<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 June 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________________ to ______________________
Commission file number 1-13664
THE PMI GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3199675
(State of Incorporation) (IRS Employer Identification No.)
601 Montgomery Street,
San Francisco, California 94111
(Address of principal executive offices) (Zip Code)
(415) 788-7878
(Registrant's telephone number including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class of Stock Par Value Date Number of Shares
-------------- --------- -------- ----------------
Common Stock $0.01 07/31/00 44,169,873
<PAGE>
THE PMI GROUP, INC.
Index to Quarterly Report on Form 10-Q
June 30, 2000
<TABLE>
<CAPTION>
Part I - Financial Information Page
----
<S> <C>
Item 1. Interim Consolidated Financial Statements and Notes (Unaudited)
Consolidated Statements of Operations for the Three Months and Six
Months Ended June 30, 2000 and 1999 3
Consolidated Balance Sheets as of June 30, 2000 and
December 31, 1999 4
Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2000 and 1999 5
Notes to Consolidated Financial Statements 6-9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 10-23
Item 3. Quantitative and Qualitative Disclosures About Market Risk 17
Part II - Other Information
Item 1. Legal Proceedings 24
Item 4. Submission of Matters to a Vote of Securities Holders 24
Item 6. Exhibits and Reports on Form 8-K 25
Signatures 26
Index to Exhibits 27
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. INTERIM FINANCIAL STATEMENTS
THE PMI GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
--------------------------- -------------------------
(In thousands except per share amounts) 2000 1999 2000 1999
---------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues
Premiums earned $ 156,833 $ 131,330 $ 305,549 $ 260,099
Investment income, less investment expense 29,035 21,827 56,118 43,528
Realized capital gains, net 370 327 1,138 344
Other income 1,655 2,689 4,506 7,453
---------- ----------- ---------- ----------
Total revenues 187,893 156,173 367,311 311,424
---------- ----------- ---------- ----------
Losses and expenses
Losses and loss adjustment expenses 26,711 22,847 54,934 52,717
Amortization of policy acquisition costs 20,416 21,144 40,814 41,967
Underwriting and other operating expenses 42,357 38,902 81,560 77,805
Interest expense 2,573 1,804 4,943 3,593
Distributions on preferred capital securities 2,077 2,077 4,155 4,155
---------- ----------- ---------- ----------
Total losses and expenses 94,134 86,774 186,406 180,237
---------- ----------- ---------- ----------
Income before income taxes 93,759 69,399 180,905 131,187
Income tax expense 28,780 19,940 55,936 38,076
---------- ----------- ---------- ----------
Net income $ 64,979 $ 49,459 $ 124,969 $ 93,111
========== =========== ========== ==========
Per common share data:
Basic net income $ 1.47 $ 1.10 $ 2.82 $ 2.07
========== =========== ========== ==========
Diluted net income $ 1.45 $ 1.09 $ 2.79 $ 2.06
========== =========== ========== ==========
Cash dividends declared $ 0.04 $ 0.03 $ 0.08 $ 0.06
========== =========== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
THE PMI GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
(Dollars in thousands) ------------- ------------
Assets (Unaudited)
<S> <C> <C>
Investments:
Available for sale, at fair value:
Fixed income securities
(amortized cost $1,504,641 and $1,485,396) $ 1,531,976 $ 1,479,310
Equity securities
Common stock (cost $58,430 and $44,714) 98,070 83,890
Preferred stock (cost $72,983 and $17,660) 70,230 17,582
Common stock of affiliates, at underlying book value 115,755 91,453
Short-term investments (at cost, which approximates fair value) 126,749 145,093
-------------- -------------
Total investments 1,942,780 1,817,328
Cash 10,536 28,076
Accrued investment income 22,601 22,058
Reinsurance recoverable and prepaid premiums 52,581 50,714
Premiums receivable 32,557 30,659
Receivable from affiliates 2,506 2,996
Deferred policy acquisition costs 68,769 69,579
Property and equipment, net 46,231 40,462
Other assets 46,967 38,890
-------------- -------------
Total assets $ 2,225,528 $ 2,100,762
============== =============
Liabilities
Reserve for losses and loss adjustment expenses $ 291,735 $ 282,000
Unearned premiums 172,956 182,089
Long-term debt 139,930 145,367
Reinsurance balances payable 26,165 25,415
Deferred income taxes 87,440 75,640
Other liabilities and accrued expenses 77,677 73,908
-------------- -------------
Total liabilities 795,903 784,419
-------------- -------------
Company-obligated mandatorily redeemable preferred capital
securities of subsidiary trust holding solely junior subordinated
deferrable interest debenture of the Company 99,092 99,075
Shareholders' equity
Preferred stock -- $.01 par value; 5,000,000 shares authorized - -
Common stock -- $.01 par value; 187,500,000 shares
authorized; 52,794,004 and 52,793,777 issued 528 528
Additional paid-in capital 265,828 265,828
Accumulated other comprehensive income 35,871 20,186
Retained earnings 1,379,046 1,258,617
Treasury stock (8,671,193 and 8,091,924 shares at cost) (350,740) (327,891)
-------------- -------------
Total shareholders' equity 1,330,533 1,217,268
-------------- -------------
Total liabilities and shareholders' equity $ 2,225,528 $ 2,100,762
============== =============
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
THE PMI GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Six Months
Ended June 30,
----------------------------
(In thousands) 2000 1999
----------- ----------
<S> <C> <C>
Cash flows from operating activities
Net income $ 124,969 $ 93,111
Adjustments to reconcile net income to net cash
provided by operating activities:
Realized capital gains, net (1,138) (344)
Equity in earnings of affiliates (4,344) (3,126)
Depreciation and amortization 7,649 3,325
Changes in:
Reserve for losses and loss adjustment expenses 9,735 8,823
Unearned premiums (9,133) (390)
Deferred policy acquisition costs 809 (7,625)
Accrued investment income (543) 541
Reinsurance balances payable 749 4,152
Reinsurance recoverable and prepaid premiums (1,866) (3,555)
Premiums receivable (1,898) (5,569)
Income taxes 1,220 2,999
Receivable from affiliates 490 1,283
Receivable from Allstate - (2,056)
Other (8,778) (26,743)
----------- ----------
Net cash provided by operating activities 117,921 64,826
----------- ----------
Cash flows from investing activities
Proceeds from sales of equity securities 22,303 16,085
Investment collections of fixed income securities 500 -
Proceeds from sales of fixed income securities 104,735 132,888
Investment purchases:
Fixed income securities (137,667) (141,700)
Equity securities (82,958) (16,239)
Net decrease (increase) in short-term investments 18,343 (18,049)
Investment in affiliates (19,506) (740)
Purchase of PMI Ltd. - (7,799)
Purchase of property and equipment (9,018) (5,129)
----------- ----------
Net cash used in investing activities (103,268) (40,683)
----------- ----------
Cash flows from financing activities
Proceeds from exercise of stock grants and options 1,168 327
Principal payments on long-term debt (4,804) -
Dividends paid to shareholders (4,540) (3,018)
Purchase of The PMI Group, Inc. common stock (24,017) (20,797)
----------- ----------
Net cash used in financing activities (32,193) (23,488)
----------- ----------
Net (decrease) increase in cash (17,540) 655
Cash at beginning of period 28,076 9,757
----------- ----------
Cash at end of period $ 10,536 $ 10,412
=========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
THE PMI GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2000
(Unaudited)
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; and PMI's wholly-owned
subsidiaries, PMI Mortgage Insurance Ltd. ("PMI Ltd."), an Australian mortgage
insurance company, PMI Mortgage Services Co. ("MSC"), a California corporation,
and other insurance, reinsurance and non-insurance subsidiaries of PMI and TPG.
