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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 333-7944
CGA GROUP, LTD.
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(Exact Name of Registrant as Specified in Its Charter)
BERMUDA 98-0173536
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Craig Appin House
8 Wesley Street
Hamilton HM11 Bermuda Not Applicable
- - ---------------------------------------- --------------
(Address of principal executive offices) (Zip Code)
(441) 296-3165
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(Registrant's telephone number, including area code)
Not Applicable
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(Former name, former address, and former fiscal year,
if changed since last report)
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
9,100,000
--------------------------
(As of September 30, 1998)
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<PAGE>
CGA GROUP, LTD.
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION PAGE
Item 1. Financial Statements
Consolidated Balance Sheets -
September 30, 1998 and December 31, 1997.............................1
Consolidated Statements of Operations -
Three Months and Nine Months Ended September 30, 1998 and
Three Months and Six Months Ended September 30, 1997.................2
Consolidated Statements of Mezzanine Equity -
Nine Months Ended September 30, 1998 and Nine Months
Ended December 31, 1997..............................................3
Consolidated Statements of Shareholders' Equity -
Nine Months Ended September 30, 1998 and Nine Months
Ended December 31, 1997..............................................4
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 1998 and Six Months Ended 1997.......5
Notes to Consolidated Financial Statements...........................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.............................................12
Item 3. Quantitative and Qualitative Disclosures About Market Risk............15
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.............................16
Item 6. Exhibits and Reports on Form 8-K......................................16
Signatures....................................................................18
<PAGE>
CGA GROUP, LTD.
CONSOLIDATED BALANCE SHEETS
(Expressed in U.S. Dollars)
(Unaudited)
<TABLE>
<CAPTION>
September 30 December 31
1998 1997
------------- -------------
<S> <C> <C>
ASSETS
Fixed maturities available for sale, ( at fair value)
(Amortized cost: $125,313,994 and $121,664,671) $ 129,938,047 $ 123,302,763
Cash and short-term investments 3,294,251 7,199,106
Note receivable -- 250,000
Premiums receivable 2,972,829 447,172
Accrued interest receivable 3,361,870 4,080,600
Deferred acquisition costs 3,116,901 1,001,883
Other assets 3,501,573 2,018,309
Organization costs -- 4,421,353
------------- -------------
Total assets $ 146,185,471 $ 142,721,186
============= =============
LIABILITIES
Unearned premiums $ 962,791 $ 270,576
Provision for losses and loss adjustment expenses 1,355,000 55,000
Reinsurance balances payable 280,847 --
Accrued costs and expenses 4,726,420 3,591,033
------------- -------------
Total liabilities 7,325,058 3,916,609
------------- -------------
MEZZANINE EQUITY
Preferred stock, $.01 par value, 20,000,000 shares authorized:
Series A 72,474,645 65,532,499
Series B 37,250,849 37,075,371
Dividends accrued on Series B 11,443,966 4,439,231
------------- -------------
Total mezzanine equity 121,169,460 107,047,101
------------- -------------
SHAREHOLDERS' EQUITY
Common stock, $.01 par value, 20,000,000 shares authorized,
9,100,000 issued and outstanding 91,000 91,000
Additional paid-in-capital 42,684,159 42,086,353
Accumulated other comprehensive income 4,624,055 1,638,092
Retained deficit (29,708,261) (12,057,969)
------------- -------------
Total shareholders' equity 17,690,953 31,757,476
------------- -------------
Total liabilities and shareholders' equity $ 146,185,471 $ 142,721,186
============= =============
The accompanying notes are an integral part of these financial statements.
</TABLE>
1
<PAGE>
CGA GROUP, LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Expressed in U.S. Dollars)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended Six Months Ended
Sept 30 Sept 30 Sept 30
---------------------------- ------------------ ----------------
1998 1997 1998 1997
<S> <C> <C> <C> <C>
REVENUES
Gross premiums written $ 3,163,321 $ 55,823 $ 6,893,540 $ 55,823
Ceded premiums (280,847) -- (453,314) --
------------ ------------ ------------ ------------
Net premiums written 2,882,474 55,823 6,440,226 55,823
Change in unearned premiums 145,062 -- (692,214) --
------------ ------------ ------------ ------------
Net premiums earned 3,027,536 55,823 5,748,012 55,823
Net investment income 1,746,653 2,923,079 5,959,548 3,065,666
Net realized gains 239,175 -- 791,556 --
Management fees 1,472,589 -- 2,154,584 --
------------ ------------ ------------ ------------
Total Revenues 6,485,953 2,978,902 14,653,700 3,121,489
------------ ------------ ------------ ------------
EXPENSES
Operating expenses 4,043,755 2,420,176 11,481,293 2,526,023
Acquisition costs 129,944 16,293 275,531 16,293
Commitment fees 151,233 149,589 448,767 172,603
Excess of loss facility 50,000 -- 150,000 --
Losses and Loss adjustment expenses 700,000 -- 1,300,000 --
------------ ------------ ------------ ------------
Total expenses 5,074,931 2,586,058 13,655,590 2,714,919
------------ ------------ ------------ ------------
Income before cumulative effect of
change in accounting principle 1,411,022 392,844 998,110 406,570
Cumulative effect of change in
accounting principle (3,928,238) -- (3,928,238) --
NET INCOME (LOSS) (2,517,216) 392,844 (2,930,128) 406,570
Other comprehensive income 2,711,047 218,341 2,985,963 53,647
------------ ------------ ------------ ------------
COMPREHENSIVE INCOME $ 193,831 $ 611,185 $ 55,835 $ 460,217
============ ============ ============ ============
Net loss available to common shareholders $ (7,991,082) $(18,399,788)
Basic and diluted loss per common share $ (0.88) $ (2.02)
============ ============
Weighted average shares outstanding 9,100,000 9,100,000
============ ============
The accompanying notes are an integral part of these financial statements.
