UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10 - Q/A
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 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 09/30/99 44,670,398
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q/A
Amendment to Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
The PMI Group, Inc., hereby amends its Form 10-Q for the quarter ended September
30, 1999 dated and filed with the Securities and Exchange Commission on November
15, 1999 by deleting the entire section titled "Item 2 Management's Discussion
and Analysis of Financial Condition and Results of Operations", and replacing it
in its entirety with the following:
"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 through
the remainder of 1999; (ii) during 1999, management expects the percentage
of PMI's risk related to risk-share programs to continue to increase as a
percentage of total risk; (iii) management expected the Fannie Mae and
Freddie Mac reduction in mortgage insurance coverage requirements would
have negatively impacted the growth rate of direct risk in force; however,
PMI's percentage of insurance in force with higher coverage percentages
continues to increase due to terminating policies being replaced by new
policies with higher coverage percentages; (iv) management anticipates that
the percentage of new insurance written ("NIW") subject to captive mortgage
reinsurance agreements will continue to increase in 1999 and beyond. In
addition, the anticipated continued growth of captive reinsurance
arrangements is expected to reduce the Company's net premiums written and
net premiums earned for customers with captive arrangements; (v) management
anticipates ceded premiums will continue to increase as a result of the
expected increase in risk-share programs; (vi) management anticipates the
percentage of insurance in force with higher coverage percentages will
continue to increase despite the
2
availability of reduced coverage requirements from Fannie Mae and Freddie
Mac; (vii) although management expects that California will continue to
account for a significant portion of total claims paid, management
anticipates that with continued improvement in the California economy,
increased benefits of loss mitigation efforts and improved default
reinstatement rates, California claims paid as a percentage of total claims
paid should continue to decline; (viii) management believes that PMI's
total default rate could increase in 1999 due to the continued maturation
of its 1995 and 1996 books of business; (ix) management anticipates that
contract underwriting will continue to generate a significant percentage of
PMI's new insurance written ("NIW"); and (x) management is uncertain about
the amount of new pool risk which will be written in 1999, but believes
total new 1999 pool risk will be less than in 1998. When a forward-looking
statement includes a statement of the assumptions or bases underlying the
forward-looking statement, the Company cautions that, while it believes
such assumptions or bases to be reasonable and makes them in good faith,
assumed facts or bases almost always vary from actual results, and the
difference between assumed facts or bases and actual results can be
material, depending on the circumstances. Where, in any forward-looking
statement, the Company or its management expresses an expectation or belief
as to future results, such expectations or belief are expressed in good
faith and believed to have a reasonable basis, but there can be no
assurance that the statement of expectation or belief will result or be
achieved or accomplished. The Company's actual results may differ
materially from those expressed in any forward-looking statements made by
the Company. These forward-looking statements involve a number of risks or
uncertainties including, but not limited to, the items addressed in the
section titled "Cautionary Statements and Investment Considerations" ("IC#
1-16") set forth below and other risks detailed from time to time in the
Company's periodic filings with the Securities and Exchange Commission.
All forward-looking statements of the Company are qualified by and should
be read in conjunction with such risk disclosure. The Company undertakes no
obligation to publicly update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise.
RESULTS OF CONSOLIDATED OPERATIONS:
THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Consolidated net income was $54.5 million in the three months ended
September 30, 1999, a 1.5% increase over the corresponding period of 1998.
The growth can be attributed to an increase in premiums earned of 16.0% and
a decrease in losses and loss adjustment expenses of 9.0%, partially offset
by a 98.8% decrease in realized capital gains, a 21.8% increase in policy
acquisition costs and a 24.9% increase in underwriting and other operating
expenses. Including capital gains, diluted earnings per share increased
5.2% to $1.21 for the third quarter of 1999. Excluding capital gains,
diluted operating earnings per share increased by 25.0% to $1.20. Excluding
PMI Holdings, earnings per
3
share for the third quarter of 1999 was $1.16. Revenues in the third
quarter of 1999 increased by 6.4% to $178.2 million compared with the same
period in 1998.
MORTGAGE INSURANCE OPERATIONS
PMI's new primary insurance written ("NIW") decreased by 5.2% to $7.3
billion in the third quarter of 1999 compared with the third quarter of
1998, primarily as a result of a slight decline in the growth in volume of
the private mortgage insurance industry as well as the decrease in PMI's
market share for the same period.
The members of the private mortgage insurance industry, as reported by the
industry's trade association, Mortgage Insurance Companies of America
("MICA"), experienced a slight decrease in total new insurance written of
1.8% to $49.7 billion in the third quarter of 1999 from the corresponding
period of 1998 primarily due to a decrease in refinancing activity.
Refinancing as a percentage of PMI's NIW decreased to 13.7% in the third
quarter of 1999 from 24.4% in the third quarter of 1998 and from 25.6% in
the second quarter of 1999. Management anticipates that the decrease in
refinancing activity will continue through the remainder of 1999. (See IC4)
The private mortgage insurance companies' market share in the three months
ended September 30, 1999 decreased to 53.3% of the total low down-payment
market (insurable loans) from 55.3% in the third quarter of 1998 but
increased from 50.9% in the three months ended June 30, 1999. Management
believes the private mortgage insurance companies' year-over-year decline
in the low down-payment market share was the result of an increase in the
maximum individual loan amount that the FHA/VA can insure as well as the
increased use of adjustable rate mortgages, which lenders tend to retain in
their portfolios or self-insure. (See IC2)
PMI's market share of NIW was 14.8% in the third quarter of 1999, a
decrease from 15.3% in the second quarter of 1999, and a decrease from
15.2% in the three months ended September 30, 1998. On a combined basis
with CMG, market share decreased to 16.1% in the third quarter of 1999
compared with 16.6% in the third quarter of 1998, and 16.5% in the second
quarter of 1999. Management believes PMI's market share decline for the
third quarter of 1999 was primarily due to an increase in pool product
offerings by competitors and a competitor insuring a large one-time
transaction that was outside of the expected flow of mortgage production.
Pool risk written totaled $90.0 million for the third quarter of 1999
compared with $201.0 million in the third quarter of 1998. Risk in force
under risk-share programs with PMI's customers, excluding pool insurance,
represented approximately 16.2% of the $20.5 billion total primary risk in
force at September 30, 1999. Risk in force under pool insurance
arrangements represented 3.1% of total risk in force at September 30, 1999,
compared with 2.0% at September 30, 1998. During 1999, management expects
the percentage of PMI's risk related to risk-share programs to continue to
increase as a percent of total risk. Management expected the Fannie Mae and
Freddie Mac reduction in mortgage insurance coverage requirements would
have negatively impacted the growth rate of direct risk in force; however,
PMI's percentage of insurance in force with higher coverage percentages
continues to increase due to terminating policies being replaced by new
policies with higher coverage percentages. (See IC10)
4
PMI's cancellations of insurance in force decreased by 21.9% to $5.0
billion in the third quarter of 1999 compared with the corresponding period
of 1998. In addition, PMI's persistency rate of 68.5% as of September 30,
1999, increased compared with 66.1% as of June 30, 1999 but was still below
the 71.0% as of September 30, 1998.
