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The PMI Group, Inc. (PMI)

Q2 2009 Earnings Call

August 7, 2009 12:00 pm ET

Executives

Bill Horning - Vice President of Investor Relations

L. Stephen Smith – Chairman and Chief Executive Officer

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

David Kacko – Executive Vice President and Chief Business Officer

Analysts

Donna Halverstadt - Goldman Sachs

Mike Grondahl - Northland Securities

Matthew Howlett - Fox-Pitt Kelton

[Anyan Chrishnen] – Four Research and Management

[Don Ferot] – Deutsche Bank

Dan Martini – ECI

Operator

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

Now I will turn the meeting over to Bill Horning, Vice President of Investor Relations.

Bill Horning

Thank you, Operator. Good morning and welcome to The PMI Group’s second 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 second quarter.

Don Lofe, PMI’s Executive Vice President, Chief Financial Officer, and Chief Administrative Officer will then address the other business results for the quarter, as well as other financial capital matters. We also have with us today David Kacko, 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 net operating income, which under SEC Regulation G we are required to reconcile with 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 our 2008 Form 10-K and our most recent Form 10-Q.

Let me also direct your attention to PMI’s updated supplemental portfolio information available on our Investor Relations section of our website. Forward-looking statements are made as of today, August 7, 2009, and we undertake no obligation to update such statements except as may be required by law.

At this time I will turn the call over to PMI’s Chairman and Chief Executive Office, Steve Smith.

L. Stephen Smith

Thanks, Bill, and good morning everyone and 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 second quarter of $222.6 million or a loss of $2.71 per share. Our consolidated results for the second quarter were driven by increased loss reserves and several significant one-time charges in our business segments.

In our US mortgage insurance operations, we had operating losses primarily as a result of a $270 million net increase in our loss reserves driven by increases in our primary and modified pool default inventories and adverse loss development in our modified pool portfolio.

In our international operations segment, we had a net loss primarily as a result of a $15 million tax adjustment on cumulative foreign exchange gains on income from PMI Europe. In the corporate and other segment, we had a $39 million charge due to a narrowing of the company’s credit spreads which resulted in an increase in the fair value of certain holding company senior debt. Don will go into more detail on these matters in his section of today’s call.

Now let me highlight for you our liquidity and capital position. At June 30, 2009, we had total shareholders equity of approximately $980 million and a book value per share of $11.90. On a consolidated basis, The PMI Group had total liquidity of $3.6 billion comprised of cash and cash equivalents of $1.3 billion and total investments of $2.4 billion. In addition, we have the benefits of $898 million in [carry through] trust balances in USMI operations at a holding company as a result of the successful renegotiation of our credit facility in May, we believe we have sufficient liquidity to meet all payment obligations through the end of 2011.

Moving to PMI Mortgage Insurance Company, our primary mortgage insurance company, we ended the second quarter of 2009 with our statutory risk in force of approximately $20 billion and policy holder surplus and contingency reserves of approximately $1 billion resulting in a risk to capital ratio of 19.6:1 as of June 30, 2009.

On an excess minimum policy owner position basis, PMI Mortgage Insurance Company ended the second quarter with approximately $186 million of excess minimum policy holder position.

Now moving to our capital initiatives, as we have discussed on previous conference calls, we have and continue to seek alternatives to enhance our capital base. We continue to focus our capital efforts in four primary areas: booking high quality new business, internal capital initiatives, regulatory reform, and external capital.

Now let me take a moment to talk about one in a little more depth. First let’s talk about booking high quality new business. In the second quarter and year-to-date, our year’s mortgage insurance operations wrote new mortgage insurance policies that are high credit quality with the potential for high persistency and without any premium sessions to [carry through] trust agreements. Absent additional economic dislocations and deterioration, we project this high quality business should generate turns approximately 20%.

