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, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________________ to __________________
Commission file number 1-13664
THE PMI GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3199675
(State of Incorporation) (IRS Employer Identification No.)
601 Montgomery Street,
San Francisco, California 94111
(Address of principal executive offices) (Zip Code)
(415) 788-7878
(Registrant's telephone number including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class of Stock Par Value Date Number of Shares
- -------------- --------- ---- ----------------
Common Stock $0.01 06/30/99 29,837,640
THE PMI GROUP, INC.
Index to Quarterly Report on Form 10-Q
June 30, 1999
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, 1999 and 1998 3
Consolidated Balance Sheets as of June 30, 1999 and December 31, 1998 4
Consolidated Statements of Cash Flows for the Six Months Ended June 30,
1999 and 1998 5
Notes to Consolidated Financial Statements 6-11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 12-28
Item 3. Quantitative and Qualitative Disclosures About Market Risk 29
Item 4. Submission of Matters to a Vote of Security Holders 29
Part II - Other Information
Item 5. Other Information 29
Item 6. Exhibits and Reports on Form 8-K 30
Signatures 31
Index to Exhibits 32
2
PART I -- FINANCIAL INFORMAITON
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) 1999 1998 1999 1998
--------- --------- --------- ---------
Revenues
Premiums earned $ 131,330 $ 118,327 $ 260,099 $ 235,173
Investment income, less investment expense 21,827 21,139 43,528 42,716
Realized capital gains 327 2,226 344 10,191
Other income 2,689 5,777 7,453 10,023
--------- --------- --------- ---------
Total revenues 156,173 147,469 311,424 298,103
--------- --------- --------- ---------
Losses and expenses
Losses and loss adjustment expenses 22,847 30,588 52,717 68,675
Policy acquisition costs 21,144 12,790 41,967 25,018
Underwriting and other operating expenses 38,902 35,529 77,805 67,478
Interest expense 1,804 1,797 3,593 3,503
Distributions on preferred capital securities 2,077 2,078 4,155 4,157
--------- --------- --------- ---------
Total losses and expenses 86,774 82,782 180,237 168,831
--------- --------- --------- ---------
Income before income taxes 69,399 64,687 131,187 129,272
Income tax expense 19,940 17,900 38,076 36,717
--------- --------- --------- ---------
Net income $ 49,459 $ 46,787 $ 93,111 $ 92,555
========= ========= ========= =========
Basic net income per common share $ 1.65 $ 1.47 $ 3.10 $ 2.88
========= ========= ========= =========
Diluted net income per common share $ 1.64 $ 1.46 $ 3.09 $ 2.86
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
3
THE PMI GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
(Dollars in thousands) 1999 1998
-------------- -------------
Assets
Investments
Available for sale, at market
Fixed income securities
(amortized cost $1,277,592 and $1,268,625) $ 1,320,173 $ 1,356,869
Equity securities
Common stock (cost $34,702 and $34,129) 63,579 58,785
Preferred stock (cost $17,203 and $17,240) 17,285 17,706
Common stock of affiliates, at underlying book value 63,426 60,450
Short-term investments (at cost, which approximates market) 56,462 38,414
-------------- -------------
Total investments 1,520,925 1,532,224
Cash 10,412 9,757
Accrued investment income 19,609 20,150
Reinsurance recoverable and prepaid premiums 45,657 42,102
Premiums receivable 29,936 24,367
Receivable from affiliates 946 2,229
Receivable from Allstate 25,713 23,657
Deferred policy acquisition costs 69,230 61,605
Property and equipment, net 39,292 37,630
Other assets 51,518 24,149
-------------- -------------
Total assets $ 1,813,238 $ 1,777,870
============== =============
Liabilities
Reserve for losses and loss adjustment expenses $ 224,082 $ 215,259
Unearned premiums 94,496 94,886
Long-term debt 99,508 99,476
Reinsurance balances payable 18,916 14,764
Deferred income taxes 85,388 96,730
Other liabilities and accrued expenses 53,009 60,200
-------------- -------------
Total liabilities 575,399 581,315
-------------- -------------
Company-obligated mandatorily redeemable preferred capital
securities of subsidiary trust holding solely junior subordinated
deferrable interest debenture of the Company 99,058 99,040
Shareholders' equity
Preferred stock -- $.01 par value; 5,000,000 shares authorized - -
Common stock -- $.01 par value; 125,000,000 shares
authorized; and 35,196,002 and 35,196,002 issued 352 352
Additional paid-in capital 265,366 265,040
Accumulated other comprehensive income 46,084 74,462
Retained earnings 1,150,839 1,060,724
Treasury stock (5,358,362 and 4,917,401 shares at cost) (323,860) (303,063)
-------------- -------------
Total shareholders' equity 1,138,781 1,097,515
-------------- -------------
Total liabilities and shareholders' equity $ 1,813,238 $ 1,777,870
============== =============
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) 1999 1998
------------ ----------
Cash flows from operating activities
Net income $ 93,111 $ 92,555
Adjustments to reconcile net income to net cash
provided by operating activities:
Realized capital gains, net (344) (10,191)
Equity in earnings of affiliates (3,127) (1,119)
Depreciation and amortization 3,325 3,093
Changes in:
Reserve for losses and loss adjustment expenses 8,823 (661)
Unearned premiums (390) (13,079)
Deferred policy acquisition costs (7,625) (10,102)
Accrued investment income 541 894
Reinsurance balances payable 4,152 1,604
Reinsurance recoverable and prepaid premiums (3,555) (3,345)
Premiums receivable (5,569) (1,349)
Income taxes 2,999 2,879
Receivable from affiliates 1,283 2,639
Receivable from Allstate (2,056) (4,778)
Other (26,742) 19,803
------------ ----------
Net cash provided by operating activities 64,826 78,843
------------ ----------
Cash flows from investing activities
Proceeds from sales of equity securities 16,085 25,688
Investment collections of fixed income securities - 17,672
Proceeds from sales of fixed income securities 132,888 58,538
Investment purchases
Fixed income securities (141,700) (81,096)
Equity securities (16,239) (37,333)
Net (increase) decrease in short-term investments (18,049) 49,834
Investment in affiliates (740) (24,953)
Purchase of MGICA, Ltd. (7,799) -
Purchase of property and equipment (5,129) (5,736)
------------ ----------
Net cash provided by (used in) investing activities (40,683) 2,614
------------ ----------
Cash flows from financing activities
Proceeds from exercise of stock grants and options 327 1,875
Dividends paid to shareholders (3,018) (3,244)
Purchase of The PMI Group, Inc. common stock (20,797) (82,327)
------------ ----------
Net cash used in financing activities (23,488) (83,696)
------------ ----------
Net increase (decrease) in cash 655 (2,239)
Cash at beginning of period 9,757 11,101
------------ ----------
Cash at end of period $ 10,412 $ 8,862
============ ==========
See accompanying notes to consolidated financial statements.
5
THE PMI GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1999
Note 1 - Basis of presentation
The accompanying unaudited consolidated financial statements include the
accounts of The PMI Group, Inc. ("TPG"), a Delaware corporation; its wholly-
owned subsidiaries, PMI Mortgage Insurance Co. ("PMI"), an Arizona corporation;
Residential Guaranty Co. ("RGC"), an Arizona Corporation; American Pioneer Title
Insurance Company ("APTIC"), a Florida corporation; PMI Mortgage Guaranty Co.
("PMG"), an Arizona corporation; Residential Insurance Co. ("RIC"), an Arizona
corporation; PMI Capital I ("PCI"), a Delaware trust; TPG Insurance Co. ("TIC"),
a Vermont corporation; TPG Segregated Portfolio Co. (Cayman) ("TSPC"), a Cayman
Islands corporation; and PMI's wholly-owned subsidiaries, PMI Mortgage Services
Co. ("MSC"), a California corporation which is engaged in the business of
contract underwriting, and PMI Securities Co. ("SEC"), a Delaware corporation,
which is an inactive broker-dealer. PMI is licensed in all 50 states of the
United States and the District of Columbia. TPG and its subsidiaries are
collectively referred to as the "Company". All material intercompany
transactions and balances have been eliminated in consolidation. In addition,
PMI owns 50% (45% at June 30, 1998) of CMG Mortgage Insurance Company ("CMG"), a
Wisconsin corporation, which also conducts a residential mortgage insurance
business and TPG owns 22.3% of RAM Holdings Ltd. and RAM Holdings II Ltd.
(collectively referred to as "RAM Re"), a financial guaranty reinsurance company
based in Bermuda. CMG and Ram Re are accounted for on the equity method in the
Company's consolidated financial statements.
The Company's unaudited consolidated financial statements have been prepared in
accordance with generally accepted accounting principles (GAAP) for interim
financial information and with the requirements of Form 10-Q. In the opinion of
management, all adjustments (consisting only of normal recurring adjustments)
considered necessary for a fair presentation of the Company's consolidated
financial condition at June 30, 1999, and its consolidated statements of
operations and cash flows for the periods ended June 30, 1999 and 1998, have
been included. Interim results for the periods ended June 30, 1999 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1999. The financial statements should be read in conjunction with
the audited consolidated financial statements and footnotes included in The PMI
Group, Inc. 1998 Annual Report to Shareholders.
Note 2 - Earnings per Share
The weighted average common shares outstanding for computing basic earnings per
share ("EPS") were 29,924,828 and 31,918,220 for the three months ended June 30,
1999 and 1998, respectively and 30,038,999 and 32,173,226 for the six months
ended June 30, 1999 and 1998, respectively. The weighted average common shares
outstanding for computing diluted EPS includes only stock options issued by the
Company that have a dilutive impact and are outstanding for the period, and had
the potential effect of increasing common shares to 30,113,398 and 32,119,224
for the three months ended June 30, 1999 and 1998, respectively and 30,164,738
and 32,361,101 for the six months ended June 30, 1999 and 1998, respectively.
Net income available to common shareholders does not change for computing
diluted EPS.
6
Note 3 -- Comprehensive Income
The reconciliation of net income to comprehensive income for the three months
and six months ended June 30, 1999 and 1998 are as follows:
Three Months Six Months
Ended June 30, Ended June 30,
-------------------------- -----------------------------
(In thousands) 1999 1998 1999 1998
------------ --------- ------------- -------------
Net income $ 49,459 $ 46,787 $ 93,111 $ 92,555
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during period (22,844) 3,213 (28,153) 8,766
Less: reclassification adjustment for gains
included in net income (213) (1,447) (224) (6,624)
------------ --------- ------------- -------------
Other comprehensive income (loss), net of tax (23,057) 1,766 (28,377) 2,142
------------ --------- ------------- -------------
Comprehensive income $ 26,402 $ 48,553 $ 64,734 $ 94,697
============ ========= ============= =============
Note 4 -- New Accounting Pronouncement
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities, which
established accounting and reporting standards for derivative instruments. The
statement, which is effective for fiscal quarters beginning after June 15, 2000,
is not expected to have a significant effect on PMI's financial position or
results of operations based on current operating activities.
