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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-11356
CMAC INVESTMENT CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 23-2691170
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1601 MARKET STREET, PHILADELPHIA, PA 19103
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(215) 564-6600
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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COMMON STOCK, $.001 PAR VALUE NEW YORK STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: 22,727,536 shares of Common
Stock, $.001 par value, outstanding on March 25, 1999, and the aggregate market
value of the voting stock held by non-affiliates of the registrant is
$799,725,173.
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PART I
ITEM 1. BUSINESS
GENERAL
CMAC Investment Corporation (the "Company") provides, through its wholly
owned subsidiary, Commonwealth Mortgage Assurance Company ("CMAC"), private
mortgage insurance coverage in the United States on residential mortgage loans.
Private mortgage insurance protects mortgage lenders and investors from
default-related losses on residential first mortgage loans made primarily to
home buyers who make down payments of less than 20% of the home's purchase
price. Private mortgage insurance also facilitates the sale of such mortgage
loans in the secondary mortgage market, principally to Freddie Mac and Fannie
Mae. CMAC is restricted, both by state insurance laws and regulations and the
eligibility requirements of Fannie Mae and Freddie Mac, to providing insurance
on residential first mortgage loans only. CMAC currently offers two principal
types of private mortgage insurance coverage, primary and pool. At December 31,
1998, primary insurance represented 92.8% of CMAC's direct risk in force and
pool insurance represented 7.2% of CMAC's direct risk in force. The volume of
pool insurance written has increased significantly in 1997 and 1998, but is
expected to decline in 1999 and beyond due primarily to capital restrictions.
CMAC has been engaged in the mortgage insurance business since 1977. The
Company acquired all of the outstanding common stock of CMAC in October 1992 in
order to facilitate the initial public offering of the Company's common stock.
In the offering, the Company's sole stockholder, Commonwealth Land Title
Insurance Company, then an indirect subsidiary of Reliance Group Holdings, Inc.,
sold all of the shares of common stock of the Company owned by it. As a result
of the offering, which was completed in November 1992, the Company became an
independent public company.
Merger with Amerin
By Agreement and Plan of Merger dated as of November 22, 1998, the Company
and Amerin Corporation agreed on a merger. The anticipated merger calls for
Amerin stockholders to receive 0.5333 shares of the Company's common stock in a
tax-free exchange for each share of Amerin common stock. The Company's
stockholders will continue to own their existing shares after the merger.
Completion of the merger is subject to approval by the stockholders of both
companies. The transaction is expected to close in May 1999 and to be accounted
for on a pooling of interests basis. Following the merger, Frank P. Filipps,
president and chief executive officer of the Company, will be chairman and chief
executive officer. Roy J. Kasmar, president and chief operating officer of
Amerin, will hold the same positions with the Company. Gerald L. Friedman,
chairman and chief executive officer of Amerin, will become chairman emeritus,
and Herbert Wender, chairman of the Company, will become chairman of the
executive committee of the board of directors. The new board will initially be
made up of the Company's board, Roy J. Kasmar and four individuals nominated by
Amerin. Based on the independent results for Amerin and the Company at December
31, 1998, and for the twelve-month period then ended, on a pro forma basis, the
combined company would have been the second largest mortgage insurance company
in the industry, measured by market share, with a combined market share of over
19%. The combined company would have had assets of $1.5 billion, common
stockholders' equity of $932 million and net income of $142 million.
Primary Insurance
Primary insurance provides mortgage default protection on individual loans
at a specified coverage percentage which is applied to the unpaid loan
principal, delinquent interest and certain expenses associated with the default
and subsequent foreclosure (collectively, the "claim amount"). CMAC's obligation
to an insured lender in respect of a claim is determined by applying the
appropriate coverage percentage to the claim amount. CMAC's "risk" on each
insured loan is the loan amount multiplied by the coverage percentage. Most of
CMAC's current business is written with 30% coverage on loans with a
loan-to-value ("LTV") ratio between 90.01% and 95% ("95s") and 25% coverage on
loans with an LTV ratio between 85.01% and 90%
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("90s"). As of December 31, 1998, approximately 60% of CMAC's insurance in force
had such "deeper coverage". Deeper coverage refers to a higher percentage of
insurance coverage than previous historical levels on 90s and 95s. Beginning in
1995, both Fannie Mae and Freddie Mac began to require such coverage on 90s and
95s. Prior to 1995, the coverage requirements were 22% on 95s and 17% on 90s. In
January 1999, Fannie Mae announced a new program which allows for lower levels
of required mortgage insurance for certain low down payment loans approved
through its "Desktop Underwriter" automated underwriting system. The insurance
levels are similar to those required prior to 1995. In March 1999, Freddie Mac
announced a similar program for loans approved though its "Loan Prospector"
automated underwriting system. The Company does not believe that these
developments will adversely affect the demand for (or profitability of) mortgage
insurance. For more information on these developments, see "Freddie Mac and
Fannie Mae" on page 17. Under its master policy, CMAC has the option of paying
the entire claim amount and taking title to the mortgaged property, or paying
the coverage percentage in full satisfaction of its obligations under the
insurance written. Recently, CMAC has underwritten most of its primary insurance
by utilizing automated or streamlined underwriting methods.
Pool Insurance
Pool insurance differs from primary insurance in that the exposure on pool
insurance is not limited to a specific coverage percentage on each individual
loan. Because of this feature and the generally lower premium rates associated
with pool insurance, the rating agency capital requirements for the pool product
are more restrictive than the capital requirements for primary insurance. There
is an aggregate exposure limit ("stop loss") on a "pool" of loans which is
generally between 1% and 10% of the initial aggregate loan balance. Modified
pool insurance has a stop loss like pool insurance, but also has exposure limits
on each individual loan. The use of modified pool insurance is much more limited
than traditional pool insurance.
CMAC offers pool insurance on a selected basis to various state housing
finance agencies on the collateral for their bond issues, as a credit
enhancement to mortgage loans included in mortgage-backed securities or in whole
loan sales, and in certain other specific situations. Since 1996, CMAC has
offered significant amounts of pool insurance on mortgage product sold to
Freddie Mac and Fannie Mae by CMAC's primary insurance customers ("GSE Pool").
This GSE Pool insurance has a very low stop loss, generally 1.0% to 1.5%, and
the insured pools contain loans with and without primary insurance. Premium
rates on this business are significantly lower than primary insurance rates and
the expected profitability on this business is lower than that of primary
insurance. The volume of such business increased significantly in 1997 and 1998
due to the strong demand for this product from CMAC's customers and due to the
increased size of the mortgage market. During 1998, CMAC had pool risk written
of $368.4 million relating specifically to GSE Pool business compared to $264.5
million in 1997. It is expected that CMAC will write less pool insurance in
1999. It is CMAC's current intention to reduce its net pool risk in force to no
more than 5% of CMAC's total risk in force. Net pool risk in force at December
31, 1998 represented 7.8% of total risk force. New premiums written for pool
insurance were $11.1 million in 1998, $4.8 million in 1997 and $2.1 million in
1996. The New York Insurance Department has issued a Circular Letter, which is
described more fully on page 16 of this Form 10-K, that could impact the terms
and conditions of future pool insurance transactions.
Structured Transactions
CMAC, from time to time, engages in structured transactions which may
include either primary insurance, pool insurance or some form of combination
thereof. A structured transaction generally involves insuring a large pool of
seasoned loans or issuing a commitment to insure new loan originations under
negotiated terms. Some structured transactions contain a risk-sharing component
under which the insured assumes a first-loss position or shares in losses in
some other manner. The amount of new premiums written in structured transactions
by CMAC were $4.7 million in 1998, $300,000 in 1997 and $400,000 in 1996.
Revenue Sharing Products
CMAC and the industry offer financial products to their customers that are
designed to allow the customer to participate in the risks and rewards of the
mortgage insurance business. One such product is
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captive reinsurance, in which a mortgage lender sets up a mortgage reinsurance
company that assumes part of the risk associated with that lender's insured book
of business. In most cases, the risk assumed by the reinsurance company is an
excess layer of aggregate losses that would be penetrated only in a situation of
adverse loss development. CMAC had four captive reinsurance agreements in place
at December 31, 1998 and expects to enter into several new agreements in 1999.
Premiums ceded to captive reinsurance companies in 1998 were $1.5 million,
representing less than 1% of total premiums written. Another revenue sharing
product is a performance note ("SUPER Note"), which allows a mortgage lender to
invest a portion of capital needed to support its insured mortgage insurance
book and to receive a return on investment that approximates the return that
CMAC achieves on that same book of business. At December 31, 1998, CMAC had $1.9
million of outstanding SUPER Notes. The aggregate amount of captive reinsurance
and SUPER Note business is not expected to have a material impact on CMAC's
balance sheet or financial results in 1999. Clarification of the Letter, which
is described more fully on page 16 of this Form 10-K, could impact the terms and
conditions of future revenue sharing transactions.
CUSTOMERS
Mortgage originators such as mortgage bankers, mortgage brokers, commercial
banks and savings institutions are CMAC's principal customers, although mortgage
borrowers generally bear the cost of primary insurance coverage. CMAC does, on a
limited basis, offer lender-paid mortgage insurance whereby mortgage insurance
premiums are charged to the mortgage lender or loan servicer. On the lender-paid
product, the interest rate to the borrower is usually higher to compensate for
the mortgage insurance premium that the lender is paying. In 1998, approximately
2.8% of CMAC's primary insurance was done on a lender-paid basis, however this
percentage could increase in 1999 and beyond if borrowers become less sensitive
to the stated interest rate and instead focus more on total monthly costs.
To obtain primary insurance from CMAC, a mortgage lender must first apply
for and receive a master policy from CMAC. CMAC's approval of a lender as a
master policyholder is based, among other factors, upon an evaluation of the
lender's financial position and its management's demonstrated adherence to sound
loan origination practices. CMAC's quality control function then monitors the
master policyholder.
The number of primary individual policies in force was 491,836 at December
31, 1998, 441,605 at December 31, 1997 and 382,243 at December 31, 1996.
CMAC's top 10 customers were responsible for 40.3% of new primary risk
written in 1998 compared to 28.4% in 1997 and 21.8% in 1996. The largest single
customer of CMAC, (including branches and affiliates of such customer), measured
by risk written, accounted for 14.4% of new primary risk written during 1998
compared to 4.9% in 1997 and 4.0% in 1996. In 1998, the Company's largest single
customer was Norwest Mortgage, Inc.
SALES, MARKETING AND COMPETITION
Sales and Marketing
CMAC employs a field sales force of approximately 100 persons, organized
into three divisions, providing local sales representation throughout the United
States. During 1997, CMAC reorganized by reducing the number of divisions from
six to three and introducing the new position of Area Sales Manager in order to
provide more direct supervision of the field sales force. Each of the three
divisions is supervised by a Divisional Sales Manager who is directly
responsible for several Area Sales Managers. The Area Sales Managers are
responsible for managing a small sales force in different areas within the
division. An increase to five regions within this structure is anticipated in
1999. CMAC sales personnel are compensated by salary, commissions on new
insurance written and a production incentive based on the achievement of various
goals. During 1998, these goals were related to volume, market share, change in
market share and business quality as measured by CMAC's mortgage scoring model
and this is generally expected to continue in 1999. In early 1997, CMAC expanded
its effort to serve larger national accounts, which have become a more integral
part of the mortgage insurance market due to consolidation in the mortgage
lending industry. Two dedicated national account positions were created and a
more focused effort to support national accounts was implemented. CMAC
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added to this effort in 1998 with two additional dedicated positions and expects
the national account area to be particularly important in 1999 and beyond.
Competition
CMAC and other private mortgage insurers compete directly with various
federal government agencies, principally the Federal Housing Administration
("FHA"). In addition to competition from federal agencies, CMAC and other
private mortgage insurers face competition from state-supported mortgage
insurance funds. The private mortgage insurance industry consists of CMAC and
seven other active mortgage insurance companies. During 1998, CMAC was the fifth
largest private mortgage insurer, measured by market share, and had, according
to industry data, a market share of new primary mortgage insurance written of
11.5%.
UNDERWRITING PRACTICES
CMAC considers effective risk management to be critical to its long-term
financial stability. Market analysis, prudent underwriting, the use of automated
risk evaluation models, quality control and customer service are all important
elements of CMAC's risk management process.
Underwriting Personnel
In addition to a centralized National Underwriting department in the home
office, each of CMAC's service divisions has a Divisional Service Manager
responsible for evaluating risk and managing all underwriting field staff in the
region. CMAC employs an underwriting and support staff of approximately 110 who
are located in CMAC's 25 service centers. Additionally, CMAC has two agency
operations in place.
Underwriting Process
CMAC has generally accepted applications for primary insurance (other than
in connection with structured transactions) under three basic programs: the
traditional fully documented program, a limited documentation program and the
delegated underwriting program. Programs that involve less than fully documented
file submissions have become more prevalent in recent years. In order to meet
this demand, in the fourth quarter of 1996, CMAC introduced to the marketplace
the process referred to as "ExpressTrac(sm)". A lender utilizing ExpressTrac can
submit loans to CMAC for insurance with abbreviated levels of documentation
based on the type of loan being submitted for insurance. During 1998, 61% of the
commitments issued for primary insurance were received by CMAC under the
ExpressTrac program. In the ExpressTrac Program, CMAC has agreed to underwrite
certain loans with less documentation by relying upon a scoring model created by
CMAC during 1996 and referred to as "Prophet Score(sm)" (described below). The
ExpressTrac program also allows for a reduction in standard premium rates (4
basis points) for loans having FICO credit scores (described below) of 680 or
greater although there is no assurance that this discount will continue in the
future. During 1998, 54% of the commitments issued by CMAC for primary insurance
qualified for this discounted rate.
Delegated Underwriting
CMAC has a delegated underwriting program with certain customers. CMAC's
delegated underwriting program, which was implemented in 1989, currently
involves only lenders that are approved by CMAC's risk management department.
Delegated underwriting programs allow the lender's underwriters to commit CMAC
to insure loans based on agreed upon underwriting guidelines. CMAC routinely
audits loans submitted under these programs. As of December 31, 1998,
approximately 41% of the primary loans on CMAC's books were originated on a
delegated basis and during 1998, 60% of the primary loans insured by CMAC were
originated on a delegated basis. This compares with 33% of the primary loans on
CMAC's books at December 31, 1997 and 55% of the primary loans originated during
1997.
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Automated Underwriting
In 1994, CMAC installed an automated underwriting system which uses
artificial intelligence technology to assist CMAC's underwriting staff in the
processing of loan files. The system allows the underwriter to eliminate the
rudimentary underwriting steps and to focus on key aspects of the loan file,
with the ultimate goal of increasing underwriting efficiency while maintaining
the same level of risk exposure. During 1995, the system was fully integrated
into the CMAC underwriting process and improved efficiency was realized. In
1996, CMAC further enhanced the automated underwriting system by adding its
Prophet Score model to the automated underwriting system's decision making
process. Direct connections between the CMAC network and Fannie Mae's Desktop
Underwriter and Freddie Mac's Loan Prospector systems were implemented in
January 1998.
Mortgage Scoring Models
During the last few years, the use of scoring mechanisms to predict loan
performance has become prevalent in the marketplace, especially with Fannie Mae
and Freddie Mac's advocacy of the use of credit scores in the mortgage loan
underwriting process. The use of credit scores was pioneered by Fair Isaac and
Company and became popular in the mid-1980s. The FICO model calculates a score
based on a borrower's credit history. This credit score based "scorecard" is
used to predict the future performance of a loan over a one or two year time
horizon. The higher the credit score the lower the likelihood that a borrower
will default on a loan. CMAC's Prophet Score begins with a FICO score then adds
specific additional data regarding the borrower, the loan and the property. CMAC
believes that it is this additional mortgage data that expands the integrity of
CMAC's Prophet Score over the entire life of the loan. In addition to the
Prophet Score, CMAC's housing analysts regularly review major metropolitan areas
to assess the impact that key indicators such as housing permits, employment
trends, and median home sale prices have on local lending. The healthier the
real estate market, the lower the risk. CMAC refers to this score as a GEOScore.
Beginning in October 1996, the Prophet Score and GEOScore appeared on each
insurance commitment that CMAC issued. In 1998, the Prophet and GEOScores were
combined into a more powerful "Composite Prophet Score" that aggregates the
credit and economic factors into one decision tool.
Alternative Products
An increasingly popular form of mortgage lending is in the area of
non-conforming loans. Two subsets of this category in which CMAC has recently
become involved are Alternative A loans and A minus loans. Alternative A
borrowers have an equal or better credit profile than CMAC's typical insured
borrowers, but these loans are underwritten with reduced documentation and
verification of information. CMAC typically charges a higher premium rate for
this business due to the reduced documentation, but does not consider this
business to be significantly more risky than its normal primary business. The A
minus loan programs typically have non-traditional credit standards which are
less stringent than standard credit guidelines. This market was created as an
avenue to homeownership for borrowers who had not properly maintained their
credit profile over time. CMAC receives a significantly higher premium for
insuring this product that is commensurate with the additional default risk and
is often a variable rate based on the Prophet Score. CMAC intends to limit its
participation in the non-conforming market to Alternative A and A minus loans
rather than "B" or "C" (lower credit) loans and to limit the business insured to
specific targeted lenders with proven good results and servicing experience in
this area. Alternative products made up less than 8% of CMAC's primary insurance
written during 1998, and most of this non-conforming product was categorized as
Alternative A business.
Contract Underwriting
CMAC utilizes its underwriting skills to provide an outsource contract
underwriting service to its customers. For a fee, CMAC underwrites fully
documented underwriting files for secondary market compliance, while at the same
time assessing the file for mortgage insurance, if applicable. The automated
underwriting service introduced in the latter part of 1997 has become a major
part of CMAC's contract underwriting service. This service offers customers
access to Fannie Mae's Desktop Underwriter and Freddie Mac's Loan Prospector
automated underwriting systems. Contract underwriting continues to be a popular
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service to our customers. During 1998, loans underwritten via contract
underwriting accounted for 33% of applications, 29% of commitments for insurance
and 24% of insurance certificates issued by CMAC. Record mortgage origination
volume during 1998 resulted in increased costs which were offset somewhat by
higher fees. CMAC gives recourse to its customers on loans it underwrites for
compliance. If the loan does not meet agreed upon guidelines and is not salable
in the secondary market for that reason, CMAC agrees to remedy the situation
either by placing mortgage insurance coverage on the loan or by purchasing the
loan. During 1998, CMAC processed requests for remedies on less than 1% of the
contract loans underwritten and sold a number of loans previously acquired as
part of the remedy process. Providing these remedies means CMAC assumes some
credit risk and interest rate risk if an error is found during the limited
remedy period in our agreements. Rising mortgage interest rates or an economic
downturn may expose CMAC to higher losses. During 1998, the financial impact of
these remedies was insignificant although there is no assurance that such
results will continue in 1999 and beyond.
RATINGS
CMAC, along with other active private mortgage insurers, has its
claims-paying ability and financial strength rated by Standard & Poor's ("S&P"),
Moody's Investors Service, Inc. ("Moody's") and Duff & Phelps Credit Rating
Company ("DCR"). These ratings are an indication to a mortgage insurer's
customers of the insurer's present financial strength and its capacity to honor
its future claims payment obligations. Ratings are generally considered critical
to an insurer's ability to compete for new insurance business. Currently, CMAC
is rated "AA" by S&P and DCR, and "Aa3" by Moody's. CMAC has received assurance
from Moody's, S&P and DCR that the merged company will maintain a rating similar
to the current rating upon completion of the merger
REINSURANCE
CMAC reinsures all direct insurance in force under an excess of loss
reinsurance program which CMAC considers to be an effective catastrophic
reinsurance coverage. Under this program, the reinsurer is responsible for 100%
of CMAC's covered losses in excess of CMAC's retention. CMAC's annual retention
is determined by a formula which contains variable components. The estimated
1999 retention is approximately $480 million of loss which represents 150% of
expected premiums earned. The reinsurer's aggregate annual limit of liability is
also determined by a formula with variable components and is currently estimated
to be $92.5 million. In addition, for 1999, a limit has been set on the amount
of annual pool insurance losses that can be counted in the reinsurance
recoverable calculation. For 1999, this limit is $90 million. If the reinsurer
decides not to renew the reinsurance arrangement and is not replaced by CMAC,
the reinsurer must provide six years of runoff coverage. There is an overall
aggregate limit of liability applicable to any runoff period equal to four times
the annual limit in effect for the calendar year of such nonrenewal. For 1999,
this aggregate limit is estimated to be $370 million. The excess of loss
reinsurance program also provides restrictions and limitations on the payment of
dividends by CMAC, investments, mergers or acquisitions involving other private
mortgage insurance companies and reinsurance of exposure retained by CMAC.
In addition, CMAC has entered into a variable quota-share ("VQS") treaty
for primary risk in the 1994 to 1997 origination years and a portion of the pool
risk written in 1997. In this treaty, quota-share loss relief is provided at
varying levels ranging from 7.5% to 15.0% based upon the loss ratio on the
reinsured book. The higher CMAC's loss ratio, the greater the potential
reinsurance relief which protects CMAC in adverse loss situations. A ceding
commission is paid by the reinsurer to CMAC and the agreement is noncancelable
for ten years by either party. As of December 31, 1998, the risk in force
covered by the VQS treaty was approximately $6.1 billion, or approximately 53%
of CMAC's primary risk in force and $84 million, or approximately 10% of CMAC's
pool risk in force. It is CMAC's present intention not to reinsure any
additional business pursuant to the VQS treaty for the 1999 origination year,
although the ultimate decision on reinsurance could be impacted by business
volume, capital adequacy and other factors.
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DEFAULTS AND CLAIMS
Defaults
The default and claim cycle on loans which have private mortgage insurance
begins with the insurer's receipt from the lender of notification of a default
on an insured loan. The master policy requires lenders to notify CMAC of an
uncured default on a mortgage loan within 75 days (45 days for an uncured
default in the first year of the loan), although many lenders do so earlier. The
incidence of default is affected by a variety of factors, including change in
borrower income, unemployment, divorce and illness, the level of interest rates
and general borrower creditworthiness. Defaults that are not cured result in
claims to CMAC. Borrowers may cure defaults by making all delinquent loan
payments or by selling the property and satisfying all amounts due under the
mortgage.
The following table shows the number of primary and pool loans insured,
related loans in default and the percentage of loans in default (default rate)
as of the dates indicated:
DEFAULT STATISTICS
DECEMBER 31
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1998 1997 1996 1995 1994
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PRIMARY INSURANCE:
Insured loans in force................. 491,836 441,605 382,243 321,090 261,750
Loans in default(1).................... 12,025 10,245 9,115 6,734 5,377
Percentage of loans in default......... 2.4% 2.3% 2.4% 2.1% 2.1%
POOL INSURANCE(2):
Insured loans in force................. 432,740 236,101 93,531 43,969 31,658
Loans in default(1).................... 3,500 2,114 1,012 595 549
Percentage of loans in default......... 0.8% 0.9% 1.1% 1.4% 1.7%
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(1) Loans in default exclude those loans 45 days past due or less and loans in
default for which CMAC feels it will not be liable for a claim payment.
(2) Includes traditional and modified pool insurance.
Regions of the United States may experience different default rates due to
varying economic conditions. The following table shows the default rates by CMAC
region as of the dates indicated, including both primary and pool loans.
DEFAULT RATES BY CMAC REGION
DECEMBER 31
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1998 1997 1996 1995 1994
---- ---- ---- ---- ----
North................................................... 2.13% 2.51% 2.64% 2.56% 2.59%
East.................................................... 2.43 3.11 3.38 3.34 3.36
Southeast............................................... 2.20 2.35 2.10 1.53 1.51
Midwest................................................. 1.03 1.16 1.28 1.12 0.61
Southwest............................................... 1.77 1.84 1.61 1.38 1.35
West.................................................... 1.88 2.42 2.87 2.52 2.14
Alaska.................................................. 0.55 1.02 0.45 0.74 0.67
As of December 31, 1998, default rates for CMAC's two largest states
measured by risk in force were 2.6% for California and 3.6% for Florida compared
to 3.6% for California and 3.8% for Florida at December 31, 1997. The relatively
high default rate in Florida is due primarily to the increased "affordable
housing" business done in Florida since 1994 and the relatively high default
development on such business.
Claims
The likelihood that a claim will result from a default and the amount of
such claim depend principally on the borrower's equity at the time of default
and the borrower's (or the lender's) ability to sell the home for an
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amount sufficient to satisfy all amounts due under the mortgage, as well as the
effectiveness of loss mitigation efforts. Claims are also affected by local
housing prices, interest rates, unemployment levels and the housing supply.
Claim activity is not evenly spread through the coverage period of a book
of business. Relatively few claims are received during the first two years
following issuance of the policy. This is followed by a period of rising claims
which, based on industry experience, has historically reached its highest level
in the third through fifth years after the year of loan origination. Thereafter,
the number of claims received has historically declined at a gradual rate,
although the rate of decline can be affected by conditions in the economy.