Insurance in force increased by 7.2% to $84.6 billion at September 30, 1999
compared with September 30, 1998 and on a combined basis with CMG,
insurance in force grew by 8.9% to $90.1 billion compared with September
30, 1998. PMI's market share of insurance in force increased by 0.3
percentage points to 14.5% and when combined with CMG increased by 0.5
percentage points to 15.4% for the period ended September 30, 1999 compared
with September 30, 1998. PMI's primary risk in force increased by 9.0% to
$20.5 billion at September 30, 1999 and when combined with CMG grew by
11.2% to $21.9 billion compared with September 30, 1998. The growth rate of
risk in force is greater than insurance in force due to terminating
policies being replaced by new policies with higher coverage percentages.
Consolidated mortgage insurance net premiums written (which includes net
cessions and refunds) grew by 21.4% to $130.0 million in the third quarter
of 1999 compared with the same period in 1998 primarily due to the
acquisition of PMI Ltd , the growth of risk in force of both primary and
pool insurance, the continued shift to deeper coverage for primary
insurance and a decrease in refunded premiums of 26.0% to $4.0 million as a
result of a greater percentage of monthly policies, which are non-
refundable, being cancelled. Approximately 28% of new insurance written in
the third quarter of 1999 was subject to captive mortgage reinsurance
agreements. Management anticipates that the percent of NIW subject to
captive mortgage reinsurance agreements will continue to increase in 1999
and beyond. In addition, the anticipated continued growth of captive
reinsurance arrangements is expected to reduce the Company's net premiums
written and net premiums earned for customers with captive arrangements.
(See IC15) Mortgage insurance premiums earned increased 14.8% to $121.3
million in the third quarter of 1999 compared with the same period in 1998
primarily due to the increase in premiums written. Ceded premiums, which
include third-party reinsurance arrangements as well as captive reinsurance
agreements, totaled $9.5 million in the third quarter of 1999, increasing
111.1% from the third quarter of 1998. Management anticipates ceded
premiums will continue to increase as a result of the expected increase in
risk-share programs. (See IC7 and IC15)
PMI's monthly premium product represented 79.0% of risk in force at
September 30, 1999, compared with 68.3% at September 30, 1998. Mortgages
with original loan-to-value ratios greater than 90% and equal to or less
than 95% ("95s") with 30% insurance coverage increased to 36.8% of risk in
force as of September 30, 1999, from 33.4% as of September 30, 1998.
Mortgages with original loan-to-value ratios greater than 85% and equal to
or less than 90% ("90s") with 25% insurance coverage increased to 31.7% of
risk in force as of September 30, 1999, compared with 27.8% as of September
30, 1998. Management anticipates the percentage of insurance in force with
higher coverage
5
percentages will continue to increase despite the availability of reduced
coverage requirements from Fannie Mae and Freddie Mac. (See IC3 and IC10)
Mortgage insurance losses and loss adjustment expenses decreased 9.4% to
$31.0 million in the third quarter of 1999 compared with the third quarter
of 1998 primarily due to the continuing improvement of the nationwide
housing markets, particularly California, and the corresponding decrease in
claim payments. Loans in default decreased by 1.7% to 15,196 at September
30, 1999 compared with September 30, 1998. PMI's national default rate
decreased by 0.13 percentage points to 2.07% at September 30, 1999 compared
with the same period in 1998, primarily due to a decrease in the loans in
default inventory and secondarily to an increase in policies in force.
Direct primary claims paid in the third quarter of 1999 decreased by 23.0%
to $20.4 million when compared with the same period in 1998 due to a 14.3%
decrease in the average claim size to approximately $20,400 and a 12.5%
decline in the number of claims paid to 1,046 for the third quarter of
1999.
The reduction in claims paid is the result of a smaller percentage of
claims originating from the California book of business and to increased
loss mitigation efforts by PMI and lenders.
Default rates on PMI's California policies decreased to 2.61% (representing
2,430 loans in default) at September 30, 1999, from 3.15% (representing
3,110 loans in default) at September 30, 1998. Policies written in
California accounted for 31.5% and 49.8% of the total dollar amount of
claims paid in the third quarter 1999 and 1998, respectively. Although
management expects that California will continue to account for a
significant portion of total claims paid, management anticipates that with
continued improvement in the California economy, increased benefits of loss
mitigation efforts and improved default reinstatement rates, California
claims paid as a percentage of total claims paid should continue to
decline. (See IC13) Management believes that PMI's total default rate could
increase in 1999 due to the continued maturation of its 1995 and 1996 books
of business. (See IC11)
Mortgage insurance policy acquisition costs incurred and deferred
(including, among other field expenses, contract underwriting expenses)
decreased by 2.4% to $20.6 million in the third quarter of 1999 compared
with the same period in 1998 as a result of the 5.2% decrease in NIW.
Amortization of policy acquisition costs increased 21.8% to $19.0 million
during the same period. (See Note 5 "Deferred Acquisition Costs" of Notes
to Consolidated Financial Statements) New policies processed by contract
underwriters represented 36.2% of PMI's third quarter NIW in 1999 compared
with 37.7% in 1998. Contract underwriting is the preferred method among
many mortgage lenders for processing loan applications. Management
anticipates that contract underwriting will continue to generate a
significant percentage of PMI's NIW. (See IC7)
Underwriting and other mortgage insurance operating expenses increased by
16.5% to $37.4 million in the third quarter of 1999 compared with the third
quarter of 1998 due
6
primarily to an increase in the amortization of certain obsolete computer
equipment and operating systems. The mortgage insurance loss ratio declined
by 6.8 percentage points to 25.6% in the period ended September 30, 1999
compared with the same period in 1998. The decrease can be attributed to
the growth in premiums earned coupled with the decrease in losses and loss
adjustment expenses, as discussed above. The expense ratio increased by 3.9
percentage points to 28.7% primarily due to the increase in the
amortization of policy acquisition costs and the increase in underwriting
and other mortgage insurance expenses and the decrease in NIW market share,
all as discussed above. In addition, a reduction in pool premiums and an
increase in captive reinsurance premium cessions negatively affected
premiums written. The combined ratio decreased by 2.9 percentage points to
54.3% in the third quarter of 1999 compared with the same period in 1998.
TITLE INSURANCE OPERATIONS
Title insurance premiums earned increased 22.2% to $26.4 million in the
three months ended September 30, 1999 compared with the same period in 1998
primarily due to an increase in the total amount of title insurance
policies written as well as APTIC's expansion into new states. APTIC was
writing business in 32 states at September 30, 1999, up from 30 states at
September 30, 1998. In the third quarter of 1999, approximately 73% of
APTIC's premiums earned came from its Florida operations, compared with
approximately 80% in the third quarter of 1998. Underwriting and other
expenses increased 23.5% to $23.1 million in the third quarter of 1999
compared with the same period in 1998 due to an increase in agency fees and
commissions related to the increase in premiums earned. The title insurance
combined ratio increased by 1.4 percentage points to 88.4%.
OTHER
Other income generated by other subsidiaries increased by 26.0% to $6.3
million in the third quarter of 1999 compared with the third quarter of
1998 primarily due to a $5.7 million adjustment related to the estimated
interest on a federal income tax recoverable from Allstate but partially
offset by a 32.5% decrease in MSC's contract underwriting revenues as a
result of the decline in refinancing activity. Underwriting and other
expenses generated by other subsidiaries decreased by 30.8% to $5.4
million, primarily due to a 24.2% decrease in expenses incurred by MSC
during the same period resulting from a decrease in refinancing and a
reduction in demand for contract underwriting services provided to the
Company's mortgage insurance customers. (See IC7)
In the quarter ended September 30, 1999, the Company's net investment
income (including realized capital gains) decreased by 30.9% to $24.2
million when compared with the third quarter of 1998 primarily due to a
$14.0 million decrease in realized gains on investments. In addition, the
yield decreased to 5.83% at September 30, 1999 from 6.09% at September 30,
1998 primarily as a result of higher yielding investments maturing and
being replaced by lower yielding investments.
