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Neena Mishra

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PMI AT A GLANCE

P/E ► -0.291   EV/EBITDA ► -0.632   ROA ► -11% AVG ROE ► -50.1% AVG Debt to Equity ► 4.02 AVG Interest Coverage Ratio ► -20.5 LOW

 

 

 

 

 

 

The PMI Group, Inc., (PMI), provides insurance coverage to mortgage lenders, commercial banks, and other financial institutions to protect them against default. The company's policies focus on a particular class of borrowers, those that are only able to pay a nominal down-payment on a house (less than 20%) both in national and international markets. The PMI Group also offers pool insurance (coverage above primary coverage) in the secondary mortgage market on low down-payment loans, mainly to Fannie Mae and Freddie Mac.

The company conducts its U.S. Mortgage Insurance Operations through its subsidiary PMI Mortgage Insurance Company. Its other subsidiary, Fairbanks Capital Holding Corporation (FCHC), provides mortgage loan servicing. The PMI Group completed the divestiture of its title insurance subsidiary, American Pioneer Title Insurance Company (APTIC) in March 2004. It is also a 42% stakeholder in the FGIC corporation, the third-largest monoline bond insurer in the U.S.

FGIC has been under scrutiny lately, as along with the top two bond insurers Ambac Financial Group (ABK) and MBIA (MBI) it had insured a considerable number of mortgage-backed securities. These assets have plummeted in the wake of the subprime lending crisis, and FGIC, Ambac, and MBIA are on the hook for billions of dollars to cover loan defaults. In February 2008, leading credit rating agency Moody's (MCO) downgraded FGIC by six notches, from a perfect AAA rating to an A3, which immediately lowers the value of all bonds that FGIC insures (insured bonds carry the credit rating of the insurer). Ambac and MBIA have so far avoided this, with Moody's saying that these firms are in relatively better positions to stabilize their balance sheets.^[1] FGIC, meanwhile, has announced that it will request to be split into two companies, one for the insurance of municipal bonds and the other responsible for structured finance bonds (including mortgage-backed securities).

Company Overview

Premiums accounted for 71.4% of PMI's $1,206.0 million in revenues for 2006. Investment income accounted for 16.2%, with 85.5% of the remaining 12.4% attributed to equity in the earnings of subsidiaries. By segment, the company's U.S. Mortgage Insurance Operations, International Operations, Financial Guaranty, and Other generated 67.8%, 20.6%, 9.1%, and 2.5%, respectively, for 2006. International operations span across Europe, Australia, New Zealand, and Hong Kong.

Low mortgage rates helped to increase demand for alternative mortgage insurance products, such as the 80/10/10 (piggyback) product. This product allows a homeowner to avoid purchasing private mortgage insurance by allowing the second mortgage, or trust, to be combined with the first mortgage. The first mortgage is set at 80% of the purchase price, which eliminates the need for private mortgage insurance. The second mortgage is set at 10% of the purchase price and then 10% is supplied in cash. These alternative mortgage insurance products have cut PMI Group's growth and could continue hurting the company, should low interest rates continue for a prolonged period.

Domestic growth has been driven by improved persistency levels (the length of time insurance remains continuously in force). The persistency rate continued to make headway reaching 73.3% in 3Q07 from below 50% in 2004. We expect persistency levels to remain favorable.

International Operations have continued to be profitable with increasing home ownership rates and developing capital markets. However, the US Mortgage Operations are currently undergoing a challenging time with the continued deterioration in the housing and mortgage markets.

Trends and Forces

• PMI's default inventory and default rate have increased significantly in 2007. More borrowers defaulted on their loans in 2007, due to delinquencies in certain adjustable rate mortgage and high LTV loans, declining home prices (particularly in California and Florida) and economic conditions in certain Midwestern states. Other portions of PMI's portfolio could also suffer increasing defaults and losses due to continued weakness in the U.S. housing and mortgage markets. It now appears that the delinquencies and defaults on mortgage loan payments may continue for a longer time than expected earlier, giving rise to increased losses for the mortgage insurers.

• PMI's high claim rates and average claim sizes are a concern. A decline in home price diminished the availability of certain loan products, and a decrease in the percentage of the default inventory has contributed to higher claim rates. Higher loan sizes and coverage levels in PMI's portfolio have contributed to an increase in the average claim size. Due to these factors, increase in claim rates and average claim sizes may continue going forward, which could be damaging for PMI's operating results.

• The decisions of ratings agencies will have major impact on PMI. In October 2007, Fitch downgraded its debt ratings of PMI Group to "A" from "A+ , and the debt ratings of PMI Capital I to "A- from "A". As above, in February 2008 Moody's downgraded bond insurer FGIC Corp. six notches, from AAA to A3, which affects PMI as it has a 42% stake in FGIC. Fitch also revised the Rating Outlook on all PMI ratings to Negative from Stable. A further rating downgrade of PMI and its insurance subsidiaries by Fitch or the other leading rating agencies, Moody's (MCO) or Standard & Poor's, could have a significant negative impact on PMI's financial and operating conditions.

• The impact of reduced new insurance written over time may reflect a shrinking market share. PMI's new insurance written (NIW), which reflects the total new business taken on by PMI during the quarter, for Q2 has decreased 60.8% year-over-year. This reflects a huge reduction in the total amount of new mortgages in the U.S. housing market. Similar drops in NIW are being experianced by all of PMI's competitors in the mortgage insurance industry. However, the decrease in NIW for some mortgage insurers will be much smaller due to a higher risk tolerence and stronger financial support, and this may lead to a reduced market share for PMI.

1. ↑ The Wall Street Journal, 2/15/2008