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| PMI > SEC Filings for PMI > Form 10-Q on 6-Nov-2008 | All Recent SEC Filings |
6-Nov-2008
Quarterly Report
CAUTIONARY STATEMENT
Statements in this report that are not historical facts, or that are preceded by, followed by or 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 federal securities laws. Forward-looking statements in this report include discussions of future potential trends relating to losses, claims paid, loss reserves, persistency, new insurance written, the make-up of our various insurance portfolios, capital initiatives, and captive reinsurance agreements. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. These uncertainties and other factors are described in more detail under the heading "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2007 and in Part II, Item 1A herein. All forward-looking statements are qualified by and should be read in conjunction with those risk factors, our consolidated financial statements, related notes and other financial information. Except as may be required by applicable law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Unless otherwise indicated, discussion under items captioned as "revenues" and "expenses" and other matters in this Management's Discussion and Analysis as well as in our consolidated financial statements relates only to continuing operations.
Financial Results for the Quarter and Nine Months Ended September 30, 2008
For the third quarter and nine months ended September 30, 2008, we recorded consolidated net losses of $229.4 million and $749.7 million, respectively, compared to a consolidated net loss of $86.8 million and consolidated net income of $99.1 million for the corresponding periods in 2007. Our consolidated net losses for the quarter and nine months ended September 30, 2008 include the financial results of our discontinued operations related to PMI Australia, PMI Asia and PMI Guaranty. Our losses in the third quarter and nine months ended September 30, 2008 were primarily driven by losses in our U.S. Mortgage Insurance Operations and International Operations segments. U.S. Mortgage Insurance Operations' net loss for the third quarter of 2008 was primarily driven by losses and loss adjustment expenses ("LAE"), impairment losses in our U.S. investment portfolio and a decrease in earned premiums from the corresponding period in 2007. U.S. Mortgage Insurance Operations' net loss for the first nine months of 2008 was primarily driven by increases in losses and LAE as compared to the corresponding period in 2007. Our International Operations segment's net losses for the third quarter and first nine months of 2008 were primarily driven by increases in losses and LAE in PMI Europe as compared to the corresponding periods in 2007. Our loss for the nine months ended September 30, 2008 was also a result of our impairment of our investment in FGIC in the first quarter of 2008, equity in losses from RAM Re and losses associated with a novation agreement executed by PMI Guaranty in the second quarter of 2008. Our financial results for the third quarter and first nine months of 2008 were positively impacted by gains related to the change in fair value of certain of our senior debt instruments in our Corporate and Other segment.
Overview of Our Business
We provide mortgage insurance and credit enhancement products that expand homeownership and strengthen communities. Our financial products are designed to reduce risk, lower costs and expand market access for our customers. We divide our business into four segments:
• U.S. Mortgage Insurance Operations. We offer mortgage insurance products in the U.S. that enable borrowers to buy homes with low down payment mortgages. The results of U.S. Mortgage Insurance Operations include PMI Mortgage Insurance Co. and its affiliated U.S. mortgage insurance and reinsurance companies (collectively, "PMI"), and equity in earnings from PMI's joint venture, CMG Mortgage Insurance Company and its affiliated companies (collectively, "CMG MI"). U.S. Mortgage Insurance Operations recorded net losses of $137.1 million and $535.5 million for the third quarter and first nine months of 2008, respectively, compared to a net loss of $65.2 million and net income of $45.2 million for the corresponding periods in 2007.
• International Operations. In August of 2008, we entered into agreements with a third party to sell our Australian mortgage insurance subsidiary and related Australian holding company (collectively "PMI Australia") and our Hong Kong subsidiary, PMI Mortgage Insurance Asia Limited ("PMI Asia"). We completed the sale of PMI Australia on October 22, 2008. The results from PMI Australia and PMI Asia have been reported as discontinued operations in our International Operations segment and in the consolidated statement of operations for all periods presented. Losses from the continuing operations of PMI Europe and PMI Canada in our International Operations segment were $46.0 million and $56.8 million for the third quarter and first nine months of 2008, respectively, compared to losses of $8.7 million and $4.5 million for the corresponding periods in 2007.