</TABLE>
2
<PAGE>
CGA GROUP, LTD.
CONSOLIDATED STATEMENTS OF MEZZANINE EQUITY
(Expressed in U.S. Dollars)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended Nine Months Ended
September 30, 1998 December 31, 1997
------------------ -----------------
<S> <C> <C>
MEZZANINE EQUITY
SERIES A PREFERRED STOCK
Balance - beginning of period $ 27,965 $ --
Stock issued -- 26,000
Pay-in-kind dividends paid 3,086 1,965
------------- -------------
Balance - end of period 31,051 27,965
------------- -------------
ADDITIONAL PAID-IN-CAPITAL - SERIES A PREFERRED
Balance - beginning of period 65,504,534 --
Stock issued -- 64,974,000
Issuance costs -- (4,571,319)
Fair value of warrants (1,347,300) --
Pay-in-kind dividends paid 7,712,344 4,911,381
Accretion to redemption value 399,990 190,472
Accretion on warrants 174,027 --
------------- -------------
Balance - end of period 72,443,594 65,504,534
------------- -------------
Total Series A Preferred Stock $ 72,474,645 $ 65,532,499
============= =============
SERIES B PREFERRED STOCK
Balance - beginning of period $ 16,000 $ --
Stock issued -- 16,000
------------- -------------
Balance - end of period 16,000 16,000
------------- -------------
ADDITIONAL PAID-IN-CAPITAL - SERIES B PREFERRED
Balance - beginning of period 37,059,371 --
Stock issued -- 39,984,000
Issuance costs -- (3,008,190)
Accretion to redemption value 175,478 83,561
------------- -------------
Balance - end of period 37,234,849 37,059,371
------------- -------------
Total Series B Preferred stock $ 37,250,849 $ 37,075,371
============= =============
PAY-IN-KIND DIVIDENDS ACCRUED-SERIES B
Balance - beginning of period $ 4,439,231 $ --
Dividends accrued 7,004,735 4,439,231
------------- -------------
Balance - end of period $ 11,443,966 $ 4,439,231
============= =============
TOTAL MEZZANINE EQUITY $ 121,169,460 $ 107,047,101
============= =============
The accompanying notes are an integral part of these financial statements.
</TABLE>
3
<PAGE>
CGA GROUP, LTD.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Expressed in U.S. Dollars)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended Nine Months Ended
September 30, 1998 December 31, 1997
------------------ -----------------
<S> <C> <C>
SHAREHOLDERS' EQUITY
COMMON STOCK
Balance - beginning of period $ 91,000 $ 12,000
Stock redeemed (12,000 shares) -- (12,000)
Stock issued (9,100,000 shares) -- 91,000
------------ ------------
Balance - end of period 91,000 91,000
------------ ------------
ADDITIONAL PAID-IN-CAPITAL - COMMON STOCK
Balance - beginning of period 42,086,353 --
Stock issued -- 45,409,000
Issuance costs -- (3,048,614)
Fair value of warrants 1,347,300 --
Accretion of Series A Preferred Stock to redemption value (399,990) (190,472)
Accretion of Series B Preferred Stock to redemption value (175,478) (83,561)
Accretion on warrants (174,027) --
------------ ------------
Balance - end of period 42,684,159 42,086,353
------------ ------------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance - beginning of period 1,638,092 --
Increase during the period 2,985,963 1,638,092
------------ ------------
Balance - end of period 4,624,055 1,638,092
------------ -------------
RETAINED EARNINGS (DEFICIT)
Balance - beginning of period (12,057,969) (2,706,182)
Net income (loss) (2,930,128) (1,318,730)
Series A pay-in-kind dividends paid (7,715,430) (4,913,346)
Series B pay-in-kind dividends accrued (7,004,734) (4,439,231)
------------ ------------
Balance - end of period (29,708,261) (12,057,969)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY $ 17,690,953 $ 31,757,476
============ ============
The accompanying notes are an integral part of these financial statements.
