FORM 10-Q
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended June 30, 2002
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 0-22342
TRIAD GUARANTY INC.
(Exact name of registrant as specified in its charter)
Delaware 56-1838519
(State of Incorporation) (I.R.S. Employer Identification
Number)
101 SOUTH STRATFORD ROAD
WINSTON-SALEM, NORTH CAROLINA 27104
(Address of principal executive offices)
(336) 723-1282
(Registrant's telephone number, including area code)
------------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
Number of shares of Common Stock, $.01 par value, outstanding as of August 1,
2002: 14,134,449 shares.
TRIAD GUARANTY INC.
INDEX
Page
Number
------
Part I. Financial Information:
Item 1. Financial Statements:
Consolidated Balance Sheets as of June 30, 2002 (Unaudited)
and December 31, 2001................................................ 3
Consolidated Income Statements for the Three and Six Months
Ended June 30, 2002 and 2001 (Unaudited)............................ 4
Consolidated Statements of Cash Flow for the Six Months
Ended June 30, 2002 and 2001 (Unaudited)............................ 5
Notes to Consolidated Financial Statements............................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................... 9
Part II. Other Information:
Item 1. Legal Proceedings............................................. 17
Item 2. Changes in Securities and Use of Proceeds...................... 17
Item 3. Defaults Upon Senior Securities................................ 17
Item 4. Submission of Matters to a Vote of Security Holders............ 17
Item 5. Other Information.............................................. 17
Item 6. Exhibits and Reports on Form 8-K............................... 17
Signatures............................................................. 18
2
TRIAD GUARANTY INC.
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2002 2001
----------- ------------
(Unaudited)
(Dollars in thousands except per share information)
Assets
Invested assets:
Fixed maturities, available-for-sale, at fair value.......... $275,148 $245,986
Equity securities, available-for-sale, at fair value......... 12,332 12,476
Short-term investments....................................... 17,029 18,739
-------- --------
304,509 277,201
Cash ............................................................ 72 854
Real estate...................................................... 506 162
Accrued investment income........................................ 3,161 3,196
Deferred policy acquisition costs................................ 28,669 25,944
Prepaid federal income taxes..................................... 69,425 62,619
Property and equipment........................................... 10,796 11,169
Reinsurance recoverable.......................................... 630 5
Other assets..................................................... 15,597 15,305
-------- --------
Total assets..................................................... $433,365 $396,455
======== ========
Liabilities and stockholders' equity
Liabilities:
Losses and loss adjustment expenses.......................... $ 18,739 $ 17,991
Unearned premiums............................................ 7,478 7,650
Amounts payable to reinsurer................................. 2,444 2,445
Current taxes payable........................................ 519 40
Deferred income taxes........................................ 81,342 74,773
Unearned ceding commission................................... 1,861 2,324
Long-term debt............................................... 34,476 34,473
Accrued interest on debt..................................... 1,275 1,275
Accrued expenses and other liabilities....................... 5,108 9,415
-------- --------
Total liabilities................................................ 153,242 150,386
Commitments and contingent liabilities - Note 4
Stockholders' equity:
Preferred stock, par value $.01 per share --- authorized
1,000,000 shares; no shares issued and outstanding........ --- ---
Common stock, par value $.01 per share --- authorized
32,000,000 shares; issued and outstanding
14,134,149 shares at June 30, 2002 and 13,691,672
at December 31, 2001...................................... 141 137
Additional paid-in capital................................... 79,536 69,057
Accumulated other comprehensive income, net of income
tax liability of $2,127 at June 30, 2002 and $522 at
December 31, 2001......................................... 3,955 975
Deferred compensation........................................ (855) (118)
Retained earnings............................................ 197,346 176,018
-------- --------
Total stockholders' equity....................................... 280,123 246,069
-------- --------
Total liabilities and stockholders' equity....................... $433,365 $396,455
======== ========
See accompanying notes.
3
TRIAD GUARANTY INC.