7
Note 5 -- Deferred Acquisition Costs ("DAC")
PMI defers certain costs related to the acquisition of primary mortgage
insurance and amortizes these costs against related premium revenue in order to
match costs and revenues in accordance with GAAP. These acquisition costs vary
with, and are primarily related to, the acquisition of new business. Specific
costs PMI defers include field underwriting, field sales, and national accounts.
To the extent PMI or any of its subsidiaries are compensated by customers for
contract underwriting, those underwriting costs are not deferred.
DAC is amortized on an accelerated basis over 24 months rather than the 5-7 year
average policy life. This method is used so that deferred costs will have been
fully amortized prior to the peak claims paying period.
The DAC asset is affected by: (a) acquisition costs deferred in a period, and
(b) amortization of previously deferred costs in such period. In periods where
there is growth in premiums (and therefore acquisition costs), the DAC asset
will increase because the amount of acquisition costs being deferred exceeds the
amount being amortized to expense. The following table reconciles beginning and
ending DAC for the periods indicated.
Three Months Six Months
Ended June 30, Ended June 30,
------------------------------- ----------------------------
(In thousands) 1999 1998 1999 1998
-------------- ------------- ------------ -------------
Beginning DAC balance $ 65,682 $ 40,690 $ 61,605 $ 37,864
Acquisition costs incurred and deferred 24,692 20,066 49,592 35,120
Amortization of deferred costs (21,144) (12,790) (41,967) (25,018)
-------------- ------------- ------------ -------------
Ending DAC balance $ 69,230 $ 47,966 $ 69,230 $ 47,966
============== ============= ============ =============
8
Note 6 -- Business Segments
The Company's reportable operating segments include Mortgage Guaranty Insurance
and Title Insurance. The Mortgage Guaranty Insurance segment includes PMI, PMG,
RGC, RIC, TIC and TSPC. The Title Insurance segment consists of the results for
APTIC. The Other segment includes TPG, MSC, PCI, and SEC. The Other segment
includes the income and expenses of the holding company, the results from the
business of contract underwriting and software licensing, and the activity of an
inactive broker-dealer. Intersegment transactions are not significant. The
Company evaluates performance primarily based on segment net income.
The following tables present information about reported segment income (loss)
and segment assets for the periods indicated:
Mortgage
Quarter Ended June 30, 1999 Guaranty Title Intersegment Consolidated
(In thousands) Insurance Insurance Other Adjustments Total
- -------------------------------------------------------------------------------------------------------------------------------
Premiums earned $ 107,339 $ 23,991 $ - $ - $ 131,330
============== ============ ============= ================ =================
Net underwriting income (expenses)
before tax-external customers $ 49,956 $ 2,715 $ (1,545) $ - $ 51,126
Investment and other income 19,390 380 790 20,560
Equity in earnings of affiliates - - 289 1,305 1,594
Interest expense - - (1,804) (1,804)
Distributions on preferred capital securities - - (2,077) (2,077)
-------------- ------------ ------------- ---------------- -----------------
Income (loss) before income tax expense 69,346 3,095 (4,347) 1,305 69,399
Income tax expense (benefit) 20,272 1,134 (1,466) - 19,940
-------------- ------------ ------------- ---------------- -----------------
Net income (loss) $ 49,074 $ 1,961 $ (2,881) $ 1,305 $ 49,459
============== ============ ============= ================ =================
Total assets $1,680,790 $ 41,776 $ 90,672 $ - $ 1,813,238
============== ============ ============= ================ =================
Mortgage
Quarter Ended June 30, 1998 Guaranty Title Intersegment Consolidated
(In thousands) Insurance Insurance Other Adjustments Total
- -------------------------------------------------------------------------------------------------------------------------------
Premiums earned $ 100,679 $ 17,648 $ - $ - $ 118,327
============== ============ ============= ================ =================
Net underwriting income (expenses)
before tax-external customers $ 43,778 $ 2,077 $ (658) $ - $ 45,197
Investment and other income 20,625 328 1,804 - 22,757
Equity in earnings of affiliates - - - 608 608
Interest expense - - (1,797) - (1,797)
Distributions on preferred capital securities - - (2,078) - (2,078)
-------------- ------------ ------------- ---------------- -----------------
Income (loss) before income tax expense 64,403 2,405 (2,729) 608 64,687
Income tax expense (benefit) 18,052 881 (1,033) - 17,900
-------------- ------------ ------------- ---------------- -----------------
Net income (loss) $ 46,351 $ 1,524 $ (1,696) $ 608 $ 46,787
============== ============ ============= ================ =================
Total assets $1,555,576 $ 35,587 $ 114,668 $ - $ 1,705,831
============== ============ ============= ================ =================
9
Mortgage
Six Months Ended June 30, 1999 Guaranty Title Intersegment Consolidated
(In thousands) Insurance Insurance Other Adjustments Total
- -------------------------------------------------------------------------------------------------------------------------------
Premiums earned $ 212,577 $ 47,522 $ - $ - $ 260,099
============== ============ ============= ================ =================
Net underwriting income (expenses)
before tax-external customers $ 93,296 $ 4,940 $ (3,173) $ - $ 95,063
Investment and other income 38,541 748 1,457 - 40,746
Equity in earnings of affiliates - - 578 2,548 3,126
Interest expense - - (3,593) - (3,593)
Distributions on preferred capital securities - - (4,155) - (4,155)
-------------- ------------ ------------- ---------------- -----------------
Income (loss) before income tax expense 131,837 5,688 (8,886) 2,548 131,187
Income tax expense (benefit) 38,919 2,071 (2,914) - 38,076
-------------- ------------ ------------- ---------------- -----------------
Net income (loss) $ 92,918 $ 3,617 $ (5,972) $ 2,548 $ 93,111
============== ============ ============= ================ =================
Total assets $1,680,790 $ 41,776 $ 90,672 $ - $ 1,813,238
============== ============ ============= ================ =================
Mortgage
Six Months Ended June 30, 1998 Guaranty Title Intersegment Consolidated
(In thousands) Insurance Insurance Other Adjustments Total
- -------------------------------------------------------------------------------------------------------------------------------
Premiums earned $ 200,823 $ 34,350 $ - $ - $ 235,173
============== ============ ============= ================ =================
Net underwriting income (expenses)
before tax-external customers $ 82,151 $ 3,694 $ (1,820) $ - $ 84,025
Investment and other income 47,379 650 3,759 - 51,788
Equity in earnings of affiliates - - - 1,119 1,119
Interest expense - - (3,503) - (3,503)
Distributions on preferred capital securities - - (4,157) - (4,157)
-------------- ------------ ------------- ---------------- -----------------
Income (loss) before income tax expense 129,530 4,344 (5,721) 1,119 129,272
Income tax expense (benefit) 37,079 1,580 (1,942) - 36,717
-------------- ------------ ------------- ---------------- -----------------
Net income $ 92,451 $ 2,764 $ (3,779) $ 1,119 $ 92,555
============== ============ ============= ================ =================
Total assets $1,555,576 $ 35,587 $ 114,668 $ - $ 1,705,831
============== ============ ============= ================ =================
The Company did not have any major customers that accounted for more than 10% of
its consolidated revenues for any of the periods presented. The Company does not
have any material revenues or assets attributed to or located outside the United
States.
Note 7 -- Subsequent Events
On August 6, 1999, TPG announced it had completed the acquisition of MGICA, Ltd.
("MGICA"), Australia's second largest mortgage insurance company. MGICA is now
an indirect wholly owned subsidiary of PMI. The transaction purchase price was
US$77.6 million. TPG has also agreed to guarantee repayment of the debt incurred
to finance a portion of the purchase price. MGICA has a Standard and Poor's
("S&P") claim paying ability rating of AA- and a Moody's Investor Services
("Moody's") financial strength rating of A1. S&P and Moody's have affirmed both
PMI's and MGICA's ratings following the acquisition based upon PMI's execution
of a Support agreement to maintain MGICA's capital at certain minimum levels.
10
On July 29, 1999, the California Department of Insurance approved the Recapture
Agreement between PMI and Forestview Mortgage Insurance Company. Closing of the
transactions that are the subject of the Recapture Agreement is subject to
additional regulatory approvals, which are expected to be received in 1999.
On July 27, 1999, the Company received $30.2 million from Allstate Insurance Co.
as payment of a tax refund due to the Company under a tax sharing agreement
executed by TPG, The Allstate Corporation, The Allstate Insurance Company and
Sears, Roebuck and Co., in connection with the Company's initial public offering
in April 1995. (See Note 7 "Income Taxes" in the 1998 Annual Report to
Shareholders.)