</TABLE>
4
<PAGE>
CGA GROUP, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Expressed in U.S. Dollars)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended Six Months Ended
September 30 September 30
1998 1997
----------------- ----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) income $ (2,930,128) $ 406,570
Changes in non-cash items
Amortization of investments 112,386 --
Depreciation expense 259,470 296,433
Realized gain on sale of investments (791,556) --
Realized loss on sale of fixed assets 26,282 --
Premiums receivable (2,525,657) (55,823)
Accrued interest 718,730 (2,974,012)
Deferred acquisition costs (2,115,018) (1,019,463)
Organization costs 4,421,353 (4,738,515)
Other assets (1,114,608) (921,461)
Unearned premiums 692,215 --
Loss adjustment expenses 1,300,000 --
Reinsurance balances payable 280,847 --
Accrued costs and expenses 1,135,387 2,753,272
------------- -------------
Net cash used in operating activities (530,297) (6,252,999)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net purchases and sales of investments (3,000,371) (122,055,573)
Net purchases of fixed assets (624,187) (547,243)
Note receivable 250,000 (1,250,000)
------------- -------------
Net cash used in investing activites (3,374,558) (123,852,816)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Redemption of Common Stock -- (12,000)
Issuance of series A preferred stock -- 27,179
Issuance of series B preferred stock -- 16,000
Issuance of common stock -- 91,000
Paid-in-capital -- 152,955,762
Issuance costs of series A preferred stock -- (4,571,318)
Issuance costs of series B preferred stock -- (3,008,190)
Issuance costs of common stock -- (3,043,310)
Series A pay-in-kind dividends paid -- (2,589,941)
Loan repaid -- (121,000)
------------- -------------
Net cash provided by financing activities -- 139,744,182
------------- -------------
NET INCREASE (DECREASE) IN CASH AND SHORT-TERM INVESTMENTS (3,904,855) 9,638,367
CASH AND SHORT-TERM INVESTMENTS - BEGINNING OF PERIOD 7,199,106 121,742
------------- -------------
CASH AND SHORT-TERM INVESTMENTS - END OF PERIOD $ 3,294,251 $ 9,760,109
============= =============
The accompanying notes are an integral part of these financial statements.
</TABLE>
5
<PAGE>
CGA GROUP, LTD.
Notes to Consolidated Financial Statements
For the Nine Months ended September 30, 1998
(Expressed in U.S. Dollars)
1. BUSINESS AND ORGANIZATION
CGA Group, Ltd. (the "Company") is a holding company, which was
incorporated in Bermuda on June 21, 1996. The Company has two wholly owned
subsidiaries. Commercial Guaranty Assurance, Ltd. ("CGA") was incorporated
in Bermuda on October 22, 1996. CGA is licensed as a class 3 insurer under
the laws of Bermuda with a AAA claims paying ability rating from Duff &
Phelps Credit Rating Company ("DCR"). CGA provides financial guaranty
insurance of structured securities, including commercial real estate,
asset-backed and other securities. The Company, CGA and all of their
employees are based in Hamilton, Bermuda. CGA Investment Management, Inc.
("CGAIM") was incorporated in Delaware, U.S.A. in July 1996 by the founders
of the Company and was acquired at nominal cost to the Company on June 9,
1997. The purchase method of accounting for the CGAIM acquisition was used.
There was no goodwill acquired and no contingent payments, options, or
commitments exist. CGAIM had not commenced operations prior to its
acquisition by the Company. CGAIM is an investment advisor and provides
financial advisory services to a variety of clients. CGAIM and its
employees are based in New York City, New York.
The Company's first fiscal year end was March 31, 1997. The Company
subsequently changed its fiscal year end to December 31. Therefore, the
comparative periods in the consolidated financial statements are not
consistent.
Operations commenced following the completion of the Company's private
placement offering which occurred on June 17, 1997 (the
"Recapitalization"). The initial capitalization of the Company consisted of
12,000 common shares with a par value of $1.00 per share. All 12,000 shares
were redeemed on June 17, 1997 at which time the Company completed its
Recapitalization.
The Company issued 2.6 million shares of Series A Preferred Stock, par
value $.01 per share, at a price of $25 per share, with a 13.75% quarterly
compounding dividend paid in additional shares of Series A Preferred Stock.
The holders of Series A Preferred Stock also received warrants, which are
transferable separately from the Series A Preferred Stock, which represent
the right to purchase on or prior to June 17, 2007, at an exercise price of
$.01 per share, a total of 270,000 shares of Common Stock. The warrants are
valued at $4.99 per share and are accounted for as additional
paid-in-capital to the Common Stock.
The Company also issued 1.6 million shares of Series B Cumulative Voting
Preference Shares, par value $.01 per share, at a price of $25 per share,
with a 20% quarterly compounding dividend paid in additional shares of
Series B Cumulative Voting Preference Shares. The Series B Cumulative
Voting Preference Shares were sold to investors in the form of Investment
Units which included commitments to purchase an additional $60 million of
Series B Preferred Stock upon the occurrence of certain funding events, in
order to maintain CGA's AAA rating from DCR. The Company pays a $600,000
annual fee to the Unit Investors for their commitments. The Investment
Units also included 7,827,957 shares of Common Stock out of a total of
9,100,000 million shares of Common Stock issued, par value $.01 per share,
at a price of $5 per share.
The remaining 1,272,043 shares of Common Stock were sold to the sponsoring
investors and certain members of management who also received 847,729
warrants, which each represent the right to purchase one share of Common
Stock on or prior to June 17, 2007 at an exercise price of $5 per share. An
additional 1,494,771 warrants have been authorized to certain employees
which each represent the right to purchase one share of Common Stock on or
prior to June 17, 2007 at an exercise price of $5 per share.
2. SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared on the basis of
accounting principles generally accepted in the United States of America
("GAAP") and include the accounts of the Company, CGA, and CGAIM. All
significant intercompany accounts and transactions have been eliminated in
consolidation. The preparation of financial statements in conformity with
GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent
6
<PAGE>
assets and liabilities at the date of the consolidated financial statements
and the reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
a) PREMIUMS
CGA's insurance contracts are classified as long-duration contracts for
accounting purposes as the contracts are expected to remain in force for an
extended period. The contracts generally are not subject to unilateral
changes in their provisions and require insurance protection for extended
periods. Premium rates generally are level throughout the period of
coverage. Premiums are recognized as written upon inception of multi-year
policies. Up-front premiums are earned pro-rata over the period of risk.
