UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10 - Q/A
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 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 10/30/98 30,343,244
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------------------
Form 10-Q/A
Amendment to Item 2
Management's Discussion and Analysis of Financial
Condition and Results of Operations
Third Quarter
1998
The PMI Group, Inc., hereby amends its Form 10-Q for the quarter ended
September 30, 1998 dated and filed with the Securities and Exchange Commission
on November 16, 1998 by deleting from Item 2 thereof the following sentence:
"Risk in force under risk-share programs, excluding pool insurance,
represented approximately 9.5% of total risk in force at September 30,
1998."
and replacing such deleted language with the following corrected sentence:
"Risk in force under risk-share programs with PMI's customers, excluding
pool insurance, represented less than two percent of total risk in force
at September 30, 1998."
Item 2 as amended and restated in its entirety is attached hereto. Unless
otherwise stated, information in the originally filed Form 10-Q is presented as
of the original filing date, and has not been updated in this amended filing.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF CONSOLIDATED OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
Consolidated net income in the three months ended September 30, 1998 was $53.7
million, a 28.2% increase over net income of $41.9 million in the corresponding
period of 1997. The increase was due to increases in realized capital gains,
premiums earned, and other income of $14.0 million, $9.8 million, and $3.2
million, respectively, and to a decrease in losses and loss adjustment expenses
of $5.2 million, partially offset by an increase in other operating expenses and
policy acquisition costs of $7.2 million and $4.3 million, respectively.
Diluted earnings per share were $1.73 in the three months ended September 30,
1998, compared with $1.26 in the corresponding period of 1997, a 37.3% increase.
Excluding capital gains, diluted earnings per share were $1.43 in the third
quarter of 1998 compared with $1.25 in the third quarter of 1997, a 14.4%
increase. Revenues in the third quarter of 1998 were $167.4 million, an 18.6%
increase over revenues of $141.2 million in the third quarter of 1997.
MORTGAGE INSURANCE OPERATIONS
PMI's new insurance written ("NIW") totaled $7.7 billion in the third quarter of
1998, compared with $4.5 billion in the third quarter of 1997, a 71.1% increase.
The increase in NIW resulted primarily from the number of new mortgage insurance
policies issued increasing to 58,200 policies in the three months ended
September 30, 1998 from 34,300 policies in the corresponding period of 1997, a
69.7% increase, and secondarily from an increase in the average loan size to
$132,500 from $129,600.
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 third quarter of 1998 compared with the corresponding period of 1997. The
private mortgage insurance industry experienced an increase in total new
insurance written of 51.8% to $50.7 billion in the third quarter of 1998 from
$33.4 billion in the corresponding period of 1997. The increase was caused
primarily by low interest rates which produced both a high degree of refinance
activity as well as purchased money mortgage activity as affordability was
enhanced. Refinancing as a percentage of PMI's NIW increased to 24.4% in the
three months ended September 30, 1998 from 10.7% 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 third quarter of 1998. PMI's market share of
NIW increased to 15.2% in the three months ended September 30, 1998 from 13.3%
in the corresponding period of 1997. On a combined basis with CMG, market share
increased to 16.6% in the third quarter of 1998 compared with 14.5% 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, and a government sponsored enterprises ("GSE") pool insurance
product offered to selected customers and entities. New pool risk written was
$201 million in the third quarter of 1998 compared with $101 million in the
second quarter of 1998. Risk in force under risk-share programs with PMI's
customers, excluding pool insurance, represented less than two percent of total
risk in force at September 30, 1998. Management expects the percentage of the
Company's total risk represented by risk-share programs and pool risk will
continue to increase in the foreseeable future. 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 $6.4 billion in the third quarter
of 1998 compared to $4.1 billion in the corresponding period of 1997. The
increase in policy cancellations is primarily due to mortgage 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 71.0% as of September 30, 1998 compared with 73.9%
as of June 30, 1998, and 82.5% as of September 30, 1997. PMI's persistency rate
may continue to decline in the fourth quarter of 1998. See Cautionary Statement
and Factors That May Affect Future Results and Market Price of Stock - Insurance
In Force.
Insurance in force increased by 1.4% to $78.9 billion at September 30, 1998
compared with $77.8 billion at December 31, 1997, and by 1.7% compared with
$77.6 billion at June 30, 1998. On a combined basis with CMG, insurance in
force grew to $82.7 billion at September 30, 1998 compared with $80.9 billion at
June 30, 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 $0.5 billion to $18.8 billion at September 30,
1998 compared with $18.3 billion at June 30, 1998 and increased by $0.7 billion
compared with $18.1 billion at December 31, 1997. On a combined basis with CMG,
risk in force was $19.7 billion at September 30, 1998 compared with $19.1
billion at June 30, 1998, and $18.7 billion at December 31, 1997.