On July 21, 1999, TPG announced that its Board of Directors declared a 3-for-2
stock split in the form of a 50 percent stock dividend, and increased its cash
dividend level to 6 cents per share on a pre-split basis. The stock split will
be payable on August 16, 1999 to shareholders of record on July 30, 1999.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAUTIONARY STATEMENT
Certain written and oral statements made or incorporated by reference from time
to time by the Company or its representatives in this document, other documents
filed with the Securities and Exchange Commission, press releases, conferences,
or otherwise that are not historical facts, or are preceded by, followed by or
that include the words "believes," "expects," "anticipates," "estimates," or
similar expressions, and that relate to future plans, events or performance are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements include the
following: (i) management anticipates that the decrease in refinancing activity
will continue in 1999; (ii) during 1999, management expects the percentage of
PMI's risk related to risk-share programs to continue to increase as a
percentage of total risk; (iii) management believes the Fannie Mae and Freddie
Mac reduction in mortgage insurance coverage requirements is expected to have a
negative impact on the growth rate of direct risk in force; (iv) management
anticipates that the percentage of NIW subject to captive mortgage reinsurance
agreements will continue to increase in 1999 and beyond. In addition, the
anticipated continued growth of captive reinsurance arrangements is expected to
have a negative effect on the Company's net premiums written and net premiums
earned for such customers with captive arrangements; (v) management anticipates
ceded premiums will continue to increase substantially as a result of the
expected increase in risk-share programs; (vi) management anticipates the
percentage of insurance in force with higher coverage percentages will decrease
in 1999 and this decreases should accelerate in the years following due to a
reduction in required mortgage insurance by Fannie Mae and Freddie Mac; (vii)
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; (viii)
management believes that PMI's total default rate could increase in 1999 due to
the continued maturation of its 1995 and 1996 books of business; (ix) management
anticipates that contract underwriting will continue to generate a significant
percentage of PMI's new insurance written ("NIW"); and (x) management is
uncertain about the amount of new pool risk which will be written in 1999, but
believes total new 1999 pool risk will be less than in 1998. When a forward-
looking statement includes a statement of the assumptions or bases underlying
the forward-looking statement, the Company cautions that, while it believes such
assumptions or bases to be reasonable and makes them in good faith, assumed
facts or bases almost always vary from actual results, and the difference
between assumed facts or bases and actual results can be material, depending on
the circumstances. Where, in any forward-looking statement, the Company or its
management expresses an expectation or belief as to future results, such
expectations or belief is expressed in good faith and believed to have a
reasonable basis, but there can be no assurance that the statement of
expectation or belief will result or be achieved or accomplished. The Company's
actual results may differ materially from those expressed in any forward-looking
statements made by the Company. These forward-looking statements involve a
number of risks or uncertainties including, but not limited to, the items
addressed in the section titled "Cautionary Statements and Investment
Considerations" ("IC# 1-15") set forth below and other risks detailed from time
to time in the Company's periodic filings with the Securities and Exchange
Commission.
All forward-looking statements of the Company are qualified by and should be
read in conjunction with such risk disclosure. The Company undertakes no
obligation to publicly update or revise any forward-looking statements, whether
as a result of new information, future events or otherwise.
12
RESULTS OF CONSOLIDATED OPERATIONS:
THREE MONTHS ENDED JUNE 30, 1999 AND 1998
Consolidated net income was $49.5 million in the three months ended June 30,
1999, a 5.8% increase over the corresponding period of 1998. The increase can be
attributed to an increase in premiums earned of 11.0% and a decrease in losses
and loss adjustment expenses of 25.3%, partially offset by a 53.5% decrease in
other income, a 85.3% decrease in realized capital gains and a 65.3% increase in
policy acquisition costs, and a 9.5% increase in underwriting and other
operating expenses. Including capital gains, diluted earnings per share
increased 12.3% to $1.64 for the second quarter of 1999. Excluding capital
gains, diluted operating earnings per share increased by 16.3% to $1.64.
Revenues in the second quarter of 1999 increased by 5.9% to $156.2 million,
compared with the same period in 1998.
MORTGAGE INSURANCE OPERATIONS
PMI's new primary insurance written ("NIW") increased by 10.1% to $7.6 billion
in the second quarter of 1999 compared with the second quarter of 1998,
primarily as a result of the growth in volume of the private mortgage insurance
industry as well as the increase in PMI's market share.
The members of the private mortgage insurance industry, as reported by the
industry's trade association, Mortgage Insurance Companies of America ("MICA"),
experienced an increase in total new insurance written of 6.9% to $49.6 billion
in the second quarter of 1999 from the corresponding period of 1998 primarily
due to strong home purchase activity partially offset by a decrease in
refinancing activity. Refinancing as a percentage of PMI's NIW decreased to
25.6% in the second quarter of 1999 from 31.5% in the second quarter of 1998 and
from 37.2% in the first quarter of 1999. Management anticipates that the
decrease in refinancing activity will continue in 1999. (See IC4) The private
mortgage insurance companies' market share in the three months ended June 30,
1999 decreased to 50.9%, of the total low down-payment market (insurable loans)
from 58.3% in the second quarter of 1998 and from 51.1% in the three months
ended March 31, 1999. Management believes the private mortgage insurance
companies' decline in the low down-payment market share was the result of an
increase in the maximum individual loan amount that the FHA/VA can insure. (See
IC2)
PMI's market share of NIW was 15.3% in the second quarter of 1999, an increase
from 14.6% in the first quarter of 1999, and an increase from 14.9% in the three
months ended June 30, 1998. On a combined basis with CMG, market share increased
to 16.5% in the second quarter of 1999 compared with 16.3% in the second quarter
of 1998, and 15.9% in the first quarter of 1999. The increases in market share
were primarily due to contract underwriting services, pool insurance products,
and risk sharing programs offered by PMI. Pool risk written totaled $61.0
million for the second quarter of 1999 compared with $38.0 million in the second
quarter of 1998. Risk in force under risk-share programs with PMI's customers,
excluding pool insurance, represented approximately 14.9% of the $19.8 billion
total primary risk in force at June 30, 1999. Risk in force under pool insurance
arrangements represented 2.8% of total risk in force at June 30, 1999, compared
with less than one percent at June 30, 1998. During 1999, management expects the
percentage of PMI's risk related to risk-share programs to continue to increase
as a percent of total risk. The Fannie Mae and Freddie Mac reduction in mortgage
insurance coverage requirements is expected to have a negative impact on the
growth rate of direct risk in force. (See IC10)
PMI's cancellations of insurance in force remained unchanged at $6.7 billion in
the second quarter of 1999 compared to the corresponding period of 1998.
However, PMI's persistency rate of 66.1% as of June 30, 1999 increased compared
with 66.0% as of March 31, 1999 but decreased compared with 73.9% as of June 30,
1998 .
Insurance in force increased by 6.1% to $82.3 billion at June 30, 1999 compared
with June 30, 1998 and when on a combined basis with CMG, insurance in force
grew by 8.0% to $87.4 billion compared with June 30, 1998. PMI's market share of
insurance in force increased by 0.1 percentage points to 14.4% and when combined
13
with CMG increased by 0.4 percentage points to 15.3% for the second quarter of
1999 compared with the second quarter of 1998. PMI's risk in force increased by
8.2% to $19.8 billion at June 30, 1999 and when combined with CMG grew by 10.5%
to $21.1 billion compared with June 30, 1998. The growth rate of risk in force
is greater than insurance in force due to terminating policies being replaced by
new policies with higher coverage percentages.
Mortgage insurance net premiums written (which includes net cessions and
refunds) grew by 14.2% to $113.5 million in the second quarter of 1999 compared
with the same period in 1998 primarily due to the growth of risk in force of
both primary and pool insurance, the continued shift to deeper coverage for
primary insurance and a decrease in refunded premiums of 34.8% to $5.3 million
as a result of a greater percentage of monthly policies, which are non-
refundable, being cancelled. Approximately 15.8% of new insurance written in the
second quarter of 1999 was subject to captive mortgage reinsurance agreements.
Management anticipates that the percent of NIW subject to captive mortgage
reinsurance agreements will continue to increase in 1999 and beyond. In
addition, the anticipated continued growth of captive reinsurance arrangements
is expected to have a negative effect on the Company's net premiums written and
net premiums earned for such customers with captive arrangements. (See IC15)
Mortgage insurance premiums earned increased 6.6% to $107.3 million in the
second quarter of 1999 compared with the same period in 1998 primarily due to
the increase in premiums written. Ceded premiums, which include third-party
reinsurance arrangements as well as captive reinsurance agreements, were $8.0
million in the second quarter of 1999, increasing 77.8% from the second quarter
of 1998. Management anticipates ceded premiums will continue to increase
substantially as a result of the expected increase in risk-share programs. (See
IC7 and IC15)
PMI's monthly product represented 76.8% of risk in force at June 30, 1999,
compared with 64.7% at June 30, 1998. Mortgages with original loan-to-value
ratios greater than 90% and equal to or less than 95% ("95s") with 30% insurance
coverage increased to 35.9% of risk in force as of June 30, 1999, from 31.6% as
of June 30, 1998. Mortgages with original loan-to-value ratios greater than 85%
and equal to or less than 90% ("90s") with 25% insurance coverage increased to
31.2% of risk in force as of June 30, 1999, compared with 26.4% as of June 30,
1998. Management anticipates the percentage of insurance in force with higher
coverage percentages will decrease in 1999 and this decrease should accelerate
in the years following due to a reduction in required mortgage insurance by
Fannie Mae and Freddie Mac. (See IC3)
Mortgage insurance losses and loss adjustment expenses decreased 26.4% to $22.6
million in the second quarter of 1999 compared with the second quarter of 1998
primarily due to the continuing improvement of the nationwide housing markets,
particularly California, and the corresponding decrease in claim payments. Loans
in default decreased by 4.2% to 14,338 at June 30, 1999 compared with June 30,
1998. PMI's national default rate decreased by 0.17 percentage points to 1.99%
at June 30, 1999 compared with the same period in 1998, primarily due to a
decrease in the loans in default inventory and secondarily to an increase in
policies in force.
Direct primary claims paid in the second quarter of 1999 decreased by 45.8% to
$18.6 million when compared with the same period in 1998 due to a 14.8% decrease
in the average claim size to approximately $20,900 and a 31.7% decline in the
number of claims paid to 965 for the second quarter of 1999. The reduction in
claims paid is the result of a smaller percentage of claims originating from the
California book of business and to increased loss mitigation efforts by PMI and
lenders.
Default rates on PMI's California policies decreased to 2.59% (representing
2,414 loans in default) at June 30, 1999, from 3.20% (representing 3,252 loans
in default) at June 30, 1998. Policies written in California accounted for 34.1%
and 52.2% of the total dollar amount of claims paid in the second quarter 1999
and 1998, respectively. Although management expects that California will
continue to account for a significant portion of total claims paid, management
anticipates that with continued improvement in the California economy, increased
benefits of loss mitigation efforts and improved default reinstatement rates,
California claims paid as a percentage of total claims paid should continue to
decline. (See IC13) Management believes that PMI's total default rate could
increase in 1999 due to the continued maturation of its 1995 and 1996 books of
business. (See IC11)
14
Mortgage insurance policy acquisition costs incurred and deferred (including,
among other field expenses, contract underwriting expenses) increased by 22.9%
to $24.7 million in the second quarter of 1999 compared with the same period in
1998 as a result of the 10.1% increase in NIW. Amortization of policy
acquisition costs increased 64.8% to $21.1 million during the same period. (See
Note 5 "Deferred Acquisition Costs" of Notes to Consolidated Financial
Statements) New policies processed by contract underwriters represented 37.1% of
PMI's second quarter NIW in 1999 compared with 33.6% in 1998. Contract
underwriting is the preferred method among many mortgage lenders for processing
loan applications. Management anticipates that contract underwriting will
continue to generate a significant percentage of PMI's NIW. (See IC7)
Underwriting and other mortgage insurance operating expenses increased by 1.5%
to $13.7 million in the second quarter of 1999 compared with the second quarter
of 1998. Included in operating expenses were Year 2000 remediation costs of $0.2
million in the second quarter of 1999, compared with $0.5 million of such costs
in the second quarter of 1998. The mortgage insurance loss ratio declined by 9.3
percentage points to 21.1% in the period ended June 30, 1999 compared with the
same period in 1998. The decrease can be attributed to the growth in premiums
earned coupled with the decrease in losses and loss adjustment expenses, as
discussed above. The expense ratio increased by 4.3 percentage points to 30.7%
primarily due to the increase in policy acquisition costs resulting from the
growth in NIW. In addition, a reduction in pool premiums and an increase in
captive reinsurance premium cessions negatively affected premiums written. The
combined ratio decreased by 5.0 percentage points to 51.8% in the second quarter
of 1999 compared with the same period in 1998.