That said, in order to conserve capital, we did reduce our new business writings on a sequential and year-over-year basis. In the second quarter, our new business writings were $2 billion compared to $4.8 billion in the first quarter of the year and $4.5 billion one year ago. With new insurance written of $6.8 billion in the first six months, we are on track to achieve our full year new insurance written target of approximately $10 billion.

Now let’s turn to internal capital initiatives. In recent quarters we have successfully completed a number of internal projects to either free up existing capital or utilize our current capital base more efficiently. An example of this was the cancellation of certain modified pool policies we completed in the first quarter which reduced our pool risk in force by approximately $425 million.

In July we executed a similar commutation which will be reflected in our results for the third quarter. We estimate that this termination will result in a third quarter statutory capital benefit of approximately $46 million to PMI Mortgage Insurance Company. We are currently pursuing other commutations within our pool insurance portfolio. We are also continuing to examine reinsurance on our 2009 and future books of business and we will continue to explore opportunities where such reinsurance makes economic sense.

Now let’s turn to regulatory reform. As you may know, there are 16 states that have MI statutes or regulations that prescribe a maximum risk to capital ratio or a minimum policy holder position. The remaining 34 states do not have explicit minimum capital requirements. In some of the 16 states with mortgage insurance laws, the Department of Insurance of the particular state may have discretion to allow a mortgage insurance company to temporarily exceed the State’s capital requirement. We do not believe this is the case in our home state of Arizona.

MICA, our trade association, and PMI, are working to amend the statutes or regulations in those 16 states by explicitly providing the state insurance department with discretion to allow a mortgage insurance company that exceeds the capital requirement to continue to write new business. North Carolina’s risk to capital requirement, for example, was recently amended to do just that.

Legislation has been introduced in California and Arizona. In Arizona the legislature is currently in its third special session primarily to deal with difficult state fiscal issues. In this special session, the House passed legislation that would provide the Department of Insurance with discretion in the event that an MI falls below the required minimum policy holders position.

The legislation is part of a budget package now pending in the Senate. We believe the Senate may vote on this package next week. The mortgage insurance legislation has the support of Arizona Department and we’re not aware of any opposition to it in the Senate. That said, we can’t be sure that the legislation will pass or if it did how the Department of Insurance would exercise its new discretion.

Now let’s move to external capital initiatives. With regards to external capital, we continue to work with our financial advisor in evaluating the capital markets for opportunities and to ensure that we’re in a position to take advantage of market opportunities if and when they develop. To that end, we may be able to utilize an existing licensed insurance subsidiary to write new business or if there was certain states in which our main insurance subsidiary, PMI, could not continue to wrote business. Of course, any such strategy would be subject to capital, regulatory, and other considerations and approvals.

Although the capital markets remain challenging for external capital, we are encouraged that some economic commentators have indicated that the housing market is approaching bottom. In addition, we are working toward bringing capital to our industry under the financial stability plan or various other programs at the US Treasury. To that end we will continue our efforts in Washington to make policy makers aware of the vital role of private mortgage insurance and how it plays an important role in the recovery of the housing markets.

Now moving to our home ownership preservation initiative, our HPI program, I’d like to say that we implemented a variety of initiatives really beginning in late 2007 to help PMI and our servicers mitigate loss. These initiatives include direct borrow outreach, placing PMI’s on-site loss mitigation consultants at our servicer’s shops and borrower counseling. We’re experiencing significantly higher levels of modifications and repayment plans as a result of our initiatives.

In the second quarter of 2009, our HPI loss mitigation efforts enabled 5,214 borrowers to retain their homes through loan modifications and payment plans. In total, this represents a reduction of approximately $250 million of original risk to PMI which reduces our credit cost and helps us conserve our capital base. Additionally, we enabled another 1,913 borrowers to avoid foreclosure through short sales and deeds in lieu of foreclosure. We expect that these increases will continue in the quarters to come.

In addition, we’re optimistic regarding the impact of the administration’s home affordable modification program and how that will have an effect on home retention work outs, although we do not expect to see any meaningful increase in cures from this program until the fourth quarter of 2009.

