| PMI GROUP INC Item 1A Risk Factors If the volume of low down payment home mortgage originations declines or if the number of mortgage loans originated that may be purchased by the GSEs declines, the amount of insurance that PMI writes could decrease, which could result in a decrease of our future revenue |
| A decline in the volume of low down payment mortgage originations could reduce the demand for private mortgage insurance and consequently, our revenues |
| The volume of low down payment mortgage originations is affected by, among other factors: the level of home mortgage interest rates; domestic economy and regional economic conditions; consumer confidence; housing affordability; the rate of household formation; the rate of home price appreciation, which in times of heavy refinancing affects whether refinance loans have loan-to-value ratios that require private mortgage insurance; and government housing policy |
| The GSEs are the principal beneficiaries of PMI’s mortgage insurance policies and a decline in the number of low down payment mortgage loans originated that are purchased or securitized by the GSEs could adversely affect PMI’s revenues |
| The GSEs have lost market share in 2004 and 2005 due in part to a higher percentage of adjustable rate mortgages, which we refer to as ARMs, and reduced documentation loans originated in 2004 and 2005 |
| Such loans are generally either retained by loan originators and not sold to the GSEs or are placed in mortgage-backed securities that are privately issued and not guaranteed by the GSEs |
| If interest rates decline, home values increase or mortgage insurance cancellation requirements change, the length of time that PMI’s policies remain in force and our revenues could decline |
| A significant percentage of the premiums PMI earns each year are generated from insurance policies written in previous years |
| As a result, a decrease in the length of time that PMI’s policies remain in force could cause our revenues to decline |
| Factors that lead to borrowers canceling their mortgage insurance include: current mortgage interest rates falling below the rates on the mortgages underlying PMI’s insurance in force, which frequently results in borrowers refinancing their mortgages; appreciation in the values of the homes underlying the mortgages PMI insures; and the availability of alternative loan products, which provide borrowers with the opportunity to at least temporarily decrease their monthly loan payments |
| If mortgage lenders and investors select alternatives to private mortgage insurance, such as piggyback loans, the amount of insurance that PMI writes could decline, which could reduce our revenues and profits |
| Mortgage lenders have been increasingly structuring mortgage originations to avoid private mortgage insurance, primarily through the use of simultaneous seconds, piggybacks, 80/10/10’s, 80/15/5’s or 80/20 loans |
| Such mortgages are structured to include a first mortgage with an 80prca loan-to-value ratio and a second mortgage with a loan-to-value ratio ranging from 5prca to 20prca |
| Over the past several years, the volume of these loans, or variations thereof, as alternatives to loans requiring mortgage insurance, has increased significantly and may continue to do so for the foreseeable future |
| Other alternatives to private mortgage insurance include: • government mortgage insurance programs, including those of the Federal Housing Administration, or FHA, and the Veterans Administration, or VA; • member institutions providing credit enhancement on loans sold to a Federal Home Loan Bank, or FHLB; • lenders and investors holding mortgages in their portfolios and self-insuring; • mortgage lenders maintaining lender recourse or participation with respect to loans sold to the GSEs; and • investors using internal credit enhancements, such as credit default or interest rate swaps, overcollateralization and subordination, as partial or complete substitutes to private mortgage insurance in mortgage backed securitizations |
| 39 ______________________________________________________________________ [82]Table of Contents These alternatives, or new alternatives to private mortgage insurance that may develop, could reduce the demand for private mortgage insurance and cause our revenues and profitability to decline |
| Although the FHLBs are not required to purchase insurance for mortgage loans, they currently use mortgage insurance on substantially all mortgage loans with a loan-to-value ratio above 80prca |
| If the FHLBs were to purchase uninsured mortgage loans or increase the loan-to-value ratio threshold above which they require mortgage insurance, the market for mortgage insurance could decrease, and we could be adversely affected |
| The risk-based capital rule applicable to the GSEs may allow large financial entities such as banks, financial guarantors, insurance companies and brokerage firms to provide or arrange for products that may efficiently substitute for some of the capital relief provided to the GSEs by private mortgage insurance |
| Our consolidated financial condition and results of operations could be harmed if the GSEs were to use these products in lieu of mortgage insurance |
| See also “Legislation and regulatory changes, including changes impacting the GSEs, could significantly affect PMI’s business and could reduce demand for private mortgage insurance” and “The implementation of new eligibility guidelines adopted by Fannie Mae could harm our profitability and reduce our operational flexibility,” below |
| PMI reinsures a portion of its mortgage insurance default risk with lender-affiliated captive reinsurance companies, which reduces PMI’s net premiums written and earned |
| Mortgage insurers including PMI offer products to lenders that are designed to allow them to participate in the risks and rewards of the mortgage insurance business |
| Many of the major mortgage lenders have established affiliated captive reinsurance companies |
| These captive reinsurance companies assume a portion of the risks associated with the lender’s insured mortgage loans in exchange for a percentage of the associated gross premiums |
| An increasing percentage of PMI’s primary flow insurance in force has been generated by customers with captive reinsurance companies |
| Because a number of our major customers have made the business decision to participate in the mortgage insurance business by establishing reinsurance companies, we believe that if PMI did not offer captive reinsurance agreements, PMI’s competitive position would suffer |
| Captive reinsurance agreements negatively impact PMI’s net premiums written and earned |