TITLE INSURANCE OPERATIONS
Title insurance premiums earned increased 36.4% to $24.0 million in the three
months ended June 30, 1999 compared with the same period in 1998 primarily due
to the record residential mortgage origination volumes, as discussed above, and
secondarily to APTIC's expansion into new states. APTIC was writing business in
31 states at June 30, 1999, up from 29 states at June 30, 1998. In the second
quarter of 1999, approximately 74.0% of APTIC's premiums earned came from its
Florida operations, compared with approximately 76.0% in 1998. Underwriting and
other expenses increased 34.6% to $21.0 million in the second quarter of 1999
compared with the same period in 1998 due to an increase in agency fees and
commissions related to the increase in premiums earned. The title insurance
combined ratio increased by 0.4 percentage points to 88.7%.
OTHER
Other income generated by other subsidiaries decreased by 53.4% to $2.7 million
in the second quarter of 1999 compared with the second quarter of 1998 primarily
due to a decrease in MSC's contract underwriting revenues as a result of the
decline in refinancing activity. Underwriting and other expenses generated by
other subsidiaries decreased by 34.4% to $4.2 million, primarily due to a $1.4
million decrease in expenses incurred by MSC resulting from contract
underwriting services provided to the Company's mortgage insurance customers.
(See IC7)
In the period ended June 30, 1999, the Company's net investment income
(including realized capital gains) decreased by 5.1% to $22.2 million when
compared with the second quarter of 1998 primarily due to a $1.9 million
decrease in realized gains on investments. In addition, the yield decreased to
5.9% at June 30, 1999 from 6.1% at June 30, 1998 primarily as a result of the
declining interest rate environment for the same period.
15
The Company's effective tax rate increased to 28.7% in the second quarter of
1999 from 27.7% in the second quarter of 1998 as a result of a decrease in the
proportion of tax-exempt investment income relative to total income.
SIX MONTHS ENDED JUNE 30, 1999 AND 1998
Consolidated net income was $93.1 million in the six months ended June 30, 1999,
a 0.5% increase over the corresponding period of 1998. The increase can be
attributed to an increase in premiums earned of 10.6% and a decrease in losses
and loss adjustment expenses of 23.3%, partially offset by a 96.6% decrease in
net realized gains, a 67.7% increase in policy acquisition costs and a 15.3%
increase in underwriting and other expenses. Including capital gains, diluted
earnings per share increased by 8.0% to $3.09 in 1999. Excluding capital gains,
diluted operating earnings per share increased by 15.8% to $3.08. Revenues in
the first half of 1999 increased by 4.5% to $311.4 million.
MORTGAGE INSURANCE OPERATIONS
PMI's NIW increased by 27.4% to $14.9 billion in the first six months of 1999
compared with the corresponding period of 1998, primarily as a result of the
growth in volume of the private mortgage insurance industry as well as the
increase in PMI's market share.
The members of the private mortgage insurance industry, as reported by the
industry's trade association, Mortgage Insurance Companies of America ("MICA"),
experienced an increase in total new insurance written of 22.1% to $99.5 billion
for the period ended June 30, 1999 from the corresponding period of 1998
primarily due to strong home purchase activity partially offset by a decrease in
refinancing activity. Refinancing as a percentage of PMI's NIW decreased to
31.3% for the six months ended June 30, 1999 from 32.8% for the same period of
1998. Management anticipates that the decrease in refinancing activity will
continue in 1999. The private mortgage insurance companies' market share
decreased to 51.8% for the six months ended June 30, 1999, of the total low
down-payment market (insurable loans) from 56.4% for the same period of 1998.
Management believes the private mortgage insurance companies' decline in the low
down-payment market share was the result of an increase in the maximum
individual loan amount that the FHA/VA can insure. (See IC2)
PMI's market share of NIW was 14.9% in the first six months of 1999, an increase
from 14.4% in the first six months of 1998. On a combined basis with CMG, market
share increased to 16.2% in the first half of 1999 compared with 15.8% in the
first half of 1998. The increases in market share were primarily due to contract
underwriting services, pool insurance products, and risk sharing programs
offered by PMI. Pool risk written totaled $103.0 million for the first six
months of 1999 compared with $52.0 million in the period ended June 30, 1998.
The Fannie Mae and Freddie Mac reduction in mortgage insurance coverage
requirements is expected to have a negative impact on the growth rate of direct
risk in force. (See IC10)
Mortgage insurance net premiums written (which includes net cessions and
refunds) grew by 12.5% to $211.9 million in the first six months of 1999
compared with the same period in 1998 primarily due to the growth of risk in
force of both primary and pool insurance, the continued shift to deeper coverage
for primary insurance, and a decrease in refunded premiums of 17.0% to $9.3
million as a result of a greater percentage of monthly policies, which are non-
refundable, being cancelled. Mortgage insurance premiums earned increased 5.9%
to $212.6 million in the first half of 1999 compared with the same period in
1998 primarily due to the increase in premiums written. Ceded premiums were
$15.6 million in the first six months of 1999, increasing 69.6% from the
corresponding period in 1998. Management anticipates ceded premiums will
continue to increase substantially as a result of the expected increase in risk-
share programs. (See IC7 and IC15)
Mortgage insurance losses and loss adjustment expenses decreased 23.8% to $52.2
million in the first half of 1999 compared with the first half of 1998 primarily
due to the continuing improvement of the nationwide housing markets,
particularly California, and the corresponding decrease in claim payments.
Direct primary claims paid in the six months ended June 30, 1999 decreased by
38.2% to $41.6 million when compared with the same period in 1998 due to a 14.8%
decrease in the average claim size to approximately $20,900 and a 27.4% decline
in the number of claims paid to 1,993. The reduction in claims paid is the
result of a smaller percentage of claims originating from the California book of
business and to increased loss mitigation efforts by PMI and lenders.
Mortgage insurance policy acquisition costs incurred and deferred (including,
among other field expenses, contract underwriting expenses) increased by 41.3%
to $49.6 million for the first six months of 1999 compared with the same period
in 1998 as a result of the 27.4% increase in NIW. Amortization of policy
acquisition costs increased 68.0% to $42.0 million for the same period. (See
Note 5 "Deferred Acquisition Costs" of Notes to Consolidated Financial
Statements) New policies processed by contract underwriters represented 38.7% of
PMI's NIW in 1999 compared with 32.1% in 1998. Contract underwriting is the
preferred method among many mortgage lenders for processing loan applications.
Management anticipates that contract underwriting will continue to generate a
significant percentage of PMI's NIW. (See IC7)
16
Underwriting and other mortgage insurance operating expenses remained virtually
unchanged at $25.1 million in the first six months of 1999 compared with the
same period of 1998. Included in operating expenses were Year 2000 remediation
costs of $0.8 million in the first half of 1999, compared with $1.0 million of
such costs in the first half of 1998. The mortgage insurance loss ratio declined
by 9.5 percentage points to 24.6% in the period ended June 30, 1999 compared
with the same period in 1998. The decrease can be attributed to the growth in
premiums earned coupled with the decrease in losses and loss adjustment
expenses, as discussed above. The expense ratio increased by 5.0 percentage
points to 31.7% primarily due to the increase in policy acquisition costs
resulting from the growth in NIW. In addition, a reduction in pool premiums and
an increase in captive reinsurance premium cessions negatively affected premiums
written. The combined ratio decreased by 4.5 percentage points to 56.3% in the
first six months of 1999 compared with the same period in 1998.
TITLE INSURANCE OPERATIONS
Title insurance premiums earned increased 38.1% to $47.5 million in the six
months ended June 30, 1999 compared with the same period in 1998 primarily due
to the record residential mortgage origination volumes, as discussed above, and
secondarily to APTIC's expansion into new states. APTIC was writing business in
31 states at June 30, 1999, up from 29 states at June 30, 1998. In the first six
months of 1999, approximately 71% of APTIC's premiums earned came from its
Florida operations, compared with approximately 76% in 1998. Underwriting and
other expenses increased 38.0% to $42.1 million in the first half of 1999
compared with the same period in 1998 due to an increase in agency fees and
commissions related to the increase in premiums earned. The title insurance
combined ratio increased by 0.3 percentage points to 89.6%.
OTHER
Other income generated by other subsidiaries decreased by 26.0% to $7.4 million
in the period ended June 30, 1999 compared with the same period of 1998
primarily due to a decrease in MSC's contract underwriting revenues
as a result of the decrease in refinancing activity. Underwriting and
other expenses generated by other subsidiaries decreased by 10.2% to $10.6
million, primarily due to expenses of $10.3 million incurred by MSC resulting
from contract underwriting services provided to the Company's mortgage insurance
customers. (See IC7)
In the period ended June 30, 1999, the Company's net investment income
(including realized capital gains) decreased 1.9% to $43.5 million when
compared with the first half of 1998 primarily due to a $9.8 million decrease in
realized gains on investments. In addition, the yield decreased to 5.9% at June
30, 1999 from 6.1% at June 30, 1998 primarily as a result of the declining
interest rate environment for the same period.
The Company's effective tax rate increased to 29.0% in the first half of 1999
from 28.4% in the first half of 1998 as a result of a decrease in the proportion
of tax-exempt investment income relative to total income.
LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION
Liquidity and capital resource considerations are different for TPG and PMI, its
principal insurance operating subsidiary. TPG's principal sources of funds are
dividends from PMI and APTIC, investment income and funds that may be raised
from time to time in the capital markets.