Although not all borrowers would qualify, we have analyzed our delinquent loans against eligibility criteria and determined that approximately 78% of our delinquent loans would be eligible to be considered for a modification under the program. The combination of our own initiatives, the administration’s programs, and servicer specific programs we believe will lead to higher levels of modifications and modifications that result in true payment relief for borrowers and ultimately lower default rates for borrowers.

As many mortgage industry experts and analysts have reported, and as we are seeing, there was a significant amount of fraud in pool underwriting in the origination of loans, particularly during 2006 and 2007. Therefore, we are reviewing a larger volume of insured loans for misrepresentations, negligent underwriting, and coverage eligibility.

As we have seen in the past when we find such activity pursuant to our insurance terms of coverage, we rescind coverage on the loan and refund all associated premiums. As a result the number of loans in which coverage has been rescinded has increased in 2008 and 2009. The aggregate dollar amount of primary risk in force of delinquent loans rescinded in the second quarter was approximately $152 million and approximately $323 million year-to-date. We expect rescission levels to remain high throughout the remainder of 2009.

It’s also worth mentioning that occasionally our servicing customers do not or are unable to produce documents necessary to perfect a claim. Most often this is due to the inability of the servicer to provide the loan origination file for our review. If after repeated requests the loan file is not produced, the claim is denied. In the second quarter of 2009, the primary delinquent risk in force associated with such claim denials was $84 million and $103 million on a year-to-date basis. Because the claim denial is recorded as a zero dollar loss, this also influences our loss severity and claim size numbers.

Let me turn the call over to Don to cover some additional benefits of the second quarter results, additional details, as well as the other liquidity and capital matters.

Donald P. Lofe, Jr.

Thank you Steve and good morning. Let me first cover certain aspects of our business operations in the quarter and then detail for you other additional financial [inaudible] matters. First, with regard to our consolidated financial results for the quarter, let me explain the per-share impact of three distinct items we reported in our second quarter results.

As you know, our reported loss from continuing operations for the second quarter of 2009 was $2.71 of loss for basic and diluted shares. The change in fair value of our senior debt obligations resulted in an after-tax charge of $25.4 million or $0.31 per basic and diluted share. Within our international operations, and specifically PMI Europe, we had a tax adjustment of $15 million or $0.18 per basic and diluted share. This tax adjustment was driven by cumulative foreign exchange gains that were triggered by our decision to no longer permanently reinvest income from PMI Europe.

Finally, we recognized investment gains in our portfolio primarily related to sales of municipal securities which contributed $15.1 million net of tax of $0.18 per basic and diluted share to our second quarter earnings per share.

Within our US Mortgage Insurance operations, we had an operating loss of $175.8 million in the second quarter of 2009 as compared to a loss of $225.9 million in the second quarter of last year. Our second quarter results were primarily driven by lower levels of premium earnings and additions to our loss reserves.

With regard to our new insurance written, and as Steve discussed, we had another quarter of high credit quality new business writings. The characteristics of our new insurance written are highlighted in our usual quarterly financial supplements and I’d also direct your attention to our relief of our supplemental portfolio presentation posted today on the Investor Relations section of our website.

Both documents highlight that our NIW is almost entirely fixed rate and 88% of those have FICO scores greater than or equal to 700 and 71% have an LPV of 90% or below. We ended the quarter with insurance in force of $120.2 billion and risk in force of $29.4 billion, both modestly lower than the prior quarter.

In the second quarter our net incurred losses in US Mortgage Insurance operations were $477 million comprised of paid claims including loss adjustment expenses of $199 million and a net addition to our reserve for losses in LEE of approximately $277.8 million.

Our total gross reserve increase was $330.7 million as our reinsurance recoverable from captive reinsurance agreements increased by $53 million in the quarter. Of the total gross reserve increase, $215.6 million or approximately 65% of this increase was in our modified pool insurance portfolio. As we’ve shown in our portfolio supplement, our modified pool portfolio includes higher concentrations of [all day] loans and loans originated in California and Florida and this is resulting in higher default inventory and higher average claim sizes as well as claim rates.