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 has equity interests in CMG Mortgage Insurance
Company and CMG Reinsurance Company (collectively referred to as "CMG"), both
of which conduct residential mortgage insurance and reinsurance business, and
also Fairbanks Capital Holding Corp. ("Fairbanks"), a special servicer of
single-family residential mortgages. TPG has an equity interest in RAM Holdings
Ltd. and RAM Holdings II Ltd. (collectively referred to as "RAM Re"), a
financial guaranty reinsurance company based in Bermuda. CMG, Fairbanks 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 the requirements of Form 10-Q and Article 7 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by GAAP for complete financial statements. In the opinion of
management, all adjustments (consisting only of normal recurring adjustments)
considered necessary for a fair presentation, have been included. Interim
results for the quarter and six months ended June 30, 2000 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2000. The financial statements should be read in conjunction with the audited
consolidated financial statements and footnotes included in The PMI Group, Inc.
1999 Annual Report to Shareholders.
Note 2 - Changes in Accounting Policy
Effective January 1, 2000 the Company changed its accounting policy for
international subsidiaries and affiliates to report operations on a one-month
lag from domestic operations. Accordingly, the results of foreign operations
for the six months ended June 30, 2000 represent five months of activity.
Note 3 - Earnings per Share
The weighted average common shares outstanding for computing basic earnings per
share ("EPS") were 44,094,069 and 44,887,242 for the three months ended June 30,
2000 and 1999, respectively, and 44,248,927 and 45,058,499 for the six months
ended June 30, 2000 and 1999, 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 such
options had the potential effect of increasing common shares to 44,736,476 and
45,170,097 for the three months ended June 30, 2000 and 1999, respectively, and
44,748,719 and 45,247,107 for the six months ended June 30, 2000 and 1999,
respectively. Net income available to common shareholders does not change for
computing diluted EPS.
6
<PAGE>
Note 4 - Comprehensive Income
The reconciliation of net income to comprehensive income for the three months
and the six months ended June 30, 2000 and 1999 are as follows:
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
------------------------ ------------------------
(In thousands) 2000 1999 2000 1999
--------- ---------- --------- ----------
<S> <C> <C> <C> <C>
Net income $ 64,979 $ 49,459 $ 124,969 $ 93,111
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period 30,536 (22,844) 20,789 (28,153)
Less: reclassification adjustment for gains
included in net income (241) (213) (740) (224)
Currency translation adjustment (2,419) - (4,364) -
--------- ---------- --------- ----------
Other comprehensive income (loss), net of tax 27,876 (23,057) 15,685 (28,377)
--------- ---------- --------- ----------
Comprehensive income $ 92,855 $ 26,402 $ 140,654 $ 64,734
========= ========== ========= ==========
</TABLE>
Note 5 - Deferred Policy Acquisition Costs ("DAC")
Consolidated mortgage insurance operations 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 that consolidated mortgage insurance
operations defers include all underwriting, contract underwriting and sales
related activities. To the extent the Company is compensated by customers for
contract underwriting, those underwriting costs are not deferred.
The DAC asset is amortized and charged against revenue in proportion to
estimated gross profits over the life of the policies using the guidance
provided by SFAS No. 97, Accounting and Reporting by Insurance Enterprises For
Certain Long-Duration Contracts and for Realized Gains and Losses From the Sale
of Investments.
The following table reconciles beginning and ending DAC balance for the periods
indicated.
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
---------------------------- ----------------------------
(In thousands) 2000 1999 2000 1999
----------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Beginning DAC balance $ 68,827 $ 65,682 $ 69,579 $ 61,605
U.S. acquisition costs incurred and deferred 18,387 24,692 37,319 49,592
U.S. amortization of deferred costs (20,416) (21,144) (40,814) (41,967)
Net change in PMI Ltd. DAC balance 1,971 - 2,685 -
----------- ---------- ----------- -----------
Ending DAC balance $ 68,769 $ 69,230 $ 68,769 $ 69,230
=========== ========== =========== ===========
</TABLE>
7
<PAGE>
Note 6 - Business Segments
The Company's reportable operating segments include Domestic Mortgage Insurance,
International Mortgage Insurance and Title Insurance. 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 immaterial. 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>
Domestic International
Quarter ended June 30, 2000 Mortgage Mortgage Title Consolidated
(In thousands) Insurance Insurance Insurance Other Total
-------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Premiums earned $ 124,972 $ 7,083 $ 24,778 $ - $ 156,833
========== ======== ======== =========== ==========
Net underwriting income (expenses)
before tax - external customers $ 69,586 $ 3,509 $ 2,537 $ (6,628) $ 69,004
Investment income (including capital gains) 21,531 3,258 457 1,348 26,594
Equity in earnings of affiliates 2,290 - - 521 2,811
Interest expense - (766) - (1,807) (2,573)
Distributions on preferred capital securities - - - (2,077) (2,077)
---------- -------- -------- ----------- ----------
Income (loss) before income tax expense 93,407 6,001 2,994 (8,643) 93,759
Income tax expense (benefit) 28,483 2,114 1,068 (2,885) 28,780
---------- -------- -------- ----------- ----------
Net income (loss) $ 64,924 $ 3,887 $ 1,926 $ (5,758) $ 64,979
========== ======== ======== =========== ==========
Total assets $1,884,029 $177,481 $ 47,938 $ 116,080 $2,225,528
========== ======== ======== =========== ==========
</TABLE>
<TABLE>
<CAPTION>
Domestic
Quarter ended June 30, 1999 Mortgage Title Consolidated
(In thousands) Insurance Insurance Other Total
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Premiums earned $ 107,339 $ 23,991 $ - $ 131,330
========== ======== ======== ===========
Net underwriting income (expenses)
before tax - external customers $ 49,956 $ 2,715 $ (1,545) $ 51,126
Investment income (including capital gains) 19,390 380 790 20,560
Equity in earnings of affiliates 1,302 - 292 1,594
Interest expense - - (1,804) (1,804)
Distributions on preferred capital securities - - (2,077) (2,077)
---------- -------- --------- -----------
Income (loss) before income tax expense 70,648 3,095 (4,344) 69,399
Income tax expense (benefit) 20,272 1,134 (1,466) 19,940
---------- -------- --------- -----------
Net income (loss) $ 50,376 $ 1,961 $ (2,878) $ 49,459
========== ======== ======== ===========
Total assets $1,680,790 $ 41,776 $ 90,672 $ 1,813,238
========== ======== ======== ===========
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
Domestic International
Six Months ended June 30, 2000 Mortgage Mortgage Title Consolidated
(In thousands) Insurance Insurance Insurance Other Total
-------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Premiums earned $ 245,507 $ 12,674 $ 47,368 $ - $ 305,549
========== ======== ======== ========= ==========
