<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 1999
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.
<TABLE>
<CAPTION>
Class of Stock Par Value Date Number of Shares
- -------------- --------- ---- ----------------
<S> <C> <C> <C>
Common Stock $0.01 09/30/99 44,670,398
</TABLE>
<PAGE>
THE PMI GROUP, INC.
Index to Quarterly Report on Form 10-Q
September 30, 1999
<TABLE>
<CAPTION>
Part I - Financial Information Page
<S> <C> <C>
Item 1. Interim Consolidated Financial Statements and Notes
Consolidated Statements of Operations for the Three and Nine
Months Ended September 30, 1999 and 1998 3
Consolidated Balance Sheets as of September 30, 1999 and December 31, 1998 4
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 1999 and 1998 5
Notes to Consolidated Financial Statements 6-11
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12-31
Part II - Other Information
Item 3. Quantitative and Qualitative Disclosures About Market Risk 32
Item 4 Submission of Matters to a Vote of Security Holders 32
Item 5. Other Information 32
Item 6. Exhibits and Reports on Form 8-K 32
Signatures 33
Index to Exhibits 34
</TABLE>
2
<PAGE>
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 amounts) 1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues
Premiums earned $147,663 $127,300 $407,761 $362,473
Investment income, less investment expense 24,050 20,736 67,579 63,452
Realized capital gains 168 14,243 512 24,434
Other income 6,313 5,130 13,767 15,153
--------- --------- --------- ---------
Total revenues 178,194 167,409 489,619 465,512
--------- --------- --------- ---------
Losses and expenses
Losses and loss adjustment expenses 31,217 34,329 83,934 103,004
Policy acquisition costs 19,004 15,564 60,971 40,582
Underwriting and other operating expenses 46,736 37,446 124,542 104,924
Interest expense 1,817 1,756 5,410 5,259
Distributions on preferred capital securities 2,077 2,077 6,232 6,234
--------- --------- --------- ---------
Total losses and expenses 100,851 91,172 281,089 260,003
--------- --------- --------- ---------
Income before income taxes 77,343 76,237 208,530 205,509
Income tax expense 22,840 22,509 60,916 59,226
--------- --------- --------- ---------
Net income $ 54,503 $ 53,728 $147,614 $146,283
========= ========= ========= =========
Basic net income per common share $ 1.22 $ 1.16 $ 3.28 $ 3.07
========= ========= ========= =========
Diluted net income per common share $ 1.21 $ 1.15 $ 3.26 $ 3.06
========= ========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
THE PMI GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
(Dollars in thousands) 1999 1998
-------------- -------------
<S> <C> <C>
Assets
Investments
Available for sale, at market
Fixed income securities
(amortized cost $1,466,571 and $1,268,625) $1,485,327 $1,356,869
Equity securities
Common stock (cost $54,198 and $34,129) 81,376 58,785
Preferred stock (cost $17,973 and $17,240) 17,164 17,706
Common stock of affiliates, at underlying book value 85,990 60,450
Short-term investments (at cost, which approximates market) 86,892 38,414
-------------- -------------
Total investments 1,756,749 1,532,224
Cash 33,167 9,757
Accrued investment income 20,715 20,150
Reinsurance recoverable and prepaid premiums 52,454 42,102
Premiums receivable 28,911 24,367
Receivable from affiliates 656 2,229
Receivable from Allstate - 23,657
Deferred policy acquisition costs 70,782 61,605
Property and equipment, net 39,381 37,630
Other assets 37,518 24,149
-------------- -------------
Total assets $2,040,333 $1,777,870
============== =============
Liabilities
Reserve for losses and loss adjustment expenses $ 279,721 $ 215,259
Unearned premiums 177,037 94,886
Long-term debt 145,351 99,476
Reinsurance balances payable 21,347 14,764
Deferred income taxes 73,944 96,730
Other liabilities and accrued expenses 74,452 60,200
-------------- -------------
Total liabilities 771,852 581,315
-------------- -------------
Company-obligated mandatorily redeemable preferred capital
securities of subsidiary trust holding solely junior subordinated
deferrable interest debenture of the Company 99,066 99,040
Shareholders' equity
Preferred stock -- $0.01 par value; 5,000,000 shares authorized - -
Common stock -- $0.01 par value; 125,000,000 shares authorized;
and 52,794,003 issued 528 528
Additional paid-in capital 265,190 264,864
Accumulated other comprehensive income 28,585 74,462
Retained earnings 1,203,555 1,060,724
Treasury stock (8,123,606 and 7,376,102 shares at cost) (328,443) (303,063)
-------------- -------------
Total shareholders' equity 1,169,415 1,097,515
-------------- -------------
Total liabilities and shareholders' equity $2,040,333 $1,777,870
============== =============
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
THE PMI GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
-----------------------------
(In thousands) 1999 1998
------------ -----------
<S> <C> <C>
Cash flows from operating activities
Net income $ 147,614 $ 146,283
Adjustments to reconcile net income to net cash
provided by operating activities:
Realized capital gains, net (512) (24,434)
Equity in earnings of affiliates (4,762) (1,834)
Depreciation and amortization 11,005 4,804
Changes in:
Reserve for losses and loss adjustment expenses 64,462 6,276
Unearned premiums 82,151 (11,251)
Deferred policy acquisition costs (9,177) (15,645)
Accrued investment income (565) 839
Reinsurance balances payable 6,583 2,094
Reinsurance recoverable and prepaid premiums (10,352) (5,127)
Premiums receivable (4,544) (7,078)
Income taxes 811 4,485
Receivable from affiliates 1,573 718
Receivable from Allstate 23,657 (5,806)
Other 77,448 27,459
------------ -----------
Net cash provided by operating activities 385,392 121,783
------------ -----------
Cash flows from investing activities
Proceeds from sales of equity securities 19,040 61,280
Investment collections of equity securities 61 -
Investment collections of fixed income securities 3,000 38,864
Proceeds from sales of fixed income securities 145,836 98,020
Investment purchases
Fixed income securities (346,459) (119,227)
Equity securities (39,396) (40,408)
Net (increase) decrease in short-term investments (48,468) 38,498
Investment in affiliates (22,009) (39,455)
Purchase of PMI, Ltd. (31,016) -
Purchase of property and equipment (13,008) (9,155)
------------ -----------
Net cash provided by (used in) investing activities (332,419) 28,417
------------ -----------
Cash flows from financing activities
Proceeds from exercise of stock grants and options 327 1,915
Dividends paid to shareholders (4,510) (4,816)
Purchase of The PMI Group, Inc. common stock (25,380) (149,749)
------------ -----------
Net cash used in financing activities (29,563) (152,650)
------------ -----------
Net increase (decrease) in cash 23,410 (2,450)
Cash at beginning of period 9,757 11,101
------------ -----------
Cash at end of period $ 33,167 $ 8,651
============ ===========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
THE PMI GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
Note 1 - Basis of presentation
The accompanying unaudited consolidated financial statements include the
accounts of The PMI Group, Inc. ("TPG"), a Delaware corporation; its
wholly-owned subsidiaries, PMI Mortgage Insurance Co. ("PMI"), an Arizona
corporation; Residential Guaranty Co. ("RGC"), an Arizona Corporation; American
Pioneer Title Insurance Company ("APTIC"), a Florida corporation; PMI Mortgage
Guaranty Co. ("PMG"), an Arizona corporation; Residential Insurance Co. ("RIC"),
an Arizona corporation; PMI Capital I ("PCI"), a Delaware trust; TPG Insurance
Co. ("TIC"), a Vermont corporation; TPG Segregated Portfolio Co. (Cayman)
("TSPC"), a Cayman Islands corporation; and PMI's wholly-owned subsidiaries, PMI
Mortgage Insurance Australia Pty Limited ("PMI Holdings") and its wholly owned
subsidiary PMI Mortgage Insurance Ltd ("PMI Ltd"), formerly known as MGICA,
Ltd., an Australian mortgage insurance company; PMI Mortgage Services Co.
("MSC"), a California corporation which is engaged in the business of contract
underwriting; and PMI Securities Co. ("SEC"), a Delaware corporation, which is
an inactive broker-dealer. PMI is licensed in all 50 states of the United States
and the District of Columbia. TPG and its subsidiaries are collectively referred
to as the "Company". All material intercompany transactions and balances have
been eliminated in consolidation. In addition, PMI owns 50% (45% at September
30, 1998) of CMG Mortgage Insurance Company ("CMG"), a Wisconsin corporation,
which also conducts a residential mortgage insurance business and TPG owns 24.9%
of RAM Holdings Ltd. and RAM Holdings II Ltd. (collectively referred to as "RAM
Re"), a financial guaranty reinsurance company based in Bermuda. CMG and Ram Re
are accounted for on the equity method in the Company's consolidated financial
statements.
The Company's unaudited consolidated financial statements have been prepared in
accordance with generally accepted accounting principles (GAAP) 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, 1999, and its consolidated statements of
operations and cash flows for the periods ended September 30, 1999 and 1998,
have been included. Interim results for the period ended September 30, 1999 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 1999. The financial statements should be read in conjunction
with the audited consolidated financial statements and footnotes included in The
PMI Group, Inc. 1998 Annual Report to Shareholders.
Note 2 - Earnings per Share
The weighted average common shares outstanding for computing basic earnings per
share ("EPS") were 44,773,670 and 46,373,789 for the three months ended
September 30, 1999 and 1998, respectively and 44,962,512 and 47,624,292 for the
nine months ended September 30, 1999 and 1998, respectively. The weighted
average common shares outstanding for computing diluted EPS includes only stock
options issued by the Company that have a dilutive impact and are outstanding
for the period, and had the potential effect of increasing common shares to
45,221,950 and 46,551,297 for the three months ended September 30, 1999 and
1998, respectively and 45,231,483 and 47,864,477 for the nine months ended
September 30, 1999 and 1998, respectively. Net income available to common
shareholders does not change for computing diluted EPS. (All
6
<PAGE>
1998 share amounts have been restated to reflect the August 16, 1999 3-for-2
share split effected in the form of a stock dividend.)
