The PMI Group, Inc. Q4 2008 Earnings Call Transcript

The PMI Group, Inc. (PMI)

Q4 2008 Earnings Call

March 16, 2009 12:00 pm ET

Executives

Bill Horning - Vice President, Investor Relations

L. Stephen Smith - Chairman, Chief Executive Officer

Donald P. Lofe, Jr. - Executive Vice President and Chief Financial Officer

David Kacko - President and Chief Operating Officer, PMI Mortgage Insurance Company

Analysts

Joseph Marino - Piper Jaffray

Donna Halverstadt - Goldman Sachs

Brian Monteleone - Barclays Capital

Mike Grondahl - Key Colony

[Dan Chandra] - Brevin Howard

Presentation

Operator

Hello and welcome to the fourth quarter 2008 earnings call for The PMI Group. (Operator Instructions)

Now I will turn the meeting over to Bill Horning, Vice President, Investor Relations. Sir, you may begin.

Bill Horning

Thanks, Julie. Hello and welcome to The PMI Group's fourth quarter and full year 2008 financial results conference call.

Today's call will begin with comments from Steve Smith, PMI's Chairman and Chief Executive Officer. Mr. Smith will discuss PMI's overall financial results and highlights for the fourth quarter. Don Lofe, PMI's Executive Vice President, Chief Financial Officer and Chief Administrative Officer will then address other business results for the quarter as well as other financial and capital matters. We also have with us today David Kacko, PMI's Executive Vice President and Chief Business Officer, who, along with Don, will be available to answer your questions following the prepared remarks.

Also on today's call we will be referencing non-generally accepted accounting principal measures such as net operating income which under SEC Regulation G we are required to reconcile to GAAP. The reconciliations of these measures with GAAP financial measures are available on our website.

Before we begin I would like to review the company's safe harbor statement under the Private Securities Litigation Reform Act of 1995. During this call we will be making forward-looking statements. Actual results may differ materially from the statements made during this call. The company's business depends on investment considerations which are highlighted in our Securities and Exchange Commission filings, including today's Form 10-K and our most recent 10-Q.

Forward-looking statements are made as of today, March 16, 2009, and we undertake no obligation to update such statements except as may be required by law.

Thanks and at this time I'll turn the call over to PMI's Chairman and Chief Executive Officer, Steve Smith.

L. Stephen Smith

Thanks, Bill. Good morning and good afternoon, everyone. Thank you for joining today's call.

As you've seen in our financial results released this morning, The PMI Group had a net loss from continuing operations in the fourth quarter of $181 million or a loss of $2.22 per share. For the full year of 2008 we reported a loss from continuing operations of $887.2 million or $10.90 per share.

We ended 2008 with consolidated cash and investments of $3.7 billion, total shareholder's equity of $1.28 billion, and book value per share of $15.65.

Now the fourth quarter financial results were disappointing and closed out what was the most challenging environment in PMI's 36-year history. Throughout that history PMI has weathered a number of downturns in the housing cycle, all the while continuing to provide credit protection for mortgage lenders, the GSEs, investors and paying insurance claims as they come due. Certainly the challenges in today's mortgage market cannot be underestimated, but it's important to recognize that PMI continues to provide these benefits as well as the expertise needed to support the nation's housing market.

Stepping back and taking a broader view, today's mortgage market is obviously suffering from significant declines in home prices, although the rate of decline appears to be decelerating, and we're also experiencing increases in delinquencies and foreclosures.

However, we've seen in recent weeks aggressive initiatives put forward by the U.S. Treasury Department, the Department of Housing and Urban Development and others to keep families in their homes. We believe that this comprehensive approach developed by Treasury and HUD in conjunction with Fannie Mae, Freddie Mac, the FHFA and industry participants will eventually stem the growing tide of foreclosures.

PMI supports the administration's plan and looks forward to working closely with the administration and our industry partners to implement the details. PMI was one of the early participants in the HOPE NOW Alliance and has been in the forefront in working with loan servicers to prevent unnecessary foreclosures. Through these collective efforts last year PMI helped approximately 18,000 homeowners to retain their homes and another 3,400 families avoid foreclosure through a range of workout programs such as forbearance plans, loan modifications and pre-foreclosure sales. Based upon PMI's own foreclosure prevention efforts, we expect to help approximately 31,000 homeowners retain their homes in 2009.