Mortgage insurance net premiums written were $107.1 million in the third quarter
of 1998 compared with $98.5 million in the corresponding period of 1997, an
increase of 8.7%. The increase is primarily attributable to the growth of risk
in force and higher average premium rates, partially offset by an increase in
refunded premiums. Refunded premiums increased to $5.4 million in the third
quarter of 1998 from $4.2 million in the third quarter of 1997, due to the
increase in policy cancellations as discussed above. Ceded premiums were $4.5
million for the three months ended September 30, 1998 and 1997. Management
anticipates ceded premiums will increase in the future as a result of the
expected increase in risk-share programs. See Cautionary Statement and Factors
That May Affect Future Results and Market Price of Stock - New Products.
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 which has a higher premium rate. PMI's monthly product represented 68.3%
of risk in force at September 30, 1998 compared with 55.6% at September 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 33.4% of
risk in force as of September 30, 1998 from 27.2% as of September 30, 1997. In
addition , mortgages with original loan-to-value ratios greater than 85% and
equal to or less than 90% ("90s") with 25% insurance coverage increased to 27.8%
of risk in force as of September 30, 1998 compared with 22.7% as of September
30, 1997.
Mortgage insurance premiums earned increased 5.0% to $105.7 million in the third
quarter of 1998 from $100.7 million in the third quarter of 1997. The increase
is primarily attributable to the increase in premiums written.
Mortgage insurance losses and loss adjustment expenses decreased to $34.2
million in the third quarter of 1998 from $39.1 million in the third quarter of
1997, a decrease of 12.5%. This decrease was due primarily to the continuing
improvement of the nationwide housing markets, particularly California, and the
corresponding decrease in the number of loans in default and claim payments.
Loans in default decreased to 15,455 loans at September 30, 1998 from 16,029
loans at September 30, 1997. Direct primary claims paid by PMI decreased to
$26.5 million in the third quarter of 1998 from $38.1 million in the third
quarter of 1997 due to a decrease in the average claim size of $21,384 in the
third quarter of 1998 compared with $26,022 in the corresponding period of 1997,
as well as a decrease in the number of claims paid to 1,239 in the third quarter
of 1998 from 1,465 in the
corresponding period of 1997 due primarily to a smaller percentage of claims
originating from the California book of business, and also to increased loss
mitigation efforts by PMI and lenders.
PMI's default rate has decreased to 2.20% at September 30, 1998 from the
September 30, 1997 rate of 2.29%. This decrease was due to the decrease in the
number of loans in default as discussed above, coupled with an increase in
policies in force. Management believes that PMI's total default rate could
increase in the fourth quarter of 1998 and into 1999 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
3.15% (representing 3,110 loans in default) at September 30, 1998, from 3.74%
(representing 4,075 loans in default) at September 30, 1997. Policies written
in California accounted for approximately 44.1% and 61.4% of the total dollar
amount of claims paid in the third 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 policy acquisition costs incurred and deferred increased by
58.6% to $21.1 million from $13.3 million in the three months ended September,
1998 and 1997, respectively. This increase relates directly to the 71.1%
increase in NIW. Amortization of policy acquisition costs increased 38.1% to
$15.6 million in the third quarter of 1998 from $11.3 million in the third
quarter of 1997. Policy acquisition costs include, among other field expenses,
contract underwriting, which is a more expensive acquisition channel. New
policies processed by contract underwriters represented 37.7% of PMI's NIW in
the third quarter of 1998 compared with 22.9% 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.
Other mortgage insurance operating expenses increased to $11.0 million in the
third quarter of 1998 from $10.9 million in the third quarter of 1997. This
increase relates primarily to Year 2000 remediation costs.
The mortgage insurance loss ratio improved to 32.4% in the third quarter of 1998
compared to 38.8% in the third quarter of 1997 due primarily to the growth in
premiums earned coupled with the decrease in losses and loss adjustment expenses
as discussed above. The expense ratio increased to 24.8% in the third quarter
of 1998 from 22.5% in the third quarter of 1997 due primarily to the increase in
policy acquisition costs resulting from the growth in NIW and secondarily to
Year 2000 remediation costs. Excluding Year 2000 remediation expenses, the
expense ratio for the third quarter of 1998 would have been 24.0%. The combined
ratio decreased to 57.2% in the third quarter of 1998 from 61.3% in the third
quarter of 1997.
TITLE INSURANCE OPERATIONS
Title insurance premiums earned increased 28.6% to $21.6 million in the third
quarter of 1998 compared with $16.8 million in the third 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 and secondarily to APTIC's expansion into new states. Underwriting and
other expenses increased 28.1% to $18.7 million in the third quarter of 1998
compared to $14.6 million in the third 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 87.0% in the third quarter of 1998 from 89.3% in the third quarter of 1997.
OTHER
The Company's net investment income decreased by 3.3% to $20.7 million in the
third quarter of 1998 from $21.4 million in the third quarter of 1997. The
decrease was primarily attributable to a slight decrease in the average
investment yield (pretax) to 6.1% in the third quarter of 1998 from 6.2% in the
third quarter of 1997. Realized capital gains (net of losses) increased to $14.2
million in the third quarter of 1998 from $0.3 million in the third quarter of
1997 due to the planned sale of $21.0 million of equity securities in July as
part of management's investment strategy.
