Our goal is to become a global provider of credit enhancement products across multiple asset and risk classes and to continue to diversify our product offerings beyond mortgage insurance, while at the same time expanding our mortgage insurance product offerings. The percentage of our consolidated net income generated by our International and Financial Guaranty segments has increased from 14% in 2001, to 15% in 2002, to 29% in 2003. We expect that our expenditures on new strategic investments will significantly decline in the near term as we concentrate on managing, growing and diversifying the product offerings in our principal businesses of mortgage insurance, other mortgage-related credit enhancement products and financial guaranty insurance.
The increase in interest expense and distribution on mandatorily redeemable preferred securities was due to the interest on the equity units issued in November 2003.
The results of our U.S. Mortgage Insurance Operations include the operating results of PMI and affiliated U.S. mortgage insurance and reinsurance companies. CMG is accounted for under the equity method of accounting and its results are recorded as equity in earnings from unconsolidated strategic investments. U.S. Mortgage Insurance Operations’ results are summarized in the table below.
PMI’s Hong Kong branch reinsures mortgage risk for the Hong Kong Mortgage Corporation. The increase in gross reinsurance premiums assumed in 2003 over 2002 was due primarily to an increase in mortgage origination activity in Hong Kong. The decrease in 2002 gross reinsurance premiums assumed was the result of a
The terms of the settlement with the FTC and HUD require changes in Fairbanks’ operations and the creation of a $40 million redress fund for the benefit of consumers to remedy the violations of law alleged by the FTC and HUD. We have guaranteed approximately two-thirds of Fairbanks’ obligations under a $30.7 million letter of credit which may be drawn upon by the FTC as security for a portion of the $40 million redress fund. In addition, in connection with the restructuring of certain of Fairbanks Capital’s financing arrangements in October 2003, we entered into a guarantee of approximately $7 million principal amount of certain of Fairbanks Capital’s outstanding senior secured debt, together with accrued interest thereon.
We currently intend to negotiate a credit facility in the range of $100 million to $150 million to be available for general corporate purposes.
Consolidated cash flows generated by investing activities, including purchases and sales of investments, investments in unconsolidated subsidiaries, and capital expenditures, was $1.0 billion in 2003 and $333 million in 2002. This increase was due primarily to our investment in FGIC of $611 million.
As of December 31, 2003, we had committed to fund, if called upon to do so, approximately $7.6 million of additional equity in certain limited partnership investments.
Standard & Poor’s Ratings Service, or S&P, has assigned The PMI Group counterparty credit and senior unsecured debt ratings of “A+” and a preferred stock rating of “A-”; has assigned PMI Mortgage Insurance Co. counterparty credit and financial strength ratings of “AA+;” and has assigned PMI Australia and PMI Europe financial strength ratings of “AA.” S&P’s outlook with respect to these ratings is negative.
We generate a significant portion of our revenues from mortgage insurance premiums on either a monthly, annual or single payment basis. Monthly premiums are earned as coverage is provided. Annual premiums are earned on a monthly pro-rated basis over the year of coverage. Single premiums are initially deferred as unearned premiums and earned over the expected policy terms. The earning cycle for single premium products is based on a range of seven to fifteen years, and the rates used to determine the earnings are estimates based on the expiration of risk. Single premiums written accounted for approximately 27% of gross premiums written from mortgage insurance in 2003. The premiums earning process begins with the notification of risk generally upon receipt of initial premium payment. Earnings pattern calculation is an estimation process and, accordingly, we review our premium earning cycle regularly and any adjustments to the estimates are reflected in the current period’s operating results.
These alternatives, or new alternatives to private mortgage insurance that may develop, could reduce the demand for private mortgage insurance and cause our revenues and profitability to decline. Over the past several
The OFHEO risk-based capital rule (discussed above) may allow large financial entities such as banks, financial guarantors, insurance companies and brokerage firms to provide or arrange for products that may efficiently substitute for some of the capital relief provided to the GSEs by private mortgage insurance. Our consolidated financial condition and results of operations could be harmed if the GSEs were to use these products in lieu of mortgage insurance. See “The institution of new eligibility guidelines by Fannie Mae could harm our profitability and reduce our operational flexibility,” below, for a discussion of Fannie Mae’s ability to purchase mortgage insurance from other than existing approved mortgage insurers.