Note 3 - Comprehensive Income
The reconciliation of net income to comprehensive income for the three months
and nine months ended September 30, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------ -------------------------
1999 1998 1999 1998
---------- --------- ----------- -----------
<S> <C> <C> <C> <C>
Net income $ 54,503 $53,728 $147,614 $146,283
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period (17,391) 7,081 (45,544) 15,847
Less: reclassification adjustment for gains
included in net income (109) (9,258) (333) (15,882)
---------- --------- ----------- -----------
Other comprehensive income (loss), net of tax (17,500) (2,177) (45,877) (35)
---------- --------- ----------- -----------
Comprehensive income $ 37,003 $51,551 $101,737 $146,248
========== ========= =========== ===========
</TABLE>
Note 4 - New Accounting Pronouncement
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities, which
established accounting and reporting standards for derivative instruments. The
statement is effective for fiscal quarters beginning after June 15, 2000. The
Company has not yet evaluated the impact of the statement.
7
<PAGE>
Note 5 - Deferred Acquisition Costs ("DAC")
PMI defers certain costs related to the acquisition of primary mortgage
insurance and amortizes these costs against related premium revenue in order to
match costs and revenues in accordance with GAAP. These acquisition costs vary
with, and are primarily related to, the acquisition of new business. Specific
costs PMI defers include field underwriting, field sales, and national accounts.
To the extent PMI or any of its subsidiaries are compensated by customers for
contract underwriting, those underwriting costs are not deferred.
DAC is amortized on an accelerated basis over 24 months rather than the 5-7 year
average policy life. This method is used so that deferred costs will have been
fully amortized prior to the peak claims paying period.
The DAC asset is affected by: (a) acquisition costs deferred in a period, and
(b) amortization of previously deferred costs in such period. In periods where
there is growth in premiums (and therefore acquisition costs), the DAC asset
will increase because the amount of acquisition costs being deferred exceeds the
amount being amortized to expense. The following table reconciles beginning and
ending DAC for the periods indicated:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------------- ----------------------------
(In thousands) 1999 1998 1999 1998
-------------- ------------- ------------ -------------
<S> <C> <C> <C> <C>
Beginning DAC balance $ 69,230 $ 47,966 $ 61,605 $ 37,864
Acquisition costs incurred and deferred 20,556 21,107 70,148 56,227
Amortization of deferred costs (19,004) (15,564) (60,971) (40,582)
-------------- ------------- ------------ -------------
Ending DAC balance $ 70,782 $ 53,509 $ 70,782 $ 53,509
</TABLE>
8
<PAGE>
Note 6 - Business Segments
The Company's reportable operating segments include Mortgage Guaranty Insurance
and Title Insurance. The U.S. Mortgage Guaranty Insurance segment includes PMI,
PMG, RGC, RIC, TIC and TSPC. The International Mortgage Guaranty Insurance
segment consists of the results for PMI Ltd. The Title Insurance segment
consists of the results for APTIC. The Other segment includes TPG, MSC, PCI, and
SEC. The Other segment includes the income and expenses of the holding company,
the results from the business of contract underwriting and software licensing,
and the activity of an inactive broker-dealer. Intersegment transactions are not
significant. The Company evaluates performance primarily based on segment net
income.
The following tables present information about reported segment income (loss)
and segment assets for the periods indicated:
<TABLE>
<CAPTION>
U.S. International
Mortgage Mortgage
Quarter Ended September 30, 1999 Guaranty Guaranty Title Intersegment Consolidated
(In thousands) Insurance Insurance Insurance Other Adjustments Total
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premiums earned $ 116,524 $ 4,786 $26,353 $ - $ - $ 147,663
============== ============= =========== =========== =============== ==============
Net underwriting income (expenses)
before tax-external customers $ 51,116 $ 1,879 $ 3,066 $ 958 $ - $ 57,019
Investment income 20,117 1,419 422 624 - 22,582
Equity in earnings of affiliates - - - (267) 1,903 1,636
Interest expense - - - (1,817) - (1,817)
Distributions on preferred capital
securities - - - (2,077) - (2,077)
-------------- ------------- ----------- ----------- --------------- --------------
Income (loss) before income tax
expense 71,233 3,298 3,488 (2,579) 1,903 77,343
Income tax expense (benefit) 21,114 1,117 1,281 (672) - 22,840
============== ============= =========== =========== =============== ==============
Net income (loss) $ 50,119 $ 2,181 $ 2,207 $ (1,907) $1,903 $ 54,503
============== ============= =========== =========== =============== ==============
Total assets $1,713,925 $176,753 $45,597 $104,058 $ - $2,040,333
============== ============= =========== =========== =============== ==============
<CAPTION>
U.S. International
Mortgage Mortgage
Quarter Ended September 30, 1998 Guaranty Guaranty Title Intersegment Consolidated
(In thousands) Insurance Insurance Insurance Other Adjustments Total
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premiums earned $ 105,713 $ - $21,587 $ - $ - $ 127,300
============== ============= =========== =========== =============== ==============
Net underwriting income (expenses)
before tax-external customers $ 44,993 $ - $ 2,818 $ (2,720) $ - $ 45,091
Investment income 31,901 - 391 1,972 - 34,264
Equity in earnings of affiliates - - - - 715 715
Interest expense - - - (1,756) - (1,756)
Distributions on preferred capital
securities - - - (2,077) - (2,077)
-------------- ------------- ----------- ----------- --------------- --------------
Income (loss) before income tax
expense 76,894 - 3,209 (4,581) 715 76,237
Income tax expense (benefit) 22,584 - 1,194 (1,269) - 22,509
============== ============= =========== =========== =============== ==============
Net income (loss) $ 54,310 $ - $ 2,015 $ (3,312) $ 715 $ 53,728
============== ============= =========== =========== =============== ==============
Total assets $1,575,121 $ - $38,850 $ 95,146 $ - $1,709,117
============== ============= =========== =========== =============== ==============
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
U.S. International
Mortgage Mortgage
Nine Months Ended September 30, 1999 Guaranty Guaranty Title Intersegment Consolidated
(In thousands) Insurance Insurance Insurance Other Adjustments Total
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premiums earned $ 329,100 $ 4,786 $73,875 $ - $ - $ 407,761
============== ============= =========== =========== =============== ==============
Net underwriting income (expenses)
before tax-external customers $ 144,411 $ 1,879 $ 8,006 $ (2,215) $ - $ 152,081
Investment income 58,658 1,419 1,170 2,081 - 63,328
Equity in earnings of affiliates - - - 3,542 1,221 4,763
Interest expense - - - (5,410) - (5,410)
Distributions on preferred capital
securities - - - (6,232) - (6,232)
-------------- ------------- ----------- ----------- --------------- --------------
Income (loss) before income tax
expense 203,069 3,298 9,176 (8,234) 1,221 208,530
Income tax expense (benefit) 60,032 1,117 3,352 (3,585) - 60,916
============== ============= =========== =========== =============== ==============
Net income (loss) $ 143,037 $ 2,181 $ 5,824 $ (4,649) $ 1,221 $ 147,614
============== ============= =========== =========== =============== ==============
Total assets $1,713,925 $176,753 $45,597 $104,058 $ - $2,040,333
============== ============= =========== =========== =============== ==============
<CAPTION>
U.S. International
Mortgage Mortgage
Nine Months Ended September 30, 1998 Guaranty Guaranty Title Intersegment Consolidated
(In thousands) Insurance Insurance Insurance Other Adjustments Total
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Premiums earned $ 306,536 $ - $55,937 $ - $ - $ 362,473
============== ============= =========== =========== =============== ==============
Net underwriting income (expenses)
before tax-external customers $ 127,145 $ - $ 6,512 $ (4,540) $ - $ 129,117
Investment income 79,279 - 1,041 5,731 - 86,051
Equity in earnings of affiliates - - - 3,653 (1,819) 1,834
Interest expense (3) - - (5,256) - (5,259)
Distributions on preferred capital
securities - - - (6,234) - (6,234)
-------------- ------------- ----------- ----------- --------------- --------------
Income (loss) before income tax
expense 206,421 - 7,553 (6,646) (1,819) 205,509
Income tax expense (benefit) 59,664 - 2,774 (3,212) - 59,226
============== ============= =========== =========== =============== ==============
Net income $ 146,757 $ - $ 4,779 $ (3,434) $(1,819) $ 146,283
============== ============= =========== =========== =============== ==============
Total assets $1,575,121 $ - $38,850 $ 95,146 $ - $1,709,117
============== ============= =========== =========== =============== ==============
</TABLE>
The Company did not have any major customers that accounted for more than 10% of
its consolidated revenues for any of the periods presented.
Note 7 - Acquisition
On August 6, 1999, TPG completed the acquisition of PMI Mortgage Insurance Ltd
("PMI Ltd"), formerly known as MGICA, Australia's second largest mortgage
insurance company, using the purchase method of accounting. PMI Ltd is now an
indirect wholly owned subsidiary of PMI and the results of operations of PMI Ltd
have been included in TPG's consolidated financial statements from the date
of acquisition. The transaction purchase price was US$77.6 million cash. The
total assets of PMI Ltd on the date of acquisition were US$187.7 million and the
total liabilities were US$86.7 million. In connection with the purchase, PMI
Holdings issued a note for US$46.0 million, and TPG has also agreed to guarantee
repayment of the debt incurred to finance a portion of the purchase price. (See
"Liquidity, Capital Resources and Financial Condition" for more information on
the terms of the credit agreement.)
10
<PAGE>
The $20.7 million excess of the estimated fair value of net assets acquired over
the cost was used to reduce the book values of certain assets and the remainder
was allocated to negative goodwill which will be amortized over 5 years.
The following table shows the Company's unaudited pro forma results for the
periods presented assuming the acquisition occurred on the first day of the
corresponding period:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------- -------------------------
1999 1998 1999 1998
------------ ----------- ------------ -----------
(In thousands except per share amounts)
<S> <C> <C> <C> <C>
Revenue $182,995 $176,823 $505,202 $489,771
Net income $ 55,984 $ 60,712 $154,665 $155,557
Basic net income per common share $ 1.25 $ 1.31 $ 3.44 $ 3.27
Diluted net income per common share $ 1.24 $ 1.30 $ 3.42 $ 3.25
</TABLE>
These unaudited pro forma results have been prepared for comparative purposes
only and do not purport to be indicative of the results of operations which
would have actually resulted had the combination been in effect during the
periods stated, or future periods.
Note 8 - Forestview Mortgage Insurance Company Commutation
On July 29, 1999, the California Department of Insurance approved a Recapture
Agreement between PMI and Forestview Mortgage Insurance Company ("Forestview").