• Corporate and Other. Our Corporate and Other segment consists of corporate debt and expenses of our holding company ("The PMI Group" or "TPG"), contract underwriting operations, and equity in earnings or losses from investments in certain limited partnerships. Our Corporate and Other segment generated net income of $27.4 million and $26.9 million for the third quarter and first nine months of 2008, respectively, compared to net losses of $11.0 million and $45.7 million for the corresponding periods in 2007.
Conditions and Trends Affecting our Business
U.S. Mortgage Insurance Operations. The financial performance of our U.S. Mortgage Insurance Operations segment is affected by a number of factors, including:
• Market Conditions and Capital Constraints. The significant weakening of employment in the United States and the U.S. credit, capital, residential mortgage, and housing markets continues to negatively affect our U.S. Mortgage Insurance Operations segment. As discussed below under Losses and LAE, PMI is experiencing higher losses. These losses, which we expect to continue in 2009, have reduced, and will continue to reduce, PMI's net assets. Partially in response to PMI's higher losses and reduced capital, on August 26, 2008, Standard & Poor's lowered its insurer financial strength rating on PMI from "A+" to "A-" and placed it under CreditWatch with Negative Implications. On October 7, 2008, Standard & Poor's removed its CreditWatch designation and affirmed PMI's "A-" rating with Negative Outlook. On October 10, 2008, Moody's placed PMI under review for possible downgrade. On October 17, 2008, Fitch lowered its insurer financial strength rating on PMI to "BBB+" from "A+" and revised the Outlook to Negative. Because of rating agency actions, we submitted written remediation plans to Fannie Mae and Freddie Mac (collectively, the "GSEs") outlining, among other things, the steps we are taking or plan to take to bolster PMI's financial strength. Each of the GSEs has stated that it will continue to treat PMI as an eligible mortgage insurer. Freddie Mac has stated that its forbearance from enforcing additional insurer requirements is wholly discretionary and subject to change and is dependent upon its evaluation of monthly updates regarding PMI's progress in implementing its remediation plan. Fannie Mae also requires periodic updates from PMI, and we engage in ongoing discussions with the GSEs regarding our remediation plans. See also Part II, Item 1A. Risk Factors - We have been negatively impacted by recent downgrades of the insurer financial strength ratings of some of our
Based on current and expected future trends, we believe that we will continue to incur and pay material losses. The ultimate amount of losses will depend in part on general economic conditions and other factors, including the health of credit markets, home price fluctuations and unemployment rates, all of which are difficult to predict. Unless we raise new capital and/or reduce PMI's NIW and risk-in-force, PMI's policyholders position will likely decline and its risk-to-capital ratio could increase beyond the levels necessary to meet certain regulatory capital adequacy requirements and/or certain credit facility financial covenants. As a result, we are considering options to reduce our risk in force through reinsurance, limiting new insurance written or other means and to obtain additional capital, which could occur through the sale of equity, debt securities or the sale or contribution of additional assets to our U.S. Mortgage Insurance Operations. Especially given current and expected future market conditions, there can be no assurance that we will be able to raise any additional capital or procure capital relief in the future, either on acceptable terms and in a timely manner, or at all. Other measures that we may take to address these issues, including, but not limited to the reduction of NIW, may be inadequate to maintain PMI's policyholder position and risk-to-capital levels within required limits. See also Part II, Item 1A. Risk Factors - Our policyholders position could decline and our risk-to-capital ratio could increase beyond the levels necessary to meet various capital adequacy requirements and There is no assurance that we will be able to raise needed capital on a timely basis and on favorable terms, or at all. In addition, any reduction in new insurance written would have an adverse effect on premiums earned.
