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FORM 10-Q
------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 2003
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from ______ to _____
Commission File Number 0-22342
TRIAD GUARANTY INC.
(Exact name of registrant as specified in its charter)
DELAWARE 56-1838519
(State of Incorporation) (I.R.S. Employer Identification Number)
101 SOUTH STRATFORD ROAD
WINSTON-SALEM, NORTH CAROLINA 27104
(Address of principal executive offices)
(336) 723-1282
(Registrant's telephone number, including area code)
------------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark whether the registrant is an accelerated filer (as
described in Exchange Act Rule 12b-2) Yes /X/ No/ /
Number of shares of Common Stock, $.01 par value, outstanding as of October 31,
2003: 14,431,138 shares.
TRIAD GUARANTY INC.
INDEX
Page
Number
Part I. Financial Information:
Item 1. Financial Statements:
Consolidated Balance Sheets as of September 30, 2003 (Unaudited)
and December 31, 2002........................................ 3
Consolidated Statements of Income for the Three and Nine Months
Ended September 30, 2003 and 2002 (Unaudited)............... 4
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2003 and 2002 (Unaudited)............... 5
Notes to Consolidated Financial Statements........................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk... 21
Item 4. Controls and Procedures...................................... 21
Part II. Other Information:
Item 1. Legal Proceedings........................................... 22
Item 2. Changes in Securities and Use of Proceeds.................... 22
Item 3. Defaults Upon Senior Securities.............................. 22
Item 4. Submission of Matters to a Vote of Security Holders.......... .22
Item 5. Other Information............................................ 22
Item 6. Exhibits and Reports on Form 8-K............................. 22
2
TRIAD GUARANTY INC.
CONSOLIDATED BALANCE SHEETS
September 30 December 31
(Dollars in thousands except per share information) 2003 2002
------------- ------------
(Unaudited)
Assets
Invested assets:
Fixed maturities, available-for-sale, at fair value $ 325,173 $ 298,470
Equity securities, available-for-sale, at fair value 12,207 10,808
Short-term investments 48,337 35,303
---------- ----------
385,717 344,581
Cash 4,271 233
Real estate 211 1,561
Accrued investment income 3,982 3,088
Deferred policy acquisition costs 29,864 28,997
Prepaid federal income taxes 92,691 77,786
Property and equipment 9,242 9,533
Reinsurance recoverable 1,047 396
Other assets 22,742 16,711
---------- ----------
Total assets $ 549,767 $ 482,886
========== ==========
Liabilities and stockholders' equity
Liabilities:
Losses and loss adjustment expenses $ 25,522 $ 21,360
Unearned premiums 14,516 8,539
Amounts payable to reinsurer 3,041 3,415
Current taxes payable 1,221 598
Deferred income taxes 108,154 94,241
Unearned ceding commission 849 1,386
Long-term debt 34,484 34,479
Accrued interest on debt 584 1,275
Accrued expenses and other liabilities 6,256 8,186
---------- ----------
Total liabilities 194,627 173,479
Commitments and contingent liabilities - Note 4 Stockholders' equity:
Preferred stock, par value $.01 per share --- authorized
1,000,000 shares; no shares issued and outstanding --- ---
Common stock, par value $.01 per share --- authorized
32,000,000 shares; issued and outstanding 14,430,395 shares
at September 30, 2003 and 14,159,601 shares at December 31, 2002 144 142
Additional paid-in capital 87,244 80,169
Accumulated other comprehensive income, net of income tax
liability of $5,603 at September 30, 2003 and $4,646 at
December 31, 2002 10,406 8,634
Deferred compensation (1,304) (658)
Retained earnings 258,650 221,120
---------- ----------
Total stockholders' equity 355,140 309,407
---------- ----------
Total liabilities and stockholders' equity $ 549,767 $ 482,886
========== ==========
See accompanying notes.
3
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Nine Months Ended
September 30 September 30
---------------------------- ---------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
(Dollars in thousands except per share information)
Revenue:
Premiums written:
Direct $ 40,448 $ 33,199 $ 112,352 $ 90,821
Assumed - 1 2 3
Ceded (7,329) (4,919) (19,715) (12,761)
----------- ----------- ----------- -----------
Net premiums written 33,119 28,281 92,639 78,063
Change in unearned premiums (2,796) (930) (5,918) (678)
----------- ----------- ----------- -----------
Earned premiums 30,323 27,351 86,721 77,385
Net investment income 4,229 4,156 12,895 11,873
Net realized investment (losses) gains 763 (446) 1,528 (2,674)
Other income 4 15 20 57
----------- ----------- ----------- -----------
35,319 31,076 101,164 86,641
----------- ----------- ----------- -----------
Losses and expenses:
Losses and loss adjustment expenses 6,056 4,390 16,703 9,787
Reinsurance recoveries (3) 2 (5) -
----------- ----------- ----------- -----------
Net losses and loss adjustment expenses 6,053 4,392 16,698 9,787
Interest expense on debt 693 693 2,079 2,078
Amortization of deferred policy acquisition costs 5,315 3,377 12,757 9,423
Other operating expenses (net of acquisition costs
deferred) 5,528 5,587 16,537 17,420
----------- ----------- ----------- -----------
17,589 14,049 48,071 38,708
----------- ----------- ----------- -----------
Income before income taxes 17,730 17,027 53,093 47,933
Income taxes:
Current 181 167 534 499
Deferred 5,002 5,095 15,029 14,341
----------- ----------- ----------- -----------
5,183 5,262 15,563 14,840
----------- ----------- ----------- -----------
Net income $ 12,547 $ 11,765 $ 37,530 $ 33,093
=========== =========== =========== ===========
Earnings per common and common equivalent share:
Basic
$ .87 $ .83 $ 2.63 $ 2.36
=========== =========== =========== ===========
Diluted
$ .86 $ .82 $ 2.59 $ 2.31
=========== =========== =========== ===========
Shares used in computing earnings per common and
common equivalent share:
Basic 14,352,980 14,139,212 14,284,781 14,031,088
=========== =========== =========== ===========
Diluted 14,558,548 14,373,988 14,470,056 14,322,151
=========== =========== =========== ===========
See accompanying notes.