As a result of the commutation and recapture of the Reinsurance Agreement with
Forestview, PMI received $45.3 million in cash on August 13, 1999. The final
settlement commuted all of Forestview's present and future mortgage insurance
obligations including mortgage pool insurance. The cash settlement was in
consideration of the recapture liability (consisting of the returned unearned
premium reserve and the reimbursement of the reserve for losses), the roll back
of 1999 reinsurance transactions, and the settlement of reimbursable fees and
prepaid expenses. In connection with the Recapture Agreement, PMI assumed
mortgage insurance obligations of approximately $42.8 million, net of expense
allocations, previously insured by Forestview.
Note 9 - Subsequent Event
On October 4, 1999, PMI paid an extraordinary dividend of $29.3 million to TPG.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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, or are preceded by, followed by or
that include the words "believes," "expects," "anticipates," "estimates," or
similar expressions, 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 include the
following: (i) management anticipates that the decrease in refinancing activity
will continue in 1999; (ii) during 1999, management expects the percentage of
PMI's risk related to risk-share programs to continue to increase as a
percentage of total risk; (iii) management expected the Fannie Mae and Freddie
Mac reduction in mortgage insurance coverage requirements would have negatively
impacted the growth rate of direct risk in force; however, PMI's percentage of
insurance in force with higher coverage percentages continues to increase due to
terminating policies being replaced by new policies with higher coverage
percentages. Management believes this increase is due to the availability of
competitive products; (iv) management anticipates that the percentage of new
insurance written ("NIW") subject to captive mortgage reinsurance agreements
will continue to increase in 1999 and beyond. In addition, the anticipated
continued growth of captive reinsurance arrangements is expected to reduce the
Company's net premiums written and net premiums earned for customers with
captive arrangements; (v) management anticipates ceded premiums will continue to
increase as a result of the expected increase in risk-share programs; (vi)
management anticipates the percentage of insurance in force with higher coverage
percentages will continue to increase despite the availability of reduced
coverage requirements from Fannie Mae and Freddie Mac; (vii) although management
expects that California will continue to account for a significant portion of
total claims paid, management anticipates that with continued improvement in the
California economy, increased benefits of loss mitigation efforts and improved
default reinstatement rates, California claims paid as a percentage of total
claims paid should continue to decline; (viii) management believes that PMI's
total default rate could increase in 1999 due to the continued maturation of its
1995 and 1996 books of business; (ix) management anticipates that contract
underwriting will continue to generate a significant percentage of PMI's new
insurance written ("NIW"); and (x) management is uncertain about the amount of
new pool risk which will be written in 1999, but believes total new 1999 pool
risk will be less than in 1998. When a forward-looking statement includes a
statement of the assumptions or bases underlying the forward-looking statement,
the Company cautions that, while it believes such assumptions or bases to be
reasonable and makes them in good faith, assumed facts or bases almost always
vary from actual results, and the difference between assumed facts or bases and
actual results can be material, depending on the circumstances. Where, in any
forward-looking statement, the Company or its management expresses an
expectation or belief as to future results, such expectations or belief are
expressed in good faith and believed to have a reasonable basis, but there can
be no assurance that the statement of expectation or belief will result or be
achieved or accomplished. 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 items addressed in the section titled
"Cautionary Statements and Investment Considerations" ("IC# 1-16") set forth
below and other risks detailed from time to time in the Company's periodic
filings with the Securities and Exchange Commission.
All forward-looking statements of the Company are qualified by and should be
read in conjunction with such risk disclosure. The Company undertakes no
obligation to publicly update or revise any forward-looking statements, whether
as a result of new information, future events or otherwise.
12
<PAGE>
RESULTS OF CONSOLIDATED OPERATIONS:
THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Consolidated net income was $54.5 million in the three months ended September
30, 1999, a 1.5% increase over the corresponding period of 1998. The growth can
be attributed to an increase in premiums earned of 16.0% and a decrease in
losses and loss adjustment expenses of 9.0%, partially offset by a 98.8%
decrease in realized capital gains, a 21.8% increase in policy acquisition costs
and a 24.9% increase in underwriting and other operating expenses. Including
capital gains, diluted earnings per share increased 5.2% to $1.21 for the third
quarter of 1999. Excluding capital gains, diluted operating earnings per share
increased by 25.0% to $1.20. Excluding PMI HOldings, earnings per share for the
third quarter of 1999 was $1.16. Revenues in the third quarter of 1999 increased
by 6.4% to $178.2 million compared with the same period in 1998.
MORTGAGE INSURANCE OPERATIONS
PMI's new primary insurance written ("NIW") decreased by 5.2% to $7.3 billion in
the third quarter of 1999 compared with the third quarter of 1998, primarily as
a result of a slight decline in the growth in volume of the private mortgage
insurance industry as well as the decrease in PMI's market share for the same
period.
The members of the private mortgage insurance industry, as reported by the
industry's trade association, Mortgage Insurance Companies of America ("MICA"),
experienced a slight decrease in total new insurance written of 1.8% to $49.7
billion in the third quarter of 1999 from the corresponding period of 1998
primarily due to a decrease in refinancing activity. Refinancing as a percentage
of PMI's NIW decreased to 13.7% in the third quarter of 1999 from 24.4% in the
third quarter of 1998 and from 25.6% in the second quarter of 1999. Management
anticipates that the decrease in refinancing activity will continue through the
remainder of 1999. The private mortgage insurance companies' market share in the
three months ended September 30, 1999 decreased to 53.3% of the total low down-
payment market (insurable loans) from 55.3% in the third quarter of 1998 but
increased from 50.9% in the three months ended June 30, 1999. Management
believes the private mortgage insurance companies' year-over-year decline in the
low down-payment market share was the result of an increase in the maximum
individual loan amount that the FHA/VA can insure as well as the increased use
of adjustable rate mortgages, which lenders tend to retain in their portfolios
or self-insure. (See IC2)
PMI's market share of NIW was 14.8% in the third quarter of 1999, a decrease
from 15.3% in the second quarter of 1999, and a decrease from 15.2% in the three
months ended September 30, 1998. On a combined basis with CMG, market share
decreased to 16.1% in the third quarter of 1999 compared with 16.6% in the third
quarter of 1998, and 16.5% in the second quarter of 1999. Management believes
PMI's market share decline for the third quarter of 1999 was primarily due to an
increase in pool product offerings by competitors and a competitor insuring a
large one-time transaction that was outside of the expected flow of mortgage
production. Pool risk written totaled $90.0 million for the third quarter of
1999 compared with $201.0 million in the third quarter of 1998. Risk in force
under risk-share programs with PMI's customers, excluding pool insurance,
represented approximately 16.2% of the $20.5 billion total primary risk in force
at September 30, 1999. Risk in force under pool insurance arrangements
represented 3.1% of total risk in force at September 30, 1999, compared with
2.0% at September 30, 1998. During 1999, management expects the percentage of
PMI's risk related to risk-share programs to continue to increase as a percent
of total risk. Management expected the Fannie Mae and Freddie Mac reduction in
mortgage insurance coverage requirements would have negatively impacted the
growth rate of direct risk in force; however, PMI's percentage of insurance in
force with higher coverage percentages continues to increase due to terminating
policies being replaced by new policies with higher coverage percentages.
(See IC10)
PMI's cancellations of insurance in force decreased by 21.9% to $5.0 billion in
the third quarter of 1999 compared with the corresponding period of 1998. In
addition, PMI's persistency rate of 68.5% as of
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September 30, 1999, increased compared with 66.1% as of June 30, 1999 but was
still below the 71.0% as of September 30, 1998.
Insurance in force increased by 7.2% to $84.6 billion at September 30, 1999
compared with September 30, 1998 and on a combined basis with CMG,
insurance in force grew by 8.9% to $90.1 billion compared with September 30,
1998. PMI's market share of insurance in force increased by 0.3 percentage
points to 14.5% and when combined with CMG increased by 0.5 percentage points to
15.4% for the period ended September 30, 1999 compared with September 30, 1998.
PMI's primary risk in force increased by 9.0% to $20.5 billion at September 30,
1999 and when combined with CMG grew by 11.2% to $21.9 billion compared with
September 30, 1998. The growth rate of risk in force is greater than insurance
in force due to terminating policies being replaced by new policies with higher
coverage percentages.
Consolidated mortgage insurance net premiums written (which includes net
cessions and refunds) grew by 21.4% to $130.0 million in the third quarter of
1999 compared with the same period in 1998 primarily due to the acquisition of
PMI Ltd , the growth of risk in force of both primary and pool insurance, the
continued shift to deeper coverage for primary insurance and a decrease in
refunded premiums of 26.0% to $4.0 million as a result of a greater percentage
of monthly policies, which are non-refundable, being cancelled. Approximately
28% of new insurance written in the third quarter of 1999 was subject to captive
mortgage reinsurance agreements. Management anticipates that the percent of NIW
subject to captive mortgage reinsurance agreements will continue to increase in
1999 and beyond. In addition, the anticipated continued growth of captive
reinsurance arrangements is expected to reduce the Company's net premiums
written and net premiums earned for customers with captive arrangements. (See
IC15) Mortgage insurance premiums earned increased 14.8% to $121.3 million in
the third quarter of 1999 compared with the same period in 1998 primarily due to
the increase in premiums written. Ceded premiums, which include third-party
reinsurance arrangements as well as captive reinsurance agreements, totaled $9.5
million in the third quarter of 1999, increasing 111.1% from the third quarter
of 1998. Management anticipates ceded premiums will continue to increase as a
result of the expected increase in risk-share programs. (See IC7 and IC15)
PMI's monthly premium product represented 79.0% of risk in force at September
30, 1999, compared with 68.3% at September 30, 1998. Mortgages with original
loan-to-value ratios greater than 90% and equal to or less than 95% ("95s") with
30% insurance coverage increased to 36.8% of risk in force as of September 30,
1999, from 33.4% as of September 30, 1998. Mortgages with original loan-to-value
ratios greater than 85% and equal to or less than 90% ("90s") with 25% insurance
coverage increased to 31.7% of risk in force as of September 30, 1999, compared
with 27.8% as of September 30, 1998. Management anticipates the percentage of
insurance in force with higher coverage percentages will continue to increase
despite the availability of reduced coverage requirements from Fannie Mae and
Freddie Mac. (See IC3 and IC10)
Mortgage insurance losses and loss adjustment expenses decreased 9.4% to $31.0
million in the third quarter of 1999 compared with the third quarter of 1998
primarily due to the continuing improvement of the nationwide housing markets,
particularly California, and the corresponding decrease in claim payments. Loans
in default decreased by 1.7% to 15,196 at September 30, 1999 compared with
September 30, 1998. PMI's national default rate decreased by 0.13 percentage
points to 2.07% at September 30, 1999 compared with the same period in 1998,
primarily due to a decrease in the loans in default inventory and secondarily to
an increase in policies in force.
