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| PMI > SEC Filings for PMI > Form 10-Q on 9-Nov-2009 | All Recent SEC Filings |
9-Nov-2009
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, default inventories and cure rates of our various insurance subsidiaries, rescission and claim denial activity and the challenges thereto, persistency, premiums, new insurance written, the make-up of our various insurance portfolios, the impact of market conditions and rising unemployment, liquidity, capital requirements and initiatives, regulatory and contractual capital adequacy requirements, potential legislative changes, potential discretionary regulatory decisions by insurance regulators, captive reinsurance agreements, restructuring opportunities associated with our modified pool policies, fair value of certain debt instruments, the performance of our derivative contracts as well as certain securities held in our investment portfolios and potential litigation. 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, 2008 and our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2009 and June 30, 2009 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, 2009
For the quarter and nine months ended September 30, 2009, we recorded consolidated net losses of $93.2 million and $431.1 million, respectively, compared to consolidated net losses of $229.4 million and $749.7 million for the corresponding periods in 2008. The decreases in our consolidated net losses in the quarter and nine months ended September 30, 2009 compared to the corresponding periods in 2008 were primarily due to lower levels of losses and loss adjustment expenses ("LAE") in our U.S. Mortgage Insurance Operations in 2009 and net realized investment losses in 2008. Our consolidated net losses in the quarter and nine months ended September 30, 2009 were primarily driven by U.S. Mortgage Insurance Operations' continued high losses and LAE and decreases in U.S. Mortgage Insurance Operations' premiums earned and investment income. Our consolidated net losses in the quarter and nine months ended September 30, 2008 were driven by losses and LAE in our U.S. Mortgage Insurance Operations, net realized
investment losses, and losses in our Financial Guaranty segment. Our Financial Guaranty segment's net losses for the third quarter and first nine months of 2008 were primarily due to losses associated with a novation agreement executed by PMI Guaranty, equity in losses from RAM Re in the second quarter of 2008 and the impairment of our investment in FGIC in the first quarter of 2008. Our consolidated net losses in the quarter and nine months ended September 30, 2008 included the financial results of our discontinued operations related to PMI Australia, PMI Asia and PMI Guaranty.
Overview of Our Business
We provide residential mortgage insurance products designed to promote homeownership and strengthen communities. Mortgage insurance protects lenders and investors from credit losses, helping to ensure that mortgages are available to prospective homebuyers. We divide our business into four segments: U.S. Mortgage Insurance Operations, International Operations, Financial Guaranty and Corporate and Other.
• 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. ("MIC") and its affiliated U.S. mortgage insurance and reinsurance companies (collectively, "PMI"), and equity in (losses) 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 $110.6 million and $414.0 million for the quarter and nine months ended September 30, 2009, respectively, compared to net losses of $137.1 million and $535.5 million for the corresponding periods of 2008.
• International Operations. Our International Operations segment includes the results of PMI Mortgage Insurance Company Limited (collectively, with our other European subsidiaries, "PMI Europe") and our wholly owned Canadian subsidiary, PMI Canada, neither of which is writing new business. We completed the sales of PMI Australia and PMI Asia in the fourth quarter of 2008. The results from PMI Australia and PMI Asia are reported as discontinued operations in our International Operations segment and in the consolidated statement of operations for the quarter and nine months ended September 30, 2008. In our International segment, net income from the continuing operations of PMI Europe and PMI Canada were $27.4 million and $20.7 million for the quarter and nine months ended September 30, 2009, respectively, compared to net losses of $46.0 million and $56.8 million for the corresponding periods in 2008.
• Financial Guaranty. Our Financial Guaranty segment includes our investment in RAM Holdings Ltd., whose wholly-owned subsidiary, RAM Reinsurance Company, Ltd., or RAM Re, is a financial guaranty reinsurer, and our investment in FGIC Corporation, whose wholly-owned subsidiary, Financial Guaranty Insurance Company (collectively, "FGIC"), is a financial guarantor. FGIC has ceased and RAM Re is not currently writing new business. Effective December 31, 2008, we merged the assets and liabilities of our wholly-owned surety company, PMI Guaranty Co. ("PMI Guaranty") into PMI. The results of operations of PMI Guaranty are reported as discontinued operations in our Financial Guaranty segment and in the consolidated statement of operations for all periods presented. Our Financial Guaranty segment did not generate income or losses for the quarter or nine months ended September 30, 2009, respectively, compared to net income of $6.5 million and a net loss of $140.8 million for the corresponding periods in 2008.