CONSOLIDATED INCOME STATEMENTS
(Unaudited)
Three Months Ended Six Months Ended
June 30 June 30
----------------------- ---------------------
2002 2001 2002 2001
---- ---- ---- ----
(Dollars in thousands except per share information)
Revenue:
Premiums written:
Direct........................................... $29,784 $21,998 $57,622 $43,791
Assumed.......................................... 1 1 2 3
Ceded............................................ (4,494) (2,222) (7,842) (4,205)
---------- ---------- ---------- ----------
Net premiums written................................ 25,291 19,777 49,782 39,589
Change in unearned premiums......................... 208 366 252 237
---------- ---------- ---------- ----------
Earned premiums..................................... 25,499 20,143 50,034 39,826
Net investment income............................... 3,953 3,657 7,717 7,134
Realized investment gains (losses).................. (729) 162 (2,228) 614
Other income........................................ 15 15 42 1,882
---------- ---------- ---------- ----------
28,738 23,977 55,565 49,456
Losses and expenses:
Losses and loss adjustment expenses................. 2,875 2,135 5,396 4,334
Reinsurance recoveries.............................. 4 (1) (1) 3
---------- ---------- ---------- ----------
Net losses and loss adjustment expenses............. 2,879 2,134 5,395 4,337
Interest expense on debt............................ 693 693 1,386 1,385
Amortization of deferred policy acquisition costs... 3,059 2,674 6,045 5,009
Other operating expenses (net)...................... 5,764 4,293 11,833 8,645
---------- ---------- ---------- ----------
12,395 9,794 24,659 19,376
---------- ---------- ---------- ----------
Income before income taxes ......................... 16,343 14,183 30,906 30,080
Income taxes:
Current.......................................... 172 92 332 93
Deferred......................................... 4,881 4,261 9,246 9,237
---------- ---------- ---------- ----------
5,053 4,353 9,578 9,330
---------- ---------- ---------- ----------
Net income.......................................... $11,290 $ 9,830 $21,328 $20,750
========== ========== ========== ==========
Earnings per common and
common equivalent share:
Basic............................................ $.80 $.73 $1.53 $1.55
========== ========== =========== ========
Diluted.......................................... $.78 $.71 $1.49 $1.49
========== ========== =========== ========
Shares used in computing earnings
per common and common equivalent share:
Basic............................................ 14,115,220 13,444,388 13,976,165 13,399,891
========== ========== ========== ==========
Diluted.......................................... 14,390,101 13,939,338 14,295,372 13,885,145
========== ========== ========== ==========
See accompanying notes.
4
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
Six Months Ended
June 30
---------------------
2002 2001
---- ----
(Dollars in thousands)
Operating activities
Net income.................................................. $21,328 $20,750
Adjustments to reconcile net income to net cash
provided by operating activities:
Loss and unearned premium reserves....................... 577 1,311
Accrued expenses and other liabilities................... (5,397) (3,578)
Current taxes payable.................................... 478 93
Amounts due to/from reinsurer............................ (706) (955)
Accrued investment income................................ 35 (240)
Policy acquisition costs deferred........................ (8,771) (7,073)
Amortization of policy acquisition costs................. 6,045 5,008
Net realized investment losses (gains)................... 2,228 (614)
Provision for depreciation............................... 1,424 1,079
Accretion of discount on investments..................... (2,137) (1,305)
Deferred income taxes.................................... 9,246 9,237
Prepaid federal income tax............................... (6,806) (7,047)
Unearned ceding commission............................... (463) 1,415
Real estate acquired in claim settlement................. (343) 1
Other assets............................................. (144) (1,029)
Other operating activities............................... 198 127
------- -------
Net cash provided by operating activities................... 16,792 17,180
Investing activities
Securities available-for-sale:
Purchases - fixed maturities.......................... (46,879) (42,927)
Sales - fixed maturities.............................. 24,382 15,843
Purchases - equities.................................. (2,040) (1,896)
Sales - equities...................................... 1,035 2,255
Purchase of property and equipment....................... (1,050) (2,593)
------- -------
Net cash used in investing activities....................... (24,552) (29,318)
Financing activities
Proceeds from exercise of stock options..................... 5,268 2,797
------- -------
Net cash provided by financing activities................... 5,268 2,797
------- -------
Net change in cash and short-term investments............... (2,492) (9,341)
Cash and short-term investments at beginning of period...... 19,593 18,525
------- -------
Cash and short-term investments at end of period............ $17,101 $ 9,184
======= =======
Supplemental schedule of cash flow information
Cash paid during the period for:
Income taxes and United States Mortgage Guaranty
Tax and Loss Bonds.................................... $ 7,306 $ 7,032
Interest................................................. $ 1,383 $ 1,383
See accompanying notes.
5
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2002
(Unaudited)
NOTE 1 -- THE COMPANY
Triad Guaranty Inc. is a holding company which, through its wholly-owned
subsidiary, Triad Guaranty Insurance Corporation ("Triad"), provides private
mortgage insurance coverage in the United States to mortgage lenders and
investors to protect the lender or investor against loss from defaults on low
down payment residential mortgage loans.
