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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
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: 001-49632
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CGA GROUP, LTD.
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(Exact Name of Registrant as Specified in its Charter)
BERMUDA 98-0173536
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
CRAIG APPIN HOUSE
8 WESLEY STREET
HAMILTON HM11 BERMUDA
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(Address of Principal Executive Offices and Zip Code)
Registrant's telephone number, including area code: (441) 296-3165
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of shares of common stock, par value $0.01 per
share of CGA Group, Ltd. held by non-affiliates of the Registrant on March 1,
1999 was approximately $9.8 million. As of March 1, 1999, 9,100,000 shares of
Common Stock, $0.01 par value per share, 3,211,890 shares of Series A Cumulative
Voting Preference Shares, $0.01 par value per share, and 1,600,000 shares of
Series B Cumulative Voting Preference Shares, $0.01 par value per share, were
outstanding.
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CGA GROUP, LTD.
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1998
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TABLE OF CONTENTS
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PAGE
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PART I
<S> <C>
Item 1. Business .................................................................................. 1
Item 2. Properties ................................................................................ 13
Item 3. Legal Proceedings ......................................................................... 13
Item 4. Submission of Matters to a Vote of Security Holders ....................................... 13
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ..................... 14
Item 6. Selected Financial Data ................................................................... 14
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ..... 14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................. 19
Item 8. Financial Statements and Supplementary Data ............................................... 23
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ...... 23
PART III
Item 10. Directors and Executive Officers of the Registrant ........................................ 24
Item 11. Executive Compensation .................................................................... 27
Item 12. Security Ownership of Certain Beneficial Owners and Management ............................ 30
Item 13. Certain Relationships and Related Transactions ............................................ 36
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K ........................... 37
Signatures ............................................................................................ 38
Index to Financial Statements and Schedules ........................................................... 39
Independent Auditors' Report on Financial Statements .................................................. 40
Financial Statements and Schedules
Index to Exhibits
Exhibits
</TABLE>
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following documents are incorporated by reference into the
indicated part(s) of this Report:
None
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FORWARD-LOOKING INFORMATION
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. This Report on Form 10-K 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. The forward-looking
statements are subject to certain uncertainties and other factors that could
cause actual results to differ materially from such statements. These
uncertainties and other factors (which are described in more detail herein and
in other documents filed by the Company with the Securities and Exchange
Commission) include, but are not limited to, (i) financial difficulties
encountered by an insured of the Company's insurance company subsidiary, (ii)
uncertainties relating to government and regulatory policies (such as subjecting
the Company and/or its subsidiaries to insurance regulation or taxation in
additional jurisdictions), (iii) the legal environment, (iv) the uncertainties
of the reserving process, (v) risks relating to the claims-paying ability rating
of the Company's insurer subsidiary, (vi) loss of the services of any of the
Company's executive officers, (vii) changing rates of inflation and other
economic conditions, (viii) ability to collect reinsurance recoverables, (ix)
the competitive environment in which the Company operates, (x) the impact of
Year 2000 related issues, (xi) developments in global financial markets which
could affect the Company's investment portfolio, and (xii) risks associated with
the development of new products and services. The words "believe", "anticipate",
"considered to be", "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.
PART I
ITEM 1. BUSINESS.
CGA Group, Ltd. (the "Company") is a holding company incorporated in
Bermuda with limited liability. The Company, through its primary and
wholly-owned subsidiary Commercial Guaranty Assurance, Ltd. ("CGA"), a Bermuda
insurance company, provides financial guaranty insurance of structured
securities, including commercial real estate backed securities and asset backed
securities. The Company also provides financial guaranty insurance of other
securities, where the Company's senior management team ("Management") has
expertise and credit enhancement opportunities are deemed attractive.
The Company also provides investment management and investment advisory
services to investment vehicles and other clients. These services are provided
through the Company's other wholly-owned subsidiary, CGA Investment Management,
Inc. ("CGAIM"), a Delaware corporation that is registered as an investment
adviser with the Securities and Exchange Commission (the "Commission") under the
Investment Advisors Act of 1940, as amended. CGA and CGAIM are sometimes
referred to herein as the "Subsidiaries."
The primary clients of CGA and CGAIM are St. George Holdings, Ltd., a
Cayman Islands company ("SG Holdings"), and its subsidiaries (collectively, "St.
George") and Cobalt Holdings LLC, a Delaware limited liability corporation
("Cobalt Holdings"), and its subsidiaries (collectively, "Cobalt"). In 1998 St.
George and Cobalt provided approximately 85% of the total premiums earned by
CGA, and 91% of the total investment management fees earned by CGAIM. These
percentages are expected to decrease in the future.
OVERVIEW
The Company was formed with a view to becoming the market leader in the
commercial real estate segment of the financial guaranty industry. The Company
utilizes its structured finance and real estate expertise to underwrite
financial guaranties for commercial real estate and other securities to a zero
loss underwriting standard. The Company's primary target market is the large
U.S. commercial real estate mortgage market, which the Company believes is
underserved. The Company also targets select segments of the private
asset-backed securities ("ABS") market.
CGA's insurance is available via unaffiliated non-U.S. insurance brokers to
a customer base that includes investment and commercial banks with significant
real estate and asset-backed advisory businesses, and commercial
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mortgage loan origination and asset-backed repackaging operations and other
participants in the securitization markets.
FINANCIAL GUARANTY INSURANCE PRODUCTS
CGA offers four defined product applications within its primary markets.
Within the commercial real estate and asset-backed markets, the Company has
identified specific market opportunities in which one or more of its four
programs can be applied.
Each of the product applications is described as follows:
o Fund Guaranty--CGA insures securities owned by investment companies
(including St. George and Cobalt), trusts, conduits or other funds,
providing the insured with the ability to efficiently finance its
operations at AAA rates.
o New Issue Guaranty--CGA is involved in the structuring and
guaranteeing of new debt securities including commercial
mortgage-backed securities ("CMBS"), ABS, corporate and government
obligations. As securities insured by CGA are rated "Triple-A", this
guaranty should lower the all-in cost of the financing and/or increase
proceeds to the issuer.
o Secondary Market Guaranty--CGA, on a selective basis, will guarantee
existing individual securities in the secondary markets. This
guaranty, used in conjunction with the Fund Guaranty, creates added
liquidity for funds, investment vehicles, or other CGA-insured
security holders.
o Portfolio Guaranty--CGA will provide insurance for portfolios of
seasoned commercial mortgages--whole loans, net leases and other
assets. This guaranty may be used by the insured to facilitate an
internal securitization of the portfolio. When the insured is a
regulated lender, such as a life insurance company, the result can be
a lowering of its regulatory capital charge.
As part of its business strategy in the commercial real estate (including
real estate investment trust ("REIT")) and asset-backed insurance markets, the
Company functions through its subsidiaries as both financial guarantor and as an
investment manager to St. George, Cobalt and other investment companies. St.
George and Cobalt purchase securities of the type that CGA would be willing to
insure, and thus it is expected that by guaranteeing such investment vehicles'
financing obligations secured by the securities purchased by St. George and
Cobalt in the secondary market, CGA will be able to rapidly grow its insured
book of business. CGA has issued insurance policies which guarantee the payment
obligations of St. George and Cobalt under their respective financing
arrangements. See below under "CGA Investment Management, Inc.--St. George and
Cobalt."
OVERVIEW OF THE SUBSIDIARIES
CGA focuses on the Company's primary business of issuing financial guaranty
insurance policies, while CGAIM provides services of investment and collateral
management and financial advisory services including transaction structuring
advice.
The main office address of the Company and CGA is Craig Appin House, 8
Wesley Street, Hamilton HM 11 Bermuda. The main office address of CGAIM is 17
State Street, New York, New York 10004.
COMMERCIAL GUARANTY ASSURANCE, LTD.
Commercial Guaranty Assurance, Ltd. ("CGA") is an insurance company
incorporated in Bermuda with limited liability. CGA was incorporated on October
22, 1996, and commenced operations in June 1997. CGA is licensed as a Class 3
insurer under the Insurance Act 1978 of Bermuda. CGA's claims-paying ability has
been rated "AAA" by Duff & Phelps Credit Rating Company ("DCR"), the highest
rating assigned by such rating agency. CGA's claims-paying ability has also been
rated in the highest rating category assigned by each of the two Canadian
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rating agencies, Dominion Bond Ratings Service ("DBRS") and Canadian Bond
Ratings Service ("CBRS"). CGA issues financial guaranty insurance policies,
which are the functional equivalent of direct-pay letters of credit, to insure
payment of interest, principal and other amounts payable in respect of notes,
securities and other financial obligations. Because CGA's credit rating is
"Triple-A", all securities and other obligations guaranteed by CGA are rated
"Triple-A" by DCR and, if applicable, DBRS and CBRS.
CGA's "Triple-A" rating is supported by an aggregate of approximately $165
million in claims-paying resources (as of December 31, 1998), consisting of (i)
approximately $115 million in statutory capital, (ii) an irrevocable capital
commitment (the "Capital Commitments") on the part of certain existing
shareholders of CGA Group to purchase an aggregate of $60 million in additional
equity securities of CGA Group in the event DCR requires such commitment to be
funded in order for CGA to maintain its "Triple-A" rating (for a description of
the Capital Commitment, see Item 12--"Security Ownership of Certain Beneficial
Owners and Management"), (iii) a $20 million excess of loss insurance policy
provided by KRE Reinsurance Ltd., an affiliate of Capital Reinsurance Company (a
shareholder of the Company), less (iv) $30 million of investments that are
unavailable for paying claims. As noted below under Item 12--"Security Ownership
of Certain Beneficial Owners and Management", the Company presently intends to
use $30 million of net proceeds of its current Rights Offering (as hereinafter
defined) which is expected to be consummated on March 31, 1999, to make a
capital investment in CGA as promptly as practicable following the consummation
of the Rights Offering, and to use the remaining net proceeds of the Rights
Offering to make a further capital investment in CGA if and to the extent that
certain reinsurance arrangements entered into by CGA are not terminated by April
30, 1999 so that CGA receives a return of premium of at least $20 million. The
effect of these transactions is that, if consummated, CGA's claims-paying
resources will be increased at a minimum by an aggregate of $50 million, to $215
million, by April 30, 1999.
As a Bermuda domiciled insurance company, CGA does not write insurance or
otherwise conduct or transact insurance business in the United States or any
other jurisdiction where it is not authorized to do so. CGA's insurance may only
be obtained through unaffiliated non-U.S. insurance brokers and consultants on a
direct-placement basis. All negotiations with, and issuances of policies by, CGA
take place in Bermuda or other locations outside of the United States.
CREDIT ENHANCEMENT BUSINESS
CGA's principal business is the issuance of financial guaranty insurance
policies which guarantee timely payment of interest, principal and other amounts
on securities and other financial obligations. CGA primarily insures investment
grade securities in the commercial real estate and asset backed securities
markets, and also insures the liabilities of investment vehicles which invest in
structured securities, including ABS, CMBS, mortgage backed securities ("MBS")
and other securities and financial obligations. A financial guaranty insurance
policy is used in the capital markets as a credit enhancement instrument to
guarantee payments of principal, interest and other amounts in accordance with
the original debt service schedule of the security. In the event the issuer of
the security defaults on its payment obligations, the financial guarantor makes
the scheduled payments. In such an instance, the insurer generally has the
option, but not the obligation, to repay the security on an accelerated basis.
The financial guaranty insurance policy is unconditional, irrevocable and
noncancellable.
The fundamental business proposition of all financial guarantors is to
elevate to a "Triple-A" level securities which would otherwise have a lower
rating. Issuers of securities rated lower than "Triple-A" purchase financial
guaranty insurance policies to enhance the rating of such securities to
"Triple-A", thereby reducing their borrowing costs and/or increasing the
liquidity of the security. In turn, the guarantor collects a premium (payable
either upon issuance of its policy or periodically in installments) equal to a
significant portion of the savings resulting from the improved trading levels of
the guaranteed securities.
Generally, an issuer will purchase a financial guaranty insurance policy to
increase the ratings of its securities to "Triple-A" only when the yield on the
uninsured security exceeds (i) the annual premium charged to upgrade the
security to "Triple-A" plus (ii) the yield on the same security when enhanced to
a "Triple-A" level. Therefore, the ability of a financial guarantor to sell its
credit enhancement is a function both of the credit spreads available in a
market (the difference, for example, in the yield of a security rated "Triple-A"
without insurance and the yield of a similar security rated "Triple-B") and the
trading level achieved as a result of the "Triple-A" guaranty policy.
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One of CGA's primary target markets is investment vehicles which purchase
structured securities. Therefore, a substantial portion of CGA's guaranty
business is generated from advisers to such investment vehicles. Such policies
typically guaranty the liabilities issued by the investment vehicle. In such
cases, and as a condition to issuing its policy, CGA will generally require that
the investment vehicle adopt investment guidelines acceptable to CGA.
ZERO-LOSS UNDERWRITING STANDARD
CGA underwrites all risks insured by it to a "zero loss" standard--that is,
obligations insured by CGA are required to be structured with sufficient levels
of excess collateral or other security so that CGA, to a high degree of
certainty, anticipates no losses on each risk insured without regard to the
premium collected thereon or the investment income related thereto. To this end,
each policy written by CGA is required to meet the criteria specified in the
underwriting guidelines adopted by its Board of Directors. CGA is able to
deviate from such guidelines on a case-by-case basis only in accordance with
procedures established by its Board of Directors. There can be no assurance,
however, that CGA will not incur losses with respect to such insured
obligations.
CGA's underwriting guidelines are intended to provide multiple layers of
loss protection. Notes or structured securities insured by CGA are generally
backed by pools of assets having reasonably predictable cash flows. These
securities typically provide for one or more forms of overcollateralization
(such as excess collateral, excess cash flow, excess "spread" or reserves) or
third-party protections (such as bank letters of credit, guarantees, net worth
maintenance agreements or reinsurance policies). On a transaction by transaction
basis, overcollateralization or third-party protections which assume the primary
risk of financial loss are used to protect CGA against losses.
Overcollateralization or third-party protections may not, however, be required
in transactions in which CGA is insuring the obligations of certain highly rated
issuers that typically are regulated or have implied or explicit government
support, or sovereign credits.
CGA manages its exposure on an ongoing basis and is closely monitored by
DCR, DBRS and CBRS to ensure that it is operating in a manner consistent with
its "Triple-A" rating.
INVESTMENT PORTFOLIO
CGA invests its capital, premiums received from its insurance business, and
earnings thereon in an investment portfolio. This investment portfolio is CGA's
primary source of claims-paying ability. CGA manages its investment portfolio
with the objectives of protecting its claims-paying ability rating, maintaining
a high level of liquidity, making investments in U.S. dollar denominated
securities which generate non-U.S. source income, and within these constraints,
obtaining superior long-term total returns. CGA's investment guidelines are
consistent with these objectives.
All of CGA's investments must comply with investment guidelines adopted by
its Board of Directors. The minimum rating level for an investment is at least
"Double-A minus" or the equivalent by a nationally recognized credit rating
agency. Investments falling below the minimum quality level are required to be
disposed of at the earliest opportunity that such disposition will not adversely
affect the investment portfolio. CGA's policy is to invest only in investments
which are readily marketable with no legal or contractual restrictions on
resale. No investment is allowed if such investment would generate U.S. source
income to CGA.
The investment manager (the "Investment Manager") for CGA is Alliance
Capital Management Corporation. Subject to the investment guidelines determined
by CGA's Board of Directors, the Investment Manager has discretion to, among
other things, buy, sell, retain, or exchange investments. The Investment Manager
has entered into an investment management agreement with CGA, which is
terminable by either party upon 30 days' written notice.
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The following tables summarize CGA's investments by country and by type of
debt security, in each case as of December 31, 1998:
COUNTRY PERCENTAGE TYPE PERCENTAGE
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Supra-national 15% Financial 38%
Other 15% Sovereign 25%
Germany 12% Banking 20%
UK 11% Industrial 9%
Japan 9% Accrued income 3%
Netherlands 6% Public utilities 3%
France 6% Corporate 2%
Cayman Islands 6% Cash equivalents 1%
Canada 6% TOTAL 100%
Sweden 3%
Italy 3%
Ireland 2%
Belgium 2%
Denmark 1%
Norway 1%
Spain 1%
Channel Islands 1%
TOTAL 100%
At December 31, 1998, no investments in CGA's investment portfolio were
rated less than "Double-A minus" or the equivalent. The average yield to
maturity on the investment portfolio was 4.7% as of December31, 1998.
CLAIMS
Even though all risks insured by CGA are underwritten to a "zero loss"
standard, CGA is prepared to deal with claims if any should materialize. CGA's
actions in respect of a potential claim would include the review and
investigation of loss reports, creation and maintenance of claim files,
establishment of proper reserves and payment of claims. CGA would monitor the
progress and ultimate outcome of claims to ensure that subrogation, salvage and
other cost recovery opportunities are fully explored. CGA may become actively
involved in the financial restructuring of a transaction if Management concludes
that losses would be minimized by so doing. When and as appropriate, CGA may
supplement its in-house capabilities in this regard with services available from
other sources. CGA monitors its exposure to insured credits on an ongoing basis.
In this regard, CGA reviews available information on the entities which issued
the insured securities, the assets underlying the insured securities, and
general trends in the relevant industry.
RESERVES
CGA maintains a general loss reserve for all risks insured. A general loss
reserve is an estimate of potential losses and loss adjustment expenses. To
determine the general loss reserve, Management reviews historical default rates
and loss severity on corporate bonds with ratings similar to the securities
insured by CGA. Expected losses on insured obligations are the product of the
probability of default and the loss severity on each obligation insured. Case
basis reserves will be established for insured risks at such time as the
likelihood of a future loss is probable or determinable.
Reserves are estimates of potential claims at a given time, based on facts
and circumstances then known to the insurer. It is possible that the ultimate
liability may exceed or be less than such estimates. CGA reviews its estimates
on an ongoing basis and, as experience develops and new information becomes
known, CGA will adjust the reserves as necessary. In the event that reserves are
increased or decreased with respect to a potential claim, a corresponding
adjustment to the Company's earnings would be made in its financial statements
for the period in which such reserve increase or decrease is made.
In October 1998, the credit ratings on asset-backed securities issued by
various trusts established and serviced by Commercial Financial Services, Inc.
("CFS"), a credit-card debt collection company, were withdrawn by the three
credit rating companies that rate the securities issued by such trusts (the "CFS
Securities"). The withdrawal of said ratings was in response to allegations of
accounting and other irregularities at CFS. The rating agencies, investors and
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insurers, as well as the Commission, have commenced an investigation into these
allegations. Clients of CGA own approximately $201 million par amount of CFS
Securities, which exposure has been guaranteed by CGA. CGA has reinsured
approximately $154 million par amount of this exposure, leaving CGA with a net
exposure of approximately $47 million par amount as of December 31, 1998. CGA
has taken a case basis reserve in respect of the CFS Securities in the amount of
approximately $20.8 million. This amount represents Management's best estimate
of potential losses in respect of the CFS Securities at this time.
CONTINGENCY RESERVE
As a Bermuda based Class 3 insurer (as defined herein), CGA is generally
not required to establish contingency reserves. If CGA were to assume
reinsurance from a U.S. domiciled financial guaranty insurer, then CGA would be
required to maintain contingency reserves, which would be maintained as part of
CGA's general reserves. See "Regulation."
REINSURANCE
On a case by case basis, CGA may arrange reinsurance with high quality and
financially strong reinsurers. To the extent that CGA utilizes reinsurance, CGA
has given Capital Reinsurance Company ("Cap Re"), a financial guarantor rated
AAA by Standard & Poor's Ratings Services ("S&P") and FitchIBCA, Ltd.
("FitchIBCA"), and Aa2 by Moody's Investors Service, Inc., a right of first
offer to provide such reinsurance. The reinsurance of risk does not relieve CGA
of its original liability to its policyholders. In the event that a reinsurer
was unable to meet its obligations under a reinsurance contract, CGA would be
liable for such defaulted amounts.
CGA has entered into an excess of loss reinsurance facility agreement dated
as of June 12, 1997, as amended, with KRE Reinsurance Ltd. (the "Reinsurer"), an
affiliate of Cap Re rated AA by S&P and AA+ by FitchIBCA. The agreement provides
for a $20 million limit of liability during the nine year term of the Agreement,
with no reinstatement of the limit in the event of loss payments. The Agreement
covers all policies and guarantees written and reinsurance assumed by CGA from
its inception.
During October, 1998, CGA took steps to mitigate risks related to its
exposure in connection with guarantees of certain client credit facilities used
to purchase asset-backed and real estate backed securities. As a result of
turmoil in certain areas of the capital markets during this time period, the
spreads over treasuries at which investors were willing to purchase certain
securities widened considerably. This spread widening caused a decrease in the
fair market value of many of the securities used as collateral for the insured
credit facilities. The estimated fair market value of these securities had
declined significantly during October. Certain of the credit facilities have
requirements that lender's operating ratios, (the portfolio market value divided
by the amount of 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 applicable cure period, the lender may
liquidate the collateral and require CGA to pay any remaining balance
outstanding under the credit facility.
On October 30, 1998, CGA provided asset specific guarantees and obtained
third party credit support on a "cut-through" basis on approximately $382
million par amount of securities in the investment portfolios of two of its
clients, St. George Investments I, Ltd. ("SGI") and St. George Investments III,
Ltd. ("SG3"). The three parties which provided such credit support are
institutional investors in the Company. The effect of this third-party credit
support was to substantially increase the market value and reduce the future
market value volatility of the credit enhanced securities. In connection with
these arrangements, CGA received a premium of $38.95 million from its two
clients, and ceded an aggregate of $38.7 million to the institutions that
provided the cut-through credit enhancement. CGA loaned $30 million to SG
Holdings, the parent corporation of SGI and SG3) in order to permit SG Holdings
to provide its subsidiaries with sufficient funds to pay the premium for such
credit support, and to meet such clients' ongoing liquidity needs. Such loan
reduced CGA's claims-paying resources by $30 million. As a result of these
arrangements, SGI and SG3 were and remain to date in full compliance with all
loan to value covenants set out in such companies' credit facilities.