Other income, primarily contract underwriting revenues generated by MSC,
increased to $5.1 million in the third quarter of 1998 from $1.9 million in the
third quarter of 1997. Other expenses, primarily expenses incurred by MSC,
increased to $7.8 million in the third quarter of 1998 compared with $4.7
million in the third quarter of 1997. These increases are primarily due to
increased contract underwriting services provided to the Company's mortgage
insurance customers. 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 increased to 29.5% in the third quarter of 1998
compared to 25.7% in the third quarter of 1997. The year over year increase in
the effective rate was caused primarily by a decrease in the percentage of tax
exempt income included in income before taxes during the third quarter of 1998.
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
Consolidated net income in the nine months ended September 30, 1998 was $146.3
million, a 9.7% increase over net income of $133.4 million in the corresponding
period of 1997. The increase was due to increases in premiums earned of $26.9
million, other income of $10.3 million, and realized gains of $5.3 million and
to a decrease in losses and loss adjustment expenses of $10.3 million, offset by
an increase in other operating expenses of $22.7 million and policy acquisition
costs of $10.9 million. Diluted earnings per share were $4.58 in the nine
months ended September 30, 1998, compared with $3.95 in the corresponding period
of 1997, a 15.9% increase. Excluding capital gains, diluted earnings per share
were $4.09 in the nine months ended September 30, 1998 compared with $3.58 in
the nine months ended September 30, 1997, a 14.2% increase. Revenues in the
nine months ended September 30, 1998 were $465.5 million compared with $421.7
million in the corresponding period of 1997, a 10.4% increase.
MORTGAGE INSURANCE OPERATIONS
PMI's NIW totaled $19.5 billion in the nine months ended September 30, 1998
compared with $11.1 billion in the nine months ended September 30, 1997, a 75.7%
increase. The increase in NIW resulted primarily from the number of new
mortgage insurance policies issued increasing to 147,800 policies in the nine
months ended
September 30, 1998 from 86,900 policies in the corresponding period of 1997, a
70.1% increase, and secondarily from an increase in the average loan size to
$131,700 from $128,200.
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 nine months ended September 30, 1998 compared with the corresponding
period of 1997. The private mortgage insurance industry experienced an increase
in total new insurance written of 51.4% to $132.2 billion in the nine months
ended September 30, 1998 from $87.3 billion in the corresponding period of 1997.
This increase was caused by low interest rates which produced both a high degree
of refinance activity as well as purchased money mortgage activity as
affordability was enhanced resulting in total mortgage originations approaching
record levels of approximately $1.0 trillion at September 30, 1998.
The secondary factor contributing to the increase in new policies issued was the
growth in PMI's market share. PMI's market share of NIW increased to 14.7% in
the nine months ended September 30, 1998 from 12.7% in the corresponding period
of 1997. On a combined basis with CMG, market share increased to 16.1% in the
nine months ended September 30, 1998 compared with 13.8% 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. New
pool risk written was $369 million in the nine months ended September 30, 1998.
There was no new pool risk written in the corresponding period of 1997.
Mortgage insurance net premiums written were $295.5 million in the nine months
ended September 30, 1998 compared with $274.0 million in the corresponding
period of 1997, an increase of 7.8%. The increase is attributable to the growth
of risk in force, as discussed above, and to higher average premium rates, as
discussed above. Refunded premiums increased to $16.6 million in the nine months
ended September 30, 1998 from $11.2 million in the corresponding period of 1997,
due to the increase in mortgage refinancing volume. Ceded premiums increased to
$13.8 million from $11.6 million in the nine months ended September 30, 1998 and
1997, respectively, due to the continued expansion of reinsurance arrangements
under risk-share programs with affiliates of customers. Management anticipates
ceded premiums will increase in the future as a result of the expected increase
in risk-share programs. See Cautionary Statement and Factors That May Affect
Future Results and Market Price of Stock - New Products.
Mortgage insurance premiums earned increased 4.7% to $306.5 million in the nine
months ended September 30, 1998 from $292.7 million in the corresponding period
of 1997. The increase is attributable to the increase in premiums written.
Mortgage insurance losses and loss adjustment expenses decreased to $102.7
million in the nine months ended September 30, 1998 from $112.2 million in the
nine months ended September 30, 1997, a decrease of 8.5%. This decrease was due
primarily to the continuing improvement of the nationwide housing markets,
particularly California, and the corresponding decrease in the inventory of
loans in default and claim payments. Direct primary claims paid by PMI
decreased to $93.8 million in the nine months ended September 30, 1998 from
$110.9 million in the corresponding period of 1997 due to a decrease in the
average claim size of $23,795 in the third quarter of 1998 compared with $26,518
in the corresponding period of 1997, as well as a decrease in the number of
claims paid to 3,942 in the third quarter of 1998 from 4,182 in the
corresponding period of 1997. Policies written in California accounted for
49.8% and 66.0% of the total dollar amount of claims paid in the nine months
ended September 30, 1998 and 1997, respectively.