PMI's ability to pay dividends to TPG is limited, among other restrictions,
under the insurance laws of Arizona. Such laws provide that: (i) PMI may pay
dividends out of available surplus and (ii) without prior approval of the
17
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.
The terms of the A$70.5 million credit agreement dated August 3, 1999 executed
among TPG, MGICA, and Bank of America, N.A., in connection with the Company's
acquisition of MGICA, provide in part that: (i) TPG's consolidated net worth
shall not be less than $600 million; (ii) PMI's statutory capital shall not be
less than $675 million; (iii) the risk to capital ratio shall not exceed 23 to
1; and (iv) TPG's consolidated debt to capital ratio shall not exceed 0.40 to
1.0. In addition, PMI's and MGICA's ability to pay dividends or incur additional
indebtedness are restricted. Failure to maintain such financial covenants or
debt restrictions may be deemed an event of default. Pursuant to the guarantee
executed by TPG in connection with the credit agreement, if an event of default
occurs under the credit agreement or under any other indebtedness, all
outstanding amounts under the credit agreement may be accelerated and become
immediately payable by TPG.
In addition to the dividend restrictions described above, the Company's other
credit agreements also limit the payment of dividends by PMI, and various credit
rating agencies and insurance regulatory authorities have broad discretion to
limit the payment of dividends to TPG by PMI or APTIC. During the first half of
1999, APTIC declared and paid a cash dividend of $3.0 million to TPG,
substantially the full amount of a dividend that can be paid by APTIC in 1999
without prior permission from the Florida Department of Insurance. On June 16,
1999, the Arizona Department of Insurance also authorized a dividend of $25
million to TPG, which was paid in cash on June 23, 1999. TPG has two bank credit
lines available totaling $50.0 million. At June 30, 1999, there were no
outstanding borrowings under the credit lines.
TPG's principal uses of funds are common stock repurchases, the payment of
dividends to shareholders, funding of acquisitions, additions to its investment
portfolio, investments in subsidiaries, and the payment of interest. The
Company announced a stock repurchase program in the amount of $100.0 million
authorized by the TPG Board of Directors in November 1998. During the first half
of 1999, TPG purchased $20.8 million of the Company's common stock.
As of June 30, 1999, TPG had approximately $52.5 million of available funds.
This amount has decreased from the December 31, 1998 balance of $56.1 million
due to the common stock repurchases in 1999, offset by dividends received from
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 $53.1 million and $66.8
million in the six months ended June 30, 1999 and 1998, respectively. The
decrease is primarily due to the decrease in net realized capital gains for the
same period.
The Company's invested assets decreased by $11.3 million at June 30, 1999
compared with December 31, 1998 partially due a decrease in net unrealized gains
on investments of $28.4 million, stock repurchases of $20.8 million and
dividends paid of $3.0 million.
Consolidated reserves for losses and loss adjustment expenses increased by 4.1%
in the first half of 1999 compared with December 31, 1998 primarily due to the
increase in pool loss reserves.
Consolidated shareholders' equity increased by $41.3 million in the first half
of 1999, consisting of increases of $93.1 million from net income and $0.4
million from exercises of stock options, offset by a $28.4 million decrease in
net unrealized gains on investments included in other comprehensive income,
common stock repurchases of $20.8 million, and dividends declared of $3.0
million.
PMI's statutory risk-to-capital ratio at June 30, 1999 was 14.5 to 1, compared
with 14.9 to 1 at December 31, 1998. (See IC9)
18
YEAR 2000 ISSUES
Impact of the Year 2000 Issue. The Company's business processes are highly
automated and dependent upon the consistent and accurate functioning of its
computer systems and the computer systems of its customers. As a result, the
Company is directing significant resources toward mitigating its exposure to the
so-called "Year 2000 issue." The Company has in place a Year 2000 project plan
to address the Year 2000 issue. The plan consists of three phases, all of which
have been completed or substantially completed as more fully discussed in the
Company's prior SEC filings. To date, PMI and CMG have met all readiness
deadlines or targets established by Fannie Mae, Freddie Mac and their
regulators.
Costs to Address the Year 2000 Issue. The Company is utilizing both internal
and external personnel and resources to implement its Year 2000 project plan.
Currently, no planned material projects involving information or non-information
technology systems have been delayed or are anticipated to be delayed as a
result of the redirection of resources to the Year 2000 remediation effort. The
Company plans to complete its Year 2000 issue remediation project at a total
external cost of approximately $5.0 million, which will be funded from operating
cash flow and is being expensed as incurred. For the three-month period ended
June 30, 1999, the Company incurred and expensed approximately $200,000 in
external costs related to its Year 2000 project plan and remediation efforts,
out of a total of $4.7 million incurred and expensed since commencement of the
Year 2000 project. The estimated costs do not include any potential costs
related to customer or other claims, or potential amounts related to executing
contingency plans. The Company does not separately track the internal costs
incurred in connection with the Year 2000 project plan, which are principally
payroll costs for employees working on the project. (See IC1 and Item 5 - Other
Information, below).
The discussion above and all prior discussions in the Company's SEC filings are
designated as Year 2000 Readiness Disclosures as defined by the Year 2000
Information and Readiness Disclosure Act of 1998.
CAUTIONARY STATEMENTS AND INVESTMENT CONSIDERATIONS
GENERAL CONDITIONS (IC1)
Several factors such as economic recessions, declining housing values, higher
unemployment rates, deteriorating borrower credit, rising interest rates,
increases in refinance activity caused by declining interest rates, changes in
legislation affecting the mortgage insurance industry, or combinations of such
factors might affect the mortgage insurance industry and demand for housing in
general and could materially and adversely affect the Company's financial
condition and results of operations. Such economic events could materially and
adversely impact the demand for mortgage insurance, cause claims on policies
issued by PMI to increase, and/or cause a similar adverse increase in PMI's loss
experience.
Other factors that may influence the amount of NIW by PMI include: mortgage
insurance industry volumes of new business; the impact of competitive
underwriting criteria and product offerings and services, including mortgage
pool insurance and contract underwriting services; the ability to recruit and
maintain a sufficient number of qualified underwriters; the effect of risk-
sharing structured transactions; changes in the performance of the financial
markets; PMI's claims-paying ability rating; general economic conditions that
affect the demand
19
for or acceptance of the Company's products; changes in government housing
policy; changes in government regulations or interpretations regarding the Real
Estate Settlement Procedures Act and customer consolidation. PMI's financial
condition and results of operations may materially and adversely be impacted by
changes in legislation which affects the ability of Fannie Mae or Freddie Mac to
offer a substitute for mortgage insurance, including self-insurance and
alternative forms of credit support, or for the FHA or the VA to increase
statutory lending limits or other expansion of eligibility for the FHA and VA.
PMI's financial condition and results of operations may materially and adversely
be impacted by changes in legislation, statutory charters and regulations
governing banks and savings institutions to form reinsurance subsidiaries or
permit the offering of other products which do not require mortgage insurance.
In addition, PMI's financial condition and results of operations may materially
and adversely be impacted by a reduction in the amount of mortgage insurance
coverage required by Fannie Mae and Freddie Mac.
The costs of Year 2000 remediation, the correctness of the Company's assessment
that it has completed one or more phases of its 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. If
the Company's recently completed remediation of its mission critical mortgage
insurance origination and application processing process is faulty or fails for
any reason to be Year 2000 compliant, this circumstance could adversely impact
its business operations and could have a material adverse affect on the
Company's financial condition, liquidity and results of operations. See
Management Discussion and Analysis - Year 2000 Issues, above and Item 5 - Other
Information, below.
MARKET SHARE AND COMPETITION (IC2)
The Company's financial condition and results of operations could be materially
and adversely affected by a decline in its market share, or a decline in market
share of the private mortgage insurance industry as a whole. Numerous factors
bear on the relative position of the private mortgage insurance industry versus
government and quasi-governmental competition (see IC3) as well as the
competition of lending institutions that choose to remain uninsured, self-insure
through affiliates, or offer residential mortgage products that do not require
mortgage insurance. The impact of captive reinsurance arrangements, competitive
underwriting criteria and product offerings, including mortgage pool insurance
and contract underwriting, has a direct impact on the Company's market share.
Further, several of the Company's competitors have greater direct or indirect
capital reserves that provide them with potentially greater flexibility than the
Company in addressing competitive issues.
PMI competes directly with federal and state governmental and quasi-governmental
agencies, principally the FHA and, to a lesser degree, the VA. The Office of
the Comptroller of the Currency has granted permission to certain national banks
to form a reinsurance company as a wholly-owned operating subsidiary for the
purpose of reinsuring mortgage insurance written on loans originated or
purchased by such bank. The Office of Thrift Supervision has also granted
permission for subsidiaries of thrift institutions to reinsure private mortgage
insurance coverage on loans originated or purchased by affiliates of such
thrift's parent organization. The Federal Reserve Board is in the process of
considering whether similar activities are permitted for bank holding companies.
The capitive 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
20
competition in the mortgage insurance industry and may materially and adversely
impact PMI's market share (See IC15).
In July 1999, the Federal Housing Finance Board ("FHFB") issued proposed
regulations which would permit the Federal Home Loan Banks ("FHLBs") to provide
mortgage insurance or substitutes for mortgage insurance, such as credit
enhancements, to its members for non-conforming mortgages. The proposal would
permit the FHLBs to buy mortgages originated by its members if the member took
some of the credit risk. In addition, the proposed regulation would introduce
risk-based capital requirements and expand the FHLBs' investment powers to
permit the FHLBs to make equity investments in enterprises that focused on low-
or moderate-income community development and housing in small business
investment corporations. The proposed regulations will be subject to a 90-day
public comment period once published in the Federal Register.
As a result of key aspects of the FHFB proposal which require clarification and
which are likely to be revised during the public comment period, management is
presently not able to ascertain the full impact of the proposed regulations on
the Company's financial condition and results of operations in 1999 and beyond.
Management believes any expansion of the FHLBs ability issue mortgage insurance
or use alternatives to mortgage insurance could materially and adversely affect
the Company's financial condition and results of operations.
Certain lenders originate a first mortgage lien with an 80% LTV ratio, a 10%
second mortgage lien, and 10% of the purchase price from borrower's funds
("80/10/10"). This 80/10/10 product competes with mortgage insurance as an
alternative for lenders selling loans in the secondary mortgage market. The
Federal Deposit Insurance Corporation and other banking regulators approved
rules to be effective April 1, 1999 that would require national banks to hold
almost twice as much risk-based capital to cover possible defaults on the
80/10/10 products when the lender holds the first and second mortgage. State-
chartered banks already are subject to the higher capital requirement. If the
80/10/10 product becomes a widely accepted alternative to mortgage insurance, it
could have a material and adverse impact on the Company's financial condition
and results of operations.