As a result of the $30 million reduction in CGA's claims-paying resources
and its exposure to the CFS securities, CGA modified its business plan pending
the receipt of additional claims paying resources. Such modifications have
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resulted in CGA not taking on any additional exposure to non-investment grade
risks, and in reducing new business volume. It should be noted, however, that
the Company presently intends to use $30 million of the net proceeds of its
current Rights Offering to make a capital investment in CGA on or about March
31, 1999. For a description of the Rights Offering, see Item 12--"Security
Ownership of Certain Beneficial Owners and Management". Such capital investment
would increase CGA's claims-paying resources by $30 million, and would eliminate
the modifications to CGA's business plan as described above. It should also be
noted that the credit support arrangements referred to above are cancelable
under certain circumstances by CGA, in which case the providers of such credit
support must generally refund to CGA a portion of the unearned premium paid by
CGA for such credit support. In the event such credit support is not cancelled
by April 30, 1999, resulting in a return of premium to CGA of at least $20
million, the Company presently intends to use the remaining net proceeds of the
Rights Offering to make a further capital investment in CGA, up to the amount of
the shortfall.
The Company has exposure totaling approximately $425 million related to the
timely payment of interest and principal on a loan to St. George Investments I,
Ltd. (SGI). The loan is payable in four equal annual installments with the first
installment due November 11, 1999. In order to meet this obligation, CGAIM, as
the advisor to SGI, has advised SGI to sell a portion of the underlying
securities to special purpose vehicles that will repackage the securities as
follows. The current terms of the proposed transaction indicate that the
underlying securities would be sold to two newly organized special purpose
vehicles, financed by three classes of certificates. The two most senior classes
of certificates, representing approximately 85% of the total, would be held by a
third party who is also an institutional investor in the Company. The Company
would also issue a 5.9% pool policy related to the underlying pool of
securities. This transaction is currently scheduled to close in April, 1999. The
proceeds from this sale under the currently negotiated terms would be sufficient
to meet SGI's obligations due in November, and CGAIM would advise SGI to use the
proceeds to meet the obligation. There can be no assurance that the sale of the
underlying securities occurs under the terms discussed above. In the event that
this transaction does not occur and SGI is not otherwise able to meet their debt
obligation, the lender may call on the Company's loan guaranty for the
shortfall. The Company may then liquidate the underlying collateral to subrogate
losses paid.
INSURANCE IN FORCE
The following table shows CGA's net par outstanding insured obligations at
December 31, 1998 by asset type and by credit rating:
<TABLE>
<CAPTION>
ASSET TYPE CREDIT RATING
---------- -------------
<S> <C> <C> <C> <C> <C>
ABS Consumer $ 456,521,235 29% AAA $ 58,203,887 4%
ABS Corporate 345,612,368 22% AA 39,454,116 3%
CMBS 185,753,755 12% A 180,310,840 12%
REIT Debt 381,777,437 24% BBB 1,049,028,508 67%
REIT Preferred 70,000,000 5% BB 175,692,856 11%
Sovereign 120,000,000 8% Not Rated 56,974,587 3%
TOTAL $1,559,664,795 100% TOTAL $1,559,664,795 100%
</TABLE>
CGA INVESTMENT MANAGEMENT, INC.
CGAIM is a Delaware corporation that is registered as an investment adviser
with the Commission under the Investment Advisors Act of 1940, as amended.
CGAIM, which commenced operations in June, 1997, provides investment management
and financial advisory services primarily to specialized investment vehicles and
for the U.S. and international structured finance markets. CGAIM's advisory team
currently includes more than twenty experienced professionals in the areas of
asset backed and structured finance, real estate finance and risk management.
GENERAL
CGAIM acts as investment manager and/or collateral manager to specialized
investment vehicles and other clients, including SG Holdings, Cobalt Holdings,
and their respective subsidiaries. Its activities in this capacity include
providing advice regarding the purchase and sale of structured and other
financial assets, the management of funding and market risk, and reporting and
accounting functions. CGAIM performs initial and ongoing credit reviews on the
assets which it recommends for purchase to its clients, and the counterparties
with which it negotiates financial hedges and derivative contracts. Investment
guidelines are developed for each client to ensure that CGAIM manages its
clients' assets pursuant to agreed upon guidelines and limits.
CGAIM also acts as a financial adviser for its clients, which include
issuers and investment banks, in evaluating structured finance alternatives and
financing structures. CGAIM's services in this capacity include providing
assistance in evaluating, structuring and documenting structured finance
transactions, and in organizing and performing due diligence relating to
financial assets and structured transactions.
INVESTMENT ADVISER/COLLATERAL MANAGEMENT SERVICES
CGAIM acts as investment manager and/or collateral manager to specialized
finance vehicles, including SG Holdings, Cobalt Holdings and their respective
subsidiaries, which invest primarily in structured fixed income securities. In
so acting, CGAIM's duties include some or all of the following:
(i) Identifying assets on behalf of its clients, including (1)
analyzing credit, legal and market/optionability (i.e. interest rate,
currency and prepayment) risks and (2) negotiating the price, covenants,
rights, remedies and all documentation relating thereto.
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(ii) Identifying swaps, financial hedges and other derivative contracts
on behalf of the client in order to manage the portfolio within prudent
market risk limits as agreed with the client.
(iii) Negotiating financing arrangements on behalf of its clients.
(iv) Preparing valuations, reports and other documents as may be
required from time to time by its clients and persons providing financing
to such clients in order to determine compliance with the clients' and
such lenders' policies and procedures.
(v) Analyzing the performance of assets including recommending the
sales of investments when appropriate.
Initial and ongoing credit reviews are performed by CGAIM on (1) the assets
which CGAIM recommends for purchase to its investment management clients and (2)
the counterparties with which CGAIM negotiates financial hedges or derivative
contracts on behalf of its clients.
Market risk management (i.e., interest rate and currency risk) and
operations are performed using systems which integrate front, middle and back
office applications with live feeds from market information services. Policies
and procedures are developed to ensure that CGAIM manages its clients' assets
pursuant to agreed upon guidelinesand limits.
FINANCIAL ADVISORY SERVICES
CGAIM also acts as a financial advisor for its clients, which include
financial asset issuers and investment banks, in evaluating structured finance
alternatives and financing structures. CGAIM charges advisory fees to its
clients for its services. CGAIM's services as financial advisor include the
following:
(i) providing assistance in evaluating, structuring and documenting
structured finance transactions (which could include the purchase of
credit enhancement provided by CGA); and
(ii) providing assistance in organizing and performing due diligence
relating to financial assets and structured transactions.
REGULATORY STATUS
CGAIM is a registered investment advisor under the United States Investment
Advisers Act of 1940, as amended, which requires registration of all non-exempt
advisors to conform their conduct to statutory norms. The Act, among other
things, addresses fee arrangements between advisors and clients, prohibits
fraudulent practices, precludes assignment of an investment advisory contract
without the client's consent, requires advisors to maintain books and records
consistent with rules that may be promulgated by the Commission, and authorizes
the Commission to inspect such books and records.
ST. GEORGE AND COBALT
SG Holdings was incorporated in the Cayman Islands as a limited liability
corporation for the purpose of forming subsidiaries which will invest in a wide
range of assets, including CMBS, MBS, ABS and corporate securities. Cobalt
Holdings was organized as a Delaware limited liability company for the purpose
of forming subsidiaries which invest in certain types of securities, primarily
debt obligations and preferred stock issued by real estate investment trusts,
certain classes of asset backed securities backed by portfolios of credit card
receivables and certain other fixed income securities. St. George and Cobalt
fund their respective investment portfolios through lending facilities provided
by banks, loans provided by commercial paper conduit vehicles, the direct
issuance of securities in the capital markets, and through synthetic purchase
arrangements such as total rate of return swaps, default swaps and repurchase
agreements. CGAIM acts as asset manager for SG Holdings, Cobalt Holdings, and
their respective subsidiaries. CGA has issued insurance policies which guarantee
the payment obligations of St. George and Cobalt under their respective
financing arrangements. Such policies generally insure the prompt payment of
interest when due, and principal on maturity, of the respective security. It is
expected that the payment obligations of any other subsidiaries of SG Holdings
and Cobalt Holdings under their respective financing arrangements will similarly
be guaranteed by CGA.
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REGULATION
BERMUDA
THE INSURANCE ACT 1978 AND RELATED REGULATIONS
The Insurance Act 1978 of Bermuda, amendments thereto and related
regulations (the "Act"), which regulates the business of CGA, provides that no
person shall carry on an insurance business in or from within Bermuda unless
registered as an insurer under the Act by the Minister of Finance (the
"Minister"). The Minister, in deciding whether to grant registration, has broad
discretion to act as he thinks fit in the public interest. The Minister is
required by the Act to determine whether the applicant is a fit and proper body
to be engaged in insurance business and, in particular, whether it has, or has
available to it, adequate knowledge and expertise. In connection with
registration, the Minister may impose conditions relating to the writing of
certain types of insurance. The registration of an applicant as an insurer is
subject to its complying with the terms of its registration and such other
conditions as the Minister may impose at any time.
An Insurance Advisory Committee appointed by the Minister advises him on
matters connected with the discharge of his functions, and sub-committees
thereof supervise and review the law and practice of insurance in Bermuda,
including reviews of accounting and administrative procedures.
The Act imposes on Bermuda insurance companies solvency and liquidity
standards and auditing and reporting requirements and grants to the Minister
powers to supervise, investigate and intervene in the affairs of insurance
companies. Significant aspects of the Bermuda insurance regulatory framework, as
it applies to Class 3 insurers such as CGA, are set forth below.
CLASSIFICATION OF INSURERS
The Act provides for four classes of registration of insurers carrying on
general business (as defined in the Act). CGA is registered and licensed as a
Class 3 insurer. Class 3 insurers are considered to be subject to a higher
degree of regulation than Classes 1 and 2 insurers, which are primarily
concerned with underwriting related or parent's risks. In addition, minimum
capital and surplus for a Class 3 insurer is $1 million, whereas the minimum
capital and surplus for Class 2 and Class 1 insurers is $250,000 and $120,000
respectively. There is also a Class 4 insurer classification which is used for
property catastrophe reinsurance companies and companies involved in the excess
liability business. By virtue of its class 3 license, CGA is authorized 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.
CANCELLATION OF INSURER'S REGISTRATION
An insurer's registration may be canceled by the Minister on certain
grounds specified in the Act, including failure of the insurer to comply with
its obligations under the Act or if, in the opinion of the Minister after
consultation with the Insurance Advisory Committee, the insurer has not been
carrying on business in accordance with sound insurance principles.
INDEPENDENT APPROVED AUDITOR
Every registered insurer must appoint an independent auditor who will
annually audit and report on the Statutory Financial Statements and the
Statutory Financial Return of the insurer, which are required to be filed
annually with the Registrar of Companies (the "Registrar"), who is the chief
administrative officer under the Act. The auditor must be approved by the
Minister as the independent auditor of the insurer. The approved auditor may be
the same person or firm which audits the insurer's financial statements and
reports for presentation to its shareholders.
LOSS RESERVE SPECIALIST
Each Class 3 insurer is required to submit an annual loss reserve opinion
by the approved loss reserve specialist when filing its Statutory Financial
Statements and Statutory Financial Return. The loss reserve specialist, who will
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normally be a qualified property/casualty actuary, must be approved by the
Minister. CGA has received an exemption from having to appoint a loss reserve
specialist and to file the annual loss reserve opinion on the condition that CGA
maintains its claims-paying ability rating of not less than AAA by DCR.
STATUTORY FINANCIAL STATEMENTS
An insurer must prepare annual Statutory Financial Statements. The Act
prescribes rules for the preparation and substance of such Statutory Financial
Statements (which include, in statutory form, a balance sheet, an income
statement, and a statement of capital and surplus, and detailed notes thereto).
The insurer is required to give detailed information and analyses regarding
premiums, claims, reinsurance and investments. The Statutory Financial
Statements are not prepared in accordance with U.S. GAAP and are distinct from
the financial statements prepared for presentation to the insurer's shareholders
under The Companies Act 1981 of Bermuda, which financial statements may be
prepared in accordance with U.S. GAAP. CGA, within a specified time, must file
its Statutory Financial Statements with the Registrar. The Statutory Financial
Statements must be maintained at the principal office of the insurer for a
period of five years.
MINIMUM SOLVENCY MARGIN
The Act provides that the statutory assets of an insurer must exceed its
statutory liabilities by an amount greater than the prescribed minimum solvency
margin which varies with the class of the insurer and the insurer's net premiums
written and loss reserve level.
MINIMUM LIQUIDITY RATIO
The Act provides a minimum liquidity ratio for general business. An insurer
engaged in general business is required to maintain the value of its relevant
assets at not less than 75% of the amount of its relevant liabilities. Relevant
assets include cash and time deposits, quoted investments, unquoted bonds and
debentures, mortgages secured by first liens on real estate, investment income
due and accrued, accounts and premiums receivable and reinsurance balances
receivable. There are certain categories of assets which, unless specifically
permitted by the Minister, do not automatically qualify as relevant assets such
as unquoted equity securities, investments in and advances to affiliates, real
estate and collateral loans. The relevant liabilities are total general business
insurance reserves and total other liabilities less deferred income tax and
sundry liabilities.
RESTRICTION ON DIVIDENDS
The payment of dividends or other distributions by CGA is limited under
Bermuda insurance regulations. In accordance therewith, CGA is prohibited from
paying dividends or other distributions unless after such payment the amount by
which its general business assets exceed its general business liabilities is the
greater of the following amounts:
(i) $1,000,000; or
(ii) the amount determined by applying the rate of 20% to net premiums
written in the subject year up to $6,000,000 plus the rate of 15%
applied to net premiums written in the subject year in excess of
$6,000,000; or
(iii) the amount determined by applying the rate of 15% to reserves for
losses and loss adjustment expenses reflected in the balance sheet
at the date of determination.
CGA may declare and pay a dividend or make a distribution out of
contributed surplus or other assets legally available for distribution provided
that after the payment of such dividend or distribution CGA will continue to
meet its minimum solvency margin and minimum liquidity ratio as detailed above.
Further, in accordance with Bermuda insurance regulations, before reducing by
15% or more its total statutory capital as set out in its previous year's
financial statements, a Class 3 insurer such as CGA must apply to the Minister
for his approval and is obliged to provide such information in connection
therewith as the Minister may require.
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In addition, Board members' fiduciary obligations to creditors,
policyholders and shareholders apply to their votes in respect of dividends,
distributions and redemptions.
The aforementioned restrictions on distributions by CGA to the Company will
restrict the ability of the Company to use the proceeds of the Capital
Commitments to pay dividends to holders of the Company's securities, because all
proceeds from the Capital Commitments will be contributed by the Company to CGA.
For a description of the Capital Commitments, see Item 12--"Security Ownership
of Certain Beneficial Owners and Management".
SUPERVISION, INVESTIGATION AND INTERVENTION
The Minister may appoint an inspector with extensive powers to investigate
the affairs of an insurer if the Minister is satisfied that an investigation is
required in the interest of the insurer's policyholders or persons who may
become policyholders. In order to verify or supplement information otherwise
provided to him, the Minister may direct an insurer and others to produce
documents or information relating to matters connected with theinsurer's
business.
If it appears to the Minister that there is a significant risk of the
insurer becoming insolvent, the Minister may direct the insurer not to take on
any new insurance business; not to vary any insurance contract if the effect
would be to increase the insurer's liabilities; not to make certain investments;
to realize certain investments; to maintain in Bermuda, or transfer to the
custody of a Bermuda bank, certain assets; and to limit its premium income.
Further, in such circumstances, the Minister may direct that no dividends be
paid.
An insurer is required to maintain a principal office in Bermuda and to
appoint and maintain a principal representative in Bermuda. The principal office
of CGA is at Craig Appin House, 8 Wesley Street, Hamilton HM11 Bermuda and
Geoffrey Kauffman, CGA's President and Chief Underwriting Officer, is CGA's
principal representative. Without a reason acceptable to the Minister, an
insurer may not terminate the appointment of its principal representative, and
the principal representative may not cease to act as such, unless 30 days'
notice in writing to the Minister is given of the intention to do so. It is the
duty of the principal representative, within 30 days of his reaching the view
that there is a likelihood of the insurer for which he acts becoming insolvent
or its coming to his knowledge, or his having reason to believe, that an "event"
has occurred, to make a report in writing to the Minister setting out all the
particulars of the case that are available to him. Examples of such an "event"
include failure by the insurer to comply substantially with a condition imposed
upon the insurer by the Minister relating to a solvency margin or a liquidity or
other ratio.
CERTAIN OTHER BERMUDA LAW MATTERS
Although the Company and CGA are incorporated in Bermuda, each is
classified as non-resident of Bermuda for exchange control purposes by the
Bermuda Monetary Authority, Foreign Exchange Control. Pursuant to its
non-resident status, the Company may hold any currency other than Bermuda
dollars and convert that currency into any other currency (other than Bermuda
dollars) without restriction.
As "exempted" companies, the Company and CGA may not, without the express
authorization of the Bermuda legislature or under a license granted by the
Minister, participate in certain business transactions, including:
(i) the acquisition or holding of land in Bermuda (except as required
for its business and held by way of lease or tenancy agreement for a term
not exceeding 50 years);
(ii) the taking of mortgages on land in Bermuda in excess of $50,000;
or
(iii) the carrying on of business of any kind in Bermuda, except in
furtherance of the business of the Company carried on outside Bermuda.
The Bermuda government actively encourages foreign investment in "exempted"
entities like the Company that are based in Bermuda but do not operate in
competition with local businesses. As well as having no restrictions on the
degree of foreign ownership, the Company and CGA are not currently subject to
taxes on their income or
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dividends or to any foreign exchange controls in Bermuda. In addition there
currently is no capital gains taxin Bermuda.
U.S. AND OTHER
CGA is not admitted to do business in any jurisdiction except Bermuda. The
insurance laws of each state of the U.S. and of many foreign countries regulate
the sale of insurance within their jurisdictions by alien insurers, such as CGA,
which are not authorized or admitted to do business within each jurisdiction.
With some exceptions, such sale of insurance within a jurisdiction where the
insurer is not admitted to do business is prohibited. It is not intended for CGA
to maintain an office or to solicit, advertise, settle claims or conduct other
insurance activities in any jurisdiction other than Bermuda where the conduct of
such activities would require that CGA be so authorizedor admitted.
It is intended that CGA will not write insurance in the U.S. It is intended
for CGA to conduct its business so as not to be subject to the licensing
requirements of insurance regulations in the U.S. or elsewhere (other than
Bermuda). The Company has developed operating guidelines, which include the
acceptance of business through insurance brokers not resident in the U.S., to
assist its personnel in conducting business in conformity with the laws of U.S.
jurisdictions. The Company intends to follow these guidelines and expects that
to the extent that these operating guidelines are followed, its activities will
comply with applicable insurance laws and regulations. There can be no
assurance, however, that insurance regulators in the U.S. or elsewhere will not
review the activities of CGA and claim that CGA is subject to such
jurisdiction's licensing requirements.
Many states impose a premium tax (typically 2--4% of gross premiums) on
U.S. insureds obtaining insurance from unlicensed foreign insurers, such as CGA,
by direct placement. The premiums charged by CGA do not include any state
premium tax. Each insured is responsible for determining whether it is subject
to any such tax and for paying such tax as may be due.
The U.S. also imposes an excise tax on insurance and reinsurance premiums
paid to foreign insurers or reinsurers by insureds who are U.S. persons with
respect to risks located in the U.S. The rates of tax applicable to premiums
paid to CGA are currently 4% for insurance premiums and 1% for reinsurance
premiums.
CGAIM has been registered under the United States Investment Advisers Act
of 1940, as amended.
COMPETITION
CGA faces potential competition from other financial guarantors, though
Management believes that none are currently active in the commercial real estate
obligations market. In markets where the financial guarantors currently write
insurance, especially the municipal bond market, CGA is at a significant
disadvantage without claims paying ability ratings from Standard & Poor's
Corporation and Moody's Investors Service, Inc. Many institutional investors
require such dual ratings from financial guaranty insurers. Furthermore, CGA's
inability to negotiate and conclude its policies in the U.S. may be a
competitive disadvantage, in that potential clients, including issuers and
investment banks located in the U.S., might not be willing to travel to Bermuda
to do business with the Company.
The financial guaranty bond insurance industry consists principally of
eight firms which are "Triple-A" rated and whose major focus is guaranteeing
municipal financial obligations and asset-backed securities. CGA operates as a
financial guarantor, but has as its primary focus the guaranteeing of securities
relating to commercial real estate transactions as well as asset-backed
securities.
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The inception of the financial guaranty industry was in 1971 when AMBAC
Indemnity Corporation ("AMBAC") insured its first municipal bond. Since 1971, a
number of financial guarantors have been created to provide credit enhancement
for municipal, asset-backed and commercial real estate related securities. The
"Triple-A" rated bond insurers which make up the industry include seven U.S.
based companies that are members of the Association of Financial Guaranty
Insurers and consist of four primary insurers and three reinsurers:
<TABLE>
<CAPTION>
INSURERS REINSURERS
-------- ----------
<S> <C>
o AMBAC Indemnity Corporation o Capital Reinsurance Company
o Financial Guaranty Insurance Company o Enhance Reinsurance Company
o Financial Security Assurance Inc. o Axa Re Finance
o Municipal Bond Investor Assurance Corporation
</TABLE>
ITEM 2. PROPERTIES.
The Company rents office space in Hamilton, Bermuda under an operating
lease which expires in 2000. CGAIM rents office space in New York under an
operating lease which expires in 2003 and has one option for a renewal period of
five years. Total rent expense was approximately $355,000 and $300,000 in 1998
and 1997 respectively. Future minimum rental commitments under the leases, are
expected to be approximately $500,000 per annum.
ITEM 3. LEGAL PROCEEDINGS.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
ITEM There were no matters submitted to a vote of security holders during
the fourth quarter of 1998.
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PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
There is currently no established public trading market for the Company's
Common Stock. No cash dividends have been declared by the Company with respect
to its Common Stock since the Company's initial capitalization in June 1997.