• Losses and LAE. PMI's losses and LAE were $348.2 million and $1.4 billion for the third quarter and first nine months of 2008, respectively, compared to $348.3 million and $575.5 million for the corresponding periods in 2007. We increased PMI's net loss reserves in the third quarter and first nine months of 2008 by $137.9 million and $859.8 million, respectively. We increased net loss reserves in the first nine months of 2008 as a result of increases in PMI's default inventory (discussed under Defaults below), higher claim rates (the rate at which delinquent insured loans result in claims), and higher average claim sizes. The increase in claim rates was driven by home price declines and diminished availability of certain loan products, both of which constrain refinancing opportunities and result in a decrease in the percentage of the default inventory that is returning to current status (cure rate). The increases in PMI's average claim size have been driven by, among other things, higher loan sizes and coverage levels and declining home prices which limit PMI's loss mitigation opportunities. During the third quarter of 2008, the increase in loss reserves was partially offset by a decrease in our estimated claim rate due to our projected impact of loss mitigation efforts and, to a lesser extent, by increased rescissions of insurance written in prior periods. PMI's losses and LAE will be negatively affected if future estimated claim rates and/or claim sizes increase. Changes in economic conditions, or a failure of economic conditions to improve, including the U.S. credit and capital markets, mortgage interest rates, job creation, unemployment rates, and home prices, could significantly impact our reserve estimates and, therefore, PMI's losses and LAE. Claims paid including LAE in the third quarter and first nine months of 2008 increased to $210.3 million and $577.9 million, respectively, compared to $95.9 million and $244.4 million in the corresponding periods in 2007.
Declining Home Prices - Declining home prices have made it significantly more difficult for many borrowers to refinance their mortgages or sell their homes, and are negatively affecting PMI's default inventory and default rate.
Decline in Cure Rate - The percentage of defaults that cure has declined due to diminished refinancing opportunities as a result of declining home prices and diminished availability of loan products. This decline in the percentage of defaults that cure has negatively affected PMI's default inventory and default rate. The decline in PMI's cure rate has been partially offset by successful loss mitigation efforts and, to a lesser extent, by increased rescissions of insurance written in prior periods.
Above-97s - PMI has experienced higher than expected levels of delinquent mortgages with loan-to-value ratios ("LTVs") exceeding 97%, which we refer to as "Above 97s", in its flow and structured channels. As of September 30, 2008, risk in force from Above-97s in all book years represented 22.6% of PMI's primary risk in force compared to 24.0% as of June 30, 2008 and 24.6% as of December 31, 2007. The default rate for Above-97s in PMI's primary portfolio as of September 30, 2008 was 15.2% compared to 12.4% as of June 30, 2008 and 9.1% as of December 31, 2007. As of September 30, 2008, of the 22.6% of PMI's primary risk in force from Above-97s, approximately half was from our 2007 book year. We no longer insure Above-97s.
Alt-A Loans - We define Alt-A loans as loans where the borrower's FICO score is 620 or higher and the borrower requests and is given the option of providing reduced documentation verifying the borrower's income, assets, deposit information, or employment. Risk in force from Alt-A loans represented 20.0% of PMI's primary risk in force as of September 30, 2008 compared to 21.9% as of June 30, 2008 and 22.8% as of December 31, 2007. The default rate for Alt-A loans was 25.8% as of September 30, 2008 compared to 21.7% as of June 30, 2008 and 13.9% as of December 31, 2007. Beginning in 2007, we began progressively tightening our underwriting guidelines related to Alt-A loans, and effective June 1, 2008, we eliminated all Alt-A loan eligibility. However, due primarily to commitments issued in 2007, approximately 0.5% and 7.0% of new insurance written in the third quarter and first nine months ended September 30, 2008, respectively, was for Alt-A loans. We expect the percentage of Alt-A loans in our portfolio to continue to decline.