7
The Company's effective tax rate remained consistent at 29.5% for both the
third quarter of 1999 and 1998.
NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Consolidated net income was $147.6 million in the nine months ended
September 30, 1999, a 0.9% increase over the corresponding period of 1998.
The increase can be attributed to an increase in premiums earned of 12.5%
and a decrease in losses and loss adjustment expenses of 18.5%, partially
offset by a 98.0% decrease in net realized gains, a 50.2% increase in
policy acquisition costs and an 18.7% increase in underwriting and other
expenses. Including capital gains, diluted earnings per share increased by
6.5% to $3.26 in 1999. Excluding capital gains, diluted operating earnings
per share increased by 19.9% to $3.26. Excluding PMI Holdings, earnings per
share for the nine months ended September 30, 1999 were $3.22. Revenues in
the first nine months of 1999 increased by 5.2% to $489.6 million.
MORTGAGE INSURANCE OPERATIONS
PMI's NIW increased by 13.8% to $22.2 billion in the first nine months of
1999 compared with the corresponding period of 1998, primarily as a result
of the growth in volume of the private mortgage insurance industry as well
as the increase in PMI's market share during the same period.
The members of the private mortgage insurance industry, as reported by the
industry's trade association, Mortgage Insurance Companies of America
("MICA"), experienced an increase in total new insurance written of 12.9%
to $149.2 billion for the period ended September 30, 1999 from the
corresponding period of 1998 primarily due to strong home purchase activity
partially offset by a decrease in refinancing activity. Refinancing as a
percentage of PMI's NIW decreased to 25.5% for the nine months ended
September 30, 1999 from 29.5% for the same period of 1998. Management
anticipates that the decrease in refinancing activity will continue in
1999. The private mortgage insurance companies' market share for the nine
months ended September 30, 1999 decreased to 51.7% of the total low down-
payment market (insurable loans) from 55.3% for the same period of 1998.
Management believes the private mortgage insurance companies' decline in
the low down-payment market share was the result of an increase in the
maximum individual loan amount that the FHA/VA can insure as well as the
increased use of adjustable rate mortgages, which lenders tend to retain in
their portfolios or self-insure. (See IC2)
PMI's market share of NIW was 14.9% in the first nine months of 1999, an
increase from 14.7% in the first nine months of 1998. On a combined basis
with CMG, market share increased to 16.2% in the first nine months of 1999
compared with 16.1% in the first nine months of 1998. The increases in
market share were primarily due to contract underwriting services, pool
insurance products, and risk sharing programs offered by PMI. Pool risk
written totaled $193 million for the first nine months of 1999 compared
with $369 million in the period ended September 30, 1998. Management
expected the Fannie Mae and Freddie Mac reduction in mortgage insurance
coverage requirements
8
would have negatively impacted the growth rate of direct risk in force;
however, PMI's percentage of insurance in force with higher coverage
percentages continues to increase due to terminating policies being
replaced by new policies with higher coverage percentages. (See IC10)
Consolidated mortgage insurance net premiums written (which includes net
cessions and refunds) grew by 15.5% to $341.9 million in the first nine
months of 1999 compared with the same period in 1998 primarily due to the
growth of risk in force of both primary and pool insurance, the continued
shift to deeper coverage for primary insurance, and a decrease in refunded
premiums of 19.9% to $13.3 million as a result of a greater percentage of
monthly policies, which are non-refundable, being cancelled. Consolidated
mortgage insurance premiums earned increased 8.9% to $333.9 million in the
first nine months of 1999 compared with the same period in 1998 primarily
due to the increase in premiums written. Ceded premiums were $25.1 million
in the first nine months of 1999, increasing 81.9% from the corresponding
period in 1998. Management anticipates ceded premiums will continue to
increase substantially as a result of the expected increase in risk-share
programs. (See IC7 and IC15)
Consolidated mortgage insurance losses and loss adjustment expenses
decreased 19.0% to $83.2 million in the first nine months of 1999 compared
with the first nine months of 1998 primarily due to the continuing
improvement of the nationwide housing markets, particularly California, and
the corresponding decrease in claim payments.
Direct primary claims paid in the nine months ended September 30, 1999
decreased by 33.9% to $62.0 million when compared with the same period in
1998 due to a 14.3% decrease in the average claim size to approximately
$20,400 and a 22.9% decline in the number of claims paid to 3,039. The
reduction in claims paid is the result of a smaller percentage of claims
originating from the California book of business and to increased loss
mitigation efforts by PMI and lenders.
Mortgage insurance policy acquisition costs incurred and deferred
(including, among other field expenses, contract underwriting expenses)
increased by 24.7% to $70.1 million for the first nine months of 1999
compared with the same period in 1998 as a result of the 13.8% increase in
NIW. Amortization of policy acquisition costs increased 50.2% to $61.0
million for the same period. (See Note 5 "Deferred Acquisition Costs" of
Notes to Consolidated Financial Statements) New policies processed by
contract underwriters represented 37.9% of PMI's NIW in 1999 compared with
34.6% in 1998. Contract underwriting is the preferred method among many
mortgage lenders for processing loan applications. Management anticipates
that contract underwriting will continue to generate a significant
percentage of PMI's NIW. (See IC7)
Underwriting and other mortgage insurance operating expenses increased by
21.2% to $112.1 million in the first nine months of 1999 compared with the
same period of 1998 due primarily to an increase in the amortization of
certain obsolete computer equipment and operating systems. Included in
operating expenses were Year 2000 remediation costs of $0.9 million in the
first nine months of 1999, compared with $1.9 million of such costs in the
first nine months of 1998. The mortgage insurance loss ratio declined by
8.6
9
percentage points to 24.9% in the period ended September 30, 1999 compared
with the same period in 1998. The decrease can be attributed to the growth
in premiums earned coupled with the decrease in losses and loss adjustment
expenses, as discussed above. The expense ratio increased by 4.6 percentage
points to 30.5% primarily due to the increase in the amortization of policy
acquisition costs, the increase in underwriting and other mortgage
insurance expenses and the decrease in NIW market share, as discussed
above. In addition, a reduction in pool premiums and an increase in captive
reinsurance premium cessions negatively affected premiums written. The
combined ratio decreased by 3.9 percentage points to 55.5% in the first
nine months of 1999 compared with the same period in 1998.
TITLE INSURANCE OPERATIONS
Title insurance premiums earned increased 32.2% to $73.9 million in the
nine months ended September 30, 1999 compared with the same period in 1998
primarily due to an increase in title insurance policies written and
APTIC's expansion into new states. APTIC was writing business in 32 states
at September 30, 1999, up from 30 states at September 30, 1998. In the
first nine months of 1999, approximately 72% of APTIC's premiums earned
came from its Florida operations, compared with approximately 74% in 1998.
Underwriting and other expenses increased 32.5% to $65.2 million in the
first nine months of 1999 compared with the same period in 1998 due to an
increase in agency fees and commissions related to the increase in premiums
earned. The title insurance combined ratio increased by 0.8 percentage
points to 89.2%.