Pursuant to the Company's Bye-laws, for so long as shares of the Company's
Series A Preferred Stock or Series B Preferred Stock are issued and outstanding,
the Company may not declare or pay dividends on the Common Stock. No equity
securities of the Company were sold by the Company during 1998. CGA's Board of
Directors has passed a resolution that CGA will not declare or pay cash
dividends during its 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. For a description of the Bermuda
regulatory restrictions on the ability of CGA to pay dividends to the Company,
see Item 1--"Business--Regulation--Restriction on Dividends."
ITEM 6. SELECTED FINANCIAL DATA.
The selected consolidated financial data below should be read in
conjunction with the consolidated financial statements and the notes thereto
presented under Item 8.
<TABLE>
<CAPTION>
AS OF OR FOR YEAR ENDED
-------------------------------------------
DECEMBER 31, DECEMBER 31, MARCH 31,
1998 1997 1997
------------ ------------ ---------
<S> <C> <C> <C>
Income Statement Data:
Gross premiums written .......................................... $ 49,217,083 $ 773,571 $ --
Net premiums written ............................................ 9,796,836 502,995 --
Net premiums earned ............................................. 9,246,289 502,995 --
Net investment income ........................................... 8,528,122 2,955,601 801
Net realized gains .............................................. 2,814,132 885,422 --
Management fees ................................................. 3,353,499 -- --
Operating expenses .............................................. 14,023,366 6,510,103 11
Acquisition costs ............................................... 433,217 53,590 --
Losses and loss adjustment expenses ............................. 22,745,000 55,000 --
Income (loss) before cumulative effect of change in
accounting principle ........................................... (14,059,541) (2,706,182) 790
Net income (loss) ............................................... (17,987,779) (2,706,182) 790
Net income (loss) available to common shareholders .............. (38,896,226) (12,332,792) 790
Loss per share on cumulative effect of change in accounting
principle ...................................................... (0.43) -- --
Basic and diluted income (loss) per common share ................ (4.27) (1.89) 0.07
Weighted average shares outstanding ............................. 9,100,000 6,522,313 12,000
Balance Sheet Data:
Fixed Maturities ................................................ 100,488,537 123,302,763 --
Other Investments ............................................... 30,000,000 -- --
Cash and short-term investments ................................. 2,598,140 7,199,106 121,742
Premiums receivable ............................................. 3,228,497 447,172 0
Reinsurance recoverable ......................................... 67,400,000 -- --
Total assets .................................................... 215,903,933 142,721,186 133,790
Provision for losses and loss adjustment expenses ............... 90,200,000 55,000 0
Total liabilities ............................................... 95,797,551 3,916,609 --
Total mezzanine equity .......................................... 126,608,249 107,047,101 0
Total shareholders' equity ...................................... (6,501,867) 31,757,476 12,790
</TABLE>
ITEM 7. 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.
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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 a "Triple-A" "claims paying ability" rating from Duff & Phelps
Credit Rating Company ("DCR") and has also been rated in the highest rating
category assigned by each of the two Canadian rating agencies, Dominion Bond
Ratings Service and Canadian Bond Ratings Service. CGA issues financial guaranty
insurance policies, which are the functional equivalent of direct-pay letters of
credit, to insure payment of interest, principal and other amounts payable in
respect of notes, securities, and other financial obligations. 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 is registered as an investment advisor with the United States
Securities and Exchange Commission under the Investment Advisors Act of 1940, as
amended. CGAIM provides investment management and financial advisory services
primarily to specialized investment vehicles and for the U.S. and international
structured finance markets. 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 sold for an aggregate purchase price of $105 million, (ii) common stock
sold for an aggregate purchase price of $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 year ended December 31, 1998 were $23.9 million, of
which $9.2 million was from financial guaranty insurance premiums, $3.4 million
was from investment management and advisory fees, $8.5 million was from
investment income and $2.8 million was from net realized gains on the sale of
investments. Total revenues for the nine month period ended December 31, 1997
were $4.3 million, of which $.5 million was from financial guaranty insurance
premiums, $3 million was from investment income and $.9 million was from net
realized gains on the sale of investments. There were no investment management
or advisory fees earned in 1997. Further comparisons between the year ended
December 31, 1998 and the nine months ended December 31, 1997 have limited
meaning, as the Company did not commence operations until after the private
placement offering was completed on June 17, 1997.
Net premiums earned were derived from $49.2 million of gross premiums
written, of which $39.4 million were ceded under reinsurance agreements. The
gross premiums written and ceded premiums include approximately $39 million from
one transaction. The transaction was entered into by CGA to mitigate risks
related to its exposure in connection with guarantees of two credit facilities
for St. George Investments I, Ltd. ("SGI") and St. George Investments III, Ltd.
("SG3") which are used to purchase asset backed and real estate backed
securities. As a result of turmoil in certain areas of the capital markets
during the month of October 1998, the spreads over treasuries at which investors
were 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 two insured credit facilities. The facilities have
requirements that the lender's operating ratio, (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 a cure period, the lender may liquidate the collateral
and require CGA to pay any remaining balance outstanding under the credit
facility. On October 30, 1998 CGA provided asset specific guarantees and
obtained third party credit support on a "cut-through" basis on approximately
$382 million par amount of securities within the two insured investment
portfolios. The three parties that provided such credit support are
institutional investors in the Company. The effect of this third party credit
support was to substantially increase the market value and reduce the future
market value volatility of the credit enhanced securities. In connection with
these arrangements, CGA received a premium of $38.95 million from its two
clients, and ceded an aggregate of $38.7 million to the institutions that
provided the cut-through credit enhancement.
The amount of CGA's insured portfolio increased from $319 million net par
as of December 31, 1997 to $1.6 billion as of December 31, 1998. The weighted
average term of the insured securities at December 31, 1998 is approximately 14
years, with 34 percent of the portfolio having an expected average life of less
than five years. The following table shows the net par insured obligations at
December 31, by asset type:
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1998 1997
(IN 000'S) (IN 000'S)
---------- ----------
Real estate investment trust debt $ 381,777 $ --
Consumer asset-backed securities 456,521 52,439
Corporate asset-backed securities 270,612 46,337
Commercial mortgage-backed securities 185,754 100,703
Sovereign debt 120,000 120,000
Corporate debt 75,000 --
REIT Preferred stock 70,000 --
Total $1,559,664 $319,479
The following table presents the credit ratings of the above assets, as
assigned by one or more nationally recognized credit rating agencies, based on
net par outstanding at December 31:
1998 1997
---- ----
"AAA" 4% --
"AA" 3% --
"A" 12% 7%
"BBB" 67% 65%
"BB" 11% 28%
Not rated 3% --
Total 100% 100%
The portfolio currently includes one problem credit consisting of four
charged-off credit card receivable transactions. These transactions comprise
three percent of CGA's net par insured portfolio as of December 31, 1998. CGA
has established a case basis reserve for this exposure which is more fully
described below.
During 1998 the par value of CGAIM's assets under management increased from
$199 million to over $1.8 billion. CGAIM generally earns a management fee of
.25% per annum on the average market value of the assets under its management.
CGAIM did not earn any management fees in 1997.
Net investment income is presented after deducting the cost of external
investment management fees which totaled $0.3 million for 1998 and $0.2 million
for the nine months ended December 31, 1997. Commencing in September 1998, CGA
modified its investment strategy to have the investment portfolio closely match
the returns of a "Double-A" or better three to five year Eurodollar bond index.
This strategy results in a less actively managed portfolio, which resulted in
the management fee being reduced by approximately twenty basis points per annum.
The new strategy also resulted in above normal turnover of the portfolio and
contributed to the significant gains realized during the year. The total market
value of the fixed maturity portfolio at December 31, 1998, including accrued
interest receivable, was $104 million. Unrealized gains on the investment
portfolio as of December 31, 1998 were $0.9 million. The average yield on the
investment portfolio was 5.8% for 1998 and 6.3% for the period ended December
31, 1997.
Operating expenses for the year ended December 31, 1998 were $14 million
compared to $6.5 million for the nine months ended December 31, 1997. These
costs are primarily personnel-related which totaled $7.4 million for 1998. The
majority of the other 1998 operating expenses were comprised of legal and
financing costs incurred to set up investment programs for CGAIM's clients
totaling $1.6 million, and professional fees of $1.3 million.
In October, 1998 the credit ratings on asset-backed securities issued by
various trusts established and serviced by Commercial Financial Services Inc.
("CFS"), a credit-card debt collection company, were withdrawn by the three
credit rating companies that rate the securities issued by such trusts (the "CFS
Securities"). The withdrawal of said ratings was in response to allegations of
accounting and other irregularities at CFS. The rating agencies, investors and
insurers, as well as the United States Securities and Exchange Commission have
commenced an investigation into these allegations. Clients of CGA own
approximately $201 million par amount of CFS Securities, which exposure has been
guaranteed by CGA. CGA has reinsured approximately $154 million par amount of
this exposure, leaving CGA with a net exposure of approximately $47 million par
amount as of December 31, 1998. CGA has taken a case basis reserve in respect of
the CFS Securities in the amount of $20.8 million. This amount represents
Management's best estimate of potential losses in respect of the CFS Securities
at this time.
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The Accounting Standards Executive Committee 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 in July 1998 which is reflected in the
financial statements as a change in accounting principle.
SUMMARY OF OPERATING SEGMENTS
The Company has two reportable segments, CGA and CGAIM. CGA issues
financial guaranty insurance policies and CGAIM provides investment management
and advisory services. The tables below presents selected financial information
for each of the operating segments:
As of and for the year ended December 31, 1998:
CGA CGAIM
------------ ----------
REVENUES
Net premiums earned $ 9,246,289 $ --
Net investment income 8,387,513 64,934
Net realized gains 2,814,132 --
Management fees -- 3,353,499
Total revenues 20,447,934 3,418,433
EXPENSES
Operating expenses 1,680,707 10,711,550
Acquisition costs 433,217 --
Losses & LAE 22,745,000 --
Extraordinary items 1,127,353 480,207
Commitment fees 600,000 --
Excess of loss facility 200,000 --
TOTAL ASSETS 214,823,536 3,752,936
As of and for the year ended December 31, 1998:
CGA CGAIM
------------ ----------
REVENUES
Net premiums earned $ 502,995 $ --
Net investment income 2,901,306 --
Net realized gains 885,422 --
Total revenues 4,289,723 --
EXPENSES
Operating expenses 597,883 5,313,368
Acquisition costs 53,590 --
Losses & LAE 55,000 --
Commitment fees 323,836 --
Excess of loss facility 107,671 --
TOTAL ASSETS 131,607,950 3,577,782
LIQUIDITY AND CAPITAL RESOURCES
The Company capitalized CGA with $125 million. Alliance Capital Management
Corporation manages CGA's entire investment portfolio. These funds are invested
in foreign corporate and government debt securities which are rated "Double-A"
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 has required funding from the Company during 1997 and 1998 totaling
$7.5 million to cover its operations. It is expected to require additional
funding in 1999 and 2000 while it continues to build its assets under management
to generate sufficient fee income to cover its operations.
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On a consolidated basis, the Company generated $1.2 million of cash from
operating activities during 1998 compared to using $9.4 million for the
nine-month period ended December 31, 1997. This $10.6 million increase in cash
flow from operations is the result of the Company moving from the start-up phase
of operations during 1997 to producing cash flow from premiums and management
fees during 1998.
The Company used $5.8 million of net cash in investing activities during
1998 which was the result of an effort to reduce cash balances and stay more
fully invested in fixed maturities. During 1997 the Company used $123.3 million
of net cash in investing activities which was the result of using the proceeds
from the private placement offering to build CGA's investment portfolio. There
were no cash flows from financing activities in 1998 and $139.7 million of net
cash flows from financing activities in 1997 resulting from the net proceeds of
the Company's private placement offering.
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.
In October 1998, CGA purchased a $30 million five year note from SG
Holdings (the parent of SGI and SG3) in order to enable SG Holdings to provide
its subsidiaries with sufficient funds to pay CGA the $38.95 million insurance
premium referred to above. The $30 million note is recorded as an investment on
CGA's books, however, it is not included in the calculation of CGA's claims
paying resources.
During November 1998 the credit facility for SGI was terminated. As of
December 31, 1998 the outstanding balance was 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. It is expected that the
facility will be repaid by a combination of asset sales and refinancing with
another lender, however, there is no certainty that SGI will be able to complete
such asset sales or refinancing. In the event that this transaction does not
occur and SGI is not otherwise able to meet its debt obligation, the lender
may call on the Company's loan guaranty for the shortfall. The Company may then
liquidate the underlying collateral to subrogate losses paid.
As a result of the $30 million reduction in CGA's claims paying resources
and its exposure to the CFS Securities, CGA modified its business plan pending
the receipt of additional claims paying resources. Accordingly, CGA acquired
additional exposure of only $41 million during the months of November and
December 1998.
CGA monitors its exposure on a routine basis and stays in close contact
with DCR to ensure that its AAA rating is maintained. CGA 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 "Triple-A" rating.
SUBSEQUENT EVENTS
On January 27, 1999 the Company held a Special General Meeting for all
shareholders, which was both preceded and followed by meetings of its Board of
Directors. The purpose of the meetings was primarily to approve and authorize
the Company to seek to raise additional capital from existing shareholders and
from one or more third party investors.
During the meetings the following resolutions were among those approved:
o That the authorized share capital of the Company be increased from
$412,000 to $3,412,000 by the creation of an additional 300,000,000
shares of a par value of $0.01 per share;
o That the Company create a new series of Preference Shares being Series
C Convertible Cumulative Voting Preference Shares (the "Series C
Preferred Stock") and offer up to $63 million to the existing holders
of the Company's Common Stock and Series B Preferred Stock (the
"Rights Offering");
o Concurrent with the closing of the Rights Offering all outstanding
shares of Series B Preferred Stock, including accrued dividends
thereon, shall be converted into shares of Common Stock based on a
value of $3 per share of Common Stock;
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o That the Company amend the terms of the Series B Preferred Stock such
that the dividend rate applicable to the Shares of Series B Preferred
Stock which may be issued in the future upon exercise of the Unit
Investors Capital Commitments or otherwise will not be greater than 7%
per annum, that any such Series B Preferred Stock shall rank junior to
the Series C Preferred Stock in all respects, and that any such Series
B Preferred Stock shall not be entitled to voting rights; and
o That the number of Directors of the Company be increased from 13 to 15
by the creation of two new vacancies and that the said two vacancies
be filled by nominees elected by the holders of the new Series C
Preferred Stock of the Company.
The Company has received irrevocable commitments from certain of its
existing investors to subscribe for an aggregate of approximately $50.7 million
(43.8 million shares) of Series C Preferred Stock. Shares of Series C Preferred
Stock may be converted into shares of Common Stock on a one-for-one basis at the
holder's option at any time, and are mandatorily convertible into shares of
Common Stock on a one-for-one basis upon the occurrence of certain events. The
anticipated closing date for the Rights Offering is March 31, 1999. The net
proceeds from the Rights Offering will be used for general corporate purposes
and to make capital investments in CGA.
The amount of new Common Stock to be issued in connection with the
conversion of the Series B Preferred Stock is projected to be approximately 18.9
million shares, which will bring the amount of total Common Stock outstanding to
approximately 28 million shares.
The Company also obtained agreements from the holders of Series A Preferred
Stock to amend the terms of the Series A Preferred Stock so that the early
redemption premium with respect thereto is eliminated.
On March 10, 1999 DCR reaffirmed its "Triple-A" claims paying rating for
CGA.
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 effects of any failure to
comply. The Company will continue to monitor Year 2000 compliance and formal
contingency plans will be formulated if the Company identifies specific areas
where there is a substantial risk of Year 2000 problems occurring. No such areas
are identified as of this date.
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.
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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
RISK MANAGEMENT
In the ordinary course of business, the Company, through its Subsidiaries,
manages a variety of risks. Of these, the primary risk is the credit risk taken
by CGA in respect of obligations insured by it. Other material risks include
those in respect of credit derivatives, liquidity, capital markets, exposure to
reinsurers, operational and legal. These risks are identified, measured and
monitored through a variety of control mechanisms, which are in place at
different levels throughout the organization.
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CREDIT RISK
The most significant risk to which the Company is exposed is credit risk.
Credit risk occurs at a number of levels, primarily in respect of the securities
and other financial obligations insured by CGA, but also in connection with
counterparties to interest rate and currency swaps, credit derivatives, and
liquidity providers.
The primary credit risk to which CGA is exposed is the risk of default on
the underlying securities or other financial obligations which it has
guaranteed. Under its financial guaranty insurance policy, CGA would generally
be liable to pay interest, principal and other amounts in respect of the insured
obligation as these become due for payment in accordance with the payment terms
of the underlying obligation, without giving effect to any acceleration thereof.
In the event the issuer of a CGA-insured security defaults on its payment
obligations, under its policy CGA would be obligated to make all scheduled
payments when due for payment. Under its insurance policies, CGA would generally
have the right, but not the obligation, to repay the defaulted security on an
accelerated basis. Upon making payment in respect of a defaulted security, CGA
would generally be subrogated to all rights and remedies of the issuer of the
security in respect of any related collateral or other security, to the extent
of the payment made by CGA.
CREDIT DERIVATIVES
CGA has exposure to counterparties in respect of certain credit
derivatives. CGA has entered into default swaps in respect of certain sovereign
and corporate exposures. CGA has also guaranteed the payment obligations of
certain subsidiaries of SG Holdings and Cobalt Holdings under default swaps and
total rate of return swaps which have been entered into by such vehicles.
Default Swaps
Default swaps are credit derivatives which enable the owner of a security
to transfer credit risk to another party. CGA has entered into default swaps
directly with banks and investment banks and has also guaranteed the obligations
of certain subsidiaries of SG Holdings and Cobalt Holdings pursuant to default
swaps.
The party taking the credit exposure in a default swap receives a net
payment that is the economic equivalent of a premium. Unless a credit event
occurs, the swap typically terminates on the maturity date of the reference
security, and there is no termination payment at maturity. Credit events relate
to the reference security and typically include:(i) bankruptcy, (ii) failure to
pay, (iii) repudiation, (iv) restructuring, and (v) cross default or
cross-acceleration. If a credit event occurs, CGA generally would be obligated
to purchase the reference security at par plus accrued interest. In some cases,
CGA would have the additional option of cash settlement, whereby CGA can make a
payment equal to the difference between the market value of the security at the
time, and the par value of the security.
Principal credit risks associated with default swaps include: (i) credit
risk--a loss may be incurred pursuant to a credit event in respect of the
underlying or reference security; (ii) market value risk--this risk is limited
to cash settlement or to the value of the reference security following a
physical settlement upon a credit event; (iii) counterparty bankruptcy
risk--from CGA's perspective, the counterparty's fixed payments would no longer
be received; however, the swap would terminate and CGA would no longer have the
credit exposure to the reference security; (iv) liquidity risk--if a credit
event occurs, CGA must fund the purchase of the reference security. The cash
amount required may be reduced in the event of a cash settlement, but this
option may not be attractive if the reference security is illiquid or is marked
at an unattractive price; and (v) assignment risk--if the reference security
carries certain rights, remedies, or obligations (such as voting rights related
to a bank loan), these should be assignable in the event of a physical
settlement. The loan documents for the reference security may not allow this.
The loan documents may also obligate the assignee to fund additional amounts
under the loan, which CGA may not be able to do in the required time period.
Total Rate of Return Swaps
Total rate of return swaps ("TRORs") are credit derivatives that are used
by certain subsidiaries of SG Holdings and Cobalt Holdings to assume credit
exposure without using cash. Effectively, the investment vehicle receives all
the economic benefits of owning the investment without financing it on balance
sheet. At the end of the TROR's term (typically one year), the investment
vehicle must purchase the underlying bond at the amount that had been financed
less any principal payments received ("Notional"). Any market value appreciation
or decline is for the investment vehicle's account.
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These swaps are either provided by investment banks selling the bond or
through a swap line provided by certain institutional lenders to St. George and
Cobalt. The TROR counterparty benefits from a CGA surety bond guaranteeing the
investment vehicle's obligations under the contract. The counterparty also
retains an ownership interest in the specific bond that is being financed. In
general, the investment vehicle's investment guidelines require no less than a
"Double-A minus" or Aa3 rating from S&P or Moody's for eligible counterparties.
There are three principal risks associated with TRORs: (i) refinancing
risk--if at the termination date the counterparty does not roll its exposure to
the investment vehicles at the then current Notional or financing rate, then the
bond will need to be refinanced at the then available market value and financing
rates; (ii) market value risk--many TRORs (but not all) have market value
triggers ranging from 5% to 10% of the Notional. If the market value of the bond
drops below the relevant dollar price, then either (a) cash collateral will need
to be posted (normally enough to bring the collateral package back to par), or
(b) an early termination event can be declared by the counterparty; and (iii)
counterparty bankruptcy risk--the investment vehicle does not have a security
interest in the underlying bond that is being financed. In the event of the
counterparty's bankruptcy, the investment vehicle would have only an unsecured
claim against the counterparty. Under its surety bond, CGA would typically
guarantee any payment default by St. George, Cobalt or other investment vehicle
under the TROR, and would thus be liable to cover any payment default by the
investment vehicle thereunder.
LIQUIDITY
The liabilities of certain CGA-insured investment vehicles (e.g., SG1 and
SG3) do not provide term funding for the assets owned by these vehicles. This
could result in incremental exposure to CGA in the event of an inability to
refinance an asset at the maturity date of the associated liability, especially
when the asset's market value is lower than its acquisition cost. Such inability
to refinance could result in a claim against CGA in the amount of the market
value loss.
As loans, notes and TRORs (liabilities) of the CGA-guaranteed investment
vehicles mature, the investment vehicle will attempt to refinance the liability
with the existing lender or issue a new CGA-insured liability to refinance the
maturing liability. In vehicles such as SG1 and SG3, if the 364-day facility is
not renewed, the facility rolls into a four-year term loan with 25% annual
amortization. Currently, for SG1 (since the facility was not rolled and SG1 is
now a 4-year term loan with an outstanding principal amount of approximately
$425 million) the assets will be refinanced or liquidated as the term loan
amortizes. CGA remains liable for current interest and principal when due in
accordance with the stated amortization schedule on such term loan.