Approximately 58% of CMAC's primary risk in force and almost all of CMAC's pool
risk in force at December 31, 1998 had not yet reached its anticipated highest
claim frequency years. CMAC's cumulative claim incidence on insurance written,
determined four years after policy issuance, was 1.5% for insurance written in
1992, 1.5% for insurance written in 1993, and 2.0% for insurance written in
1994. Certain "affordable housing" loans insured in 1994 and 1995 have
experienced higher than normal early default and claim rates, although these
results are not anticipated to have a material effect on the Company's financial
statements due to the relatively small component of such loans in CMAC's book.
Many of the reasons for these early defaults have been addressed in the
underwriting of such loans since 1996.
LOSS MITIGATION
CMAC's loan workout staff consists of 20 employees, including 13 full-time
loan workout specialists who proactively intervene in the default process,
working with borrowers to reduce the frequency and severity of foreclosure
losses. Once a notice of default is received, CMAC scores the default using a
proprietary model that predicts the likelihood that the default will become a
claim. Using this model, the loan workout specialists prioritize cases for
proactive intervention to counsel and assist borrowers. Loss mitigation
techniques include pre-foreclosure sales, extensions of credit to borrowers to
reinstate insured loans, loan modifications and deficiency settlements. CMAC
considers its loss mitigation efforts to be an effective way to reduce claim
payments.
HOMEOWNERSHIP COUNSELING
In 1995, CMAC established a Homeownership Counseling Center (the "Center")
to work with borrowers receiving insured loans under Community Homebuyer, 97%
loan-to-value ("97s") or other "affordable housing" programs. CMAC considers
this counseling to be very important to the future success of those particular
borrowers with regard to sustaining their mortgage payments. In addition, the
Center counsels such borrowers early in the default process in an attempt to
help cure the loan and assist the borrower in meeting their mortgage obligation.
LOSS RESERVES
CMAC establishes reserves to provide for the estimated costs of settling
claims in respect of loans reported to be in default and loans that are in
default which have not yet been reported to CMAC. Consistent with generally
accepted accounting principles and industry accounting practices, CMAC does not
establish loss reserves for future claims on insured loans which are not
currently in default. In determining the liability for unpaid losses related to
reported outstanding defaults, CMAC establishes loss reserves on a case-by-case
basis. The amount reserved for any particular loan is dependent upon the status
of the loan as reported by the servicer of the insured loan, as well as the
economic condition and estimated foreclosure period in the area in which the
default exists. As the default progresses closer to foreclosure, the amount of
loss reserve for that particular loan will be increased, in stages, to
approximately 100% of CMAC's exposure. CMAC also reserves for defaults that have
occurred but have not been reported using historical information on defaults not
reported on a timely basis by lending institutions. The estimates are
continually reviewed and adjustments are made to the liability as necessary.
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ANALYSIS OF PRIMARY RISK IN FORCE
CMAC's business strategy has been to disperse risk as widely as possible.
CMAC analyzes its portfolio in a number of ways to identify any concentrations
or imbalances in risk dispersion. CMAC believes the quality of its insurance
portfolio is affected significantly by:
- the geographic dispersion of the properties securing the insured loans;
- the quality of loan originations;
- the types of loans insured (including LTV ratio, purpose of the loan,
type of loan instrument and type of underlying property securing the
loan); and
- the age of the loans insured.
Geographic Dispersion
The following tables reflect the percentage of direct primary risk in force
on CMAC's book of business (by location of property) for the top ten states and
top 15 metropolitan statistical areas ("MSAs") as of December 31, 1998 and 1997:
TOP TEN STATES 1998 1997
- -------------- ---- ----
California.................................................. 18.1% 18.6%
Florida..................................................... 8.2 8.3
New York.................................................... 7.9 8.4
Texas....................................................... 5.4 5.5
Georgia..................................................... 4.8 5.0
New Jersey.................................................. 4.6 4.5
Pennsylvania................................................ 4.1 4.5
Arizona..................................................... 4.1 4.3
Illinois.................................................... 2.6 N/A
Maryland.................................................... 2.5 2.6
Tennessee................................................... N/A 2.5
--- ---
Total............................................. 62.3% 64.2%
=== ===
TOP FIFTEEN MSAs 1998 1997
- ---------------- ---- ----
Los Angeles, CA............................................. 4.7% 5.3%
Atlanta, GA................................................. 3.8 3.9
Phoenix, AZ................................................. 3.4 3.5
Philadelphia, PA............................................ 3.0 3.2
New York, NY................................................ 2.8 3.0
Nassau/Suffolk, NY.......................................... 2.6 2.7
Washington, DC-MD-VA........................................ 2.5 2.5
Chicago, IL................................................. 2.3 2.1
Orange County, CA........................................... 2.0 2.2
Riverside-San Bernadino, CA................................. 2.0 1.8
Dallas, TX.................................................. 1.6 1.8
Miami, FL................................................... 1.5 1.4
Tampa-St. Petersburg, FL.................................... 1.4 1.5
Ft. Lauderdale, FL.......................................... 1.4 1.4
Houston, TX................................................. 1.3 N/A
Boston, MA.................................................. N/A 1.5
--- ---
Total............................................. 36.3% 37.8%
=== ===
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Lender and Product Characteristics
While geographic dispersion is an important component of overall risk
dispersion and it has been a strategy of the Company to reduce its exposure in
the top 10 states and top 15 MSAs, the Company believes the quality of the risk
in force should be considered in conjunction with other elements of risk
dispersion, such as product distribution, as well as CMAC's risk management and
underwriting practices.
The following table reflects the percentage of direct risk in force (as
determined on the basis of information available on the date of mortgage
origination) by the categories indicated as of December 31, 1998 and 1997.
DIRECT RISK IN FORCE
1998 1997
----- -----
Product Type:
Primary................................................... 92.8% 94.4%
Pool(1)................................................... 7.2 5.6
----- -----
Total............................................. 100.0% 100.0%
===== =====
DIRECT PRIMARY RISK IN FORCE
1998 1997
------- -------
Direct Primary Risk in Force (dollars in millions).......... $11,595 $10,009
Lender Concentration:
Top 10 lenders (by original applicant).................... 28.8% 24.0%
Top 20 lenders (by original applicant).................... 38.3% 33.6%
LTV:
95.01% to 97.00%.......................................... 3.5% 2.6%
90.01% to 95.00%.......................................... 44.8 45.4
85.01% to 90.00%.......................................... 44.2 46.0
85.00% and below.......................................... 7.5 6.0
------- -------
Total............................................. 100.0% 100.0%
======= =======
Loan Type:
Fixed..................................................... 87.9% 82.9%
Adjustable rate mortgage ("ARM") (fully indexed)(2)....... 10.8 14.7
ARM (potential negative amortization)(3).................. 1.3 2.4
------- -------
Total............................................. 100.0% 100.0%
======= =======
Mortgage Term:
15 years and under........................................ 3.5% 3.4%
Over 15 years............................................. 96.5 96.6
------- -------
Total............................................. 100.0% 100.0%
======= =======
Property Type:
Non-condominium (principally single-family detached)...... 96.2% 95.7%
Condominium or cooperative................................ 3.8 4.3
------- -------
Total............................................. 100.0% 100.0%
======= =======
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1998 1997
------- -------
Occupancy Status:
Primary residence......................................... 96.9% 97.2%
Second home............................................... 1.4 1.1
Non-owner occupied........................................ 1.7 1.7
------- -------
Total............................................. 100.0% 100.0%
======= =======
Mortgage Amount:
$200,000 or less.......................................... 86.4% 88.4%
Over $200,000............................................. 13.6 11.6
------- -------
Total............................................. 100.0% 100.0%
======= =======
Loan Purpose:
Purchase.................................................. 80.5% 84.0%
Refinance................................................. 19.5 16.0
------- -------
Total............................................. 100.0% 100.0%
======= =======
- ---------------
(1) Includes traditional and modified pool insurance.
(2) Refers to loans where payment adjustments are the same as mortgage interest
rate adjustments.
(3) Loans with potential negative amortization will not have increasing
principal balances unless interest rates increase as contrasted with
scheduled negative amortization where an increase in loan balance will occur
even if interest rates do not change.
One of the most important determinants of claim incidence is the relative
amount of borrower's equity in the home, or down payment. The expectation of
claim incidence on 95s is approximately two times the expected claim incidence
on 90s. CMAC believes that the higher premium rates it charges on 95s adequately
reflect the additional risk on these loans. The industry and CMAC have been
insuring 97s since 1995. These loans are expected to have a higher claim
incidence than 95s; however, with proper counseling efforts and by limiting
insurance on these loans to sensible affordable housing programs, it is CMAC's
belief that the claim incidence should not be materially (more than one and
one-half times) worse than on 95s, although this cannot be certain. Early
defaults on 97s as compared to other loans have confirmed CMAC's expectations,
although the eventual performance of these loans cannot yet be accurately
projected. Premium rates on 97s are higher than on 95s to compensate for the
additional risk and the higher expected frequency and severity of claims. The
amount of 97s insured in 1998 and 1997 was between 3% and 4% of the total loans
insured each year and the percentage of primary risk in force on insured 97s
went from 2.6% at the end of 1996 to 3.5% at the end of 1998. The percentage of
97s written in 1999 should approximate the 1998 and 1997 figures.
In recent years, CMAC has increased its insurance on mortgages identified
by its customers as "affordable housing" loans. These loans are typically made
to low- and moderate-income borrowers in conjunction with special programs
developed by state or local housing agencies, Fannie Mae or Freddie Mac. Such
programs usually include 95s and 97s and may require certain underwriting
guidelines to be liberalized in order to achieve their objectives. CMAC's
participation in these programs is dependent upon acceptable borrower
counseling. Early default experience on these programs has been worse than
non-"affordable housing" loans, however CMAC does not believe the ultimate
claims will materially affect its financial results due to the relatively small
amount of such business combined with higher premium rates and risk-sharing
elements.
CMAC's claim frequency on insured ARMs has been higher than on all other
loan types. The Company believes that the risk on ARM loans is greater than on
fixed rate loans due to possible monthly payment increases if interest rates
rise.
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The Company believes that 15-year mortgages present a lower level of risk
than 30-year mortgages, primarily as a result of the faster amortization and the
more rapid accumulation of borrower equity in the property. Premium rates for
15-year mortgages are lower to reflect the lower risk.
The Company believes that the risk of claim is also affected by the type of
property securing the insured loan. In the Company's opinion, loans on
single-family detached housing are subject to less risk of claim incidence than
loans on other types of properties. Conversely, loans on attached housing types,
particularly condominiums and cooperatives, are generally considered by the
Company to be a higher risk, due to the higher density of such properties and
because a detached unit is the preferred housing type in most areas. CMAC's more
stringent underwriting guidelines on condominiums and cooperatives reflect this
higher expected risk.
The Company believes that the risk of claim on relocation loans and loans
originated by credit unions is extremely low and offers lower premium rates on
such loans to compensate for the lower risk.
The Company believes that loans on non-owner occupied homes purchased for
investment purposes represent a substantially higher risk of claim incidence,
and are subject to greater value declines than loans on either primary or second
homes. CMAC underwrites loans on non-owner occupied homes more stringently, and
sometimes requires that the investor indemnify CMAC directly for any loss
suffered by CMAC.
CMAC also charges a significantly higher premium rate than the rate charged
for insuring loans on owner occupied homes.
The Company believes that higher priced properties experience wider
fluctuations in value than moderately priced residences and that the income of
many people who buy higher priced homes is less stable than that of people with
moderate incomes. Underwriting guidelines for such higher priced properties
reflect this concern.
INVESTMENT PORTFOLIO
The Company's income from its investment portfolio is one of the Company's
primary sources of cash flow to support its operations and claim payments.
The Company follows an investment policy which, at a minimum, requires:
- 95% of its investment portfolio to consist of cash equivalents and debt
securities (including redeemable preferred stocks) which, at the date of
purchase, were rated investment grade by a nationally recognized rating
agency (e.g., "BBB" or better by S&P); and
- at least 50% of its investment portfolio (together with cash assets) to
consist of cash, cash equivalents and debt securities (including
redeemable preferred stocks) which, at the date of purchase, were rated
the highest investment grade by a nationally recognized rating agency
(e.g., "AAA" by S&P).
In December 1997, the Company's investment policy was amended to permit
investment in equity securities (which includes convertible debt and convertible
preferred stock). This equity component is not permitted to exceed 20% of the
total investment portfolio and the Company began investing in equity securities
in 1998. The 95% investment-grade requirement was not changed. In addition, all
investments purchased in 1998 were classified as available for sale in contrast
to primarily held to maturity, as was typical during prior years. However, the
portfolio still contains mostly held to maturity investments.
At December 31, 1998, the Company's investment portfolio had a carrying
value of $736.3 million and a market value of $743.7 million, including $18.6
million of short-term investments. At December 31, 1998, the Company's
investment portfolio did not include any real estate or mortgage loans. The
portfolio included 10 privately placed, investment-grade securities with an
aggregate carrying value of $6.4 million. At December 31, 1998, 96.3% of the
Company's investment portfolio (which excludes cash) consisted of cash
equivalents and debt securities (including redeemable preferred stocks) rated
investment grade.
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The Company's investment policies and strategies are subject to change
depending upon regulatory, economic and market conditions and the then existing
or anticipated financial condition and operating requirements, including the tax
position, of the Company.
The diversification of the Company's investment portfolio (other than
short-term investments) at December 31, 1998 is shown in the table below:
INVESTMENT PORTFOLIO DIVERSIFICATION
DECEMBER 31, 1998
-------------------------------------
AMORTIZED
COST FAIR VALUE PERCENT(1)
--------- ---------- ----------
(IN THOUSANDS)
Fixed maturities held to maturity:
US government securities(2).............................. $ 12,551 $ 13,156 2.6%
State and municipal obligations(3)....................... 464,967 499,212 97.4
-------- -------- -----
Total............................................ $477,518 $512,368 100.0%
======== ======== =====
Fixed maturities available for sale:
U.S. government securities(2)............................ 186 191 0.1%
U.S. government agency securities(2)..................... 32,276 32,783 15.8
State and municipal obligations(3)....................... 116,131 117,056 56.6
Corporate obligations(3)................................. 16,034 16,522 7.8
Redeemable preferred stock(3)............................ 40,420 46,219 19.7
-------- -------- -----
Total............................................ $205,047 $212,771 100.0%
======== ======== =====
Equity securities available for sale:
Equity securities........................................ $ 25,109 $ 27,425 100.0%
======== ======== =====
- ---------------
(1) Percentage of amortized cost.
(2) Substantially all of these securities are backed by the full faith and
credit of the U.S. government.
(3) Consists of investment-grade securities.
The following table shows the scheduled maturities of the securities held
in the Company's investment portfolio at December 31, 1998:
INVESTMENT PORTFOLIO SCHEDULED MATURITY (1)
DECEMBER 31, 1998
-------------------------
CARRYING
VALUE PERCENT
-------------- -------
(IN THOUSANDS)
Short-term investments...................................... $ 18,596 2.5%
Less than one year.......................................... 3,642 0.5
One to five years........................................... 94,652 12.9
Five to ten years........................................... 206,054 28.0
Over ten years.............................................. 306,939 41.7
Mortgage-backed securities(2)............................... 32,783 4.4
Redeemable preferred stock(3)............................... 46,219 6.3
Equity securities(3)........................................ 27,425 3.7
-------- -----
Total............................................. $736,310 100.0%
======== =====
- ---------------
(1) Actual maturities may differ as a result of calls prior to scheduled
maturity.
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(2) Substantially all of these securities are backed by the Government National
Mortgage Association ("GNMA").
(3) No stated maturity date.
The following table shows the ratings of the Company's investment portfolio
(other than short-term investments) as of December 31, 1998:
INVESTMENT PORTFOLIO BY S&P RATING
DECEMBER 31, 1998
-------------------------
CARRYING
RATING(1) VALUE PERCENT
- --------- -------------- -------
(IN THOUSANDS)
Fixed maturities:
U.S. government and agency securities....................... $ 45,525 6.3%
AAA......................................................... 443,891 61.8
AA.......................................................... 103,714 14.5
A........................................................... 37,725 5.3
BBB......................................................... 14,859 2.1
Not rated(2)................................................ 44,575 6.2
Equity securities........................................... 27,425 3.8
-------- -----
Total............................................. $717,714 100.0%
======== =====
- ---------------
(1) Current ratings assigned by S&P.
(2) These securities are not rated by S&P, but are rated investment grade by at
least one other nationally recognized securities rating agency.
REGULATION
Direct Regulation
State Regulation
The Company and its insurance subsidiaries are subject to comprehensive,
detailed regulation principally designed for the protection of policyholders,
rather than for the benefit of investors, by the insurance departments in the
various states where the Company and its insurance subsidiaries are licensed to
transact business. Insurance laws vary from state to state, but generally grant
broad supervisory powers to agencies or officials to examine insurance companies
and enforce rules or exercise discretion affecting almost every significant
aspect of the insurance business.
Insurance regulations relate, among other things to:
- the licensing of companies to transact business;
- claims handling;
- reinsurance requirements;
- premium rates and policy forms offered to customers;
- financial statements;
- periodic reporting;
- permissible investments; and
- adherence to financial standards relating to surplus, dividends and other
criteria of solvency intended to assure the satisfaction of obligations
to policyholders.
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Mortgage insurers are generally restricted to writing residential mortgage
guaranty insurance business only. This restriction essentially prohibits CMAC
from using its capital resources in support of other types of insurance or
non-insurance business. The non-insurance businesses of the Company, which
consist of mortgage insurance related services, are not generally subject to
regulation under state insurance laws.
Insurance Holding Company Regulation. All states have enacted legislation
that requires each insurance company in an insurance holding company system to
register with the insurance regulatory authority of its state of domicile and to
furnish to such regulator financial and other information concerning the
operations of companies within the holding company system that may materially
affect the operations, management or financial condition of insurers within the
system.
Because the Company is an insurance holding company and CMAC is a
Pennsylvania insurance company, the Pennsylvania insurance laws regulate, among
other things, certain transactions in the Company's common stock and certain
transactions between CMAC, the company's other insurance subsidiaries and their
parent or affiliates. Specifically, no person may, directly or indirectly, offer
to acquire or acquire "control" of the Company, CMAC or the other insurance
subsidiaries unless such person files a statement and other documents with the
Pennsylvania Commissioner of Insurance and obtains the Commissioner's prior
approval. The Commissioner may hold a public hearing on the matter. "Control" is
presumed to exist if 10% or more of CMAC or another of the Company's insurance
subsidiaries' voting securities is owned or controlled, directly or indirectly,
by a person, although the Pennsylvania Commissioner of Insurance may find that
"control" in fact does or does not exist where a person owns or controls a
lesser amount of securities. In addition, material transactions between CMAC and
the Company's other insurance subsidiaries and their parent or affiliates are
subject to certain conditions, including that they be "fair and reasonable."
These restrictions generally apply to all persons controlling or under common
control with CMAC or the Company's other insurance subsidiaries. Certain
transactions between the Company's insurance subsidiaries and their parent or
affiliates may not be entered into unless the Pennsylvania Commissioner of
Insurance is given 30 days prior notification and does not disapprove the
transaction during such 30-day period.
Dividends. The insurance laws of Pennsylvania establish a test limiting
the maximum amount of dividends which may be paid without prior approval by the
Pennsylvania Insurance Commissioner. Under such test, CMAC may pay dividends
during any 12-month period in an amount equal to the greater of:
- 10% of the preceding year-end statutory policyholders' surplus; or
- the preceding year's statutory net income.
In accordance with such restrictions, $105.3 million would be available for
dividends in 1999. However, an amendment to the Pennsylvania statute, effective
in 1994, requires that dividends and other distributions be paid out of an
insurer's unassigned surplus. Because of the unique nature of the method of
accounting for contingency reserves, CMAC has negative unassigned surplus. Thus,
prior approval by the Pennsylvania Insurance Commissioner is required for CMAC
to pay dividends or make other distributions so long as CMAC has negative
unassigned surplus. The Pennsylvania Insurance Commissioner has approved all
distributions by CMAC since the passage of this amendment, and management has
every expectation that the Insurance Department will continue to approve such
distributions in the future, provided that the financial condition of CMAC does
not materially change. The State of California has a statute requiring mortgage
insurers to pay dividends or make other distributions out of unassigned surplus.
CMAC and the California Department of Insurance have reached an understanding
under which CMAC will be able to pay dividends or make other distributions to
the Company provided that the financial condition of CMAC does not materially
change.
Risk to Capital. A number of states and Freddie Mac limit a private
mortgage insurer's risk in force to 25 times the total of the insurer's
policyholders' surplus plus the statutory contingency reserve, commonly known as
the "risk-to-capital" requirement. As of December 31, 1998, CMAC's
risk-to-capital ratio was 18.1 to 1, compared to 18.3 to 1 in 1997.
15
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Reserves. For statutory reporting, CMAC is annually required to provide
for additions to the contingency reserve in an amount equal to 50% of earned
premiums. Such amounts cannot be withdrawn for a period of 10 years except under
certain circumstances. The contingency reserve, designed to be a reserve against
catastrophic losses, essentially restricts dividends and other distributions by
CMAC. Prior to 1995, CMAC had included the contingency reserve as a component of
policyholders' surplus. The Pennsylvania Insurance Department has determined
that the contingency reserve should be classified as a liability in the
statutory balance sheet rather than as a component of policyholders' surplus. In
response to this determination, commencing in January 1995, CMAC began
classifying the contingency reserve as a liability. At December 31, 1998, CMAC
had policyholders' surplus of $149.3 million and a contingency reserve of $467.9
million.
Premium Rates and Policy Forms. CMAC's premium rates and policy forms are
subject to regulation in every state in which it is licensed to transact
business in order to protect policyholders against the adverse effects of
excessive, inadequate or unfairly discriminatory rates and to encourage
competition in the insurance marketplace. In most states, premium rates and
policy forms must be filed prior to their use. In some states, such rates and
forms must also be approved prior to use. Changes in premium rates are subject
to justification, generally on the basis of the insurer's loss experience,
expenses and future trend analysis. The general default experience in the
mortgage insurance industry may also be considered.
Reinsurance. Certain restrictions apply under the laws of several states
to any licensed company ceding business to an unlicensed reinsurer. Under such
laws, if a reinsurer is not admitted or approved in such states, the company
ceding business to the reinsurer cannot take credit in its statutory financial
statements for the risk ceded to such reinsurer absent compliance with certain
reinsurance security requirements. In addition, several states also have special
restrictions on mortgage guaranty insurance. Also, several states limit the
amount of risk a mortgage insurer may retain with respect to coverage on an
insured loan to 25% of the insured's claim amount. Coverage in excess of 25%
(i.e., deep coverage) must be reinsured.
Examination. The Company's insurance subsidiaries are subject to
examination of their affairs by the insurance departments of each of the states
in which they are licensed to transact business.
New York Circular Letter. The New York Insurance Department (the
"Department") issued Circular Letter No. 2 dated February 1, 1999 (the "Letter")
which discusses the Department's position concerning various transactions
between mortgage guaranty insurance companies licensed in New York and mortgage
lenders. The Letter confirms that captive reinsurance transactions are
permissible if they "constitute a legitimate transfer of risk" and "are fair and
equitable to the parties." The Department is currently in the process of
developing guidelines for determining which captives are, in fact, permissible.
In addition, the Letter states that "supernotes/performance notes," "dollar
pool" insurance, and "un-captive captives" violate New York law. The Company is
in the process of seeking further guidance with regard to the Letter and
revising its revenue-sharing products as appropriate to ensure compliance with
the Letter's requirements.
Federal Regulation
RESPA. The origination or refinance of a federally regulated mortgage loan
is a settlement service, and therefore subject to the Real Estate Settlement
Practices Act of 1974, and the regulations promulgated thereunder (collectively,
"RESPA"). In December 1992, regulations were issued which made clear that
mortgage insurance is also a settlement service, and therefore, that mortgage
insurers are subject to the provisions of Section 8(a) of RESPA, which generally
prohibits persons from accepting anything of value for referring real estate
settlement services to any provider of such services. Although many states
prohibit mortgage insurers from giving rebates, RESPA has been interpreted to
cover many non-fee services as well. HUD's interest in pursuing violations of
RESPA has increased awareness of both mortgage insurers and their customers of
the possible sanctions of this law.
HMDA. Most originators of mortgage loans are required to collect and
report data relating to a mortgage loan applicant's race, nationality, gender,
marital status and census tract to HUD or the Federal Reserve under the Home
Mortgage Disclosure Act of 1975 ("HMDA"). The purpose of HMDA is to detect
possible discrimination in home lending and, through disclosure, to discourage
such discrimination. Mortgage
16
18
insurers are not required pursuant to any law or regulation to report HMDA data,
although under the laws of several states, mortgage insurers are currently
prohibited from discriminating on the basis of certain classifications.
The active mortgage insurers, through their trade association, Mortgage
Insurance Companies of America ("MICA"), entered into an agreement with the
Federal Financial Institutions Examinations Council ("FFIEC") to report the same
data on loans submitted for insurance as is required for most mortgage lenders
under HMDA. The first report of HMDA-type data was collected by MICA from its
members for the fourth quarter of 1993 and reported to the FFIEC in the first
quarter of 1994. Subsequent reports of HMDA-type data for the mortgage insurance
industry were submitted by MICA to the FFIEC in March 1995, 1996 and 1997.