The original risk in force of our modified pool with deductibles was approximately $1.1 billion for which we hold approximately $470 million of loss reserves at the end of the second quarter. In addition the original risk in force of our modified pool without deductibles was approximately $600 million for which we hold $94 million of reserves as of the end of the second quarter.

For our total modified pool portfolio, we added approximately $216 million in the second quarter of 2009 and approximately $341 million for the first six months of the year. We expect to increase modified pool loss reserves significantly over the next two years. However, we do not expect these future reserve additions to be at the rate of those made in the second quarter or the first six months of this year.

Loss development emerged more slowly in the modified pool portfolio than primary given that the majority of these loans were originated in 2006 and prior periods and at a lower LPV which resulted in more equity in the property. Additionally, unlike primary insurance, claims on modified pool policies are not paid until the lender forecloses or resells the property. Due to current extended marketing time, our severity on these claims and expected future claims increased significantly.

Now in terms of flow insurance, the addition to loss reserves was $115.2 million and which was primarily due to sequential increases in the default inventory from 117.5 thousand to 126.4 thousand NODs at the end of the second quarter. In spite of the absolute increase in notices and default, we have noticed a favorable mix shift in terms of geography and product type. Specifically, we’ve seen a lower proportion of new delinquencies from troubled states such as Florida and California and [inaudible].

The newer notices of default appear at this time to have a higher propensity to cure and a lower likelihood of ultimate claim. In the second quarter our reinsurance recoverables totaled $602.3 million and are supported by captive trust account balances of $898 million. Although we are not ceding new business into captive, we expect the captive trust balances to replenish in the future as a result of continued premium sessions related to existing insurance loans subject to captive.

As shown on page 38 of our supplemental portfolio presentation at the end of the second quarter, the total ever to date incurred loss benefit from captive was $648 million while the cumulative paid losses were $52.5 million. We continue to expect that the incurred loss benefits from our captive reinsurance agreement will be approximately $245 million for the full year 2009 and $130 million in 2010.

Now moving to our international operations, in the second quarter of 2009 this segment had a net loss of $13.5 million. The segment’s net loss for the second quarter was primarily due to a $15 million tax expense adjustment which I discussed earlier in my remarks. Also, as you may have seen in a rating agency presentation published last week, since we are no longer originating new business in Europe, we have requested the withdrawal of ratings from that entity from the rating agencies.

Additionally, we have requested the withdrawal of ratings from PMI Insurance Company which is primarily a reinsurance subsidiary that had been writing direct business in the State of New York since 2007. Our new business writings within the State of New York will continue uninterrupted within PMI Mortgage Insurance Company, our primary mortgage insurance company, beginning August 1. The withdrawal of ratings for both these entities will reduce costs and enable us to potentially more efficiently deploy our capital.

Now with regard to our holding company matters, The PMI Group, Inc. ended the second quarter with cash and liquidity investments of $81.9 million. As Steve mentioned in his remarks, we continue to believe that the liquidity at the holding company is sufficient to meet our payment obligations through the end of 2011.

Now let me update you on two primary facility covenants of our holding company’s amended and restated credit agreement which we successfully renegotiated in the second quarter. The two primary covenants in the facility are now an adjusted net worth covenant and the pledged note relating to our sales PMI and what we refer to as the QBE note. The minimum required adjusted net worth at June 30, 2009 was $1.2 billion. We exceeded that requirement by approximately $475 million with an adjusted net worth of $1.68 billion at June 30, 2009.

From July 1 until December 31 of this year the adjusted net worth requirement drops to $700 million and is further reduced to $500 million from January 1, 2010 through the majority of the credit facility in October of 2011. At June 30, 2009 the value of the QBE note was approximately $194 million representing the original principal balance of $187 million plus the accrual of interest since October of 2008.