In the event a CGA-insured liability cannot be issued to refinance a
maturing liability, CGA will (i) direct the investment vehicle to sell the
related asset with or without CGA insurance or (ii) attempt to arrange for the
purchase of the asset by another CGA-insured investment vehicle. Refinance
options for maturing TRORs include: (i) refinance or "term out" the full amount
of the maturing TROR with the existing TROR counterparty; (ii) refinance the
maturing TROR with the existing TROR counterparty or new counterparty at the
related security's market value; (iii) sell the asset with or without a CGA
guaranty; and (iv) attempt to arrange for the purchase of the asset by another
CGA-insured investment vehicle. In the case of (ii), (iii) and (iv), CGA would
be liable for any market value shortfall not otherwise covered by the terms of
the refinancing.
The Company has exposure totaling approximately $425 million related to the
timely payment of interest and principal on a loan to St. George Investments I,
Ltd. (SGI). The loan is payable in four equal annual installments with the first
installment due November 11, 1999. In order to meet this obligation, CGAIM, as
the advisor to SGI, has advised SGI to sell a portion of the underlying
securities to special purpose vehicles that will repackage the securities as
follows. The current terms of the proposed transaction indicate that the
underlying securities would be sold to two newly organized special purpose
vehicles, financed by three classes of certificates. The two most senior classes
of certificates, representing approximately 85% of the total, would be held by a
third party who is also an institutional investor in the Company. The Company
would also issue a 5.9% pool policy related to the underlying pool of
securities. This transaction is currently scheduled to close in April, 1999. The
proceeds from this sale under the currently negotiated terms would be sufficient
to meet SGI's obligations due in November, and CGAIM would advise SGI to use the
proceeds to meet the obligation. There can be no assurance that the sale of the
underlying securities occurs under the terms discussed above. In the event that
this transaction does not occur and SGI is not otherwise able to meet their debt
obligation, the lender may call on the Company's loan guaranty for the
shortfall. The Company may then liquidate the underlying collateral to subrogate
losses paid.
CAPITAL MARKETS
Spread Risk (Credit Spread and Swap Spread Widening/Compression)
The market value of a fixed income asset has two components, duration risk
and credit spread risk. Duration risk is the risk of change in price of a
fixed-rate bond as a result of changes in interest rates. St. George and Cobalt
investment vehicles, which generally borrow at floating, LIBOR based rates, are
required by their investment guidelines to hedge this risk, through interest
rate swaps, to minimize fluctuations in the market value of their portfolios
resulting from movements in the Treasury market. Such interest rate swaps
effectively convert fixed rate assets into synthetic floating rate bonds. Credit
spread risk is the risk resulting from change in price of any non-government
bond as a result of a change in the market's willingness to hold the issuer's
risk. The Company believes that the change in the price of a bond due to credit
spread movements (risk premium) cannot be hedged in today's market for the type
of assets in the St. George and Cobalt investment portfolios. Credit derivative
contracts with market value triggers are also subject to credit spread risk.
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The following hold true for spread volatility: (i) the shorter life of the
asset, the lower the credit spread volatility; (ii) higher rated assets have
lower credit spread volatility than lower rated assets; and (iii) assets with
better liquidity (tighter bid/ask spread) have lower credit spread volatility.
The market value volatility of a portfolio of assets and/or derivative
contracts is simply the weighted average of the volatility of the individual
assets. Credit spreads move for the following reasons: (i) underlying changes in
the credit quality of the securities; (ii) supply/demand equation; and (iii)
absences of liquidity, such as occurred in the capital markets in the second
half of 1998.
Interest Rate Movements
The market value of fixed rate bonds fluctuates as underlying interest
rates change (parallel shifts and/or twists). This is commonly measured by the
modified duration of the bond. CGAIM manages the duration risk of the assets in
its clients' portfolios by swapping the fixed rate cash flows into LIBOR
floating rate basis. The interest rate hedge is generally put on simultaneously
with the purchase by the client of the fixed rate bond. CGAIM monitors the
interest rate risks as agreed with each client and set forth in the investment
guidelines for such client. Pursuant to the client's investment guidelines, each
client's investment portfolio must be managed so as to remain within certain
parameters in this market risk category.
Interest Rate Swaps
CGA-insured investment vehicles are required by their respective investment
guidelines to swap all fixed rate investments to LIBOR. This is intended to
ensure that the vehicles lock-in the intended spread on their respective
investments and have sufficient resources to pay interest on their respective
financings. The bankruptcy of a provider of an interest rate swap could leave
CGA exposed to the marked-to-market value of the interest rate swap. In general,
the investment guidelines for the various St. George and Cobalt vehicles require
that swap counterparties be rated not less than "Single-A" by one or more
nationally recognized credit agencies. Certain of the St. George and Cobalt
vehicles have higher or additional requirements for swap counterparties.
ST. GEORGE AND COBALT
INTEREST RATE SWAP COUNTERPARTY EXPOSURE
AS OF DECEMBER 31, 1998
DEBT RATINGS
----------------
S&P MOODY'S NOTIONAL ($MM)
--- ------- --------------
AAA Aaa 9
AAA Aa1 35
AA+ Aa1 20
AA Aa2 124
AA- Aa3 82
A+ Aa2 85
A+ Aa3 124
A+ A1 400
Aa3 9
Counterparty derivative exposures are a function of the notional amount and
tenor of the derivative contracts outstanding, as well as the yield curve. Since
the future paths of the yield curve are probabilistic, there are a number of
analytical approaches to measure the credit exposures from interest rate swaps.
The Company applies a stressed (3-Sigma) expected mark-to-market approach and
aggregates counterparty risks across the CGA-guaranteed investment vehicles and
swap contracts. The "starting point" for the 3-Sigma measurement is the current
marked-to-market value of each derivative contract.
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Most of the long dated interest rate swaps to which St. George and Cobalt
are party have "true-up" provisions which allow either counterparty to terminate
a swap contract in five years. This provision provides both counterparties with
a credit risk mitigant. At the current time, CGA-guaranteed vehicles have over
$700 million of long dated interest rate swaps with this type of provision.
Spread Deterioration Risk
Certain of the St. George and Cobalt investment vehicles fund their
LIBOR-based portfolios by borrowings under asset backed commercial paper
facilities. This could subject the vehicle to basis risk if LIBOR and asset
backed commercial paper rates diverge. These two indices normally trade with a
high degree of correlation; i.e. asset backed commercial paper generally yields
around LIBOR minus 5 basis points. However, in times of market disruption, such
as occurred in September and October of 1998, asset-backed commercial paper
widened to as much as LIBOR plus 20 basis points. To the extent that the
LIBOR-based cash flow generated by such St. George and Cobalt investment
vehicles is insufficient to cover such vehicles' increased funding cost due to
excessive widening of asset-backed commercial paper rates, CGA would generally
be liable for any shortfall pursuant to the insurance issued by it.
REINSURANCE
In the ordinary course of its business, CGA cedes exposures under various
reinsurance contracts primarily designed to minimize losses from large risks and
to protect capital and surplus. The reinsurance of risk does not relieve the
ceding insurer of its original liability to policyholders. In the event that any
or all of the reinsurers were unable to meet their obligations to CGA under
these reinsurance arrangements, CGA would be liable for such defaulted amounts.
CGA's exposure to reinsurers was $607.18 million as of December 31, 1998. All
such exposure is with counterparties which are institutional shareholders (or
affiliates of institutional shareholders) of the Company.
CGA's exposure relating to its reinsurers is the joint probability of both
an asset and a reinsurer defaulting at the same time. Generally speaking, this
risk is considered to be non-correlated, and is therefore considered to be a low
probability risk. Assuming that there is no correlation between the default of
an asset and a reinsurer, the probability of simultaneous default would be
product of the individual default probabilities. For example, a five year
Baa3-rated asset backed security should have a default probability of
approximately 3.7%, according to Moody's Default Study. Similarly, a Aa3 rated
reinsurer should have a five-year default probability of approximately .60%.
Therefore, the joint probability of simultaneous default would be only .02%. The
risk mitigation gained from the non-correlation of asset and counterparty is
extremely valuable and it is the basis for the capital relief provided by
reinsurance.
OPERATIONAL
Operational risk relates to the potential for loss caused by a breakdown in
information, communication and settlement systems. The Company and the
Subsidiaries attempt to mitigate operational risk by maintaining a comprehensive
system of internal controls. This includes the establishment of systems and
procedures to monitor transactions and positions, documentation and confirmation
of transactions and ensuring compliance with applicable regulations.
LEGAL
Legal risk relates to the uncertainty of the enforceability, through legal
or judicial processes, of the obligations of the Company's and the Subsidiaries'
counterparties, including contractual provisions intended to reduce exposure by
providing for the offsetting or netting of mutual obligations. The Company seeks
to remove or minimize such uncertainties through continuous consultation with
internal and external legal advisors to analyze and understand the nature of
legal risk, to improve documentation and to strengthen transaction structure.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements listed in the accompanying Index to Financial
Statements and Schedules are filed as part of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
DIRECTORS AND OFFICERS OF THE COMPANY AND THE SUBSIDIARIES
The table below sets forth the names, ages (as of March 31, 1999) and
titles of the persons who are the members of the board of directors of CGA Group
and the executive officers of the Company and the Subsidiaries.
NAME AGE POSITION
---- --- --------
Richard A. Price ........ 52 Director, Chief Executive Officer and
President, CGA Group
James R. Reinhart ....... 42 Vice President and Chief Financial Officer,
CGA Group and CGA
Geoffrey N. Kauffman .... 40 President, CGA
Kem H. Blacker .......... 43 Managing Director and Chief Operating
Officer, CGAIM
Michael M. Miran ........ 46 Managing Director and General Counsel,
CGAIM
Jean-Michel Wasterlain .. 41 Managing Director, CGAIM
Jay H. Shidler .......... 52 Chairman of the Board of Directors
David M. Barse .......... 36 Director
Robert L. Denton ........ 46 Director
Richard S. Frary ........ 51 Director
Eric A. Gritzmacher ..... 51 Director
Alan S. Roseman ......... 42 Director
Donald Kramer ........... 61 Director
Jeffrey P. Krasnoff ..... 43 Director
Michael J. Morrissey .... 51 Director
Paul A. Rubin ........... 36 Director
Richard G. Schoninger ... 40 Director
Jay S. Sugarman ......... 36 Director
The Company's Board consists of thirteen members. The Board has been
elected in accordance with the Company's Bye-laws and holds office until the
next annual general meeting of the shareholders of the Company. Pursuant to the
Company's Bye-laws, the Board of Directors of the Company has the following
composition: the Chairman (currently Jay H. Shidler), the CEO Member (currently
Richard A. Price), the Management Member (currently Robert L. Denton) and ten
Members elected by the Eligible Investment Units Investors (as defined in the
Bye-laws). In connection with the Rights Offering (see Item 12--Security
Ownership of Certain Beneficial Owners and Management), the size of the Board
has been increased to fifteen members, with the two new vacancies to be filled
by nominees elected by the holders of the Company's Series C Preferred Stock. As
of March 31, 1999, the two additional directors had not yet been elected. The
quorum necessary for the transaction of business at a meeting of the Board is a
majority of the number of Directors constituting the Board.
Pursuant to the Bye-laws, the Board has established four committees. The
Compensation Committee is comprised of Donald Kramer, Alan S. Roseman (as
Chairman), Paul A. Rubin and Richard G. Schoninger, and is responsible for
determining compensation for the officers of the Company and the Subsidiaries
and for authorizing and approving the Company's employee benefits plans. The
Audit Committee will review the adequacy and effectiveness of the external
auditors and the audit report and is composed of Jeffrey P. Krasnoff (as
Chairman), Michael J. Morrissey, Richard S. Frary, Paul A. Rubin and David M.
Barse. The Underwriting Committee is responsible for approving the credit
underwriting guidelines for CGA and is composed of Donald Kramer, Jay H.
Shidler, Jeffrey P. Krasnoff, Eric A. Gritzmacher (as Chairman), Richard G.
Schoninger, and Jay S. Sugarman. The Investment Committee is responsible for
recommending investment asset allocations, approving the investment guidelines
which provide standards to ensure portfolio liquidity and safety, recommending
to the Board investment managers and custodians for portfolio assets. The
Investment Committee is composed of David M. Barse (as Chairman), Michael J.
Morrissey, Robert L. Denton, Richard S. Frary and Jay S. Sugarman.
24
<PAGE>
Under certain circumstances described in the Company's Series A
Subscription Agreement, two additional members of the Board may be elected by
the holders of the Series A Preferred Stock as a class.
The Company's Bye-Laws contain provisions for the election of alternate
directors.
BIOGRAPHICAL INFORMATION
RICHARD A. PRICE--Director, Chief Executive Officer and President of the
Company since July 5, 1996. Until July, 1996, Mr. Price was one of the top
executives at Financial Guaranty Insurance Company ("FGIC"), which he joined in
1985. Most recently, Mr. Price was President of FGIC Capital Markets Services, a
wholly-owned subsidiary of General Electric Capital Corporation ("GE Capital").
The FGIC Capital Market Services companies provide various capital market
services to municipalities and public finance bankers including investment
advice, investment contracts and liquidity for tax-exempt variable rate debt
issues. Mr. Price was responsible to GE Capital for forming these companies,
marketing these products and services and establishing market, credit and
operating risk controls. In 1988, Mr. Price led FGIC's entry into the structured
finance markets, establishing FGIC's ABS, MBS and commercial real estate
securitization activities. Mr. Price was a member of FGIC's three person Credit
Policy Committee, along with FGIC's Chief Executive Officer and FGIC's Chief
Credit Officer.
Prior to FGIC, Mr. Price spent 11 years with Chemical Bank in a number of
areas including Chemical's commercial real estate division where he was Vice
President. He also spent several years at Bankers Trust with the responsibility
of expanding Bankers' third party commercial paper dealer activities.
Mr. Price received a bachelor's degree from Cornell University and a MBA
from the Wharton Schoolof Business.
JAMES R. REINHART--Chief Financial Officer of the Company and CGA since
January 1, 1997. Prior to joining the Company, Mr. Reinhart served as Chief
Financial Officer and Executive Vice President of TriNet Corporate Realty Trust,
Inc. from its inception in May 1993. Mr. Reinhart was previously Chief Financial
Officer at Holman/Shidler Corporate Capital, TriNet's predecessor company and an
affiliate company of The Shidler Group, which he joined in 1986. Prior to
joining The Shidler Group, Mr. Reinhart was a Division Controller for Coldwell
Banker Real Estate Group, a staff auditor at the accounting firm of McKeehan,
Hallstein, Kendall & Warner and served as an officer in the U.S. Marine Corps.
Mr. Reinhart is a CPA and received a bachelor's degree in accounting from
Bryant College and a MBA from National University.
GEOFFREY N. KAUFFMAN--President of CGA since June 30, 1998, and Chief
Underwriting Officer of CGA from January 1, 1997. Prior to joining CGA, Mr.
Kauffman worked at AMBAC Financial Group, Inc. ("AMBAC"), where he was a First
Vice President in the Structured Finance & International Department. Mr.
Kauffman joined AMBAC's Structured Finance & International Department in March
of 1995 to help the group build a presence in international structured finance,
and joined the MBIA/AMBAC International joint venture upon its inception in the
fourth quarter of 1995. When the joint venture opened its London office in April
1996, Mr. Kauffman transferred temporarily to London to launch the joint
venture's structured finance effort in London.
Prior to joining AMBAC, Mr. Kauffman was the Acting Director of the Asset
Backed Securities Group at Financial Guaranty Insurance Company ("FGIC") and a
member of FGIC's European Strategy Team. Mr. Kauffman joined FGIC in 1989 to
help establish FGIC's presence in the asset backed securities market.
Mr. Kauffman received a bachelor's degree from Vassar College and a MBA
from Carnegie Mellon University.
KEM H. BLACKER--Managing Director and Chief Operating Officer of CGAIM
since January 1, 1997. For the twelve years prior to joining CGAIM, Mr. Blacker
served in various key positions at FGIC. As Senior Product Manager at FGIC
Capital Markets Services Group, Mr. Blacker invested in structured assets
sourced in the Euromarkets for the municipal GIC business and organized
off-balance sheet vehicles. From 1990 to 1993, he served as FGIC's Director of
Marketing & Product Development in London, launching the firm's expansion into
the Euromarkets.
Prior to his time at FGIC, Mr. Blacker held Vice President positions with
J.J. Lowry & Company and with E.F. Hutton in both its San Francisco and New York
offices.
Mr. Blacker received a bachelor's degree in economics from the University
of California.
25
<PAGE>
MICHAEL M. MIRAN--Managing Director and General Counsel of CGAIM since June
30, 1997. Prior to joining CGAIM, Mr. Miran was Vice President and Senior
Counsel at FGIC, where he was responsible for structuring, negotiating and
documenting a wide range of commercial real estate, MBS and ABS transactions,
including all of FGIC's international asset backed transactions. More recently,
Mr. Miran also served as FGIC's Chief Compliance Officer, with responsibility
over regulatory and corporate compliance.
Before joining FGIC in 1990, Mr. Miran was an attorney for seven years with
Weil, Gotshal and Manges in New York, where his practice covered a broad range
of commercial transactions, including mergers and acquisitions, secured
financings, debt restructurings and workouts, and capital markets and securities
transactions.
Mr. Miran received a bachelor of arts degree from New York University, and
a juris doctorate degree from Fordham University School of Law.
JEAN-MICHEL WASTERLAIN--Managing Director of CGAIM since June 1, 1997. Mr.
Wasterlain manages CGAIM's real estate group. Prior to joining CGAIM, Mr.
Wasterlain was responsible for real estate lending and securitization at ING
Barings. At ING, he created a commercial mortgage conduit which originated time
sensitive and complex real estate loans, and structured commercial mortgage loan
securitizations backed by these loans. Mr. Wasterlain's other responsibilities
at ING included establishing and managing a $300 million commercial mortgage
securities investment portfolio, and securing third party financing for ING's
other real estate assets.
Mr. Wasterlain also has previous experience in the financial guaranty
business, at FGIC, and in investment banking, at Lehman Brothers. At FGIC, from
1990 to 1993, he worked on the credit enhancing of over $1 billion of commercial
mortgage securities. At Lehman Brothers, from 1985 to 1990, he was involved in
residential and commercial mortgage-backed securities, as well as providing
investment banking coverage to financial institutions.
Mr. Wasterlain received a bachelor's degree in economics from Stanford
University and a MBA from the Wharton Graduate School of Business.
JAY H. SHIDLER--Chairman of the Board of Directors of the Company since
June 21, 1996. Mr.Shidler is the Founder and Managing Partner of The Shidler
Group, which he founded in 1970. Mr. Shidler is a founder of, and since June
1994, Chairman of, First Industrial Realty Trust, Inc. (NYSE: FR). Since October
1997, Mr. Shidler has served as Chairman of Corporate Office Properties Trust
(NYSE: OSC).
DAVID M. BARSE--Director of the Company since June 18, 1997. Since May
1998, he has served as President and Chief Operating Officer of Third Avenue
Trust, an open-end management investment company, where he served as
Vice-President and Chief Operating Officer from June 1995 until his election as
President. From April 1995 until February 1998, Mr. Barse served as
Vice-President and Chief Operating Officer of EQSF Advisors, Inc., Third
Avenue's investment advisor, where he currently serves as President and Chief
Operating Officer. Since June 1995, Mr. Barse has been the President of M.J.
Whitman, Inc., a registered broker-dealer, and of M.J. Whitman Holding Corp. Mr.
Barse joined the predecessors of M.J. Whitman in December 1991 as general
counsel.
ROBERT L. DENTON--Director of the Company since July 5, 1996. Since January
1995, Mr. Denton has served as a Managing Partner of The Shidler Group and
resident principal in its New York office. Prior to joining The Shidler Group,
Mr. Denton was employed from December 1991 to December 1994 as an investment
banker at Providence Capital, Inc., which he co-founded. Prior to joining
Providence Capital, Mr. Denton was employed as a management consultant at Booz,
Allen & Hamilton, Inc.
RICHARD S. FRARY--Director of the Company since June 18, 1997. Since 1990,
Mr. Frary has worked in Investment Banking and Real Estate Investment at
Tallwood Associates, which he co-founded and for which he serves as President.
Mr. Frary is also a director of Washington Homes, Inc.
ERIC A. GRITZMACHER--Director of the Company since June 18, 1997. Since
1987, Mr. Gritzmacher has served as Vice President, Investments for Pacific Life
Insurance Company (formerly Pacific Mutual Life Insurance Company).
DONALD KRAMER--Director of the Company since June 18, 1997. Mr. Kramer is
currently a Director and, since July 1996, Vice Chairman of ACE Limited and its
affiliated companies ACE Insurance Company Limited, ACE US, ACE London
Underwriting Limited, Methuen Underwriting Limited, ACE Europe Limited, Tempest
Reinsurance Company Limited and Corporate Officers and Directors Assurance Ltd.
Mr. Kramer serves as a director of National Benefit Life Insurance Company of
New York City, and of Rosgal Insurance Company, Moscow. Mr. Kramer is
26
<PAGE>
President and CEO of Tempest Reinsurance Company Limited, where he has served
since 1993. From March until September 1993, he was President of the Kramer
Capital Corporation.
JEFFREY P. KRASNOFF--Director of the Company since June 18, 1997. Mr.
Krasnoff became the President of LNR Property Corporation when it was formed in
June, 1997 and he became a director in December 1997. From 1987 until June 1997,
he was a Vice President of Lennar Corporation. From 1990 until he became the
President of LNR, Mr. Krasnoff was involved almost entirely in Lennar's real
estate investment and management division.
MICHAEL J. MORRISSEY--Director of the Company since June 18, 1997. Mr.
Morrissey has served as the Chairman and CEO of The Firemark Group, an
investment management firm specializing in public and private insurance related
investments, for the past fifteen years. He also serves as a director of NewCap
Re, ONYX, Health Care First, FinPac and Post Acute Care.
ALAN S. ROSEMAN--Director of the Company since January 27, 1999. Mr.
Roseman is currently a Director, and since 1989, General Counsel of Capital
Reinsurance Corporation, where he also serves as Executive Vice President and
Secretary.