| Economic factors have adversely affected and may continue to adversely affect PMI’s loss experience |
| PMI’s loss experience has increased over the past year and could continue to increase in the year(s) to come as a result of: national or regional economic recessions, including any economic downturns that may arise in local communities impacted by the 2005 hurricane season; declining values of homes; higher unemployment rates; higher levels of consumer credit; deteriorating borrower credit; interest rate volatility; war or terrorist activity; or other economic factors |
| PMI’s loss experience may increase as PMI’s policies continue to age |
| We expect the majority of losses and LAE on insured loans in PMI’s current portfolio to occur during the second through the fourth years after loan origination |
| Primary insurance written from the period of January 1, 2002 through December 31, 2004 represented 57dtta7prca of PMI’s primary risk in force as of December 31, 2005 |
| Accordingly, a significant majority of PMI’s primary portfolio is in, or approaching, its peak loss years |
| In addition, PMI’s 2004 book of business represents 26dtta3prca of its risk in force as of December 31, 2005 and we believe that it will enter its peak loss year in 2006 with continued impact in 2007 |
| We believe PMI’s loss experience could increase as PMI’s policies age |
| If the claim frequency on PMI’s risk in force significantly exceeds the claim frequency that was assumed in setting PMI’s premium rates, our consolidated financial condition and results of operations would be harmed |
| Since PMI generally cannot cancel mortgage insurance policies or adjust renewal premiums, unanticipated claims could cause our financial performance to suffer |
| PMI generally cannot cancel the mortgage insurance coverage that it provides or adjust renewal premiums during the life of a mortgage insurance policy |
| As a result, the impact of unanticipated claims generally cannot be 40 ______________________________________________________________________ [83]Table of Contents offset by premium increases on policies in force or mitigated by non-renewal or cancellation of insurance coverage |
| The premiums PMI charges may not be adequate to compensate us for the risks and costs associated with the insurance coverage provided to PMI’s customers |
| An increase in the number or size of unanticipated claims could adversely affect our consolidated financial condition and results of operations |
| Geographic concentration of PMI’s primary insurance in force could increase claims and losses and harm our financial performance |
| We could be affected by economic downturns, natural disasters and other events in specific regions of the United States where a large portion of PMI’s business is concentrated |
| As of December 31, 2005, 10dtta3prca of PMI’s primary risk in force was located in Florida, 7dtta4prca was located in Texas and 6dtta9prca was located in California |
| In addition, refinancing of mortgage loans can have the effect of concentrating PMI’s insurance in force in economically weaker areas of the US As of December 31, 2005, 12dtta3prca of PMI’s policies in force related to loans located in Michigan, Kentucky, Indiana and Ohio |
| Collectively these states experienced higher default rates in 2005 than other regions of the US The ultimate impact from the 2005 hurricane season is not yet known |
| Ongoing effects could increase claims and losses and harm our overall financial performance |
| While the effects of the 2005 hurricane season negatively impacted our consolidated results of operations for the year ended December 31, 2005, primarily through loss reserve increases, we cannot predict whether the 2005 hurricane season will have a material adverse effect on our consolidated results of operations in the future |
| The lingering effects of the 2005 hurricane season in the future could, among other things, cause increased notices of delinquencies and claims and claim severity in affected areas, could reduce demand for mortgages and consequently mortgage insurance in the affected areas, and could require additional loss reserve increases by PMI The effects of the 2005 hurricane season could also negatively impact FGIC, RAM Reinsurance Company and CMG Mortgage Insurance Company, which would negatively affect our equity in earnings from those investments |
| The effects also could reduce the monthly payments we expect to receive in connection with the sale of our interest in SPS Holding Corp |
| The premiums PMI charges for mortgage insurance on high LTV loans, ARMs, less-than-A quality loans, Alt-A loans, interest only loans and payment option ARMs, and the associated investment income, may not be adequate to compensate for future losses from these loans |
| In 2004 and 2005, PMI’s primary new insurance written and risk in force included higher percentages of: • Loans with LTVs exceeding 97prca, known as high LTV loans |
| At December 31, 2005, 14prca of PMI’s primary risk in force consisted of high LTV loans, compared to 12prca and 9prca at 2004 and 2003 year end, respectively |
| At December 31, 2005, 20prca of PMI’s primary risk in force consisted of ARMs, compared to 15prca and 10prca at 2004 and 2003 year end, respectively |
| At December 31, 2005, 17prca of PMI’s primary risk in force consisted of Alt-A loans, compared to 13prca and 9prca at 2004 and 2003 year end, respectively |
| At December 31, 2005, we estimate that approximately 6prca of PMI’s primary risk in force consisted of interest only loans |
| At December 31, 2005, we estimate that approximately 3prca of PMI’s primary risk in force consisted of payment option ARMs |
| At December 31, 2005, 9prca of PMI’s primary risk in force consisted of less-than-A quality loans, compared to 11prca and 12prca at 2004 and 2003 year end, respectively |
| 41 ______________________________________________________________________ [84]Table of Contents We expect higher default and claim rates for high LTV loans, ARMs, Alt-A loans, interest only loans, payment option ARMs, and less-than-A quality loans |
| Although we attempt to incorporate these higher default and claim rates into our underwriting and pricing models, there can be no assurance that the premiums earned and the associated investment income will prove adequate to compensate for future losses from these loans |
| Our loss reserves may be insufficient to cover claims paid and loss-related expenses incurred |
| We establish loss reserves to recognize the liability for unpaid losses related to insurance in force on mortgages that are in default |