Management is not aware of any pending or expected actions by governmental
agencies in response to the reports submitted by MICA to the FFIEC.
Mortgage Insurance Cancellation. The Homeowners Protection Act of 1998
(the "Act") was signed into law on July 29, 1998. The legislation imposes
certain cancellation and termination requirements for borrower-paid private
mortgage insurance and requires certain disclosures to borrowers regarding their
rights under the law. Specifically, the Act provides that private mortgage
insurance on most loans originated on or after July 29, 1999 may be canceled at
the request of the borrower once the LTV reaches 80%, provided that certain
conditions are satisfied. Private mortgage insurance must be canceled
automatically once the LTV reaches 78% or, if the loan is not current on that
date, on the date that the loan becomes current. The Act establishes special
rules for the termination of private mortgage insurance in connection with loans
that are "high risk". The Act does not define "high risk" loans but leaves that
determination to Fannie Mae and Freddie Mac for loans up to the conforming loan
limit and to the mortgagee for any other loan. For "high risk" conforming loans,
it appears from the Act that Fannie Mae and Freddie Mac can determine how long
private mortgage insurance must remain in effect. For "high risk" loans above
the conforming loan limit, private mortgage insurance must be terminated on the
date that the LTV is first scheduled to reach 77%. In no case, however, may
private mortgage insurance be required beyond the midpoint of the amortization
period of the loan if the mortgagor is current on the payments required by the
terms of the mortgage. The Company does not believe that the Act will have a
material effect on its financial condition or results of operations.
Other Direct Regulation
Freddie Mac and Fannie Mae
As the most significant purchasers and sellers of conventional mortgage
loans and beneficiaries of private mortgage insurance, Freddie Mac and Fannie
Mae impose requirements on private mortgage insurers in order for such insurers
to be eligible to insure loans sold to such agencies. Freddie Mac's current
eligibility requirements impose limitations on the type of risk insured,
standards for the geographic and customer diversification of risk, procedures
for claims handling, acceptable underwriting practices and financial
requirements which generally mirror state insurance regulatory requirements.
These requirements are subject to change from time to time. Fannie Mae also has
eligibility requirements, although such requirements are not published. CMAC is
an approved mortgage insurer for both Freddie Mac and Fannie Mae.
In 1995, Freddie Mac and Fannie Mae began to require deeper coverage on
certain loans with LTV ratios greater than 85%. The Company believes that this
deeper coverage does not have a material effect on its financial results,
although premiums earned and the provision for losses increased and the
risk-to-capital ratio is higher as a result of the increase in risk.
In 1995, CMAC issued a new Master Policy which applied to all business
written after June 1, 1995. Changes in the terms included a broader scope of
coverage for certain environmental and bankruptcy related claims, and somewhat
more limited rights to reject claim payments, neither of which the Company
believes will have a material adverse effect on CMAC's operations or financial
results. The new Master Policy was approved by Fannie Mae and Freddie Mac, as
well as by all states which require approval of policy forms.
In January 1999, Fannie Mae announced a new program which allows for lower
levels of required mortgage insurance coverage for low down payment 30-year
fixed rate loans approved through its Desktop Underwriter automated underwriting
system. The insurance levels are similar to those required prior to 1995.
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In March 1999, Freddie Mac announced a similar program for loans approved
through its Loan Prospector underwriting system. Fannie Mae will replace some of
the coverage with a layer of investor mortgage insurance coverage provided by at
least two mortgage insurers, one of which will be CMAC. Fannie Mae also
announced that it intends to purchase additional insurance for certain eligible
"Flex 97" and investor loans, and CMAC has been selected to provide this
coverage on a pilot basis. The Company does not believe that these developments
will adversely affect the demand for or the profitability of mortgage insurance
in the near future.
Indirect Regulation
The Company and CMAC are also indirectly, but significantly, impacted by
regulations affecting originators and purchasers of mortgage loans, particularly
Freddie Mac and Fannie Mae, and regulations affecting governmental insurers such
as the FHA and VA. Private mortgage insurers, including CMAC, are highly
dependent upon federal housing legislation and other laws and regulations which
affect the demand for private mortgage insurance and the housing market
generally. For example, legislation which increases the number of persons
eligible for FHA or VA mortgages could have a material adverse effect on the
Company's ability to compete with the FHA or VA.
The FHA single family loan limits were raised in the fall of 1998. These
increased loan limits vary by geographic region from $109,032 to $197,620. The
Company does not believe that demand for private mortgage insurance has been or
will be materially adversely affected by this change.
Proposals have been advanced which would allow Fannie Mae and Freddie Mac
additional flexibility in determining the amount and nature of alternative
recourse arrangements or other credit enhancements which they could utilize as
substitutes for private mortgage insurance. The Company cannot predict if or
when any of the foregoing legislation or proposals will be adopted, but if
adopted and depending upon the nature and extent of revisions made, demand for
private mortgage insurance may be adversely affected. There can be no assurance
that other federal laws affecting such institutions and entities will not
change, or that new legislation or regulations will not be adopted. In addition,
Fannie Mae and Freddie Mac have entered into, and may in the future seek to
enter into, alternative recourse arrangements or other credit enhancements based
on their existing legislative authority.
In the fall of 1998, Freddie Mac proposed to Congress an amendment to its
charter that would have permitted it to substitute other forms of loss
protection for private mortgage insurance. Although the proposed amendment was
defeated, Freddie Mac may be actively exploring alternatives to conventional
mortgage insurance. Although it is not clear what, if any, changes or new
products may emerge, there is a possibility that any changes in this regard may
materially affect the mortgage insurance industry.
Recent discussions with the Federal Trade Commission with regard to the
adverse action disclosure provisions of the Fair Credit Reporting Act ("FCRA")
have raised the possibility that CMAC will need to make certain changes to its
loan servicing and tracking procedures in order to give FCRA adverse action
notices directly to borrowers. The Company does not believe that such changes
will have a material effect on its operations.
There can be no assurance that the above-mentioned federal laws and
regulations or other federal laws and regulations affecting lenders, private and
governmental mortgage insurers, or purchasers of insured mortgage loans, will
not be amended, or that new legislation or regulations will not be adopted, in
either case, in a manner which will adversely affect the demand for private
mortgage insurance.
YEAR 2000 ISSUE
Starting with the year 2000 ("Y2K"), computerized systems and computer
programs which store the year component of a date as two digits may experience
difficulties and produce unexpected results. Arithmetic calculations involving
dates, Boolean expressions involving dates, and program logic testing for the
occurrence of an event may produce errors.
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In 1997, the Company replaced all strategic and mission critical hardware,
including computers, network and communications devices. Additionally, all
operating systems, network operating systems and layered products were upgraded
to Y2K certified versions.
In 1998, the Company allocated approximately 80% of Information Services
("IS") staff to the Y2K software remediation project. Program modifications were
completed in early September 1998. All programs were then unit and system tested
in a dedicated environment capable of date shifting. Testing was performed by
the Company's IS programmers. Their results were verified and the systems
retested by the Company's IS Quality Control department. All test scripts,
procedures and results were documented. The Company believes that it does not
have material exposure to the Y2K issue with respect to its information systems.
The Company continues to analyze whether others with whom it does business
have Y2K issues. These include lenders and the custodian of the Company's
investment accounts. The Company is currently unable to predict the extent to
which the Y2K issue will affect these persons, or the extent to which the
Company would be vulnerable to their failure to remediate any Y2K issues on a
timely basis. The failure of any one of these persons subject to the Y2K issue
to convert its systems on a timely basis or a conversion that is incompatible
with the Company's systems could have a material adverse effect on the Company's
operations.
Currently, the Company believes its most reasonably likely Y2K worst case
scenario would involve the failure of its business partners' loan origination,
renewal processing or default reporting systems. The Company is an active
participant in the mortgage industry Y2K testing project and has developed
contingency plans to minimize the risks of business disruptions resulting from
business partners' Y2K issues. These include:
- accepting non-Y2K compliant data and using "windowing" logic to process
dates correctly;
- encouraging customers to order mortgage insurance via the internet using
the Company's MI Online system;
- accepting paper or fax submissions;
- encouraging customers to effect servicing transactions via the internet
using the Company's ServiceLink system;
- deferring or delaying renewal billing of policyholders to a mutually
agreed upon date; and
- suspending automatic cancellation for non-payment.
With respect to the Company's non-information technology systems, the Company
has made reasonable efforts to contact providers of products and services
concerning their Y2K readiness. Discussions with suppliers of electronic and
electro-mechanical devices deemed critical to the Company's business operations
are ongoing. Based on this contact and discussions, the Company believes that it
does not have material exposure to the Y2K issue with respect to its
non-information systems.
The Company did not incur any significant incremental expense related to
Y2K issues as of December 31, 1998 and does not expect that its Y2K compliance
program will result in any material costs or have any material impact on its
financial condition or results of operations. The Company has not used any
independent verification and/or validation processes to assure the reliability
of its risk and cost estimates.
EMPLOYEES
At December 1998, CMAC had 825 employees, of which approximately one-third
were located at its Philadelphia headquarters facility. CMAC's employees are not
unionized and management considers employee relations to be very good.
ITEM 2. PROPERTIES
The Company leases approximately 59,000 square feet for its corporate
headquarters in Philadelphia under leases which expire in 2003. In addition,
CMAC leases space for its Divisional, Service Center and On-Site offices
throughout the United States comprising approximately 57,000 square feet with
leases expiring
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between 1999 and 2001. With respect to all facilities, the Company believes it
will be able to obtain satisfactory lease renewal terms.
The Company believes its existing properties are well utilized and are
suitable and adequate for its present circumstances.
The Company maintains a mini-computer network from its corporate data
center located in its headquarters building to support its data processing
requirements for accounting, claims, marketing, risk management, underwriting
and non-insurance operations. In 1997, the Company centralized all computer
operations. All the service centers are linked to the home office in
Philadelphia via a high speed frame-relay network. The centralized environment
is based on the Business Recovery Server ("BRS") architecture. The BRS consists
of two geographically dispersed, identical data centers. Each data center is
currently running at 30% of capacity. Either data center is capable of
supporting the entire company. The data centers are linked via a fibre-optic
link allowing simultaneous data updates through disk shadowing. Each center is
part of a separate power grid. This redundant configuration provides disaster
tolerance and automatic back-up, resource sharing and fail-over.
ITEM 3. LEGAL PROCEEDINGS
CMAC is involved in certain litigation arising in the normal course of its
business. CMAC is contesting the allegations in each pending action and
believes, based on current knowledge and after consultation with counsel, that
the outcome of such litigation will not have a material adverse effect on the
Company's consolidated financial position and results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of 1998 to a vote of
holders of the Company's common stock.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
CMAC Investment Corporation common stock is listed on the New York Stock
Exchange under the symbol CMT. At December 31, 1998, there were 22,705,958
shares outstanding and approximately 6,800 holders of record. The following
table sets forth the high and low sale prices of the Company's common stock as
reported on the New York Stock Exchange Composite Tape:
1998 1997
---------------- ----------------
HIGH LOW HIGH LOW
---- ---- ---- ----
1st Quarter............................................... $69 1/4 $55 15/16 $37 3/8 $32 3/8
2nd Quarter............................................... 67 1/4 57 1/16 47 7/8 33 1/4
3rd Quarter............................................... 68 11/16 36 5/8 55 44 1/16
4th Quarter............................................... 48 13/16 28 60 13/16 50 13/16
Cash dividends for each share of the Company's common stock were $.03 for
each quarter during 1997 and 1998. For a description of restrictions on the
payment of dividends applicable to the Company and to CMAC, see note 7 of Notes
to Consolidated Financial Statements set forth on page F-15 herein.
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ITEM 6. SELECTED FINANCIAL DATA
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
SELECTED FINANCIAL AND STATISTICAL DATA
1998 1997 1996 1995 1994
------- ------- ------- ------- ------
(IN MILLIONS, EXCEPT PER-SHARE AMOUNTS AND RATIOS)
CONSOLIDATED STATEMENT OF INCOME
Premiums earned........................... $ 282.2 $ 237.7 $ 187.9 $ 137.1 $106.1
Net investment income..................... 38.6 33.8 30.0 25.9 22.6
Total revenues............................ 333.0 277.3 222.6 165.6 130.5
Provision for losses...................... 132.0 117.1 91.9 57.8 38.6
Policy acquisition costs and other
operating expenses...................... 75.1 57.7 48.1 39.6 35.6
Pretax income............................. 125.8 102.5 82.6 68.2 56.4
Net income................................ 91.1 75.0 62.2 50.8 41.1
Net income per share(1)(2)................ $ 3.72 $ 3.06 $ 2.55 $ 2.09 $ 1.70
Average shares outstanding(1)(2).......... 23.6 23.4 23.1 22.7 22.2
CONSOLIDATED BALANCE SHEET
Assets.................................... $ 968.2 $ 782.1 $ 649.2 $ 540.3 $435.5
Investments............................... 736.3 596.9 513.2 437.5 358.7
Unearned premiums......................... 49.4 49.3 53.4 56.1 61.9
Reserve for losses........................ 201.3 148.6 108.2 67.3 46.7
Redeemable preferred stock................ 40.0 40.0 40.0 40.0 40.0
Common stockholders' equity............... 523.0 429.9 356.3 298.6 239.7
Book value per share(2)................... $ 23.03 $ 19.08 $ 15.91 $ 13.42 $10.91
STATUTORY RATIOS
Loss ratio................................ 47.7% 50.6% 50.6% 44.3% 37.7%
Expense ratio............................. 24.2 21.2 23.2 28.5 27.6
------- ------- ------- ------- ------
Combined ratio............................ 71.9% 71.8% 73.8% 72.8% 65.3%
======= ======= ======= ======= ======
OTHER STATUTORY DATA
New primary insurance written............. $21,880 $13,707 $12,301 $10,607 $9,354
Direct primary insurance in force......... 53,763 46,900 39,438 32,362 25,809
Direct primary risk in force.............. 11,595 10,010 8,352 6,672 5,031
Direct pool risk in force................. 907 594 342 223 167
- ---------------
(1) Diluted net income per share and share information per Statement of
Financial Accounting Standards No. 128, "Earnings Per Share." See note 1 of
Notes to Consolidated Financial Statements set forth on page F-7 herein.
(2) All share and per-share data for prior periods have been restated to reflect
the stock split. See note 1 of Notes to Consolidated Financial Statements
set forth on page F-7 herein.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
1998 COMPARED TO 1997
Net income for 1998 was $91.1 million, a 20.5% increase compared to $75.0
million for 1997. This improvement was a result of significant growth in
premiums earned, net investment income and other income, partially offset by a
higher provision for losses, policy acquisition costs and other operating
expenses.
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New primary insurance written during 1998 was $21.9 billion, a 59.6%
increase compared to $13.7 billion for 1997. The increase in CMAC's primary new
insurance written was primarily due to a 55.3% increase in primary new insurance
written volume in the private mortgage insurance industry for 1998 as compared
to 1997. In addition, CMAC completed a bulk transaction in the second quarter of
1998, insuring approximately $700 million of seasoned California loans with a
risk profile similar to the Company's regular business. CMAC's market share of
the industry volume increased to 11.5% in 1998, compared to 11.2% for 1997.
Additionally, in 1998, CMAC wrote an increased amount of pool insurance which
represented risk written of $389.4 million as compared to $277.5 million in
1997. Most of this pool insurance volume relates to a group of structured
transactions composed primarily of Fannie Mae- and Freddie Mac-eligible
conforming mortgage loans that are geographically well dispersed throughout the
United States and have lower average loan-to-value ratios than CMAC's primary
business. The performance of this business to date has been better than
anticipated although the business is relatively young and the historical
performance might not be an indication of future performance. Under a pool
insurance transaction, the exposure to CMAC on each individual loan is uncapped;
however, the aggregate stop-loss percentage (typically 1.0% to 1.5% of the
aggregate original loan balance in the Fannie Mae/Freddie Mac transactions) is
the maximum that can be paid out in losses before the insurer's exposure
terminates. The Company expects its pool insurance activity to decline during
1999 as certain outstanding commitments expire and are not renewed. Premium
rates on such pool insurance are significantly lower than on primary insurance
loans due to the low stop-loss levels, which limit the overall risk exposure to
CMAC, and the focus of such product on high quality primary insurance customers.
Both S&P and Moody's have determined that the capital requirements to support
such pool insurance will be significantly more stringent than on primary
insurance due to the low premium rates.
CMAC's volume in 1998 was positively impacted by low interest rates which
affected the entire mortgage industry. The trend toward lower interest rates,
which began in the third quarter of 1997, caused refinancing activity during
1998 to continue at a higher rate than normal and strong housing prices have
caused a large percentage of the refinanced loans to be closed without private
mortgage insurance at an LTV of 80% or below. Therefore, the rate of growth in
the private mortgage industry has not been as high as that of the entire
mortgage market. CMAC's refinancing activity as a percentage of primary new
insurance written was 32.0% for 1998 as compared to 17.0% in 1997. However, for
the fourth quarter of 1998, refinanced loans represented 38.0% of new primary
insurance written as compared to only 24.0% for the third quarter of 1998 as a
result of the slight decline in interest rates during the fourth quarter. The
persistency rate, which is defined as the percentage of policies in force that
are renewed in any given year, was 68.0% for 1998 as compared to 84.2% for 1997.
This large decline was consistent with the increase in the level of refinancing
activity during 1998. The persistency rate for the beginning of 1999 should
continue at a level similar to 1998 although if the current refinance boom
slows, the persistency rate could improve.
CMAC also has recently become involved in insuring non-conforming loans,
specifically Alternative A and A minus loans. Alternative A borrowers have an
equal or better credit profile than CMAC's typical insured borrowers, but these
loans are underwritten with reduced documentation and verification of
information. CMAC typically charges a higher premium rate for this business due
to the reduced documentation, but does not consider this business to be
significantly more risky than its normal primary business. The A minus loan
programs typically have non-traditional credit standards which are less
stringent than standard credit guidelines. To compensate for this additional
risk, CMAC receives a significantly higher premium for insuring this product
that is commensurate with the additional default risk. During 1998, Alternative
A and A minus business accounted for 7.6% of CMAC's new primary insurance
written.
Net premiums earned in 1998 were $282.2 million, an 18.7% increase compared
to $237.7 million for 1997. This increase reflected the insurance in force
growth resulting from strong new insurance volume and the increase in pool
insurance written during 1998, and was partially offset by the decline in
persistency levels. The strong volume led to an increase in direct primary
insurance in force during 1998 of 14.6%, from $46.9 billion at December 31, 1997
to $53.8 billion at December 31, 1998. Direct pool risk in force also grew to
$907.3 million at December 31, 1998 from $593.9 million at the end of 1997, an
increase of 52.8% for the year. CMAC and the industry have entered into
risk-sharing arrangements with various customers that are designed to allow the
customer to participate in the risks and rewards of the mortgage insurance
business. One such
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product is captive reinsurance, in which a mortgage lender sets up a mortgage
reinsurance company that assumes part of the risk associated with that lender's
insured book of business. In most cases, the risk assumed by the reinsurance
company is an excess layer of aggregate losses that would be penetrated only in
a situation of adverse loss development. For 1998, premiums ceded under captive
reinsurance arrangements were $1.5 million or less than 1% of total premiums
earned during 1998 and new primary insurance written under captive reinsurance
arrangements was $2.6 billion, or 12.1% of total new primary insurance written.
CMAC expects to enter into several new agreements in 1999, although the
aggregate amount of captive reinsurance is not expected to have a material
financial impact on CMAC's balance sheet or financial results in 1999.
Net investment income for 1998 was $38.6 million, a 14.1% increase compared
to $33.8 million in 1997. This increase was a result of continued growth in
invested assets primarily due to positive operating cash flows of $132.3 million
during 1998. The Company has continued to invest new operating cash flow in tax-
advantaged securities, primarily municipal bonds, although the Company did
modify its investment policy to allow the purchase of various other asset
classes, including common stock and convertible securities, beginning in the
second quarter of 1998. The Company's intent is to target the common equity
exposure at a maximum of 5% of the investment portfolio's market value while the
convertible securities and mortgage-backed securities exposures are targeted not
to exceed 10% each. During 1998, the Company purchased a total of $26.0 million
of common equities which led to a slight decrease in the growth in investment
income during 1998. Although there will be a short-term decline in investment
income from this change in investment policy, the Company expects no material
long-term impact on total investment returns as a result of this investment
diversification.
The provision for losses was $132.0 million in 1998, an increase of 12.7%
compared to $117.1 million in 1997. This increase reflected the significant
growth and maturation of CMAC"s book of business over the past several years,
which has caused an increase in the number of defaults reported to CMAC, the
continued adverse experience of California loans (despite signs of an improving
trend in California), and the continued poor experience of certain "affordable
housing" program loans insured in 1994 and 1995, especially in Florida. Although
the ultimate performance of the books of business that originated since 1994
cannot yet be determined, it appears that the ultimate loss levels will be
slightly higher than average, partially due to the presence of these "affordable
housing" loans. Claim activity is not evenly spread throughout the coverage
period of a book of business. Relatively few claims are received during the
first two years following issuance of the policy. Historically, claim activity
has reached its highest level in the third through fifth years after the year of
loan origination. Approximately 58% of CMAC's primary risk in force and almost
all of CMAC's pool risk in force at December 31, 1998 had not yet reached its
anticipated highest claim frequency years. CMAC's overall default rate at
December 31, 1998 was 1.68% as compared to 1.82% at December 31, 1997, while the
default rate on the primary business was 2.44% at December 31, 1998 as compared
to 2.32% at December 31, 1997. The number of defaults rose from 12,359 at
December 31, 1997 to 15,525 at December 31, 1998 and the average loss reserve
per default rose from $12,026 at the end of 1997 to $12,965 at December 31,
1998. This increase in average loss reserve per default reflected the Company's
continued implementation of a more conservative reserve calculation for certain
loans in default perceived as having a higher risk of claim incidence. In
addition, an increase in the average loan balance and the coverage percentage on
loans originated beginning in 1995 has necessitated a higher reserve balance on
loans in a default status due to the increased ultimate exposure on these loans.
The default rate in California was 2.6% (including pool) at December 31, 1998 as
compared to 3.6% at December 31, 1997 and claims paid in California during 1998
were $41.8 million, representing approximately 43.1% of total claims as compared
to 57.0% in 1997. California represented 18.3% of primary risk in force at
December 31, 1998 as compared to 18.6% at December 31, 1997. The default rate in
Florida was 3.6% (including pool) at December 31, 1998 as compared to 3.8% at
December 31, 1997 and claims paid in Florida during 1998 were $11.5 million,
representing approximately 11.9% of total claims as compared to only 6.6% in
1997. Florida represented 8.2% of primary risk in force at December 31, 1998 as
compared to 8.3% at December 31, 1997. The "affordable housing" early default
experience is a result of insuring certain loans in which the borrowers'
principal and interest reserves and other credit factors were not as strong as
on prior years' books of business. Certain underwriting changes were implemented
near the end of 1996 to compensate for the factors that contributed to the early
default experience on these "affordable housing" loans; however, it is too early
to determine the impact of such changes. In addition, the Company has
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reported an increased number of defaults on the Alternative A and A minus
business insured beginning in 1997. Although the default rate for this business
is higher than on CMAC's normal books, it is not currently higher than was
expected for this type of business and the higher premium rates charged are
expected to compensate for the increased level of risk. Direct losses paid in
1998 were $83.8 million as compared to direct losses paid during 1997 of $82.1
million, an increase of only 2.1%.
Underwriting and other operating expenses were $75.1 million for 1998, an
increase of 30.3% compared to $57.7 million for 1997. These expenses consisted
of policy acquisition expenses, which relate directly to the acquisition of new
business, and other operating expenses, which primarily represent contract
underwriting expenses, overhead and administrative costs.
Policy acquisition costs were $36.1 million in 1998, an increase of 15.5%
compared to $31.3 million in 1997. This increase reflects the growth in variable
sales- and underwriting-related expenses relating to the Company's continued
growth in new insurance written. The Company has continued development of its
marketing infrastructure needed to support a focus on larger, national mortgage
lenders in order to take advantage of the widespread consolidation occurring in
the mortgage lending industry. Other operating expenses for 1998 were $39.0
million, an increase of 47.8% compared to $26.4 million for 1997. Most of the
increase continued to result from an increase in expenses associated with the
Company's ancillary services, specifically contract underwriting. Contract
underwriting expenses for 1998 included in other operating expenses were $20.7
million as compared to $10.6 million for 1997, an increase of 96.3%. The $10.1
million increase in contract underwriting expenses during 1998 represented 80.9%
of the $12.6 million increase in other operating expenses. Some of these
additional contract underwriting expenses were correspondingly offset by
increases to other income, which rose 112.2% from $5.0 million in 1997 to $10.6
million in 1998. During 1998, loans underwritten via contract underwriting
accounted for 33% of applications, 29% of insurance commitments, and 24% of
certificates issued by CMAC as compared to 29% of applications, 25% of
commitments and 22% of certificates in 1997. In 1999, these percentages are
expected to increase if there is a decrease in refinancing activity. Changing
market conditions have caused the cost of contract underwriting to increase
during 1997 and 1998 due to the high demand for available resources. However, as
further efficiencies are realized in the contract underwriting process due to
the integration with Freddie Mac's Loan Prospector and Fannie Mae's Desktop
Underwriter origination systems, the cost per contract underwriting loan
underwritten could decrease.