OTHER
Other income generated by other subsidiaries decreased by 8.7% to $13.7
million in the period ended September 30, 1999 compared with the same
period of 1998 primarily due to a 31.1% decrease in MSC's contract
underwriting revenues as a result of the decrease in refinancing activity.
Underwriting and other expenses generated by other subsidiaries decreased
by 18.5% to $15.9 million, primarily due to a 11.4% decrease in expenses
incurred by MSC during the same period resulting from a decrease in
refinancings and a reduction in demand for contract underwriting services
provided to the Company's mortgage insurance customers. (See IC7)
In the period ended September 30, 1999, the Company's net investment income
(including realized capital gains) decreased 22.5% to $68.1 million when
compared with the first nine months of 1998 primarily due to a $23.9
million decrease in realized gains on investments. In addition, the yield
decreased to 5.88% at September 30, 1999 from 6.10% at September 30, 1998
primarily as a result of higher yielding investments maturing and being
replaced by lower yielding investments.
The Company's effective tax rate increased to 29.2% in the first nine
months of 1999 from 28.8% in the first nine months of 1998 as a result of a
decrease in the proportion of tax-exempt investment income relative to
total income.
10
LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION
Liquidity and capital resource considerations are different for TPG and
PMI, its principal insurance operating subsidiary. TPG's principal sources
of funds are dividends from PMI and APTIC, investment income and funds that
may be raised from time to time in the capital markets.
PMI's ability to pay dividends to TPG is limited, among other restrictions,
under the insurance laws of Arizona. Such laws provide that: (i) PMI may
pay dividends out of available surplus and (ii) without prior approval of
the Arizona Insurance Director, such dividends during any 12-month period
may not exceed the lesser of 10% of policyholders' surplus as of the
preceding year end, or the last calendar year's investment income.
The laws of Florida limit the payment of dividends by APTIC to TPG in any
one year to 10% of available and accumulated surplus derived from realized
net operating profits and net realized capital gains.
On August 6, 1999, TPG announced it had completed the acquisition of PMI
Mortgage Insurance Ltd, ("PMI Ltd"), formerly known as MGICA, Australia's
second largest mortgage insurance company. PMI , Ltd., is now an indirect
wholly owned subsidiary of PMI. The transaction purchase price was US$77.6
million. PMI Holdings has also issued a note for US$46.0 million and TPG
agreed to guarantee repayment of the debt incurred to finance a portion of
the purchase price. PMI Ltd has a Standard and Poor's ("S&P") claim paying
ability rating of AA- and a Moody's Investors Service ("Moody's") financial
strength rating of A1. S&P and Moody's have affirmed both PMI's and PMI
Ltd's ratings following the acquisition based upon PMI's execution of a
Support agreement to maintain PMI Ltd's capital at certain minimum levels.
The terms of the US$46.0 million credit agreement dated August 3, 1999
executed among TPG, PMI Holdings, and Bank of America, N.A., in connection
with the Company's acquisition of PMI Ltd, provide in part that: (i) TPG's
consolidated net worth shall not be less than $600 million; (ii) PMI's
statutory capital shall not be less than $675 million; (iii) the risk to
capital ratio shall not exceed 23 to 1; and (iv) TPG's consolidated debt to
capital ratio shall not exceed 0.40 to 1.0. In addition, PMI's and PMI
Ltd's ability to pay dividends or incur additional indebtedness is
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.
Further, pursuant to the terms of an indenture for $100 million 6 3/4%
senior notes ("Note") issued by TPG on November 15, 1996; and the terms of
two lines of credit agreements each in the amount of $25 million ("Credit
Lines"), in the event of default under any indebtedness, all outstanding
amounts under the Credit Lines and Note may be accelerated and become
immediately payable by TPG.
11
In addition to the dividend restrictions described above, the Company's
other credit agreements also limit the payment of dividends by PMI, and
various credit rating agencies and insurance regulatory authorities have
broad discretion to limit the payment of dividends to TPG by PMI or APTIC.
During the first nine months of 1999, APTIC declared and paid a cash
dividend of $3.0 million to TPG, substantially the full amount of a
dividend that can be paid by APTIC in 1999 without prior permission from
the Florida Department of Insurance. On June 16, 1999, the Arizona
Department of Insurance also authorized a dividend of $65.0 million to TPG,
which was to be paid in cash in three installments. The first installment
of $25.0 million was paid on June 23, 1999 and the second installment of
$20.0 million was paid on September 2, 1999. The third installment has not
yet been paid as of November 15, 1999. In addition, TPG has two bank credit
lines available totaling $50.0 million. At September 30, 1999, there were
no outstanding borrowings under the Credit Lines.
TPG's principal uses of funds are common stock repurchases, the payment of
dividends to shareholders, funding of acquisitions, additions to its
investment portfolio, investments in subsidiaries, and the payment of
interest. The Company announced a stock repurchase program in the amount of
$100.0 million authorized by the TPG Board of Directors in November 1998.
During the first nine months of 1999, TPG purchased $25.4 million of the
Company's common stock.
As of September 30, 1999, TPG had approximately $84.5 million of available
funds. This amount has increased from the December 31, 1998 balance of
$56.1 million primarily due to the $30.2 million federal income tax
recoverable from Allstate and dividends received from subsidiaries,
partially offset by common stock repurchases.
The principal sources of funds for PMI are premiums received on new and
renewal business and amounts earned from the investment of this cash flow.
The principal uses of funds by PMI are the payment of claims and related
expenses, policy acquisition costs and other operating expenses, investment
in subsidiaries, and dividends to TPG. PMI generates positive cash flows
from operations as a result of premiums being received in advance of the
payment of claims. Cash flows generated from PMI's operating activities
totaled $189.2 million and $104.3 million in the nine months ended
September 30, 1999 and 1998, respectively. The increase is primarily due to
the decrease in reinsurance recoverable and prepaid premiums, and the
decrease in net realized capital gains for the same period.
The Company's invested assets increased by $224.5 million at September 30,
1999 compared with December 31, 1998 partially due to PMI Ltd investments
of $148.2 million and the $30.2 million payment of tax refund due from
Allstate partially offset by a decrease in net unrealized gains on
investments of $45.9 million, stock repurchases of $25.4 million and
dividends declared of $4.8 million.
Consolidated reserves for losses and loss adjustment expenses increased by
30.0% in the nine months of 1999 compared with December 31, 1998 primarily
due to the $42.7
12
million increase in pool loss reserves as a result of the Recapture
Agreement between PMI and Forestview and secondarily due to pool and
primary reserve increases.
Consolidated shareholders' equity increased by $71.9 million in the first
nine months of 1999, consisting of increases of $147.6 million from net
income and $0.3 million from exercises of stock options, offset by a $45.9
million decrease in net unrealized gains on investments included in other
comprehensive income, common stock repurchases of $25.4 million, and
dividends declared of $4.8 million.