Installment premiums are earned over each installment period.
b) DEFERRED ACQUISITION COSTS
Deferred acquisition costs are expenses that vary with and are primarily
related to the production of business. These costs include compensation and
related costs of underwriting and marketing, certain rating agency fees,
and administrative expenses. Policy acquisition costs are amortized on a
straight-line basis over the estimated term of the related insured risks.
c) REINSURANCE
In the ordinary course of business, the company cedes exposures under
various reinsurance contracts designed to limit losses from certain risks
and to protect capital and surplus. The reinsurance of risk does not
relieve the company of its original liability to its policyholders. In the
event that a reinsurer was unable to meet its obligations under the
existing reinsurance contracts, the Company would be liable for such
defaulted amounts.
d) PROVISION FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
A case basis reserve for unpaid losses and loss adjustment expenses may be
recorded at the present value of the estimate loss when, in management's
opinion, the likelihood of a future loss is probable and determinable at
the balance sheet date. A general reserve is calculated by applying a loss
factor to the total net par amount outstanding of CGA's insured obligations
over the expected term of such insured obligations.
Management believes that the current level of the provision is adequate to
cover the ultimate net cost of claims. The provision is necessarily an
estimate and there can be no assurance that the ultimate liability will not
differ from such estimates. The Company will monitor the provision on an
ongoing basis and may periodically adjust the provision based on actual
loss experience, the future mix of business and economic conditions. See
footnote number four regarding subsequent events.
e) ORGANIZATION EXPENSES
Organization costs consisted of expenses incurred to form the Company and
were amortized over a five-year period starting from the date of
commencement of operations using the straight-line method. The Accounting
Standards Executive issued Statement of Position 98-5, "Reporting on Costs
of Start-Up Activities", effective for fiscal years beginning after
December 15, 1998. This statement requires the Company to expense
organization costs as incurred. On July 1, 1998, the Company expensed the
remaining unamortized organization costs which is reflected in the
financial statements as a change in accounting principle.
f) INVESTMENTS
In accordance with the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," investments in debt securities designated as
available-for-sale are recorded at fair value. Any resulting unrealized
gains or losses are reflected as a separate component of shareholders'
equity until realized. The periodic unrealized gains or losses are
reflected as other comprehensive income on the statement of income.
Bond discounts and premiums are accreted or amortized on the effective
interest method over the term of the related securities. Short-term
investments, which are those investments with a maturity of less than one
year at time of purchase, are carried at cost, which approximates fair
value. Realized gains or losses on
7
<PAGE>
sale of investments are determined on the basis of specific identification.
Investment income is recognized when earned. The Company previously used
foreign currency forward contracts for the purpose of managing certain
investment portfolio exposures. As of June 30, 1998 the investment in
non-U.S. dollar denominated securities was discontinued, eliminating the
need to utilize foreign currency forward contracts.
g) STATEMENT OF CASH FLOWS
For purposes of the statements of cash flows, short-term deposits are
composed of deposits with original maturities which are less than three
months.
h) LOSS PER COMMON SHARE
The Company computed loss per share in accordance with SFAS No. 128,
"Earnings Per Share." Loss per common share is calculated using the loss
for the period adjusted for preference dividends, accretion of preference
stock to redemption value, and accretion on warrants divided by the
weighted average number of common shares outstanding and, if dilutive,
shares issuable under outstanding warrants.
The following is a reconciliation of the numerators and denominators of the
basic and diluted loss per share.
- - --------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, 1998 September 30, 1998
- - --------------------------------------------------------------------------------
Basic Loss Per Share ("EPS")
Numerator:
Net income (loss) $ (2,517,216) $ (2,930,128)
Series A - Pay-in-kind dividends paid (2,826,050) (7,715,430)
Series A - Accretion to redemption value (114,283) (399,990)
Series A - Accretion on warrants (33,683) (174,027)
Series B - Pay-in-kind dividends accrued (2,449,713) (7,004,735)
Series B - Accretion to redemption value (50,137) (175,478)
------------ ------------
Net Loss Available to Common Shareholders (7,991,082) (18,399,788)
------------ ------------
Denominator:
Weighted Average Shares Outstanding 9,100,000 9,100,000
------------ ------------
Basic EPS $ (0.87) $ (2.02)
============ ============
Diluted Loss Per Share
Numerator $ (7,991,082) $(18,399,788)
------------ ------------
Denominator 9,100,000 9,100,000
------------ ------------
Diluted EPS $ (0.87) $ (2.02)
============ ============
- - --------------------------------------------------------------------------------
The Company has outstanding warrants which were not included in the
computation of the diluted loss per share as the effect of these warrants
is antidilutive for the periods presented above.
On June 17, 1997 the Company issued warrants to purchase 270,000 shares of
common stock in connection with the issuance of 2.6 million shares of
Series A Preferred Stock. All of the warrants are outstanding as
8
<PAGE>
of June 30, 1998. These warrants are excerciseable at any time on or prior
to June 17, 2007 at an exercise price of $.01.
