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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 1934 For the fiscal year ended December 31, 2000
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the transition period from ___________ to ___________
Commission file number 0-22342
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TRIAD GUARANTY INC.
(Exact name of registrant as specified in its charter)
DELAWARE 56-1838519
(State or other jurisdiction of (I.R.S.Employer Identification No.)
incorporation or organization)
101 SOUTH STRATFORD ROAD, SUITE 500
WINSTON-SALEM, NORTH CAROLINA 27104
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (336) 723-1282
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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 27, 2001, computed by reference to the last reported
price at which the stock was sold on such date, was $202,941,295.
The number of shares of the registrant's common stock, par value $.01 per share,
outstanding as of March 27, 2001, was 13,356,610.
Portions of the following documents Part of this Form 10-K
are incorporated by reference into which the document is
into this Form 10-K: incorporated by reference:
TRIAD GUARANTY INC. PART III
PROXY STATEMENT FOR 2001 ANNUAL MEETING
OF STOCKHOLDERS
PART I
ITEM 1. BUSINESS
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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."
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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 35% as of December 31, 2000) is applied, generally ranges from
110% to 115% of the unpaid principal balance of the loan. The Company's
obligation to an insured lender with respect to a claim is determined by
applying the appropriate coverage percentage to the claim amount. Under its
master policy, the Company has the option of paying the entire claim amount and
taking title to the mortgaged property or paying the coverage percentage in full
satisfaction of its obligations under the insurance written. Primary insurance
can be placed on many types of loan instruments and generally applies to loans
secured by mortgages on owner occupied homes. The Company underwrites primary
insurance on a loan-by-loan basis and on a delegated underwriting basis to a
select group of lenders. Mortgage originators who participate in the Company's
delegated program are allowed to issue a certificate of insurance on the loans
it underwrites if certain strict qualifications are met.
The Company offers primary coverage generally from 6% to 35% of the claim
amount, with most coverage from 15% to 35% as of December 31, 2000. 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 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.
Since 1999, Fannie Mae and Freddie Mac have accepted lower coverage
percentages for certain categories of mortgages when the loan is approved by
their automated underwriting services. The reduced coverage percentages limit
loss exposure to 80% or less of the property's value at the time the loan is
originated.
The Company's premium rates vary depending upon the loan-to-value (LTV)
ratio, loan type, mortgage term, coverage amount, documentation required, and
use of property, which all affect the perceived risk of a claim on the insured
mortgage loan. Generally, premium rates cannot be changed after 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
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.
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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 approximately 96% of new insurance written in
2000. 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 mortgage loan closing with annual renewal
payments, which are generally less than the first year premium, 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
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.
POOL INSURANCE
Pool insurance generally has 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. The Company does not offer this traditional form of pool insurance.
In the second quarter of 2000, the Company began to participate in modified
pool insurance programs on loans purchased by Freddie Mac. 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. To date insurance subject to modified pool
programs represents an immaterial amount of production.
BULK TRANSACTIONS
A bulk transaction generally involves insuring a large group of previously
originated or newly originated mortgages under negotiated terms. In 2000 the
Company implemented a process to analyze and price mortgage insurance as a
credit enhancement on these bulk transactions consistent with its risk
management approach.
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RISK SHARING PRODUCTS
The Company has in place mortgage insurance programs designed to allow
lenders to share in the risks of mortgage insurance. One such program is the
captive reinsurance program. Under the captive reinsurance program, a
reinsurance company, generally an affiliate of the lender, assumes a portion of
the risk associated with the lender's insured book of business in exchange for a
percentage of the premium. Typically, the reinsurance program is an excess of
loss arrangement with a maximum exposure for the captive reinsurance company.
These captive reinsurance programs may also be in the form of a quota share
arrangement. In addition, the Company has insurance in force under programs
which increases a 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.
Approximately 25% of the Company's insurance in force at December 31, 2000, was
subject to risk sharing programs.
Regulatory and industry issues exist regarding the future of risk-sharing
programs currently being marketed within the mortgage insurance industry.
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 a loan servicer cancel insurance on a mortgage loan
when the 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 lenders when the outstanding loan amount is 78% or
less of the property's original purchase price.
Mortgage insurance coverage can also be cancelled when an insured loan is
refinanced. If the Company provides insurance on the refinanced mortgage, the
policy on the refinanced home loan is considered 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 from refinanced loans was 13.2%, 25.0%,
and 31.7% in 2000, 1999, and 1998, respectively.
To the extent canceled insurance coverage in areas experiencing economic
growth is not replaced by new insurance in such areas, the percentage of the
Company's book of business in economically weaker areas may increase. This
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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. The
percentage of the Company's insurance in force at the end of the previous year
that was canceled during the following year was 17.4%, 22.9%, and 30.0% in 2000,
1999, and 1998, respectively. The cancellations have not had a material impact
on the geographic dispersion of the Company's risk in force.
CUSTOMERS
Residential mortgage lenders such as mortgage bankers, mortgage brokers,
commercial banks and savings institutions are the principal customers of the
Company. At December 31, 2000, approximately 62% of the Company's risk in force
came from mortgage bankers, 18% from mortgage brokers, 16% from commercial
banks, and 4% from savings institutions. 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. 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
evaluation of the lender's financial position and 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 7,190 master policyholders at December 31, 2000, compared to 6,948 at
December 31, 1999.
The Company's ten largest customers were responsible for 30.0%, 31.0%, and
31.7% of direct risk in force at December 31, 2000, 1999, and 1998,
respectively. No single customer of the Company (including branches and
affiliates of that customer) accounted for revenues greater than 10% of total
revenues for 2000. The largest single customer of the Company accounted for
6.6%, 9.2%, and 9.5% of risk in force at December 31, 2000, 1999, and 1998,
respectively.
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SALES AND MARKETING
The Company currently markets its insurance products through a sales force,
including sales management, of approximately 50 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 a
license application pending in one state.
In 2000, the Company strengthened its sales force by restructuring the
sales team into five sales regions, each with its own manager. These regional
managers report to a field administrator who oversees all account executive
activities. The field administrator reports directly to a senior executive who
oversees all sales activities for the Company, including those of the national
account market representatives. This reporting structure allows the senior
executive in charge of all sales activities to focus time on large, national
accounts while remaining in control of all other sales activities. Currently the
Company is approved to do business with 19 of the top 30 lenders and production
from these lenders accounted for approximately 33% of the Company's new
insurance written in 2000 compared to 13% in 1999. 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 sales
force and its general agency. For 2000, the Company's commissioned general
agency produced approximately 8% of the Company's new direct insurance written
while the salaried account executives and the national account representatives
produced the remainder.
The marketing department's mission is to develop and implement programs in
support of the Company's sales objectives. A variety of tools are used to
achieve this goal including direct mail, public relations, marketing materials,
internal/external publications, convention trade shows, and the World Wide Web.
A national advertising and public relations campaign designed to raise corporate
visibility to lenders and investors is also being utilized to achieve this goal.
In 1999, the Company strengthened its marketing team by restructuring the
department and hiring a senior level marketing executive to oversee all
marketing efforts. Also in 1999, the Company completely revised its web site to
be more user-friendly and to provide more functionality for customers,
investors, homebuyers, and real estate professionals.
The Company provides fee-based 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.
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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 41% of high LTV
loans in 2000 and 48% in 1999. 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,
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 have the ability to modify the required level of
mortgage insurance coverage which should be maintained by lenders on loans for
resale to the secondary market. 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 periodically 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 2000 market share and, according to
industry data, had a 2.7% share of net new mortgage insurance written in 2000
compared to 2.3% in 1999.
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, responsive and versatile technology, 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
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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
department in the home office, the Vice President of Underwriting is responsible
for the Company's regional offices in Arizona, California, Colorado, Georgia,
Illinois, Pennsylvania, and Texas. 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 34 at December 31, 2000. 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.
The Company also utilizes various non-employee underwriters to perform
contract underwriting services. The number can vary substantially depending on
the need for this service.
RISK MANAGEMENT APPROACH
The Company's risk management objective is to build a portfolio of
insurance in force which produces earned premiums in excess of paid claims. The
Company evaluates risk 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:
o 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, including
loan level risk characteristics, of all customers that hold a master
policy. This information is factored into determining the loan
programs the Company approves for various lenders. The Company assigns
delegated underwriting authority only to lenders with substantial
financial resources and established records of originating good
quality loans.
o PURPOSE AND TYPE OF LOAN. The Company analyzes five general
characteristics of a loan to evaluate its level of risk: (i) LTV
ratio; (ii) purpose of the loan; (iii) type of loan instrument; (iv)
level of documentation; and, (v) type of property. The Company seeks
loan types with proven track records for which an assessment of risk
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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 scheduled negatively
amortizing ARMs, investment properties, and subprime loans.
o INDIVIDUAL LOAN AND BORROWER. Except to the extent that the Company's
delegated underwriting program and Freddie Mac's and Fannie Mae's
automated underwriting services are being utilized, the Company
evaluates insurance applications based on analysis of the borrower's
ability and willingness to repay the mortgage loan and the
characteristics and value of the mortgaged property. The analysis of
the borrower includes reviewing the borrower's housing and total debt
ratios as well as the borrower's Fair, Isaac and Co., Inc. ("FICO")
credit score, as reported by credit rating agencies. Loans may be
submitted under the Stick With Triad program provided the loans meet
the program requirements. Within this program, the degree to which the
borrower must meet certain underwriting standards, as well as the
amount of documentation required, is a function of the credit score.
(For further description of the Stick With Triad program, see
Underwriting Process below.) 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.
o GEOGRAPHIC SELECTION OF RISK. The Company places significant emphasis
on the condition of the regional housing markets in determining
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:
a 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 also accepts loans approved through Feddie
Mac's or Fannie Mae's automated underwriting systems.
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 also are
largely influenced by Freddie Mac and Fannie Mae underwriting guidelines. The
Company believes its guidelines generally are consistent with those used by
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other private mortgage insurers with respect to the types of loans that the
Company will insure. Specific underwriting guidelines applicable to a given
local, state, or regional market are modified to address concerns resulting from
the Company's review of regional economies and housing patterns.
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
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 2.4% at both December 31, 2000 and 1999.
The Company's Stick With Triad program featuring the Slam Dunk Loan SM
approval process allows lenders to submit insurance applications with reduced
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 system. The Company issues a
certificate of insurance without the standard underwriting process if certain
program parameters are met and the borrower has a credit score above established
thresholds. Documentation submission requirements for non-automated underwritten
loans vary depending on the borrower's credit score. The Stick With Triad
program represented approximately 65% of the Company's commitment volume in both
2000 and 1999. 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
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 23% of commitments received in 2000 compared to 17% in
1999 and 16% in 1998. Many lenders who are not part of the delegated
underwriting program 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.