4
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30
------------------------
(Dollars in thousands) 2003 2002
--------- ---------
Operating activities
Net income $ 37,530 $ 33,093
Adjustments to reconcile net income to net cash provided
by operating activities:
Loss, loss adjustment expenses and unearned premium reserves 10,139 2,841
Accrued expenses and other liabilities (1,930) (4,314)
Current taxes payable 623 619
Amounts due to/from reinsurer (1,084) (236)
Accrued investment income (894) (87)
Policy acquisition costs deferred (13,624) (12,712)
Amortization of policy acquisition costs 12,757 9,423
Net realized investment losses (gains) (1,528) 2,674
Provision for depreciation 2,132 2,138
Accretion of discount on investments (2,852) (3,389)
Deferred income taxes 15,029 14,341
Prepaid federal income taxes (14,905) (10,907)
Unearned ceding commission (537) (702)
Real estate acquired in claim settlement 1,350 (824)
Accrued interest on debt (691) (691)
Other assets (2,517) (813)
Other operating activities 512 298
--------- ---------
Net cash provided by operating activities 39,510 30,752
Investing activities
Securities available-for-sale:
Purchases - fixed maturities (82,157) (62,700)
Sales - fixed maturities 58,538 34,376
Purchases - equities (1,744) (2,140)
Sales - equities 914 1,625
Net change in short-term investments (13,034) (6,055)
Purchases of property and equipment (1,842) (1,252)
--------- ---------
Net cash used in investing activities (39,325) (36,146)
Financing activities
Proceeds from exercise of stock options 3,853 5,372
--------- ---------
Net cash provided by financing activities 3,853 5,372
--------- ---------
Net change in cash 4,038 (22)
Cash at beginning of period 233 853
--------- ---------
Cash at end of period $ 4,271 $ 831
========= =========
Supplemental schedule of cash flow information
Cash paid during the period for:
Income taxes and United States Mortgage Guaranty
Tax and Loss Bonds $ 15,723 $ 11,536
Interest 2,765 2,765
See accompanying notes.
5
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
(Unaudited)
NOTE 1 -- THE COMPANY
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 and investors to protect the lender or investor against loss from
defaults on low down payment residential mortgage loans.
NOTE 2 -- ACCOUNTING POLICIES AND BASIS OF PRESENTATION
BASIS OF PRESENTATION - The accompanying unaudited consolidated financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three and nine months ended September 30,
2003 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2003. For further information, refer to the
consolidated financial statements and footnotes thereto included in the Triad
Guaranty Inc. annual report on Form10-K for the year ended December 31, 2002.
STOCK OPTIONS - The Company grants stock options to employees and directors for
a fixed number of shares 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 using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and
accordingly, recognizes no compensation expense for the stock option grants.
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):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2003 2002 2003 2002
----------------------------------------
Net income - as reported $ 12,547 $ 11,765 $ 37,530 $ 33,093
Net income - pro forma $ 12,408 $ 11,565 $ 37,046 $ 32,471
Earnings per share - as reported:
Basic $ 0.87 $ 0.83 $ 2.63 $ 2.36
Diluted $ 0.86 $ 0.82 $ 2.59 $ 2.31
Earnings per share - pro forma:
Basic $ 0.86 $ 0.82 $ 2.59 $ 2.31
Diluted $ 0.85 $ 0.80 $ 2.56 $ 2.27
6
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
(Unaudited)
NOTE 3 -- CONSOLIDATION
The consolidated financial statements include Triad Guaranty Inc. and its
wholly-owned subsidiary, Triad Guaranty Insurance Corporation ("Triad"), and
Triad's wholly-owned subsidiaries, Triad Guaranty Assurance Corporation and
Triad Re Insurance Corporation (collectively referred to as "the Company"). All
significant intercompany accounts and transactions have been eliminated.
NOTE 4 -- COMMITMENTS AND CONTINGENT LIABILITIES
REINSURANCE - Triad assumes and cedes certain premiums and losses from/to
reinsurers under various reinsurance agreements. Reinsurance contracts do not
relieve Triad from its obligations to policyholders. Failure of the reinsurer to
honor its obligation could result in losses to Triad; consequently, allowances
are established for amounts when deemed uncollectible.
INSURANCE IN FORCE, DIVIDEND RESTRICTIONS, AND STATUTORY RESULTS - Insurance
regulations generally limit the writing of mortgage guaranty insurance to an
aggregate amount of insured risk no greater than 25 times the total of statutory
capital and surplus and the statutory contingency reserve. The amount of net
risk for insurance in force at September 30, 2003 and December 31, 2002, as
presented below, was computed by applying the various percentage settlement
options and applicable stop-loss parameters to the insurance in force amounts
based on the original insured amount of the loan. Triad's ratio is as follows:
September 30, December 31,
2003 2002
----------- ----------
(Dollars in thousands)
Net risk................................. $ 6,209,900 $ 5,534,420
=========== ===========
Statutory capital and surplus............ $ 122,401 $ 112,874
Statutory contingency reserve............ 289,503 245,006
----------- ----------
Total.................................... $ 411,904 $ 357,880
=========== ===========
Risk-to-capital ratio.................... 15.1-to-1 15.5-to-1
=========== ===========
Triad and its wholly-owned subsidiaries, Triad Guaranty Assurance
Corporation and Triad Re Insurance Corporation, are each required under their
respective domiciliary state's insurance code to maintain a minimum level of
statutory capital and surplus. Triad, an Illinois domiciled insurer, is required
under the Illinois Insurance Code (the "Code") to maintain minimum statutory
capital and surplus of $5 million. The Code permits dividends to be paid only
out of earned surplus and also requires prior approval of extraordinary
dividends. An extraordinary dividend is any dividend or distribution of cash or
other property, the fair value of which, together with that of other dividends
or distributions made within a period of twelve consecutive months, exceeds the
greater of (a) ten percent of statutory surplus as regards policyholders, or (b)
statutory net income for the calendar year preceding the date of the dividend.
7
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2003
(Unaudited)
Net income as determined in accordance with statutory accounting principles
was $51.0 million and $44.7 million for the nine months ended September 30, 2003
and 2002, respectively, and $61.8 million for the year ended December 31, 2002.
At September 30, 2003 and December 31, 2002, the amount of Triad's equity
that could be paid out in dividends to stockholders was $38.7 million and $29.2
million, respectively, which was the earned surplus of Triad on a statutory
basis on those dates.
LOSS RESERVES - The Company establishes loss reserves to provide for the
estimated costs of settling claims with respect to loans reported to be in
default and loans in default which have not been reported to the Company.
