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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 September 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
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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 10/31/97 32,457,221
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THE PMI GROUP, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
SEPTEMBER 30, 1997
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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
Nine Months Ended September 30, 1997 and 1996.............. 3
Consolidated Balance Sheets as of September 30, 1997 and
December 31, 1996.......................................... 4
Consolidated Statements of Cash Flows for the Nine Months
Ended September 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 1. Legal Proceedings.................................................... 20
Item 6. Exhibits and Reports on Form 8-K..................................... 20
SIGNATURES...................................................................... 21
INDEX TO EXHIBITS............................................................... 22
</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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- --------------------
(In thousands except for per share 1997 1996 1997 1996
amounts) --------- --------- --------- ---------
<S> <C> <C> <C> <C>
REVENUES
Premiums earned................................................. $117,544 $104,953 $335,541 $293,237
Investment income, less investment expense...................... 21,434 16,449 62,181 49,937
Realized capital gains, net..................................... 292 4,190 19,106 14,174
Other income.................................................... 1,934 1,858 4,831 5,064
-------- -------- -------- --------
TOTAL REVENUES................................................. 141,204 127,450 421,659 362,412
-------- -------- -------- --------
LOSSES AND EXPENSES
Losses and loss adjustment expenses............................. 39,512 36,770 113,262 100,273
Underwriting and other expenses................................. 41,519 32,208 111,893 94,097
Interest expense................................................ 1,693 -- 5,068 --
Distributions on redeemable capital
securities of subsidiary trust (Note 2)...................... 2,078 -- 5,542 --
-------- -------- -------- --------
TOTAL LOSSES AND EXPENSES...................................... 84,802 68,978 235,765 194,370
-------- -------- -------- --------
INCOME BEFORE INCOME TAXES........................................ 56,402 58,472 185,894 168,042
INCOME TAX EXPENSE................................................ 14,489 17,192 52,530 48,552
-------- -------- -------- --------
NET INCOME........................................................ $ 41,913 $ 41,280 $133,364 $119,490
======== ======== ======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING............................... 33,299 35,100 33,783 35,101
======== ======== ======== ========
NET INCOME PER SHARE............................................. $1.26 $1.18 $3.95 $3.40
======== ======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
3
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THE PMI GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
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<CAPTION>
SEPTEMBER 30, DECEMBER 31,
(Dollars in thousands) 1997 1996
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ASSETS
Investments
Available for sale, at market
Fixed income securities
(amortized cost $1,223,153 and $1,042,570).......................... $1,282,433 $1,085,514
Equity securities
Common stock (cost $37,594 and $77,775).............................. 70,116 112,583
Preferred stock (cost $12,055 and $305).............................. 12,262 388
Common stock of affiliate, at underlying book value...................... 15,562 11,385
Short-term investments (at cost, which approximates market).............. 74,200 81,876
---------- ----------
TOTAL INVESTMENTS.......................................... 1,454,573 1,291,746
Cash....................................................................... 7,737 6,592
Accrued investment income.................................................. 21,007 19,439
Reinsurance recoverable and prepaid premiums............................... 28,305 83,379
Receivable from affiliates................................................. 9,307 10,525
Receivable from Allstate................................................... 16,822 16,822
Deferred policy acquisition costs.......................................... 35,794 31,633
Property and equipment, net................................................ 27,704 22,519
Other assets............................................................... 47,592 27,264
---------- ----------
TOTAL ASSETS............................................ $1,648,841 $1,509,919
========== ==========
LIABILITIES
Reserve for losses and loss adjustment expenses............................ $ 199,798 $ 199,774
Unearned premiums.......................................................... 97,594 116,951
Long-term debt............................................................. 99,547 99,342
Reinsurance balances payable............................................... 11,056 13,295
Deferred income taxes...................................................... 58,701 50,786
Other liabilities and accrued expenses..................................... 54,718 42,909
---------- ----------
TOTAL LIABILITIES....................................... 521,414 523,057
---------- ----------
COMPANY-OBLIGATED MANDATORILY REDEEMABLE CAPITAL SECURITIES
OF SUBSIDIARY TRUST HOLDING SOLELY JUNIOR SUBORDINATED
DEFERRABLE INTEREST DEBENTURE OF THE COMPANY (NOTE 2)................... 99,022 -
SHAREHOLDERS' EQUITY
Preferred stock -- $.01 par value; 5,000,000 shares authorized............. - -
Common stock -- $.01 par value; 125,000,000 shares
