UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the quarterly period ended March 31, 2004
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 April 15,
2004: 14,476,873 shares.
TRIAD GUARANTY INC.
INDEX
Page
Number
Part I. Financial Information:
Item 1. Financial Statements:
Consolidated Balance Sheets as of March 31, 2004 (Unaudited)
and December 31, 2003................................................ 1
Consolidated Statements of Income for the Three Months
Ended March 31, 2004 and 2003 (Unaudited)............................ 2
Consolidated Statements of Cash Flows for the Three Months
Ended March 31, 2004 and 2003 (Unaudited)............................ 3
Notes to Consolidated Financial Statements.............................. 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................ 7
Item 3. Quantitative and Qualitative Disclosures about Market Risk...... 22
Item 4. Controls and Procedures......................................... 22
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................................ 23
Signature............................................................... 23
TRIAD GUARANTY INC.
CONSOLIDATED BALANCE SHEETS
March 31 December 31
(Dollars in thousands except per share information) 2004 2003
----------- ----------
(Unaudited)
Assets
Invested assets:
Fixed maturities, available-for-sale, at fair value $403,568 $375,097
Equity securities, available-for-sale, at fair value 12,477 12,771
Short-term investments 12,863 25,659
-------- --------
428,908 413,527
Cash 4,736 973
Real estate 145 146
Accrued investment income 4,848 4,575
Deferred policy acquisition costs 30,863 29,363
Prepaid federal income taxes 98,124 98,124
Property and equipment 9,883 9,369
Reinsurance recoverable 1,551 881
Other assets 16,508 18,621
-------- --------
Total assets $595,566 $575,579
======== ========
Liabilities and stockholders' equity
Liabilities:
Losses and loss adjustment expenses $ 29,945 $ 27,186
Unearned premiums 14,158 15,629
Amounts payable to reinsurer 3,474 3,243
Current taxes payable 578 6
Deferred income taxes 121,480 115,459
Unearned ceding commission 549 669
Long-term debt 34,488 34,486
Accrued interest on debt 584 1,275
Accrued expenses and other liabilities 4,051 7,696
-------- --------
Total liabilities 209,307 205,649
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 14,476,623 shares
at March 31, 2004 and 14,438,637 shares at December 31, 2003 145 144
Additional paid-in capital 89,313 87,513
Accumulated other comprehensive income, net of income tax
liability of $6,898 at March 31, 2004 and $6,025 at
December 31, 2003 12,810 11,190
Deferred compensation (2,265) (1,128)
Retained earnings 286,256 272,211
-------- --------
Total stockholders' equity 386,259 369,930
-------- --------
Total liabilities and stockholders' equity $595,566 $575,579
======== ========
See accompanying notes.
1
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended
March 31
-------------------------
2004 2003
---- ----
(Dollars in thousands except
per share information)
Revenue:
Premiums written:
Direct $ 40,316 $ 34,026
Assumed 1 1
Ceded (7,971) (5,887)
---------- ---------
Net premiums written 32,346 28,140
Change in unearned premiums 1,466 (8)
---------- ---------
Earned premiums 33,812 28,132
Net investment income 4,586 4,333
Net realized investment gains 577 219
Other income 3 12
---------- ---------
38,978 32,696
Net losses and loss adjustment expenses 8,883 5,265
Interest expense on debt 693 693
Amortization of deferred policy acquisition costs 3,185 3,418
Other operating expenses (net of acquisition
costs deferred) 6,340 5,841
---------- ---------
19,101 15,217
---------- ---------
Income before income taxes 19,877 17,479
Income taxes:
Current 558 171
Deferred 5,275 4,956
---------- ---------
5,833 5,127
---------- ---------
Net income $ 14,044 $ 12,352
========== ==========
Earnings per common and common equivalent
share:
Basic $ .97 $ .87
========== ==========
Diluted $ .96 $ .86
========== ==========
Shares used in computing earnings per
common and common equivalent share:
Basic 14,458,667 14,221,218
========== ==========
Diluted 14,671,346 14,398,800
========== ==========
See accompanying notes.
2
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31
-------------------------
(Dollars in thousands) 2004 2003
---- ----
Operating activities
Net income $ 14,044 $ 12,352
Adjustments to reconcile net income to net cash provided by operating
activities:
Loss, loss adjustment expenses and unearned premium reserves 1,288 1,734
Accrued expenses and other liabilities (3,302) (3,288)
Current taxes payable 572 321
Amounts due to/from reinsurer (439) (1,507)
Accrued investment income (273) (821)
Policy acquisition costs deferred (4,685) (4,471)
Amortization of deferred policy acquisition costs 3,185 3,418
Net realized investment gains (577) (219)
Provision for depreciation 790 695
Accretion of discount on investments (303) (1,103)
Deferred income taxes 5,274 4,956
Prepaid federal income taxes - (936)
Unearned ceding commission (120) (180)
Real estate acquired in claim settlement 1 502
Accrued interest on debt (691) (691)
Other assets 2,113 (135)
Other operating activities 252 146
--------- ---------
Net cash provided by operating activities 17,129 10,773
Investing activities
Securities available-for-sale:
Purchases - fixed maturities (44,661) (37,375)
Sales - fixed maturities 19,241 19,142
Purchases - equities (114) (120)
Sales - equities 390 210
Net change in short-term investments 12,796 8,089
Purchases of property and equipment (1,304) (394)
--------- ---------
Net cash used in investing activities (13,652) (10,448)
Financing activities
Proceeds from exercise of stock options 286 779
--------- ---------
Net cash provided by financing activities 286 779
--------- ---------
Net change in cash 3,763 1,104
Cash at beginning of period 973 233
--------- ---------
Cash at end of period $ 4,736 $ 1,337
========= =========
Supplemental schedule of cash flow information
Cash paid during the period for:
Income taxes and United States Mortgage Guaranty Tax and Loss Bonds $ - $ 1,017
Interest 1,383 1,383
See accompanying notes.
3
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2004
(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 residential 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 and to facilitate
the sale of mortgage loans in the secondary market.
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 months ended March 31, 2004 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2004. 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, 2003.
STOCK OPTIONS - Currently, the Company grants stock options to employees
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
March 31
---------------------------
2004 2003
---- ----
Net income - as reported $ 14,044 $ 12,352
Net income - pro forma $ 13,907 $ 12,170
Earnings per share - as reported:
Basic $ 0.97 $ 0.87
Diluted $ 0.96 $ 0.86
Earnings per share - pro forma:
Basic $ 0.96 $ 0.86
Diluted $ 0.95 $ 0.85
4
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2004
(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 and if 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 March 31, 2004 and December 31, 2003, as
presented below, was computed by applying the various percentage settlement
options to the insurance in force amounts, adjusted by risk ceded under
reinsurance agreements and by applicable stop-loss limits, to the insurance in
force amounts based on the original insured amount of the loan. Triad's ratio is
as follows (dollars in thousands):
March 31, December 31,
2004 2003
----------- -----------
Net risk $ 6,734,121 $ 6,590,222
=========== ===========
Statutory capital and surplus $ 125,392 $ 128,212
Statutory contingency reserve 318,880 302,740
----------- -----------
Total $ 444,272 $ 430,952
=========== ===========
Risk-to-capital ratio 15.2-to-1 15.3-to-1
=========== ===========
Triad and its wholly owned subsidiaries, Triad Guaranty Assurance
Corporation and Triad Re Insurance Corporation, are each required under their
respective domiciliary states' insurance code to maintain a minimum level of
statutory capital and surplus. Triad, an Illinois domiciled insurer, is required
under the Illinois Insurance Code (the "Code") to maintain minimum statutory
capital and surplus of $5 million. The Code permits dividends to be paid only
out of earned surplus and also requires prior approval of extraordinary
dividends. An extraordinary dividend is any dividend or distribution of cash or
other property, the fair value of which, together with that of other dividends
or distributions made within a period of twelve consecutive months, exceeds the
greater of (a) ten percent of statutory surplus as regards policyholders, or (b)
statutory net income for the calendar year preceding the date of the dividend.
5
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2004
(Unaudited)
Net income as determined in accordance with statutory accounting practices
was $18.6 million and $16.5 million for the three months ended March 31, 2004
and 2003, respectively, and $69.8 million for the year ended December 31, 2003.
At March 31, 2004 and December 31, 2003, the amount of Triad's equity that
could be paid out in dividends to stockholders was $41.7 million and $44.5
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 - Two lawsuits have been filed against the Company in the
ordinary course of the Company's business alleging violations of the Real Estate
Settlement Procedures Act and the Fair Credit Reporting Act. In the opinion of
management, the ultimate resolution of these pending litigation matters 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 denominators 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 March 31, 2004 and 2003, the Company's comprehensive income was $15.7
million and $13.4 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.
6
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 months ended March 31, 2004
and 2003 of Triad Guaranty Inc. and its consolidated subsidiaries. The
discussion supplements Management's Discussion and Analysis in Form 10-K for the
year ended December 31, 2003 and should be read in conjunction with the interim
financial statements and notes contained therein.
Certain of the statements contained herein, other than statements of
historical fact, are forward-looking statements. These statements are made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995 and include estimates and assumptions related to economic,
competitive, and legislative developments. These forward-looking statements are
subject to change and uncertainty which are, in many instances, beyond our
control and have been made based upon our expectations and beliefs concerning
future developments and their potential effect on us. There can be no assurance
that future developments will be in accordance with our expectations or that the
effect of future developments on the Company will be those anticipated by us.
Actual results could differ materially from those expected by us, depending on
the outcome of certain factors, including the possibility of general economic
and business conditions that are different than anticipated, legislative or
regulatory developments, changes in interest rates or the stock markets,
stronger than anticipated competitive activity, and the factors described in the
forward-looking statements.
UPDATE ON CRITICAL ACCOUNTING ESTIMATES
Our Form 10-K describes the accounting policies that are critical to the
understanding of our results of operations and our financial position. These
critical accounting policies relate to the assumptions and judgments utilized in
establishing the reserve for losses and loss adjustment expenses, in determining
if declines in fair values of investments are other than temporary investments,
and in establishing appropriate initial amortization schedules for and
periodically adjusting amortization of deferred policy acquisition costs.
We continue to believe that these are the critical accounting policies
applicable to the Company and further believe that these policies were applied
in a consistent manner during the first three months of 2004.
OVERVIEW
As detailed in our Form 10-K, we provide mortgage guaranty insurance
coverage to residential mortgage lenders and investors as a credit-enhancement
vehicle. None of our basic operating strategies that were described in our Form
10-K have changed in the first three months of 2004. Our profitability continues
to depend largely on a) the adequacy of our product pricing and underwriting
discipline relative to the risks insured; b) persistency levels; c) operating
efficiencies; and d) the level of investment yield, including realized gains and
losses on our investment portfolio.
7
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS
Following is a summary of our results for the three months ended March 31,
2004 and 2003 (dollars in thousands except per share information):
2004 2003
---- ----
Earned premiums $33,812 $28,132
Net investment income 4,586 4,333
Net realized investment gains 577 219
Other income 3 12
------- -------
Total revenues 38,978 32,696
Net losses and loss adjustment expenses 8,883 5,265
Interest expense on debt 693 693
Amortization of deferred policy
acquisition costs 3,185 3,418
Other operating expenses (net of
acquisition costs deferred) 6,340 5,841
------- -------
Income before income taxes 19,877 17,479
Income taxes 5,833 5,127
------- -------
Net income $14,044 $12,352
======= =======
Diluted earnings per share $ 0.96 $ 0.86
======= =======
The primary positive driver of our results for the first quarter of 2004
was persistency. We define persistency as the percentage of insurance in force
remaining from twelve months prior. We saw persistency drop through most of
2003, reaching its low point in the third quarter. The quarterly persistency run
rate for the first quarter of 2004 was 68.5% compared to 46.3% for the fourth
quarter of 2003, 19.3% for the third quarter of 2003 and 50.8% for the first
quarter of 2003. Improvements in persistency positively affect our net income
primarily in two ways: a) renewal earned premiums increase and b) expenses
decrease because of reduced amortization of deferred policy acquisition costs.
Another important component of our results in the first quarter of 2004 is
the loss development pattern that has emerged. Our insurance in force has grown
58% over the past two years. This growth, coupled with the low levels of
persistency realized over the past two years, has produced a relatively
unseasoned book of business. Experience has shown that the highest claims
incidence generally occurs three to six years after the policy is written. Prior
to this period of increased claims incidence, estimates for these anticipated
future claims would be provided through an increase in reserves based upon
delinquencies reported to us. Our unseasoned book of business is reaching the
period where we expect both higher delinquencies and claims. This fact, coupled
with the significant growth in insurance in force, contributed to the increase
in losses and loss adjustment expenses in the first quarter of 2004 when
compared to the same period in 2003.
8
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
Two other important drivers of our results have been the increase in bulk
production and our continued commitment to risk-sharing arrangements with our
lender partners. We address these drivers and the impact each had in the
detailed year-by-year comparisons that follow this discussion. The information
is presented in three categories: Production and In Force, Revenues, and Losses
and Expenses.
FIRST QUARTER 2004 COMPARED TO FIRST QUARTER 2003
Net income for the first quarter of 2004 increased 13.7% to $14.0 million
from $12.4 million in the first quarter of 2003. Net income per share on a
diluted basis increased 11.6% to $.96 for the first three months of 2004 from
$.86 per share in the same period of 2003. This improvement in net income was
driven primarily by an increase of $5.7 million in earned premiums, offset by a
$3.6 million increase in net losses.
PRODUCTION AND IN FORCE
Total insurance written in the first quarter of 2004 was $4.7 billion
compared to $3.8 billion in the first quarter of 2003, an increase of 23.8%.
Total insurance written includes insurance written from flow production and
structured bulk transactions.
Flow insurance written for the first quarter of 2004 decreased 34.4% to
$2.4 billion from $3.6 billion in the first quarter of 2003. This decrease was
primarily the result of the slowdown in the refinance market due to generally
rising rates during the first quarter of 2004 compared to generally declining
rates during the 2003 first quarter. This slowed the overall production of the
entire industry.
Insurance written in the first quarter of 2004 attributable to structured
bulk transactions totaled $2.3 billion compared to $136 million in the first
quarter of 2003. Secondary mortgage market participants who wish to use mortgage
insurance as a credit enhancement generally initiate structured bulk
transactions. We compete against other mortgage insurers as well as other forms
of credit enhancement provided by capital markets for these transactions.
Insurance written for structured bulk transactions is likely to vary
significantly from period to period, as opposed to insurance written from flow
originations, due to a) the limited number of transactions (but with larger
size) occurring in this market, b) competition from other mortgage insurers, c)
the relative attractiveness in the marketplace of mortgage insurance versus
other forms of credit enhancement, and d) the acceptability of changing loan
composition and underwriting criteria in the bulk market.
The risk characteristics of the loans in our bulk portfolio have not
changed significantly from December 31, 2003. We predominantly enter into
transactions insuring loans that are classified as Alt-A, which we have defined
as having high credit quality and an average loan-to-value ("LTV") of 75% that
have been underwritten with reduced, streamlined or no documentation.
Additionally, over 80% of the bulk transactions entered into during the first
quarter of 2004 have been structured with deductibles putting us in the second
loss position.
We estimate our national market share of net new primary insurance written,
which includes insurance written on a flow basis as well as that attributed to
structured bulk transactions, was 7.0% for the first quarter of 2004 compared to
3.9% for the first three months of 2003. Our national market share of net new
primary insurance written on a flow basis was 4.7% for the first three months of
9
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
2004 compared to 4.8% for the first quarter of 2003. We estimate that we had
21.4% of the national market share attributable to structured bulk transactions
for the first quarter of 2004 compared to a negligible percentage in the first
three months of 2003.
Periodically we enter into structured bulk 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 situation occurs, we accrue
premiums that are due but not yet paid based upon the estimated commitment
amount of the transaction in the reporting period with respect to each loan's
insurance effective date. However, the policies are not reflected in our in
force, insurance written, or related industry data totals until the loan level
detail is reported to us. At March 31, 2004, we had approximately $392 million
of structured transactions with effective dates within the first quarter for
which loan level detail had not been received and, therefore, are not included
in our own data or industry totals. These amounts will be reported as new
production and insurance in force totals when the issuer provides loan level
detail to us. We have properly included in premium written and premium earned
the respective amounts due and earned during the first quarter of 2004 related
to this insurance. There were no bulk transactions at March 31, 2003 for which
loan level detail was not provided by the issuer.
Total direct insurance in force reached $33.9 billion at March 31, 2004
compared to $31.7 billion at December 31, 2003 and $26.0 billion at March 31,
2003.
Annual persistency was 54.6% at March 31, 2004 compared to 50.7% at
December 31, 2003 and 59.1% at March 31, 2003. The quarterly persistency run
rate for the first quarter of 2004 was 68.5% compared to 46.3% for the fourth
quarter of 2003, 19.3% for the third quarter of 2003 and 50.8% for the first
quarter of 2003. The major driver of the increasing persistency rates over the
two most recent quarters has been the general rise in mortgage interest rates
which led to a corresponding decline in refinance activity. Triad's refinance
activity for the first three months of 2004 was 35.4% of flow insurance written
compared to 42.1% in the fourth quarter of 2003 and 57.2% in the first quarter
of 2003.
The quality of our existing insurance in force portfolio has remained
relatively consistent in spite of a 25% growth in insurance in force from March
31, 2003 to March 31, 2004. Fair, Isaac and Co., Inc. ("FICO") credit scores are
one of the major factors used in determining credit risk in an existing book of
business. The following table presents the FICO credit score distribution of our
insurance in force for both flow and bulk at March 31, 2004 and 2003.
Flow Bulk
---- ----
2004 2003 2004 2003
---- ---- ---- ----
Credit score less than 575 0.8% 0.7% 3.0% 3.4%
Credit score between 575 and 619 4.2% 4.3% 6.2% 11.4%
Credit score greater than 619 95.0% 95.0% 90.8% 85.2%
As the table shows, we insure very few loans that have FICO credit scores
below 575. We believe that these loans have a higher probability of loss than a
loan with a FICO credit score of 575 or greater. We do not expect loans with
FICO scores less than 575 to become a significant portion of our insurance in
force.
10
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
REVENUES
Total direct premiums written were $40.3 million for the first three months
of 2004, an increase of 18.5% compared to $34.0 million for the first quarter of
2003. Contributing to the increase in direct premiums written for the first
quarter of 2004 were significant writings related to structured bulk
transactions. For the first quarter of 2004, earned premium relating to bulk
transactions amounted to $6.9 million or 20.1% of the total. Earned premium
related to bulk transactions amounted to $3.5 million or 12.3% of the total
during the first quarter of 2003.
Net premiums written increased 14.9% to $32.3 million for the first quarter
of 2004 compared to $28.1 million for the first quarter of 2003. The primary
difference between direct premiums written and net premiums written is ceded
premium. Ceded premium is comprised of premiums paid on excess of loss
reinsurance treaties as well as risk-sharing arrangements with our lender
partners (referred to as captive reinsurance arrangements). Driven by an
increase in the amount of premium subject to captive reinsurance arrangements,
ceded premiums written increased 35.4% to $8.0 million in the 2004 first quarter
from $5.9 million in the first three months of 2003. Our premium cede rate (the
ratio of ceded premiums written to direct premiums written) was 19.8% for the
first quarter of 2004 compared to 17.3% for the same period in 2003. Our premium
cede rate for captive reinsurance arrangements (the ratio of ceded premiums
written under captive reinsurance arrangements to total direct premiums written)
was 17.6% during the first three months of 2004 compared to 14.5% for 2003.
During the first quarter of 2004, approximately 60.3% of flow insurance written
(30.8% of total insurance written including structured bulk transactions) was
subject to captive reinsurance arrangements compared to 48% of flow insurance
written (47% including structured bulk transactions), in the same period of
2003. The increase in the percentage of flow insurance written subject to
captive reinsurance arrangements from 2003 to 2004 is primarily a result of a
decline in production from our lender-paid mortgage insurance program that is
not subject to captive programs. Additionally, none of our structured bulk
transactions are subject to captive reinsurance arrangements. We anticipate that
ceded premiums will continue to increase as a result of the expected increase in
insurance in force subject to captive reinsurance arrangements.
We continue to see the success of our strategic initiatives to provide
captive risk-sharing alternatives to selected lender partners. We remain
committed to the concept of captive reinsurance arrangements on a
lender-by-lender basis. We will continue to be an active participant with our
lender partners in structures utilizing alternative attachment points, risk
bands, cede rates, and ceding commissions. Several of our competitors have
announced that they will discontinue or limit the amount of deep ceded captive
arrangements. Where prudent, we plan to continue to participate in captive
risk-sharing arrangements, including deep ceded arrangements, on a
lender-by-lender basis. It is uncertain at this time what impact, if any, the
competitors' decisions, as described above, will have on our production of
insurance subject to captive reinsurance arrangements.
Earned premiums increased 20.2% to $33.8 million for the first three months
of 2004 from $28.1 million for the same period in 2003. The difference between
net written premiums and earned premiums for the quarter is due to the
significant writings of our bulk premium product primarily prepaid on an annual
basis and the related increase in the unearned premium reserve. Our unearned
premium liability increased to $14.2 million at March 31, 2004 from $8.6 million
at March 31, 2003.
11
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
Net investment income for the first three months of 2004 was $4.6 million,
a 5.8% increase over $4.3 million in the first quarter of 2003. Average invested
assets grew by $69 million to $421 million for the three months ended March 31,
2004, an increase of 19.6% from an average of $352 million for the first three
months of 2003. The increase in average invested assets was attributable to
funds derived from 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 investment yields.
We reported $577,000 of net realized investment gains during the first
quarter of 2004 compared to $219,000 of net realized investment gains in the
same period of 2003. Included in net realized gains were impairment write-downs
totaling $100,000 in the first quarter of 2004 versus $439,000 in the first
quarter of 2003 as discussed further in the Realized Gains, Losses and
Impairments section below.
LOSSES AND EXPENSES
Net incurred losses and loss adjustment expenses (net of reinsurance
recoveries) increased by 68.7% in the first three months of 2004 to $8.9 million
from $5.3 million in the first quarter of 2003. The increase in losses and loss
adjustment expenses of our relatively unseasoned book of business was
anticipated based upon the growth in the number of delinquencies and is
reflective of our overall growth of both flow and bulk insurance in force. Net
paid losses, excluding loss adjustment expenses, increased to $6.0 million
during the first quarter of 2004 from $3.4 million during the first three months
of 2003, an increase of 74.5%. The increase in net paid losses approximates the
increase in incurred losses and was within our expected range. Average severity
(direct paid losses divided by number of claims paid) was approximately $27,400
during the first quarter of 2004 compared to $22,700 for the same period in
2003. The increase in severity over the past year is due to a higher proportion
of claims being concentrated in insurance written in recent policy years. Claims
arising from recent policy years have not fully benefited from the mitigating
effects of extended real estate appreciation and amortization of the principal
balance. The following table provides detail on net paid losses excluding loss
adjustment expenses from flow business and structured bulk business (in
thousands of dollars).
Three Months Ended March 31
---------------------------
2004 2003
---- ----
Flow business $5,254 $3,309
Bulk business 755 137
------ ------
Total $6,009 $3,446
====== ======
Our loss ratio (the ratio of incurred losses to earned premiums) was 26.3%
for the first three months of 2004 compared to 18.7% for the 2003 first quarter.
As mentioned earlier, the increase in the loss ratio is consistent with our
expectations given the overall growth of insurance in force and the increase in
severity of reserves due to the lack of seasoning of our in force business. We
expect the first quarter 2004 loss ratio of 26.3% to trend upward as the
unseasoned book continues to fully develop.
Due to the high refinancing in the past two years, our insurance in force
is relatively unseasoned. We believe, based upon our experience and industry
12
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
data, that claims incidence for flow business is generally highest in the third
through sixth years after loan origination. We believe that the period of
highest claims incidence for structured bulk transactions is earlier than that
for flow business. We expect our incurred losses to increase as a greater amount
of our insurance in force reaches its anticipated highest claim frequency years.
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 decreased by 6.8% to $3.2
million during the first quarter of 2004 from $3.4 million for the first quarter
of 2003. The decrease in amortization reflects the increased persistency in the
first quarter of 2004 compared to the first three months of 2003. A full
discussion of the impact of persistency on DAC amortization is included under
the subheading `Deferred Policy Acquisition Costs' under Financial Position
later in this section.
Other operating expenses increased 8.6% to $6.3 million for the first three
months of 2004 from $5.8 million for the same period in 2003. The modest rise in
other operating expenses is primarily the result of increased general and
administrative expenses necessary to service the 25% increase in the insurance
in force during the same period. The expense ratio (ratio of the amortization of
deferred policy acquisition costs and other operating expenses to net premiums
written) for the first quarter of 2004 was 29.4% compared to 32.9% for first
three months of 2003. The expense ratio for the first quarter 2004 improved
because of increases in net written premium at a rate faster than other
operating expenses coupled with a decline in DAC amortization.
Our effective tax rate was 29.3% for both the first quarter of 2004 and
2003. We expect our effective tax rate to range between 28.5% and 30.0% for the
remainder of the year depending on the relationship of tax-free investment
income from our municipal bond portfolio to total revenues.
SIGNIFICANT CUSTOMERS
Our objective is controlled, profitable growth in both the flow and bulk
arenas while adhering to our risk management strategies. Our strategy is to
continue our focus on national lenders while maintaining the productive
relationships that we have built with regional lenders. Consolidation within the
mortgage origination industry has resulted in a greater percentage of production
volume being concentrated among a smaller customer base. Our ten largest
customers were responsible for 72% of flow insurance written during the first
quarter of 2004 compared to 75% in the first three months of 2003. Our two
largest customers were responsible for 54% of flow insurance written during the
first three months of 2004 compared to 56% in the first quarter of 2003. The
loss of one or more of these significant customers could have an adverse effect
on our business.
13
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
FINANCIAL POSITION
Total assets increased to $596 million at March 31, 2004 compared to $576
million at December 31, 2003, a 14% annualized growth rate. Total liabilities
increased to $209 million at March 31, 2004, from $206 million at December 31,
2003. This section identifies several items on our balance sheet that are
important in the overall understanding of our financial position. These items
include deferred policy acquisition costs, prepaid federal income tax and
related deferred income taxes, and loss and loss adjustment expense reserves.
Our mortgage insurance operations and reserves are primarily supported by our
investment portfolio, which contains most of our assets. A separate Investments
Portfolio section follows the Financial Position section and reviews our
investment portfolio, key portfolio management strategies, and methodologies by
which we manage credit risk.
DEFERRED POLICY ACQUISITION COSTS
In accordance with generally accepted accounting principles, costs expended
to acquire new business are capitalized as deferred policy acquisition costs
(DAC) and recognized as expense over the anticipated premium earning life of the
policy. We employ dynamic models that calculate amortization of DAC separately
for each book year. The models rely on assumptions that we make based upon
historical industry experience and our own unique experience regarding the
annual persistency development of each book year. Persistency is the most
important assumption utilized in determining the timing of reported amortization
expense reflected in the income statement and the carrying value of DAC on the
balance sheet. A change in the assumed persistency development will impact the
current and future amortization expense as well as the carrying value on the
balance sheet. However, our models are dynamic and adjust when actual book year
persistency is lower than the assumptions employed in the models. When this
happens, the DAC amortization is accelerated through a dynamic adjustment in
order to better match the timing of amortization expense with the life of the
policies on which the acquisition costs were originally deferred. The following
table shows the DAC asset for the previous two years and the effect of
persistency on amortization (amounts in thousands):
Three Months Ended March 31
---------------------------
2004 2003
---- ----
Balance -beginning of period $ 29,363 $ 28,997
Costs capitalized 4,685 4,471
Amortization - normal (3,097) (3,122)
Amortization - dynamic adjustment (88) (296)
-------- --------
Total amortization (3,185) (3,418)
-------- --------
Balance - end of period $ 30,863 $ 30,050
======== ========
Quarterly Persistency Rate 68.5% 50.8%
======== ========
14
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
PREPAID FEDERAL INCOME TAXES AND DEFERRED INCOME TAXES
See Form 10-K for a description of the special contingency reserve
deduction afforded to mortgage insurers and the related Federal Tax and Loss
Bonds permitted to be purchased. During the first quarter of 2004, we did not
purchase any additional Tax and Loss bonds nor did any mature.
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVE
We establish reserves using estimated claim rates (frequency) and claim
amounts (severity) to estimate ultimate losses. Our reserving process
incorporates numerous factors in a formula that gives effect to current economic
conditions and profiles delinquencies by such factors as 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, we perform sensitivity analyses to
test the reasonableness of the best estimate generated by the loss reserve
process. Adjustments to reserve estimates are reflected in the financial
statements in the periods in which the adjustments are made.
Our loss and loss adjustment expense reserves increased to $29.9 million at
March 31, 2004, compared to $27.2 million at December 31, 2003 and $23.1 million
at March 31, 2003.
Loss and loss adjustment expense reserves are established on insured
mortgage loans when any notices of default are received from the lender, no
matter what the age of default. Reserves also are established for estimated
losses incurred on notices of default not yet reported by the lender. Consistent
with industry practices, we do not establish loss reserves for future claims on
insured loans that are not currently in default. Over 58% of our insurance in
force was written within the last two years. Experience indicates that years
three through six have the highest incidence of claims. With the continued
seasoning of our insurance in force coupled with the significant growth of the
in-force, we expect the actual number of loans in default to continue to grow.
The increase in reserves in the first quarter of 2004 is indicative of the
increase in the number of loans in default and an expected growth in severity.
We expect loss reserves to continue to grow, reflecting the growth and aging of
our insurance in force.
The following table shows default statistics as of March 31, 2004, December
31, 2003, and March 31, 2003.
Default Statistics
-------------------------------------
March 31 December 31 March 31
2004 2003 2003
---- ---- ----
Number of insured loans in force 249,683 236,234 195,928
Number of loans in default 4,722 4,242 3,009
Percentage of loans in
default (default rate) 1.89% 1.80% 1.54%
Number of insured loans in force
excluding bulk loans 207,314 205,033 178,868
Number of loans in default
excluding bulk loans 3,343 3,053 2,280
Percentage of loans in default
excluding bulk loans 1.61% 1.49% 1.27%
Number of bulk loans in force 42,369 31,201 17,060
Number of bulk loans in default 1,379 1,189 729
Percentage of bulk loans in default 3.25% 3.81% 4.27%
15
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
The number of loans in default reported above includes all reported
delinquencies that are in excess of two payments in arrears at the reporting
date and all reported delinquencies that were previously in excess of two
payments in arrears and have not been brought current. As mentioned earlier, we
provided reserves on all loans for which we have been notified of default,
regardless of the age of the default. The increase in the absolute number of
loans in default for both flow and bulk business is attributable primarily to
the growth in the amount of insurance in force. The percentage of loans in
default for the flow business has increased due to the maturing of the portfolio
and the higher expected default rates as the portfolio seasons. Contributing to
changes in default rates are 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 the policies in force 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 occurrences for both flow business and
structured bulk business are consistent with management's expectation.
INVESTMENT PORTFOLIO
PORTFOLIO DESCRIPTION
Our strategy for managing our investment portfolio is to meet or exceed
regulatory and rating agency requirements while appropriately managing credit
risk. We invest for the long term, and most of our investments are held until
they mature. Our investment portfolio includes primarily fixed income
securities, and the majority of these are tax-sheltered state and municipal
bonds. We have established a formal investment policy that describes our overall
quality and diversification objectives and limits. Our investment policies and
strategies are subject to change depending upon regulatory, economic, and market
conditions, as well as anticipated financial condition and operating
requirements, including the tax position, of the Company. Our investment
portfolio consists entirely of available-for-sale securities; therefore, all
values are carried on our balance sheet at fair value. The following schedule
shows the growth and diversification of our investment portfolio (dollars in
thousands).
March 31, 2004 December 31, 2003
-------------- -----------------
Amount Percent Amount Percent
------ ------- ------ -------
Fixed maturity securities:
U. S. government obligations $ 14,642 3.5% $ 15,623 3.8%
Mortgage-backed bonds 93 0.0 99 0.0
State and municipal bonds 362,563 84.5 330,228 79.9
Corporate bonds 26,270 6.1 29,147 7.0
-------- ----- ------- ------
Total fixed maturities 403,568 94.1 375,097 90.7
Equity securities 12,477 2.9 12,771 3.1
-------- ----- ------- ------
Total available-for-sale securities 416,045 97.0 387,868 93.8
Short-term investments 12,863 3.0 25,659 6.2
-------- ----- ------- ------
$428,908 100.0% $413,527 100.0%
======== ===== ======== ======
We seek to provide liquidity in our investment portfolio through cash
equivalent investments and through diversification and investment in publicly
traded securities. We attempt to maintain a level of liquidity and duration in
our investment portfolio consistent with our business outlook and the expected
16
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
timing, direction, and degree of changes in interest rates. The duration to
maturity of the fixed maturity portfolio was 11.9 years at March 31, 2004 with
an effective maturity of 7.2 years. This compared to the duration to maturity at
December 31, 2003 of 11.4 years and an effective maturity of 6.4 years. Another
way that we manage risk and liquidity is to limit our exposure on individual
securities. As of March 31, 2004 and December 31, 2003, no investment in the
securities of any single issuer exceeded 2% of our investment portfolio.
The growth in net investment income has moderated recently in spite of an
increase in our overall investment portfolio. The drop in the effective pre-tax
yield reflects the decrease in new money rates available for investment coupled
with our strategies to increase the overall credit quality of the portfolio and
increase our investment in state and municipal bonds. The portfolio's yield was
also affected by a higher percentage of the fixed income portfolio invested in
short-term investments at low yielding money market rates.
CREDIT RISK
We manage credit risk in our investment portfolio by following internal
investment quality guidelines and diversification. One way we attempt to limit
the inherent credit risk in the portfolio is to maintain higher-rated
investments. The following table describes our fixed maturity portfolio by
credit ratings (dollars in thousands).
March 31, 2004 December 31, 2003
-------------- -----------------
Amount Percent Amount Percent
------ ------- ------ -------
Fixed Maturities:
U.S. treasury and agency bonds $ 14,985 3.7% $ 15,722 4.2%
AAA 262,221 65.0 256,291 68.3
AA 56,078 13.9 50,428 13.4
A 54,925 13.6 35,937 9.6
BBB 10,145 2.4 10,347 2.8
BB 344 0.1 2,204 0.6
B 1,034 0.3 1,669 0.4
CCC and lower 213 0.1 525 0.1
Not rated 3,623 0.9 1,974 0.5
--------- ----- --------- -----
Total fixed maturities $ 403,568 100.0% $ 375,097 100.0%
========= ===== ========= =====
Credit risk is inherent in an investment portfolio. We manage this risk
through a structured approach in which we assess the effects of the changing
economic landscape. In identifying "potentially distressed securities", we first
identify all securities that have a fair value to cost or amortized cost ratio
of less than 80%. Additionally, as part of this identification process, we
utilize the following information for possible inclusion on the "potentially
distressed securities" list:
o Length of time the fair value was below amortized cost
o Industry factors or conditions related to a geographic area negatively
affecting the security
17
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
o Downgrades by a rating agency
o Past due interestor principal payments or other violation of covenants
o Deterioration of the overall financial condition of the specific
issuer
In analyzing our "potentially distressed securities" list for
other-than-temporary impairments, we pay special attention to securities that
have been on the list for a period greater than six months. Our ability and
intent to retain the investment for a sufficient time to recover its value is
also considered. We assume that, absent reliable contradictory evidence, a
security that is potentially distressed for a continuous period greater than
nine months has incurred an other-than-temporary impairment. Such reliable
contradictory evidence might include, among other factors, a liquidation
analysis performed by our investment advisers or outside consultants, improving
financial performance of the issuer, or valuation of underlying assets
specifically pledged to support the credit.
Should we conclude that the decline is other than temporary, the security
is written down to fair value through a charge to realized investment gains and
losses. We adjust the amortized cost for securities that have experienced
other-than-temporary impairments to reflect fair value at the time of the
impairment. We consider factors that lead to an other-than-temporary impairment
of a particular security in order to determine whether these conditions have
impacted other similar securities.
UNREALIZED LOSSES
The following table represents the cost, unrealized gains and unrealized
losses in the investment portfolio at March 31, 2004.
Cost or Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------------------------------------
Fixed maturity securities:
Corporate $ 22,842 $ 3,567 $ 139 $ 26,270
U.S. Government 14,445 275 78 14,642
Mortgage-backed 85 8 - 93
State and municipal 348,430 14,448 315 362,563
----------------------------------------------
Total 385,802 18,298 532 403,568
Equity securities 10,534 2,018 75 12,477
----------------------------------------------
Total $ 396,336 $ 20,316 $ 607 $ 416,045
==============================================
These unrealized gains and losses do not necessarily represent future gains
or losses that we will realize. Changing conditions related to specific
securities, overall market interest rates, or credit spreads, as well as our
decisions concerning the timing of a sale, may impact values we ultimately
realize. We monitor unrealized losses through further analysis according to
maturity date, credit quality, individual creditor exposure and the length of
time the individual security has continuously been in an unrealized loss
position. Unrealized losses related to fixed maturities amounted to $532,000 at
March 31, 2004, with the preponderance of the unrealized losses related to bonds
with a maturity date in excess of ten years. The largest individual unrealized
loss on any one security at March 31, 2004, was $139,000 on a $1 million par
bond.
Of the $607,000 gross unrealized losses at March 31, 2004, none was
included in our potentially distressed securities list mentioned above.
Information about unrealized gains and losses is subject to changing
conditions. Securities with unrealized gains and losses will fluctuate, as will
18
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
those securities that we have identified as potentially distressed. The recent
volatility of financial markets has led to an increase in both unrealized gains
and losses. We consider all of the factors discussed earlier when we determine
if an unrealized loss is other than temporary, including our ability and intent
to hold the security until the value recovers. Our current evaluation of
other-than-temporary impairments reflects our positive intent to hold certain
securities until maturity. However, we may subsequently decide to sell certain
of these securities in future periods within the overall context of our
portfolio management strategies. If we make the decision to dispose of a
security with an unrealized loss, we will write down the security to its fair
value if we have not sold it by the end of the reporting period.
REALIZED GAINS, LOSSES, AND IMPAIRMENTS
During the first quarter of 2004, we wrote down one security in the amount
of $100,000. This was a $250,000 par value preferred stock in an international
airline for which the fair value had fluctuated near the 80% value for close to
one year. This particular security is not currently in default; however, we
determined that the impairment was other than temporary. We hold no other equity
or fixed maturity investments in the airline industry.
LIQUIDITY AND CAPITAL RESOURCES
Our 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 prepaid federal income taxes in the form of Tax
and Loss Bonds.
We generated positive cash flow from operating activities of $17.1 million
in the first quarter of 2004 compared to $10.8 million for the first three
months of 2003. The increase in cash flow from operating activities in 2004
reflects the growth in premiums in excess of increases in other operating
expenses paid and claims paid. Our business does not routinely require
significant capital expenditures other than for enhancements to our 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 insurance laws of the State of Illinois impose certain restrictions on
dividends that an insurance subsidiary can pay the parent company. These
restrictions, based on statutory accounting practices, include requirements that
dividends may be paid only out of statutory earned surplus and that limit the
amount of dividends that may be paid without prior approval of the Illinois
Insurance Department. There have been no dividends paid by the insurance
subsidiaries to the parent company.