Legislation and regulatory changes affecting the FHA have affected demand for
private mortgage insurance. Effective January 1, 1999, the Department of Housing
and Urban Development announced an increase in the maximum individual loan
amount that FHA can insure to $208,800 from $197,620. The maximum individual
loan amount that the VA can insure is $203,150. The Omnibus Spending Bill of
1999, signed into law on October 21, 1998, among other items, streamlined the
FHA down-payment formula by eliminating tiered minimum cash investment
requirements and establishing maximum loan-to-value ratios based on loan size
and closing costs, making FHA insurance more competitive with private mortgage
insurance in areas with higher home prices.
Management believes the decline in the MICA members' share of the mortgage
insurance business from 56.3% at December 31, 1998 to approximately 50.9% at
June 30, 1999 results in part from the increase in the maximum individual loan
amount the FHA can insure. Any increase in the maximum FHA loan amount would
likely have an adverse effect on the competitive position of PMI and,
consequently, could materially and adversely affect the Company's financial
condition and results of operations.
FANNIE MAE AND FREDDIE MAC (IC3)
The GSEs are permitted by charter to purchase conventional high-LTV mortgages
from lenders who obtain mortgage insurance on those loans. Fannie Mae and
Freddie Mac have some discretion to increase or decrease the amount of private
mortgage insurance coverage they require on loans, provided the minimum
insurance coverage requirement is met. During 1999, Fannie Mae and Freddie Mac
separately announced programs where reduced mortgage insurance coverage will be
made available for lenders that deliver loans approved by the GSEs' automated
underwriting services, Desktop Underwriter and Loan ProspectorSM, respectively.
Generally, Fannie Mae's and Freddie Mac's reduced mortgage insurance coverage
options provide for: (i) across-the-board reductions in required MI coverage on
30-year fixed-rate loans recommended for approval by GSE's automated
underwriting services to the levels in effect in 1994; (ii) reduction in
required MI coverage, for loans with only a 5 percent down payment (a 95 percent
LTV), from 30 percent to 25 percent of the mortgage loan covered by MI; (iii)
reduction in required MI coverage, for loans with a 10 percent down payment (a
90 percent LTV loan), from 25 percent to 17 percent of the mortgage loan covered
by MI. In addition, the GSE's announced programs to further reduce MI coverage
upon the payment of an additional fee by the lender. Under this option, a 95
percent LTV loan will require 18 percent of the mortgage loan have mortgage
insurance coverage. Similarly, a 90 percent LTV loan will require 12 percent of
the mortgage loan have mortgage insurance. In order for the home buyer to have
MI at these levels, such loans would require a payment at closing or a higher
note rate.
Management believes it is too early to assess the impact of the GSEs' reduction
of required levels of mortgage insurance on the Company's financial condition
and results of operation. If the reduction in required levels of
21
mortgage insurance were to become widely accepted by mortgage lenders and their
customers, however, such reduction could have a materially adverse impact on the
Company's financial condition and results of operation.
The Federal Housing Enterprises Financial Safety and Soundness Act of 1992,
requires the Office of Federal Housing Enterprise Oversight ("OFHEO") to develop
a risk-based capital regulation for the GSEs. On April 13, 1999 a notice of
proposed rulemaking was published in the Federal Register announcing OFHEO's
development of proposed risk-based capital regulations. Public comments
regarding the proposed regulations were due on August 11, 1999, however, OFHEO
recently extended the due date until December 11, 1999, to allow interested
parties adequate time to analyze and review the rule and submit constructive
comments. After consideration of the comments received on the proposal, OFHEO
will determine whether to issue a final rule or to issue a revised proposal.
OFHEO is not authorized to enforce the risk-based standard until one year after
the final rule is published. The regulation specifies a risk-based capital
stress test that, when applied to the GSEs, determines the amount of capital
that a GSE must hold to maintain positive capital throughout a 10-year period of
economic stress. The stress test is designed to simulate the financial
performance, including cash flows of the GSEs under severe economic conditions.
Such conditions would include high levels of mortgage defaults and associated
losses, and large interest rate shocks. The proposed regulations could require a
GSE to hold more than double the capital it presently maintains for loans with
loan-to-value ratios ("LTV") of 95 percent or higher. Further the proposed
capital regulations could treat more favorably credit enhancements issued by
private mortgage insurance companies with a claims-paying ability rating of AAA
or higher compared with those companies with a AA or lower rating.
Because of the numerous aspects of the OFHEO proposal which require
clarification and which are likely to be revised during the public comment
period, management is presently not able to ascertain the full impact of the
proposed risk-based capital regulations on the Company's financial condition and
results of operations in 1999 and beyond. Although management believes that it
is too early to ascertain the impact of the risk-based capital regulations as
proposed, management believes any shifts in the GSE's preferences for private
mortgage insurance to other forms of credit enhancement, including a tiering of
mortgage insurers based on their credit rating, could materially and adversely
affect the Company's financial condition and results of operations.
During October 1998, Freddie Mac sought to amend its charter to allow it to use
any method of default loss protection that is financially equal or superior, on
an individual or pooled basis, to the protection provided by private mortgage
insurance companies. The legislation containing the proposed charter amendment
was subsequently rescinded. Currently, Freddie Mac can purchase loans with down-
payments of less than 20%, only if the loans are insured or use other limited
methods to protect against default.
Subsequent to the withdrawal 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.
In June 1999, a coalition of financial industry trade associations was formed
under the name "FM Watch". FM Watch works with affordable housing and consumer
advocates, taxpayer groups and financial institutions, and is dedicated to
monitoring the activities of Fannie Mae and Freddie Mac. FM Watch's efforts are
designed to support HUD's efforts to strengthen the affordable housing goals for
the GSEs, and to promote policies that do not allow the GSEs to move beyond
their unique charters into markets and services already provided by the private
sector. Current members of FM Watch include: the American Financial Services
Association, the Appraisal Institute, the Association of Financial Guaranty
Insurors, the Consumer Bankers Association, the Consumer Mortgage Coalition, the
Financial Services Roundtable, the Home Equity
22
Lender Leadership Organization, the Mortgage Insurance Companies of America, and
the National Home Equity Mortgage Association.
In July 1999 HUD announced new affordable housing goals for the GSEs. The
proposed affordable housing goals would raise the target for low- and moderate-
income business from 42 percent of the GSEs' annual volume to 50 percent. The
goal would increase to 48 percent in year 2000 and to 50 percent for year 2001.
In addition, HUD announced proposed increases in two other components of the
GSEs' affordable housing goals. Currently, the GSEs are expected to generate 24
percent of their mortgage business in central cities, rural areas and other
underserved markets. Under the proposal, this target would increase up to 31
percent. The special affordable housing goal, which measures funding for
families with very-low household income or living in low-income areas, would
increase from 14 percent to 20 percent. The proposed goals are subject to
review by the Office of Management and Budget and would be subject to a public
comment period prior to final revisions or enactment by HUD.
Fannie Mae's and Freddie Mac's current guidelines regarding cancellation of
mortgage insurance generally provide that a borrower's written request to cancel
mortgage insurance should be honored if: (a) the borrower has a satisfactory
payment record, no payment more than 30 days delinquent in the 12-month period
preceding the request for cancellation; and (b) the unpaid principal balance of
the mortgage is not greater than 80% of the original value of the property. (See
IC4 for a discussion of Federal legislation providing for guidelines for
automatic mortgage insurance cancellation)
In January, Fannie Mae and Freddie Mac announced increases in the maximum
principal balance of loans eligible for purchase for purchase by Fannie Mae and
Freddie Mac to $240,000. Although management believes that it is too early to
ascertain the impact of the increase in the maximum individual loan amount the
GSEs can insure, management believes any increase in the maximum loan amount
would likely increase the number of loans eligible for mortgage insurance and
may have the effect of increasing the size of the mortgage insurance market, and
have a positive effect on the competitive position of PMI and consequently could
materially affect the Company's financial condition and results of operations.
Fannie Mae and Freddie Mac impose requirements on private mortgage insurers for
such insurers to be eligible to insure loans sold to such agencies. Under Fannie
Mae and Freddie Mac regulations, PMI needs to maintain at least an "AA-" or
equivalent claims-paying ability rating in order to provide mortgage insurance
on loans purchased by the GSEs. Failure to maintain such a rating would
effectively cause PMI to be ineligible to provide mortgage insurance. A loss of
PMI's existing eligibility status, either due to a failure to maintain a minimum
claims-paying ability rating from the various rating agencies or non-compliance
with other eligibility requirements, would have a material, adverse effect on
the Company's financial condition and results of operations. (See IC2)
INSURANCE IN FORCE (IC4)
A significant percentage of PMI's premiums earned is generated from its existing
insurance in force and not from new insurance written. PMI's policies for
insurance coverage typically have a policy duration of six to eight years. The
policy owner or servicer of the loan may cancel insurance coverage at any time.
PMI has no control over the owner's or servicer's decision to cancel insurance
coverage and self-insure or place coverage with another mortgage insurance
company. There can be no assurance that policies for insurance coverage
originated in a particular year or for a particular customer will not be
canceled at a later time or that the Company will be able to regain such
insurance coverage at a later time. As a result, the Company's financial
condition and results
23
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.
Upon request by an insured, PMI must cancel the mortgage insurance for a
mortgage loan. In addition, The Home Owners Protection Act of 1998 (the "Act"),
which is effective on July 29, 1999, provides for the automatic termination, or
cancellation upon a borrower's request, of private mortgage insurance upon
satisfaction of certain conditions. The Act applies to owner-occupied
residential mortgage loans regardless of lien priority, with borrower-paid
mortgage insurance, which closed after the effective date of the Act. FHA loans
are not covered by the Act. Under the Act, automatic termination of mortgage
insurance would generally occur once the loan-to-value ratio ("LTV") reaches
78%. A borrower may generally request cancellation of mortgage insurance once
the LTV reaches 80% of the home's original value, or when actual payments reduce
the loan balance to 80% of the home's original value, whichever occurs earlier.
For borrower initiated cancellation of mortgage insurance, the borrower must
have a good payment history. Good payment history generally requires that there
have been no payments during the 12-month period preceding the loan's
cancellation date 30 days or more past due, or 60 days or more past due during
the 12-month period beginning 24 months before the loan's cancellation date.