Direct primary claims paid in the third quarter of 1999 decreased by 23.0% to
$20.4 million when compared with the same period in 1998 due to a 14.3% decrease
in the average claim size to approximately $20,400 and a 12.5% decline in the
number of claims paid to 1,046 for the third quarter of 1999.
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The reduction in claims paid is the result of a smaller percentage of claims
originating from the California book of business and to increased loss
mitigation efforts by PMI and lenders.
Default rates on PMI's California policies decreased to 2.61% (representing
2,430 loans in default) at September 30, 1999, from 3.15% (representing 3,110
loans in default) at September 30, 1998. Policies written in California
accounted for 31.5% and 49.8% of the total dollar amount of claims paid in the
third quarter 1999 and 1998, respectively. Although management expects that
California will continue to account for a significant portion of total claims
paid, management anticipates that with continued improvement in the California
economy, increased benefits of loss mitigation efforts and improved default
reinstatement rates, California claims paid as a percentage of total claims paid
should continue to decline. (See IC13) Management believes that PMI's total
default rate could increase in 1999 due to the continued maturation of its 1995
and 1996 books of business. (See IC11)
Mortgage insurance policy acquisition costs incurred and deferred (including,
among other field expenses, contract underwriting expenses) decreased by 2.4%
to $20.6 million in the third quarter of 1999 compared with the same period in
1998 as a result of the 5.2% decrease in NIW. Amortization of policy acquisition
costs increased 21.8% to $19.0 million during the same period. (See Note 5
"Deferred Acquisition Costs" of Notes to Consolidated Financial Statements) New
policies processed by contract underwriters represented 36.2% of PMI's third
quarter NIW in 1999 compared with 37.7% in 1998. Contract underwriting is the
preferred method among many mortgage lenders for processing loan applications.
Management anticipates that contract underwriting will continue to generate a
significant percentage of PMI's NIW. (See IC7)
Underwriting and other mortgage insurance operating expenses increased by 16.5%
to $37.4 million in the third quarter of 1999 compared with the third quarter of
1998 due primarily to an increase in the amortization of certain obsolete
computer equipment and operating systems. The mortgage insurance loss ratio
declined by 6.8 percentage points to 25.6% in the period ended September 30,
1999 compared with the same period in 1998. The decrease can be attributed to
the growth in premiums earned coupled with the decrease in losses and loss
adjustment expenses, as discussed above. The expense ratio increased by 3.9
percentage points to 28.7% primarily due to the increase in the amortization of
policy acquisition costs and the increase in underwriting and other mortgage
insurance expenses and the decrease in NIW market share, all as discussed above.
In addition, a reduction in pool premiums and an increase in captive reinsurance
premium cessions negatively affected premiums written. The combined ratio
decreased by 2.9 percentage points to 54.3% in the third quarter of 1999
compared with the same period in 1998.
TITLE INSURANCE OPERATIONS
Title insurance premiums earned increased 22.2% to $26.4 million in the three
months ended September 30, 1999 compared with the same period in 1998 primarily
due to an increase in the total amount of title insurance policies written as
well as APTIC's expansion into new states. APTIC was writing business in 32
states at September 30, 1999, up from 30 states at September 30, 1998. In the
third quarter of 1999, approximately 73% of APTIC's premiums earned came from
its Florida operations, compared with approximately 80% in the third quarter of
1998. Underwriting and other expenses increased 23.5% to $23.1 million in the
third quarter of 1999 compared with the same period in 1998 due to an increase
in agency fees and commissions related to the increase in premiums earned. The
title insurance combined ratio increased by 1.4 percentage points to 88.4%.
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OTHER
Other income generated by other subsidiaries increased by 26.0% to $6.3 million
in the third quarter of 1999 compared with the third quarter of 1998 primarily
due to a $5.7 million adjustment related to the estimated interest on a federal
income tax recoverable from Allstate but partially offset by a 32.5% decrease in
MSC's contract underwriting revenues as a result of the decline in refinancing
activity. Underwriting and other expenses generated by other subsidiaries
decreased by 30.8% to $5.4 million, primarily due to a 24.2% decrease in
expenses incurred by MSC during the same period resulting from a decrease in
refinancing and a reduction in demand for contract underwriting services
provided to the Company's mortgage insurance customers. (See IC7)
In the quarter ended September 30, 1999, the Company's net investment income
(including realized capital gains) decreased by 30.9% to $24.2 million when
compared with the third quarter of 1998 primarily due to a $14.0 million
decrease in realized gains on investments. In addition, the yield decreased to
5.83% at September 30, 1999 from 6.09% at September 30, 1998 primarily as a
result of higher yielding investments maturing and being replaced by lower
yielding investments.
The Company's effective tax rate remained consistent at 29.5% for both the third
quarter of 1999 and 1998.
NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Consolidated net income was $147.6 million in the nine months ended September
30, 1999, a 0.9% increase over the corresponding period of 1998. The increase
can be attributed to an increase in premiums earned of 12.5% and a decrease in
losses and loss adjustment expenses of 18.5%, partially offset by a 98.0%
decrease in net realized gains, a 50.2% increase in policy acquisition costs and
an 18.7% increase in underwriting and other expenses. Including capital
gains,diluted earnings per share increased by 6.5% to $3.26 in 1999. Excluding
capital gains, diluted operating earnings per share increased by 19.9% to $3.26.
Excluding PMI Holdings, earnings per share for the nine months ended September
30, 1999 were $3.22. Revenues in the first nine months of 1999 increased by 5.2%
to $489.6 million.
MORTGAGE INSURANCE OPERATIONS
PMI's NIW increased by 13.8% to $22.2 billion in the first nine months of 1999
compared with the corresponding period of 1998, primarily as a result of the
growth in volume of the private mortgage insurance industry as well as the
increase in PMI's market share during the same period.
The members of the private mortgage insurance industry, as reported by the
industry's trade association, Mortgage Insurance Companies of America ("MICA"),
experienced an increase in total new insurance written of 12.9% to $149.2
billion for the period ended September 30, 1999 from the corresponding period of
1998 primarily due to strong home purchase activity partially offset by a
decrease in refinancing activity. Refinancing as a percentage of PMI's NIW
decreased to 25.5% for the nine months ended September 30, 1999 from 29.5% for
the same period of 1998. Management anticipates that the decrease in refinancing
activity will continue in 1999. The private mortgage insurance companies' market
share for the nine months ended September 30, 1999 decreased to 51.7% of the
total low down-payment market (insurable loans) from 55.3% for the same period
of 1998. Management believes the private mortgage insurance companies' decline
in the low down-payment market share was the result of an increase in the
maximum individual loan amount that the FHA/VA can insure as well as the
increased use of adjustable rate mortgages, which lenders tend to retain in
their portfolios or self-insure. (See IC2)
PMI's market share of NIW was 14.9% in the first nine months of 1999, an
increase from 14.7% in the first nine months of 1998. On a combined basis with
CMG, market share increased to 16.2% in the first nine months of 1999 compared
with 16.1% in the first nine months of 1998. The increases in market share were
primarily due to contract underwriting services, pool insurance products, and
risk sharing programs offered by PMI. Pool risk
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written totaled $193 million for the first nine months of 1999 compared with
$369 million in the period ended September 30, 1998. Management expected that
the Fannie Mae and Freddie Mac reduction in mortgage insurance coverage
requirements would have negatively impacted the growth rate of direct risk in
force; however, PMI's percentage of insurance in force with higher coverage
percentages continues to increase due to the availability of competitive
products. (See IC10)
Consolidated mortgage insurance net premiums written (which includes net
cessions and refunds) grew by 15.5% to $341.9 million in the first nine months
of 1999 compared with the same period in 1998 primarily due to the growth of
risk in force of both primary and pool insurance, the continued shift to deeper
coverage for primary insurance, and a decrease in refunded premiums of 19.9% to
$13.3 million as a result of a greater percentage of monthly policies, which are
non-refundable, being cancelled. Consolidated mortgage insurance premiums earned
increased 8.9% to $333.9 million in the first nine months of 1999 compared with
the same period in 1998 primarily due to the increase in premiums written. Ceded
premiums were $25.1 million in the first nine months of 1999, increasing 81.9%
from the corresponding period in 1998. Management anticipates ceded premiums
will continue to increase substantially as a result of the expected increase in
risk-share programs. (See IC7 and IC15)
Consolidated mortgage insurance losses and loss adjustment expenses decreased
19.0% to $83.2 million in the first nine months of 1999 compared with the first
nine months of 1998 primarily due to the continuing improvement of the
nationwide housing markets, particularly California, and the corresponding
decrease in claim payments.
Direct primary claims paid in the nine months ended September 30, 1999 decreased
by 33.9% to $62.0 million when compared with the same period in 1998 due to a
14.3% decrease in the average claim size to approximately $20,400 and a 22.9%
decline in the number of claims paid to 3,039. The reduction in claims paid is
the result of a smaller percentage of claims originating from the California
book of business and to increased loss mitigation efforts by PMI and lenders.
Mortgage insurance policy acquisition costs incurred and deferred (including,
among other field expenses, contract underwriting expenses) increased by 24.7%
to $70.1 million for the first nine months of 1999 compared with the same period
in 1998 as a result of the 13.8% increase in NIW. Amortization of policy
acquisition costs increased 50.2% to $61.0 million for the same period. (See
Note 5 "Deferred Acquisition Costs" of Notes to Consolidated Financial
Statements) New policies processed by contract underwriters represented 37.9% of
PMI's NIW in 1999 compared with 34.6% in 1998. Contract underwriting is the
preferred method among many mortgage lenders for processing loan applications.
Management anticipates that contract underwriting will continue to generate a
significant percentage of PMI's NIW. (See IC7)
Underwriting and other mortgage insurance operating expenses increased by 21.2%
to $112.1 million in the first nine months of 1999 compared with the same period
of 1998 due primarily to an increase in the amortization of certain obsolete
computer equipment and operating systems. Included in operating expenses were
Year 2000 remediation costs of $0.9 million in the first nine months of 1999,
compared with $1.9 million of such costs in the first nine months of 1998. The
mortgage insurance loss ratio declined by 8.6 percentage points to 24.9% in the
period ended September 30, 1999 compared with the same period in 1998. The
decrease can be attributed to the growth in premiums earned coupled with the
decrease in losses and loss adjustment expenses, as discussed above. The expense
ratio increased by 4.6 percentage points to 30.5% primarily due to the increase
in the amortization of policy acquisition costs, the increase in underwriting
and other mortgage insurance expenses and the decrease in NIW market share, as
discussed above. In addition, a reduction in pool premiums and an increase in
captive reinsurance premium cessions negatively affected premiums written. The
combined ratio decreased by 3.9 percentage points to 55.5% in the first nine
months of 1999 compared with the same period in 1998.