Our industry and The PMI Group have clearly been challenged by today's mortgage market. As a result, we'll pay billions of dollars in insurance claims due to home foreclosures. These are losses that would otherwise flow through to Fannie Mae, Freddie Mac, lenders and mortgage investors.

That said, the challenges facing mortgage insurers only serve to validate the industry's underlying claims paying ability, derived from a strong regulatory framework and rigorous third-party scrutiny. State insurance regulators require mortgage insurers to hold significant contingency reserves and meet stringent risk-to-capital ratios. As of December 31, 2008, The PMI Group and its consolidated subsidiaries had total liquidity of $3.7 billion comprised of cash and cash equivalents and $1.5 billion [and] investments of $2.2 billion.

In addition, we have the benefit of $861 million in captive trust balances in USMI operations. Our principal mortgage insurance company - PMI Mortgage Insurance Company - ended 2008 with statutory risk in force of approximately $25 billion and policyholder surplus and contingency reserve of approximately $1.35 billion, resulting in a risk-to-capital ratio of 18.5 to 1 as of December 31, 2008. On a minimum policyholders' position or MPP basis, we ended the second half of with $424 million of excess MPP.

While PMI has significant financial resources to pay our insurance claims, we have seen a reduction in the amount of excess capital available to write new mortgage insurance. In 2008 we significantly tightened underwriting guidelines and increased prices, which limited our new business writings to $22.7 billion of new insurance written. In 2009 we are currently planning to limit new insurance written to a range of $10 to $12 billion; however, the opportunity to write high-quality credit business is larger, so enhancing our capital position will be an important part of our 2009 plans.

In 2008 we executed on our five-point plan for progress and took many necessary steps to position the company for 2009 and beyond.

Now let me turn the call over to Don to cover the additional details of the fourth quarter results as well as other liquidity and capital matters. Don?

Donald P. Lofe, Jr.

Thank you, Steve, and good morning and good afternoon. Let me first cover certain aspects of our business in the fourth quarter and then detail for you other additional financial and liquidity matters.

With the U.S. mortgage insurance operation we again had a quarter of high credit quality new business writings with returns that we expect to be very favorable. In the fourth quarter of 2008 we booked $5.7 billion of new insurance written, bringing our year to date total to $22.6 billion. Additional characteristics of our NIW are available in the supplemental financial information that was put on our website this morning.

In the fourth quarter our net incurred losses in U.S. mortgage insurance operations were $398 million, comprised of paid claims of $224 million, loss adjustment expenses of $11.6 million, and a net addition to our reserve for losses and LAE of approximately $162 million. For the full year of 2008, our U.S. mortgage insurance operation paid claims and LAE of $814 million, which was in line with our guidance of between $810 to $835 million.

Now with regards to our paid claims guidance for 2009, we believe that claims will be significantly higher than claims paid in 2008; however, this is uncertain as to the range and timing of paid claims given the various public and private foreclosure prevention and loan modification programs in the market. In the fourth quarter our reinsurance recoverables increased by approximately $90 million to $482.7 million and our total captive trust balances were $860 million at December 31, 2008. And at year end our gross reserves for losses and LAE were $2.63 billion, an increase of $275 million from the third quarter and an increase of $1.5 billion from year end 2007.

Now let me move to the fourth quarter financial and liquidity matters. With respect to our credit facility and our recent financing activities, these efforts have included our efforts to amend our revolving credit facility. We began these negotiations proactively earlier in the year and not as a result of the company being in violation of any covenants of the facility at December 31, 2008. Rather, we approached our bank group and are working with them to structure a facility that would meet our holding company needs now and through the facility's maturity date of October 2011.

To date our discussions with the bank group have progress, but time was insufficient to reach an agreement by today. Therefore, the banks offered and we accepted an amendment to the facility which was effective yesterday, March 15th, that amends our covenants that relate to risk to capital, minimum consolidated net worth and our ratings covenant. This amendment and covenant changes extend until April 15th of 2009, by which time we hope to finalize a renegotiated facility. Upon finalization of the agreement, we will publicly disclose the details in terms of the new credit facility.