The Company also issued 847,729 warrants to certain investors and members
of management in connection with the issuance of 1.6 million investment
units. Each warrant represents the right to purchase one share of common
stock on or prior to June 17, 2007. The warrants have an exercise price of
$5 per share and were outstanding at September 30, 1998. In addition, the
Company has authorized 1,494,771 warrants for certain employees which each
represent the right to purchase one share of common stock on or prior to
June 17, 2007 at an exercise price of $5 per share. The employee rights
will vest ratably over a four-year period and expire if not excercised
within thirty days of the employee's termination of employment. As at
September 30, 1998, there are 1,428,129 warrants outstanding of which
357,032 warrants were exercisable.
i) TAXATION
The Company and CGA, which are domiciled in Bermuda, have received from the
Minister of Finance of Bermuda an assurance under the Exempted Undertakings
Tax Protection Act, 1966 of Bermuda, that generally protects them from
incurring taxation by Bermuda tax authorities until March 28, 2016. Since
the Company and CGA are not engaged in a trade or business in the U.S.
there should be no U.S. income taxes due, however, CGA intends to file
protective U.S. income tax returns. CGAIM will be subject to U.S. taxation
at regular corporate tax rates, but has tax losses carried forward of
approximately $3.9 million as of December 31, 1997, for which no benefit
has been recorded in the financial statements. These tax loss
carry-forwards expire in the year 2012.
j) ACCOUNTING STANDARDS
The Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standard No. 130 ("SFAS 130"), "Reporting
Comprehensive Income", effective for fiscal years beginning after December
15, 1997. This statement requires the Company to report in the financial
statements, in addition to net income, comprehensive income and its
components. The Company has adopted SFAS 130 in these consolidated
financial statements.
The FASB issued Statement of Financial Accounting Standard No. 131 ("SFAS
131"), "Disclosures about Segments of an Enterprise and Related
Information", which the company will be required to adopt for fiscal year
1998. This statement established standards for reporting information about
operating segments in annual financial statements and requires selected
information about operating segments in interim financial reports issued to
shareholders. It also established standards for related disclosures about
products and services, geographic areas and major customers. Under SFAS
131, operating segments are to be determined consistent with the way that
management organizes and evaluates financial information internally for
making operating decisions and assessing performance. The Company has
chosen to adopt SFAS 131 effective December 31, 1998. Segment information
will be reported separately for the Company's investment management and
insurance operations.
The Accounting Standards Executive issued Statement of Position 98-5,
"Reporting on Costs of Start-Up Activities", effective for fiscal years
beginning after December 15, 1998. This statement requires the Company to
expense organization costs as incurred. On July 1, 1998, the Company
expensed the remaining unamortized organization costs which is reflected in
the financial statements as a change in accounting principle.
On June 15, 1998, the FASB issued Statement of Financial Accounting
Standard No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and
Hedging Activities" effective for fiscal years beginning after June 15,
1999, but earlier application is permitted as of the beginning of any
fiscal quarter subsequent to June 15, 1998. SFAS 133 requires all
derivatives to be recognized in the statement of financial position as
either assets or liabilities and measured at fair value. The Company does
not believe the application of SFAS 133 will have a material effect on its
consolidated financial statements.
3. MEZZANINE EQUITY
The Company's Series A Preferred Stock is subject to mandatory redemption
including all accrued and unpaid dividends thereon, on June 17, 2007. The
Series A Preferred Stock is also redeemable at the election of the Company
at any time after June 17, 2002, subject to the payment of early redemption
premiums starting at 11% initially, declining to 8% after June 17, 2003 and
declining by 2% annually
9
<PAGE>
through June 16, 2007. The Series B Preferred Stock is subject to mandatory
redemption including all accrued and unpaid dividends thereon, on June 17,
2012.
The dividends on the Series A Preferred Stock are declared quarterly by the
Board of Directors and paid in additional shares of Series A Preferred
Stock. The Company was obligated to pay an additional pay-in-kind dividend
of .5% on the Series A Preferred Stock from December 15, 1997 to the
effective date of the registration statement. The Company registered the
Series A Preferred Stock with the Securities and Exchange Commission
effective August 6, 1998 at which time the accrual of the additional .5%
dividend on the Series A Preferred Stock ceased. The payment of the
additional dividend was paid on September 30, 1998. The dividend
on the Series B Preferred Stock is not declared quarterly, however, the
mandatory redemption provision requires that at redemption the Company is
obligated to pay 100% of the stated value of the shares plus accrued and
unpaid dividends thereon. Accordingly, the liability for dividends payable
on the Series B Cumulative Voting Preference Shares is accrued and the
charge against retained earnings is recorded.
4. SUBSEQUENT EVENTS
In October, the credit ratings on asset-backed securities issued by
Commercial Financial Services Inc. ("CFS"), a credit-card debt collection
company, were withdrawn by the three credit rating companies that rate the
most recently issued CFS securities. The withdrawal of the ratings was in
response to allegations of accounting irregularities at CFS. The rating
agencies, investors and insurors have commenced an investigation into the
allegations. Clients of CGAIM own approximately $157 million par of the CFS
securities and CGA has insured the credit facilities used to finance their
purchase. CGA had previously reinsured approximately $140 million par of
this exposure. In addition, CGA has exposure of approximately $47 million
par to CFS securities through a financial guaranty policy issued to a
client that purchased the securities for their own account. CGA previously
reinsured approximately $16 million par of this exposure. In summary, CGA
has exposure to a total of $204 million par of CFS issued securities, of
which $156 million par has been reinsured, leaving a net exposure of
approximately $48 million par. No estimate of potential losses, if any, can
be made until additional information becomes available.