authorized; 35,120,862 and 35,047,619 issued............................. 351 350
Additional paid-in capital................................................. 260,680 258,059
Unrealized net gains on investments........................................ 60,834 50,709
Retained earnings.......................................................... 836,265 707,885
Treasury stock (2,351,900 and 537,800 shares at cost)...................... (129,725) (30,141)
---------- ----------
TOTAL SHAREHOLDERS' EQUITY.............................. 1,028,405 986,862
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.............. $1,648,841 $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>
NINE MONTHS
ENDED SEPTEMBER 30,
----------------------
(In thousands) 1997 1996
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CASH FLOWS FROM OPERATING ACTIVITIES
Net income............................................................. $ 133,364 $ 119,490
Adjustments to reconcile net income to net cash
provided by operating activities
Realized capital gains, net........................................ (19,106) (14,174)
Equity in (earnings) loss of affiliate............................. (1,002) 308
Depreciation and amortization...................................... 3,700 2,312
Changes in:
Reserve for losses and loss adjustment expenses.................. 24 7,410
Unearned premiums................................................ (19,357) (22,647)
Deferred policy acquisition costs................................ (4,161) (3,466)
Accrued investment income........................................ (1,568) 2,024
Reinsurance balances payable..................................... (2,239) 3,985
Reinsurance recoverable and prepaid premiums..................... 55,074 (16,087)
Income taxes..................................................... 2,459 443
Receivable from affiliates....................................... 1,218 (12,438)
Receivable from Allstate......................................... -- (1,851)
Other............................................................ (9,257) (4,643)
--------- ---------
Net cash provided by operating activities.................... 139,149 60,666
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of equity securities............................... 79,205 79,682
Investment collections of fixed income securities...................... 9,125 31,503
Proceeds from sales of fixed income securities......................... 330,498 143,598
Investment purchases
Fixed income securities............................................ (519,351) (292,617)
Equity securities.................................................. (30,115) (64,713)
Net decrease in short-term investments................................. 7,676 59,688
Investment in affiliate................................................ (3,108) (1,350)
Purchase of property and equipment..................................... (8,900) (7,920)
--------- ---------
Net cash used in investing activities........................ (134,970) (52,129)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of redeemable capital securities (Note 2)..................... 99,000 --
Proceeds from exercise of stock options................................ 2,621 822
Dividends paid to shareholders......................................... (5,071) (5,250)
Purchase of The PMI Group, Inc. common stock........................... (99,584) (4,167)
--------- ---------
Net cash used in financing activities........................ (3,034) (8,595)
--------- ---------
NET INCREASE (DECREASE) IN CASH........................................ 1,145 (58)
CASH AT BEGINNING OF PERIOD............................................ 6,592 3,654
--------- ---------
CASH AT END OF PERIOD.................................................. $ 7,737 $ 3,596
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
5
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THE PMI GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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". PMI
also owns 45% of CMG Mortgage Insurance Company ("CMG"). CMG is accounted for
on the equity method in the Company's consolidated financial statements. 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 September 30, 1997, and its consolidated statements of
operations and cash flows for the periods ended September 30, 1997 and 1996,
have been included. Interim results for the periods ended September 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 or 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 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.
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
6
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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 September
30, 1997 and 1996, respectively, and $3.96 and $3.41 in the nine months ended
September 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. Management has not determined if it will
adopt an earlier application of SFAS No. 130 and 131.
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 SEPTEMBER 30, 1997 AND 1996
Consolidated net income in the three months ended September 30, 1997 was $41.9
million, a 1.5% increase over net income of $41.3 million in the corresponding
period of 1996. The increase was attributable to increases primarily in
premiums earned and secondarily in investment income of 12.0% and 30.3%,
respectively, partially offset by increases primarily in underwriting and other
expenses of 28.9%, secondarily to a $3.9 million reduction in realized capital
gains, and also to interest and other charges of $3.8 million not incurred
during 1996 and to increases in losses and loss adjustment expenses of 7.5%.
Premiums earned increased primarily from the growth in mortgage insurance
operations, secondarily to increases in the title operations, and also 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 $1.26 in the three months ended September 30,
1997, compared with $1.18 in the corresponding period of 1996, a 6.8% increase.