The effective tax rate for 1998 was 27.6% as compared to 26.9% for 1997.
Operating income accounted for 68.1% of net income in 1998 as compared to 66.2%
in 1997 thus resulting in the increase in effective tax rate for 1998.
1997 COMPARED TO 1996
Net income for 1997 was $75.0 million, a 20.5% increase compared to $62.2
million for 1996. This improvement was a result of significant growth in
premiums earned and net investment income, partially offset by a higher
provision for losses, policy acquisition costs and other operating expenses.
New primary insurance written during 1997 was $13.7 billion, an 11.4%
increase compared to $12.3 billion for 1996. This increase reflected a market
share increase which was primarily due to CMAC's continued focus on large,
national primary insurance customers and continued geographic expansion into
markets previously underrepresented by CMAC such as the Northwest and Midwest.
The increase resulted despite a 4.4% decline in new insurance written volume in
the private mortgage insurance industry in 1997. CMAC's market share of the
industry increased to 11.2% in 1997, compared to 9.6% for 1996 and for the
fourth quarter of 1997, CMAC's market share was 12.1%. Additionally, in 1997,
CMAC wrote an increased amount of pool insurance which represented an addition
to risk of $277.5 million as compared to $108.9 million in 1996. Most of this
pool insurance volume related to a group of structured transactions composed
primarily of Fannie Mae- and Freddie Mac-eligible conforming mortgage loans that
are geographically dispersed throughout the United States and that have lower
average loan-to-value ratios than CMAC's primary business. Under a pool
insurance transaction, the exposure to CMAC on each individual loan is uncapped;
however, the aggregate stop-loss percentage (typically 1.0% to 1.5% in the
Fannie Mae/Freddie
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Mac transactions) is the most that can be paid out in losses before the
insurer's exposure terminates. The Company expects its pool insurance activity
to continue at this same level in 1998 due its demand in the marketplace.
Premium rates on such pool insurance are significantly lower than on primary
insurance loans due to the low stop-loss levels, which limit the overall risk
exposure to CMAC, and the focus of such product on high quality primary
insurance customers. Nonetheless, this pool insurance has contributed to the
increase in earned premiums during 1997. Standard & Poor's has recently
determined that the capital requirements to support such pool insurance will be
significantly more stringent than on primary insurance due to the low premium
rates and CMAC has reviewed its capital levels to ensure compliance with these
requirements. The average stop-loss on pool insurance written during 1997 was
1.5%.
Refinanced loans represented 17.0% of new primary insurance written during
1997 as compared to 16.5% in 1996. However, for the fourth quarter of 1997,
refinanced loans represented 21.8% of new primary insurance written as compared
to only 13.4% for the fourth quarter of 1996 as lower interest rates in the
third quarter of 1997 caused refinance activity to increase significantly in the
fourth quarter. The persistency rate was 84.2% for 1997 as compared to 83.9% for
1996. This increase was consistent with the slight decline in the level of
refinancing activity during 1997.
The majority of CMAC's business in 1997 reflected the deeper insurance
coverage required by Fannie Mae and Freddie Mac beginning in 1995. That
coverage, which is 25% on loans written with an LTV between 85.01% and 90% and
30% on loans with LTVs greater than 90%, results in higher premiums and losses
than the older coverages of 17% and 22%, respectively, but should not materially
affect the Company's financial results. Approximately 60% of CMAC's direct
primary insurance in force had such deeper coverage at the end of 1997. Monthly
premium plans, which allow borrowers to pay premiums on a monthly basis rather
than annually in advance, accounted for 93.8% of CMAC's primary new insurance
written in 1997 as compared to 91.6% in 1996. Although this program reapportions
the cash flow from an insured loan over the life of the loan, there should be no
material financial effect from its widespread use. At the end of 1995, the
industry and CMAC introduced a variation of the monthly premium plan in which
the borrower does not need to pay any mortgage insurance premium at closing and
under which some portion of the first month's premium can be deferred or
forgiven. During 1997, business written under this program was approximately 31%
of CMAC's total as compared to 11% in 1996.
Net premiums earned in 1997 were $237.7 million, a 26.5% increase compared
to $187.9 million for 1996. This increase reflected a continuation of high
persistency levels, the insurance in force growth resulting from strong new
insurance volume, increased premium rates on deeper coverages and higher
LTV-insured products during 1997 and the increase in pool insurance written
during 1997. The strong volume and high persistency led to an increase in direct
primary insurance in force during 1997 of 18.9%, from $39.4 billion at December
31, 1996 to $46.9 billion at December 31, 1997. Direct pool risk in force also
grew to $593.9 million at December 31, 1997 from $341.9 million at the end of
1996, an increase of 73.7% for the year. Primary new insurance written on loans
with LTVs greater than 90% represented 42.1% of the total amount written in 1997
as compared to 45.5% in 1996.
Net investment income for 1997 was $33.8 million, a 12.6% increase compared
to $30.0 million in 1996. This increase was a result of continued growth in
invested assets primarily due to positive operating cash flows of $93.5 million,
offset slightly by a small decrease in investment yields. The Company's pre-tax
investment yield declined from 6.2% at December 31, 1996 to 6.0% at December 31,
1997. The Company has continued to invest new operating cash flow in
tax-advantaged securities, primarily municipal bonds.
The provision for losses was $117.1 million in 1997, an increase of 27.5%
compared to $91.9 million in 1996. This increase reflected the significant
growth and maturation of CMAC's book of business over the past several years,
the continued adverse experience of California loans, and the relatively poor
experience of certain "affordable housing" program loans insured starting in
1994. Although the ultimate performance of the books of business that originated
since 1994 cannot yet be determined, it appears that the ultimate loss levels
will be higher than average, due in part to the presence of these "affordable
housing" loans. CMAC's overall default rate at December 31, 1997 was 1.8% as
compared to 2.1% at December 31, 1996. The number of defaults rose from 10,127
at December 31, 1996 to 12,359 at December 31, 1997 and the average loss reserve
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per default rose from $10,685 at the end of 1996 to $12,026 at December 31,
1997. This increase in average loss reserve per default reflected the Company's
continued implementation of a more conservative reserve calculation for certain
loans in default perceived as having a higher risk of claim incidence. In
addition, an increase in the coverage percentage on loans originated beginning
in 1995 has necessitated a higher reserve balance on loans in a default status
due to the increased ultimate exposure on these loans. The default rate in
California was 3.6% (including pool) at December 31, 1997 as compared to 4.0% at
December 31, 1996 and claims paid in California during 1997 were $48.2 million,
representing approximately 57.0% of total claims as compared to 61.9% in 1996.
The "affordable housing" early default experience is a result of insuring
certain loans in which the borrowers' principal and interest reserves and other
credit factors were not as strong as on prior years' books of business. Certain
underwriting changes were implemented near the end of 1996 to compensate for the
factors that contributed to the early default experience on these "affordable
housing" loans; however, it is too early to determine the impact of such
changes. The Company believes that many loan servicers have changed the timing
of reporting loans in default, which has continued to result in an incremental
increase in the number of loans in default. This change allows for earlier
intervention with borrowers in default, which might lead to a higher cure rate
for such loans.
Underwriting and other operating expenses were $57.7 million for 1997, an
increase of 19.8% compared to $48.1 million for 1996. These expenses consisted
of policy acquisition expenses, which relate directly to the acquisition of new
business, and other operating expenses, which primarily represent overhead and
administrative costs.
Policy acquisition costs were $31.3 million in 1997, an increase of 16.5%
compared to $26.9 million in 1996. This reflects the increase in sales-and
underwriting-related expenses relating to the Company's continued market share
expansion and the development of the Company's marketing infrastructure needed
to support a focus on larger, national mortgage lenders in order to take
advantage of the widespread consolidation occurring in the mortgage lending
industry. Other operating expenses for 1997 were $26.4 million, an increase of
24.0% compared to $21.3 million for 1996. Much of the increase continued to
result from an expansion of the Company's technology efforts and an increase in
expenses associated with the company's ancillary services, specifically contract
underwriting. Some of these additional contract underwriting expenses were
correspondingly offset by increases to other income, which rose 31.9% from $3.8
million in 1996 to $5.0 million in 1997, although the main purpose of the
contract underwriting effort is to support the sales effort by generating
incremental mortgage insurance business. During 1997, loans underwritten via
contract underwriting accounted for 29% of applications, 25% of insurance
commitments, and 22% of certificates issued by CMAC as compared to 35% of
applications, 21% of commitments and 18% of certificates in 1996. Changing
market conditions caused the cost of contract underwriting to increase during
1997 due to the shortage of available resources.
The effective tax rate for 1997 was 26.9% as compared to 24.6% for 1996.
Operating income was 66.2% of pretax income in 1997 as compared to 62.6% in
1996, thus resulting in the increase in effective tax rate for 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of funds consist primarily of premiums and investment
income. Funds are applied primarily to the payment of CMAC's claims and
operating expenses. The Company generated positive cash flows from operating
activities in 1998, 1997 and 1996 of $132.3 million, $93.5 million and $84.5
million. The significant increases in operating cash flows reflect the growth in
premiums written and insurance in force that has more than offset any increases
in claims paid and other expenses. Positive cash flows are invested pending
future payments of claims and other expenses; cash flow shortfalls, if any, are
funded primarily through sales of short-term investments and other investment
portfolio securities.
Total investments were $736.3 million at December 31, 1998, including $18.6
million of short-term investments with maturities of 90 days or less and $45.5
million of U.S. Treasury equivalents and government agency securities. At
December 31, 1998, approximately 96.3% of the Company's investments consisted of
money market and investment-grade, readily marketable, fixed-income securities,
concentrated in maturities
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of greater than five years. In addition, at December 31, 1998, the Company's
investment portfolio included $27.4 million of equity securities, which includes
convertible debt and convertible preferred stock.
Loss reserves increased from $148.6 million at December 31, 1997 to $201.3
million at December 31, 1998. This increase in loss reserves due to newly
reported defaults, new loans in default that were not reported, and increases to
loss reserves on existing defaults was a result of continued adverse California
and Florida experience as well as the continued growth of the in force insurance
book. In addition, an increase in the average loan balance and the coverage
percentage on loans originated beginning in 1995 has necessitated a higher
reserve balance on loans in a default status due to the increased ultimate
exposure on these loans. CMAC has experienced abnormally high early defaults on
the 1994 and 1995 origination year books of business, which reflected the
increase in "affordable housing" program loans insured in the period. CMAC also
experienced an increase in defaults under the Alternative A and A minus programs
insured starting in late 1997 which is a typical pattern for such business.
Unearned premiums increased slightly from $49.3 million at December 31, 1997 to
$49.4 million at December 31, 1998 due to unearned premium resulting from the
bulk loan transaction insured in 1998 and from certain pool insurance
transactions.
Stockholders' equity plus redeemable preferred stock increased to $563.0
million at December 31, 1998, an increase of 19.8% from $469.9 million at
December 31, 1997. This increase resulted primarily from net income for 1998 of
$91.1 million, a $2.6 million increase (net of tax) in the market value of
securities available for sale and proceeds from the issuance of common stock of
$5.4 million, offset by $6.0 million of dividends.
As protection against a period of adverse loss development, the Company has
entered into a variable quota share reinsurance treaty for the primary books of
business originated in 1994, 1995, 1996 and 1997 as well as some portion of the
pool book of business originated in 1997. As per the terms of the reinsurance
treaties, the Company receives variable quota share loss relief at levels
ranging from 7.5% to 15.0% based upon the loss ratio on the covered book of
business. A ceding commission is paid by the reinsurer to the Company except for
certain circumstances where the loss ratio on the covered book exceeds a stated
level. These treaties remain in force for a period of ten years and are
noncancelable by either party until after ten years have elapsed except under
certain circumstances. Premiums are payable to the reinsurer on a quarterly
basis net of ceding commissions due to the Company and any losses calculated
under the variable quota share coverage are recovered on a quarterly basis. At
the end of the fourth, seventh and tenth years of each treaty, depending on the
extent of losses recovered to date on the calendar year quota share portion of
the treaty, a calculation is made to determine an amount of Underwriting Year
Excess Coverage, if any, due to the Company.
As part of its Year 2000 remediation effort, the Company will upgrade all
desktop and laptop personal computers and vendor software programs that are not
currently Year 2000 compliant (see Year 2000 Issue below) during 1999. The cost
of this upgrade is currently estimated at $814,000. In addition, the Company
plans to implement system and network monitoring software during 1999 at a cost
of approximately $200,000 that will enhance the efficiency of the Company's
operating systems.
The Company believes that CMAC will have sufficient funds to satisfy its
claims payments and operating expenses and to pay dividends to the Company for
at least the next 12 months. The Company also believes that it will be able to
satisfy its long-term (more than 12 months) liquidity needs with cash flow from
CMAC. As a holding company, the Company conducts its principal operations
through CMAC. The company's ability to pay dividends on the $4.125 Preferred
Stock is dependent upon CMAC's ability to pay dividends or make other
distributions to the Company. Based on the company's current intention to pay
quarterly common stock dividends of approximately $0.03 per share, the Company
will require distributions from CMAC of $6.0 million annually to pay the
dividends on the outstanding shares of $4.125 Preferred Stock and common stock.
There are regulatory and contractual limitations on the payment of dividends or
other distributions (See note 7 to the Consolidated Financial Statements.) The
Company does not believe that these restrictions will prevent the payment by
CMAC or the Company of these anticipated dividends or distributions in the
foreseeable future.
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YEAR 2000 ISSUE
Many existing computer programs use only two digits to identify a year in
the date field. These programs were designed and developed without considering
the impact of the upcoming change in the century. If not corrected, many
computer applications could fail or create erroneous results by or at the year
2000. The Company has conducted an analysis of its systems and has completed its
Year 2000 project with the result that all of its systems were Year 2000
compliant by the end of 1998. "Year 2000 compliant" means fault-free performance
in the processing of data and date related data (including, but not limited to,
calculating, comparing and sequencing) by all hardware and software products,
individually and in combination. Fault-free performance must include the
manipulation of data when dates are in the 20th or 21st century and must be
transparent to the user.
The Company has completed the necessary program modifications to make them
Year 2000 compliant and all date sensitive files have been appropriately
modified and updated. The Company has built a stand-alone testing environment
that allowed simulation of different year-end scenarios and testing of the Year
2000 programming changes and file modifications was completed in October 1998.
In addition, the Company has undertaken a review of all of its hardware systems
to assess Year 2000 compliance. The Company's servers are currently Year 2000
compliant and any desktop or laptop systems not currently Year 2000 compliant
are scheduled for replacement in 1999.
Although the Company will be Year 2000 compliant, in the event that third
parties with whom the Company transacts business are not Year 2000 compliant,
potential for an adverse effect on the Company's operations may remain. The
Company has taken precautions to minimize this risk by contacting each of its
mission critical business partners to ascertain their Year 2000 compliance
status. Currently, the Company believes its most reasonably likely Year 2000
worst case scenario would involve the failure of its business partners' loan
origination, renewal processing or default reporting systems. The Company is an
active participant in the mortgage industry's Year 2000 testing project and has
developed contingency plans to minimize the risks of business disruptions
resulting from its business partners' Year 2000 issues.
With respect to the Company's non-information technology systems, the
Company has made reasonable efforts to contact providers of products and
services concerning their Year 2000 readiness. Discussions with suppliers of
electronic and electro-mechanical devices deemed critical to the Company's
business operations are ongoing. Based on this contact and discussions, the
Company believes that it does not have material exposure to the Year 2000 issue
with respect to its non-information systems.
The Company did not incur any significant incremental expense related to
Year 2000 issues during 1998 and does not expect that its Year 2000 compliance
program will result in any material costs or have a material impact on its
financial condition or results of operations. The Company has not used any
independent verification and/or validation processes to assure the reliability
of its risk and cost estimates.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is not exposed to market risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The condensed consolidated financial statements and supplementary data are
indexed in the Index to Consolidated Financial Statements and Financial
Statement Schedules which appears on page 41 and are incorporated in this item
by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information provided herein as to personal background has been provided
by each director as of December 31, 1998.
THE FOLLOWING DIRECTORS ARE NOMINEES FOR ELECTION AT THE 1999 ANNUAL MEETING FOR
TERMS EXPIRING IN 2002:
David C. Carney............ Mr. Carney has been the Executive Vice President of
Jefferson Health Systems since October 1996. From
April 1995 until October 1996 he was Chief
Executive Officer of D.C. Carney Consulting
Service. He served as Chief Financial Officer of
CoreStates Financial Corp, a banking and financial
services holding company from April 1991 until
April 1995. Mr. Carney is a certified public
accountant and from 1980 to 1991, he was Area
Managing Partner for Ernst & Young. He has been a
director of ImageMax, Inc. since 1987 and a
director of the Company since November 1992. Age:
61.
Claire M. Fagin............ Dr. Fagin is Dean Emerita and Professor Emerita of
the School of Nursing, University of Pennsylvania
and is currently an independent consultant. She has
been associated with the University of Pennsylvania
since 1977, where she served as Interim President
from 1993 to 1994. From 1977 through 1992 she was
the Dean of the School of Nursing of the University
of Pennsylvania. She was a director of Salomon Inc.
from 1994 until the end of 1997, when it was
acquired by Travelers Group. She serves on the
Advisory Committee of Provident Mutual Life
Insurance Company where she retired from her
directorship in December 1996. She has been a
Director of the Company since July 1994. Age: 72.
Ronald W. Moore............ Mr. Moore has been an Adjunct Professor of Business
Administration, Graduate School of Business
Administration, Harvard University since 1990. He
is a director of Orion Capital Corporation. Mr.
Moore has been a director of the Company since
November 1992. Age: 53.
THE FOLLOWING DIRECTORS ARE CONTINUING IN OFFICE WITH THEIR TERMS EXPIRING IN
2000:
Frank P. Filipps........... Mr. Filipps joined the Company and CMAC as Senior
Vice President and Chief Financial Officer in
November 1992, and became Executive Vice President
and Chief Operating Officer of the Company and CMAC
in 1994. In January 1995 he became President of the
Company and Chairman of the Board, President and
Chief Executive Officer of CMAC. In January 1996
Mr. Filipps was named Chief Executive Officer of
the Company. From 1975 until October 1992 he was an
executive with American International Group, Inc.,
an insurance holding company, serving as Vice
President and Treasurer from 1989 to 1992. He has
been a director of Impac Mortgage Holdings since
November 1995 and a director of Impac Commercial
Holdings since February 1997. He has been a
director of the Company since May 1995. Age: 51.
James C. Miller............ Mr. Miller was President of the Company from July
1992 until his retirement in December 1994. He
served as President and Chief Operating Officer and
a director of CMAC from October 1983 until August
1992. From August 1992 through December 1994 he
served as Chairman of the Board, President and
Chief Executive Officer of
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CMAC. He has been a director of the Company since
July 1992. Age: 68.
Anthony W. Schweiger....... Mr. Schweiger is an independent consultant
providing specialized management services for
turnaround situations and complex operations
problems for a variety of businesses. He served as
acting Chief Executive Officer of Care Systems in
1995. He was Managing Director of the Stafford
Companies, an investment banking firm, from
November 1994 until April 1995. From November 1993
through August 1994 he served as the Executive Vice
President of First Advantage Mortgage Corporation,
a mortgage banking company. Prior to that he served
as President and Chief Executive Officer of
Meridian Mortgage Corporation, a mortgage banking
company, from 1987 until December 1992. He has been
a director of the Company since November 1992. Age:
57.
THE FOLLOWING DIRECTORS ARE CONTINUING IN OFFICE WITH THEIR TERMS EXPIRING IN
2001:
Herbert Wender............. Mr. Wender has served as Chairman of the Board of
Directors of the Company since August 1992. He was
Chairman of the Board and Chief Executive Officer
of CMAC, from June 1983 until July 1992. Mr. Wender
has been Vice Chairman of Land America Financial
Group, Inc. since February 1998. He was Chairman of
the Board and Chief Executive Officer of
Commonwealth Land Title Insurance Company
("Commonwealth"), from June 1983 until February
1998. He has been a director of the Company since
July 1992. Age: 61.
James W. Jennings.......... Mr. Jennings has been a partner in the Philadelphia
office of the law firm of Morgan, Lewis & Bockius
LLP (which firm is counsel to the Company) since
1970. He has been a director of the Company since
January 1993. Age: 61.
Robert W. Richards......... Mr. Richards was Chairman of the Board of Directors
of Source One Mortgage Services Corporation, a
mortgage banking company, from 1989 until his
retirement in 1996. He held a number of managerial
positions with Source One from 1971 through 1996,
serving as President from 1987 to 1989. He has been
a director of the Company since November 1992. Age:
56.
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934
The Company believes that during the year ended December 31, 1998, its
directors and executive officers complied with all applicable filing
requirements of Section 16(a) of the Securities Exchange Act of 1934 with the
exception of William Carroll, who failed to file a Form 4 timely when he sold
shares of Common Stock in the Company in April, 1998. The foregoing statement is
based solely upon a review of copies of reports furnished to the Company and
written representations of its directors and executive officers that no other
reports were required.
EXECUTIVE OFFICERS OF THE COMPANY
Set forth below is certain information regarding each of the current
executive officers of the Company as of December 31, 1998. The executive
officers of the Company are elected annually by the Board of Directors to serve
in their respective capacities until their successors are duly elected and
qualified or until their earlier resignation or removal.
Frank P. Filipps........... Mr. Filipps joined the Company and CMAC, as Senior
Vice President and Chief Financial Officer in
November 1992, and became Executive
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Vice President and Chief Operating Officer of the
Company and CMAC in 1994. In January 1995 he became
President of the Company and Chairman of the Board,
President and Chief Executive Officer of CMAC. In
January 1996 Mr. Filipps was named Chief Executive
Officer of the Company. From 1975 until October
1992 he was an executive with American
International Group, Inc., an insurance holding
company, serving as Vice President and Treasurer
from 1989 to 1992. He has been a director of Impac
Mortgage Holdings since November 1995 and a
director of Impac Commercial Holdings since
February 1997. He has been a director of the
Company since May 1995. Age: 51.
William W. Carroll......... Mr. Carroll was named Senior Vice President,
National Sales Manager of CMAC in January 1997.
From 1986 through 1997 he served various senior
level positions within the mortgage banking
industry, most recently at Barnett Bank as a Senior
Consultant. Age: 61.
Paul F. Fischer............ Mr. Fischer was named Vice President, Risk
Management of CMAC in June 1990 and was named
Senior Vice President, Risk Management in June
1991. He was named a Vice President of the Company
in January 1993. He served as Vice President,
Administration and Controller of CMAC from April
1985 until June 1990. Age: 44.
Douglas J. MacLeod......... Mr. MacLeod was named as Senior Vice President,
Capital Markets of CMAC in October 1997. He served
as Senior Vice President of Marketing of CMAC from
January 1997 to October 1997. From June 1991 to
January 1997 he was Senior Vice President,
Marketing and National Sales Manager of CMAC. He
was named a Vice President of the Company in
January 1993. From 1985 until March 1991 he served
as a corporate officer of Financial Insurance
Guaranty Company, a financial guaranty company, in
the areas of sales, marketing and new product
development. Age: 52.
C. Robert Quint............ Mr. Quint was named Senior Vice President and Chief
Financial Officer of the Company and CMAC in
January 1996. He joined CMAC as Vice President,
Administration and Controller in August 1990. In
July 1992 he became Vice President, Administration
and Controller of the Company. In January 1995, he
was named Vice President, Finance and Controller of
the Company and CMAC. From June 1987 until August
1990 he served as an Assistant Controller for
Reliance Development Group, a commercial real
estate developer. Age: 39.
Scott C. Stevens........... Mr. Stevens was named Senior Vice President, Human
Resources and Administration of CMAC and the
Company in July 1998. He joined CMAC as Vice
President, Human Resources in 1995. He has held
management positions within the lending industry in
the human resources field since 1978. Age: 43.
Andrew R. Luczakowsky...... Mr. Luczakowsky was named Senior Vice President,
Information Systems of CMAC in July 1998. He was
named Vice President of CMAC in April 1984. He has
been employed by CMAC in an information technology
related capacity since 1982. Age: 52.
Howard S. Yaruss........... Mr. Yaruss joined the Company and CMAC in July 1997
as Senior Vice President, Secretary and General
Counsel. From July 1991 until July 1997 he served
as Vice President and Assistant General Counsel of
Capital Reinsurance Company, a reinsurance company.
Age: 40.