Net underwriting income (expenses)
before tax - external customers $ 129,114 $ 7,229 $ 4,068 $ (7,664) $ 132,747
Investment income (including capital gains) 42,621 6,585 914 2,793 52,914
Equity in earnings of affiliates 4,071 - - 273 4,344
Interest expense (13) (1,286) - (3,646) (4,945)
Distributions on preferred capital securities - - - (4,155) (4,155)
---------- -------- -------- --------- ----------
Income (loss) before income tax expense 175,793 12,528 4,982 (12,398) 180,905
Income tax expense (benefit) 53,384 4,228 1,666 (3,342) 55,936
---------- -------- -------- --------- ----------
Net income (loss) $ 122,409 $ 8,300 $ 3,316 $ (9,056) $ 124,969
========== ======== ======== ========= ==========
Total assets $1,884,029 $177,481 $ 47,938 $ 116,080 $2,225,528
========== ======== ======== ========= ==========
</TABLE>
<TABLE>
<CAPTION>
Domestic
Six Months ended June 30, 1999 Mortgage Title Consolidated
(In thousands) Insurance Insurance Other Total
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Premiums earned $ 212,577 $ 47,522 $ - $ 260,099
========== ======== ======== ===========
Net underwriting income (expenses)
before tax - external customers $ 93,297 $ 4,940 $ (3,174) $ 95,063
Investment income (including capital gains) 38,541 748 1,457 40,746
Equity in earnings of affiliates 2,563 - 563 3,126
Interest expense - - (3,593) (3,593)
Distributions on preferred capital securities - - (4,155) (4,155)
---------- -------- -------- -----------
Income (loss) before income tax expense 134,401 5,688 (8,902) 131,187
Income tax expense (benefit) 38,919 2,071 (2,914) 38,076
---------- -------- -------- -----------
Net income (loss) $ 95,482 $ 3,617 $ (5,988) $ 93,111
========== ======== ======== ===========
Total assets $1,680,790 $ 41,776 $ 90,672 $ 1,813,238
========== ======== ======== ===========
</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.
9
<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. Forward-looking statements in this document
include: (i) management's expectation that secondary market bulk transactions
will continue to be a portion of MICA's total origination volume during the year
2000, creating volatility in quarterly market share results of individual
companies, including PMI; (ii) management's belief that the persistency rate may
continue to increase if interest rates remain stable or rise during 2000; (iii)
management's anticipation that the percentage of NIW subject to captive mortgage
reinsurance agreements and other risk-share programs will continue to increase
in 2000 and beyond, reducing the Company's net premiums written and net premiums
earned; (iv) management's expectation that the amount of pool risk written by
PMI in the year 2000 will be less than the amount written in 1999; (v)
management's anticipation that the percentage of PMI's risk relating to risk-
share programs will continue to increase as a percentage of total risk; (vi)
management's belief that PMI's default rate may increase by year-end due to the
maturation of insurance in force and seasonality; (vii) management's
expectation that California will continue to account for a significant portion
of total claims paid during the year 2000; (viii) management's expectation
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 may continue to decline; (ix)
and management's anticipation that a significant percentage of NIW will be
delivered through the contract underwriting channel during 2000. 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 is 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 the Investment Considerations set forth below. 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.
10
<PAGE>
RESULTS OF CONSOLIDATED OPERATIONS:
THREE MONTHS ENDED JUNE 30, 2000 AND 1999
Consolidated net income was $65.0 million in the three months ended June 30,
2000, a 31.3% increase over the corresponding period of 1999. The growth can be
attributed to increases in premiums earned of 19.4% and net investment income of
33.0%, partially offset by a decrease in other income of 37.0%, an increase in
losses and loss adjustment expenses of 17.1%, and an increase in interest
expense of 44.4%. Included in the 2000 financial results are the operations
from PMI Ltd., which was acquired in the third quarter of 1999 and contributed
$3.9 million of net income in the three months ended June 30, 2000. Diluted net
income per share increased by 33.0% to $1.45 in 2000. Excluding capital gains,
operating earnings per share increased by 33.0% to $1.45. Revenues in the
second quarter of 2000 increased by 20.3% to $187.9 million compared with the
second quarter of 1999.
U.S. MORTGAGE INSURANCE OPERATIONS
The Company's primary operating subsidiary, PMI, contributed approximately 80%
of total revenues in the second quarter of 2000, generated by mortgage guaranty
insurance written in the United States. PMI's new insurance written ("NIW")
decreased by 14.5% to $6.5 billion in the second quarter of 2000 compared with
the corresponding period of 1999, primarily as a result of a decline in total
residential mortgage origination activity and the corresponding decrease in
total volume of the private mortgage insurance industry.
The members of the private mortgage insurance industry, as reported by the
industry's trade association, Mortgage Insurance Companies of America ("MICA"),
experienced a decrease in total new insurance written of 15.9% to $41.7 billion
in the second quarter of 2000 from the corresponding period of 1999. This
decrease was primarily due to a decline in total residential mortgage
originations, particularly in refinancing activity, brought on by the rising
interest rate environment. Total residential mortgage originations are
estimated at $276 billion compared with $381 billion in the corresponding period
of 1999, a 27.6% drop. Refinancing as a percentage of PMI's NIW decreased to
8.1% in the second quarter of 2000 from 25.6% in the corresponding period of
1999. The private mortgage insurance companies' market share increased to 60.3%
of the total low down-payment market (insurable loans) from 50.9% in the second
quarter of 1999. Management believes that the private mortgage insurance
companies' increase in market share was primarily the result of an expansion of
the MICA market through secondary market bulk transactions, which were
generally not insured by MICA in 1999. (See IC2)
PMI's market share of NIW increased to 15.6% in the second quarter of 2000,
compared with 15.3% in the second quarter of 1999. On a combined basis with CMG,
market share increased to 17.1% in the second quarter of 2000 compared with
16.5% in the second quarter of 1999. PMI's market share decreased from the first
quarter 2000 level of 18.1% due to a bulk transaction in the first quarter
representing approximately $1 billion of NIW insured by PMI. Management believes
the industry insured bulk NIW during the second quarter, in which PMI did not
participate. Management expects these secondary market bulk transactions to
continue to be a portion of MICA's total origination volume during 2000.
Accordingly, management expects volatility in quarterly market share results of
individual companies, including PMI.
PMI's cancellations of primary insurance in force decreased by 35.8% to $4.3
billion in the second quarter of 2000 compared with the corresponding period of
1999 primarily due to the decrease in refinancing activity previously discussed.