| These loss reserves are regularly reviewed and are based upon our estimates of the claim rate and average claim amounts, as well as the estimated costs, including legal and other fees, of settling claims |
| Any adjustments, which may be material, resulting from these reviews are reflected in our consolidated results of operations |
| Our consolidated financial condition and results of operations could be harmed if our reserve estimates are insufficient to cover the actual related claims paid and loss-related expenses incurred |
| PMI delegates underwriting authority to mortgage lenders which could cause PMI to insure mortgage loans that do not conform to its underwriting guidelines, and thereby increase claims and losses |
| A significant percentage of PMI’s new insurance written is underwritten pursuant to a delegated underwriting program under which, subject to routine audit, certain mortgage lenders may determine whether mortgage loans meet PMI’s program guidelines and commit us to issue mortgage insurance |
| We may expand the availability of delegated underwriting to additional customers |
| If an approved lender commits us to insure a mortgage loan, PMI generally may not refuse, except in limited circumstances, to insure, or rescind coverage on, that loan even if it reevaluates that loan’s risk profile and determines the risk profile to be unacceptable or the lender fails to follow PMI’s delegated underwriting guidelines |
| If we fail to properly underwrite mortgage loans when we provide contract underwriting services, we may be required to provide monetary and other remedies to the customer |
| Our subsidiary MSC provides contract underwriting services for a fee |
| As a part of the contract underwriting services, MSC provides monetary and other remedies to its customers in the event that it fails to properly underwrite a mortgage loan |
| As a result, we assume credit and, to a lesser extent, interest rate risk in connection with our contract underwriting services |
| Generally, the remedies provided by MSC are in addition to those contained in PMI’s master policies |
| Contract underwriting services apply to a significant percentage of PMI’s insurance in force and the costs relating to the investigation and/or provision of remedies could have a material adverse effect on our consolidated financial condition and results of operations |
| Worsening economic conditions or other factors that could increase PMI’s default rate could also cause the number and severity of remedies to increase |
| Our revenues and profits could decline if PMI loses market share as a result of industry competition or if our competitive position suffers as a result of our inability to introduce and successfully market new products and programs |
| The principal sources of PMI’s competition include: other private mortgage insurers, some of which are wholly-owned or partially-owned subsidiaries of well-capitalized, diversified public companies with direct or indirect capital reserves that provide them with potentially greater resources than we have as well as the various alternatives to private mortgage insurance discussed above |
| See also, “If mortgage lenders and investors select alternatives to private mortgage insurance, such as piggyback loans, the amount of insurance that PMI writes could decline, which could reduce our revenues and profits |
| With respect to PMI’s structured transaction channel, PMI competes with other external credit enhancers, primarily other private mortgage insurers and financial guarantors, as well as with capital markets participants, including aggregators and loan originators, who are continually devising new forms of structures in which to 42 ______________________________________________________________________ [85]Table of Contents securitize mortgage loans without external credit enhancement, including private mortgage insurance |
| To successfully compete in the structured finance arena, PMI must introduce competitive new products and programs and maintain its competitive pricing |
| If PMI is unable to successfully compete with other private mortgage insurers, other external credit enhancers and the various other private mortgage insurance alternatives, or if we experience delays in introducing competitive new products and programs or if these products or programs are less profitable than our existing products and programs, our business will suffer |
| The risk-based capital rule issued by the Office of Federal Housing Enterprise Oversight could require us to obtain a claims-paying ability rating of “AAA” and could cause PMI’s business to suffer |
| The Office of Federal Housing Enterprise Oversight, the agency which currently regulates the GSEs, or OFHEO, has issued a risk-based capital rule that treats credit enhancements issued by private mortgage insurance companies with claims-paying ability ratings of “AAA” more favorably than those issued by private mortgage insurance companies with “AA” ratings |
| has been assigned financial strength ratings of “AA” by S&P, “AA+” by Fitch and “Aa2” by Moody’s |
| The rule also provides capital guidelines for Fannie Mae and Freddie Mac, or the GSEs, in connection with their use of other types of credit protection counterparties in addition to mortgage insurers |
| Although it has not occurred to date, if the rule resulted in the GSEs increasing their use of either “AAA” rated mortgage insurers instead of “AA” rated entities or credit protection counterparties other than mortgage insurers, our consolidated financial condition and results of operations could be adversely affected |
| Legislation and regulatory changes, including changes impacting the GSEs, could significantly affect PMI’s business and could reduce demand for private mortgage insurance |
| Mortgage origination transactions are subject to compliance with various federal and state consumer protection laws, including the Real Estate Settlement Procedures Act of 1974, or RESPA, the Equal Credit Opportunity Act, the Fair Housing Act, the Homeowners Protection Act, the Fair Credit Reporting Act, or FCRA, the Fair Debt Collection Practices Act and others |
| Among other things, these laws prohibit payments for referrals of settlement service business, require fairness and non-discrimination in granting or facilitating the granting of credit, require cancellation of insurance and refunding of unearned premiums under certain circumstances, govern the circumstances under which companies may obtain and use consumer credit information, and define the manner in which companies may pursue collection activities |
| Changes in these laws or regulations could adversely affect the operations and profitability of our mortgage insurance business |