Also during October, CGA took steps to mitigate risks related to its
exposure in connection with guarantees of client credit facilities used to
purchase asset-backed and real estate securities. As a result of recent
turmoil in certain areas of the capital markets, the spreads over
treasuries at which investors are willing to purchase certain securities
widened considerably. This spread widening caused a decrease in the fair
value of many of the securities used as collateral for the insured credit
facilities. The estimated market value of these securities had declined
significantly during the month. Certain of the credit facilities have
requirements that lender's operating ratios, ( the portfolio market value
divided by the loan outstanding ) be maintained above certain levels. In
the event that an operating ratio falls below the required level and is not
brought into compliance within the cure period, the lender may liquidate
the collateral and require CGA to pay any remaining balance outstanding
under the credit facility.
10
<PAGE>
During October, two of CGAIM's clients worked with CGA to provide a
solution to reduce the impact of any future spread widening on the
operating ratios. CGA provided credit support on approximately $382 million
of securities within the two insured portfolios, which was further
supported by a "AAA" rated reinsurer, using documentation that would permit
the insured party to proceed directly against the reinsurer. The effect of
the described credit support arrangements was to substantially increase the
market value of the subject securities. CGA received a premium of $38.95
million from its clients in connection with these credit support
arrangements, and ceded $38.7 million to the aforementioned reinsurer. The
reinsurer is a shareholder of the Company who has contracted with two other
shareholders of the Company to participate in the above-described credit
arrangements. CGA purchased a $30 million note from St. George Holdings,
Ltd. (the parent of the referred-to clients) in order to enable St. George
Holdings, Ltd. to provide its subsidiaries (the referred-to clients) with
sufficient funds to pay to CGA the described premium, while leaving these
entities with sufficient liquidity to manage any future market value
declines. This outflow of $30 million from CGA reduced the claims-paying
resources of CGA by 14% from approximately $210 million to approximately
$180 million.
During November, the credit facility for St. George Investments I, Ltd.
("SGI"), was not renewed. This facility is insured by CGA and has an
outstanding balance of approximately $425 million. The terms of the
facility require repayment over four years with four equal principal
installments due at the end of each year with the first installment being
due in November, 1999. It is expected that the facility will be refinanced
with another lender, however, there is no certainty that SGI will be able
to obtain such refinancing.
The #30 million reduction in CGA's claims paying resources will require
that CGA modify its business plan until such time that the funds are repaid
by St. George Holdings, Ltd. or new capital is raised. Likely modifications
will result in not adding exposure to any non-investment grade securities,
and a reduction of new business volume.
11
<PAGE>
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion should be read in conjunction with, and is qualified in
its entirety by, the consolidated financial statements of the Company and the
related notes thereto included elsewhere in this report.
GENERAL
CGA Group, Ltd. (the "Company"), a holding company, was incorporated in Bermuda
on June 21, 1996. The Company has two wholly owned subsidiaries. Commercial
Guaranty Assurance, Ltd. ("CGA"), was incorporated in Bermuda on October 22,
1996. CGA is licensed as a class 3 insurer under the Insurance Act 1978 of
Bermuda (the "Act") which authorizes it to carry on insurance business of all
classes in or from within Bermuda subject to its compliance with the solvency
margin, liquidity ratio and other requirements imposed on it by the Act. CGA has
an AAA "claims paying ability" rating from Duff & Phelps Credit Rating Company
("DCR). CGA provides financial guaranty insurance of structured securities,
including commercial real estate, asset-backed, and other securities. CGA
Investment Management, Inc. ("CGAIM") was incorporated in Delaware, U.S.A. in
July 1996 by the founders of the Company and was acquired at nominal cost to the
Company on June 9, 1997. CGAIM did not commence operations until after its
acquisition by the Company. CGAIM acts as an investment advisor and provides
financial advisory services to a variety of clients. The Company and its
subsidiaries were inactive until June 17, 1997, on which date the Company's
private placement offering was completed and the Company was recapitalized with
(i) two classes of preferred stock totaling $105 million, (ii) common stock
totaling $45.5 million and (iii) commitments to purchase $60 million of
additional preferred stock upon the occurrence of certain events.
RESULTS OF OPERATIONS
Total revenues for the three months ended September 30, 1998 were $6.5 million,
of which $3.0 million was derived from financial guaranty insurance premiums,
$1.4 million was derived from management fees and $2.0 million was derived from
investments. Net premiums earned were derived from $3.2 million of gross
premiums written, of which $.3 million were ceded under reinsurance agreements,
and a decrease of $.1 million in unearned premiums. Revenues for the three
months ended September 30, 1997 were $3.0 million, of which $.1 million was from
insurance premiums and $2.9 million was from investments. Further revenue
comparisons between the quarters ended September 30, 1998 and 1997 are not
meaningful due to the Company's limited operating history.
The following table shows the net par outstanding of insured obligations at
September 30, 1998 by asset type:
(in thousands)
REIT Debt...................................... $ 528,479 29%
Consumer asset-backed securities............... 445,657 24%
Corporate asset-backed securities.............. 414,149 23%
Commercial mortgage-backed securities.......... 258,500 14%
Sovereign credit derivatives................... 120,000 6%
REIT Preferred stock........................... 70,000 4%
Total ......................................... $1,836,785 100%
Based on net par outstanding, the credit ratings of the above assets were 3%
"AAA", 3% "AA", 14% "A", 70% "BBB" and 10% "BB".
