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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[x] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934For the fiscal year ended December 31, 1999
[ ] 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
incorporation or organization) Identification No.)
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
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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
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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 March 2, 2000, computed by reference to the last reported price
at which the stock was sold on such date, was $134,504,077.
The number of shares of the registrant's common stock, par value $.01 per share,
outstanding as of March 2, 2000 was 13,313,194.
Portions of the following documents Part of this Form 10-K into
are incorporated by reference into which the document is
this Form 10-K: incorporated by reference:
TRIAD GUARANTY INC. PART III
PROXY STATEMENT FOR 2000 ANNUAL MEETING
OF STOCKHOLDERS
PART I
ITEM 1. BUSINESS.
Triad Guaranty Inc. is a holding company which, through its wholly-owned
subsidiary, Triad Guaranty Insurance Corporation ("Triad"), provides private
mortgage insurance ("MI") coverage in the United States to residential mortgage
lenders, including mortgage bankers, mortgage brokers, commercial banks, and
savings institutions. Triad Guaranty Inc. and its subsidiaries are collectively
referred to as the "Company." The "Company" when used within this document
refers to the holding company and/or one or more of its subsidiaries, as
appropriate.
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 most financial 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 PRODUCTS
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, 1999) 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 underwrities 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, 1999.
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. In January 1999, Fannie Mae announced that it
would accept lower coverage percentages from lenders on certain loans for resale
to the secondary market than it previously required. In conjunction with the
announcement, Fannie Mae reduced the coverage requirement so that its loss
exposure on loans processed by its automated underwriting system will be limited
to 80% or less of the property's value at the time of origination. In March
1999, Freddie Mac introduced a similar program.
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. Thereafter level monthly premiums
are collected by the loan servicer for monthly remittance to the Company. The
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Company also offers a plan under which the first monthly 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 96% of new insurance written in 1999. The
Company expects that the percentage of new business written on monthly premium
plans will remain near 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 from the borrower 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.
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.
RISK SHARING PRODUCTS
The Company has in place mortgage insurance programs designed to enable the
Company to better meet the needs and requirements of its lender customers. One
such program, introduced in 1997, 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. In 1999, the Company began marketing certain captive
reinsurance programs which allow a reinsurance company, generally an affiliate
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of the lender, to assume mortgage insurance default losses up to a maximum
exposure. Regulatory and industry issues exist regarding the future of certain
risk sharing programs currently being marketed within the mortgage insurance
industry. The resolution of the regulatory and industry questions regarding risk
sharing programs makes the continued viability of such programs uncertain.
Management is unable to predict the impact of the regulatory issues on these
products.
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. Pursuant to federal legislation enacted in 1998, most loans made
on or after July 29, 1999, are required to have their private mortgage insurance
canceled automatically by the lenders when the outstanding loan amount is 78% or
less of the original property purchase price.
When a borrower refinances a Company-insured mortgage loan by paying it off
in full with the proceeds of a new Company-insured 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 the Company'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 25.0%, 31.7%, and 14.0% in 1999, 1998, and
1997, respectively, reflecting the low interest rate environment during all of
1998 and early 1999 and increases in interest rates in recent months.
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 insurance in force at
the end of the previous year that was canceled during the following year was
22.9%, 30.0%, and 16.5% in 1999, 1998, and 1997, respectively. The cancellations
have not had a material impact on the geographic dispersion of the Company's
risk in force.
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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, 1999, approximately 57% of the Company's risk in force
came from mortgage bankers, 19% from mortgage brokers, 18% from commercial
banks, and 6% from savings institutions. At December 31, 1998, approximately 55%
of the Company's risk in force came from mortgage bankers, 20% from mortgage
brokers, 18% from commercial banks, and 7% 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 underwriting 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 6,948 master policy holders at December 31, 1999, compared to 6,214 at
December 31, 1998.
The Company's ten largest customers were responsible for 31.0%, 31.7%, and
32.2% of direct risk in force at December 31, 1999, 1998, and 1997,
respectively. No single customer of the Company (including branches and
affiliates of that customer) accounted for revenues greater than 10% of total
revenues for 1999. The largest single customer of the Company, measured by risk
in force, accounted for 9.2%, 9.5%, and 10.2% at December 31, 1999, 1998, and
1997, respectively.
SALES AND MARKETING
The Company currently markets its insurance products through a sales force,
including sales management, of 49 professionals and an exclusive commissioned
general agency serving a specific geographic market. The Company is licensed to
do business in 46 states and the District of Columbia and has licenses pending
in two states. The Company is actively serving mortgage originators in 38 states
and the District of Columbia.
In 1999, the Company strengthened its sales force by restructuring the
sales team into four sales regions, each with its own manager. These four
regional mangers report to a field administrator who oversees all account
executive activities. The field administrator reports directly to the senior
executive officer who oversees all sales activities for the Company, including
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those of the national account market representatives. This reporting structure
allows the senior executive in charge of all sales activities to focus time on
the growing national account market of larger lenders while remaining in control
of all other sales activities. Currently, the Company is approved to do business
with 21 of the top 30 lenders compared to 24 at year end 1998. This reduction is
due solely to three new entrants into the top 30 ranking with which Triad has
not yet developed a relationship. 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 internal
sales force and general agents. For 1999, the Company's commissioned general
agency produced approximately 11% of the Company's new 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 the general agency could have a material adverse effect on the
Company's operations.
In 1999, the Company strengthened its marketing team by restructuring the
department and hiring a senior level marketing executive to oversee all
marketing efforts. The Company's marketing focus is to support the sales team
members and to build a positive image of the Company. These goals are
accomplished through a comprehensive sales support program which includes
assistance with presentation, training, and administrative material, and a
national advertising and public relations campaign designed to raise corporate
visibility within the sights of lenders and investors. The Company also
completely revised its web site in 1999 to be more user-friendly and to provide
more functionality for customers, investors, home buyers, and real estate
professionals.
The Company provides, for a fee, contract underwriting services that enable
customers to improve the efficiency of their operations by outsourcing all or
part of their mortgage loan underwriting. Contract underwriting services have
become increasingly important to lenders as they seek to reduce fixed costs.
Accordingly, contract underwriting significantly contributes to the Company's
mortgage insurance production. The Company provides contract underwriting
services through its own employees as well as independent contractors. The
Company's inability to maintain and provide a sufficient number of qualified
underwriters could have a material adverse effect on the Company's operations.
COMPETITION AND MARKET SHARE
The Company 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 48% of high LTV
loans in 1999 and 44% in 1998. In addition to competition from federal agencies,
the Company and other private mortgage insurers face competition from
state-supported mortgage insurance funds. Several of these states (among them,
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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.
Fannie Mae and Freddie Mac announced in the first quarter of 1999 that they
would accept lower coverage percentages from lenders on certain loans for resale
to the secondary market than had been previously required. The reduction in the
amount of private mortgage insurance coverage required or the adoption of
private mortgage insurance substitutes by Fannie Mae or Freddie Mac could
adversely affect the Company's financial condition and results of operations.
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 eight 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, and Radian Guaranty Inc. Triad is the seventh
largest private mortgage insurer based on 1999 market share and, according to
industry data, had a 2.3% share of net new mortgage insurance written in 1999
compared to 2.6% in 1998.
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, and innovative products.
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 Senior Vice President of Risk Management and Vice President
of Underwriting have been in their positions since shortly after the Company was
founded and report directly to the Executive Vice President in charge of
Services and Risk Management. In addition to a centralized underwriting
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department in the home office, the Vice President of Underwriting is responsible
for the Company's regional offices in Georgia, Texas, Illinois, Arizona,
Pennsylvania, Colorado, and California. The Senior Vice President of Risk
Management is responsible for assessing the risk factors used by the Company in
its underwriting procedures and for the quality control function.
The Company employed an underwriting staff of forty-one at December 31,
1999. 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
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. The Company underwrites based on
historical performance of risk factors and utilizes automated underwriting
systems in the risk selection process to assist the underwriter with
decision-making. This process evaluates the following categories of risk:
* MORTGAGE LENDER. The Company reviews each lender's financial
statements and management experience before issuing a master policy.
The Company also tracks the historical risk performance of all
customers that hold a master policy. This information is factored into
the determination of the loan programs that the Company will approve
for various lenders. The Company assigns delegated underwriting
authority only to lenders with substantial financial resources and
established records of originating good quality loans.
* 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,
(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
not actively pursued by the Company because such loans are deemed to
have a disproportionate amount of risk, including negatively
amortizing ARMs and ARMs with maximum annual and lifetime caps that
are not prudent.
* 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
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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.
* 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 expects its internal and contract underwriters to
utilize their experience and business judgement in evaluating each loan on its
own merits. Accordingly, the Company's underwriting staff has discretionary
authority to insure loans which deviate in certain minor respects from the
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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 2.1% and 2.4% at December 31, 1999 and 1998,
respectively.
The Company's Stick With Triad program featuring the Slam Dunk Loan SM
approval process allows lenders to submit insurance applications that do not
include all standard documentation. Under this program, 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 systems. 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 1999, the Stick With Triad program represented 65%
of the Company's commitment volume, compared to 59% in 1998. The Company
randomly and through adverse selection audits lenders' files on loans submitted
under this program.
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 17% of commitments received in 1999 compared
to 16% in 1998 and 18% in 1997. Many lenders who are not part of the delegated
underwriting process participate in the Stick With Triad underwriting 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 addition, the
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Company offers 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 business activity which involve an underwriting decision are included, with
emphasis on new products, new procedures, contract underwritten loans, delegated
loans, new employees, and new master policyholders and branches of an existing
master policy holder. 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's 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 Rating
Services, a division of the McGraw-Hill Companies, Inc. ("S&P"), Fitch IBCA
("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).
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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 is rated "AA" by S&P, Fitch, and Duff
& Phelps. These ratings allow Triad to compete on similar risk-to- capital
guidelines as its competitors. 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 policyholder 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.
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 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 was 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.
13
REINSURANCE
The use of reinsurance as a source of capital and as a risk management tool
is well established within the mortgage insurance industry. 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.
Certain premiums and losses are assumed from and ceded to non-affiliated
insurance companies under various quota share reinsurance agreements. The ceding
agreement principally provides the Company with increased capacity to write
business and achieve a more favorable geographic dispersion of risk. Less than
0.1% of Triad's risk in force at December 31, 1999, and direct premiums written
in 1999 were ceded in quota share arrangements to non-affiliated reinsurance
companies. In addition, the Company reinsures portions of the risk written on
loans originated by certain lenders with captive reinsurance companies
affiliated with such lenders.
Pursuant to deeper coverage requirements imposed by Fannie Mae and Freddie
Mac, certain 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. Although changes by Fannie Mae and Freddie Mac are
expected to reduce how many loans are insured over 25%, the need for reinsurance
channels is not expected to change for Triad. 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, 1999, TGAC had assumed approximately $63.5 million in risk
from Triad.
Captive mortgage insurance has become popular in the mortgage insurance
market and a mortgage insurer must offer it to remain competitive within the
industry. Triad entered the captive reinsurance market in 1999 with the LEAPSM
(Lower Entry- Additional Profitability) program. The LEAP program is an excess
of loss mortgage reinsurance program that provides lenders an opportunity to
share in the risk and return of mortgage insurance on loans the lender
originates or services. Under LEAP, the lender may elect a risk band with a
flexible entry and exit point. LEAP also permits cessions significantly greater
than the 25% industry standard arrangements that existed prior to this program.