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TITLE INSURANCE OPERATIONS
Title insurance premiums earned increased 32.2% to $73.9 million in the nine
months ended September 30, 1999 compared with the same period in 1998 primarily
due to an increase in title insurance policies written and APTIC's expansion
into new states. APTIC was writing business in 32 states at September 30, 1999,
up from 30 states at September 30, 1998. In the first nine months of 1999,
approximately 72% of APTIC's premiums earned came from its Florida operations,
compared with approximately 74% in 1998. Underwriting and other expenses
increased 32.5% to $65.2 million in the first nine months of 1999 compared with
the same period in 1998 due to an increase in agency fees and commissions
related to the increase in premiums earned. The title insurance combined ratio
increased by 0.8 percentage points to 89.2%.
OTHER
Other income generated by other subsidiaries decreased by 8.7% to $13.7 million
in the period ended September 30, 1999 compared with the same period of 1998
primarily due to a 31.1% decrease in MSC's contract underwriting revenues as a
result of the decrease in refinancing activity. Underwriting and other expenses
generated by other subsidiaries decreased by 18.5% to $15.9 million, primarily
due to a 11.4% decrease in expenses incurred by MSC during the same period
resulting from a decrease in refinancings and a reduction in demand for contract
underwriting services provided to the Company's mortgage insurance customers.
(See IC7)
In the period ended September 30, 1999, the Company's net investment income
(including realized capital gains) decreased 22.5% to $68.1 million when
compared with the first nine months of 1998 primarily due to a $23.9 million
decrease in realized gains on investments. In addition, the yield decreased to
5.88% at September 30, 1999 from 6.10% at September 30, 1998 primarily as a
result of higher yielding investments maturing and being replaced by lower
yielding investments.
The Company's effective tax rate increased to 29.2% in the first nine months of
1999 from 28.8% in the first nine months of 1998 as a result of a decrease in
the proportion of tax-exempt investment income relative to total income.
LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION
Liquidity and capital resource considerations are different for TPG and PMI, its
principal insurance operating subsidiary. TPG's principal sources of funds are
dividends from PMI and APTIC, investment income and funds that may be raised
from time to time in the capital markets.
PMI's ability to pay dividends to TPG is limited, among other restrictions,
under the insurance laws of Arizona. Such laws provide that: (i) PMI may pay
dividends out of available surplus and (ii) without prior approval of the
Arizona Insurance Director, such dividends during any 12-month period may not
exceed the lesser of 10% of policyholders' surplus as of the preceding year end,
or the last calendar year's investment income.
The laws of Florida limit the payment of dividends by APTIC to TPG in any one
year to 10% of available and accumulated surplus derived from realized net
operating profits and net realized capital gains.
On August 6, 1999, TPG announced it had completed the acquisition of PMI
Mortgage Insurance Ltd, ("PMI Ltd"), formerly known as MGICA, Australia's second
largest mortgage insurance company. PMI , Ltd., is now an indirect wholly owned
subsidiary of PMI. The transaction purchase price was
18
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US$77.6 million. PMI Holdings has also issued a note for A$70.5 million and TPG
agreed to guarantee repayment of the debt incurred to finance a portion of the
purchase price. PMI Ltd has a Standard and Poor's ("S&P") claim paying ability
rating of AA- and a Moody's Investors Service ("Moody's") financial strength
rating of A1. S&P and Moody's have affirmed both PMI's and PMI Ltd's ratings
following the acquisition based upon PMI's execution of a Support agreement to
maintain PMI Ltd's capital at certain minimum levels.
The terms of the US$46.0 million credit agreement dated August 3, 1999 executed
among TPG, PMI Holdings, and Bank of America, N.A., in connection with the
Company's acquisition of PMI Ltd, provide in part that: (i) TPG's consolidated
net worth shall not be less than $600 million; (ii) PMI's statutory capital
shall not be less than $675 million; (iii) the risk to capital ratio shall not
exceed 23 to 1; and (iv) TPG's consolidated debt to capital ratio shall not
exceed 0.40 to 1.0. In addition, PMI's and PMI Ltd's ability to pay dividends or
incur additional indebtedness are restricted. Failure to maintain such financial
covenants or debt restrictions may be deemed an event of default. Pursuant to
the guarantee executed by TPG in connection with the credit agreement, if an
event of default occurs under the credit agreement or under any other
indebtedness, all outstanding amounts under the credit agreement may be
accelerated and become immediately payable by TPG.
In addition to the dividend restrictions described above, the Company's other
credit agreements also limit the payment of dividends by PMI, and various credit
rating agencies and insurance regulatory authorities have broad discretion to
limit the payment of dividends to TPG by PMI or APTIC. During the first nine
months of 1999, APTIC declared and paid a cash dividend of $3.0 million to TPG,
substantially the full amount of a dividend that can be paid by APTIC in 1999
without prior permission from the Florida Department of Insurance. On June 16,
1999, the Arizona Department of Insurance also authorized a dividend of $65.0
million to TPG, which was to be paid in cash in three installments. The first
installment of $25.0 million was paid on June 23, 1999 and the second
installment of $20.0 million was paid on September 2, 1999. The third
installment has not yet been paid as of November 15, 1999. In addition, TPG has
two bank credit lines available totaling $50.0 million. At September 30, 1999,
there were no outstanding borrowings under the credit lines.
TPG's principal uses of funds are common stock repurchases, the payment of
dividends to shareholders, funding of acquisitions, additions to its investment
portfolio, investments in subsidiaries, and the payment of interest. The Company
announced a stock repurchase program in the amount of $100.0 million authorized
by the TPG Board of Directors in November 1998. During the first nine months of
1999, TPG purchased $25.4 million of the Company's common stock.
As of September 30, 1999, TPG had approximately $84.5 million of available
funds. This amount has increased from the December 31, 1998 balance of $56.1
million primarily due to the $30.2 million federal income tax recoverable from
Allstate and dividends received from subsidiaries, partially offset by common
stock repurchases.
The principal sources of funds for PMI are premiums received on new and renewal
business 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, policy
acquisition costs and other operating expenses, investment in subsidiaries, and
dividends to TPG. PMI generates positive cash flows from operations as a result
of premiums being received in advance of the payment of claims. Cash flows
generated from PMI's operating activities totaled $189.2 million and $104.3
million in the nine months ended September 30, 1999 and 1998, respectively. The
increase is primarily due to the decrease in reinsurance recoverable and prepaid
premiums, and the decrease in net realized capital gains for the same period.
The Company's invested assets increased by $224.5 million at September 30, 1999
compared with December 31, 1998 partially due to PMI Ltd investments of $148.2
million and the $30.2 million payment of tax refund due from Allstate partially
offset by a decrease in net unrealized gains on investments of $45.9 million,
stock repurchases of $25.4 million and dividends declared of $4.8 million.
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Consolidated reserves for losses and loss adjustment expenses increased by 30.0%
in the nine months of 1999 compared with December 31, 1998 primarily due to the
$42.7 million increase in pool loss reserves as a result of the Recapture
Agreement between PMI and Forestview and secondarily due to pool and primary
reserve increases.
Consolidated shareholders' equity increased by $71.9 million in the first nine
months of 1999, consisting of increases of $147.6 million from net income and
$0.3 million from exercises of stock options, offset by a $45.9 million decrease
in net unrealized gains on investments included in other comprehensive income,
common stock repurchases of $25.4 million, and dividends declared of $4.8
million.
On July 27, 1999, the Company received $30.2 million from Allstate Insurance Co,
as payment of a tax refund due to the Company under a tax sharing agreement
executed by TPG, The Allstate Corporation, The Allstate Insurance Company and
Sears, Roebuck and Co., in connection with the Company's initial public offering
in April 1995. (See Note 7 "Income Taxes" in the 1998 Annual Report to
Shareholders)
On July 21, 1999, TPG announced that its Board of Directors declared a 3-for-2
stock split in the form of a 50 percent stock dividend, and increased its cash
dividend level to 6 cents per share on a pre-split basis. The stock split was
paid on August 16, 1999 to shareholders of record on July 30, 1999.
PMI's statutory risk-to-capital ratio at both September 30, 1999 and December
31, 1998 was 14.9 to 1. (See IC9)
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YEAR 2000 ISSUES
Impact of the Year 2000 Issue. The Company's business processes are highly
automated and dependent upon the consistent and accurate functioning of its
computer systems and the computer systems of its customers. As a result, the
Company is directing significant resources toward mitigating its exposure to the
so-called "Year 2000 issue." The Company has in place a Year 2000 project plan
to address the Year 2000 issue. The plan consists of three phases, all of which
have been completed or substantially completed as more fully discussed in the
Company's prior SEC filings. To date, PMI and CMG have met all readiness
deadlines or targets established by Fannie Mae, Freddie Mac and their
regulators.
Costs to Address the Year 2000 Issue. The Company is utilizing both internal and
external personnel and resources to implement its Year 2000 project plan.
Currently, no planned material projects involving information or non-information
technology systems have been delayed or are anticipated to be delayed as a
result of the redirection of resources to the Year 2000 remediation effort. The
Company plans to complete its Year 2000 issue remediation project at a total
external cost of approximately $5.0 million, which will be funded from operating
cash flow and is being expensed as incurred. For the three-month period ended
September 30, 1999, the Company incurred and expensed approximately $64 thousand
in external costs related to its Year 2000 project plan and remediation efforts,
out of a total of $4.8 million incurred and expensed since commencement of the
Year 2000 project. The estimated costs do not include any potential costs
related to customer or other claims, or potential amounts related to executing
contingency plans. The Company does not separately track the internal costs
incurred in connection with the Year 2000 project plan, which are principally
payroll costs for employees working on the project. (See IC1 and Item 5 - Other
Information, below).
The discussion above and all prior discussions in the Company's SEC filings are
designated as Year 2000 Readiness Disclosures as defined by the Year 2000
Information and Readiness Disclosure Act of 1998.