12
<PAGE>
Total revenues for the nine months ended September 30, 1998 were $14.7 million,
of which $5.7 million was derived from financial guaranty insurance premiums,
$2.1 million was from management fees and $6.8 million was from investments. Net
premiums earned were derived from $6.9 million of gross premiums written, of
which $.5 million were ceded under reinsurance agreements. CGA intends to build
upon the current book of business as its underwriting volume and risk in force
grow, thereby layering new business on top of a base of prior business that
creates an increasing annuity-like stream of revenue.
CGA monitors its exposure on a routine basis and stays in close contact with DCR
to ensure that its AAA rating is maintained. GCA has a $20 million excess of
loss reinsurance facility agreement and can also arrange reinsurance on an as
needed basis to manage its exposure. The Company also has commitments which
expire June 17, 2002, from certain institutional shareholders to purchase an
aggregate of $60 million of additional Series B Preferred Stock. Should those
commitments be called upon, the proceeds would likely be used to increase the
capital of CGA. The commitments must be funded in the event that DCR notifies
the Company at least 45 days prior to June 17, 2002 that CGA's rating will
otherwise be downgraded below a AAA rating.
Net investment income for the three and nine month periods ending September 30,
1998 was comprised of $1.7 and $6.0 million respectively, of interest earned on
debt securities and short-term investments, and $.2 and $.8 million of net
realized gains. Net investment income is presented after deducting the cost of
external investment management fees which totaled $.1 million for the quarter
and $.3 million for the nine month period. The total market value of the fixed
maturity portfolio at September 30, 1998, including accrued interest receivable,
was $133.3 million. Unrealized gains on the investment portfolio as of September
30, 1998 were $4.6 million. The average yield on the investment portfolio was
6%.
Operating expenses for the three months ended September 30, 1998 were $4.0
million compared to $2.7 million for the same period last year as a result of
increased staffing. These costs consist primarily of personnel costs and legal
and financing costs incurred to set up investment programs for CGAIM's clients.
Total operating expenses for the nine month period ended September 30, 1998 were
$11.5 million.
In response to the Accounting Standards Executive issued Statement of Position
98-5, "Reporting on Costs of Start-Up Activities", effective for fiscal years
beginning after December 15, 1998, which requires the Company to expense
organization costs as incurred, the Company expensed the remaining unamortized
organization costs totaling $3.9 million which is reflected in the financial
statements as a change in accounting principle.
LIQUIDITY AND CAPITAL RESOURCES
The Company capitalized CGA with $125 million. Alliance Capital Management
Corporation currently manages CGA's entire investment portfolio. These funds are
invested in foreign corporate and government debt securities which are rated AA
or higher and denominated in U.S. dollars. The portfolio maintains a weighted
average duration of two to five years. CGAIM was initially capitalized with $3
million. It will require additional funding during 1998 and 1999 from the
Company to cover its operations while it builds its assets under management to
generate sufficient fee income. On a consolidated basis, the Company used $.5
million of cash from operating activities for the nine month period ended
September 30, 1998.
The Company does not expect to pay cash dividends to its shareholders. CGA's
Board of Directors has passed a resolution that CGA will not declare or pay cash
dividends during the first five years of operations. After such five-year
period, CGA intends to comply with dividend restrictions, if any, imposed by DCR
subject to covenants contained in the subscription agreements for the various
classes of the Company's stock. In addition, CGA's dividend payments are subject
to certain limitations under Bermudian insurance regulations that require
minimum solvency margins and liquidity ratios.
13
<PAGE>
SUBSEQUENT EVENTS
In October, the credit ratings on asset-backed securities issued by Commercial
Financial Services Inc. ("CFS"), a credit-card debt collection company, were
withdrawn by the three credit rating companies that rate the most recently
issued CFS securities. The withdrawal of the ratings was in response to
allegations of accounting irregularities at CFS. The rating agencies, investors
and insurors have commenced an investigation into the allegations. Clients of
CGAIM own approximately $157 million par of the CFS securities and CGA has
insured the credit facilities used to finance their purchase. CGA had previously
reinsured approximately $140 million par of this exposure. In addition, CGA has
exposure of approximately $47 million par to CFS securities through a financial
guaranty policy issued to a client that purchased the securities for their own
account. CGA previously reinsured approximately $16 million par of this
exposure. In summary, CGA has exposure to a total of $204 million par of CFS
issued securities, of which $156 million par has been reinsured, leaving a net
exposure of approximately $48 million par. No estimate of potential losses, if
any, can be made until additional information becomes available.
Also during October, CGA took steps to mitigate risks related to its exposure in
connection with guarantees of client credit facilities used to purchase
asset-backed and real estate securities. As a result of recent turmoil in
certain areas of the capital markets, the spreads over treasuries at which
investors are willing to purchase certain securities widened considerably. This
spread widening caused a decrease in the market value of many of the securities
used as collateral for the insured credit facilities. The estimated fair value
of these securities had declined significantly during the month. Certain of the
credit facilities have requirements that lender's operating ratios, ( the
portfolio market value divided by the loan outstanding ) be maintained above
certain levels. In the event that an operating ratio falls below the required
level and is not brought into compliance within the cure period, the lender may
liquidate the collateral and require CGA to pay any remaining balance
outstanding under the credit facility.
