The PMI Group Inc. Q1 2009 Earnings Call Transcript

The PMI Group, Inc. (PMI)

Q1 2009 Earnings Call

May 11, 2009; 12:00 pm ET

Executives

Steve Smith - Chairman & Chief Executive Officer

Don Lofe - Executive Vice President, Chief Financial Officer & Chief Administrative Officer

David Katkov - Executive Vice President & Chief Business Officer

Bill Horning - Vice President, Investor Relations

Analysts

Donna Halverstadt - Goldman Sachs

Connor Ryan - Deutsche Bank

Adam Sklar - Monarch

Mike Toyo - Darling Capital

Presentation

Operator

Welcome to the first quarter 2009 earnings call for the PMI Group. At this time all participants are in a listen-only mode. Following the presentation we will conduct a question-and-answer session. (Operator Instructions)

I’ll now turn the meeting over to Mr. Bill Horning, Vice President of Investor Relations.

Bill Horning

Thanks Julian. Good morning and welcome to the PMI Groups first quarter 2009 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 first 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 matter.

We also have with us today David Katkov, PMI’s Executive Vice President and Chief Business Officer, who along with Steve and Don will be available to answer your questions, following today’s prepared remarks.

Also on today’s call we will be referencing non-generally accepted accounting principal measures such as non-operating income, which under SEC Regulation G we are required to reconcile with GAAP. These reconciliations and 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 maybe 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 our 2008 Form 10-K and most recent Form 10-Q filing. Forward-looking statements are made as of today, May 11, 2009 and we undertake no obligation to update such statements except as maybe required by law.

With that, I’ll turn the call over to PMI Chairman and Chief Executive Officer, Steve Smith.

Steve Smith

Thanks Bill. Good morning everyone and thank you for joining on 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 first quarter of $115.3 million or a loss of $1.41 per share. We entered the first quarter with total shareholders equity of $1.2 billion and book value per share of $14.16.

As of March 31, 2009, the PMI Group and its consolidated subsidiaries had total liquidity of $3.6 billion comprised of cash and cash equivalents of $1.3 billion, and total investments of $2.3 billion. In addition we have the benefit of $894 million in captive trust balances in USMI Operations.

Our principal mortgage insurance company, PMI mortgage insurance company ended the first quarter of 2009 with net statutory risk in force of approximately $21 billion and policyholders surplus, and contingency reserves of approximately $1.15 billion resulting in risk-to-capital ratio of 18.7 to 1 as of March 31, 2009.

Now while PMI has significant financial resources to pay our insurance claims, we have seen a reduction in the amount of excess capital available to right new mortgage insurance. In the first quarter our new business writings were $4.8 billion compared to $6.1 billion one year ago. We continue to target our new insurance written for the full year 2009 in the range of $10 billion to $12 billion, and I believe we are on a trajectory to achieve that target.

As we discussed in our recent SEC filings, we have and continue to seek alternatives to enhance our liquidity and capital at the holding company and our primary mortgage insurance company. Because the equity and debt markets are effectively closed to us at this time and reinsurance capacity may not be cost effective, we believe capital will need to come from a third party or from our own internal restructuring or other capital initiatives.

At the current time third party capital, if available would most likely come from the U.S. treasury under their financial stability plan or under various other government programs. We are evaluating several of these options in order to position ourselves to take advantage of the opportunities, if and when they develop.

In addition to these external efforts to raise capital we are successfully complete a number of internal projects to free up existing capital or utilize our current capital based more efficiently. An example of these is the computation of certain modified pool policies we executed in the first quarter.

This project involved the restructuring or cancellation of certain modified pool agreements, which resulted in a net risk reduction of approximately $425 million. As a result we reduced our pool risk in force to $2.3 billion at March 31, 2009, from $2.7 billion at the end of the prior quarter.

Another example of these internal efforts is our work along with the industry, with the regulatory community to implement the recently issued regulatory guidance relating to the calculation of the risk to capital ratio.