| During 2004 and 2005, Congress considered proposed legislation which was intended to be a comprehensive overhaul of the GSEs’ existing regulatory structure and encompasses substantially all of the GSEs’ operations, including their affordable housing initiatives, the GSEs’ products and marketing activities, the GSEs’ minimum capital standards, and their risk-based capital requirements |
| The passage of such legislation in the future could limit the growth of the GSEs, which could result in a reduction in the size of the mortgage insurance market |
| We do not know what form, if any, such legislation will take, if any, or, if it is enacted, its impact, if any, on our financial condition and results of operations |
| In July 2002, the Department of Housing and Urban Development, or HUD, proposed a rule under RESPA that, if implemented as proposed, would have, among other things, given lenders and other packagers the option of offering a Guaranteed Mortgage Package, or GMP, or providing a good faith estimate of settlement costs subject to a 10prca tolerance level |
| The proposed rule provided that qualifying packages were entitled to a “safe harbor” from litigation under RESPA’s anti-kickback rules |
| Mortgage insurance would have been included in the package to the extent an upfront premium is charged |
| Inclusion in the package could have caused mortgage insurers to experience reductions in the prices of their services or products |
| HUD withdrew that proposed rule in March 2004 |
| In late 2004, HUD announced that it will submit a new proposed rule under RESPA to the Office of Management and Budget for review |
| As of December 31, 2005, HUD had not proposed a new rule, and we do not know what form, if any, the rule will take and whether it will be approved |
| 43 ______________________________________________________________________ [86]Table of Contents In addition, increases in the maximum loan amount or other features of the FHA mortgage insurance program can reduce the demand for private mortgage insurance |
| Future legislative and regulatory actions could decrease the demand for private mortgage insurance, which could harm our consolidated financial condition and results of operations |
| PMI could lose premium revenue if the GSEs reduce the level of private mortgage insurance coverage required for low down payment mortgages or reduce their need for mortgage insurance |
| The GSEs are the beneficiaries on a substantial majority of the insurance policies we issue as a result of their purchases of qualifying mortgage loans from lenders or investors |
| The GSEs offer programs that require less mortgage insurance coverage on mortgages approved by their automated underwriting systems |
| They also have reduced coverage requirements for certain expanding market products |
| If the reduction in required levels of mortgage insurance becomes widely accepted by mortgage lenders, or if the GSEs further reduce mortgage insurance coverage requirements for loans they purchase, PMI’s premium revenue would decline and our consolidated financial condition and results of operations could suffer |
| Products introduced by the GSEs, if widely accepted, could harm our profitability |
| The GSEs have products for which they will, upon receipt from lenders of loans with primary insurance, restructure the mortgage insurance coverage by reducing the amount of primary insurance coverage and adding a second layer of insurance coverage, usually in the form of pool insurance |
| Under these programs, the GSEs may provide services to the mortgage insurer and the mortgage insurer may be required to pay fees to the GSEs for the benefits provided through the reduced insurance coverage or the services provided |
| If they become widely accepted, these products could harm our consolidated financial condition and results of operations |
| Lobbying activities by large mortgage lenders calling for expanded federal oversight and legislation relating to the role of the GSEs in the secondary mortgage market could damage PMI’s relationships with those mortgage lenders and the GSEs |
| The GSEs, mortgage lenders and PMI jointly develop and make available various products and programs |
| These arrangements involve the purchase of PMI’s mortgage insurance products and frequently feature cooperative arrangements between the parties |
| FM Policy Focus, a lobbying organization representing financial services and housing-related trade associations, including the Mortgage Insurance Companies of America, supports increased federal oversight of the GSEs |
| The GSEs have criticized the activities of FM Policy Focus |
| FM Policy Focus, the GSEs and other groups are engaged in extensive lobbying activities with respect to the legislation pending in Congress that would change the way GSEs are regulated |
| These activities could polarize Fannie Mae, Freddie Mac, members of FM Policy Focus, PMI’s customers and us |
| Any such polarization could limit PMI’s opportunities to do business with the GSEs as well as with some mortgage lenders |
| Either of these outcomes could harm our consolidated financial condition and results of operations |
| The implementation of new eligibility guidelines by the GSEs could harm our profitability and reduce our operational flexibility |
| Effective January 2005, Fannie Mae revised its approval requirements for mortgage insurers, including PMI, with new guidelines for borrower-paid and lender-paid mortgage insurance |
| These requirements became effective for PMI on January 1, 2005 |
| The guidelines cover substantially all areas of PMI’s mortgage insurance operations, require the disclosure of certain activities and new products, give Fannie Mae the right to purchase mortgage insurance from other than existing approved mortgage insurers, including insurers that are either rated below “AA” or are unrated, and provide Fannie Mae with increased rights to revise the eligibility standards of insurers |
| Future changes in the guidelines of the GSEs could reduce PMI’s operational flexibility and cause our profitability to suffer |
| 44 ______________________________________________________________________ [87]Table of Contents Our business and financial performance could suffer if PMI were to lose the business of a major customer |
| Through their various origination channels, PMI’s top ten customers accounted for 42dtta8prca of PMI’s premiums earned in 2005 |
| A single customer represented 7dtta3prca of PMI’s earned premiums in 2005 |