Now with regards to the holding company, The PMI Group ended 2008 with $236 million of investments, cash and liquidity type investments. Additionally, we have reduced the interest and operating expenses at the holding company to a reduction in operating expenses, the realignment of our businesses and a reduction in work force in 2008. As a result, on an annualized basis we would expect the operating expenses at the holding company to be meaningfully reduced.

Additionally, as we've stated in our 2008 Form 10-K which was filed today, the Board of Directors of our company have suspended our common share dividend for the foreseeable future, which will also enhance the holding company liquidity.

Lastly, it is also important to mention that our next maturing debt obligation at the holding other than our revolving credit facility in October of 2011 is our $250 million senior notes which are due September 2016.

And finally, I would like to direct those interested in a reconciliation of our consolidated net loss to our consolidated net operating loss to review the disclosure material posted on our website. With regards to PMI Europe, we have treated our CDS marked-to-market adjustments as non-operating only to the extent any adjustments are deemed to relate to increases in credit spreads only. And we have treated the fair value adjustment for FAS 159, early retirement and restructuring and severance costs and other related costs of PMI Europe and Canada, net realized investment losses and losses from discontinued operations as non-operating. Therefore, as presented in the reconciliation, our consolidated net operating loss from continuing operations in the fourth quarter of 2008 was $145.6 million or $1.79 per common share.

Now let me turn the call back to Steve for some closing remarks before we open up the call for questions. Steve?

L. Stephen Smith

Thanks, Don. I wanted to leave you with some closing thoughts before we begin our question-and-answer session.

First, we made measurable and significant progress in 2008 towards refocusing the company, booking high-quality business, mitigating losses, reducing expenses, and enhancing our capital and liquidity. All of these will continue to be important initiatives for 2009 as well.

With regards to liquidity, the holding company enhanced its liquidity in 2008, ending the year with investments, cash and cash equivalents of $236 million, and we're working with our bank group to structure our credit facility to meet our holding company needs now and through the facility's maturity in October of 2011.

At the operating company level, as a result of our efforts in 2008 we have increased our liquidity by approximately $1.3 billion. As a result, at December 31, 2008 our consolidated, cash equivalents and investments were approximately $3.7 billion.

The federal government, the GSEs and our lenders continue to make necessary steps to stabilize the housing market. PMI is well positioned to be a partner in that effort. However, to fully meet the liquidity, credit and capital relief needs of the market, in 2009 we will continue to make it a priority to enhance our own liquidity and capital.

With that, let's open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Joseph Marino - Piper Jaffray.

Joseph Marino - Piper Jaffray

Could you give us some commentary on some trends that happened in the first quarter? How has business been so far this quarter and this year, I guess, to date?

L. Stephen Smith

Yes, Joseph. So far through February the trends are as we expected and in some cases a little bit favorable to our expectations so far.

Joseph Marino - Piper Jaffray

More favorable than fourth quarter trends?

L. Stephen Smith

I can't relate it to the fourth quarter, but in terms of what we're expecting for the year, many of the trends are favorable as we built our plan.

Joseph Marino - Piper Jaffray

What were your paid losses in the fourth quarter, paid claims?

Donald P. Lofe, Jr.

$243 million.

Operator

Your next question comes from Donna Halverstadt - Goldman Sachs.

Donna Halverstadt - Goldman Sachs

You suggested a hold co cost down significantly this year. What's a good estimated annual run rate on the non-interest hold co costs?

Donald P. Lofe, Jr.

There's two things, Donna. One, you've got to look at it from an expense point of view. And from FAS 123(R), option costs, that's roughly about $5 million on a pre-tax basis, and then other allocated costs would be about $3 to $4 million on an annualized basis. And both those numbers are pre-tax.

Donna Halverstadt - Goldman Sachs

And what's the annual run rate cost on the facility?

Donald P. Lofe, Jr.

The facility at this point in time is roughly from a cost perspective about $9 million. But again, as we talked about, we're in discussions to amend that. That would be total interest and facility fees and things such as that, so that's an all-in cost.

Donna Halverstadt - Goldman Sachs

And then thinking about resources, you mentioned the cash and investments at the hold co. There's also the receivable from PMI related to the tax-sharing agreement. Can you talk about how large that is, when it might be forthcoming, whether or not payment to you is subject to regulatory approval, and whether or not there's anything else other than insurance regulators that could stop payment of that receivable to the hold co?

