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, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period
from................................to.........................
Commission file number 1-13664
THE PMI GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3199675
(State of Incorporation) (IRS Employer Identification No.)
601 MONTGOMERY STREET,
SAN FRANCISCO, CALIFORNIA 94111
(Address of principal executive offices) (Zip Code)
(415) 788-7878
(Registrant's telephone number including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS OF STOCK PAR VALUE DATE NUMBER OF SHARES
- -------------- --------- ---- ----------------
Common Stock $0.01 7/31/98 31,290,045
THE PMI GROUP, INC.
Index to Quarterly Report on Form 10-Q
JUNE 30, 1998
PART I - FINANCIAL INFORMATION PAGE
----
Item 1. Interim Consolidated Financial Statements and Notes.
Consolidated Statements of Operations for the
Three Months and Six Months Ended June 30,
1998 and 1997............................................ 3
Consolidated Balance Sheets as of June 30,
1998 and December 31, 1997................................ 4
Consolidated Statements of Cash Flows for the Six
Months Ended June 30, 1998 and 1997....................... 5
Notes to Consolidated Financial Statements................. 6-7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................ 8-21
Item 3. Quantitative and Qualitative Disclosures About
Market Risk................................................ 21
PART II - OTHER INFORMATION
Item 1. Legal Proceedings........................................... 22
Item 4. Submission of Matters to a Vote of Security Holders......... 22
Item 5. Other Information........................................... 22
Item 6. Exhibits and Reports on Form 8-K............................ 23
SIGNATURES............................................................ 24
INDEX TO EXHIBITS..................................................... 25
2
PART I - FINANCIAL INFORMATION
ITEM 1. INTERIM FINANCIAL STATEMENTS
THE PMI GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- ---------------------
(In thousands except for per share amounts) 1998 1997 1998 1997
------ ------ ------ ------
REVENUES
Premiums earned $118,327 $109,906 $235,173 $217,997
Investment income, less investment expense 21,139 20,752 42,716 40,747
Realized capital gains, net 2,226 546 10,191 18,814
Other income 5,777 1,705 10,023 2,897
-------- -------- -------- --------
TOTAL REVENUES 147,469 132,909 298,103 280,455
-------- -------- -------- --------
LOSSES AND EXPENSES
Losses and loss adjustment expenses 30,588 34,235 68,675 73,750
Underwriting and other expenses 48,319 35,959 92,496 70,374
Interest expense 1,797 1,687 3,503 3,375
Distributions on redeemable preferred capital
securities 2,078 2,079 4,157 3,464
TOTAL LOSSES AND EXPENSES -------- -------- -------- --------
82,782 73,960 168,831 150,963
-------- -------- -------- --------
INCOME BEFORE INCOME TAXES 64,687 58,949 129,272 129,492
INCOME TAX EXPENSE 17,900 16,670 36,717 38,041
-------- -------- -------- --------
NET INCOME $ 46,787 $ 42,279 $ 92,555 $ 91,451
======== ======== ======== ========
BASIC NET INCOME PER SHARE $ 1.47 $ 1.26 $ 2.88 $ 2.70
======== ======== ======== ========
DILUTED NET INCOME PER SHARE $ 1.46 $ 1.25 $ 2.86 $ 2.69
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
3
THE PMI GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31,
(Dollars in thousands) 1998 1997
----------------- -----------------
ASSETS
Investments
Available for sale, at market
Fixed income securities
(amortized cost $1,239,164 and $1,234,178) $1,316,078 $1,308,768
Equity securities
Common stock (cost $49,722 and $38,221) 86,273 73,596
Preferred stock (cost $22,235 and $12,049) 22,320 12,360
Common stock of affiliates, at underlying book value 43,080 16,987
Short-term investments (at cost, which approximates market) 29,056 78,890
---------- ----------
TOTAL INVESTMENTS 1,496,807 1,490,601
Cash 8,862 11,101
Accrued investment income 19,900 20,794
Reinsurance recoverable and prepaid premiums 35,021 31,676
Premiums receivable 21,105 19,756
Receivable from affiliates 5,966 8,605
Receivable from Allstate 21,600 16,822
Deferred policy acquisition costs 47,966 37,864
Property and equipment, net 34,161 31,393
Other assets 14,443 17,991
---------- ----------
TOTAL ASSETS $1,705,831 $1,686,603
========== ==========
LIABILITIES
Reserve for losses and loss adjustment expenses $ 201,726 $ 202,387
Unearned premiums 81,071 94,150
Long-term debt 99,442 99,409
Reinsurance balances payable 13,432 11,828
Deferred income taxes 80,427 76,395
Other liabilities and accrued expenses 58,485 42,248
---------- ----------
TOTAL LIABILITIES 534,583 526,417
---------- ----------
COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED CAPITAL
SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY JUNIOR
SUBORDINATED DEFERRABLE INTEREST DEBENTURE OF THE COMPANY 99,023 99,006
SHAREHOLDERS' EQUITY
Preferred stock -- $.01 par value; 5,000,000 shares authorized - -
Common stock -- $.01 par value; 125,000,000 shares
authorized; 35,194,275 and 35,145,247 issued 352 351
Additional paid-in capital 264,324 262,448
Unrealized net gains on investments 74,078 71,936
Retained earnings 965,941 876,588
Treasury stock (3,751,600 and 2,684,000 shares at cost) (232,470) (150,143)
---------- ----------
TOTAL SHAREHOLDERS' EQUITY 1,072,225 1,061,180
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,705,831 $1,686,603
========== ==========
See accompanying notes to consolidated financial statements.
4
THE PMI GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS
ENDED JUNE 30,
------------------------------------
(In thousands) 1998 1997
---------------- ------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 92,555 $ 91,451
Adjustments to reconcile net income to net cash
provided by operating activities:
Realized capital gains, net (10,191) (18,814)
Equity in earnings of affiliates (1,119) (659)
Depreciation and amortization 3,093 2,052
Changes in:
Reserve for losses and loss adjustment expenses (661) (1,485)
Unearned premiums (13,079) (17,261)
Deferred policy acquisition costs (10,102) (2,156)
Accrued investment income 894 (1,169)
Reinsurance balances payable 1,604 (3,219)
Reinsurance recoverable and prepaid premiums (3,345) 59,940
Premiums receivable (1,349) (1,842)
Income taxes 2,879 1,653
Receivable from affiliates 2,639 196
Receivable from Allstate (4,778) --
Other 19,803 (7,314)
-------- ---------
Net cash provided by operating activities 78,843 101,373
-------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of equity securities 25,688 74,665
Investment collections of fixed income securities 17,672 7,500
Proceeds from sales of fixed income securities 58,538 232,113
Investment purchases
Fixed income securities (81,096) (376,785)
Equity securities (37,333) (22,136)
Net (increase) decrease in short-term investments 49,834 (47,828)
Investment in affiliates (24,953) (2,700)
Purchase of property and equipment (5,736) (5,576)
-------- ---------
Net cash provided by (used in) investing activities 2,614 (140,747)
-------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of redeemable preferred capital securities -- 99,000
Proceeds from exercise of stock options 1,875 2,078
Dividends paid to shareholders (3,244) (3,398)
Purchase of The PMI Group, Inc. common stock (82,327) (59,908)
-------- ---------
Net cash provided by (used in) financing activities (83,696) 37,772
-------- ---------
NET DECREASE IN CASH (2,239) (1,602)
CASH AT BEGINNING OF PERIOD 11,101 6,592
-------- ---------
CASH AT END OF PERIOD $ 8,862 $ 4,990
======== =========
See accompanying notes to consolidated financial statements.