| Mortgage insurers, including PMI, may acquire significant percentages of their business through negotiated, structured transactions (including bulk primary insurance, modified pool insurance and captive reinsurance) with a limited number of customers |
| The loss of a significant customer could reduce our revenue, and if not replaced, harm our consolidated financial condition and results of operations |
| The US mortgage insurance industry and PMI are subject to litigation risk |
| The mortgage insurance industry and PMI face litigation risk in the ordinary course of operations, including the risk of class action lawsuits |
| Consumers are bringing a growing number of lawsuits against home mortgage lenders and settlement service providers |
| In recent years, mortgage insurers, including PMI, have been involved in litigation alleging violations of RESPA and FCRA PMI is subject to several lawsuits in which plaintiffs seek large or indeterminate amounts of damages, including punitive damages, which may remain unknown or unresolved for substantial periods of time |
| In September 2005, an action against PMI was filed in the federal district court of the Northern District of California entitled Hogan, et al |
| In the action, the plaintiffs seek certification of a nationwide class of consumers and allege that they were required to pay for private mortgage insurance written by PMI at rates greater than PMI’s “best available rate |
| ” The action seeks, among other relief, actual and statutory damages and declaratory and injunctive relief |
| On January 4, 2006, plaintiffs filed an amended complaint in the action, which adds additional claims under state law and FCRA, alleging that PMI did not have a permissible purpose to access the plaintiffs’ credit information |
| PMI cannot predict the outcome of this or any similar litigation and cannot be sure what impact, if any, this or similar litigation will have on our consolidated financial position, results of operations or cash flows |
| An action alleging similar causes of action was filed against PMI in February 2006 in federal district court in Montgomery, Alabama |
| In the past, a number of lawsuits have challenged the actions of private mortgage insurers, including PMI, under RESPA, alleging that the insurers have provided products or services at improperly reduced prices in return for the referral of mortgage insurance |
| RESPA precludes PMI from providing services or products to mortgage lenders free of charge, charging fees for services that are lower than their reasonable or fair market value, and paying fees for services that others provide that are higher than their reasonable or fair market value, in exchange for the referral of settlement services |
| In the future, we cannot predict whether other civil, regulatory or criminal actions might be brought against us or other mortgage insurers |
| Any such proceedings could have an adverse effect on our consolidated financial condition, results of operations or cash flows |
| The US mortgage insurance industry and PMI are subject to regulatory risk and have been subject to recent scrutiny relating to the use of captive reinsurance arrangements |
| PMI and the mortgage insurance industry are also subject to comprehensive, detailed regulation by state insurance departments |
| Although their scope varies, state insurance laws generally grant broad powers to supervisory agencies and officials to examine and investigate insurance companies and to enforce rules or exercise discretion touching almost every aspect of PMI’s business |
| Recently, the insurance industry has become the focus of increased scrutiny by regulatory and law enforcement authorities concerning certain practices, including captive reinsurance arrangements |
| Increased federal or state regulatory scrutiny could lead to new legal precedents, new regulations or new practices, or regulatory actions or investigations, which could adversely affect PMI’s business and its financial condition and results of operation |
| In 2005, PMI, certain of our other mortgage insurance subsidiaries, and CMG Mortgage Insurance Company (collectively, “the MIs”) each responded to a request from the New York Insurance Department (the “NYID”) for information regarding captive reinsurance arrangements |
| In a February 2006 letter that we believe was addressed to other mortgage insurers as well as us, the NYID requested additional information regarding captive 45 ______________________________________________________________________ [88]Table of Contents reinsurance arrangements, including the business purpose of those arrangements |
| The NYID also requested that we review the premium rates currently in use in New York based upon recent years’ experience |
| The letter states that if we believe that recent years’ experience would not alter the rates being charged, we should provide a detailed explanation, in addition to an actuarial opinion, as to the assumptions underlying such position |
| If recent years’ experience would alter the rates being charged, the letter states that we must file adjusted rates with the NYID We are in the process of responding to the NYID’s February 2006 letter |
| In January 2006, PMI received an administrative subpoena for information from the Minnesota Department of Commerce primarily regarding captive reinsurance arrangements |
| We have provided the Minnesota Department of Commerce with information pursuant to this subpoena and may provide additional information in the future |
| Other federal and state regulatory agencies, including state insurance departments, may also request information regarding captive reinsurance arrangements |
| We cannot predict whether the New York Insurance Department’s requests or the Minnesota Department of Commerce’s administrative subpoena will lead to further inquiries, or investigations, of these matters, or the scope, timing or outcome of any inquiry or actions by those Departments or any inquiry or actions that may be commenced by other regulators |
| A downgrade of PMI’s insurer financial strength ratings could materially harm our financial performance |
| PMI’s insurer financial strength is currently rated “AA” by S&P, “AA+” by Fitch, and “Aa2” by Moody’s |
| These ratings may be revised or withdrawn at any time by one or more of the rating agencies and are based on factors relevant to PMI’s policyholders and are not applicable to our common stock or debt |
| The rating agencies could lower or withdraw our ratings at any time as a result of a number of factors, including: underwriting or investment losses; the necessity to make capital contributions to our subsidiaries pursuant to capital support agreements; other developments negatively affecting PMI’s risk-to-capital ratio, financial condition or results of operations; or changes in the views or modeling of rating agencies of our risk profile or of the mortgage insurance industry |