On July 27, 1999, the Company received $30.2 million from Allstate
Insurance Co, as payment of a tax refund due to the Company under a tax
sharing agreement executed by TPG, The Allstate Corporation, The Allstate
Insurance Company and Sears, Roebuck and Co., in connection with the
Company's initial public offering in April 1995. (See Note 7 "Income Taxes"
in the 1998 Annual Report to Shareholders)
On July 21, 1999, TPG announced that its Board of Directors declared a 3-
for-2 stock split in the form of a 50 percent stock dividend, and increased
its cash dividend level to 6 cents per share on a pre-split basis. The
stock split was paid on August 16, 1999 to shareholders of record on July
30, 1999. PMI's statutory risk-to-capital ratio at both September 30, 1999
and December 31, 1998 was 14.9 to 1. (See IC9)
YEAR 2000 ISSUES
Impact of the Year 2000 Issue. The Company's business processes are highly
automated and dependent upon the consistent and accurate functioning of its
computer systems and the computer systems of its customers. As a result,
the Company is directing significant resources toward mitigating its
exposure to the so-called "Year 2000 issue." The Company has in place a
Year 2000 project plan to address the Year 2000 issue. The plan consists of
three phases, all of which have been completed or substantially completed
as more fully discussed in the Company's prior SEC filings. To date, PMI
and CMG have met all readiness deadlines or targets established by Fannie
Mae, Freddie Mac and their regulators.
Costs to Address the Year 2000 Issue. The Company is utilizing both
internal and external personnel and resources to implement its Year 2000
project plan. Currently, no planned material projects involving information
or non-information technology systems have been delayed or are anticipated
to be delayed as a result of the redirection of resources to the Year 2000
remediation effort. The Company plans to complete its Year 2000 issue
remediation project at a total external cost of approximately $5.0 million,
which will be funded from operating cash flow and is being expensed as
incurred. For the three-month period ended September 30, 1999, the Company
incurred and expensed approximately $64 thousand in external costs related
to its Year 2000 project plan and remediation efforts, out of a total of
$4.8 million incurred and expensed since commencement of the Year 2000
project. The estimated costs do not include any potential costs related to
customer or other claims, or potential amounts related to
13
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)
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 for or acceptance of the
Company's products; changes in government housing policy; changes in
government regulations or interpretations regarding the Real Estate
Settlement Procedures Act and customer consolidation. PMI's financial
condition and results of operations may materially and adversely be
impacted by changes in legislation which affects the ability of Fannie Mae
or Freddie Mac to offer a substitute for mortgage insurance, including
self-insurance and alternative forms of credit support, or for the FHA or
the VA to increase statutory lending limits or other expansion of
eligibility for the FHA and VA. PMI's financial condition and results of
operations may materially and adversely be impacted by changes in
legislation, statutory charters and regulations governing banks and savings
institutions to form reinsurance subsidiaries or permit the offering of
other products which do not require mortgage insurance. (See IC 16) In
addition, PMI's financial condition and results of operations may
materially and adversely be impacted by a reduction in the amount of
mortgage insurance coverage required by Fannie Mae and Freddie Mac.)
The costs of Year 2000 remediation, the correctness of the Company's
assessment that is has completed one or more phases of its remediation, the
dates on which the Company estimates that it will complete other
remediation phases and possible risks associated with
14
the Year 2000 issue are based upon the Company's current estimates and are
subject to various uncertainties that could cause the actual results to
differ materially from the Company's expectations. Such uncertainties
include, among others, the success of the Company in identifying systems
that are not Year 2000 compliant, the nature and amount of programming
required to remediate each affected system, the nature and adequacy of
testing performed by the Company, the availability of qualified personnel,
consultants and other resources, and the success of the Year 2000
remediation efforts of others. If the Company's recently completed
remediation of its mission critical mortgage insurance origination and
application processing process is faulty or fails for any reason to be Year
2000 compliant, this circumstance could adversely impact its business
operations and could have a material adverse affect on the Company's
financial condition, liquidity and results of operations. See Management
Discussion and Analysis - Year 2000 Issues.
MARKET SHARE AND COMPETITION (IC2)
The Company's financial condition and results of operations could be
materially and adversely affected by a decline in its market share, or a
decline in market share of the private mortgage insurance industry as a
whole. Numerous factors bear on the relative position of the private
mortgage insurance industry versus government and quasi-governmental
competition (see IC3) as well as the competition of lending institutions
that choose to remain uninsured, self-insure through affiliates, or offer
residential mortgage products that do not require mortgage insurance. The
impact of captive reinsurance arrangements, competitive underwriting
criteria and product offerings, including mortgage pool insurance and
contract underwriting, has a direct impact on the Company's market share.
Further, several of the Company's competitors have greater direct or
indirect capital reserves that provide them with potentially greater
flexibility than the Company in addressing competitive issues.
PMI competes directly with federal and state governmental and quasi-
governmental agencies, principally the FHA and, to a lesser degree, the VA.
Historically, the Office of the Comptroller of the Currency has granted
permission to certain national banks to form a reinsurance company as a
wholly-owned operating subsidiary for the purpose of reinsuring mortgage
insurance written on loans originated or purchased by such bank. In
addition, the Office of Thrift Supervision has also granted permission for
subsidiaries of thrift institutions to reinsure private mortgage insurance
coverage on loans originated or purchased by affiliates of such thrift's
parent organization. The Federal Reserve Board is in the process of
considering whether similar activities are permitted for bank holding
companies. The captive reinsurance subsidiaries of national banks, savings
institutions, or bank holding companies could become significant
competitors of the Company in the future. (See IC15) Recently, however,
President Clinton signed into law the Gramm-Leach-Bliley Act of 1999, which
will allow financial services companies to combine and offer banking,
insurance and equity services simultaneously, which could lead to
additional significant competitors of the Company in the future and may
materially and adversely impact PMI's market share. (See IC16) 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. The Gramm-Leach-Bliley Act
15
allows a bank holding company to form an insurance subsidiary, licensed
under state insurance law, to issue insurance products directly. Management
believes that such bank holding company subsidiaries will increase
competition in the mortgage insurance industry and may materially and
adversely impact PMI's market share.
On October 4 1999, the Federal Housing Finance Board ("FHFB") adopted
resolutions which authorizes each Federal Home Loan Bank ("FHLB") to offer
programs to fund or purchase single-family conforming mortgage loans
originated by participating member institutions under the single-family
member mortgage assets program ("Single-Family MMA") program. The FHFB
resolutions superceded a regulation previously proposed by the FHFB in July
1999 that would have allowed FHLBs to provide mortgage insurance or
substitutes for mortgage insurance, and would have expanded the FHLBs'
investment powers to permit equity investments in enterprises that focused
on low-or moderate-income community development and housing in small
business investment corporations.
Under the Terms and Conditions of the Single-Family MMA program, each FHLB
is also authorized to provide credit enhancements in the form of a first
loss account, through which a member or eligible nonmember borrower may
bear responsibility for losses up to a certain amount. In addition, each
FHLB may establish additional loss coverage, (beyond coverage provided by
the first loss account) in an amount sufficient to raise the loan or loan
pool to the fourth highest credit rating category. A member or nonmember
eligible borrower may satisfy a portion of the additional loss coverage
requirement by providing supplemental loan-level mortgage insurance
provided by a mortgage insurer rated not lower than double-A. The total
principal amount of mortgage loans funded through members and purchased
from members under all FHLB Single-Family MMA programs shall not exceed $9
billion.
The Company is presently not able to ascertain the full impact of the
Single-Family MMA program on the Company's financial condition and results
of operations in 1999 and beyond. The Company believes any expansion of the
FHLBs' ability to issue mortgage insurance or use alternatives to mortgage
insurance could materially and adversely affect the Company's financial
condition and results of operations.