Excluding capital gains, operating earnings per share were $1.25 in the third
quarter of 1997 compared with $1.10 in the third quarter of 1996, a 13.6%
increase. Revenues in the third quarter of 1997 were $141.2 million, an increase
of 10.8% over revenues of $127.5 million in the third quarter of 1996.
PMI's new insurance written ("NIW") totaled $4.5 billion in the third quarter of
1997, compared with $5.0 billion in the third quarter of 1996, a 10.0% decrease.
The decrease in NIW resulted from the number of new mortgage insurance policies
issued decreasing by 14.4%, to 34,342 policies in the three months ended
September 30, 1997 from 40,100 policies in the corresponding period of 1996,
partially offset by an increase in the average loan size to $129,600 from
$125,550.
The primary factor contributing to the decrease in new policies issued was a
decline in market share. PMI's market share of NIW decreased to 13.3% in the
three months ended September 30, 1997 from 14.7% in the corresponding period of
1996, but increased in the third quarter of 1997 from 12.6% in the second
quarter of 1997. On a combined basis with CMG, market share decreased to 14.5%
in the third quarter of 1997 compared with 15.5% in the corresponding period of
1996, but increased in the third quarter of 1997 from 13.7% in the second
quarter of 1997. The year over year 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. PMI recently filed policy forms with various state insurance
regulators which would allow PMI to offer a GSE pool insurance product to state
housing finance authorities and a select group of quality lenders with well-
diversified loan pools as part of PMI's value-added strategy. Management
presently cannot predict the impact this pool insurance product will have on
PMI's market share.
A secondary 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 third quarter of 1997 compared with the corresponding period of
1996. The private mortgage insurance industry experienced a decline in total new
insurance written of approximately 2% to $33.4 billion in the third quarter of
1997 from $34.0 billion in the corresponding period of 1996, which was caused by
a decrease in the new home purchase market partially offset by an increase in
refinancing activity. Refinancing as a percentage of PMI's NIW increased
slightly to 10.7% in the three months ended September 30, 1997 from 10.4% in the
corresponding period of 1996.
8
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PMI's cancellations of insurance in force were $4.1 billion in the third quarter
of 1997 compared to $2.7 billion in the corresponding period of 1996. This
increase is primarily due to the increase in refinancing activity throughout the
mortgage origination industry brought on by lower interest rates, and
secondarily to the maturation of PMI's 1992 and 1993 book of business.
PMI's persistency rate (percentage of insurance remaining in force from one year
prior) decreased 0.3 percentage points, and stands at 82.5% as of September 30,
1997 compared with 82.8% in the corresponding period of 1996. This decrease is
due primarily to the policy cancellations discussed above. Insurance in force
as of September 30, 1997 was $77.8 billion compared with $77.3 billion as of
December 31, 1996. The annualized growth rate of insurance in force was 0.9%
and 8.6% as of September 30, 1997 and 1996, respectively. This decrease was due
primarily to lower NIW and higher policy cancellations in 1997 compared with
1996. The lower growth rate in insurance in force may have an adverse impact on
the rate of growth, if any, of PMI's future renewal premiums. See Cautionary
Statement.
Mortgage insurance net premiums written were $98.5 million in the third quarter
of 1997 compared with $92.1 million in the corresponding period of 1996, an
increase of 6.9%. The increase is attributable primarily to the effect of the
Centre Re cessions in 1996, secondarily to the growth of insurance in force from
one year prior, and also to higher average premium rates and higher average loan
sizes, offset by a decrease in new premiums written resulting from the decrease
in NIW from the 1996 level and a slight increase in refunds. Refunded premiums
increased in the third quarter of 1997 to $4.2 million from $3.5 million in the
third quarter of 1996, due primarily to an increase in policy cancellations
discussed above.
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 partially offset by a
decrease in use of adjustable rate mortgages ("ARMs"). Although 95s with 30%
coverage remained unchanged at approximately 43% of NIW in the third quarter of
1997 and 1996, this deep-coverage book of business had a greater impact on
renewal premiums as the percent of 95s with 30% coverage increased to 20.7% of
insurance in force as of September 30, 1997 from 14.4% as of September 30, 1996.
ARMs decreased to 12.4% of NIW in the third quarter of 1997 compared with 17.4%
in the third quarter of 1996. The monthly premium plan as a percent of NIW
represented 97.8% of NIW in the three months ended September 30, 1997 compared
with 95.8% in the three months ended September 30, 1996.