Interest Only Loans - Interest only loans, also known as deferred amortization loans, have more exposure to declining home prices than traditional loans, in part because principal is not reduced during an initial deferral period. Risk in
force from interest only loans represented 12.5% of PMI's primary risk in force as of September 30, 2008 compared to 13.8% as of June 30, 2008 and 14.2% as of December 31, 2007. The default rate for interest only loans was 23.5% as of September 30, 2008 compared to 19.3% as of June 30, 2008 and 11.0% as of December 31, 2007. In the third quarter and first nine months of 2008, PMI primarily insured interest only loans through our flow channel and most of such loans were sold by the originating lenders to the GSEs. Due to the tightening of underwriting guidelines in late 2007 and early 2008, approximately 5% of new insurance written for the quarter ended September 30, 2008 was in connection with interest only loans, compared to 6% and 12% for the quarters ended June 30, 2008 and December 31, 2007, respectively. None of the above categories (or risk characteristics) are mutually exclusive, and PMI's portfolio may contain loans with one or more of such characteristics.
Geographic Factors - Declining home prices, particularly in California and Florida, and weak economic conditions in California, as well as in Michigan, Indiana, Ohio, and Illinois (the "Auto States"), have negatively affected the development of PMI's portfolio. PMI's default rates in California and Florida continued to increase above PMI's average default rate as of September 30, 2008. The default rate from California as of September 30, 2008 was 21.0% compared to 18.0% as of June 30, 2008 and 10.9% as of December 31, 2007. The default rate from Florida as of September 30, 2008 was 22.6% compared to 18.2% as of June 30, 2008 and 10.6% as of December 31, 2007. As of September 30, 2008, risk in force from California and Florida insured loans represented 8.2% and 10.5% of PMI's primary risk in force, respectively. The default rate of the Auto States as of September 30, 2008 was 13.6% compared to 12.1% as of June 30, 2008 and 10.6% as of December 31, 2007. As of September 30, 2008, risk in force from the Auto States represented 13.4% of PMI's primary risk in force. Effective March 1, 2008, PMI implemented a Distressed Market Policy. For those areas (principally metropolitan statistical areas (MSAs)) that are designated as distressed, PMI caps the maximum insured loan-to-value ratio generally at 90% (certain distressed areas may be eligible up to 95% LTV) and prescribes additional limiting criteria for certain property types and loan purposes. PMI's distressed markets list is reviewed and updated on a quarterly basis or as needed depending on our on-going assessment of the market.
• Voluntary Early Retirement Program. We initiated in the third quarter of 2008 a Voluntary Early Retirement Program (the "Program"). The Program was made available to employees (other than the CEO) who were at least 52 years of age and had seven or more years of service. We estimate that PMI will incur net expenses between $20 million and $30 million in the fourth quarter of 2008 as a result of this Program. In addition, we are currently evaluating the need to make future contributions to the Retirement Plan. Based on current projections, we may contribute between $9 million and $20 million to the Retirement Plan in the fourth quarter of 2008 or first quarter of 2009.
• New Insurance Written (NIW). PMI's primary NIW decreased by 57.1% in the third quarter and by 54.4% in the first nine months of 2008 compared to the corresponding periods in 2007. These decreases were principally due to changes to PMI's pricing and underwriting guidelines implemented during the second half of 2007 and early 2008 that reduce the types of loans that PMI will insure. To a lesser extent, the continuing slowdown in the mortgage origination and non-agency mortgage capital markets and increased competition from the Federal Housing Administration's mortgage insurance programs have contributed to PMI's declining NIW. Capital constraints may likely cause PMI to limit NIW in 2009.
• Captive Reinsurance. Under captive reinsurance agreements, PMI transfers portions of its risk written on loans originated by certain lender-customers to captive reinsurance companies affiliated with such customers. In return, PMI cedes a share of its gross premiums written to these captive reinsurance companies. As of September 30, 2008, 50.0% of PMI's primary insurance in force was subject to captive reinsurance agreements. As of September 30, 2008, we recorded $393.7 million in reinsurance recoverables primarily from captive arrangements related to PMI's gross loss reserves. Due to the delay between establishing a reserve and the payment of claims, we have only received $0.8 million and $1.7 million in claim payments from captive trusts in the third quarter and first nine months of 2008, respectively. As of September 30, 2008, assets in captive trust accounts held for the benefit of PMI totaled approximately $824.5 million. We expect that reinsurance payments to PMI from captive trusts assets will increase in the remainder of 2008 and substantially increase in 2009.