PAUL A. RUBIN--Director of the Company since June 18, 1997. In April 1995,
Mr. Rubin became a principal of Olympus Partners, an investment limited
partnership, and he became partner of Olympus in December 1996. Prior to joining
Olympus in April 1995, Mr. Rubin worked as Vice President at Summit Partners, a
venture capital firm in Boston, which he joined in July 1990.
RICHARD G. SCHONINGER--Director of the Company since June 18, 1997. Mr.
Schoninger is managing director and head of Real Estate Investment Banking at
Prudential Securities, a wholly owned subsidiary of Prudential Securities Group,
Inc.
JAY S. SUGARMAN--Director of the Company since June 18, 1997. Mr. Sugarman
is currently President and since November 1997, Chief Executive Officer, of
Starwood Financial Trust, a finance company focused exclusively on commercial
real estate. Prior to his arrival in 1993 at Starwood Capital Group, a real
estate fund, where he has served as Senior Managing Director, Mr. Sugarman
managed a diversified, privately-owned investment fund.
ITEM 11. EXECUTIVE COMPENSATION.
EXECUTIVE COMPENSATION
The information set forth below describes the components of the total
compensation of the Chief Executive Officer and the other four most highly
compensated executive officers of the Company for services rendered during the
fiscal year ended December 31, 1998 (the "Named Executive Officers").
27
<PAGE>
<TABLE>
SUMMARY COMPENSATION TABLE
<CAPTION>
LONG TERM
ANNUAL COMPENSATION COMPENSATION
- - -------------------------------------------------------------------------------------- -------------
(A) (B) (C) (D) (E) (F) (G)
OTHER ANNUAL ALL OTHER
NAME AND SALARY BONUS COMPENSATION LTIP PAYOUTS COMPENSATION
PRINCIPAL POSITION YEAR ($) ($) ($) ($) ($)
------------------ ---- --- --- --- --- ---
<S> <C> <C> <C> <C> <C> <C>
Richard A. Price ................ 1998 300,000 75,000 144,931(1) 0 0
Chief Executive Officer, 1997 162,500 160,274 45,061(2) 0 0
President and Director, CGA
Group, Ltd.
Jean-Michel Wasterlain .......... 1998 175,000 175,000 5,000 0 0
Managing Director, 1997 94,792 225,000 179,994(3)(4) 0 0
CGAIM
Michael M. Miran ................ 1998 200,000 145,000 5,000 0 0
Managing Director and 1997 100,769 150,000 0 0 0
General Counsel,
CGAIM
Kem H. Blacker .................. 1998 225,000 105,000 5,000 0 0
Chief Operating Officer, 1997 121,875 200,000 73,745(3) 0 0
CGAIM
Landon D. Parsons ............... 1998 170,000 145,000 5,000 0 0
Director and Co-Head 1997 63,750 155,000 0 0 0
of Structured Finance,
CGAIM
</TABLE>
- - ----------
(1) Includes housing allowance of $126,385.
(2) Includes housing allowance of $36,750.
(3) Amounts include payments by the Company of $50,244 and $68,995 made to
Messrs. Wasterlain and Blacker, respectively, for services rendered prior
to June 17, 1997, pursuant to the Company's assumption of such individuals'
employment agreements with CGA Funding, L.P.
(4) Amount includes payment by the Company of $125,000 made to Mr. Wasterlain
as buyout of his bonus arrangement with previous employer.
DIRECTOR COMPENSATION AND BENEFITS
The Chairman and the Directors do not receive compensation in connection
with their service as members of the Company's Board. All members of the
Company's Board are reimbursed by the Company for transportation to all meetings
of the Board or a committee thereof as well as all reasonable expenses in
connection with such service.
DIRECTORS AND OFFICERS INSURANCE
Management maintains insurance to insure against liabilities asserted
against any director, officer, employee or agent of the Company arising out of
the performance of such duties.
REMUNERATION AND EMPLOYEE AGREEMENTS
LONG-TERM INCENTIVE PLANS
The Company adopted a stock warrant plan (the "Stock Warrant Plan") to
promote equity ownership of the Company by selected employees, Founders of the
Company and Sponsoring Investors of the Company and its
28
<PAGE>
Subsidiaries, to increase their proprietary interest in the success of the
Company and/or to encourage them to remain in the employ of the Company and the
Subsidiaries. On June 17, 1997, 2,342,500 warrants were issued. Each warrant
represents a right to purchase, on or prior to the tenth anniversary of the
closing date, one share of Common Stock at an exercise price of $5.00 per share.
The warrants issued to employees vest ratably over a four-year period. All
warrants issued to the Founders and Sponsoring Investors pursuant to the Stock
Warrant Plan vested immediately. In addition, the warrants contain certain
adjustments for dilutive events and certain protections for reorganization, and
consolidations or mergers.
401(K) PLAN
The Company maintains a qualified retirement plan (401(K) plan) for all its
employees. The amounts contributed by the Company for the named executive
officers during the fiscal year ended December 31, 1998 was $25,000.
MANAGEMENT CONTRACTS
As of January 1, 1997, the Company entered into an employment agreement
with Richard A. Price, as Chief Executive Officer and President of the Company,
for a term of three years and subject to annual renewal thereafter. Mr. Price's
employment agreement with the Company provides for the payment of a base salary
of $300,000 and a discretionary annual cash bonus based upon an annual incentive
plan approved by the compensation committee of the Company's Board. The
employment agreement automatically renews for a one-year period upon the end of
the term of such agreement, unless terminated by the Company or Mr. Price, and
provides that if his employment is terminated other than for "cause", he shall
receive a severance payment of not less than one-half of his then-current base
salary plus certain relocation expenses.
CGAIM has entered into employment agreements with Kem H. Blacker, Michael
M. Miran, Jean-Michel Wasterlain and Landon D. Parsons, in each case for a term
of one year. The employment agreements of Messrs. Blacker, Miran, Wasterlain and
Parsons provide for the payment of base salaries of $200,000, $200,000, $175,000
and $170,000 per annum, respectively, and discretionary annual cash bonuses in
an amount based upon an annual incentive plan approved by the compensation
committee of the Company's Board. Each such employment agreement automatically
renews for a one-year period upon the anniversary of such agreement, unless
terminated by the Company or the employee. The employment agreements of Messrs.
Blacker, Miran, Wasterlain and Parsons each provide that if the employee's
employment is terminated other than for "cause", such employee shall receive a
severance payment of not less than one-half of his then-current base salary.
Each of the employment agreements described above contains provisions
relating to the payment of base salary and discretionary bonus with respect to
the contract period, grants of warrants to purchase common stock of the Company,
the exclusivity of the employee's services, severance benefits in the event of
termination other than for "cause", noncompetition and confidentiality. In
addition, the directors and officers of the Company shall be indemnified and
secured harmless out of the assets of the Company from and against all actions,
costs and charges that they may incur or sustain by or by reason of any act done
in or about execution of their duty. The Company has also purchased insurance
for its business obligations.
BERMUDA-BASED EMPLOYEES
Richard A. Price, James R. Reinhart and Geoffrey N. Kauffman are based in
Bermuda. Since none of the key employees based in Bermuda are Bermudian, their
employment in Bermuda is subject to the specific permission of the appropriate
governmental authority. While the Company is not currently aware of any reasons
why the current work permits for these officers will not be renewed, there can
be no assurance that they will be.
CONFLICTS
The Company's Board has adopted a resolution to the effect that future
transactions between the Company or any of its subsidiaries or affiliates, on
one hand, and Jay Shidler, The Shidler Group or any affiliates of The Shidler
Group, on the other hand, is restricted. Management believes that Mr. Shidler's
real estate investments do not pose a conflict of interest with the business of
the Company. However, to eliminate any appearance of a conflict, the Company,
its subsidiaries and its affiliates have established a policy of not providing
insurance guaranties or investment services to
29
<PAGE>
Mr. Shidler or his affiliates. In addition, Mr. Shidler does not receive any
compensation while he serves as Chairman or otherwise as a director of the
Company, except reimbursements for travel expenses.
Except for the arrangement described below under Item 13--"Certain
Relationships and Related Transactions", the Company does not, and does not
permit any of its Restricted Subsidiaries to, directly or indirectly, conduct
any business with any of the Directors or any of their affiliates, unless such
transaction or series of transactions are (i) in the best interests of the
Company as determined by the disinterested members of the Board and (ii) entered
into on an arms-length basis.
CGA may not insure risks of stockholders or their affiliates without
bringing such proposed action to the attention of the Board. The decision
whether CGA may insure such risks will be determined by a vote by the Board.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The Company was incorporated on June26, 1996, and commenced operations on
June17, 1997 when its private placement offering was completed. Pursuant to such
private placement, the Company was capitalized (the "Recapitalization") in an
aggregate amount of $210.5 million, consisting of $45,500,000 of common stock
("Common Stock"), $65,000,000 of SeriesA Preferred Stock ("Series A Preferred
Stock"), $40,000,000 of SeriesB Preferred Stock ("SeriesB Preferred Stock"), and
capital commitments in the aggregate amount of $60,000,000 (the "Capital
Commitments" or "Commitments") to acquire additional shares of SeriesB Preferred
Stock upon the occurrence of certain events. An aggregate of $125 million in
cash proceeds, as well as the Capital Commitments, were then contributed by the
Company as capital to CGA.
The initial investors in CGA Group (the "Investors") include a range of
insurance, commercial real estate, strategic and other institutional investors.
None of the Investors are obligated to pay any claims against or liabilities of
the Company or CGA or, except with respect to their Commitments, make any
additional capital contributions to the Company or CGA. The Company is not
obligated to pay any claims against or liabilities of CGA, or to make any
additional capital contributions to the CGA (other than in respect of the
Commitments).
Those Investors which provided Commitments are obligated to purchase an
additional $60 million of Series B Preferred Stock upon the occurrence of
certain events. Each Investor not rated "Double-A" or higher by at least one
nationally recognized statistical rating agency has secured its obligations in
respect of its Commitment by posting a letter of credit or equivalent from a
bank rated at least "Double-A" by at least one nationally recognized credit
rating agency. The Commitments expire June17, 2002.
The Company has received irrevocable commitments from certain of its
existing Investors to subscribe for an aggregate of approximately $50.7 million
(43.8 million shares) of SeriesC Convertible Preferred Stock pursuant to a
rights offering made to holders of its Common and SeriesB Preferred Stock (the
"Rights Offering"). Shares of SeriesC Convertible Preferred Stock may be
converted into shares of Common Stock at the holder's option at any time, and
are mandatorily convertible into shares of Common Stock upon the occurrence of
certain events. The anticipated closing date for the Rights Offering is March31,
1999. In connection with the Rights Offering, all issued and outstanding shares
of SeriesB Preferred Stock (including accrued and unpaid dividends thereon) will
be converted into approximately 18.9million shares of Common Stock. The net
proceeds from the Rights Offering will be used by the Company for general
corporate purposes and, at the Company's discretion, to make capital investments
in CGA.
The Company presently intends to use $30 million of net proceeds of the
Rights Offering to make a capital investment in CGA as promptly as practicable
following the closing of the Rights Offering. In addition, in the event that
certain reinsurance arrangements entered into by CGA are not terminated by April
30, 1999 so that CGA receives a refund of premium of at least $20 million, the
Company presently intends to use the remaining proceeds of the Rights Offering
to make an additional capital investment in CGA, in an amount by which the
refunded premium is less than $20 million.
30
<PAGE>
<TABLE>
PRO-FORMA CAPITALIZATION OF CGA GROUP(1)
as of December31, 1998
Giving Effect to the Rights Offering
<CAPTION>
NUMBER OF
SHARES TOTAL DOLLAR CAPITAL PRO-FORMA WITH
OUTSTANDING AMOUNT(1) COMMITMENT COMMITMENT(1)
----------- --------- ---------- -------------
<S> <C> <C> <C> <C>
Common Stock ............................... 28,005,648 $ 70,202,750 $ -- $ 70,202,750
Series A Preferred Stock ................... 3,211,890 80,297,250 -- 80,297,250
Series B Preferred Stock ................... -- -- 60,000,000 60,000,000
Series C Convertible Preferred Stock ....... 43,815,760 50,723,640 -- 50,723,640
TOTAL .................................. N/A $201,223,640 $60,000,000 $261,223,640
</TABLE>
- - ----------
(1) Dollar amounts are before issuance costs and adjustments for net income or
losses to date and represent the dollar amount of all shares outstanding as
well as accrued but unissued as pay-in-kind dividends.
Pursuant to the organizational documents of the Company, dividends on the
Series A Preferred Stock which accrue through June12, 2002 may only be paid in
additional shares of Series A Preferred Stock, and dividends on the Series B
Preferred Stock (if and to the extent any additional shares of SeriesB Preferred
Stock are issued in the event the Capital Commitments are called upon) may only
be paid in additional shares of Series B Preferred Stock for so long as any
shares of Series A Preferred Stock are outstanding.
31
<PAGE>
The following tables set forth certain information regarding the ownership
of the Company's securities as of December 31, 1998 of (i) each person known by
the Company to own beneficially five percent or more of the outstanding shares
of any class of the Company's voting securities; (ii) each of the Company's
directors; (iii) each of the Company's executive officers; and (iv) all
directors and executive officers of the Company as a group. None of the
directors or executive officers of the Company own beneficially any shares of
the Company's Series A Preferred Stock or Series B Preferred Stock.
<TABLE>
SERIES A PREFERRED STOCK (as of December 31, 1998).
<CAPTION>
NUMBER OF SHARES
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED PERCENT OF CLASS
------------------------------------ ------------------ ----------------
<S> <C> <C>
Putnam Investments (10 funds)(1)(2)
One Post Office Square, Boston, MA 02109 ............................. 815,325 25.4
Oppenheimer (6 funds)(1)(3)
Two World Trade Center, 34th Floor, New York, NY 10048 ............... 617,673 19.2
Lennar Capital Services, Inc.
760 N.W. 107th Ave., Suite 300, Miami, FL 33172 ...................... 395,307 12.3
Mutual Discovery Fund(4)
51 John F. Kennedy Parkway, Short Hills, NJ 07078 .................... 296,483 9.2
Mutual Qualified Fund(4)
51 John F. Kennedy Parkway, Short Hills, NJ 07078 .................... 296,483 9.2
Pacific Life Insurance Company (2 companies)(1)(5)
700 Newport Center Drive, Newport Beach, CA 92660 .................... 247,069 7.7
ACE Limited
Suite 653, 48 Par-La Ville Road, Hamilton, HM11, Bermuda ............. 247,068 7.7
Third Avenue Trust on behalf of the
Third Avenue Value Fund Series
767 Third Ave., New York, NY 10017 ................................... 247,068 7.7
Capital Reinsurance Company
1325 Avenue of the Americas
New York, NY 10019 ................................................... 49,414 1.5
</TABLE>
- - ----------
(1) These parties are investment managers with discretion for various funds
under their control.
(2) The ten funds are: The Putnam Fiduciary Trust Company on behalf of Putman
High Yield Fixed Income Trust (DBT) and Putnam High Yield Managed Trust,
Putnam Diversified Income Trust, Putnam Diversified Income Trust II, Putnam
Funds Trust-Putnam High Yield Total Return Fund, Putnam High Yield
Advantage Fund, Putnam High Yield Trust, Putnam Managed High Yield Trust,
Putnam Variable Trust-Putnam VT Diversified Income Fund, Putnam Variable
Trust-Putnam VT High Yield Fund.
(3) The six funds are: Oppenheimer Champion Income Fund, Oppenheimer High Yield
Fund, Oppenheimer Multi-Sector Income Trust, Oppenheimer Strategic Income
Fund, Oppenheimer Variable Account Funds for the account of Oppenheimer
High Income Fund.
(4) In connection with the Rights Offering, Mutual Discovery Fund and Mutual
Qualified Fund have agreed to sell their shareholdings in the Company to
Olympus Growth Fund II, L.P. and Third Avenue Trust, each of which is a
current shareholder of the Company. Such transfers will be consummated on
March 31, 1999, concurrent with the consummation of the Rights Offering.
(5) The two companies are: Pacific Life Insurance Company and PM Group Life
Insurance Company.
32
<PAGE>
<TABLE>
SERIES B PREFERRED STOCK (as of December 31, 1998; share amounts do not
include accrued pay-in-kind (PIK) dividends)
<CAPTION>
NUMBER OF SHARES
BENEFICIALLY
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED PERCENT OF CLASS
------------------------------------ ------------------ ----------------
<S> <C> <C>
Capital Reinsurance Company
1325 Avenue of the Americas, New York, NY 10019 ........................ 200,000 12.5
Pacific Life Insurance Company
700 Newport Center Drive, Newport Beach, CA 92660 ...................... 200,000 12.5
Morgan Guaranty Trusts (2 trusts)(1)(2)
522 Fifth Avenue, New York, NY 10036 ................................... 177,142 11.1
Third Avenue Trust
767 Third Ave., New York, NY 10017 ..................................... 171,429 10.7
Olympus Partners (2 funds)(1)(3)
Metro Centre, One Station Place, Stamford, CT 06902 .................... 171,429 10.7
ACE Limited
Suite 653, 48 Par-La Ville Road, Hamilton, HM11, Bermuda ............... 171,429 10.7
Lennar CGA Holdings, Inc.
760 N.W. 107th Ave., Suite 400, Miami, FL 33172 ........................ 137,142 8.6
The Equitable Life Assurance Society of the United States
1290 Avenue of the Americas, New York, NY 10104 ........................ 114,286 7.1
CGA Firemark Venture Fund I, LLC
67 Park Place, Morristown, NJ 07960 .................................... 85,714 5.4
</TABLE>
- - ----------
(1) These parties are investment managers with discretion for various funds
under their control.
(2) The two trusts are: Morgan Guaranty Trust Company of New York as Trustee of
the Multi-market Special Investment Trust Fund of Morgan Guaranty Trust
Company of New York and Morgan Guaranty Trust Company of New York as
Trustee of the Commingled Pension Trust Fund (Multi-market Special
Investment Fund II) of Morgan Guaranty Trust Company of New York.
(3) The two funds are: Olympus Growth Fund II, L.P. and Olympus Executive Fund,
L.P.
33
<PAGE>
<TABLE>
COMMON STOCK (as of December 31, 1998)
<CAPTION>
NUMBER OF SHARES
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED PERCENT OF CLASS
------------------------------------ ------------------ ----------------
<S> <C> <C>
Pacific Life Insurance Company(1)
700 Newport Center Drive, Newport Beach, CA 92660 ...................... 999,264 11.0
Capital Reinsurance Company(2)
1325 Avenue of the Americas, New York, NY 10019 ........................ 982,649 10.8
Morgan Guaranty Trust (2 trusts)(3)(4)
522 Fifth Avenue, New York, NY 10036 ................................... 866,666 9.5
ACE Limited(5)
Suite 653, 48 Par-La Ville Road, Hamilton, HM11, Bermuda ............... 859,479 9.4
Third Avenue Value Fund(6)
767 Third Avenue, New York, NY 10017 ................................... 859,479 9.4
Olympus Partners (2 funds)(3)(7)
Metro Centre, One Station Place, Stamford, CT 06902 .................... 838,710 9.2
Lennar CGA Holdings, Inc.(8)
760 N.W. 107th Ave., Suite 400, Miami, FL 33172 ........................ 704,198 7.7
The Equitable Life Assurance Society of the United States
1290 Avenue of the Americas, New York, NY 10104 ........................ 559,140 6.1
DIRECTORS AND EXECUTIVE OFFICERS
David M. Barse (9) ...................................................... 0 0
Robert L. Denton (10) ................................................... 165,607 1.8
Richard S. Frary ........................................................ 0 0
Eric A. Gritzmacher (11) ................................................ 0 0
Donald Kramer (12) ...................................................... 0 0
Jeffrey P. Krasnoff (13) ................................................ 0 0
Michael J. Morissey (14) ................................................ 0 0
Richard A. Price (15) ................................................... 386,157 4.1
Alan S. Roseman (16) .................................................... 0 0
Paul A. Rubin (17) ...................................................... 0 0
Richard G. Schoninger (18) .............................................. 0 0
Jay H. Shidler (19) ..................................................... 937,913 9.9
Jay S. Sugarman (20) .................................................... 0 0
Kem H. Blacker (21) ..................................................... 68,969 *
Jean-Michel Wasterlain (22) ............................................. 59,990 *
Michael M. Miran (23) ................................................... 21,080 *
Landon D. Parsons (24) .................................................. 12,161 *
DIRECTORS AND OFFICERS AS A GROUP ....................................... 1,712,059 15.3
</TABLE>
- - ----------
* Less than one percent.
(1) Includes 978,465 shares of Common Stock and warrants to purchase 20,769
shares of Common Stock.
(2) Includes 978,495 shares of Common Stock and warrants to purchase 4,154
shares of Common Stock.
(3) These parties are investment managers with discretion for various Funds
under their control.
(4) The two trusts are: Morgan Guaranty Trust Company of New York as Trustee of
the Multi-market Special Investment Trust Fund of Morgan Guaranty Trust
Company of New York and Morgan Guaranty Trust Company of New York as
Trustee of the Commingled Pension Trust Fund (Multi-market Special
Investment Fund II) of Morgan Guaranty Trust Company ofNew York.
(5) Includes 838,710 shares of Common Stock and warrants to purchase 20,769
shares of Common Stock.
(6) Includes 838,710 shares of Common Stock and warrants to purchase 20,769
shares of Common Stock.
(7) The two funds are: Olympus Growth Fund II, L.P. and Olympus Executive Fund,
L.P.
34
<PAGE>
(8) Includes 670,967 shares of Common Stock and warrants to purchase 33,231
shares of Common Stock.
(9) Excludes 838,710 shares of Common Stock, warrants to purchase 20,769 shares
of Common Stock, 247,068 shares of Series A Preferred Stock and 171,429
shares of Series B Preferred Stock held of record by Third Avenue Trust,
for which Mr. Barse, a Director of the Company, serves as President and
Chief Operating Officer. Mr. Barse disclaims beneficial ownership of such
securities held by Third Avenue Trust.