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ITEM 11. EXECUTIVE COMPENSATION
DIRECTOR COMPENSATION
Mr. Wender, Chairman of the Board of the Company, receives $100,000 per
year, payable quarterly, for his services. All other directors of the Company
who did not serve as executive officers of the Company received an annual fee
for their services of $20,000, a $2,000 annual fee for serving as a Chairman of
a Committee, and a $1,500 fee for each Board of Directors meeting, a $1,500 fee
for each committee meeting attended not in conjunction with a Board of Directors
meeting and a $500 fee for each committee meeting attended in conjunction with a
Board of Directors meeting attended in 1998. In addition, non-employee directors
are reimbursed for their out-of-pocket expenses incurred in connection with a
Board of Directors or Committee meeting. Directors who are employees do not
receive additional compensation for such service. Each non-employee director
automatically receives, at each December Board of Directors meeting, an option
under the Company's stock option plan to acquire 1,200 shares of Common Stock of
the Company at the fair market value of such Common Stock on the date of the
grant. These options become vested and fully exercisable on the first
anniversary of the date of the grant, provided that the optionee is a director
of the Company on such anniversary date. Options are exercisable for ten years
after the date of the grant, provided that the optionee remains a director of
the Company. The exercise price of such options is 100% of the fair market value
of the Common Stock on the date of the grant. In 1997, the Directors of the
Company undertook, with the assistance of an outside consultant, a review of the
Company's policies with respect to director and board compensation.
EXECUTIVE COMPENSATION
The following table sets forth certain information for the years ended
December 31, 1998, 1997 and 1996 as to the compensation of (i) the Chief
Executive Officer of the Company, and (ii) the four most highly compensated
executive officers of the Company other than the Chief Executive Officer.
SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION
AWARDS
-----------------------
ANNUAL COMPENSATION ALL OTHER
---------------------------- SECURITIES COMPEN-
NAME AND SALARY BONUS UNDERLYING SATION
PRINCIPAL POSITION YEAR (1) (2) OPTIONS(3) (4)
------------------ ---- -------- -------- ---------- ---------
Frank P. Filipps......................... 1998 $400,000 $600,000 0 $19,920
President & CEO 1997 $300,000 $450,000 50,000 $ 8,000
1996 $250,000 $250,000 0 $ 7,500
William W. Carroll(5).................... 1998 $190,000 $228,000 0 $14,475
Sr. V.P. Sales -- CMAC 1997 $168,269 $218,750 19,500 $ 8,000
Paul F. Fischer.......................... 1998 $190,000 $209,000 0 $17,250
Sr. V.P. Risk Management -- CMAC 1997 $177,000 $177,000 28,500 $ 8,000
1996 $165,000 $165,000 0 $ 7,500
Douglas J. MacLeod....................... 1998 $187,000 $150,000 0 $17,235
Sr. V.P. Capital Markets -- CMAC 1997 $187,000 $149,600 23,000 $ 8,000
1996 $185,000 $173,000 0 $ 7,500
C. Robert Quint.......................... 1998 $180,000 $225,000 0 $15,387
Sr. V.P. Chief Financial Officer 1997 $167,000 $208,750 26,500 $ 8,000
1996 $160,000 $160,000 0 $ 7,500
- ---------------
(1) Includes salary deferrals and employee contributions to the Company's
Savings Incentive Plan.
(2) Bonus amounts are for services rendered in the calendar year noted but paid
in the subsequent Year.
(3) Options were granted on January 20, 1997 in consideration for 1996
performance and on December 2, 1997 in consideration for 1997 performance.
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(4) Includes matching contributions by the Company under the Company's Savings
Incentive Plan and other fringe benefits.
(5) Mr. Carroll's employment with CMAC commenced January 20, 1997.
The following table sets forth certain information concerning exercises of
stock options during the year ended December 31, 1998 and the value of
unexercised stock options at December 31, 1998 for (i) the Chief Executive
Officer of the Company, and (ii) the four most highly compensated executive
officers of the Company other than the Chief Executive Officer.
AGGREGATED OPTION/EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END
OPTION/VALUES(1)
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING OPTIONS AT IN-THE-MONEY OPTIONS
SHARES DECEMBER 31, 1998 AT DECEMBER 31, 1998
ACQUIRED VALUE --------------------------- ---------------------------
NAME ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ---------- ----------- ------------- ----------- -------------
Frank P. Filipps.......... 0 $ 0 143,750 96,250 $4,237,031 $1,451,718
William W. Carroll........ 0 $ 0 0 19,500 $ 0 $ 0
Paul F. Fischer........... 48,000 $2,429,622 40,000 58,500 $1,091,800 $ 969,293
Douglas J. MacLeod........ 7,000 $ 356,625 80,000 53,000 $2,281,200 $ 952,625
C. Robert Quint........... 0 $ 0 52,000 44,500 $1,513,980 $ 620,565
- ---------------
(1) At December 31, 1998, the closing price of a share of Common Stock on the
New York stock Exchange was $43.375.
PENSION PLAN
The Board of Directors of the Company has established the CMAC Investment
Corporation Pension Plan (the "Pension Plan"). The Pension Plan is intended to
be tax-qualified under Section 401(a) of the Internal Revenue Code. All salaried
and hourly employees of the Company are eligible to participate in the Pension
Plan upon the attainment of 20 years of age and one year of eligible service. A
participant is generally fully vested after five years of service subsequent to
age 18.
The amount of the annual normal retirement benefit of a participant is the
sum of (i) 1.1% of his average base salary (up to a statutory maximum equal to
$160,000 in 1998) for the five consecutive calendar years for which such average
is highest ("Average Annual Salary") multiplied by his number of years of
credited service not in excess of 35 years, plus (ii) 0.5% of the participant's
Average Annual Salary in excess of the average of the annual Social Security
taxable wage bases in effect for each of the 35 calendar years ending with the
calendar year in which he attains Social Security retirement age multiplied by
his number of years of credited service not in excess of 35 years, plus (iii)
0.5% of the participant's Average Annual Salary multiplied by his number of
years of credited service in excess of 35 years.
In January 1997, the Board of Directors of the Company established a
nonqualified Supplemental Executive Retirement Plan ("SERP"). This plan is
intended to provide certain executive officers with a supplemental retirement
program to the qualified pension plan. The difference between the SERP and the
qualified pension plan is that the SERP is not subject to the statutory cap on
compensation that may be taken into account for the calculation of benefits
($160,000 in 1998) and the statutory cap on actual benefits ($130,000 in 1998).
The benefit under the SERP is determined using the same formula as that under
the qualified pension plan but is based on total compensation (inclusive of
salary and bonus) up to 150% of average base pay for the three consecutive
calendar years for which such base pay is the highest. Under the terms of the
SERP, the Board of Directors must annually designate which executive officers
are eligible to participate in the SERP.
The following table sets forth the approximate annual pension that a
full-time employee, including an executive officer, may receive under the
Pension Plan, assuming selection of a single life annuity and
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retirement at age 65, based on the indicated assumptions as to Average Annual
Salary and years of credited service. The following table assumes that the
Company was in existence for the entire year of 1992. Benefits shown in the
following table in excess of $130,000 are payable by the Company only to persons
designated by the Board of Directors as participants in the SERP.
PENSION PLAN TABLE
YEARS OF CREDITED SERVICE
-------------------------------------------------------------------------
REMUNERATION 5 10 15 20 25 30 35
- ------------ ------- -------- -------- -------- -------- -------- --------
$100,000............. 7,250 14,500 21,750 29,000 36,250 43,500 50,750
$150,000............. 11,250 22,500 33,750 45,000 56,250 67,500 78,750
$160,000............. 12,050 24,100 36,150 48,200 60,250 72,300 84,350
$200,000............. 15,250 30,500 45,750 61,000 76,250 91,500 106,750
$250,000............. 19,250 38,500 57,750 77,000 96,250 115,500 134,750
$300,000............. 23,250 46,500 69,750 93,000 116,250 139,500 162,750
$500,000............. 39,250 78,500 117,750 157,000 196,250 235,500 274,750
$750,000............. 59,250 118,500 177,750 237,000 296,250 355,500 414,750
$1,000,000........... 79,250 158,500 237,750 317,000 396,250 475,500 554,750
For the year ended December 31, 1998, the base salary for purposes of the
Pension Plan for the executive officers named in the Summary Compensation Table
is set forth in the salary column of the Summary Compensation Table. The
credited years of service as of December 31, 1998 for each such executive
officer is as follows: Mr. Filipps -- 6 years; Mr. Carroll -- 2 years; Mr.
Fischer -- 22 years; Mr. MacLeod -- 7 years; and Mr. Quint -- 9 years.
STOCK OPTION AND COMPENSATION COMMITTEE REPORT ON COMPENSATION OF EXECUTIVE
OFFICERS OF THE COMPANY
The Stock Option and Compensation Committee (the "Committee") has provided
the following report on executive compensation for the year ended December 31,
1998:
COMPENSATION PHILOSOPHY
The Committee believes that the Company's executive compensation program
should be closely related to the services that the executives deliver to the
Company and the value such services bring to the stockholders of the Company.
The Committee believes an executive's compensation should be based, in
part, on the achievement by the Company of certain specified financial
objectives and, in part, on the achievement by the executive of specific,
individual objectives. The Company's financial objectives are recommended by
management and are approved by the Stock Option and Compensation Committee and
further ratified by the full Board of Directors. Achievement of both the
corporate and individual objectives should lead to improved performance and
greater value to the stockholders. The Stock Option and Compensation Committee
hired an outside consultant to review the Company's compensation programs in
light of those provided by similar organizations.
EXECUTIVE OFFICERS
The Company's executive compensation program is comprised of three
components: (i) annual base salary; (ii) annual bonus; and (iii) long-term
equity incentives. The variable portions of the executive compensation program
(annual bonus and stock options) are directly tied to the Company's results of
operations. The annual bonus has been designed to recognize shorter-term results
while awards of stock options have been implemented to recognize sustained
corporate growth and profitability. The annual bonus plan is designed to reflect
the achievement of specific individual and corporate goals and objectives
including specific net income and return on equity targets. The amount of the
annual bonus actually awarded to an executive officer is dependent on the
meeting or exceeding of specific targets which are developed at the
34
36
beginning of each year by the executive and the Company. Failure to reach the
targeted goals results in lower annual bonus awards and may, in the appropriate
circumstances, result in no award. Since the attainment of the goals and
objectives of the Company leads to increased stockholder returns, the annual
bonus plan creates a direct relationship between executive compensation and the
creation of additional value for the stockholders.
COMPENSATION OF THE CHIEF EXECUTIVE OFFICER
Mr. Filipps' annual compensation is fixed by the Committee. The Committee
may grant periodic salary increases, if warranted, after a review of Mr.
Filipps' performance and an assessment of the competitiveness of Mr. Filipps'
current base salary. The award of an annual bonus recognizes Mr. Filipps'
contributions to the Company's overall results. Contributions are measured
against specific goals and objectives which are established by the Committee at
the beginning of each year. The Committee considers the Company's return on
equity, combined ratio, market share, growth in earnings and revenue, reduction
in expenses, increases in profitability, as well as Mr. Filipps' individual
goals and objectives.
ANNUAL BASE SALARY
The annual base salary levels for the Company's executive officers are
intended to be competitive with salaries for executive officers in comparable
industries with similar levels of responsibility. The Company believes the
salaries are competitive. Salaries paid to executive officers are fixed by the
Committee. The Committee grants periodic salary increases, if warranted, after a
review of individual performance and an assessment of the competitiveness of the
executive's current salary.
ANNUAL BONUS
The award of an annual bonus recognizes the individual contributions of an
executive officer to the Company's overall results of operations. Contributions
are measured against specific goals and objectives established at the beginning
of the year for each executive officer and the Company. Among the factors
considered are the Company's return on equity, combined ratio, market share,
growth in earnings and revenue, reduction in expenses, increases in
productivity, etc. Individual objectives are based on the executive's position
with the Company or an affiliate.
The President and the next three most highly compensated executive officers
of the Company are eligible for bonuses of 100% of their annual base salary.
Subject to the requirements of Section 162(m) of the Internal Revenue Code, as
discussed in detail below, a bonus in excess of 100% may be awarded at the
discretion of the Board of Directors. In addition to the bonus eligibility of
the highly compensated executive officers as indicated above, the remaining
executive officers of the Company have the opportunity to earn annual bonuses
ranging from 50% to 75% of their annual base salary.
The Chairman and the President of the Company review the performance of all
executive officers and make specific recommendations to the Committee regarding
the amount of annual bonus, if any, to be awarded. The amount of the annual
bonus is dependent upon achieving specific goals and objectives.
LONG-TERM EQUITY INCENTIVE
The Company's 1992 Stock Option Plan and 1995 Equity Compensation Plan
provide the Company the opportunity to reward the contributions of key
employees, executive officers and others. In 1994, the Company undertook a
review of the compensation practices of corporations similar in size and/or
business to the Company. Based on this review, the President determined that the
use of stock option awards based on salary levels was the best method of
long-term incentive compensation of executive officers, and one that would
ensure that the executive officers hold equity stakes in the Company. The
Company's management modified the existing stock option grant guidelines and
suggested that the Committee adopt these modifications. Based upon the review
and management's recommendations, the Committee approved guidelines that provide
for stock option grants to executive officers (and key employees) upon the
occurrence of one (or more) of the following events: (i) initial employment,
(ii) promotion to a new, higher level position with increased responsibility and
accountability, and/or, (iii) the attainment of specific goals and objectives by
an executive
35
37
officer or key employee and the Company. Pursuant to these guidelines, the
President recommends the number of stock options to be granted to an executive
officer (or key employee) and presents this recommendation to the Committee
along with supporting data for its review and approval. The President may make a
recommendation to the Committee that deviates from the guidelines in appropriate
circumstances.
The Committee reviews the individual performance of Messrs. Wender and
Filipps. Mr. Filipps reviews the performances of the executive officers of the
Company and makes specific recommendations to the Committee regarding
eligibility for and the amount of stock options to be granted to those executive
officers (and key employees) of the Company he feels have made significant
contributions to the Company's results of operations.
The Committee evaluates the performance of the Company during a calendar
year by examining a number of factors including the Company's competitive
position in the mortgage insurance industry, growth in earnings, return on
equity and other specific corporate goals and objectives. The Committee also
examines the recommendations of the Chief Executive Officer. The Committee
grants, subject to approval and ratification by the Board of Directors, stock
options to the Chief Executive Officer and other executive officers and key
employees.
During 1998, the executive officers of the Company as a group were not
granted options to purchase shares.
COMPLIANCE WITH INTERNAL REVENUE CODE SECTION 162(m)
Section 162(m) of the Internal Revenue Code, enacted in 1993, generally
disallows a tax deduction to public companies for compensation over $1 million
paid to a corporation's Chief Executive Officer and the four next most highly
compensated executive officers except to the extent that any amount in excess of
such limit is paid pursuant to a plan containing a performance standard or a
stock option plan that meets certain requirements. The amendments for the 1992
Stock Option Plan approved at the 1995 Annual Meeting were designed to bring the
1992 Stock Option Plan into compliance with Section 162(m). The 1995 Equity
Compensation Plan was also drafted to comply with Section 162(m). To the extent
readily determinable and as one of the factors in its consideration of
compensation matters, the Stock Option and Compensation Committee considers the
anticipated tax treatment to the Company and to the executive officers of
various payments and benefits. The Stock Option and Compensation Committee
intends to retain the deductibility of compensation pursuant to Section 162(m),
but reserves the right to provide non-deductible compensation if it determines
that such action is in the best interests of the Company and its stockholders.
MEMBERS OF THE STOCK OPTION AND COMPENSATION COMMITTEE FOR 1998 WERE:
Robert W. Richards (Chairman), Claire M. Fagin and Ronald W. Moore. All of
the members of the compensation committee are non-employee directors.
PERFORMANCE GRAPH
The Securities and Exchange Commission requires that the Company's total
return to its stockholders be compared to a relevant market index and a similar
industry index for the last five years or such shorter period of time as the
Company has been publicly traded. The Company became a publicly-traded company
on October 30, 1992, when its initial public offering commenced. The following
compares the total return to stockholders of (i) a $100 investment in the
Company's Common Stock, (ii) the Standard and Poor's 500 index, and (iii) a peer
group constructed by the Company for the period December 31, 1993 through
December 31, 1998. The three companies in the peer group, MGIC Investment
Corporation, a publicly-traded mortgage insurance company, Fannie Mae and the
Federal Home Loan Mortgage Corporation ("Freddie Mac") have been selected
because their core businesses involve residential mortgage lending.
Total stockholder return is determined by dividing (i) the sum of the
cumulative amount of dividends for a given period (assuming dividend
reinvestment) and the difference between the share price at the end of the
beginning of the period, by (ii) the share price at the end of the period.
36
38
COMPUSTAT CUSTOM STUDY
TOTAL SHAREHOLDER RETURNS
(DIVIDENDS REINVESTED)
PERFORMANCE GRAPH
CMAC INVESTMENT
CORP S&P 500 INDEX PEER GROUP
--------------- ------------- ----------
'1994' 4.82 1.32 -1.32
'1995' 53.12 37.58 72.53
'1996' 67.62 22.96 28.10
'1997' 64.75 33.36 55.81
'1998' -23.73 28.58 32.97
PERFORMANCE GRAPH
CMAC INVESTMENT CORP S&P 500 INDEX PEER GROUP
-------------------- ------------- ----------
'1993' 100.00 100.00 100.00
'1994' 104.82 101.32 98.68
'1995' 160.49 139.40 170.24
'1996' 269.01 171.40 218.08
'1997' 443.18 228.59 339.79
'1998' 338.01 293.91 451.82
FOOTNOTES:
(1) Returns were prepared by Standard & Poor's Compustat, a division of
McGraw-Hill, Inc.
(2) The return for the peer group for the periods shown assumes the base period
to be equal to $100.00 and is calculated by weighing the returns for each
company in the peer group by the market capitalization at the beginning of
the periods shown.
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(3) Past total stockholder returns may not be indicative of returns to be
achieved in the future or for periods of time longer than the periods shown
in the above graph.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table indicates, as of December 31, 1998, information
relating to each person known to be the beneficial owner of more than five
percent (5%) of the Company's Common Stock.
SHARES PERCENT
VOTING POWER INVESTMENT POWER
-----------------------
BENEFICIALLY OF ----------------
NAME AND BUSINESS ADDRESS OWNED(1)(2) CLASS(3) SOLE SHARED SOLE SHARED
- ------------------------- ------------ -------- ---- --------- ---- ---------
Morgan Stanley, Dean Witter, Discover & Co.... 1,437,352 6.33% -0- 1,417,352 -0- 1,437,352
1585 Broadway
New York, New York 10036
- ---------------
(1) All the information in the table is presented in reliance on information
disclosed by the named individual and group in Schedule 13G, filed with the
Securities and Exchange Commission reporting as of March 2, 1999, as
amended.
(2) Van Kampen American Capital Asset Management Incorporated, a registered
investment advisor and wholly-owned subsidiary of Morgan Stanley, Dean
Witter, Discover & Co., is the beneficial owner of 1,274,000 of the shares
reported as a result of serving as investment manager with respect to
various investment accounts.
(3) The percentage has been determined based upon the number of shares
outstanding as of December 31, 1998.
OWNERSHIP OF COMMON STOCK BY DIRECTORS AND OFFICERS
The following table sets forth, as of December 31, 1998, all shares of
Common Stock of the Company which are deemed to be beneficially held by each
director of the Company, its Chief Executive Officer, the next four most highly
compensated executive officers of the Company, and the directors and all current
executive officers of the Company as a group.
NUMBER OF SHARES PERCENTAGE
BENEFICIAL OWNER BENEFICIALLY OWNED (1)(2)(3) OF CLASS(5)
- ---------------- ---------------------------- -----------
Herbert Wender........................................... 261,500 1.15%
Frank P. Filipps......................................... 167,064 *
Paul F. Fischer.......................................... 57,389 *
Douglas J. MacLeod....................................... 96,011 *
James C. Miller.......................................... 50,995(4)(6) *
C. Robert Quint.......................................... 65,097 *
David C. Carney.......................................... 20,600 *
James W. Jennings........................................ 19,600 *
Ronald W. Moore.......................................... 19,000 *
Robert W. Richards....................................... 18,500 *
Anthony W. Schweiger..................................... 19,000 *
Claire M. Fagin.......................................... 12,000 *
William Carroll.......................................... 186 *
All directors and current executive officers as a group
(16 persons)........................................... 831,796 3.66%
- ---------------
(1) Shares are "beneficially owned" by a person if such person, directly or
indirectly, has or shares (i) the voting power thereof, including the power
to vote or direct the voting of such shares, or (ii) the power to dispose or
direct the disposition of such shares. In addition, a person is deemed to
beneficially own any
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shares which such person has the right to acquire beneficial ownership of
within 60 days. Directors and officers have sole voting and investment
powers of the shares shown unless otherwise indicated.
(2) Includes shares of Common Stock allocable to employee contributions under
the CMAC Investment Corporation Savings Incentive Plan as of December 31,
1998, as to which the employee has dispositive power, as follows: Mr.
Filipps -- 1,814 shares, Mr. Fischer -- 2,215 shares, Mr. MacLeod -- 2,035
shares, Mr. Quint -- 2,947 shares, Mr. Carroll -- 186 shares, and current
executive officers as a group -- 12,051 shares.
(3) Includes shares that may be acquired within 60 days after the ownership date
reflected, upon exercise of employee and director stock options. Options are
included for the following individuals: Mr. Wender, 235,500 shares; Mr.
Filipps, 161,250 shares; Mr. Fischer, 54,125 shares; Mr. MacLeod, 93,750
shares; Mr. Quint, 60,750 shares; Messrs. Carney, Moore and Richards, 18,000
shares each; Mr. Schweiger, 13,500 shares; Mr. Jennings, 17,000 shares; Dr.
Fagin, 12,000 shares; and all current directors and executive officers as a
group, 722,875 shares.
(4) Includes shares of Common Stock allocable to employee contributions under
the CMAC Investment Corporation Savings Incentive Plan as of December 31,
1998, which Mr. Miller accumulated during his time as an employee of the
Company. Under the CMAC Investment Corporation Savings Incentive Plan, Mr.
Miller has dispositive power as to 3,795 shares held therein.
(5) "*" indicates less than one percent of class.
(6) Includes 200 shares owned by Mr. Miller's daughter as to which he disclaims
beneficial ownership.
CHANGE OF CONTROL AGREEMENTS
See "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" for a description of
change of control agreements between the Company and its executive officers.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Prior to the Company's initial public offering in October 1992 (the
"Offering"), the Company and CMAC were indirect subsidiaries of Reliance Group
Holdings, Inc. ("Reliance"). Mr. Wender, Chairman of the Board of the Company,
was Chairman of the Board and Chief Executive Officer of Commonwealth, an
indirect subsidiary of Reliance at that time.
Concurrently with the Offering, Commonwealth purchased 800,000 shares of
the Company's $4.125 Preferred Stock (the "Preferred Stock") for an aggregate
purchase price of $40.0 million. On February 27, 1998, Commonwealth was acquired
by Land America Financial Group, Inc. and as successor to Commonwealth, now owns
the Preferred Stock. Dividends on the Preferred Stock are payable quarterly and
for the year ended December 31, 1998 totaled $3.3 million. The Preferred Stock
is redeemable at the option of the Company at $54.125 per share beginning August
15, 2002 and declining to $50.00 per share, in ten annual installments of 72,000
shares beginning in 2002 and the remaining 80,000 shares in 2012. In the event
that dividends on the Preferred Stock are in arrears and unpaid in an amount
equal to six quarterly dividends, the size of the Company's Board of Directors
will be increased by two to permit the holders of the Preferred Stock, voting
separately as a class, to elect two directors. The Company may not consummate
any Fundamental Transaction (defined as a merger, consolidation, sale of assets
or similar transaction on which the holders of the Common Stock are entitled to
vote) unless such transaction is approved by two-thirds of the outstanding
shares of the Preferred Stock. In connection with the sale of Preferred Stock,
the Company granted to Commonwealth certain rights to register the Preferred
Stock under the Securities Act of 1933, as amended.
The Company has entered into change of control agreements with each of
Messrs. Filipps, Fischer, MacLeod, Quint, Carroll, Stevens and Yaruss. The
change of control agreements have initial terms of three years and upon
expiration of such period will be automatically extended for successive one-year
terms, unless terminated by either party. The change of control agreements
provide that in the event that, within two years after a "change in control" of
the Company or CMAC, the executive's employment is terminated (i) by the
39
41
Company for any reason other than (1) the executive's continued illness, injury
or incapacity for a period of twelve consecutive months or (2) for "cause",
which shall mean misappropriation of funds, habitual insobriety, substance
abuse, conviction of a crime involving moral turpitude, or gross negligence in
the performance of duties, which gross negligence has had a material adverse
effect on the business, operations, assets, properties or financial condition of
the Company and its subsidiaries taken as a whole, or (ii) by the executive in
the event of relocation or certain specified adverse changes in employment
status and compensation, the executive would be entitled to a lump-sum cash
payment equal to 2.0 times (1) the executive's then current annual base
compensation plus (2) the target bonus for the year in which a termination
occurs. Additionally, upon a change of control (as defined in the agreements),
all options not then vested would fully vest, and any restricted stock
previously granted to the executive which has not yet vested or become freely
transferable would become fully vested and freely transferable.
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PART IV
ITEM 14. FINANCIAL STATEMENT SCHEDULES, EXHIBITS AND REPORTS ON FORM 8-K
(a) 1. Financial statements -- The financial statements listed in the
accompanying Index to Consolidated Financial Statements and
Financial Statement Schedules are filed as part of this Form
10-K.