As clarified in the recent guidance we believe it is appropriate to exclude risk in force related to all delinquent loans in this calculation, because sufficient capital is already allocated to such loans in the form of loss reserves. As a result our risk to capital at the end of the first quarter was 18.7 to 1 and we have restated our fourth quarter 2008 risk to capital ratio from the previously reported 18.5 to 1 to 16.6 to 1.

Now, the methodology of our other regulatory measure, minimal policyholder’s position or MPP did not change in the first quarter. With respect to MPP, PMI mortgage insurance company ended the first quarter with $247 million of excess MPP. Our homeowner’s preservation initiative for HPI program is also helping to distressed borrowers find alternative to foreclosures, and in the process helping us to conserve our capital.

In the first quarter of 2009 our HPI loss mitigation efforts enabled 5,353 borrowers to retain their homes, representing approximately $253 million of risk to PMI. Additionally we enabled another 1,569 borrowers to avoid foreclosure, and I would add that both of these measures have increased by over 300% compared to the levels of one year ago. Clearly our HPI initiatives are really gaining significant traction in 2009.

In addition, we are also experiencing a reduction in losses and risk in force due to recessions, and as Don will discussing more detail a renegotiation of our revolving credit facility entails the pledging of the note receivable from the sale of PMI Australia at the holding company level. As you may recall, under GAAP and statutory accounting conventions PMI mortgage insurance company receives no benefit from holding this note until its scheduled maturity in September 2011.

In exchange for a move to the note up to the holding company, PMI mortgage insurance company will receive $75 million upon transfer and another potential $25 million at maturity adding to its capital and claims paying resources.

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

Don Lofe

Thank you, Steve and good morning. Let me first cover certain aspects of our business operations in the first quarter and then detail for you other additional financial and liquidity matters. Within the U.S. Mortgage Insurance Operations, we again had a quarter of high credit quality, new business writings with returns that we expect to be very favorable.

As highlighted in our financial supplement, this quarters NIW was characterized by high FICO, fixed rate and an average LTV of approximately 90%. Our persistency rate measured 82.5% for the first three months of the year. As a result we ended the quarter with insurance in force of $123.9 billion and risk in force of $30.4 billion, both only modestly lower than the prior quarter.

In the first quarter our net incurred losses in U.S. Mortgage Insurance Operations were $380 million, comprised of paid claims including loss adjustment expenses of $260 million and a net addition to our reserve of losses in LTV of approximately $164 million. Of the total reserve increase approximately $125 million was attributable to full insurance.

This addition to reserves is driven primarily by increase in the default inventory and higher average claim sizes in modified co instant. The remainder of the increase in loss reserves are approximately $39 million, was within our primary insurance business. There, the key driver was an increase in notices of default inventory from 109,580,000 at the end of the prior quarter to 107,503,000 at March 31, 2009.

In the first quarter, our reinsurance recoverables increased by approximately $67 million to $549 million which Steve mentioned are supported by captive trust account balances to the $194 million. We continue to expect the incurred loss benefit from our captive reinsurance agreements will be approximately $245 million for the full-year 2009.

As March 31, 2009, our gross reserve for losses in LAE and U.S. Mortgage Insurance Operations were $2.85 billion or an increase of $230 million from the fourth quarter of 2008, and an increase of $1.27 billion from the first quarter of 2008. It is also worth mentioning that in the first quarter of 2009, we had net income of $6.7 million from our International Operations. This profit was driven by net income for PMI Europe at $7.5 million for the quarter, which was prime due to changes in the fair market value of PMI Europe’s credit default swaps.

Our most recent financing activity is in the successful renegotiation of our revolving credit facility. As we announced in the press release last Friday, we reached an agreement with our lender group upon binding terms, and conditions of an amendment and a restated credit agreement to replace the existing credit facility agreement in its entirety. The restated credit agreement will become effective if we successfully meet the conditions precedence to the effectiveness on or before May 29, 2009.