Certain lenders originate a first mortgage lien with an 80% LTV ratio, a
10% second mortgage lien, and 10% of the purchase price from borrower's
funds ("80/10/10"). This 80/10/10 product competes with mortgage insurance
as an alternative for lenders selling loans in the secondary mortgage
market. The Federal Deposit Insurance Corporation and other banking
regulators approved rules to be effective April 1, 1999 that would require
national banks to hold almost twice as much risk-based capital to cover
possible defaults on the 80/10/10 products when the lender holds the first
and second mortgage. State-chartered banks already are subject to the
higher capital requirement. If the 80/10/10 product becomes a widely
accepted alternative to mortgage insurance, it could have a material and
adverse impact on the Company's financial condition and results of
operations.
16
Legislation and regulatory changes affecting the FHA have affected demand
for private mortgage insurance. Effective January 1, 1999, the Department
of Housing and Urban Development announced an increase in the maximum
individual loan amount that FHA can insure to $208,800 from $197,620. The
maximum individual loan amount that the VA can insure is $203,150. The
Omnibus Spending Bill of 1999, signed into law on October 21, 1998, among
other items, streamlined the FHA down-payment formula by eliminating tiered
minimum cash investment requirements and establishing maximum loan-to-value
ratios based on loan size and closing costs, making FHA insurance more
competitive with private mortgage insurance in areas with higher home
prices. Management believes the decline in the MICA members' share of the
mortgage insurance business from 56.3% at December 31, 1998 to
approximately 50.9% at September 30, 1999 results in part from the increase
in the maximum individual loan amount the FHA can insure. Any increase in
the maximum FHA loan amount would likely have an adverse effect on the
competitive position of PMI and, consequently, could materially and
adversely affect the Company's financial condition and results of
operations.
FANNIE MAE AND FREDDIE MAC (IC3)
The GSEs are permitted by charter to purchase conventional high-LTV
mortgages from lenders who obtain mortgage insurance on those loans. Fannie
Mae and Freddie Mac have some discretion to increase or decrease the amount
of private mortgage insurance coverage they require on loans, provided the
minimum insurance coverage requirement is met. During 1999, Fannie Mae and
Freddie Mac separately announced programs where reduced mortgage insurance
coverage will be made available for lenders that deliver loans approved by
the GSEs' automated underwriting services, Desktop Underwriter(TM) and Loan
Prospector(SM), respectively. Generally, Fannie Mae's and Freddie Mac's
reduced mortgage insurance coverage options provide for: (i) across-the-
board reductions in required MI coverage on 30-year fixed-rate loans
recommended for approval by GSE's automated underwriting services to the
levels in effect in 1994; (ii) reduction in required MI coverage, for loans
with only a 5 percent down payment (a 95 percent LTV), from 30 percent to
25 percent of the mortgage loan covered by MI; (iii) reduction in required
MI coverage, for loans with a 10 percent down payment (a 90 percent LTV
loan), from 25 percent to 17 percent of the mortgage loan covered by MI. In
addition, the GSE's announced programs to further reduce MI coverage upon
the payment of an additional fee by the lender. Under this option, a 95
percent LTV loan will require 18 percent of the mortgage loan have mortgage
insurance coverage. Similarly, a 90 percent LTV loan will require 12
percent of the mortgage loan have mortgage insurance. In order for the home
buyer to have MI at these levels, such loans would require a payment at
closing or a higher note rate.
Management believes it is too early to assess the impact of the GSEs'
reduction of required levels of mortgage insurance on the Company's
financial condition and results of operations. If the reduction in required
levels of mortgage insurance were to become widely accepted by mortgage
lenders and their customers, however, such reduction could have a
materially adverse impact on the Company's financial condition and results
of operations.
17
The Federal Housing Enterprises Financial Safety and Soundness Act of 1992,
requires the Office of Federal Housing Enterprise Oversight ("OFHEO") to
develop a risk-based capital regulation for the GSEs. On April 13, 1999, a
notice of proposed rulemaking was published in the Federal Register
announcing OFHEO's development of proposed risk-based capital regulations.
Public comments regarding the proposed regulations were due on August 11,
1999. However, OFHEO recently announced a second extension of the due date
until March 10, 2000 to allow interested parties adequate time to analyze
and review the rule and submit constructive comments. After consideration
of the comments received on the proposal, OFHEO will determine whether to
issue a final rule or to issue a revised proposal. OFHEO is not authorized
to enforce the risk-based standard until one year after the final rule is
published. The regulation specifies a risk-based capital stress test that,
when applied to the GSEs, determines the amount of capital that a GSE must
hold to maintain positive capital throughout a 10-year period of economic
stress. The stress test is designed to simulate the financial performance,
including cash flows of the GSEs under severe economic conditions. Such
conditions would include high levels of mortgage defaults and associated
losses, and large interest rate shocks. The proposed regulations could
require a GSE to hold more than double the capital it presently maintains
for loans with loan-to-value ratios ("LTV") of 95 percent or higher.
Further, the proposed capital regulations could treat more favorably credit
enhancements issued by private mortgage insurance companies with a claims-
paying ability rating of AAA or higher compared with those companies with
an 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 made several
announcements that it would pursue a permanent charter amendment that would
allow Freddie Mac to utilize alternative forms of default loss protection,
such as spread accounts, or otherwise forego the use of private mortgage
insurance on higher loan-to-value mortgages. In addition, Fannie Mae
announced it is interested in pursuing new risk management options and is
working with mortgage insurers and lenders on appropriate
18
risk management and dispersion of risk, which may include a reduction in
the use of mortgage insurance.
In June 1999, a coalition of financial industry trade associations was
formed under the name "FM Watch". FM Watch works with affordable housing
and consumer advocates, taxpayer groups and financial institutions, and is
dedicated to monitoring the activities of Fannie Mae and Freddie Mac. FM
Watch's efforts are designed to support HUD's efforts to strengthen the
affordable housing goals for the GSEs, and to promote policies that do not
allow the GSEs to move beyond their unique charters into markets and
services already provided by the private sector. Current members of FM
Watch include: the American Financial Services Association, the Appraisal
Institute, the Association of Financial Guaranty Insurors, the Consumer
Bankers Association, the Consumer Mortgage Coalition, the Financial
Services Roundtable, the Home Equity Lender Leadership Organization, the
Mortgage Insurance Companies of America, and the National Home Equity
Mortgage Association.
In July 1999, HUD announced new affordable housing goals for the GSEs. The
proposed affordable housing goals would raise the target for low- and
moderate-income business from 42 percent of the GSEs' annual volume to 50
percent. The goal would increase to 48 percent in year 2000 and to 50
percent for year 2001. In addition, HUD announced proposed increases in two
other components of the GSEs' affordable housing goals. Currently, the GSEs
are expected to generate 24 percent of their mortgage business in central
cities, rural areas and other underserved markets. Under the proposal, this
target would increase up to 31 percent. The special affordable housing
goal, which measures funding for families with very-low household income or
living in low-income areas, would increase from 14 percent to 20 percent.
The proposed goals are subject to review by the Office of Management and
Budget and would be subject to a public comment period prior to final
revisions or enactment by HUD.
Fannie Mae's and Freddie Mac's current guidelines regarding cancellation of
mortgage insurance generally provide that a borrower's written request to
cancel mortgage insurance should be honored if: (a) the borrower has a
satisfactory payment record, no payment more than 30 days delinquent in the
12-month period preceding the request for cancellation; and (b) the unpaid
principal balance of the mortgage is not greater than 80% of the original
value of the property. (See IC4 for a discussion of Federal legislation
providing for guidelines for automatic mortgage insurance cancellation)
In January, Fannie Mae and Freddie Mac announced increases in the maximum
principal balance of loans eligible for purchase by Fannie Mae and Freddie
Mac to $240,000. Although management believes that it is too early to
ascertain the impact of the increase in the maximum individual loan amount
the GSEs can insure, management believes any increase in the maximum loan
amount would likely increase the number of loans eligible for mortgage
insurance and may have the effect of increasing the size of the mortgage
insurance market, and have a positive effect on the competitive position of
PMI and consequently could materially affect the Company's financial
condition and results of operations.