NOTE 2 -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the three and six months ended June 30, 2002 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2002. For further information, refer to the consolidated financial statements
and footnotes thereto included in the Triad Guaranty Inc. annual report on Form
10-K for the year ended December 31, 2001.
NOTE 3 -- CONSOLIDATION
The consolidated financial statements include Triad Guaranty Inc. and its
wholly-owned subsidiary, Triad Guaranty Insurance Corporation ("Triad"), and
Triad's wholly-owned subsidiaries, Triad Guaranty Assurance Corporation and
Triad Re Insurance Corporation (collectively referred to as "the Company"). All
significant intercompany accounts and transactions have been eliminated.
NOTE 4 -- COMMITMENTS AND CONTINGENT LIABILITIES
REINSURANCE - Triad assumes and cedes certain premiums and losses from/to
reinsurers under various reinsurance agreements. Reinsurance contracts do not
relieve Triad from its obligations to policyholders. Failure of the reinsurer to
honor its obligation could result in losses to Triad; consequently, allowances
are established for amounts when deemed uncollectible.
6
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2002
(Unaudited)
INSURANCE IN FORCE, DIVIDEND RESTRICTIONS, AND STATUTORY RESULTS - Insurance
regulations limit the writing of mortgage guaranty insurance to an aggregate
amount of insured risk no greater than 25 times the total of statutory capital
and surplus and the statutory contingency reserve. The amount of net risk for
insurance in force at June 30, 2002 and December 31, 2001, as presented below,
was computed by applying the various percentage settlement options and
applicable stop-loss parameters to the insurance in force amounts based on the
original insured amount of the loan. Triad's ratio is as follows:
June 30, December 31,
2002 2001
(Dollars in thousands)
Net risk.............................. $ 5,039,445 $ 4,471,705
=========== ===========
Statutory capital and surplus......... $ 104,261 $ 105,306
Statutory contingency reserve......... 218,243 193,747
----------- -----------
Total................................. $ 322,504 $ 299,053
=========== ===========
Risk-to-capital ratio................. 15.6-to-1 15.0-to-1
=========== ===========
Triad and its wholly-owned subsidiaries, Triad Guaranty Assurance
Corporation and Triad Re Insurance Corporation, are each required under their
respective domiciliary states' insurance code to maintain a minimum level of
statutory capital and surplus. Triad, an Illinois domiciled insurer, is required
under the Illinois Insurance Code (the "Code") to maintain minimum statutory
capital and surplus of $5 million. The Code permits dividends to be paid only
out of earned surplus and also requires prior approval of extraordinary
dividends. An extraordinary dividend is any dividend or distribution of cash or
other property, the fair value of which, together with that of other dividends
or distributions made within a period of twelve consecutive months, exceeds the
greater of (a) ten percent of statutory surplus as regards policyholders, or (b)
statutory net income for the calendar year preceding the date of the dividend.
Net income as determined in accordance with statutory accounting practices
was $27.8 million for the six months ended June 30, 2002 and $55.4 million for
the year ended December 31, 2001.
At June 30, 2002 and December 31, 2001, the amount of Triad's equity that
could be paid out in dividends to stockholders was $20.5 million and $21.6
million, respectively, which was the earned surplus of Triad on a statutory
basis on those dates.
LOSS RESERVES - The Company establishes loss reserves to provide for the
estimated costs of settling claims with respect to loans reported to be in
default and loans in default which have not been reported to the Company.
7
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2002
(Unaudited)
Reserves are established by management using estimated claim rates (frequency)
and claim amounts (severity) to estimate ultimate losses. The reserving process
gives effect to current economic conditions and profiles delinquencies by such
factors as policy year, geography, chronic late payment characteristics and age.
Due to the inherent uncertainty in estimating reserves for losses and loss
adjustment expenses, there can be no assurance that the reserves will prove to
be adequate to cover ultimate loss development.
NOTE 5 - - EARNINGS PER SHARE
Basic and diluted earnings per share are based on the weighted-average
daily number of shares outstanding. For diluted earnings per share, the
denominator includes the dilutive effect of stock options on the
weighted-average shares outstanding. There are no other reconciling items
between the denominator used in basic earnings per share and diluted earnings
per share. The numerator used in basic earnings per share and diluted earnings
per share is the same for all periods presented.
NOTE 6 - - COMPREHENSIVE INCOME
Comprehensive income consists of net income and other comprehensive income.