If it becomes effective, the restated credit agreement will reduce the size of the credit facility to $125 million and will eliminate certain financial covenants and investment default currently contained in the facility including the following; the elimination of the maximum total debt to total capital capitalization percentage; the elimination of the maximum risk to capital ratio; the removal of the [inaudible] to fall; and the termination of the existing pledge of the capital stock of PMI Mortgage Insurance Company to the lenders.

The restated credit agreement would also revise the minimum adjusted consolidated net worth requirement as defined in the credit facility to not be less than $1.2 billion through June 30, 2009, $700 million from July 1, 2009, through December 31, 2009 and $500 million from January 1, 2010 through the maturity date of the facility of October 24, 2011.

Conditions precedent of the effectiveness of the restated agreement include the following: The sale to the holding company of the contingent note PMI received in connection with the sale of PMI Australia; the pledge of the note to the lenders by the company; the termination of the existing pledge of capital stock of PMI to the lenders; and finally the company’s repayment of its borrowings under the facility to $125 million.

Satisfaction of certain conditions precedent will require the consents of third-parties and a regulatory approval and there can be no assurance that such consents and approvals will be obtained by May 29, 2009. Whether the company has satisfied the conditions precedent is within the sole discretion of the lenders.

Now with regard to the holding company liquidity, the PMI Group ended the first quarter with cash and investment of $234 million, which included $200 million outstanding under a revolving credit facility. Upon completion of the conditions precedent on or before May 29, 2009, we will repay $75 million of the outstanding borrowings from the credit facility and with the approval of the Arizona Department of Insurance.

The holding company will also make a payment of $75 million to PMI Mortgage Insurance Company in considerations for the PMI Australia notes receivable. Upon maturity of the note in September 2011, the holding company will make an additional payment of $25 million to PMI Mortgage Insurance Company depending on the ultimate value realized for the note.

Now let me take a moment and explain the cash flows at the holding company over the next couple of years. First, moving the PMI Australia note receivable to the PMI group holding company will enable the holding company to potentially realize upon maturity in September 20011 to $208 million in principle and accrued interest for the note.

Of course, this assumes the indicated Australia portfolio as measured by the note structure, performance as we expect and there is no reduction in the principal amount of the note. The holding company will also benefit from the tax sharing agreement with PMI mortgage insurance company in 2009, 2010 and 2011.

These tax settlements relate to the taxable loss position of the holding company caused by the debt interest expense of the holding company and the corresponding loss. In inter company sharing agreement relates to the tax benefits that arise because of this matter between the operating and the holding company.

The holding company receives the first of these installments in the first quarter 2009 and over the next two years, we would expect the holding company to receive annual payments in the range of $15 million to $20 million. Again, let me be clear in this issue, these payments are going from the operating company to the holding company. Additionally we expect some benefit at the holding company for tax refunds directly from the IRS in the latter half of 2009.

Now with respect to expenses, the holding company has only nominal corporate operating cash expenses of several million dollars a year and annual interest and financing expenses of approximately $48 million.

Assuming the completion of the amended credit agreement and after consideration of the anticipated note maturity value, we believe that the liquidity at the holding company will be sufficient to pay all operating cash expenses and make all interest and financing payments, including the maturity of the credit facility through the ends of 2011.

Lastly, it is important to reiterate that our next maturing debt obligation at the holding company, other than revolving credit facility is $250 million of the senior notes due in September 2016. 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 regard to PMI Europe, we have treated our credit to default swap mark-to-market adjust is not operating, only to the extent and the adjustments are deemed to relate to changes in credit spreads, and we have treated the fair value adjustment for SFAS 157 and 159, early retirement charges, restructuring charges, 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 first quarter of 2009 was $127.7 million or a loss of $1.56 per common share.

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

Steve Smith

Thanks, Don. I want to do leave you with some closing thoughts before we begin our Q-&-A session. As Don described, a successful completion of the renegotiation of our revolving credit facilities, terms and conditions places our holding company in a good liquidity position through the ends of 2011.