Donald P. Lofe, Jr.

Sure. There's two components of this for 2009. There's a refund that is attributable to the 2007 year, and we expect that to be paid in the first half of 2009. And so we don't see any issues with respect to that.

And with respect to the tax-sharing arrangements, we don't expect there to be any issue from a regulatory perspective, and those are agreements that have been in place for quite some time. We would expect that first settlement to occur in the first quarter of 2009, and that's principally related to the 2008 year.

So again, we don't see any issues with respect to that; that's why we detailed that in the 10-K.

Donna Halverstadt - Goldman Sachs

And is TPG ever at risk of having to pay amounts back to the op co under that agreement?

Donald P. Lofe, Jr.

Not that we foresee.

Donna Halverstadt - Goldman Sachs

And one last tax-type question. Are there any tax-sharing payments either to or from Allstate or Sears that could impact the hold co liquidity?

Donald P. Lofe, Jr.

Not that we're aware of, no.

Operator

Your next question comes from Brian Monteleone - Barclays Capital.

Brian Monteleone - Barclays Capital

I know you guys had approached the Arizona Department of Insurance about having the promissory note from QVE included in the STAT financials as an admitted asset. Is the fact that it wasn't recorded as an asset for STAT or GAAP purposes as of year end, should that be taken as an indication that Arizona's not allowing that to be included as an admitted asset or is that negotiation ongoing?

Donald P. Lofe, Jr.

I think it's a fair assessment as of 12/31 for both STAT and GAAP that - obviously statutory's the focus with Arizona. That was not permitted to be accrued for value at 12/31. However, we have ongoing discussions with Arizona with respect to the note and the value therefore for that note and how we can recognize or realize value from that. So those discussions will continue.

Brian Monteleone - Barclays Capital

The value as of 12/31, they feel that it’s not an admitted asset? What could change their mind? Would you have to sell it or is there something else that could happen?

Donald P. Lofe, Jr.

Well, I don't think selling is really what the focus is. The value would be as to additional development with the portfolio; that could be given consideration. There could be other opportunities to utilize that with potentially our bank facility discussions. So there's other opportunities here, and I just really can't get into the detail. But what I would stress is that we have good and ongoing dialogue with the Arizona DOI.

Brian Monteleone - Barclays Capital

And just real quick, it looks like about half of PMI Europe's assets have been posted as collateral to counterparties. Can you refresh us on the capital support agreement between PMI Europe and how that works?

Donald P. Lofe, Jr.

Firstly, the capital support agreement is in place between the PMI Mortgage Insurance Company and Europe and it obligates the mortgage insurance company to put forth appropriate capital support to maintain appropriateness of a capital base in Europe. And it is also guaranteed by the TPG holding company.

Operator

Your next question comes from Mike Grondahl - Key Colony.

Mike Grondahl - Key Colony

Can you talk a little bit about the different capital options or opportunities you're looking at? And then secondly, do you have any outlook on the loan modification program from the government or Fannie and Freddie and just sort of how you think it's going to help you guys going forward?

L. Stephen Smith

Sure, Mike, this is Steve. I'll start. In terms of the capital initiatives, obviously, as you know, we've engaged investment bankers some 15 plus or maybe 18 months ago. They were very helpful in some of our initiatives that we had in 2008. We will continue to look at initiatives that are either private or public equity to see if those are potential solutions for the company, but as you know, those markets are somewhat closed at this point in time.

We'll continue as an industry and as a company to look at various federal initiatives, a TARP type or TARP or TARP-like program, or looking at the public-private investment fund under the new initiatives that have been implemented by the administration. There are also a host of reinsurance-type proposals that we are looking at, either with private companies or potentially restructurings with the GSEs. So there are a number of initiatives that are in place that would come under the area of capital.

Relative to loan modifications, David, do you want to start that conversation?

David Kacko

Sure. As you know, the vast majority of our insured portfolio has either Fannie Mae or Freddie Mac as the beneficiary, and I think as you also know, the primary thrust of the foreclosure prevention programs that have been announced over the last several weeks really are for the benefit of the GSEs. So from our perspective, some of the numbers that Steve shared in the script in terms of foreclosure prevention in our own portfolio I think will only be enhanced as those initiatives are played out throughout the year.