Now assuming full repayment of the note, we will realize a maturity in September of 2011 of $208 million which again includes interest. As you may recall, the amount we ultimately received under the QBE note is subject to the actual and projected loss performance of PMI Australia’s policies in force as of June 30, 2008. While losses associated with these policies have increased since June 30, 2008, we do not currently expect as of June 30, 2009 the ultimate projection of losses in the portfolio will trigger a reduction in the QBE note.

The ultimate performance of this portfolio, however, will depend on a number of factors, including the performance of the Australian housing market and economy over the next several years.

Finally, I’d like to direct those who are interested in a reconciliation of our consolidated net loss to our consolidated net operating loss to review the disclosure materials posted on our website. With regard to PMI Europe, we treated our CBS mark 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 or SFSF 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 second quarter of 2009 was $216 million or $2.63 per common share.

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

L. Stephen Smith

Thanks Don. I wanted to leave you with some brief closing thoughts before we began our question and answer session. First, from a liquidity standpoint, at both our operating and holding company, we’re in a good position. Liquidity remains strong and our primary mortgage insurance company and our holding company we believe we have sufficient liquidity through the end of 2011.

From a capital position we continue to explore all opportunities that may be available. We’re executing on and investigating a number of initiatives to internally build capital and we’re actually engaged in seeking regulatory change at the state level to [inaudible] continued writings of new business and we continue to explore all external capital options.

Finally, as we discussed on today’s call, we feel strongly that the new business we are writing is a very high credit quality and should be very profitable for the company.

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 had a couple of quick questions. The first one I had for lack of a better description, is there any sort of statute of limitations so to speak on rescissions and denials for misrepresentation? If a loan performs for six months or 12 months or whatever the time frame is, does it somehow become ineligible to be reviewed for misrepresentation?

L. Stephen Smith

There isn’t technically a statute of limitations but we have normal procedures and processes that we conform to that we have consistently done over time in terms of doing that. Typically you will begin to look at early payment defaults and we typically define an early payment default as a loan that has gone delinquent within the first 13 months so that is kind of the beginning process; however, having said that, there are other considerations over time as well.

Donna Halverstadt - Goldman Sachs

The other thing I was curious about, and I only looked at your materials briefly because of other things that were going on this morning, but I had expected to see some additional disclosure on the performance of the Australian pool. I thought that was something you are considering. Did I miss it or did you decide not to give more disclosure on the performance of the pool underlying the QBE note?

Donald P. Lofe, Jr.

You are correct, we were considering and did consider in significant fashion additional disclosure. We will be filing our Q later today. However, we are going to just make the statement that I made in my remarks that we don’t expect to have any deterioration at the QBE note value and we would expect at December 2011 repayment of $208 million.

Donna Halverstadt - Goldman Sachs

I note you were very clear that you feel you have enough liquidity at the hold co to get through 2011. Would you care to give us your estimate for year end hold co cash at year end ’09 and year end 2010?

Donald P. Lofe, Jr.

To give you 2009 we would estimate approximately $67 to $70 million at 2009 and I’m not going to speak to 2010 at this time.

Donna Halverstadt - Goldman Sachs

I’m sorry, I didn’t hear what you said for ’09.

Donald P. Lofe, Jr.

$67 million to $70 million.

Operator

Your next question comes from Mike Grondahl - Northland Securities.

Mike Grondahl - Northland Securities

Your risk to capital at 19.6:1, will you guys take a guess at where you think that’s going to be at the end of next quarter or at the end of the year? You got this commutation benefit coming in 3Q so can you kind of walk us through that, and then secondly, I think you gave us this 2Q benefit of fraud rescissions of $152 million and then you talked about $84 million from missing documents I think. So do we look at the total benefit adding those or is the $84 million in that $152 million?

Donald P. Lofe, Jr.