Mortgage insurance premiums earned increased 10.3% to $100.7 million in the
third quarter of 1997 from $91.3 million in the third 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 third quarter of 1997 was $21.4
million compared with $16.4 million in the third quarter of 1996, an increase of
30.5%. 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 6.3%
in the third quarter of 1997 from 6.0% in the third quarter of 1996 due
primarily to a reallocation of the company's investment portfolio. Realized
capital gains (net of losses) experienced a decrease from 1996 to $0.3 million
in the third quarter of 1997 from $4.2 million in the third quarter of 1996
because of a decrease in activity in the Company's equity portfolio.
Mortgage insurance losses and loss adjustment expenses increased to $39.1
million in the third quarter of 1997 from $36.4 million in the third quarter of
1996, an increase of 7.4%. This increase was due primarily to the effect of the
Centre Re cessions in 1996, secondarily to the growth and maturation of
insurance in force and a related increase in the default rate.
9
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PMI's default rate has increased to 2.29% at September 30, 1997 from 2.03% at
September 30, 1996. This increase was due primarily to the policy cancellations
discussed above, and secondarily to normal delinquency development in states
where PMI has expanded its market presence and 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.
The default rates on PMI's California policies increased to 3.74% (representing
4,075 loans in default) at September 30, 1997, from 3.63% (representing 4,018
loans in default) at September 30, 1996. This increase was primarily due to
policy cancellations discussed above. Policies written in California accounted
for approximately 61% and 76% of the total dollar amount of claims paid in the
third quarter of 1997 and third quarter of 1996, respectively. Although
management expects that California should continue to account for the majority
of total claims paid, management anticipates that with continued improvement in
the California economy, increased benefits of loss mitigation and improved
default reinstatement rates, California claims paid as a percentage of total
claims paid should continue to decline. Accordingly, management anticipates
that PMI's average claim size will continue to decrease for the foreseeable
future. See Cautionary Statement.
Mortgage insurance underwriting and other expenses increased 29.8% to $22.2
million in the third quarter of 1997 from $17.1 million in the third quarter of
1996. This increase was primarily attributable to an increase in contract
underwriting expenses, and secondarily to the effect of the Centre Re cessions
in 1996. 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 processing loan applications. Management
anticipates that contract underwriting will continue to process loans that will
generate a significant percentage of PMI's NIW. See Cautionary Statement.
Contract underwriting processed loans represented 22.9% of PMI's NIW in the
three months ended September 30, 1997 compared to 13.8% in the corresponding
period of 1996.
The mortgage insurance loss ratio improved to 38.8% in the third quarter of 1997
compared to 39.9% in the third 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 to 22.5% in the third quarter of 1997 from
18.6% in the third quarter of 1996, due primarily to the increase in
underwriting costs discussed above, resulting in a combined ratio of 61.4% in
1997, 2.9 percentage points higher than the 1996 ratio of 58.5%.
Interest expense of $1.7 million was incurred in the third quarter of 1997
related to the long-term debt issued by the Company in November 1996. Also, 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 22.6% to $16.8 million in the third
quarter of 1997 compared with $13.7 million in the third quarter of 1996. This
improvement was due to increasing current markets combined with successful
ongoing expansion efforts into twelve new markets. Underwriting and other
expenses increased 21.7% to $14.6 million in the third quarter of 1997 compared
to $12.0 million in the third quarter of 1996. This increase is directly
attributable to the increase in fees and commissions payable to third parties
based on premiums earned. The title insurance combined ratio decreased to 89.3%
in the third quarter of 1997 from 90.2% in the third quarter of 1996.
Other income, primarily generated by MSC's contract underwriting services,
remained unchanged at $1.9 million in the third quarter of 1997 compared with
the corresponding period of 1996.
The Company's effective tax rate decreased to 25.7% in the third quarter of 1997
compared to 29.4% in the third quarter of 1996. The benefits of tax-preference
investment income and other permanent differences reduced the
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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, and secondarily by an increase in income earned on the
tax-exempt bond portfolio.