As a result of the decrease in cancellation activity, PMI's persistency rate
increased to 78.8% as of June 30, 2000 compared with 71.9% as of December 31,
1999 and 66.1% as of June 30, 1999. Management believes that if interest rates
remain stable or rise during 2000, the persistency rate may continue to
increase.
11
<PAGE>
Insurance in force increased by 10.7% to $91.1 billion at June 30, 2000 compared
with June 30, 1999. On a combined basis with CMG, insurance in force grew by
11.7% to $97.6 billion at June 30, 2000 compared with June 30, 1999. PMI's risk
in force increased by 12.1% to $22.2 billion at June 30, 2000 compared with June
30, 1999. On a combined basis with CMG, risk in force grew by 12.7% to $23.8
billion compared with June 30, 1999. The strong growth rates in insurance and
risk in force were primarily due to the decrease in cancellation activity (and
the corresponding increase in persistency) and secondarily to the bulk
transaction discussed above.
Consolidated U.S. mortgage insurance net premiums written grew by 8.5% to $123.1
million in the second quarter of 2000 compared with the corresponding period of
1999. This increase was primarily due to the growth of insurance and risk in
force discussed above, the continued shift to deeper coverage products and to a
recapture agreement of an old pool business reinsurance arrangement in the third
quarter of 1999 (see Note 7 "Reinsurance" of the Notes to the Consolidated
Financial Statements included in the PMI Group, Inc. 1999 Annual Report to
Shareholders). The old pool risk in force was $1.4 billion at June 30, 2000.
Refunded premiums decreased by 53.8% to $2.6 million as a result of the decrease
in policy cancellations. Ceded premiums written increased by 8.2% to $8.0
million for the quarter ended June 30, 2000 due to the increasing use of captive
reinsurance arrangements, offset by the lack of ceded premiums in 2000 related
to the Old Pool reinsurance recapture agreement. Approximately 33% of new
insurance written in the second quarter of 2000 was subject to captive mortgage
reinsurance agreements compared with approximately 20% in the corresponding
period of 1999. Management anticipates that the percent of the NIW subject to
captive mortgage reinsurance agreements and other risk-share programs will
continue to increase in 2000 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. Mortgage insurance premiums earned
increased 16.5% to $125.0 million in the second quarter of 2000 primarily due to
the increase in premiums written.
GSE pool risk written totaled $24 million for the second quarter of 2000,
compared with $61 million in the corresponding period of 1999. Management
expects the amount of pool risk written in 2000 to be less than the amount of
pool risk written in 1999. GSE pool risk in force was $725 million as of June
30, 2000, representing 3.3% of direct primary risk in force. Risk in force
under risk-share programs with PMI's customers, represented approximately 24%
of direct primary risk in force at June 30, 2000, compared to approximately 20%
at June 30, 1999. During 2000, management anticipates the percentage of PMI's
risk related to risk-share programs to continue to increase as a percent of
total risk. (See IC10)
The percentage of PMI's insurance in force with deeper coverage continued to
increase. Mortgages with original loan-to-value ratios greater than 90% and
equal to or less than 95% ("95s") with 30% insurance coverage increased to 37.6%
of risk in force as of June 30, 2000, from 35.9% as of June 30, 1999. 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 June 30, 2000, compared with 31.2% as of June 30, 1999.
Mortgage insurance losses and loss adjustment expenses increased 9.3% to $24.7
million in the second quarter of 2000 compared with the second quarter of 1999
primarily due to an increase in the inventory of loans in default and the
corresponding increase in loss reserves. Loans in default increased by 5.3% to
15,096 at June 30, 2000 compared with June 30, 1999. However, PMI's national
default rate decreased by 0.06 percentage points to 1.93% at June 30, 2000
compared with June 30, 1999, due to an 8.3% increase in policies in force to
781,087 at June 30, 2000. Management believes that PMI's default rate may
increase by year-end due to the maturation of insurance in force and
seasonality. (See IC12)
Direct primary claims paid in the second quarter of 2000 decreased by 17.2% to
$15.4 million compared with the same period in 1999, due to a 5.1% decrease in
the average claim size to approximately $18,570 and a 13.2% decline in the
number of claims paid to 867. The reduction in the average claim size is the
result of a smaller
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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 2.21% at June 30, 2000,
from 2.59% at June 30, 1999. Policies written in California accounted for 11.8%
and 31.6% of the total dollar amount of claims paid in the second quarter of
2000 and 1999, respectively. Management expects that California will continue
to account for a significant portion of total claims paid during 2000. However,
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 could continue to decline. (See IC13)
Mortgage insurance policy acquisition costs incurred and deferred decreased by
25.5% to $18.4 million in the second quarter of 2000 compared with the same
period in 1999 as a result of the 14.5% decrease in NIW and a decrease in
contract underwriting. Amortization of policy acquisition costs decreased by
3.3% to $20.4 million. A significant portion of policy acquisition costs
relates to contract underwriting. New policies processed by contract
underwriters represented 23.7% of PMI's NIW in the second quarter of 2000
compared with 35.8% in the corresponding period of 1999. Management anticipates
that a significant percentage of NIW will be delivered through the contract
underwriting channel during 2000. (See IC7) Other mortgage insurance operating
expenses decreased by 23.3% to $10.5 million in the second quarter of 2000
compared with the second quarter of 1999, due to 1999 Y2K remediation costs,
and reengineering efforts in 1999 and 2000.
The mortgage insurance loss ratio declined by 1.3 percentage points to 19.8% in
the quarter ended June 30, 2000 compared with the corresponding period in 1999.
The decrease is attributed primarily to the growth in premiums which outstripped
the slight increase in loss expenses as discussed above. The gross expense
ratio (GAAP basis) decreased by 10.4 percentage points to 23.4% compared with
the corresponding period in 1999 primarily due to the increase in premiums
written along with the decrease in underwriting & other operating expenses. The
combined ratio decreased by 6.9 percentage points to 44.9% in the second quarter
of 2000 compared with the same period in 1999.
INTERNATIONAL MORTGAGE INSURANCE OPERATIONS
During 1999, the Company commenced operations in Australia and Hong Kong. The
Company's Australian affiliate, PMI Ltd., was acquired on August 6, 1999. For
the quarter ended June 30, 2000, PMI Ltd. generated $12.6 million of net
premiums written and $7.1 million in net premiums earned. PMI Ltd.'s losses and
loss adjustment expenses were $1.8 million and underwriting and other expenses
were $2.6 million for the second quarter 2000. Investment income for PMI Ltd.
was $3.3 million in the second quarter of 2000. NIW for PMI Ltd. was $2.1
billion in the second quarter while insurance in force grew to $18.2 billion as
of June 30, 2000. Financial results for the operations in Hong Kong were
immaterial during the second quarter of 2000.
TITLE INSURANCE OPERATIONS
Title insurance premiums earned increased 3.3% to $24.8 million in the three
months ended June 30, 2000 compared with the same period in 1999 primarily due
to continued geographic expansion efforts offset by the decrease in residential
mortgage originations as previously noted. In the second quarter of 2000,
approximately 70.6% of APTIC's premiums earned were generated from the state of
Florida, compared with approximately 74.0% in the corresponding period of 1999.