We cede business to captive reinsurance subsidiaries 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 $386.3 million at March 31, 2004,
from $369.9 million at December 31, 2003. This increase resulted primarily from
the first quarter 2004 net income of $14.0 million, an increase in net
unrealized gains on invested assets classified as available-for-sale of $1.6
million (net of income tax), and additional paid-in-capital of $1.8 million
resulting from the exercise of employee stock options and the related tax
benefit, offset by an increase in deferred compensation, representing additional
unvested restricted stock.
Total statutory policyholders' surplus for our insurance subsidiaries
decreased to $125.4 million at March 31, 2004, from $128.2 million at December
31, 2003. The primary difference between statutory policyholders' surplus and
equity computed under generally accepted accounting principles is the statutory
19
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
contingency reserve. The balance in the statutory contingency reserve was $318.9
million at March 31, 2004, compared to $302.7 million at December 31, 2003.
Statutory capital, for the purpose of computing the total risk in force to
statutory capital, includes both policyholders' surplus and the contingency
reserve. Statutory capital amounted to $444.3 million at March 31, 2004,
compared to $431.0 million at December 31, 2003.
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 March 31,
2004, Triad's risk-to-capital ratio was 15.2-to-1 as compared to 15.3-to-1 at
December 31, 2003, and 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 as the
denominator.
There have been no changes in our financial ratings or outlook by the
rating agencies since December 31, 2003 as detailed in our Form 10-K. Triad is
rated "AA" by both Standard & Poor's Ratings Services and Fitch Ratings and
"Aa3" by Moody's Investors Service. A reduction in Triad's rating or outlook,
while not anticipated, could adversely affect our operations.
There have been legislative and regulatory proposals to change the
oversight of both Fannie Mae and Freddie Mac. Significant changes in the
regulation of these entities could impact the entire mortgage industry and our
Company.
OFF BALANCE SHEET ARRANGEMENTS AND AGGREGATE CONTRACTUAL OBLIGATIONS
We lease office facilities, automobiles, and office equipment under
operating leases with minimum lease commitments that range from one to ten
years. We have no capitalized leases or material purchase commitments. Our
long-term debt has a single maturity date of 2028. There have been no material
changes to the aggregate contractual obligations shown in the December 31, 2003
Form 10-K.
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 prices increase or decrease from their current levels;
20
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS - (CONTINUED)
o housing transactions requiring mortgage insurance may decrease for
many reasons including changes in interest rates or economic
conditions;
o our 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 our financial condition and competitive position could be affected by
legislation or regulation impacting the mortgage guaranty industry or
the Government Sponsored Entities, specifically, and the financial
services industry in general;
0 rating agencies may revise methodologies for determining our financial
strength ratings and may revise or withdraw the assigned ratings at
any time;
0 decreases in persistency, which are affected by loan refinancing in
periods of low interest rates, may have an adverse effect on earnings;
0 the amount of insurance written and the growth in insurance in force
or risk in force as well as our performance may be adversely impacted
by the competitive environment in the private mortgage insurance
industry, including the type, structure, and pricing of our products
and services and our competitors;
0 if we fail to properly underwrite mortgage loans under contract
underwriting service agreements, we may be required to assume the
costs of repurchasing those loans;
0 with consolidation occurring among mortgage lenders and our
concentration of insurance in force generated through relationships
with significant lender customers, our margins may be compressed and
the loss of a significant customer may have an adverse effect on our
earnings;
0 our performance may be impacted by changes in the performance of the
financial markets and general economic conditions;
0 economic downturns in regions where our risk is more concentrated
could have a particularly adverse effect on our financial condition
and loss development;
0 OFHEO risk-based capital rules could severely limit our ability to
compete against various types of credit protection counterparties,
including "AAA" rated private mortgage insurers;
0 changes in the eligibility guidelines of Fannie Mae or Freddie Mac
could have an adverse effect on the Company;
0 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 our 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.
21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's market risk exposures at March 31, 2004 have not materially
changed from those identified at December 31, 2003.
ITEM 4. CONTROLS AND PROCEDURES
a) We carried out an evaluation, under the supervision and with the
participation of our management, including the Chief Executive Officer
(CEO) and Chief Financial Officer (CFO), of the effectiveness of our
disclosure controls and procedures pursuant to Securities Exchange Act
of 1934 (Act) Rule 13a-15. Based on that evaluation, our management,
including our CEO and CFO, concluded, as of the end of the period
covered by this report, that our disclosure controls and procedures
were effective. Disclosure controls and procedures include controls
and procedures designed to ensure that management, including our CEO
and CFO, is alerted to material information required to be disclosed
in our filings under the Act so as to allow timely decisions regarding
our disclosures. In designing and evaluating disclosure controls and
procedures, we recognized that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance
of achieving the desired control objectives, as ours are designed to
do.
b) There have been no changes in our internal controls over financial
reporting identified in connection with the evaluation described in
the above paragraph that occurred during the first quarter 2004 that
have materially affected, or are reasonably likely to materially
affect, our internal controls over financial reporting.
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
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ITEM 6A. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
See exhibit index on Page 23
(b) Reports on Form 8-K since December 31, 2003
January 30, 2004 - Triad Guaranty Inc. issued a news release
announcing its financial results for the fourth quarter and
the fiscal year ended December 31, 2003.
April 27, 2004 - Triad Guaranty Inc. issued a news release
announcing its financial results for the first quarter of 2004.
SIGNATURE
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: May 6, 2004
/s/ Kenneth S. Dwyer
---------------------
Kenneth S. Dwyer
Vice President and Chief
Accounting Officer
EXHIBIT INDEX
Exhibit Number Description
-------------- ------------
31(i) Certification of Chief Executive Officer pursuant to
Exchange Act Rule 13a-14(a), as adopted 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), as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32 Certifications 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.
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