Reserves are established by management using estimated claim rates (frequency)
and claim amounts (severity) to estimate ultimate losses. The reserving process
gives effect to current economic conditions and profiles delinquencies by such
factors as policy year, geography, chronic late payment characteristics and age.
Due to the inherent uncertainty in estimating reserves for losses and loss
adjustment expenses, there can be no assurance that the reserves will prove to
be adequate to cover ultimate loss development.
LITIGATION - A class action lawsuit has been filed against the Company in the
ordinary course of the Company's business alleging that contract underwriting
and captive reinsurance violate the Real Estate Settlement Procedures Act. In
the opinion of management, the ultimate resolution of this pending litigation
will not have a material adverse effect on the financial position or results of
operations of the Company.
NOTE 5 - - EARNINGS PER SHARE
Basic and diluted earnings per share are based on the weighted-average
daily number of shares outstanding. For diluted earnings per share, the
denominator includes the dilutive effect of stock options on the
weighted-average shares outstanding. There are no other reconciling items
between the denominator used in basic earnings per share and diluted earnings
per share. The numerator used in basic earnings per share and diluted earnings
per share is the same for all periods presented.
NOTE 6 - - COMPREHENSIVE INCOME
Comprehensive income consists of net income and other comprehensive income.
For the Company, other comprehensive income is composed of unrealized gains or
losses on available-for-sale securities, net of income tax. For the three months
ended September 30, 2003 and 2002, the Company's comprehensive income was $8.7
million and $19.3 million, respectively. For the nine months ended September 30,
2003 and 2002, the Company's comprehensive income was $39.3 million and $43.6
million, respectively.
NOTE 7 - - INCOME TAXES
Income tax expense differs from the amounts computed by applying the
Federal statutory income tax rate to income before income taxes primarily due to
tax-exempt interest that the Company earns from its investments in municipal
bonds.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations analyzes the consolidated financial condition, changes in financial
position, and results of operations for the three month and nine month periods
ended September 30, 2003, as compared to the same periods in 2002 of Triad
Guaranty Inc. The discussion supplements Management's Discussion and Analysis of
Financial Condition and Results of Operations and Item 1 in Form 10-K and should
be read in conjunction with the interim financial statements and notes contained
herein.
RESULTS OF OPERATIONS
Net income for the first nine months of 2003 increased 13.4% to $37.5
million or $2.59 per diluted share compared to $33.1 million or $2.31 per
diluted share in the first nine months of 2002. Net income for the third quarter
of 2003 increased 6.6% to $12.5 million or $0.86 per diluted share from $11.8
million or $0.82 per diluted share in the third quarter of 2002. This
improvement in net income was led by an increase in earned premiums partially
offset by increases in net losses and loss adjustment expenses and amortization
of deferred policy acquisition costs. Net income for the first nine months of
2003 includes $1.5 million of net realized investment gains while net income for
the first nine months of 2002 included $2.7 million of net realized investment
losses. For the third quarter of 2003 and 2002, net income includes $763,000 of
net realized investment gains and $446,000 of net realized investment losses,
respectively.
PRODUCTION AND IN FORCE
Total insurance written was $15.3 billion for the first nine months of 2003
compared to $9.7 billion for the first nine months of 2002, an increase of
57.7%. For the third quarter of 2003, total insurance written was $6.7 billion
compared to $3.5 billion for the comparable period of 2002, an increase of
91.9%. Total insurance written includes insurance written attributable to
traditional flow production and to structured bulk transactions.
Traditional flow insurance written in the first nine months of 2003
increased 57.9% to $13.3 billion from $8.4 billion in the first nine months of
2002. For the third quarter of 2003, traditional flow insurance written
increased 68.3% to $5.0 billion from $3.0 billion for the comparable period of
2002. This increase was primarily the result of expanding relationships with
national lenders, strong demand for risk-sharing arrangements and other product
offerings, and a lower interest rate environment that contributed to a very
strong refinance market.
Insurance written in the first nine months of 2003 attributable to
structured bulk transactions totaled $1.9 billion ($1.6 billion in the third
quarter) compared to $1.2 billion ($478 million in the third quarter) in the
first nine months of 2002. Structured bulk transactions are generally initiated
by secondary mortgage market participants who wish to use mortgage insurance as
a credit enhancement. The Company competes against other mortgage insurers as
well as other forms of credit enhancement provided by capital markets for these
transactions. Insurance written attributed to structured bulk transactions is
likely to vary significantly from period to period due to the relatively small
number of transactions that encompass this market (as opposed to the traditional
flow market), competitiveness with other mortgage insurers, the attractiveness
in the marketplace of mortgage insurance versus other forms of credit
enhancements, and the changing loan composition and underwriting criteria of the
market. Although terms vary, the bulk market can be broadly categorized into
three different segments or tiers depending on the risk characteristics of the
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
loans comprising a transaction. The loan characteristics of the three segments
are: 1) predominantly high credit quality, low LTV, fully underwritten loans
that may have niche characteristics such as non-conforming loan balances and
concentrations such as geography, transaction purpose or occupancy type; 2)
loans that generally have high credit quality and low to moderate LTVs that have
been underwritten with reduced or streamlined documentation; and, 3) generally
fully underwritten loans with credit impaired borrowers (FICO credit score less
than 575). In general, the Company believes that its bulk business originated in
segments 2 and 3 will report a higher default rate than its flow business.
However, the Company believes that the lower LTV's associated with its bulk
business will ultimately generate proportionately lower claim rates and lower
levels of severity than its flow business. The Company enters into bulk
transactions primarily in the first two segments mentioned above. At September
30, 2003, approximately 5% of the Company's insurance in force attributable to
structured bulk transactions is categorized in segment 3.
The Company periodically enters into structured transactions involving
loans that have insurance effective dates within the current reporting period
but for which detailed loan information regarding the insured loans is not
provided by the issuer of the transaction until later. When this occurs, the
Company accrues due premium in the reporting period based on each loan's
insurance effective date; however, the loans are not reflected in the Company's
inforce, insurance written, and related data totals (collectively referred to as
"statistical account totals") until the loan level detail is reported to the
Company. Approximately $1.0 billion of the $1.6 billion of insurance written
attributable to structured bulk transactions in the third quarter of 2003 had
effective dates of coverage in the second quarter of 2003 but due to this delay
in the reporting of detailed loan information regarding the insured loans, the
loans were not reflected in the Company's statistical account totals until the
third quarter. At September 30, 2003, the Company had approximately $1.2 billion
of structured transactions with effective dates within the third quarter for
which loan level detail had not been received and therefore are not included in
the statistical account totals herein. These amounts will be reported in the
statistical account totals during the fourth quarter of 2003 once loan level
detail is provided to the Company by the issuer of the transaction. The Company
has properly included in premium written and premium earned the respective
amounts due and earned by the Company during the third quarter of 2003 related
to this insurance.