Underwriting and other expenses increased 4.8% to $22.0 million in the second
quarter of 2000 compared with the same period in 1999 due to a increase in
agency fees and commissions related to the increase in premiums earned. The
title insurance combined ratio increased by 1.1 percentage points to 89.8%.
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OTHER
Other income, which was generated primarily by MSC, decreased by 37.0% to $1.7
million in the second quarter of 2000 compared with the second quarter of 1999
primarily due to the decrease in contract underwriting services. Other expenses
increased by 92.9% to $8.1 million, primarily due to international expansion
and diversification efforts and secondarily to equity based compensation,
partially offset by a decrease in contract underwriting expenses. (See IC7)
In the quarter ended June 30, 2000, the Company's net investment income
(including realized capital gains) increased by 33.0% to $29.0 million compared
with the second quarter of 1999 primarily due to the growth in the investment
portfolio of $422 million over the second quarter of 1999. This increase is due
to the acquisition of PMI Ltd. and positive cash flows generated by the Company.
In addition, the current portfolio book yield increased to 6.1% at June 30, 2000
from 5.9% at June 30, 1999 primarily as a result of the increasing interest rate
environment.
The Company's effective tax rate increased to 30.7% in the second quarter of
2000 from 28.7% in the second quarter of 1999 as a result of the increase in
domestic and international underwriting operations relative to the increase in
tax-exempt investment income.
SIX MONTHS ENDED JUNE 30, 2000 AND 1999
Consolidated net income was $125.0 million in the six months ended June 30,
2000, a 34.3% increase over the corresponding period of 1999. The growth can be
attributed to increases in premiums earned of 17.5% and net investment income of
29.0%, partially offset by an increase in underwriting and other expenses of
2.2%, a decrease in other income of 40.0%, an increase in losses and loss
adjustment expenses of 4.2%, and an increase in interest expense of 36.1%.
Included in the 2000 financial results are the operations from PMI Ltd., which
was acquired in the third quarter of 1999 and contributed $8.3 million of net
income for the six months ended June 30, 2000. Diluted net income per share
increased by 35.4% to $2.79 in 2000. Excluding capital gains, operating earnings
per share increased by 35.2% to $2.78. Revenues in the first half of 2000
increased by 18.0% to $367.3 million compared with the first six months of 1999.
U.S. MORTGAGE INSURANCE OPERATIONS
The Company's primary operating subsidiary, PMI, contributed approximately 80%
of total revenues in the first half of 2000, generated by mortgage guaranty
insurance written in the United States. PMI's NIW decreased by 16.8% to $12.4
billion in the first six months of 2000 compared with the corresponding period
of 1999, primarily as a result of a decline in total residential mortgage
origination activity and the corresponding decrease in total volume of the
private mortgage insurance industry, partially offset by an increase in PMI's
market share.
The private mortgage insurance industry experienced a decrease in total new
insurance written of 25.2% to $74.4 billion for the six months ended June 30,
2000 compared with the corresponding period of 1999. This decrease was
primarily due to a decrease in total residential mortgage originations,
particularly in refinancing activity, brought on by the rising interest rate
environment. Total residential mortgage originations are estimated at $464
billion for the first six months of 2000 compared with $732 billion in the
corresponding period of 1999. Refinancing as a percentage of PMI's NIW
decreased to 9.1% for the six months ended June 30, 2000 from 31.3% in the
corresponding period of 1999. The private mortgage insurance companies' market
share increased to 60.9% of the total low down-payment market (insurable loans)
from 51.8% in the same period of 1999. Management believes that the private
mortgage insurance companies' increase in market share was primarily the
result of an expansion of the MICA market through secondary market bulk
transactions which were generally not insured by MICA in 1999. (See IC2)
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PMI's market share of NIW increased to 16.7% in the first six months of 2000
compared with 14.9% in the first six months of 1999. On a combined basis with
CMG, market share increased to 18.1% in the first half of 2000 compared with
16.2% in the first half of 1999. Management believes the increase in PMI's
market share was primarily the result of a bulk secondary market transaction
representing approximately $1 billion in NIW insured by PMI during the first
quarter of 2000, offset by bulk NIW insured by PMI's competitors in the second
quarter of 2000. Management expects these bulk-type transactions to continue to
be a portion of MICA's total origination volume during 2000. Accordingly,
management expects volatility in market share results of individual companies,
including PMI.
Consolidated U.S. mortgage insurance net premiums written grew by 13.3% to
$240.1 million in the first six months of 2000 compared with the corresponding
period of 1999. This increase was primarily due to the growth of insurance and
risk in force as discussed above, the continued shift to deeper coverage
products, and to a recapture agreement of an old pool business reinsurance
arrangement in the third quarter of 1999 (see Note 7 "Reinsurance" of the Notes
to the Consolidated Financial Statements included in the PMI Group, Inc. 1999
Annual Report to Shareholders). Refunded premiums decreased by 46.2% to $5.0
million as a result of the decrease in policy cancellations. Ceded premiums
written decreased slightly by 1.8% to $16.2 million due to the lack of ceded
premiums in 2000 related to the Old Pool reinsurance recapture agreement offset
by the increasing popularity and usage of captive reinsurance arrangements.
Approximately 30% of new insurance written in the second quarter of 2000 was
subject to captive mortgage reinsurance agreements compared with approximately
20% in the corresponding period of 1999. Management anticipates that the percent
of the NIW subject to captive mortgage reinsurance agreements and other risk-
share programs will continue to increase in 2000 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. Mortgage
insurance premiums earned increased 15.5% to $245.5 million in the second
quarter of 2000 primarily due to the increase in premiums written.
GSE pool risk written totaled $44 million for the six months ended June 30,
2000, compared with $103 million in the corresponding period of 1999.
Management expects the amount of pool risk written in 2000 to be less than the
amount of pool risk written in 1999.
Mortgage insurance losses and loss adjustment expenses increased 0.1% to $52.3
million in the first six months of 2000 compared with the first six months of
1999 primarily due to an increase in the inventory of loans in default and the
corresponding increase in loss reserves.
Direct primary claims paid in the first half of 2000 decreased by 16.8% to $34.6
million compared with the same period in 1999 due to a 6.8% decrease in the
average claim size to approximately $19,500 and a 10.7% decline in the number of
claims paid to 1,779. The reduction in the average claim size 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 decreased by
24.8% to $37.3 million for the six months ended June 30, 2000 compared with the
same period in 1999 as a result of the 16.8% decrease in NIW and a decrease in
contract underwriting. Amortization of policy acquisition costs decreased by
2.9% to $40.8 million. Contract underwriting generated 22.7% of NIW for the six
months ended June 30, 2000 compared with 39.5% in the same period in 1999.