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:
• Capital Constraints, Initiatives and Requirements. Rising unemployment rates in the United States and ongoing weakness in U.S. credit, capital, residential mortgage, and housing markets continue to negatively affect our U.S. Mortgage Insurance Operations segment. As discussed below under Losses and LAE, PMI continues to experience elevated losses, which we expect to continue throughout 2009 and 2010. These losses have reduced, and will continue to reduce, PMI's net assets. Partially in response to PMI's increased losses and reduced capital, Standard & Poor's, Moody's and Fitch each lowered its insurer financial strength rating on PMI from "AA" or equivalent to "BB-", "Ba3" and "BB", respectively. On October 27, 2009, Standard & Poor's announced that, due to a longer than expected loss cycle, it was placing the ratings of several mortgage insurers, including PMI, on "CreditWatch". Because of rating agency actions in 2008, 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. To date, each of the GSEs has continued to treat PMI as an eligible mortgage insurer. There can be no assurance that the GSEs will continue to treat PMI as an eligible mortgage insurer.
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. We are significantly limiting PMI's new business writings to conserve capital and are exploring other alternatives, including, restructuring certain pool contracts, debt or equity offerings, obtaining reinsurance for our insurance subsidiaries' current and/or future books of business, potentially obtaining capital or other relief under the U.S. Treasury's Financial Stability Plan (including the Troubled Asset Relief Program, or TARP) and/or other capital relief initiatives at PMI.
We completed the following capital relief initiatives which positively impacted MIC's statutory capital as of September 30, 2009:
Interaffiliate Excess of Loss Reinsurance Agreements - Effective September 30, 2009, MIC entered into three excess of loss reinsurance agreements with three affiliated reinsurance companies. In aggregate, the agreements provide MIC with a layer of risk remote reinsurance of MIC's 2007 non-delinquent risk-in-force as of September 30, 2009, subject to potential adjustment each quarter based on the affiliate's risk-to-capital ratios. By entering into the agreements, MIC's excess minimum policyholders position increased by approximately $41 million as of September 30, 2009.
Modified Pool Restructuring - In the third quarter of 2009, the restructuring (including commutation and other restructuring) of certain modified pool policies discussed below resulted in the acceleration of claims paid at a discount of the reserves established on such modified pool policies and the release of loss reserves, which resulted in positive statutory capital benefits to MIC and PMI Insurance Co. ("PIC").
In addition to these initiatives, TPG expects to contribute 100% of the common stock of PIC owned by it to our main operating company, MIC. TPG will conclude this contribution upon notice of non-objection from the applicable insurance department and we have been informed by that department that the notice is forthcoming. We expect this contribution will increase MIC's excess above minimum policyholders position by approximately $92 million. As this contribution remains, among other things, subject to receipt of the notice of non-objection, there can be no assurance that TPG will consummate this transaction.
Unless we raise substantial additional capital or achieve significant additional statutory capital relief, PMI's policyholders position will decline and risk-to-capital ratio will increase beyond levels necessary to meet regulatory capital adequacy requirements, which could occur as early as the fourth quarter of 2009. In sixteen states, if a mortgage insurer does not meet a required minimum policyholders position or exceeds a maximum permitted risk-to-capital ratio (generally 25 to 1), it may be prohibited from writing new business until its risk-to-capital ratio falls below the limit or its policyholders position meets the minimum, as applicable. In certain of those states, the applicable regulations require a mortgage insurer to immediately cease writing new business if and so long as it fails to meet the applicable capital adequacy requirements. In other states, the applicable regulator has discretion as to whether the mortgage insurer may continue writing new business. North Carolina, Arizona and California recently adopted legislation giving the respective state's insurance regulators such discretion. North Carolina's new law was effective July 1, 2009, Arizona's new law is effective November 24, 2009 and California's new law is effective January 1, 2010. Thirty-four other states do not have specific capital adequacy requirements for mortgage insurers. We and other mortgage insurers continue to discuss with those states that have regulations requiring a mortgage insurer to immediately cease writing new business if capital adequacy requirements are not met the potential adoption of legislation similar to the new laws enacted in Arizona, California and North Carolina.