| If PMI’s insurer financial strength rating falls below “AA-” from S&P or Fitch, or “Aa3” from Moody’s, investors, including Fannie Mae and Freddie Mac, may not purchase mortgages insured by PMI Such a downgrade could also negatively affect our ability to compete in the capital markets, our holding company ratings or the ratings of our other licensed insurance subsidiaries |
| Any of these events would harm our consolidated financial condition and results of operations |
| Our ongoing ability to pay dividends to our shareholders and meet our obligations primarily depends upon the receipt of dividends and returns of capital from our insurance subsidiaries |
| We are a holding company and conduct all of our business operations through our subsidiaries |
| Our principal sources of funds are dividends from our insurance subsidiaries and funds that may be raised from time to time in the capital markets |
| Factors that may affect our ability to maintain and meet our capital and liquidity needs as well as to pay dividends to our shareholders include: the level and severity of claims experienced by our insurance subsidiaries; the performance of the financial markets; standards and factors used by various credit rating agencies; financial covenants in our credit agreements; and standards imposed by state insurance regulators relating to the payment of dividends by insurance companies |
| In addition, a protracted economic downturn, or other factors, could cause issuers of the fixed-income securities that we, FGIC and RAM Re own to default on principal and interest payments, which could cause our investment returns and net income to decline and reduce our ability to satisfy all of our capital and liquidity needs |
| If we are unable to keep pace with the technological demands of our customers or with the technology-related products and services offered by our competitors, our business and financial performance could be significantly harmed |
| Participants in the mortgage lending and mortgage insurance industries rely on e-commerce and other technology to provide and expand their products and services |
| Our customers generally require that we provide 46 ______________________________________________________________________ [89]Table of Contents our products and services electronically via the Internet or electronic data transmission, and the percentage of our new insurance written and claims processing which is delivered electronically has increased |
| We expect this trend to continue, and accordingly, we believe that it is essential that we continue to invest substantial resources in maintaining electronic connectivity with our customers and, more generally, in e-commerce and technology |
| Our business may suffer if we do not keep pace with the technological demands of our customers and the technological capabilities of our competitors |
| The implementation of the Basel II Capital Accord may limit the domestic and international use of mortgage insurance |
| The Basel II Capital Accord, the Basel Committee on Banking Supervision’s proposal to implement a new international capital accord, will affect the capital treatment provided to mortgage insurance by domestic and international banks in both their origination and securitization activities |
| Accordingly, the Basel II provisions related to residential mortgages and mortgage insurance could alter the competitive positions and financial performance of mortgage insurers as well as the capital available to our bank customers for their mortgage origination and securitization activities |
| PMI’s opportunities to participate in structured transactions, and US financial institutions preferences with respect to mortgage insurance, may be significantly impacted by the implementation in the United States of Basel II In 2005, US federal banking agencies jointly announced that the US implementation of Basel II would be delayed until at least 2008 and proposed an interim capital accord that has not been finalized |
| US implementation of Basel II standards for credit risk exposures, including residential mortgages, is focused on application of the Advanced Internal Rating Based (A-IRB) approach by large internationally active banking organizations |
| US bank supervisors have indicated their intent to recognize the loss mitigating impacts of private mortgage insurance policies for banking organizations computing minimum capital requirements under the A-IRB approach |
| PMI Australia’s regulator, the Australian Prudential Regulation Authority (“APRA”) intends to implement Basel II capital requirements for financial institutions effective January 1, 2008 |
| Such implementation may have a significant impact on the future market acceptance of mortgage insurance in Australia |
| APRA’s Basel II proposals, if adopted as proposed, could reduce the available market for mortgage insurance among PMI Australia’s bank customers |
| Currently, European banking supervisors do not explicitly recognize mortgage insurance as a risk mitigant for bank capital requirements |
| In October 2005, the European Union adopted new legislation, the Capital Requirements Directive (“CRD”), which provides a revised framework for EU member nation banking supervisors to implement new Basel II risk based capital guidelines starting in 2007 |
| The CRD prescribes standard criteria for credit risk mitigation instruments eligible to provide banks with risk relief |
| We believe the CRD facilitates recognition of mortgage insurance benefits for European banks under certain circumstances |
| The CRD is subject to further clarification by the European Commission and incorporation into the regulatory framework of EU member countries |
| Our consolidated results of operations could suffer if demand for our mortgage insurance products was diminished as a result of the failure to give appropriate capital recognition to mortgage insurance |
| Our international insurance subsidiaries subject us to numerous risks associated with international operations |
| We have subsidiaries in Australia and Europe and a branch office in Hong Kong |
| We have committed and may in the future commit additional significant resources to expand our international operations |
| Accordingly, in addition to the general economic and insurance business-related factors discussed above, we are subject to a number of risks associated with our international business activities |