Secondly, we are actually involved in seeking alternatives to enhance our liquidity and capital from our external sources and internally. Our external efforts are focused on our Washington, D.C. outreach where we along with the mortgage insurance companies of America, our trade association are very involved with making policy makers and the treasury aware of the important role, private mortgage insurance plays in today’s mortgage market.

We are also pursuing various capital projects internally, and we have successfully executed on a number of initiatives to free of capital and to ensure that we have efficiently deploy our existing capital base and finally, we are very pleased with the results of our homeownership preservation initiatives and the significant contribution to loss mitigation this is making for PMI.

We are also encouraged by the various GSE and government initiatives, such as the administrations, Home Affordable Refinance Program that we believe will also have a meaningful impact on keeping qualified borrowers in their homes and reducing our credit losses.

With that let’s open up the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Donna Halverstadt - Goldman Sachs.

Donna Halverstadt - Goldman Sachs

I was wondering if you could talk a little bit more about the TPG guarantee of capital support with PMI Europe and what’s the outlook there is, and more specifically if you could update us on for both the reinsurance and the CDs in Europe, what the amount of collateral has been posted. What they paid claims were in the reinsurance business during the quarter and where the reserves stood at the end of the quarter on the reinsurance business?

Don Lofe

Okay, first with respect to the capital support agreement as we talked before, give you some feedback here. The capital support agreement is unlimited in nature and supports the capital required European operation. At this time there is no obligation as far as required [Inaudible] under that currently, and at this time we don’t expect any payment concerning the capital support agreement.

Concerning reserves in totality in Europe, there’s $60.6 million U.S. based as of March 31, 2009, and the most significant component of that is the U.S. subprime insurance arrangements of approximately $46 million of that component. The remaining reserves are from our Italian business and German business with respect to that.

Concerning the collateral, the collateral posted in $331 is approximately $110 million and the most significant component of that is the U.S. subprime risk associated with that and again that’s in U.S. dollars. Did I cover all your questions?

Donna Halverstadt - Goldman Sachs

Yes, the $110 is collateral both for the reinsurance business as well as the CDs?

Don Lofe

Yes, it is.

Donna Halverstadt - Goldman Sachs

Okay. I was also curious, if you could remind us or tell us a bit more with respect to the Australian contingent note. You said, to the extent it performs as expected, there was no reduction in principal. Can you give us more color on what specific performance metrics tied to principal reduction, how that works?

Don Lofe

Yes, it’s a fairly simplistic calculation. I think I mentioned this on the call before. When the transaction was completed, it was based upon ultimately the realizable value again on premium reserve that was residents in the Australian entity at 630, 2008 and to remind everybody that in US dollars is $475 million approximately.

The note is tied to that balance and the way it works basically is that 50% of that is the obligation of the PMI Australian entity or the prior entity. Over and above those 50% criteria, and just again from a mathematical point of view, that’s $237.6 million. The note begins to have some deterioration in value.

So, that will be a value we’ll continue to look at on a quarterly basis and evaluate it with respect to that. Donna, yet one another question I think was claimed paid for Europe and year-to-date was approximately $20 million U.S.

Donna Halverstadt - Goldman Sachs

Then one last quick one and then I’ll get back in line. At the end of the quarter, what was adjusted consolidated worth as defined in the credit facility?

Don Lofe

Sure, and this is based upon three 331 data as we have filed with the lender group. Adjusted consolidated net worth was $1.737 billion. We have evaluated that against the new minimum amount of $1.2 billion. So that excess is approximately $537.3 million.

Operator

Your next question comes from Connor Ryan - Deutsche Bank.

Connor Ryan - Deutsche Bank

I was just curious as to what the cash balance was at the holding company and whether you have the ability to fund interest expense at the holding company from the operating company?