PMI's principal regulator is the Arizona Department of Insurance (the "Department"). In part in anticipation of the legislative change effective in the fourth quarter of 2009 in Arizona, the Department notified PMI in the third quarter of its intent to conduct a limited scope examination to determine, among other things, whether to exercise discretion and permit PMI to continue writing new business in the event PMI fails to maintain Arizona's minimum policyholders position. In response to the Department's examination, PMI has provided extensive information to the Department relating to its capital, risk-in-force, loss reserves, claims procedures, underwriting, liquidity and investments. We believe that the Department currently intends to conclude its limited scope examination in the fourth quarter of 2009. If we fail to meet the minimum
policyholders position required by Arizona law and the Department does not exercise its discretion to permit PMI to continue writing new business, we would be required to suspend writing new business in all states. Even if Arizona were to permit PMI to continue writing new business, other states could require PMI to cease new business writings if we fail to maintain the applicable capital adequacy requirements.
We are in discussions with one state regarding its interpretation of that state's financially hazardous condition regulation generally applicable to licensed insurance companies and that state's interpretive position that we are in violation of that regulation. There can be no assurances that we will be successful in those discussions. If we are unsuccessful in those discussions, we may be required to cease writing business in that state. Although most other states have similar financially hazardous condition regulations, no other state has taken a similar interpretive position to date.
In the event that PMI is unable to continue to write new mortgage insurance in one or more states, we are working on a plan to enable us to write new mortgage insurance in those states by an existing subsidiary of PMI, currently known as Commercial Loan Insurance Corporation ("CLIC"), to be renamed PMI Mortgage Assurance Co. ("PMAC"). PMAC is currently licensed to write insurance in all states except Connecticut, Michigan and New York. In several other states, PMAC will need to revise the line of insurance business it is authorized to transact so that it may begin writing residential mortgage guaranty insurance in those states. There is no guarantee that PMAC will be able to obtain insurance licenses in Connecticut, Michigan or New York or revise its existing licenses in other impacted states. In addition, among other things, before PMAC can begin writing new business, the Arizona and Wisconsin Departments of Insurance must approve its redomestication from Wisconsin to Arizona, the Arizona Department and/or the GSEs may require, or require approval for, a capital contribution from PMI to PMAC, and the GSEs must approve PMAC as an eligible mortgage insurer. We have had preliminary discussions with the Arizona and Wisconsin Departments of Insurance and the GSEs regarding PMAC.
Especially given current and expected future market conditions, there can be no assurance that we will be able to raise any additional capital or achieve statutory capital relief, either on acceptable terms and in a timely manner, or at all. Moreover, there can be no assurances that the Arizona Department will exercise its discretion to permit PMI to continue writing business if we fail to satisfy applicable capital adequacy requirements or that our plan to write new mortgage insurance in certain states through PMAC will be successful. See Part II, Item 1A. Risk Factors - Unless we raise capital or achieve significant capital relief, PMI likely will fail to meet various capital adequacy requirements and could be required to cease writing new business and be subject to the terms of its runoff support agreement with Allstate 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.
• Defaults. PMI's primary default inventory increased to 141,261 as of September 30, 2009 from 109,580 as of December 31, 2008 and 93,670 as of September 30, 2008. PMI's primary default rate increased to 19.5% as of September 30, 2009 from 14.1% as of December 31, 2008 and from 12.1% as of September 30, 2008. PMI's modified pool default inventory increased to 47,380 as of September 30, 2009 from 46,600 as of December 31, 2008 and 38,973 as of September 30, 2008. PMI's modified pool default rate increased to 24.0% as of September 30, 2009 from 17.6% as of December 31, 2008 and 14.31% as of September 30, 2008. The increases in the default rates are due to the combined effect of higher default inventories and fewer policies in force. We expect PMI's primary and modified pool default inventories and default rates to remain at elevated levels through 2009 and into 2010. The increases in PMI's default inventories and default rates in the first nine months of 2009 were driven by a number of factors including:
Declining Home Prices and Rising Unemployment - Rising unemployment has made it significantly more difficult for many borrowers to remain current on their mortgage payments, while declining home prices have reduced the opportunities for borrowers to refinance their mortgages or sell their homes. These factors are negatively affecting PMI's default inventories and default rates.