Mortgage insurance policy acquisition costs incurred and deferred increased
66.3% to $56.2 million from $33.8 million in the nine months ended September 30,
1998 and 1997, respectively. This increase relates directly to the 75.7%
increase in NIW. Amortization of policy acquisition costs increased 36.7% to
$40.6 million from $29.7 million in the nine months ended September 30, 1998 and
1997, respectively. Policy acquisition costs include, among other field
expenses, contract underwriting, which is a more expensive acquisition channel.
New policies processed by contract underwriters represented 34.6% of PMI's NIW
in the nine months ended September 30, 1998 compared with 19.6% 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. Due to the increasing demand of contract
underwriting services, the limited number of underwriting personnel available,
and heavy price competition among mortgage insurance companies, underwriter
hourly rates increased in 1998 over 1997. 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.
Other mortgage insurance operating expenses increased to $36.2 million in the
nine months ended September 30, 1998 from $33.2 million in the corresponding
period of 1997. This increase relates primarily to Year 2000 remediation costs
of $1.9 million.
The mortgage insurance loss ratio improved to 33.5% in the nine months ended
September 30, 1998 compared to 38.3% 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 26.0% in the nine
months ended September 30, 1998 from 23.0% in the nine months ended September
30, 1997, due primarily to the increase in policy acquisition costs from the
growth in NIW and secondarily to Year 2000 remediation costs. Excluding Year
2000 remediation expenses, the expense ratio for the nine months ended September
30, 1998 would have been 25.3%. The combined ratio decreased to 59.5% in the
nine months ended September 30, 1998 from 61.3% in the nine months ended
September 30, 1997.
TITLE INSURANCE OPERATIONS
Title insurance premiums earned increased 30.6% to $55.9 million in the nine
months ended September 30, 1998 compared with $42.8 million in the nine months
ended September 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 and secondarily to APTIC's expansion
into new states. Underwriting and other expenses increased 29.1% to $49.2
million in the nine months ended September 30, 1998 compared with $38.1 million
in the nine months ended September 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
88.4% in the nine months ended September 30, 1998 from 91.6% in the nine months
ended September 30, 1997.
OTHER
The Company's net investment income in the nine months ended September 30, 1998
was $63.5 million compared with $62.2 million in the nine months ended September
30, 1997, an increase of 2.1%. 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 nine months ended September 30, 1998
and 1997. Realized capital
gains (net of losses) increased to $24.4 million in the nine months ended
September 30, 1998 from $19.1 million in the nine months ended September 30,
1997.
Other income, primarily revenues generated by MSC, increased to $15.2 million in
the nine months ended September 30, 1998 from $4.8 million in the nine months
ended September 30, 1997. Other expenses, primarily expenses incurred by MSC,
increased to $19.5 million in the nine months ended September 30, 1998 compared
with $10.8 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. 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 increased to 28.8% in the nine months ended
September 30, 1998, compared to 28.3% in the nine months ended September 30,
1997. The year over year increase in the effective rate was caused by a
decrease in the percentage of tax exempt income during the first nine months of
1998.
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.
PMI's ability to pay dividends to TPG is limited, among other restrictions,
under the insurance laws of Arizona. Such laws provide that: (i) PMI may pay
dividends out of available surplus and (ii) without prior approval of the
Arizona Insurance Director, such dividends during any 12-month period may not
exceed the lesser of 10% of policyholders' surplus as of the preceding year end,
or the last calendar year's investment income.
The laws of Florida limit the payment of dividends by APTIC to TPG in any one
year to 10% of available and accumulated surplus derived from realized net
operating profits and net realized capital gains. As a result, APTIC may be
limited in its ability to pay dividends to TPG. CMG's ability to pay dividends
to PMI is subject to the laws of Wisconsin.
In addition to the dividend restrictions described above, the Company's credit
agreements, various credit rating agencies and insurance regulatory authorities
have broad discretion to limit the payment of dividends by PMI, APTIC or CMG.
For example, if insurance regulators determine that payment of a dividend or any
other payments to an affiliate (such as payments under a tax sharing agreement,
payments for employee or other services, or payments pursuant to a surplus note)
would, because of the financial condition of the paying insurance company or
otherwise, be hazardous to such insurance company's policyholders or creditors,
the regulators may block payments that would otherwise be permitted without
prior approval.
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. PMI declared and paid extraordinary dividends of $100 million to
TPG in 1998. It is not expected that PMI will declare and pay any additional
dividends in 1998. TPG has two bank credit lines available totaling $50.0
million. At October 31, 1998, there were no outstanding borrowings under the
credit lines. See Cautionary Statement and Factors That May Affect Future
Results and Market Price of Stock - Liquidity.
