PMI Group 10-Q 2007
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10 - Q
For the quarterly period ended June 30, 2007
For the transition period from to
Commission file number 1-13664
THE PMI GROUP, INC.
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and larger accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨
Indicate by check mark whether the registration is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
TABLE OF CONTENTS
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes to consolidated financial statements.
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of The PMI Group, Inc. (The PMI Group or TPG), a Delaware corporation and its direct and indirect wholly-owned subsidiaries, including: PMI Mortgage Insurance Co., an Arizona corporation, and its affiliated U.S. mortgage insurance and reinsurance companies (collectively PMI); PMI Mortgage Insurance Ltd and its holding company, PMI Mortgage Insurance Australia (Holdings) Pty Limited (collectively PMI Australia); PMI Mortgage Insurance Company Limited and its holding company, PMI Europe Holdings Limited, the Irish insurance companies (collectively PMI Europe); PMI Mortgage Insurance Asia Ltd. (PMI Asia); PMI Mortgage Insurance Company Canada and its holding company, PMI Mortgage Insurance Holdings Canada Inc. (collectively PMI Canada); PMI Guaranty Co. (PMI Guaranty); and other insurance, reinsurance and non-insurance subsidiaries. The PMI Group and its subsidiaries are collectively referred to as the Company. All material inter-company transactions and balances have been eliminated in the consolidated financial statements.
The Company has a 42.0% equity ownership interest in FGIC Corporation, the holding company of Financial Guaranty Insurance Company (collectively FGIC), a New York-domiciled financial guaranty insurance company. The Company also has equity ownership interests in CMG Mortgage Insurance Company, CMG Mortgage Reinsurance Company and CMG Mortgage Assurance Company (collectively CMG MI), which conduct residential mortgage insurance business for credit unions. The Company also has equity ownership interests in RAM Holdings Ltd., the holding company of RAM Reinsurance Company, Ltd. (collectively RAM Re), a financial guaranty reinsurance company based in Bermuda. The Company also has ownership interests in several limited partnerships. In addition, the Company owns 100% of PMI Capital I (Issuer Trust), an unconsolidated wholly-owned trust that privately issued debt in 1997.
On October 4, 2005, the Company sold to Credit Suisse First Boston (USA), Inc. (CSFB) its equity ownership interest in SPS Holding Corp. (SPS). The Company has received cash payments of approximately $3.4 million during the first half of 2007 from the residual interest in SPS mortgage servicing assets. As of June 30, 2007, there was no remaining carrying value of this residual interest.
The Companys unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) and disclosure requirements for interim financial information and the requirements of Form 10-Q and Articles 7 and 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete consolidated financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments considered necessary for a fair presentation, have been included. Interim results for the three months and six months ended June 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007. The consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in The PMI Groups annual report on Form 10-K for the year ended December 31, 2006.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair presentation for the periods presented, have been included.
Significant accounting policies are as follows:
Investments The Company has designated its entire portfolio of fixed income and equity securities as available-for-sale. These securities are recorded at fair value based on quoted market prices with
unrealized gains and losses, net of deferred income taxes, accounted for as a component of accumulated other comprehensive income in shareholders equity. The Company evaluates its investments regularly to determine whether there are declines in value and whether such declines meet the definition of other-than-temporary impairment in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities and Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) No. 59, Accounting for Noncurrent Marketable Equity Securities. The fair value of a security below cost or amortized cost for consecutive quarters is a potential indicator of an other-than-temporary impairment. When the Company determines a security has suffered an other-than-temporary impairment, the impairment loss is recognized, to the extent of the decline, as a realized investment loss in the current periods net income.
The Companys short-term investments have maturities of greater than three and less than 12 months when purchased and are carried at fair value. Realized gains and losses on sales of investments are determined on a specific-identification basis. Investment income consists primarily of interest and dividends. Interest income and preferred stock dividends are recognized on an accrual basis. Dividend income on common stocks is recognized on the date of declaration. Net investment income represents interest and dividend income, net of investment expenses.
Cash and Cash Equivalents The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.
Investments in Unconsolidated Subsidiaries Investments in the Companys unconsolidated subsidiaries include both equity investees and other unconsolidated subsidiaries. Investments in equity investees with ownership interests of 20-50% are generally accounted for using the equity method of accounting, and investments of less than 20% ownership interest are generally accounted for using the cost method of accounting if the Company does not have significant influence over the entity. Limited partnerships with ownership interests greater than 3% but less than 50% are primarily accounted for using the equity method of accounting. The Company reports the equity in earnings from FGIC and CMG MI on a current month basis, and RAM Re and the Companys interest in limited partnerships on a one-quarter lag basis. The carrying value of the investments in the Companys unconsolidated subsidiaries also includes the Companys share of net unrealized gains and losses in the unconsolidated subsidiaries investment portfolios.
Periodically, or as events dictate, the Company evaluates potential impairment of its investments in unconsolidated subsidiaries. Accounting Principles Board (APB) Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock, (APB No. 18), provides criteria for determining potential impairment. In the event a loss in value of an investment is determined to be an other-than-temporary decline, an impairment charge would be recognized in the consolidated statement of operations. Evidence of a loss in value that could indicate impairment might include, but would not necessarily be limited to, the absence of an ability to recover the carrying amount of the investment or the inability of the investee to sustain an earnings capacity which would justify the carrying amount of the investment. Realized capital gains or losses resulting from the sale of the Companys ownership interests of unconsolidated subsidiaries are recognized as net realized investment gains or losses in the consolidated statement of operations.