Decline in Cure Rate - The percentage of defaults that cure has declined primarily due to rising unemployment, diminished refinancing opportunities and implementation of the U.S. Treasury's Home Affordable Modification Program ("HAMP"). Typically, with a traditional loan modification, a loan default is cured within a relatively short time period after the modification is
approved. For loans approved for HAMP modifications, however, the borrower is subject to 90 to 150 days trial period, during which the borrower must adhere to the trial modification plan in order to complete the modification process. Certain loans in PMI's default inventory have entered the HAMP trial period. We do not remove from PMI's inventory a loan subject to a HAMP trial modification period unless and until the trial period is completed, all required documents have been received, the loan modification is closed, and the default is officially cured. The decline in PMI's cure rate has been partially offset by loss mitigation efforts unrelated to HAMP and by increased rescissions of insurance written in prior periods.
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. We eliminated Alt-A loan eligibility in 2008 through the implementation of tighter underwriting guidelines. Due primarily to commitments issued prior to our elimination of Alt-A loan eligibility, we had an immaterial amount of new insurance written ("NIW") on Alt-A loans in the third quarter and first nine months of 2009, compared to 0.5% and 7.0% of NIW in the corresponding periods in 2008. Risk in force from Alt-A loans represented 17.3% of PMI's primary risk in force as of September 30, 2009 compared to 18.8 % as of December 31, 2008 and 20.0% as of September 30, 2008. The primary default rate for Alt-A loans was 41.3% as of September 30, 2009 compared to 30.6% as of December 31, 2008 and 25.8% as of September 30, 2008. The modified pool default rate for Alt-A loans was 28.4% as of September 30, 2009 compared to 19.4% as of December 31, 2008 and 15.0% as of September 30, 2008.
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. Prior to 2009, we stopped insuring Above-97s, and, as a result, none of our total primary NIW for the quarter and first nine months of 2009 consisted of Above-97s, compared to 0.1% and 6.4% for the corresponding periods in 2008. As of February 1, 2009, we stopped insuring loans with LTVs exceeding 95%. As of September 30, 2009, risk in force from Above-97s in all book years represented 20.5% of PMI's primary risk in force compared to 22.6% as of September 30, 2008. As of September 30, 2009, of the 20.5% of PMI's primary risk in force consisting of Above-97s, approximately half was from our 2007 book year. The default rate for Above-97s in PMI's primary portfolio was 26.0% as of September 30, 2009 compared to 18.3% as of December 31, 2008 and 15.2% as of September 30, 2008.
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. Due to the tightening of underwriting guidelines and because interest only loan originations have substantially declined in the market, new insurance written in the third quarter and first nine months of 2009 was not material for interest only loans, compared to 4.6% and 6.4% for the corresponding periods in 2008. Risk in force from interest only loans represented 11.0% of PMI's primary risk
in force as of September 30, 2009 compared to 11.8% as of December 31, 2008 and 12.5% as of September 30, 2008. The default rate for interest only loans was 40.8% as of September 30, 2009 compared to 28.6% as of December 31, 2008 and 23.5% as of September 30, 2008.
The above categories (or risk characteristics) are not mutually exclusive, and PMI's portfolio may contain loans having one or more of such characteristics. We expect the percentage of the above categories of loans in our portfolio to continue to decline in 2009 as a result of our underwriting guideline changes and NIW.
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 continue to exceed PMI's average default rate. The default rate from California was 34.3% as of September 30, 2009 compared to 24.7% as of December 31, 2008 and 21.0% as of September 30, 2008. The default rate from Florida was 38.2% as of September 30, 2009 compared to 27.8% as of December 31, 2008 and 22.6% as of September 30, 2008. As of September 30, 2009, risk in force from Florida and California insured loans represented 10.1% and 7.7% of PMI's primary risk in force, respectively. The default rate of the Auto States was 19.9% as of September 30, 2009 compared to 15.1% as of December 31, 2008 and 13.6% as of September 30, 2008. As of September 30, 2009, risk in force from the Auto States represented 13.4% of PMI's primary risk in force. For certain geographic areas (principally metropolitan statistical areas (MSAs)) that are designated as distressed, PMI caps the maximum insured loan-to-value ratio and/or prescribes additional limiting criteria and underwriting guidelines. PMI assesses MSAs on a regular basis.
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