Congress is currently considering proposed legislation relating to the regulatory oversight of the GSEs. Under certain proposals, regulatory oversight of the GSEs would be conducted by a new federal agency with authority over the GSEs’ products and marketing activities, the GSEs’ minimum capital standards as well as their risk-based capital requirements. We do not know what form, if any, such legislation will take or, if it will be enacted, or its impact, if any, on our financial condition and results of operations.
Mortgage lenders increasingly require PMI to reinsure a portion of the mortgage insurance default risk on mortgages that they originate with their captive reinsurance companies, which reduces PMI’s net premiums written.
Like PMI, the financial results of our Australian and New Zealand mortgage insurance operations, or PMI Australia, are affected by domestic and regional economic conditions, including movements in interest and unemployment rates, and property value fluctuations. These economic factors could impact PMI Australia’s loss experience or the demand for mortgage insurance in the markets PMI Australia serves. PMI Australia is also subject to significant regulation. Future legislative or regulatory changes could adversely affect PMI Australia. PMI Australia’s primary regulator, the Australian Prudential Regulatory Authority, or APRA, is considering, and has sought comment on, a proposal to eliminate the requirement that mortgage insurance companies be mono-line insurers. If adopted, this proposal could facilitate the entry of new competitors in the Australian mortgage insurance market.
Demand for financial guaranty insurance is dependent upon many factors beyond FGIC’s control, including interest rate fluctuations, availability of alternative structures and market acceptance of financial guaranty products.
Risks and uncertainties-PMI is dependent upon mortgage originators to provide mortgage loans to insure. In the event any of its ten largest customers choose to stop providing PMI with mortgage loans to insure, the Company’s ability to generate new insurance business could be adversely affected. Our U.S. Mortgage Insurance Operations’ ten largest customers generated approximately 42% and 44% of its premiums earned in 2003 and 2002, respectively.
unconsolidated variable interest entities if the entities do not effectively disperse risk among the parties involved. In October 2003, FASB deferred the effective date for applying the provisions of FIN No. 46 until the end of the first interim or annual period ending after December 15, 2003. Upon adoption of FIN No. 46, as revised, at December 31, 2003, the Company deconsolidated the trust subsidiary that issued mandatorily redeemable preferred securities. The mandatorily redeemable preferred securities outstanding in the amount of $48.5 million are no longer recognized. As of December 31, 2003, the Company recognized $51.6 million of junior subordinated debentures which are included in long-term debt and $3.1 million representing its investment in the trust in other assets.
Mandatorily Redeemable Preferred Capital Securities and Junior Subordinated Deferrable Interest Debenture-In February 1997, The PMI Group, through a wholly-owned trust, privately issued $100.0 million of 8.309% preferred Capital Securities, Series A (the “Capital Securities”). The Capital Securities are redeemable after February 1, 2007 at a premium or upon occurrence of certain tax events and mature on February 1, 2027. The Capital Securities were issued by PMI Capital I (“Issuer Trust”). The sole asset of the Issuer Trust consists of $103.1 million principal amount of a junior subordinated debenture issued by The PMI Group to the Issuer Trust. The subordinated debenture bears interest at the rate of 8.309% per annum and matures on February 1, 2027. In 2001, the Company repurchased $51.5 million of the Capital Securities. The early extinguishment of a portion of this debt resulted in an extraordinary loss of $2.9 million, net of tax in 2002.
In October 2003, PMI Europe entered into a definitive agreement to acquire the U.K. lenders’ mortgage insurance portfolio from R&SA. The portfolio encompasses primary mortgage insurance written since January 1, 1993. R&SA transferred all loss reserves, unearned premium reserves and central provisions associated with the portfolio to PMI Europe totaling approximately $55 million. The acquisition is subject to U.K. and Irish regulatory approval, followed by U.K. court approval, which is anticipated to take approximately six to nine months, and other customary closing conditions. In connection with this transaction, PMI Europe, has agreed to reinsure the R&SA portfolio to be acquired on a 100% quota share basis during the period from July 1, 2003 until regulatory and court approval.
Income Taxes-In the fourth quarter of 2002 and the second quarter of 2003, the Company received notices of assessment from the California Franchise Tax Board (“FTB”) for 1997 through 2000 in amounts totaling of
Various other 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. The Company determined that the liability related to the fair value of the guarantees provided to a related party, in accordance with FIN No. 45, was not material.
PMI has entered into capital support agreements with its European and Australian subsidiaries that could require PMI to make additional capital contributions to those subsidiaries in order to maintain their credit ratings. With respect to the European and Australian subsidiaries, the Company guarantees the performance of PMI’s capital support agreements.