TPG's principal uses of funds are common stock repurchases, the payment of
dividends to shareholders, funding of acquisitions, additions to its investment
portfolio, investments in subsidiaries, and the payment of interest. The $150
million stock buy-back program authorized by the TPG Board of Directors in
November 1997 was completed in the third quarter of 1998.
As of September 30, 1998, TPG had approximately $63.0 million of available
funds. This amount has decreased from the December 31, 1997 balance of $134.2
million due primarily to the investment in RAM Re and the common stock
repurchases through 1998, offset by dividends received from PMI and APTIC.
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 $104.3
million and $139.1 million in the nine months ended September 30, 1998 and 1997,
respectively. The 1997 amount includes the collection of $53.6 million as a
result of a termination and commutation of a reinsurance treaty.
On October 1, 1998, PMI increased its equity investment in CMG to 50% through
the purchase of additional shares of common stock at a total cost of $4.8
million.
PMI has commenced a project to prepare the Company's operating and insurance
systems for the year 2000 (See Year 2000 Issues). Management expects to
complete this project in the first quarter of 1999 at a total cost of $4.5
million, which will be funded through operating cash flows. These costs are
being expensed as they are incurred.
The Company's invested assets decreased to $1,479.1 million at September 30,
1998 from $1,490.6 million at December 31, 1997 due to stock repurchases of
$149.7 million and dividends paid of $4.8 million offset by cash flows from
operations of $121.8 million.
Consolidated reserve for losses and loss adjustment expenses increased to $208.7
million at September 30, 1998 from $202.4 million at December 31, 1997. The
increase in the consolidated reserve for losses and loss adjustment expense is
due primarily to the increase in PMI's reserve per default to $12,900 at
September 30, 1998 from $11,600 at December 31, 1997. PMI's default inventory
decreased from December 31, 1997 due primarily to improvements in PMI's
California book of business.
Consolidated shareholders' equity decreased from $1,061.2 million at December
31, 1997 to $1,054.9 million at September 30, 1998. The change in shareholders'
equity consisted of increases of $146.3 million from net income and $1.8 million
from stock option activity, offset by common stock repurchases of $149.7
million, and dividends declared of $4.7 million.
PMI's statutory risk-to-capital ratio at September 30, 1998 was 15.1:1, compared
to 14.7:1 at December 31, 1997. See Factors That May Affect Future Results and
Market Price of Stock - Rating Agencies and Risk-to-Capital Ratio.
YEAR 2000 ISSUES
Impact of the Year 2000 Issue. The Company's business processes are highly
automated and dependent upon the consistent and accurate functioning of it
computer systems and the computer systems of its customers. As a result, the
Company is directing significant resources toward mitigating its exposure to the
so-called "Year
2000 issue." The Year 2000 issue arises from the failure of computer software
and hardware to process dates into and through the year 2000: the number "00,"
for example, would be read as "1900" rather than "2000." The technical problem
is multifaceted and is composed of several different potential deficiencies
including, among others: (1) the inability of hardware to interpret years
greater than 1999; (2) the failure of software to process date data from, into,
and between the twentieth and twenty-first centuries; (3) the inability of the
number "99" to register an actual date -- 1999 -- rather than indefinite or
unknown information (i.e., an employee's date of retirement, if unknown, would
be characterized as "99-99-99"); (4) the inability of systems to recognize that
the year 2000 is a leap year; and (5) the failure of systems that are otherwise
Year 2000 compliant to transfer data between each other because each system has
used a different "fix," and the methods are incompatible with each other. When
any of these deficiencies occurs, the system may produce miscalculations and/or
"crash" and be unable to transfer or process data, causing disruption in one or
more aspects of the Company's operations. The problem also affects many of the
microprocessors that control systems and equipment.
State of Readiness. The Company has in place a Year 2000 project plan to
address the Year 2000 issue. The plan consists of three phases. The first
phase involved collecting data with respect to date processing issues,
determining the project scope, identification of resources to implement
remediation, budgeting and completion of the formal project plan. This phase
was completed in early 1998, and included a priority ranking designed to direct
resources to the most critical systems first. As a result of its first phase
assessment, the Company determined that it will be required to modify or replace
a significant portion of its software so that software will properly utilize
dates beyond December 31, 1999. The Company also determined that remediation of
the critical mortgage insurance origination and processing applications used by
PMI and CMG needs to be substantially completed by the first business day of
1999 in order to avoid possible date calculation errors in 1999 and to satisfy
the requirements of the GSEs and the federal and state regulators of the
Company's customers. The GSEs generally require that PMI and CMG be Year 2000
ready by the end of 1998, and to confirm their readiness by January 31, 1999.
Fannie Mae has established a March 31, 1999 compliance date. The Federal
Financial Institutions Examination Council guidelines for banks and thrifts
set various interim milestones for third party service providers such as the
Company, with final testing and substantial implementation required by June
30, 1999. Remediation of less critical applications is expected to be
completed during 1999. The Company anticipates that it will be required to
replace its telephone switches during 1999, but believes that other hardware
and non-information technology systems will not require significant
modifications, if any, to mitigate any Year 2000 issues.