For the Company, other comprehensive income is composed of unrealized gains or
losses on available-for-sale securities, net of income tax. For the three months
ended June 30, 2002 and 2001, the Company's comprehensive income was $15.1
million and $8.7 million, respectively. For the six months ended June 30, 2002
and 2001, the Company's comprehensive income was $24.3 million and $20.4
million, respectively.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Net income for the first six months of 2002 increased 2.8% to $21.3 million
or $1.49 per diluted share compared to $20.8 million or $1.49 per diluted share
for the first six months of 2001. Net income for the first six months of 2001
included the receipt of a nonrecurring incentive payment of approximately $1.9
million or $0.09 per diluted share relating to the cancellation of one of the
Company's excess of loss reinsurance contracts. The payment was reported as
other income in the first quarter of 2001. Net income for the second quarter of
2002 increased 14.9% to $11.3 million or $0.78 per diluted share from $9.8
million or $0.71 per diluted share in the second quarter of 2001. Earnings per
share for the first six months of 2002 includes $0.10 per share of net realized
investment losses compared to $0.02 per share of net realized investment gains
in the first six months of 2001. For the second quarter of 2002 and 2001,
earnings per share includes $0.04 per share of net realized investment losses
and $0.01 per share of net realized investment gains, respectively.
Operating earnings for the first six months of 2002 increased 11.9% to
$22.8 million from $20.4 million for the first six months of 2001. For the
second quarter of 2002, operating earnings increased 21.0% to $11.8 million from
$9.7 million in the second quarter of 2001. Operating earnings exclude realized
investment losses of $2.2 million in the first six months of 2002 and realized
investment gains of $614,000 in the first six months of 2001. For the second
quarter of 2002 and 2001, operating earnings exclude realized investment losses
of $729,000 and realized investment gains of $162,000, respectively. Operating
earnings per share on a diluted basis were $1.59 for the first six months of
2002 compared to $1.47 per share for the same period of 2001. For the second
quarter of 2002, operating earnings per share on a diluted basis were $0.82
compared to $0.70 per share for the second quarter of 2001. Excluding the
effects of the nonrecurring incentive payment from operating results for the
first six months of 2001, operating earnings increased 19.0% and operating
earnings per diluted share increased 15.2% for the first six months of 2002
compared to the first six months of 2001. The improvement in operating earnings
is attributable primarily to a 25.6% (26.6% in the second quarter) increase in
earned premiums and an 8.2% (8.1% in the second quarter) increase in net
investment income.
Insurance written was $6.2 billion for the first six months of 2002 as
compared to $4.7 billion for the first six months of 2001, an increase of 32.8%.
For the second quarter of 2002, insurance written was $3.5 billion compared to
$1.9 billion for the second quarter of 2001, an increase of 77.9%. Traditional
flow production for the first six months of 2002 increased 62.6% to $5.5 billion
from $3.4 billion in the first six months of 2001. For the second quarter of
2002, traditional flow production was $2.7 billion compared to $1.9 billion in
the second quarter of 2001, an increase of 38.4%. The increase in new insurance
written from traditional flow production was primarily the result of expanding
relationships with national lenders, strong demand for risk-sharing
arrangements, and a lower interest rate environment. Insurance written in the
first six months of 2002 attributable to bulk transactions totaled $766 million
(all in the second quarter of 2002) compared to $1.3 billion in the first six
months of 2001 (all in the first quarter of 2001).
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CONTINUED
Consolidation within the mortgage origination industry and Triad's
continued focus on national lenders has resulted in a greater percentage of
production volume being concentrated among a smaller customer base. The loss of
one or more of these significant customers could have a significant adverse
effect on the Company's business. According to industry data, Triad's national
market share of net new primary insurance written increased to 3.2% for the
second quarter and 3.4% for the first six months of 2002 from 2.6% and 2.7% for
the respective periods in 2001. Net new primary insurance written excludes
insurance placed on loans more than 12 months after loan origination, insurance
placed on loans already covered by primary mortgage insurance, and insurance
placed on loans where lender exposure is effectively reduced below defined
minimums. This treatment is consistent with the new definitions adopted by the
Company and the industry in the third quarter of 2001 regarding the computation
of new insurance written for market share purposes. Total direct insurance in
force reached $23.8 billion at June 30, 2002, compared to $17.3 billion at June
30, 2001, an increase of 37.3%.