The LEAP program allows the lender to take advantage of the Company's
innovative Capital GardSM program. Capital Gard is an additional tool to manage
catastrophic loss risks on captive excess of loss structures. Capital Gard
permits a captive reinsurer to spread its risk to other non-affiliated
14
reinsurance companies in the event of an economic depression just as property
and casualty reinsurers purchase catastrophic coverage to protect themselves
against severe natural disasters. The combination of the LEAP and Capital Gard
programs offer unmatched risk management opportunities with increased
flexibility, based on the specific needs of each individual lender. Ceded
premium under captive reinsurance agreements represented 0.2% of direct written
premiums in 1999.
The Company also has in place reinsurance agreements with non-affiliated
reinsurers in association with certain of the Company's non-captive risk sharing
programs. The reinsurance agreements are excess of loss contracts whereby the
reinsurer will indemnify the Company with respect to losses covered as defined
by the reinsurance agreements. In 1999, 1.1% of the Company's direct written
premium was ceded to reinsurers under these agreements.
At the end of 1999, 15.4% of Triad's insurance in force had been insured
under some type of risk-sharing arrangement as compared to 11.1% at year end
1998. Risk-sharing arrangements represented 22.9% of Triad's net new insurance
written in 1999.
In November 1999, Triad formed Triad Re Insurance Corporation ("Triad Re")
as a wholly-owned sponsored captive reinsurance company domiciled in Vermont.
Triad Re was capitalized in February 2000, with regulatory capital of $1.0
million. As of December 31, 1999, no risk had been ceded to Triad Re.
The Company continues to maintain excess of loss reinsurance arrangements
designed to protect the Company in the event of a catastrophic level of losses.
Throughout 1999, Triad maintained $25 million of excess of loss reinsurance
through a non-affiliated reinsurer. In late 1999, Triad obtained access to an
additional $100 million of excess of loss reinsurance coverage. The additional
reinsurance further strengthens Triad's ability to weather an adverse economic
event and is beneficial in maintaining rating agency ratings.
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
15
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.
Default Statistics
December 31
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
Number of insured loans in force.................... 108,623 97,222 82,682 62,334 49,791
Number of loans in default.......................... 690 518 388 273 206
Percentage of loans in default (default rate)....... 0.64% 0.53% 0.47% 0.44% 0.41%
Dollar amount of insured loans in default (000's)... $67,802 $50,882 $37,828 $25,253 $19,907
Dollar amount of direct risk with respect to
insured loans in default (000's).................... $18,108 $13,216 $9,249 $5,770 $4,071
Reserve per delinquent loan......................... $21,378 $23,442 $23,094 $23,097 $22,277
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.
16
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.
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 1999,
the Company exercised the option to acquire one property. This property was
valued at $145,515 on December 31, 1999, which is the lower of cost or net
realizable value. In 1998, the Company did not exercise the option to acquire
any property and did not own any real estate acquired through claim settlements
at December 31, 1998.
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
17
has paid out only 67% of its potential exposure on claims paid ever-to-date
through December 31, 1999.
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
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, 1999, 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. 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.
18
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)
1999 1998 1997 1996 1995
---- ---- ---- ------ -----
Reserve for losses and LAE, net of related
reinsurance recoverables, at beginning of year...... $ 12,116 $ 8,909 $ 5,974 $ 3,703 $ 2,466
Add losses and LAE incurred in respect of
defaults occurring in:
Current year (1)................................ 9,322 7,953 6,023 4,673 3,191
Prior years (1) (2)............................. (2,211) (944) (846) (1,394) (974)
-------- ------- ------- ------- -------
Total incurred losses and LAE........................ 7,111 7,009 5,177 3,279 2,217
Deduct losses and LAE paid in respect of
defaults occurring in:
Current year.................................... 236 267 210 167 216
Prior years..................................... 4,268 3,535 2,032 841 764
-------- ------- ------- ------- -------
Total payments....................................... 4,504 3,802 2,242 1,008 980
Reserve for losses and LAE, net of the related
reinsurance recoverables, at end of year ........... 14,723 12,116 8,909 5,974 3,703
Reinsurance recoverables on unpaid losses and
LAE, at the end of year ............................ 28 27 51 331 886
-------- ------- ------- ------- -------
Reserve for unpaid losses and LAE, before
deduction of reinsurance recoverables on unpaid
losses, at end of year............................... $ 14,751 $12,143 $ 8,960 $ 6,305 $ 4,589
======== ======= ======= ======= =======
- -----------
(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.
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.
19
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.
20
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, 1999 and 1998:
Direct Risk in Force
December 31
Product Type: 1999 1998
---- ----
Primary.................................................. 100.0% 100.0%
Pool..................................................... 0.0% 0.0%
----- -----
Total.................................................... 100.0% 100.0%
===== =====
Direct Primary Risk in Force
December 31
1999 1998
----- ----
Direct Risk in Force (dollars in millions)................ $3,223 $2,777
Lender Concentration:
Top 10 lenders (by original applicant).................... 31.0% 31.7%
LTV:
95.01% and above.......................................... 2.0% 1.0%
90.01% to 95.00%.......................................... 50.0% 50.4%
90.00 and below........................................... 48.0% 48.6%
----- -----
Total..................................................... 100.0% 100.0%
===== =====
Loan Type:
Fixed..................................................... 94.5% 92.4%
ARM (positive amortization) (1)........................... 5.5% 7.6%
ARM (potential negative amortization) (2)................. 0.0% 0.0%
ARM (scheduled negative amortization) (2)................. 0.0% 0.0%
Other..................................................... 0.0% 0.0%
----- -----
Total..................................................... 100.0% 100.0%
===== =====
Mortgage Term:
15 years and under........................................ 6.8% 7.0%
Over 15 years............................................. 93.2% 93.0%
----- -----
Total..................................................... 100.0% 100.0%
===== =====
Property Type:
Noncondominium (principally single-family detached)....... 95.6% 95.5%
Condominium............................................... 4.4% 4.5%
----- -----
Total..................................................... 100.0% 100.0%
===== =====
Occupancy Status:
Primary residence......................................... 98.6% 100.0%
Second home............................................... 1.1% 0.0%
Nonowner occupied......................................... 0.3% 0.0%
----- -----
Total..................................................... 100.0% 100.0%
===== =====
Mortgage Amount:
$200,000 or less.......................................... 92.5% 93.9%
Over $200,000............................................. 7.5% 6.1%
----- -----
Total..................................................... 100.0% 100.0%
====== =====
(1) Refers to loans where payment adjustments are the same as mortgage interest
rate adjustments.
(2) 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.
21
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.
Approximately 2% of the Company's risk in force is comprised of the 97% LTV
product ("97s"), which is offered primarily to low and moderate income
borrowers. 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. The Company does not
routinely delegate the underwriting of its 97% LTV product.
The Company actively pursues only positively amortizing ARMs with industry
standard caps. 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" negative amortization. ARMs with "potential" negative amortization
characteristics due to differences in the timing of interest rate and payment
changes are accepted under limited conditions.
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
detached and attached townhouse units with fee simple ownership, condominiums,
and cooperatives. Triad does not insure cooperatives.
22
Loans on primary residences that were owner occupied at the time of loan
origination constituted approximately 99% of the Company's risk in force at
December 31, 1999. Because management believes that loans on non-owner occupied
properties represent a substantially higher risk of claim incidence and are
subject to greater value declines than loans on primary homes, the Company does
not actively pursue these loans.
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 2.8 years at December 31, 1999, and 2.4 years
at December 31, 1998, compared to an estimated industry average of 3.7 years at
December 31, 1999.
The following table shows the percentage of direct risk in force as of
December 31, 1999, for policies written from 1988 through 1999 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, 1999, 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 $ 0.7 0.0% 14.4%
1989 1.0 0.0 24.1
1990 2.3 0.1 17.9
1991 8.8 0.3 11.5
1992 34.8 1.1 8.2
1993 99.1 3.1 5.1
1994 89.1 2.7 7.7
1995 154.0 4.8 7.9
1996 243.9 7.6 7.0
1997 536.7 16.6 4.1
1998 1,086.1 33.7 0.3
1999 966.0 30.0 0.0
------ -----
Total $ 3,222.5 100.0%
========= =====
- -------------------------
(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.
23
GEOGRAPHIC DISPERSION
The following tables reflect the percentage of direct risk in force 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, 1999. 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 69.4% for
1999 compared to 70.6% and 73.9% for 1998 and 1997, respectively. The percentage
of the Company's direct risk in force by top ten MSAs was 36.3% for 1999
compared to 33.0% and 36.8% for 1998 and 1997, respectively.
Top Ten States Top Ten MSAs
-------------- ------------
December 31 December 31
1999 1999
---- ----
California 11.5% Chicago, IL 11.0%
Illinois 11.4 Los Angeles, CA 4.6
Georgia 9.1 Washington, DC 4.0
Florida 7.8 Atlanta, GA 3.8
Texas 7.4 San Francisco/Oakland, CA 2.5
North Carolina 6.3 Philadelphia, PA 2.5
Virginia 4.6 Houston/Galveston, TX 2.3
Pennsylvania 4.1 Phoenix, AZ 2.0
Colorado 3.8 Charlotte/Gastonia, NC 1.9
Arizona 3.4 Dallas/Forth Worth, TX 1.7
----- ----
Total 69.4% Total 36.3%
===== ====
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, Western, 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. The Company
has an investment advisory agreement with CML for management of its portfolio.
The Company follows an investment policy which requires: (i) 80% 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
24
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 two highest investment grades by a nationally recognized rating agency. At
December 31, 1999, the Company's total investment portfolio had a fair market
value of $191.6 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, 1999, 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'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
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
Average investments (1)................. $183,987,661 $151,711,923 $103,804,750 $89,577,031 $79,253,289
Pre-tax net investment income........... $10,545,663 $9,289,026 $6,234,142 $5,446,672 $4,836,461
Effective pre-tax yield (1)............. 5.7% 6.1% 6.0% 6.1% 6.1%
Tax-equivalent yield (2)................ 7.7% 7.9% 8.0% 7.7% 7.5%
Pre-tax realized gain (loss)
on sale of investments.................. $1,153,191 $880,502 $34,330 $(162,385) $172,992
- -------------------------
(1) Based on historical cost adjusted for amortization and accretion of premium
and discount.
(2) Based on book value and the Company's marginal tax rate.
25
The diversification of the Company's investment portfolio at December 31,
1999, is shown in the table below:
INVESTMENT PORTFOLIO DIVERSIFICATION
December 31, 1999
----------------------------------------
Amortized Cost Fair Value Percent(1)
-------------- ---------- ----------
Available-for-sale securities:
Fixed maturity securities:
U.S. government obligations.......... $ 7,106,820 $ 7,103,956 3.7%
Mortgage-backed bonds................ 1,112,041 1,143,066 0.6
State and municipal bonds............ 124,379,747 117,836,936 61.5
Industrial & miscellaneous........... 41,380,256 38,495,458 20.1
------------ ------------
Total fixed maturities........... 173,978,864 164,579,416
Equity securities...................... 10,952,390 13,075,648 6.8
------------ ------------
Total available-for-sale securities... 184,931,254 177,655,064
Short-term investments................. 13,908,666 13,908,666 7.3
------------ ------------ -----
$198,839,920 $191,563,730 100.0%
============ ============ ======
- ----------------
(1) Percentage of fair value.
The following table shows the scheduled maturities at December 31, 1999, of
the fixed maturity securities held in the Company's investment portfolio:
INVESTMENT PORTFOLIO SCHEDULED MATURITY
December 31, 1999
----------------------------
Fair Value Percent
---------- -------
One year or less......................... $ 3,614,071 2.2%
After one year through five years........ 20,865,314 12.7
After five years through ten years....... 25,138,329 15.3
After ten years though twenty years...... 86,790,318 52.7
After twenty years....................... 27,028,318 16.4
Mortgage-backed securities (1)........... 1,143,066 0.7
----------- -----
Total........................... $164,579,416 100.0%
============ =====
(1)Substantially all of these securities are guaranteed by U.S. Government
Agencies.
26
The following table shows the ratings of the Company's investment
portfolio as of December 31, 1999:
INVESTMENT PORTFOLIO BY RATING
December 31, 1999
-------------------------
Rating(1) Fair Value Percent
- --------- ---------- -------
Fixed maturities:
U.S. Treasury and U.S. agency bonds..... $ 8,247,022 5.0%
AAA..................................... 54,485,984 33.1
AA...................................... 25,252,960 15.4
A....................................... 35,638,813 21.7
BBB..................................... 21,388,071 13.0
BB...................................... 7,792,717 4.7
B....................................... 5,602,196 3.4
C....................................... 126,000 0.1
D....................................... 383,085 0.2
NR...................................... 5,662,568 3.4
------------- -----
Total fixed maturities............. $ 164,579,416 100.0%
============= =====
Equities:
AAA..................................... $ 491,250 3.8%
AA...................................... 471,444 3.6
A....................................... 9,255,479 70.8
BBB..................................... 956,255 7.3
BB...................................... 0 0.0
B....................................... 1,901,220 14.5
------------- -----
Total equities...................... $ 13,075,648 100.0%
============= =====
Total Portfolio.................................. $ 177,655,064
=============
-------------------------
(1) Current ratings as assigned by the NRSRO (Nationally Recognized Statistical
Rating Organization). The NRSRO includes the following nationally recognized
rating agencies: S&P, Moody's, Duff & Phelps, and Fitch.
27
REGULATION
DIRECT REGULATION
The Company's insurance subsidiaries are subject to comprehensive, detailed
regulation, principally for the protection of policyholders and their borrowers
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.
28
Triad is required by Illinois insurance laws to provide for a contingency
reserve in an amount equal to at least 50% of earned premiums in its statutory
financial statements. 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,
1999, Triad had statutory policyholders' surplus of $94.6 million and statutory
contingency reserve of $113.8 million. At December 31, 1998, Triad had statutory
policyholders' surplus of $89.5 million and a statutory contingency reserve of
$81.6 million. Triad's statutory earned surplus was $10.9 million at year end
1999 versus $5.8 million at year end 1998, 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.
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.
Triad Re was organized as a subsidiary of Triad under the insurance laws of
the state of Vermont in November 1999, and as a Vermont domiciled insurer, is
subject to Vermont insurance regulatory requirements.
Triad, TGAC, and Triad Re are 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 Insurance Director and Vermont Insurance Commissioner
periodically conduct financial examinations of insurance companies domiciled in
their states. The most recent examinations of Triad and TGAC, were issued by the
Illinois Insurance Department on February 3, 2000, and covered the period
29
January 1, 1995, through December 31, 1998. No material recommendations were
made as a result of these examinations.
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 and Freddie Mac is
currently considering modifications to its existing eligibility guidelines.
Fannie Mae also has eligibility requirements, although such requirements are not
published. Triad is an approved mortgage insurer for both Freddie Mac and Fannie
30
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. In addition, to the extent Fannie Mae or Freddie Mac assumes
default risk for itself that would otherwise be insured, changes current
guarantee fee arrangements, allows alternative credit enhancement, alters or
liberalizes underwriting guidelines on low down payment mortgages they purchase,
or otherwise changes its business practices or processes with respect to such
mortgages, private mortgage insurers may be affected.
Government Sponsored Enterprises (GSE) Fannie Mae and Freddie Mac both
accept reduced mortgage insurance coverage from lenders that deliver loans
approved by the GSEs' automated underwriting services, Desktop Underwriter and
Loan Prospector, respectively. Generally, Fannie Mae's and Freddie Mac's reduced
mortgage insurance coverage options provide for: (i) across-the-board reductions
in required MI coverage on 30-year fixed-rate loans recommended for approval by
GSE's automated underwriting services to the levels in effect in 1994; (ii)
reduction in required MI coverage, for loans with only a 5% down payment (a 95%
LTV), from 30% to 25% of the mortgage loan covered by MI; and, (iii) reduction
in required MI coverage, for loans with a 10% down payment (a 90% LTV loan),
from 25% to 17% of the mortgage loan covered by MI. In addition, the GSE's have
implemented other programs that further reduce MI coverage upon the payment of
an additional fee by the lender. Under this option, a 95% LTV loan will require
18% of the mortgage loan to have mortgage insurance coverage. Similarly, a 90%
LTV loan will require 12% of the mortgage loan to have mortgage insurance. In
order for the home buyer to have MI at these levels, such loans would require a
payment at closing or a higher note rate.
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
31
("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.
Various lawsuits filed in US district court in Augusta, Georgia assert that
defendant mortgage insurers have violated RESPA guidelines by offering pool
insurance, captive reinsurance, and contract underwriting services at
preferential below market prices as an illegal inducement to persuade lenders to
use those mortgage insurers for primary insurance coverage. The lawsuits seek
class action status. In particular, the suits contend that pool insurance has
been underpriced in regard to the amount of risk involved. Triad has not been
named in the lawsuits and does not offer pool insurance. Management does not
know if Triad will be named in the lawsuits, what the outcome of the legal
proceedings will be, or the future impact of these lawsuits on the mortgage
insurance industry.
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 its subsidiaries 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 costs to be financed by loans insured by
FHA, a significant increase from the previous 57% limit. Also, in April 1994,
HUD reduced the initial premium (payable at loan origination) for FHA insurance
from 3.0% to 2.25%. Effective January 2000, the maximum individual loan amount
that the FHA could insure increased from $208,800 to $219,849. 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.
32
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 benefits of FIRREA and the guidelines for real estate
lending policies to the mortgage insurance industry, including Triad, may be
curtailed or eliminated.
The Office of Federal Housing Enterprise Oversight ("OFHEO") has proposed a
risk- based capital regulation for Fannie Mae and Freddie Mac. The proposal sets
up "hair cuts" for different types of credit enhancement utilized by the GSEs
based on the rating given the entity providing the enhancement and the nature of
the credit enhancement provided. For example, derivative and nonderivative
counterparties are treated differently as are entities with different credit
ratings. The proposed regulation is currently open for comment. Management does
not know what the outcome of the proposal will be or the future impact of the
proposal, if adopted, on the mortgage insurance industry. If the proposal is
adopted and AA-rated entities are treated less favorably than AAA-rated
entities, the regulation may adversely affect mortgage insurers that cannot
obtain a AAA rating.
Fannie Mae and Freddie Mac each provide their own automated underwriting
system to be used by mortgage originators selling mortgages to them. These
systems, which are provided by Triad 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, 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.
33
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 borrower paid mortgage insurance
when specified conditions are met. The Homeowners Protection Act of 1998,
effective July 29, 1999, requires mortgage lenders to periodically update
borrowers about their private mortgage insurance. Under the legislation, lenders
must inform borrowers that: 1) they have private mortgage insurance; and 2) they
may request cancellation of borrower paid mortgage insurance when their home
equity (loan-to-value or LTV ratio) has reached 80% and other conditions are
met. The legislation further requires lenders to automatically cancel borrower
paid private mortgage insurance when home equity reaches 78% if certain
conditions are met. 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 due to the enactment of this legislation.
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 approve 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.
In November 1999, the Gramm-Leach-Bliley Act, also known as the Financial
Services Modernization Act of 1999, became effective and allows holding
companies of banks also to own a company that underwrites insurance. As a result
of this Act, banking organizations that previously were not allowed to be
affiliated with insurance companies may now do so. Management does not know to
what extent this expanded opportunity for banks will be utilized or how it will
affect the mortgage insurance industry. However, the evolution of federal law
making it easier for banks to engage in the mortgage guaranty business through
affiliates may subject mortgage guaranty insurers to more intense competition
and risk-sharing with bank lender customers.
EMPLOYEES
As of December 31, 1999, the Company employed 170 persons. Employees are
not covered by any collective bargaining agreement. The Company considers its
employee relations to be satisfactory.
34
EXECUTIVE OFFICERS
The executive officers of the Company are as follows:
Name Position Age
- ---- -------- ---
William T. Ratliff, III Chairman of the Board of 46
the Company and Triad
Darryl W. Thompson President, Chief Executive 59
Officer, and Director of the
Company and Triad
Ron D. Kessinger Executive Vice President and 45
Chief Financial Officer of the
Company and Executive Vice
President of Triad
John H. Williams Executive Vice President and 52
Director of Triad
Henry B. Freeman Senior Vice President of Triad 50
Earl F. Wall Senior Vice President, Secretary, 42
and General Counsel of the
Company and Triad
Michael R. Oswalt Senior Vice President, Controller, 38
Treasurer, and Principal Accounting
Officer of the Company and Triad
35
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.
RON D. KESSINGER has been Executive Vice President and Chief Financial
Officer of the Company since December 1999. Mr. Kessinger has been Executive
Vice President of Insurance Operations of Triad since June 1996. Mr. Kessinger
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.
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.
HENRY B. FREEMAN has been Senior Vice President of Risk Management of Triad
since January 1999, and was a Vice President from 1987 till 1999. From 1981 to
1987, Mr. Freeman was employed by Home Guaranty Insurance Corporation, where he
performed underwriting and claims management services.
36
EARL F. WALL has been Senior Vice President of Triad since December 1999,
General Counsel of Triad since January 1996, and Secretary since June 1996. Mr.
Wall was Vice President of Triad from 1996 till 1999. Mr. Wall has been Senior
Vice President of the Company since December 1999, and Secretary and General
Counsel of the Company since September 1996. Mr. Wall was Vice President of the
Company from 1996 to 1999. 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.
MICHAEL R. OSWALT has been Senior Vice President and Treasurer of the
Company since December 1999, and Controller of the Company since March 1994. Mr.
Oswalt has been a Senior Vice President and Treasurer of Triad since December
1999, and Controller of Triad since June 1996. Mr. Oswalt was Vice President of
the Company and Triad from December 1994 to December 1999. 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.
As of December 31, 1999, the Company leases office space in its
Winston-Salem headquarters and its ten underwriting offices located throughout
the country comprising approximately 41,593 square feet under leases expiring
between 2000 and 2002 and which require annual lease payments of $643,542 in
2000. 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.
37
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.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock trades on The Nasdaq Stock Market(R) under the
symbol "TGIC." At December 31, 1999, 13,303,194 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.
1999 1998
---- ----
High Low High Low
First Quarter............ 22 3/4 13 9/16 42 1/8 30
Second Quarter........... 18 1/16 12 40 3/4 29 3/4
Third Quarter............ 20 1/8 16 5/8 35 7/8 22 3/4
Fourth Quarter .......... 23 1/2 16 7/16 25 3/8 13 1/2
As of March 15, 2000, the number of stockholders of record of Company
Common Stock was approximately 400. In addition, there were an estimated 3,000
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.
38
ITEM 6. SELECTED FINANCIAL DATA
Year Ended December 31
------------------------------------------------------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars in thousands, except per share amounts)
Income Statement Data (for period ended):
Premiums written:
Direct....................................... $ 65,381 $ 52,974 $ 40,083 $ 26,152 $ 18,890
Assumed...................................... 11 13 20 26 34
Ceded........................................ (1,665) (1,090) (1,772) (2,217) (3,924)
----------- ----------- ----------- ------------ ------------
$ 63,727 $ 51,897 $ 38,331 $ 23,961 $ 15,000
=========== =========== =========== ============ ============
Earned premiums................................... $ 63,970 $ 52,822 $ 38,522 $ 24,727 $ 15,478
Net investment income............................. 10,546 9,289 6,234 5,447 4,836
Realized investments gains (losses)............... 1,153 880 34 (162) 173
Other income...................................... 13 14 8 -- 1
----------- ----------- ----------- ------------ ------------
Total revenues............................... 75,682 63,005 44,798 30,012 20,488
Net losses and loss adjustment expenses........... 7,111 7,009 5,177 3,279 2,217
Interest expense on debt.......................... 2,780 2,554 -- -- --
Amortization of deferred policy acquisition cost.. 6,955 5,955 4,120 3,235 2,289
Other operating expenses (net of acquisition
cost deferred)............................ 15,061 12,435 10,257 7,259 4,753
----------- ----------- ----------- ------------ ------------
Income before income taxes........................ 43,775 35,052 25,244 16,239 11,229
Income taxes...................................... 13,365 10,678 8,002 5,042 3,470
----------- ----------- ----------- ------------ ------------
Net income........................................ $ 30,410 $ 24,374 $ 17,242 $ 11,197 $ 7,759
=========== =========== =========== ============ ============
Basic earnings per share (1)................. $ 2.28 $ 1.83 $ 1.30 $ 0.84 $ 0.59
Diluted earnings per share (1)............... $ 2.23 $ 1.76 $ 1.26 $ 0.83 $ 0.58
----------- ----------- ----------- ------------ ------------
Weighted average common and common share
equivalents outstanding (1)
Basic ................................... 13,312,104 13,342,749 13,291,160 13,277,853 13,196,067
Diluted.................................. 13,640,716 13,843,382 13,713,538 13,541,551 13,333,014
Balance Sheet Data (at year end):
Total assets (2)............................. $ 263,141 $ 230,512 $ 155,272 $ 122,397 $ 105,664
Total invested assets........................ $ 191,564 $ 177,301 $ 119,877 $ 98,027 $ 85,978
Losses and loss adjustment expenses.......... $ 14,751 $ 12,143 $ 8,960 $ 6,305 $ 4,589
Unearned premiums............................ $ 6,831 $ 7,055 $ 7,988 $ 8,216 $ 9,086
Long-term debt .............................. $ 34,462 $ 34,457 $ -- $ -- $ --
Stockholders' equity......................... $ 157,072 $ 137,531 $ 111,781 $ 91,680 $ 80,441
Statutory Ratios (3):
Loss ratio................................... 11.1% 13.3% 14.2% 16.0% 14.3%
Expense ratio................................ 40.5% 42.3% 42.5% 49.6% 59.1%
----------- ----------- ----------- ------------ ------------
Combined ratio............................... 51.6% 55.6% 56.7% 65.6% 73.4%
=========== =========== =========== ============ ============
GAAP Ratios:
Loss ratio................................... 11.1% 13.3% 13.4% 13.3% 14.3%
Expense ratio................................ 34.5% 35.4% 37.5% 43.8% 46.9%
----------- ----------- ----------- ------------ ------------
Combined ratio............................... 45.6% 48.7% 50.9% 57.1% 61.2%
=========== =========== =========== ============ ============
Other Statutory Data (dollars in millions) (3):
Direct insurance in force.................... $ 13,038.0 $ 11,256.6 $ 9,176.7 $ 6,556.3 $ 5,080.3
Direct risk in force (gross)................. $ 3,222.5 $ 2,777.4 $ 2,231.4 $ 1,515.4 $ 1,090.6
Risk-to-capital.............................. 15.4:1 16.2:1 19.3:1 15.8:1 11.1:1
(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) Prior periodshave been restated to reflect reclassification of Tax and Loss bonds.
(3) Based on statutory accounting practices and derived from consolidated statutory financial statements of Triad.
39
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION.
RESULTS OF OPERATIONS
1999 COMPARED TO 1998
Net income for 1999 increased 24.8% to $30.4 million compared to $24.4
million in 1998. This improvement is attributable primarily to a 21.1% increase
in earned premiums, a 13.5% increase in net investment income, and an improved
combined loss and expense ratio for all of 1999.
Net income per share on a diluted basis increased 26.6% to $2.23 for 1999
compared to $1.76 per share for 1998. Operating earnings per share were $2.17
for 1999 compared to $1.72 for 1998. Operating earnings exclude net realized
gains of approximately $1.2 million in 1999 and of approximately $881,000 in
1998.
Net new insurance written was $4.4 billion for 1999 as compared to $4.8
billion for 1998, a decrease of 7.8%. For the fourth quarter, net new insurance
written decreased 41.5% in 1999 to $892 million as compared to $1.5 billion in
1998. The Company also produced approximately $11 million of new insurance
written on seasoned loans in 1999 compared to $225 million in 1998. The decrease
in new insurance written was the result of changing business relationships and
declines in the mortgage insurance market, especially during the fourth quarter
of 1999. Driven by a higher interest rate environment, the total net new
mortgage insurance written market decreased 27% in the fourth quarter of 1999
compared to the fourth quarter of 1998, according to industry data. Based upon
this information, Triad's national market share of net new insurance written was
2.3% for all of 1999 compared to 2.6% for 1998. Total direct insurance in force
reached $13.0 billion at December 31, 1999, compared to $11.3 billion at
December 31, 1998, an increase of 15.8%.
Total direct premiums written were $65.4 million for 1999, an increase of
23.4% compared to $53.0 million for 1998. Net premiums written increased by
22.8% to $63.7 million in 1999 compared to $51.9 million for 1998. Earned
premiums increased 21.1% to $64.0 million for 1999 from $52.8 million for 1998.
This growth in written and earned premium resulted from both new insurance
production in 1999 and an improvement in the Company's persistency.
Approximately 22.9% of new insurance written in 1999 was subject to captive
mortgage reinsurance and similar arrangements compared to 6.6% of new insurance
written in 1998. Ceded premiums for 1999, which includes third party reinsurance
arrangements as well as captive reinsurance agreements, increased 53% over 1998.
Management anticipates ceded premiums will continue to increase as a result of
the expected increase in risk-sharing programs.
40
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
Refinance activity was 25.0% (11.5% in fourth quarter) of new insurance
written in 1999 compared to 31.7% (34.3% in fourth quarter) of insurance written
in 1998, reflecting the rise in interest rates during the year. Persistency, or
the amount of insurance in force remaining from one year prior, was 77.1% at
December 31, 1999, compared to 70.0% at December 31, 1998. Persistency for the
fourth quarter of 1999 improved to an annualized rate of 83.6% reflecting the
trend of rising interest rates and declining cancellations. Sales under the
Company's monthly premium plan represented 96.4% of new insurance written in
1999 compared to 97.3% in the same period of 1998.
Net investment income for 1999 was $10.5 million, a 13.5% increase over
$9.3 million in 1998. This increase in investment income is the result of growth
in the average book value of invested assets by $32.3 million to $184.0 million
at December 31, 1999, from $151.7 million at December 31, 1998. The growth in
invested assets is attributable to normal operating cash flow. The yield on
average invested assets declined to 5.7% for 1999, as compared to 6.1% for all
of 1998, reflecting the Company's continued investment strategy to emphasize tax
preferred securities which yield lower pre-tax rates than similar fully taxable
securities. The portfolio's tax-equivalent yield was 7.7% for 1999 versus 7.9%
for 1998. Approximately 71% or $124.4 million of the Company's fixed maturity
portfolio at December 31, 1999, was composed of state and municipal
tax-preferred securities as compared to 70% or $107.5 million at December 31,
1998.
The Company's loss ratio (the ratio of incurred losses to earned premiums)
was 11.1% for 1999 compared to 13.3% for 1998. The loss ratio was 7.8% for the
fourth quarter of 1999 compared to 18.6% for the fourth quarter of 1998. The
Company's favorable loss ratio reflects the low level of delinquencies compared
to the number of insured loans and the fact that approximately 79% (78% as of
December 31, 1998) of the Company's insurance in force was originated in the
last 36 months. Management believes, based upon its experience and industry
data, that claims incidence for it and other private mortgage insurers is
generally highest in the third through sixth years after loan origination.
Although the claims experience on 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
claim frequencies on future earnings.
During periods of significant refinancing activity, it is possible that
policies on stronger loans may be canceled and policies on 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.
41
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
Net losses and loss adjustment expenses (net of reinsurance recoveries)
increased by 1.5% in 1999 to $7.1 million compared to $7.0 million in 1998. This
increase reflects the growing amount of the Company's insurance in force and the
resulting recognition of a greater amount of insurance in force reaching its
higher claim frequency years.
Amortization of deferred policy acquisition costs increased by 16.8% to
$7.0 million in 1999 compared to $6.0 million for 1998. The increase in
amortization reflects both a growing balance of deferred policy acquisition
costs to amortize as the Company builds its total insurance in force and high
cancellations due to refinance activity during 1999.
Other operating expenses increased 21.1% to $15.1 million for 1999 compared
to $12.4 million for the same period in 1998. This increase in expenses is
primarily attributable to advertising, personnel, and 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 1999 was 34.5% compared to 35.4% for 1998. Contributing to this improvement
is the higher level of written premiums in 1999 partially offset by the increase
in expenses.
The effective tax rate for 1999 and 1998 was 30.5%. Management expects the
Company's effective tax rate to remain about the same as long as yields from new
funds invested in tax-preferred securities remain favorable in relation to fully
taxable securities.
1998 COMPARED TO 1997
Net income for 1998 increased 41.4% to $24.4 million compared to $17.2
million in 1997. This improvement was attributable to a 37.1% increase in earned
premiums, a 49.0% increase in net investment income, and an improved combined
loss and expense ratio.
Net income per share on a diluted basis increased 40.0% to $1.76 for 1998
compared to $1.26 per share for 1997. Operating earnings per share were $1.72
for 1998 compared to $1.26 for 1997. Operating earnings exclude net realized
gains of approximately $881,000 and $34,000 in 1998 and 1997, respectively.
Net new insurance written was $4.8 billion for 1998 as compared to $2.9
billion for 1997, an increase of 66.2%. For the fourth quarter 1998, net new
insurance written increased 106.2% to $1.5 billion compared to $740 million in
the fourth quarter 1997. The Company also produced approximately $225 million of
new insurance written on seasoned loans in 1998 compared to $950 million in
1997. The increase in new insurance written was the result of a strong economy,
continued geographic expansion, the penetration of Triad's products in the
marketplace to both new and existing customers, and the introduction of new
products. According to industry data, Triad's national market share of net new
42
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
insurance written increased to 2.6% for all of 1998 and to 2.8% for the fourth
quarter as compared to 2.4% reported for all of 1997.
The growth in new insurance written also reflected the favorable interest
rate environment in 1998 which caused home buying and refinance activities to
remain strong. Refinance activity was 31.7% of new insurance written in 1998
compared to 14.0% in 1997. Total direct insurance in force reached $11.3 billion
at December 31, 1998, compared to $9.2 billion at December 31, 1997, an increase
of 22.7%.
Total direct premiums written were $53.0 million for 1998, an increase of
32.2% compared to $40.1 million for 1997. Net premiums written increased by
35.4% to $51.9 million in 1998 compared to $38.3 million for 1997. Earned
premiums increased 37.1% to $52.8 million for 1998 from $38.5 million for 1997.
This growth in written and earned premium resulted from the increase in new
insurance written offset by a decline in the Company's persistency rate. The
Company's persistency, or the percentage of insurance remaining in force from
one year prior, was 70.0% at December 31, 1998, compared to 83.5% at December
31, 1997. Sales under the Company's monthly premium plan represented 97.3% of
new insurance written in 1998 compared to 94.3% in 1997.
Net investment income for 1998 was $9.3 million, a 49.0% increase over $6.2
million in 1997. This increase in investment income is the result of growth in
the average book value of invested assets by $47.9 million to $151.7 million at
December 31, 1998, from $103.8 million at December 31, 1997. The growth in
invested assets is attributable to the investment of the proceeds of the
Company's $35.0 million debt offering, completed in late January 1998, as well
as the increase in invested assets due to normal operating cash flow. The yield
on average invested assets was 6.1% for 1998 compared to 6.0% for 1997. The
portfolio's tax-equivalent yield was 7.9% for 1998 versus 8.0% for 1997.
Approximately 70%, or $107.5 million of the Company's fixed maturity portfolio
at December 31, 1998, was composed of state and municipal tax-preferred
securities as compared to 72%, or $68.7 million, at December 31, 1997.
The Company's loss ratio (the ratio of incurred losses to earned premiums)
was 13.3% for 1998 compared to 13.4% for 1997. The loss ratio was 18.6% for the
fourth quarter of 1998 compared to 12.1% for the fourth quarter of 1997. The
Company's favorable loss ratio reflected the low level of delinquencies compared
to the number of insured loans and the fact that approximately 78% of the
Company's insurance in force was originated in the past 36 months.
Net losses and loss adjustment expenses (net of reinsurance recoveries)
increased by 35.4% in 1998 to $7.0 million compared to $5.2 million in 1997.
This increase reflected the growing amount of the Company's insurance in force
43
IITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
and the resulting recognition of a greater amount of insurance in force reaching
its higher claim frequency years.
Amortization of deferred policy acquisition costs increased by 44.5% to
$6.0 million in 1998 compared to $4.1 million for 1997. The increase in
amortization reflected an increasing deferred policy acquisition costs asset to
amortize as the Company builds its total insurance in force and a higher
cancellation rate during 1998.
In January 1998, the Company completed a $35.0 million private offering of
notes due January 15, 2028, which bear interest at a rate of 7.9% per annum.
Interest expense relating to this debt was $2.6 million for 1998.
Standard & Poor's Corporation, in February 1999, affirmed the "AA"
Financial Strength and counterparty credit rating of Triad. In addition, the "A"
issuer credit rating and senior debt rating of the Company were also affirmed.
Other operating expenses increased 21.2% to $12.4 million for 1998 compared
to $10.3 million for 1997. This increase in expenses was primarily attributable
to advertising, personnel, and 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 1998 was 35.4% compared to 37.5% for 1997. Contributing to this year-to-date
improvement was the higher level of written premiums in 1998 partially offset by
the increase in expenses.
The effective tax rate for 1998 was 30.5% compared to 31.7% for 1997. This
decrease was primarily the result of the increase in investment in tax preferred
securities.
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of operating funds consist primarily of premiums
written and investment income. Operating cash flow is applied primarily to the
payment of claims, interest, expenses, and taxes.
The Company generated positive cash flow from operating activities for 1999
of $30.8 million compared to $23.3 million for 1998. 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, interest, and
other expenses.
The Company's business does not routinely require significant capital
expenditures other than for enhancements to its computer systems and
technological capabilities. Positive cash flows are invested pending future
44
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
payments of claims and expenses. Cash flow shortfalls, if any, could be funded
through sales of short-term investments and other investment portfolio
securities.
The parent company's cash flow is dependent on interest income and
payments from Triad including cash dividends, management fees, and interest
payments under surplus notes. 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. The Illinois Insurance Department permits
expenses of the parent company to be reimbursed by Triad in the form of
management fees.
Consolidated invested assets were $191.6 million at December 31, 1999,
compared to $177.3 million at December 31, 1998. Fixed maturity securities and
equity securities classified as available-for-sale totaled $177.7 million at the
end of 1999. Net unrealized investment gains were $2.1 million on equity
securities, and net unrealized investment losses were $9.4 million on fixed
maturity securities at December 31, 1999. The fixed maturity portfolio consisted
of approximately 71% municipal securities, 24% corporate securities, 4% U.S.
government obligations, and 1% mortgage-backed bonds at December 31, 1999.
Fixed maturity securities represent approximately 86% of the Company's
invested assets at December 31, 1999, and the fair value of these fixed rate
securities generally bears an inverse relationship to changes in prevailing
market interest rates. The Company's long-term debt bears interest at a fixed
rate of 7.9% per annum, and as a result, the fair value of this debt is
sensitive to changes in prevailing interest rates. A 10% relative increase or
decrease in market interest rates that affect the Company's financial
instruments would not have a material impact on earnings during the next fiscal
year, and would not materially affect the fair value of the Company's financial
instruments.
The Company's loss reserves increased to $14.8 million at December 31,
1999, compared to $12.1 million at December 31, 1998. 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 $21,400 at December 31,
1999, compared to $23,400 at December 31, 1998. The Company's delinquency ratio,
the ratio of delinquent insured loans to total insured loans, was 0.64% at
December 31, 1999, compared to 0.53% at December 31, 1998.
45
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
Total stockholders' equity increased to $157.1 million at December 31,
1999, from $137.5 million at December 31, 1998. This increase resulted primarily
from net income of $30.4 million for 1999 offset by the change in net unrealized
gains and losses on invested assets classified as available-for-sale of $8.6
million (net of income tax) and the retirement of 146,000 shares of the
Company's stock purchased for $2.6 million.
Triad's total statutory policyholders' surplus increased to $94.6 million
at December 31, 1999, from $89.5 million at December 31, 1998. This increase
resulted primarily from statutory net income of $40.0 million offset by an
increase in the statutory contingency reserve of $32.2 million. Triad's
statutory earned surplus was $10.9 million at December 31, 1999, compared to
$5.8 million at December 31, 1998, reflecting, primarily, growth in statutory
net income greater than the increase in the statutory contingency reserve.
Approximately $1.0 and $1.9 million of the statutory earned surplus for December
31, 1999, and December 31, 1998, respectively, was attributable to unrealized
gains. The balance in the statutory contingency reserve was $113.8 million at
December 31, 1999, compared to $81.6 million at December 31, 1998.
Triad's ability to write insurance depends on the maintenance of its
claims-paying ability ratings and the adequacy of its 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 also generally limit Triad's risk-to-capital ratio to 25-to-1. As of
December 31, 1999, Triad's risk-to-capital ratio was 15.4-to-1, as compared to
16.2-to-1 at December 31, 1998, and 14.8-to-1 for the industry as a whole at
December 31, 1998, the latest industry data available.
The Company is undertaking modifications and upgrades to enhance its
computer systems and technological capabilities. The Company expects to incur
approximately $5.7 million for this system conversion and upgrade (approximately
$4.3 million in capitalized costs have been incurred for the project through
December 31, 1999) and is funding the project through cash flow from operations.
The Company has experienced no significant disruptions in its computer
systems, third party systems, or other systems with which the Company conducts
business relating to date- related issues. All critical systems were tested for
Year 2000 Compliance before year end 1999 and all costs relating to the testing
were expensed as incurred and were immaterial.
46
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
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; the Company's financial condition and competitive position could be
affected by legislation impacting the mortgage guaranty industry specifically
and the financial services industry in general; rating agencies may revise
methodologies for determining the Company's claims-paying ability ratings and
may revise or withdraw the assigned ratings at any time; decreases in
persistency, which are affected by loan refinancings in periods of low interest
rates, may have an adverse effect on earnings; the amount of new insurance
written and the growth of insurance in force or risk in force as well as the
performance of the Company may be adversely impacted by the competitive
environment in the private mortgage industry, including the type, structure, and
pricing of products and services offered by the Company and its competitors; 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 effect
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.
47
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 2000 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 2000
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 2000
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 2000
Annual Meeting of Stockholders, and is hereby incorporated by reference.
48
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, 1999.
(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.
49
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 23rd day of
March, 2000.
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 23rd day of March, 2000 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/ Ron D. Kessinger Executive Vice President and Chief Financial
- --------------------------- Officer
Ron D. Kessinger
/s/ Michael R. Oswalt Senior Vice President, Controller, Treasurer,
- --------------------------- and Principal Accounting Officer
Michael R. Oswalt
/s/ David W. Whitehurst Director
- ---------------------------
David W. Whitehurst
/s/ Robert T. David Director
- ---------------------------
Robert T. David
/s/ Raymond H. Elliott Director
- ---------------------------
Raymond H. Elliott
50
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
CONSOLIDATED FINANCIAL STATEMENTS
FINANCIAL STATEMENT SCHEDULES
CERTAIN EXHIBITS
YEAR ENDED DECEMBER 31, 1999
TRIAD GUARANTY INC.
WINSTON-SALEM, NORTH CAROLINA
51
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
(ITEM 14(A) 1 AND 2)
CONSOLIDATED FINANCIAL STATEMENTS Page
- --------------------------------- ----
Report of Independent Auditors.......................................... 55
Consolidated Balance Sheets at December 31, 1999 and 1998............... 56 - 57
Consolidated Statements of Income for each of the
three years in the period ended December 31, 1999.................... 58
Consolidated Statements of Changes in Stockholders' Equity
for each of the three years in the period ended December 31, 1999.... 59
Consolidated Statements of Cash Flows for each of the three years in
the period ended December 31, 1999................................... 60
Notes to Consolidated Financial Statements.............................. 61 - 78
FINANCIAL STATEMENT SCHEDULES
- -----------------------------
Schedules at and for each of the three years in the period ended December 31,
1999
Schedule I - Summary of Investments - Other Than Investments
in Related Parties................................................. 79
Schedule II - Condensed Financial Information of Registrant.......... 80 - 84
Schedule IV - Reinsurance............................................ 85
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.
52
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.(8)
(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)
53
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)
*10.21 Excess of Loss Reinsurance Agreement between Triad Guaranty Insurance
Corporation, Capital Mortgage Reinsurance Company, and Federal
Insurance Company. (Exhibit 10.21)
*21.1 Subsidiaries of the Registrant (Exhibit 21.1)
*23.1 Consent of Ernst & Young LLP (Exhibit 23.1)
*27.1 Financial Data Schedule (Exhibit 27.1)
- -----------------
* 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.
(8) Incorporated by reference to the exhibit identified in parentheses,
filed as an exhibit in the 1997 Form 10-K.
54
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, 1999 and 1998, 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, 1999. 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 auditing standards generally accepted
in the United States. 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 financial position of Triad Guaranty
Inc. and subsidiaries at December 31, 1999 and 1998, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1999 in conformity with accounting principles
generally accepted in the United States.
/s/ Ernst & Young LLP
---------------------
Ernst & Young LLP
Raleigh, North Carolina
January 19, 2000
55
TRIAD GUARANTY INC.
CONSOLIDATED BALANCE SHEETS
December 31
1999 1998
----------------------------------
Assets
Invested assets:
Securities available-for-sale, at fair value:
Fixed maturities (amortized cost:
1999-$173,978,864; 1998-$153,868,237) $164,579,416 $157,391,829
Equity securities (cost: 1999-$10,952,390;
1998-$11,550,510) 13,075,648 14,024,012
Short-term investments 13,908,666 5,885,192
----------------------------------
191,563,730 177,301,033
Cash 215,553 444,200
Real estate 145,515 -
Accrued investment income 2,591,612 2,258,878
Deferred policy acquisition costs 19,906,877 16,015,559
Property and equipment, at cost less accumulated depreciation
(1999-$3,009,638; 1998-$2,292,770) 5,915,262 3,446,656
Prepaid federal income tax 35,415,666 25,256,666
Reinsurance recoverable 29,980 610,817
Other assets 7,356,357 5,178,627
----------------------------------
Total assets $263,140,552 $230,512,436
==================================
56
December 31
1999 1998
--------------------------------
Liabilities and stockholders' equity
Liabilities:
Losses and loss adjustment expenses $ 14,751,348 $ 12,142,990
Unearned premiums 6,831,290 7,054,737
Amounts payable to reinsurer 319,294 5,341
Current taxes payable 70,272 45,787
Deferred income taxes 41,750,341 33,187,544
Unearned ceding commission 400,521 621,161
Long-term debt 34,461,979 34,457,080
Accrued interest on debt 1,274,972 1,274,972
Accrued expenses and other liabilities 6,208,079 4,191,484
--------------------------------
Total liabilities 106,068,096 92,981,096
Commitments and contingencies (Note 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
32,000,000 shares, issued and outstanding
13,303,194 shares at December 31, 1999 and
13,408,869 at December 31, 1998 133,032 134,089
Additional paid-in capital 61,972,312 61,538,613
Accumulated other comprehensive income, net of income
tax asset of $2,546,666 at December 31, 1999 and
income tax liability of $2,101,170 at December 31, 1998 (4,723,775) 3,907,920
Deferred compensation (69,414) -
Retained earnings 99,760,301 71,950,718
--------------------------------
Total stockholders' equity 157,072,456 137,531,340
--------------------------------
Total liabilities and stockholders' equity $263,140,552 $230,512,436
================================
See accompanying notes.
57
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF INCOME
Year ended December 31
1999 1998 1997
----------------------------------------------
Revenue:
Premiums written:
Direct $65,380,631 $52,973,589 $40,082,507
Assumed 11,377 13,052 20,061
Ceded (1,665,179) (1,089,955) (1,772,039)
----------------------------------------------
Net premiums written 63,726,829 51,896,686 38,330,529
Change in unearned premiums 242,971 925,045 191,163
----------------------------------------------
Earned premiums 63,969,800 52,821,731 38,521,692
Net investment income 10,545,663 9,289,026 6,234,142
Net realized investment gains 1,153,191 880,502 34,330
Other income 13,039 13,652 7,716
----------------------------------------------
75,681,693 63,004,911 44,797,880
Losses and expenses:
Losses and loss adjustment expenses 7,121,002 7,005,420 5,317,812
Reinsurance recoveries (9,686) 3,198 (140,734)
----------------------------------------------
Net losses and loss adjustment expenses 7,111,316 7,008,618 5,177,078
Interest expense on debt 2,779,915 2,554,126 -
Amortization of deferred policy
acquisition costs 6,955,273 5,954,915 4,120,469
Other operating expenses (net of
acquisition costs deferred) 15,060,376 12,434,890 10,256,815
----------------------------------------------
31,906,880 27,952,549 19,554,362
----------------------------------------------
Income before income taxes 43,774,813 35,052,362 25,243,518
Income taxes:
Current 24,166 38,928 2,613
Deferred 13,340,340 10,639,361 7,999,081
----------------------------------------------
13,364,506 10,678,289 8,001,694
----------------------------------------------
Net income $30,410,307 $24,374,073 $17,241,824
==============================================
Earnings per common and common
equivalent share:
Basic $ 2.28 $ 1.83 $ 1.30
Diluted $ 2.23 $ 1.76 $ 1.26
==============================================
Shares used in computing earnings per
common and common equivalent share:
Basic 13,312,104 13,342,749 13,291,160
Diluted 13,640,716 13,843,382 13,713,538
==============================================
See accompanying notes.
58
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Additional Accumulated Other
Common Paid-In Comprehensive Deferred Retained
Stock Capital Income Compensation Earnings Total
---------------------------------------------------------------------------------------
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
Other comprehensive income - net
of tax:
Change in unrealized gain - - 2,836,515 - - 2,836,515
------------
Comprehensive income - - - - - 20,078,339
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) -
---------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1997 132,937 59,369,223 4,405,315 - 47,873,316 111,780,791
Net income - - - - 24,374,073 24,374,073
Other comprehensive income - net
of tax:
Change in unrealized gain - - (497,395) - - (497,395)
------------
Comprehensive income - - - - - 23,876,678
Issuance of 122,648 shares of common
stock under stock option plans 1,227 954,629 - - - 955,856
Tax effect of exercise of
non-qualified stock options - 916,711 - - - 916,711
Purchase and subsequent retirement of
15,000 shares of common stock (150) - - - (296,671) (296,821)
Issuance of 7,500 shares of
restricted stock 75 298,050 - - - 298,125
---------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1998 134,089 61,538,613 3,907,920 - 71,950,718 137,531,340
Net income - - - - 30,410,307 30,410,307
Other Comprehensive income - net
of tax:
Change in unrealized gain - - (8,631,695) - - (8,631,695)
------------
Comprehensive income 21,778,612
Issuance of 34,500 shares of common
stock under stock option plans 345 199,928 - - - 200,273
Tax effect of exercise of
non-qualified stock options - 129,706 - - - 129,706
Purchase and subsequent retirement of
146,000 shares of common stock (1,460) - - - (2,600,724) (2,602,184)
Issuance of 5,825 shares of
restricted stock 58 104,065 - (104,123) - -
Amortization of deferred
compensation - - - 34,709 - 34,709
---------------------------------------------------------------------------------------
BALANCE AT DECEMBER 31, 1999 $133,032 $61,972,312 $(4,723,775) $ (69,414) $99,760,301 $157,072,456
=======================================================================================
See accompanying notes.
59
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWs
Year ended December 31
1999 1998 1997
------------------------------------------------
OPERATING ACTIVITIES
Net income $ 30,410,307 $24,374,073 $ 17,241,824
Adjustments to reconcile net income to net cash
provided by operating activities:
Loss and unearned premium reserves 2,384,911 2,248,974 2,426,878
Accrued expenses and other liabilities 2,033,465 1,450,310 901,991
Current taxes payable 24,485 42,469 1,722
Amounts due to/from reinsurer 875,266 (547,469) 378,771
Accrued investment income (332,734) (798,710) (333,526)
Policy acquisition costs deferred (10,846,591) (9,383,119) (6,509,427)
Amortization of policy acquisition costs 6,955,273 5,954,915 4,120,469
Net realized investment gains (1,153,191) (880,502) (34,330)
Provision for depreciation 720,456 750,097 621,050
Accretion of discount on investments (1,046,470) (1,013,820) (620,762)
Deferred income taxes 13,340,340 10,557,543 8,000,081
Prepaid federal income taxes (10,159,000) (8,964,000) (6,300,000)
Unearned ceding commission (220,640) 621,161 (80,573)
Accrued interest on debt - 1,274,972 -
Other assets (2,158,206) (2,559,112) (1,914,971)
Other operating activities (50,215) 192,489 -
------------------------------------------------
Net cash provided by operating activities 30,777,456 23,320,271 17,899,197
INVESTING ACTIVITIES
Securities available-for-sale:
Purchases - fixed maturities (45,489,517) (74,664,883) (25,487,708)
Sales - fixed maturities 26,280,714 17,449,277 16,186,544
Purchases - equities (3,216,099) (7,507,782) (3,835,769)
Sales - equities 5,035,504 5,591,607 1,678,286
Purchases of property and equipment (3,191,320) (1,665,430) (1,431,278)
------------------------------------------------
Net cash used in investing activities (20,580,718) (60,797,211) (12,889,925)
FINANCING ACTIVITIES
Proceeds from issuance of long-term debt - 34,452,898 -
Retirement of common stock (2,602,184) (296,821) -
Proceeds from exercise of stock options 200,273 955,856 22,416
------------------------------------------------
Net change by financing activities (2,401,911) 35,111,933 22,416
Net change in cash and short-term investments 7,794,827 (2,365,007) 5,031,688
Cash and short-term investments at beginning of year 6,329,392 8,694,399 3,662,711
------------------------------------------------
Cash and short-term investments at end of year $14,124,219 $ 6,329,392 $ 8,694,399
================================================
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION
Cash paid during the period for:
Income taxes and United States
Mortgage Guaranty Tax and Loss Bonds $10,158,677 $ 8,963,726 $ 6,299,891
Interest $ 2,775,017 $ 1,274,972 -
Non-cash investing and finance activities:
Exchange of restricted common stock for
intangible assets - $ 298,125 -
See accompanying notes.
60
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
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 consolidated 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.
In November 1999, Triad incorporated Triad Re Insurance Corporation ("Triad Re")
as a wholly-owned sponsored captive reinsurance company domiciled in Vermont. As
of December 31, 1999, no business activity had occurred in Triad Re.
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 accumulated other comprehensive income. The Company does not have
any securities classified as "held-to-maturity" or "trading".
61
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 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 makes appropriate adjustments to reflect policy
cancellations.
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.
LOSS 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.
62
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.
Triad purchases ten-year non-interest bearing United States Mortgage Guaranty
Tax and Loss Bonds ("Tax and Loss Bonds") in lieu of paying federal income
taxes. The purchase of these Tax and Loss Bonds is treated as prepaid federal
income taxes, since the payment for Tax and Loss Bonds is essentially a
prepayment of federal income taxes that will become due at a later 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.
The Company does not have the option to reunderwrite these contracts. For annual
payment policies, the first year premium exceeds the renewal premium. 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 in the month that coverage is provided.
63
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
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.
COMPREHENSIVE INCOME
The only element of other comprehensive income applicable to the Company is
changes in unrealized gains and losses on securities classified as
available-for-sale, which are displayed in the following table, along with
related tax effects.
1999 1998 1997
-----------------------------------------
Unrealized gains (losses) arising
during the period, before taxes $(12,126,338) $ 115,278 $ 4,398,198
Income taxes 4,244,218 (40,347) (1,539,369)
-----------------------------------------
Unrealized gains (losses) arising
during the period, net of taxes (7,882,120) 74,931 2,858,829
-----------------------------------------
Less reclassification adjustment:
Gains realized in net income 1,153,191 880,502 34,330
Income taxes (403,616) (308,176) (12,016)
-----------------------------------------
Reclassification adjustment for
gains realized in net income 749,575 572,326 22,314
-----------------------------------------
Other comprehensive income - change
in unrealized gains $ (8,631,695) $(497,395) $ 2,836,515
=========================================
64
1. ACCOUNTING POLICIES (CONTINUED)
RECLASSIFICATION
Certain amounts in the prior year have been reclassified to conform to the 1999
presentation. Specifically, the purchases of Tax and Loss Bonds have been
treated as prepaid federal income taxes and a reclassification has been made to
the 1998 Balance Sheet to include this prepaid federal income tax as an asset
and to record the corresponding deferred tax liability. The change had the
effect on increasing both assets and liabilities by $25,256,666 at December 31,
1998. These reclassifications have no effect on previously reported
stockholders' equity or net income.
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, 1999
Available-for-sale securities:
Fixed maturity securities:
Corporate $ 41,380,256 $ 132,060 $ 3,016,858 $ 38,495,458
U.S. Government 7,106,820 82,992 85,856 7,103,956
Mortgage-backed 1,112,041 31,025 - 1,143,066
State and municipal 124,379,747 492,756 7,035,567 117,836,936
-----------------------------------------------------------------
Total 173,978,864 738,833 10,138,281 164,579,416
Equity securities 10,952,390 2,899,342 776,084 13,075,648
-----------------------------------------------------------------
Total $184,931,254 $3,638,175 $10,914,365 $177,655,064
=================================================================
AT DECEMBER 31, 1998
Available-for-sale securities:
Fixed maturity securities:
Corporate $ 36,386,473 $ 599,664 $ 1,688,249 $ 35,297,888
U.S. Government 8,587,562 340,609 - 8,928,171
Mortgage-backed 1,359,163 52,768 - 1,411,931
State and municipal 107,535,039 4,317,425 98,625 111,753,839
-----------------------------------------------------------------
Total 153,868,237 5,310,466 1,786,874 157,391,829
Equity securities 11,550,510 3,027,626 554,124 14,024,012
-----------------------------------------------------------------
Total $165,418,747 $8,338,092 $ 2,340,998 $171,415,841
=================================================================
65
2. INVESTMENTS (CONTINUED)
The amortized cost and estimated fair value of investments in fixed maturity
securities, at December 31, 1999, are summarized by stated maturity as follows:
Available-for-Sale
------------------
Amortized Fair
Cost Value
-----------------------------
Maturity:
One year or less $ 3,597,288 $ 3,614,071
After one year through five years 20,775,731 20,865,314
After five years through ten years 26,638,436 25,138,329
After ten years 121,855,368 113,818,636
Mortgage-backed securities 1,112,041 1,143,066
-----------------------------
Total $173,978,864 $164,579,416
=============================
Realized gains and losses on sales of investments are as follows:
Year ended December 31
1999 1998 1997
-------------------------------------
Securities available-for-sale:
Fixed maturity securities:
Gross realized gains $ 468,368 $307,255 $ 35,274
Gross realized losses (613,015) (73,329) (270,818)
Equity securities:
Gross realized gains 1,430,241 707,695 360,066
Gross realized losses (208,956) (91,425) (117,810)
Other investments:
Gross realized gains 129,864 30,306 42,520
Gross realized losses (53,311) - (14,902)
-------------------------------------
Net realized gains $1,153,191 $880,502 $ 34,330
=====================================
Net unrealized appreciation (depreciation) on fixed maturity securities changed
by $(12,923,040), $(445,759), and $2,809,249, in 1999, 1998, and 1997,
respectively; the corresponding amounts for equity securities were $(350,244),
$(325,711), and $1,571,472.
66
2. INVESTMENTS (CONTINUED)
Major categories of the Company's net investment income are summarized as
follows:
Year ended December 31
1999 1998 1997
--------------------------------------
Income:
Fixed maturities $ 9,863,671 $8,625,387 $5,849,084
Preferred stocks 392,297 280,032 114,610
Common stocks 268,091 256,918 279,640
Cash and short-term investments 465,544 494,565 212,033
--------------------------------------
10,989,603 9,656,902 6,455,367
Expenses 443,940 367,876 221,225
--------------------------------------
Net investment income $10,545,663 $9,289,026 $6,234,142
======================================
At December 31, 1999 and 1998, investments with an amortized cost of $6,445,356
and $6,314,934, 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
1999 1998 1997
--------------------------------------
Balance at beginning of year $16,015,559 $12,587,355 $10,198,397
Acquisition costs deferred:
Sales compensation 7,090,015 6,353,311 4,265,208
Underwriting and issue expenses 3,756,576 3,029,808 2,244,219
--------------------------------------
10,846,591 9,383,119 6,509,427
Amortization of acquisition expenses 6,955,273 5,954,915 4,120,469
--------------------------------------
Net increase 3,891,318 3,428,204 2,388,958
--------------------------------------
Balance at end of year $19,906,877 $16,015,559 $12,587,355
======================================
67
4. RESERVE FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity for the reserve for unpaid losses and loss adjustment expenses for
1999, 1998 and 1997 are summarized as follows:
1999 1998 1997
------------------------------------
Reserve for losses and loss
adjustment expenses at January 1,
net of reinsurance recoverables $12,115,934 $ 8,909,121 $5,974,664
Incurred losses and loss adjustment
expenses net of reinsurance recoveries
(principally in respect of default
notices occurring in):
Current year 9,322,142 7,953,412 6,022,700
Redundancy on prior years (2,210,826) (944,794) (845,622)
------------------------------------
Total incurred losses and loss
adjustment expenses 7,111,316 7,008,618 5,177,078
Loss and loss adjustment expense
payments net of reinsurance recoveries
(principally in respect of default
notices occurring in):
Current year 236,250 266,983 210,493
Prior years 4,267,808 3,534,822 2,032,128
------------------------------------
Total loss and loss adjustment
expense payments 4,504,058 3,801,805 2,242,621
------------------------------------
Reserve for losses and loss
adjustment expenses at December 31,
net of reinsurance recoverables of
$28,156, $27,056, $51,290 in 1999,
1998 and 1997, respectively $14,723,192 $12,115,934 $8,909,121
====================================
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 on default notices occurring in prior years for amounts less
than expected or reducing incurred but not reported reserves.
68
5. COMMITMENTS
The Company leases certain office facilities and equipment under operating
leases. Rental expense for all leases was $1,154,671, $902,866, and $835,596 for
1999, 1998, and 1997, respectively. Future minimum payments under noncancellable
operating leases at December 31, 1999 are as follows:
2000 $1,066,034
2001 896,532
2002 409,543
2003 60,702
Thereafter -
----------
$2,432,811
==========
6. FEDERAL INCOME TAXES
Income tax expense differed from the amounts computed by applying the Federal
statutory income tax rate to income before taxes as follows:
1999 1998 1997
-------------------------------------
Income tax computed at statutory rate $15,321,185 $12,268,326 $ 8,835,231
Increase (decrease) in taxes
resulting from:
Tax-exempt interest (2,095,576) (1,559,067) (1,002,062)
Other 138,897 (30,970) 168,525
-------------------------------------
Income tax expense $13,364,506 $10,678,289 $ 8,001,694
=====================================
69
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, 1999 and
1998 are presented below:
1999 1998
----------------------------
Deferred tax liabilities
Statutory contingency reserve $37,382,052 $26,521,712
Deferred policy acquisition costs 6,967,407 5,605,446
Unrealized investment gain - 2,101,170
Other 2,131,148 861,296
----------------------------
Total deferred tax liabilities 46,480,607 35,089,624
Deferred tax assets
Exercise of employee stock options 1,046,418 916,711
Unearned premiums 514,658 536,397
Capital loss carryforward 149,680 -
Losses and loss adjustment expenses 365,981 341,449
Unrealized investment loss 2,546,666 -
Other 106,863 107,523
----------------------------
Total deferred tax assets 4,730,266 1,902,080
----------------------------
Net deferred tax liability $41,750,341 $33,187,544
============================
At December 31, 1999 and 1998, Triad was obligated to purchase approximately
$726,000 and $154,000, respectively, of Tax and Loss Bonds.
70
7. INSURANCE IN FORCE, DIVIDEND RESTRICTION, AND STATUTORY RESULTS
Approximately 58% of Triad's net risk in force is concentrated in seven states
including 12% in California, 11% in Illinois, 9% in Georgia, 8% in Florida, 7%
in Texas, 6% in North Carolina, and 5% in Virginia. 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, 1999 and 1998, 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:
1999 1998
-----------------------------------
Net risk $3,218,850,073 $2,776,205,499
===================================
Statutory capital and surplus $ 94,602,027 $ 89,539,785
Contingency reserve 113,813,344 81,614,277
-----------------------------------
Total $ 208,415,371 $ 171,154,062
===================================
Risk-to-capital ratio 15.4 to 1 16.2 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. Consolidated net income as determined
in accordance with statutory accounting practices was $40,019,488, $31,252,891,
and $22,916,215 for the years ended December 31, 1999, 1998, and 1997,
respectively. At December 31, 1999, the amount of the Company's equity that can
be paid out in dividends to the stockholders is $10,886,099, which is the earned
surplus of Triad on a statutory basis.
71
8. RELATED PARTY TRANSACTIONS
The Company pays unconsolidated affiliated companies for management, investment,
and other services. The total expense incurred for such items was $353,432,
$336,143, and $284,660 in 1999, 1998, and 1997, respectively. In addition, in
1998, the Company began providing certain investment accounting, reporting and
maintenance functions for an unconsolidated affiliate. Income earned during 1999
and 1998, respectively, for such services was $17,444 and $12,309. Management
believes that the income and expenses incurred for such services approximate
costs that the Company and affiliates 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 $281,728, $225,797, and
$151,134 for the years ended December 31, 1999, 1998, and 1997, 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 agreements
principally provide Triad with increased capacity to write business and achieve
a more favorable geographic dispersion of risk.
72
10. REINSURANCE (CONTINUED)
Reinsurance activity for the years ended December 31, 1999, 1998, and 1997,
respectively is as follows:
1999 1998 1997
---------------------------------------------
Earned premiums ceded $1,645,655 $1,098,515 $1,809,012
Losses ceded 9,686 (3,198) 140,734
Earned premiums assumed 13,866 15,500 19,804
Losses assumed 30,057 50,241 67,903
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.
73
11. LONG-TERM STOCK INCENTIVE PLAN (CONTINUED)
Information concerning the stock option plan is summarized below:
Weighted
Number of Option Average
Shares Price Exercise Price
-----------------------------------------------
1997
Outstanding, beginning of year 993,696 $ 4.58 - 15.13 $ 7.38
Granted 184,550 14.81 - 38.27 20.13
Exercised 2,999 4.58 - 8.92 7.47
Outstanding, end of year 1,175,247 4.58 - 38.27 9.39
Exercisable, end of year 887,462 4.58 - 15.13 6.91
1998
Outstanding, beginning of year 1,175,247 4.58 - 38.27 9.39
Granted 126,675 22.50 - 49.08 42.52
Exercised 122,648 4.58 - 20.07 7.79
Canceled 667 14.81 14.81
Outstanding, end of year 1,178,607 4.58 - 49.08 13.11
Exercisable, end of year 934,027 4.58 - 49.08 9.05
1999
Outstanding, beginning of year 1,178,607 4.58 - 49.08 13.11
Granted 204,840 17.00 - 23.24 22.05
Exercised 34,500 4.58 - 10.17 5.81
Canceled 14,500 17.88 - 38.27 30.86
Outstanding, end of year 1,334,447 4.58 - 49.08 14.48
Exercisable, end of year 1,069,218 4.58 - 49.08 11.72
74
11. LONG-TERM STOCK INCENTIVE PLAN (CONTINUED)
Information concerning stock options outstanding and exercisable at December 31,
1999, is summarized below:
Outstanding Exercisable
- ------------------------------------------------------ ----------------------
Weighted- Weighted- Weighted-
Average Average Average
Number of Exercise Remaining Number of Exercisable
Shares Option Price Price Life Shares Price
- ------------------------------------------------------ ----------------------
641,650 $ 4.58 - $8.92 $ 6.20 4.2 641,650 $ 6.20
282,013 10.17 - 17.88 13.07 6.8 226,681 12.12
291,109 20.07 - 29.44 22.09 8.2 137,528 21.67
58,900 37.75 - 39.75 39.04 8.2 25,586 38.74
60,775 41.94 - 49.08 48.11 8.1 37,773 48.56
- ---------- ---------
1,334,447 1,069,218
========== =========
At December 31, 1999, 1,778,580 shares of the Company's common stock were
reserved and 444,133 shares were available for issuance under the Plan.
The options issued under the Plan in 1999, 1998 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.
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 1999, 1998, 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 6.5% for 1999, 5.1% for 1998, and 5.7% for 1997; dividend yield of 0.0%;
expected volatility of .42 for 1999, .40 for 1998, and .29 for 1997; and a
weighted-average expected life of the option of seven years.
75
11. LONG-TERM STOCK INCENTIVE PLAN (CONTINUED)
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 1999, 1998,
and 1997:
Weighted-Average Weighted-Average
Exercise Price Fair Value
Type of Option 1999 1998 1997 1999 1998 1997
- ---------------------------- ------------------------ -----------------------
Stock Price = Exercise Price $17.49 $37.87 $18.65 $6.74 $13.42 $5.73
Stock Price < Exercise Price $23.24 $49.08 $20.78 $5.96 $11.29 $3.88
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):
1999 1998 1997
-------------------------------------
Net Income - as reported $30,410 $24,374 $17,242
Net Income - pro forma $29,675 $23,779 $16,937
Earnings per share - as reported:
Basic $ 2.28 $ 1.83 $ 1.30
Diluted $ 2.23 $ 1.76 $ 1.26
Earnings per share - pro forma:
Basic $ 2.23 $ 1.78 $ 1.28
Diluted $ 2.18 $ 1.72 $ 1.24
76
12. LONG-TERM DEBT
In January 1998, the Company completed a $35 million private offering of notes
due January 15, 2028. Proceeds from the offering, net of debt issue costs of
$547,102, totaled $34,542,898. The notes, which represent unsecured obligations
of the Company, bear interest at a rate of 7.9% per annum and are non-callable.
13. FAIR VALUE OF FINANCIAL INVESTMENTS
The carrying values and fair values of financial instruments as of December 31,
1999 and 1998 are summarized below:
1999 1998
-------------------------- ---------------------------
Carrying Fair Carrying Fair
Value Value Value Value
-------------------------- ---------------------------
FINANCIAL ASSETS
Fixed maturities
available-for-sale $164,579,416 $164,579,416 $157,391,829 $157,391,829
Equity securities
available-for-sale 13,075,648 13,075,648 14,024,012 14,024,012
FINANCIAL LIABILITIES
Long-term debt 34,461,979 32,837,000 34,457,080 38,468,000
The fair values of cash and short-term investments approximate their carrying
values due to their short-term maturity or availability.
The fair values of fixed maturity securities and equity securities have been
determined using quoted market prices for securities traded in the public market
or prices using bid or closing prices for securities not traded in the public
marketplace. These fair values are disclosed in Note 2.
The fair value of the Company's long-term debt is estimated using discounted
cash flow analysis, based on the Company's current incremental borrowing rates
for similar types of borrowing arrangements.
77
14. UNAUDITED QUARTERLY FINANCIAL DATA
The following is a summary of the unaudited quarterly results of operations for
the years ended December 31, 1999 and 1998 (in thousands except per share data):
1999 Quarter
----------------------------------------
First Second Third Fourth Year
---------------------------------------------------
Net premiums written $14,846 $15,493 $16,635 $16,752 $63,726
Earned premiums 14,986 15,461 16,505 17,018 63,970
Net investment income 2,449 2,637 2,657 2,802 10,545
Net losses incurred 2,915 1,355 1,519 1,322 7,111
Underwriting and other
expenses 5,961 6,182 6,253 6,400 24,796
Net income 6,579 7,445 7,874 8,512 30,410
Basic earnings per share .49 .56 .59 .64 2.28
Diluted earnings per share .48 .55 .58 .62 2.23
1998 Quarter
----------------------------------------
First Second Third Fourth Year
---------------------------------------------------
Net premiums written $11,335 $12,532 $13,372 $14,658 $51,897
Earned premiums 11,930 12,659 13,656 14,577 52,822
Net investment income 2,039 2,326 2,424 2,501 9,290
Net losses incurred 1,477 1,107 1,716 2,709 7,009
Underwriting and other
expenses 4,841 5,301 5,423 5,379 20,944
Net income 5,383 6,045 6,463 6,483 24,374
Basic earnings per share .40 .45 .48 .48 1.83
Diluted earnings per share .39 .44 .47 .47 1.76
78
SCHEDULE I
SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES
TRIAD GUARANTY INC.
DECEMBER 31, 1999
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................ $ 7,107 $ 7,104 $ 7,104
Mortgage-backed securities................. 1,112 1,143 1,143
State and municipal bonds.................. 124,380 117,837 117,837
Corporate bonds............................ 40,424 37,616 37,616
Public utilities........................... 956 879 879
-------- -------- --------
Total .............................. 173,979 164,579 164,579
-------- -------- --------
Equity securities, available-for-sale:
Common stocks:
Public utilities......................... 498 1,244 1,244
Bank, Trust, and Insurance............... 568 1,180 1,180
Industrial & miscellaneous............... 3,516 4,624 4,624
Preferred Stock ............................. 6,370 6,028 6,028
-------- -------- --------
Total....................................... 10,952 13,076 13,076
-------- -------- --------
Short-term investments.......................... 13,909 13,909 13,909
-------- -------- --------
Total investments other than investments in
related parties................................ $198,840 $191,564 $191,564
======== ======== ========
79
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS
TRIAD GUARANTY INC.
(PARENT COMPANY)
December 31
1999 1998
---- ----
(dollars in thousands)
Assets:
Fixed maturities- available-for-sale..... $ 6,511 $ 9,439
Equity securities- available-for-sale.... --- 271
Notes receivable from subsidiary......... 25,000 25,000
Investment in subsidiaries............... 158,499 136,369
Cash and short-term investments.......... 1,433 943
Accrued investment income................ 1,206 1,225
Deferred income taxes.................... 230 86
-------- --------
Total assets............................. $192,879 $173,333
======== ========
Liabilities and stockholders' equity:
Liabilities:
Current taxes payable.................... $ 70 $ 45
Long-term debt........................... 34,462 34,457
Accrued interest on long-term debt....... 1,275 1,275
Accrued expenses and other liabilities... --- 25
-------- --------
Total liabilities........................ 35,807 35,802
Stockholders' equity:
Common stock............................. 133 134
Additional paid-in capital............... 61,972 61,538
Accumulated other comprehensive income... (4,724) 3,908
Deferred compensation.................... (69) ---
Retained earnings........................ 99,760 71,951
-------- --------
Total stockholders' equity.................. 157,072 137,531
-------- --------
Total liabilities and stockholders' equity.. $192,879 $173,333
======== ========
See notes to condensed financial statements.
80
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF INCOME
TRIAD GUARANTY INC.
(PARENT COMPANY)
Year Ended December 31
-------------------------------
1999 1998 1997
---- ---- ----
(dollars in thousands)
Revenues:
Net investment income.............................. $ 2,875 $ 2,787 $ 22
Realized investment gains.......................... (124) 14 ---
------- ------- -------
2,751 2,801 22
------- ------- -------
Expenses:
Interest on long-term debt......................... 2,780 2,554 ---
Operating expenses................................. 35 5 6
------- ------- -------
2,815 2,559 6
------- ------- -------
Income (loss) before federal income taxes and
equity in undistributed income of subsidiaries..... (64) 242 16
Income Taxes:
Current............................................ 24 38 2
Deferred........................................... (46) 42 ---
------- ------- -------
(22) 80 2
------- ------- -------
Income (loss) before equity in undistributed income
of subsidiaries.................................... (42) 162 14
Equity in undistributed income of subsidiaries........ 30,452 24,213 17,228
------- ------- -------
Net income............................................ $30,410 $24,375 $17,242
======= ======= =======
See notes to condensed financial statements.
81
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
TRIAD GUARANTY INC.
(PARENT COMPANY)
Year Ended December 31
------------------------------
1999 1998 1997
---- ---- ----
(dollars in thousands)
Operating Activities
Net income............................................ $30,410 $24,375 $17,242
Adjustments to reconcile net income
to net cash provided by operating activities:
Equity in undistributed income of subsidiaries...... (30,452) (24,213) (17,228)
Accrued investment income........................... 19 (1,225) ---
Other assets........................................ --- 56 (40)
Deferred income taxes............................... (46) 42 ---
Current tax payable................................. 25 42 2
Accrued interest on long-term debt.................. --- 1,275 ---
Accretion of discount on investments................ (86) (130) ---
Amortization of deferred compensation............... 34 --- ---
Amortization of debt issue costs.................... 5 4 ---
Realized investment loss (gain) on securities....... 124 (14) ---
Accrued expenses and other liabilities.............. (25) (10) 30
------- ------- -------
Net cash provided by operating activities............. 8 202 6
Investing Activities
Securities available-for-sale:
Fixed maturities:
Purchases..................................... (3,682) (13,909) ---
Sales......................................... 6,282 4,276 ---
Equity securities:
Purchases..................................... --- (300) ---
Sales......................................... 284 --- ---
Issuance of Surplus Note to subsidiary.............. --- (25,000) ---
------- ------- -------
Net cash provided by (used in) investing activities... 2,884 (34,933) ---
Financing Activities
Proceeds from issuance of long term debt............ --- 34,453 ---
Proceeds from exercise of stock options............. 200 956 22
Retirement of common stock.......................... (2,602) (297) --
------- ------- -------
Net cash (used in) provided by financing activities... (2,402) 35,112 22
------- ------- -------
Increase in cash and short-term investments........... 490 381 28
Cash and short-term investments at beginning of year.. 943 562 534
------- ------- -------
Cash and short-term investments at end of year........ $ 1,433 $ 943 $ 562
======= ======= =======
See notes to condensed financial statements.
82
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
The amortized cost and the fair value of investments held by the parent
company are as follows (dollars in thousands):
Gross Gross
Amortized Unrealized Unrealized Fair
At December 31, 1999 Cost Gains Losses Value
---------- ---------- ----------- --------
Available-for-sale securities:
Fixed maturity securities:
Corporate $7,155 $22 $666 $6,511
------ ------- ------- ------
Total 7,155 22 666 6,511
Equity Securities -- -- -- --
------ ------- ------- ------
Total $7,155 $22 $666 $6,511
====== ======= ======= ======
Gross Gross
Amortized Unrealized Unrealized Fair
At December 31, 1998 Cost Gains Losses Value
---------- ---------- ----------- --------
Available-for-sale securities:
Fixed maturity securities:
Corporate $ 9,777 $113 $451 $9,439
------- ------- ------- -------
Total 9,777 113 451 9,439
Equity Securities 300 -- 29 271
------- ------- ------- -------
Total $10,077 $113 $480 $9,710
======= ======= ======= =======
83
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
TRIAD GUARANTY INC.
(PARENT COMPANY)
SUPPLEMENTARY NOTES
NOTE 3 (CONTINUED)
Major categories of the parent company's investment income are summarized as
follows (dollars in thousands):
Year ended December 31
1999 1998 1997
---- ----- ----
Income:
Fixed maturities $ 645 $ 679 --
Equity securities 18 17 --
Cash and short-term investments 42 71 $22
Note receivable from subsidiary 2,225 2,052 --
------ ------ ------
2,930 2,819 22
Expenses 55 32 --
------ ------ ------
Net investment income $2,875 $2,787 $22
====== ====== ======
NOTE 4
In January of 1998, the Company completed a $35 million private offering of
notes due January 15, 2028. Proceeds from the offering, net of debt issue costs
of $547,102, totaled $34,542,898. The notes, which represent unsecured
obligations of the Company, bear interest at a rate of 7.9% per annum and are
non-callable.
84
SCHEDULE IV - REINSURANCE
TRIAD GUARANTY INC.
MORTGAGE INSURANCE PREMIUM EARNED
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
Percentage of
Ceded To Assumed Amount
Gross Other From Other Net Assumed
Amount Companies Companies Amount to Net
-------- ---------- ---------- -------- ------------
(dollars in thousands)
1999..... $65,602 $1,646 $14 $63,970 0.0%
======= ====== === =======
1998..... $53,905 $1,099 $16 $52,822 0.0%
======= ====== === =======
1997..... $40,311 $1,809 $20 $38,522 0.1%
======= ====== === =======
85