5
THE PMI GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include the
accounts of The PMI Group, Inc. ("TPG"), its wholly-owned subsidiaries, PMI
Mortgage Insurance Co. ("PMI"), Residential Guaranty Co., American Pioneer Title
Insurance Company ("APTIC"), PMI Mortgage Guaranty Co., Residential Reinsurance
Co., PMI Capital I and TPG Financial Insurance, and PMI's wholly-owned
subsidiaries, PMI Mortgage Services Co. ("MSC") and PMI Securities Co.,
collectively referred to as the "Company." All material intercompany
transactions and balances have been eliminated in consolidation. In addition,
PMI owns 45% of CMG Mortgage Insurance Company ("CMG") and TPG owns 22.3% of RAM
Holdings Ltd. and RAM Holdings II Ltd. (collectively referred to as "RAM Re").
These companies 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 for interim financial
information and with the requirements of Form 10-Q. In the opinion of
management, all adjustments (consisting only of normal recurring adjustments)
considered necessary for a fair presentation of the Company's consolidated
financial condition at June 30, 1998, and its consolidated statements of
operations and cash flows for the periods ended June 30, 1998 and 1997, have
been included. Interim results for the periods ended June 30, 1998 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1998. The financial statements should be read in conjunction with
the audited consolidated financial statements and footnotes included in The PMI
Group, Inc. 1997 Annual Report to Shareholders.
NOTE 2 - EARNINGS PER SHARE
The weighted average common shares outstanding for computing basic earnings per
share ("EPS") were 31,918,220 for the three months ended June 30, 1998,
33,617,783 for the three months ended June 30, 1997, 32,173,226 for the six
months ended June 30, 1998, and 33,919,981 for the six months ended June 30,
1997. 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 32,119,224 for the three months ended June 30, 1998, 33,715,966
for the three months ended June 30, 1997, 32,361,101 for the six months ended
June 30, 1998, and 34,026,349 for the six months ended June 30, 1997. Net
income available to common shareholders does not change for computing diluted
EPS.
NOTE 3 - COMPREHENSIVE INCOME
In 1998, the Company adopted Financial Accounting Standards Board ("FASB")
Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting
Comprehensive Income. SFAS No. 130 requires that an enterprise report, by major
component and as a single total, the change in its net assets during the period
from non-owner sources.
The reconciliation of net income to comprehensive income for the three months
and six months ended June 30, 1998 and June 30, 1997 are as follows:
6
Three Months Six Months
ended June 30 ended June 30
---------------------- ----------------------
1998 1997 1998 1997
------ ------- -------- --------
(In thousands)
COMPREHENSIVE INCOME
Net Income $46,787 $42,279 $ 92,555 $ 91,451
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gains arising during period 3,213 22,147 8,766 9,754
Less: reclassification adjustment for gains
included in net income (1,447) (355) (6,624) (12,229)
------- ------- -------- --------
Other comprehensive income (loss), net of tax 1,766 21,792 2,142 (2,475)
------- ------- -------- --------
COMPREHENSIVE INCOME $48,553 $64,071 $ 94,697 $ 88,976
======= ======= ======== ========
NOTE 4 - NEW ACCOUNTING PRONOUNCEMENT
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. SFAS No. 131 establishes annual and interim
reporting standards for an enterprise's operating segments and related
disclosures about its products, services, geographic areas and major customers.
Adoption of SFAS No. 131 will not impact the Company's financial condition,
results of operations or cash flows, and any effect will be limited to the form
and content of its disclosures. The statement is effective for 1998 and is
not required for interim financial statements in the initial year of
application.
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF CONSOLIDATED OPERATIONS
THREE MONTHS ENDED JUNE 30, 1998 AND 1997
Consolidated net income in the three months ended June 30, 1998 was $46.8
million, a 10.6% increase over net income of $42.3 million in the corresponding
period of 1997. The increase was primarily due to increases in premiums earned,
other income, and realized capital gains of $8.4 million, $4.1 million, and $1.7
million respectively, and secondarily to a decrease in losses and loss
adjustment expenses of $3.6 million, partially offset by an increase in
underwriting and other expenses of $12.4 million. Diluted earnings per share
were $1.46 in the three months ended June 30, 1998, compared with $1.25 in the
corresponding period of 1997, a 16.8% increase. Excluding capital gains, diluted
earnings per share were $1.41 in the second quarter of 1998 compared with $1.24
in the second quarter of 1997, a 13.7% increase. Revenues in the second quarter
of 1998 were $147.5 million, an 11.0% increase over revenues of $132.9 million
in the second quarter of 1997.
MORTGAGE INSURANCE OPERATIONS
PMI's new insurance written ("NIW") totaled $6.9 billion in the second quarter
of 1998, compared with $3.6 billion in the second quarter of 1997, a 91.7%
increase. The increase in NIW resulted primarily from the number of new mortgage
insurance policies issued increasing to 52,900 policies in the three months
ended June 30, 1998 from 28,400 policies in the corresponding period of 1997, an
86.3% increase, and secondarily from an increase in the average loan size to
$130,800 from $127,200.
The primary factor contributing to the increase in new policies issued was the
growth in the volume of insured loans in the private mortgage insurance industry
in the second quarter of 1998 compared with the corresponding period of 1997.
The private mortgage insurance industry experienced an increase in total new
insurance written of 61.7% to $46.4 billion in the second quarter of 1998 from
$28.7 billion in the corresponding period of 1997. The increase was caused
primarily by the continued high levels of refinancing activity brought on by
lower interest rates, and secondarily to a strong home purchase market.
Refinancing as a percentage of PMI's NIW increased to 31.5% in the three months
ended June 30, 1998 from 10.5% in the corresponding period of 1997.