(10) Includes 68,511 and 17,024 shares of Common Stock and warrants to purchase
64,135 and 15,937 shares of Common Stock held of record by Mr. Denton and
Mr. Denton's wife, Doreen A. Denton, respectively.
(11) Excludes 978,495 shares of Common Stock, warrants to purchase 20,769 shares
of Common Stock, 247,069 shares of Series A Preferred Stock and 200,000
shares of Series B Preferred Stock held of record by Pacific Life Insurance
Company for which Mr. Gritzmacher, a Director of the Company, serves as
Vice President, and its affiliates. Mr. Gritzmacher disclaims beneficial
ownership of such securities held of record by such entities.
(12) Excludes 838,710 shares of Common Stock, warrants to purchase 20,769 shares
of Common Stock, 247,068 shares of Series A Preferred Stock and 171,429
shares of Series B Preferred Stock held of record by ACE Limited, for which
Mr. Kramer, a Director of the Company, serves as director. Mr. Kramer
disclaims beneficial ownership of such securities held of record by ACE
Limited.
(13) Excludes 670,967 shares of Common Stock, warrants to purchase 33,231 shares
of Common Stock and 137,142 shares of Series B Preferred Stock held of
record by Lennar CGA Holdings Inc. and 395,307 shares of Series A Preferred
Stock held of record by Lennar Capital Services. Mr. Krasnoff serves as
President of LNR Property Corporation, an affiliate of Lennar CGA Holdings,
Inc. and of Lennar Capital Services, Inc. Mr. Krasnoff disclaims beneficial
ownership of such securities held of record by Lennar CGA Holdings, Inc.
(14) Excludes 419,354 shares of Common Stock and 85,714 shares of Series B
Preferred Stock held of record by CGA Firemark Venture Fund I, LLC. Mr.
Morrissey, a Director of the Company, serves as Chairman and Chief
Executive Officer of the Firemark Group, an affiliate of CGA Firemark
Venture Fund I, LLC. Mr. Morrissey disclaims beneficial ownership of such
securities held of record by CGA Firemark Venture Fund I, LLC.
(15) Includes 164,211 shares of Common Stock and warrants to purchase 221,946
shares of Common Stock.
(16) Excludes 978,495 shares of Common Stock, warrants to purchase 4,154 shares
of Common Stock, 49,414 shares of Series A Preferred Stock and 200,000
shares of Series B Preferred Stock held of record by Capital Reinsurance
Company, for which Mr. Roseman, a Director of the Company, serves as
General Counsel, Executive Vice President and Secretary of Capital
Reinsurance Company. Mr. Roseman disclaims beneficial ownership of such
securities held of record by Capital Reinsurance Corporation.
(17) Excludes 838,710 shares of Common Stock and 171,429 shares of Series B
Preferred Stock held of record by Olympus Growth Fund II, L.P. and Olympus
Executive Fund, L.P. Mr. Rubin, a Director of the Company, is a partner of
Olympus Partners, an affiliate of these two funds. Mr. Rubin disclaims
beneficial ownership of such securities held of record by such entities.
(18) Excludes 279,570 shares of Common Stock and 57,143 shares of Series B
Preferred Stock held of record by Prudential Securities Group, Inc., for
which Mr. Schoninger, a Director of the Company, serves as managing
director. Mr. Schoninger disclaims beneficial ownership of such securities
held of record by Prudential Securities Group, Inc.
(19) Includes 7,720 shares of Common Stock and warrants to purchase 7,227 shares
of Common Stock held of record by Shidler/CGA Corp., 3,741 shares of Common
Stock and warrants to purchase 3,502 shares of Common Stock held of record
by Shidler Equities Corp., and 529,869 shares of Common Stock and warrants
to purchase 385,854 shares of Common Stock held by Shidler Equities, L.P.
(20) Excludes 279,570 shares of Common Stock and 57,143 shares of Series B
Preferred Stock held of record by Starwood CGA, LLC. Mr. Sugarman, a
Director of the Company, is President and Chief Executive Officer of
Starwood Financial Trust, an affiliate of Starwood CGA, LLC. Mr. Sugarman
disclaims beneficial ownership of such securities held of record by
Starwood CGA, LLC.
(21) Includes 13,333 shares of Common Stock and warrants to purchase 55,636
shares of Common Stock.
(22) Includes 17,000 shares of Common Stock and warrants to purchase 42,990
shares of Common Stock.
(23) Includes 12,000 shares of Common Stock and warrants to purchase 9,080
shares of Common Stock.
(24) Includes 5,000 shares of Common Stock and warrants to purchase 7,161 shares
of Common Stock.
35
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
CGA and Cap Re have entered into an agreement as of June 4, 1997 which
grants Cap Re the right to make the first offer to provide reinsurance for all
insurance contracts, including contracts of financial guaranty as reinsurance,
issued by CGA ("Right of First Offer Agreement"). Cap Re's rights under the
Right of First Offer Agreement terminate on the earlier of (a) the date that Cap
Re no longer owns 5% of the common stock of the Company or (b) a Qualified
Public Offering (as defined in the CGA Group Bye-laws) by CGA Group.
CGAIM has entered into asset management agreements with each of the
existing subsidiaries of SG Holdings, Cobalt Holdings, and each of their
respective subsidiaries. Pursuant to such agreements, CGAIM will perform
advisory, asset management and related services for such companies. CGA has
guaranteed the payment obligations of such companies under their financing
arrangements, and its expected to guarantee the payment obligations of any other
subsidiaries of SG Holdings or Cobalt Holdings which may be established in the
future in respect of their financing obligations. See Item 1--"Business--CGA
Investment Management, Inc.--St. George and Cobalt."
In October 1998, CGA provided asset-specific guarantees and obtained third
party credit support on a "cut-through" basis on approximately $382 million par
amount of securities in the investment portfolios of two of its clients, SG1 and
SG3. The three parties which provided such credit support are institutional
investors in the Company. In connection with these arrangements, CGA received a
premium of $38.95 million from SG1 and SG3, and ceded an aggregate of $38.7
million to the three institutions which provided such credit support. CGA loaned
$30 million to SG Holdings (the parent corporation of SG1 and SG3) in order to
permit SG Holdings to provide its subsidiaries with sufficient funds to pay the
premium for such credit support, and to meet its clients' liquidity needs. See
Item 1--"Business--Commercial Guaranty Assurance, Ltd.--Reinsurance."
The Company pays the holders of Investment Units an aggregate of $600,000
per annum as a fee with respect to the $60 million in Capital Commitments. See
Item 12--"Security Ownership of Certain Beneficial Owners and Management".
The Company held a note receivable from the Company's Chief Executive
Officer (the "CEO") for $1.25 million which was issued in connection with the
June 17, 1997 Recapitalization in exchange for 250,000 shares of the Company's
common stock. The note was interest-bearing at a rate of 7% compounded
semi-annually. On October 8, 1997 the CEO repaid $1 million of the note along
with the accrued interest thereon. The loan was then repaid in full on January
31, 1998.
36
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(A) 1. FINANCIAL STATEMENTS AND SCHEDULES.
The Financial Statements listed in the accompanying Index to Financial
Statements and Schedules are filed as part of this Report.
2. EXHIBITS.
The exhibits listed on the accompanying Index to Exhibits are filed as part
of this report.
(B) REPORTS ON FORM 8-K.
No reports on Form 8-K were filed during the quarter ended December 31,
1998.
37
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CGA GROUP, LTD.
------------------------------
(Registrant)
Date: March 26, 1999 By /s/ JAMES R. REINHART
------------------------------
James R. Reinhart
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Date: March 26, 1999 By /s/ RICHARD A. PRICE
--------------------------------------
Richard A. Price
Chief Executive Officer, President
and Director
Date: March 26, 1999 By /s/ DAVID M. BARSE
-------------------------------------
David M. Barse, Director
Date: March 26, 1999 By /s/ ERIC A. GRITZMACHER
-------------------------------------
Eric A. Gritzmacher, Director
Date: March 26, 1999 By /s/ ALAN S. ROSEMAN
-------------------------------------
Alan S. Roseman, Director
Date: March 26, 1999 By /s/ JEFFREY P. KRASNOFF
-------------------------------------
Jeffrey P. Krasnoff, Director
Date: March 26, 1999 By /s/ MICHAEL J. MORRISSEY
-------------------------------------
Michael J. Morrissey, Director
Date: March 26, 1999 By /s/ PAUL A. RUBIN
--------------------------------------
Paul A. Rubin, Director
Date: March 26, 1999 By /s/ F. FULLER O'CONNOR
--------------------------------------
F. Fuller O'Connor, Alternate Director
Date: March 26, 1999 By /s/ JAY H. SHIDLER
--------------------------------------
Jay H. Shidler, Director
Date: March 26, 1999 By /s/ JAY S. SUGARMAN
--------------------------------------
Jay S. Sugarman, Director
38
<PAGE>
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
PAGE
----
Financial Statements of CGA Group, Ltd.
Report of Independent Auditors on Financial Statements ............. 40
Consolidated Balance Sheets at December 31, 1998 and 1997 .......... 41
Consolidated Statements of Operations for the year
ended December 31, 1998, the nine months ended
December 31, 1997 and for the period from June 21, 1996
to March 31, 1997 ................................................. 42
Consolidated Statements of Mezzanine Equity for the year
ended December 31, 1998 and the nine months ended
December 31, 1997 ................................................ 43
Consolidated Statements of Shareholders' Equity for the year
ended December 31, 1998 and the nine months ended
December 31, 1997 ................................................ 44
Consolidated Statements of Cash Flow for the year ended
December 31, 1998, the nine months ended December 31, 1997
and for the period from June 21, 1996 to March 31, 1997 .......... 45
Notes to Consolidated Financial Statements ......................... 46
Financial Schedule(s)
All financial statement schedules have been omitted because they are
not applicable or are not required, or the information required to be set
forth therein is included in the Consolidated Financial Statements or Notes
thereto.
39
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE SHAREHOLDERS OF CGA GROUP, LTD.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, mezzanine equity, shareholders' equity
and of cash flows present fairly, in all material respects, the financial
position of CGA Group, Ltd. and its subsidiaries at December 31, 1998 and 1997,
and the results of their operations and their cash flows for the period from
June 21, 1996 to March 31, 1997, the period from April 1, 1997 to December 31,
1997 and the year ended December 31, 1998, in conformity with generally accepted
accounting principles in the United States of America. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards in the United States of America which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide reasonable
basis for the opinion expressed above.
PricewaterhouseCoopers
Hamilton, Bermuda
March 31, 1999
40
<PAGE>
<TABLE>
CGA GROUP, LTD.
CONSOLIDATED BALANCE SHEETS
(EXPRESSED IN U.S. DOLLARS)
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1997
------------ ------------
ASSETS
<S> <C> <C>
Fixed maturities available for sale, (at fair value)
(Amortized cost: $99,560,861 and $121,664,671) .......................... $100,488,537 $123,302,763
Other investments ........................................................ 30,000,000 --
Cash and short-term investments .......................................... 2,598,140 7,199,106
Premiums receivable ...................................................... 3,228,497 447,172
Management fees receivable ............................................... 1,093,411 --
Accrued interest receivable .............................................. 3,679,763 4,080,600
Deferred acquisition costs ............................................... 3,202,557 1,001,883
Prepaid reinsurance premiums ............................................. 1,286,782 --
Reinsurance recoverable .................................................. 67,400,000 --
Other assets ............................................................. 2,926,246 2,018,309
Note receivable .......................................................... -- 250,000
Organization costs ....................................................... -- 4,421,353
------------ ------------
Total assets ........................................................... $215,903,933 $142,721,186
============ ============
LIABILITIES
Unearned premiums ........................................................ $ 821,124 $ 270,576
Provision for losses and loss adjustment expenses ........................ 90,200,000 55,000
Reinsurance balances payable ............................................. 420,660 --
Accrued costs and expenses ............................................... 4,355,767 3,591,033
Contingencies and commitments (Note 14)................................... -- --
------------ ------------
Total liabilities ...................................................... 95,797,551 3,916,609
------------ ------------
MEZZANINE EQUITY
Preferred stock, $.01 par value, 20,000,000 shares authorized:
Series A ................................................................ 75,291,100 65,532,499
Series B ................................................................ 37,300,985 37,075,371
Dividends accrued on Series B ............................................ 14,016,164 4,439,231
------------ ------------
Total mezzanine equity ................................................. 126,608,249 107,047,101
------------ ------------
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 ............................................... 42,486,057 42,086,353
Accumulated other comprehensive income ................................... 927,676 1,638,092
Deficit .................................................................. (50,006,600) (12,057,969)
------------ ------------
Total shareholders' (deficit) equity ................................... (6,501,867) 31,757,476
------------ ------------
Total liabilities and shareholders' equity ............................. $215,903,933 $142,721,186
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
41
<PAGE>
<TABLE>
<CAPTION>
CGA GROUP, LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
(EXPRESSED IN U.S. DOLLARS)
NINE MONTHS
YEAR ENDED ENDED JUNE 21, 1996
DECEMBER 31, DECEMBER 31, TO MARCH 31,
1998 1997 1997
------------ -------------- --------------
<S> <C> <C> <C>
REVENUES
Gross premiums written ................................... $ 49,217,083 $ 773,571 $ --
Ceded premiums ........................................... (39,420,247) (270,576) --
------------ ------------ ------
Net premiums written ..................................... 9,796,836 502,995 --
Change in unearned premiums .............................. (550,547) -- --
------------ ------------ ------
Net premiums earned ...................................... 9,246,289 502,995 --
Net investment income .................................... 8,528,122 2,955,601 801
Net realized gains ....................................... 2,814,132 885,422 --
Management fees .......................................... 3,353,499 -- --
------------ ------------ ------
Total Revenues ......................................... 23,942,042 4,344,018 801
------------ ------------ ------
EXPENSES
Operating expenses ....................................... 14,023,366 6,510,103 11
Acquisition costs ........................................ 433,217 53,590 --
Commitment fees .......................................... 600,000 323,836 --
Excess of loss facility .................................. 200,000 107,671 --
Losses and loss adjustment expenses
(Net of reinsurance of $67.4 million in 1998) ........... 22,745,000 55,000 --
------------ ------------ ------
Total expenses ......................................... 38,001,583 7,050,200 11
------------ ------------ ------
Income (loss) before cumulative effect of
change in accounting principle .......................... (14,059,541) (2,706,182) 790
Cumulative effect of change in accounting principle ...... (3,928,238) -- --
NET INCOME (LOSS) ......................................... (17,987,779) (2,706,182) 790
------------ ------------ ------
Other comprehensive income ................................ (710,417) 1,638,092 --
------------ ------------ ------
COMPREHENSIVE INCOME (LOSS) ............................... $(18,698,196) $ (1,068,090) $ 790
============ ============ ======
Net income (loss) available to common shareholders ........ $(38,896,226) $(12,332,792) $ 790
Basic and diluted income (loss) per common share .......... $ (4.27) $ (1.89) $ 0.07
============ ============ ======
Weighted average common shares outstanding ................ 9,100,000 6,522,313 12,000
============ ============ ======
The accompanying notes are an integral part of these financial statements.
</TABLE>
42
<PAGE>
CGA GROUP, LTD.
CONSOLIDATED STATEMENTS OF MEZZANINE EQUITY
(EXPRESSED IN U.S. DOLLARS)
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31,
1998 1997
------------ --------------
MEZZANINE EQUITY
<S> <C> <C>
SERIES A PREFERRED STOCK
Balance--beginning of period .............................................. $ 27,965 $ --
Stock issued .............................................................. -- 26,000
Pay-in-kind dividends paid ................................................ 4,154 1,965
------------ ------------
Balance--end of period .................................................... 32,119 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 ................................................ 10,379,765 4,911,381
Accretion to redemption value ............................................. 514,273 190,472
Accretion on warrants ..................................................... 207,709 --
------------ ------------
Balance--end of period .................................................... 75,258,981 65,504,534
------------ ------------
TOTAL SERIES A PREFERRED STOCK ............................................ $ 75,291,100 $ 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 ............................................. 225,614 83,561
------------ ------------
Balance--end of period .................................................... 37,284,985 37,059,371
------------ ------------
TOTAL SERIES B PREFERRED STOCK ............................................ $ 37,300,985 $ 37,075,371
============ ============
PAY-IN-KIND DIVIDENDS ACCRUED-SERIES B
Balance--beginning of period .............................................. $ 4,439,231 $ --
Dividends accrued ......................................................... 9,576,933 4,439,231
------------ ------------
Balance--end of period .................................................... $ 14,016,164 $ 4,439,231
============ ============
Total Mezzanine Equity .................................................... $126,608,249 $107,047,101
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
43
<PAGE>
<TABLE>
CGA GROUP, LTD.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(EXPRESSED IN U.S. DOLLARS)
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31,
1998 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 ............ (514,273) (190,472)
Accretion of Series B Preferred Stock to redemption value ............ (225,614) (83,561)
Accretion on warrants ................................................ (207,709) --
------------- -----------
Balance--end of period ............................................... 42,486,057 42,086,353
------------- -----------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance--beginning of period ......................................... 1,638,092 --
Increase (decrease) during the period ................................ (710,416) 1,638,092
------------- -----------
Balance--end of period ............................................... 927,676 1,638,092
------------- -----------
RETAINED EARNINGS (DEFICIT)
Balance--beginning of period ......................................... (12,057,969) 790
Net loss ............................................................. (17,987,779) (2,706,182)
Series A pay-in-kind dividends paid .................................. (10,383,919) (4,913,346)
Series B pay-in-kind dividends accrued ............................... (9,576,933) (4,439,231)
------------- -----------
Balance--end of period ............................................... (50,006,600) (12,057,969)
------------- -----------
TOTAL SHAREHOLDERS' (DEFICIT) EQUITY ................................. $ (6,501,867) $ 31,757,476
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
44
<PAGE>
<TABLE>
CGA GROUP, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(EXPRESSED IN U.S. DOLLARS)
<CAPTION>
NINE MONTHS JUNE 21, 1996
YEAR ENDED ENDED TO
DECEMBER 31 DECEMBER 31 MARCH 31,
1998 1997 1997
----------- ----------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) ........................................ $(17,987,779) $ (2,706,182) $ 790
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Amortization of investments ............................ (176,711) 1,314,765 --
Depreciation expense ................................... 354,587 51,076 --
Realized gain on sale of investments ................... (2,814,132) (885,422) --
Realized loss on sale of fixed assets .................. 26,282 -- --
Changes in assets and liabilities:
Premiums receivable .................................... (2,781,325) (447,172) --
Accrued interest ....................................... 400,837 (4,080,600) --
Deferred acquisition costs ............................. (2,200,674) (1,001,883) --
Prepaid reinsurance premiums ........................... (1,286,782) -- --
Management fees receivable ............................. (1,093,411) -- --
Organization costs ..................................... 4,421,353 (4,409,373) (11,980)
Reinsurance recoverable ................................ (67,400,000) -- --
Other assets ........................................... (175,510) (1,159,177) (68)
Unearned premiums ...................................... 550,548 270,576 --
Provision for losses and loss adjustment expenses ...... 90,145,000 55,000 --
Reinsurance balances payable ........................... 420,660 -- --
Accrued costs and expenses ............................. 764,734 3,591,033 --
------------ ------------- --------
Net cash provided by (used in) operating activities ..... 1,167,677 (9,407,359) (11,258)
------------ ------------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Cost of fixed maturity investments acquired ............. (143,845,735) (278,498,706) --
Proceeds from sale of fixed maturity investments ........ 138,940,387 156,404,692 --
Purchases of fixed assets ............................... (1,113,295) (910,140) --
Note receivable ......................................... 250,000 (250,000) --
------------ ------------- --------
Net cash used in investing activities ................... (5,768,643) (123,254,154) --
------------ ------------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Redemption of Common Stock .............................. -- (12,000) --
Proceeds on issuance of series A preferred stock ........ -- 65,000,000 --
Proceeds on issuance of series B preferred stock ........ -- 40,000,000 --
Proceeds on issuance of common stock .................... -- 45,500,000 12,000
Issuance costs of series A preferred stock .............. -- (4,571,319) --
Issuance costs of series B preferred stock .............. -- (3,008,190) --
Issuance costs of common stock .......................... -- (3,048,614) --
Loan received (repaid) .................................. -- (121,000) 121,000
------------ ------------- --------
Net cash provided by financing activities ............... -- 139,738,877 133,000
------------ ------------- --------
NET INCREASE (DECREASE) IN CASH AND SHORT-TERM
INVESTMENTS ............................................ (4,600,966) 7,077,364 121,742
CASH AND SHORT-TERM INVESTMENTS--
BEGINNING OF PERIOD .................................... 7,199,106 121,742 --
------------ ------------- --------
CASH AND SHORT-TERM INVESTMENTS--END OF PERIOd .......... $ 2,598,140 $ 7,199,106 $121,742
============ ============= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
45
<PAGE>
CGA GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEAR ENDED DECEMBER 31, 1998 AND THE NINE MONTHS ENDED
DECEMBER 31, 1997
(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
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 a "Triple-A" "claims paying ability" rating
from Duff & Phelps Credit Rating Company ("DCR") and has also been rated in the
highest rating category assigned by each of the two Canadian rating agencies,
Dominion Bond Ratings Service and Canadian Bond Ratings Service. CGA issues
financial guaranty insurance policies, which are the functional equivalent of
direct-pay letters of credit, to insure payment of interest, principal and other
amounts payable in respect of notes, securities, and other financial
obligations. 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 is registered as an investment
advisor with the United States Securities and Exchange Commission under the
Investment Advisors Act of 1940, as amended. CGAIM provides investment
management and financial advisory services primarily to specialized investment
vehicles and for the U.S. and international structured finance markets. 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 with a
par value of $.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
Series A Preferred Stockholders 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 with a par value of $.01 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
"Triple-A" 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 out of a total of 9,100,000 million shares of Common Stock issued with a
par value of $.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.
The primary clients of CGA and CGAIM are St. George Holdings, Ltd. ("SG
Holdings") and Cobalt Holdings, Ltd. ("Cobalt") and their respective
subsidiaries. In 1998 they provided approximately 85% of the total premiums
earned by CGA, and 91% of the total investment management fees earned by CGAIM.