Total direct premiums written were $57.6 million for the first six months
of 2002, an increase of 31.6% from $43.8 million for the first six months of
2001. Direct premiums written for the second quarter of 2002 increased 35.4% to
$29.8 million compared to $22.0 million for the same period of 2001. Net
premiums written were $49.8 million in the first six months of 2002, an increase
of 25.7% from $39.6 million for the same period of 2001. Net premiums written
for the second quarter of 2002 increased by 27.9% to $25.3 million compared to
$19.8 million for the same period of 2001. Earned premiums increased 25.6% to
$50.0 million for the first six months of 2002 from $39.8 million for the first
six months of 2001. Earned premiums for the second quarter of 2002 were $25.5
million compared to $20.1 million for the same period of 2001, an increase of
26.6%. This growth in written and earned premiums resulted from strong levels of
new insurance written offset by the impact of a low persistency rate.
Growth in direct premiums written was partially offset by the increase in
ceded premiums written. Driven by increases in risk-sharing arrangements, ceded
premium written increased 86.5% to $7.8 million for the first six months of 2002
from $4.2 million for the first six months of 2001. Ceded premiums written in
the second quarter of 2002 were $4.5 million compared to $2.2 million in the
same period of 2001, an increase of 102.2%. The Company's premium ceded rate
(the ratio of ceded premiums written to direct premiums written) was 13.6% in
the first six months of 2002 (15.1% in the second quarter) compared to 9.6% in
the first six months of 2001 (10.1% in the second quarter). Approximately 50% of
flow insurance written (44% including bulk transactions) during the first six
months of 2002 is subject to risk-sharing arrangements compared to 57% of
insurance written (41% including bulk transactions) in the first six months of
2001. Management anticipates ceded premiums will continue to increase as a
result of the expected increase in risk-sharing programs.
Refinance activity was 39.9% of insurance written in the first half of 2002
compared to 29.9% of insurance written in the first half of 2001. Refinance
activity was 33.0% of insurance written in the second quarter of 2002 compared
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CONTINUED
to 40.1% of insurance written in the same period of 2001. Persistency, or the
percentage of insurance in force remaining from one-year prior, was 62.4% at
June 30, 2002 compared to 67.6% at December 31, 2001, and 75.8% at June 30,
2001. The decrease in persistency is reflective of the low interest rate
environment that has been in place over the previous 12 months, and the
resulting high level of refinance activity. The annualized quarterly persistency
run rate for the second quarter of 2002 was 65.5%, up from 60.7% in the second
quarter of 2001.
Net investment income for the first six months of 2002 was $7.7 million, an
8.2% increase over $7.1 million in the first six months of 2001. Net investment
income for the second quarter of 2002 was $4.0 million compared to $3.7 million
in the same period of 2001, an increase of 8.1%. This increase in investment
income is the result of growth in the average book value of invested assets by
$46.7 million to $286.8 million at June 30, 2002 from $240.1 million at June 30,
2001. The growth in invested assets is attributable to normal operating cash
flow. The pre-tax yield on average invested assets decreased to 5.4% for the
first six months of 2002 compared to 5.9% for the first six months of 2001,
reflecting the current low interest rate environment for new money investments
and the disposal of a number of higher yielding, lower quality securities during
the past twelve months to enhance the overall quality of the portfolio. The
portfolio's tax-equivalent yield-to-maturity was 7.9% for the first half of 2002
versus 8.0% for the first half of 2001. Based on fair value, approximately 77%
and 71% of the Company's fixed maturity portfolio at June 30, 2002 and 2001,
respectively, was composed of state and municipal tax-preferred securities. At
June 30, 2002, based on fair value, approximately 95% of the Company's fixed
maturity portfolio was either a U.S. government or U.S. agency obligation or was
rated investment grade by at least one nationally recognized securities rating
organization compared to approximately 92% of the Company's fixed maturity
portfolio at June 30, 2001.
The Company actively monitors investment securities considered to be at
risk for impairment. When the Company determines that it is probable that it
will be unable to collect all amounts due according to the contractual terms of
a security, an other-than-temporary impairment loss has occurred. In the event
of permanent impairment, the Company writes down the cost basis of the security
to its fair value and recognizes a realized loss for the amount of the
writedown. Realized losses in the first six months of 2002 included impairment
writedowns of approximately $1.3 million on bonds held in the Company's
portfolio, with approximately $600,000 of impairment writedowns occurring in the
second quarter. The writedowns involved securities in the telecommunications and
technology sectors.