2. Financial statement schedules -- The financial statement
schedules listed in the accompanying Index to Consolidated
Financial Statements and Financial Statement Schedules are filed
as part of this Form 10-K.
3. Exhibits -- The exhibits listed in the accompanying Index to
Exhibits are filed as part of this Form 10-K.
(b) Reports on Form 8-K.
On November 25, 1998, the Registrant filed one report on Form 8-K with
respect to an Agreement and Plan of Merger dated as of November 22, 1998 between
CMAC Investment Corporation and Amerin Corporation.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
(ITEMS 14(A) 1 AND 2)
------------------------
PAGE
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated balance sheets at December 31, 1998 and 1997... F-1
Consolidated statements of income for each of the three
years in the period ended December 31, 1998............... F-2
Consolidated statements of changes in common stockholders'
equity and comprehensive income for each of the three
years in the period ended December 31, 1998............... F-3
Consolidated statements of cash flows for each of the three
years in the period ended December 31, 1998............... F-4
Notes to consolidated financial statements.................. F-5 to F-22
Independent auditors' report................................ F-23
FINANCIAL STATEMENT SCHEDULES
Schedule I -- Summary of investments -- other than
investments in related parties (December 31, 1998)........ S-1
Schedule III -- Condensed financial information of
Registrant (December 31, 1998)............................ S-2 to S-6
Schedule VI -- Reinsurance (December 31, 1998).............. S-7
All other schedules are omitted since the required information is not
present or is not present in amounts sufficient to require submission of the
schedules, or because the information required is included in the consolidated
financial statements and notes thereto.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on April 15, 1999.
CMAC Investment Corporation
By: /s/ FRANK P. FILIPPS
------------------------------------
Frank P. Filipps
(principal executive officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on April 15, 1999 by the following persons on
behalf of the registrant and in the capacities indicated.
NAME TITLE
---- -----
/s/ HERBERT WENDER Chairman of the Board and Director
- -----------------------------------------------------
Herbert Wender
/s/ FRANK P. FILIPPS President, Chief Executive Officer and
- ----------------------------------------------------- Director
Frank P. Filipps
/s/ C. ROBERT QUINT Senior Vice President, Chief Financial
- ----------------------------------------------------- Officer (principal accounting officer)
C. Robert Quint
/s/ DAVID C. CARNEY Director
- -----------------------------------------------------
David C. Carney
/s/ CLAIRE M. FAGIN, PH.D., R.N. Director
- -----------------------------------------------------
Claire M. Fagin, Ph.D., R.N.
/s/ JAMES W. JENNINGS Director
- -----------------------------------------------------
James W. Jennings
/s/ JAMES C. MILLER Director
- -----------------------------------------------------
James C. Miller
/s/ RONALD W. MOORE Director
- -----------------------------------------------------
Ronald W. Moore
/s/ ROBERT W. RICHARDS Director
- -----------------------------------------------------
Robert W. Richards
/s/ ANTHONY W. SCHWEIGER Director
- -----------------------------------------------------
Anthony W. Schweiger
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INDEX TO EXHIBITS
(ITEM 14(A) 3)
EXHIBIT
NUMBER EXHIBIT
- ------ -------
2.1 Agreement and Plan of Merger dated as of November 22, 1998
between Registrant and Amerin Corporation.(11)(Exhibit 2.1)
3.1 Amended and restated Certificate of Incorporation of the
Company.(2)(Exhibit 3.1)
3.2 Amended and restated by-laws of the Company. (4) (Exhibit
3.2)
4.1 Specimen certificate for Common Stock.(1)(Exhibit 4.1)
4.2 Certificate of Designations relating to $4.125 Preferred
Stock of the Company.(2)(Exhibit 4.2)
4.3 Specimen certificate for $4.125 Preferred Stock of the
Company.(1)(Exhibit 4.3)
4.4 Standstill and Voting Agreement dated October 27, 1992
between the Company and Reliance Group Holdings,
Inc.(2)(Exhibit 4.4)
4.5 Shareholders Rights Agreement.(10)(Exhibit 4)
10.1 Tax Indemnification Agreement dated October 28, 1992 among
the Company, Commonwealth Land Title Insurance Company,
Reliance Insurance Company and Reliance Group Holdings,
Inc.(2)(Exhibit 10.3)
10.2 Tax Allocation Agreement dated as of April 1, 1992, among
Reliance Insurance Company and certain of its subsidiaries,
including Commonwealth Mortgage Assurance
Company.(1)(Exhibit 10.4)
10.3 Form of Change of Control Agreement dated January 25, 1995,
between the Company and each of Frank P. Filipps, Douglas J.
MacLeod, Paul F. Fischer and C. Robert Quint.(5)(9) (Exhibit
10.6)
10.4 Change of Control Agreements dated October 30, 1997, between
the Company and both Howard S. Yaruss and William
Carroll.(7)(9) (Exhibit 10.7)
*10.5 Change of Control Agreement dated February 6, 1998, between
the Company and Scott C. Stevens.(9)
10.6 CMAC Investment Corporation Pension Plan.(2)(9)(Exhibit
10.8)
10.7 CMAC Investment Corporation Savings Incentive Plan, as
amended and restated through January 1, 1994.(5)(9)(Exhibit
10.9)
10.8 CMAC Investment Corporation 1992 Stock Option Plan as
amended as of January 1, 1995.(5)(9)(Exhibit 10.10)
*10.9 CMAC Investment Corporation Equity Compensation Plan as
amended and restated through April 13, 1999.(9)
10.10 Purchase Agreement dated October 29, 1992 between the
Company and Commonwealth Land Title Insurance Company
regarding $4.125 Preferred Stock.(2)(Exhibit 10.14)
10.11 Registration Rights Agreement dated October 27, 1992 between
the Company and Commonwealth Land Title Insurance
Company.(2)(Exhibit 10.15)
10.12 Form of Commonwealth Mortgage Assurance Company Master
Policy.(1)(Exhibit 10.16)
10.13 Risk-to-Capital Ratio Maintenance Agreement between the
Company and Commonwealth Mortgage Assurance Company
regarding matters relating to Moody's financial strength
rating as amended through October 22, 1993.(3)(Exhibit
10.15)
10.14 Reserve Account Agreement dated August 14, 1992, between the
Company and Commonwealth Mortgage Assurance Company
regarding $4.125 Preferred Stock.(1)(Exhibit 10.18)
10.15 First Layer Binder of Reinsurance, effective March 1, 1992,
among Commonwealth Mortgage Assurance Company, Commonwealth
Mortgage Assurance Company of Arizona, and AXA Reinsurance
SA.(1)(Exhibit 10.19)
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EXHIBIT
NUMBER EXHIBIT
- ------ -------
10.16 Capital Mortgage Reinsurance Company Variable Quota Share
Reinsurance Agreement, effective January 1, 1994, between
Commonwealth Mortgage Assurance Company and its affiliates
and Capital Mortgage Reinsurance Company.(4)(Exhibit 10.19)
10.17 Capital Reinsurance Company Reinsurance Agreement, effective
January 1, 1994, between Commonwealth Mortgage Assurance
Company and Capital Reinsurance Company.(4)(Exhibit 10.20)
10.18 Capital Mortgage Reinsurance Company Variable Quota Share
Reinsurance Agreement, effective January 1, 1995, between
Commonwealth Mortgage Assurance Company and its affiliates
and Capital Mortgage Reinsurance Company.(5)(Exhibit 10.20)
10.19 Capital Mortgage Reinsurance Company Variable Quota Share
Reinsurance Agreement, effective January 1, 1996, between
Commonwealth Mortgage Assurance Company and its affiliates
and Capital Mortgage Reinsurance Company.(6)(Exhibit 10.21)
10.20 Capital Mortgage Reinsurance Company Variable Quota Share
Reinsurance Agreement, effective January 1, 1997, between
Commonwealth Mortgage Assurance Company and its affiliates
and Capital Mortgage Reinsurance Company.(7)(Exhibit 10.22)
10.21 Amended form of Commonwealth Mortgage Assurance Company
Master Policy, effective June 1, 1995.(4)(Exhibit 10.22)
10.22 CMAC Investment Corporation 1997 Employee Stock Purchase
Plan.(8)
22.1 Revised Subsidiaries of the Company.(1)(Exhibit 22.1)
*24.1 Consent of Deloitte & Touche LLP.
*27 Financial Data Schedule.
- ---------------
* Filed herewith.
(1) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the Registrant's Registration Statement on Form S-1 filed
August 24, 1992 and amendments thereto (File No. 33-51188).
(2) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the Registrant's Annual Report on Form 10-K filed March
30, 1993.
(3) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the Registrant's Annual Report on Form 10-K filed March
30, 1994.
(4) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the Registrant's Annual Report on Form 10-K filed March
30, 1995.
(5) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the Registrant's Annual Report on Form 10-K filed March
29, 1996.
(6) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the Registrant's Annual Report on Form 10-K filed March
31, 1997.
(7) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the Registrant's Annual Report on Form 10-K filed March
31, 1998.
(8) Incorporated by reference filed in the Registrant's Registration Statement
on Form S-8 filed November 19, 1997 (File No. 333-40623).
(9) Management contract or compensatory plan or arrangement required to be
filed pursuant to Item 14(c) of Form 10-K.
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46
(10) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the Registrant's Report on Form 8-K filed May 1, 1998.
(11) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the Registrants' Report on Form 8-K filed November 25,
1998.
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47
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31
----------------------
1998 1997
--------- ---------
(IN THOUSANDS,
EXCEPT SHARE AMOUNTS)
ASSETS
Investments
Fixed maturities held to maturity -- at amortized cost
(fair value $512,368 and $517,931)..................... $477,518 $487,941
Fixed maturities available for sale -- at fair value
(amortized cost $205,047 and $91,949).................. 212,771 97,962
Equity securities -- at fair value (cost $25,109)........... 27,425 --
Short-term investments...................................... 18,596 11,027
Cash........................................................ 2,191 2,364
Deferred policy acquisition costs........................... 32,144 25,025
Prepaid federal income taxes................................ 103,763 78,213
Provisional losses recoverable.............................. 32,718 31,325
Other assets................................................ 61,047 48,208
-------- --------
$968,173 $782,065
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Unearned premiums........................................... $ 49,424 $ 49,332
Reserve for losses.......................................... 201,276 148,628
Deferred federal income taxes............................... 112,055 83,991
Accounts payable and accrued expenses....................... 42,449 30,171
-------- --------
405,204 312,122
-------- --------
Redeemable preferred stock, par value $.001 per share;
800,000 shares issued and outstanding -- at redemption
value..................................................... 40,000 40,000
-------- --------
Commitments and contingencies
Common stockholders' equity
Common stock, par value $.001 per share; 80,000,000 shares
authorized; 22,705,958 and 22,536,674 shares,
respectively, issued and outstanding................... 23 22
Additional paid-in capital................................ 185,219 179,846
Retained earnings......................................... 331,201 246,166
Accumulated other comprehensive income.................... 6,526 3,909
-------- --------
522,969 429,943
-------- --------
$968,173 $782,065
======== ========
See notes to consolidated financial statements.
F-1
48
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31
-----------------------------------------
1998 1997 1996
----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS)
Revenues
Net premiums written..................................... $281,084 $233,026 $183,676
Decrease in unearned premiums............................ 1,068 4,684 4,245
-------- -------- --------
Premiums earned.......................................... 282,152 237,710 187,921
Net investment income.................................... 38,550 33,787 30,011
Gain on sales of investments, net........................ 1,641 806 868
Other income............................................. 10,623 5,007 3,796
-------- -------- --------
332,966 277,310 222,596
-------- -------- --------
Expenses
Provision for losses..................................... 132,023 117,149 91,894
Policy acquisition costs................................. 36,139 31,287 26,850
Other operating expenses................................. 38,980 26,381 21,277
-------- -------- --------
207,142 174,817 140,021
-------- -------- --------
Pretax income.............................................. 125,824 102,493 82,575
Provision for income taxes................................. (34,770) (27,526) (20,354)
-------- -------- --------
Net income................................................. 91,054 74,967 62,221
Dividends to preferred stockholder......................... 3,300 3,300 3,300
-------- -------- --------
Net income available to common stockholders................ $ 87,754 $ 71,667 $ 58,921
======== ======== ========
Basic net income per share................................. $ 3.87 $ 3.19 $ 2.64
======== ======== ========
Diluted net income per share............................... $ 3.72 $ 3.06 $ 2.55
======== ======== ========
See notes to consolidated financial statements.
F-2
49
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN COMMON STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
ACCUMULATED
ADDITIONAL OTHER
COMMON PAID-IN RETAINED COMPREHENSIVE
STOCK CAPITAL EARNINGS INCOME TOTAL
------ ---------- -------- ------------- --------
(IN THOUSANDS)
Balance, January 1, 1996........... $11 $163,665 $131,816 $3,124 $298,616
Comprehensive income:
Net income......................... -- -- 62,221 -- 62,221
Unrealized holding gains arising
during period, net of tax of
$75.............................. -- -- -- 139
Less: Reclassification adjustment
for net gains included in net
income, net of tax of $305....... -- -- -- (567)
------
Net unrealized loss on investments,
net of tax of ($230)............. -- -- -- (428) (428)
--------
Comprehensive income............... 61,793
Issuance of common stock........... -- 1,581 -- -- 1,581
Two-for-one stock split............ 11 11,185 (11,196) -- --
Dividends.......................... -- -- (5,646) -- (5,646)
--- -------- -------- ------ --------
Balance, December 31, 1996......... 22 176,431 177,195 2,696 356,344
Comprehensive income:
Net income......................... -- -- 74,967 -- 74,967
Unrealized holding gains arising
during period, net of tax of
$938............................. -- -- -- 1,742
Less: Reclassification adjustment
for net gains included in net
income, net of tax of $285....... -- -- -- (529)
------
Net unrealized gain on investments,
net of tax of $653............... -- -- -- 1,213 1,213
--------
Comprehensive income............... 76,180
Issuance of common stock........... -- 3,415 -- -- 3,415
Dividends.......................... -- -- (5,996) -- (5,996)
--- -------- -------- ------ --------
Balance, December 31, 1997......... 22 179,846 246,166 3,909 429,943
Comprehensive income:
Net income......................... -- -- 91,054 -- 91,054
Unrealized holding gains arising
during period, net of tax of
$1,920........................... -- -- -- 3,566
Less: Reclassification adjustment
for net gains included in net
income, net of tax of $511....... -- -- -- (949)
------
Net unrealized gain on investments,
net of tax of $1,409............. -- -- -- 2,617 2,617
--------
Comprehensive income............... 93,671
Issuance of common stock........... 1 5,373 -- -- 5,374
Dividends.......................... -- -- (6,019) -- (6,019)
--- -------- -------- ------ --------
Balance, December 31, 1998......... $23 $185,219 $331,201 $6,526 $522,969
=== ======== ======== ====== ========
See notes to consolidated financial statements.
F-3
50
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31
-------------------------------
1998 1997 1996
--------- -------- --------
(IN THOUSANDS)
Cash flows from operating activities
Net income................................................ $ 91,054 $ 74,967 $ 62,221
Adjustments to reconcile net income to net cash provided
by operating activities
Gain on sales of fixed maturity investments, net....... (1,668) (806) (868)
Loss on sales of equity securities available for
sale................................................. 26 -- --
Increase (decrease) in unearned premiums............... 92 (4,052) (2,731)
Amortization of deferred policy acquisition costs...... 36,139 31,287 26,850
Increase in deferred policy acquisition costs.......... (43,258) (32,412) (29,400)
Increase in reserve for losses......................... 52,648 40,422 40,905
Increase in deferred federal income taxes.............. 26,655 21,622 14,942
Increase in prepaid federal income taxes............... (26,250) (21,000) (15,250)
Increase in provisional losses recoverable............. (1,393) (13,126) (10,026)
Net change in other assets, accounts payable and
accrued expenses..................................... (1,770) (3,366) (2,166)
--------- -------- --------
Net cash provided by operating activities................... 132,275 93,536 84,477
--------- -------- --------
Cash flows from investing activities
Proceeds from sales of fixed maturity investments
available for sale..................................... 30,178 18,995 8,974
Proceeds from sales of fixed maturity investments held to
maturity............................................... 1,031 -- --
Proceeds from sales of equity securities available for
sale................................................... 698 -- --
Proceeds from redemptions of fixed maturity investments
available for sale..................................... 23,973 13,076 12,389
Proceeds from redemptions of fixed maturity investments
held to maturity....................................... 13,843 4,945 890
Proceeds from redemptions of equity securities available
for sale............................................... 125 -- --
Purchases of fixed maturity investments available for
sale................................................... (166,931) (12,814) (19,755)
Purchases of fixed maturity investments held to
maturity............................................... -- (98,875) (78,876)
Purchases of equity securities available for sale......... (25,958) -- --
Purchases of short-term investments, net.................. (7,569) (5,831) (245)
Purchases of real estate owned, net....................... (102) (6,330) (700)
Other..................................................... (1,091) (4,946) (3,546)
--------- -------- --------
Net cash used in investing activities....................... (131,803) (91,780) (80,869)
--------- -------- --------
Cash flows from financing activities
Dividends paid............................................ (6,019) (5,996) (5,646)
Proceeds from issuance of common stock.................... 5,374 3,415 1,581
--------- -------- --------
Net cash used in financing activities....................... (645) (2,581) (4,065)
--------- -------- --------
Decrease in cash............................................ (173) (825) (457)
Cash, beginning of year..................................... 2,364 3,189 3,646
--------- -------- --------
Cash, end of year........................................... $ 2,191 $ 2,364 $ 3,189
========= ======== ========
Supplemental disclosures of cash flow information
Income taxes paid......................................... $ 31,000 $ 25,750 $ 19,250
========= ======== ========
Interest paid............................................. $ 66 $ -- $ 70
========= ======== ========
See notes to consolidated financial statements.
F-4
51
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
CMAC Investment Corporation (the "Company") was incorporated in December
1991 in order to hold the capital stock of Commonwealth Mortgage Assurance
Company ("CMAC"). In the fourth quarter of 1992, a merger among controlled
subsidiaries of CMAC was completed with the effect that the Company acquired all
of the outstanding stock of CMAC, and CMAC's sole stockholder, Commonwealth Land
Title Insurance Company ("Commonwealth"), then an indirect wholly owned
subsidiary of Reliance Group Holdings, Inc. ("Reliance"), acquired all of the
outstanding capital stock of the Company.
In the fourth quarter of 1992, an initial public offering of the Company's
common stock (the "Offering") was completed. In this Offering, Commonwealth sold
all of the 7,000,000 shares owned by it, and the Company issued and sold
3,950,000 shares. In addition, the Company issued and sold 800,000 shares of
$4.125 Preferred Stock to Commonwealth. Aggregate proceeds to the Company from
the sale of common stock were approximately $67,200,000 and from the sale of
preferred stock were $40,000,000.
CMAC and its subsidiaries provide private mortgage insurance and risk
management services to mortgage lending institutions located throughout the
United States. Consistent with the private mortgage insurance industry, CMAC's
highest state concentration of risk is in California. As of December 31, 1998,
California accounted for 18.3% of CMAC's total direct primary risk in force and
8.5% of CMAC's total direct pool risk in force. In addition, California
accounted for 18.5% of CMAC's direct new insurance written for the year ended
December 31, 1998. Private mortgage insurance protects lenders from
default-related losses on residential first mortgage loans made to home buyers
who make down payments of less than 20 percent of the purchase price and
facilitates the sale of these mortgages in the secondary market.
The consolidated financial statements are prepared in accordance with
generally accepted accounting principles and include the accounts of all
subsidiaries. All material intercompany balances and transactions have been
eliminated in consolidation.
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company to make estimates and
assumptions that affect the reported amounts of assets and liabilities as of the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Proposed Merger
On November 22, 1998, the board of directors of the Company and the board
of directors of Amerin Corporation each approved an Agreement and Plan of Merger
pursuant to which the Company and Amerin will merge. The anticipated merger
calls for Amerin stockholders to receive 0.5333 shares of the Company's common
stock in a tax-free exchange for each share of Amerin common stock that they
own. The Company's stockholders will continue to own their existing shares after
the merger. Completion of the merger is subject to approval by the stockholders
of both companies and, pending this approval, the transaction is expected to
close in May 1999. The merger transaction will be accounted for on a pooling of
interests basis.
Insurance Premiums
Premiums written on an annual and multiyear basis are initially deferred as
unearned premiums and earned over the policy term, and premiums written on a
monthly basis are primarily earned as they are received. Annual premiums are
amortized on a monthly, straight-line basis. Multiyear premiums are amortized
over the terms of the contracts in accordance with the anticipated claim payment
pattern based on historical industry experience. Ceded premiums written are
initially set up as prepaid reinsurance and are amortized in accordance with
direct premiums earned.
F-5
52
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Reserve for Losses
The reserve for losses consists of the estimated cost of settling claims on
defaults reported and defaults that have occurred but have not been reported.
Consistent with generally accepted accounting principles and industry accounting
practices, the Company does not establish loss reserves for future claims on
insured loans that are not currently in default. In determining the liability
for unpaid losses related to reported outstanding defaults, the Company
establishes loss reserves on a case-by-case basis. The amount reserved for any
particular loan is dependent upon the status of the loan as reported by the
servicer of the insured loan as well as the economic condition and estimated
foreclosure period in the area in which the default exists. As the default
progresses closer to foreclosure, the amount of loss reserve for that particular
loan is increased, in stages, to approximately 100 percent of the Company's
exposure and that adjustment is included in current operations. The Company also
reserves for defaults that have occurred but have not been reported using
historical information on defaults not reported on a timely basis by lending
institutions. The estimates are continually reviewed and, as adjustments to
these liabilities become necessary, such adjustments are reflected in current
operations.
Deferred Policy Acquisition Costs
Costs associated with the acquisition of mortgage insurance business,
consisting of compensation, premium taxes and other policy issuance and
underwriting expenses, are initially deferred. The costs related to annual and
multiyear policies are amortized on a basis consistent with the recognition of
income while costs related to monthly policies are amortized over a period of
two years.
Income Taxes
Deferred income taxes are provided for the temporary difference between the
financial reporting basis and the tax basis of the Company's assets and
liabilities using enacted tax rates applicable to future years.
Investments
The Company is required to group its investment portfolio in three
categories: held to maturity, available for sale, and trading securities. Debt
securities for which the Company has the positive intent and ability to hold to
maturity are classified as held to maturity and reported at amortized cost. Debt
and equity securities purchased and held principally for the purpose of selling
them in the near term are classified as trading securities and reported at fair
value, with unrealized gains and losses included in earnings. The Company had no
trading securities in its portfolio at December 31, 1998 or 1997. All other
investments are classified as available for sale and are reported at fair value,
with unrealized gains and losses (net of tax) reported in a separate component
of stockholders' equity. Realized gains and losses are determined on a specific
identification method and are included in income.
Fair Values of Financial Instruments
The following methodology was used by the Company in estimating the fair
value disclosures for its financial instruments: fair values for fixed maturity
securities (including redeemable preferred stock) and equity securities are
based on quoted market prices, dealer quotes, and prices obtained from
independent pricing services. The carrying amounts reported on the balance sheet
for cash and short-term investments approximate their fair values.
Accounting for Stock-Based Compensation
The Company accounts for stock-based compensation in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation". SFAS 123 requires
F-6
53
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
expanded disclosures of stock-based compensation arrangements with employees and
encourages, but does not require the recognition of compensation expense for the
fair value of stock options and other equity instruments granted as compensation
to employees. The Company has chosen to continue to account for stock-based
compensation using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees,"
("APB 25") and related interpretations. Accordingly, compensation cost for stock
options is measured as the excess, if any, of the quoted market price of the
Company's stock at the date of the grant over the amount an employee must pay to
acquire the stock.
Net Income Per Share
In March 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 128, "Earnings Per Share". SFAS 128 requires the Company to disclose
both "basic" earnings per share and "diluted" earnings per share. Basic net
income per share is based on the weighted average number of common shares
outstanding, while diluted net income per share is based on the weighted average
number of common shares outstanding and common share equivalents that would
arise from the exercise of stock options. On October 15, 1996, the Board of
Directors authorized a stock split, payable December 2, 1996, in the form of a
dividend of one additional share of the Company's common stock for each share
owned by stockholders of record on November 7, 1996. The dividend was accounted
for as a two-for-one stock split and the par value of the common stock remained
at $.001 per share. Accordingly, all references to common per-share data have
been adjusted to give effect to the stock split. The calculation of the basic
and diluted net income per share, after giving effect to the stock split, was as
follows (in thousands, except per-share amounts):
1998 1997 1996
------- ------- -------
Net income.................................................. $91,054 $74,967 $62,221
Preferred stock dividend adjustment......................... (3,300) (3,300) (3,300)
------- ------- -------
Adjusted net income......................................... $87,754 $71,667 $58,921
------- ------- -------
Average diluted stock options outstanding................... 1,489.4 1,526.6 1,494.3
Average exercise price per share............................ $ 19.79 $ 16.64 $ 14.21
Average market price per share -- diluted basis............. $ 54.67 $ 44.66 $ 29.73
Average common shares outstanding........................... 22,657 22,471 22,340
Increase in shares due to exercise of options -- diluted
basis..................................................... 917 945 770
Adjusted shares outstanding -- diluted...................... 23,574 23,416 23,110
Net income per share -- basic............................... $ 3.87 $ 3.19 $ 2.64
======= ======= =======
Net income per share -- diluted............................. $ 3.72 $ 3.06 $ 2.55
======= ======= =======
Comprehensive Income
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income," which requires an entity to present, as a component of comprehensive
income, the amounts from transactions and other events which are currently
excluded from the statement of income and are recorded directly to stockholders'
equity. The Company adopted SFAS No. 130 in 1998.