Other mortgage insurance operating expenses decreased by 6.8% to $23.4 million
in the first six months of 2000 compared with the same period in 1999 due to
1999 Y2K remediation costs and reengineering efforts in 1999 and 2000.
The mortgage insurance loss ratio declined by 3.3 percentage points to 21.3% for
the six months ended June 30, 2000 compared with the corresponding period in
1999. The decrease is attributed to the growth in premiums earned as discussed
above. The gross expense ratio (GAAP basis) decreased by 10 percentage points
to 25.3%
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primarily due to the increase in premiums written and a decrease in expenses as
discussed above. The combined ratio decreased by 8.2 percentage points to 48.1%
in the first half of 2000 compared with the same period in 1999.
INTERNATIONAL MORTGAGE INSURANCE OPERATIONS
For the six months ended June 30, 2000, PMI Ltd. generated $18.6 million of net
premiums written and $12.7 million in net premiums earned. PMI Ltd.'s losses
and loss adjustment expenses were $2.2 million and underwriting and other
expenses were $4.6 million for the first six months of 2000. Investment income
for PMI Ltd. was $6.6 million in the first half of 2000. NIW for PMI Ltd. was
$2.9 billion in the first half of 2000. Financial results for the operations in
Hong Kong were immaterial for the first six months of 2000.
TITLE INSURANCE OPERATIONS
Title insurance premiums earned decreased 0.2% to $47.4 million for the six
months ended June 30, 2000 compared with the same period in 1999 primarily due
to the decrease in residential mortgage originations offset by geographic
expansion, as previously noted. In the first half of 2000, approximately 69.8%
of APTIC's premiums earned were generated from the state of Florida, compared
with approximately 71.0% in the corresponding period of 1999. Underwriting and
other expenses increased 1.7% to $42.8 million in the first half of 2000
compared with the same period in 1999 due to geographic expansion efforts. The
title insurance combined ratio increased by 1.8 percentage points to 91.4%.
OTHER
Other income, which was generated primarily by MSC, decreased by 40.0% to $4.5
million in the first half of 2000 compared with the first half of 1999 primarily
due to the decrease in contract underwriting services. Other expenses decreased
by 13.2% to $12.0 million, primarily due to the decrease in contract
underwriting services, offset by increased investment in diversification
efforts.
In the six months ended June 30, 2000, the Company's net investment income
(including realized capital gains) increased by 29.0% to $56.1 million compared
with the first half of 1999 primarily due to the growth in the investment
portfolio of $422 million over the first half of 1999. This increase is due to
the acquisition of PMI Ltd. and positive cash flows generated by the Company.
The Company's effective tax rate increased to 30.9% in the first half of 2000
from 29.0% in the first half of 1999 as a result of the increase in domestic
and international underwriting operations relative to the increase in tax-exempt
investment 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 by, among other restrictions,
the insurance laws of Arizona. Such laws provide that PMI may pay: (i) out of
available surplus, (ii) without prior approval of the Arizona Insurance
Director, (iii) dividends during any 12-month period not to exceed the lesser of
10% of policyholders' surplus as
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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. In addition to the dividend restrictions
by state laws, the Company's credit agreements 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 quarter of 2000, APTIC declared a cash dividend of $3.0 million
to TPG, substantially the full amount of a dividend that can be paid by APTIC in
2000 without prior permission from the Florida Department of Insurance. During
July 2000, the Arizona Department of Insurance approved a return of capital of
$50 million to be paid by PMI to TPG in the second half of 2000.
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 and other
expenses incurred by the holding company. 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 first half of 2000, TPG purchased $24.0
million of the Company's common stock. As of June 30, 2000, $51.2 million
remained available under the 1998 authorization.
As of June 30, 2000, TPG had approximately $62.9 million of available funds.
This amount has decreased from the December 31, 1999 balance of $93.1 million
due primarily to the common stock repurchases in 2000 and investment in
Fairbanks. In addition, TPG has two bank credit lines available totaling $50.0
million. At June 30, 2000, there were no outstanding borrowings under the
credit lines.
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 $103.3
million and $53.1 million in the six months ended June 30, 2000 and 1999,
respectively. The increase in cash flows during this period was the result of a
temporary timing difference relating primarily to the payment of income taxes in
1999 and to the increase in net income in 2000.
The Company's invested assets increased by $125.5 million at June 30, 2000
compared with December 31, 1999. This increase is primarily due to positive cash
flows from consolidated operations and to the acquisition of PMI Ltd.
Consolidated reserves for losses and loss adjustment expenses increased by 3.4%
to $291.7 million compared with December 31, 1999 primarily due to slight
increases in the reserve balances for the primary and GSE pool books of business
consistent with slight increases in the default inventory, partially offset by a
decrease in the old pool reserve balance.
Consolidated shareholders' equity increased by 9.3% to $1.33 billion as of June
30, 2000 compared with December 31, 1999, due primarily to increases of $125.0
million from net income and $15.7 million from other comprehensive income, and
$1.2 million from equity based compensation, offset by the common stock
repurchases of $24.0 million and dividends declared of $4.5 million.
PMI's statutory risk-to-capital ratio at June 30, 2000 was 14.1 to 1, compared
with 14.8 to 1 at December 31, 1999. (See IC9)
Item 3 - Quantitative and Qualitative Disclosures about Market Risk
There have been no significant changes in market risk since December 31, 1999.
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CAUTIONARY STATEMENTS AND INVESTMENT CONSIDERATIONS
GENERAL ECONOMIC CONDITIONS (IC1)
Changes in economic conditions, including economic recessions, declining housing
values, higher unemployment rates, deteriorating borrower credit, rising
interest rates, increases in refinance activity caused by declining interest
rates, or combinations of these factors, could reduce the demand for mortgage
insurance, cause claims on policies issued by PMI to increase, and/or increase
PMI's loss experience.
MARKET SHARE AND COMPETITION (IC2)
The Company's financial condition and results of operations could be harmed by a
decline in its market share or a decline in market share of the private mortgage
insurance industry as a whole. Numerous factors bear on the relative position of
the private mortgage insurance industry versus government and quasi-governmental
competition as well as the competition from lending institutions that choose not
to insure against borrower default, self-insure through affiliates, or offer
residential mortgage products that do not require mortgage insurance.
The mortgage insurance industry is highly competitive. Several of the Company's
competitors in the mortgage insurance industry have greater direct or indirect
capital reserves that provide them with potentially greater flexibility than the
Company.
PMI also competes directly with federal and state governmental and quasi-
governmental agencies, principally the FHA and, to a lesser degree, the VA. In
addition, the captive reinsurance subsidiaries of national banks, savings
institutions, or bank holding companies could become significant competitors of
the Company in the future. Other mortgage lenders are also forming reinsurance
affiliates that compete with the Company. The Gramm-Leach-Bliley Act of 1999
could lead to additional significant competitors of the Company in the future.