Consolidation within the mortgage origination industry and Triad's
continued focus on national lenders have resulted in a greater percentage of
production volume being concentrated among a smaller customer base. The
Company's ten largest customers were responsible for 75% of traditional flow
insurance written in the first nine months of 2003 compared to 73% in all of
2002. The Company's two largest customers generated 58% of traditional flow
insurance written in the first nine months of 2003 compared to 53% in all of
2002. The loss of one or more of these major customers could have a significant
adverse effect on the Company's business.
According to industry data, Triad's national market share of net new
primary insurance written, which includes insurance written on a traditional
flow basis as well as that attributed to structured bulk transactions, increased
to 4.7% for the first nine months and 5.4% for the third quarter of 2003
compared to 3.6% and 4.0% for the respective periods of 2002. Triad's national
market share of net new primary insurance written on a traditional flow basis
was 5.1% for both the first nine months of 2003 and the third quarter of 2003
compared to 4.2% and 4.3% for the respective periods of 2002. Net new primary
insurance written excludes insurance placed upon loans more than 12 months after
loan origination, insurance placed upon loans already covered by primary
mortgage insurance, and insurance placed upon loans where lender exposure is
effectively reduced below defined minimums.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
Total direct insurance in force reached $29.3 billion at September 30,
2003, compared to $25.4 billion at December 31, 2002, and $25.0 billion at
September 30, 2002. Significant refinance activity in 2002 and in the first nine
months of 2003 resulted in a high level of policy cancellations that
substantially offset the impact that the high level of insurance written had on
in force growth. As a result, insurance in force increased by only $3.9 billion
in the first nine months of 2003, even though insurance written during the same
period was $15.3 billion.
Refinance activity increased to 55.6% of total insurance written (54.6%
excluding structured bulk transactions) in the first nine months of 2003 from
37.4% of total insurance written (37.0% excluding structured bulk transactions)
in the first nine months of 2002. This increase reflected the record low
interest rate environment that prevailed during the first nine months of 2003.
Refinance activity was 54.6% of total insurance written (52.3% excluding
structured bulk transactions) in the third quarter of 2003 compared to 33.0% of
total insurance written (31.2% excluding structured bulk transactions) in the
same period of 2002. Persistency, or the percentage of insurance in force
remaining from 12 months prior, was 49.0% at September 30, 2003 compared to
60.9% at December 31, 2002, and 61.3% at September 30, 2002. The high level of
refinance activity and the resulting decrease in persistency is reflective of
the low interest rate environment that has been in place during the past year.
The annualized quarterly persistency run rate for the third quarter of 2003 was
19.3% compared to 33.6% for the second quarter of 2003 and 57.9% for the third
quarter of 2002. Changes in interest rates generally take a few months to affect
persistency. During the third quarter of 2003, interest rates moderately
increased from the record low levels seen in June and July. If these interest
rate levels persist or if interest rates increase further, the Company believes
that persistency should show modest improvement in the fourth quarter of 2003
(this would be primarily reflected in the quarterly run rate). However, if rates
decline from current levels, persistency could remain at the low levels seen in
the first nine months of the year.
The Company defines persistency as the percentage of insurance in force
remaining from 12 months prior. Run off, defined as cancelled or terminated
policies, of production originated during the past 12 months is not considered
in the Company's calculation of persistency. The Company calculates persistency
by determining the run off over the prior 12 months of each individual policy
year (exclusive of current year production). This method of calculating
persistency may vary from that of other mortgage insurers. The Company believes
that its calculation presents an accurate measure of the percentage of insurance
in force remaining from 12 months prior. The Company's current method of
calculating persistency is consistent with the methodology used by the Company
in prior years.
FICO credit scores are one of the factors used by the Company in
determining credit risk. The following table presents the FICO credit score
distribution of the Company's insurance in force at September 30, 2003 and
December 31, 2002.
- --------------------------------------------------------------------------------
Percent of Insurance In Force
September 30, 2003 December 31, 2002
------------------ -----------------
- -Credit score less than 575 1.2% 0.9%
Credit score between 575 and 619 4.8% 4.8%
Credit score greater than 619 94.0% 94.3%
- --------------------------------------------------------------------------------
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
As the table shows, the Company insures some loans that have FICO credit scores
below 575. The Company believes that these loans have a higher probability of
loss than a loan with a FICO credit score of 575 or greater. The Company does
not expect loans with FICO scores less than 575 to become a significant portion
of its insurance in force.
REVENUES
Total direct premiums written were $112.4 million for the first nine months
of 2003, an increase of 23.7% from $90.8 million for the comparable period of
2002. Direct premiums written for the third quarter of 2003 increased 21.8% to
$40.4 million from $33.2 million in the third quarter of 2002. Net premiums
written increased by 18.7% to $92.6 million in the first nine months of 2003
from $78.1 million for the comparable period of 2002. Net premiums written for
the third quarter of 2003 increased 17.1% to $33.1 million from $28.3 million in
the third quarter of 2002. Contributing to the increase in premiums written for
the third quarter and for the first nine months of 2003 were significant
writings under the Company's annual premium payment plan. The annual premium
payment plan requires a first-year premium paid at mortgage loan closing, with
the entire amount reported as premium written. This is in contrast to the
Company's monthly premium payment plan which involves, in general, the payment
of one or two months' premium at mortgage loan closing, with the associated
amounts reported as premium written. During the first nine months of 2003, 32%
of total insurance written (38% during the third quarter) was under the
Company's annual premium payment plan compared to 17% of total insurance written
during the first nine months of 2002 (15% during the third quarter).