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
Consolidated net income in the nine months ended September 30, 1997 was $133.4
million, an 11.6% increase over net income of $119.5 million in the
corresponding period of 1996. The increase was attributable to increases
primarily in premiums earned of 14.4%, secondarily in investment income of
24.5%, and also to increases in realized capital gains of 34.8%, partially
offset by increases primarily in losses and loss adjustment expenses of 13.0%,
secondarily in underwriting and other expenses of 18.9% and also to interest and
other charges of $10.6 million not incurred during 1996. Premiums earned
increased primarily from the growth in mortgage insurance operations and
secondarily from the effect of the Centre Re termination. The 1996 results of
operations include reinsurance transactions pursuant to the reinsurance treaty
with Centre Re in effect during 1996. Earnings per share were $3.95 in the nine
months ended September 30, 1997, compared with $3.40 in the corresponding period
of 1996, a 16.2% increase. Excluding capital gains, operating earnings per
share were $3.58 in the nine months ended September 30, 1997 compared with $3.14
in the corresponding period of 1996, a 14.0% increase. Revenues in the nine
months ended September 30, 1997 were $421.7 million, a 16.4% increase over
revenues of $362.4 million in the nine months ended September 30, 1996.
PMI's NIW totaled $11.1 billion in the nine months ended September 30, 1997,
compared with $13.9 billion in the nine months ended September 30, 1996, a 20.1%
decrease. The decrease in NIW resulted from the number of new mortgage insurance
policies issued decreasing by 22.0%, to 86,877 policies in the nine months ended
September 30, 1997 from 111,350 policies in the nine months ended September 30,
1996, partially offset by an increase in the average loan size to $128,200 from
$125,000.
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 nine months ended September 30, 1997 compared with the
corresponding period of 1996. The private mortgage insurance industry
experienced a decline in total NIW of 11.0% to $87.3 billion in the nine months
ended September 30, 1997 from $98.1 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 12.8% in the
nine months ended September 30, 1997 from 14.2% in the corresponding period of
1996. Including CMG, market share was 13.8% in the nine months ended September
30, 1997 compared with 14.8% 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. PMI recently filed policy
forms with various state insurance regulators which would allow PMI to offer a
GSE pool product to state housing finance authorities and a select group of
quality lenders with well-diversified loan pools as part of PMI's value-added
strategy. Management presently cannot predict the impact this pool insurance
product will have on PMI's market share.
PMI's cancellations of insurance in force were $10.6 billion in the nine months
ended September 30, 1997 compared to $9.4 billion in the corresponding period of
1996. This increase is primarily due to an increase in refinancing activity
throughout the industry brought on by lower interest rates, and secondarily to
the maturation of PMI's 1992 and 1993 book of business.
Mortgage insurance net premiums written were $274.0 million in the nine months
ended September 30, 1997 compared with $236.7 million in the corresponding
period of 1996, an increase of 15.8%. 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 decrease in
refunded premiums to $11.2 million in
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the nine months ended September 30, 1997 from $12.3 million in the corresponding
period of 1996, and 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 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 42.9% of NIW in the nine months ended September 30,
1997 compared with 41.0% in the nine months ended September 30, 1996. Despite a
5% decline in the third quarter of 1997, ARMs increased to 13.3% of NIW in the
nine months ended September 30, 1997 compared with 12.5% in the nine months
ended September 30, 1996.
Mortgage insurance premiums earned were $292.7 million in the nine months ended
September 30, 1997 compared with $255.4 million in the nine months ended
September 30, 1996, an increase of 14.6%. 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 nine months ended September 30, 1997
was $62.2 million compared with $49.9 million in the nine months ended September
30, 1996, an increase of 24.7%. The increase was primarily attributable to the
growth in the average amount of invested assets, which resulted from positive
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, partially offset by a decrease in the average
investment yield (pretax) to 6.1% in the nine months ended September 30, 1997
from 6.2% in the corresponding period of 1996. Realized capital gains (net of
losses) increased over 1996, to $19.1 million in the nine months ended September
30, 1997 from $14.2 million in the nine months ended September 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 $112.2
million in the nine months ended September 30, 1997 from $99.0 million in the
nine months ended September 30, 1996, an increase of 13.3%. This increase was
due primarily to the effect of the Centre Re cessions in 1996, secondarily to
the growth and maturation of insurance in force and a related increase in the
default rate. Primary claims paid in the nine months ended September 30, 1997
were approximately $111 million compared with approximately $106 million for the
nine months ended September 30, 1996.
Mortgage insurance underwriting and other expenses increased 25.1% to $62.9
million in the nine months ended September 30, 1997 from $50.3 million in the
nine months ended September 30, 1996. This increase was primarily attributable
to an increase in contract underwriting expenses, and secondarily to the effect
of Centre Re cessions in 1996. 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 processing loan
applications. Management anticipates that contract underwriting will continue
to process loans that will generate a significant percentage of PMI's NIW. See
Cautionary Statement. Contract underwriting processed loans represented 19.6%
of PMI's NIW in the nine months ended September 30, 1997 compared to 12.1% in
the corresponding period of 1996.