A secondary factor contributing to the increase in new policies issued was the
growth in PMI's market share in the second quarter of 1998. PMI's market share
of NIW increased to 14.9% in the three months ended June 30, 1998 from 12.6% in
the corresponding period of 1997. On a combined basis with CMG, market share
increased to 16.3% in the second quarter of 1998 compared with 13.7% in the
corresponding period of 1997. The increase in market share was primarily due to
the expansion of value-added products and services, primarily contract
underwriting, offered to mortgage lenders and the offering of a government
sponsored enterprises ("GSE") pool insurance product to selected lenders and
entities sponsoring affordable housing initiatives during the fourth quarter of
1997 and the first half of 1998. New pool risk written was $38 million in the
second quarter of 1998 compared with $14 million in the first quarter of 1998.
Risk in force under risk-share programs with mortgage lenders represented less
than one percent of total risk in force at June 30, 1998. Management expects new
pool risk written and the percent of risk share programs to increase in the
second half of 1998. See Cautionary Statement and Factors That May Affect Future
Results and Market Price of Stock - Changes in Composition of Insurance Risk
Written; Pool Insurance.
PMI's cancellations of insurance in force were $6.7 billion in the second
quarter of 1998 compared to $3.8 billion in the corresponding period of 1997.
The increase in policy cancellations is primarily due to mortgage
8
prepayments as a result of the continued high levels of refinancing activity
experienced by PMI as discussed above. As a result of the higher cancellation
activity, PMI's persistency rate decreased to 73.9% as of June 30, 1998 compared
with 77.6% as of March 31, 1998, 80.8% as of December 31, 1997, and 83.9% as of
June 30, 1997.
The drop in persistency resulted in a decrease in insurance in force to $77.6
billion at June 30, 1998 compared with $77.8 billion at December 31, 1997.
However, insurance in force increased by $0.2 billion compared with $77.4
billion at March 31, 1998. On a combined basis with CMG, insurance in force
grew to $80.9 billion at June 30, 1998 compared with $80.1 billion at March 31,
1998, and $80.2 billion at December 31, 1997.
As a result of the cancellations of older, lower coverage policies (with lower
premium rates) being replaced by higher coverage loans (with higher premium
rates), risk in force has been experiencing faster growth rates than insurance
in force. Risk in force grew by $0.2 billion to $18.3 billion at June 30, 1998
compared with $18.1 billion at March 31, 1998 and December 31, 1997, and grew by
$0.6 billion compared with $17.7 billion at June 30, 1997. On a combined basis
with CMG, risk in force was $19.1 billion at June 30, 1998 compared with $18.8
billion at March 31, 1998, and $18.7 billion at December 31, 1997.
Mortgage insurance net premiums written were $99.4 million in the second quarter
of 1998 compared with $92.1 million in the corresponding period of 1997, an
increase of 7.9%. The increase is attributable to the growth of risk in force
and higher average premium rates. The increase in premium rates is caused by
two factors: higher coverage percentages, and the continuing shift of PMI's
policies in force to the monthly product with a higher premium rate.
PMI's monthly product represented 64.7% of risk in force at June 30, 1998
compared with 52.3% at June 30, 1997. Mortgages with original loan-to-value
ratios greater than 90% and equal to or less than 95% ("95s") with 30% insurance
coverage increased to 31.6% of risk in force as of June 30, 1998 from 25.2% as
of June 30, 1997. Similarly, mortgages with original loan-to-value ratios
greater than 85% and equal to or less than 90% ("90s") with 25% insurance
coverage increased to 26.4% of risk in force as of June 30, 1998 compared with
21.6% as of June 30, 1997.
Mortgage insurance premiums earned increased 4.6% to $100.7 million in the
second quarter of 1998 from $96.3 million in the second quarter of 1997. The
increase is attributable to the increase in premiums written, offset by
increases in refunded and ceded premiums. Refunded premiums increased to $6.1
million in the second quarter of 1998 from $3.8 million in the second quarter of
1997, due primarily to the increase in policy cancellations as discussed above.
Ceded premiums increased to $4.5 million in the second quarter of 1998 from $4.1
million in the second quarter of 1997 due to the continued expansion of
reinsurance arrangements under risk-share programs with affiliates of customers.
Mortgage insurance losses and loss adjustment expenses decreased to $30.7
million in the second quarter of 1998 from $33.9 million in the second quarter
of 1997, a decrease of 9.4%. This decrease was due primarily to the continuing
improvement of the California housing markets and the corresponding decrease in
the number of loans in default and claim payments. Loans in default decreased
to 14,965 loans at June 30, 1998 from 15,368 loans at June 30, 1997. Direct
primary claims paid by PMI decreased to $34.4 million in the second quarter of
1998 from $35.6 million in the second quarter of 1997 due to a decrease in the
average claim size in the second quarter of 1998 compared to the corresponding
period of 1997, partially offset by an increase in the number of claims filed.
The improved claim results are due primarily to a smaller percentage of claims
originating from the California book of business, and also to increased loss
mitigation efforts by PMI.
9
PMI's default rate has decreased to 2.16% at June 30, 1998 from the June 30,
1997 rate of 2.20%. This decrease was due primarily to the continuing
improvement in the California real estate market. Management believes that
PMI's total default rate could increase in 1998 due to the continued maturation
of its 1994 and 1995 books of business. See Cautionary Statement and Factors
That May Affect Future Results and Market Price of Stock - Regional
Concentration.
Default rates on PMI's California policies continue to improve, decreasing to
3.20% (representing 3,252 loans in default) at June 30, 1998, from 3.65%
(representing 4,041 loans in default) at June 30, 1997. Policies written in
California accounted for approximately 49.1% and 65.5% of the total dollar
amount of claims paid in the second quarters of 1998 and 1997, respectively.
Although management expects that California should 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
Cautionary Statement and Factors That May Affect Future Results and Market Price
of Stock - Loss Reserves and Regional Concentration.
Mortgage insurance underwriting and other expenses increased 27.1% to $26.3
million in the second quarter of 1998 from $20.7 million in the second quarter
of 1997. This increase was primarily attributable to the growth in mortgage
origination volume which caused increases in policy acquisition costs, including
contract underwriting expenses. New policies processed by contract underwriters
represented 33.6% of PMI's NIW in the second quarter of 1998 compared with 18.2%
in the corresponding period of 1997. Contract underwriting is more expensive on
a per application basis than underwriting a mortgage insurance application in
PMI's field offices, and has become 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 and
that customer demand for contract underwriting services will increase. In
addition, management anticipates that the rate of growth of policy acquisition
costs will exceed the growth rate of premiums, if any, for the remainder of the
year. See Cautionary Statement and Factors That May Affect Future Results and
Market Price of Stock - Contract Underwriting Services; New Products.