The SEC requires public companies to disclose condensed financial statement information for significant equity investees and unconsolidated majority owned subsidiaries, individually or in the aggregate, if (i) the Companys investments in and advances to the subsidiaries are in excess of 10% of the total consolidated assets of the Company, (ii) the Companys proportionate share of unconsolidated majority-owned subsidiaries total assets is in excess of 10% of total consolidated assets of the Company, or (iii) equity in income from continuing operations before income taxes, extraordinary items and the cumulative effect of a change in accounting principle of the unconsolidated subsidiaries is in excess of 10% of such income of the Company. Furthermore, if certain of the above tests exceed 20% with respect to any unconsolidated subsidiary, summarized financial statement information of that unconsolidated subsidiary is required to be included in the registrants interim SEC filings. As of June 30, 2007, the Companys equity in income before taxes as described in item (iii) above of FGIC exceeded 20% of such income of the Company, and accordingly, summarized financial statement information of FGIC is included in Note 5, Investments in Unconsolidated Subsidiaries. The Company has determined that its other equity investees do not meet any of the tests outlined above on a stand-alone or aggregate basis.
Related Party Receivables As of June 30, 2007 and December 31, 2006, related party receivables were $1.4 million and $0.7 million, respectively, which were comprised of non-trade receivables from unconsolidated subsidiaries.
Deferred Policy Acquisition Costs The Company defers certain costs in its mortgage insurance operations relating to the acquisition of new insurance and amortizes these costs against related premium revenue in order to match costs and revenues. To the extent the Company is compensated by customers for contract underwriting, those underwriting costs are not deferred. Costs related to the acquisition of mortgage insurance business are initially deferred and reported as deferred policy acquisition costs. SFAS No. 60, Accounting and Reporting by Insurance Enterprises, (SFAS No. 60), specifically excludes mortgage guaranty insurance from its guidance relating to the amortization of deferred policy acquisition costs. Consistent with industry accounting practice, amortization of these costs for each underwriting year book of business is charged against revenue in proportion to estimated gross profits. Estimated gross profits are composed of earned premiums, interest income, losses and loss adjustment expenses as well as the amortization of deferred policy acquisition costs. The rate of amortization is not adjusted for monthly and annual policy cancellations unless it is determined that the policy cancellations are of such magnitude that impairment of the deferred costs is probable. The deferred costs related to single premium policies are adjusted as appropriate for policy cancellations to be consistent with the Companys revenue recognition policy. The amortization estimates for each underwriting year are monitored regularly to reflect actual experience and any changes to persistency or loss development.
Property, Equipment and Software Property and equipment, including software, are carried at cost and are depreciated using the straight-line method over the estimated useful lives of the assets, ranging from three to thirty nine years. Leasehold improvements are recorded at cost and amortized over the lesser of the useful life of the assets or the remaining term of the related lease. The Companys accumulated depreciation and amortization was $173.4 million and $156.9 million as of June 30, 2007 and December 31, 2006, respectively.
Under the provisions of Statement of Position (SOP) No. 98-1, Accounting for the Cost of Computer Software Developed or Obtained for Internal Use, the Company capitalizes costs incurred during the application development stage related to software developed for internal use purposes and for which it has no substantive plan to market externally. Capitalized costs are amortized at such time as the software is ready for its intended use on a straight-line basis over the estimated useful life of the asset, which is generally three to seven years. The Company capitalized costs associated with software developed for internal use of $8.7 million for both the six months ended June 30, 2007 and 2006.
Derivatives The Company enters into credit default swap contracts and purchases certain foreign currency put options, both of which are considered derivatives under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS No. 133). The Company has not designated either the credit default swaps or foreign currency put options as SFAS No. 133 hedges. Accordingly, both categories of derivatives are determined to be free standing, with changes in fair values recognized in the current periods consolidated results of operations.
SFAS No. 149, Amendment of SFAS No. 133 on Derivative Instruments and Hedging Activities (SFAS No. 149) requires certain credit default swaps similar to those entered into by PMI Europe after July 1, 2003 to be accounted for as derivatives and reported on the consolidated balance sheet at fair value, and subsequent changes in fair value are recorded in consolidated net income. In addition, as required by EITF Issue No. 02-3, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities (EITF No. 02-3), for certain credit default swaps entered into by PMI Europe where the fair value cannot be determined by reference to quoted market prices, current market transactions for similar contracts, or based on a valuation technique incorporating observable market data or inputs, initial fair values related to the credit default swaps are deferred and recognized in consolidated net income in proportion to the expiration of the associated insured risk. Gains or losses are recognized in consolidated net income at inception for all other derivative contracts where the fair value can be readily determined from market sources.
In 2007, the Company purchased foreign currency put options to partially mitigate the negative financial impact of a potential strengthening U.S. dollar relative to both the Australian dollar and the Euro. These Australian dollar and Euro put options expire ratably over the calendar year and had combined costs of $1.3 million. In 2007, the Company recorded a realized loss of $1.3 million (pre-tax) in other income related to amortization of option costs and mark-to-market adjustments.
Special Purpose Entities Certain insurance transactions entered into by PMI and PMI Europe require the use of foreign special purpose wholly-owned subsidiaries principally for regulatory purposes. These special purpose entities are consolidated in the Companys consolidated financial statements.
Reserve for Losses and Loss Adjustment Expenses The consolidated reserve for losses and loss adjustment expenses (LAE) for our U.S. Mortgage Insurance and International Operations are the estimated claim settlement costs on notices of default that have been received by the Company, as well as loan defaults that have been incurred but have not been reported by the lenders. For reporting and internal tracking purposes, the Company does not consider a loan to be in default until it has been delinquent for two consecutive monthly payments. The Companys U.S. mortgage insurance primary master policy defines default as the borrowers failure to pay when due an amount equal to the scheduled monthly mortgage payment under the terms of the mortgage. Generally, however, the master policy requires an insured to notify PMI of a default no later than the last business day of the month following the month in which the borrower becomes three monthly payments in default. SFAS No. 60 specifically excludes mortgage guaranty insurance from its guidance relating to reserves for losses and LAE. Consistent with industry accounting practices, the Company considers its mortgage insurance policies as short-duration contracts and, accordingly, does not establish loss reserves for future claims on insured loans that are not currently in default. The Company establishes loss reserves on a case-by-case basis when insured loans are identified as currently in default using estimated claim rates and average claim amounts for each report year, net of salvage recoverable. The Company also establishes loss reserves for defaults that it believes have been incurred but not yet reported to the Company prior to the close of an accounting period using estimated claim rates and claim amounts applied to the estimated number of defaults not reported. The reserve levels as of the consolidated balance sheet date represent managements best estimate of existing losses and LAE incurred. The estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known to the Company. Such adjustments, to the extent of increasing or decreasing loss reserves, are recognized in the current periods consolidated results of operations.