Loans that are deemed "high risk" by the GSEs, require automatic termination of
mortgage insurance coverage once the LTV is first scheduled to reach 77% of the
original value of the property without regard to the actual outstanding balance.
The Act preempts all but more protective, preexisting state laws. Protected
state laws are preempted if inconsistent with the Act. Protected state laws are
consistent with the Act if they require: (i) termination of mortgage insurance
at an earlier date or higher mortgage principal balance than required by the
Act, or (ii) disclosure of more, earlier, or more frequent information. States
that enacted mortgage insurance cancellation laws on or before January 2, 1998,
have until July 29, 2000 to make their statutes consistent with the Act. States
that currently have mortgage insurance cancellation or notification laws
include: California, Connecticut, Illinois, Maryland, Minnesota, Missouri, New
York, Texas and Washington. Management is uncertain about the impact of the Act
on PMI's insurance in force, but believes any reduction in premiums attributed
to the Act's required cancellation of mortgage insurance, will not have a
significant impact on the Company's financial condition and results of operation
for the foreseeable future. (See IC10)
During an environment of falling interest rates, an increasing number of
borrowers refinance their mortgage loans. PMI and other mortgage insurance
companies generally experience an increase in the prepayment rate of insurance
in force, resulting from policy cancellations of older books of business with
higher rates of interest. Although PMI has a history of expanding business
during low interest rate environments, the resulting increase of NIW may
ultimately prove to be inadequate to compensate for the loss of insurance in
force arising from policy cancellations. During the first half of 1999, mortgage
loan refinancings continued at a higher than expected rate. Management
anticipates that the refinancing trend will decrease in the second half of 1999.
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 (IC5)
PMI's claims-paying ability is currently rated "AA+" (Excellent) by Standard and
Poor's Rating Services, "Aa2" (Excellent) by Moody's Investors Service, Inc.,
"AA+" (Very Strong) by Fitch IBCA, and "AA+" (Very High) by Duff & Phelps Credit
Rating Co. These ratings are subject to revisions or withdrawal at any time by
the assigning rating organization. The ratings by the organizations are based
upon factors relevant to PMI's policyholders, principally PMI's capital
resources as computed by the rating agencies, and are not applicable to the
Company's common stock or outstanding debt. During June 1999, Standard & Poor's
and Moody's affirmed the AA+
24
and Aa2, respectively, financial strength rating and claims-paying ability
rating of PMI. During March 1999, Moody's announced that it changed PMI's and
TPG's rating outlook from stable to negative, stating such action was based on
TPG's stock repurchases, PMI's writing of GSE pool and diversification into new
sectors.
Rating agencies generally assess capital charges on pool insurance policies
based on price and structure. One published methodology for assessing the
capital requirement for pool insurance is based on the real estate depression
that occurred in oil producing states during the mid-1980's. Management believes
the current capital charge that could be levied on pool insurance risk by one
rating agency is approximately $1.00 of capital for each $1.40 of pool insurance
risk. In comparison, primary mortgage insurance regulators specifically limit
the amount of insurance risk that may be written by PMI according to a number of
financial tests, including limiting risk, to a multiple of 25 times PMI's
statutory capital (which includes the contingency reserve). The rating agencies
could change their view as to the capital charges that are assessed on pool
insurance products at any time. (See IC10)
Management believes that a reduction in PMI's claims-paying ratings below AA-
could have a material, adverse effect on the Company's financial condition and
results of operations. (See IC3 and IC6)
LIQUIDITY (IC6)
In the mortgage guaranty insurance industry, liquidity refers to the ability of
an enterprise to generate adequate amounts of cash from its normal operations,
including premiums received and investment income, in order to meet its
financial commitments, which are principally obligations under the insurance
policies it has written. The level and severity of claims significantly
influence liquidity requirements.
TPG's principal sources of funds are dividends from PMI and APTIC, investment
income and funds that may be raised from time to time in the capital markets.
Numerous factors bear on the Company's ability to maintain and meet its capital
and liquidity needs, including the performance of the financial markets,
standards and factors used by various credit rating agencies, financial
covenants in credit agreements, and standards imposed by state insurance
regulators relating to the payment of dividends by insurance companies. Any
significant change in the performance of the financial markets negatively
affecting the Company's ability to secure sources of capital, or changes in the
standards used by credit rating agencies which adversely impact PMI's claims-
paying ability rating, or changes in the insurance laws of Arizona, Florida or
Wisconsin that restrict the ability of PMI, APTIC or CMG to pay dividends at
currently permissible levels, could adversely affect the Company's ability to
maintain capital resources to meet its business needs, and thereby have a
material, adverse affect on the Company's financial condition, liquidity and
results of operations.
CONTRACT UNDERWRITING SERVICES; NEW PRODUCTS (IC7)
The Company provides contract underwriting services for a fee that enable
customers to improve the efficiency and quality of their operations by
outsourcing all or part of their mortgage loan underwriting. As a part of its
contract underwriting services, PMI provides remedies that may include the
assumption of some of the costs of repurchasing insured and uninsured loans from
the GSEs and other investors. Generally, the scopes of these remedies are in
addition to those contained in PMI's master primary insurance policies. Due to
the increasing demand of contract underwriting services, the limited number of
underwriting personnel available, and heavy price competition among mortgage
insurance companies, PMI's inability to recruit and maintain a sufficient number
of qualified underwriters, or any significant increase in the cost PMI incurs to
satisfy remedy obligations
25
for underwriting services, could materially and adversely affect its market
share and materially and adversely affect the Company's financial condition and
results of operations.
TPG and PMI, from time to time, introduce new mortgage insurance products or
programs. The Company's financial condition and results of operations could be
materially and adversely affected if PMI or the Company experiences delays in
introducing competitive new products and programs. In addition, for any
introduced product, there can be no assurance that such products, including any
mortgage pool type products, or programs will be as profitable as the Company's
existing products and programs.
NEW YORK DEPARTMENT OF INSURANCE (IC8)
In February 1999, the New York Department of Insurance stated in Circular Letter
No. 2, addressed to all private mortgage insurers licensed in New York that
certain pool risk-share and structured products and programs would be considered
to be illegal under New York law. PMI believes that it complies with the
requirements of Circular Letter No. 2 with respect to transactions that are
governed by it. In the event the New York Department of Insurance determined PMI
was not in compliance with Circular Letter No. 2, it could materially and
adversely affect the Company's financial condition and results of operations.
RISK-TO-CAPITAL RATIO (IC9)
The State of Arizona, PMI's state of domicile for insurance regulatory purposes,
and other regulators specifically limit the amount of insurance risk that may be
written by PMI, by a variety of financial factors. For example, Arizona law
provides that if a mortgage guaranty insurer domiciled in Arizona does not have
the amount of minimum policyholders position required, it must cease transacting
new business until its minimum policyholders position meets the requirements.
Under Arizona law, minimum policyholders position is calculated based on the
face amount of the mortgage, the percentage coverage or claim settlement option
and the loan to value ratio category, net of reinsurance ceded, but including
reinsurance assumed. For example, under Arizona law, a mortgage guaranty insurer
would have to maintain minimum policyholders position equal to $1.00 per each
one hundred dollars of the face amount of the mortgage, provided the LTV was
greater than seventy-five percent and the coverage percent was twenty-five
percent. The amount of minimum policyholders position would generally increase
if the mortgage amount remained constant, but the coverage percentages and/or
LTV amounts increased.
Other factors affecting PMI's risk-to-capital ratio include: (i) limitations
under the Runoff Support Agreement with Allstate, which prohibit PMI from paying
any dividends if, after the payment of any such dividend, PMI's risk-to-capital
ratio would equal or exceed 23 to 1; (ii) TPG's credit agreements and the terms
of its guaranty of the debt incurred to purchase MGICA; and (iii) TPG's and
PMI's credit or claims-paying ability ratings which generally require that the
rating agencies' risk-to-capital ratio not exceed 20 to 1.
Significant losses could cause a material reduction in statutory capital,
causing an increase in the risk-to-capital ratio and thereby limit PMI's ability
to write new business. The inability to write new business could materially and
adversely affect the Company's financial condition and results of operations.
CHANGES IN COMPOSITION OF INSURANCE WRITTEN; POOL INSURANCE (IC10)
The composition of PMI's NIW has included an increasing percentage of mortgages
with LTVs in excess of 90% and less than or equal to 95% ("95s"). At June 30,
1999, 45.9% of PMI's risk in force consisted of 95s, which, in
26
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, 1999, 4.1% of PMI's risk in force consisted of 97s that have even
higher risk characteristics than 95s and greater uncertainty as to pricing
adequacy. PMI's NIW also includes adjustable rate mortgages ("ARMs"), which,
although priced higher, have risk characteristics that exceed the risk
characteristics associated with PMI's book of business as a whole. Since the
fourth quarter of 1997, PMI has offered a new pool insurance product. Pool
insurance is generally used as an additional credit enhancement for certain
secondary market mortgage transactions and generally covers the loss on a
defaulted mortgage loan that exceeds the claim payment under the primary
coverage, if primary insurance is required on that mortgage loan. Pool insurance
also generally covers the total loss on a defaulted mortgage loan that did not
require primary insurance, in each case up to a stated aggregate loss limit. New
pool risk written was $61.0 million for the quarter ended June 30, 1999 and
$103.0 million for the six months ended June 30, 1999. Management is uncertain
about the amount of new pool risk that will be written in 1999, but believes
total new 1999 pool risk will be less than in 1998. Although PMI charges higher
premium rates for loans that have higher risk characteristics, including ARMs,
95s, 97s and pool insurance products, the premiums earned on such products, and
the associated investment income, may ultimately prove to be inadequate to
compensate for future losses from such products. Such losses could materially
and adversely affect the Company's financial condition and results of
operations. (See IC5)
POTENTIAL INCREASE IN CLAIMS (IC11)
Mortgage insurance coverage generally cannot be canceled by PMI and remains
renewable at the option of the insured until required to be canceled under
applicable Federal or state laws for the life of the loan. As a result, the
impact of increased claims from policies originated in a particular year
generally cannot be offset by premium increases on policies in force or
mitigated by nonrenewal of insurance coverage. There can be no assurance,
however, that the premiums charged will be adequate to compensate PMI for the
risks and costs associated with the coverage provided to its customers. (See
IC5)
LOSS RESERVES (IC12)
PMI establishes loss reserves based upon estimates of the claim rate and average
claim amounts, as well as the estimated costs, including legal and other fees,
of settling claims. Such reserves are based on estimates, which are regularly
reviewed and updated. There can be no assurance that PMI's reserves will prove
to be adequate to cover ultimate loss development on incurred defaults. The
Company's financial condition and results of operations could be materially and
adversely affected if PMI's reserve estimates are insufficient to cover the
actual related claims paid and expenses incurred.