The difference between direct premiums written and net premiums written is
primarily attributable to ceded premium. Driven by an increase in insurance
subject to lender risk-sharing arrangements, ceded premiums written increased
54.5% to $19.7 million for the first nine months of 2003 from $12.8 million for
the first nine months of 2002. Ceded premiums written in the third quarter of
2003 were $7.3 million compared to $4.9 million for the same period of 2002, an
increase of 49.0%. The Company also continues to maintain $125 million of excess
of loss reinsurance coverage for which the payment is included in ceded premium
written. The Company's premium cede rate (the ratio of ceded premiums written to
total direct premiums written) was 17.5% in the first nine months of 2003 (18.1%
in the third quarter) compared to 14.1% in the first nine months of 2002 and
14.8% in the third quarter of 2002. The Company's premium cede rate for captive
reinsurance (the ratio of ceded premiums written under captive reinsurance
arrangements to total direct premiums written) was 15.1% in the first nine
months of 2003 (15.8% in the third quarter) compared to 12.0% in the first nine
months of 2002 (12.7% in the third quarter). The average premium cede rate for
direct premiums written subject to the Company's captive reinsurance
arrangements was 35.0% for the first nine months of 2003 (36.5% in the third
quarter) compared to 36.3% in the first nine months of 2002 (36.2% in the third
quarter). Approximately $6.0 billion of insurance written, or 45% of flow
insurance written (39% of total insurance written including structured bulk
transactions), during the first nine months of 2003 was subject to risk-sharing
arrangements compared to $4.4 billion of insurance written, or 53% of flow
insurance written (46% including structured bulk transactions), in the same
period of 2002. Through September 30, 2003, structured bulk transactions have
not been subject to captive mortgage reinsurance or other risk-sharing
arrangements. Approximately 47% of direct insurance in force is subject to
risk-sharing arrangements at September 30, 2003, compared to 43% at September
30, 2002. This increase in insurance in force subject to risk-sharing
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
arrangements is due primarily to the increased market penetration of the
Company's risk-sharing arrangements and the high level of refinance activity
during the past twelve months, as policies previously not subject to
risk-sharing arrangements refinanced and new policies issued that were subject
to risk-sharing arrangements. Management anticipates ceded premiums will
continue to increase as a result of the expected increase in risk-sharing
programs.
Under the Company's excess of loss lender risk-sharing arrangements, the
reinsurer may elect a risk band with a flexible entry and exit point. One of the
Company's competitors announced that effective April 1, 2003, it will not
participate in excess of loss risk-sharing arrangements where the net premium
cede rate is greater than 25% ("deep ceded"). According to recent articles
published in Inside Mortgage Finance, two of the Company's other competitors
have recently announced that they will limit the amount of premium they will
cede under captive arrangements. The Company believes that its risk-sharing
arrangements provide valuable reinsurance protection and potentially reduce the
risk of volatility in the Company's earnings. The Company plans to continue to
participate in excess of loss risk-sharing arrangements, including deep ceded
arrangements. It is uncertain at this time what impact, if any, the competitors'
decisions, as described above, will have on the Company's direct insurance in
force subject to risk-sharing arrangements and the Company's market share.
Earned premiums increased 12.1% to $86.7 million for the first nine months
of 2003 from $77.4 million for the comparable period of 2002. Earned premiums
for the third quarter of 2003 increased 10.9% to $30.3 million from $27.4
million in the third quarter of 2002. The variance between net written premiums
and earned premiums for the first nine months of 2003 and for the third quarter
of 2003 is due to the significant writings of the Company's annual premium
product and the related increase in the unearned premium reserve. The Company's
unearned premium liability increased to $14.5 million at September 30, 2003 from
$11.7 million at June 30, 2003, $8.6 million at March 31, 2003, and $8.5 billion
at December 31, 2002. Direct written premium from the annual premium product
represented 18.6% of direct premium written for the third quarter of 2003, 17.5%
of direct premium written for the second quarter of 2003, and 7.9% of direct
premium written for the first quarter of 2003. For all of 2002, direct written
premium from the annual premium product represented 7.0% of direct premium
written. The growth in written and earned premiums resulted from strong levels
of new insurance written offset by the impact of a declining persistency rate
due to a high level of mortgage refinancings and by the increase in ceded
premiums.
Net investment income for the first nine months of 2003 was $12.9 million,
an 8.6% increase over $11.8 million in the first nine months of 2002. Net
investment income for the third quarter of 2003 was $4.2 million, an increase of
1.8% from $4.2 million in the third quarter of 2002. This increase is the result
of growth in the average book value of invested assets by 19.2% to $350.3
million at September 30, 2003 from $294.0 million at September 30, 2002, which
is attributable to the investment of normal operating cash flow. The percentage
increase in net investment income was much lower than the percentage increase in
invested assets primarily due to a decrease in the Company's investment yields.
The pre-tax yield on average invested assets, calculated on the basis of
amortized cost, decreased to 4.9% for the first nine months of 2003 compared to
5.4% for the first nine months of 2002. The portfolio's tax-equivalent
yield-to-maturity was 7.2% for the first nine months of 2003 versus 7.9% for the
first nine months of 2002. The decrease in yield reflects the low interest rate
environment for new money investments made over the past several quarters and
the disposal of a number of higher yielding securities during the past twelve
months to enhance the overall quality of the portfolio. The portfolio's yield
was also affected by a higher percentage of the fixed income portfolio invested
in municipal securities and a higher percentage invested at low yielding money
market rates. Based on fair value, approximately 84% and 79% of the Company's
fixed maturity portfolio at September 30, 2003 and 2002, respectively, was
composed of state and municipal tax-preferred securities. Approximately 96% of
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
the Company's fixed maturity portfolio, based on fair value, at September 30,
2003 was either a U.S. government or U.S. agency obligation or was rated
investment grade by at least one nationally recognized securities rating
organization compared to approximately 95% at September 30, 2002. U.S.
government, U.S. agency, and investment grade securities generally have a lower
yield, in return for less default risk, than securities rated below investment
grade.
The Company reported $1.5 million of net realized investment gains in the
first nine months of 2003 and $2.7 million of net realized investment losses in
the same period of 2002. For the third quarter of 2003, the Company reported
$763,000 of net realized investment gains compared to $446,000 of reported net
realized investment losses in the third quarter of 2002. The Company actively
monitors investment securities considered to be at risk for impairment. When the
Company determines that a decline in the value of a security below its amortized
cost is other-than-temporary, an impairment loss has occurred. In the event of
impairment, the Company writes down the cost basis of the security to its fair
value and recognizes a realized loss for the amount of the writedown. Net
realized gains of $1.5 million during the first nine months of 2003 included
approximately $780,000 of impairment writedowns. Net realized gains of $763,000
during the third quarter of 2003 included an impairment writedown on an equity
in the pharmaceutical sector of approximately $165,000.