Reinsurance The Company uses reinsurance to reduce net risk in force, optimize capital allocation and comply with a statutory provision adopted by several states that limits the maximum mortgage insurance coverage to 25% for any single risk. The Companys reinsurance agreements typically provide for a recovery of a proportionate level of claim expenses from reinsurers, and a reinsurance recoverable is recorded as an asset. The Company remains liable to its policyholders if the reinsurers are unable to satisfy their obligations under the agreements. Reinsurance recoverables on loss estimates are based on the Companys actuarial analysis of the applicable business. Amounts the Company will ultimately recover could differ materially from amounts recorded as reinsurance recoverables. Reinsurance transactions are recorded in accordance with the accounting guidance provided in SFAS No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts. Accordingly, management assesses, among other factors, risk transfer criteria for all reinsurance arrangements.
Revenue Recognition Mortgage guaranty insurance policies are contracts that are generally non-cancelable by the insurer, are renewable at a fixed price, and provide payment of premiums on a monthly, annual or single basis. Upon renewal, the Company is not able to re-underwrite or re-price its policies. SFAS No. 60 specifically excludes mortgage guaranty insurance from its guidance relating to the earning of insurance premiums. Premiums written on a monthly basis are earned as coverage is provided. Monthly premiums accounted for 65.7% and 66.2% of gross premiums written from the Companys mortgage insurance operations in the three and six months ended June 30, 2007, respectively, and 72.3% and 70.9% in the three and six months ended June 30, 2006, respectively. Premiums written on an annual basis are amortized on a monthly pro rata basis over the year of coverage. Primary mortgage insurance premiums written on policies covering more than one year are referred to as single premiums. A portion of the revenue from single premiums is recognized in premiums earned in the current period, and the remaining portion is deferred as unearned premiums and earned over the expected life of the policy, a range of seven to fifteen
years. If single premium policies related to insured loans are cancelled due to repayment by the borrower, and the premium is non-refundable, then the remaining unearned premium related to each cancelled policy is recognized as earned premiums upon notification of the cancellation. Unearned premiums represent the portion of premiums written that is applicable to the estimated unexpired risk of insured loans. Rates used to determine the earning of single premiums are estimates based on actuarial analysis of the expiration of risk. The premiums earnings pattern calculation methodology is an estimation process and, accordingly, the Company reviews its premium earnings cycle for each policy acquisition year (Book Year) annually and any adjustments to these estimates are reflected for each Book Year as appropriate.
Income Taxes The Company accounts for income taxes using the liability method in accordance with SFAS No. 109, Accounting for Income Taxes. The liability method measures the expected future tax effects of temporary differences at the enacted tax rates applicable for the period in which the deferred asset or liability is expected to be realized or settled. Temporary differences are differences between the tax basis of an asset or liability and its reported amount in the consolidated financial statements that will result in future increases or decreases in taxes owed on a cash basis compared to amounts already recognized as tax expense in the consolidated statement of operations. The Companys effective tax rates were 19.4% and 22.0% for the three and six months ended June 30, 2007, respectively, compared to the federal statutory rate of 35.0% due to equity in earnings from FGIC and income derived from certain international operations, which have lower effective tax rates, combined with the Companys municipal bond investment income. The Company records a federal tax expense relating to its proportionate share of net income available to FGICs common shareholders at a rate of 7% based on its assessment that it will ultimately receive those earnings in the form of dividends from FGIC.
As of January 1, 2007, the Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes An Interpretation of FASB Statement No. 109 (FIN 48). See Note 11, Income Taxes, for further discussion.
Benefit Plans The Company provides pension benefits to all eligible U.S. employees under The PMI Group, Inc. Retirement Plan (the Retirement Plan), and to certain employees of the Company under The PMI Group, Inc. Supplemental Employee Retirement Plan. In addition, the Company provides certain health care and life insurance benefits for retired employees under another post-employment benefit plan. On December 31, 2006, the Company adopted the recognition and disclosure provisions of SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R) (SFAS No. 158). SFAS No. 158 requires the Company to recognize the funded status (i.e., the difference between the fair value of plan assets and the projected benefit obligations) of its defined benefit postretirement plans, with a corresponding adjustment to accumulated other comprehensive income.
On May 17, 2007, The PMI Groups Board of Directors approved an amendment to the Retirement Plan. The amendment will change the Plans benefit formula from a final pay pension formula to a cash balance formula. The amendment will take effect immediately for employees hired or rehired on or after September 1, 2007. For employees hired before and continuously employed on September 1, 2007, the amendment will take effect on January 1, 2011. Under the new cash balance plan formula, the Company will contribute 8% of qualified employees compensation to cash balance accounts and credit interest at a rate equal to the 30-year Treasury Bond rate.
All U.S. full-time, part-time and certain temporary employees of the Company are eligible to participate in The PMI Group, Inc. Savings and Profit-Sharing Plan (401(k) Plan). Eligible employees who participate in the 401(k) Plan may receive, within certain limits, matching Company contributions. Contract underwriters are covered under The PMI Group, Inc. Alternate 401(k) Plan, under which there are no matching Company contributions. In addition to the 401(k) Plan, the Company has an officers deferred compensation plan (ODCP) available to certain employees, and an Employee Stock Purchase Plan (ESPP). The ODCP is available to certain of the Companys officers, and permits each participant to elect to defer receipt of part or all of his or her eligible compensation on a pre-tax basis. Under the ODCP, the Company makes a matching contribution of its common shares for each participant equal to 25% of the initial contribution to the extent the participant selects the Companys common shares from the investment choices available under the ODCP. These matching contributions are subject to a three year vesting period. The ESPP allows eligible employees to purchase shares of the Companys stock at a 15% discount to fair
market value as determined by the plan. The ESPP offers participants the 15% discount to current fair market value or fair market value with a look-back provision of the lesser of the duration an employee has participated in the ESPP or two years.