| These risks include: the need for regulatory 47 ______________________________________________________________________ [90]Table of Contents and third party approvals; challenges in attracting and retaining key foreign-based employees, customers and business partners in international markets; economic downturns in targeted foreign mortgage origination markets; interest rate volatility in a variety of countries; unexpected changes in foreign regulations and laws; the burdens of complying with a wide variety of foreign laws; potentially adverse tax consequences; restrictions on the repatriation of earnings; foreign currency exchange rate fluctuations; potential increases in the level of defaults and claims on policies insured by foreign-based subsidiaries; the need to successfully develop and market products appropriate to the foreign market, including the development and marketing of credit enhancement products to European lenders and for mortgage securitizations |
| PMI Australia is subject to many of the same risks facing PMI Like PMI, the financial results of our Australian and New Zealand mortgage insurance operations, or PMI Australia, are affected by domestic and regional economic conditions, including movements in interest and unemployment rates, and property value fluctuations |
| These economic factors could impact PMI Australia’s loss experience or the demand for mortgage insurance in the markets PMI Australia serves |
| PMI Australia is also subject to significant regulation |
| PMI Australia’s primary regulator, APRA, has recently issued regulations or sought comment on proposals to, among other things, increase the capital requirements for lenders mortgage insurance companies, change the requirements for acceptable lenders mortgage insurers, and increase compliance and governance requirements for general insurers including lenders mortgage insurers |
| Partly as a result of these regulations and proposals, PMI Australia is likely to face new competition in the future |
| Such competition may take a number of forms including domestic and off-shore lenders mortgage insurers, reinsurers of residential mortgage credit risk, increased risk appetite from lender owned captive insurers and non insurance forms of credit risk transfer |
| New market competitors have the potential to impact PMI Australia’s market share and to impact pricing of credit risk in the market as a whole |
| A significant portion of PMI Australia’s business is acquired through quota share reinsurance agreements with several of its customers’ captive mortgage insurers |
| In 2005, as a result of APRA’s new capital requirements for lenders mortgage insurers, a major customer restructured its captive reinsurance arrangement with PMI Australia |
| As a result, the customer’s affiliated captive reinsurer now retains higher levels of mortgage default risk |
| We believe that the restructuring of PMI Australia’s captive arrangements will negatively impact its premiums written in 2006 |
| PMI Australia is currently rated “AA” by S&P and Fitch and “Aa2” by Moody’s |
| These ratings are based in part upon a capital support agreement between PMI and PMI Australia and a guarantee of that agreement by The PMI Group |
| Termination or amendment of this support structure could negatively impact PMI Australia’s ratings |
| PMI Australia’s business is dependent on maintaining its ratings |
| Any negative impact on its ratings will negatively affect its financial results |
| PMI Australia’s five largest customers provided 62dtta9prca of PMI Australia’s gross premiums written in 2005 and one of these customers represented the majority of this percentage |
| PMI Australia’s loss of a significant customer, if not replaced, could harm PMI Australia’s and our financial condition and results of operations |
| A significant increase in PMI Australia’s claims could harm our financial condition and results of operations |
| We may not be able to execute our strategy to expand our European operations |
| We have devoted resources to expand our European operations, PMI Europe, and we plan to continue these efforts |
| The success of our efforts will depend partly upon legislative and regulatory policies in Europe that support homeownership and provide capital relief for institutions that obtain credit enhancement with respect to their mortgage loan portfolios |
| If European legislative and regulatory agencies do not adopt such policies, our European operations may be adversely affected |
| PMI Europe is currently rated “AA” by S&P and Fitch and “Aa3” by Moody’s |
| These ratings are based in part upon a capital support agreement between PMI and PMI Europe and a guarantee of that agreement by The 48 ______________________________________________________________________ [91]Table of Contents PMI Group |
| Termination or amendment of this support structure could negatively impact PMI Europe’s ratings |
| PMI Europe’s business is dependent on maintaining its ratings |
| Any negative impact on its ratings will negatively affect its overall financial results |
| The performance of our equity investees could harm our consolidated financial results |
| We have made significant investments in the equity securities of privately-held companies, including FGIC Corporation, the parent of Financial Guaranty Insurance Company (collectively, “FGIC”), a financial guaranty insurer; and RAM Holdings Ltd |
| and RAM Holdings II Ltd, which are the holding companies for RAM Re, a financial guaranty reinsurance company based in Bermuda |
| Our investments in FGIC and RAM Re are accounted for on the equity method of accounting in our consolidated financial statements |
| The nature of the businesses conducted by these companies differs significantly from our core business of providing residential mortgage insurance |
| These companies are subject to a number of significant risks that arise from the nature of their businesses |
| Some of the various risks affecting FGIC are discussed below |
| Because we do not control these companies, we are dependent upon the management of these companies to independently operate their businesses and report their financial results, and, accordingly, we may be unable to take actions unilaterally to avoid or mitigate those risks |
| In addition, any prospective or retroactive change in their financial reporting could affect our financial condition and results of operations |
| Such changes could occur as a result of, among other things, changes in accounting principles or comments made by regulatory agencies, including the SEC in connection with its ordinary course review of filings made with it (such as its current review of the registration statement filed by RAM Holdings in connection with its proposed initial public offering) |