Accounting Principles Issued and Not Yet Adopted
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The statement is effective for fiscal years
beginning after June 15, 1999 and will not be applied retroactively. The
statement establishes accounting and reporting standards for derivative
instruments and hedging activity and requires that all derivatives be measured
at fair value and recognized as either assets or
F-7
54
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
liabilities in the financial statements. The impact of the statement will depend
on the extent of derivatives and embedded derivatives at the date the statement
is adopted. The Company is currently evaluating the effect this statement might
have on the consolidated financial position or results of operations.
In October 1998, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants issued Statement of Position
98-7, "Deposit Accounting; Accounting for Insurance and Reinsurance Contracts
That Do Not Transfer Insurance Risk." This statement provides guidance on how to
apply the deposit method of accounting when it is required for insurance and
reinsurance contracts that do not transfer insurance risk. This statement is
effective for financial statements for fiscal years beginning after June 15,
1999. Management does not believe that the impact of applying this statement
will be material to the consolidated financial position or results of operations
of the Company when adopted.
Reclassifications
Certain items in the 1997 consolidated financial statements have been
reclassified to conform with the presentation in the 1998 consolidated financial
statements. Among the items reclassified is an adjustment relating to the
treatment of tax and loss bonds as more fully disclosed in note 6.
2. INVESTMENTS
Fixed maturity and equity investments at December 31, 1998 and 1997
consisted of (in thousands):
DECEMBER 31, 1998
-------------------------------------------------
GROSS GROSS
AMORTIZED FAIR UNREALIZED UNREALIZED
COST VALUE GAINS LOSSES
--------- -------- ---------- ----------
Fixed maturities held to maturity at amortized
cost:
Bonds and notes:
United States government................... $ 12,551 $ 13,156 $ 605 $ --
State and municipal obligations............ 464,967 499,212 34,307 62
-------- -------- ------- ------
$477,518 $512,368 $34,912 $ 62
======== ======== ======= ======
Fixed maturities available for sale:
Bonds and notes:
United States government................... $ 186 $ 191 $ 5 $ --
State and municipal obligations............ 116,131 117,056 1,175 250
Corporate.................................. 16,034 16,522 661 173
Mortgage-backed securities.................... 32,276 32,783 522 15
Redeemable preferred stock.................... 40,420 46,219 5,815 16
-------- -------- ------- ------
$205,047 $212,771 $ 8,178 $ 454
======== ======== ======= ======
Equity securities available for sale:
Equity securities.......................... $ 25,109 $ 27,425 $ 3,823 $1,507
======== ======== ======= ======
F-8
55
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31, 1997
-------------------------------------------------
GROSS GROSS
AMORTIZED FAIR UNREALIZED UNREALIZED
COST VALUE GAINS LOSSES
--------- -------- ---------- ----------
Fixed maturities held to maturity at amortized
cost:
Bonds and notes:
United States government................... $ 13,242 $ 13,710 $ 468 $ --
State and municipal obligations............ 474,699 504,221 29,758 236
-------- -------- ------- ------
$487,941 $517,931 $30,226 $ 236
======== ======== ======= ======
Fixed maturities available for sale:
Mortgage-backed securities.................... $ 13,605 $ 14,169 $ 565 $ 1
Redeemable preferred stock.................... 78,344 83,793 7,546 2,097
-------- -------- ------- ------
$ 91,949 $ 97,962 $ 8,111 $2,098
======== ======== ======= ======
The contractual maturities of fixed maturity investments are as follows (in
thousands):
DECEMBER 31, 1998
---------------------
AMORTIZED FAIR
COST VALUE
--------- --------
Fixed maturities held to maturity:
1999................................................. $ 3,642 $ 3,676
2000-2003............................................ 48,925 51,815
2004-2008............................................ 187,022 202,495
2009 and thereafter.................................. 237,929 254,382
-------- --------
$477,518 $512,368
======== ========
Fixed maturities available for sale:
1999................................................. $ -- $ --
2000-2003............................................ 6,362 6,684
2004-2008............................................ 5,325 5,361
2009 and thereafter.................................. 120,664 121,724
Mortgage-backed securities........................... 32,276 32,783
Redeemable preferred stock........................... 40,420 46,219
-------- --------
$205,047 $212,771
======== ========
Net investment income consisted of (in thousands):
YEAR ENDED DECEMBER 31
-----------------------------
1998 1997 1996
------- ------- -------
Investment income:
Fixed maturities.................................... $37,006 $32,892 $29,190
Equity securities................................... 291 -- --
Short-term investments.............................. 1,026 440 348
Other............................................... 449 642 688
------- ------- -------
38,772 33,974 30,226
Investment expenses................................... (222) (187) (215)
------- ------- -------
$38,550 $33,787 $30,011
======= ======= =======
F-9
56
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Net gain on sales of investments consisted of (in thousands):
YEAR ENDED DECEMBER 31
----------------------
1998 1997 1996
------ ---- ----
Gains on sales and redemptions of fixed maturity investments
available for sale........................................ $1,868 $828 $873
Losses on sales and redemptions of fixed maturity
investments available for sale............................ (221) (15) (2)
Gains on sales and redemptions of fixed maturity investments
held to maturity.......................................... 43 -- --
Losses on redemptions of fixed maturity investments held to
maturity.................................................. (23) (7) (3)
Gains on sales and redemptions of equity securities
available for sale........................................ 37 -- --
Losses on sales and redemptions of equity securities
available for sale........................................ (63) -- --
------ ---- ----
$1,641 $806 $868
====== ==== ====
For the year ended December 31, 1998, the Company sold a fixed maturity
investment held to maturity with an amortized cost of $1,061,000 which resulted
in a gross realized gain of $30,000. The investment was sold in response to a
significant deterioration in the issuer's creditworthiness.
Net unrealized appreciation (depreciation) on investments consisted of (in
thousands):
YEAR ENDED DECEMBER 31
----------------------------
1998 1997 1996
------ ------- -------
Fixed maturities held to maturity...................... $4,860 $13,611 $(2,847)
====== ======= =======
Fixed maturities available for sale.................... $1,711 $ 1,866 $ (659)
Deferred tax (provision) benefit....................... (599) (653) 231
------ ------- -------
$1,112 $ 1,213 $ (428)
====== ======= =======
Equity securities available for sale................... $2,316 $ -- $ --
Deferred tax provision................................. (811) -- --
------ ------- -------
$1,505 $ -- $ --
====== ======= =======
Securities on deposit with various state insurance commissioners amounted
to $4,932,000 at December 31, 1998 and $4,318,000 at December 31, 1997.
3. REINSURANCE
CMAC utilizes reinsurance to reduce net risk in force to meet regulatory
risk to capital requirements and to comply with the regulatory maximum policy
coverage percentage limitation of 25 percent. Although the use of reinsurance
does not discharge an insurer from its primary liability to the insured, the
reinsuring company assumes the related liability. Included in other assets are
amounts recoverable from reinsurers pertaining to unpaid claims, claims incurred
but not reported and unearned premiums (prepaid reinsurance). Prepaid
reinsurance premiums were $9,236,000 and $8,077,000 at December 31, 1998 and
1997, respectively.
F-10
57
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The effect of reinsurance on premiums written and earned is as follows for
the years ended December 31 (in thousands):
1998 1997 1996
-------- -------- --------
Premiums written:
Direct........................................... $313,354 $254,134 $200,228
Assumed.......................................... 97 143 181
Ceded............................................ (32,367) (21,251) (16,733)
-------- -------- --------
Net premiums written............................. $281,084 $233,026 $183,676
======== ======== ========
Premiums earned:
Direct........................................... $313,231 $258,148 $203,042
Assumed.......................................... 129 181 147
Ceded............................................ (31,208) (20,619) (15,268)
-------- -------- --------
Net premiums earned.............................. $282,152 $237,710 $187,921
======== ======== ========
The 1998, 1997 and 1996 figures included $26,676,000, $18,847,000 and
$13,659,000 for premiums written and $27,126,000, $18,759,000 and $13,494,000
for premiums earned, respectively, for reinsurance ceded under variable quota
share treaties entered into in 1997, 1996, 1995 and 1994 covering the books of
business originated in those years. The 1998, 1997 and 1996 figures included
$3,614,000, $1,801,000 and $2,398,000 for premiums written and $2,042,000,
$1,211,000 and $1,072,000 for premiums earned, respectively, of reinsurance
ceded under an excess of loss reinsurance program that was entered into in 1992.
Provisional losses recoverable of $32,718,000 and $31,325,000 for 1998 and
1997, respectively, represent amounts due under variable quota share treaties
entered into in 1997, 1996, 1995 and 1994, covering the books of business
originated in those years. The term of each treaty is ten years and is
non-cancelable by either party except under certain conditions. The treaties
also include underwriting year excess coverage in years four, seven and ten of
the treaty.
Under the terms of the contract, the Company cedes premium to the reinsurer
based on 15% of the premiums received by the Company on the covered business.
The Company is entitled to receive a ceding commission ranging from 30% to 32%
of the premium paid under the treaty provided that certain loss ratios are not
exceeded. In return for the payment of premium, the Company receives variable
quota share loss relief at levels ranging from 7.5% to 15.0% based upon the loss
ratio on the covered business.
In addition, the Company is entitled to receive, under the underwriting
year excess coverage, 8% of the ceded premium written under each treaty to the
extent that this amount is greater than the total amount received under the
variable quota share coverage on paid losses.
Premiums are payable to the reinsurer on a quarterly basis net of ceding
commissions due and any losses calculated under the variable quota share
coverage. At the end of the fourth, seventh and tenth years of each treaty,
depending on the extent of losses recovered to date under the variable quota
share provisions of the treaty, the Company may recover amounts due under the
underwriting year excess coverage provisions of the treaty.
The Company accounts for this reinsurance coverage under guidance provided
in EITF 93-6, "Accounting for Multiple-Year Retrospectively Rated Contracts by
Ceding and Assuming Enterprises". Under EITF 93-6, the Company recognizes an
asset for amounts due from the reinsurer based on experience to date under the
contract.
F-11
58
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
For the years ended December 31, 1998, 1997 and 1996, the Company paid
$26,676,000, $18,847,000 and $13,659,000, respectively, less ceding commissions
of $9,076,000, $9,317,000 and $6,680,000 and recovered variable quota share
losses under the treaties of $4,600,000, $4,877,000 and $3,121,000,
respectively.
4. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
As described in note 1, the Company establishes reserves to provide for the
estimated costs of settling claims in respect of loans reported to be in default
and loans that are in default which have not yet been reported to the Company.
The default and claim cycle on loans that the Company covers begins with
our receipt from the lender of notification of a default on an insured loan. Our
master policy with each lender requires them to inform the Company of an uncured
default on a mortgage loan within 75 days of the default. The incidence of
default is influenced by a number of factors, including change in borrower
income, unemployment, divorce and illness, the level of interest rates and
general borrower creditworthiness. Defaults that are not cured result in claims
to the Company. Borrowers may cure defaults by making all delinquent loan
payments or by selling the property and satisfying all amounts due under the
mortgage.
Different regions of the country experience different default rates due to
varying economic conditions and each state has different rules regarding the
foreclosure process. These rules can impact the amount of time that it takes for
a default to reach foreclosure, so the Company has developed a reserving
methodology that takes these different time periods into account in calculating
the reserve.
When a specific loan initially defaults, it is uncertain that the default
will result in a claim. It is the Company's experience that a significant
percentage of loans in default end up being cured. Therefore, by increasing the
reserve in stages as the foreclosure progresses, we are approximating the
estimated total loss for that particular claim. At any time during the
foreclosure process, until the lender takes title to the property, the borrower
may cure the default. Therefore, it is appropriate to increase the reserve in
stages as new insight and information is obtained. At the time of title
transfer, the Company has approximately 100% of the estimated total loss
reserved.
F-12
59
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table presents information relating to the liability for
unpaid claims and related expenses (in thousands):
1998 1997 1996
--------- -------- --------
Balance at January 1.............................. $ 148,628 $108,206 $ 67,301
Less reinsurance recoverables..................... -- 1,033 481
--------- -------- --------
Net balance at January 1.......................... 148,628 107,173 66,820
--------- -------- --------
Add losses and LAE incurred in respect of default
notices received in:
Current year.................................... 143,541 112,188 95,298
Prior years..................................... (11,518) 4,961 (3,404)
--------- -------- --------
Total incurred.................................... 132,023 117,149 91,894
--------- -------- --------
Deduct losses and LAE paid in respect of default
notices received in:
Current year.................................... 13,808 14,371 14,774
Prior years..................................... 65,567 61,323 36,767
--------- -------- --------
Total paid........................................ 79,375 75,694 51,541
--------- -------- --------
Net balance at December 31........................ 201,276 148,628 107,173
Plus reinsurance recoverables..................... -- -- 1,033
--------- -------- --------
Balance at December 31............................ $ 201,276 $148,628 $108,206
========= ======== ========
As a result of changes in estimates of insured events in prior years, the
provision for losses and loss adjustment expenses (net of reinsurance recoveries
of $11,180,000, $6,504,000 and $2,913,000 in 1998, 1997 and 1996, respectively)
decreased by $11,518,000 in 1998 due primarily to lower than anticipated claim
payments as compared to the amounts reserved as a result of strong housing
prices, increased by $4,961,000 in 1997 due primarily to higher than anticipated
losses on certain "affordable housing" program loans insured in 1994 and 1995
and higher than anticipated losses in California and decreased by $3,404,000 in
1996 due primarily to lower than anticipated claim payments as compared to the
amounts reserved.
5. REDEEMABLE PREFERRED STOCK
Preferred stock is entitled to cumulative annual dividends of $4.125 per
share, payable quarterly in arrears. The preferred stock is redeemable at the
option of the Company at $54.125 per share on or after August 15, 2002, and
declining to $50.00 per share on or after August 15, 2005 (plus in each case
accumulated and unpaid dividends), or is subject to mandatory redemption at a
redemption price of $50.00 per share plus accumulated and unpaid dividends based
upon specified annual sinking fund requirements from 2002 to 2011.
6. INCOME TAXES
Deferred income taxes at the end of each period are determined by applying
enacted statutory tax rates applicable to the years in which the taxes are
expected to be paid or recovered. Deferred income taxes reflect the net tax
effects of temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts for income tax
purposes. The effect on deferred taxes of a change in the tax rate is recognized
in earnings in the period that includes the enactment date.
Provision for income taxes includes a net deferred tax provision in 1998,
1997 and 1996 of $26,654,000, $21,622,000 and $18,143,000, respectively. Of the
1998, 1997 and 1996 provisions, $25,547,000, $21,916,000
F-13
60
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and $18,455,000, respectively, were due to a deduction related to the purchase
of U.S. government non-interest-bearing tax and loss bonds as allowed by federal
tax regulations, with the 1998, 1997 and 1996 purchase deduction offset by
$4,979,000, $4,060,000 and $2,636,000, respectively, of alternative minimum tax
adjustments. Prior to 1998, purchases of these tax and loss bonds were treated
as a reduction of the deferred tax liability. Beginning in 1998, these purchases
have been treated as prepaid federal income taxes and a reclassification has
been made to include this prepaid federal income tax in the balance sheet as an
asset and to reinstate the corresponding deferred tax liability. This change is
being made to more appropriately classify the deduction relating to the tax and
loss bond purchase as a deferred tax liability that will eventually be reversed.
The payment for the tax and loss bonds is essentially a prepayment of federal
income taxes that will become due at a later date. The change had the effect of
increasing both assets and liabilities by $103,700,000 in 1998 and $77,450,000
in 1997. All other amounts arose principally from differences in accounting for
deferred policy acquisition costs and insurance reserve tax adjustments required
as a result of the Tax Reform Act of 1986.
The significant components of the Company's net deferred tax assets and
liabilities are summarized as follows (in thousands):
DECEMBER 31
---------------------
1998 1997
--------- --------
Deferred tax assets:
Unearned premiums................................... $ 2,563 $ 2,043
Loss reserves....................................... 4,180 3,346
Employee benefits................................... 473 326
Other............................................... 667 338
--------- --------
7,883 6,053
--------- --------
Deferred tax liabilities:
Deferred policy acquisition costs................... (11,253) (8,761)
Net unrealized gain on investments.................. (3,514) (2,105)
Depreciation........................................ (621) (369)
Deduction related to purchase of tax and loss
bonds............................................ (103,700) (77,450)
Other............................................... (850) (1,359)
--------- --------
(119,938) (90,044)
--------- --------
Net deferred tax liability............................ $(112,055) $(83,991)
========= ========
The reconciliation of taxes computed at the statutory tax rate of 35
percent for 1998, 1997 and 1996 to the provision for income taxes is as follows
(in thousands):
1998 1997 1996
------- ------- -------
Provision for income taxes computed at the statutory
tax rate............................................ $44,038 $35,873 $28,901
Change in tax provision resulting from:
Tax-exempt municipal bond interest and dividends
received deduction (net of proration)............ (9,620) (8,472) (8,498)
Other, net.......................................... 352 125 (49)
------- ------- -------
Provision for income taxes............................ $34,770 $27,526 $20,354
======= ======= =======
F-14
61
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. STOCKHOLDERS' EQUITY AND DIVIDEND RESTRICTIONS
The Company is a holding company whose principal source of income is
dividends from CMAC. The ability of CMAC to pay dividends on its common stock is
restricted by certain provisions of the insurance laws of the Commonwealth of
Pennsylvania, its state of domicile. The insurance laws of Pennsylvania
establish a test limiting the maximum amount of dividends that may be paid by an
insurer without prior approval by the Pennsylvania Insurance Commissioner. Under
such test, CMAC may pay dividends during any 12-month period in an amount equal
to the greater of (i) 10 percent of the preceding year-end statutory
policyholders' surplus or (ii) the preceding year's statutory net income. In
accordance with such restrictions, $105,264,000 would be available for dividends
in 1999. However, an amendment to the Pennsylvania statute, effective in 1994,
requires that dividends and other distributions be paid out of an insurer's
unassigned surplus. Because of the unique nature of the method of accounting for
contingency reserves, CMAC has negative unassigned surplus. Thus, prior approval
by the Pennsylvania Insurance Commissioner is required for CMAC to pay dividends
or make other distributions so long as CMAC has negative unassigned surplus. The
Pennsylvania Insurance Commissioner has approved all distributions by CMAC since
the passage of this amendment, and management has every expectation that the
Commissioner of Insurance will continue to approve such distributions in the
future, provided that the financial condition of CMAC does not materially
change.
The State of California has a statute requiring mortgage insurers to pay
dividends or make other distributions out of unassigned surplus. CMAC and the
California Department of Insurance have reached an understanding under which
CMAC will be able to pay dividends or make other distributions to the Company,
provided that the financial condition of CMAC does not materially change.
The Company and CMAC have entered into an agreement, pursuant to which the
Company has agreed to establish and, for as long as any shares of $4.125
Preferred Stock remain outstanding, maintain a reserve account in an amount
equal to three years of dividend payments on the outstanding shares of $4.125
Preferred Stock (currently $9,900,000), and not to pay dividends on the common
stock at any time when the amount in the reserve account is less than three
years of dividend payments on the shares of $4.125 Preferred Stock then
outstanding. This agreement between the Company and CMAC provides that the
holders of the $4.125 Preferred Stock are entitled to enforce the agreement's
provisions as if such holders were signatories to the agreement.
The Company may not pay any dividends on shares of common stock unless the
Company has paid all accrued dividends on, and has complied with all sinking
fund and redemption obligations relating to, its outstanding shares of $4.125
Preferred Stock.
CMAC's current excess of loss reinsurance arrangement prohibits the payment
of any dividend that would have the effect of reducing the total of its
statutory policyholders' surplus plus its contingency reserve below $85,000,000.
As of December 31, 1998, CMAC had statutory policyholders' surplus of
$149,281,000 and a contingency reserve of $467,856,000, for a total of
$617,137,000.
CMAC, domiciled in Pennsylvania, prepares its statutory financial
statements in accordance with the accounting practices prescribed or permitted
by the Commonwealth of Pennsylvania Insurance Department. Prescribed statutory
accounting practices include a variety of publications of the National
Association of Insurance Commissioners ("NAIC") as well as state laws,
regulations and general administrative rules. Permitted statutory accounting
practices encompass all accounting practices not so prescribed.
CMAC's statutory policyholders' surplus at December 31, 1998 and 1997 was
$149,281,000 and $148,087,000, respectively. CMAC's statutory net income for
1998, 1997 and 1996 was $105,264,000, $93,390,000 and $75,344,000, respectively.
The differences between the statutory net income and surplus and
F-15
62
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the consolidated net income and equity presented on a GAAP basis represent
differences between GAAP and statutory accounting practices for the following
reasons:
Under statutory accounting practices, mortgage guaranty insurance companies
are required to establish each year a contingency reserve equal to 50% of
premiums earned in such year. Such amount must be maintained in the contingency
reserve for 10 years after which time it is released to unassigned surplus.
Prior to 10 years, the contingency reserve may be reduced with regulatory
approval to the extent that losses in any calendar year exceed 35 percent of
earned premiums for such year. Under GAAP, the contingency reserve is not
required.
Under statutory accounting practices, insurance policy acquisition costs
are charged against operations in the year incurred. Under GAAP, these costs are
deferred and amortized as the related premiums are earned.
Statutory financial statements only include a provision for current income
taxes due, and purchases of tax and loss bonds are accounted for as investments.
GAAP financial statements provide for deferred income taxes, and purchases of
tax and loss bonds are recorded as payments of deferred income taxes.
Under statutory accounting practices, fixed maturity investments are valued
at amortized cost. Under GAAP, those investments that CMAC does not have the
ability or intent to hold to maturity are considered to be available for sale
and are recorded at market value, with the unrealized gain or loss recognized,
net of tax, as an increase or decrease to shareholders' equity.
Under statutory accounting practices, certain assets, designated as
non-admitted assets, are charged directly against statutory surplus. Such assets
are reflected on the GAAP financial statements.
In March 1998, the National Association of Insurance Commissioners adopted
the Codification of Statutory Accounting Principles ("Codification"). The
Codification, which is intended to standardize regulatory accounting and
reporting for the insurance industry, is proposed to be effective January 1,
2001. However, statutory accounting principles will continue to be established
by individual state laws and permitted practices. The Commonwealth of
Pennsylvania will require adoption of the Codification for the preparation of
statutory financial statements effective January 1, 2001. The Company has not
finalized the quantification of the effects of Codification on its statutory
financial statements.
In April, 1998, the Company's Board of Directors approved a stockholder
rights plan designed to help ensure that all stockholders receive fair value for
their shares of common stock in the event of any proposed takeover of the
Company and to guard against the use of partial tender offers or other coercive
tactics to gain control of the Company without offering fair value to the
stockholders.
8. RELATED PARTY TRANSACTIONS
In July 1992, the Company and Commonwealth entered into a sublease
agreement for office space, which provided for payments equal to Commonwealth's
cost, including base rent and a pass-through of certain building expenses. In
August 1993, substantially all of this subleased space was leased back to
Commonwealth at a market rental rate. The sublease expired May 31, 1996. The net
amount paid for the subleased space was $95,000 in 1996.
Prior to the Offering, CMAC was included in the consolidated federal tax
return filed by Reliance, and CMAC was a party to a tax-sharing agreement with
Commonwealth. The tax-sharing agreement was terminated upon completion of the
Offering; however, CMAC has reimbursed Reliance for federal income taxes
attributable to CMAC's 1992 operations through the completion of the Offering as
though the tax-sharing agreement were still in effect. CMAC has agreed to
reimburse Reliance for federal income taxes, if any (together with any related
interest or penalties), attributable to CMAC for periods during which CMAC was a
member of Reliance's consolidated group. Reliance has agreed to limit the amount
of such reimbursement, if any, by CMAC to $1,853,000, the amount included in the
federal tax liability account on
F-16
63
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the Company's June 30, 1992 balance sheet (plus the amount of the tax benefit,
if any, obtained by the Company from making such reimbursement). In addition,
CMAC has agreed to reimburse Reliance for any future federal income taxes (plus
post-closing date interest) resulting from CMAC's operations while a member of
Reliance's consolidated group if CMAC could be benefited by a related adjustment
to CMAC's federal income taxes in an amount calculated as if CMAC were entitled
to such benefit. Reliance will reimburse CMAC for any future federal income
taxes resulting from CMAC's operations while a member of Reliance's consolidated
group which actually decrease Reliance's consolidated federal income taxes.