CAUTIONARY STATEMENTS AND INVESTMENT CONSIDERATIONS
GENERAL CONDITIONS (IC1)
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, changes in
legislation affecting the mortgage insurance industry, 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 product offerings and services, including mortgage
pool insurance and contract underwriting services; the ability to recruit and
maintain a sufficient number of qualified underwriters; the effect of
risk-sharing structured transactions; changes in the performance of the
financial markets; PMI's claims-paying ability rating; general economic
conditions that affect the demand
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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 and customer consolidation. PMI's financial
condition and results of operations may materially and adversely be impacted by
changes in legislation which affects the ability of Fannie Mae or Freddie Mac to
offer a substitute for mortgage insurance, including self-insurance and
alternative forms of credit support, or for the FHA or the VA to increase
statutory lending limits or other expansion of eligibility for the FHA and VA.
PMI's financial condition and results of operations may materially and adversely
be impacted by changes in legislation, statutory charters and regulations
governing banks and savings institutions to form reinsurance subsidiaries or
permit the offering of other products which do not require mortgage insurance.
(See IC 16) In addition, PMI's financial condition and results of operations may
materially and adversely be impacted by a reduction in the amount of mortgage
insurance coverage required by Fannie Mae and Freddie Mac.)
The costs of Year 2000 remediation, the correctness of the Company's assessment
that is has completed one or more phases of its remediation, the dates on which
the Company estimates that it will complete other remediation phases and
possible risks associated with the Year 2000 issue are based upon the Company's
current estimates and are subject to various uncertainties that could cause the
actual results to differ materially from the Company's expectations. Such
uncertainties include, among others, the success of the Company in identifying
systems that are not Year 2000 compliant, the nature and amount of programming
required to remediate each affected system, the nature and adequacy of testing
performed by the Company, the availability of qualified personnel, consultants
and other resources, and the success of the Year 2000 remediation efforts of
others. If the Company's recently completed remediation of its mission critical
mortgage insurance origination and application processing process is faulty or
fails for any reason to be Year 2000 compliant, this circumstance could
adversely impact its business operations and could have a material adverse
affect on the Company's financial condition, liquidity and results of
operations. See Management Discussion and Analysis - Year 2000 Issues.
MARKET SHARE AND COMPETITION (IC2)
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 (see IC3) as well as the
competition of lending institutions that choose to remain uninsured, self-insure
through affiliates, or offer residential mortgage products that do not require
mortgage insurance. The impact of captive reinsurance arrangements, competitive
underwriting criteria and product offerings, including mortgage pool insurance
and contract underwriting, has a direct impact on the Company's market share.
Further, several of the Company's competitors have greater direct or indirect
capital reserves that 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. Historically, 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. In addition, the Office of Thrift
Supervision has also granted permission for subsidiaries of thrift institutions
to reinsure private mortgage insurance coverage on loans originated or purchased
by affiliates of such thrift's parent organization. The Federal Reserve Board is
in the process of considering whether similar activities are permitted for bank
holding companies. The captive reinsurance subsidiaries of national banks,
savings institutions, or bank holding companies could become significant
competitors of the Company in the future. Recently, however, President Clinton
signed into law the Gramm-Leach-Bliley Act of 1999, which will allow financial
services companies to combine and offer banking, insurance and equity services
simultaneously, which could lead to additional significant competitors of the
Company in the future and may materially and adversely impact PMI's market
share. (See IC15 and IC16) Mortgage lenders, other than banks, thrifts or their
affiliates, are forming reinsurance affiliates that are typically regulated
solely by the
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insurance authority of their state of domicile. The Gramm-Leach-Bliley Act
allows a bank holding company to form an insurance subsidiary, licensed under
state insurance law, to issue insurance products directly. Management believes
that such bank holding company subsidiaries will increase competition in the
mortgage insurance industry and may materially and adversely impact PMI's market
share (See IC15).
In July 1999, the Federal Housing Finance Board ("FHFB") issued proposed
regulation which would permit the Federal Home Loan Banks ("FHLBs") to provide
mortgage insurance or substitutes for mortgage insurance, such as credit
enhancements, to its members for non-conforming mortgages. The proposal would
permit the FHLBs to buy mortgages originated by its members if the member took
some of the credit risk. In addition, the proposed regulation would introduce
risk-based capital requirements and expand the FHLBs' investment powers to
permit the FHLBs to make equity investments in enterprises that focused on low-
or moderate-income community development and housing in small business
investment corporations. The proposed regulations will be subject to a 90-day
public comment period once published in the Federal Register.
As a result of key aspects of the FHFB proposal which require clarification and
which are likely to be revised during the public comment period, management is
presently not able to ascertain the full impact of the proposed regulations on
the Company's financial condition and results of operations in 1999 and beyond.
Management believes any expansion of the FHLBs' ability to issue mortgage
insurance or use alternatives to mortgage insurance could materially and
adversely affect the Company's financial condition and results of operations.
Certain lenders originate a first mortgage lien with an 80% LTV ratio, a 10%
second mortgage lien, and 10% of the purchase price from borrower's funds
("80/10/10"). This 80/10/10 product competes with mortgage insurance as an
alternative for lenders selling loans in the secondary mortgage market. The
Federal Deposit Insurance Corporation and other banking regulators approved
rules to be effective April 1, 1999 that would require national banks to hold
almost twice as much risk-based capital to cover possible defaults on the
80/10/10 products when the lender holds the first and second mortgage.
State-chartered banks already are subject to the higher capital requirement. If
the 80/10/10 product becomes a widely accepted alternative to mortgage
insurance, it could have a material and adverse impact on the Company's
financial condition and results of operations.
Legislation and regulatory changes affecting the FHA have affected demand for
private mortgage insurance. Effective January 1, 1999, the Department of Housing
and Urban Development announced an increase in the maximum individual loan
amount that FHA can insure to $208,800 from $197,620. The maximum individual
loan amount that the VA can insure is $203,150. The Omnibus Spending Bill of
1999, signed into law on October 21, 1998, among other items, streamlined the
FHA down-payment formula by eliminating tiered minimum cash investment
requirements and establishing maximum loan-to-value ratios based on loan size
and closing costs, making FHA insurance more competitive with private mortgage
insurance in areas with higher home prices. Management believes the decline in
the MICA members' share of the mortgage insurance business from 56.3% at
December 31, 1998 to approximately 50.9% at September 30, 1999 results in part
from the increase in the maximum individual loan amount the FHA can insure. Any
increase in the maximum FHA loan amount would likely have an adverse effect on
the competitive position of PMI and, consequently, could materially and
adversely affect the Company's financial condition and results of operations.
FANNIE MAE AND FREDDIE MAC (IC3)
The GSEs are permitted by charter to purchase conventional high-LTV mortgages
from lenders who obtain mortgage insurance on those loans. Fannie Mae and
Freddie Mac have some discretion to increase or decrease the amount of private
mortgage insurance coverage they require on loans, provided the minimum
insurance coverage requirement is met. During 1999, Fannie Mae and Freddie Mac
separately announced programs where reduced mortgage insurance coverage will be
made available for lenders that deliver loans approved by the
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GSEs' automated underwriting services, Desktop Underwriter(TM) and Loan
Prospector(SM), respectively. Generally, Fannie Mae's and Freddie Mac's reduced
mortgage insurance coverage options provide for: (i) across-the-board reductions
in required MI coverage on 30-year fixed-rate loans recommended for approval by
GSE's automated underwriting services to the levels in effect in 1994; (ii)
reduction in required MI coverage, for loans with only a 5 percent down payment
(a 95 percent LTV), from 30 percent to 25 percent of the mortgage loan covered
by MI; (iii) reduction in required MI coverage, for loans with a 10 percent down
payment (a 90 percent LTV loan), from 25 percent to 17 percent of the mortgage
loan covered by MI. In addition, the GSE's announced programs to further reduce
MI coverage upon the payment of an additional fee by the lender. Under this
option, a 95 percent LTV loan will require 18 percent of the mortgage loan have
mortgage insurance coverage. Similarly, a 90 percent LTV loan will require 12
percent of the mortgage loan have mortgage insurance. In order for the home
buyer to have MI at these levels, such loans would require a payment at closing
or a higher note rate.
Management believes it is too early to assess the impact of the GSEs' reduction
of required levels of mortgage insurance on the Company's financial condition
and results of operation. If the reduction in required levels of mortgage
insurance were to become widely accepted by mortgage lenders and their
customers, however, such reduction could have a materially adverse impact on the
Company's financial condition and results of operations.
The Federal Housing Enterprises Financial Safety and Soundness Act of 1992,
requires the Office of Federal Housing Enterprise Oversight ("OFHEO") to develop
a risk-based capital regulation for the GSEs. On April 13, 1999, a notice of
proposed rulemaking was published in the Federal Register announcing OFHEO's
development of proposed risk-based capital regulations. Public comments
regarding the proposed regulations were due on August 11, 1999. However, OFHEO
recently announced a second extension of the due date until March 10, 2000 to
allow interested parties adequate time to analyze and review the rule and submit
constructive comments. After consideration of the comments received on the
proposal, OFHEO will determine whether to issue a final rule or to issue a
revised proposal. OFHEO is not authorized to enforce the risk-based standard
until one year after the final rule is published. The regulation specifies a
risk-based capital stress test that, when applied to the GSEs, determines the
amount of capital that a GSE must hold to maintain positive capital throughout a
10-year period of economic stress. The stress test is designed to simulate the
financial performance, including cash flows of the GSEs under severe economic
conditions. Such conditions would include high levels of mortgage defaults and
associated losses, and large interest rate shocks. The proposed regulations
could require a GSE to hold more than double the capital it presently maintains
for loans with loan-to-value ratios ("LTV") of 95 percent or higher. Further,
the proposed capital regulations could treat more favorably credit enhancements
issued by private mortgage insurance companies with a claims-paying ability
rating of AAA or higher compared with those companies with a AA or lower rating.
Because of the numerous aspects of the OFHEO proposal which require
clarification and which are likely to be revised during the public comment
period, management is presently not able to ascertain the full impact of the
proposed risk-based capital regulations on the Company's financial condition and
results of operations in 1999 and beyond. Although management believes that it
is too early to ascertain the impact of the risk-based capital regulations as
proposed, management believes any shifts in the GSE's preferences for private
mortgage insurance to other forms of credit enhancement, including a tiering of
mortgage insurers based on their credit rating, could materially and adversely
affect the Company's financial condition and results of operations.