Net losses and loss adjustment expenses (net of reinsurance recoveries)
increased by 24.4% in the first six months of 2002 to $5.4 million from $4.3
million for the same period of 2001. Net losses and loss adjustment expenses
were $2.9 million in the second quarter of 2002 compared to $2.1 million in the
second quarter of 2001, an increase of 34.9%. This rise reflects an increase in
paid losses and delinquent loans as the Company's insurance in force matures.
Net paid losses and loss adjustment expenses were $4.6 million in the first six
months of 2002, up from $2.8 million in the first six months of 2001. Net paid
losses and loss adjustment expenses were $2.4 million in the second quarter of
2002 compared to $1.7 million in the second quarter of 2001. Reported delinquent
loans totaled 1,684 at June 30, 2002, compared to 1,420 at December 31, 2002 and
928 at June 30, 2001. The delinquency inventory count includes all reported
delinquencies that are three or more payments in arrears at the reporting date
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CONTINUED
and all reported delinquencies that were previously three or more payments in
arrears and have not made payments to the current due date. Reserves are
established for all insured loans reported as delinquent to the Company by the
loan servicer. The Company's loss ratio (the ratio of incurred losses to earned
premiums) was 10.8% for the first half of 2002 compared to 10.9% for the first
half of 2001 and 10.7% for all of 2001. The loss ratio was 11.3% for the second
quarter of 2002 and 10.6% for the second quarter of 2001.
As of June 30, 2002, approximately 78% of the Company's insurance in force
was originated in the last 36 months. Management believes, based upon its
experience and industry data, that claims incidence for it and other private
mortgage insurers is generally highest in the third through sixth years after
loan origination. Although the claims experience on insurance written in
previous years has been quite favorable, management does not expect losses to
remain at the low levels currently reported. The Company expects its incurred
losses to increase as a greater amount of its insurance in force reaches its
anticipated highest claim frequency years. Furthermore, changes in the economic
environment could accelerate paid and incurred loss development. Due to the
inherent uncertainty of future premium levels, losses, economic conditions, and
other factors that affect earnings, it is impossible to predict with any degree
of certainty the impact of such higher claim frequencies on future earnings.
Amortization of deferred policy acquisition costs increased by 20.7% to
$6.0 million in the first six months of 2002 from $5.0 million for the first six
months of 2001. These costs were $3.1 million in the second quarter of 2002
compared to $2.7 million in the second quarter of 2001, an increase of 14.4%.
The increase in amortization reflects growth in deferred policy acquisition
costs related to the expansion of the Company's insurance in force and
accelerated amortization due to higher cancellations from refinance activity in
the first half of 2002, although this trend abated in the second quarter.
Other operating expenses increased 36.9% to $11.8 million for the first
half of 2002 from $8.6 million for the same period of 2001. For the second
quarter of 2002, other operating expenses were $5.8 million compared to $4.3
million in the second quarter of 2001, an increase of 34.3%. This increase in
expenses is primarily attributable to personnel, technology amortization, and
equipment costs required to support the Company's increased levels of
production, product development, system enhancements, and geographic expansion.
The expense ratio (ratio of underwriting expenses to net premiums written) for
the first six months of 2002 was 35.9% compared to 34.5% for the first six
months of 2001 and 35.1% for all of 2001. The expense ratio for the second
quarter of 2002 was 34.9% compared to 35.2% for the second quarter of 2001.
The effective tax rate for both the first six months of 2002 and 2001 was
31.0%. The effective tax rate was 30.9% for the second quarter of 2002 compared
to 30.7% for the second quarter of 2001. Management expects the Company's
effective tax rate to remain near current levels as long as yields from new
funds invested in tax-preferred securities remain favorable in relation to fully
taxable securities.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CONTINUED
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of operating funds consist primarily of premiums
written and investment income. Operating cash flow is applied primarily to the
payment of claims, interest, operating expenses, and taxes.
The Company generated positive cash flow from operating activities for the
first six months of 2002 of $16.8 million compared to $17.2 million for the same
period of 2001. Triad's positive operating cash flow in the first half of 2002
reflects premiums and investment income received that were greater than expenses
and losses paid. The decrease in operating cash flow from the prior-year level
reflects primarily the receipt of a $1.9 million cash payment in the prior-year
period from the cancellation of an excess of loss reinsurance contract.
The Company's business does not routinely require significant capital
expenditures other than for enhancements to its computer systems and
technological capabilities. Positive cash flows are invested pending future
payments of claims and expenses. Cash flow shortfalls, if any, could be funded
through sales of short-term investments and other investment portfolio
securities.