The mortgage insurance loss ratio improved to 30.4% in the second quarter of
1998 compared to 35.2% in the second quarter of 1997 due primarily to the growth
in premiums earned coupled with the decrease in losses and loss adjustment
expenses. The expense ratio increased to 26.4% in the second quarter of 1998
from 22.5% in the second quarter of 1997 due primarily to the increase in policy
acquisition costs resulting from the growth in NIW. The combined ratio decreased
to 56.8% in the second quarter of 1998 from 57.7% in the second quarter of 1997.
TITLE INSURANCE OPERATIONS
Title insurance premiums earned increased 29.4% to $17.6 million in the second
quarter of 1998 compared with $13.6 million in the second quarter of 1997. This
increase was primarily attributable to the continuing growth in residential
mortgage originations resulting from the continued high levels of refinancing
activity and a strong new home purchase market in the states where APTIC
operates. Underwriting and other expenses increased 28.9% to $15.6 million in
the second quarter of 1998 compared to $12.1 million in the second quarter of
1997. This increase is directly attributable to an increase in agency fees and
commissions related to the increase in premiums earned. The title insurance
combined ratio decreased to 88.3% in the second quarter of 1998 from 91.9% in
the second quarter of 1997.
OTHER
The Company's net investment income increased by 1.4% to $21.1 million in the
second quarter of 1998 from $20.8 million in the second quarter of 1997. The
increase was primarily attributable to the growth in the average amount of
invested assets, partially offset by a slight decrease in the average investment
yield (pretax) to 6.1% in
10
the second quarter of 1998 from 6.2% in the second quarter of 1997. Realized
capital gains (net of losses) increased to $2.2 million in the second quarter of
1998 from $0.5 million in the second quarter of 1997.
Other income, primarily contract underwriting revenues generated by MSC,
increased to $5.8 million in the second quarter of 1998 from $1.7 million in the
second quarter of 1997. Other expenses, primarily expenses incurred by MSC,
increased to $6.4 million in the second quarter of 1998 compared with $3.1
million in the second quarter of 1997. These increases are primarily due to
increased contract underwriting services provided to the Company's mortgage
insurance customers, and secondarily to other ancillary services. See
discussions above and Cautionary Statement and Factors That May Affect Future
Results and Market Price of Stock - Contract Underwriting Services; New
Products.
The Company's effective tax rate decreased to 27.7% in the second quarter of
1998 compared to 28.3% in the second quarter of 1997. The year over year
decrease in the effective rate was caused primarily by an increase in the
percentage of tax exempt income included in income before taxes during the
second quarter of 1998, offset by the increase in realized capital gains.
SIX MONTHS ENDED JUNE 30, 1998 AND 1997
Consolidated net income in the six months ended June 30, 1998 was $92.6 million,
a 1.2% increase over net income of $91.5 million in the corresponding period of
1997. The increase was primarily due to increases in premiums earned of $17.2
million and other income of $7.1 million, to a decrease in losses and loss
adjustment expenses of $5.1 million, offset by an increase in underwriting and
other expenses of $22.1 million and a decrease in realized capital gains of $8.6
million. Diluted earnings per share were $2.86 in the six months ended June 30,
1998, compared with $2.69 in the corresponding period of 1997, a 6.3% increase.
Excluding capital gains, diluted earnings per share were $2.66 in the six months
ended June 30, 1998 compared with $2.33 in the six months ended June 30, 1997, a
14.2% increase. Revenues in the six months ended June 30, 1998 were $298.1
million compared with $280.5 million in the corresponding period of 1997, a 6.3%
increase.
MORTGAGE INSURANCE OPERATIONS
PMI's new insurance written ("NIW") totaled $11.7 billion in the six months
ended June 30, 1998 compared with $6.7 billion in the six months ended June 30,
1997, a 74.6% increase. The increase in NIW resulted primarily from the number
of new mortgage insurance policies issued increasing to 89,550 policies in the
six months ended June 30, 1998 from 52,550 policies in the corresponding period
of 1997, a 70.4% increase, and secondarily from an increase in the average loan
size to $131,100 from $127,200.
The primary factor contributing to the increase in new policies issued was the
growth in the volume of insured loans in the private mortgage insurance industry
in the six months ended June 30, 1998 compared with the corresponding period of
1997. The private mortgage insurance industry experienced an increase in total
new insurance written of 51.0% to $81.4 billion in the six months ended June 30,
1998 from $53.9 billion in the corresponding period of 1997. The secondary
factor contributing to the increase in new policies issued was the growth in
PMI's market share in the second quarter of 1998. PMI's market share of NIW
increased to 14.4% in the six months ended June 30, 1998 from 12.4% in the
corresponding period of 1997. On a combined basis with CMG, market share
increased to 15.8% in the six months ended June 30, 1998 compared with 13.4% in
the corresponding period of 1997. These increases in market share were
primarily due to the expansion of value-added products and services, primarily
contract underwriting, offered to mortgage lenders, and the offering of a GSE
pool insurance product to selected lenders and entities sponsoring affordable
housing initiatives during the fourth quarter of 1997 and the first half of
1998. New pool risk written was $52 million in the six months ended June 30,
1998.
11
Mortgage insurance net premiums written were $188.4 million in the six months
ended June 30, 1998 compared with $175.5 million in the corresponding period of
1997, an increase of 7.4%. The increase is attributable to the growth of risk in
force and to higher average premium rates. The increase in premium rates is
attributable to higher coverage percentages, and the continuing shift of PMI's
policies in force to the monthly product with a higher premium rate as discussed
under the results of consolidated operations for the second quarter.
Mortgage insurance premiums earned increased 4.6% to $200.8 million in the six
months ended June 30, 1998 from $192.0 million in the corresponding period of
1997. The increase is attributable to the increase in premiums written, offset
by increases in refunded and ceded premiums. Refunded premiums increased to
$11.2 million in the six months ended June 30, 1998 from $7.0 million in the
corresponding period of 1997, due primarily to the increase in mortgage
refinancing volume in the first half of 1998. Ceded premiums increased to $9.3
million in the six months ended June 30, 1998 from $7.2 million in the six
months ended June 30, 1997 due to the continued expansion of reinsurance
arrangements under risk-share programs with affiliates of customers.
Mortgage insurance losses and loss adjustment expenses decreased to $68.5
million in the six months ended June 30, 1998 from $73.1 million in the six
months ended June 30, 1997, a decrease of 6.3%. This decrease was due primarily
to the continuing improvement of the California housing markets and the
corresponding decrease in the inventory of loans in default and claim payments.
Direct primary claims paid by PMI decreased to $67.3 million in the six months
ended June 30, 1998 from $72.8 million in the corresponding period of 1997, a
7.6% decrease. Policies written in California accounted for approximately 52.2%
and 68.4% of the total dollar amount of claims paid in the six months ended June
30, 1998 and 1997, respectively.