Foreign Currency Translation The financial statements of the Companys foreign subsidiaries have been translated into U.S. dollars in accordance with SFAS No. 52, Foreign Currency Translation. Assets and liabilities denominated in non-U.S. dollar functional currencies are translated using the period-end spot exchange rates. Revenues and expenses are translated at monthly-average exchange rates. The effects of translating operations with a functional currency other than the reporting currency are reported as a component of accumulated other comprehensive income included in total shareholders equity. Gains and losses on foreign currency re-measurement incurred by PMI Australia, PMI Europe, PMI Asia and PMI Canada represent the revaluation of assets and liabilities denominated in non-functional currencies into the functional currency, the Australian dollar, the Euro, the Hong Kong dollar and the Canadian dollar, respectively.
Comprehensive Income Comprehensive income includes net income, the change in foreign currency translation gains or losses, changes in unrealized gains and losses on investments and from derivatives designated as cash flow hedges, and reclassification of realized gains and losses previously reported in comprehensive income, net of related tax effects.
Business Segments The Companys reportable operating segments are U.S. Mortgage Insurance Operations, International Operations, Financial Guaranty, and Corporate and Other. U.S. Mortgage Insurance Operations includes the results of operations of PMI Mortgage Insurance Co., affiliated U.S. reinsurance companies and the equity in earnings from CMG MI. International Operations includes the results of operations of PMI Australia, PMI Europe, PMI Asia, and PMI Canada. Financial Guaranty includes the equity in earnings from FGIC and RAM Re, and the financial results of PMI Guaranty. The Companys Corporate and Other segment consists of our holding company and contract underwriting operations.
Earnings Per Share Basic earnings per share (EPS) excludes dilution and is based on consolidated net income available to common shareholders and the actual weighted-average of the common shares that are outstanding during the period. Diluted EPS is based on consolidated net income available to common shareholders, which includes consideration of share-based compensation required by SFAS No. 123 (revised 2004), Share-Based Payment (SFAS No. 123R), adjusted for the effects of dilutive securities and the weighted-average of dilutive common shares outstanding during the period. The weighted-average dilutive common shares reflect the potential increase of common shares if contracts to issue common shares, including stock options issued by the Company that have a dilutive impact, were exercised, or if outstanding securities were converted into common shares.
The following is a reconciliation of consolidated net income to net income for purposes of calculating diluted EPS for the periods set forth below:
The following is a reconciliation of the weighted-average common shares used to calculate basic EPS to the weighted-average common shares used to calculate diluted EPS for the periods set forth below:
Share-Based Compensation The Company applies SFAS No. 123R for share-based payment transactions. SFAS No. 123R requires that such transactions be accounted for using a fair value-based method and recognized as expense in the consolidated results of operations. For share-based payments granted and unvested upon the adoption of SFAS No. 123R, the Company recognizes the fair value of share-based payments, including employee stock options and employee stock purchase plan shares, granted to employees as compensation expense in the consolidated results of operations.
Reclassifications Certain items in the prior corresponding periods consolidated financial statements have been reclassified to conform to the current periods consolidated financial statement presentation.
NOTE 3. NEW ACCOUNTING STANDARDS
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an Amendment of FASB Statement No. 115 (SFAS No. 159). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 does not eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in FASB Statements No. 157, Fair Value Measurements (SFAS No. 157), and No. 107, Disclosures about Fair Value of Financial Instruments. SFAS No. 159 is effective as of the beginning of an entitys first fiscal year that begins after November 15, 2007. The Company is still evaluating the impact of SFAS No. 159 on its consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, which defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements but does not expand the use of fair value in any new circumstances. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is still evaluating the impact of SFAS No. 157 on its consolidated financial statements.
NOTE 4. INVESTMENTS
Fair Values and Gross Unrealized Gains and Losses on InvestmentsThe cost or amortized cost, estimated fair value and gross unrealized gains and losses on investments are shown in the tables below:
Net Investment Income Net investment income consists of the following for the three and six months ended:
Aging of Unrealized Losses The following table shows the gross unrealized losses and fair value of the Companys investments, aggregated by investment category and the length of time the individual securities have been in a continuous unrealized loss position as of June 30, 2007.
Unrealized losses on fixed income securities were primarily due to an increase in interest rates in 2007 and are not considered to be other-than-temporarily impaired as we have the intent and ability to hold such investments until they recover in value or mature. We determined that the decline in the market value of certain investments met the definition of other-than-temporary impairment and recognized realized losses of $1.3 million and $0.2 million in the first half of 2007 and 2006, respectively.
NOTE 5. INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES
Investments in the Companys unconsolidated subsidiaries include both equity investees and other unconsolidated subsidiaries. The carrying values of the Companys investments in unconsolidated subsidiaries consisted of the following as of June 30, 2007 and December 31, 2006:
As of June 30, 2007, the carrying value of the Companys investment in FGIC was $896.7 million, which included $617.0 million of cash and capitalized acquisition costs, with the balance representing equity in earnings and the Companys proportionate share of FGICs net unrealized gains in its investment portfolio.
Equity in earnings (losses) from unconsolidated subsidiaries consisted of the following for the periods presented below:
FGIC Corporations condensed balance sheets as of June 30, 2007 and December 31, 2006, and condensed statements of operations for the three and six months ended June 30, 2007 and 2006 are as follows:
NOTE 6. DEFERRED POLICY ACQUISITION COSTS
The following table summarizes deferred policy acquisition cost activity as of and for the three months and six months ended June 30, 2007 and 2006:
Deferred policy acquisition costs are affected by qualifying costs that are deferred in the period and amortization of previously deferred costs in such periods. In periods where new business activity is declining, the asset will generally decrease because the amortization of previously deferred policy acquisition costs exceeds the amount of acquisition costs being deferred. Conversely, in periods where there is significant growth in new business, the asset will generally increase because the amount of acquisition costs being deferred exceeds the amortization of previously deferred policy acquisition costs.