During October 1998, Freddie Mac sought to amend its charter to allow it to use
any method of default loss protection that is financially equal or superior, on
an individual or pooled basis, to the protection provided by private mortgage
insurance companies. The legislation containing the proposed charter amendment
was subsequently rescinded. Currently, Freddie Mac can purchase loans with
down-payments of less than 20% only if the loans are insured or use other
limited methods to protect against default.
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Subsequent to the withdrawal of the legislation, Freddie Mac made several
announcements that it would pursue a permanent charter amendment that would
allow Freddie Mac to utilize alternative forms of default loss protection, such
as spread accounts, or otherwise forego the use of private mortgage insurance on
higher loan-to-value mortgages. In addition, Fannie Mae announced it is
interested in pursuing new risk management options and is working with mortgage
insurers and lenders on appropriate risk management and dispersion of risk,
which may include a reduction in the use of mortgage insurance.
In June 1999, a coalition of financial industry trade associations was formed
under the name "FM Watch". FM Watch works with affordable housing and consumer
advocates, taxpayer groups and financial institutions, and is dedicated to
monitoring the activities of Fannie Mae and Freddie Mac. FM Watch's efforts are
designed to support HUD's efforts to strengthen the affordable housing goals for
the GSEs, and to promote policies that do not allow the GSEs to move beyond
their unique charters into markets and services already provided by the private
sector. Current members of FM Watch include: the American Financial Services
Association, the Appraisal Institute, the Association of Financial Guaranty
Insurors, the Consumer Bankers Association, the Consumer Mortgage Coalition, the
Financial Services Roundtable, the Home Equity Lender Leadership Organization,
the Mortgage Insurance Companies of America, and the National Home Equity
Mortgage Association.
In July 1999, HUD announced new affordable housing goals for the GSEs. The
proposed affordable housing goals would raise the target for low- and moderate-
income business from 42 percent of the GSEs' annual volume to 50 percent. The
goal would increase to 48 percent in year 2000 and to 50 percent for year 2001.
In addition, HUD announced proposed increases in two other components of the
GSEs' affordable housing goals. Currently, the GSEs are expected to generate 24
percent of their mortgage business in central cities, rural areas and other
underserved markets. Under the proposal, this target would increase up to 31
percent. The special affordable housing goal, which measures funding for
families with very-low household income or living in low-income areas, would
increase from 14 percent to 20 percent. The proposed goals are subject to review
by the Office of Management and Budget and would be subject to a public comment
period prior to final revisions or enactment by HUD.
Fannie Mae's and Freddie Mac's current guidelines regarding cancellation of
mortgage insurance generally provide that a borrower's written request to cancel
mortgage insurance should be honored if: (a) the borrower has a satisfactory
payment record, no payment more than 30 days delinquent in the 12-month period
preceding the request for cancellation; and (b) the unpaid principal balance of
the mortgage is not greater than 80% of the original value of the property. (See
IC4 for a discussion of Federal legislation providing for guidelines for
automatic mortgage insurance cancellation)
In January, Fannie Mae and Freddie Mac announced increases in the maximum
principal balance of loans eligible for purchase by Fannie Mae and Freddie Mac
to $240,000. Although management believes that it is too early to ascertain the
impact of the increase in the maximum individual loan amount the GSEs can
insure, management believes any increase in the maximum loan amount would likely
increase the number of loans eligible for mortgage insurance and may have the
effect of increasing the size of the mortgage insurance market, and have a
positive effect on the competitive position of PMI and consequently could
materially affect the Company's financial condition and results of operations.
Fannie Mae and Freddie Mac impose requirements on private mortgage insurers for
such insurers to be eligible to insure loans sold to such agencies. Under Fannie
Mae and Freddie Mac regulations, PMI needs to maintain at least an "AA-" or
equivalent claims-paying ability rating in order to provide mortgage insurance
on loans purchased by the GSEs. Failure to maintain such a rating would
effectively cause PMI to be ineligible to provide mortgage insurance. A loss of
PMI's existing eligibility status, either due to a failure to maintain a minimum
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claims-paying ability rating from the various rating agencies or non-compliance
with other eligibility requirements, would have a material, adverse effect on
the Company's financial condition and results of operations. (See IC2)
INSURANCE IN FORCE (IC4)
A significant percentage of PMI's premiums earned is generated from its existing
insurance in force and not from new insurance written. PMI's policies for
insurance coverage typically have a policy duration of six to eight years. The
policy owner or servicer of the loan may cancel insurance coverage 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 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 operations could be materially and adversely affected
by greater than anticipated policy cancellations or lower than projected
persistency resulting in declines in insurance in force.
Upon request by an insured, PMI must cancel the mortgage insurance for a
mortgage loan. In addition, The Home Owners Protection Act of 1998 (the "Act"),
which is effective on July 29, 1999, provides for the automatic termination, or
cancellation upon a borrower's request, of private mortgage insurance upon
satisfaction of certain conditions. The Act applies to owner-occupied
residential mortgage loans regardless of lien priority, with borrower-paid
mortgage insurance, which closed after the effective date of the Act. FHA loans
are not covered by the Act. Under the Act, automatic termination of mortgage
insurance would generally occur once the loan-to-value ratio ("LTV") reaches
78%. A borrower may generally request cancellation of mortgage insurance once
the LTV reaches 80% of the home's original value, or when actual payments reduce
the loan balance to 80% of the home's original value, whichever occurs earlier.
For borrower initiated cancellation of mortgage insurance, the borrower must
have a good payment history. Good payment history generally requires that there
have been no payments during the 12-month period preceding the loan's
cancellation date 30 days or more past due, or 60 days or more past due during
the 12-month period beginning 24 months before the loan's cancellation date.
Loans that are deemed "high risk" by the GSEs, require automatic termination of
mortgage insurance coverage once the LTV is first scheduled to reach 77% of the
original value of the property without regard to the actual outstanding balance.
The Act preempts all but more protective, preexisting state laws. Protected
state laws are preempted if inconsistent with the Act. Protected state laws are
consistent with the Act if they require: (i) termination of mortgage insurance
at an earlier date or higher mortgage principal balance than required by the
Act, or (ii) disclosure of more, earlier, or more frequent information. States
that enacted mortgage insurance cancellation laws on or before January 2, 1998,
have until July 29, 2000 to make their statutes consistent with the Act. States
that currently have mortgage insurance cancellation or notification laws
include: California, Connecticut, Illinois, Maryland, Minnesota, Missouri, New
York, Texas and Washington. Management is uncertain about the impact of the Act
on PMI's insurance in force, but believes any reduction in premiums attributed
to the Act's required cancellation of mortgage insurance, will not have a
significant impact on the Company's financial condition and results of
operations for the foreseeable future. (See IC10)
During an environment of falling interest rates, an increasing number of
borrowers refinance their mortgage loans. PMI and other mortgage insurance
companies generally experience an increase in the prepayment rate of insurance
in force, resulting from policy cancellations of older books of business with
higher rates of interest. Although PMI has a history of expanding business
during low interest rate environments, the resulting increase of NIW may
ultimately prove to be inadequate to compensate for the loss of insurance in
force arising from policy cancellations. During the first half of 1999, mortgage
loan refinancings continued at a higher than expected rate. Management
anticipates that the refinancing trend will decrease in the second half of 1999.
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A decrease in persistency, resulting from policy cancellations of older books of
business affected by refinancing (which is affected, among other things, by
decreases in interest rates) may materially and adversely impact the level or
rate of growth of insurance in force or risk in force and consequently have
similar impacts on the Company's financial condition and results of operations.
RATING AGENCIES (IC5)
PMI's claims-paying ability is currently rated "AA+" (Excellent) by Standard and
Poor's Rating Services, "Aa2" (Excellent) by Moody's Investors Service, Inc.,
"AA+" (Very Strong) by Fitch IBCA, and "AA+" (Very High) by Duff & Phelps Credit
Rating Co. 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, principally PMI's capital
resources as computed by the rating agencies, and are not applicable to the
Company's common stock or outstanding debt. During June 1999, Standard & Poor's
and Moody's affirmed the AA+ and Aa2, respectively, financial strength rating
and claims-paying ability rating of PMI. During March 1999, Moody's announced
that it changed PMI's and TPG's rating outlook from stable to negative, stating
such action was based on TPG's stock repurchases, PMI's writing of GSE pool and
diversification into new sectors.
Rating agencies generally assess capital charges on pool insurance policies
based on price and structure. One published methodology for assessing the
capital requirement for pool insurance is based on the real estate depression
that occurred in oil producing states during the mid-1980's. Management believes
the current capital charge that could be levied on pool insurance risk by one
rating agency is approximately $1.00 of capital for each $1.40 of pool insurance
risk. In comparison, primary mortgage insurance regulators specifically limit
the amount of insurance risk that may be written by PMI according to a number of
financial tests, including limiting risk, to a multiple of 25 times PMI's
statutory capital (which includes the contingency reserve). The rating agencies
could change their view as to the capital charges that are assessed on pool
insurance products at any time. (See IC10)
Management believes that a reduction in PMI's claims-paying ratings below AA-
could have a material, adverse effect on the Company's financial condition and
results of operations. (See IC3 and IC6)
LIQUIDITY (IC6)
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. The level and severity of claims significantly
influence liquidity requirements.
TPG's principal sources of funds are dividends from PMI and APTIC, investment
income and funds that may be raised from time to time in the capital markets.
Numerous factors bear on the Company's ability to maintain and meet its capital
and liquidity needs, including the performance of the financial markets,
standards and factors used by various credit rating agencies, financial
covenants in credit agreements, and standards imposed by state insurance
regulators relating to the payment of dividends by insurance companies. Any
significant change in the performance of the financial markets negatively
affecting the Company's ability to secure sources of capital, or changes in the
standards used by credit rating agencies which adversely impact PMI's
claims-paying ability rating, or changes in the insurance laws of Arizona,
Florida or Wisconsin that restrict the ability of PMI, APTIC or CMG to pay
dividends at currently permissible levels, could adversely affect the Company's
ability to maintain capital resources to meet its business needs, and thereby
have a material, adverse affect on the Company's financial condition, liquidity
and results of operations.
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CONTRACT UNDERWRITING SERVICES; NEW PRODUCTS (IC7)
The Company provides contract underwriting services for a fee that enable
customers to improve the efficiency and quality of their operations by
outsourcing all or part of their mortgage loan underwriting. As a part of its
contract underwriting services, PMI provides remedies that may include the
assumption of some of the costs of repurchasing insured and uninsured loans from
the GSEs and other investors. Generally, the scopes of these remedies are in
addition to those contained in PMI's master primary insurance policies. 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, or any significant increase in the cost PMI incurs to
satisfy remedy obligations for underwriting services, 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 experiences 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.