Mortgage insurance underwriting and other expenses increased 23.0% to $50.2
million in the six months ended June 30, 1998 from $40.8 million in the six
months ended June 30, 1997. This increase was primarily attributable to the
growth in mortgage origination volume which caused increases in policy
acquisition costs, including contract underwriting expenses, as discussed
under the results of consolidated operations for the second quarter. New
policies processed by contract underwriters represented 32.1% of PMI's NIW in
the six months ended June 30, 1998 compared with 17.3% in the corresponding
period of 1997.
The mortgage insurance loss ratio improved to 34.1% in the six months ended June
30, 1998 compared to 38.1% in the corresponding period of 1997, due primarily to
the growth in premiums earned coupled with the decrease in losses and loss
adjustment expenses. The expense ratio increased to 26.7% in the six months
ended June 30, 1998 from 23.2% in the six months ended June 30, 1997, due
primarily to the increase in policy acquisition costs from the growth in NIW.
The combined ratio decreased to 60.8% in the six months ended June 30, 1998 from
61.3% in the six months ended June 30, 1997.
TITLE INSURANCE OPERATIONS
Title insurance premiums earned increased 32.3% to $34.4 million in the six
months ended June 30, 1998 compared with $26.0 million in the six months ended
June 30, 1997. This increase was primarily attributable to the continuing
growth in residential mortgage originations resulting from the continued high
levels of refinancing activity and a strong new home purchase market in the
states where APTIC operates. Underwriting and other expenses increased 29.8% to
$30.5 million in the six months ended June 30, 1998 compared to $23.5 million in
the six months ended June 30, 1997. This increase is directly attributable to
the increase in agency fees and commissions paid related to the increase in
premiums earned. The title insurance combined ratio decreased to 89.3% in the
six months ended June 30, 1998 from 93.1% in the six months ended June 30, 1997.
12
OTHER
The Company's net investment income in the six months ended June 30, 1998 was
$42.7 million compared with $40.7 million in the six months ended June 30, 1997,
an increase of 4.9%. The increase was primarily attributable to the growth in
the average amount of invested assets. The Company's average investment yield
(pretax) was 6.1% in the six months ended June 30, 1998 and 1997. Realized
capital gains (net of losses) decreased to $10.2 million in the six months ended
June 30, 1998 from $18.8 million in the six months ended June 30, 1997.
Other income, primarily revenues generated by MSC, increased to $10.0 million in
the six months ended June 30, 1998 from $2.9 million in the six months ended
June 30, 1997. Other expenses, primarily expenses incurred by MSC, increased to
$11.8 million in the six months ended June 30, 1998 compared with $6.1 million
in the corresponding period of 1997. These increases are primarily due to
increased contract underwriting services provided to the Company's mortgage
insurance customers and secondarily to other ancillary services. See
discussions above and Cautionary Statement and Factors That May Affect Future
Results and Market Price of Stock - Contract Underwriting Services; New
Products.
The Company's effective tax rate decreased to 28.4% in the six months ended June
30, 1998, compared to 29.4% in the six months ended June 30, 1997. The year
over year decrease in the effective rate was caused primarily by an increase in
the percentage of tax exempt income included in income before taxes during the
first half of 1998, and secondarily by the decrease in realized capital gains.
LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION
Liquidity and capital resource considerations are different for TPG and PMI, its
principal insurance operating subsidiary, as discussed below.
TPG's principal sources of funds are dividends from PMI and APTIC, investment
income and funds that may be raised from time to time in the capital markets.
During the first quarter of 1998, APTIC declared and paid a cash dividend of
$3.2 million to TPG, substantially the full amount of a dividend that can be
paid by APTIC in 1998 without prior permission from the Florida Department of
Insurance. On March 24, 1998, the Arizona Department of Insurance authorized
PMI to declare and pay an extraordinary dividend of $50 million to TPG, which
was paid in cash on April 3, 1998. In addition, the Arizona Department of
Insurance also authorized an extraordinary dividend of $50 million payable after
the Department has reviewed the operating results of PMI for the six months
ended June 30, 1998. It is not expected that PMI will declare and pay any
dividends in 1998 in addition to those already authorized by the Arizona
Department of Insurance. TPG has two bank credit lines available totaling
$50.0 million. At June 30, 1998, 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. In
November 1997, an additional $150 million stock buy-back program was authorized
by the TPG Board of Directors. As of July 31, 1998, TPG has $57 million
available to repurchase additional shares under the authorization.
As of June 30, 1998, TPG had approximately $101.1 million of available funds.
This amount has decreased from the December 31, 1997 balance of $134 million due
primarily to the investment in RAM Re and the common stock repurchases in the
first half of 1998, offset by dividends received from PMI and APTIC.
13
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 $66.8 million and $102.1
million in the six months ended June 30, 1998 and 1997, respectively. The first
half of 1997 included the collection of $53.6 million as a result of a
termination and commutation of a reinsurance treaty.
PMI has commenced a project to prepare the Company's operating and insurance
systems for the year 2000 (See Factors That May Affect Future Results and Market
Price of Stock - Year 2000 Issues). Management expects to complete this project
in the first quarter of 1999 at a total cost of $3 million, which will be funded
through operating cash flows. These costs are being expensed as they are
incurred.
The Company's invested assets increased to $1,496.8 million at June 30, 1998
from $1,490.6 million at December 31, 1997 primarily due to cash flows from
operations of $78.8 million and an increase of $3.3 million in net unrealized
gains on investments available for sale, offset by stock repurchases of $82.3
million, and dividends paid of $3.2 million.
Consolidated reserve for losses and loss adjustment expenses decreased from
$202.4 million at December 31, 1997, to $201.7 million at June 30, 1998. The
decrease in the consolidated reserve for losses and loss adjustment expense is
due primarily to the decrease in PMI's default inventory from December 31, 1997
which was the result of the improvements in PMI's California book of business.
However, PMI's reserve per default was strengthened to $12,800 at June 30, 1998
from $11,600 at December 31, 1997.
Consolidated shareholders' equity increased from $1,061.2 million at December
31, 1997, to $1,072.2 million at June 30, 1998. The change in shareholders'
equity consisted of increases of $92.6 million from net income, an increase of
$2.1 million in net unrealized gains on investments available for sale (net of
tax), and $1.9 million from stock option activity, offset by common stock
repurchases of $82.3 million, and dividends declared of $3.3 million.
PMI's statutory risk-to-capital ratio at June 30, 1998 was 14.3:1, compared to
14.6:1 at December 31, 1997. See Factors That May Affect Future Results and
Market Price of Stock - Rating Agencies and Risk-to-Capital Ratio.