The second phase, involving project staff procurement, code remediation and
unit testing, test plan development, Year 2000 policies and procedures
development and vendor readiness assessment, is substantially complete, although
continuing activity on this phase is expected during the remainder of 1998. The
third phase, which involves string and system testing and system installation,
is currently in progress and is projected to be substantially completed by the
first business day of 1999. Additional testing, including industry-sponsored
testing and testing of customer interfaces, is expected to continue through
1999.
The Company currently believes that if the planned modifications to
existing software and conversions to new software utilized by the Company in its
internal systems and operations are implemented in a timely and effective
manner, the Year 2000 issue will not have a material adverse impact on the
Company's internal systems or operations. If, however, the Company's
remediation efforts are either not timely or ineffective, significant
disruptions to the Company's operations could ensue which could have a material
adverse affect on the Company's liquidity, financial condition and results of
operations.. Furthermore, the Company relies on financial institutions,
government agencies, utility companies, telecommunications service companies and
other service providers outside of its control. There can be no assurance that
such third parties will not suffer a Year 2000 business disruption and it is
conceivable that such failures could, in turn, have a material adverse effect on
the Company's liquidity, financial condition and results of operations.
As part of its Year 2000 project plan, the Company has initiated
communications with all of its large customers and significant suppliers to
determine the extent to which the Company is vulnerable to those third parties'
failure to remediate their own Year 2000 issues. The Company's vulnerability
would likely result from the inability of the Company's or customers' systems to
process data received from the other, which could disrupt the Company's mortgage
insurance origination and claims processing, and/or a disruption in the supply
of goods and services procured from suppliers. Currently, a substantial
majority of the Company's mortgage insurance business is originated through non-
electronic channels, which serves to mitigate this type of customer risk,
although the Company anticipates that electronic originations will increase in
future periods. The Company has begun to receive responses from suppliers and
customers but has not independently confirmed the information received from
third parties with respect to their Year 2000 compliance status. The Company's
total Year 2000 project cost and estimates include the estimated costs and time
associated with assessing the impact of third parties' Year 2000 issues, and are
based in part upon such unconfirmed information. Because of the early stage of
the Company's testing and the large number of variables involved, the Company
cannot provide an estimate of the damage it might suffer if any of the Company's
significant customers or vendors failed to remediate their Year 2000 issues,
although the Company believes that the business disruption likely to result from
any prolonged Year 2000 non-compliance by customers or suppliers could have a
material adverse effect on the Company's liquidity, financial condition and
results of operations.
Costs to Address the Year 2000 Issue. The Company is utilizing both
internal and external personnel and resources to implement its Year 2000 project
plan. Currently, no planned material projects involving information or non-
information technology systems have been delayed or are anticipated to be
delayed as a result of the redirection of resources to the Year 2000 remediation
effort. The Company plans to complete its Year 2000 issue remediation project
at a total external cost of approximately $4.5 million, which will be funded
from operating cash flow and is being expensed as incurred. As of September 30,
1998, the Company has incurred and expensed approximately $1.9 million in
external costs related to its Year 2000 project plan and remediation efforts.
The estimated costs do not include any potential costs related to customer or
other claims, or potential amounts related to executing contingency plans. The
Company does not separately track the internal costs incurred in connection with
the Year 2000 project plan, which are principally payroll costs for employees
working on the project.
Contingency Plans. The Company is currently assessing possible contingency
plans designed to limit, to the extent possible, the business disruption and
financial effects of a failure by the Company to complete its Year 2000
remediation project in a timely manner. Although no formal contingency plan is
yet in place, the Company has considered its likely response in certain
circumstances. For example, if any of the Company's critical systems, such as
the mortgage insurance system's origination or billing applications, are
disrupted due to the Year 2000 issue, it is possible that the Company might need
to process data manually . The Company's intention in this event would be to
seek to procure clerical personnel from temporary recruitment firms to process
data. Hiring such temporary personnel would materially increase the Company's
personnel expense and have a corresponding negative effect on operating income.
In the event of a major system disruption, the Company will have access to
duplicate records of critical data from the Company's systems which are
maintained and stored at an offsite location as a routine procedure related to
the Company's Disaster Recovery Program. These duplicate records could be of
assistance in any Year 2000 recovery operation. The Company's contingency
assessment will continue through 1999 as the Company learns more about the
preparations and vulnerabilities of third parties regarding the Year 2000 issue
and a formal contingency plan is expected to be finalized by June 30, 1999.
See Cautionary Statement and Factors That May Affect Future Results and Market
Price of Stock - General Conditions.
THE DISCUSSION ABOVE IS DESIGNATED AS A YEAR 2000 READINESS DISCLOSURE AS
DEFINED BY THE YEAR 2000 INFORMATION AND READINESS DISCLOSURE ACT OF 1998.