REGIONAL CONCENTRATION (IC13)
In addition to nationwide economic conditions, PMI could be particularly
affected by economic downturns in specific regions where a large portion of its
business is concentrated, particularly California, Florida, and Texas, where PMI
has 16.6%, 7.5% and 7.3% of its risk in force concentrated and where the default
rate on all PMI policies in force is 2.59%, 2.66% and 1.87% compared with 1.99%
nationwide as of June 30, 1999.
27
CONTINUING RELATIONSHIPS WITH ALLSTATE AND AFFILIATE (IC14)
In December 1993, PMI entered into a Mortgage Pool Mortgage Guaranty Insurance
Reinsurance Treaty ("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. The Reinsurance Treaty was amended in October 1994 to add a cut-
through provision and to provide that Forestview would assume PMI's obligations
under the run-off mortgage pool insurance policies after receipt of all
regulatory and policyholder approvals. The majority of Forestview's business is
currently comprised of the run-off mortgage pool business ceded by PMI pursuant
to the Reinsurance Treaty.
Pursuant to the Recapture Agreement, PMI and Forestview have agreed to commute
the Reinsurance Treaty and to recapture liabilities ceded by PMI to Forestview
under both the Reinsurance Treaty and a Mortgage Guaranty Insurance Reinsurance
Treaty ("Deep Cover Treaty") effective December 31, 1991, and terminated as of
October 27, 1994, pursuant to a Termination Agreement. Closing of the
transactions that are the subject of the Recapture Agreement is subject to
regulatory approvals, which are expected to be received in 1999.
On October 28, 1994, TPG entered into a Runoff Support Agreement (the "Runoff
Support Agreement") with Allstate Insurance Company ("Allstate") to replace
various capital support commitments that Allstate had previously provided to
PMI. Allstate agreed to pay claims on certain insurance policies issued by PMI
prior to October 28, 1994, if PMI's financial condition deteriorates below
specified levels, or if a third party brings a claim thereunder. Alternatively,
Allstate may make contributions directly to PMI or TPG. In the event that
Allstate makes payments or contributions under the Runoff Support Agreement
(which possibility management believes is remote), Allstate would receive
subordinated debt or preferred stock of PMI or TPG in return. No payment
obligations have arisen under the Runoff Support Agreement.
CAPTIVE REINSURANCE ARRANGEMENTS; RISK-SHARING TRANSACTIONS (IC15)
PMI offers various risk-sharing structured transactions, including a captive
reinsurance arrangement as part of its strategic relationships with its
customers. PMI's customers have indicated an increasing demand for captive
reinsurance arrangements. Such arrangements allow a reinsurance company,
generally an affiliate of the lender, to assume a portion of the mortgage
insurance default risk in exchange for a portion of the insurance premiums. An
increasing percentage of PMI's NIW is being generated by customers with captive
reinsurance companies, and it is expected that this trend will increase,
resulting in a decrease in net premiums written which may negatively impact the
yield obtained in the Company's net premiums earned for such customers with
captive reinsurance arrangements. There can be no assurance that PMI's risk-
sharing structured transactions, including captive reinsurance arrangements,
will continue to be accepted by its customers. The inability of the Company to
provide its customers with acceptable risk-sharing structured transactions,
including potentially increasing levels of premium cessions in captive
reinsurance arrangements, would likely have an adverse effect on the competitive
position of PMI and consequently could materially and adversely affect the
Company's financial condition, liquidity and results of operations.
28
THE PMI GROUP, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION
June 30, 1999
Item 3 - Quantitative and Qualitative Disclosures about Market Risk
At June 30, 1999, the average duration of the Company's fixed income investment
portfolio was 5.6 years, and the Company had no derivative financial instruments
in its investment portfolio. The result of a 1% increase in interest rates would
be a 5.8% decrease in the value of the Company's investment portfolio, while the
result of a 1% decrease in interest rates would be a 5.0% increase in the value
of the Company's investment portfolio.
Item 4 - Submission of Matters to a Vote of Security Holders
At the Company's Annual Meeting of Stockholders held on May 20, 1999, the
following individuals were elected to the Board of Directors:
1. Election of Directors
Votes For Votes Withheld
---------- --------------
Dr. James C. Castle 25,118,855 6,599
Donald C. Clark 25,118,620 6,834
W. Roger Haughton 25,119,195 6,259
Wayne E. Hedien 25,119,255 6,199
Raymond L. Ocampo Jr. 25,118,955 6,499
John D. Roach 25,119,060 6,394
Dr. Kenneth T. Rosen 25,119,020 6,434
Richard L. Thomas 25,119,295 6,159
Mary Lee Widener 25,118,855 6,599
Ronald H. Zech 25,118,920 6,534
The following proposals were 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 1999 25,119,861 2,508 3,085 0
3. Approval of amendment and restatement
of the Company's Equity Incentive Plan 19,008,169 5,101,893 23,670 991,722
4. Approval of the Company's
Employee Stock Purchase Plan 23,903,678 213,188 16,866 991,722
5. Approval of the Company's
Bonus Incentive Plan 24,761,395 342,356 21,703 0
Item 5 - Other Information
New federal legislation relating to the year 2000 issue (the "Y2K Act") was
adopted on July 20, 1999. The purpose of the Y2K Act is to restructure how
litigation associated with the year 2000 date change will proceed.
29
The Y2K Act does not create any new causes of action or expand any liability
otherwise imposed or limit any defense otherwise available under Federal or
State law. The Y2K Act applies to all types of civil litigation brought after
January 1, 1999 for a Y2K failure occurring before January 1, 2003, excluding
actions filed in foreign courts, personal injury or wrongful death claims,
arbitration claims before an arbitration panel, claims arising under securities
law, and actions brought by a government entity acting in a regulatory or
supervisory or enforcement capacity. Major provisions of the Y2K Act include a
requirement that: (1) plaintiffs give potential defendants notice of their
damages and an opportunity to fix the problem; (2) plaintiffs specify damages
with particularity; (3) limits parties suffering economic losses to contract
damages only; (4) strict enforcement of the terms of contracts, including
disclaimers of warranties; (5) assessment of liability on a proportional basis;
(6) limitation on punitive damages; and (7) a requirement that in a class
action, any product defect be material as to a majority of the class.
Generally, the Y2K Act supersedes state law to the extent such law is
inconsistent with the Federal statute. The Y2K Act, however, does grant
deference to any State law that provides stricter limits on damages and
liabilities or affords greater protection to defendants in Y2K actions (e.g.,
cap on damages and liabilities at a lower amount, greater burden of proof, or
limits on types of damages available than provided under the federal statute).
States that currently have legislation that reallocate liability for Y2K
failures or alter procedures used to adjudicate Y2K disputes include: Alaska,
Arizona, California, Colorado, Connecticut, Florida, Hawaii, Minnesota,
Nebraska, North Carolina, North Dakota, Oklahoma, South Carolina, South Dakota,
Tennessee, Texas, Virginia, and Washington.
The Y2K Act also precludes foreclosures on any residential mortgage against a
consumer as a result of an actual Y2K failure that results in an inability
accurately or timely to process any mortgage payment. Generally, a consumer
must take action, by notifying in writing the person receiving mortgage
payments, within seven business days of learning of the Y2K failure and of their
inability to fulfill their payment obligations. Unless the servicer of the
mortgage has granted a longer extension, a consumer may obtain an extension of
the foreclosure action until the later of (1) four weeks after January 1 2000,
or (2) fours weeks after the consumer provided notification, provided the
notification was provided before March 15, 2000. The limited protections from
foreclosure do not apply to any mortgage upon which a default has occurred
before December 15, 1999, or with respect to which an imminent default was
foreseeable before such date.
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits - The exhibits listed in the accompanying Index to
Exhibits are filed as part of this Form 10-Q
(b) Reports on Form 8-K:
(i) On June 10, 1999, TPG filed a report on Form 8-K
announcing that it agreed to acquire MGICA, Ltd., the
second largest mortgage insurance company in Australia.
(ii) On July 21, 1999, TPG filed a report on Form 8-K
announcing that its Board of Directors declared a 3-for-2
stock split and increased its quarterly cash dividend
rate, effective for the third quarter, to six (6) cents
pre-split per share. The record date for the stock split
is July 30, 1999. The payment date for the stock split is
August 16, 1999.
30
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 16, 1999.
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
31
INDEX TO EXHIBITS
(Part II, Item 6)
Exhibit
Number Description of Exhibit
- ----------------- --------------------------------------------------------------------------------------
4.1 Credit Agreement, dated as of August 3, 1999 by and among PMI Mortgage Insurance
Australia (Holdings) Pty Limited, The PMI Group, Inc., and Bank of America, N.A. The
Company agrees to furnish to the Securities and Exchange Commission, upon request,
copies of all instruments defining the rights of holders of long-term debt of the
Company where the total amount of securities authorized under each issue does not
exceed ten percent of the Company's total assets.
4.2 Credit Agreement, dated as of February 1, 1996, between The PMI Group, Inc., and The
Chase Manhattan Bank, as amended. The Company agrees to furnish to the Securities
and Exchange Commission, upon request, copies of all instruments defining the rights
of holders of long-term debt of the Company where the total amount of securities
authorized under each issue does not exceed ten percent of the Company's total assets.
4.3 Credit Agreement, dated as of February 13, 1996, between The PMI Group, Inc., and
Bank of America National Trust and Savings Association, as amended. The Company
agrees to furnish to the Securities and Exchange Commission, upon request, copies of
all instruments defining the rights of holders of long-term debt of the Company where
the total amount of securities authorized under each issue does not exceed ten
percent of the Company's total assets.
10.1 The PMI Group, Inc., Employee Stock Purchase Plan (amended and restated as of May 20,
1999)
10.2 The PMI Group, Inc., Stock Plan For Non-employee Directors (amended and restated as
of May 20, 1999)
10.3 The PMI Group, Inc., Supplemental Employee Retirement Plan (amended and restated as
of May 20, 1999)
10.4 The PMI Group, Inc., Additional Benefit Plan dated as of February 18, 1999
10.5 The PMI Group, Inc., Directors' Deferred Compensation Plan (amended and restated as
of July 21, 1999)
11.1 Computation of Net Income Per Share
27.1 Financial Data Schedule
32