Don Lofe

Connor, it’s Don. The balance is $234 million at 331, comprised of cash and cash investments and if understood your question correctly, “That do we have the ability to fund interest costs from the operating company to the holding company?” Is that your specific question?

Connor Ryan - Deutsche Bank

Yes.

Don Lofe

We do not. The number that I read in my remarks annual estimated cost for interest and financing expense of $48 million is the obligation of the holding company.

Operator

Your next question comes from Adam Sklar - Monarch.

Adam Sklar - Monarch

I’m sorry, just one clarification on the prior question. The $234 million is as of 331, but is that pro forma for the $75 million pay down to the credit facility and the $75 million purchase for the note?

Don Lofe

No, Adam, that does not include those two payments.

Adam Sklar - Monarch

On a pro forma basis, its closer to $85 million?

Don Lofe

Yes, it if you just back out those two components that’s correct, but obviously you have to add in the other matters that I spoke about relative to cost and net all.

Operator

Next question comes from [Mike Toyo - Darling Capital].

Mike Toyo - Darling Capital

I was wondering, if you could just give us some sort of update on the performance of the Australia book versus the performance targets you were talking about earlier?

Don Lofe

The only comment that we would want to make is that clearly we watch it very closely, as I just said in my previous remarks and it’s performing as we expected.

Mike Toyo - Darling Capital

Will you provide updates in the future since that’s such a critical part of your holding company’s liquidity situation?

Don Lofe

It’s a very good point and good question. We’re considering that as we speak right now and as I mentioned in my previous remarks, we’re evaluating as to what procedures we would do with respect to that on a quarterly basis. So we’re going to consider disclosure of that in first quarter, but at this time we haven’t made a final decision.

Mike Toyo - Darling Capital

One last question, with regard to MIC what is the current surplus and contingency reserve there?

Don Lofe

Contingency reserves are $770 million at 331 and policyholder surplus is $380 million at 331.

Operator

Your next question comes from Donna Halverstadt - Goldman Sachs.

Donna Halverstadt - Goldman Sachs

Hi, just a couple quick things. In terms of the why risk to cap is currently being calculated? Is that a permanent change for the industry or is that change going to not be there. Is that just temporary?

Steve Smith

Donna, this is Steve. We expect that to be a permanent change.

Donna Halverstadt - Goldman Sachs

Any update on losses in the investment portfolio during the quarter?

Don Lofe

The only significant impairment, Donna was approximately $5 million and that was predominantly one security in the preferred portfolio, but actually since 331 the portfolio has increased in value. So really the only impairment was the matter I just spoke about I. We had some minor impairment in Europe and Canada.

Donna Halverstadt - Goldman Sachs

So I think you said $245 million for ’09, but what do you expect the cash benefit to be from captives during ‘09.

Don Lofe

I don’t want to comment on the cash component, but as of 331, the actual cash effect that we received was approximately $20 million and if you look at the captive benefits including quarter year-to-date is approximately $40 million.

Donna Halverstadt - Goldman Sachs

And then the last question. Do you do the PDR analysis quarterly?

Don Lofe

Yes, we do, on a GAAP and staff basis.

Operator

Your last question comes from Connor Ryan - Deutsche Bank.

Connor Ryan - Deutsche Bank

Just a quick question, have you given any guidance by any chance on what kind of range do you think you could see on the tax refunds this year?

Don Lofe

No, we haven’t, but it would be in our opinion minor in nature. The refund is as I mentioned in my remarks would be obviously just filing the return and or amended return. We just gave the remarks of $15 million to $20 million for the tax sharing agreements. As that begins to true itself up, Connor we’ll continue to evaluate that for disclosure.

Operator

(Operator Instructions) I have no questions at this time. I would like turn the conference back over to Mr. Bill Horning.

Bill Horning

Thanks, operator. This concludes our question-and-answer portion of the conference call. Thank you for joining us on today’s call, and as always we thank you for your ownership and interest in the PMI group. Have a good day.

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