Let me take the first part of your question regarding risk to capital and embedded in your question also is MPP. I often tell the audience that with respect to forecasting for [inaudible] metrics it’s just a very inherently difficult process and is subject to many different factors, specifically economic conditions, regulatory reform that we talked about in the remarks, and other financial efforts related to these metrics and this is very difficult to estimate that at this point in time and just the timing of these actual metrics and how these specific matters plan to that is just very uncertain. However, if we’re not able to successfully obtain either the regulatory relief or generate statutory capital benefits that we’ve spoken about in our remarks, there will be pressure in the fourth quarter with respect to risk to capital and MPP and possibly as early as the third quarter.

Mike Grondahl - Northland Securities

Don, when you say there will be pressure, do you mean you could pierce 25:1 or can you just explain that?

Donald P. Lofe, Jr.

We’re not going to comment on specific metrics. There will be pressure on those metrics relative to meeting an excess for MPP or moving above 25:1.

L. Stephen Smith

On your second question, the industry refers to investigation activity as rescissions and denials. So that’s why we broke out the two areas for clarification and transparency. The $152 million relates to rescissions and those are related to misrepresentation, negligent underwriting, non-compliance, those sorts of things, so that’s where that $152 million is a rescission number. [inaudible] it as a denial. That really will be reflected in our overall severity as well as our average claim size because that’s recorded as a zero loss. So it’s two different processes. You’ve heard others refer to it as rescission and denials and we’re trying to break both out for you.

Operator

Your next question comes from Matthew Howlett - Fox-Pitt Kelton.

Matthew Howlett - Fox-Pitt Kelton

On the reserve build in at the USMI, the $331 million, just walk me through what was due to be modified, what was due to the primary flow and bulk by category.

Donald P. Lofe, Jr.

Let me just walk you through with respect to our remarks. The total gross reserve increase is $330.7 million for the quarter. Of that increase, $215.6 million or 65% of the increase was an adjustment related to modified pool insurance portfolio and the remaining was the primary provisioning. You can see that effect on page 14 of our financial supplement and it lays that out in detail.

Matthew Howlett - Fox-Pitt Kelton

With respect to reserving versus rescissions, I know you said you expect the claim rate to go up, what are you embedding in each of those categories? Can you rescind on more bulk because it’s not GSC? Are you doing it different for each category? What are you baking in in terms of rescissions based on what you did in reserves this quarter? Or are you not taking any of it until you actually receive it, look at the file?

L. Stephen Smith

You mentioned a process problem there. We don’t differentiate in terms of bulk or flow in terms of our rescission process. What we have to match it to his our contract and what writes we have and then whether or not there has been misrepresentation or non-compliance or negligent underwriting related to the file so the processes are consistent with the contracts so let me start with that part and Don do you want to address the other question?

Donald P. Lofe, Jr.

We’ve taken into consideration the aspects that you raised in your question. We’re not going to disclose the big amount other than what we’ve done in our remarks but the aspect which again you indicated in your question, do we take into consideration both on a monthly and a basis.

Matthew Howlett - Fox-Pitt Kelton

On the modified pool, how much of that is GSC percentage wise versus non-GSC?

Donald P. Lofe, Jr.

Virtually all of it.

Matthew Howlett - Fox-Pitt Kelton

Then the last question on, there’s been some news articles about potentially sort of a good bank, bad bank for the GSCs and privatization of the guarantees, I know it’s early, there’s a lot of things going on with how those two entities are going to shake out, how do you look at it versus your business if the guaranty business is profitized and there is no charter that requires, how do you look at that impacting the industry overall?

L. Stephen Smith

I think at this point it would be highly speculative to really address that question. I know it’s been in the press in recent days and there’s been some conflicting signals on that issue in the press in recent days. I think the administration has indicated they’ll come out with something in February of next year. There are a lot of [inaudible] working on that. It would really be very premature to comment on that.

Matthew Howlett - Fox-Pitt Kelton

Can you update us anything more on potentially getting access to TARP? I know you said that the MICA continues to lobby for it. Is there anything that’s changed over the last few months that would give you an indication that you could gain access to that?