NOTE 7. RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES (LAE)
The Company establishes reserves for losses and LAE to recognize the estimated liability for potential losses and LAE related to insured mortgages that are in default. The establishment of a loss reserve is subject to inherent uncertainty and requires significant judgment by management. The following table provides a reconciliation of the beginning and ending consolidated reserves for losses and LAE between January 1 and June 30, 2007 and 2006:
The increase in total consolidated loss reserves at June 30, 2007 compared to June 30, 2006 was primarily due to increases in the reserve balances for U.S. Mortgage Insurance Operations and PMI Australia. These increases were primarily driven by higher levels of delinquent loans, claim sizes and claim rates. Generally, it takes approximately 12 to 36 months from the receipt of a default notice to result in a claim payment. Accordingly, most losses paid relate to default notices received in prior years.
NOTE 8. COMMITMENTS AND CONTINGENCIES
Indemnification mortgage-backed securities In connection with structured transactions in the U.S., Europe and Australia, the Company is often required to provide narrative and/or financial information relating to the Company and its subsidiaries to mortgage-backed securities issuers for inclusion in the relevant offering documents and the issuers ongoing SEC filings. In connection with the provision of such information, the Company and its subsidiaries may be required to indemnify the issuer of the mortgage-backed securities and the underwriters of the offering with respect to the informations accuracy and completeness and its compliance with applicable securities laws and regulations.
Indemnification SPS As part of the sale of the Companys interest in SPS in 2005, the Company and SPSs other prior shareholders have indemnified CSFB for certain liabilities relating to SPSs operations, including litigation and regulatory actions, and this indemnification obligation may potentially reduce the monthly proceeds that the Company receives post sale. The maximum indemnification obligation for SPSs operations is $33.7 million. The Companys portion of this obligation is 61.4% or $20.7 million. As of June 30, 2007, the Company had recorded a liability of $6.4 million with respect to this indemnification obligation.
Guarantees The PMI Group has guaranteed certain payments to the holders of the privately issued debt securities (Capital Securities) issued by PMI Capital I. Payments with respect to any accrued and unpaid distributions payable, the redemption amount of any Capital Securities that are called and amounts due upon an involuntary or voluntary termination, winding up or liquidation of the Issuer Trust are subject to the guarantee. In addition, the guarantee is irrevocable, is an unsecured obligation of the Company and is subordinate and junior in right of payment to all senior debt of the Company.
Funding Obligations The Company has invested in certain limited partnerships with ownership interests greater than 3% but less than 50%. As of June 30, 2007, the Company had committed to fund, if called upon to do so, $6.8 million of additional equity in certain limited partnership investments.
Legal Proceedings Various legal actions and regulatory reviews are currently pending that involve the Company and specific aspects of its conduct of business. In the opinion of management, the ultimate liability in one or more of these actions is not expected to have a material effect on the consolidated financial condition, results of operations or cash flows of the Company.
NOTE 9. COMPREHENSIVE INCOME
The components of comprehensive income for the three months and six months ended June 30, 2007 and 2006 are shown in the table below.
The changes in unrealized gains in the second quarter and first half of 2007 and 2006 were primarily due to increases in fixed income security interest rates, which caused market value declines relative to the consolidated fixed income portfolio as well as the Companys share of unrealized losses arising in the Companys unconsolidated subsidiaries investment portfolios. The changes in foreign currency translation gains for the second quarter and the first half of 2007 were due primarily to strengthening of the Australian dollar and Euro spot exchange rate relative to the U.S. dollar.
NOTE 10. BENEFIT PLANS
The following table provides the components of net periodic benefit cost for the pension and other post-retirement benefit plans:
In the first half of 2007, the Company contributed approximately $10 million to its Retirement Plan. The Company currently does not expect to make additional contributions to its Retirement Plan in 2007.
The amendment discussed in Note 2 reduced the Plans projected benefit obligation by $11.8 million and the reduction was recorded as an adjustment to accumulated other comprehensive income on the Companys consolidated balance sheet. The adjustment will be amortized through other underwriting and operating expenses over time.
NOTE 11. INCOME TAXES
The Company adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, the Company recognized an approximately $15.6 million increase in deferred tax liabilities, which was accounted for as a reduction to the January 1, 2007 balance of consolidated retained earnings. This liability was accrued upon adoption of FIN 48 and after consideration of certain 2004 California legislation relating to the taxation of insurance companies that could impact our future tax payments. Additionally, the Company has unrecognized tax benefits of approximately $2.5 million as of June 30, 2007 that had been previously accrued, and which if recognized, would affect the Companys future effective tax rate.
When incurred, the Company recognizes interest accrued related to unrecognized tax benefits in tax expense. During the quarters ended June 30, 2007 and 2006, the Company incurred no significant interest or penalties, and had no interest or penalties accrued as of June 30, 2007 or December 31, 2006. The Company remains subject to examination in the following major tax jurisdictions: in the United States from 2001 to present, in California from 2002 to present, in Australia from 2001 to present, in Ireland from 2005 to present, in Canada from 2006 to present, and in Hong Kong from 2006 to present.
NOTE 12. REINSURANCE
The following table shows the effects of reinsurance on premiums written, premiums earned and losses and loss adjustment expenses of the Companys operations for the years ended:
The majority of the Companys existing reinsurance contracts are captive reinsurance agreements in U.S. Mortgage Insurance Operations. Under captive reinsurance agreements, a portion of the risk insured by PMI is reinsured with the mortgage originator or investor through a reinsurer that is affiliated with the mortgage originator or investor. Reinsurance recoverables on losses incurred in U.S. Mortgage Insurance Operations were $2.6 million at June 30, 2007 and $2.9 million as of December 31, 2006.