During the third quarter of 2008, two of PMI's lender-customers did not meet their capital deposit obligations, as required under their respective captive reinsurance agreements. As a result, PMI terminated the agreements and recovered approximately $25.8 million remaining in the captive trust accounts. We recorded the $25.8 million cash payment as a reduction of the total claims paid, which principally offset previously recorded reinsurance recoverables. Accordingly, there was no significant impact to our results of operations for the current period. To the extent that other lender-customers do not meet their capital deposit obligations now or in the future, the agreements will either be placed into runoff or terminated according to the express terms of their respective contracts or by mutual agreement of the parties, in which event PMI would reassume the ceded risk and recover all trust assets.
On September 29, 2008, PMI announced that, effective January 1, 2009, it would no longer seek reinsurance under excess-of-loss ("XOL") captive reinsurance agreements. On January 1, 2009, in-force XOL contracts will be placed into runoff and will mature pursuant to their existing terms and conditions, and PMI will cease obtaining XOL captive reinsurance on loans incepted on or after such date. We expect that captive trust balances will continue to increase through the remainder of 2008; however, due to termination and runoff of certain captive reinsurance agreements as described above, as well as expected claim payments, we do not expect the aggregate trust assets to continue to increase in 2009.
International Operations. Factors affecting the financial performance of our International Operations segment include:
• PMI Australia. On October 22, 2008, we sold PMI Australia for an aggregate
purchase price of approximately $920 million (approximately 100% of the
net tangible asset value of PMI Australia under GAAP as of June 30, 2008),
plus certain adjustments for pre-completion interest and changes in the
value of PMI Australia's investment portfolio. With these adjustments, PMI
received approximately $746 million in cash and $187 million in contingent
consideration paid in the form of a note (the "Note"), with interest
accruing through September 2011 when it matures and is payable. The actual
amount owed under the Note is subject to reductions to the extent
(i) performance of PMI Australia's existing insurance portfolio as of
June 30, 2008 does not achieve specified targets, (ii) PMI is required to
satisfy any claims for any breach of warranties under the Sale Agreement
and (iii) subject to our completion of the sale of PMI Asia, performance
of PMI Asia's existing insurance portfolio as of June 30, 2008 does not
achieve specified targets and the amount of the note to be issued by the
third party purchaser in connection with the sale of PMI Asia has been
reduced to zero. In connection with the transaction, PMI funded premiums
of approximately $46.5 million to procure an excess-of-loss reinsurance
cover for PMI Australia. The agreement provides for reinsurance
profit-sharing for one-half of the reinsurance premiums (equivalent to $25
million) at the end of the three-year policy life. PMI Australia was
recorded as discontinued operations in the consolidated financial
statements for all periods presented and in connection with recording PMI
Australia as discontinued operations, in the third quarter of 2008, we
recognized an after tax loss with respect to the writedown of the carrying
amount of PMI Australia to its fair value less cost to sell.
• PMI Asia. On August 29, 2008, we announced our agreement to sell PMI Asia for an aggregate purchase price of $56 million, subject to certain adjustments, of which 80% of the purchase price will be paid in cash on the date of closing, and the remaining 20% of the purchase price will be paid in the form of a note (the "Hong Kong Note") issued upon closing. The Hong Kong note, once issued, matures and is payable in September 2011, and the actual amount payable on the Hong Kong Note will be reduced to the extent (i) the performance of PMI Asia's existing insurance portfolio as of June 30, 2008 does not achieve specified targets, (ii) we are required to satisfy any claims for any breach of warranties under the sale agreement and (iii) performance of PMI Australia's existing insurance portfolio as of June 30, 2008 does not achieve specified targets and the amount of the Australia note has been reduced to zero. We are currently discussing post-closing issues with the buyer. While we expect the sale of PMI Asia to close in the fourth quarter of 2008, there can be no assurance that the transaction will be completed upon the agreed upon terms or at all. PMI Asia was recorded as discontinued operations in the consolidated . . .
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