L. Stephen Smith

I can’t really address any changes. MICA as well as the industry continues to represent our value proposition in DC and we’ll just have to wait and see.

Operator

Your next question comes from Mike Grondahl - Northland Securities.

Mike Grondahl - Northland Securities

I think you were saying that you’re starting to see a favorable mix of new delinquencies coming in. Can you just expand on that a little bit and can you talk about the volume of new delinquents coming in. Was it down sequentially from 1Q or what’s that volume doing?

L. Stephen Smith

I heard the first part of your question but you’re a little far away from the microphone. I didn’t hear the second part of your question.

Mike Grondahl - Northland Securities

The second part of the question just had to do with volume. From 1Q to 2Q, was there any sequential decrease or slowdown in volume and just expand on the favorable mix shift if you would.

L. Stephen Smith

Why don’t I start and David and Don, I’ll turn it over to you. When we refer to a favorable mix on the NODs, what we’re specifically referring to is less California, less Florida, and less [all state] mix from new NODs. So that is favorable. In terms of the NOD receipt, there was a sequential decline in the second quarter versus the first quarter.

Mike Grondahl - Northland Securities

Was it significant?

Donald P. Lofe, Jr.

It had a significant effect, just leave it at that.

Operator

Your next question comes from [Anyan Chrishnen] – Four Research and Management.

[Anyan Chrishnen] – Four Research and Management

First, I wanted to understand the [inaudible] modifications is having in terms of paid losses and also from a go-forward basis, how much of a factor, is there any way you can quantify [inaudible]?

L. Stephen Smith

We mentioned in our comments that we had a little over 5200 loans that were modified in the second quarter or put on payment plans. We did say that was a significant increase, first as prior periods, and we mentioned some of the things that we are doing relative to modification plans in terms of borrower outreach, borrower counseling, as well as having our own consultants and lender shops working on those programs in their shops which we all think will be beneficial. We do think those activities will continue to increase and will continue to deliver a benefit. We also mentioned the home affordable mortgage plan which is a modification plan rather which is now gaining momentum in the marketplace but we don’t expect to see significant cures for that program coming until the fourth quarter because I think you know those loans are subject to a 90 day trial period so although we expect future benefits, we’re actually only observing the actual results from what we have done and what we see.

[Anyan Chrishnen] – Four Research and Management

I noticed in the USMI side the average primary claim size declined sequentially and year-over-year as well. So just wanted to see how to think about that.

L. Stephen Smith

That was really related to what I was referring to earlier in the conversation relative to denials which do affect the severity and the average claims size because that’s recorded as a zero loss. So that will affect those two numbers.

[Anyan Chrishnen] – Four Research and Management

The impact of new players entering the space, what does that mean for you guys?

David Kacko

At this time that player that you’re referring to has not been approved by Fannie and Freddie to insure so we’ll have to see how that plays out. I think you do have to take some encouragement from the fact that private capital at least in this one particular case is willing to enter the space so relative to a question we got a little bit earlier, I actually view this as positive and we’ll have to see when they get their approval.

Operator

Your next question comes from Donna Halverstadt - Goldman Sachs.

Donna Halverstadt - Goldman Sachs

I just had one other question I wanted to ask. As you go through the process of rescinding or denying, are you running into any sort of pushback and if the answer is no, do you expect pushback in the future as the amount of rescissions and denials increases?

L. Stephen Smith

When we go through the process we always have insured responses, it’s an interactive process with the lender and we have had that and we expect that to continue. In terms of what happens after the disclosure files, normally there’s agreement in terms of what we’ve done.

Operator

Your next question comes from [Don Ferot] – Deutsche Bank.

[Don Ferot] – Deutsche Bank

Have you guys had any issues with lenders trying to push back on rescissions up to this point?