9. STOCK-BASED COMPENSATION
In November 1992, the Company's Board of Directors adopted the CMAC
Investment Corporation 1992 Stock Option Plan (the "Stock Option Plan"), which
provides for the granting of nonqualified stock options, either alone or
together with stock appreciation rights. Originally up to 500,000 shares were
subject to stock options. This amount was amended by a vote of the stockholders
to 900,000 in May 1993. These options may be granted to directors, officers, and
key employees of the Company at prices that are not less than 90 percent of fair
market value on the date the options are granted, although all options have been
granted with an exercise price equal to the fair value of the Company's stock at
the date of grant. Accordingly, no compensation expense has been recognized for
the Company's stock-based compensation plans. Each stock option is exercisable
for a period of ten years from the date of the grant and is subject to a vesting
schedule as approved by the Company's Stock Option and Compensation Committee.
In May 1995, the CMAC Investment Corporation Equity Compensation Plan was
instituted by a vote of the stockholders. This plan provides for the granting of
nonqualified stock options, under terms similar to those in the Stock Option
Plan, or other forms of equity-based compensation. The aggregate number of
shares that may be issued under this new plan was 1,100,000, which brought the
total number of shares subject to stock options or other forms of equity-based
compensation to 2,000,000. Effective with the stock split in December 1996, all
share totals within the plans were doubled, bringing the total number of shares
subject to stock options or other forms of equity-based compensation to
4,000,000.
F-17
64
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Information regarding the Stock Option Plan and Equity Compensation Plan is
as follows, after giving effect to the stock split:
WEIGHTED AVERAGE
NUMBER OF EXERCISE PRICE
SHARES PER SHARE
--------- ----------------
Outstanding, January 1, 1996..................... 1,628,080 $14.10
Granted........................................ 9,000 24.69
Exercised...................................... (122,658) 10.22
Cancelled...................................... (62,300) 16.52
---------
Outstanding, December 31, 1996................... 1,452,122 14.39
Granted........................................ 343,100 43.21
Exercised...................................... (126,970) 11.35
Cancelled...................................... (27,250) 19.57
---------
Outstanding, December 31, 1997................... 1,641,002 20.56
Granted........................................ -- --
Exercised...................................... 158,350 13.04
Cancelled...................................... 23,500 23.34
---------
Outstanding December 31, 1998.................... 1,459,152 21.33
=========
Exercisable, December 31, 1998................... 856,202 14.03
=========
Available for grant, December 31, 1998........... 1,833,950
=========
The Company applies APB 25 in accounting for its stock-based compensation
plans. Had compensation cost for the Company's stock option plans been
determined based upon the fair value at the grant date for awards under these
plans consistent with the methodology prescribed under SFAS 123, the Company's
net income and earnings per share would have been reduced by approximately
$1,879,000 ($0.08 per share), $1,460,000 ($0.06 per share) and $1,026,000 ($0.04
per share) in 1998, 1997 and 1996, respectively. The pro forma effect on net
income for 1998, 1997 and 1996 is not representative of the pro forma effect on
net income in future years, because it does not take into consideration pro
forma compensation expense related to grants made prior to 1995.
The weighted average fair values of the stock options granted during 1997
and 1996 were $22.97 and $18.25, respectively. There were no stock options
granted during 1998. The fair value of each stock option grant is estimated on
the date of grant using the Black-Scholes option pricing model with the
following weighted average assumptions used for grants:
1997 1996
----- -----
Expected life (years)....................................... 8.03 9.06
Risk-free interest rate..................................... 6.29% 5.26%
Volatility.................................................. 37.06% 64.44%
Dividend yield.............................................. 0.29% 0.32%
F-18
65
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes information concerning currently outstanding
and exercisable options at December 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- -----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
- ------------------------ ----------- ------------ -------- ----------- --------
$ 9.00 -- $13.50.................... 339,052 3.94 $ 9.15 339,052 $ 9.15
$13.94 -- $14.69.................... 525,300 5.44 14.62 366,850 14.62
$22.13 -- $32.50.................... 405,250 7.36 26.08 144,300 22.79
$39.00 -- $52.94.................... 189,550 8.85 43.34 6,000 43.47
--------- -------
1,459,152 856,202
========= =======
In July 1997, the Company's Board of Directors adopted the 1997 CMAC
Investment Corporation Employee Stock Purchase Plan (the "ESPP") and shareholder
approval was granted during the Company's 1998 Annual Meeting. A total of
200,000 shares of the Company's authorized but unissued common stock has been
made available under the ESPP. The ESPP allows eligible employees to purchase
shares of the Company's stock at a discount of 15 percent of the
beginning-of-period or end-of-period (each period being the first and second six
calendar months) fair market value of the stock, whichever is lower. Eligibility
under the ESPP is determined based on standard weekly work hours and tenure with
the Company and eligible employees are limited to a maximum contribution of $400
per payroll period toward the purchase of the Company's stock. Under the ESPP,
the Company sold 1,900 shares in 1998. The Company applies APB 25 in accounting
for the ESPP. The pro forma effect on the Company's net income and earnings per
share had compensation cost been determined under SFAS 123 was deemed immaterial
in 1998.
10. BENEFIT PLANS
In 1997, the FASB issued SFAS No. 132, "Employer's Disclosures about
Pensions and Other Postretirement Benefits." This statement, which is effective
for periods beginning after December 15, 1997, modifies previous disclosure
requirements. This statement does not impact the Company's balance sheets,
statements of income or statements of cash flows. The Company adopted SFAS No.
132 in 1998.
The Company maintains a noncontributory defined benefit pension plan
covering substantially all full-time employees that is similar to the pension
plan of Commonwealth that covered all of the Company's employees prior to the
Offering. The new plan did not require an asset transfer, and all eligible
Company employees are entitled to benefits from both plans. The projected
benefit obligation that arose when the new plan was consummated is approximately
$675,000. This obligation is being amortized into pension expense over the
longer of the expected remaining service life of eligible employees or 15 years.
Retirement benefits are a function of the years of service and the level of
compensation. Assets of the plan consist primarily of balanced mutual funds.
The Company also provides a nonqualified deferred compensation plan
covering certain key executives designated by the Board of Directors. Under this
plan, participants are eligible to receive benefits in addition to those paid
under the defined benefit pension plan if their base compensation is in excess
of the current IRS compensation limitation for the defined benefit pension plan.
Retirement benefits under the nonqualified plan are a function of the years of
service and the level of compensation and are reduced by any benefits paid under
the defined benefit plan.
In addition to providing pension benefits, the Company will provide certain
health care and life insurance benefits to retired employees. The Company
accounts for such benefits under SFAS No. 106, "Employers'
F-19
66
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Accounting for Postretirement Benefits Other Than Pensions," and accrues the
estimated costs of retiree medical and life benefits over the period during
which employees render the service that qualifies them for benefits.
The funded status of the defined benefit plans and the postretirement
benefit plan were as follows (in thousands):
PENSION BENEFITS OTHER BENEFITS
------------------ --------------
1998 1997 1998 1997
------- ------- ----- -----
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year................ $ 4,991 $ 3,336 $ 306 $ 237
Service cost........................................... 748 588 19 18
Interest cost.......................................... 362 281 22 19
Plan amendments........................................ -- 215 -- --
Actuarial loss (gain).................................. (823) 592 23 39
Benefits paid.......................................... (20) (21) (5) (7)
------- ------- ----- -----
Benefit obligation at end of year...................... $ 5,258 $ 4,991 $ 365 $ 306
------- ------- ----- -----
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year......... $ 2,501 $ 1,684 $ -- $ --
Actual return on plan assets........................... 595 318 -- --
Employer contributions................................. 638 520 5 7
Benefits paid.......................................... (20) (21) (5) (7)
------- ------- ----- -----
Fair value of plan assets at end of year............... $ 3,714 $ 2,501 $ -- $ --
------- ------- ----- -----
Underfunded status of the plan......................... $(1,544) $(2,490) $(365) $(306)
Unrecognized prior service cost........................ 525 594 (150) (161)
Unrecognized net actuarial (gain) loss................. (221) 1,018 (119) (149)
------- ------- ----- -----
Accrued benefit cost................................... $(1,240) $ (878) $(634) $(616)
======= ======= ===== =====
The components of net pension and net periodic postretirement benefit costs
are as follows (in thousands):
POSTRETIREMENT
DEFINED BENEFIT PLANS BENEFIT PLANS
------------------------ --------------------
1998 1997 1996 1998 1997 1996
------ ----- ----- ---- ---- ----
Service cost.............................. $ 748 $ 588 $ 479 $ 19 $ 18 $ 18
Interest cost............................. 362 281 213 22 19 16
Expected return on plan assets............ (219) (166) (109) -- -- --
Amortization of prior service cost........ 69 69 55 (11) (11) (11)
Recognized net actuarial loss (gain)...... 40 28 45 (8) (9) (10)
------ ----- ----- ---- ---- ----
Net periodic benefit cost................. $1,000 $ 800 $ 683 $ 22 $ 17 $ 13
====== ===== ===== ==== ==== ====
F-20
67
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Assumptions used to determine net pension and net periodic postretirement
benefit costs are as follows:
DEFINED POSTRETIREMENT
BENEFIT PLANS BENEFIT PLANS
-------------------- --------------------
1998 1997 1996 1998 1997 1996
---- ---- ---- ---- ---- ----
Weighted average assumptions as of December 31:
Discount rate.................................. 6.75% 7.25% 7.50% 6.75% 7.25% 7.75%
Expected return on plan assets................. 8.50% 8.50% 8.50% 8.50% 8.50% 8.50%
Rate of compensation increase.................. 4.00% 6.00% 6.00% -- -- --
Due to the nature of the postretirement welfare plan, no increase is
assumed in the Company's obligation due to any increases in the per capita cost
of covered health care benefits.
In addition to the defined benefit plan, the nonqualified deferred
compensation plan, and the postretirement benefit plan, the Company also
maintains a Savings Incentive Plan, which covers substantially all full-time
employees and all part-time employees employed for a minimum of 90 consecutive
days. Participants can contribute up to 15 percent of their base earnings as
pre-tax contributions. The Company will match at least 25 percent of the first 5
percent of base earnings contributed in any given year. These matching funds are
subject to certain vesting requirements. The expense to the Company for matching
funds for the years ended December 31, 1998, 1997 and 1996 was $641,000,
$544,000 and $474,000, respectively.
11. COMMITMENTS AND CONTINGENCIES
CMAC is involved in certain litigation arising in the normal course of its
business. CMAC is contesting the allegations in each pending action and
believes, based on current knowledge and consultation with counsel, that the
outcome of such litigation will not have a material adverse effect on the
Company's consolidated financial position or results of operations.
CMAC utilized its underwriting skills to provide an outsource contract
underwriting service to its customers. CMAC often gives recourse to its
customers on loans it underwrites for compliance. If the loan does not meet
agreed upon guidelines and is not salable in the secondary market for that
reason, CMAC agrees to remedy the situation either by placing mortgage insurance
coverage on the loan or by purchasing the loan. During 1998, less than 1 percent
of all loans were subject to these remedies and the costs associated with these
remedies were negligible.
The Company and CMAC shared a $5,000,000 discretionary line of credit to be
used for general corporate purposes. There were no draws against this line of
credit during 1997, and it was revoked in early 1998.
The Company leases office space for use in its underwriting, sales, loan
workout and administrative support operations. Net rental expense in connection
with these leases totaled $2,154,000, $1,990,000 and $1,468,000 in 1998, 1997
and 1996, respectively. The commitment for noncancelable operating leases in
future years is as follows (in thousands):
1999........................................................ $2,438
2000........................................................ 2,276
2001........................................................ 2,015
2002........................................................ 1,597
2003........................................................ 1,026
------
$9,352
======
F-21
68
CMAC INVESTMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. QUARTERLY FINANCIAL DATA (UNAUDITED) (IN THOUSANDS, EXCEPT PER-SHARE
INFORMATION)
1998 QUARTER
----------------------------------------------------
FIRST SECOND THIRD FOURTH YEAR
------- ------- ------- ------- --------
Net premiums written.................... $62,245 $70,788 $68,472 $79,579 $281,084
Net premiums earned..................... 67,180 69,528 71,708 73,736 282,152
Net investment income................... 9,304 9,467 9,673 10,106 38,550
Provision for losses.................... 33,037 32,973 32,973 33,040 132,023
Policy acquisition and other expenses... 16,989 17,802 18,952 21,376 75,119
Net income.............................. 21,052 22,225 23,423 24,354 91,054
Net income per share(1)(2).............. $ 0.86 $ 0.91 $ 0.96 $ 1.00 $ 3.72
Average shares outstanding(1)........... 23,633 23,632 23,566 23,467 23,574
1997 QUARTER
----------------------------------------------------
FIRST SECOND THIRD FOURTH YEAR
------- ------- ------- ------- --------
Net premiums written.................... $47,084 $56,638 $60,591 $68,713 $233,026
Net premiums earned..................... 54,312 57,772 61,354 64,272 237,710
Net investment income................... 8,084 8,428 8,426 8,849 33,787
Provision for losses.................... 26,753 28,266 30,194 31,936 117,149
Policy acquisition and other expenses... 13,384 14,084 14,681 15,519 57,668
Net income.............................. 17,284 18,562 19,288 19,833 74,967
Net income per share(1)(2).............. $ 0.71 $ 0.76 $ 0.78 $ 0.81 $ 3.06
Average shares outstanding(1)........... 23,263 23,462 23,522 23,569 23,416
- ---------------
(1) Diluted net income per share and average shares outstanding per SFAS No.
128, "Earnings Per Share." See note 1.
(2) Net income per share is computed independently for each period presented.
Consequently, the sum of the quarters may not equal the total net income per
share for the year.
F-22
69
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
CMAC Investment Corporation
Philadelphia, Pennsylvania
We have audited the accompanying consolidated balance sheets of CMAC
Investment Corporation and subsidiaries (the "Company") as of December 31, 1998
and 1997, and the related consolidated statements of income, changes in common
stockholders' equity and comprehensive income and cash flows for each of the
three years in the period ended December 31, 1998. Our audits also included the
financial statement schedules listed in the Index at Item 14. These financial
statements and financial statement schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of CMAC Investment Corporation and
subsidiaries at December 31, 1998 and 1997, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1998 in conformity with generally accepted accounting principles. Also, in
our opinion, such financial statement schedules, when considered in relation to
the basic consolidated financial statements taken as a whole, present fairly in
all material respects the information set forth therein.
/s/ DELOITTE & TOUCHE LLP
- ---------------------------------------
Philadelphia, Pennsylvania
January 29, 1999
F-23
70
CMAC INVESTMENT CORPORATION
SCHEDULE I
SUMMARY OF INVESTMENTS -- OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1998
AMOUNT
AT WHICH
SHOWN ON
AMORTIZED FAIR THE BALANCE
TYPE OF INVESTMENT COST VALUE SHEET
- ------------------ --------- -------- -----------
(IN THOUSANDS)
Fixed Maturities:
Bonds:
United States government and government agencies and
authorities......................................... $ 45,013 $ 46,130 $ 45,525
State and municipal obligations....................... 581,098 616,268 582,023
Corporate obligations................................. 16,034 16,522 16,522
Redeemable preferred stock............................... 40,420 46,219 46,219
-------- -------- --------
Total fixed maturities..................................... 682,565 725,139 690,289
Equity Securities.......................................... 25,109 27,425 27,425
Short-term investments..................................... 18,596 18,596 18,596
-------- -------- --------
Total investments other than investments in related
parties.................................................. $726,270 $771,160 $736,310
======== ======== ========
S-1
71
CMAC INVESTMENT CORPORATION
SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS
PARENT COMPANY ONLY
DECEMBER 31
--------------------
1998 1997
-------- --------
(IN THOUSANDS)
ASSETS
Investments
Fixed maturities held to maturity -- at amortized cost.... $ 9,757 $ 9,734
Short-term investments.................................... 122 30
Cash........................................................ 229 60
Investment in subsidiaries, at equity in net assets......... 555,919 461,010
Federal income taxes........................................ 148 156
Other assets................................................ 1,599 504
-------- --------
$567,774 $471,494
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable -- affiliates............................ $ 2,302 $ 995
Accounts payable -- other................................. 47 109
Notes payable............................................. 2,043 34
Other liabilities......................................... 413 413
-------- --------
4,805 1,551
-------- --------
Redeemable preferred stock, par value $.001 per share;
800,000 shares issued and outstanding -- at redemption
value..................................................... 40,000 40,000
-------- --------
COMMON STOCKHOLDERS' EQUITY
Common stock, par value $.001 per share; 80,000,000 shares
authorized; 22,705,958 and 22,536,674 shares,
respectively, issued and outstanding................... 23 22
Additional paid-in capital................................ 185,219 179,846
Retained earnings......................................... 331,201 246,166
Net unrealized gain on investments, net of tax............ 6,526 3,909
-------- --------
522,969 429,943
-------- --------
$567,774 $471,494
======== ========
See supplementary notes.
S-2
72
CMAC INVESTMENT CORPORATION
SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF INCOME
PARENT COMPANY ONLY
YEAR ENDED DECEMBER 31
-----------------------------
1998 1997 1996
------- ------- -------
(IN THOUSANDS)
Revenues
Equity in undistributed net income of subsidiaries........ $87,868 $71,249 $62,800
Dividends received from subsidiaries...................... 4,000 4,300 --
Net investment income..................................... 625 819 776
------- ------- -------
92,493 76,368 63,576
------- ------- -------
Expenses
Operating expenses........................................ 1,893 1,734 1,693
------- ------- -------
Pretax income............................................... 90,600 74,634 61,883
Income tax benefit.......................................... 454 333 338
------- ------- -------
Net income.................................................. $91,054 $74,967 $62,221
======= ======= =======
See supplementary notes.
S-3
73
CMAC INVESTMENT CORPORATION
SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
PARENT COMPANY ONLY
YEAR ENDED DECEMBER 31
-----------------------------
1998 1997 1996
------- ------- -------
(IN THOUSANDS)
Cash flows from operating activities
Net income................................................ $91,054 $74,967 $62,221
Adjustments to reconcile net income to net cash provided
by operating activities
Equity in undistributed net income of subsidiaries........ (87,868) (71,249) (62,800)
Increase in federal income taxes.......................... 8 130 532
Increase in notes payable................................. 2,009 34 --
Net change in other assets, accounts payable and other
liabilities............................................ 150 (199) 3,955
------- ------- -------
Net cash provided by operating activities................... 5,353 3,683 3,908
------- ------- -------
Cash flows from investing activities
(Purchases) sales of short-term investments -- net........ (92) 461 4
Other..................................................... (23) (21) (9)
------- ------- -------
Net cash provided by (used in) investing activities......... (115) 440 (15)
------- ------- -------
Cash flows from financing activities
Dividends paid............................................ (6,019) (5,996) (5,646)
Capital contribution...................................... (1,759) (34) --
Proceeds from issuance of common stock.................... 2,709 1,915 1,581
------- ------- -------
Net cash used in financing activities....................... (5,069) (4,115) (4,065)
------- ------- -------
Increase (decrease) in cash................................. 169 8 (172)
Cash, beginning of year..................................... 60 52 224
------- ------- -------
Cash, end of year........................................... $ 229 $ 60 $ 52
======= ======= =======
See supplementary notes.
S-4
74
CMAC INVESTMENT CORPORATION
SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY
SUPPLEMENTARY NOTES
NOTE A
The accompanying Parent Company financial statements should be read in
conjunction with the Consolidated Financial Statements and Notes to Consolidated
Financial Statements appearing on pages F-1 through F-22 of the CMAC Investment
Corporation 1998 Form 10-K.
NOTE B
CMAC Investment Corporation (the "Company") was incorporated in December,
1991 in order to hold the capital stock of Commonwealth Mortgage Assurance
Company ("CMAC"). In the fourth quarter of 1992, a merger among controlled
subsidiaries of CMAC was consummated with the effect that the Company acquired
all of the outstanding stock of CMAC, and CMAC's sole stockholder, Commonwealth
Land Title Insurance Company ("Commonwealth"), then an indirect wholly owned
subsidiary of Reliance Group Holdings, Inc., acquired all of the outstanding
capital stock of the Company.
In the fourth quarter of 1992, the initial public offering of the Company's
common stock (the "Offering") was consummated. In the Offering, Commonwealth
sold all of the 7,000,000 shares owned by it, and the Company issued and sold
3,950,000 shares. In addition, the Company issued and sold 800,000 shares of
$4.125 Preferred Stock to Commonwealth. Aggregate proceeds to the Company from
the sale of common stock were approximately $67,200,000 and from the sale of
preferred stock were $40,000,000.
The preferred stock, issued in connection with the Offering, is entitled to
cumulative annual dividends of $4.125 per share, payable quarterly in arrears.
The preferred stock is redeemable at the option of the Company at $54.125 per
share on or after August 15, 2002, and declining to $50.00 per share on or after
August 15, 2005 (plus in each case accumulated and unpaid dividends), or is
subject to mandatory redemption at a redemption price of $50.00 per share plus
accumulated and unpaid dividends based upon specified annual sinking fund
requirements from 2002 to 2011.
The Company is a holding company whose principal source of income is
dividends from CMAC. The ability of CMAC to pay dividends on its common stock is
restricted by certain provisions of the insurance laws of the Commonwealth of
Pennsylvania, its state of domicile. The insurance laws of Pennsylvania
establish a test limiting the maximum amount of dividends which may be paid by
an insurer without prior approval by the Pennsylvania Insurance Commissioner.
Under such test, CMAC may pay dividends during any 12-month period in an amount
equal to the greater of (i) 10% of the preceding year-end statutory
policyholders' surplus or (ii) the preceding year's statutory net income. In
accordance with such restrictions, $105,264,000 would be available for dividends
in 1999. However, an amendment to the Pennsylvania statute, effective in 1994,
requires that dividends and other distributions be paid out of an insurer's
unassigned surplus. Because of the unique nature of the method of accounting for
contingency reserves, CMAC has negative unassigned surplus. Thus, prior approval
by the Pennsylvania Insurance Commissioner is required for CMAC to pay dividends
or make other distributions so long as CMAC has negative unassigned surplus. The
Pennsylvania Insurance Commissioner has approved all distributions by CMAC since
the passage of this amendment and management has every expectation that the
Commissioner of Insurance will continue to approve such distributions in the
future, provided that the financial condition of CMAC does not materially
change.
The State of California has a statute requiring mortgage insurers to pay
dividends or make other distributions out of unassigned surplus. CMAC and the
California Department of Insurance have reached an understanding under which
CMAC will be able to pay dividends or make other distributions to the Company
provided that the financial condition of CMAC does not materially change.
In addition, CMAC's current excess of loss reinsurance arrangement
prohibits the payment of any dividend which would have the effect of reducing
the total of its statutory policyholders' surplus plus its
S-5
75
CMAC INVESTMENT CORPORATION
SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY
SUPPLEMENTARY NOTES -- (CONTINUED)
contingency reserve below $85,000,000. As of December 31, 1998, CMAC had
statutory policyholders' surplus of $149,281,000 and a contingency reserve of
$467,856,000, for a total of $617,137,000.
The Company and CMAC have entered into an agreement pursuant to which the
Company has agreed to establish and, for so long as any shares of $4.125
Preferred Stock remain outstanding, maintain a reserve account in an amount
equal to three years of dividend payments on the outstanding shares of $4.125
Preferred Stock (currently $9.9 million), and not to pay dividends on the common
stock at any time when the amount in the reserve account is less than three
years of dividend payments on the shares of $4.125 Preferred Stock then
outstanding. This agreement between the Company and CMAC provides that the
holders of the $4.125 Preferred Stock are entitled to enforce the agreement's
provisions as if such holders were signatories to the agreement.
The Company may not pay any dividends on shares of common stock unless the
Company has paid all accrued dividends on and has complied with all sinking fund
and redemption obligations relating to its outstanding shares of $4.125
Preferred Stock.
NOTE C
On October 15, 1996, the Board of Directors authorized a stock split, paid
on December 2, 1996, in the form of a dividend of one additional share of the
Company's common stock for each share owned by stockholders of record on
November 7, 1996. The dividend was accounted for as a two-for-one stock split
and par value remained at $.001 per share.
Accordingly, all references to common share and per-share data have been
adjusted to give effect to the stock split.
NOTE D
On November 22, 1998, the Board of Directors of the Company and the Board
of Directors of Amerin Corporation each approved an Agreement and Plan of Merger
pursuant to which the Company and Amerin will merge. The anticipated merger
calls for Amerin stockholders to receive 0.5333 shares of the Company's common
stock in a tax-free exchange for each share of Amerin common stock that they
own. The Company's stockholders will continue to own their existing shares after
the merger. Completion of the merger is subject to approval by the stockholders
of both companies and, pending this approval, the transaction is expected to
close in May 1999. The merger transaction will be accounted for on a pooling of
interests basis.
S-6
76
CMAC INVESTMENT CORPORATION
SCHEDULE VI -- REINSURANCE
MORTGAGE INSURANCE PREMIUMS EARNED
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
ASSUMED PERCENTAGE
CEDED TO FROM OF AMOUNT
GROSS OTHER OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
-------- --------- --------- -------- ----------
(IN THOUSANDS)
1998................................ $313,231 $31,208 $129 $282,152 0.05%
======== ======= ==== ========
1997................................ $258,148 $20,619 $181 $237,710 0.08%
======== ======= ==== ========
1996................................ $203,042 $15,268 $147 $187,921 0.00%
======== ======= ==== ========
S-7
77
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