CAUTIONARY STATEMENT
Certain written and oral statements made or incorporated by reference from time
to time by the Company or its representatives in this document, other documents
filed with the Securities and Exchange Commission, press releases, conferences,
or otherwise that are not historical facts, or are preceded by, followed by or
that include the words "believes", "expects", "anticipates", "estimates", or
similar expressions, and that relate to future plans, events or performance are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements include the
following: (i) management expects the percentage of the Company's total risk
represented by risk-share programs and pool risk will continue to increase in
the foreseeable future; (ii) PMI's persistency may continue to decline in
the fourth quarter of 1998; (iii) management anticipates ceded premiums to
increase in the future as a result of the expected increase in risk-share
programs; (iv) management believes that PMI's total default rate could increase
in the fourth quarter of 1998 and into 1999 due to the continued maturation of
its 1994 and 1995 books of business; (v) 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; (vi) 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; and (vii) management anticipates ceded premiums will increase in the
future as a result of the expected increase in risk-share programs. 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.
The costs of Year 2000 remediation, the dates on which the Company estimates
that it will complete such remediation and possible risks associated with the
Year 2000 issue are based upon the Company's current estimates and are subject
to various uncertainties that could cause the actual results to differ
materially from the Company's expectations. Such uncertainties include, among
others, the success of the Company in identifying systems that are not Year 2000
compliant, the nature and amount of programming required to remediate each
affected system, the nature and adequacy of testing performed by the Company,
the availability of qualified personnel, consultants and other resources, and
the success of the Year 2000 remediation efforts of others. The Company's
failure to remediate its mission critical mortgage insurance origination and
procession applications in a timely
fashion could adversely impact its business operations and could have a material
adverse affect on the Company's financial condition, liquidity and results of
operation. See Management Discussion and Analysis - Year 2000 Issues.
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.
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 (see Fannie Mae
and Freddie Mac, below). 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.
The GSEs are offering programs which allow a borrower to secure financing for a
mortgage that has a loan-to-value ratio ("LTV") in excess of 95% and less than
or equal to 97% ("97s"), which generally allow greater flexibility for the
source of down payment. These programs created an opportunity for private
mortgage insurers, including PMI, to compete more effectively with the FHA
in this segment of the market. Freddie Mac's "Alt 97" program, is similar to
Fannie Mae's "Flexible 97" program. The GSEs believe the risk profile for Alt 97
and Flexible 97 is reduced because of the different credit evaluation standards
and underwriting criteria applied, in contrast to the standards for the
traditional 97s product. These GSE programs require eighteen percent mortgage
insurance coverage, in comparison to the 97s which required a range of 25 to 30
percent mortgage insurance coverage. Management believes it is too early to
ascertain the impact of the GSEs 97s programs. PMI has experienced an increase
in 97s that it has insured in the nine months ending September 30, 1998 over the
comparable period in 1997 and believes the increase is due primarily to the GSE
programs. However as noted the GSE 97s feature shallower mortgage insurance
coverage, and correspondingly lower premiums for PMI. If the GSE 97s reduced
coverage programs
are expanded across broader LTV limits it could have a material and adverse
impact on the Company's financial condition and results of operations.
PMI offers various risk-sharing structured transactions, including a captive
reinsurance program as part of its strategic relationships with its customers.
PMI's customers have indicated an increasing demand for such products. PMI's
captive reinsurance program allows a reinsurance company, generally an affiliate
of the lender, to assume mortgage insurance default losses at a specified entry
point up to a maximum aggregate exposure, up to an agreed upon amount of total
coverage. Captive reinsurance programs currently generate an increasing
percentage of PMI's NIW and will continue to generate an increasing percentage
of PMI's business revenue. Based on the current structure, such products have
the potential of reducing the Company's business revenues as more premiums are
ceded to customer captives. There can be no assurance that PMI's risk-sharing
structured transactions will continue to be accepted by its customers or
generate the levels of business revenues experienced to date. The inability of
the Company to provide acceptable risk-sharing structured transactions to its
customers would likely have an adverse affect on the competitive position of PMI
and consequently could materially and adversely affect the Company's financial
condition, liquidity 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 Omnibus Spending Bill of 1999, signed into law on October 21, 1998,
increased the maximum individual loan amount that the FHA can insure to $197,620
from $170,362. The maximum individual loan amount that the VA can insure is
$203,150. The Omnibus Spending Bill of 1999 also streamlined the FHA
downpayment formula by eliminating tiered minimum cash investment requirements
and establishing 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.
During October 1998, Freddie Mac sought to amend its charter to allow it to use
any method of default loss protection that is financially equal or superior, on
an individual or pooled basis, to the protection provided by private mortgage
insurance companies. The legislation containing the proposed charter amending
was subsequently rescinded. Currently, Freddie Mac can purchase loans with down
payments of less than 20%, only if the loans are insured or use other limited
methods to protect against default.