14
CAUTIONARY STATEMENT
Certain written and oral statements made or incorporated by reference from time
to time by the Company or its representatives in this document, other documents
filed with the Securities and Exchange Commission, press releases, conferences,
or otherwise that are not historical facts, and that relate to future plans,
events or performance are forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements include the following: (i) management expects new pool risk written
and the percent of risk share programs to increase in the second half of 1998;
(ii) management believes that PMI's total default rate could increase in 1998
due to the continued maturation of its 1994 and 1995 books of business; (iii)
although management expects that California should 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 and improved default reinstatement rates, California claims paid as a
percentage of total claims paid should continue to decline; and (iv) Management
anticipates that contract underwriting will continue to generate a significant
percentage of PMI's NIW and that customer demand for contract underwriting
services will increase. In addition, management anticipates that the rate of
growth of policy acquisition costs will exceed the growth rate of premiums, if
any, for the remainder of the year. The Company's actual results may differ
materially from those expressed in any forward-looking statements made by the
Company. These forward-looking statements involve a number of risks or
uncertainties including, but not limited to, the factors set forth below and in
the Company's periodic filings with the Securities and Exchange Commission.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
GENERAL CONDITIONS
Several factors such as economic recessions, declining housing values, higher
unemployment rates, deteriorating borrower credit, rising interest rates,
increases in refinance activity caused by declining interest rates, legislation
impacting borrowers' rights, or combinations of such factors might affect the
mortgage insurance industry and demand for housing in general and could
materially and adversely affect the Company's financial condition and results of
operations. Such economic events could materially and adversely impact the
demand for mortgage insurance, cause claims on policies issued by PMI to
increase, and/or cause a similar adverse increase in PMI's loss experience.
Other factors that may influence the amount of NIW by PMI include: mortgage
insurance industry volumes of new business; the impact of competitive
underwriting criteria and 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 for or acceptance of the Company's products; changes in
government housing policy; changes in government regulations or interpretations
regarding the Real Estate Settlement Procedures Act ("RESPA"); changes in the
statutory charters, regulations, powers and coverage requirements of government
sponsored enterprises ("GSEs"), banks and savings institutions; and customer
consolidation.
15
MARKET SHARE AND COMPETITION
The Company's financial condition and results of operations could be materially
and adversely affected by a decline in its market share, or a decline in market
share of the private mortgage insurance industry as a whole. Numerous factors
bear on the relative position of the private mortgage insurance industry versus
government and quasi-governmental competition as well as the competition of
lending institutions that choose to remain uninsured, self-insure through
affiliates, or offer residential mortgage products that do not require mortgage
insurance. The impact of 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. Further, the
Office of the Comptroller of the Currency has granted permission to certain
national banks to form reinsurance companies as wholly-owned operating
subsidiaries for the purpose of reinsuring mortgage insurance written on loans
originated or purchased by such banks. In addition, the Federal Reserve Board
and the Office of Thrift Supervision are in the process of considering whether
similar activities are permitted for bank holding companies and savings
institutions, respectively. The reinsurance subsidiaries of national banks,
savings institutions, or bank holding companies could become significant
competitors of the Company in the future. Mortgage lenders, other than banks,
thrifts or their affiliates, are forming reinsurance affiliates that are
typically regulated solely by the insurance authority of their state of
domicile. Management believes that such reinsurance affiliates will increase
competition in the mortgage insurance industry and may materially and adversely
impact PMI's market share.
Certain lenders originate a first mortgage lien with an 80 percent LTV ratio, a
10 percent second mortgage lien, and 10 percent 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. 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 and certain commercial
banks that forego insurance have affected demand for private mortgage insurance.
The maximum individual loan amount that the FHA can insure is currently $170,362
and the maximum individual loan amount that the VA can insure is $203,150.
Recently, the Senate passed its Fiscal Year 1999 appropriations bill for the
Department of Housing and Urban Development ("HUD") with provisions that would
increase the maximum individual loan amount that the FHA can insure to $197,620
and simplify the downpayment formula. The streamlined downpayment formula for
FHA loans would eliminate tiered minimum cash investment requirements and
establish four maximum loan-to-values based on loan size and closing costs,
making FHA insurance more competitive with private mortgage insurance in areas
with higher home prices. Although management believes that it is too early to
ascertain the impact of any final FHA provisions included in the Fiscal Year
1999 appropriations bill for HUD, any increase in the FHA loan limit, or other
expansion of eligibility for the FHA and VA would likely have an adverse affect
on the competitive position of PMI and consequently could materially and
adversely affect the Company's financial condition and results of operations.
INSURANCE IN FORCE
A significant percentage of PMI's premiums earned is generated from its existing
insurance in force and not from new insurance written. PMI's policies for
insurance coverage typically have a policy duration of five to seven years.
Insurance coverage may be canceled by the policy owner or servicer of the loan
at any time. PMI has no
16
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 operation could be
materially and adversely affected by greater than anticipated policy
cancellations or lower than projected persistency resulting in declines in
insurance in force.
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.
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. Any significant decrease in PMI's insurance in force could
materially and adversely affect the Company's financial condition and results of
operations.
Insurance in force as of June 30, 1998 was $77.6 billion compared with $77.8
billion as of December 31, 1997. The decrease in insurance in force is
primarily due to higher policy cancellations caused by the refinancing activity
in the first half of 1998. The decline in insurance in force will have an
adverse impact on PMI's future renewal premiums.
FANNIE MAE, FREDDIE MAC AND FHA
PMI and other private mortgage insurers are affected by Fannie Mae and Freddie
Mac. These GSEs are permitted by statute to purchase conventional high-LTV
mortgages from lenders who obtain mortgage insurance on those loans. Fannie Mae
and Freddie Mac have the discretion to reduce the amount of private mortgage
insurance they require on loans. Any reduction in the amount of private
mortgage insurance coverage could materially and adversely affect the Company's
financial condition and results of operations.
Fannie Mae and Freddie Mac have guidelines which give borrowers the right to
request cancellation of mortgage insurance when specified conditions are met.
PMI cannot generally cancel its mortgage insurance policies once issued, but
must cancel mortgage insurance for a mortgage loan upon the request of the
insured.
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
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.
RATING AGENCIES
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 and are not applicable to the
Company's common stock or outstanding debt.
Certain rating agencies have assessed capital charges on pool insurance policies
based on
17
price and structure. The methodology for assessing the capital requirement for
pool insurance is based on the real estate depression which occurred in oil
producing states during the mid-1980's. Management believes the capital charge
that is levied currently on pool insurance risk by the rating agencies is
generally $1.00 of capital for each $1.40 of pool insurance risk. Regulators
specifically limit the amount of insurance risk that may be written by PMI to
a multiple of 25 times PMI's statutory capital (which includes the contingency
reserve). The rating agencies could change their view as to the capital
charges that are assessed on pool insurance products at any time.