The parent company's cash flow is dependent on interest income and payments
from Triad including management fees and interest payments under surplus notes.
The Illinois Insurance Department permits expenses of the parent company to be
reimbursed by Triad in the form of management fees. Payment of dividends also is
permitted although none have been paid.
The insurance laws of the State of Illinois impose certain restrictions on
dividends that Triad can pay the parent company. These restrictions, based on
statutory accounting practices, include requirements that dividends may be paid
only out of statutory earned surplus and limit the amount of dividends that may
be paid without prior approval of the Illinois Insurance Department.
Consolidated invested assets were $304.5 million at June 30, 2002 compared
to $277.2 million at December 31, 2001. Fixed maturity securities and equity
securities classified as available-for-sale totaled $287.5 million at June 30,
2002. Net unrealized investment gains were $6.2 million on fixed maturity
securities and net unrealized investment losses were $119,000 on equity
securities at June 30, 2002. Based on fair value, the fixed maturity portfolio
consisted of approximately 77% municipal securities, 18% corporate securities,
and 5% U.S. government obligations at June 30, 2002.
The Company's loss reserves were $18.7 million at June 30, 2002 compared to
$18.0 million at December 31, 2001. Reserves are established for reported
insurance losses and loss adjustment expenses based on when notices of default
on insured mortgage loans are received. Reserves also are established for
estimated losses incurred on notices of default not yet reported by the lender.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CONTINUED
Consistent with industry practices, the Company does not establish loss reserves
for future claims on insured loans that are not currently in default. The growth
in loss reserves is the result of the increase in reported defaults and the
maturing of the Company's risk in force. The Company expects loss reserves to
continue to grow, reflecting the growth and aging of its insurance in force.
Including bulk loans, the Company's delinquency ratio (the ratio of delinquent
insured loans to total insured loans) was 0.95% at June 30, 2002 compared to
0.89% at December 31, 2001. The Company's delinquency ratio for bulk loans was
0.88% at June 30, 2002. There were no reported delinquencies for bulk loans at
December 31, 2001.
Reserves are established by management using estimated claim rates
(frequency) and claim amounts (severity) to estimate ultimate losses. The
reserving process incorporates a multi-dimensional analytical form that gives
effect to current economic conditions and profiles delinquencies by such factors
as policy year, geography, and chronic late payment characteristics in addition
to profiling them by age. Because the estimate for loss reserves is sensitive to
the estimates of claims frequency and severity, management performs sensitivity
analyses to test the reasonableness of the best estimate generated by the loss
reserve process. These sensitivity analyses allow management to use alternative
assumptions related to claims frequency and claims severity to develop a range
of reasonably possible loss reserve outcomes that can be used to challenge the
best estimate. The loss reserve estimation process and the sensitivity analyses
support the reasonableness of the best estimate of loss reserves recorded as a
liability in the financial statements. Management periodically reviews the loss
reserve process in order to improve its estimate of ultimate losses on loans
currently in default. Adjustments to reserve estimates are reflected in the
financial statements in the periods in which the adjustments are made.
Total stockholders' equity increased to $280.1 million at June 30, 2002
from $246.1 million at December 31, 2001. This increase resulted primarily from
net income of $21.3 million for the first half of 2002, additional
paid-in-capital of $10.5 million resulting from the exercise of employee stock
options and the related tax benefit, and from net unrealized gains on invested
assets classified as available-for-sale of $3.0 million (net of income tax).
Triad's total statutory policyholders' surplus decreased to $104.3 million
at June 30, 2002 from $105.3 million at December 31, 2001. Triad's statutory
earned surplus decreased to $20.5 million at June 30, 2002 from $21.6 million at
December 31, 2001. The decrease in Triad's statutory policyholders' surplus and
statutory earned surplus resulted from the increase in the statutory contingency
reserve and the increase in non-admitted assets which offset the increase in
statutory net income. The balance in the statutory contingency reserve was
$218.2 million at June 30, 2002 compared to $193.7 million at December 31, 2001.
Triad's ability to write insurance depends on the maintenance of its
financial strength ratings and the adequacy of its capital in relation to risk
in force. A lowered financial strength rating, a significant reduction of
capital, or a significant increase in risk may impair Triad's ability to write
additional insurance. A number of states also generally limit Triad's
risk-to-capital ratio to 25-to-1. As of June 30, 2002, Triad's risk-to-capital
ratio was 15.6-to-1 compared to 15.0-to-1 at December 31, 2001, and to 11.1-to-1
for the industry as a whole at December 31, 2001, the latest industry data
available.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CONTINUED
Triad is rated "AA" by both Standard & Poor's Ratings Services and Fitch
Ratings and "Aa3" by Moody's Investors Service.
The Office of Federal Housing Enterprise Oversight (OFHEO) issued its
risk-based capital rules for Fannie Mae and Freddie Mac in the first quarter of
2002. The regulation provides a more preferential capital credit for insurance
from a "AAA" rated private mortgage insurer than for insurance from a "AA" rated
private mortgage insurer. The phase-in period for the new rules is ten years.
The presence of a capital charge differential in the new rules could adversely
affect Triad. Triad is evaluating various business approaches and options
available to address the capital differential contained in the rule. What
response, if any, Triad makes and the ultimate impact of the regulation on Triad
is unknown at this time, and will not be known until Fannie Mae and Freddie Mac
determine their requirements under the rules. Based on information available at
this time, the Company does not believe that the new rules will have a
significant adverse impact on the Company.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Management's Discussion and Analysis and this Report contain
forward-looking statements relating to future plans, expectations, and
performance which involve various risks and uncertainties, including but not
limited to the following: interest rates may increase from their current levels;
housing transactions and mortgage insurance may decrease for many reasons
including changes in interest rates or economic conditions; the Company's market
share may change as a result of changes in underwriting criteria or competitive
products or rates; the amount of insurance written could be adversely affected
by changes in federal housing legislation, including changes in the Federal
Housing Administration loan limits and coverage requirements of Freddie Mac and
Fannie Mae; the Company's financial condition and competitive position could by
affected by legislation impacting the mortgage guaranty industry specifically
and the financial services industry in general; rating agencies may revise
methodologies for determining the Company's financial strength ratings and may
revise or withdraw the assigned ratings at any time; decreases in persistency,
which are affected by loan refinancings in periods of low interest rates, may
have an adverse effect on earnings; the amount of insurance written and the
growth in insurance in force or risk in force as well as the performance of the
Company may be adversely impacted by the competitive environment in the private
mortgage insurance industry, including the type, structure, and pricing of
products and services offered by the Company and its competitors; if the Company
fails to properly underwrite mortgage loans under contract underwriting service
agreements, the Company may be required to assume the cost of repurchasing those
loans; with consolidation occurring among mortgage lenders and the Company's
concentration of insurance in force generated through relationships with
significant lender customers, the loss of a significant customer may have an
adverse effect on earnings; the Company's performance may by impacted by changes
in the performance of the financial markets and general economic conditions.
Economic downturns in regions where Triad's risk is more concentrated could have
a particularly adverse effect on Triad's financial condition and loss
development.
New OFHEO risk-based capital rules for Fannie Mae and Freddie Mac could
severely limit the ability of Triad to compete with "AAA" rated private mortgage
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CONTINUED
insurers. The ultimate effect of the new rules on Triad and the mortgage
insurance industry in general is not known at this time and will not be known
until Fannie Mae and Freddie Mac determine their requirements under the rules.
Accordingly, actual results may differ from those set forth in the
forward-looking statements. Attention also is directed to other risk factors set
forth in documents filed by the Company with the Securities and Exchange
Commission.
16
PART II
ITEM 1. LEGAL PROCEEDINGS - None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS - None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders was held on May 16, 2002. Shares
entitled to vote at the Annual Meeting totaled 14,079,538 of which 13,185,267
shares were represented at the meeting.
The following five directors were elected at the Annual Meeting. Also shown
are the number of shares cast for and authorization withheld for each nominee.
Name of Nominee Number of Votes for Authorization withheld
--------------- ------------------- ----------------------
Robert T. David 13,059,786 125,481
Michael A. F. Roberts 13,059,676 125,591
William T. Ratliff, III 13,062,970 122,297
Darryl W. Thompson 12,212,738 972,529
David W. Whitehurst 13,059,917 125,350
ITEM 5. OTHER INFORMATION - None
ITEM 6.
a. EXHIBITS
10.23 Employment Agreement between Registrant and Earl F. Wall
(Exhibit 10.23)
10.24 Employment Agreement between Registrant and Michael R. Oswalt
(Exhibit 10.24)
b. REPORTS ON FORM 8-K - None
17
SIGNATURES
Pursuant to the requirements 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.
TRIAD GUARANTY INC.
Date: August 14, 2002
/s/ Michael E. Crow
------------------------------
Michael E. Crow
Vice President and Controller,
Principal Accounting Officer
18