But nevertheless, I think we've said this before pretty strongly, we've invested substantial resources in our own homeownership preservation initiatives and that has paid off significantly. We expect that to happen again in 2009.

But the bottom line is it's a little early to quantify the government programs other than to say generally we're very bullish that they will be beneficial.

Mike Grondahl - Key Colony

Could you talk about the number of fraud rescissions in the fourth quarter versus the third quarter and maybe the second quarter just to give us a sense of the trend there?

L. Stephen Smith

The trend is up, but we haven't disclosed and aren't disclosing the actual numbers. But the trend has been up.

Mike Grondahl - Key Colony

Could you disclose dollars?

L. Stephen Smith

No, we haven't disclosed that.

Operator

Your next question comes from [Dan Chandra] - Brevin Howard.

Dan Chandra - Brevin Howard

Can you talk more about your pool losses? I noticed that the default rate ticked up from like 12.7% to 15.5%, but you guys aren't really paying out a lot of claims in that. When do you expect to start paying out substantial claims on that and will they be substantial?

David Kacko

Let me give you just a quick little background. We've shared this before, but just to remind everybody on the call. Most of those pool transactions were constructed with one or both of the GSEs as the beneficiary. It's referred to as modified pool and the reason we say that is that there is a loss-sharing feature of those with the GSE most often in first loss position.

So you're absolutely right. You haven't seen paid claims come from PMI because we're still developing losses in that initial layer that is taken by one or other of the GSEs. Obviously, we're not forecasting losses today, but you're also correct that we would expect to see loss development starting to develop in '09 and going into 2010.

Dan Chandra - Brevin Howard

You've listed this balance sheet asset of captive reinsurance and I understand that's mostly from the banks. When do you expect to actually realize that as coming as assets on the [estate]?

Donald P. Lofe, Jr.

That's obviously going to be - firstly, it's the total incurred effect and it's a benefit, as you indicated, on the balance sheet. And that's going to be paid out over time as the actual claims are paid out. So it'll take several years for that ultimately to be paid out. But it clearly is a valid benefit to the total incurred effect.

Operator

Your next question comes from Donna Halverstadt - Goldman Sachs.

Donna Halverstadt - Goldman Sachs

Most of my follow ups were captured, but one thing I was wondering about, the guarantee from TPG on PMI's capital support agreement with PMI Europe. Is there any cap on that or is it unlimited?

Donald P. Lofe, Jr.

It is unlimited.

Donna Halverstadt - Goldman Sachs

And I had one question about the runoff support agreement with Allstate. If you breach the risk to cap on that one and your liquid assets get put into a trust for the benefit of policyholders, are liquid assets defined in such a way that it would be almost the entire investment portfolio?

And I was also curious to understand given that the op co assets already are in essence protected by insurance regulators, what does the additional step of putting those assets in trust for policyholders really accomplish and how shall we think about that?

Donald P. Lofe, Jr.

Donna, there's a lot there in your question so I'm going to try to brief with respect to that.

I think firstly what the deal is is that as long as we're making the obligations for our claim payments that we are in essence in accordance with that agreement. To your second point or point embedded in your question regarding the portfolio, that is a correct statement regarding the overall portfolio to be utilized. So again, those are the two points.

And what was your third point again?

Donna Halverstadt - Goldman Sachs

I think there were just two.

Donald P. Lofe, Jr.

Okay, just a lot there in your question.

Donna Halverstadt - Goldman Sachs

Yes. And the last thing, could you just remind us whether or not under your senior bonds or cap security whether or not loss of GSE status and/or regulatory action is a stated event of default?

Donald P. Lofe, Jr.

Not in the senior debt.

Donna Halverstadt - Goldman Sachs

What about the cap security?

Donald P. Lofe, Jr.

The junior debentures?

Donna Halverstadt - Goldman Sachs

Yes.

Donald P. Lofe, Jr.

No.

Operator

(Operator Instructions) I'm not showing any further questions. I'll turn the call back over to Bill Horning.

Bill Horning

Okay. Thanks, Julie. This concludes our question-and-answer portion of the call. Thanks for joining us on today's conference call and, as always, thank you for your ownership and interest in The PMI Group.

Operator

Thank you for participating in today's conference call and have a great day.

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