The mortgage insurance loss ratio decreased slightly to 38.3% in the nine months
ended September 30, 1997 from 38.8% in the nine months ended September 30, 1996.
This decrease was due to the growth in mortgage net premiums earned offset by
the increase in losses and loss adjustment expenses discussed above. The expense
ratio increased to 23.0% in the nine months ended September 30, 1997 from 21.2%
in the nine months ended September 30, 1996, due primarily to the increase in
underwriting costs, resulting in a combined ratio of 61.3% in 1997, 1.3
percentage points higher than the 1996 ratio of 60.0%.
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<PAGE>
Interest expense of $5.1 million was incurred in the nine months ended September
30, 1997 related to the long-term debt issued by the Company in November of
1996. The Company incurred an additional $5.5 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 13.2% to $42.8 million in the nine
months ended September 30, 1997 compared with $37.8 million in the nine months
ended September 30, 1996. This improvement was due to increasing current markets
combined with successful ongoing expansion efforts into twelve new markets.
Underwriting and other expenses increased 13.1% to $38.1 million in the nine
months ended September 30, 1997 compared to $33.7 million in the nine months
ended September 30, 1996. This increase is directly attributable to the
increase in fees and commissions payable to third parties based on premiums
earned. The title insurance combined ratio decreased to 91.6% in the nine
months ended September 30, 1997 from 92.5% in the nine months ended September
30, 1996.
Other income, primarily revenues generated by MSC, decreased to $4.8 million in
the nine months ended September 30, 1997 from $5.1 million in the nine months
ended September 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 nine months of
1997. Management anticipates that contract underwriting will continue to
process loans that will generate a significant percentage of PMI's NIW. See
Cautionary Statement.
The Company's effective tax rate decreased to 28.3% in the nine months ended
September 30, 1997, compared to 28.9% in the nine months ended September 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.
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.
PMI has paid regular and extraordinary dividends to TPG totaling $76.4 million
during 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, funding of acquisitions, additions to its investment
portfolio and investments in subsidiaries. As of the date of this filing, the
Company has substantially utilized the funds under the stock buy-back program
authorized by the TPG Board of Directors.
As of September 30, 1997, TPG had approximately $161.0 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
million redeemable capital securities issue and $76.4 million in dividends from
PMI, less common stock repurchases of $99.6 million through the first nine
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 $45.1 million from Forestview in the nine months ended
September 30, 1997), and amounts earned from the investment of this cash flow.
The principal
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<PAGE>
uses of funds by PMI are the payment of claims and related expenses, reinsurance
premiums, other operating expenses and dividends to TPG.
The majority of claims paid 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 58.2% of PMI's insurance in force at September 30, 1997, with the
1993 book of business representing 19.2%. Primary claims paid were
approximately $111 million and $106 million for the nine months ended September
30, 1997 and 1996, respectively.
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 $135.2 million and $54.9
million for the nine months ended September 30, 1997 and 1996, respectively.
This increase is due primarily to the collection of $53.6 million as a result of
the Centre Re termination and commutation and secondarily to the increase in
premiums written of $37.3 million in the nine months ended September 30, 1997
compared to the corresponding period of 1996.
Consolidated shareholders' equity increased from $986.9 million at December 31,
1996, to $1,028.4 million at September 30, 1997, an increase of $41.5 million,
or 4.2%. The change in shareholders' equity consisted of increases of $133.4
million from net income, $2.6 million from stock option activity, and an
increase of $10.0 million in net unrealized gains on investments available for
sale (net of tax), offset by common stock repurchases of $99.6 million, and
dividends declared of $4.9 million.
PMI's risk-to-capital ratio at September 30, 1997 was 15.1:1, compared to 15.9:1
at December 31, 1996.