19
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 of operations could
be materially and adversely affected by greater than anticipated policy
cancellations or lower than projected persistency resulting in declines in
insurance in force.
Upon request by an insured, PMI must cancel the mortgage insurance for a
mortgage loan. In addition, The Home Owners Protection Act of 1998 (the
"Act"), which is effective on July 29, 1999, provides for the automatic
termination, or cancellation upon a borrower's request, of private mortgage
insurance upon satisfaction of certain conditions. The Act applies to
owner-occupied residential mortgage loans regardless of lien priority, with
borrower-paid mortgage insurance, which closed after the effective date of
the Act. FHA loans are not covered by the Act. Under the Act, automatic
termination of mortgage insurance would generally occur once the loan-to-
value ratio ("LTV") reaches 78%. A borrower may generally request
cancellation of mortgage insurance once the LTV reaches 80% of the home's
original value, or when actual payments reduce the loan balance to 80% of
the home's original value, whichever occurs earlier. For borrower initiated
cancellation of mortgage insurance, the borrower must have a good payment
history. Good payment history generally requires that there have been no
payments during the 12-month period preceding the loan's cancellation date
30 days or more past due, or 60 days or more past due during the 12-month
period beginning 24 months before the loan's cancellation date. Loans that
are deemed "high risk" by the GSEs, require automatic termination of
mortgage insurance coverage once the LTV is first scheduled to reach 77% of
the original value of the property without regard to the actual outstanding
balance. The Act preempts all but more protective, preexisting state laws.
Protected state laws are preempted if inconsistent with the Act. Protected
state laws are consistent with the Act if
20
they require: (i) termination of mortgage insurance at an earlier date or
higher mortgage principal balance than required by the Act, or (ii)
disclosure of more, earlier, or more frequent information. States that
enacted mortgage insurance cancellation laws on or before January 2, 1998,
have until July 29, 2000 to make their statutes consistent with the Act.
States that currently have mortgage insurance cancellation or notification
laws include: California, Connecticut, Illinois, Maryland, Minnesota,
Missouri, New York, Texas and Washington. Management is uncertain about the
impact of the Act on PMI's insurance in force, but believes any reduction
in premiums attributed to the Act's required cancellation of mortgage
insurance, will not have a significant impact on the Company's financial
condition and results of operations for the foreseeable future. (See IC10)
During an environment of falling interest rates, an increasing number of
borrowers refinance their mortgage loans. PMI and other mortgage insurance
companies generally experience an increase in the prepayment rate of
insurance in force, resulting from policy cancellations of older books of
business with higher rates of interest. Although PMI has a history of
expanding business during low interest rate environments, the resulting
increase of NIW may ultimately prove to be inadequate to compensate for the
loss of insurance in force arising from policy cancellations. During the
first half of 1999, mortgage loan refinancings continued at a higher than
expected rate. Management anticipates that the refinancing trend will
decrease in the second half of 1999.
A decrease in persistency, resulting from policy cancellations of older
books of business affected by refinancing (which is affected, among other
things, by decreases in interest rates) may materially and adversely impact
the level or rate of growth of insurance in force or risk in force and
consequently have similar impacts on the Company's financial condition and
results of operations.
RATING AGENCIES (IC5)
PMI's claims-paying ability is currently rated "AA+" (Excellent) by
Standard and Poor's Rating Services, "Aa2" (Excellent) by Moody's Investors
Service, Inc., "AA+" (Very Strong) by Fitch IBCA, and "AA+" (Very High) by
Duff & Phelps Credit Rating Co. These ratings are subject to revisions or
withdrawal at any time by the assigning rating organization. The ratings by
the organizations are based upon factors relevant to PMI's policyholders,
principally PMI's capital resources as computed by the rating agencies, and
are not applicable to the Company's common stock or outstanding debt.
During June 1999, Standard & Poor's and Moody's affirmed the AA+ and Aa2,
respectively, financial strength rating and claims-paying ability rating of
PMI. During March 1999, Moody's announced that it changed PMI's and TPG's
rating outlook from stable to negative, stating such action was based on
TPG's stock repurchases, PMI's writing of GSE pool and diversification into
new sectors.
Rating agencies generally assess capital charges on pool insurance policies
based on price and structure. One published methodology for assessing the
capital requirement for pool insurance is based on the real estate
depression that occurred in oil producing states during the mid-1980's.
Management believes the current capital charge that could be
21
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
22
qualified underwriters, or any significant increase in the cost PMI incurs
to satisfy remedy obligations for underwriting services, could materially
and adversely affect its market share and materially and adversely affect
the Company's financial condition and results of operations.
TPG and PMI, from time to time, introduce new mortgage insurance products
or programs. The Company's financial condition and results of operations
could be materially and adversely affected if PMI or the Company
experiences delays in introducing competitive new products and programs. In
addition, for any introduced product, there can be no assurance that such
products, including any mortgage pool type products, or programs will be as
profitable as the Company's existing products and programs.
NEW YORK DEPARTMENT OF INSURANCE (IC8)
In February 1999, the New York Department of Insurance stated in Circular
Letter No. 2, addressed to all private mortgage insurers licensed in New
York that certain pool risk-share and structured products and programs
would be considered to be illegal under New York law. PMI believes that it
complies with the requirements of Circular Letter No. 2 with respect to
transactions that are governed by it. In the event the New York Department
of Insurance determined PMI was not in compliance with Circular Letter No.
2, it could materially and adversely affect the Company's financial
condition and results of operations.
RISK-TO-CAPITAL RATIO (IC9)
The State of Arizona, PMI's state of domicile for insurance regulatory
purposes, and other regulators specifically limit the amount of insurance
risk that may be written by PMI, by a variety of financial factors. For
example, Arizona law provides that if a mortgage guaranty insurer domiciled
in Arizona does not have the amount of minimum policyholders position
required, it must cease transacting new business until its minimum
policyholders position meets the requirements. Under Arizona law, minimum
policyholders position is calculated based on the face amount of the
mortgage, the percentage coverage or claim settlement option and the loan
to value ratio category, net of reinsurance ceded, but including
reinsurance assumed. For example, under Arizona law, a mortgage guaranty
insurer would have to maintain minimum policyholders' position equal to
$1.00 per each one hundred dollars of the face amount of the mortgage,
provided the LTV was greater than seventy-five percent and the coverage
percent was twenty-five percent. The amount of minimum policyholders
position would generally increase if the mortgage amount remained constant,
but the coverage percentages and/or LTV amounts increased.
Other factors affecting PMI's risk-to-capital ratio include: (i)
limitations under the Runoff Support Agreement with Allstate, which
prohibit PMI from paying any dividends if, after the payment of any such
dividend, PMI's 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
23
purchase PMI LTD; and (iii) TPG's and PMI's credit or claims-paying ability
ratings which generally require that the rating agencies' risk-to-capital
ratio not exceed 20 to 1.
Significant losses could cause a material reduction in statutory capital,
causing an increase in the risk-to-capital ratio and thereby limit PMI's
ability to write new business. The inability to write new business could
materially and adversely affect the Company's financial condition and
results of operations.