NOTE 13. BUSINESS SEGMENTS
Reporting segments are based upon our internal organizational structure, the manner in which the Companys operations are managed, the criteria used by our chief operating decision-maker to evaluate segment performance, the availability of separate financial information, and overall materiality considerations.
The following tables present information for reported segment income or loss and segment assets as of and for the periods indicated:
Statements in this report that are not historical facts, or that are preceded by, followed by or include the words believes, expects, anticipates, estimates or similar expressions, and that relate to future plans, events or performance are forward-looking statements within the meaning of the federal securities laws. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. These uncertainties and other factors are described in more detail under the heading Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2006. All forward-looking statements are qualified by and should be read in conjunction with those risk factors, our consolidated financial statements, related notes and other financial information. Such uncertainties and other factors include, but are not limited to, the following:
Except as may be required by applicable law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Overview of Our Business
We are a global provider of credit enhancement products that expand homeownership and strengthen communities by delivering innovative solutions to financial markets worldwide. We offer first loss, mezzanine and risk remote financial insurance across the credit spectrum. Our financial products are designed to reduce risk, lower costs and expand market access for our customers. We divide our business into four segments:
Conditions and Trends Affecting our Business
Overview of Financial Results for the Quarter and Six Months Ended June 30, 2007
Our consolidated net income decreased in the second quarter and first half of 2007 to $83.8 million and $185.9 million, respectively, from $109.6 million and $215.0 million for the corresponding periods in 2006. (See Results of Operations table below.) These decreases were primarily due to higher losses and loss adjustment expenses (LAE) in 2007 in the U.S. and, to a lesser extent, Australia. The decreases in net income were partially offset by higher premiums earned in the U.S. and higher equity in earnings from FGIC.
Conditions and Trends Affecting Financial Performance
U.S. Mortgage Insurance Operations. The financial performance of our U.S. Mortgage Insurance Operations segment is affected by a number of factors, including:
International Operations. Factors affecting the financial performance of our International Operations segment include:
Financial Guaranty. Factors affecting the financial performance of our Financial Guaranty segment include:
Corporate and Other. Factors affecting the financial performance of our Corporate and Other segment include:
RESULTS OF OPERATIONS
The following table presents our consolidated financial results:
Our consolidated net income decreased in the second quarter and first half of 2007 compared to the corresponding periods in 2006 primarily due to higher losses and LAE in 2007 in the U.S. and, to a lesser extent, Australia. The decreases in net income were partially offset by higher premiums earned in the U.S. and higher equity in earnings from FGIC.
The increases in premiums earned in the second quarter and first half of 2007 compared to the corresponding periods in 2006 were driven by higher levels of PMIs primary flow NIW and higher U.S. average primary premium rates (largely reflective of changes described above under Credit and Portfolio Characteristics) and insured loan sizes. PMI Australias insurance in force growth also contributed to the increases in premiums earned.
The increases in net investment income in the second quarter and first half of 2007 compared to the corresponding periods in 2006 were due to increases in our consolidated book yield, growth in PMI Australias investment portfolio and a stronger Australian dollar relative to the U.S. dollar. Our consolidated pre-tax book yield was 5.43% and 5.29% as of June 30, 2007 and 2006, respectively.
We account for our unconsolidated subsidiaries and limited partnerships using the equity method of accounting. Equity in earnings from FGIC increased to $27.4 million and $56.8 million for the second quarter and first half of 2007, respectively, from $24.8 million and $46.8 million for the same periods in 2006. FGICs net income was positively affected by premium and investment income growth and reimbursements of Hurricane Katrina-related claims paid in 2005 and 2006. In addition, FGICs net income was positively impacted by $12.2 million of income tax adjustments in 2007. FGICs net income for the second quarter and first half of 2007 was negatively impacted in the second quarter of 2007 by mark-to-market losses of $16.3 million and $15.9 million, respectively, related to CDS contracts on certain mortgage-related CDOs due principally to a lack of liquidity and widening credit spreads.
The increases in our losses and LAE in the second quarter and first half of 2007 compared to the corresponding periods in 2006 were due to higher claims paid and increases to loss reserves in the U.S. and Australia. The increase in U.S. Mortgage Insurance Operations losses and LAE in the second quarter was due to a $20.7 million increase in claims paid compared to the second quarter of 2006 and a $58.7 million increase to net loss reserves in the quarter. The increase in PMI Australias loss and LAE in the second quarter of 2007 was due to a $4.1 million increase in claims paid and a $2.8 million increase to net loss reserves. In the first half of 2007, U.S. Mortgage Insurance Operations claims paid increased by $35.5 million over the corresponding period in 2006 while net loss reserves were increased by $78.7 million during the period. PMI Australias claims paid increased $11.3 million in the first half of 2007 compared to the first half of 2006 while net loss reserves were increased by $10.6 million in the first half of 2007.
The increases in other underwriting and operating expenses in the second quarter and first half of 2007 compared to the corresponding periods in 2006 were primarily due to higher employee compensation expenses in 2007 and growth in our International Operations.
Our income tax expense decreased in the second quarter and first half of 2007 compared to the corresponding periods in 2006 primarily as a result of lower pre-tax income and lower effective tax rates. Our effective tax rates were 19.4% and 22.0% for the quarter and six months ended June 30, 2007, respectively, compared to 26.4% and 25.9% for the corresponding periods in 2006. The changes in our effective tax rate were primarily due to decreases in U.S. Mortgage Insurance Operations and International Operations net income (excluding net investment income and equity in earnings) which are taxed at effective tax rates between 30% and 35%.
The following table presents consolidated net income and net income (loss) for each of our segments:
U.S. Mortgage Insurance Operations
U.S. Mortgage Insurance Operations results are summarized in the table below.