These percentages are expected to decrease in the future.
46
<PAGE>
CGA GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS--(CONTINUED) FOR THE YEAR ENDED DECEMBER 31, 1998
AND THE NINE MONTHS ENDED DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
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 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,
underwriting, certain rating agency fees, legal and other expenses. Deferred
acquisition costs are amortized on a straight-line basis over the estimated term
of the related insured risks. The Company evaluates the recoverability of
deferred acquisition costs whenever changes in circumstances warrant. If it is
determined that an impairment exists, the excess of the amortized balance over
deferred acquisition costs will be charged to earnings.
c) Reinsurance
In the ordinary course of business, CGA 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 CGA of its
original liability to its policyholders. In the event that a reinsurer was
unable to meet its obligations under the existing reinsurance contracts, CGA
would be liable for such defaulted amounts.
Prepaid reinsurance premiums represent the portion of premiums ceded to
reinsurers applicable to the unexpired terms of the reinsurance contracts in
force.
d) Provision for losses and loss adjustment expenses
A case basis reserve for unpaid losses and loss adjustment expenses is
recorded at the present value of the estimated 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. On July 1, 1998, the
47
<PAGE>
CGA GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS--(CONTINUED) FOR THE YEAR ENDED DECEMBER 31, 1998
AND THE NINE MONTHS ENDED DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
Company expensed the remaining unamortized organization costs which is reflected
in the financial statements as a change in accounting principle. (See footnote
(i.) regarding Statement of Position 98-5 issued by the Accounting Standards
Executive Committee.)
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 are designated as
available-for-sale and are recorded at fair value, being quoted market value.
Any resulting unrealized gains or losses are reflected as a separate component
of shareholders' equity as accumulated other comprehensive income and as a
separate component of the statement of operations as other comprehensive income.
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. Other investments are carried at cost, which approximates fair value.
Bond discounts and premiums are accreted or amortized on the effective
interest method over the term of the related securities. Realized gains or
losses on sale of investments are determined on the basis of specific
identification. Net investment income is recognized when earned and includes
interest and amortization of market premiums and discounts and is net of
investment management and custody fees.
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 computes 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.
i) Earnings per share
In 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per share".
This statement requires the Company to report basic earnings per share and
diluted earnings per share. Basic earnings per share are calculated utilizing
weighted average shares outstanding and exclude any dilutive effects of options,
warrants and convertible securities. Diluted earnings per share include the
effect of dilutive securities outstanding. The Company has adopted SFAS 128 in
these consolidated financial statements.
j) Comprehensive income
The 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.
k) Segments
The FASB issued Statement of Financial Accounting Standard No. 131 ("SFAS
131"), "Disclosures about Segments of an Enterprise and Related Information",
which the Company has adopted in these consolidated financial
48
<PAGE>
CGA GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS--(CONTINUED) FOR THE YEAR ENDED DECEMBER 31, 1998
AND THE NINE MONTHS ENDED DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
statements. 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. Segment information is reported separately
for the Company's investment management and insurance operations.
l) Start-up activities
The Accounting Standards Executive Committee 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.
3. NOTE RECEIVABLE
The Company held a note receivable from the Company's Chief Executive
Officer (the "CEO") for $1.25 million which was issued in connection with the
Recapitalization in exchange for 250,000 shares of the Company's common stock.
The note was interest-bearing at a rate of 7% compounded semi-annually. On
October 8, 1997 the CEO repaid $1 million of the note along with the accrued
interest thereon. The loan was then repaid in full on January 31, 1998.
4. INVESTMENTS
a) Fixed maturities
The fair values, gross unrealized gains and losses and amortized cost of
fixed maturities at December 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
1998 COST GAINS LOSSES FAIR VALUE
------------ ---------- --------- ------------
<S> <C> <C> <C> <C>
Non-U.S. Government ...................... $ 12,024,005 $ 77,789 $ (82,384) $ 12,019,410
Corporate ................................ 85,488,892 1,316,526 (384,255) 86,421,163
Short-term ............................... 2,047,964 -- -- 2,047,964
------------ ---------- --------- ------------
Fixed Maturities ........................ $ 99,560,861 $1,394,315 $(466,639) $100,488,537
============ ========== ========= ============
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED
1997 COST GAINS LOSSES FAIR VALUE
------------ ---------- --------- ------------
<S> <C> <C> <C> <C>
Non-U.S. Government ...................... $ 52,514,059 $1,382,523 $(308,775) $ 52,788,537
Corporate ................................ 69,150,612 583,353 (19,009) 70,514,226
------------ ---------- --------- ------------
Fixed Maturities ........................ $121,664,671 $1,965,876 $(327,784) $123,302,763
============ ========== ========= ============
</TABLE>
49
<PAGE>
CGA GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1998 AND
THE NINE MONTHS ENDED DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
Fixed maturities at December 31, 1998 and 1997, by contractual maturity,
are shown below. Expected maturities could differ from contractual maturities
because borrowers may have the right to call or prepay obligations, with or
without call or prepayment penalties.
<TABLE>
<CAPTION>
1998 1998 1997 1997
Maturity Period Fair Value Amortized Cost Fair Value Amortized Cost
- - ------------------- ------------ -------------- ------------ --------------
<S> <C> <C> <C> <C>
Less than 1 year ........................... $ 2,047,964 $ 2,047,964 $ 16,443,261 $ 15,634,565
1-5 years .................................. 91,006,565 90,195,974 87,997,633 87,641,105
5-10 years ................................. 7,434,010 7,316,923 18,861,869 18,389,001
Greater than 10 years ...................... -- -- -- --
------------ ------------ ------------ ------------
Total fixed maturities ................... $100,488,537 $ 99,560,861 $123,302,763 $121,664,671
============ ============ ============ ============
</TABLE>
Realized gains for the year ended December 31, 1998 were $3,436,817 and for
the nine months ended December 31, 1997 were $1,895,725. Realized losses for the
year ended December 31, 1998 were $622,685 and for the nine months ended
December 31, 1997 were $1,010,303. Investments are made predominantly in U.S.
dollar denominated foreign corporate and government securities. The rating level
for an investment cannot be below "Double-A minus". The portfolio consists of
"Double-A" rated investments on average. The portfolio manager operates under
guidelines to maintain a weighted average duration of two to five years.
(b) Net investment income
Net investment income for the year ended December 31, 1998 and the nine
months ended December 31, 1997 was derived from the following sources:
1998 1997
--------- ---------
Fixed maturities ................................ $8,400,894 $2,849,428
Other ........................................... 501,677 331,297
--------- ---------
Gross investment income ......................... 8,902,571 3,180,725
Investment expense .............................. (374,449) (225,124)
--------- ---------
Net investment income ........................... $8,528,122 $2,955,601
========= =========
5. OTHER INVESTMENTS
Other investments are comprised of a $30 million note issued by SG
Holdings which is the parent company of certain clients of CGAIM. The note is
carried at its original cost which approximates fair value. The note bears
interest of 3 month LIBOR plus 1% per annum payable quarterly and has a five
year term with no prepayment penalty. The 3 month LIBOR rate at December 31,
1998 was 5.066. The note was purchased to provide SG Holdings and its
subsidiaries with cash to manage their liquidity and to pay for additional
financial guaranty insurance.
50
<PAGE>
CGA GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1998 AND
THE NINE MONTHS ENDED DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
6. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS
1998 1997
---------- ----------
Other Assets
Other prepaid Expenses ..................... $ 222,752 $ 276,164
Prepaid commitment fees .................... 276,164 148,669
Fixed Assets, net of depreciation .......... 1,603,600 844,892
Deposits ................................... 280,000 293,717
Accounts Receivable ........................ 368,730 430,785
Other ...................................... 175,000 24,082
---------- ----------
Total Other Assets ....................... $2,926,246 $2,018,309
========== ==========
7. LOSSES AND LOSS EXPENSES
The provision for losses and loss adjustment expenses ("LAE") is
established in an amount equal to the CGA's estimate of unidentified or case
basis reserves and unallocated losses including costs of settlement, on the
obligations it has insured. Case basis reserves are established when specific
insured issues are identified as currently or likely to be in default. Such a
reserve is based on the present value of the expected loss and LAE. The general
provision for losses and LAE is calculated by applying a loss factor, determined
based on an independent rating agency study of bond defaults, to net par amount
outstanding of the insured obligations.
The provision for losses and LAE is comprised of the following at December
31, 1998 and 1997:
1998 1997
----------- ------
Case basis reserve $88,200,000 $ --
General reserve 2,000,000 55,000
----------- ------
Total provision for losses and LAE $90,200,000 $55,000
=========== =======
The activity in the provision for losses and LAE is as follows:
1998 1997
----------- ------
Provision for losses and LAE
Balance at January 1 $ 55,000 $ --
Less reinsurance recoverables -- --
----------- ------
Net Balance at January 1 55,000 --
Net losses and loss expenses incurred 22,745,000 55,000
Net losses and loss expenses paid -- --
----------- ------
Net provision for losses and LAE
Balance at December 31 22,800,000 55,000
Reinsurance recoverable 67,400,000 --
----------- ------
Provision for losses and LAE, gross of
reinsurance recoverable Balance at
December 31 $90,200,000 $55,000
=========== =======
In October, 1998 the credit ratings on asset-backed securities originated
and serviced by Commercial Financial Services Inc. ("CFS"), a credit-card debt
collection company, were withdrawn by the three credit rating companies
51
<PAGE>
CGA GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1998 AND
THE NINE MONTHS ENDED DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
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 insurers have commenced an investigation into the
allegations. Clients of CGAIM own approximately $155 million par of the CFS
securities and CGA has insured the credit facilities used to finance their
purchase. CGA had previously reinsured approximately $138 million par of this
exposure. In addition, CGA has exposure of approximately $46 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 $201
million par of CFS issued securities, of which $154 million par has been
reinsured, leaving a net exposure of approximately $47 million par. CGA
estimates the loss on its net exposure of the CFS securities to be $20.8 million
for which a case basis reserve has been established for the year ended December
31, 1998.
8. REINSURANCE
In the ordinary course of business, CGA cedes exposures under various
reinsurance contracts primarily designed to minimize losses from large risks and
to protect capital and surplus. The reinsurance of risk does not relieve the
ceding insurer of its original liability to its policyholders. In the event that
all or any of the reinsurers are unable to meet their obligations to CGA under
the existing reinsurance agreements, CGA would be liable for such defaulted
amounts. CGA also has a $20 million excess of loss reinsurance facility. As of
December 31, 1998 prepaid reinsurance of approximately $1.3M was associated with
a single reinsurer.
As stated above in note seven, CGA has reinsured approximately $154 million
par of its total exposure to $201 million par of CFS issued securities, leaving
a net exposure of approximately $47 million par. CGA has reinsurance recoverable
of $67.4 million relating to the CFS securities as of December 31, 1998.
Also during October, 1998, 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 turmoil in
certain areas of the capital markets during this time period, the spreads over
treasuries at which investors were 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 fair value of these securities had declined significantly during
October. 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, 1998 two of CGAIM's clients worked with CGA to reduce the
impact of any future spread widening on their operating ratios. CGA provided
credit support on approximately $382 million of securities within the two
insured portfolios, which was further supported by a "Triple-A" rated reinsurer,
using documentation that would permit the insured 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.
52
<PAGE>
CGA GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1998 AND
THE NINE MONTHS ENDED DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
9. MEZZANINE EQUITY
1998 1997
$ $
---------- ----------
Series A : 3,211,890 and 2,796,534 shares
issued and outstanding ......................... 32,119 27,965
Additional paid in capital ...................... 75,258,981 65,504,534
---------- ----------
Total series A preferred stock .................. 75,291,100 65,532,499
Series B: 1,600,000 and 1,600,000 shares
issued and outstanding ......................... 16,000 16,000
Additional paid in capital ...................... 37,284,985 37,059,371
---------- ----------
Total series B preferred stock ................ 37,300,985 37,075,371
========== ==========
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 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 a
registration statement with respect to the Series A Preferred Stock. 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 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 Preferred Stock is accrued and the charge
against retained earnings is recorded.
Both Series A Preferred Stock and Series B Preferred Stock were recorded at
fair value, being the net proceeds received. The difference between fair value
and the redemption value (excluding pay-in-kind dividends) is being accreted
over the mandatory redemption period by a charge to retained deficit.
Both the Series A Preferred Stock and Series B Preferred Stock are voting
securities with Series A Preferred Stock carrying 7 votes per share and Series B
Preferred Stock carrying 5 votes per share. Series A Preferred Stock comes first
in preference in a liquidation of the Company followed by Series B Preferred
Stock and then the Company's Common Stock.
10. COMMON STOCK
The number of shares of Common Stock of the Company outstanding during the
year ended December 31, 1998 and the nine months ended December 31, 1997 was as
follows:
1998 1997
--------- ---------
Issued and outstanding ........................... 9,100,000 9,100,000
Weighted average number of shares ................ 9,100,000 6,522,313
53
<PAGE>
CGA GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1998 AND
THE NINE MONTHS ENDED DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
The Common Stock carries 2 votes per share. During the nine months ended
December 31, 1997 9,100,000 shares were issued for cash proceeds of $45,500,000.
11. LOSS PER COMMON SHARE
The following table sets forth the computation of basic and diluted loss
per share for the year endedDecember 31, 1998 and the period ended December 31,
1997.
<TABLE>
<CAPTION>
Nine Months
Year Ended Ended
December 31, December 31,
1998 1997
----------- -----------
<S> <C> <C>
Basic Loss Per Share ("EPS")
Numerator:
Net loss ...................................... $(17,987,779) $ (2,706,182)
Series A--Pay-in-kind dividends paid .......... (10,383,919) (4,913,346)
Series A--Accretion to redemption value ....... (514,273) (190,472)
Series A--Accretion on warrants ............... (207,709) --
Series B--Pay-in-kind dividends accrued ....... (9,576,932) (4,439,231)
Series B--Accretion to redemption value ....... (225,614) (83,561)
----------- -----------
Net Loss Available to Common Shareholders ...... (38,896,226) (12,332,792)
----------- -----------
Denominator:
Weighted Average Shares Outstanding ........... 9,100,000 6,522,313
Basic EPS ...................................... $ (4.27) $ (1.89)
=========== ===========
Diluted Loss Per Share
Numerator ...................................... $(38,896,226) $(12,332,792)
----------- -----------
Denominator .................................... 9,100,000 6,522,313
----------- -----------
Diluted EPS .................................... $ (4.27) $ (1.89)
=========== ===========
Loss per share on cumulative effect of change in
accounting principle .......................... $ (0.43) $ --
=========== ===========
</TABLE>
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 of December 31, 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 December 31, 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 of December 31, 1998, there were 1,348,129
warrants outstanding, of which 337,032 warrants were exercisable. As of December
31, 1997 there were 1,348,129 warrants outstanding, of which none were
exercisable.
54
<PAGE>
CGA GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1998 AND
THE NINE MONTHS ENDED DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
12. INSURANCE IN FORCE
CGA principally insures structured securities including asset-backed
securities, mortgage-backed securities and commercial mortgage-backed
securities. CGA's potential liability in the event of nonperformance by the
issuer of the insured obligation is represented by its proportionate share of
the aggregate outstanding principal and interest payable ("insurance in force")
on such insured obligation. At December 31, 1998, CGA's aggregate insurance in
force was approximately $1.6 billion, net of reinsurance.
The following table shows the net par outstanding of insured obligations,
net of reinsurance, at December 31, by asset type:
1998 1997
(in 000's) (in 000's)
---------- ----------
REIT Debt ........................... $ 381,777 $ --
Consumer asset-backed securities .... 456,521 52,439
Corporate asset-backed securities ... 270,612 46,337
Commercial mortgage-backed securities 185,754 100,703
Sovereign debt ...................... 120,000 120,000
Corporate debt ...................... 75,000 --
REIT Preferred stock ................ 70,000 --
---------- ----------
Total ............................. $1,559,664 $ 319,479
========== ==========
The following table presents the credit ratings of the above assets, based
on net par outstanding at December 31:
1998 1997
---- ----
"AAA" ......................... 4% --
"AA" .......................... 3% --
"A" ........................... 12% 7%
"BBB" ......................... 67% 65%
"BB" .......................... 11% 28%
Not rated ..................... 3% --
--- ---
Total ........................ 100% 100%
=== ===
13. SEGMENT REPORTING
The Company has two reportable segments: CGA and CGAIM (see description of
each segment in Note 1). The Company's management has identified the operating
segments on the basis that they are separate legal entities with each entity
carrying on a different type of business. CGA provides financial guaranty
insurance. CGAIM provides investment management services to third party
investment vehicles and provides investment advisory services including
transaction structuring. The accounting policies of each of the segments are the
same as those described in the summary of significant accounting policies.
55
<PAGE>
CGA GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1998 AND
THE NINE MONTHS ENDED DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
The table below presents financial information for each of the operating
segments. As of and for the year ended December 31, 1998.
<TABLE>
<CAPTION>
CGA CGAIM Other (a) Total
----------- --------- --------- -----------
REVENUES
<S> <C> <C> <C> <C>
Net premiums earned ............................ $ 9,246,289 $ -- $ -- $ 9,246,289
Net investment income .......................... 8,387,513 64,934 75,675 8,528,122
Net realized gains ............................. 2,814,132 -- -- 2,814,132
Management fees ................................ -- 3,353,499 -- 3,353,499
Intersegment revenue ........................... -- 122,301 -- 122,301
TOTAL REVENUES ............................... 24,064,343
EXPENSE ITEMS
Operating expenses ............................. 1,680,707 10,711,550 1,753,410 14,145,667
Acquisition costs .............................. 433,217 -- -- 433,217
Commitment fees ................................ 600,000 -- -- 600,000
Excess of loss facility ........................ 200,000 -- -- 200,000
Losses and loss adjustment expenses ............ 22,745,000 -- -- 22,745,000
TOTAL EXPENSES ............................... 38,123,884
Cumulative effect of change in accounting
policy ........................................ 1,127,353 480,207 2,320,678 3,928,238
----------- --------- --------- -----------
ASSETS
Total assets ................................. 214,823,536 3,752,936 7,860,816 226,437,288
=========== ========= ========= ===========
</TABLE>
(a) The "other" segment is comprised of CGA Group, Ltd., the holding company,
which does not meet any of the quantitative thresholds for determining a
reportable segment.
As of and for the nine months ended December 31, 1997.
<TABLE>
<CAPTION>
CGA CGAIM Other Total
----------- --------- --------- -----------
REVENUES
<S> <C> <C> <C> <C>
Net premiums earned ........................... $ 502,995 $ -- $ -- $ 502,995
Net investment income ......................... 2,901,306 2,955,601
Net realized gains ............................ 885,422 -- -- 885,422
TOTAL REVENUES .............................. 4,344,018
EXPENSE ITEMS
Operating expenses ............................ 597,883 5,313,368 598,852 6,510,103
Acquisition costs ............................. 53,590 -- -- 53,590
Commitment fees ............................... 323,836 -- -- 323,836
Excess of loss facility ....................... 107,671 -- -- 107,671
Losses and loss adjustment expenses ........... 55,000 -- -- 55,000
----------- --------- --------- -----------
TOTAL EXPENSES .............................. 7,050,200
ASSETS
Total Assets ................................ 131,607,950 3,577,782 11,085,250 146,270,982
=========== ========= ========= ===========
</TABLE>
56
<PAGE>
CGA GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1998 AND
THE NINE MONTHS ENDED DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
The following are reconciliations of reportable segment revenues, expenses
and assets to the Company's consolidated totals in the financial statements.
Depreciation expense is included in operating expenses.
<TABLE>
<CAPTION>
1998 1997
------------- -------------
REVENUES
<S> <C> <C>
Total revenues for reportable segments .............. $ 24,064,343 $ 4,344,018
Elimination of intersegment revenues ................ (122,301) --
------------- -------------
Total consolidated revenues ....................... $ 23,942,042 $ 4,344,018
============= =============
EXPENSES
Total expenses for reportable segments .............. $ 38,123,884 $ 7,050,200
Elimination of intersegment operating expenses ...... (122,301) --
------------- -------------
Total consolidated expenses ....................... $ 38,001,583 $ 7,050,200
------------- -------------
ASSETS
Total assets for reportable segments ................ $ 226,437,288 $ 146,270,982
Intercompany loans .................................. (7,551,429) (3,549,796)
Other intercompany balances ......................... (2,981,926) --
------------- -------------
Total consolidated assets ......................... $ 215,903,933 $ 142,721,186
============= =============
</TABLE>
14. CONTINGENCIES AND COMMITMENTS
The Company has exposure totaling approximately $425 million related to the
timely payment of interest and principal on a loan to St. George Investments I,
Ltd. (SGI). The loan is payable in four equal annual installments with the first
installment due November 11, 1999. In order to meet this obligation, CGAIM, as
the advisor to SGI, has advised SGI to sell a portion of the underlying
securities to special purpose vehicles that will repackage the securities as
follows. The current terms of the proposed transaction indicate that the
underlying securities would be sold to two newly organized special purpose
vehicles, financed by three classes of certificates. The two most senior classes
of certificates, representing approximately 85% of the total, would be held by a
third party who is also an institutional investor in the Company. The Company
would also issue a 5.9% pool policy related to the underlying pool of
securities. This transaction is currently scheduled to close in April, 1999. The
proceeds from this sale under the currently negotiated terms would be sufficient
to meet SGI's obligations due in November, and CGAIM would advise SGI to use the
proceeds to meet the obligation. There can be no assurance that the sale of the
underlying securities occurs under the terms discussed above. In the event that
this transaction does not occur and SGI is not otherwise able to meet their debt
obligation, the lender may call on the Company's loan guaranty for the
shortfall. The Company may then liquidate the underlying collateral to subrogate
losses paid.
(b) Lease commitments
The Company rents office space in Hamilton, Bermuda under an operating
lease which expires in 2000. CGAIM rents office space in New York, under an
operating lease which expires in 2003 with one option for a renewal period of
five years. Total rent expense was approximately $355,000 and $300,000 in 1998
and 1997 respectively. Future minimum rental commitments under the leases, are
expected to be approximately $500,000 per annum.