L. Stephen Smith

Again, in terms of insured responses to the rescission activity, it really is an interactive process with lenders and we have had normally the agreement rate has been quite high with the lenders once we’ve completed that process.

[Don Ferot] – Deutsche Bank

Has the process itself, how long are you guys seeing that take?

L. Stephen Smith

In terms of the investigation process?

Donald P. Lofe, Jr.

I guess from claim determination to investigation to rescission.

David Kacko

That process can actually be quite lengthy, anywhere from 12 to 18 months.

[Don Ferot] – Deutsche Bank

Okay. And do you think from a market share perspective going forward obviously it sounds like all the MIs are pushing back a lot or have significant rescissions, do you think that’s going to impact market share across the space or for you guys specifically?

David Kacko

I really can’t comment on how it could affect our competitors. I can tell you from the standpoint of PMI there’s a word that we use internally and I think we’ve discussed externally which is our processes are very consistent. This is not a new phenomenon. I think what has shown more light on it is just the sheer volume alone that were originated during the periods that we’ve discussed and as Steve talked about in his remarks, unfortunately, a high preponderance of fraud. Honestly I just can’t speculate whether or not it could affect our market share. That’s really not hwy we do it. We don’t make a decision to investigate because of market share implications. It’s a totally distinct process.

L. Stephen Smith

I guess the only thing I would add to that is our customers are well aware of our contracts and policy terms.

Operator

Your next question comes from Dan Martini - ECI.

Dan Martini – ECI

I just had a question for you, two questions, first of all, your rescission trends Q1 to Q2, you appear to be the only company with a down trend Q1 to Q2. In fact, some of your peers are reporting meaningful spikes in that number. I was wondering for trend purposes if you might give us Q3 and Q4 ’08 numbers and we can have a better handle on how that has developed since late ’08 and secondly, as I just look at a few conservative metrics, it appears that the whole industry reserved based on risk pretty much on the same lines and as I look at your numbers relative to some of your peers, it appears that your reserves have meaningfully begun to outpace what your peers are discounting as they look into the future. I’d love your comments on that and I’d love to know if there’s anything specific about either your contracts or your book of business that you think would justify what looks to me to be almost 300 basis points of excess risk reserved relative to some of your peers as of Q2.

L. Stephen Smith

Let me start with the first then I’ll turn your third question over to Don. In terms of we’re not forecasting rescission activity, so I can’t give you forecast for third and fourth quarter, but I think if you’ll look at the supplements you’ll find that the actual claims paid was actually lower in the second quarter versus the first quarter so to some extent the rescission activity does follow the level of actual claims payment, although I’ll have to mention here not entirely. But that is part of the reason that number was down. In addition as you know, there are a variety of moratoriums relative to foreclosure etc. that effect those numbers.

Dan Martini – ECI

So am I hearing you correctly, that when you continue to provision, you’re not assuming rescissions are important, you said earlier you are assuming continued growth and rescissions throughout 2009. Do your reserve additions reflect that?

Donald P. Lofe, Jr.

Yes, they do take into consideration as we build the provisioning for both primary and modified pool which I’ll come back to. They consider the rescission aspects that you were just discussing. With respect to the second part of your question, there’s two parts as I had in my remarks and as we’ve spoken about on the call here. The situation with respect to the modified pool insurance portfolio is really driving the material portion of our total grosses of increase for the quarter. Again, just to come back to those numbers, it was approximately $331 million. Of that, $215.16 million is modified pool. If you look at the primary [tease] that was approximately $115 million so numerically, and I’m picking up exactly what you said, we do understand how you could get there with respect to that, so again, I want to focus you on those two components at the reserve.

Operator

At this time there are no further questions and I will now turn the call back to Mr. Horning for closing remarks.

Bill Horning

Thank you Operator. This concludes the question and answer portion of our conference call. Thank you for joining us on today’s call and as always, thanks for your ownership and interest in The PMI Group.

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Source: The PMI Group, Inc. Q2 2009 Earnings Call Transcript
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