During October, two of CGAIM's clients worked with CGA to provide a solution to
reduce the impact of any future spread widening on the operating ratios. CGA
provided credit support on approximately $382 million of securities within the
two insured portfolios, which was further supported by a "AAA" rated reinsurer,
using documentation that would permit the insured party to proceed directly
against the reinsurer. The effect of the described credit support arrangements
was to substantially increase the market value of the subject securities. CGA
received a premium of $38.95 million from its clients in connection with these
credit support arrangements, and ceded $38.7 million to the aforementioned
reinsurer. The reinsurer is a shareholder of the Company who has contracted with
two other shareholders of the Company to participate in the above-described
credit arrangements. CGA purchased a $30 million note from St. George Holdings,
Ltd. (the parent of the referred-to clients) in order to enable St. George
Holdings, Ltd. to provide its subsidiaries (the referred-to clients) with
sufficient funds to pay to CGA the described premium, while leaving these
entities with sufficient liquidity to manage any future market value declines.
This outflow of $30 million from CGA reduced the claims-paying resources of CGA
by 14% from approximately $210 million to approximately $180 million.
During November, the credit facility for St. George Investments I, Ltd. ("SGI"),
was not renewed. This facility is insured by CGA and has an outstanding balance
of approximately $425 million. The terms of the facility require repayment over
four years with four equal principal installments due at the end of each year,
with the first installment being due in November, 1999. It is expected that the
facility will be refinanced with another lender, however, there is no certainty
that SGI will be able to obtain such refinancing.
The #30 million reduction in CGA's claims paying resources will require that CGA
modify its business plan until such time that the funds are repaid by St. George
Holdings, Ltd. or new capital is raised. Likely modifications will result in not
adding exposure to any non-investment grade securities, and a reduction of new
business volume.
RECENT ACCOUNTING PRONOUNCEMENTS
On June 15, 1998, the FASB issued Statement of Financial Accounting Standard No.
133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities"
effective for fiscal years beginning after June 15, 1999, but earlier
application is permitted as of the beginning of any fiscal quarter subsequent to
June 15, 1998. SFAS 133 requires all derivatives to be recognized in the
statement of financial position as either assets or liabilities and measured at
fair value. The Company does not believe the application of SFAS 133 will have a
material effect on its consolidated financial statements.
14
<PAGE>
YEAR 2000
The Company's primary uses of software systems are for corporate and investment
portfolio accounting, as well as investment underwriting and analysis. The
Company's current systems have recently been purchased or leased as the Company
commenced operations in June, 1997, and are believed to be Year 2000 compliant
Therefore, the Company believes that the risk of Year 2000 compliance is not
significant as it relates to its computer software systems. The Company has
incurred no material costs to date and expects to incur no material costs in the
future to make its systems Year 2000 compliant.
The Company is also in the process of reviewing its exposure to Year 2000 issues
resulting from its vendors' computer systems. The Company has contacted vendors
regarding the state of their remediation activities for material Year 2000
issues. The Company does not expect that there will be material disruptions to
its business or material costs associated with any Year 2000 disruption by its
vendors. However, the cost and timing of third party Year 2000 compliance is not
within the Company's control and no assurances can be given with respect to the
cost or timing of such efforts or the potential efffects of any failure to
comply. Formal contingency plans will not be formulated until the Company has
identified specific areas where there is a substantial risk of Year 2000
problems occurring, and no such areas are identified as of this date.
FORWARD LOOKING INFORMATION
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward looking statements. This Form 10-Q or any other written or oral
statements made by or on behalf of the Company may include forward looking
statements which reflect the Company's current views with respect to future
events and financial performance. These forward-looking statements are subject
to certain uncertainties and other factors that could cause actual results to
differ materially from such statements. The words "believe", "anticipate",
"project", "plan", "expect", "intend", "will likely result" or "will continue"
and similar expressions, identify forward-looking statements. Readers are
cautioned not to place undue emphasis on these forward-looking statements, which
speak only as of their dates. The Company undertakes no obligation to publicly
update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by Item 305 of Regulation S-K is included in Item 2
hereof, "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
15
<PAGE>
PART II -- OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(d) On August 6, 1998, the Company's Registration Statement on Form S-1
(Commission file number 333-7944) (the "S-1 Registration Statement") with
respect to the Series A Preferred Stock was declared effective by the
Securities and Exchange Commission. The S-1 Registration Statement is intended
to satisfy certain obligations of the Company under the Series A Subscription
Agreement dated as of June 9, 1997 among the Company and the Selling
Stockholders (the "Series A Preferred Stock Subscription Agreement"). The
Company will not receive any proceeds from sales of Series A Preferred Stock, if
any, effected pursuant to the S-1 Registration Statement and the prospectus
included therein, and has agreed to pay the expenses of the performance of its
obligations under the Series A Preferred Stock Subscription Agreement with
respect to the S-1 Registration Statement.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
EXHIBIT NUMBER DESCRIPTION
- - -------------- -----------
27.1 Financial Data Schedules.
- - ----------
(b) Reports on Form 8-K.
The Company has not filed any reports on Form 8-K.
16
<PAGE>
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.
CGA GROUP, LTD.
---------------
Registrant
Date: November 16, 1998 /s/ JAMES R. REINHART
--------------------------------------
James R. Reinhart
Chief Financial Officer
(principal financial officer)
17
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