In October 1999, the Federal Housing Finance Board ("FHF Board") adopted
resolutions which authorize each Federal Home Loan Bank ("FHLB") to offer
programs to fund or purchase single-family conforming mortgage loans originated
by participating member institutions under the single-family member mortgage
assets program and in July 2000 the FHF Board gave permanent authority to each
FHLB to purchase such loans from member institutions. Under the FHF Board's
rules, FHLBs and member institutions are also authorized to provide credit
enhancement for eligible loans. Any expansion of the FHLBs ability to issue
mortgage insurance or use alternatives to mortgage insurance could reduce the
demand for private mortgage insurance and harm 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 require the remaining 10% of the purchase price from a
borrower's funds ("80/10/10"). This 80/10/10 product, as well as similar
products, competes with mortgage insurance as an alternative for lenders selling
loans in the secondary mortgage market. If the 80/10/10 product or a similar
product becomes a widely accepted alternative to mortgage insurance, the
Company's financial condition and results of operations could suffer.
Legislation and regulatory changes affecting the FHA have affected demand for
private mortgage insurance. In particular, increases in the maximum loan amount
that the FHA can insure can reduce the demand for private mortgage insurance.
For example, management believes the decline in the MICA members' share of the
mortgage insurance business from 56.3% at December 31, 1998 to approximately
52.4% at December 31, 1999 resulted in part from an increase in the maximum
individual loan amount the FHA can insure. In January 2000, the maximum
individual loan amount that FHA can insure increased to $219,849 from $208,800.
This increase may cause demand for private mortgage insurance to decrease. In
addition, the Omnibus Spending Bill of 1999
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streamlined the FHA down-payment formula and made FHA insurance more competitive
with private mortgage insurance in areas with higher home prices.
FANNIE MAE AND FREDDIE MAC (IC3)
Fannie Mae and Freddie Mac are collectively referred to as government-sponsored
enterprises ("GSEs"). 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 GSEs automated underwriting services. Although management has
not seen any significant movement towards the reduced coverage programs offered
by the GSEs to date, if the reduction in required levels of mortgage insurance
becomes widely accepted by mortgage lenders and their customers, the reduction
could harm the Company's financial condition and results of operations. The GSEs
also have separately introduced new "tiered primary" products pursuant to which
the GSEs, upon receipt from lenders of loans with traditional borrower paid
mortgage insurance, restructure the mortgage insurance coverage with reduced
amounts of primary coverage and deeper pool coverage. Wide acceptance by
lenders of the GSEs' "tiered primary" products could reduce levels of primary
coverage traditionally provided by PMI and, therefore, could have a material
adverse affect upon the Company's financial condition and results of operations.
On April 13, 1999 the Office of Federal Housing Enterprise Oversight ("OFHEO")
announced proposed risk-based capital regulations, which could treat credit
enhancements issued by private mortgage insurance companies with claims-paying
ability ratings of AAA or higher more favorably than those issued by companies
with AA or lower ratings. The director of OFHEO has stated that the agency
expects to draft and publish in the Federal Register final regulations by the
end of the year 2000. Shifts in the GSEs' preference for private mortgage
insurance to other forms of credit enhancement, including a tiering of mortgage
insurers based on their credit rating, could harm the Company's financial
condition and results of operations.
Freddie Mac has made several announcements that it would pursue a permanent
charter amendment that would allow it to utilize alternative forms of default
loss protection 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 approaches, which may include a
reduction in the use of mortgage insurance.
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. A loss of PMI's existing eligibility
status, either due to a failure to maintain the minimum 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.
INSURANCE IN FORCE (IC4)
A significant percentage of PMI's premiums earned is generated from existing
insurance in force and not from new insurance written. The policy owner or
servicer of the loan may cancel insurance coverage at any time. A decline in
insurance in force as a result of a decrease in persistency due to policy
cancellations of older books of business could harm the Company's financial
condition and results of operations.
The Home Owners Protection Act of 1998 ("Act") provides for the automatic
termination or cancellation upon a borrower's request of private mortgage
insurance upon satisfaction of certain conditions. Management is uncertain of
the Act's impact on PMI's insurance in force, but believes any reduction in
premiums attributed to the Act's
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required cancellation of mortgage insurance will not have a significant impact
on the Company's financial condition and results of operations.
During a period of falling interest rates, an increasing number of borrowers
refinance their mortgage loans and PMI generally experiences 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 periods of low interest rate, the resulting
increase of NIW may ultimately prove to be inadequate to compensate for the loss
of insurance in force arising from policy cancellations.
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. On March 10, 2000, Standard & Poor's
affirmed the AA+ financial strength rating and claims-paying ability rating of
PMI. During June 1999, Moody's affirmed the Aa2 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. A reduction in PMI's claims-paying ratings
below AA- could seriously harm the Company's financial condition and results of
operations (See IC3).
LIQUIDITY (IC6)
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 level and severity of claims experienced by
the Company's insurance subsidiaries, 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 these factors could adversely affect the Company's ability
to maintain capital resources to meet its business needs.
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. The Company also
generally agrees to assume the cost of repurchasing underwritten-deficient loans
that have been contract underwritten, a remedy not available under the Company's
master primary insurance policies. Due to the demand of contract underwriting
services, limitations on the number of available underwriting personnel, 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 its underwriting services
obligations could harm 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
suffer if PMI or the Company experiences delays in introducing competitive new
products and programs or if these products or programs are less profitable than
the Company's existing products and programs.
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<PAGE>
INSURANCE REGULATORY MATTERS (IC8)
On January 31, 2000, the Illinois Department of Insurance issued a letter
addressed to all mortgage guaranty insurers licensed in Illinois. The letter
states that it may be a violation of Illinois law for mortgage insurers to offer
to Illinois mortgage lenders the opportunity to purchase certain notes issued by
a mortgage insurer or an affiliate, or to participate in loan guaranty programs.
The letter also states that a violation might occur if mortgage insurers offer
lenders coverage on pools of mortgage loans at a discounted or below market
premium in return for the lenders' referral of primary mortgage insurance
business. In addition, the letter stated that, to the extent a performance
guaranty actually transfers risk to the lender in return for a fee, the lender
may be deemed to be doing an insurance business in Illinois without
authorization. The letter announced that any mortgage guaranty insurer that is
participating in the described or similar programs in the State of Illinois
should cease such participation or alternatively, provide the Department with a
description of any similar programs, giving the reason why the provisions of
Illinois are not applicable or not violated. If the Illinois Department of
Insurance were to determine that PMI was not in compliance with Illinois law,
the Company's financial condition and results of operations could be harmed.
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, the Company's financial
condition and results of operations could suffer.
RISK-TO-CAPITAL RATIO (IC9)
The State of Arizona, PMI's state of domicile for insurance regulatory purposes,
and other regulators 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.
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 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 harm 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 LTV's in excess of 90% and less than or equal to 95% ("95s"). At June 30,
2000, 46.5% 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 LTV's
equal to or less than 90% and over 85% ("90s"). PMI also offers coverage for
mortgages with LTV's in excess of 95% and up to 97% ("97s"). At June 30, 2000,
5.3% of PMI's risk in force consisted of 97s that have even higher risk
characteristics than 95s and greater uncertainty as to pricing adequacy. In June
2000, PMI introduced expanded coverage for certain mortgages with LTV's in
excess of 97%. This expanded coverage has commensurately higher risk
characteristics and pricing uncertainty. PMI's NIW also includes adjustable
rate mortgages ("ARMs"),
21
<PAGE>
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,
which is generally used as an additional credit enhancement for certain
secondary market mortgage transactions. New pool risk written was $24 million
for the quarter ended June 30, 2000. This new pool insurance product provides
coverage to certain loans with non-conforming, and therefore higher risk,
characteristics. 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 these products, and the associated investment
income, may ultimately prove to be inadequate to compensate for future losses
from these products.