Premiums written and earned PMIs net premiums written refers to the amount of premiums recorded based on effective coverage during a given period, net of refunds and premiums ceded primarily under captive reinsurance agreements. Under captive reinsurance agreements, PMI transfers portions of its risk written on loans originated by certain lender-customers to captive reinsurance companies affiliated with such lender-customers. In return, portions of PMIs gross premiums written are ceded to those captive reinsurance companies. PMIs premiums earned refers to the amount of premiums recognized as earned, net of changes in unearned premiums. The components of PMIs net premiums written and premiums earned are as follows:
The increases in gross and net premiums written and premiums earned in the second quarter and first half of 2007 compared to the corresponding periods in 2006 were primarily due to higher levels of primary flow and modified pool NIW and higher average primary premium rates. PMIs average primary premium rates increased primarily as a result of changes in the business mix of PMIs portfolio.
As of June 30, 2007, 50.3% of primary insurance in force and 50.2% of primary risk in force were subject to captive reinsurance agreements compared to 53.3% and 53.9% as of June 30, 2006. These decreases were primarily due to a higher percentage of NIW generated by products that are generally not subject to captive reinsurance agreements.
Net investment income The decrease in net investment income in the second quarter of 2007 compared to the same period in 2006 was primarily due to a decrease in municipal bond refundings in the second quarter of 2007 partially offset by higher book yields. The higher pre-tax book yield (5.26% at June 30, 2007 compared to 5.21% at June 30, 2006) was driven by higher interest rates. The increase in net investment income for the first half of 2007 compared to the same period in 2006 was due primarily to increased municipal bond refundings in the first quarter of 2007.
Equity in earnings from unconsolidated subsidiaries U.S. Mortgage Insurance Operations equity in earnings are derived entirely from the results of operations of CMG MI. Equity in earnings from CMG MI decreased in the second quarter and first half of 2007 compared to the same periods in 2006 primarily as a result of higher losses and underwriting expenses, partially offset by higher premiums earned.
Losses and LAE PMIs losses and LAE represent claims paid, certain expenses related to default notification and claim processing and changes to loss reserves during the applicable period. Because losses and LAE includes changes to net loss reserves, it reflects our best estimate of PMIs future claim payments and costs to process claims relating to PMIs current inventory of loans in default. Claims paid including LAE includes amounts paid on primary and pool insurance claims, and LAE. PMIs losses and LAE and related claims data are shown in the following table.
Claims paid including LAE increased in the second quarter and first half of 2007 compared to the corresponding periods in 2006 primarily as a result of increases in the number of primary claims paid and average claim size. The increases in the number of primary claims paid in the second quarter and first half of 2007 reflect PMIs higher claim rate in the second quarter and first half of 2007. PMIs claim rate (as well as its default inventory and default rate) increased as a result of higher concentrations of high LTV, Alt-A and interest only loans in its portfolio and the accelerated loss development of PMIs structured finance portfolio. PMIs claim rate was also negatively affected by moderating or declining home prices and diminished liquidity available for certain loan products, both of which constrained refinancing opportunities for certain borrowers. The increases in PMIs average claim size were driven by higher loan sizes and coverage levels in PMIs portfolio, and moderating or declining home prices which limit PMIs loss mitigation opportunities. Primary claims paid were $67.8 million and $132.7 million in the second quarter and first half of 2007, respectively, compared to $47.5 million and $98.3 million in the corresponding periods in 2006. Pool insurance claims paid were $4.9 million and $9.7 million in the second quarter and first half of 2007, respectively, compared to $4.7 million and $9.5 million in the corresponding periods in 2006.
We increased PMIs net loss reserves in the second quarter and first half of 2007 as a result of the factors described in the paragraph above, an increase in PMIs default inventory and a decrease in PMIs cure rate. The decline in PMIs cure rate resulted from, among other things, a slowdown in the time to resolution of defaults (either through cure or claim payment) some or all of which may be attributable to an increase in workout activity by loan servicers attempting to resolve delinquencies and prevent foreclosures. We expect these workout activities to continue to cause delays in the resolution of delinquent loans during 2007. These delays, at least in the short to mid-term, negatively impact PMIs loss reserves as we assign higher expected claim rates to the default inventory as it ages. Future declines in PMIs cure rate, or higher default or claim rates, could lead to further increases in losses and LAE in 2007. Changes in economic conditions, including mortgage interest rates, job creation and home prices could significantly impact our reserve estimates, and therefore, PMIs losses and LAE. In addition, changes in economic conditions may not necessarily be reflected in PMIs loss development in the quarter or year in which such changes occur.
PMIs primary mortgage insurance master policies define default as the borrowers failure to pay when due an amount equal to the scheduled monthly mortgage payment under the terms of the mortgage. Generally, the master policies require an insured to notify PMI of a default no later than the last business day of the month following the month in which the borrower becomes three monthly payments in default. For reporting and internal tracking purposes, we do not consider a loan to be in default until the borrower
has missed two consecutive payments. Depending upon its scheduled payment date, a loan delinquent for two consecutive monthly payments could be reported to PMI between the 31st and the 60th day after the first missed payment.
PMIs primary default data are presented in the table below.
PMIs primary default rate was 5.34% at March 31, 2007 and 5.55% at December 31, 2006. Primary loans in default as of June 30, 2007 were 42,349 compared to 39,206 as of March 31, 2007 and 39,997 as of December 31, 2006.
PMIs modified pool default data are presented in the table below.
The decrease in PMIs total modified pool default rate from June 30, 2006 to June 30, 2007 was primarily due to the increase in new modified pool policies written since June 30, 2006. The increases in loans in default and policies in force for modified pool without deductible were due to a large modified pool transaction in which PMI insured predominantly seasoned, less-than-A quality loans. We expect higher default rates for less-than-A quality loans, particularly when due to their seasoning they are approaching or in their peak period of loss development. More generally, we expect PMIs modified pool loans in default to increase as its modified pool portfolio seasons. However, we believe that PMIs modified pool insurance products risk reduction features, including a stated stop loss limit, exposure limits on each individual loan in the pool and, in some cases, deductibles, reduce our potential loss exposure on loans insured by those products.