In the mortgage guaranty insurance industry, liquidity refers to the ability
of an enterprise to generate adequate amounts of cash from its normal
operations, including premiums received and investment income, in order to
meet its financial commitments, which are principally obligations under the
insurance policies it has written. Liquidity requirements are significantly
influenced by the level and severity of claims. Management believes that a
significant reduction in PMI's liquidity could adversely impact its claims-
paying ratings which could have a material, adverse effect on the Company's
financial condition and results of operations.
CONTRACT UNDERWRITING SERVICES; NEW PRODUCTS
The Company provides contract underwriting services that enable customers to
improve the efficiency and quality of their operations by outsourcing all or
part of their mortgage loan underwriting. Contract underwriting services have
become increasingly important to mortgage lenders as they seek to reduce
costs, including the cost of repurchasing loans from the GSEs and other
investors which are not underwritten to relevant guidelines. As a part of its
contract underwriting services, PMI provides remedies which may include the
assumption of some of the costs of repurchasing insured and uninsured loans
from the GSEs and other investors. Generally, the scope of these remedies
exceed those contained in PMI's master primary insurance policies. Contract
underwriting currently generates a significant percentage of PMI's NIW.
Management anticipates that contract underwriting will continue to generate a
significant percentage of PMI's NIW. Due to the increasing demand of contract
underwriting services, the limited number of underwriting personnel available,
and heavy price competition among mortgage insurance companies, PMI's
inability to recruit and maintain a sufficient number of qualified
underwriters could materially and adversely affect its market share and
materially and adversely affect the Company's financial condition and results
of operations. Based on the factors above, underwriter hourly rates increased
in 1998 over 1997.
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.
YEAR 2000 ISSUES
The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions in all phases of the Company's
operations.
Based on previous assessments, the Company determined that it will be required
to modify or replace significant portions of its software so that its computer
systems will properly utilize dates beyond December 31, 1999. The Company
presently believes that with modifications to existing software and conversions
to new software, the Year 2000 Issue can be mitigated. However, if such
modifications and conversions are not made, or are not completed in a timely
manner, the Year 2000 Issue could have a material impact on the operations of
the Company.
18
The Company has initiated formal communications with all of its significant
suppliers and large customers to determine the extent to which the Company is
vulnerable to those third parties' failure to remediate their own Year 2000
Issue. The Company's total Year 2000 project cost and estimates to complete
include the estimated costs and time associated with assessing the impact of a
third parties' Year 2000 Issues, and are based on presently available
information. However, there can be no guarantee that the systems of other
companies on which the Company's systems rely will be timely converted, or that
a failure to convert by another company, or a conversion that is incompatible
with the Company's systems, would not have a material adverse effect on the
Company.
The Company is utilizing both internal and external resources to reprogram and
test the software for Year 2000 modifications. The Company plans to complete the
Year 2000 project in the first quarter of 1999 at a total cost of $3.0 million,
which will be funded through operating cash flows and is being expensed as
incurred. As of June 30, 1998, the Company has incurred and expensed
approximately $1.3 million related to its Year 2000 project and the development
of a remediation plan.
The Company is currently assessing contingency plans that will address failure
to remediate its Year 2000 Issue in a timely manner. Although it is highly
unlikely given the assessments of the required modifications, PMI might need to
process data manually if the Company's critical systems, such as the mortgage
insurance system's origination or billing process, fail due to the Year 2000
Issue. In this event, PMI would procure clerical personnel from temporary
recruitment firms. Additionally, duplicate records of critical data on
Company maintained computer systems are maintained and stored at an offsite
location as a routine procedure related to the Company's Disaster Recovery
Program. These duplicate records would be available to restore operations
disrupted by earthquake, fire or other natural disasters, and may assist in any
Year 2000 contingency plan recovery operation. The failure of any of PMI's
significant customers or vendors to remediate their Year 2000 Issue, however,
is difficult if not impossible to fully address in any contingency plan.
The costs of the project and the date on which the Company plans to complete the
Year 2000 modifications are based on management's best estimates, which were
derived utilizing numerous assumptions of future events. However, there can be
no guarantee that these estimates will be achieved and actual results could
differ materially from those plans. Specific factors that might cause such
material differences include, but are not limited to, the availability and cost
of personnel trained in this area, the ability to locate and correct all
relevant computer codes, and similar uncertainties.
NEW YORK DEPARTMENT OF INSURANCE
The Company offers a number of risk-share and structured products and programs
that are designed to encourage quality originations and loss mitigation by its
customers. To date, these products and programs do not represent a significant
portion of the Company's revenues or a significant percent of PMI's NIW. In
March 1997, the New York Department of Insurance stated in a letter addressed to
all private mortgage insurers that certain risk-share and structured products
and programs would be considered to be illegal under New York law.
Representatives of the mortgage insurance industry have been in discussions with
the New York Department of Insurance regarding its March 1997 letter.
Management is unable to predict at this time the results of these discussions.
RISK-TO-CAPITAL RATIO
Regulators specifically limit the amount of insurance risk that may be written
by PMI to a multiple of 25 times PMI's statutory capital (which includes the
contingency reserve). Other factors affecting PMI's risk-to-capital ratio
include: (i) regulatory review and oversight by the State of Arizona, PMI's
state of domicile for insurance regulatory purposes; (ii) limitations under the
Runoff Support Agreement with Allstate, which prohibit PMI from paying any
dividends if, after the payment of any such dividend, PMI's risk-to-capital
ratio would equal or exceed 23 to 1; (iii) TPG's credit agreements; and (iv)
TPG's and PMI's credit or claims-paying ability ratings which require that the
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
The composition of PMI's NIW has included an increasing percentage of mortgages
with LTVs in excess of 90% and less than or equal to 95% ("95s"). At June 30,
1998, 46.3% of PMI's risk in force consisted of 95s, which, in
19
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 June 30, 1998, 2.4% of PMI's risk in force consisted of 97s which have even
higher risk characteristics than 95s and greater uncertainty as to pricing
adequacy. PMI's NIW also includes adjustable rate mortgages ("ARMs"), which,
although priced higher, have risk characteristics that exceed the risk
characteristics associated with PMI's book of business as a whole. Since the
fourth quarter of 1997, PMI has offered a pool insurance product to state
housing finance authorities and certain lenders. 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 which did not require primary insurance, in
each case up to a stated aggregate loss limit. New pool risk written was $38
million in the second quarter of 1998, and $52 million in the six months ended
June 30, 1998. Management expects new pool risk written to increase
significantly throughout the year and into 1999. 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.