POTENTIAL INCREASE IN CLAIMS (IC11)
Mortgage insurance coverage and premiums 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.
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 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 RISKS (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 15.1%, 7.6% and 7.2% of its risk in force concentrated and where the default
rate on all PMI policies in force is 2.21%, 2.49% and 1.77% compared with 1.89%
nationwide as of June 30, 2000.
CAPTIVE REINSURANCE ARRANGEMENTS; RISK-SHARING TRANSACTIONS (IC14)
PMI's customers have indicated an increasing demand for captive reinsurance
arrangements, which 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
management expects that this trend will continue. An increase in captive
reinsurance arrangements would decrease in net premiums written which may
negatively impact the yield obtained in the Company's net premiums earned for
customers with captive reinsurance arrangements. 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 harm PMI's competitive position.
22
<PAGE>
GRAMM-LEACH-BLILEY ACT (IC15)
On November 12, 1999, the President signed the Gramm-Leach-Bliley Act of 1999
(the "Act") into law. Among other things, the Act allows bank holding companies
to engage in a substantially broader range of activities, including insurance
underwriting, and allows insurers and other financial service companies to
acquire banks. The Act allows a bank holding company to form an insurance
subsidiary, licensed under state insurance law, to issue insurance products
directly, including mortgage insurance. The Company expects that, over time,
the Act will allow consumers the ability to shop for their insurance, banking
and investment needs at one financial services company. The Company believes
that the Act may lead to increased competition in the mortgage insurance
industry by facilitating the development of new savings and investment products,
resulting in the Company's customers offering mortgage insurance directly rather
than through captive reinsurance arrangements with the Company's insurance
subsidiaries and encouraging large, well-capitalized financial service companies
to enter the mortgage insurance business.
INTERNATIONAL MORTGAGE INSURANCE; STRATEGIC INVESTMENTS (IC16)
As the Company seeks to expand its business internationally, it increasingly
will be subject to risks associated with international operations, including:
the need for regulatory and third party approvals; challenges retaining key
foreign-based employees and key relationships with customers and business
partners in international markets; the economic strength of the foreign mortgage
origination markets targeted; changes in foreign regulations and laws; foreign
currency exchange; potential increases in the level of defaults and claims on
policies insured by foreign-based subsidiaries; and the need to integrate PMI's
risk management technology systems and products with those of its foreign
operations. In particular, the performance of the Company's Australian
subsidiary could be materially and adversely affected by various factors
affecting the Australian economy including, but not limited to, a weakening in
the demand for housing, interest rate volatility, and/or an increase in claims.
The performance of the Company's other strategic investments could materially
and adversely be affected by changes in the real estate, mortgage lending,
mortgage servicing, title and financial guaranty markets; future movements in
interest rates; those operations' future financial condition and performance;
the ability of those entities to execute future business plans; and PMI's
dependence upon management to operate those companies in which PMI does not own
a controlling share.
23
<PAGE>
THE PMI GROUP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
June 30, 2000
Item 1 - Legal Proceedings
On December 17, 1999, G. Craig Baynham and Linnie Baynham (collectively, the
"Plaintiffs") filed a putative RESPA class action lawsuit against PMI Mortgage
Insurance Co., the Company's mortgage insurance subsidiary. (For details
relating to this action, see the Company's Form 8-K filed June 5, 2000.)
On May 15, 2000, Plaintiffs filed a motion for leave to file a Second Amended
Complaint, naming Jerry M. Tucker and Ann Helms as additional plaintiffs, and
including additional allegations in support of their contention that RESPA's one
year stature of limitations should be equitably tolled as to claims of putative
class member who paid mortgage insurance premiums on or after December 17, 1996.
The court granted Plaintiffs' motion for leave to file a Second Amended
Complaint and Plaintiffs served the Second Amended Complaint on PMI on June 9,
2000.
The Company continues to contest this action vigorously. Based upon the
information presently available to the Company, management believes that this
matter will not have a material adverse effect on the Company's financial
position of results of operations. However, the outcome of litigation is
inherently uncertain and accordingly there can be no assurance that the ultimate
outcome of this matter will not have a material adverse effect on the Company's
financial position of results of operations.
Item 4 - Submission of Matters to a Vote of Securities Holders
At the Company's Annual Meeting of Stockholders held on May 18, 2000, the
following individuals were elected to the Board of Directors:
1. Election of Directors
<TABLE>
<CAPTION>
Votes For Votes Withheld
---------- --------------
<S> <C> <C>
Dr. James C. Castle 40,241,537 42,514
Donald C. Clark 40,241,549 42,502
W. Roger Haughton 40,241,015 43,036
Wayne E. Hedien 40,241,549 42,502
Raymond L. Ocampo Jr. 40,237,049 47,002
John D. Roach 40,240,399 43,652
Dr. Kenneth T. Rosen 40,241,549 42,502
Richard L. Thomas 40,241,534 42,517
Mary Lee Widener 40,240,926 43,125
Ronald H. Zech 40,241,549 42,502
</TABLE>
24
<PAGE>
The following proposals were approved at the Company's Annual Meeting
Votes for Votes against Votes Withheld
---------- ------------- --------------
2. Appointment of Ernst & Young LLP
as Independent auditors of the
Company for 2000. 40,280,073 1,682 2,296
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:
(i) On May 2, 2000 the Company filed a report on Form 8-K to amend
the "Cautionary Statement" contained in the April 26, 2000
press release relating to projected operating earnings for the
year 2001.
(ii) On June 5, 2000 the Company filed a report on Form 8-K
relating to a putative RESPA class action lawsuit filed against
PMI Mortgage Insurance Co. by G. Craig Baynham and Linnie
Baynham on December 17, 1999.
25
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, on August 11, 2000.
The PMI Group, Inc.
/s/ John M. Lorenzen, Jr.
------------------------------
John M. Lorenzen, Jr.
Executive Vice President and
Chief Financial Officer
/s/ Brian P. Shea
------------------------------
Brian P. Shea
Vice President and Controller,
Chief Accounting Officer
26
<PAGE>
INDEX TO EXHIBITS
(Part II, Item 6)
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
------- ----------------------
<S> <C>
10.2* Amendment No. 1 to The PMI Group, Inc. Equity Incentive Plan. (Restated as of August 16, 1999)
10.3* Amendment No. 1 to The PMI Group, Inc. Stock Plan for Non-Employee Directors.
(Restated as of August 16, 1999)
11.1 Computation of Net Income Per Share
27.1 Financial Data Schedule
</TABLE>
-------------
* Compensatory or benefit plan in which certain executive officers or Directors
of the PMI Group, Inc. or its subsidiaries are eligible to participate.
