from $164.1 million in the six months ended June 30,
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 six months ended June 30, 1997 was
$40.7 million compared with $33.5 million in the six months ended June 30, 1996,
an increase of 21.5%. The increase was primarily attributable to the growth in
the average amount of invested assets as discussed above. The Company's average
investment yield (pretax) was 6.1% in the six months ended June 30, 1997 and
1996. Realized capital gains (net of losses) increased over 1996, up $8.8
million to $18.8 million in the six months ended June 30, 1997 from $10.0
million in the six months ended June 30, 1996. This was due primarily to the
sale of approximately $50.0 million of equity securities in the first quarter of
1997.
Mortgage insurance losses and loss adjustment expenses increased to $73.1
million in the six months ended June 30, 1997 from $62.6 million in the six
months ended June 30, 1996, an increase of 16.8%. 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. Primary claims paid in the six
months ended June 30, 1997 were approximately $73 million compared with
approximately $67 million for the six months ended June 30, 1996. Policies
written in California accounted for approximately 68% and 72% of the total
dollar amount of claims paid in the six months ended June 30, 1997 and 1996,
respectively.
Mortgage insurance underwriting and other expenses increased 22.6% to $40.7
million in the six months ended June 30, 1997 from $33.2 million in the six
months ended June 30, 1996. This increase was primarily attributable to the
effect of Centre Re cessions on 1996 expenses and secondarily to an increase in
contract underwriting expenses.
12
<PAGE>
The mortgage insurance loss ratio in the six months ended June 30, 1997 and 1996
was 38.1%. The expense ratio increased slightly over 1996, to 23.2% in the six
months ended June 30, 1997 from 22.9% in the six months ended June 30, 1996,
resulting in a combined ratio of 61.3% in 1997, 0.3 percentage points higher
than the 1996 ratio of 61.0%.
Interest expense of $3.4 million was incurred in the six months ended June 30,
1997 related to the long-term debt issued by the Company in November of 1996.
The Company incurred an additional $3.5 million of expenses related to
distributions on the redeemable capital securities (see Note 2 of Notes to
Consolidated Financial Statements above).
Title insurance premiums earned increased 7.9% to $26.0 million in the six
months ended June 30, 1997 compared with $24.1 million in the six months ended
June 30, 1996. This improvement was due to the ongoing expansion efforts of the
title business. Underwriting and other expenses increased 7.8% to $23.5 million
in the six months ended June 30, 1997 compared to $21.8 million in the six
months ended June 30, 1996. This increase is directly attributable to the
increase in premiums earned. The title insurance combined ratio decreased to
93.0% in the six months ended June 30, 1997 from 93.9% in the six months ended
June 30, 1996.
Other income, primarily revenues generated by MSC, decreased to $2.9 million in
the six months ended June 30, 1997 from $3.2 million in the six months ended
June 30, 1996. This decrease is representative of the volume decreases in
mortgage loan originations. Contract underwriting services have generated a
significant percentage of PMI's NIW in the first half of 1997, and are expected
to do so in the foreseeable future. See Cautionary Statement.
The Company's effective tax rate increased to 29.4% in the six months ended June
30, 1997, compared to 28.6% in the six months ended June 30, 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 $31.4 million during 1997
without prior regulatory approval. In June of 1997, the Arizona Department of
Insurance approved an extraordinary dividend of $45.0 million, payable in July
1997. Accordingly, PMI has paid dividends to TPG totaling $76.4 million through
July 1997. TPG has two available bank credit lines totaling $50.0 million.
There were no outstanding borrowings under the credit lines during 1997. 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 $60.0 million of common
stock as of June 30, 1997.
13
<PAGE>
As of June 30, 1997, TPG had approximately $145.3 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 1997 $100.0 redeemable
capital securities issue, less common stock repurchases of $59.9 million through
the first six months 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 $32.5 million from Forestview in the six months ended June
30, 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 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 $102.1 million and $25.3
million for the six months ended June 30, 1997 and 1996, respectively. This
increase is due primarily to the collection of $53.6 million as a result of the
Centre Retermination and commutation and secondarily to the increase in premiums
written of $30.9 million in the six months ended June 30 1997 compared to the
corresponding period of 1996.
Consolidated reserve for losses and loss adjustment expenses decreased from
$199.8 million at December 31, 1996, to $198.3 million at June 30, 1997. The
decrease in the consolidated reserve for losses and loss adjustment expense is
due primarily to the improvements in PMI's California book of business,
resulting in lower average claims.
Consolidated shareholders' equity increased from $986.9 million at December 31,
1996, to $1,014.7 million at June 30, 1997, an increase of $27.8 million, or
2.8%. The change in shareholders' equity consisted of increases of $91.5
million from net income and $2.1 million from stock option activity, offset by
common stock repurchases of $59.9 million, dividends declared of $3.3 million
and a decrease of $2.6 million in net unrealized gains on investments available
for sale (net of tax).
PMI's risk-to-capital ratio at June 30, 1997 was 14.8:1, compared to 15.9:1 at
December 31, 1996.
CAUTIONARY STATEMENT
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 market share has stabilized in the second quarter of
1997 after decreases experienced during the fourth quarter of 1996
14
<PAGE>
and first quarter of 1997 and further expects that PMI will continue to grow
market share in the second half of the year; (ii) Management expects the default
rate to increase slightly during the remainder of 1997; (iii) 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 Company average claim size will continue
to decrease for the foreseeable future; (iv) Contract underwriting services are
expected to generate a significant percentage of PMI's NIW in 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 in the next section.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
GENERAL CONDITIONS
Several factors such as economic recessions, falling housing values, rising
unemployment rates, deteriorating borrower credit, interest rate volatility,
increases in refinance activity caused by declining interest rates, 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.
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 government regulations or interpretations regarding the Real Estate
Settlement Procedures Act ("RESPA"), changes in the statutory charters,
regulations, powers and coverage requirements of government-sponsored
enterprises ("GSEs"), banks and savings institutions, customer consolidation and
other risk factors listed from time to time in the Company's Securities and
Exchange Commission filings.
REGIONAL CONCENTRATION
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 21.7% of its
risk in force concentrated and where the default rate on all PMI policies in
force is 3.65% compared to 2.20% nationwide as of June 30, 1997.
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.
15
<PAGE>
CHANGES IN COMPOSITION OF INSURANCE WRITTEN
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 June 30,
1997, approximately 45% 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.
INSURANCE IN FORCE
A significant percentage of PMI's premiums earned is generated from its existing
insurance in force and not from new insurance written. In the six months ended
June 30, 1997 approximately 94% of the mortgage insurance premiums earned were
generated from renewal premiums received on existing insurance in force. PMI's
policies for insurance coverage typically have a life expectancy of 5 to 7
years. Insurance coverage may be canceled by the policy owner or servicer of the
loan at any time. PMI has no control over the owner's or servicer's decision to
cancel insurance coverage and self-insure or place coverage with another
mortgage insurance company. There can be no assurance that policies for
insurance coverage originated in a particular year or for a particular customer
will be not be canceled at a later time or that the Company will be able to
regain such insurance coverage at a later time. As a result, the Company's
financial condition and results of operation could be materially and adversely
affected by a significant increase in policy cancellations.
LOSS RESERVES
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; CONTRACT UNDERWRITING SERVICES
Management believes that market share has stabilized in the second quarter of
1997 after decreases experienced during the fourth quarter of 1996 and first
quarter of 1997, and management expects that PMI will continue to grow market
share in the second half of the year. The Company's financial condition and
results of operations could be materially and adversely affected by a decline in
its market share, or a decline in market share of the private mortgage insurance
industry. 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
16
<PAGE>
loans. Any legislative or statutory change that would eliminate or decrease the
use of mortgage insurance in connection with the purchase of high-LTV loans 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.
The Company 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.
Accordingly, contract underwriting generates a significant percentage of PMI's
NIW, and is expected to do so in the foreseeable future. Due to the increasing
demand of contract underwriting services, the limited number of underwriting
personnel available, 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 operations.
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 and 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.
The maximum principle balance of loans eligible for purchase by Fannie Mae and
Freddie Mac is $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 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.
Statues giving borrowers' cancellation rights and or preventing premiums from
being paid by borrowers presently exist in five states, including California.
Management presently believes that the current statues will not have a material
impact on the Company's financial condition or results of operations. Management
believes it is too early to ascertain the impact of the enactment of any
additional 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 the private
mortgage insurance industry competes principally with
17
<PAGE>
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 certain national banks to form 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 could 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 offers both a captive reinsurance structure and a risk-sharing product (a
performance note) that is designed to encourage quality originations and loss
mitigation by lenders. To date, neither product has 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 as well as its captive reinsurance arrangements with
certain of its customers. The Company indicated to the New York Department of
Insurance that it disagrees with the statements in the letter. Management is
unable to predict at this time the results of these discussions.
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 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 AFFILIATE
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
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<PAGE>
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 $6.3 million of pool
premiums to Forestview and collected $32.5 million of reimbursed pool claims
from Forestview in the six months ended June 30, 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
Transaction of Notes to Consolidated Financial Statements.