POTENTIAL INCREASE IN CLAIMS
Mortgage insurance coverage generally cannot be canceled by PMI and remains
renewable at the option of the insured for the life of the loan. As a result,
the impact of increased claims from policies originated in a particular year
generally cannot be offset by premium increases on policies in force or
mitigated by nonrenewal of insurance coverage. There can be no assurance,
however, that the premiums charged will be adequate to compensate PMI for the
risks and costs associated with the coverage provided to its customers.
LOSS RESERVES
PMI establishes loss reserves based upon estimates of the claim rate and average
claim amounts, as well as the estimated costs, including legal and other fees,
of settling claims. Such reserves are based on estimates, which are regularly
reviewed and updated. There can be no assurance that PMI's reserves will prove
to be adequate to cover ultimate loss development on incurred defaults. The
Company's financial condition and results of operations could be materially and
adversely affected if PMI's reserve estimates are insufficient to cover the
actual related claims paid and expenses incurred.
REGIONAL CONCENTRATION
In addition to nationwide economic conditions, PMI could be particularly
affected by economic downturns in specific regions where a large portion of its
business is concentrated, particularly California, Florida, and Texas, where PMI
has 19.3%, 7.2%, and 6.8% of its risk in force concentrated and where the
default rate on all PMI policies in force is 3.20%, 2.59% and 1.97% compared
with 2.16% nationwide as of June 30, 1998.
CONTINUING RELATIONSHIPS WITH ALLSTATE AND AFFILIATE
In December 1993, PMI entered into a Reinsurance Treaty with Forestview Mortgage
Insurance Company ("Forestview") whereby Forestview agreed to reinsure all
liabilities (net of amounts collected from third party reinsurers and
indemnitors) in connection with PMI's mortgage pool insurance business in
exchange for
20
premiums received. In 1994, Forestview also agreed that as soon as practicable
after November 1, 1994, Forestview and PMI would seek regulatory approval for
the Reinsurance Treaty to be deemed to be an assumption agreement and that, upon
receipt of the requisite approvals, Forestview would assume such liabilities.
The parties are in the process of seeking regulatory approval to complete the
assumption of the mortgage pool insurance policies. Until Forestview has assumed
directly such mortgage pool insurance policies, PMI will remain primarily liable
on the unassumed policies. Forestview's previous claims-paying ability rating of
"AA" (Excellent) was withdrawn by Standard and Poor's Rating Services ("S&P").
Management is uncertain at this time what impact the withdrawal of the claims-
paying ability rating will have on the parties' ability to timely consummate the
assumption transaction. Pursuant to this agreement, PMI ceded $4.9 million of
pool premiums to Forestview and Forestview reimbursed PMI for pool claims on the
covered policies in the amount of $14.6 million in the six months ended June 30,
1998. It is anticipated that additional pool claims significantly in excess of
pool premiums will be paid in 1998 and beyond. As of June 30, 1998, the Company
has a $65.4 million reinsurance recoverable from Forestview, of which $59.7
million is related to estimated claims not yet received. The failure of
Forestview to meet its contractual commitments would materially and adversely
affect the Company's financial condition and results of operations.
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
obligation arose under the Runoff Support Agreement in the first half of 1998.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
21
THE PMI GROUP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
JUNE 30, 1998
ITEM 1 - LEGAL PROCEEDINGS
In the September 30, 1997 Quarterly Report on Form 10-Q, the Company reported
the filing of a complaint in the Superior Court of Fulton County, State of
Georgia, against The PMI Group, Inc. and PMI Mortgage Insurance Co. On December
18, 1997, The PMI Group, Inc. and PMI Mortgage Insurance Co. filed a
counterclaim against BISYS Creative Solutions, Inc. On July 15, 1998, the
parties executed a confidential settlement agreement and mutual release of the
parties' counterclaims and all claims contained in the complaint captioned BISYS
Creative Solutions, Inc., v. The PMI Group, Inc., and PMI Mortgage Insurance Co.
(case#-62326).
- -------------
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Company's Annual Meeting of Stockholders held on May 21, 1998, the
following individuals were elected to the Board of Directors:
1. Election of Directors
Votes For Votes Withheld
-------- --------------
James C. Castle 24,971,558 3,441,050
Donald C. Clark 24,971,858 3,440,750
W. Roger Haughton 24,972,017 3,440,591
Wayne E. Hedien 24,971,858 3,440,750
John D. Roach 24,972,133 3,440,475
Kenneth T. Rosen 24,972,133 3,440,475
Richard L. Thomas 24,971,488 3,441,120
Mary Lee Widener 24,974,087 3,438,521
Ronald H. Zech 24,971,758 3,440,850
The following proposal was approved at the Company's Annual Meeting:
Votes for Votes against Votes withheld Broker Non-Vote
------------ -------------- ---------------- ------------------
2. Appointment of Deloitte & Touche LLP
as independent auditors of the Company
for 1998 28,173,306 11,794 6,908 4,234,030
ITEM 5 - OTHER INFORMATION
In accordance with Rule 14a-4(c)(1) promulgated by the Securities and Exchange
Commission, shareholder proxies obtained by the Company in connection with the
1999 annual meeting of shareholders will confer on proxyholders discretionary
authority to vote on any matter presented at the meeting, unless notice of the
matter to be presented at the meeting is received by the Secretary of TPG not
before February 20, 1999 or after March 22, 1999 in compliance with TPG's
Bylaws. As stated in the 1998 proxy statement, any proposals intended to be
presented at the 1999 annual meeting of shareholders must be received by the
Secretary of the Company on or before December 22, 1998, in order to be
considered for inclusion in the Company's proxy statement and form of proxy
relating to such meeting.
22
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - The exhibits listed in the accompanying Index to
Exhibits are filed as part of this Form 10-Q
(b) Reports on Form 8-K
None.
23
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 13, 1998.
THE PMI GROUP, INC.
/s/ John M. Lorenzen, Jr.
--------------------------
John M. Lorenzen, Jr.
Executive Vice President and
Chief Financial Officer
/s/ William A. Seymore
-----------------------
William A. Seymore
Vice President and Chief
Accounting Officer
24
INDEX TO EXHIBITS
(PART II, ITEM 6)
Exhibit
Number DESCRIPTION OF EXHIBIT
------- ----------------------
10.2* The PMI Group, Inc. Equity Incentive Plan as amended
10.3* The PMI Group, Inc. Stock Plan for Non-Employee Directors as amended
10.20* Supplemental Employee Retirement Plan as amended
10.31* The PMI Group, Inc. Directors' Deferred Compensation Plan as amended
11.1 Computation of Net Income Per Share
27.1 Financial Data Schedule
* Compensatory or benefit plan in which certain executive officers or Directors
of The PMI Group, Inc. or its subsidiaries are eligible to participate.
25