NEW YORK DEPARTMENT OF INSURANCE (IC8)
In February 1999, the New York Department of Insurance stated in Circular Letter
No. 2, addressed to all private mortgage insurers licensed in New York that
certain pool risk-share and structured products and programs would be considered
to be illegal under New York law. PMI believes that it complies with the
requirements of Circular Letter No. 2 with respect to transactions that are
governed by it. In the event the New York Department of Insurance determined PMI
was not in compliance with Circular Letter No. 2, it could materially and
adversely affect the Company's financial condition and results of operations.
RISK-TO-CAPITAL RATIO (IC9)
The State of Arizona, PMI's state of domicile for insurance regulatory purposes,
and other regulators specifically limit the amount of insurance risk that may be
written by PMI, by a variety of financial factors. For example, Arizona law
provides that if a mortgage guaranty insurer domiciled in Arizona does not have
the amount of minimum policyholders position required, it must cease transacting
new business until its minimum policyholders position meets the requirements.
Under Arizona law, minimum policyholders position is calculated based on the
face amount of the mortgage, the percentage coverage or claim settlement option
and the loan to value ratio category, net of reinsurance ceded, but including
reinsurance assumed. For example, under Arizona law, a mortgage guaranty insurer
would have to maintain minimum policyholders' position equal to $1.00 per each
one hundred dollars of the face amount of the mortgage, provided the LTV was
greater than seventy-five percent and the coverage percent was twenty-five
percent. The amount of minimum policyholders position would generally increase
if the mortgage amount remained constant, but the coverage percentages and/or
LTV amounts increased.
Other factors affecting PMI's risk-to-capital ratio include: (i) 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
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risk-to-capital ratio would equal or exceed 23 to 1; (ii) TPG's credit
agreements and the terms of its guaranty of the debt incurred to purchase PMI
LTD; and (iii) TPG's and PMI's credit or claims-paying ability ratings which
generally require that the rating agencies' 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; POOL INSURANCE (IC10)
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, 1999, 46.2% 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, 1999, 4.5% of PMI's risk in force consisted of 97s that 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. Since the
fourth quarter of 1997, PMI has offered a new pool insurance product. Pool
insurance is generally used as an additional credit enhancement for certain
secondary market mortgage transactions and generally covers the loss on a
defaulted mortgage loan that exceeds the claim payment under the primary
coverage, if primary insurance is required on that mortgage loan. Pool insurance
also generally covers the total loss on a defaulted mortgage loan that did not
require primary insurance, in each case up to a stated aggregate loss limit. New
pool risk written was $90 million for the quarter ended September 30, 1999 and
$193 million for the nine months ended September 30, 1999. Management is
uncertain about the amount of new pool risk that will be written in 1999, but
believes total new 1999 pool risk will be less than in 1998. Although PMI
charges higher premium rates for loans that have higher risk characteristics,
including ARMs, 95s, 97s and pool insurance products, 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 losses could
materially and adversely affect the Company's financial condition and results of
operations. (See IC5)
POTENTIAL INCREASE IN CLAIMS (IC11)
Mortgage insurance coverage generally cannot be canceled by PMI and remains
renewable at the option of the insured until required to be canceled under
applicable Federal or state laws 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. (See
IC5)
LOSS RESERVES (IC12)
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
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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 (IC13)
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, Florida, and Texas, where PMI
has 16.1%, 7.8% and 7.3% of its risk in force concentrated and where the default
rate on all PMI policies in force is 2.61%, 2.84% and 1.92% compared with 2.07%
nationwide as of September , 1999.
CONTINUING RELATIONSHIPS WITH ALLSTATE AND AFFILIATE (IC14)
On October 28, 1994, TPG entered into a Runoff Support Agreement (the "Runoff
Support Agreement") with Allstate Insurance Company ("Allstate") to replace
various capital support commitments that Allstate had previously provided to
PMI. Allstate agreed to pay claims on certain insurance policies issued by PMI
prior to October 28, 1994, if PMI's financial condition deteriorates below
specified levels, or if a third party brings a claim thereunder. Alternatively,
Allstate may make contributions directly to PMI or TPG. In the event that
Allstate makes payments or contributions under the Runoff Support Agreement
(which possibility management believes is remote), Allstate would receive
subordinated debt or preferred stock of PMI or TPG in return. No payment
obligations have arisen under the Runoff Support Agreement. The Runoff Support
Agreement provides PMI with additional capital support for rating agency
purposes (See IC15).
CAPTIVE REINSURANCE ARRANGEMENTS; RISK-SHARING TRANSACTIONS (IC15)
PMI offers various risk-sharing structured transactions, including a captive
reinsurance arrangement as part of its strategic relationships with its
customers. PMI's customers have indicated an increasing demand for captive
reinsurance arrangements. Such arrangements allow a reinsurance company,
generally an affiliate of the lender, to assume a portion of the mortgage
insurance default risk in exchange for a portion of the insurance premiums. An
increasing percentage of PMI's NIW is being generated by customers with captive
reinsurance companies, and it is expected that this trend will increase,
resulting in a decrease in net premiums written which may negatively impact the
yield obtained in the Company's net premiums earned for such customers with
captive reinsurance arrangements. There can be no assurance that PMI's
risk-sharing structured transactions, including captive reinsurance
arrangements, will continue to be accepted by its customers. The inability of
the Company to provide its customers with acceptable risk-sharing structured
transactions, including potentially increasing levels of premium cessions in
captive reinsurance arrangements, would likely have an adverse effect on the
competitive position of PMI and consequently could materially and adversely
affect the Company's financial condition, liquidity and results of operations.
GRAMM-LEACH-BLILEY ACT (IC16)
On November 12, 1999, the President signed the Gramm-Leach-Bliley Act of 1999
(the "Act") into law. Among other things, the Modernization Act will allow bank
holding companies to engage in a substantially broader range of activities,
including insurance underwriting, and will allow insurers and other financial
service companies to acquire banks. The Company expects that, over time, the
Modernization Act will allow consumers the ability to shop for their insurance,
banking and investment needs at one financial services company. For example, a
typical consumer would be able to buy a wide range of products including CD's,
home equity loans, credit cards, insurance policies and other investments from
affiliates of a single company.
30
<PAGE>
Because of the many aspects of the Act which require clarification and
promulgation of specific regulations, management is not yet able to ascertain
the full impact of the Act on the Company. However, management believes that the
Act will facilitate the combination of the investment banking, commercial
banking and insurance businesses and will hasten the development of new savings
and investment products which will increase competition in the financial
services area including for the Company. In addition, the ability of insurance,
banking and investment firms to affiliate will increase the likelihood that
existing bank holding companies with significantly more capital will be allowed
and able to enter into mortgage insurance business, which may result in material
and adverse impact on the results of operations and financial condition of the
Company.
The new financial privacy provisions will generally prohibit financial
institutions, including the Company, from disclosing non-public, personal
financial information to third parties unless customers have the opportunity to
"opt out" of the disclosure. The Act also modifies other current financial laws,
including laws related to financial privacy.
31
<PAGE>
THE PMI GROUP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
September 30, 1999
Item 3 - Quantitative and Qualitative Disclosures about Market Risk
At September 30, 1999, the average duration of the Company's fixed income
investment portfolio was 5.6 years, and the Company had no derivative financial
instruments in its investment portfolio. The result of a 1% increase in interest
rates would be a 5.8% decrease in the value of the Company's investment
portfolio, while the result of a 1% decrease in interest rates would be a 5.0%
increase in the value of the Company's investment portfolio.
Item 4 - Submission of Matters to a Vote of Security Holders
None.
Item 5 - Other Information
None.
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits - The exhibits listed in the accompanying Index to
Exhibits are filed as part of this Form 10-Q
(b) Reports on Form 8-K:
On November 2, 1999, TPG filed a report on Form 8-K
relating to comments made during an Analyst/Investor
conference it held that same day.
32
<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 November 15, 1999.
The PMI Group, Inc.
/s/ John M. Lorenzen, Jr.
------------------------------
John M. Lorenzen, Jr.
Executive Vice President and
Chief Financial Officer
33
<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
34
<PAGE>
EXHIBIT 11.1
THE PMI GROUP, INC. AND SUBSIDIARIES
COMPUTATION OF RESTATED NET INCOME PER SHARE (1)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -----------------------
(In thousands, except for per share data) 1999 1998 1999 1998
<S> <C> <C> <C> <C>
Basic net income per common share:
Net income $54,503 $53,728 $147,614 $146,283
Average common shares outstanding 44,774 46,374 44,963 47,624
---------- -------- --------- ---------
Basic net income per common share $ 1.22 $ 1.16 $ 3.28 $ 3.07
========== ======== ========= =========
Diluted net income per common share:
Net income $54,503 $53,728 $147,614 $146,283
---------- -------- --------- ---------
Average common shares outstanding 44,774 46,374 44,963 47,624
Net shares to be issued upon exercise of dilutive
stock options after applying treasury stock method 448 177 269 240
---------- -------- -------- ---------
Average shares outstanding 45,222 46,551 45,232 47,864
---------- -------- --------- ---------
Diluted net income per common share $ 1.21 $ 1.15 $ 3.26 $ 3.06
========== ======== ======== =========
</TABLE>
(1) Restated to conform with Statement of Financial Accounting Standards
No. 128, Earnings per Share.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<DEBT-HELD-FOR-SALE> 1,485,327
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 184,530
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 1,756,749
<CASH> 33,167
<RECOVER-REINSURE> 52,454
<DEFERRED-ACQUISITION> 70,782
<TOTAL-ASSETS> 2,040,333
<POLICY-LOSSES> 279,721
<UNEARNED-PREMIUMS> 177,037
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 145,351
0
0
<COMMON> 528
<OTHER-SE> 1,168,887
<TOTAL-LIABILITY-AND-EQUITY> 2,040,333
407,761
<INVESTMENT-INCOME> 67,579
<INVESTMENT-GAINS> 512
<OTHER-INCOME> 13,767
<BENEFITS> 83,934
<UNDERWRITING-AMORTIZATION> 60,971
<UNDERWRITING-OTHER> 124,542
<INCOME-PRETAX> 208,530
<INCOME-TAX> 60,916
<INCOME-CONTINUING> 147,614
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 147,614
<EPS-BASIC> 3.28
<EPS-DILUTED> 3.26
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