CHANGES IN COMPOSITION OF INSURANCE WRITTEN; POOL INSURANCE (IC10)
The composition of PMI's NIW has included an increasing percentage of
mortgages with LTVs in excess of 90% and less than or equal to 95% ("95s").
At September 30, 1999, 46.2% of PMI's risk in force consisted of 95s,
which, in PMI's experience, have had a claims frequency approximately twice
that of mortgages with LTVs equal to or less than 90% and over 85% ("90s").
PMI also offers coverage for mortgages with LTVs in excess of 95% and up to
97% ("97s"). At September 30, 1999, 4.5% of PMI's risk in force consisted
of 97s that have even higher risk characteristics than 95s and greater
uncertainty as to pricing adequacy. PMI's NIW also includes adjustable rate
mortgages ("ARMs"), which, although priced higher, have risk
characteristics that exceed the risk characteristics associated with PMI's
book of business as a whole. Since the fourth quarter of 1997, PMI has
offered a new pool insurance product. Pool insurance is generally used as
an additional credit enhancement for certain secondary market mortgage
transactions and generally covers the loss on a defaulted mortgage loan
that exceeds the claim payment under the primary coverage, if primary
insurance is required on that mortgage loan. Pool insurance also generally
covers the total loss on a defaulted mortgage loan that did not require
primary insurance, in each case up to a stated aggregate loss limit. New
pool risk written was $90 million for the quarter ended September 30, 1999
and $193 million for the nine months ended September 30, 1999. Management
is uncertain about the amount of new pool risk that will be written in
1999, but believes total new 1999 pool risk will be less than in 1998.
Although PMI charges higher premium rates for loans that have higher risk
characteristics, including ARMs, 95s, 97s and pool insurance products, the
premiums earned on such products, and the associated investment income, may
ultimately prove to be inadequate to compensate for future losses from such
products. Such losses could materially and adversely affect the Company's
financial condition and results of operations. (See IC5)
POTENTIAL INCREASE IN CLAIMS (IC11)
Mortgage insurance coverage generally cannot be canceled by PMI and remains
renewable at the option of the insured until required to be canceled under
applicable Federal or state laws for the life of the loan. As a result, the
impact of increased claims from policies originated in a particular year
generally cannot be offset by premium increases on policies in force or
mitigated by nonrenewal of insurance coverage. There can be no assurance,
however, that the premiums charged will be adequate to compensate
24
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 16.1%, 7.8% and 7.3% of its risk in force concentrated and
where the default rate on all PMI policies in force is 2.61%, 2.84% and
1.92% compared with 2.07% nationwide as of September 30, 1999.
CONTINUING RELATIONSHIPS WITH ALLSTATE AND AFFILIATE (IC14)
On October 28, 1994, TPG entered into a Runoff Support Agreement (the
"Runoff Support Agreement") with Allstate Insurance Company ("Allstate") to
replace various capital support commitments that Allstate had previously
provided to PMI. Allstate agreed to pay claims on certain insurance
policies issued by PMI prior to October 28, 1994, if PMI's financial
condition deteriorates below specified levels, or if a third party brings a
claim thereunder. Alternatively, Allstate may make contributions directly
to PMI or TPG. In the event that Allstate makes payments or contributions
under the Runoff Support Agreement (which possibility management believes
is remote), Allstate would receive subordinated debt or preferred stock of
PMI or TPG in return. No payment obligations have arisen under the Runoff
Support Agreement. The Runoff Support Agreement provides PMI with
additional capital support for rating agency purposes (See IC15).
CAPTIVE REINSURANCE ARRANGEMENTS; RISK-SHARING TRANSACTIONS (IC15)
PMI offers various risk-sharing structured transactions, including a
captive reinsurance arrangement as part of its strategic relationships with
its customers. PMI's customers have indicated an increasing demand for
captive reinsurance arrangements. Such arrangements allow a reinsurance
company, generally an affiliate of the lender, to assume a portion of the
mortgage insurance default risk in exchange for a portion of the insurance
premiums. An increasing percentage of PMI's NIW is being generated by
customers with captive
25
reinsurance companies, and it is expected that this trend will increase,
resulting in a decrease in net premiums written which may negatively impact
the yield obtained in the Company's net premiums earned for such customers
with captive reinsurance arrangements. There can be no assurance that PMI's
risk-sharing structured transactions, including captive reinsurance
arrangements, will continue to be accepted by its customers. The inability
of the Company to provide its customers with acceptable risk-sharing
structured transactions, including potentially increasing levels of premium
cessions in captive reinsurance arrangements, would likely have an adverse
effect on the competitive position of PMI and consequently could materially
and adversely affect the Company's financial condition, liquidity and
results of operations.
GRAMM-LEACH-BLILEY ACT (IC16)
On November 12, 1999, the President signed the Gramm-Leach-Bliley Act of
1999 (the "Act") into law. Among other things, the Act will allow bank
holding companies to engage in a substantially broader range of activities,
including insurance underwriting, and will allow insurers and other
financial service companies to acquire banks.
The Act allows a bank holding company to form an insurance subsidiary,
licensed under state insurance law, to issue insurance products directly,
including mortgage insurance. However, any such mortgage insurance
subsidiary would be subject to state insurance regulations, including
capital and reserve requirements, diversification of risk and restrictions
on the payments of dividends. Further, before any loans insured by the
subsidiary are eligible for purchase by the GSEs, the insurance subsidiary
must meet Fannie Mae and Freddie Mac eligibility standards, which currently
require, among other things, a claims-paying ability rating of at least
AA-, and the establishment of comprehensive operating policies,
procedures and processes.
The Company expects that, over time, the Act will allow consumers the
ability to shop for their insurance, banking and investment needs at one
financial services company. For example, a typical consumer would be able
to buy a wide range of products including CD's, home equity loans, credit
cards, insurance policies and other investments from affiliates of a single
company. As a result, the Company's financial condition and results of
operations could be materially and adversely affected if the Act results in
the Company's customers choosing to offer mortgage insurance directly
instead of through captive reinsurance arrangements with it and the Company
is not able to replace lost revenues.
Because of the many aspects of the Act which require clarification and
promulgation of specific regulations, the Company is not yet able to
ascertain the full impact of the Act on the Company. However, the Company
believes that the Act will facilitate the combination of the investment
banking, commercial banking and insurance businesses and will hasten the
development of new savings and investment products that will increase
competition in the financial services area including for the Company. In
addition, the ability of insurance, banking and investment firms to
affiliate will increase the likelihood that existing bank holding companies
with significantly more capital will
26
be allowed and able to enter into mortgage insurance business, which may
result in material and adverse impact on the results of operations and
financial condition of the Company.
The new financial privacy provisions will generally prohibit financial
institutions, including the Company, from disclosing non-public, personal
financial information to third parties unless customers have the
opportunity to "opt out" of the disclosure. The Act also modifies other
current financial laws, including laws related to financial privacy. The
Company believes the privacy provisions of the Act will not materially and
adversely affect its results of operations, however."
Unless otherwise stated, information in the originally filed Form 10-Q is
presented as of the original filing date, and has not been updated in this
amended filing.
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, on November 18, 1999.
The PMI Group, Inc.
/s/ John M. Lorenzen, Jr.
-------------------------
John M. Lorenzen, Jr.
Executive Vice President and
Chief Financial Officer and as
Authorized Signatory on behalf of
Registrant
27