| As a significant portion of our consolidated net income is derived from FGIC and its financial guaranty business, we are subject to various risks and uncertainties associated with the financial guaranty business |
| A significant portion of our consolidated net income is derived from FGIC and its financial guaranty business |
| Accordingly, we are subject to the risks and uncertainties associated with that business |
| In addition, FGIC has historically operated its financial guaranty business principally in limited portions of the public finance and structured finance markets |
| FGIC has expanded its business lines and products into markets and asset classes that historically have experienced higher default rates than those in which it has historically operated |
| The risks and uncertainties to which we may be exposed as a result of the FGIC acquisition include the following, among others: • FGIC’s ability to attract new business and to compete with other large, triple-A rated monoline financial guarantors is largely dependent on the triple-A financial strength ratings assigned to it by the major rating agencies |
| FGIC’s current ratings may be lowered or withdrawn at any time by one or more of the rating agencies |
| FGIC’s ability to compete or otherwise engage in its business as currently conducted, and FGIC’s consolidated results of operations and financial condition, would be materially and adversely affected by any reduction in FGIC’s ratings or the announcement of a potential reduction or change in outlook |
| • Prior to 2005, FGIC operated its financial guaranty business principally in the public finance market and, to a limited extent, the structured finance market in the United States |
| However, in 2005 FGIC continued its expansion into new markets both domestically and internationally |
| Unanticipated issues may arise in the implementation of FGIC’s strategy, which could impair its ability to expand its business as expected |
| In addition, any expansion of its business may be subject to challenges in attracting and retaining employees with relevant experience, establishing name recognition in new markets and gaining knowledge of those markets and asset classes |
| The execution of FGIC’s expansion plans could result in it having greater losses than those it has historically experienced |
| • FGIC is subject to extensive competition from other monoline financial guaranty insurance companies, other providers of third party credit enhancement and providers of alternative transaction structures and executions that do not use financial guaranty insurance |
| We cannot be sure that FGIC will be able to 49 ______________________________________________________________________ [92]Table of Contents continue to compete effectively in its current markets or in any markets or asset classes into which it expands |
| • Demand for financial guaranty insurance is constantly changing and is dependent upon a number of factors, including changes in interest rates, regulatory changes and supply of bond issues |
| A general reduction in demand for financial guaranty insurance could harm FGIC’s consolidated results of operations and business prospects |
| • The financial guaranty business is subject to extensive regulation |
| Future legislative, regulatory or judicial changes affecting the financial guaranty industry or public finance or structured finance markets, including changes in tax laws, could adversely affect FGIC’s business |
| • FGIC’s loss reserves are necessarily based on estimates and subjective judgments about the outcome of future events |
| We cannot be sure that losses in FGIC’s insured portfolio will not exceed by a material amount the loss reserves previously established by FGIC or that additional significant reserves will not need to be established |
| • FGIC’s structured finance portfolio contains concentrations of individual issuers and servicers of those obligations as well as a concentration of mortgage-related securities |
| FGIC also has a number of individual large exposures to single obligors in its public finance portfolio, concentration in infrastructure sectors, and concentrations in certain geographic areas |
| An adverse event or series of events with respect to one or more of these concentrations that is more severe than the assumptions used by FGIC in its stress scenario at the time of the underwriting of the related credit could result in disproportionate and significant losses to FGIC and could harm its consolidated financial position and results of operations |
| • FGIC’s exposure to insuring public finance obligations relating to airports has experienced increased stress as a result of terrorism and general global unrest, including a downgrading of the ratings of some of those issuers |
| Other sectors currently insured by FGIC or into which FGIC may expand could also see direct increased stress as a result of terrorism and general global unrest |
| FGIC may incur material losses due to such exposures if the economic stress caused by such events is more severe than FGIC currently foresees or has assumed or will assume in the future in underwriting its exposures |
| As of December 31, 2005, 7dtta3prca of our US investment portfolio consists of FGIC-insured non-refunded bonds |
| As a result of our investment in FGIC, we have amended our investment policy to provide that no more than 15prca of our US investment portfolio consists of FGIC-insured non-refunded bonds |
| We are subject to various risks and uncertainties in connection with the sale of equity interest in SPS Holding Corp, or SPS In October 2005, we sold our interest in SPS to Credit Suisse First Boston (USA), Inc, or CSFB Under the terms of the transaction, we received cash payments of approximately dlra99 million and expect to receive additional monthly cash payments through the first quarter of 2008 from a residual interest in mortgage servicing assets that had an estimated fair value at closing of approximately dlra21 million |
| In addition, we agreed to indemnify CSFB for certain liabilities relating to SPS’s operations, including litigation and regulatory actions, and this indemnification obligation may potentially reduce the proceeds that we receive from the sale |
| Our maximum indemnification obligation for SPS’s operations will not exceed approximately dlra21 million |
| Our consolidated financial position and results of operations could be harmed if the monthly contingent payments we receive are less than anticipated or if we are required to indemnify CSFB for claims or liabilities relating to SPS’s operations up to the date of closing |