LOSSES AND EXPENSES
Net losses and loss adjustment expenses (net of reinsurance recoveries)
increased by 70.6% in the first nine months of 2003 to $16.7 million from $9.8
million for the same period of 2002. Net losses and loss adjustment expenses
were $6.1 million in the third quarter of 2003 compared to $4.4 million in the
third quarter of 2002, an increase of 37.8%. The growth of net losses and loss
adjustment expenses reflects an increase in both paid losses and reserves. The
increase was anticipated in the current year and is reflective of the Company's
overall growth of insurance in force, relative growth of the Company's
participation in the bulk market, and the cumulative effect of job losses on the
economy. Net paid losses and loss adjustment expenses were $12.5 million in the
first nine months of 2003 compared to $7.7 million in the first nine months of
2002. Net paid losses and loss adjustment expenses were $4.9 million in the
third quarter of 2003, up from $3.0 million in the third quarter of 2002.
Average severity (direct paid losses divided by number of claims paid) for the
first nine months of 2003 was approximately $22,800 compared with $21,900 for
the respective period of 2002. The following table provides detail on direct
paid losses from traditional flow business and structured bulk business.
- --------------------------------------------------------------------------------
Direct Paid Losses
(In Thousands)
Three Months Ending Nine Months Ending
September 30, September 30,
2003 2002 2003 2002
- -------------------------------------------------------------------------
Flow $3,983 $2,909 $10,984 $7,373
Bulk 841 - 1,211 -
------ ------ ------- ------
Total $4,824 $2,909 $12,195 $7,373
- -------------------------------------------------------------------------
The Company's loss ratio (the ratio of incurred losses to earned premiums)
was 19.3% for the first nine months of 2003 compared to 12.6% for the first nine
months of 2002 and 13.4% for all of 2002. The loss ratio was 20.0% in the third
quarter of 2003 and 16.1% for the third quarter of 2002. The increase in the
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
loss ratio is consistent with management's expectations given the current
operating environment.
As of September 30, 2003, approximately 91% of the Company's insurance in
force was originated in the last 36 months compared to 80% at September 30,
2002. Management believes, based upon its experience and industry data, that
claims incidence for traditional flow business is generally highest in the third
through sixth years after loan origination. Furthermore, management believes
that the period of highest claim incidence for business attributable to
structured bulk transactions is earlier than that for traditional flow business.
The Company expects its incurred losses to increase as a greater amount of its
insurance in force reaches its anticipated highest claim frequency years.
Furthermore, changes in the economic environment could accelerate paid and
incurred loss development. Due to the inherent uncertainty of future premium
levels, losses, economic conditions, and other factors that affect earnings, it
is difficult to predict with any degree of certainty the impact of such higher
claim frequencies on future earnings.
Amortization of deferred policy acquisition costs increased by 35.4% to
$12.8 million in the first nine months of 2003 from $9.4 million for the first
nine months of 2002. For the third quarter of 2003, we recognized $5.3 million
of amortization, a 32.5% increase over the $4.0 recorded in the second quarter
of 2003 and a 57.4% increase from $3.4 million in the third quarter of 2002. The
increase in amortization reflects growth in deferred policy acquisition costs
related to the expansion of the Company's insurance in force and accelerated
amortization due to higher cancellations from refinance activity in the first
nine months of 2003. The Company's model calculates the amortization of deferred
policy acquisition costs separately for each book year. The model accelerates
the amortization of deferred policy acquisition costs through a dynamic
adjustment when persistency for a book year is lower than a historical baseline
level in order to match the amortization expense with the life of the policies
on which the acquisition costs were originally deferred. Low persistency levels
during the first nine months of 2003 and 2002 resulted in additional
amortization of deferred policy acquisition costs through dynamic adjustments
totaling $3.4 million in the first nine months of 2003 ($2.1 million in the
third quarter) and $890,000 in the first nine months of 2002 ($459,000 in the
third quarter). While the Company believes that persistency may show slight
improvement in the fourth quarter if interest rates remain at current levels or
rise, the Company utilizes an annual persistency model in the calculation of
amortization and does not expect to have significant improvement in amortization
of deferred policy acquisition costs in the fourth quarter of 2003.
Other operating expenses decreased 5.1% to $16.5 million for the first nine
months of 2003 from $17.4 million for the same period of 2002. For the third
quarter of 2003, other operating expenses were $5.5 million compared to $5.6
million in the third quarter of 2002, a decrease of 1.1%. The decline in other
operating expenses is primarily the result of operational efficiencies achieved
through the use of technology. The Company has made substantial investments in
technology that allows increased insurance writings without a proportional
increase in operating expenses. The expense ratio (ratio of the amortization of
deferred policy acquisition costs and other operating expenses to net premiums
written) for the first nine months of 2003 was 31.6% compared to 34.4% for the
first nine months of 2002 and 34.6% for all of 2002. The expense ratio for the
third quarter of 2003 was 32.7% compared to 31.7% in the third quarter of 2002.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
The expense ratios for the first nine months of 2003 and for the third quarter
of 2003 were positively affected by the decrease in other operating expenses as
well as the increase in net written premium, which was impacted by increased
production of the annual premium product. The expense ratios for the first nine
months of 2003 and especially for the third quarter of 2003 were negatively
affected by the accelerated amortization of deferred policy acquisition costs.
The effective tax rate for the first nine months of 2003 was 29.3% compared
to 31.0% for the first nine months of 2002. The effective tax rate for the third
quarter of 2003 was 29.2% compared to 30.9% for the third quarter of 2002. The
decrease in the effective tax rate is due primarily to an increase in tax-exempt
interest resulting from a higher percentage of assets being invested in
tax-preferred securities. Management expects the Company's effective tax rate to
remain near current levels or decline slightly as long as yields from new funds
invested in tax-preferred securities remain favorable in relation to fully
taxable 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, operating expenses, and taxes.
The Company generated positive cash flow from operating activities for the
first nine months of 2003 of $39.5 million compared to $30.8 million for the
same period of 2002. The increase in operating cash flow in the first nine
months of 2003 reflects the growth in premiums and investment income and a
decrease in underwriting expenses paid offset partially by an increase in losses
paid. The Company's business does not routinely require significant capital
expenditures other than for enhancements to its computer systems and
technological capabilities. Positive cash flows are invested pending future
payments of claims and expenses. Cash flow shortfalls, if any, could be funded
through sales of short-term investments and other investment portfolio
securities.
The parent company's cash flow is dependent on interest income and payments
from Triad including management fees and interest payments under surplus notes.
The Illinois Insurance Department permits expenses of the parent company to be
reimbursed by Triad in the form of management fees. Payment of dividends is also
permitted, although none have been paid to date.
The insurance laws of the State of Illinois impose certain restrictions on
dividends that Triad can pay the parent company. These restrictions, based on
statutory accounting principles, include requirements that dividends may be paid
only out of statutory earned surplus and that limit the amount of dividends that
may be paid without prior approval of the Illinois Insurance Department.
Consolidated invested assets were $385.7 million at September 30, 2003
compared to $344.6 million at December 31, 2002. This increase was primarily
attributable to the Company's operating cash flow for the first nine months of
2003. Fixed maturity securities and equity securities classified as
available-for-sale totaled $337.4 million at September 30, 2003 compared to
$309.3 million at December 31, 2002. Contributing to this increase in invested
assets and securities classified as available-for-sale was an increase in net
unrealized investment gains on fixed maturity securities from year-end levels
and a net unrealized investment gain on equity securities at September 30, 2003
compared to a net unrealized investment loss at year-end. Net unrealized
investment gains on fixed maturity securities were $15.0 million at September
30, 2003 compared to $13.7 million at December 31, 2002. Net unrealized
investment gains on equity securities were $975,000 at September 30, 2003
compared to a net unrealized investment loss of $458,000 at December 31, 2002.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
Based on fair value, the fixed maturity portfolio consisted of approximately 84%
municipal securities, 11% corporate securities, and 5% U.S. government
obligations at September 30, 2003 compared to a composition of 81% municipal
securities, 15% corporate securities, and 4% U.S. government obligations at
December 31, 2002.
The Company's loss and loss adjustment expense reserves were $25.5 million
at September 30, 2003 compared to $21.4 million at December 31, 2002. Loss and
loss adjustment expense reserves are established for all insured loans reported
as delinquent to the Company by the loan servicer. Reserves also are established
for estimated losses incurred on notices of default not yet reported by the
servicer. Consistent with industry practices, the Company does not establish
loss reserves for future claims on insured loans that are not currently in
default. The growth in loss reserves is the result of the increase in reported
defaults. The Company expects loss reserves and the number of flow and bulk
loans in default to continue to grow, reflecting the growth and aging of its
insurance in force.
The following table shows default statistics as of September 30, 2003 and
December 31, 2002:
- --------------------------------------------------------------------------------
Default Statistics
- --------------------------------------------------------------------------------
September 30, December 31,
2003 2002
------------ ------------
Number of insured loans in force 221,053 190,480
Number of loans in default 3,700 2,379
Percentage of loans in default (default rate) 1.67% 1.25%
Number of insured loans in force excluding bulk loans 198,366 171,723
Number of loans in default excluding bulk loans 2,675 2,120
Percentage of loans in default excluding bulk loans 1.35% 1.23%
Number of bulk loans in force 22,687 18,757
Number of bulk loans in default 1,025 259
Percentage of bulk loans in default 4.52% 1.38%
- -------------------------------------------------------------------------------
The number of loans in default includes all reported delinquencies that are
three or more payments in arrears at the reporting date and all reported
delinquencies that were previously three or more payments in arrears and have
not made payments to the current due date. The increase in the default rate for
bulk business is primarily attributable to the maturing of the bulk portfolio
and the higher expected default rate as previously mentioned. Contributing to
changes in default rates is changes in the number of policies in force, which is
the denominator in the default rate calculation. All else being equal, an
increase/decrease in this number results in a lower/higher default rate. As a
result, production levels as well as persistency have an effect on the reported
default rates. The default occurrence for both traditional flow business and
structured bulk business is consistent with management's expectation.
Reserves are established by management using estimated claim rates
(frequency) and claim amounts (severity) to estimate ultimate losses. The
reserving process incorporates numerous factors in a formula that gives effect
to current economic conditions and profiles delinquencies by such factors as
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
policy year, geography, chronic late payment characteristics, and the number of
months the policy has been in default. Because the estimate for loss reserves is
sensitive to the estimates of claims frequency and severity, management performs
sensitivity analyses to test the reasonableness of the best estimate generated
by the loss reserve process. These sensitivity analyses allow management to use
alternative assumptions related to claims frequency and claims severity to
develop a range of reasonably possible loss reserve outcomes that can be used to
challenge the best estimate. The loss reserve estimation process and the
sensitivity analyses support the reasonableness of the best estimate of loss
reserves recorded as a liability in the financial statements. Management
periodically reviews the loss reserve process in order to improve its estimate
of ultimate losses on loans currently in default. Adjustments to reserve
estimates are reflected in the financial statements in the periods in which the
adjustments are made.
Triad cedes business to captive reinsurance subsidiaries and/or affiliates
of certain mortgage lenders ("captives") primarily under excess of loss
reinsurance agreements. Generally, reinsurance recoverables on loss reserves and
unearned premiums ceded to these captives are backed by trust funds or letters
of credit.
Total stockholders' equity increased to $355.1 million at September 30,
2003 from $309.4 million at December 31, 2002. This increase resulted primarily
from net income of $37.5 million for the first nine months of 2003, an increase
in unrealized gains on investments, net of tax, of $1.8 million, and additional
paid-in capital of $5.9 million resulting from the exercise of employee stock
options and the related tax benefits.
Triad's total statutory policyholders' surplus increased to $122.4 million
at September 30, 2003 from $112.9 million at December 31, 2002. Triad's
statutory earned surplus increased to $38.7 million at September 30, 2003 from
$29.2 million at December 31, 2002. The increase in Triad's statutory
policyholders' surplus and statutory earned surplus resulted, primarily, from
statutory net income of $51.0 million and a change in unrealized investment
gains of approximately $1.5 million which exceeded the net increase in the
statutory contingency reserve of $44.5 million. The balance in the statutory
contingency reserve was $289.5 million at September 30, 2003 compared to $245.0
million at December 31, 2002.
Triad's ability to write insurance depends on the maintenance of its
financial strength ratings and the adequacy of its capital in relation to risk
in force. A 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 September
30, 2003, Triad's risk-to-capital ratio was 15.1-to-1 compared to 15.5-to-1 at
December 31, 2002, and to 11.0-to-1 for the industry as a whole at December 31,
2002, the latest industry data available. The risk-to-capital ratio is
calculated using net risk in force, which takes into account risk ceded under
reinsurance arrangements including captive risk-sharing arrangements as well as
any applicable stop-loss limits, as the numerator and statutory capital, which
includes statutory policyholders' surplus and the balance in the contingency
reserve, as the denominator. The decrease in Triad's risk-to-capital ratio is
due to a higher growth rate in statutory capital than that in net risk in force.
Triad is rated "AA" by both Standard & Poor's Ratings Services (S&P) and
Fitch Ratings (Fitch) and "Aa3" by Moody's Investors Service (Moody's).
In July of 2003, S&P revised its rating outlook for the U.S. private
mortgage insurance industry to "Negative" from "Stable". According to S&P,
industry outlooks are primarily determined by the expected course of rating
actions during the next one to two years. S&P stated that they see little chance
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
that there will be any outlook or rating improvements among the mortgage
insurers in the next one to two years, but they do see a considerable
possibility that there will be some negative revisions in outlooks and ratings.
In January of 2003, Fitch revised its rating outlook for the U.S. private
mortgage insurance industry to "Negative" from "Stable" (as referred to in Form
10-K). As of the filing of this Form 10-Q, Fitch, S&P, and Moody's all report a
"Stable" ratings outlook for Triad. A reduction in the Company's rating or
outlook could adversely affect the Company's operations.
Fannie Mae is in the process of revising its approval requirements for
mortgage insurers. The new requirements, which have not yet been finalized,
would require prior approval by Fannie Mae for many of Triad's activities and
new products, allow for other approved types of mortgage insurers rated less
than "AA," and give Fannie Mae increased rights to revise the eligibility
standards of mortgage insurers. The final form the eligibility guidelines will
take is unknown at this time, but new guidelines, if issued, could have an
adverse effect on the Company.
The Office of Federal Housing Enterprise Oversight (OFHEO) issued its
risk-based capital rules for Fannie Mae and Freddie Mac in the first quarter of
2002. The regulation provides capital guidelines for Fannie Mae and Freddie Mac
in connection with their use of various types of credit protection
counterparties including a more preferential capital credit for insurance from a
"AAA" rated private mortgage insurer than for insurance from a "AA" rated
private mortgage insurer. The phase-in period for the new rules is ten years.
The Company does not believe the new rules had an adverse impact on it in the
first nine months of 2003 nor that the new rules will have a significant adverse
impact on the Company in the future. However, if the new capital guidelines
result in future changes to the preferences of Fannie Mae and Freddie Mac
regarding their use of the various types of credit enhancements or their choice
of mortgage insurers based on their credit rating, the Company's financial
condition could be significantly harmed.
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:
o interest rates may increase or decrease from their current levels;
o housing transactions requiring mortgage insurance may decrease for
many reasons including changes in interest rates or economic
conditions;
o the Company's market share may change as a result of changes in
underwriting criteria or competitive products or rates;
o the amount of insurance written could be adversely affected by changes
in federal housing legislation, including changes in the Federal
Housing Administration loan limits and coverage requirements of
Freddie Mac and Fannie Mae;
o 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;
o rating agencies may revise methodologies for determining the Company's
financial strength ratings and may revise or withdraw the assigned
ratings at any time;
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - CONTINUED
o decreases in persistency, which are affected by loan refinancings in
periods of low interest rates, may have an adverse effect on earnings;
o the amount of insurance written and the growth in insurance in force
or risk in force as well as the performance of the Company may be
adversely impacted by the competitive environment in the private
mortgage insurance industry, including the type, structure, and
pricing of products and services offered by the Company and its
competitors;
o if the Company fails to properly underwrite mortgage loans under
contract underwriting service agreements, the Company may be required
to assume the costs of repurchasing those loans;
o with consolidation occurring among mortgage lenders and the Company's
concentration of insurance in force generated through relationships
with significant lender customers, the loss of a significant customer
may have an adverse effect on earnings;
o the Company's performance may be impacted by changes in the
performance of the financial markets and general economic conditions;
o 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;
o OFHEO risk-based capital rules could severely limit the Company's
ability to compete against various types of credit protection
counterparties, including "AAA" rated private mortgage insurers;
o changes in the eligibility guidelines of Fannie Mae or Freddie Mac
could have an adverse effect on the Company;
o proposed regulation by the Department of Housing and Urban Development
to exclude packages of real estate settlement services, which may
include any required mortgage insurance premium paid at closing, from
the anti-referral provisions of the Real Estate Settlement Procedures
Act could adversely affect the Company's earnings.
Accordingly, actual results may differ from those set forth in the
forward-looking statements. Attention also is directed to other risk factors set
forth in documents filed by the Company with the Securities and Exchange
Commission.
20
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's market risk exposures at September 30, 2003 have not
materially changed from those identified at December 31, 2002.
ITEM 4. CONTROLS AND PROCEDURES
The Company's management, with the participation of the Company's Chief
Executive Officer (CEO) and Chief Financial Officer (CFO), has evaluated the
Company's disclosure controls and procedures (as defined in Rule 13a - 15(e)
under the Securities Exchange Act of 1934, as amended) as of the end of the
period covered by this Quarterly Report on Form 10-Q. Based upon such
evaluation, the Company's management, including the CEO and CFO, concluded that
such disclosure controls and procedures were effective as of the end of the
period.
Additionally, the Company's management, with the participation of the CEO
and CFO, evaluated whether any change in the Company's internal control over
financial reporting that occurred during the quarter covered by this Quarterly
Report on Form 10-Q materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting. Based on that
evaluation, there have been no such changes during such quarter.
21
PART II
ITEM 1. LEGAL PROCEEDINGS - None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS - None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - None
ITEM 5. OTHER INFORMATION - None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
31(i) Certification of Chief Executive Officer pursuant to
Exchange Act Rule 13a-14(a) pursuant to section 302 of the
Sarbanes-Oxley Act of 2002.
31(ii) Certification of Chief Financial Officer pursuant to
Exchange Act Rule 13a-14(a) pursuant to section 302 of the
Sarbanes-Oxley Act of 2002.
32 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) REPORTS ON FORM 8-K
On October 28, 2003, the Company filed a current report on Items
7 and 12 of Form 8-K relating to the issuance of its results of
operations for the third quarter ended September 30, 2003 in an
earnings release.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TRIAD GUARANTY INC.
Date: November 14, 2003
/s/ Kenneth S. Dwyer
------------------------------
Kenneth S. Dwyer
Vice President and controller,
Principal Accounting Officer