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The Company utilizes its underwriting staff as well as contract personnel
to provide contract underwriting services to customers. For a fee, Triad
underwrites applications for secondary market compliance, while at the same time
assessing the application for mortgage insurance, if applicable. In addition,
the Company offers Fannie Mae's Desktop Originator(R) and Desktop
Underwriter(R), 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(R). 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.
A comprehensive audit plan determines whether underwriting decisions being
made are consistent with the policies, procedures, and expectations for quality
set forth by management. All areas of business activity which involve an
underwriting decision are examined, with emphasis on new products, new
procedures, contract underwritten loans, delegated loans, new employees, new
master policyholders, and new branches of an existing master policyholder. The
process used to identify categories of loans selected for audit begins with
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 insurer
issuing private mortgage insurance coverage has a claims-paying ability rating
of at least "AA-" by either Standard & Poor's Rating Services ("S&P") or Fitch,
Inc. ("Fitch") or a financial strength rating from Moody's Investors Service
("Moody's") of at least "Aa3." 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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Credit ratings generally are considered an important element in a mortgage
insurer's ability to compete for new business, indicating the insurer's present
financial strength and capacity to pay future claims. Fannie Mae and Freddie Mac
require mortgage guaranty insurers to maintain two ratings of "AA-" or better.
Triad is rated "AA" by both S&P and Fitch and, in the first quarter of 2001,
received a rating of Aa3 from Moody's.
S&P defines insurers rated "AA" as having very strong financial security
characteristics, differing only slightly from those rated higher. Fitch defines
insurance companies rated "AA" as possessing very strong capacity to meet
policyholder and contract obligations, risk factors are modest, and the impact
of any adverse business and economic factors is expected to be very small.
Moody's defines insurers rated "Aa" as offering exceptional financial security
but appearing to have somewhat larger long-term risks than companies rated
"Aaa". Ratings from S&P and Fitch are modified with a "+" or "-" sign to
indicate the relative position of a company within its category. Moody's uses
numeric modifiers to refer to the ranking within a group - with "1" being the
highest and "3" being the lowest.
When assigning a claims-paying ability rating, S&P, Fitch, and Moody's
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, which are rated "A" by S&P and "A+" by Fitch, were issued to provide
additional capital considered in the rating agency's depression models.
S&P, Fitch, and Moody's will periodically review Triad's claims-paying
ability, as they do with all rated insurers. Ratings can be withdrawn or changed
at any time by a rating agency.
REINSURANCE
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
13
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, 2000, and direct premiums written
in 2000 were ceded in quota share arrangements to non-affiliated reinsurance
companies.
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%. Certain states limit the amount of risk a mortgage insurer may retain with
respect to coverage of an insured loan to 25% of the claim amount, and, as a
result, the deeper coverage portion of such insurance must be reinsured. To
minimize reliance on third party reinsurers and to permit the Company to retain
the premiums and related risk on deeper coverage business, Triad reinsures this
deeper coverage business with its wholly-owned subsidiary Triad Guaranty
Assurance Corporation ("TGAC"). As of December 31, 2000, TGAC had assumed
approximately $62.4 million in risk from Triad.
Triad's product offerings include captive mortgage reinsurance programs
whereby an affiliate of a lender reinsures a portion of the insured risk on
loans originated or purchased by the lender. 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 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
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 risk management opportunities with increased flexibility, based
on the specific needs of each individual lender. Ceded premium under captive
reinsurance agreements represented 2.1% of direct written premiums in 2000
compared to 0.2% 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 formed to allow small and mid-sized lenders to participate in
14
captive reinsurance arrangements with reduced up-front capital costs and without
co-mingling its risk with other lenders. Triad Re was initially capitalized in
February 2000, with regulatory capital of $1.0 million. As of December 31, 2000,
approximately $4 million of Triad's risk in force had been ceded to sponsored
captive reinsurer cells under participating agreements with Triad Re.
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 2000, 1.9% of the Company's direct written
premium was ceded to reinsurers under these agreements as compared to 1.1% in
1999.
At the end of 2000, 24.8% of Triad's insurance in force had been insured
under some type of risk-sharing arrangement as compared to 15.4% at year end
1999. Risk-sharing arrangements represented 42.9% of Triad's net new insurance
written in 2000 as compared to 22.9% in 1999.
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 2000, Triad maintained $75 million and had incremental access to an
additional $50 million of excess of loss reinsurance through non-affiliated
reinsurers that have claims-paying ability ratings of "AA" or "AAA" from
Standard & Poors.
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 affecting the loan commences, whichever occurs
first. Notification is required within 45 days of default if it occurs when the
first payment is due. The incidence of default is affected by a variety of
factors including, but not limited to, change in borrower income, unemployment,
divorce, illness, the level of interest rates, and general borrower
creditworthiness. Defaults that are not cured generally 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.
15
The following table shows default statistics as of December 31, 2000, and
the preceding four year ends:
Default Statistics
December 31
-----------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
Number of insured loans in force........................ 123,046 108,623 97,222 82,682 62,334
Number of loans in default.............................. 740 690 518 388 273
Percentage of loans in default (default rate)........... 0.60% 0.64% 0.53% 0.47% 0.44%
Dollar amount of insured loans in default (000's)....... $77,423 $67,802 $50,882 $37,828 $25,253
Dollar amount of direct risk (gross of reinsurance)
with respect to insured loans in default (000's)..... $20,743 $18,108 $13,216 $9,249 $5,770
Reserve per delinquent loan............................. $20,253 $21,378 $23,442 $23,094 $23,097
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. The ability
to mitigate a claim is affected by the local housing market, interest rates,
employment growth, the housing supply, and the borrower's desire to avoid
foreclosure. During the default period, the Company works with the insured as
well as the borrower in an effort to either reinstate the loan or sell the
property for an amount which results in a reduced claim prior to foreclosure.
The payment of claims is not evenly spread through the coverage period.
Relatively few claims are paid during the first two years following issuance of
insurance. A period of rising claim payments 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 claim payments
made has historically declined at a gradual rate, although the rate of decline
can be affected by local economic conditions. There can be no assurance that the
historical pattern of claims will continue in the future.
Generally, the Company does not pay a claim for loss under the master
policy if the application for insurance for the loan in question contains
fraudulent information, material omissions, or misrepresentations which increase
the risk characteristics of the loan. The Company's master policy also excludes
any cost or expense related to the repair or remedy of any physical damage
16
(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. Depending on the applicable state foreclosure law, an average of about
12 months elapses from date of default to 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 35% 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 chooses the claim
settlement option believed to cost the least. In general, the Company settles
claims by paying the coverage percentage of the claim amount. At December 31,
2000, the Company held one property with a net realizable value of $99,482 which
was acquired by exercising its option to pay 100% of the claim amount.
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 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
paid out approximately 68% of its potential exposure on claims in 2000 compared
to 66% in 1999.
LOSS RESERVES
The Company establishes reserves to provide for the estimated costs of
settling claims on loans reported in default and estimates of loans in default
17
which have not been reported. Consistent with industry accounting practices, the
Company does not establish loss reserves for future claims on insured loans
currently not in default. Although the Company believes that overall reserve
levels at December 31, 2000, are adequate to meet future obligations, due to the
inherent uncertainty of the reserving process there can be no assurance that
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 loan
servicer. As a default progresses closer to foreclosure, the amount of loss
reserve for a particular loan increases incrementally up to approximately 120%
of the Company's exposure, which includes claims-related expenses. The Company
periodically reviews and adjusts reserve estimates to address changes in
economic conditions as well as loss experience developments.
The Company also establishes reserves for the estimated costs of settling
claims ("loss adjustment expenses" or "LAE"), which include, but not limited to,
legal fees and general expenses of administering the claims settlement process,
and for losses and loss adjustment expenses incurred from defaults which have
occurred but 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. Economic conditions that have affected the development of 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
reserves will 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)
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
Reserve for losses and LAE,
net of related reinsurance
recoverables, at beginning of year....... $14,723 $12,116 $ 8,909 $ 5,974 $ 3,703
Add losses and LAE incurred in respect
of defaults occurring in:
Current year (1)..................... 11,229 9,322 7,953 6,023 4,673
Prior years (1) (2).................. (3,642) (2,211) (944) (846) (1,394)
------- ------- ------- ------- -------
Total incurred losses and LAE............. 7,587 7,111 7,009 5,177 3,279
Deduct losses and LAE paid in respect
of defaults occurring in:
Current year......................... 574 236 267 210 167
Prior years.......................... 6,760 4,268 3,535 2,032 841
------ ------- ------- ------- ------
Total payments............................ 7,334 4,504 3,802 2,242 1,008
Reserve for losses and LAE, net
of related reinsurance
recoverables, at end of year ........... 14,976 14,723 12,116 8,909 5,974
Reinsurance recoverables on unpaid
losses and LAE, at
the end of year ....................... 11 27 28 51 331
------ ------- ------- ------- ------
Reserve for unpaid losses and LAE,
before deduction of reinsurance
recoverables on unpaid losses, at
end of year............................. $14,987 $14,751 $12,143 $ 8,960 $ 6,305
======= ======= ======= ======= =======
(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.
19
The middle section of the above table shows claims paid on insurance
policies with respect to defaults which occurred in the current period and in
prior periods, respectively. Since it takes, on average, about 12 months for a
default which is not cured to eventually develop into a paid claim, most losses
paid relate to defaults occurring in prior periods.
Analysis of Direct Risk in Force
A foundation of the Company's business strategy is proactive risk
selection. The Company analyzes its portfolio in a number of ways to identify
any concentrations of risk or imbalances in risk dispersion. The Company
believes that the quality of its insurance portfolio is affected predominantly
by (i) the quality of loan originations (including the strength of the borrower
and the marketability of the property); (ii) the attributes of loans insured
(including LTV ratio, purpose of the loan, type of loan instrument and type of
underlying property securing the loan); (iii) the seasoning of the loans
insured; (iv) the geographic dispersion of the underlying properties subject to
mortgage insurance; and, (v) the quality and integrity of lenders from which the
Company receives loans to insure.
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, 2000 and 1999:
20
DIRECT RISK IN FORCE
December 31
-----------
PRODUCT TYPE: 2000 1999
----- ----
Primary............................................ 100.0% 100.0%
Pool............................................... 0.0% 0.0%
------- -------
Total.............................................. 100.0% 100.0%
======= =======
Direct Primary Risk in Force
December 31
-----------
2000 1999
----- ----
DIRECT RISK IN FORCE (dollars in millions)........... $3,760 $3,223
LENDER CONCENTRATION:
Top 10 lenders (by original applicant)............... 30.0% 31.0%
LTV:
95.01% and above..................................... 2.5% 2.0%
90.01% to 95.00%..................................... 50.7% 50.0%
90.00 and below...................................... 46.8% 48.0%
------- -------
Total................................................ 100.0% 100.0%
======= =======
LOAN TYPE:
Fixed................................................ 94.9% 94.5%
ARM (positive amortization) (1)...................... 5.1% 5.5%
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 (3):
15 years and under................................... 3.2% 4.0%
Over 15 years........................................ 96.8% 96.0%
------- -------
Total................................................ 100.0% 100.0%
======= =======
PROPERTY TYPE:
Noncondominium (principally single-family detached).. 96.2% 95.6%
Condominium.......................................... 3.8% 4.4%
------- -------
Total................................................ 100.0% 100.0%
======= =======
OCCUPANCY STATUS:
Primary residence.................................... 98.1% 98.6%
Second home.......................................... 1.2% 1.1%
Nonowner occupied.................................... 0.7% 0.3%
------- -------
Total................................................ 100.0% 100.0%
======= =======
MORTGAGE AMOUNT (3):
$200,000 or less..................................... 82.3% 84.9%
Over $200,000........................................ 17.7% 15.1%
------- -------
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 Companyas 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.
(3) The 1999 amounts have been restated to conform with current year results.
21
An important determinant of claim incidence is the relative amount of
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 claim
incidence on loans with LTV ratios equal to or less than 90%. The Company
believes the higher premium rates charged on high LTV loans adequately reflects
the additional risk.
Approximately 2.5% 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.
In 2000 the State of Illinois Insurance Department, as well as the
insurance departments of several other states, began to permit mortgage insurers
to write coverage on loans in excess of 97% up to 100% and, in certain
instances, up to 103%. This request was made in response to the development by
certain entities of the mortgage securitization market, including Fannie Mae and
Freddie Mac, of programs that allowed LTV's in excess of 97%. These programs are
designed to accommodate the credit-worthy borrower who lacks the ability or
interest to provide a down payment on a home. The Company accepts loans with
LTV's greater than 97% on a limited basis.
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 possible interest rate increases and borrower payment
option changes are accepted under limited conditions for approved lenders.
Historical evidence indicates that higher-priced properties experience
wider fluctuations in value than moderately priced residences. These
fluctuations exist primarily because there is a 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.
22
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.
Triad does not insure cooperatives.
Loans on primary residences that were owner occupied at the time of loan
origination constituted approximately 98% of the Company's risk in force at
December 31, 2000. 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, 2000, consistent
with the weighted average life at year-end 1999, compared to an estimated
industry average of 3.4 years at December 31, 2000.
23
The following table shows the percentage of direct risk in force as of
December 31, 2000, for policies written from 1988 through 2000, 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, 2000, 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 $ 0.5 0.0% 15.4%
1989 0.8 0.0 24.0
1990 1.8 0.0 18.8
1991 7.2 0.2 11.9
1992 25.7 0.7 8.7
1993 76.7 2.0 5.2
1994 69.9 1.9 9.8
1995 122.8 3.3 10.9
1996 203.0 5.4 10.7
1997 435.1 11.6 6.4
1998 948.2 25.2 2.1
1999 891.3 23.7 0.8
2000 977.0 26.0 0.0
--------- -----
Total $ 3,760.0 100.0%
========= =====
- ----------------
(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.
24
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 statesand
the top ten metropolitan statistical areas ("MSAs") as of December 31, 2000:
Top Ten States Top Ten MSAs(1)
---------------------------- --------------------------------------
December 31 December 31
2000 2000
---- ----
California 11.8% Chicago, IL 9.2%
Illinois 9.6 Atlanta, GA 3.6
Florida 8.2 Los Angeles/Long Beach, CA 2.6
Georgia 8.1 Phoenix/Mesa, AZ 2.3
Texas 7.6 Houston, TX 2.1
North Carolina 6.4 Charlotte, NC 1.6
Pennsylvania 4.1 Philadelphia, PA 1.5
Virginia 4.0 Minneapolis/St. Paul, MN 1.4
Colorado 3.7 Dallas, TX 1.4
Arizona 3.5 Denver, CO 1.3
----- -----
Total 67.0% Total 27.0%
===== =====
- ---------------------
(1) Current year MSA reporting reflects the MSA/PMSA designation. This
designation, which is consistent with industry standards, reflects a more
narrowly defined statistical area than has been reported in prior years.
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
25
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, 2000, the Company's total investment portfolio had a fair
market value of $232.0 million and did not include any real estate or mortgage
loans. The investment portfolio was composed of approximately 88% fixed maturity
securities, 5% equities, and 7% short-term investments.
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, 2000, 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
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
Average investments (1)................ $212,029,383 $183,987,661 $151,711,923 $103,804,750 $89,577,031
Pre-tax net investment income.......... $12,645,321 $10,545,663 $ 9,289,026 $ 6,234,142 $5,446,672
Effective pre-tax yield (1)............ 6.0% 5.7% 6.1% 6.0% 6.1%
Tax-equivalent yield (2)............... 8.2% 7.7% 7.9% 8.0% 7.7%
Pre-tax realized gain (loss) on sale of
Investments................... $ 285,849 $ 1,153,191 $ 880,502 $ 34,330 $ (162,385)
- ---------------------
(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.
26
The diversification of the Company's investment portfolio at December 31,
2000, is shown in the table below:
INVESTMENT PORTFOLIO DIVERSIFICATION
December 31, 2000
-------------------------------------------
Amortized Cost Fair Value Percent (1)
-------------- ---------- -------
Available-for-sale securities:
Fixed maturity securities:
U. S. government obligations.......... $ 12,933,975 $ 13,238,313 5.7%
Mortgage-backed bonds.................. 933,215 981,245 0.4
State and municipal bonds.............. 139,926,385 143,721,798 61.9
Corporate Bonds........................ 47,986,616 45,983,296 19.8
------------ ------------
Total fixed maturities............... 201,780,191 203,924,652
Equity securities........................ 9,630,441 11,088,525 4.8
------------ ------------
Total available-for-sale securities.. 211,410,632 215,013,177
Short-term investments................... 17,012,080 17,012,080 7.4
------------ ------------ ------
$228,422,712 $232,025,257 100.0%
============ ============ ======
- ----------------
(1) Percentage of fair value.
The following table shows the scheduled maturities at December 31, 2000, of
the fixed maturity securities held in the Company's investment portfolio:
INVESTMENT PORTFOLIO SCHEDULED MATURITY
December 31, 2000
---------------------------
Fair Value Percent
---------- -------
One year or less.......................... $3,864,589 1.9%
After one year through five years......... 23,426,372 11.5
After five years through ten years........ 30,841,881 15.1
After ten years though twenty years....... 103,899,668 50.9
After twenty years........................ 40,910,897 20.1
Mortgage-backed securities (1)............ 981,245 0.5
------------ ------
Total........................... $203,924,652 100.0%
============ ======
- ---------------------
(1)Substantially all of these securities are guaranteed by U.S. Government
Agencies.
27
The following table shows the ratings of the Company's investment portfolio
as of December 31, 2000:
Investment Portfolio by Rating
December 31, 2000
----------------------------
Rating(1) Fair Value Percent
---------- -------
Fixed maturities:
U.S. Treasury and U.S. agency bonds.... $ 5,217,023 2.6%
AAA.................................... 79,443,654 39.0
AA..................................... 27,253,100 13.4
A...................................... 51,479,757 25.1
BBB.................................... 23,359,844 11.5
BB..................................... 8,000,251 3.9
B...................................... 5,418,940 2.7
C...................................... 57,000 0.0
D...................................... 168,983 0.1
NR..................................... 3,526,100 1.7
------------- ------
Total fixed maturities............ $ 203,924,652 100.0%
============= ======
Equities:
AAA.................................... $ 483,125 4.3%
AA..................................... 0 0.0
A...................................... 7,038,892 63.5
BBB.................................... 970,568 8.8
BB..................................... 0 0.0
B...................................... 2,595,940 23.4
------------- ------
Total equities................... $ 11,088,525 100.0%
============= ======
Total Portfolio................................. $ 215,013,177
=============
- ----------------
(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, and Fitch.
28
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, 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, and
varying degrees of control over claims handling practices, reinsurance
requirements, 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 of Insurance 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.
29
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,
2000, Triad had statutory policyholders' surplus of $101.0 million and a
statutory contingency reserve of $150.8 million. At December 31, 1999, Triad had
statutory policyholders' surplus of $94.6 million and a statutory contingency
reserve of $113.8 million. Triad's statutory earned surplus was $17.3 million at
year-end 2000 versus $10.9 million at year-end 1999, 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 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.
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 also may 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 each subject to examination of their affairs
by the insurance departments of every state in which they are 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
30
issued by the Illinois Insurance Department on February 3, 2000, and covered the
period 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 25 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 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. Freddie Mac most recently
modified its eligibility guidelines in June 2000. Fannie Mae also has
eligibility requirements, although such requirements are not published. Triad is
an approved mortgage insurer for both Freddie Mac and Fannie Mae and meets all
eligibility requirements. There can be no assurance, however, that such
31
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 enhancements, alters or
liberalizes underwriting guidelines on low down payment mortgages it purchases,
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
the GSEs' 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 GSEs 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 homebuyer 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 or Fitch 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 and Fitch and a rating of "Aa3"
from Moody's. S&P, Fitch, and Moody's include Triad's consolidated operations
and financial position in determining the 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.
32
Various lawsuits filed in US district court in Augusta, Georgia against
each of the national mortgage insurers assert that defendant mortgage insurers
have violated RESPA guidelines by offering pool insurance, captive reinsurance,
contract underwriting, and other 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. Three
mortgage insurers have entered into preliminary settlements of the lawsuits.
Triad's motion for summary judgement has been granted and is expected to be
appealed. Triad believes that its products and services comply with RESPA as
well as all other applicable laws and regulations. Management does not know 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.
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, provides
for certain termination and cancellation requirements for borrower-paid mortgage
insurance and requires mortgage lenders to periodically update borrowers about
their private mortgage insurance. Under the legislation, borrowers may generally
request termination of mortgage insurance once the LTV reaches 80%, provided
that certain 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. The legislation also requires lenders
to notify borrowers that they have private mortgage insurance and requires
certain disclosures to borrowers of their rights under the law. 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.
33
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 and the Department of Veterans Affairs ("VA"), 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 2001, the maximum individual loan amount that the FHA could
insure increased from $219,849 to $239,250. The maximum individual loan amount
the VA can insure presently is $203,000. The maximum loan amounts that the FHA
and VA can insure are subject to adjustment and may increase in the future. Any
future legislation that increases the number of persons eligible for FHA or VA
mortgages could have an adverse effect on the Company's ability to compete with
the FHA or VA.
Pursuant to the Financial Institutions Reform, Recovery, and Enforcement
Act of 1989 ("FIRREA"), the Office of Thrift Supervision ("OTS") issued
risk-based capital rules for savings institutions. These rules establish a lower
capital requirement for a low down payment loan that is insured with private
mortgage insurance, as opposed to remaining uninsured. Furthermore, the
guidelines for real estate lending policies applicable to savings institutions
and commercial banks provide that such institutions should require appropriate
credit enhancement in the form of either mortgage insurance or readily
marketable collateral for any high LTV mortgage. To the extent FIRREA's
risk-based capital rules or the guidelines for real estate lending policies
applicable to savings institutions and commercial banks are changed in the
future, some of the 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. 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
34
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.
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, purchased, or serviced 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, 2000, the Company employed 179 persons. Employees are
not covered by any collective bargaining agreement. The Company considers its
employee relations to be satisfactory.
35
EXECUTIVE OFFICERS
The executive officers of the Company are as follows:
Name Position Age
- ---- -------- ---
William T. Ratliff, III Chairman of the Board of 47
the Company and Triad
Darryl W. Thompson President, Chief Executive 60
Officer, and Director of the
Company and Triad
Ron D. Kessinger Executive Vice President and 46
Chief Financial Officer of the
Company and Triad
John H. Williams Executive Vice President and 53
Director of Triad
Henry B. Freeman Senior Vice President of Triad 51
Earl F. Wall Senior Vice President, Secretary, 43
and General Counsel of the
Company and Triad
Michael R. Oswalt Senior Vice President, Controller, 39
Treasurer, and Principal Accounting
Officer of the Company and Triad
36
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. Since 1995, he has served as President of Collat, Inc., CML's
corporate general partner. 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 Chief
Financial Officer of Triad since November 1999 and 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
was Vice President of Underwriting and Claims from 1982 to 1985 and Vice
President of Risk Management from 1985 to 1987.
37
EARL F. WALL has been Senior Vice President of Triad since November 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 November
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, 2000, the Company leases office space in its
Winston-Salem headquarters and its eleven underwriting offices located
throughout the country comprising approximately 45,000 square feet under leases
expiring between 2001 and 2008 and which require annual lease payments of
approximately $893,000 in 2001. 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.
38
ITEM 3. LEGAL PROCEEDINGS.
- ------- ------------------
The Company is involved in litigation in the ordinary course of business.
No pending litigation is expected to have a material adverse affect on the
financial position of the Company.
Triad is a defendant in PATTON V. TRIAD. This action was commenced on June
30, 2000 with the filing of a complaint in Federal District Court for the
Southern District of Georgia seeking class action status on behalf of a
nationwide class of home mortgage borrowers. The complaint alleges that Triad
violated the Real Estate Settlement Procedures Act ("RESPA") by entering into
transactions with lenders (including captive mortgage reinsurance and contract
underwriting) that were not properly priced, in return for the referral of
mortgage insurance. The complaint seeks damages of three times the amount of the
mortgage insurance premiums that have been paid and that will be paid at the
time of judgement for the mortgage insurance that is found to be involved in a
violation of RESPA. The complaint also seeks injunctive relief, including
prohibiting Triad from receiving future premium payments. In August 2000, Triad
filed a motion for summary judgement in the case which was granted on February
13, 2001. This decision is expected to be appealed. Six other mortgage insurers
are also defendants in equivalent lawsuits pending in the Federal District Court
for the Southern District of Georgia. While the ultimate outcome of the RESPA
litigation is uncertain, the litigation is not expected to have a material
adverse affect on the financial position of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
- ------- ----------------------------------------------------
None.
39
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, 2000, 13,351,694 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.
2000 1999
---- ----
High Low High Low
----- --- ---- ---
First Quarter........ $22.625 $14.875 $22.750 $13.563
Second Quarter....... $23.438 $18.250 $18.063 $12.000
Third Quarter........ $29.750 $21.500 $20.125 $16.625
Fourth Quarter ...... $34.250 $26.250 $23.500 $16.438
As of March 15, 2001, the number of stockholders of record of Company
Common Stock was approximately 300. In addition, there were an estimated 3,200
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.
40
Item 6. Selected Financial Data
- ------- -----------------------
Year Ended December 31
-----------------------------------------------------------------------
2000 1999 1998 1997 1996
---- ---- ---- ---- ----
Income Statement Data (for period ended): (Dollars in thousands, except per share amounts)
Premiums written:
Direct.................................. $ 76,867 $ 65,381 $ 52,974 $ 40,083 $ 26,152
Assumed..................................... 8 11 13 20 26
Ceded....................................... (4,993) (1,665) (1,090) (1,772) (2,217)
----------- ----------- ----------- ------------ ------------
$ 71,882 $ 63,727 $ 51,897 $ 38,331 $ 23,961
=========== =========== =========== ============ ============
Earned premiums.................................. $ 71,843 $ 63,970 $ 52,822 $ 38,522 $ 24,727
Net investment income............................ 12,645 10,546 9,289 6,234 5,447
Realized investments gains (losses).............. 286 1,153 880 34 (162)
Other income..................................... 37 13 14 8 --
----------- ----------- ----------- ------------ ------------
Total revenues.......................... 84,811 75,682 63,005 44,798 30,012
Net losses and loss adjustment expenses.......... 7,587 7,111 7,009 5,177 3,279
Interest expense on debt......................... 2,770 2,780 2,554 -- --
Amortization of deferred policy acquisition cost. 8,211 6,955 5,955 4,120 3,235
Other operating expenses (net of acquisition
cost deferred)........................... 16,008 15,061 12,435 10,257 7,259
----------- ----------- ----------- ------------ ------------
Income before income taxes....................... 50,235 43,775 35,052 25,244 16,239
Income taxes..................................... 15,237 13,365 10,678 8,002 5,042
----------- ----------- ----------- ------------ ------------
Net income....................................... $ 34,998 $ 30,410 $ 24,374 $ 17,242 $ 11,197
=========== =========== =========== ============ ============
Basic earnings per share (1)................ $ 2.63 $ 2.28 $ 1.83 $ 1.30 $ 0.84
Diluted earnings per share (1).............. $ 2.55 $ 2.23 $ 1.76 $ 1.26 $ 0.83
----------- ----------- ----------- ------------ ------------
Weighted average common and common share
equivalents outstanding (1)
Basic .................................. 13,321,901 13,312,104 13,342,749 13,291,160 13,277,853
Diluted................................. 13,726,088 13,640,716 13,843,382 13,713,538 13,541,551
Balance Sheet Data (at year end):
Total assets (2)............................ $ 328,377 $ 263,141 $ 230,512 $ 155,272 $ 122,397
Total invested assets....................... $ 232,025 $ 191,564 $ 177,301 $ 119,877 $ 98,027
Losses and loss adjustment expenses......... $ 14,987 $ 14,751 $ 12,143 $ 8,960 $ 6,305
Unearned premiums........................... $ 6,933 $ 6,831 $ 7,055 $ 7,988 $ 8,216
Long-term debt ............................. $ 34,467 $ 34,462 $ 34,457 $ -- $ --
Stockholders' equity........................ $ 199,831 $ 157,072 $ 137,531 $ 111,781 $ 91,680
Statutory Ratios (3):
Loss ratio.................................. 10.6% 11.1% 13.3% 14.2% 16.0%
Expense ratio............................... 37.4% 40.5% 42.3% 42.5% 49.6%
----------- ----------- ----------- ------------ ------------
Combined ratio.............................. 48.0% 51.6% 55.6% 56.7% 65.6%
=========== =========== =========== ============ ============
GAAP Ratios:
Loss ratio.................................. 10.6% 11.1% 13.3% 13.4% 13.3%
Expense ratio............................... 33.7% 34.5% 35.4% 37.5% 43.8%
----------- ----------- ----------- ------------ ------------
Combined ratio.............................. 44.3% 45.6% 48.7% 50.9% 57.1%
=========== =========== =========== ============ ============
Other Statutory Data (dollars in millions) (3):
Direct insurance in force................... $ 15,123.5 $ 13,038.0 $ 11,256.6 $ 9,176.7 $ 6,556.3
Direct risk in force (gross)................ $ 3,760.0 $ 3,222.5 $ 2,777.4 $ 2,231.4 $ 1,515.4
Risk-to-capital............................. 14.8:1 15.4:1 16.2:1 19.3:1 15.8:1
(1) Periods have been restated to reflect the two-for-one stock split on October 28, 1997.
(2) Periods prior to 1999 have 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.
41
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------- FINANCIAL CONDITION AND RESULTS OF OPERATION
--------------------------------------------
RESULTS OF OPERATIONS
2000 COMPARED TO 1999
Net income for 2000 increased 15.1% to $35.0 million compared to $30.4
million in 1999. This improvement is attributable primarily to a 12.3% increase
in earned premiums, a 19.9% increase in net investment income, and an improved
combined loss and expense ratio for all of 2000.
Net income per share on a diluted basis increased 14.4% to $2.55 for 2000
compared to $2.23 per share for 1999. Included in 2000 earnings per share is
$0.01 per share of net realized investment gains compared to $0.06 per share in
1999. Operating earnings per share, which exclude net realized investment gains,
were $2.54 for 2000 compared to $2.17 for 1999, an increase of 16.6%.
Net new insurance written was $4.4 billion for 2000, a decrease of less
than 1% from 1999 levels. For the fourth quarter, net new insurance written
increased 49.7% to $1.3 billion in 2000 compared to $892 million in 1999. Triad
achieved this level of new insurance written during a year in which industry new
insurance written decreased 13.6%, although this decline moderated substantially
in the third and fourth quarters. For 2000, new insurance written was driven by
expanded relationships with national lenders as well as innovative product
offerings. According to industry data, Triad's national market share of new
insurance written increased to 2.7% for all of 2000 (3.1% in the fourth quarter)
from 2.3% for all of 1999. Total direct insurance in force reached $15.1 billion
at December 31, 2000, compared to $13.0 billion at December 31, 1999, an
increase of 16.0%.
Total direct premiums written were $76.9 million for 2000, an increase of
17.6% compared to $65.4 million for 1999. Net premiums written increased by
12.8% to $71.9 million in 2000 compared to $63.7 million for 1999. Earned
premiums increased 12.3% to $71.8 million for 2000 from $64.0 million for 1999.
This growth in written and earned premium resulted from both new insurance
production in 2000 and an improvement in the Company's persistency. The growth
in direct premiums written was offset somewhat by the increase in ceded premium
written. Driven primarily by increases in risk-sharing arrangements and excess
of loss reinsurance, ceded premium written for 2000 increased 200% to $5.0
million compared to $1.7 million in 1999. Approximately 42.9% of new insurance
written in 2000 was subject to captive mortgage reinsurance and similar
arrangements compared to 22.9% in 1999. Management anticipates ceded premiums
will continue to increase as a result of the expected increase in risk-sharing
programs.
42
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------- FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
----------------------------------------------------------
Refinance activity was 13.2% (15.2% in the fourth quarter) of new insurance
written in 2000 compared to 25.0% (11.5% in the fourth quarter) in 1999,
reflecting the continued rise in interest rates through the first six months of
the year. Persistency, or the amount of insurance in force remaining from
one-year prior, was 82.6% at December 31, 2000, compared to 77.1% at December
31, 1999.
Net investment income for 2000 was $12.6 million, a 19.9% increase over
$10.5 million in 1999. This increase in investment income is the result of
growth in the average book value of invested assets by $28.0 million to $212.0
million for the year ended December 31, 2000, from $184.0 million for 1999. The
growth in invested assets is attributable to normal operating cash flow. The
pre-tax yield on average invested assets increased to 6.0% for 2000 as compared
to 5.7% for all of 1999. The portfolio's tax-equivalent yield was 8.2% for 2000
versus 7.7% for 1999. Approximately 69% or $139.9 million of the Company's fixed
maturity portfolio at December 31, 2000, was composed of state and municipal
tax-preferred securities as compared to approximately 71% or $124.4 million at
December 31, 1999.
The Company realized net investment gains of approximately $290,000 during
2000 compared to $1.2 million in 1999. For the fourth quarter of 2000, the
Company realized net investment losses of approximately $1.4 million, which were
primarily attributable to a repositioning of the fixed maturity portfolio.
Net losses and loss adjustment expenses (net of reinsurance recoveries)
increased by 6.7% in 2000 to $7.6 million compared to $7.1 million in 1999. 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
highest claim frequency years.
The Company's loss ratio (the ratio of net incurred losses to earned
premiums) was 10.6% for 2000 compared to 11.1% for 1999. The loss ratio was
10.6% for the fourth quarter of 2000 compared to 7.8% for the fourth quarter of
1999. The Company's favorable loss ratio reflects the low level of delinquencies
compared to the number of insured loans and the fact that approximately 75% (79%
at year-end 1999) 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 does not expect its loss ratio to remain at its current
low level and expects incurred losses to increase as a greater amount of
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 affect earnings, it is impossible to predict with any
degree of certainty the impact of such higher claim frequencies on future
earnings.
43
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------- FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
----------------------------------------------------------
Amortization of deferred policy acquisition costs increased by 18.1% to
$8.2 million in 2000 compared to $7.0 million for 1999. The increase in
amortization reflects a growing balance of deferred policy acquisition costs to
amortize as the Company builds its total insurance in force.
Other operating expenses increased 6.3% to $16.0 million for 2000 compared
to $15.1 million for the same period in 1999. 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 production. Amortization of the
company's policy administration system began in December of 2000 and accounted
for approximately $129,000 of other operating expenses. Amortization of this
system is expected to contribute approximately $1.5 million to other operating
expenses in 2001.
The expense ratio (ratio of underwriting expenses to net premiums written)
for 2000 was 33.7% compared to 34.5% for 1999. Contributing to this improvement
is the higher level of written premiums in 2000 partially offset by the increase
in expenses.
The effective tax rate for 2000 was 30.3% compared to 30.5% in 1999. For
the fourth quarter of 2000, the effective tax rate was 29.6%. The lower fourth
quarter rate was primarily the result of a higher percentage of pre-tax income
being generated from tax-preferred securities. Management expects the Company's
effective tax rate to remain at about the same annual rate as long as yields
from new funds invested in tax-preferred securities remain favorable in relation
to fully taxable securities.
1999 COMPARED TO 1998
Net income for 1999 increased 24.8% to $30.4 million compared to $24.4
million in 1998. This improvement was 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. Included in 1999 earnings per share is
$0.06 per share of net realized investment gains compared to $0.04 per share in
1998. Operating earnings per share, which exclude net realized investment gains,
were $2.17 for 1999 compared to $1.72 for 1998, an increase of 26.5%.
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
44
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------- FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
----------------------------------------------------------
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 approximately 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. In 1999,
22.9% of new insurance written 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 52.8% over 1998.
Refinance activity was 25.0% (11.5% in the fourth quarter) of new insurance
written in 1999 compared to 31.7% (34.3% in the fourth quarter) 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.
Net investment income for 1999 was $10.5 million, a 13.5% increase over
$9.3 million in 1998. This increase in investment income was the result of
growth in the average book value of invested assets by $32.3 million to $184.0
million for the year ended December 31, 1999, from $151.7 million for 1998. The
growth in invested assets was attributable to normal operating cash flow. The
pre-tax yield on average invested assets declined to 5.7% for 1999 as compared
to 6.1% for all of 1998, reflecting the Company's 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 approximately 70% or $107.5 million at
December 31, 1998.
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
45
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------- FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
----------------------------------------------------------
increase reflected the growing amount of the Company's insurance in force and
the resulting recognition of a greater amount of insurance in force reaching its
highest claim frequency years.
The Company's loss ratio (the ratio of net 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 reflected the low level of delinquencies
compared to the number of insured loans and the fact that approximately 79% (78%
at year-end 1998) of the Company's insurance in force was originated in the last
36 months.
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 reflected 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 was
primarily attributable to advertising, personnel, and facilities and equipment
costs required to support the Company's product development, technology
enhancements, geographic expansion, and 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
was 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%. This effective rate
reflected the Company's continued investments 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 2000
of $32.7 million compared to $30.8 million for 1999. The increase in operating
cash flow reflects the growth in insurance written, insurance in force, and
Triad's investment portfolio, partially offset by the increase in paid claims
and other operating 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
payments of claims and expenses. Cash flow shortfalls, if any, could be funded
through sales of short-term investments and other investment portfolio
securities.
46
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------- FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
----------------------------------------------------------
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 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 $232.0 million at December 31, 2000,
compared to $191.6 million at December 31, 1999. Fixed maturity securities and
equity securities classified as available-for-sale totaled $215.0 million at the
end of 2000. Net unrealized investment gains were $1.5 million on equity
securities and $2.1 million on fixed maturity securities at December 31, 2000.
The fixed maturity portfolio consisted of approximately 69% municipal
securities, 24% corporate securities, 6% U.S. government obligations, and 1%
mortgage-backed bonds at December 31, 2000.
Fixed maturity securities represent approximately 88% of the Company's
invested assets at December 31, 2000, 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.
In December 2000, the Company completed the initial phase of its policy
management system conversion and began amortization of the system asset. The
Company incurred approximately $7.7 million for this phase of its policy system
conversion and upgrade, and the Company has funded this project through cash
flow from operations. This new system will be amortized over 60 months.
Amortization on the system began in December of 2000.
The Company's loss reserves increased to $15.0 million at December 31,
2000, compared to $14.8 million at December 31, 1999. 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 that are not currently in
default. The Company's reserves per delinquent loan were $20,300 at December 31,
2000, compared to $21,400 at December 31, 1999. The Company's delinquency ratio,
the ratio of delinquent insured loans to total insured loans, was 0.60% at
December 31, 2000, compared to 0.64% at December 31, 1999.
47
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ------- FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
----------------------------------------------------------
Total stockholders' equity increased to $199.8 million at December 31,
2000, from $157.1 million at December 31, 1999. This increase resulted primarily
from net income of $35.0 million and net unrealized gains on invested assets
classified as available-for-sale of $7.1 million (net of income tax).
Triad's total statutory policyholders' surplus increased to $101.0 million
at December 31, 2000, from $94.6 million at December 31, 1999. This increase
resulted primarily from statutory net income of $47.8 million, offset by
increases in the statutory contingency reserve of $36.9 million and in
non-admitted assets of $3.9 million. Triad's statutory earned surplus was $17.3
million at December 31, 2000, compared to $10.9 million at December 31, 1999,
reflecting, primarily, growth in statutory net income greater than the increase
in the statutory contingency reserve. Approximately $540,000 and $1.0 million of
the statutory earned surplus for December 31, 2000, and December 31, 1999,
respectively, was attributable to unrealized gains. The balance in the statutory
contingency reserve was $150.8 million at December 31, 2000, compared to $113.8
million at December 31, 1999.
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, 2000, Triad's risk-to-capital ratio was 14.8-to-1 as compared to
15.4-to-1 at December 31, 1999, and 13.5-to-1 for the industry as a whole at
December 31, 1999, the latest industry data available.
48
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.
49
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 2001 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 2001
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 2001
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 2001
Annual Meeting of Stockholders, and is hereby incorporated by reference.
50
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, 2000.
(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 separate section of this report.
51
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 21st day of
March, 2001.
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 21st day of March, 2001 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
52
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, 2000
TRIAD GUARANTY INC.
WINSTON-SALEM, NORTH CAROLINA
53
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
(Item 14(a) 1 and 2)
CONSOLIDATED FINANCIAL STATEMENTS Page
--------------------------------- ----
Report of Independent Auditors..................................... 57
Consolidated Balance Sheets at December 31, 2000 and 1999.......... 58 - 59
Consolidated Statements of Income for each of the three years
in the period ended December 31, 2000........................... 60
Consolidated Statements of Changes in Stockholders' Equity for
each of the three years in the period ended December 31, 2000... 61
Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 2000..................... 62
Notes to Consolidated Financial Statements......................... 63 - 80
FINANCIAL STATEMENT SCHEDULES
- -----------------------------
Schedules at and for each of the three years in the period ended December 31,
2000
Schedule I - Summary of Investments - Other Than
Investments in Related Parties............................... 81
Schedule II - Condensed Financial Information of Registrant..... 82 - 86
Schedule IV - Reinsurance....................................... 87
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.
54
Index To Exhibits
(Item 14(a) 3)
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------ ----------------------
3.1 Certificate of Incorporation of the Registrant, as amended (5)
(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.(6)
(Exhibit 4.2)
10.1 1993 Long-Term Stock Incentive Plan (1)(3) (Exhibit 10(a))
10.3 Agreement for Administrative Services among Triad Guaranty Insurance
Corporation and CollateralInvestment 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)
10.16 Economic Value Added Incentive Bonus Program (Senior Management)
(4) (Exhibit 10.16)
55
10.17 Amendment to Employment Agreement between the Registrant and
Darryl W. Thompson (3)(4) (Exhibit 10.17)
10.18 Amendment to Employment Agreement between the Registrant and
John H. Williams (3)(4) (Exhibit 10.18)
10.19 Amendment to Employment Agreement between the Registrant and
Henry B. Freeman (3)(4) (Exhibit 10.19)
10.20 Amendment to Employment Agreement between the Registrant and
Ron D. Kessinger (3)(4) (Exhibit 10.20)
10.21 Excess of Loss Reinsurance Agreement between Triad Guaranty
Insurance Corporation, Capital Mortgage Reinsurance Company, and
Federal Insurance Company. (7) (Exhibit 10.21)
* 10.22 Excess of Loss Reinsurance Agreement between Triad Guaranty
Insurance Corporation and Ace Capital Mortgage Reinsurance Company.
(Exhibit 10.22)
21.1 Subsidiaries of the Registrant (7) (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 1996 Form 10-K.
(5) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the June 30, 1997 Form 10-Q.
(6) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the 1997 Form 10-K.
(7) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the 1999 Form 10-K.
56
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, 2000 and 1999, 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, 2000. 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, 2000 and 1999, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2000, in conformity with accounting principles
generally accepted in the United States.
/s/ERNST & YOUNG LLP
Winston-Salem, North Carolina
January 17, 2001
57
Triad Guaranty Inc.
Consolidated Balance Sheets
December 31
2000 1999
-----------------------------------
Assets
Invested assets:
Securities available-for-sale, at fair value:
Fixed maturities (amortized
cost: 2000-$201,780,191;
1999-$173,978,864) $ 203,924,652 $ 164,579,416
Equity securities (cost: 2000-$9,630,441;
1999-$10,952,390) 11,088,525 13,075,648
Short-term investments 17,012,080 13,908,666
-----------------------------------
232,025,257 191,563,730
Cash 1,512,578 215,553
Real estate 99,482 145,515
Accrued investment income 2,896,977 2,591,612
Deferred policy acquisition costs 22,815,422 19,906,877
Property and equipment, at cost less accumulated
depreciation (2000-$3,867,336; 1999-$3,009,638) 9,234,757 5,915,262
Prepaid federal income tax 49,374,666 35,415,666
Reinsurance recoverable 5,587 29,980
Other assets 10,411,877 7,356,357
-----------------------------------
Total assets $ 328,376,603 $ 263,140,552
===================================
58
December 31
2000 1999
------------------------------------
Liabilities and stockholders' equity
Liabilities:
Losses and loss adjustment expenses $ 14,986,988 $ 14,751,348
Unearned premiums 6,933,259 6,831,290
Amounts payable to reinsurer 1,288,712 319,294
Current taxes payable 85,062 70,272
Deferred income taxes 60,651,647 41,750,341
Unearned ceding commission 1,481,691 400,521
Long-term debt 34,467,285 34,461,979
Accrued interest on debt 1,274,972 1,274,972
Accrued expenses and other liabilities 7,375,503 6,208,079
-----------------------------------
Total liabilities 128,545,119 106,068,096
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 13,351,694 shares at December 31,
2000 and 13,303,194 at December 31, 1999
133,517 133,032
Additional paid-in capital 62,723,667 61,972,312
Accumulated other comprehensive income, net of
income tax liability of $1,262,863 at
December 31, 2000 and income tax
asset of $2,546,666 at December 31, 1999 2,351,065 (4,723,775)
Deferred compensation (135,041) (69,414)
Retained earnings 134,758,276 99,760,301
-----------------------------------
Total stockholders' equity 199,831,484 157,072,456
-----------------------------------
Total liabilities and stockholders' equity $ 328,376,603 $ 263,140,552
===================================
See accompanying notes.
59
Triad Guaranty Inc.
Consolidated Statements of Income
Year ended December 31
2000 1999 1998
-------------------------------------------------
Revenue:
Premiums written:
Direct $ 76,867,728 $65,380,631 $52,973,589
Assumed 7,776 11,377 13,052
Ceded (4,993,059) (1,665,179) (1,089,955)
-------------------------------------------------
Net premiums written 71,882,445 63,726,829 51,896,686
Change in unearned premiums (39,355) 242,971 925,045
-------------------------------------------------
Earned premiums 71,843,090 63,969,800 52,821,731
Net investment income 12,645,321 10,545,663 9,289,026
Net realized investment gains 285,849 1,153,191 880,502
Other income 36,785 13,039 13,652
-------------------------------------------------
84,811,045 75,681,693 63,004,911
Losses and expenses:
Losses and loss adjustment expenses 7,562,228 7,121,002 7,005,420
Reinsurance recoveries 25,009 (9,686) 3,198
-------------------------------------------------
Net losses and loss adjustment expenses 7,587,237 7,111,316 7,008,618
Interest expense on debt 2,770,307 2,779,915 2,554,126
Amortization of deferred policy
acquisition costs 8,210,776 6,955,273 5,954,915
Other operating expenses (net of
acquisition costs deferred) 16,008,210 15,060,376 12,434,890
-------------------------------------------------
34,576,530 31,906,880 27,952,549
-------------------------------------------------
Income before income taxes 50,234,515 43,774,813 35,052,362
Income taxes:
Current 14,996 24,166 38,928
Deferred 15,221,544 13,340,340 10,639,361
-------------------------------------------------
15,236,540 13,364,506 10,678,289
-------------------------------------------------
Net income $ 34,997,975 $30,410,307 $24,374,073
=================================================
Earnings per common and common
equivalent share:
Basic $ 2.63 $ 2.28 $ 1.83
Diluted $ 2.55 $ 2.23 $ 1.76
=================================================
Shares used in computing earnings per
common and common equivalent share:
Basic 13,321,901 13,312,104 13,342,749
Diluted 13,726,088 13,640,716 13,843,382
=================================================
See accompanying notes.
60
Triad Guaranty Inc.
Consolidated Statements of Changes in Stockholders' Equity
Accumulated
Additional Other
Common Paid-In Comprehensive Deferred Retained
Stock Capital Income Compensation Earnings Total
--------------------------------------------------------------------------------------
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
Net income - - - - 34,997,975 34,997,975
Other comprehensive income - net of
tax:
Change in unrealized gain - - 7,074,840 - - 7,074,840
-------------
Comprehensive income 42,072,815
Issuance of 41,500 shares of common
stock under stock option plans 415 471,157 - - - 471,572
Tax effect of exercise of
non-qualified stock options - 129,768 - - - 129,768
Issuance of 7,000 shares of
restricted stock 70 150,430 - (150,500) - -
Amortization of deferred
compensation - - - 84,873 - 84,873
--------------------------------------------------------------------------------------
Balance at December 31, 2000 $ 133,517 $ 62,723,667 $ 2,351,065 $ (135,041) $ 134,758,276 $ 199,831,484
======================================================================================
See accompanying notes.
61
Triad Guaranty Inc.
Consolidated Statements of Cash Flows
Year ended December 31
2000 1999 1998
--------------------------------------------
OPERATING ACTIVITIES
Net income $ 34,997,975 $ 30,410,307 $ 24,374,073
Adjustments to reconcile net income to net
cash provided by operating activities:
Loss and unearned premium reserves 337,609 2,384,911 2,248,974
Accrued expenses and other liabilities 1,167,424 2,033,465 1,450,310
Current taxes payable 14,790 24,485 42,469
Amounts due to/from reinsurer 931,198 875,266 (547,469)
Accrued investment income (305,365) (332,734) (798,710)
Policy acquisition costs deferred (11,119,321) (10,846,591) (9,383,119)
Amortization of policy acquisition costs 8,210,776 6,955,273 5,954,915
Net realized investment gains (285,849) (1,153,191) (880,502)
Provision for depreciation 859,879 720,456 750,097
Accretion of discount on investments (1,577,713) (1,046,470) (1,013,820)
Deferred income taxes 15,221,544 13,340,340 10,557,543
Prepaid federal income taxes (13,959,000) (10,159,000) (8,964,000)
Unearned ceding commission 1,081,170 (220,640) 621,161
Accrued interest on debt - - 1,274,972
Other assets (2,992,907) (2,158,206) (2,559,112)
Other operating activities 136,214 (50,215) 192,489
--------------------------------------------
Net cash provided by operating activities 32,718,424 30,777,456 23,320,271
INVESTING ACTIVITIES
Securities available-for-sale:
Purchases - fixed maturities (51,835,382) (45,489,517) (74,664,883)
Sales - fixed maturities 23,279,996 26,280,714 17,449,277
Purchases - equities (1,663,169) (3,216,099) (7,507,782)
Sales - equities 5,608,372 5,035,504 5,591,607
Purchases of property and equipment (4,179,374) (3,191,320) (1,665,430)
---------------------------------------------
Net cash used in investing activities (28,789,557) (20,580,718) (60,797,211)
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 471,572 200,273 955,856
--------------------------------------------
Net change in financing activities 471,572 (2,401,911) 35,111,933
Net change in cash and short-term investments 4,400,439 7,794,827 (2,365,007)
Cash and short-term investments at beginning of year 14,124,219 6,329,392 8,694,399
--------------------------------------------
Cash and short-term investments at end of year $ 18,524,658 $ 14,124,219 $ 6,329,392
============================================
SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION
Cash paid during the period for:
Income taxes and United States Mortgage
Guaranty Tax and Loss Bonds $ 13,959,208 $ 10,158,677 $ 8,963,726
Interest 2,765,000 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.
62
Triad Guaranty Inc.
Notes to Consolidated Financial Statements
December 31, 2000
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 subsidiary, Triad Guaranty Insurance Corporation ("Triad"),
and Triad's wholly-owned subsidiaries Triad Guaranty Assurance Corporation
("TGAC") and Triad Re Insurance Corporation ("Triad Re"). Triad Re, a sponsored
captive reinsurance company, is domiciled in Vermont and began operations in
2000. All significant intercompany accounts and transactions have been
eliminated.
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
INVESTMENTS
Securities classified as "available-for-sale" are carried at fair value and
unrealized gains and losses on such securities, net of tax, 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".
63
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
1. ACCOUNTING POLICIES (CONTINUED)
Fair value generally represents quoted market value prices for securities traded
in the public market or prices analytically determined using bid or closing
prices for securities not traded in the public marketplace. Realized investment
gains or losses are determined 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, generally three to ten
years, of the 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.
64
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
1. ACCOUNTING POLICIES (CONTINUED)
REINSURANCE
Certain premiums and losses are assumed from and ceded to other insurance
companies under various reinsurance agreements. Reinsurance premiums, claim
reimbursement, and reserves related to reinsurance business are accounted for on
a basis consistent with those used in accounting for the original policies
issued and the terms of the reinsurance contracts. The Company may receive a
ceding commission in connection with ceded reinsurance. If so, 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.
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. Purchases of these Tax and Loss Bonds are 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 generally are earned in the month that coverage is provided.
65
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
1. ACCOUNTING POLICIES (CONTINUED)
STOCK OPTIONS
The Company grants stock options for a fixed number of shares to employees with
an exercise price equal to or greater than the fair value of the shares at the
date of grant. The Company accounts for stock option grants in accordance with
APB Opinion No. 25, Accounting for Stock Issued to Employees, and, accordingly,
recognizes no compensation expense for the stock option grants.
EARNINGS PER SHARE
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.
2000 1999 1998
-------------------------------------------
Unrealized gains (losses)
arising during the
period, before taxes $ 11,170,218 $ (12,126,338) $ 115,278
Income taxes (3,909,576) 4,244,218 (40,347)
-------------------------------------------
Unrealized gains (losses)
arising during the
period, net of taxes 7,260,642 (7,882,120) 74,931
-------------------------------------------
Less reclassification adjustment:
Gains realized in net income 285,849 1,153,191 880,502
Income taxes (100,047) (403,616) (308,176)
-------------------------------------------
Reclassification adjustment for
gains realized in net income 185,802 749,575 572,326
-------------------------------------------
Other comprehensive income -
change in unrealized gains $ 7,074,840 $ (8,631,695) $ (497,395)
===========================================
66
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
1. ACCOUNTING POLICIES (CONTINUED)
NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities (SFAS 133), which was effective for all fiscal quarters
of all fiscal years beginning after June 15, 2000. The statement establishes
accounting and reporting standards for derivative instruments and for hedging
activities. Management has determined that the adoption of SFAS 133 will have no
impact on the Company's results of operations or its financial position due to
its limited use of derivative instruments.
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, 2000
Available-for-sale securities:
Fixed maturity securities:
Corporate $ 47,986,616 $ 949,415 $ 2,952,735 $ 45,983,296
U.S. Government 12,933,975 332,841 28,503 13,238,313
Mortgage-backed 933,215 48,030 - 981,245
State and municipal 139,926,385 4,880,661 1,085,248 143,721,798
------------------------------------------------------------
Total 201,780,191 6,210,947 4,066,486 203,924,652
Equity securities 9,630,441 2,022,360 564,276 11,088,525
------------------------------------------------------------
Total $ 211,410,632 $ 8,233,307 $ 4,630,762 $ 215,013,177
============================================================
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
============================================================
67
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
2. INVESTMENTS (CONTINUED)
The amortized cost and estimated fair value of investments in fixed maturity
securities, at December 31, 2000, are summarized by stated maturity as follows:
Available-for-Sale
--------------------------------
Fair
Amortized Cost Value
--------------------------------
Maturity:
One year or less $ 3,811,041 $ 3,864,589
After one year through five years 23,372,340 23,426,372
After five years through ten years 31,492,288 30,841,881
After ten years 142,171,307 144,810,565
Mortgage-backed securities 933,215 981,245
---------------------------------
Total $ 201,780,191 $ 203,924,652
=================================
Realized gains and losses on sales of investments are as follows:
Year ended December 31
2000 1999 1998
-----------------------------------------
Securities available-for-sale:
Fixed maturity securities:
Gross realized gains $ 225,989 $ 468,368 $ 307,255
Gross realized losses (2,255,251) (613,015) (73,329)
Equity securities:
Gross realized gains 2,560,569 1,430,241 707,695
Gross realized losses (401,663) (208,956) (91,425)
Other investments:
Gross realized gains 156,205 129,864 30,306
Gross realized losses - (53,311) -
-----------------------------------------
Net realized gains $ 285,849 $ 1,153,191 $ 880,502
=========================================
Net unrealized appreciation (depreciation) on fixed maturity securities changed
by $11,543,909, $(12,923,040) and $(445,759), in 2000, 1999 and 1998,
respectively; the corresponding amounts for equity securities were $(665,174),
$(350,244) and $(325,711).
68
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
2. INVESTMENTS (CONTINUED)
Major categories of the Company's net investment income are summarized as
follows:
Year ended December 31
2000 1999 1998
-------------------------------------------
Income:
Fixed maturities $ 11,754,951 $ 9,863,671 $ 8,625,387
Preferred stocks 490,002 392,297 280,032
Common stocks 230,446 268,091 256,918
Cash and short-term investments 635,272 465,544 494,565
-------------------------------------------
13,110,671 10,989,603 9,656,902
Expenses 465,350 443,940 367,876
-------------------------------------------
Net investment income $ 12,645,321 $ 10,545,663 $ 9,289,026
===========================================
At December 31, 2000 and 1999, investments with an amortized cost of $6,537,653
and $6,445,356, 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
2000 1999 1998
-----------------------------------------
Balance at beginning of year $ 19,906,877 $ 16,015,559 $ 12,587,355
Acquisition costs deferred:
Sales compensation 5,218,844 5,361,233 4,926,075
Underwriting and issue expenses 5,900,477 5,485,358 4,457,044
-----------------------------------------
11,119,321 10,846,591 9,383,119
Amortization of acquisition expenses 8,210,776 6,955,273 5,954,915
-----------------------------------------
Net increase 2,908,545 3,891,318 3,428,204
-----------------------------------------
Balance at end of year $ 22,815,422 $ 19,906,877 $ 16,015,559
=========================================
69
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
4. RESERVE FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity for the reserve for unpaid losses and loss adjustment expenses for
2000, 1999 and 1998 is summarized as follows:
2000 1999 1998
----------------------------------------
Reserve for losses and loss
adjustment expenses at January 1,
net of reinsurance recoverables $ 14,723,192 $ 12,115,934 $ 8,909,121
Incurred losses and loss adjustment
expenses net of reinsurance
recoveries (principally in respect
of default notices occurring in):
Current year 11,229,124 9,322,142 7,953,412
Redundancy on prior years (3,641,887) (2,210,826) (944,794)
---------------------------------------
Total incurred losses and loss
adjustment expenses 7,587,237 7,111,316 7,008,618
Loss and loss adjustment expense
payments net of reinsurance recoveries
(principally in respect of default
notices occurring in):
Current year 573,874 236,250 266,983
Prior years 6,760,375 4,267,808 3,534,822
----------------------------------------
Total loss and loss adjustment
expense payments 7,334,249 4,504,058 3,801,805
----------------------------------------
Reserve for losses and loss adjustment
expenses at December 31, net of
reinsurance recoverables of $10,808,
$28,156, and $27,056 in 2000, 1999
and 1998, respectively $ 14,976,180 $ 14,723,192 $ 12,115,934
========================================
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.
70
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
5. COMMITMENTS
The Company leases certain office facilities and equipment under operating
leases. Rental expense for all leases was $1,398,586, $1,154,671, and $902,866
for 2000, 1999, and 1998, respectively. Future minimum payments under
noncancellable operating leases at December 31, 2000 are as follows:
2001 $ 1,197,332
2002 834,805
2003 294,851
2004 20,787
Thereafter 7,591
-----------
$ 2,355,366
===========
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:
2000 1999 1998
----------------------------------------------
Income tax computed at
statutory rate $ 17,582,080 $ 15,321,185 $ 12,268,326
Increase (decrease) in
taxes resulting from:
Tax-exempt interest (2,640,938) (2,095,576) (1,559,067)
Other 295,398 138,897 (30,970)
----------------------------------------------
Income tax expense $ 15,236,540 $ 13,364,506 $ 10,678,289
==============================================
71
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
6. FEDERAL INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant portions
of deferred tax assets and deferred tax liabilities at December 31, 2000 and
1999 are presented below:
2000 1999
--------------------------------
Deferred tax liabilities
Statutory contingency reserve $ 51,025,055 $ 37,382,052
Deferred policy acquisition costs 7,985,398 6,967,407
Unrealized investment gain 1,262,863 -
Other 2,859,749 2,131,148
--------------------------------
Total deferred tax liabilities 63,133,065 46,480,607
Deferred tax assets
Exercise of employee stock options 1,176,185 1,046,418
Unearned premiums 535,471 514,658
Capital loss carryforward 280,356 149,680
Losses and loss adjustment expenses 368,630 365,981
Unrealized investment loss - 2,546,666
Other 120,776 106,863
--------------------------------
Total deferred tax assets 2,481,418 4,730,266
--------------------------------
Net deferred tax liability $ 60,651,647 $ 41,750,341
================================
At December 31, 2000 and 1999, Triad was obligated to purchase approximately
$537,000 and $726,000 respectively, of Tax and Loss Bonds.
72
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
7. INSURANCE IN FORCE, DIVIDEND RESTRICTION AND STATUTORY RESULTS
Approximately 56% of Triad's net risk in force is concentrated in seven states
including 12% in California, 10% in Illinois, 8% in Georgia, 8% in Florida, 8%
in Texas, 6% in North Carolina, and 4% in Pennsylvania. 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, 2000 and 1999, 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:
2000 1999
----------------------------------
Net risk $ 3,738,596,850 $ 3,218,850,073
==================================
Statutory capital and surplus $ 101,045,355 $ 94,602,027
Contingency reserve 150,762,722 113,813,344
----------------------------------
Total $ 251,808,077 $ 208,415,371
==================================
Risk-to-capital ratio 14.8 to 1 15.4 to 1
==================================
Triad and its wholly-owned subsidiaries, Triad Guaranty Assurance Corporation
and Triad Re Insurance Corporation are each required under their respective
domiciliary states' insurance code to maintain a minimum level of statutory
capital and surplus. Triad, an Illinois domiciled insurer, is required under the
Illinois Insurance Code (the "Code") to maintain minimum statutory capital and
surplus of $5,000,000.
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 $47,830,174,
$40,019,488, and $31,252,891 for the years ended December 31, 2000, 1999 and
1998, respectively. At December 31, 2000, the amount of the Company's equity
that can be paid out in dividends to the stockholders is $17,329,427, which is
the earned surplus of Triad on a statutory basis.
73
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
7. INSURANCE IN FORCE, DIVIDEND RESTRICTION AND STATUTORY RESULTS (CONTINUED)
The NAIC revised the Accounting Practices and Procedures Manual in a process
referred to as Codification. The revised manual will be effective January 1,
2001. The domiciliary states of Triad and its subsidiaries have adopted the
provisions of the revised manual. The revised manual has changed, to some
extent, prescribed statutory accounting practices and will result in changes to
the accounting practices that Triad and its subsidiaries use to prepare their
statutory-basis financial statements. Management believes the impact of these
changes to Triad and its subsidiaries statutory-basis capital and surplus as of
January 1, 2001 will not be significant.
8. RELATED PARTY TRANSACTIONS
The Company pays unconsolidated affiliated companies for management, investment,
and other services. The total expense incurred for such items was $398,872,
$353,432 and $336,143 in 2000, 1999, and 1998, respectively. In addition, the
Company provides certain investment accounting, reporting and maintenance
functions for an affiliate. Income earned during 2000, 1999, and 1998,
respectively, for such services was $21,780, $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 $301,281, $281,728 and
$225,797 for the years ended December 31, 2000, 1999, and 1998, 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.
74
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
10. REINSURANCE (CONTINUED)
Reinsurance activity for the years ended December 31, 2000, 1999 and 1998,
respectively is as follows:
2000 1999 1998
--------------------------------------
Earned premiums ceded $ 4,930,445 $ 1,645,655 $ 1,098,515
Losses ceded (25,009) 9,686 (3,198)
Earned premiums assumed 9,106 13,866 15,500
Losses assumed 8,514 30,057 50,241
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.
75
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
11. LONG-TERM STOCK INCENTIVE PLAN (CONTINUED)
Information concerning the stock option plan is summarized below:
Weighted-
Number of Option Average
Shares Price Exercise Price
--------------------------------------------
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
2000
Outstanding, beginning of year 1,334,447 4.58 - 49.08 14.48
Granted 193,875 18.56 - 28.00 26.91
Exercised 41,500 4.58 - 27.88 11.36
Canceled 2,100 17.00 - 41.94 23.19
Outstanding, end of year 1,484,722 4.58 - 49.08 16.17
Exercisable, end of year 1,257,142 4.58 - 49.08 14.41
76
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
11. LONG-TERM STOCK INCENTIVE PLAN (CONTINUED)
Information concerning stock options outstanding and exercisable at December 31,
2000 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
- ------------------------------------------------ -------------------------
618,650 $ 4.58 - 8.92 $ 6.23 3.20 618,650 $ 6.23
276,913 10.17 - 18.56 13.17 5.87 246,175 12.60
469,984 20.07 - 28.00 24.07 7.96 288,392 22.80
58,900 37.75 - 39.75 39.04 7.21 46,233 38.85
60,275 41.94 - 49.08 48.16 7.08 57,692 48.44
--------- ---------
1,484,722 1,257,142
========= =========
At December 31, 2000, 1,730,080 shares of the Company's common stock were
reserved and 245,358 shares were available for issuance under the Plan.
The options issued under the Plan in 2000, 1999 and 1998 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 2000, 1999, and 1998 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 5.3% for 2000, 6.5% for 1999 and 5.1% for 1998; dividend yield of 0.0%;
expected volatility of .42 for 2000, .42 for 1999 and .40 for 1998; and a
weighted-average expected life of the option of seven years.
77
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
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 2000, 1999,
and 1998:
Weighted-Average Weighted-Average
Exercise Price Fair Value
Type of Option 2000 1999 1998 2000 1999 1998
- ---------------------------- ------------------------ ----------------------
Stock Price = Exercise Price $22.38 $17.49 $37.87 $8.17 $6.74 $13.42
Stock Price < Exercise Price $27.95 $23.24 $49.08 $6.70 $5.96 $11.29
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):
2000 1999 1998
---------------------------------------
Net Income - as reported $ 34,998 $ 30,410 $ 24,374
Net Income - pro forma $ 34,107 $ 29,675 $ 23,779
Earnings per share - as reported:
Basic $ 2.63 $ 2.28 $ 1.83
Diluted $ 2.55 $ 2.23 $ 1.76
Earnings per share - pro forma:
Basic $ 2.56 $ 2.23 $ 1.78
Diluted $ 2.48 $ 2.18 $ 1.72
78
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
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 $34,452,898. 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,
2000 and 1999 are summarized below:
2000 1999
----------------------------- -------------------------
Carrying Fair Carrying Fair
Value Value Value Value
---------------------------- -------------------------
Financial Assets
Fixed maturities
available-for-sale $ 203,924,652 $ 203,924,652 $ 164,579,416 $164,579,416
Equity securities
available-for-sale 11,088,525 11,088,525 13,075,648 13,075,648
Financial Liabilities
Long-term debt 34,467,285 36,778,000 34,461,979 32,837,000
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.
79
Triad Guaranty Inc.
Notes to Consolidated Financial Statements (continued)
14. Unaudited Quarterly Financial Data
The following is a summary of the unaudited quarterly results of operations for
the years ended December 31, 2000 and 1999 (in thousands except per share data):
2000 Quarter
--------------------------------------
First Second Third Fourth Year
-----------------------------------------------
Net premiums written $ 17,063 $ 17,718 $ 18,293 $ 18,808 $ 71,882
Earned premiums 17,144 17,836 18,071 18,792 71,843
Net investment income 2,926 3,067 3,156 3,496 12,645
Net losses incurred 1,596 2,060 1,932 1,999 7,587
Underwriting and other expenses
6,804 6,723 6,482 6,980 26,989
Net income 8,652 8,486 9,484 8,376 34,998
Basic earnings per share .65 .64 .71 .63 2.63
Diluted earnings per share .63 .62 .69 .61 2.55
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
80
Schedule I
Summary of Investments - Other Than Investments in Related Parties
Triad Guaranty Inc.
December 31, 2000
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..... $ 12,934 $ 13,238 $ 13,238
Mortgage-backed securities...... 933 981 981
State and municipal bonds....... 139,926 143,722 143,722
Corporate bonds................. 46,832 44,877 44,877
Public utilities................ 1,155 1,106 1,106
-------- -------- --------
Total 201,780 203,924 203,924
-------- -------- --------
Equity securities,
available-for-sale:
Common stocks:
Public utilities.............. 105 59 59
Bank, Trust, and Insurance.... 1,076 1,844 1,844
Industrial & miscellaneous.... 2,028 2,996 2,996
Preferred Stock .................. 6,422 6,190 6,190
-------- -------- --------
Total............................ 9,631 11,089 11,089
-------- -------- --------
Short-term investments............... 17,012 17,012 17,012
-------- -------- --------
Total investments other than
investments in related parties...... $228,423 $232,025 $232,025
======== ======== ========
81
Schedule II - Condensed Financial Information of Registrant
Condensed Balance Sheets
Triad Guaranty Inc.
(Parent Company)
December 31
2000 1999
---- ----
(dollars in thousands)
Assets:
Fixed maturities, available-for-sale....... $ 6,563 $ 6,511
Notes receivable from subsidiary........... 25,000 25,000
Investment in subsidiaries................. 200,952 158,499
Cash and short-term investments............ 1,302 1,433
Accrued investment income.................. 1,221 1,206
Deferred income taxes...................... 389 230
Other assets............................... 216 -
-------- -------
Total assets............................... $235,643 $192,879
======== ========
Liabilities and stockholders' equity:
Liabilities:
Current taxes payable...................... $ 70 $ 70
Long-term debt............................. 34,467 34,462
Accrued interest on long-term debt......... 1,275 1,275
-------- -------
Total liabilities.......................... 35,812 35,807
Stockholders' equity:
Common stock............................... 134 133
Additional paid-in capital................. 62,723 61,972
Accumulated other comprehensive income..... 2,351 (4,724)
Deferred compensation..................... (135) (69)
Retained earnings.......................... 134,758 99,760
-------- --------
Total stockholders' equity.................... 199,831 157,072
-------- --------
Total liabilities and stockholders' equity.... $235,643 $192,879
======== ========
See notes to condensed financial statements.
82
Schedule II - Condensed Financial Information of Registrant
Condensed Statements of Income
Triad Guaranty Inc.
(Parent Company)
Year Ended December 31
------------------------------
2000 1999 1998
---- ---- ----
(dollars in thousands)
Revenues:
Net investment income................... $ 2,908 $ 2,875 $ 2,787
Realized investment gains............... (373) (124) 14
------- ------- -------
2,535 2,751 2,801
------- ------- -------
Expenses:
Interest on long-term debt.............. 2,770 2,780 2,554
Operating expenses...................... 90 35 5
------- ------- -------
2,860 2,815 2,559
------- ------- -------
Income (loss) before federal
income taxes and equity in
undistributed income of subsidiaries... (325) (64) 242
Income Taxes:
Current................................. - 24 38
Deferred................................ (129) (46) 42
------- ------- -------
(129) (22) 80
------- ------- -------
Income (loss) before equity
in undistributed income of
subsidiaries........................... (196) (42) 162
Equity in undistributed income
of subsidiaries........................ 35,194 30,452 24,213
------- ------- -------
Net income................................. $34,998 $30,410 $24,375
======= ======= =======
See notes to condensed financial statements.
83
Schedule II - Condensed Financial Information of Registrant
Condensed Statements of Cash Flows
Triad Guaranty Inc.
(Parent Company)
Year Ended December 31
-----------------------
2000 1999 1998
---- ---- ----
OPERATING ACTIVITIES (dollars in thousands)
Net income........................................ $34,998 $30,410 $24,375
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Equity in undistributed income of subsidiaries... (35,194) (30,452) (24,213)
Accrued investment income........................ (15) 19 (1,225)
Other assets..................................... (216) - 56
Deferred income taxes............................ (129) (46) 42
Current tax payable.............................. - 25 42
Accrued interest on long-term debt............... - - 1,275
Accretion of discount on investments............. (60) (86) (130)
Amortization of deferred compensation............ 85 34 -
Amortization of debt issue costs................. 5 5 4
Realized investment loss (gain) on securities.... 373 124 (14)
Accrued expenses and other liabilities........... - (25) (10)
------- -------- -------
Net cash (used in) provided by operating
activities.................................. (153) 8 202
INVESTING ACTIVITIES
Securities available-for-sale:
Fixed maturities:
Purchases.................................. (2,951) (3,682) (13,909)
Sales...................................... 2,501 6,282 4,276
Equity securities:
Purchases.................................. - - (300)
Sales...................................... - 284 -
Issuance of Surplus Note to subsidiary........... - - (25,000)
------- ------- -------
Net cash (used in) provided by investing
activities.................................. (450) 2,884 (34,933)
FINANCING ACTIVITIES
Proceeds from issuance of long-term debt......... - - 34,453
Proceeds from exercise of stock options.......... 472 200 956
Retirement of common stock....................... - (2,602) (297)
------- ------ ------
Net cash provided by (used in) financing
activities.................................. 472 (2,402) 35,112
------- ------- ------
Increase in cash and short-term investments....... (131) 490 381
Cash and short-term investments at
beginning of year............................ 1,433 943 562
------- ------- -------
Cash and short-term investments at end of year.... $ 1,302 $ 1,433 $ 943
======= ======= =======
See notes to condensed financial statements.
84
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
Cost Gains Losses Value
-------------------------------------------
At December 31, 2000
Available-for-sale securities:
Fixed maturity securities:
Corporate $7,292 $93 $822 $6,563
-------------------------------------------
Total 7,292 93 822 6,563
Equity Securities - - - -
-------------------------------------------
Total $7,292 $93 $822 $6,563
===========================================
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-------------------------------------------
At December 31, 1999
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
===========================================
85
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
2000 1999 1998
----------------------------
Income:
Fixed maturities $ 664 $ 645 $ 679
Equity securities - 18 17
Cash and short-term investments 55 42 71
Note receivable from subsidiary 2,225 2,225 2,052
----------------------------
2,944 2,930 2,819
Expenses 36 55 32
----------------------------
Net investment income $2,908 $2,875 $2,787
============================
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 $34,452,898. The notes, which represent unsecured
obligations of the Company, bear interest at a rate of 7.9% per annum and are
non-callable.
86
Schedule IV - Reinsurance
Triad Guaranty Inc.
Mortgage Insurance Premium Earned
Years Ended December 31, 2000, 1999 and 1998
Ceded To Assumed Percentage of
Gross Other From Other Net Amount Assumed
Amount Companies Companies Amount to Net
---------------------------------------------------------------
(dollars in thousands)
2000........ $76,764 $4,930 $9 $71,843 0.0%
======= ====== === =======
1999........ $65,602 $1,646 $14 $63,970 0.0%
======= ====== === =======
1998........ $53,905 $1,099 $16 $52,822 0.0%
======= ====== === =======
87