CAUTIONARY STATEMENT
Certain written and oral statements made or incorporated by reference from time
to time by the Company or its representatives in this document, other documents
filed with the Securities and Exchange Commission, press releases, conferences,
or otherwise that are not historical facts, and that relate to future plans,
events or performance are forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements in this document include the following: (i) The lower growth rate in
insurance in force may have an adverse impact on the rate of growth, if any, of
PMI's future renewal premiums; (ii) Management expects the default rate to
increase slightly during the remainder of 1997; (iii) Although management
expects that California will continue to account for the majority of total
claims paid, management anticipates that with the continued improvement in the
California economy, increased benefits of loss mitigation, and improved
reinstatements rates, California claims paid as a percentage of total claims
paid will continue to decline. Accordingly, management anticipates that PMI's
average claim size will continue to decrease for the foreseeable future; (iv)
Management anticipates that contract underwriting will continue to process loans
that will generate a significant percentage of PMI's NIW; (v) Management
presently believes that the current statutes will not have a material impact on
the Company's financial condition or results of operations. Management believes
it
14
<PAGE>
is too early to ascertain the impact of the enactment of any additional
mortgage cancellation proposals; (vi) The Company presently believes that it
will be able to resolve the Year 2000 Issues in a timely manner and that the
cost of addressing such matter will not have a material effect on the Company's
current financial position, liquidity or results of operations; and (vii) 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, declining housing values, higher
unemployment rates, deteriorating borrower credit, rising interest rates,
increases in refinance activity caused by declining interest rates, legislation
impacting borrowers' rights, or combinations of such factors might affect the
mortgage insurance industry and demand for housing 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.
MARKET SHARE; COMPETITION
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 as a whole. 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 or self-insure through
affiliates. Further, several of the Company's competitors have greater direct
or indirect capital reserves which provide them with potentially greater
flexibility than the Company in addressing competitive issues.
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. In
addition, the Office of the Comptroller of the Currency has granted permission
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 or purchased 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.
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<PAGE>
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. In February 1997, the maximum principle
balance of loans eligible for purchase by Fannie Mae and Freddie Mac was
increased to $214,600 from $207,000. 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.
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 the FHA, any increase in
the FHA's maximum individual loan amount could make the FHA more competitive
with PMI.
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 nine months ended
September 30, 1997 approximately 95% of the mortgage insurance premiums earned
were generated from gross 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 greater than anticipated policy cancellations or lower
than projected persistency resulting in declines in insurance in force.
Insurance in force as of September 30, 1997 was $77.8 billion compared with
$77.3 billion as of December 31, 1996. The annualized growth rate of insurance
in force was 0.9% and 8.6% as of September 30, 1997 and 1996, respectively. The
period over period decrease is primarily due to lower NIW and higher policy
cancellations. The lower growth rate in insurance in force may have an adverse
impact on PMI's future renewal premiums.
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.
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.
Statutes giving borrowers' cancellation rights and or preventing
16
<PAGE>
premiums from being paid by borrowers presently exist in five states, including
California. Management presently believes that the current statutes 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. See Cautionary
Statement.
CONTRACT UNDERWRITING SERVICES; NEW PRODUCTS
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. Management anticipates that contract underwriting will continue to process
loans that will generate a significant percentage of PMI's NIW. See Cautionary
Statement. 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, including any
mortgage pool type products, or programs will be as profitable as the Company's
existing products and programs.
YEAR 2000 ISSUES
The Company is heavily dependent upon complex computer systems for all phases of
its operations, including customer service, servicing the insurance portfolio,
risk analysis, underwriting, and loss reserves. Since many of the Company's
older computer software programs recognize only the last two digits of the year
in any date (e.g., "97" for 1997), some software may fail to operate properly in
1999 or 2000 if the software is not reprogrammed or replaced (the "Year 2000
Issue"). The Company believes that many of its suppliers and customers also
have Year 2000 Issues which could affect the Company. The Company has commenced
a plan intended to mitigate and/or prevent the adverse effects of Year 2000
Issues. Presently, the Company can neither quantify the cost of this work, nor
the financial effect of the Year 2000 Issue if it is not resolved in a timely
manner. However, the Company presently believes that it will be able to resolve
the Year 2000 Issues in a timely manner and that the cost of addressing such
matter will not have a material effect on the Company's current financial
position, liquidity or results of operations. See Cautionary Statement.
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.
17
<PAGE>
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 with Allstate, 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.
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 September
30, 1997, 45.6% 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"). At
September 30, 1997, 1.6% of PMI's risk in force consisted of 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.
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.
LOSS RESERVES
PMI establishes loss reserves based upon estimates of the claim rate and average
claim amounts, 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.
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
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21.1% of its risk in force concentrated and where the default rate on all PMI
policies in force is 3.74% compared to 2.29% nationwide as of September 30,
1997.