Total pool loans in default (which includes modified and other pool products) as of June 30, 2007 and 2006 were 20,238 and 17,458, respectively. The default rates for total pool loans as of June 30, 2007 and 2006 were 5.17% and 5.60%, respectively.
Total underwriting and operating expenses PMIs total underwriting and operating expenses are as follows:
PMIs policy acquisition costs are those costs that vary with, and are related to, our acquisition, underwriting and processing of new mortgage insurance policies, including contract underwriting and sales related activities. To the extent that we are compensated by customers for contract underwriting, those underwriting costs are not deferred. We defer policy acquisition costs when incurred and amortize these costs in proportion to estimated gross profits for each policy year by type of insurance contract (i.e. monthly, annual and single premium). Policy acquisition costs incurred and deferred are variable and fluctuate with the volume of new insurance applications processed and NIW, and can be reduced by increased use of PMIs electronic origination and delivery methods.
The decreases in amortization of deferred policy acquisition costs in the second quarter and first half of 2007 compared to the corresponding periods in 2006 were primarily due to expense savings realized from field office restructurings in 2006. PMIs deferred policy acquisition cost asset increased slightly to $43.9 million at June 30, 2007 from $43.5 million at December 31, 2006.
Other underwriting and operating expenses generally consist of all costs that are not attributable to the acquisition of new business and are recorded as expenses when incurred. Other underwriting and operating expenses increased in the second quarter and first half of 2007 compared to the corresponding 2006 periods primarily as a result of higher employee compensation expenses. PMI incurs underwriting expenses related to contract underwriting services for mortgage loans without mortgage insurance coverage. These costs are allocated to PMI Mortgage Services Co., or MSC, which is reported in our Corporate and Other segment, thereby reducing PMIs underwriting and operating expenses. Contract underwriting expenses allocated to MSC were $3.6 million and $6.1 million in the second quarter and first half of 2007, respectively, compared to $3.5 million and $7.1 million in the corresponding periods in 2006. The decline in allocated expenses in the first half of 2007 compared to the corresponding period in 2006 was due to a decrease in contract underwriting activity.
Ratios PMIs loss, expense and combined ratios are shown below.
PMIs loss ratio is the ratio of losses and LAE to premiums earned. The loss ratio increased in the second quarter and first half of 2007 compared to the corresponding periods in 2006 as a result of higher losses and LAE, partially offset by higher premiums earned.
PMIs expense ratio is the ratio of total underwriting and operating expenses to net premiums written. The decrease in PMIs expense ratio was primarily due to an increase in net premiums written in the second quarter and first half of 2007 compared to the corresponding periods in 2006. The combined ratio is the sum of the loss ratio and the expense ratio.
Primary NIW The components of PMIs primary NIW are as follows:
The increases in PMIs primary flow NIW in the second quarter and first half of 2007 compared to the corresponding periods in 2006 were primarily driven by a larger private mortgage insurance market. We believe that the private mortgage insurance market grew in 2007 primarily as a result of a decline in the origination of alternative loan products, particularly 80/20 loans, that do not require mortgage insurance. We believe that the decline in the use of alternative products was due to diminished liquidity in the capital markets for these products. We also believe that the private mortgage insurance market increased as a result of tax deductibility for eligible borrowers of borrower-paid mortgage insurance premiums relating to loans closed in 2007 and an increase in the number of low down payment mortgage loans purchased by Fannie Mae and Freddie Mac.
Modified pool insurance PMI currently offers modified pool insurance products that may be attractive to investors and lenders seeking a reduction in the severity of the impact of borrower defaults beyond the protection provided by existing primary insurance or with respect to loans that do not require primary insurance, or for capital relief purposes. PMI wrote $120.1 million and $296.1 million of modified pool risk in the second quarter and first half of 2007, respectively, compared to $107.1 million and $209.5 million in the corresponding periods in 2006. Modified pool risk in force was $2.8 billion at June 30, 2007, $2.5 billion at December 31, 2006, and $2.0 billion as of June 30, 2006.
Insurance and risk in force PMIs primary insurance in force and primary and pool risk in force are shown in the table below.
Primary insurance in force and risk in force as of June 30, 2007 increased from June 30, 2006 primarily as a result of lower policy cancellations and higher levels of NIW. The improvement in PMIs persistency rate, which is based on the percentage of primary insurance in force at the beginning of a 12-month period that remains in force at the end of that period, reflects lower levels of residential mortgage refinance activity and slowing home price appreciation.
The following table sets forth the percentages of PMIs primary risk in force as of June 30, 2007 and December 31, 2006 in the ten states with the highest risk in force in PMIs primary portfolio.
Credit and portfolio characteristics PMI insures less-than-A quality loans and Alt-A loans through all of its acquisition channels. Less-than-A quality loans generally include loans with credit scores less than 620. We consider a loan Alt-A if it has a credit score of 620 or greater and has certain characteristics such as reduced documentation verifying the borrowers income, assets, deposit information, and/or employment. The following table presents PMIs less-than-A quality loans and Alt-A loans as percentages of its flow channel and structured finance channel primary NIW:
The following table presents PMIs ARMs (mortgage loans with interest rates that may adjust prior to their fifth anniversary) and high LTV loans (loans exceeding 97% LTV) as percentages of its flow channel and structured finance channel primary NIW:
Interest only loans, also known as deferred amortization loans, and payment option ARMs have more exposure to declining home prices than fixed rate loans or traditional ARMs. Borrowers with interest only loans do not reduce principal during an initial deferral period. With a payment option ARM, a borrower generally has the option every month to make a payment consisting of principal and interest, interest only, or an amount established by the lender that may be less than the interest owed in which case the interest shortfall is added to the principal amount of the loan. The following table presents PMIs interest only loans and payment option ARMs as percentages of its flow channel and structured finance channel primary NIW: