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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[x] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 For the fiscal year ended December 31, 1997
[ ] 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
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TRIAD GUARANTY INC.
(Exact name of registrant as specified in its charter)
DELAWARE 56-1838519
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
101 South Stratford Road, Suite 500
Winston-Salem, North Carolina 27104
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (336) 723-1282
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
Common Stock, par value $.01 per share
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./ /
The aggregate market value of the voting stock held by nonaffiliates of the
registrant as of February 17, 1998, computed by reference to the last reported
price at which the stock was sold on such date, was $287,675,048.
The number of shares of the registrant's common stock, par value $.01 per share,
outstanding as of February 17, 1998 was 13,302,721.
Portions of the following documents are Part of this Form 10-K into which
incorporated by reference into this the document isincorporated
Form 10-K: by reference:
Triad Guaranty Inc. Part III
Proxy Statement for 1998 Annual Meeting
of Stockholders
PART I
ITEM 1. BUSINESS.
Triad Guaranty Inc. (the" Company") 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 residential
mortgage lenders, including mortgage bankers, mortgage brokers, commercial banks
and savings institutions.
Private mortgage insurance, also known as mortgage guaranty insurance, is
issued in most home purchases and refinancings involving conventional
residential first mortgage loans to borrowers with equity of less than 20%. If
the homeowner defaults, private mortgage insurance reduces, and in some
instances eliminates, the loss to the insured lender. Private mortgage insurance
also facilitates the sale of low down payment mortgage loans in the secondary
mortgage market, principally to the Federal Home Loan Mortgage Corporation
("Freddie Mac") and the Federal National Mortgage Association ("Fannie Mae").
Under risk-based capital regulations applicable to savings institutions, private
mortgage insurance also reduces the capital requirement for such lenders on
residential mortgage loans with equity of less than 20%.
Triad was formed in 1987 as a wholly-owned subsidiary of Primerica
Corporation and began writing private mortgage insurance in 1988. In September
1989, Triad was acquired by Collateral Mortgage, Ltd. ("CML"), a mortgage
banking and real estate lending firm located in Birmingham, Alabama. In 1990,
CML contributed the outstanding stock of Triad to its affiliate, Collateral
Investment Corp. ("CIC"), an insurance holding company.
The Company was incorporated by CIC in Delaware in August 1993 for the
purpose of holding all the outstanding stock of Triad and to undertake the
initial public offering of the Company's Common Stock, which was completed in
November 1993. CIC currently owns 20.1% and CML owns 19.3% of the outstanding
Common Stock of the Company.
The principal executive offices of the Company are located at 101 South
Stratford Road, Suite 500, Winston-Salem, North Carolina 27104. Its telephone
number is (336) 723-1282.
TYPES OF MORTGAGE INSURANCE
There are two principal types of private mortgage insurance coverage:
"primary" and "pool". The Company offers only primary insurance.
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PRIMARY INSURANCE
Primary insurance provides mortgage default protection on individual loans
and covers unpaid loan principal, delinquent interest and certain expenses
associated with the default and subsequent foreclosure (collectively, the "claim
amount"). The claim amount, to which the appropriate coverage percentage
(typically 15% to 30% as of December 31, 1997) is applied, generally ranges from
110% to 115% of the unpaid principal balance of the loan. The Company's
obligation to an insured lender with respect to a claim is determined by
applying the appropriate coverage percentage to the claim amount. Under its
master policy, the Company 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. Primary insurance
can be placed on many types of loan instruments and generally applies to loans
secured by mortgages on owner occupied homes. The Company underwrites primary
insurance on a loan-by-loan basis and on a "delegated underwriting" basis to a
select group of lenders. Mortgage originators who participate in the Company's
delegated program are allowed to issue a certificate of insurance on the loans
it underwrites if certain strict qualifications are met.
The Company offers primary coverage generally ranging from 6% to 35% of the
claim amount with most coverage in the 15% to 30% range as of December 31, 1997.
The coverage percentage provided by the Company is selected by the insured
lender, subject to the Company's underwriting approval, usually in order to
comply with existing Freddie Mac and Fannie Mae requirements to reduce their
loss exposure on loans they purchase to 75% or less of the property's value at
the time the loan is originated.
The Company's premium rates vary depending upon the loan-to-value (LTV)
ratio, loan type, mortgage term, coverage amount and type, which all affect the
perceived risk of a claim on the insured mortgage loan. Generally, premium rates
cannot be changed after the issuance of coverage. The Company, consistent with
industry practice, generally utilizes a nationally based, rather than a regional
or local, premium rate structure.
Mortgage insurance premiums are usually paid by the mortgage borrower to
the mortgage lender or servicer, which in turn remits the premiums to the
mortgage insurer. The Company has three basic types of borrower paid premium
plans. The first is a monthly premium plan under which only one or two months'
premium is paid at the mortgage loan closing and in some cases no premiums are
paid at closing. Thereafter level monthly premiums are collected by the loan
servicer for monthly remittance to the Company. In 1996, the Company introduced
a variation of the monthly premium plan under which the initial mortgage
insurance payment is deferred until the first loan payment is remitted to the
Company. This deferred monthly premium product decreases the amount of cash
required from the borrower at closing, therefore, making home ownership more
affordable. Monthly premium plans represented 94% of new insurance written in
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1997. Based on the positive response from mortgage borrowers to the monthly
premium plan product, the Company expects that the percentage of new business
written on monthly premium plans will remain at least at the current level.
The second type of premium payment plan is an annual premium plan in which
a first-year premium is paid at the mortgage loan closing and annual renewal
payments, which are generally less than the first year premium, are paid
thereafter. Renewal payments are collected monthly and held in escrow by the
mortgage lender or servicer for annual remittance in advance of each renewal
year.
The third type of premium payment plan requires a single payment paid at
the loan closing. The single premium payment can be financed by the borrower by
adding it to the principal amount of the mortgage or can be paid in cash at
closing by the borrower.
In addition to the borrower paid plans, the Company has a lender-paid plan
whereby mortgage insurance premiums are charged to the mortgage lender or loan
servicer, which pays the premium to the Company. The lender builds the mortgage
insurance premium into the borrower's interest rate. The Company's lender-paid
plan allows the lender to offer borrowers lower cost mortgages by reducing the
necessary closing costs compared to certain borrower paid plans. The Company's
lender-paid plan has been approved for use by Fannie Mae and Freddie Mac.
In 1997, the Company introduced a mortgage insurance program to enable the
Company to better meet the needs and requirements of larger national lenders.
The program increases the lender's share of the risk of loss on an insured book
of business and provides for a fee to the lender for this increased risk.
Regulatory and industry issues exist regarding the future of certain risk
sharing programs, such as captive reinsurance, currently being marketed within
the mortgage insurance industry. A significant portion of Triad's 1997
production, which does not include captive reinsurance, resulted from Triad's
new risk sharing programs. However, the resolution of the regulatory and
industry questions regarding risk sharing programs makes the continued viability
of such programs uncertain.
POOL INSURANCE
Pool insurance has generally been offered by private mortgage insurers to
lenders as an additional "credit enhancement" for certain mortgage-backed
securities and provides coverage for the full amount of the net loss on each
individual loan included in the pool, subject to a provision limiting aggregate
losses to a specified percentage of the total original balances of all loans in
the pool. Modified pool insurance provides coverage for a specified percentage
of the claim amount for each loan insured, subject to an overall stop-loss
provision applicable to the entire pool of loans insured. The Company does not
offer pool insurance.
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CANCELLATION OF INSURANCE
Mortgage insurance coverage cannot be canceled by the Company except for
nonpayment of premium or certain material violations of the master policy, and
remains renewable at the option of the insured lender. Generally, mortgage
insurance is renewable at a rate fixed when the insurance on the loan was
initially issued.
Insured lenders may cancel insurance at any time at their option. A
borrower may request that an insured servicer cancel insurance on a mortgage
loan when its loan balance is less than 80% of the property's current value, but
loan servicers are generally restricted in their ability to grant such requests
by secondary market requirements as well as by certain other regulatory
restrictions. Legislation currently is being discussed, however, which could
affect the cancellation of private mortgage insurance. See "Regulation -
Indirect Regulation".
When a borrower refinances a Triad-insured mortgage loan by paying it off
in full with the proceeds of a new mortgage, the insurance on that existing
mortgage is canceled, and insurance on the new mortgage is considered to be new
insurance written. Therefore, continuation of Triad's coverage from a refinanced
loan to a new loan results in both a cancellation of insurance and new insurance
written. The percentage of new insurance written represented by refinanced loans
was 14.0%, 16.9%, and 9.3% in 1997, 1996, and 1995, respectively.
To the extent canceled insurance coverage in areas experiencing economic
growth is not replaced by new insurance in such areas, the percentage of the
Company's book of business in economically weaker areas may increase. This
development may occur during periods of heavy mortgage refinancing. Refinanced
loans in regions experiencing economic growth are less likely to require private
mortgage insurance, while borrowers in economically distressed areas are less
likely to qualify for refinancing because of depreciated real estate values.
Throughout the 1990's high refinancing activity occurred because of lower
mortgage interest rates. The percentage of the Company's policies in force at
the end of the year that were canceled during the following year was 15.6%,
14.7%, and 13.6% in 1997, 1996, and 1995, respectively. The cancellations which
have occurred since 1988 have not had a material impact on the geographic
dispersion of the Company's risk in force.
CUSTOMERS
Residential mortgage lenders such as mortgage bankers, mortgage brokers,
commercial banks and savings institutions are the principal customers of the
Company. At December 31, 1997, approximately 53% of the Company's risk in force
came from mortgage bankers, 22% from mortgage brokers, 16% from commercial banks
and 9% from savings institutions. At December 31, 1996, 47% of the Company's
risk in force came from mortgage bankers, 24% from mortgage brokers, 17% from
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commercial banks and 12% from savings institutions. Although mortgage lenders
are the Company's principal customers, individual mortgage borrowers generally
bear the cost of primary insurance coverage.
To obtain primary insurance from the Company, a mortgage lender must first
apply for and receive a master policy from the Company. The Company'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.
The master policy sets forth the terms and conditions of the Company's
mortgage insurance policy. The master policy does not obligate the lender to
obtain insurance from the Company, nor does it obligate the Company to issue
insurance on a particular loan. The master policy provides that the lender must
submit individual loans for insurance to the Company and the loan, subject to
certain stringent criteria, must be approved by the Company to effect coverage
(except in the case of delegated underwriting and when the originator has the
authority to approve coverage within certain guidelines). The Company had
approximately 6,096 master policy holders at December 31, 1997, compared to
5,750 at December 31, 1996.
The Company's ten largest customers were responsible for 32.2%, 23.4%, and
23.7% of direct risk in force at December 31, 1997, 1996, and 1995,
respectively. The largest single customer of the Company (including branches and
affiliates of that customer), measured by risk in force, accounted for 10.2%,
3.3%, and 3.4% at December 31, 1997, 1996, and 1995, respectively.
SALES AND MARKETING
The Company currently markets its insurance products through a field sales
force of twenty-five salaried account executives, three regional sales managers,
four national accounts representatives and two exclusive commissioned general
agencies each serving a specific geographic market. The Company is licensed to
do business in 43 states and the District of Columbia and has licenses pending
in three states. The Company is actively serving mortgage originators in 34
states and the District of Columbia.
In 1997, the Company added to its existing sales force with new
representation in the Pacific Northwest, the Upper Midwest, and two new
representatives to service the national account market of larger mortgage
lenders. Currently, the Company is approved to do business with 21 of the top 30
lenders. The Company will continue to evaluate geographic expansion
opportunities, as well as the need for additional sales representation.
The success of the Company is dependent upon the services of its account
executives and general agents. For 1997, the Company's two exclusive
commissioned general agencies produced approximately 18% of the Company's new
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direct insurance written while the salaried account executives and the national
account representatives produced the remainder. The loss of the services of any
of its key account executives or general agencies could have a material adverse
effect on the Company's operations.
COMPETITION AND MARKET SHARE
Triad and other private mortgage insurers compete directly with federal and
state governmental and quasi-governmental agencies, principally the Federal
Housing Administration (" FHA"). These agencies sponsor government-backed
mortgage insurance programs which accounted for approximately 46% of high LTV
loans in 1997 and 45% in 1996. In addition to competition from federal agencies,
Triad and other private mortgage insurers face competition from state-supported
mortgage insurance funds. Several of these states (among them, California,
Connecticut, Massachusetts, New York and Vermont) have state housing insurance
funds which are either independent agencies or affiliated with state housing
agencies. Indirectly, the Company also competes with certain mortgage lenders
which forego private mortgage insurance and self-insure against the risk of loss
from defaults on all or a portion of their low down payment mortgage loans.
Various proposals are being discussed by Congress and certain federal
agencies to reform or modify the FHA. Management is unable to predict the scope
and content of such proposals, or whether any such proposals will be enacted
into law, and if enacted, the effect on the Company.
The private mortgage insurance industry consists of nine active mortgage
insurance companies including Triad, Mortgage Guaranty Insurance Corporation,
General Electric Mortgage Insurance Corporation, PMI Mortgage Insurance Co., CMG
Mortgage Insurance Co., United Guaranty Residential Insurance Company, Republic
Mortgage Insurance Company, Commonwealth Mortgage Assurance Company and Amerin
Guaranty Corporation. Triad is the eighth largest private mortgage insurer based
on 1997 market share and, according to industry data, had a 2.4% share of net
new mortgage insurance written during 1997, up from 1.7% in 1996.
Management believes the Company competes with other private mortgage
insurers principally on the basis of personalized and professional service, a
strong management and sales team, an experience-based pricing structure and
innovative products. Triad was the first in the industry to provide preferred
rates to approved lenders that maintain lower loss ratios on loans which they
insure with Triad.
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UNDERWRITING PRACTICES
The Company considers effective risk management to be critical to its
long-term financial stability. Market analysis, prudent underwriting, the use of
automated risk evaluation models, auditing and customer service are all
important elements of the Company's risk management process.
UNDERWRITING PERSONNEL
The Company's Vice Presidents of Risk Management and Underwriting report
directly to the President of the Company and the Executive Vice President of
Sales and Marketing, respectively. In addition to a centralized underwriting
department in the home office, the Vice President of Underwriting is responsible
for the Company's regional offices in Georgia, Texas, Illinois, Arizona and
California. The Vice President of Risk Management is responsible for assessing
the risk factors for the Company and for the quality control function.
The Company employed an underwriting staff of twenty at December 31, 1997.
The Company's field underwriters and underwriting managers are limited in their
authority to approve programs for certain mortgage loans. The authority levels
are tied to underwriting position, knowledge and experience and relate primarily
to loan amounts and property type. All loans insured by the Company are subject
to quality control reviews.
RISK MANAGEMENT APPROACH
From its inception in 1988, Triad has adhered to conservative risk
management strategies that were developed, in part, as a result of management's
assessment of the private mortgage insurance industry's loss experience in the
late 1980s. The Company's risk management objective is to build a portfolio of
insurance in force with a claims incidence less than the expected claims rates
on which its premium rates are based. In order to meet this objective the
Company focuses its risk management efforts on five key elements:
o MORTGAGE LENDER. The Company reviews each lender's financial
statements and management experience before issuing a master policy.
This analysis permits the Company to determine if that lender is
predisposed to maintaining a loss ratio on loans which it insures with
the Company that will allow the continued use of the Company's
preferred premium schedule after the three year grace period. The
Company assigns delegated underwriting authority only to lenders with
substantial financial resources and established records of originating
good quality loans.
o PURPOSE AND TYPE OF LOAN. The Company analyzes four general
characteristics of a loan to evaluate its level of risk: (i) LTV
ratio; (ii) purpose of the loan; (iii) type of loan instrument; and
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(iv) type of property. The Company seeks only the most basic loan
types with proven track records for which an assessment of risk can be
readily made and the premium received sufficiently offsets that risk.
Loans having higher LTV ratios are charged a higher premium, as are
other loans which have been shown to carry higher risks, such as
adjustable rate mortgages ("ARMs"). Certain categories of loans are
generally not insured by the Company because such loans are deemed to
have an unacceptable level of risk, including negatively and potential
negatively amortizing ARMs, ARMs with maximum annual and lifetime caps
greater than two and six percentage points, respectively, and loans
for investor properties.
o INDIVIDUAL LOAN AND BORROWER. Except to the extent that the Company's
delegated underwriting program and Freddie Mac's and Fannie Mae's
automated underwriting services are being utilized, the Company
evaluates insurance applications based on its analysis of the
borrower's ability and willingness to repay the mortgage loan and the
characteristics and value of the mortgaged property. The analysis of
the borrower includes reviewing the borrower's housing and total debt
ratios as well as the borrower's Fair, Isaac and Co., Inc. ("FICO")
credit score, as reported by credit rating agencies. Loans may be
submitted under the Stick With Triad program provided the loans meet
the program requirements. Further description of the Stick with Triad
program is located in the Underwriting Process section. Within this
program, the degree to which the borrower must meet certain
underwriting standards, as well as the amount of documentation that is
required, is a function of the credit score. In the case of delegated
underwriting, compliance with program parameters is monitored by
periodic audits of delegated business. With the automated underwriting
services provided by Freddie Mac and Fannie Mae, lenders are able to
obtain approval for mortgage guaranty insurance with any participating
mortgage insurer. Triad works with both agencies in offering insurance
services through their systems, while monitoring the risk quality of
loans insured through such systems.
0 EXPERIENCE-BASED PREMIUM STRUCTURE. To increase profitability, the
Company targets lower risk business through the Company's preferred
premium rate schedules. The Company was the first in the industry to
provide preferred rates to lenders maintaining lower loss ratios on
loans which they insure with the Company. These rates, which are lower
than those generally available throughout the industry, are offered to
lenders for the first three years under a master policy so that a loss
ratio on loans which a lender insures with the Company can be fairly
determined. After that point, approved lenders maintaining a loss
ratio of 40% or less will continue to operate under the preferred rate
schedule. Those with loss ratios greater than 40% will be charged
higher premiums on new business (as well as higher premiums on renewal
business if a variable renewal program was chosen) until the loss
ratio is reduced. These higher premiums are comparable to those
premiums typically charged by the Company's competitors. This
experience-based structure encourages lenders to maintain low loss
ratios on loans which they insure with the Company.
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o GEOGRAPHIC SELECTION OF RISK. The Company places significant emphasis
on the condition of the regional housing markets in determining its
marketing and underwriting policies. Using both internal and external
data, the Company's risk management department continually monitors
the economic conditions in the Company's active and potential markets.
UNDERWRITING PROCESS
The Company accepts applications for insurance under three basic programs:
the traditional fully documented program, a credit score driven reduced
documentation program, and a delegated underwriting program, which allows a
lender's underwriters to commit insurance to a loan based on strict agreed upon
underwriting guidelines.
The Company utilizes nationwide underwriting guidelines to evaluate the
potential risk of default on mortgage loans submitted for insurance coverage.
These guidelines have evolved over time and take into account the loss
experience of the entire private mortgage insurance industry. They are also
largely influenced by Freddie Mac and Fannie Mae underwriting guidelines. The
Company believes its guidelines are generally consistent with those used by
other private mortgage insurers with respect to the types of loans that the
Company will insure. As a result of the Company's review of regional economies
and housing patterns, specific underwriting guidelines applicable to a given
local, state or regional market will be modified to address concerns in that
market.
Subject to the Company's underwriting guidelines and exception approval
procedures, the Company allows its underwriters to utilize their experience and
business judgement in evaluating each loan on its own merits. Accordingly, the
Company underwriters have discretionary authority to insure loans which deviate
in certain minor respects from the Company's underwriting guidelines. More
significant exceptions are subject to management approval. In all such cases,
compensating factors must be identified. The predominant reason for such
deviations involves instances where the borrower's debt-to-income ratio exceeds
the Company's guidelines. To compensate for exceptions, the Company's
underwriters give favorable consideration to such factors as excellent borrower
credit history, the availability of satisfactory cash reserves after closing and
employment stability.
In addition to the borrower's willingness and ability to repay the loan,
the Company believes that mortgage default risk is affected by a variety of
other factors, including the borrower's employment status. Insured mortgage
loans made to self-employed borrowers are perceived by the Company to have
higher risk of claim, all other factors being equal, than loans to borrowers
employed by third parties. The Company's percentage of risk in force involving
self-employed borrowers was 3.7% and 3.8% at December 31, 1997 and 1996,
respectively.
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In 1996, the Company introduced the Stick With Triad program featuring the
Slam Dunk Loan(SM) approval process whereby Triad issues a certificate of
insurance based on the borrower's FICO credit score or the approval of the loan
through Fannie Mae's or Freddie Mac's automated underwriting programs. Under
this program, the Company issues a certificate of insurance without the standard
underwriting process if certain program parameters are met and the borrower has
a predetermined minimum credit score. Documentation submission requirements for
non-automated underwritten loans vary depending on the borrower's credit score.
In 1997, the Stick With Triad program represented 60% of the Company's
commitment volume.
The Company's delegated underwriting program, in addition to the Company's
conservative risk management strategies, utilizes extensive "quality control"
practices including reunderwriting, reappraisal and similar procedures following
issuance of the policy. Standards for type of loan, property type and credit
history of the borrower are established consistent with the Company's risk
strategy. The program has allowed the Company to serve a greater number of the
larger, well established mortgage originators. The Company's delegated
underwriting program accounted for 18% of commitments received in 1997 compared
to 38% in 1996 and 25% in 1995. The decline in the volume of delegated
commitments is a result of the lenders' acceptance of the Company's Stick With
Triad program. The performance of loans insured under the delegated underwriting
program has been comparable to the Company's non-delegated business.
The Company utilizes its underwriting skills to provide a contract
underwriting service to its customers. For a fee, Triad underwrites fully
documented underwriting files for secondary market compliance, while at the same
time assessing the file for mortgage insurance, if applicable. In 1996, the
Company began offering Fannie Mae's Desktop Originator and Desktop Underwriter,
as well as the personnel to conduct the underwriting tasks, as a service to its
contract underwriting customers. The Company also offers its contract
underwriting customers direct access to Freddie Mac's Loan Prospector. These
products, which are designed to streamline and reduce costs in the mortgage
origination process, supply the Company's customers with fast and accurate
service regarding loan compliance and Fannie Mae's or Freddie Mac's decision for
loan purchase or securitization.
OTHER RISK MANAGEMENT
Another important aspect of the Company's risk management is the tracking
of risk exposure in condominium projects. The Company's risk management computer
system tracks the exposure in each project and alerts the underwriter once
predetermined limits are reached. The Company's computer system also identifies
certain exceptions in loan files that deserve special underwriter attention.
The Company uses a comprehensive audit plan designed to determine whether
the underwriting decisions being made are consistent with the policies,
procedures and expectations for quality as set forth by management. All areas of
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business activity which involve an underwriting decision are included, with
emphasis on new products, procedures and new master policyholders. The process
used to identify categories of loans selected for an audit begins with the
identification and evaluation of certain defined and verifiable risk elements.
Each loan is then tested against these elements to identify loans which fail to
meet prescribed policies or an identified norm. The procedure allows the Company
management to identify concerns not only at the loan level but also portfolio
concerns which may exist within a given category of business.
CLAIMS-PAYING ABILITY RATINGS
Certain national mortgage lenders and a large segment of the mortgage
securitization market, including Fannie Mae and Freddie Mac, generally will not
purchase high LTV mortgages or mortgage-backed securities unless the private
mortgage insurance coverage on the mortgages has been issued by an insurer with
a claims-paying ability rating of at least "AA-" from Standard & Poor's
Corporation ("S&P"), Fitch Investors Service, L.P. ("Fitch") or Duff & Phelps
Credit Rating Co. ("Duff & Phelps") or a financial strength rating from Moody's
Investor Service ("Moody's") of at least "Aa3". Fannie Mae and Freddie Mac
require mortgage guaranty insurers to maintain two ratings of "AA-" or better.
Private mortgage insurers are not rated by any other independent
nationally-recognized insurance industry rating organization or agency (such as
the A.M. Best Company).
Triad has its claims-paying ability rated by S&P, Fitch and Duff & Phelps.
These ratings are an indication to a mortgage insurer's customers of the
insurer's present financial strength and its capacity to pay future claims.
Ratings are generally considered an important element in a mortgage insurer's
ability to compete for new business. Triad's claims-paying ability rating by S&P
was upgraded to "AA" from "AA-" in January 1997, and the "AA" rating was
reaffirmed in January 1998. Triad's improved rating from S&P allows it to
compete on similar risk-to-capital guidelines as its competitors. Triad is also
rated "AA" by Fitch and Duff & Phelps. Triad has not sought and does not
presently intend to seek a financial strength rating from Moody's.
S&P defines insurers rated "AA" as offering excellent financial security
and having the capacity to meet policy holder obligations that is strong under a
variety of economic and underwriting conditions. Fitch defines insurance
companies rated "AA" as having a very strong claims-paying ability and to be
only slightly more susceptible than companies rated "AAA" to exhibiting any
weakening of financial strength due to adverse business and economic
developments. Duff & Phelps defines insurers rated "AA" as having a very high
claims-paying ability with only modest risk which may vary slightly over time
due to economic and/or underwriting conditions. Ratings from S&P, Fitch and Duff
& Phelps are modified with a "+" or "-" sign to indicate the relative position
of a company within its category.
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When assigning a claims-paying ability rating, S&P, Fitch, and Duff &
Phelps generally consider: (i) the specific risks associated with the mortgage
insurance industry, such as regulatory climate, market demand, growth and
competition; (ii) management depth, corporate strategy and effectiveness of
operations; (iii) historical operating results and expectations of current and
future performance; and (iv) long-term capital structure, the ratio of debt to
equity, the ratio of risk to capital, near-term liquidity and cash flow levels,
as well as any reinsurance relationships and the claims-paying ability ratings
of such reinsurers. Claims-paying ability ratings are based on factors relevant
to policyholders, agents, insurance brokers, and intermediaries. Such ratings
are not directed to the protection of investors and do not apply to any
securities issued by the Company.
Rating agencies issue claims-paying ability ratings based, in part, upon a
company's performance sensitivity to various economic depression scenarios. In
determining capital levels required to maintain a company's claims-paying
ability rating, the rating agencies allow the use of different forms of capital
including statutory capital, reinsurance and debt. In January 1998 the Company
completed a $35 million private offering of senior notes due January 15, 2028.
The notes are rated "A" by S&P and "A+" by Fitch. The Company contributed $25
million of the net proceeds from the sale of the notes to Triad. The effect of
the Company's contribution of $25 million to the capital of Triad will be to
improve its risk-to- capital ratio and to provide additional capital considered
in the rating agency's depression models.
S&P, Fitch and Duff & Phelps periodically review Triad's claims-paying
ability, as they do with all rated insurers. Ratings can be withdrawn or changed
at any time by a rating agency.
REINSURANCE
In January 1996 the Company eliminated quota share reinsurance on new
business and recaptured substantial portions of its coverages on renewal
business. In October 1997 the Company recaptured most of its remaining coverages
on renewal business. The restructured reinsurance program reduced the Company's
quota share cede rate to 1.7% of direct premium written in 1997 compared to 5.3%
in 1996 and 20.8% in 1995. The recapture of business previously ceded resulted
in increased premium revenues for the Company. The Company continues to maintain
$25 million in excess of loss reinsurance designed to protect the Company in the
event of catastrophic levels of losses.
Reinsurance does not legally discharge an insurer from its primary
liability for the full amount of the risk it insures, although it does make the
reinsurer liable to the primary insurer. There can be no assurance that the
Company's reinsurers will be able to meet their obligations under the
reinsurance agreements.
13
Pursuant to deeper coverage requirements imposed by Fannie Mae and Freddie
Mac, loans eligible for sale to such agencies with a loan-to-value ratio of over
90% require insurance with a coverage percentage of 30%, in contrast to the 25%
coverage previously required. Certain states limit the amount of risk a mortgage
insurer may retain with respect to coverage of an insured loan to 25% of the
claim amount, and, as a result, the deeper coverage portion of such insurance
must be reinsured. To minimize reliance on third party reinsurers and to permit
the Company to retain the premiums and related risk on deeper coverage business,
Triad reinsures this deeper coverage business with its wholly-owned subsidiary
Triad Guaranty Assurance Corporation ("TGAC"). As of December 31, 1997, TGAC had
assumed approximately $81.5 million in risk from Triad.
DEFAULTS AND CLAIMS
DEFAULTS
The claim process on private mortgage insurance begins with the insurer's
receipt of notification from the lender of a default on an insured's loan.
Default is defined in the primary master policy as the failure by the borrower
to pay, when due, an amount at least equal to the scheduled monthly mortgage
payment under the terms of the mortgage. The master policy requires lenders to
notify the Company of default on a mortgage payment within 10 days of either (i)
the date on which the borrower becomes four months in default or (ii) the date
on which any legal proceeding which affects the loan has been commenced,
whichever occurs first. Notification is required within 45 days of the default
if it occurs when the first payment is due. The incidence of default is affected
by a variety of factors, including change in borrower income, unemployment,
divorce, illness, the level of interest rates and general borrower
creditworthiness. Defaults that are not cured result in a claim 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.
The following table shows the number of loans insured, related loans in
default, percentage of loans in default (default rate as of the dates
indicated), dollar amount of insured loans in default, dollar amount of direct
risk (gross of reinsurance) with respect to insured loans in default, and
reserves per delinquent loan:
14
Default Statistics
December 31
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Number of insured loans in force.................... 82,682 62,334 49,791 41,358 30,497
Number of loans in default.......................... 388 273 206 156 102
Percentage of loans in default (default rate)....... 0.47% 0.44% 0.41% 0.38% 0.33%
Dollar amount of insured loans in default (000's)... $37,828 $25,253 $19,907 $14,356 $9,177
Dollar amount of direct risk with respect to
insured loans in default (000's).................... $9,249 $5,770 $4,071 $2,827 $1,810
Reserve per delinquent loan......................... $23,094 $23,097 $22,277 $20,281 $22,111
CLAIMS
Claims result from defaults that are not cured. The frequency of claims
does not directly correlate to the frequency of defaults due in part to the
Company's loss mitigation efforts and the borrower's ability to overcome
temporary financial setbacks. The likelihood that a claim will result from a
default, and the amount of such claim, principally depend 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 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, the
housing supply and the borrower's desire to avoid foreclosure. During the
default period, the Company works with the insured for possible early disposal
of underlying properties when the chance of the loan reinstating is minimal.
Such dispositions typically result in a reduced claim amount to the Company.
Claim activity is not evenly spread through the coverage period. Relatively
few claims are received during the first two years following issuance of
insurance. A period of rising claims follows, which, based on industry
experience, has historically reached its highest level in the third through
sixth years after the loan origination. Thereafter, the number of claims
received has historically declined at a gradual rate, although the rate of
decline can be affected by economic and other conditions. There can be no
assurance that the historical pattern of claims will continue in the future.
Generally, the Company does not pay a claim for loss under the master
policy if the application for insurance for the loan in question contains
fraudulent information, material omissions or misrepresentations which increase
the risk characteristics of the loan. The Company's master policy also excludes
any cost or expense related to the repair or remedy of any physical damage
(other than "normal wear and tear") to the property collateralizing an insured
mortgage loan. Such physical damage may be caused by accident, natural
occurrence or otherwise.
15
Under the terms of the master policy, the lender is required to file a
claim with the Company no later than 60 days after it has acquired good and
marketable title to the underlying property through foreclosure. A primary
insurance claim amount includes (i) the amount of unpaid principal due under the
loan; (ii) the amount of accumulated delinquent interest due on the loan
(excluding late charges) to the date of claim filing; (iii) expenses advanced by
the insured under the terms of the master policy, such as hazard insurance
premiums, property maintenance expenses and property taxes to the date of claim
filing; and (iv) certain foreclosure and other expenses, including attorneys
fees. Such claim amount is subject to review and possible adjustment by the
Company. An average of about 12 months elapses from the date of default to a
payment of claim on an uncured default. The Company's experience indicates that
the claim amount on a policy generally ranges from 110% to 115% of the unpaid
principal amount of a foreclosed loan.
Within 60 days after the claim has been filed, the Company has the option
of either (i) paying the coverage percentage specified on the certificate of
insurance (usually 15% to 30% of the claim), with the insured retaining title to
the underlying property and receiving all proceeds from the eventual sale of the
property or (ii) paying 100% of the claim amount in exchange for the lender's
conveyance of good and marketable title to the property to the Company, with the
Company selling the property for its own account. The Company attempts to choose
the claim settlement option which costs the least. In general, the Company
settles claims by paying the coverage percentage of the claim amount. In 1997,
the Company exercised the option to acquire the property on less than 1% of the
primary claims processed for payment. At December 31, 1997, the Company owned
$141,999 of real estate acquired through claim settlements valued at the lower
of cost or net realizable value and owned no real estate as of December 31,
1996.
LOSS MITIGATION
Once a default notice is received, the Company attempts to mitigate its
loss. Through proactive intervention with insured lenders and borrowers, the
Company has been successful in reducing the number and severity of its claims
for loss. Loss mitigation techniques include pre-foreclosure sales, advances to
assist distressed borrowers who have suffered a temporary economic setback, and
the use of new repayment schedules, refinances, loan modifications, forbearance
agreements and deeds-in-lieu of foreclosure. Such mitigation efforts typically
result in a savings to the Company over the percentage coverage amount payable
under the certificate of insurance. Through loss mitigation efforts, the Company
has paid out only 65% of its potential exposure on claims paid through December
31, 1997.
LOSS RESERVES
The Company establishes reserves to provide for the estimated costs of
settling claims with respect to loans reported to be in default and estimates of
loans in default which have not been reported. Consistent with industry
16
accounting practices, the Company does not establish loss reserves for future
claims on insured loans which are not currently in default. Although the Company
believes that its overall reserve levels at December 31, 1997, are adequate to
meet its future obligations, due to the inherent uncertainty of the reserving
process there can be no assurance that its reserves will prove to be adequate to
cover ultimate loss developments.
In determining the liability for unpaid losses related to outstanding
defaults, the Company establishes loss reserves on a case-by-case basis using
historical experience and by making various assumptions and judgements about the
ultimate amount to be paid on loans in default. 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 the default progresses closer to foreclosure,
the amount of loss reserve for that particular loan will be increased, in
stages, to approximately 120% of the Company's exposure, which includes
claims-related expenses. The Company periodically reviews and adjusts its
reserve estimates to address changes in economic conditions as well as
developments in its loss experience.
The Company also establishes reserves to provide for the estimated costs of
settling claims, including legal and other fees, and general expenses of
administering the claims settlement process ("loss adjustment expenses" or
"LAE") and for losses and loss adjustment expenses incurred arising from
defaults which have occurred, but which have not yet been reported to the
insurer ("Incurred But Not Reported" or "IBNR").
The Company's reserving process is based upon the assumption that past
experience, adjusted for the anticipated effect of current economic conditions
and projected future economic trends, provides a reasonable basis for estimating
future events. However, estimation of loss reserves is a difficult and inexact
process, especially in light of the rapidly changing economic conditions over
the past few years in certain regions of the United States. In addition,
economic conditions that have affected the development of the loss reserves in
the past may not necessarily affect development patterns in the future in either
a similar manner or degree. 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 developments on
loans in default, currently or in the future. The Company's profitability and
financial condition could be adversely affected to the extent that the Company's
estimated reserves are insufficient to cover losses on loans in default.
17
The following table represents a reconciliation of the beginning and ending
loss reserves (net of reinsurance) for the periods indicated.
Reconciliation of Losses and Loss Adjustment Expense Reserves
Year Ended December 31
(in thousands)
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Reserve for losses and LAE, net
of related reinsurance
recoverables, at beginning of year.. $5,974 $3,703 $2,466 $1,805 $1,073
Add losses and LAE incurred in
respect of defaults occurring in:
Current year (1)................ 6,023 4,673 3,191 2,053 1,489
Prior years (1) (2)............. (846) (1,394) (974) (791) (205)
------- ------- ------- ------- ------
Total incurred losses and LAE........ 5,177 3,279 2,217 1,262 1,284
Deduct losses and LAE paid in
respect of defaults occurring in:
Current year..................... 210 167 216 86 95
Prior years...................... 2,032 841 764 515 457
------- ------- ------- ------- ------
Total payments........................ 2,242 1,008 980 601 552
Reserve for losses and LAE, net
of the related reinsurance
recoverables, at end of year......... 8,909 5,974 3,703 2,466 1,805
Reinsurance recoverables on unpaid
losses and LAE, at the end
of year ............................. 51 331 886 698 450
------- ------- ------- ------- ------
Reserve for unpaid losses and LAE,
before deduction of reinsurance
recoverables on unpaid losses, at
end of year.......................... $8,960 $6,305 $4,589 $3,164 $2,255
====== ====== ====== ====== ======
- --------------
(1) Includes loss and LAE reserves relating to loans which are in default but
for which default notices have not been received.
(2) Indicates a cumulative redundancy in loss reserves at the beginning of each
period. Redundancies result from overestimating ultimate claim amounts.
The top section of the above table shows losses incurred on insurance
policies with respect to defaults which occurred in the current and prior
periods. The amount of losses incurred relating to defaults occurring in the
current period represents the estimated amount to be ultimately paid on defaults
occurring in that period. The amount of losses incurred relating to defaults
occurring in prior periods represents an adjustment made in the current period
for defaults which were included in the loss reserve at the end of the prior
period.
18
The middle section of the above table shows claims paid on insurance
policies with respect to defaults which occurred in the current period and in
prior periods, respectively. Since it takes, on average, about 12 months for a
default which is not cured to eventually develop into a paid claim, most losses
paid relate to defaults occurring in prior periods.
ANALYSIS OF DIRECT RISK IN FORCE
A foundation of the Company's business strategy is proactive risk
selection. The Company analyzes its portfolio in a number of ways to identify
any concentrations of risk or imbalances in risk dispersion. The Company
believes that the quality of its insurance portfolio is affected predominantly
by (i) the quality of loan originations (including the strength of the borrower
and the marketability of the property); (ii) the attributes of loans insured
(including LTV ratio, purpose of the loan, type of loan instrument and type of
underlying property securing the loan); (iii) the seasoning of the loans
insured; (iv) the geographic dispersion of the underlying properties subject to
mortgage insurance; and (v) the quality and integrity of lenders from which the
Company receives loans to insure.
19
LENDER AND PRODUCT CHARACTERISTICS
The following table reflects the percentage of direct gross risk in force
(as determined on the basis of information available on the date of mortgage
origination) by the categories indicated on December 31, 1997 and 1996:
Direct Risk in Force
December 31
1997 1996
---- ----
Product Type:
Primary............................................... 100.0% 100.0%
Pool.................................................. 0.0% 0.0%
------ ------
Total................................................. 100.0% 100.0%
====== ======
Direct Primary Risk in Force
December 31
1997 1996
---- ----
Direct Risk in Force (dollars in millions)............ $2,231 $1,515
Lender Concentration:
Top 10 lenders (by original applicant)................ 32.2% 23.4%
LTV:
90.01% to 95.00% (1).................................. 52.0% 49.4%
90.00 and below....................................... 48.0% 50.6%
------ ------
Total................................................. 100.0% 100.0%
====== ======
Loan Type:
Fixed................................................. 88.2% 85.6%
ARM (positive amortization) (2)....................... 11.8% 14.4%
ARM (potential negative amortization) (3)............. 0.0% 0.0%
ARM (scheduled negative amortization) (3)............. 0.0% 0.0%
Other................................................. 0.0% 0.0%
------ ------
Total................................................. 100.0% 100.0%
====== ======
Mortgage Term:
15 years and under.................................... 4.3% 5.6%
Over 15 years......................................... 95.7% 94.4%
------ ------
Total................................................. 100.0% 100.0%
====== ======
Property Type:
Noncondominium (principally single-family detached)... 94.9% 94.3%
Condominium........................................... 5.1% 5.7%
------ ------
Total................................................. 100.0% 100.0%
====== ======
Occupancy Status:
Primary residence..................................... 100.0% 100.0%
Second home........................................... 0.0% 0.0%
Nonowner occupied..................................... 0.0% 0.0%
------ ------
Total................................................. 100.0% 100.0%
====== ======
Mortgage Amount:
$200,000 or less...................................... 95.3% 92.1%
Over $200,000......................................... 4.7% 7.9%
------ ------
Total................................................. 100.0% 100.0%
====== ======
(1) Includes 97s, representing less than 1% of risk in force at December 31,
1997.
(2) Refers to loans where payment adjustments are the same as mortgage interest
rate adjustments.
(3) Scheduled negative amortization is defined by the Company as the increase in
loan balance that will occur if interest rates do not change. Loans with
potential negative amortization will not have increasing principal balances
unless interest rates increase.
20
One of the most important determinants of claim incidence is the relative
amount of the borrower's equity in the home (which at the time of origination is
the down payment). For the industry as a whole, historical evidence indicates
that claim incidence on loans having a LTV ratio in excess of 90% is greater
than the claim incidence on loans with LTV ratios equal to or less than 90%. The
Company believes that the higher premium rates it charges on these high LTV
loans adequately reflects the additional risk.
In 1995, the mortgage insurance industry introduced a 97% LTV product
("97s") which was offered to low and moderate income borrowers under certain
pilot programs. The Company believes that these "affordable housing" loans have
higher risks than its other insured business and has often attracted borrowers
with weak credit histories, generally resulting in higher loss ratios. In
keeping with the Company's established risk strategy, the Company has not
aggressively solicited this segment of the industry, and, as of December 31,
1997, 97s constituted less than 1% of direct risk in force. The Company does not
routinely delegate the underwriting of its 97% LTV product.
The Company generally insures only positively amortizing ARMs with maximum
annual and lifetime caps of two and six percentage points, respectively.
Payments on these loans adjust fully with interest rate adjustments. To date,
the performance of the Company's ARM loans has been consistent with that of the
fixed rate portfolio. However, since historical claim frequency data on ARMs has
not yet been tested during a prolonged period of economic stress, there can be
no assurance that claim frequency on ARMs may not eventually be higher,
particularly during a period of rising interest rates combined with decreasing
housing prices. In its normal course of operations, the Company's existing
underwriting policy does not permit coverage of ARMs with "scheduled" or
"potential" negative amortization.
Historical evidence indicates that higher priced properties experience
wider fluctuations in value than moderately priced residences. These
fluctuations exist primarily because there is a much smaller pool of qualified
buyers for higher priced homes which, in turn, reduces the likelihood of
achieving a quick sale at fair market value when necessary to avoid a default.
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. Accordingly, the
Company charges lower premium rates on these loans than on comparable 30-year
mortgages.
The Company believes that the risk of claim is also affected by the type of
property securing the insured loan. In management's opinion, loans on
single-family detached housing are subject to less risk of claim incidence than
loans on other types of properties. The Company believes that attached housing
types, particularly condominiums and cooperatives, are a higher risk because in
most areas condominiums and cooperatives tend to be more susceptible to downward
fluctuations in value than single family detached dwellings in the same market.
The term "single-family" applies to all one-to-four unit dwellings and includes
21
detached and attached townhouse units with fee simple ownership,
condominiums and cooperatives.
Loans on primary residences that were owner occupied at the time of loan
origination constituted almost all of the Company's risk in force at December
31, 1997. Because management believes that loans on nonowner occupied properties
represent a substantially higher risk of claim incidence and are subject to
greater value declines than loans on primary homes, the Company insures these
types of loans only on a case-by-case basis and only after stringent management
review.
The Company's book of business is less mature than that of the private
mortgage insurance industry as a whole, with the Company's direct risk in force
having a weighted average life of 2.3 years at December 31, 1997, and 2.4 years
at December 31, 1996, compared to an estimated industry average of 3.3 years at
December 31, 1997.
The following table shows the percentage of direct risk in force as of
December 31, 1997, for policies written from 1988 through 1997 by the Company,
as well as the cumulative loss ratio (calculated as losses paid divided by
premiums written, in each case for a particular certificate year) which has
developed, through December 31, 1997, for the policies written during the years
indicated and excludes the effects of reinsurance:
Certificate Percent Cumulative Ratio of Losses
Year Direct Risk in Force of Total Paid to Premiums Written(1)
---- -------------------- -------- ---------------------------
(in millions)
1988 $ 1.9 0.1% 14.6
1989 2.6 0.1 23.8
1990 4.8 0.2 16.1
1991 18.9 0.8 10.6
1992 83.0 3.7 7.1
1993 184.9 8.3 4.2
1994 196.6 8.9 4.7
1995 319.9 14.3 3.1
1996 505.6 22.7 1.0
1997 913.2 40.9 0.0
-------- ------
Total $2,231.4 100.0%
======== ======
- -------------------------
(1) Claim activity is not spread evenly throughout the coverage period of the
book of business. Based on the Company's and the industry's historical
experience, claims incidence is highest in the third through sixth years after
loan origination, and relatively few claims are paid during the first two years
after loan origination. Thus, the cumulative loss experience of recent
certificate years is not indicative of ultimate losses.
22
GEOGRAPHIC DISPERSION
The following tables reflect the percentage of direct risk in force,
net of reinsurance, on the Company's book of business (by location of property)
for the top ten states and the top ten metropolitan statistical areas ("MSAs")
as of December 31, 1997. The Company continues to diversify its risk in force
geographically. The percentage of the Company's direct risk in force by top ten
states declined to 73.9% for 1997 compared to 77.5% and 78.6% for 1996 and 1995,
respectively. The percentage of the Company's direct risk in force by top ten
MSAs declined to 36.8% for 1997 compared to 41.9% and 42.9% for 1996 and 1995,
respectively.
Ten States Top Ten MSAs
---------- ------------
December 31 December 31
1997 1997
---- ----
Georgia 13.2% Chicago, IL 12.3%
Illinois 12.9 Atlanta, GA 7.0
Florida 9.5 Washington D.C. 3.6
Virginia 7.2 San Francisco/Oakland, CA 2.2
California 7.1 Houston/Galveston, TX 2.0
Texas 5.8 Baltimore, MD 2.0
North Carolina 5.3 Minneapolis-St. Paul, MN 2.0
Pennsylvania 5.1 Richmond, VA 2.0
Colorado 3.9 Charlotte-Gastonia, NC 2.0
Maryland 3.9 Denver, CO 1.7
----- -----
Total 73.9% Total 36.8%
===== =====
While the Company continues to diversify its risk in force geographically,
a prolonged regional recession, particularly in its high concentration areas,
such as the Southeastern, Middle Atlantic and upper Mid-Western states, or a
prolonged national economic recession, could significantly increase loss
development.
INVESTMENT PORTFOLIO
Income from its investment portfolio is one of the Company's primary
sources of cash flow to support its operations and claims payments. Triad has an
investment advisory agreement with CML for management of its portfolio.
The Company follows an investment policy which requires: (i) 75% of its
investment portfolio (together with cash assets) to consist of cash, short-term
investments 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 (ii) at least 50% of its
investment portfolio (together with cash assets) to consist of cash, cash
equivalents and securities which, at the date of purchase, were rated one of the
23
two highest investment grades by a nationally recognized rating agency. At
December 31, 1997, the Company's total investment portfolio had a fair market
value of $119.9 million and did not include any real estate or mortgage loans.
Liquidity is sought through cash equivalent investments and through
diversification and investment in publicly traded securities. The Company
attempts to maintain a level of liquidity and a duration in its investment
portfolio consistent with its business outlook and the expected timing,
direction and degree of changes in interest rates. As of December 31, 1997, no
investment in the securities of any single issuer (other than the U.S.
government and its agencies) exceeded 2% of the Company's investment portfolio.
The Company intends to invest the proceeds of the note offering in
accordance with its investment policy. To date, the Company's investments have
emphasized tax-preferred securities. Because of restrictions imposed under
federal income tax laws, investment by the Company of proceeds of the note
offering must be made principally in taxable securities. Through investment of a
portion of the net proceeds of the note offering, the Company plans to increase
its investments in higher yielding non-investment grade securities to
approximately 10% of its consolidated portfolio, up from approximately 3% at
December 31, 1997.
The Company's investment policies and strategies are subject to change
depending upon regulatory, economic and market conditions and the existing or
anticipated financial condition and operating requirements, including the tax
position, of the Company.
The following table shows the results of the Company's investment portfolio
for the periods indicated:
Investment Portfolio Results
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Average investments (1) (2)............. $103,804,750 $89,577,031 $79,253,289 $73,774,699 $31,211,740
Pre-tax net investment income........... $6,234,142 $5,446,672 $4,836,461 $4,180,876 $1,896,639
Effective pre-tax yield (2)............. 6.0% 6.1% 6.1% 5.7% 6.1%
Tax-equivalent yield (3)................ 8.0% 7.7% 7.5% 7.2% 6.2%
Pre-tax realized gain (loss) on sale of
investments............................ $34,330 $(162,385) $172,992 $(162,723) $(15,852)
(1) Excludes the Company's investment in Southwide Life Insurance Corp. for all
periods during which it was held.
(2) Based on historical cost adjusted for amortization and accretion of premium
and discount.
(3) Based on book value and the Company's marginal tax rate.
24
The diversification of the Company's investment portfolio at December 31,
1997, is shown in the table below:
Investment Portfolio Diversification
December 31, 1997
-----------------
Amortized Fair
Cost Value Percent(1)
---- ----- ----------
Available-for-sale securities:
Fixed maturity securities:
U. S. government obligations.......... $ 9,823,960 $ 10,197,431 8.5%
Mortgage-backed bonds................. 4,679,115 4,801,355 4.0
State and municipal bonds............. 68,789,100 71,819,355 59.9
Industrial & miscellaneous............ 12,463,961 12,907,346 10.7
------------ -------------
Total fixed maturities............... 95,756,136 99,725,487
Equity securities....................... 8,666,815 11,466,028 9.6
------------ -------------
Total available-for-sale securities.. 104,422,951 111,191,515
Short-term investments.................. 8,685,842 8,685,842 7.3
------------ ------------- ------
_________________ $113,108,793 $119,877,357 100.0%
============ ============ ======
(1) Percentage of fair value.
The following table shows the scheduled maturities at December 31, 1997, of
the fixed maturity securities held in the Company's investment portfolio:
Investment Portfolio Scheduled Maturity
December 31, 1997
-----------------
Fair Value Percent
---------- -------
One year or less............................ $ 1,181,270 1.2%
After one year through five years........... 23,101,381 23.2
After five years through ten years.......... 19,592,870 19.6
After ten years though twenty years......... 45,984,210 46.1
After twenty years.......................... 5,064,401 5.1
Mortgage-backed securities (1).............. 4,801,355 4.8
----------- ------
Total.............................. $ 99,725,487 100.0%
=========== ======
- ------------
(1) Substantially all of these securities are guaranteed by U.S. Government
Agencies.
25
The following table shows the ratings of the Company's investment portfolio
as of December 31, 1997:
Investment Portfolio by S&P Rating
December 31, 1997
-----------------
Rating(1) Fair Value Percent
---------- -------
Fixed maturities:
U.S. Treasury and U.S. agency bonds..... $ 4,801,355 4.8%
AAA..................................... 43,965,748 44.1
AA...................................... 20,539,938 20.6
A....................................... 14,979,834 15.0
BBB..................................... 11,960,617 12.0
BB...................................... 287,798 0.3
B....................................... 282,000 0.3
NR...................................... 2,908,197 2.9
------------- ------
Total fixed maturities............. $ 99,725,487 100.0%
============= ======
Equities:
AAA..................................... $ 508,750 4.4%
AA...................................... 1,208,441 10.5
A....................................... 8,974,909 78.3
B....................................... 773,928 6.8
-------------- ------
Total equities..................... $ 11,466,028 100.0%
============== ======
Total Portfolio.................................. $ 111,191,515
==============
- --------------
(1) Current ratings assigned by S&P.
26
REGULATION
DIRECT REGULATION
The Company's insurance subsidiaries are subject to comprehensive, detailed
regulation, principally for the protection of policyholders rather than for the
benefit of investors, by the insurance departments of the various states in
which each insurer is licensed to transact business. Although their scope varies
by state, state insurance laws in general grant broad powers to supervisory
agencies or officials to examine companies and to enforce rules or exercise
discretion touching almost every significant aspect of the insurance business.
These include the licensing of companies to transact business, claims handling
practices, reinsurance requirements, varying degrees of control over premium
rates, the forms and policies offered to customers, financial statements,
periodic financial reporting, permissible investments and adherence to financial
standards relating to statutory surplus, dividends and other criteria of
solvency intended to assure the satisfaction of obligations to policyholders.
All states have enacted legislation that requires each insurance company in
a holding company system to register with the insurance regulatory authority of
its state of domicile and furnish to the 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 the insurers within the system. Generally, all transactions within
a holding company system between an insurer and its affiliates must be fair and
reasonable and the insurer's statutory policyholders' surplus following any
transaction with an affiliate must be both reasonable in relation to its
outstanding liabilities and adequate for its needs. Most states also regulate
transactions between insurance companies and their parents and/or affiliates.
There can be no assurance that state regulatory requirements will not become
more stringent in the future and have an adverse effect on the Company.
Because the Company is an insurance holding company and Triad is an
Illinois domiciled insurance company, the Illinois insurance laws regulate,
among other things, certain transactions in the Company's Common Stock and
certain transactions between Triad and the Company or affiliates. Specifically,
no person may, directly or indirectly, offer to acquire or acquire beneficial
ownership of more than 10% of any class of outstanding securities of the Company
or its subsidiaries unless such person files a statement and other documents
with the Illinois Director and obtains the Director's prior approval. In
addition, material transactions between Triad and the Company 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 the insurance companies. "Control" is presumed to exist if 10% or
more of Triad's voting securities is owned or controlled, directly or
indirectly, by a person, although the Illinois Director may find that "control"
in fact does or does not exist where a person owns or controls either a lesser
or greater amount of securities. Other states in addition to Illinois may
regulate affiliated transactions and the acquisition of control of the Company
or its insurance subsidiaries.
27
Triad is required by Illinois insurance laws to provide for a contingency
reserve in an amount equal to at least 50% of earned premiums. Such reserves
must be maintained for a period of 10 years except in circumstances where high
levels of losses exceed regulatory thresholds. The contingency reserve, designed
to provide a cushion against the effect of adverse economic cycles, has the
effect of reducing statutory surplus and restricting dividends and other
distributions by Triad. At December 31, 1997, Triad had statutory policyholders'
surplus of $60.9 million and statutory contingency reserve of $54.8 million. At
December 31, 1996, Triad had statutory policyholders' surplus of $57.1 million
and a statutory contingency reserve of $35.1 million. Triad's statutory earned
surplus was $2.5 million at year end 1997 versus a deficit of $1.3 million at
year end 1996, reflecting growth in statutory net income greater than the
increase in the statutory contingency reserve.
The insurance laws of Illinois provide that Triad may pay dividends only
out of statutory earned surplus as of the end of the preceding calendar year and
further establish standards limiting the maximum amount of dividends which may
be paid without prior approval by the Illinois Director. Under such standards,
Triad may pay dividends during any 12-month period equal to the greater of (i)
10% of the preceding year-end statutory policyholders' surplus or (ii) the
preceding year's net income. In addition, insurance regulatory authorities have
broad discretion to limit the payment of dividends by insurance companies. As a
mortgage guaranty insurer, Triad is required by Illinois insurance laws to
provide a contingency reserve. The contingency reserve has the effect of
reducing statutory surplus and restricting dividends and other distributions by
Triad.
Although not subject to a rating law in Illinois, premium rates for
mortgage insurance are subject to regulation in most states to protect
policyholders against the adverse effects of excessive, inadequate or unfairly
discriminatory rates and to encourage competition in the insurance marketplace.
Any increase in premium rates must be justified, generally on the basis of the
insurer's loss experience, expenses and future trend analysis. The general
mortgage default experience may also be considered.
Triad is subject to examination of its affairs by the insurance departments
of each of the states in which it is licensed to transact business. The Illinois
Director periodically conducts a financial examination of insurance companies
domiciled in Illinois. The most recent examination of Triad was issued by the
Illinois Insurance Department on September 6, 1995, and covered the period
January 1, 1991, through December 31, 1994. No material recommendations were
made as a result of this examination. The next examination has not been
scheduled.
TGAC was organized as a subsidiary of Triad under the insurance laws of the
state of Illinois in December, 1994 and as an Illinois domiciled insurer, is
subject to all Illinois insurance regulatory requirements applicable to Triad
described above. To date the Illinois Director has not conducted or scheduled an
examination of TGAC.
28
A number of states generally limit the amount of insurance risk which may
be written by a private mortgage insurer to twenty-five times the insurer's
total policyholders' surplus. This restriction is commonly known as the
"risk-to-capital" requirement.
Mortgage insurers are generally restricted by state insurance laws and
regulations to writing residential mortgage guaranty insurance business only.
This restriction generally prohibits Triad from using its capital resources in
support of other types of insurance and restricts its noninsurance business.
However, noninsurance businesses of the Company would not generally be subject
to regulation under state insurance laws.
Regulation of reinsurance varies by state. Except for Illinois, Wisconsin,
New York, Ohio and California, most states have no special restrictions on
reinsurance that would apply to private mortgage insurers other than standard
reinsurance requirements applicable to property and casualty insurance
companies. Certain restrictions, including reinsurance trust fund or letter of
credit requirements, apply under Illinois law to domestic companies and under
the laws of several other states to any licensed company ceding business to
unlicensed reinsurers. If a reinsurer is not admitted or approved, the company
doing business with the reinsurer cannot take credit in its statutory financial
statements for the risk ceded to such reinsurer absent compliance with the
reinsurance security requirements. In addition, some states in which Triad does
business have limited private mortgage insurers to a maximum policy coverage
limit of 25% of the insured's claim amount and require coverages in excess of
25% to be reinsured through another licensed mortgage insurer.
The National Association of Insurance Commissioners ("NAIC") adopted a
risk-based capital ("RBC") formula designed to help regulators identify
property/casualty insurers in need of additional capital. The RBC formula
establishes minimum capital needs based upon risks applicable to individual
insurers, including asset risks, off balance sheet risks (such as guarantees for
affiliates and contingent liabilities), and credit risks (such as reinsurance
ceded and receivables). The NAIC and the Illinois Department of Insurance
currently do not require mortgage guaranty insurers to file RBC analysis in
their annual statements.
As the dominant purchasers and sellers of conventional mortgage loans and
beneficiaries of private mortgage guaranty 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. Triad is
an approved mortgage insurer for both Freddie Mac and Fannie Mae and meets all
eligibility requirements. There can be no assurance, however, that such
requirements will not change or that Triad will continue to meet such
requirements.
29
Certain national mortgage lenders and a large segment of the mortgage
securitization market, including Fannie Mae and Freddie Mac, generally will not
purchase mortgages or mortgage-backed securities unless the private mortgage
insurance on the mortgages has been issued by an insurer with a claims-paying
ability rating of at least "AA-" from S&P, Fitch, or Duff & Phelps or a
financial strength rating of at least "Aa3" from Moody's. Fannie Mae and Freddie
Mac require mortgage guaranty insurers to maintain two ratings of "AA-" or
better. Triad has a claims-paying ability rating of "AA" from S&P, Fitch, and
Duff & Phelps. These ratings meet the eligibility requirements of Fannie Mae and
Freddie Mac. S&P, Fitch, and Duff & Phelps include TGAC operations and financial
position with those of Triad in rating Triad's claims-paying ability. There can
be no assurance that Triad's claims-paying ability rating, the method by which
this rating is determined or the eligibility requirements of Fannie Mae and
Freddie Mac will not change.
The Real Estate Settlement and Procedures Act of 1974 ("RESPA") applies to
most residential mortgages insured by Triad, and related regulations provide
that mortgage insurance is a "settlement service" for purposes of loans subject
to RESPA. Subject to limited exceptions, RESPA 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. The
recently renewed interest of the Department of Housing and Urban Development
("HUD") in investigating transactions for compliance with RESPA has increased
awareness of both mortgage insurers and their customers of the possible
implications of this law.
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 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, the Mortgage Insurance Companies of America ("MICA"), have 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.
INDIRECT REGULATION
The Company, Triad and TGAC are also indirectly, but significantly,
impacted by regulations affecting purchasers of mortgage loans, such as Freddie
Mac and Fannie Mae, and regulations affecting governmental insurers such as the
FHA as well as lenders. Private mortgage insurers, including Triad, 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, housing legislation enacted in 1992 permits up to 100%
of borrower closing cost to be financed by loans insured by FHA, a significant
increase from the previous 57% limit. Also, in April 1994, HUD reduced the
30
initial premium (payable at loan origination) for FHA insurance from 3.0% to
2.25%. Effective January 1, 1998, the maximum individual loan amount that the
FHA could insure was increased from $160,950 to $170,362. The maximum individual
loan amount the VA can insure presently is $203,000. The maximum loan amounts
that the FHA and VA can insure are subject to adjustment and may increase in the
future. Any future legislation that increases the number of persons eligible for
FHA or VA mortgages could have an adverse effect on the Company's ability to
compete with the FHA or VA.
Pursuant to the Financial Institutions Reform, Recovery, and Enforcement
Act of 1989 ("FIRREA"), the Office of Thrift Supervision ("OTS") issued
risk-based capital rules for savings institutions. These rules establish a lower
capital requirement for a low down payment loan that is insured with private
mortgage insurance, as opposed to remaining uninsured. Furthermore, the
guidelines for real estate lending policies applicable to savings institutions
and commercial banks provide that such institutions should require appropriate
credit enhancement in the form of either mortgage insurance or readily
marketable collateral for any high LTV mortgage. To the extent FIRREA's
risk-based capital rules or the guidelines for real estate lending policies
applicable to savings institutions and commercial banks are changed in the
future, some of the anticipated benefits of FIRREA and the guidelines for real
estate lending policies to the mortgage insurance industry, including Triad, may
be curtailed or eliminated.
In 1995, Fannie Mae and Freddie Mac each introduced their own automated
underwriting system to be used by mortgage originators selling mortgages to
them. These systems, which are provided as a service to the Company's contract
underwriting customers, streamline the mortgage process and reduce costs. As a
result of the increased acceptance of these products in 1997 and for other
reasons, the process by which mortgage originators sell loans to Fannie Mae and
Freddie Mac is becoming increasingly automated, a trend which is expected to
continue. As a result, Fannie Mae and Freddie Mac could develop the capability
to become the decision maker regarding selection of a private mortgage insurer
for loans sold to them, a decision traditionally made by the mortgage
originator. The Company, however, is not aware of any plans to do so. The
concentration of purchasing power that would be attained if such development in
fact occurred could adversely affect, from the Company's perspective, the terms
on which mortgage insurance is written on loans sold to Fannie Mae and Freddie
Mac.
Additionally, 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 regulation will not be adopted.
31
Upon request by an insured, Triad must cancel the mortgage insurance for a
mortgage loan. Fannie Mae and Freddie Mac guidelines, as well as several
existing and proposed state statutes, contain various provisions which give
borrowers the right to request cancellation of mortgage insurance when specified
conditions are met. In addition, legislation currently is being considered in
the Senate and House banking committees regarding the cancellation of private
mortgage insurance. Such legislation would require mortgage servicers to inform
consumers of their right to cancel their private mortgage insurance once the
home owners have achieved 20% equity in their home. Among other options being
proposed regarding the cancellation of mortgage insurance are automatic
cancellation of private mortgage insurance once the prescribed equity level of
20% has been achieved and automatic cancellation of private mortgage insurance
half-way through the term of the loan. Because most mortgage borrowers who
obtain private mortgage insurance do not achieve 20% equity in their homes
before the homes are sold or the mortgages refinanced, the Company does not
expect to lose a significant amount of its insurance in force if such proposals
are adopted. The Company cannot predict, however, the financial burden
associated with borrower notification or automatic termination if any of the
related costs are delegated to mortgage insurers.
In 1996, the Office of the Comptroller of the Currency ("OCC") granted
permission to national banks to have a reinsurance company as a wholly-owned
operating subsidiary for the purpose of reinsuring mortgage insurance written on
loans originated or purchased by such banks. Several subsequent applications by
banks to offer reinsurance have been approved by the OCC including at least one
request to engage in quota share reinsurance. The OTS, which regulates thrifts
and savings institutions, has announced that it would consider applications for
such captive arrangements as well. The reinsurance subsidiaries of national
banks or savings institutions could become significant competitors of the
Company in the future.
EMPLOYEES
As of December 31, 1997, the Company employed 119 persons. Employees
are not covered by any collective bargaining agreement. The Company considers
its employee relations to be satisfactory.
32
EXECUTIVE OFFICERS
The executive officers of the Company are as follows:
Name Position Age
- ---- -------- ---
William T. Ratliff, III Chairman of the Board of 44
the Company and Triad
Darryl W. Thompson President, Chief Executive 57
Officer and Director of the
Company and Triad
David W. Whitehurst Executive Vice President, 48
Chief Financial Officer,
Treasurer and Director of the
Company; Vice President
and Director of Triad
John H. Williams Executive Vice President and 50
Director of Triad
Ron D. Kessinger Executive Vice President of 43
Triad
Earl F. Wall Vice President, Secretary and 40
General Counsel of the
Company and Triad
Henry B. Freeman Vice President of Triad 48
Michael R. Oswalt Vice President, Controller 36
and Principal Accounting Officer
of the Company and Triad
33
WILLIAM T. RATLIFF, III has been the Chairman of the Board of the Company
since 1993. Mr. Ratliff has also been Chairman of the Board of Triad since 1989,
President of CIC since 1990 and was President and General Partner of CML from
1987 to 1995. Mr. Ratliff has been Chairman of New South Federal Savings Bank
("New South") since 1986 and President and Director of New South Bancshares,
Inc., New South's parent company, since 1995. From March 1994 until December
1996, Mr. Ratliff served as President of Southwide Life Insurance Corp., of
which he had been Executive Vice President since 1993. Mr. Ratliff joined CML in
1981 after completing his doctoral degree with a study of planning processes in
an insurance company. Previously, he trained and worked as an educator,
counselor and organizational consultant.
DARRYL W. THOMPSON has been the President, Chief Executive Officer and a
Director of the Company since 1993. Mr. Thompson has also been President, Chief
Executive Officer and a Director of Triad since its inception in 1987. From 1986
to 1989, Mr. Thompson also served as President and Chief Executive Officer of
Triad Life Insurance Company, which sold mortgage insurance products. From 1976
to 1985, Mr. Thompson served as Senior Vice President/Southeast Division Manager
of MGIC. Mr. Thompson joined MGIC in 1972.
DAVID W. WHITEHURST has been Executive Vice President, Chief Financial
Officer, Treasurer and a Director of the Company since 1993, and served as
Secretary of the Company from 1993 until 1996. Mr. Whitehurst has also been a
Vice President and Director of Triad since 1989, Executive Vice President of CIC
since 1995 (Vice President from 1990 to 1995), was Chief Financial Officer of
CIC from 1990 through 1995, was Executive Vice President of Southwide Life
Insurance Corp. from 1992 until 1996 and has been a director of New South since
1989. Since January 1997, Mr. Whitehurst has been the President, Treasurer and a
Director of Southland National Insurance Corp. and its subsidiaries. Mr.
Whitehurst joined CML in 1989 and served as Vice President of CML and its
affiliates until 1992, when he began devoting all of his time to CIC and its
affiliates. Mr. Whitehurst is a certified public accountant.
JOHN H. WILLIAMS has been Executive Vice President and a Director of Triad
since its inception in 1987. From 1986 to 1987, Mr. Williams was employed by
Triad Life Insurance Company to develop and organize Triad. From 1978 to 1985,
Mr. Williams was employed by MGIC, most recently serving as Vice President of
Secondary Market Trading.
RON D. KESSINGER has been Executive Vice President of Insurance Operations
of Triad since June 1996 and was Vice President of Claims and Administration of
Triad from January 1991 to June 1996. From 1985 to 1991, Mr. Kessinger was
employed by Integon Mortgage Guaranty Insurance Corporation, most recently
serving as Vice President of Operations. Prior to joining Integon Mortgage
Guaranty Insurance Corporation, Mr. Kessinger was employed by the parent company
of Integon Mortgage Guaranty Insurance Corporation.
34
EARL F. WALL has been Vice President and General Counsel of Triad since
January 1996 and Secretary since June 1996. Mr. Wall has been Vice President,
Secretary and General Counsel of the Company since September 1996. From 1982 to
1995, Mr. Wall was employed by Integon in a number of capacities including Vice
President, Associate General Counsel and Director of Integon Life Insurance
Corporation and Georgia International Life Insurance Corporation, Vice President
and General Counsel of Integon Mortgage Guaranty Insurance Corporation, and Vice
President, General Counsel and Director of Marketing One, Inc.
HENRY B. FREEMAN has been Vice President of Risk Management of Triad since
its inception in 1987. From 1981 to 1987, Mr. Freeman was employed by Home
Guaranty Insurance Corporation, where he performed underwriting and claims
management services.
MICHAEL R. OSWALT has been Vice President and Controller of the Company
since March 1994, Vice President of Triad since December 1994, and Controller of
Triad since June 1996. Mr. Oswalt previously served as Vice President and
Controller of CIC and Southwide Life Insurance Corp. from February 1994 until
June 1996. From January 1993 to February 1994, Mr. Oswalt was employed by
Complete Health Services, Inc. where he performed internal audit services. From
1991 to 1993, Mr. Oswalt was employed by Arthur Andersen & Co. Prior to joining
Arthur Andersen & Co., Mr. Oswalt was employed by Deloitte & Touche from 1988 to
1991. Mr. Oswalt is a certified public accountant.
Officers of the Company serve at the discretion of the Board of Directors
of the Company.
ITEM 2. PROPERTIES.
The Company leases office space in its Winston-Salem headquarters and its
six underwriting offices located throughout the country comprising approximately
31,582 square feet under leases expiring between 1998 and 2002 and which require
annual lease payments of $531,613 in 1998. With respect to all facilities, the
Company has, or believes it will be able to obtain, lease renewals on
satisfactory terms. The Company believes its existing properties are well
utilized and are suitable and adequate for its present circumstances.
The Company maintains mid-range and micro-computer systems from its
corporate data center located in its headquarters building to support its data
processing requirements for accounting, claims, marketing, risk management and
underwriting. The Company has in place back-up procedures in the event of
emergency situations.
ITEM 3. LEGAL PROCEEDINGS.
The Company and its subsidiaries, in common with other private mortgage
insurers, are subject to litigation in the normal course of their businesses.
There is no material litigation currently pending against the Company or its
subsidiaries.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
35
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock trades on the Nasdaq National Market tier of the
Nasdaq Stock MarketSM under the symbol "TGIC". At December 31, 1997, 13,293,721
shares were issued and outstanding. The following table sets forth the highest
and lowest closing prices of the Company's Common Stock, $0.01 par value, as
reported by Nasdaq during the periods indicated (closing prices have been
restated to reflect the three-for-two stock split on June 28, 1996, and the
two-for-one stock split on October 28, 1997).
1997 1996
---- ----
High Low High Low
First Quarter.......... 15 7/8 14 10 21/32 8 27/32
Second Quarter......... 22 11/16 14 3/4 12 1/4 10
Third Quarter.......... 28 1/2 20 1/2 14 3/4 11 5/8
Fourth Quarter ........ 31 26 1/4 16 3/4 13 5/8
As of March 4, 1998, the number of stockholders of record of Company Common
Stock was approximately 176. In addition, there were an estimated 2,744
beneficial owners of shares held by brokers and fiduciaries.
Payments of future dividends are subject to declaration by the Company's
Board of Directors. The dividend policy is dependent also on the ability of
Triad to pay dividends to the Company. Because of regulatory dividend
restrictions by the Illinois Department of Insurance and Triad's need to
maintain capital levels required by rating agencies, the Company has no present
intention to pay dividends.
36
ITEM 6. SELECTED FINANCIAL DATA
Year Ended December 31
-------------------------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
INCOME STATEMENT DATA (for period ended): (Dollars in thousands, except per share amounts)
Premiums written:
Direct ...................................... $ 40,083 $ 26,152 $ 18,890 $ 16,172 $ 13,522
Assumed ..................................... 20 26 34 38 222
Ceded ....................................... (1,772) (2,217) (3,924) (4,034) (3,926)
------------ ------------ ------------ ------------ -----------
$ 38,331 $ 23,961 $ 15,000 $ 12,176 $ 9,818
============ ============ ============ ============ ===========
Earned premiums .................................. $ 38,522 $ 24,727 $ 15,478 $ 10,999 $ 7,911
Net investment income ............................ 6,234 5,447 4,836 4,181 1,897
Realized investments gains (losses) .............. 34 (162) 173 (163) (16)
Other income ..................................... 8 0 1 5 14
------------ ------------ ------------ ------------ -----------
Total revenues .............................. 44,798 30,012 20,488 15,022 9,806
Net losses and loss adjustment expenses .......... 5,177 3,279 2,217 1,262 1,284
Amortization of deferred policy acquisition cost . 4,120 3,235 2,289 1,726 1,533
Other operating expenses (net of acquisition
cost deferred) ........................... 10,257 7,259 4,753 3,658 2,371
------------ ------------ ------------ ------------ -----------
Income before income taxes ....................... 25,244 16,239 11,229 8,376 4,618
Income taxes ..................................... 8,002 5,042 3,470 2,594 1,251
------------ ------------ ------------ ------------ -----------
Net income ....................................... $ 17,242 $ 11,197 $ 7,759 $ 5,782 $ 3,367
============ ============ ============ ============ ===========
Basic earnings per share (1) ................ $ 1.30 $ 0.84 $ 0.59 $ 0.44 $ 0.51
Diluted earnings per share (1) .............. $ 1.26 $ 0.83 $ 0.58 $ 0.43 $ 0.51
------------ ------------ ------------ ------------ -----------
Weighted average common and common share
equivalents outstanding (1)
Basic ................................... 13,291,160 13,277,853 13,196,067 13,181,459 6,586,365
Diluted ................................. 13,713,538 13,541,551 13,333,014 13,305,786 6,587,716
Balance Sheet Data (at year end):
Total assets ................................ $ 138,979 $ 112,403 $ 99,017 $ 86,664 $ 78,634
Total invested assets ....................... $ 119,877 $ 98,027 $ 85,978 $ 75,364 $ 70,800
Losses and loss adjustment expenses ......... $ 8,960 $ 6,305 $ 4,589 $ 3,164 $ 2,255
Unearned premiums ........................... $ 7,988 $ 8,216 $ 9,086 $ 9,893 $ 8,774
Stockholders' equity ........................ $ 111,781 $ 91,680 $ 80,441 $ 70,108 $ 64,726
Statutory Ratios (2):
Loss ratio .................................. 14.2% 16.0% 14.3% 11.5% 16.2%
Expense ratio ............................... 42.5% 49.6% 59.1% 61.8% 49.1%
------------ ------------ ------------ ------------ -----------
Combined ratio .............................. 56.7% 65.6% 73.4% 73.3% 65.3%
============ ============ ============ ============ ===========
GAAP Ratios:
Loss ratio .................................. 13.4% 13.3% 14.3% 11.5% 16.2%
Expense ratio ............................... 37.5% 43.8% 46.9% 44.2% 39.8%
------------ ------------ ------------ ------------ -----------
Combined ratio .............................. 50.9% 57.1% 61.2% 55.7% 56.0%
============ ============ ============ ============ ===========
Other Statutory Data (dollars in millions) (2):
Direct insurance in force ................... $ 9,176.7 $ 6,556.3 $ 5,080.3 $ 4,111.4 $ 2,967.8
Direct risk in force (gross) ................ $ 2,231.4 $ 1,515.4 $ 1,090.6 $ 814.1 $ 569.8
Risk-to-capital ............................. 19.3:1 15.8:1 11.1:1 8.9:1 6.5:1
(1) Periods have been restated to reflect the three-for-two stock split on June
28, 1996, and the two-for-one stock split on October 28, 1997.
(2) Based on statutory accounting practices and derived from consolidated
statutory financial statements of Triad.
37
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operation.
RESULTS OF OPERATIONS
1997 COMPARED TO 1996
Net income for 1997 increased 54.0% to $17.2 million compared to $11.2
million in 1996. This improvement was primarily attributable to a 55.8% increase
in earned premiums, a 14.5% increase in net investment income and an improved
combined loss and expense ratio.
Net income per share on a diluted basis, which reflects the two-for-one
stock split effective on October 28, 1997, increased 52.1% to $1.26 for 1997
compared to $0.83 per share for 1996. Operating earnings per share were $1.26
for 1997 compared to $0.84 for 1996, an increase of 50.3%. Operating earnings
exclude net realized investment gains of approximately $34,000 in 1997 and net
realized investment losses of approximately $162,000 in 1996.
New insurance written, which includes insurance on new and seasoned loans,
was $3.8 billion for 1997 as compared to $2.2 billion in 1996, an increase of
74.0%. For the fourth quarter, new insurance written increased 32.9% to $740
million in 1997 compared to $557 million in 1996. This increase in gross new
insurance written was the result of continued geographic expansion and the
penetration of Triad's products in the marketplace including Triad's new risk
sharing programs. Approximately 25% of 1997 new insurance written resulted from
Triad's risk sharing programs. Uncertainty exists regarding the future of risk
sharing programs in the mortgage insurance industry. The resolution of
regulatory and industry questions regarding risk sharing programs makes the
continued viability of such programs uncertain. Of the $3.8 billion in total new
insurance production, approximately $950 million was attributable to seasoned
loans. The Company does not expect to produce a significant amount of new
business attributable to seasoned loans in 1998.
The growth in new insurance written also reflects the favorable interest
rate environment in 1997 which caused home buying activities to remain strong.
Refinance activity was 14.0% (18.3% in fourth quarter) of new insurance written
in 1997 compared to 16.9% (11.2% in fourth quarter) of insurance written in
1996. Total direct insurance in force reached $9.2 billion at December 31, 1997
compared to $6.6 billion at December 31, 1997, an increase of 40.0%.
The Company also benefited from the January 1997 upgrade of Triad's
claims-paying ability rating from "AA-" to "AA" by Standard & Poor's
Corporation. In January 1998, Standard & Poor's Corporation affirmed Triad's
"AA" claims-paying ability rating.
38
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operation -- Continued
Net new insurance written, which includes coverage on new loans only, was
$2.9 billion for 1997 compared to $2.2 billion for 1996, an increase of 30.9%.
According to industry data, Triad's national market share, which is calculated
based on net new insurance written, increased by approximately 39% to 2.4% for
1997 (2.2% in the fourth quarter) compared to 1.7% for all of 1996.
Total direct premiums written were $40.1 million for 1997, an increase of
53.3% compared to $26.2 million in 1996. Net premiums written increased by 60.0%
to $38.3 million in 1997 compared to $24.0 million in 1996. Earned premiums
increased 55.8% to $38.5 million for 1997 from $24.7 million in 1996. This
growth in written and earned premium resulted from the increase in new insurance
written, offset slightly by the decline in the Company's persistency rate. Sales
under the Company's monthly premium plan represented 94.3% of new insurance
written in 1997 compared to 93.0% in 1996. Annualized persistency was 84.2% for
1997 compared to 85.3% for 1996.
In late 1996, Triad introduced its Stick With Triad program featuring the
Slam Dunk Loan SM approval process whereby Triad issues a certificate of
insurance based on the borrower's credit score. In 1997, the Stick With Triad
products accounted for 60.1% of new commitments. The popularity, to a large
extent, of this product has reduced customer use of Triad's delegated
underwriting program in 1997. Commitments processed through Triad's delegated
underwriting program accounted for 18.2% of commitments received for 1997,
compared to 38.0% for 1996.
Net investment income for 1997 was $6.2 million, a 14.5% increase over $5.4
million in 1996. This increase resulted from the growth in the average book
value of invested assets to $103.8 million at December 31, 1997 from $89.6
million at December 31, 1996. The yield on average invested assets was 6.0% for
1997 compared to 6.1% for 1996. This slight decrease is attributable to the
Company's continued investment in lower yielding municipal tax-preferred
securities. The portfolio's tax-equivalent yield was 8.0% for 1997 up from 7.7%
for 1996. Approximately 71.8% or $68.7 million of the Company's fixed maturity
portfolio at December 31, 1997 was composed of state and municipal tax-preferred
securities as compared to 53% at December 31, 1996 and 37% at December 31, 1995.
The Company's loss ratio (the ratio of incurred losses to earned premiums)
was 13.4% for 1997 compared to 13.3% for 1996. The loss ratio was 12.1% for the
fourth quarter of 1997 compared to 14.3% for the same period of 1996. The
Company's favorable loss ratio reflects the low level of delinquencies compared
to the number of insured loans and the fact that approximately 73% 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
39
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operation -- Continued
sixth years after loan origination. Although the claims experience on new
insurance written in previous years has been quite favorable, the Company
expects its incurred losses to increase as a greater amount of its insurance in
force reaches its anticipated highest claim frequency years. Due to the inherent
uncertainty of future premium levels, losses, economic conditions and other
factors that impact earnings, it is impossible to predict with any degree of
certainty the impact of such higher claims frequencies on future earnings.
During periods of significant refinancing activity, it is possible that
policies on stronger loans may lapse and that weaker loans may remain in force,
thus potentially increasing the loss ratio on older business. Substantial
increases in production of new business during these periods can offset the
increased loss ratio on the older business.
Net losses and loss adjustment expenses (net of reinsurance recoveries)
increased by 57.9% in 1997 to $5.2 million compared to $3.3 million in 1996.This
increase reflects the increase in the Company's insurance in force and the
resulting recognition of a greater amount of insurance in force reaching
itshigher claim frequency years.
Amortization of deferred policy acquisition costs increased by 27.4% to
$4.1 million in 1997 compared to $3.2 million for 1996. The increase in
amortization reflects a growing balance of deferred policy acquisition costs to
amortize as the Company builds its total insurance in force.
Other operating expenses increased 41.3% to $10.3 million for 1997 compared
to $7.3 million for 1996. This increase in expenses is primarily attributable to
advertising, personnel, facilities and equipment costs required to support the
Company's product development, technology enhancements, geographic expansion and
increased production.
The expense ratio (ratio of underwriting expenses to net premiums written)
for 1997 was 37.5% compared to 43.8% for 1996. Contributing to this improvement
is the higher level of written premiums partially offset by the increase in
expenses.
The effective tax rate for 1997 was 31.7% compared to 31.0% in 1996. This
increase is primarily the result of the phase-in of the 35% federal statutory
income tax rate applicable to companies with annual taxable income above $10
million. Management expects the Company's effective tax rate to increase
slightly as new funds from the debt offering in January 1998 are invested in
taxable securities and the Company's taxable income grows faster than its tax
preferred investment income.
40
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operation -- Continued
1996 COMPARED TO 1995
Net income for 1996 increased 44.3% to $11.2 million compared to $7.8
million in 1995. This improvement was attributable to a 59.8% increase in earned
premiums, a 12.6% increase in net investment income, an improved expense ratio
and a continuing low loss ratio.
Net income per share on a diluted basis, reflecting stock splits, increased
42.1% to $0.83 for 1996 compared to $0.58 per share in 1995. Operating earnings
per share were $0.84 for 1996 compared to $0.57 per share in 1995. Operating
earnings exclude realized investment losses of approximately $162,000 in 1996
and realized investment gains of approximately $173,000 in 1995.
New insurance written was $2.2 billion in 1996 compared to $1.6 billion in
1995, an increase of 36.4%. New insurance written was $557 million in the fourth
quarter of 1996 compared to $479 million in the same period of 1995. The
increase in new insurance written in 1996 was the result of the continued
penetration of Triad's products in the marketplace coupled with a favorable
interest rate environment for much of 1996, which caused both refinance and home
buying activities to remain strong for the year. Refinance activity accounted
for 16.9% of new insurance written in 1996 compared to 9.3% for 1995. Total
direct insurance in force reached $6.6 billion at December 31, 1996 compared to
$5.1 billion the previous year, an increase of 29.1%.
According to industry data, Triad's share of total new mortgage insurance
written increased to 1.7% for 1996 compared to 1.5% for all of 1995. This
increase was primarily the result of the Company's geographic expansion into new
territories and the success of a marketing focus on larger, national mortgage
lenders.
Total direct premiums written were $26.2 million for 1996, an increase of
38.4% compared to $18.9 million in 1995. Net premiums written increased by 59.7%
to $24.0 million for 1996 compared to $15.0 million for 1995. Earned premiums
increased 59.8% to $24.7 million in 1996 from $15.5 million in 1995.
Contributing to this growth were the strong mortgage market, the Company's
continued expansion into new territories, the secondary mortgage market
requirements for deeper coverages and increased renewal premium due to the
growth of our monthly premium product. Sales under the Company's monthly premium
plan represented 93.0% of new insurance written in 1996 compared to 82.6% in
1995. Offsetting the premium growth somewhat was the decrease in Triad's
persistency rate, reflecting the 1996 increase in refinancing activity.
Annualized persistency was 85.3% in 1996 compared to 86.4% in 1995.
In January 1996, the Company eliminated its quota share reinsurance on new
business, recaptured substantial portions of its quota share coverage on renewal
business and secured excess of loss reinsurance to protect against catastrophic
losses. These changes reduced the Company's quota share cede rate to 5.3% of
41
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operation -- Continued
direct premium written in 1996 compared to 20.8% in 1995. Premiums ceded under
the Company's quota share reinsurance agreements for 1996 totaled $1.4 million
compared to $3.9 million in 1995. Had the Company retained its quota share
reinsurance in 1996 and maintained a cede rate comparable to 1995, the Company's
net written premium would have increased approximately 38.0% rather than the
59.7% noted above.
Net investment income for 1996 was $5.4 million, a 12.6% increase over $4.8
million in 1995. This increase resulted from the growth in average invested
assets of $10.3 million to $89.6 million at December 31, 1996. The yield on
average invested assets was 6.1% for both 1996 and 1995. The portfolio's tax
equivalent yield was 7.7% in 1996 and 7.5% in 1995. This yield reflected the
Company's investment strategy to emphasize tax-preferred securities which yield
lower pre-tax rates than similar fully-taxable securities.
The Company's loss ratio was 13.3% for 1996 compared to 14.3% for 1995. The
favorable loss ratio reflects the low level of delinquencies compared to the
number of insured loans and the fact that 71% of the insurance in force was
originated in the prior 36 months.
Net losses and loss adjustment expenses (net of reinsurance recoveries)
increased by 47.9% in 1996 to $3.3 million compared to $2.2 million in 1995,
reflecting the increase in the Company's insurance in force and the resulting
recognition of a greater amount of insurance in force reaching its higher claim
frequency years. A decrease in reinsurance recoveries, attributable to the
Company's restructuring of its reinsurance program for 1996, also contributed to
the increase in net losses and loss adjustment expenses.
Amortization of deferred policy acquisition costs increased by 41.3% to
$3.2 million in 1996 compared to $2.3 million for 1995. The increase in
amortization reflects a growing balance of deferred policy acquisition costs to
amortize as the Company builds its total insurance in force.
Other operating expenses increased to $7.3 million for 1996 compared to
$4.8 million for 1995. This increase in expenses was primarily attributable to
personnel, facilities and equipment costs required to support Triad's geographic
expansion and increased production coupled with a reduction in ceding
commissions earned following changes in the Company's reinsurance program for
1996. Ceding commissions paid to the Company are reported as a reduction in
other operating expenses and decreased to $572,000 in 1996 compared to $1.5
million in 1995.
The Company's expense ratio for 1996 was 43.8% compared to 46.9% for 1995.
Contributing to this improvement was the higher level of written premiums for
1996 offset somewhat by the increase in expenses.
42
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operation -- Continued
The effective tax rate for all of 1996 was 31.0% compared to 30.9% for
1995. In 1996, the Company began a phase-in of the 35% Federal statutory income
tax rate applicable to companies with annual taxable income above $10 million.
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of operating cash flow consist primarily of premiums
written and investment income. Operating cash flow is applied primarily to the
payment of claims and expenses.
For 1997, the Company generated positive cash flow from operating
activities of $17.9 million compared to $12.5 million for 1996. The increase in
Triad's operating cash flow reflects the growth in renewal premiums and
insurance written that has more than offset the increases in claims paid and
other expenses.
The Company's business does not routinely require significant capital
expenditures. 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 cash dividends and revenues
from management fees from Triad. The insurance laws of the State of Illinois
impose certain restrictions on dividends from Triad. These restrictions, based
on statutory accounting practices, include requirements that dividends may be
paid only out of statutory earned surplus as of the end of the preceding fiscal
year and limit the amount of dividends that may be paid without prior approval
of the Illinois Insurance Department. Triad had an earned surplus of $2.5
million at December 31, 1997 and a deficit of $1.3 million at December 31, 1996.
The Illinois Insurance Department permits expenses of the parent company to be
paid by Triad in the form of management fees.
In January 1998 the Company completed a $35 million private offering of
senior notes due January 15, 2028. The notes, which represent unsecured
obligations of the Company, bear interest at a rate of 7.9% per annum and are
non-callable. The notes are rated "A" by Standard and Poor's Corporation and
"A+" by Fitch Investors Service. The Company contributed $25 million of the net
proceeds from the sale of the notes to Triad in exchange for a surplus
debenture. The Company will be dependent upon payments under the surplus
debenture issued by Triad and upon possible future dividends from Triad, all of
which will be subject to significant payment restrictions under Illinois
insurance laws, to provide funds for the payment of the Company's obligations
under the notes. The Company retained the balance of the net proceeds of the
offering, approximately $9.4 million, which will be available for general
43
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operation -- Continued
corporate purposes, including, without limitation, investment, payments of
principal and interest on the notes and possible future contributions to the
capital of Triad.
The Company intends to invest the proceeds of the note offering in
accordance with its investment policy. To date, the Company's investments have
emphasized tax-preferred securities. Because of restrictions imposed under
federal income tax laws, investment by the Company of proceeds of the note
offering must be made principally in taxable securities. Through investment of a
portion of the net proceeds of the note offering, the Company plans to increase
its investments in higher yielding non-investment grade securities to
approximately 10% of its consolidated portfolio, up from approximately 3% at
December 31, 1997.
Consolidated invested assets were $119.9 million at December 31, 1997,
including a total of $111.2 million in fixed maturity securities and equity
securities classified as available-for-sale. Net unrealized investment gains
were $2.8 million on equity securities and $4.0 million on fixed maturity
securities at December 31, 1997.
Approximately 4.8% or $4.8 million of the Company's fixed maturity
portfolio at December 31, 1997 was composed of mortgage-backed securities,
substantially all of which are guaranteed by U.S. Government Agencies. Certain
mortgage-backed securities are subject to significant prepayment risk due to the
fact that, in periods of declining interest rates, mortgages may be repaid more
rapidly than scheduled as borrowers refinance higher rate mortgages to take
advantage of lower rates. As a result, holders of mortgage-backed securities may
receive large prepayments on their investments which must be reinvested at then
current rates.
The Company's loss reserves increased to $9.0 million at December 31, 1997
compared to $6.3 million at December 31, 1996. This growth is the result of the
increases in new insurance written and the maturing of the Company's risk in
force. Consistent with industry practices, the Company does not establish loss
reserves for future claims on insured loans which are not currently in default.
The Company's reserves per delinquent loan were $23,100 at both December 31,
1997 and December 31, 1996. The Company's ratio of delinquent insured loans to
total insured loans was 0.47% at December 31, 1997 compared to 0.44% at December
31, 1996.
The Company's unearned premium reserve of $8.0 million at December 31, 1997
decreased from $8.2 million at December 31, 1996. This decline is attributable
primarily to the continued production of the monthly premium product, which
produces little unearned premium compared to annual and single premium products.
Cancellation activity also can contribute to the decrease in unearned premiums,
whereby older annual premium policies are canceled or replaced by monthly
premium policies.
44
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operation -- Continued
Total stockholders' equity increased to $111.8 million at December 31, 1997
from $91.7 million at December 31, 1996. This increase resulted primarily from
net income of $17.2 million for 1997 and an increase in net unrealized gains on
invested assets classified as available-for-sale of $2.8 million (net of income
tax).
Triad's total statutory policyholders' surplus increased to $60.9 million
at December 31, 1997 from $57.1 million at December 31, 1996. This increase
resulted from statutory net income of $22.9 million and unrealized gains on
equity securities of $1.6 million offset primarily by an increase in the
statutory contingency reserve of $19.7 million. Triad's statutory earned surplus
was $2.5 million at December 31, 1997 compared to a deficit of $1.3 million at
December 31, 1996, reflecting growth in statutory net income greater than the
increase in the statutory contingency reserve. The balance in the statutory
contingency reserve was $54.8 million at December 31, 1997 compared to $35.1
million at December 31, 1996.
The Company is undertaking modifications and upgrades to enhance its
computer systems and technological capabilities. The Company expects that
approximately $1.6 million will be expended in 1998 to complete this system
upgrade and that the project will be funded through cash flow from operations.
As a part of this effort, management has initiated a program to prepare the
Company's computer systems and applications to be year 2000 compliant. The
Company expects to incur internal staff costs as well as consulting and other
expenses related to infrastructure and facilities enhancement necessary to
prepare the systems for the year 2000. Most of the modifications will be made as
part of the Company's capital upgrade to its computer systems throughout 1998.
Triad's ability to write insurance depends on the adequacy of its statutory
capital in relation to risk in force. A significant reduction of capital or a
significant increase in risk may impair Triad's ability to write additional
insurance. A number of states limit Triad's risk-to-capital ratio to 25-to-1. As
of December 31, 1997 Triad's risk-to-capital ratio was 19.3-to-1, and as of
December 31, 1996 was 15.8-to-1, as compared to 19.4-to-1 for the industry as a
whole at December 31, 1996, the latest industry data available.
Rating agencies also require capital levels based on a company's
performance sensitivity to various depression scenarios. In determining capital
levels, the rating agencies allow the use of different forms of capital
including statutory capital, reinsurance and debt. The effect of the Company's
contribution of $25 million of its $35 million senior note offering to the
capital of Triad in January 1998 will be to improve its risk-to-capital ratio
and to provide additional capital considered in the rating agency's depression
models. Had the contribution been made as of year end 1997, Triad's
risk-to-capital ratio would have been approximately 15.9-to-1. There can be no
assurance that the Company will continue to meet such capital requirements.
45
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operation -- Continued
NEW ACCOUNTING STANDARDS
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings per Share. Statement No. 128 replaced the calculation of primary and
fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. All earnings per share amounts for all periods have been
presented, and where appropriate, restated to conform to Statement 128.
In June 1997, the Financial Accounting Standards Board issued Statement No.
130, Reporting Comprehensive Income, which is effective for fiscal years
beginning after December 31, 1997. The Statement establishes standards for the
reporting and display of comprehensive income and its components in financial
statements. The Company expects to adopt the provisions of Statement No. 130 in
the first quarter of 1998 and will present the financial statements for earlier
periods provided for comparative purposes as required by the Statement. The
application of the new rules will not have an impact on the Company's financial
position or results of operations.
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 issuance 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 new insurance written could be 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; rating agencies may revise methodologies for determining the Company's
claims-paying ability ratings and may revise or withdraw the assigned ratings at
any time; the Company's performance may be 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 affect on Triad's financial condition and loss development.
Accordingly, actual results may differ from those set forth in the forward
looking statements. Attention is also directed to other risk factors set forth
in documents filed by the Company with the Securities and Exchange Commission.
46
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Financial Statements and Supplementary Data are presented in a separate
section of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information regarding directors and nominees for directors of the Company
is included in the Company's Proxy Statement for the 1998 Annual Meeting of
Stockholders, and is hereby incorporated by reference.
For information regarding the executive officers of the Company, reference
is made to the section entitled "Executive Officers of the Company" in Part I,
Item 1 of this Report.
ITEM 11. EXECUTIVE COMPENSATION.
This information is included in the Company's Proxy Statement for the 1998
Annual Meeting of Stockholders, and is hereby incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
This information is included in the Company's Proxy Statement for the 1998
Annual Meeting of Stockholders, and is hereby incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
This information is included in the Company's Proxy Statement for the 1998
Annual Meeting of Stockholders, and is hereby incorporated by reference.
47
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT
SCHEDULES, AND REPORTS ON FORM 8-K.
(a) (1) and (2) The response to this portion of Item 14 is submitted as
a separate section of this report.
(a) (3) Listing of Exhibits-- The response to this portion of Item 14
is submitted as a separate section of this report.
(b) Reports on Form 8-K.
No reports on form 8-K were filed during the quarter ended
December 31, 1997.
(c) Exhibits-- The response to this portion of Item 14 is submitted as
a separate section of this report.
(d) Financial Statement Schedules-- The response to this portion of
Item 14 is submitted as a separated section of this report.
48
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 the 26th day of
March, 1998.
By /s/ Darryl W. Thompson
-------------------------
Darryl W. Thompson
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below on the 26th day of March, 1998 by the
following persons on behalf of the Registrant in the capacities indicated.
SIGNATURE TITLE
/s/ William T. Ratliff, III Chairman of the Board
- ---------------------------
William T. Ratliff, III
/s/ Darryl W. Thompson President, Chief Executive Officer and Director
- ---------------------------
Darryl W. Thompson
/s/ David W. Whitehurst Executive Vice President, Chief Financial
- --------------------------- Officer, Treasurer and Director
David W. Whitehurst
/s/ Michael R. Oswalt Vice President and Controller, Principal
- --------------------------- Accounting Officer
Michael R. Oswalt
/s/ Robert T. David Director
- ---------------------------
Robert T. David
/s/ Raymond H. Elliott Director
- ---------------------------
Raymond H. Elliott
49
ANNUAL REPORT ON FORM 10-K
ITEM 8, ITEM 14(a)(1) and (2), (3), (c) and (d)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
INDEX TO EXHIBITS
FINANCIAL STATEMENTS
FINANCIAL STATEMENT SCHEDULES
CERTAIN EXHIBITS
YEAR ENDED DECEMBER 31, 1997
TRIAD GUARANTY INC.
WINSTON-SALEM, NORTH CAROLINA
50
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
(Item 14(a) 1 and 2)
CONSOLIDATED FINANCIAL STATEMENTS PAGE
- --------------------------------- ----
Report of Independent Auditors................ ....................... 54
Consolidated Balance Sheets at December 31, 1997 and 1996............. 55 - 56
Consolidated Statements of Income for each of the three
years in the period ended December 31, 1997....................... 57
Consolidated Statements of Changes in Stockholders' Equity
for each of the three years in the period ended December 31, 1997.. 58
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 1997.............................. 59
Notes to Consolidated Financial Statements............................. 60 - 76
FINANCIAL STATEMENT SCHEDULES
Schedules at and for each of the three years in the
period ended December 31, 1997
Schedule I - Summary of investments - other than
investments in related parties...................... 77
Schedule II - Condensed financial information of Registrant...... 78 - 81
Schedule IV - Reinsurance........................................ 82
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.
51
INDEX TO EXHIBITS
(ITEM 14(A) 3)
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------ ----------------------
3.1 Certificate of Incorporation of the Registrant, as amended (7)
(Exhibit 3.1)
3.2 By-Laws of the Registrant (1) (Exhibit 3(b))
4.1 Form of Common Stock certificate (1) (Exhibit 4(a))
*4.2 Indenture Between Triad Guaranty Inc. and Banker's Trust Co.
(Exhibit 4.2)
10.1 1993 Long-Term Stock Incentive Plan (1)(3) (Exhibit 10(a))
10.2 Proportional Reinsurance Agreement between Triad Guaranty Insurance
Corporation and PMI Mortgage Insurance Co. (1) (Exhibit 10(b))
10.3 Agreement for Administrative Services among Triad Guaranty Insurance
Corporation and Collateral Investment Corp. and Collateral Mortgage,
Ltd. (1) (Exhibit 10(c))
10.4 Investment Advisory Agreement between Triad Guaranty Insurance
Corporation and Collateral Mortgage, Ltd. (1) (Exhibit 10(d))
10.6 Registration Agreement among the Registrant, Collateral Investment
Corp. and Collateral Mortgage, Ltd. (2) (Exhibit 10.6)
10.7 Employment Agreement between the Registrant and Darryl W. Thompson
(2)(3) (Exhibit 10.7)
10.8 Employment Agreement between the Registrant and John H. Williams (2)
(3)(Exhibit 10.8)
10.10 Employment Agreement between the Registrant and Henry B. Freeman (2)
(3)(Exhibit 10.10)
10.11 Employment Agreement between the Registrant and Ron D. Kessinger (2)
(3)(Exhibit 10.11)
10.13 Proportional Reinsurance Agreement between Triad Guaranty Insurance
Corporation and PMI Mortgage Insurance Co. (4) (Exhibit 10.13)
10.15 Excess of Loss Reinsurance Agreement between Triad Guaranty
Insurance Corporation and National Union Fire Insurance
Company of Pittsburgh, PA.(5) (Exhibit 10.15)
10.16 Economic Value Added Incentive Bonus Program (Senior Management)
(6) (Exhibit 10.16)
52
10.17 Amendment to Employment Agreement between the Registrant and
Darryl W.Thompson (3)(6) (Exhibit 10.17)
10.18 Amendment to Employment Agreement between the Registrant and John H.
Williams (3)(6) (Exhibit 10.18)
10.19 Amendment to Employment Agreement between the Registrant and
Henry B. Freeman (3)(6) (Exhibit 10.19)
10.20 Amendment to Employment Agreement between the Registrant and Ron D.
Kessinger (3)(6) (Exhibit 10.20)
*11.1 Statement Re Computation of Net Income per share (Exhibit 11.1)
21.1 Subsidiaries of the Registrant (6) (Exhibit 21.1)
*23.1 Consent of Ernst & Young LLP (Exhibit 23.1)
*27.1 Financial Data Schedule (Exhibit 27.1)
*27.2 Financial Data Schedule (Exhibit 27.2)
*27.3 Financial Data Schedule (Exhibit 27.3)
- -----------------
* 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 October 22, 1993 and amendments thereto.
(2) Incorporated by reference to the exhibit identified in parentheses,
filed as an exhibit in the 1993 Form 10-K.
(3) Denotes management contract or compensatory plan of arrangement
required to be filed as an exhibit to this report pursuant to Item 601
of Regulation S-K.
(4) Incorporated by reference to the exhibit identified in parentheses,
filed as an exhibit in the 1994 Form 10-K.
(5) Incorporated by reference to the exhibit identified in parentheses,
filed as an exhibit in the 1995 Form 10-K.
(6) Incorporated by reference to the exhibit identified in parentheses,
filed as an exhibit in the 1996 Form 10-K.
(7) Incorporated by reference to the exhibit identified in parentheses,
filed as an exhibit in the June 30, 1997 Form 10-Q.
53
Report of Independent Auditors
Board of Directors
Triad Guaranty Inc.
We have audited the accompanying consolidated balance sheets of Triad Guaranty
Inc. and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements 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, the financial statements referred to above present fairly, in
all material respects, the consolidated financsent fairly, in all material
respects, the consolidated financial position of Triad Guaranty Inc. and
subsidiaries at December 31, 1997 and 1996, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1997 in conformity with generally accepted accounting
principles.
Ernst & Young LLP
January 22, 1998
54
Triad Guaranty Inc.
Consolidated Balance Sheets
December 31
1997 1996
---- ----
Assets
Invested assets:
Securities available-for-sale, at fair value:
Fixed maturities (amortized cost:
1997-$95,756,136;1996-$86,069,753)............ $ 99,725,487 $ 87,229,855
Equity securities (cost: 1997-$8,666,815;
1996-$6,267,076).............................. 11,466,028 7,494,817
Short-term investments ......................... 8,685,842 3,302,125
------------ ------------
119,877,357 98,026,797
Cash .............................................. 8,557 360,586
Accrued investment income ......................... 1,460,168 1,126,642
Deferred policy acquisition costs ................. 12,587,355 10,198,397
Property and equipment, at cost less accumulated
depreciation (1997-$1,563,289; 1996-$956,538) .. 2,524,228 1,705,389
Prepaid reinsurance premiums ...................... 23,263 300,200
Reinsurance recoverable ........................... 49,447 153,274
Other assets ...................................... 2,448,685 531,238
------------ ------------
Total assets ..................................... $138,979,060 $112,402,523
============ ============
55
December 31
1997 1996
---- ----
Liabilities and stockholders' equity Liabilities:
Losses and loss adjustment expenses .......... $ 8,960,411 $ 6,305,397
Unearned premiums ............................ 7,988,342 8,216,478
Amounts payable to reinsurer ................. -- 1,993
Current taxes payable ........................ 3,318 1,596
Deferred income taxes ........................ 7,521,874 4,276,081
Unearned ceding commission ................... -- 80,573
Accrued expenses and other liabilities ....... 2,724,324 1,840,369
----------- ------------
Total liabilities ............................... 27,198,269 20,722,487
Commitments and contingencies (Notes 5 and 7)
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 20,000,000 shares,13,293,721
at December 31, 1997 and 6,645,361 at
December 31, 1996 issued and
outstanding shares......................... 132,937 66,453
Additional paid-in capital................... 59,369,223 59,346,832
Unrealized gain on available-for-sale
securities, net of income tax liability
of $2,368,998 at December 31, 1997 and
$823,287 at December 31, 1996.............. 4,405,315 1,568,800
Retained earnings............................ 47,873,316 30,697,951
------------ ------------
Total stockholders' equity...................... 111,780,791 91,680,03
------------ ------------
Total liabilities and stockholders' equity...... $138,979,060 $112,402,523
============ ============
See accompanying notes.
57
Triad Guaranty Inc.
Consolidated Statements of Income
Year ended December 31
1997 1996 1995
---- ---- ----
Revenue:
Premiums written:
Direct ....................................... $ 40,082,507 $ 26,151,650 $ 18,889,933
Assumed ...................................... 20,061 26,222 33,891
Ceded ........................................ (1,772,039) (2,216,417) (3,923,625)
------------ ------------ ------------
Net premiums written ............................ 38,330,529 23,961,455 15,000,199
Change in unearned premiums ..................... 191,163 766,286 477,841
------------ ------------ ------------
Earned premiums ................................. 38,521,692 24,727,741 15,478,040
Net investment income ........................... 6,234,142 5,446,672 4,836,461
Net realized investment gains (losses) .......... 34,330 (162,385) 172,992
Other income .................................... 7,716 -- 261
------------ ------------ ------------
44,797,880 30,012,028 20,487,754
Losses and expenses:
Losses and loss adjustment expenses .......... 5,317,812 3,444,354 2,691,608
Reinsurance recoveries ....................... (140,734) (165,224) (474,822)
------------ ------------ ------------
Net losses and loss adjustment expenses ......... 5,177,078 3,279,130 2,216,786
Amortization of deferred policy
acquisition costs .............................. 4,120,469 3,234,876 2,289,121
Other operating expenses (net
of acquisition costs deferred) ................ 10,256,815 7,259,271 4,752,934
------------ ------------ ------------
19,554,362 13,773,277 9,258,841
------------ ------------ ------------
Income before income taxes ...................... 25,243,518 16,238,751 11,228,913
Income taxes:
Current ...................................... 2,613 (37,292) 38,717
Deferred ..................................... 7,999,081 5,079,077 3,431,304
------------ ------------ ------------
8,001,694 5,041,785 3,470,021
------------ ------------ ------------
Net income ...................................... $ 17,241,824 $ 11,196,966 $ 7,758,892
============ ============ ============
Earnings per common and
common equivalent share:
Basic ...................................... $1.30 $.84 $.59
Diluted .................................... 1.26 .83 .58
============ ============ ============
Shares used in computing earnings
per common and common equivalent share:
Basic ...................................... 13,291,160 13,277,853 13,196,067
Diluted .................................... 13,713,538 13,541,551 13,333,014
============ ============ ============
See accompanying notes.
57
Triad Guaranty Inc.
Consolidated Statements of Changes in Stockholders' Equity
Unrealized
Gain (Loss)
Additional on Available-
Common Paid-In for-Sale Retained Deferred
Stock Capital Securities Earnings Compensation Total
-------- ------- ------------- -------- ------------ ------
Balance at December 31, 1994.. $ 44,189 $ 59,082,010 $ (632,877) $ 11,764,244 $ (149,539) $ 70,108,027
Net income ................. -- -- 7,758,892 -- 7,758,892
Amortization of deferred
compensation............... -- -- -- -- 149,539 149,539
Tax benefit on
restricted stock........... -- 59,798 -- -- -- 59,798
Change in unrealized
(loss) gain................ -- -- 2,365,086 -- -- 2,365,086
-------- ------------ ---------- ------------ ---------- -----------
Balance at December 31, 1995.. 44,189 59,141,808 1,732,209 19,523,136 -- 80,441,342
Net income ................. -- -- -- 11,196,966 -- 11,196,966
Issuance of 11,316 shares
of common stock under
stock option plans........ 113 205,536 -- -- -- 205,649
Three-for-two stock split
effected in the form of
a 50% stock dividend...... 22,151 -- -- (22,151) -- --
stock dividend
Retirement of common
stock.................... -- (512) -- -- -- (512)
Change in unrealized
gain..................... -- -- (163,409 -- -- (163,409)
-------- ------------ ---------- ------------ ---------- -----------
Balance at December 31, 1996.. 66,453 59,346,832 1,568,800 30,697,951 -- 91,680,036
Net income ................ -- -- -- 17,241,824 -- 17,241,824
Issuance of 2,499 shares
of common stock under
stock option plans....... 25 22,391 -- -- -- 22,416
Two-for-one stock split
effected in the form of
a 100% stock dividend.... 66,459 -- -- (66,459) -- --
Change in unrealized
gain..................... -- -- 2,836,515 -- -- 2,836,515
-------- ------------ ---------- ------------ ---------- -----------
Balance at December 31, 1997.. $132,937 $ 59,369,223 $4,405,315 $ 47,873,316 $ -- $ 11,780,791
======== ============ ========== ============ ========== ===========
See accompanying notes.
58
Triad Guaranty Inc.
Consolidated Statements of Cash Flows
Year ended December 31
1997 1996 1995
---- ---- ----
Operating activities
Net income ......................................... $ 17,241,824 $ 11,196,966 $ 7,758,892
Adjustments to reconcile net income to net
cash provided by operating activities:
Loss and unearned premium reserves ............ 2,426,878 846,498 618,079
Accrued expenses and other liabilities ........ 901,991 362,459 229,364
Current taxes payable ......................... 1,722 (38,335) 26,118
Amounts due to/from reinsurer ................. 378,771 1,787,428 125,574
Accrued investment income ..................... (333,526) (230,985) (104,490)
Policy acquisition costs deferred ............. (6,509,427) (5,856,589) (3,994,830)
Amortization of policy acquisition costs ...... 4,120,469 3,234,876 2,289,121
Net realized investment (gains) losses ........ (34,330) 162,385 (172,992)
Provision for depreciation .................... 621,050 394,282 329,758
Amortization of bond discount ................. (620,762) (591,336) (555,771)
Amortization of deferred compensation ......... -- -- 149,539
Deferred income taxes ......................... 1,700,081 1,573,810 170,955
Unearned ceding commission .................... (80,573) (539,542) (86,623)
Other assets .................................. (1,914,971) 171,949 (291,593)
------------ ----------- ----------
Net cash provided by operating activities .......... 17,899,197 12,473,866 6,491,101
Investing activities
Securities available-for-sale:
Purchases - fixed maturities .................... (25,487,708) (19,823,655) (16,552,078)
Sales - fixed maturities ....................... 16,186,544 8,036,070 12,960,894
Purchases - equities ............................ (3,835,769) (2,732,179) (2,222,254)
Sales - equities ................................ 1,678,286 1,838,226 1,781,793
Purchases of property and equipment ................ (1,431,278) (760,202) (467,526)
------------ ----------- ----------
Net cash used in investing activities .............. (12,889,925) (13,441,740) (4,499,171)
Financing activities
Proceeds from exercise of stock options ............ 22,416 205,649 --
Retirement of common stock ......................... -- (512) --
------------ ----------- ----------
Net cash provided by financing activities .......... 22,416 205,137 --
------------ ----------- ----------
Net change in cash and short-term investments ...... 5,031,688 (762,737) 1,991,930
Cash and short-term investments at beginning of year 3,662,711 4,425,448 2,433,518
------------ ----------- ----------
Cash and short-term investments at end of year ..... $ 8,694,399 $ 3,662,711 $ 4,425,448
============ ============ ============
Supplemental schedule of cash flow information
Cash paid during the period for income taxes
and United States Mortgage Guaranty Tax and
Loss Bonds....................................... $ 6,299,891 $ 3,348,000 $ 3,260,349
============ ============ ============
See accompanying notes.
59
Triad Guaranty Inc.
Notes to Consolidated Financial Statements
December 31, 1997
1. ACCOUNTING POLICIES
NATURE OF BUSINESS
Triad Guaranty Inc. (the "Company") 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 to protect the lender against loss from defaults on low down payment
residential mortgage loans.
BASIS OF PRESENTATION
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles, which vary in some respects from
statutory accounting practices which are prescribed or permitted by the various
insurance departments.
CONSOLIDATION
The consolidated financial statements include the amounts of Triad Guaranty Inc.
and its wholly-owned subsidiaries, Triad Guaranty Insurance Corporation
("Triad") and Triad Guaranty Assurance Corporation ("TGAC"), a wholly-owned
subsidiary of Triad Guaranty Insurance Corporation. All significant intercompany
accounts and transactions have been eliminated.
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
INVESTMENTS
Securities classified as "available-for-sale" are carried at fair value and
unrealized gains and losses on such securities are reported as a separate
component of stockholders' equity. The Company does not have any securities
classified as "held-to-maturity" or "trading."
60
Triad Guaranty Inc.
Notes to Consolidated Financial Statements(continued)
1. ACCOUNTING POLICIES (CONTINUED)
Fair value generally represents quoted market value prices for securities traded
in the public market or prices analytically determined using bid or closing
prices for securities not traded in the public marketplace. Realized investment
gains or losses are determined primarily on a specific identification basis and
are included in net income. Short-term investments are defined as short-term
highly liquid investments both readily convertible to known amounts of cash and
having maturities of three months or less upon acquisition by the Company.
DEFERRED POLICY ACQUISITION COSTS
The costs of acquiring new business, principally commissions and certain policy
underwriting and issue costs, which generally vary with and are primarily
related to the production of new business, are deferred. Amortization of such
policy acquisition costs is charged to expense in proportion to premium revenue
recognized over the estimated policy life. The Company reviews the persistency
of policies in force and maar Property and Equipment
Property and equipment is recorded at cost and is amortized principally on a
straight-line basis over the estimated useful lives of depreciable assets.
Property and equipment primarily consists of furniture and equipment, and
computer hardware and software.
LOSSES AND LOSS ADJUSTMENT EXPENSE RESERVES
Reserves are provided for the estimated costs of settling claims in respect of
loans reported to be in default and estimates of loans in default which have not
been reported to the Company. Consistent with industry accounting practices, the
Company does not establish loss reserves for future claims on insured loans
which are not currently in default. Loss reserves are established by management
using historical experience and by making various assumptions and judgments
about the ultimate amount to be paid on loans in default. The estimates are
continually reviewed and, as adjustments to these liabilities become necessary,
such adjustments are reflected in current operations.
61
Triad Guaranty Inc.
Notes to Consolidated Financial Statements(continued)
1. ACCOUNTING POLICIES (CONTINUED)
REINSURANCE
Certain premiums and losses are assumed from and ceded to other insurance
companies under various reinsurance agreements. Reinsurance premiums, claim
reimbursement and reserves related to reinsurance business are accounted for on
a basis consistent with those used in accounting for the original policies
issued and the terms of the reinsurance contracts. The Company receives a ceding
commission in connection with ceded reinsurance. The ceding commission is earned
on a monthly pro rata basis in the same manner as the premium and is recorded as
a reduction of other operating expenses. The reinsurance treaties provide for
profit commissions on ceded reinsurance based on the loss ratio associated with
the business ceded.
INCOME TAXES
The Company uses the asset and liability method of accounting for income taxes.
Under the asset and liability method, deferred tax assets, net of a valuation
allowance, and deferred tax liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled, and the effect on deferred
tax assets and liabilities of a change in tax rates is recognized in income in
the period that includes the enactment date.
INCOME RECOGNITION
The Company writes policies that are guaranteed renewable contracts at the
borrower's option on single premium, annual premium, and monthly premium bases.
For annual payment policies, the first year premium exceeds the renewal premium.
The Company does not have the option to reunderwrite these contracts. Premiums
written on annual policies are earned on a monthly pro rata basis. Single
premium policies covering more than one year are amortized over the estimated
policy life in accordance with the expiration of risk. Premiums written on a
monthly basis are generally earned when received.
62
Triad Guaranty Inc.
Notes to Consolidated Financial Statements(continued)
1. ACCOUNTING POLICIES (CONTINUED)
STOCK OPTIONS
The Company grants stock options for a fixed number of shares to employees with
an exercise price equal to or greater than the fair value of the shares at the
date of grant. The Company accounts for stock option grants in accordance with
APB Opinion No. 25, Accounting for Stock Issued to Employees, and, accordingly,
recognizes no compensation expense for the stock option grants.
EARNINGS PER SHARE
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
Earnings per Share. Statement 128 replaced the calculation of primary and fully
diluted earnings per share with basic and diluted earnings per share. Unlike
primary earnings per share, basic earnings per share excludes any dilutive
effects of options. Diluted earnings per share is very similar to the previously
reported fully diluted earnings per share. All earnings per share amounts for
all periods have been presented, and where appropriate, restated to conform to
the Statement 128 requirements.
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 employee 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, and the
numerator used in basic earnings per share and diluted earnings per share is the
same for all periods presented.
STOCK SPLITS
The Company had a three-for-two stock split in 1996 in the form of a 50% stock
dividend. The Company also had a two-for-one stock split in 1997 in the form of
a 100% stock dividend. All earnings per share amounts and stock option
information prior to the stock splits have been restated to reflect post-split
amounts.
63
Triad Guaranty Inc.
Notes to Consolidated Financial Statements(continued)
1. ACCOUNTING POLICIES (CONTINUED)
NEW ACCOUNTING PRONOUNCEMENT
In June 1997, the Financial Accounting Standards board issued Statement No. 130,
"Reporting Comprehensive Income", which is effective for fiscal years beginning
after December 31, 1997. The Statement establishes standards for the reporting
and display of comprehensive income and its components in financial statements.
The Company expects to adopt the provisions of Statement 130 in the first
quarter of 1998 and will reclassify the financial statements for earlier periods
provided for comparative purposes as required by the Statement. The application
of the new rules will not have an impact on the Company's financial position or
results of operations.
2. INVESTMENTS
The amortized cost and the fair value of investments are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---- ----- ------ -----
At December 31, 1997
Available-for-sale securities:
Fixed maturity securities:
Corporate .............. $ 12,260,852 $ 475,211 $ 38,842 $ 12,697,221
U.S. Government ........ 9,823,960 374,877 1,406 10,197,431
Mortgage-backed ........ 4,679,115 127,190 4,950 4,801,355
State and municipal .... 68,789,100 3,039,784 9,529 71,819,355
Public utilities ....... 203,109 7,016 -- 210,125
------------ ---------- -------- ------------
Total .................... 95,756,136 4,024,078 54,727 99,725,487
Equity securities ...... 8,666,815 2,810,028 10,815 11,466,028
------------ ---------- -------- ------------
Total .................... $104,422,951 $6,834,106 $ 65,542 $111,191,515
============ ========== ======== ============
At December 31, 1996
Available-for-sale securities:
Fixed maturity securities:
Corporate ............... $ 14,620,814 $ 427,065 $200,114 $ 14,847,765
U.S. Government ......... 9,311,329 360,899 16,484 9,655,744
Mortgage-backed ......... 16,545,818 84,823 381,003 16,249,638
State and municipal ..... 45,087,458 1,005,494 132,936 45,960,016
Public utilities ........ 504,334 12,358 -- 516,692
------------ ---------- -------- ------------
Total ..................... 86,069,753 1,890,639 730,537 87,229,855
Equity securities ....... 6,267,076 1,294,831 67,090 7,494,817
------------ ---------- -------- ------------
Total ..................... $ 92,336,829 $3,185,470 $797,627 $ 94,724,672
============ ========== ======== ============
64
Triad Guaranty Inc.
Notes to Consolidated Financial Statements(continued)
2. INVESTMENTS (CONTINUED)
The amortized cost and estimated fair value of investments in fixed maturity
securities, at December 31, 1997 are summarized by stated maturity as follows:
Available-for-Sale
------------------
Amortized Fair
Cost Value
---- -----
Maturity:
One year or less ................. $ 1,171,591 $ 1,181,270
After one year through five years 22,306,492 23,101,381
After five years through ten years 18,617,950 19,592,870
After ten years .................. 48,980,988 51,048,611
Mortgage-backed securities ....... 4,679,115 4,801,355
----------- -----------
Total ............................... $95,756,136 $99,725,487
=========== ===========
Realized gains and losses on sales of investments are as follows:
Year ended December 31
1997 1996 1995
---- ---- ----
Securities available-for-sale:
Fixed maturity securities:
Gross realized gains..... $ 35,274 $ 28,425 $ 131,968
Gross realized losses ... (270,818) (48,112) (202,123)
Equity securities:
Gross realized gains..... 360,066 86,607 208,061
Gross realized losses ... (117,810) (106,244) (7,372)
Other investments:
Gross realized gains..... 42,520 30,509 96,056
Gross realized losses ... (14,902) (153,570) (53,598)
--------- --------- ---------
Net realized gains (losses) .. $ 34,330 $(162,385) $ 172,992
========= ========= =========
Net unrealized appreciation (depreciation) on fixed maturity securities changed
by $2,809,249, $(1,228,326), and $6,689,443 in 1997, 1996 and 1995,
respectively; the corresponding amounts for equity securities were $1,571,472,
$961,475 and $495,328.
65
Triad Guaranty Inc.
Notes to Consolidated Financial Statements(continued)
2. INVESTMENTS (CONTINUED)
Major categories of the Company's net investment income are summarized as
follows:
Year ended December 31
1997 1996 1995
---- ---- ----
Income:
Fixed maturities .............. $5,849,084 $5,260,073 $4,677,448
Preferred stocks .............. 114,610 37,858 11,417
Common stocks ................. 279,640 236,715 234,249
Cash and short-term investments 212,033 122,461 153,087
---------- ---------- ----------
6,455,367 5,657,107 5,076,201
Expenses ......................... 221,225 210,435 239,740
---------- ---------- ----------
Net investment income ............ $6,234,142 $5,446,672 $4,836,461
========== ========== ==========
At December 31, 1997 and 1996, investments with an amortized cost of $6,404,051
and $6,214,410, respectively, were on deposit with state insurance departments
to satisfy regulatory requirements.
3. DEFERRED POLICY ACQUISITION COSTS
An analysis of deferred policy acquisition costs is as follows:
Year ended December 31
1997 1996 1995
---- ---- ----
Balance at beginning of year ....... $10,198,397 $ 7,576,684 $5,870,975
Acquisition costs deferred:
Sales compensation .............. 4,039,086 2,766,809 1,995,312
Underwriting and issue expenses . 2,470,341 3,089,780 1,999,518
----------- ----------- ----------
6,509,427 5,856,589 3,994,830
Amortization of acquisition expenses 4,120,469 3,234,876 2,289,121
----------- ----------- ----------
Net increase ....................... 2,388,958 2,621,713 1,705,709
----------- ----------- ----------
Balance at end of year ............. $12,587,355 $10,198,397 $7,576,684
=========== =========== ==========
66
Triad Guaranty Inc.
Notes to Consolidated Financial Statements(continued)
4. RESERVE FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity for the reserve for unpaid losses and loss adjustment expenses for
1997, 1996 and 1995 are summarized as follows:
1997 1996 1995
---- ---- ----
Reserve for losses and loss
adjustment expenses at January 1,
net of reinsurance recoverables
of $330,733, $885,852 and
$697,393 in 1997, 1996, and
1995,respectively................... $5,974,664 $ 3,703,251 $2,466,461
Incurred losses and loss adjustment
expenses net of reinsurance recoveries
(principally in respect of default
notices occurring in):
Current year.................... 6,022,700 4,673,130 3,190,786
Redundancy on prior years....... (845,622) (1,394,000) (974,000)
---------- ----------- ---------
Total incurred losses and
loss adjustment expenses........ 5,177,078 3,279,130 2,216,786
Loss and loss adjustment expense
payments net of reinsurance
recoveries (principally in respect
of default notices occurring in):
Current year.................... 210,493 166,717 215,996
Prior years..................... 2,032,128 841,000 764,000
---------- ----------- ---------
Total loss and loss adjustment
expense payments................... 2,242,621 1,007,717 979,996
---------- ----------- ---------
Reserve for losses and loss
adjustment expenses at
December 31, net of reinsurance
recoverables of $51,290, $330,733,
and $885,852 in 1997, 1996 and
1995, respectively................. $8,909,121 $ 5,974,664 3,703,251
========== =========== =========
The foregoing reconciliation shows a redundancy in reserves has emerged for each
of the years presented. These redundancies resulted principally from settling
case-basis reserves for amounts less than expected or reducing incurred but not
reported reserves on default notices occurring in prior years.
67
Triad Guaranty Inc.
Notes to Consolidated Financial Statements(continued)
5. COMMITMENTS
The Company leases certain office facilities and equipment under operating
leases. Rental expense for all leases was $835,596, $609,215, and $512,692 for
1997, 1996 and 1995, respectively. Future minimum payments under noncancellable
operating leases at December 31, 1997 are as follows:
1998............. $ 531,613
1999............. 456,945
2000............. 346,211
2001............. 280,674
2002............. 127,192
----------
$1,742,635
==========
6. FEDERAL INCOME TAXES
Triad purchases ten-year non-interest bearing United States Mortgage Guaranty
Tax and Loss Bonds in lieu of paying federal income taxes. At December 31, 1997
and 1996, Triad was obligated to purchase approximately $425,000 and $215,000,
respectively, of United States Mortgage Guaranty Tax and Loss Bonds.
Income tax expense differed from the amounts computed by applying the Federal
statutory income tax rate to income before taxes as follows:
1997 1996 1995
---- ---- ----
Income tax computed at statutory rate .. $ 8,835,231 $ 5,683,563 $ 3,817,830
Increase (decrease) in taxes
resulting from:
Tax-exempt interest ................. (1,002,062) (751,407) (352,486)
Other ............................... 168,525 109,629 4,677
----------- ----------- -----------
Income tax expense ................ $ 8,001,694 $ 5,041,785 $ 3,470,021
=========== =========== ===========
68
Triad Guaranty Inc.
Notes to Consolidated Financial Statements(continued)
6. FEDERAL INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant portions
of deferred tax assets and deferred tax liabilities at December 31, 1997 and
1996 are presented below:
1997 1996
---- ----
Deferred tax liabilities
Statutory contingency reserve ....... $17,370,996 $10,708,063
Deferred policy acquisition costs ... 4,405,574 3,518,447
Prepaid reinsurance premiums ........ 53,911 159,792
Amounts payable to reinsurer ........ 11,367 169,947
Fixed maturities .................... 202,884 168,895
Unrealized investment gain .......... 2,368,998 823,287
Other ............................... 418,775 223,621
----------- -----------
Total deferred tax liabilities ...... 24,832,505 15,772,052
Deferred tax assets
United States Mortgage Guaranty
Tax and Loss Bonds ................ 16,293,366 9,994,366
Unearned premiums ................... 611,467 706,015
Unearned ceding commission .......... -- 27,798
Losses and loss adjustment expenses.. 250,599 602,109
Other ............................... 155,199 165,683
----------- -----------
Total deferred tax assets ........... 17,310,631 11,495,971
----------- -----------
Net deferred tax liability .......... $ 7,521,874 $ 4,276,081
=========== ===========
69
Triad Guaranty Inc.
Notes to Consolidated Financial Statements(continued)
7. INSURANCE IN FORCE, DIVIDEND RESTRICTION AND STATUTORY RESULTS
Approximately 57% of Triad's net risk in force is concentrated in six states
including 14% in Georgia, 13% in Illinois, 10% in Florida, 7% in Virginia, 7% in
California, and 6% in Texas. While Triad continues to diversify its risk in
force geographically, a prolonged recession in its high concentration areas
could result in higher incurred losses and loss adjustment expenses for Triad.
Insurance regulations limit the writing of mortgage guaranty insurance to an
aggregate amount of insured risk no greater than twenty-five times the total of
statutory capital and surplus and the statutory contingency reserve. The amount
of net risk for insurance in force at December 31, 1997 and 1996, as presented
below, was computed by applying the various percentage settlement options to the
insurance in force amounts based on the original insured amount of the loan.
Triad's ratio is as follows:
1997 1996
---- ----
Net risk........................... $2,231,572,130 $1,452,824,414
============== ==============
Statutory capital and surplus...... $ 60,929,830 $ 57,070,475
Contingency reserve................ 54,766,669 35,072,109
-------------- --------------
Total.............................. $ 115,696,499 $ 92,142,584
============== ==============
Risk-to-capital ratio.............. 19.3 to 1 15.8 to 1
============== ==============
Triad and TGAC are each required under the Illinois Insurance Code (the "Code")
to maintain minimum statutory capital and surplus of $5,000,000. 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 market 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 $22,916,215, $13,369,769, and $9,337,430
for the years ended December 31, 1997, 1996 and 1995, respectively. At December
31, 1997, the amount of the Company's equity that can be paid out in dividends
to the stockholders is $2,512,027, which is the earned surplus of Triad on a
statutory basis.
70
Triad Guaranty Inc.
Notes to Consolidated Financial Statements(continued)
8. RELATED PARTY TRANSACTIONS
The Company and Triad pay affiliated companies for management, investment, and
other services. The total expense incurred for such items was $284,660, $303,555
and $438,200 in 1997, 1996 and 1995, respectively. Management believes that the
expenses incurred for suchtively. Management believes that the expenses incurred
for such services approximate costs that the Company would have incurred if
those services had been provided by unaffiliated third parties.
9. EMPLOYEE BENEFIT PLAN
Substantially all employees participate in the Company's 401(k) Profit Sharing
Plan. Under the plan, employees elect to defer a portion of their wages, with
the Company matching deferrals at the rate of 50% of the first 8% of the
employee's salary deferred. The Company contributed $151,134, $123,699, and
$81,675 for the years ended December 31, 1997, 1996 and 1995, respectively, to
the plan.
10. REINSURANCE
Certain premiums and losses are assumed from and ceded to other insurance
companies under various reinsurance agreements. The ceding agreement principally
provides Triad with increased capacity to write business and achieve a more
favorable geographic dispersion of risk.
Effective January 1, 1996, Triad eliminated quota share reof its coverage on
renewal business. Triad received approximately $1,100,000 and re-established
reserves, unearned premiums, and deferred acquisition costs for the previously
ceded business with no effect on income. Also, effective January 1, 1996, Triad
obtained $25 million in excess of loss reinsurance designed to provide
reinsurance protection in case of catastrophic levels of losses.
Effective October 1, 1997, Triad recaptured most of the remaining coverage on
renewal business. Triad received approximately $168,000 and re-established
reserves, unearned premiums, and deferred acquisition costs for the previously
ceded business with no effect on income.
71
Triad Guaranty Inc.
Notes to Consolidated Financial Statements(continued)
10. REINSURANCE (CONTINUED)
Reinsurance activity for the years ended December 31, 1997 and 1996 is as
follows:
1997 1996
---- ----
Earned premiums ceded ... $1,809,012 $2,319,927
Losses ceded ............ 140,734 165,224
Earned premiums assumed.. 19,804 29,012
Losses assumed .......... 67,903 99,910
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 deemed
uncollectible. Triad evaluates the financial condition of its reinsurers and
monitors credit risk arising from similar geographic regions, activities, or
economic characteristics of its reinsurers to minimize its exposure to
significant losses from reinsurer insolvency.
11. LONG-TERM STOCK INCENTIVE PLAN
In August 1993 the Company adopted the 1993 Long-Term Stock Incentive Plan (the
"Plan"). Under the Plan, certain directors, officers and key employees are
eligible to be granted various stock-based awards. The number of shares of
common stock which may be issued or sold or for which options or stock
appreciation rights may be granted under the Plan is 2,100,000 shares. All
information relating to the number of shares and option price have been adjusted
to reflect the three-for-two stock split in 1996 and the two-for-one stock split
in 1997.
72
Triad Guaranty Inc.
Notes to Consolidated Financial Statements(continued)
11. LONG-TERM STOCK INCENTIVE PLAN (CONTINUED)
Information concerning the stock option plan is summarized below:
Weighted
Average
Number of Option Exercise
Shares Price Price
------ ----- -----
1995
Outstanding, beginning of year .. 570,000 5.33 - 6.93 6.22
Granted ......................... 227,850 4.58 - 8.92 5.84
Exercised ....................... -- -- --
Canceled ........................ -- -- --
Outstanding, end of year ........ 797,850 4.58 - 8.92 6.13
Exercisable, end of year ........ 638,950 4.58 - 8.92 6.17
1996
Granted ......................... 239,254 8.84 - 15.13 11.47
Exercised ....................... 33,948 5.34 - 6.94 6.06
Canceled ........................ 9,462 5.96 - 11.49 9.56
Outstanding, end of year ........ 993,694 4.58 - 15.13 7.38
Exercisable, end of year ........ 738,229 4.58 - 11.49 6.54
1997
Granted ......................... 184,550 14.81 - 38.27 20.13
Exercised ....................... 2,999 4.58 - 8.92 7.47
Canceled ........................ -- -- --
Outstanding, end of year ........ 1,175,245 4.58 - 38.27 9.39
Exercisable, end of year ........ 887,462 4.58 - 15.13 6.91
At December 31, 1997, 1,941,553 shares of the Company's common stock were
reserved and 766,308 shares were available for issuance under the Plan. The
weighted-average remaining contractual life of the options outstanding at
December 31, 1997, is 7.1 years.
The options issued under the Plan in 1995, 1996 and 1997 vest over three years.
Certain of the options will immediately vest in the event of a change in control
of the Company. Options granted under the Plan terminate no later than 10 years
following the date of grant.
73
Triad Guaranty Inc.
Notes to Consolidated Financial Statements(continued)
11. LONG-TERM STOCK INCENTIVE PLAN (CONTINUED)
Pro forma information required by Financial Accounting Standards Board Statement
No. 123, Accounting for Stock-Based Compensation, has been estimated as if the
Company had accounted for stock-based awards under the fair value method of that
Statement. The fair value of options granted in 1995, 1996, and 1997 was
estimated at the date of the grant using a Black-Scholes option pricing model
with the following weighted-average input assumptions: risk-free interest rate
of 6.4% for 1995, 6.2% for 1996, and 5.7% for 1997; dividend yield of 0.0%;
expected volatility of .20 for 1995, .20 for 1996, and .29 for 1997; and a
weighted-average expected life of the option of 7 years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's stock options have characteristics significantly different from
those of traded options, and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its employee stock options.
The following table summarizes the fair value of options granted in 1995, 1996,
and 1997:
Weighted-Average Weighted-Average
Exercise Price Fair Value
Type of Option 1997 1996 1995 1997 1996 1995
- ------------------------------ ------ ------ ----- ----- ----- -----
Stock Price equals
Exercise Price........... $18.65 $11.44 $5.65 $5.73 $3.16 $1.59
Stock Price less than
Exercise Price.......... $20.78 $11.48 $5.96 $3.88 $1.70 $0.90
74
Triad Guaranty Inc.
Notes to Consolidated Financial Statements(continued)
11. LONG-TERM STOCK INCENTIVE PLAN (CONTINUED)
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. Had compensation
expense for stock options been recognized using the fair value method on the
grant date, net income and earnings per share on a pro forma basis would have
been (in thousands except for earnings per share information):
1997 1996 1995
---- ---- ----
Net Income - as reported .............. $ 17,242 $ 11,197 $ 7,759
Net Income - pro forma ................ $ 16,937 $ 11,054 $ 7,713
Earnings per share - as reported
Basic ............................ $ 1.30 $ 0.84 $ 0.59
Diluted .......................... $ 1.26 $ 0.83 $ 0.58
Earnings per share - pro forma
Basic ............................ $ 1.28 $ 0.83 $ 0.59
Diluted .......................... $ 1.24 $ 0.82 $ 0.58
The preceding effects of applying Statement 123 are not likely to be indicative
of the effects on net income and earnings per share in future years due to the
vesting period of awards granted in these years.
75
Triad Guaranty Inc.
Notes to Consolidated Financial Statements(continued)
12. UNAUDITED QUARTERLY FINANCIAL DATA
The following is a summary of the unaudited quarterly results of operations for
the years ended December 31, 1997 and 1996 (in thousands except per share data):
1997 Quarter
First Second Third Fourth Year
----- ------ ----- ------ ----
Net premiums written ........... $7,379 $9,128 $10,611 $11,213 $38,331
Earned premiums ................ 7,849 8,985 10,378 11,310 38,522
Net investment income .......... 1,472 1,502 1,730 1,530 6,234
Net losses incurred ............ 1,196 1,090 1,520 1,371 5,177
Underwriting and other expenses 3,095 3,530 3,754 3,998 14,377
Net income ..................... 3,447 4,033 4,738 5,024 17,242
Basic EPS ...................... .26 .30 .36 .38 1.30
Diluted EPS .................... .25 .30 .34 .36 1.26
1996 Quarter
First Second Third Fourth Year
----- ------ ----- ------ ----
Net premiums written ........... $5,073 $5,559 $ 6,684 $ 6,645 $23,961
Earned premiums ................ 5,479 5,763 6,513 6,973 24,728
Net investment income .......... 1,279 1,364 1,368 1,435 5,446
Net losses incurred ............ 653 614 1,013 999 3,279
Underwriting and other expenses 2,387 2,590 2,658 2,859 10,494
Net income ..................... 2,549 2,652 2,889 3,107 11,197
Basic EPS ...................... .19 .20 .22 .23 .84
Diluted EPS .................... .19 .20 .21 .23 .83
13. SUBSEQUENT EVENT
On January 22, 1998, the Company completed a $35 million private offering of
notes due January 15, 2028. The notes, which represent unsecured obligations of
the Company, bear int
76
Schedule I
Summary of Investments - Other Than Investments In Related Parties
Triad Guaranty Inc.
December 31, 1997
Amount at
Which Shown
Amortized Fair in Balance
Type of Investment Cost Value Sheet
---------------------------------
(dollars in thousands)
Fixed maturity securities,
available-for-sale:
Bonds:
U.S. Government obligations ..... $ 9,824 $ 10,198 $ 10,198
Mortgage-backed securities ...... 4,679 4,801 4,801
State and municipal bonds ....... 68,789 71,819 71,819
Corporate bonds ................. 12,261 12,697 12,697
Public utilities ................ 203 210 210
------- -------- -------
Total ............................. 95,756 99,725 99,725
-------- -------- -------
Equity securities, available-for-sale:
Common stocks:
Public utilities .............. 627 885 885
Industrial & miscellaneous .... 5,140 7,597 7,597
Preferred Stock ................... 2,900 2,984 2,984
------- -------- -------
Total ............................ 8,667 11,466 11,466
------- -------- -------
Short-term investments ............... 8,686 8,686 8,686
------- -------- -------
Total investments other than
investments in related parties .... $113,109 $119,877 $119,877
======== ======== ========
77
Schedule Ii - Condensed Financial Information Of Registrant
Condensed Balance Sheets
Triad Guaranty Inc.
(Parent Company)
December 31
1997 1996
---- ----
(dollars in thousands)
Assets:
Investment in subsidiaries ......................... $111,200 $91,136
Cash and short-term investments .................... 562 534
Other assets ....................................... 56 16
-------- -------
Total assets ....................................... $111,818 $91,686
======== =======
Liabilities and stockholders' equity:
Liabilities:
Current taxes payable .............................. $ 3 $ 1
Accrued expenses and other liabilities ............. 35 5
-------- -------
Total liabilities .................................. 38 6
Stockholders' equity:
Common stock ....................................... 133 66
Additional paid-in capital ......................... 59,369 59,347
Unrealized gain on invested assets (all from
subsidiaries) ..................................... 4,405 1,569
Retained earnings .................................. 47,873 30,698
-------- -------
Total stockholders' equity ............................ 111,780 91,680
-------- -------
Total liabilities and stockholders' equity ............ $111,818 $91,686
======== =======
See notes to condensed financial statements.
78
Schedule Ii - Condensed Financial Information Of Registrant
Condensed Statements Of Income
Triad Guaranty Inc.
(Parent Company)rant
Year Ended December 31
1997 1996 1995
---- ---- ----
(dollars in thousands)
Revenues:
Net investment income ....................... $ 22 $ 17 $ 14
------- -------- -------
22 17 14
------- -------- -------
Expenses:
Operating expenses .......................... 6 6 152
------- -------- -------
6 6 152
------- -------- -------
Income (loss) before federal income taxes and
equity in undistributed income of subsidiaries 16 11 (138)
Federal income tax expense ..................... 2 151 22
------- -------- -------
Income (loss) before equity in undistributed
income of subsidiaries ........................ 14 (140) (160)
Equity in undistributed income of subsidiaries.. 17,228 11,337 7,919
------- -------- -------
Net income ..................................... $17,242 $ 11,197 $ 7,759
======= ======== =======
See notes to condensed financial statements.
79
Schedule II - Condensed Financial Information of Registrant
Condensed Statements of Cash Flows
Triad Guaranty Inc.
(Parent Company)
Year Ended December 31
1997 1996 1995
---- ---- ----
(dollars in thousands)
Operating Activities
Net income ..................................... $ 17,242 $ 11,197 $ 7,759
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Equity in undistributed income of subsidiaries.. (17,228) (11,337) (7,919)
Amortization of deferred compensation .......... -- -- 149
(Increase) decrease in other assets ............ (40) 20 (14)
Decrease in deferred income taxes .............. -- 151 21
Increase (decrease) in current tax payable ..... 2 -- (3)
Increase (decrease) in accrued expenses and
other liabilities ........................... 30 (15) (18)
-------- -------- -------
Net cash provided by (used in)
operating activities......................... 6 16 (25)
Financing Activities
Proceeds from exercise of stock options...... .. 22 206 --
-------- -------- -------
Net cash provided by financing activities ......... 22 206 --
-------- -------- -------
Increase (decrease) in cash and
short-term investments.......................... 28 222 (25)
Cash and short-term investments at
beginning of year .............................. 534 312 337
-------- ------- -------
Cash and short-term investments at end of year .... $ 562 $ 534 $ 312
======== ======= =======
See notes to condensed financial statements.
80
Schedule II - Condensed Financial Information of Registrant
Triad Guaranty Inc.
(Parent Company)
Supplementary Notes
NOTE 1
In the parent company financial statements, the Company's investment in its
subsidiaries is stated at cost plus equity in undistributed earnings of the
subsidiaries. The Company's share of net income of its subsidiaries is included
in income using the equity method. The accompanying Parent Company financial
statements should be read in conjunction with the Consolidated Financial
Statements and Notes to Consolidated Financial Statements included as part of
this Form 10-K.
NOTE 2
Triad Guaranty Inc. (the "Company") 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 to protect the lender against loss from defaults on low down payment
residential mortgage loans.
NOTE 3
In January 1998 the Company completed a $35 million private offering of
notes due January 15, 2028. The notes, which represent unsecured obligations of
the Company, bear interest at a rate of 7.9% per annum and are non-callable.
81
Schedule IV - Reinsurance
Triad Guaranty Inc.
Mortgage Insurance Premium Earned
Years Ended December 31, 1997, 1996 and 1995
Percentage of
Ceded To Assumed Amount
Gross Other From Other Net Assumed
Amount Companies Companies Amount to Net
------ --------- --------- ------ ------
(dollars in thousands)
1997............ $40,311 $1,809 $20 $38,522 0.1%
======= ====== === =======
1996............ $27,019 $2,320 $29 $24,728 0.1%
======= ====== === =======
1995............ $19,699 $4,253 $32 $15,478 0.2%
======= ====== === =======
82