19
<PAGE>
THE PMI GROUP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
JUNE 30, 1997
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Company's Annual Meeting of Stockholders held on May 13, 1997, the
following individuals were elected to the Board of Directors:
1. Election of Directors
Votes For Votes Withheld
--------- --------------
James C. Castle 31,500,451 27,596
Donald C. Clark 31,500,426 27,621
W. Roger Haughton 31,500,826 27,221
Wayne E. Hedien 31,500,801 27,246
Edward M. Liddy 31,500,801 27,246
John D. Roach 31,500,451 27,596
Kenneth T. Rosen 31,500,451 27,596
Richard L. Thomas 31,500,351 27,696
Mary Lee Widener 31,500,251 27,796
The following proposal was approved at the Company's Annual Meeting:
<TABLE>
<CAPTION>
Votes for Votes against Votes withheld
--------- ------------- --------------
<S> <C> <C> <C>
2. Appointment of Deloitte & Touche LLP
as independent auditors of the Company
for 1997 31,363,861 4,196 159,990
</TABLE>
ITEM 5 - OTHER INFORMATION
On July 14, 1997, TPG's Board of Directors increased the size of the board from
9 members to 10 members and elected Harold M. Messmer, Jr. to the board. Mr.
Messmer, age 51, is currently chairman of the board, president and chief
executive officer of Robert Half International Inc., an international
specialized staffing services company. Mr. Messmer is a member and Vice Chair of
the Compensation and Nominating Committee.
On June 2, 1997, Thomas C. Brown, age 48, was named Senior Vice President of
National Accounts for PMI. Mr. Brown was most recently president and chief
executive officer of Centerbank Mortgage Company and has held these positions
since 1989.
On August 4, 1997, John H. Fulford, age 48, was named Senior Vice President of
National Sales for PMI. Mr. Fulford was most recently senior vice president of
marketing at Fannie Mae. He first joined Fannie Mae in 1983,
20
<PAGE>
serving as senior assistant regional vice president of marketing and in 1985
became the company's senior vice president for its western regional office, a
position he held for eleven years.
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
None.
21
<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 August 11, 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
22
<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
23
<PAGE>
EXHIBIT 11.1
THE PMI GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF NET INCOME PER SHARE
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------------- --------------------------
(In thousands, except per share data) 1997 1996 1997 1996
------------ ----------- ----------- ------------
<S> <C> <C> <C> <C>
PRIMARY NET INCOME PER SHARE
Adjusted shares outstanding:
Average common shares outstanding 33,618 35,011 33,920 35,011
Net shares to be issued upon exercise of
dilutive stock options after
applying treasury stock method 98 79 106 94
------- ------- ------- -------
Average shares outstanding 33,716 35,090 34,026 35,105
======= ======= ======= =======
Net income $42,279 $41,220 $91,451 $78,210
======= ======= ======= =======
Primary net income per share $ 1.25 $ 1.17 $ 2.69 $ 2.23
======= ======= ======= =======
FULLY DILUTED NET INCOME PER SHARE
Adjusted shares outstanding:
Average common shares outstanding 33,618 35,011 33,920 35,011
Net shares to be issued upon exercise of
dilutive stock options after
applying treasury stock method 153 79 156 94
------- ------- ------- -------
Average shares outstanding 33,771 35,090 34,076 35,105
======= ======= ======= =======
Net income $42,279 $41,220 $91,451 $78,210
======= ======= ======= =======
Fully diluted net income per share $ 1.25 $ 1.17 $ 2.68 $ 2.23
======= ======= ======= =======
</TABLE>
24
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> APR-01-1997
<PERIOD-END> JUN-30-1997
<DEBT-HELD-FOR-SALE> 1,224,661
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 89,263
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 1,443,628
<CASH> 4,990
<RECOVER-REINSURE> 23,439
<DEFERRED-ACQUISITION> 33,789
<TOTAL-ASSETS> 1,615,069
<POLICY-LOSSES> 198,289
<UNEARNED-PREMIUMS> 99,690
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 351
<OTHER-SE> 1,014,311
<TOTAL-LIABILITY-AND-EQUITY> 1,615,069
109,906
<INVESTMENT-INCOME> 20,676
<INVESTMENT-GAINS> 546
<OTHER-INCOME> 1,705
<BENEFITS> 34,235
<UNDERWRITING-AMORTIZATION> 0
<UNDERWRITING-OTHER> 35,883
<INCOME-PRETAX> 58,949
<INCOME-TAX> 16,670
<INCOME-CONTINUING> 42,279
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 42,279
<EPS-PRIMARY> 1.25
<EPS-DILUTED> 1.25
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
