Will the U.S. Mortgage Market Keep PMI Group Down?

On Thursday, PMI Group, Inc. (PMI) announced that they are selling their Australian mortgage insurance subsidiary to QBE Insurance Group [QBE] for approximately $920 million. Steve Smith, Chairman & CEO, stated,

PMI Australia’s customers will benefit from the financial strength, expertise, and operational excellence of QBE, and PMI Australia’s employees will gain the scale and resources QBE will bring them to expand and grow their business in Australia.

Ok, it does make sense for a U.S.-based company with an Australian subsidiary to sell to an Australian-based company, but it’s important to know why they are selling and if the sale would benefit PMI.

The deal is being structured as 80% cash at closing and 20% in an interest-bearing note issued by QBE. According to PMI’s press release:

The promissory note matures and is payable in September 2011, and the actual amount payable on the note could be reduced to the extent that the performance of PMI Australia's existing insurance portfolio as of June 30, 2008 does not achieve specified targets.

Although this amount is variable depending on the loan loss ratio over a three year period, currently PMI stands to make approximately $200 million.

In addition, PMI will fund $46.5 million in premiums to cover reinsurance losses for PMI Australia. And not only that, they’ve agreed to sell PMI Asia, based in Hong Kong, with net tangible assets amounting to $55 million. Although there is no solid deal yet, this capital will be used to help shore up the balance sheet, according to management.

However, let’s not forget that PMI came out on May 12 to affirm its guidance on paid claims, which came out to be between $825 million - $975 million. That’s a lot of money. They also reported a Q2 loss of $246.3 million, $3.03 per share. $225.9 million of the total net loss figure amounted to increases in paid claims and loss adjustment expenses (LAEs) in addition to adding to the reserve for U.S. Mortgage Insurance Operations.

More updates (according to Q2 results):

• PMI Canada will cease operations and expects to transfer approximately $60 million in capital to the struggling U.S. Mortgage Insurance Operations.
• PMI Guaranty Co. paid approximately $144 million to PMI. PMI expects to reinvest 80% of its capital into U.S. Mortgage Insurance Operations.
• Reserves for losses and LAE (loss adjustment expenses) for U.S. Mortgage Insurance Operations totaled $2.1 billion by June 30, 2008. Since there is usually a one year lag time, expect payouts in claims to begin in 2009.
• Payout claims increased from $72.3 million in Q2 2007 to $192.7 million for the Q2 2008.
• PMI Australia, PMI Europe, and PMI Asia have all recorded a net profit ($24 million, $5.8 million, and $2.5 million, respectively).

It’s pretty clear: As long as the housing, mortgage, and credit markets continue to deteriorate in the U.S., PMI will continue to struggle directly from high payouts resulting from the high level of mortgage defaults and wave of foreclosures.

However, combining the favorable terms of sale (pending successful closings) and with $2.1 billion already in loss reserves, PMI will be in a much greater capital position going forward into 2009. Management has taken a proactive step toward eliminating risks related to Australia’s deteriorating mortgage market. They show that they are flexible enough to sell off or close down even profitable international subsidiaries to focus on domestic operations and to provide much needed liquidity to stabilize PMI’s capital position during this difficult time.

How difficult? The stock nearly lost over 95% of its value throughout the past 12 months before participating in the S&P financials rally. On Thursday, PMI gapped up and closed 49.46% higher on 18.64 million shares traded, or 6x the daily average volume. The announcement also helped lift PMI’s peers: MGIC Investment Corp. (MTG) surged 9.7% to $7.80, Radian Group, Inc. (RDN) lifted 13.4% to $3.65, LandAmerica Financial Group (LFG) climbed to 14.4% to $15.81, Ambac Financial Group, Inc. (ABK) jumped 15.7% to $4.56, and MBIA, Inc. (MBI) spiked 17.9% to $10.32.

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Full Disclosure: The author does not hold any positions in PMI, MTG, RDN, LFG, ABK, or MBI

 

Comments

[lucky lenny:]

Mr. Lee,

- PMI's in better shape than most people realize. At the current time, despite the worst of times, PMI is indeed cash flow positive. Per the press release, paid claims w/ at most be $975 bill for 2008. Per 1Q08 earnings release, annual revenues in 2008 will be approx $1.3 bill. Even throwing in some overhead, PMI is cash flow postive. Revenues come from very reliable sources; such as grade A bonds & in-force premiums. PMI closed at $4.27; just a fraction of its $20 or so book value.

2008 Aug 17 08:49 AM

[rm:]

They're also carefully monitoring the servicers, which should help to curb unnecessary losses.

2008 Aug 17 04:30 PM

[Ishortyou:]

the mortgage industry is still profitable despite the defaults from John Does working at the C-store, and this is been realized as the smoke clears up in the finantial sector.

2008 Aug 17 11:22 PM

[John C. Lee:]

profitable depending on what their loan portfolios look like and they can clear non-performing assets

2008 Aug 20 08:40 PM

[BHMTom:]

John, anyone, help me understand. Is this PMI the same PMI, Principal morgage insurance, an individual would have been required to pay if they did not put down the 20% down payment on a home purchase?
I've always wondered where the PMI payments went, and wouldn't it insulate Morgage companies from losing out on a foreclosure.
If This PMI company is the ultimate one holding the bag for bad loans, why all the crisis talk.
You can not get a loan TODAY! and expect to get a 90,95, 100% morgage. PMI will not be getting any new customers since that segment of the population will no longer be able to purchase a home beyond thier means. A flush out and death of PMI group?
Looking for clairity
tcd60 at yahoo
Thanks!

Feb 19 01:58 AM