CONTINUING RELATIONSHIPS WITH ALLSTATE AND AFFILIATE
In December 1993, PMI entered into a 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. The parties are in 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's previous claims-paying rating of "AA" (Excellent) was withdrawn by
Standard and Poor's Rating Services ("S&P"). Management is uncertain at this
time what impact the withdrawal of the claims-paying rating will have on the
parties ability to timely consummate the assumption transaction. PMI ceded $9.2
million of pool premiums to Forestview and collected $45.1 million of reimbursed
pool claims from Forestview in the nine months ended September 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 Cautionary
Statement.
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THE PMI GROUP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
SEPTEMBER 30, 1997
ITEM 1 - LEGAL PROCEEDINGS
In the September 30, 1996 Quarterly Report on Form 10-Q, the Company reported
the filing of a complaint in the U.S. District Court, Southern District of
Florida, against the American Pioneer Title Insurance Company, a wholly owned
subsidiary of the Company (case #96-2708-CIV-HIGHSMITH). On July 31, 1997, the
complaint was dismissed without prejudice for lack of subject matter
jurisdiction.
On October 29, 1997, BISYS Creative Solutions, Inc. ("BISYS") filed a lawsuit
against the Company and PMI Mortgage Insurance Co. The complaint captioned
BISYS Creative Solutions, Inc. v. The PMI Group, Inc. and PMI Mortgage Insurance
- --------------------------------------------------------------------------------
Co. (case #E-62326) was filed in the Superior Court of Fulton County, State of
- ---
Georgia and alleges that the Company and PMI Mortgage Insurance Co. have
breached their contractual obligations to BISYS and have wrongfully interfered
with the contractual relations of BISYS. Based on information presently
available to the Company, management believes that the ultimate outcome of this
matter will not have a material adverse effect on the Company's financial
position or results of operations.
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.
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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 November 13, 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
21
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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
22
<PAGE>
EXHIBIT 11.1
THE PMI GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF NET INCOME PER SHARE
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- -------------------
(In thousands, except per share data) 1997 1996 1997 1996
--------- --------- --------- --------
PRIMARY NET INCOME PER SHARE
Adjusted shares outstanding:
<S> <C> <C> <C> <C>
Average common shares outstanding.................... 33,180 35,011 33,671 35,011
Net shares to be issued upon exercise of
dilutive stock options after applying
treasury stock method.............................. 119 89 112 90
------- ------- -------- --------
Average shares outstanding........................... 33,299 35,100 33,783 35,101
======= ======= ======== ========
Net income................................................ $41,913 $41,280 $133,364 $119,490
======= ======= ======== ========
Primary net income per share.............................. $ 1.26 $ 1.18 $ 3.95 $ 3.40
======= ======= ======== ========
FULLY DILUTED NET INCOME PER SHARE
Adjusted shares outstanding:
Average common shares outstanding.................... 33,180 35,011 33,671 35,011
Net shares to be issued upon exercise of
dilutive stock options after applying
treasury stock method.............................. 119 117 124 117
------- ------- -------- --------
Average shares outstanding........................... 33,299 35,128 33,795 35,128
======= ======= ======== ========
Net income................................................ $41,193 $41,280 $133,364 $119,490
======= ======= ======== ========
Fully diluted net income per share........................ $ 1.26 $ 1.18 $ 3.95 $ 3.40
======= ======= ======== ========
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JUL-01-1997
<PERIOD-END> SEP-30-1997
<DEBT-HELD-FOR-SALE> 1,282,433
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 97,940
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 1,454,573
<CASH> 7,737
<RECOVER-REINSURE> 28,305
<DEFERRED-ACQUISITION> 35,794
<TOTAL-ASSETS> 1,648,841
<POLICY-LOSSES> 199,798
<UNEARNED-PREMIUMS> 97,594
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 351
<OTHER-SE> 1,028,054
<TOTAL-LIABILITY-AND-EQUITY> 1,648,841
117,544
<INVESTMENT-INCOME> 21,434
<INVESTMENT-GAINS> 292
<OTHER-INCOME> 1,934
<BENEFITS> 39,512
<UNDERWRITING-AMORTIZATION> 0
<UNDERWRITING-OTHER> 41,519
<INCOME-PRETAX> 56,402
<INCOME-TAX> 14,489
<INCOME-CONTINUING> 41,913
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 41,913
<EPS-PRIMARY> 1.26
<EPS-DILUTED> 1.26
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