Subsequent to the recession of the legislation, Freddie Mac announced that it
would pursue a permanent charter amendment that would allow Freddie Mac to
utilize alternative forms of default loss protection, such as spread accounts,
or otherwise forego the use of private mortgage insurance on higher loan-to-
value mortgages. In addition, Fannie Mae announced it is interested in pursuing
new risk management options and is working with mortgage insurers and lenders on
appropriate risk management and dispersion of risk, which may include a
reduction in the use of mortgage insurance.
Although management believes that it is too early to ascertain the impact of the
increase in the maximum individual loan amount the FHA can insure for HUD, any
increase in the FHA loan limit, or any change in legislation which affects the
ability of FHA, Freddie Mac, Fannie Mae of the VA to offer a substitute for
mortgage insurance 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. See Fannie Mae and
Freddie Mac below.
FANNIE MAE AND FREDDIE MAC
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. See
Market Share and Competition, above.
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 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. A decrease in persistency, resulting from policy cancellations
of older books of business affected by refinancings (which are affected, among
other things by decreases in interest rates) may materially and adversely
impact the level or rate of growth of insurance in force or risk in force and
consequently have similar impacts on the Company's financial condition and
results of operations.
RATING AGENCIES
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, principally PMI's capital resources
as computed by the rating agencies.
Rating agencies generally assess capital charges on pool insurance policies
based on price and structure. One published methodology for assessing the
capital requirement for pool insurance is based on the real estate depression
which occurred in oil producing states during the mid-1980's. Management
believes the current capital charge that could be levied on pool insurance risk
by one rating agency is approximately $1.00 of capital for each $1.40 of pool
insurance risk. In comparison, primary mortgage insurance regulators
specifically limit the amount of insurance risk that may be written by PMI to a
multiple of 25 times PMI's statutory capital (which includes the contingency
reserve). The rating agencies could change their view as to the capital charges
that are assessed on pool insurance products at any time. See Changes in
Composition of Insurance Risk Written; Pool insurance, below.
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.
LIQUIDITY
TPG's principal sources of funds are dividends from PMI and APTIC, investment
income and funds that may be raised from time to time in the capital markets.
Numerous factors bear on the Company's ability to maintain and meet its capital
and liquidity needs, including the performance of the financial markets,
standards and factors used by various credit rating agencies, financial
covenants in credit agreements, and standards imposed by state insurance
regulators relating to the payment of dividends by insurance companies. Any
significant change in the performance of the financial markets negatively
affecting the Company's ability to secure sources of capital, or changes in the
standards used by credit rating agencies which adversely impact PMI's claim-
paying ability rating, or changes in the insurance laws of Arizona, Florida or
Wisconsin that restrict the ability of PMI, APTIC or CMG to pay dividends at
currently permissible levels, could adversely affect the Company's ability to
maintain capital resources to meet its business needs, and thereby have a
material, adverse affect on the Company's financial condition, liquidity and
results of operations.
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.
TPG and PMI, from time to time, introduce new mortgage insurance products or
programs. The Company's financial condition and results of operations could be
materially and adversely affected if PMI or the Company experiences delays in
introducing competitive new products and programs. In addition, for any
introduced product, there can be no assurance that such products, including any
mortgage pool type products, or programs will be as profitable as the Company's
existing products and programs.
NEW YORK DEPARTMENT OF INSURANCE
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 RISK 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 September
30, 1998, 46.3% of PMI's risk in force consisted of 95s, which, in PMI's
experience, have had a claims frequency approximately twice that of mortgages
with LTVs equal to or less than 90% and over 85% ("90s"). PMI also offers
coverage for mortgages with LTVs in excess of 95% and up to 97% ("97s"). At
September 30, 1998, 2.8% 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 $201
million in the third quarter of 1998, and $369 million in the nine months ended
September 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. See Rating Agencies, above.
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. See
Rating Agencies, above.
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 18.3%, 7.3%, and 7.0% of its risk in force concentrated and where the
default rate on all PMI policies in force is 3.15%, 3.04% and 2.13% compared
with 2.20% nationwide as of September 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 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 claims-paying
ability is currently rated "AA" by Fitch IBCA. Forestview's previous claims-
paying ability rating of "AA" (Excellent) was withdrawn by Standard and Poor's
Rating Services ("S&P") in 1997. These ratings are subject to revisions or
withdrawal at any time by the assigning rating organization 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 $7.1 million of pool premiums
to Forestview and Forestview reimbursed PMI for pool claims on the covered
policies in the amount of $23.0 million in the nine months ended September 30,
1998. It is anticipated that additional pool claims significantly in excess of
pool premiums will be paid in 1998 and beyond. As of September 30, 1998, the
Company has a $55.6 million reinsurance recoverable from
Forestview, of which $49.6 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.
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, on November 18, 1998.
THE PMI GROUP, INC.
/s/ John M. Lorenzen, Jr.
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John M. Lorenzen, Jr.
Executive Vice President and
Chief Financial Officer
/s/ William A. Seymore
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William A. Seymore
Vice President and Chief
Accounting Officer