15. 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, as amended, 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 does 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 $7.65 million and $5.3
million as at December 31, 1998 and 1997 respectively, for which no benefit has
been recorded in the financial statements. These tax loss carry-forwards expire
in the year 2013 and 2012 respectively.
16. STATUTORY FINANCIAL DATA
Under The Insurance Act 1978, amendments thereto and related regulations,
CGA is required to file an annual Statutory Financial Return and Statutory
Financial Statements to maintain certain measures of solvency and liquidity
during the period. The statutory capital and surplus at December 31, 1998 and
1997 were $114,681,031 and $127,041,276, respectively. Statutory net loss for
the year ended December 31, 1998 was $11,264,214 and for the nine months ended
December 31, 1997 statutory net income was $3,152,533. The principal differences
between capital and surplus and statutory net income and shareholders' equity
and income as reported in conformity with GAAP
57
<PAGE>
CGA GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1998 AND
THE NINE MONTHS ENDED DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
relates to deferred acquisition costs and prepaid expenses of the Company. There
were no statutory restrictions on payment of dividends from the retained
earnings of the Company as the required level of solvency was met by the common
stock in issue.
17. 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.
18. SUBSEQUENT EVENTS
On January 27, 1999 the Company held a Special General Meeting for all
shareholders, which was both preceded and followed by meetings of its Board of
Directors. The purpose of the meetings was primarily to approve and authorize
the seeking of additional capital from existing shareholders and from one or
more third party investors.
During the meetings the following resolutions were among those approved:
o That the authorized share capital of the Company be increased from
$412,000 to $3,412,000 by the creation of an additional 300,000,000
shares of a par value of $0.01.
o That the Company create a new series of Preference Shares being Series
C Convertible Cumulative Voting Preference Shares (the "Series C
Preferred Stock") and offer up to $63 million of such stock to the
existing holders of the Company's Common Stock and Series B Preferred
Stock (the "Rights Offering").
o Concurrent with the closing of the Rights Offering all outstanding
shares of Series B Preferred Stock, including accrued dividends
thereon, shall be converted into shares of Common Stock based on a
value of $3 per share of Common Stock.
o That the Company amend the terms of the Series B Preferred Stock such
that the dividend rate applicable to the Shares of Series B Preferred
Stock which may be issued in the future upon exercise of the Unit
Investors Capital Commitments or otherwise will not be greater than 7%
per annum, that any such Series B Preferred Stock shall rank junior to
the Series C Preferred Stock in all respects, and that any such Series
B Preferred Stock shall not be entitled to voting rights.
o That the number of Directors of the Company be increased from 13 to 15
by the creation of two new vacancies and that the said two vacancies
be filled by nominees elected by the holders of the new Series C
Preferred Stock of the Company.
The Company has received irrevocable commitments from certain of its
existing investors to purchase approximately $50.7 million of Series C Preferred
Stock. Such amount is comprised of approximately 31.8 million shares priced at
$1.50 per share and 12 million shares priced at $0.25 per share. The Rights
Offering is scheduled to close upon the receipt of the funds on March 31, 1999.
The Company also obtained agreements from the Series A Preferred
Shareholders to amend the terms of the Series A Preferred Stock so that the
early redemption premium referred to in the mezzanine equity footnote above is
eliminated.
58
<PAGE>
CGA GROUP, LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1998 AND
THE NINE MONTHS ENDED DECEMBER 31, 1997
(EXPRESSED IN U.S. DOLLARS)
The amount of new Common Stock to be issued in connection with the
conversion of the Series B Preferred Stock is projected to be approximately 18.9
million shares which will bring the amount of total Common Stock outstanding to
approximately 28 million shares.
19. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr Total
--------- --------- --------- --------- ----------
<S> <C> <C> <C> <C> <C>
Net premiums written .................. $1,949,993 $1,607,759 $2,882,474 $3,356,610 $ 9,796,836
Net premiums earned ................... 1,071,135 1,649,341 3,027,536 3,498,277 9,246,289
Net investment income and net
realized gains ....................... 1,646,061 3,119,215 1,985,828 4,591,150 11,342,254
Management fees ....................... 189,056 492,939 1,472,589 1,198,915 3,353,499
--------- --------- --------- --------- ----------
Total Revenues ...................... 2,906,252 5,261,495 6,485,953 9,288,342 23,942,042
========= ========= ========= ========= ==========
Operating Expenses .................... 3,063,863 4,366,129 4,043,755 2,549,619 14,023,366
Acquisition costs ..................... 53,245 92,342 129,944 157,686 433,217
Commitment fees and excess of
loss facility ........................ 197,945 199,589 201,233 201,233 800,000
Losses and loss adjustment
expenses, net ........................ 195,000 405,000 700,000 21,445,000 22,745,000
--------- --------- --------- --------- ----------
Total Expenses ...................... 3,510,053 5,063,060 5,074,932 24,353,538 38,001,583
========= ========= ========= ========= ==========
Net income (loss) ..................... (603,801) 198,435 (2,517,216) (15,065,197) (17,987,779)
Net income (loss) available to
shareholders ......................... (5,683,130) (4,909,349) (7,991,082) (20,312,665) (38,896,226)
Basic and fully diluted earnings
(loss) per share ..................... ($0.62) ($0.54) ($0.88) ($2.23) ($4.27)
</TABLE>
59
<PAGE>
INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION
3.1 Memorandum of Association and Certificate of
Incorporation of CGA Group, Ltd., incorporated herein by
reference to Exhibit 3.1 to the Registration Statement
on Form S-1 (No. 333-7944) of the Company (the
"Registration Statement ")
3.2 Bye-laws of CGA Group, Ltd., incorporated herein by
reference to Exhibit 3.2 to the Registration Statement
3.3 Appendices to Bye-laws of CGA Group, Ltd., incorporated
herein by reference to Exhibit 3.3 to the Registration
Statement
4.1 CGA Group, Ltd. Shareholders Agreement, incorporated
herein by reference to Exhibit 4.1 to the Registration
Statement
4.2 Amendment No. 1 to CGA Group, Ltd. Shareholders
Agreement
10.1 Series A Subscription Agreement dated as of June 9,
1997, by and among CGA Group, Ltd. and the holders of
the Series A Preferred Stock, incorporated herein by
reference to Exhibit 10.1 to the Registration Statement
10.2 Common Stock Warrant Acquisition Agreement, dated as of
June 9, 1997, by and among CGA Group, Ltd. and the
holders of the Series A Preferred Stock, incorporated
herein by reference to Exhibit 10.2 to the Registration
Statement
10.3 Investment Units Subscription Agreement dated as of June
4, 1997, by and among CGA Group, Ltd. and the holders of
the Investment Units, incorporated herein by reference
to Exhibit 10.3 to the Registration Statement
10.4 Right of First Refusal Agreement dated as of June 17,
1997, by and between CGA Group, Ltd. and Capital
Reinsurance Company, incorporated herein by reference to
Exhibit 10.4 to the Registration Statement
10.5 Discretionary Investment Advisory Agreement, dated as of
December 18, 1996 between Alliance Capital Management,
L.P. and Commercial Guaranty Assurance, Ltd.,
incorporated herein by reference to Exhibit 10.5 to the
Registration Statement
10.6 Investment Management Agreement dated as of December 27,
1996, between J.P. Morgan Investment Management Inc. and
Commercial Guaranty Assurance, Ltd., incorporated herein
by reference to Exhibit 10.6 to the Registration
Statement
10.7 Letter Agreement, dated June 17, 1997 between CGA Group,
Ltd. and DCR (and Attachments), incorporated herein by
reference to Exhibit 10.7 to the Registration Statement
10.8 Employee Warrant Agreement, incorporated herein by
reference to Exhibit 10.8 to the Registration Statement
10.9 CGA Group, Ltd. Employee Stock Warrant Plan,
incorporated herein by reference to Exhibit 10.9 to the
Registration Statement
10.10 CGA Group, Ltd. Sponsoring Investors and Founders Stock
Warrant Plan, incorporated herein by reference to
Exhibit 10.10 to the Registration Statement
10.11 Excess of Loss Agreement, dated as of June 12, 1997, by
and between CGA Group, Ltd. and KRE Reinsurance Ltd.,
incorporated herein by reference to Exhibit 10.11 to the
Registration Statement
10.12 Employment Agreement, as of January 1, 1997, by and
between CGA Group, Ltd. and Richard A. Price,
incorporated herein by reference to Exhibit 10.12 to the
Registration Statement
60
<PAGE>
10.13 Employment Agreement, as of January 1, 1997, by and
between CGA Group, Ltd. and Jean-Michel Wasterlain,
incorporated herein by reference to Exhibit 10.20 to the
Registration Statement
10.14 Employment Agreement, as of June 30, 1997, by and
between Commercial Guaranty Assurance, Ltd. and Michael
M. Miran, incorporated herein by reference to Exhibit
10.18 to the Registration Statement
10.15 Employment Agreement, as of January 1, 1997, by and
between CGA Investment Management, Inc. and Kem H.
Blacker, incorporated herein by reference to Exhibit
10.16 to the Registration Statement
10.16 Employment Agreement, as of August 1, 1997, by and
between CGA Investment Management, Inc. and Landon D.
Parsons
10.17 CGA Group, Ltd. Founders' Common Stock Subscription
Agreement, dated as of June 12, 1997, among CGA Group,
Ltd., CGA Funding, L.P., and certain Founders of CGA
Group, Ltd., incorporated herein by reference to Exhibit
10.19 to the Registration Statement
21.1 Subsidiaries of CGA Group, Ltd.
27.1 Financial Data Schedule
61
EXHIBIT 4.2
AMENDMENT NO. 1 TO CGA GROUP, LTD. SHAREHOLDERS AGREEMENT
AMENDMENT NO. 1 TO SHAREHOLDERS AGREEMENT, dated as of December 15, 1997
(the "Amendment"), by and among CGA Group, Ltd., a company with limited
liability incorporated under the laws of Bermuda (the "Company"), and the Common
Holders party hereto.
WITNESSETH
WHEREAS, the Company and the Common Holders are parties to that certain
Shareholders Agreement, dated as of June 12, 1997 (the "Original Shareholders
Agreement "); and
WHEREAS, the parties hereto desire to effect certain amendments to the
Original Shareholders Agreement, all as more fully set forth herein;
NOW, THEREFORE, the parties hereto agree as follows:
ARTICLE I
AMENDMENTS
SECTION 1.1. Amendment to Section 4(c).
Section 4(c) of the Original Shareholders Agreement is amended by deleting
such Section in its entirety and by inserting in lieu thereof the following new
Section 4(c):
Business Report. The Company shall prepare and deliver to each Common
Holder within 45 days after the end of each calendar quarter a report as to
the implementation of the Company's business plan during such quarter,
which report shall be accompanied by a certificate signed by the Chief
Executive Officer and the Chief Financial Officer of the Company as to the
Company's compliance with its operating guidelines during such quarter;
provided, however, that in lieu of providing such certified report to those
Common Holders whose names are set forth on Schedule I hereto (each a
"Sponsoring Investor" and, collectively, the "Sponsoring Investors") on a
quarterly basis, the Company need only furnish to the Sponsoring Investors
such report, accompanied by the certificate referred to above, within 45
days after the end of each calendar year, as to the Company's compliance
with its operating guidelines during such year.
ARTICLE II
MISCELLANEOUS
SECTION 2.1. All capitalized terms used in this Amendment which are not
defined in this Amendment shall have the respective meanings assigned thereto in
the Original Shareholders Agreement.
SECTION 2.2. All references to the "Agreement" in the Original Shareholders
Agreement shall, from and after the date of this Amendment, be deemed to refer
to the Original Shareholders Agreement, as amended by this Amendment.
SECTION 2.3. Except as and to the extent amended hereby, the Original
Shareholders Agreement shall be and remain in full force and effect in
accordance with its terms.
SECTION 2.4. This Amendment may be executed in any number of counterparts,
each of which when executed and delivered shall be an original, but all of which
shall together constitute one and the same instrument.
SECTION 2.5. This Amendment shall take effect as of the first date on which
counterparts hereof, when taken together, shall have been executed by Common
Holders that own at least ninety percent (90%) of the Common Stock, as provided
by Section 6(b) of the Original Shareholders Agreement.
1
<PAGE>
SECTION 2.6. This Amendment shall be governed by, and shall be construed
and interpreted in accordance with, the laws of the State of New York without
giving effect to the principles of conflicts of laws thereof, all as more fully
set forth in Section 6(j) of the Original Shareholders Agreement.
IN WITNESS WHEREOF, the parties hereto have caused their duly authorized
officers to execute and deliver this Agreement as of the date first above
written.
CGA GROUP, LTD.
By: /s/ RICHARD A. PRICE
-------------------------------
Name: Richard A. Price
Title: President and CEO
COMMON HOLDERS
CAPITAL REINSURANCE COMPANY
By:
-------------------------------
Name:
Title:
THIRD AVENUE TRUST, ON BEHALF OF THE
THIRD AVENUE VALUE FUND SERIES
By:
-------------------------------
Name:
Title:
OLYMPUS GROWTH FUND II, L.P.
By:
-------------------------------
Name:
Title:
OLYMPUS EXECUTIVE FUND, L.P.
By:
-------------------------------
Name:
Title:
ACE LIMITED
By:
-------------------------------
Name:
Title:
2
<PAGE>
LENNAR CGA HOLDINGS, INC.
By:
-------------------------------
Name:
Title:
THE EQUITABLE LIFE ASSURANCE SOCIETY
OF THE UNITED STATES
By:
-------------------------------
Name:
Title:
FIREMARK VENTURE FUND I, LLC
By:
-------------------------------
Name:
Title:
PACIFIC MUTUAL LIFE INSURANCE COMPANY
By:
-------------------------------
Name:
Title:
MORGAN GUARANTY TRUST COMPANY OF
NEW YORK AS TRUSTEE OF THE MULTI-MARKET
SPECIAL INVESTMENT TRUST FUND OF
MORGAN GUARANTY TRUST COMPANY OF NEW YORK
By:
-------------------------------
Name:
Title:
MORGAN GUARANTY TRUST COMPANY OF
NEW YORK AS TRUSTEE OF THE COMMINGLED
PENSION TRUST FUND (MULTI-MARKET SPECIAL
INVESTMENT FUND II) OF MORGAN GUARANTY
TRUST COMPANY OF NEW YORK
By:
-------------------------------
Name:
Title:
STARWOOD CGA, LTD.
By:
-------------------------------
Name:
Title:
3
<PAGE>
MUTUAL DISCOVERY FUND
By:
-------------------------------
Name:
Title:
PRUDENTIAL SECURITIES GROUP, INC.
By:
-------------------------------
Name:
Title:
MUTUAL QUALIFIED FUND
By:
-------------------------------
Name:
Title:
4
<PAGE>
SCHEDULE I
SPONSORING INVESTORS
CGA FUNDING, L.P.
SHIDLER/CGA CORPORATION
SHIDLER EQUITIES, L.P.
SHIDLER EQUITIES CORP.
Robert L. Denton
Richard A. Price
Paul T. Lambert
REYNOLDS PARTNERS
LBCW LIMITED PARTNERSHIP
Robert W. Holman, Jr.
MICHAEL T. TOMASZ REVOCABLE TRUST UAD 2/5/90
NAGELBERG FAMILY PARTNERSHIP, L.P.
Samuel Tang
Doreen A. Denton
Mark S. Whiting
Duane H. Lund
Stephen J. Meringoff
MATTISON FAMILY TRUST
Lawrence J. Taff
MARILYN E. TOMASZ REVOCABLE TRUST UAD 2/5/90
Michael J. Brennan
RADNOR CAPITAL CORPORATION PENSION TRUST
Johannson Yap
Kimberly F. Aquino
Gary H. Heigl
Stephen B. Oresman
Susan G. Burrus
Michael J. Havala
Wallace McDowell
William Walton
James R. Reinhart
Anthony R. Montemurno
Geoffrey Kauffman
5
EXHIBIT 10.16
CGA INVESTMENT MANAGEMENT, INC.
August 1, 1997
Mr. Landon Parsons
75 Skyline Drive
Millington, NJ 07946
Dear Landon:
I am pleased to offer you a position as Director with CGA Investment
Management Inc. (the "Company"), a subsidiary of CGA Group, Ltd. ("CGA Group").
As a valued member of our original management team you will be in a position to
make an important and significant contribution to the Company's success and
directly share in that success through your equity participation in CGA Group. I
am writing to confirm the specifics of our offer of employment to you. Set forth
below are the details relating to your compensation, equity participation and
terms of employment:
Base Salary: You will receive a guaranteed base salary through
June30, 1998 at a per annum rate equal to
$170,000, payable in installments in accordance
with the regular payroll practices of the Company.
Bonus: You will receive a bonus of $155,000 payable in
January 1998 (your "Guaranteed Bonus ").
Thereafter, you may receive a discretionary annual
bonus, payable at the same time that bonuses are
paid to employees generally, as may be determined
by the senior management of the Company, based
upon, among other things, your performance and the
performance of the Company during the relevant
year. Please note that a portion of your
Guaranteed Bonus, and a portion of any bonus
payable to you in 1999 in respect of the 1998
calendar year (your "1998 Bonus "), will be
applied, on an after-tax basis, against the
purchase price of shares of CGA Group common
stock, as set out more fully below under the
caption "CGA Group Stock and Warrants.
Equity Participation: Plan Warrants: You will receive an initial grant
of warrants to purchase 23,645 shares of CGA Group
common stock at an exercise price of $5 per share,
pursuant to CGA Group's Employee Stock Warrant
Plan, which is a qualified plan under the Internal
Revenue Code. Such warrants will vest in 25%
installments on each of the first through fourth
anniversaries of your commencing employment. CGA
Group Stock and Warrants: On the date that your
Guaranteed Bonus is paid to you, and on the date
any 1998 Bonus is paid to you (each such date a
"Bonus Payment Date "), you will have the
obligation to purchase 2,000 shares of CGA Group
common stock, and you will have the option to
purchase up to 3,000 additional shares of CGA
Group common stock, on each such Bonus Payment
Date. The purchase price of such stock will be
equal to $5.00 per share, plus funding costs of 7%
per annum commencing on June17, 1997 through the
date of acquisition of the relevant shares. The
purchase price for any such stock will be deducted
from the amount of the cash bonus, on an after tax
basis, otherwise payable to you on the relevant
Bonus Payment Date. In connection with each such
purchase of shares of CGA common stock, you will
receive warrants exercisable for one share of CGA
common stock for every four shares of CGA common
stock so purchased, at an exercise price of $5.00
per share. Such shares and warrants will be fully
vested upon acquisition.
1
<PAGE>
Vacation: You will be entitled to an annual vacation of four
weeks in accordance with the Company's vacation
policy as in effect from time to time, which
vacation will be taken at a time or times mutually
agreeable to you and the Company.
Benefits: You will be entitled to participate in or receive
benefits under, subject to meeting any applicable
eligibility requirements, all plans and benefits
generally accorded to similarly situated employees
of the Company of the same level of seniority and
responsibility, including, but not limited to,
pension, profit sharing, supplemental retirement,
incentive compensation, disability income, life
insurance, medical and hospitalization insurance
and similar or comparable plans.
You may terminate your employment under this arrangement at any time after
giving not less than 30 days advance written notice to the Company. Upon your
voluntary termination, you will be paid any accrued and unpaid base salary due
as of the date of termination and any other unpaid amounts to which you are
entitled under any employee benefit plan or program of the Company. Upon your
voluntary termination, no bonus or other payments (except as set forth to in the
immediately preceding sentence) will be payable by the Company to you.
The Company may terminate you for "cause" whereupon you will be paid
similarly as explained directly above. For the purposes of this agreement,
"cause" shall include, but not be limited to: refusal to follow written
directions from your business leader; material failure to perform your duties;
your disregard or failure to comply with Company policies or procedures,
including CGA Group's Operating Guidelines, or engaging in misconduct injurious
to the Company or any of its affiliates; or your having been convicted of a
felony or a crime of moral turpitude.
In the event the Company terminates your employment other than for "cause"
or your disability, or in the event of your death, the Company will pay you (or
your estate) upon termination:
1. in a lump sum, the greater of (a) your remaining guaranteed base
salary through June30, 1998 and (b) three month's base salary;
2. any accrued but unpaid base salary due as of the date of termination;
3. if such termination occurs in the 1997 calendar year, the bonus
specified above (such bonus to be paid all in cash and none in CGA
Group stock and warrants), and;
4. any other unpaid amounts to which you are entitled under any employee
benefit plan or program of the Company.
You acknowledge that, during the course of your employment, you will
produce and have access to materials, records, data, trade secrets and
information not generally available to the public regarding the Company and its
subsidiaries and affiliates (collectively, the "Confidential Information").
Accordingly, you agree that you will at all times hold in confidence, and not
directly or indirectly disclose, use, copy or make lists of any such
Confidential Information, except to the extent that such information is or
thereafter becomes lawfully available from public sources, or such disclosure is
authorized in writing by the Company, or required by a law or any competent
administrative agency or judicial authority, or otherwise as reasonably
necessary or appropriate in connection with your performance of your duties. All
records, files, documents and other materials or copies thereof relating to the
Company's and its affiliates' businesses which you may prepare or use shall be
and remain the sole property of the Company, shall not be removed from the
Company's premises without its prior written consent other than in the ordinary
course of business, and shall be promptly returned to the Company upon
termination of your employment hereunder. You agree to abide by the Company's
policies, as in effect from time to time, respecting avoidance of interests
conflicting with those of the Company.
In addition to terms set out in this letter, you also agree to comply with
the provisions of the Company's Employee Manual, a copy of which will be
provided to you upon your commencement of employment with the Company.
2
<PAGE>
Our ultimate success will be determined by the talent and quality of our
employees. We look forward to your joining our team.
Sincerely,
/s/ KEM H. BLACKER
-------------------
Kem H. Blacker
Principal
Accepted and agreed to this ___ day of August, 1997
/s/ LANDON PARSONS
----------------
Landon Parsons
3
EXHIBIT 21.1
SUBSIDIARIES OF CGA GROUP, LTD.
-- Commercial Guaranty Assurance, Ltd. (100%) (Bermuda)
-- CGA Investment Management, Inc. (100%) (Delaware)
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