AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 19, 1999
REGISTRATION NO. 333-
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
----------
CGA GROUP, LTD.
(Exact name of registrant as specified in its charter)
BERMUDA 6351 98-0173536
----------------------------- ------------------------- --------------
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
----------
CRAIG APPIN HOUSE
8 WESLEY STREET
HAMILTON HM11 BERMUDA
(441) 296-5144
(Address, including zip code, and telephone number,
including area code, of Registrant's principal executive offices)
----------
CT CORPORATION SYSTEM
1633 BROADWAY
NEW YORK, NEW YORK 10019
(212) 664-1666
(Name, address, including zip code, and telephone number,
including area code, of agents for service)
----------
Copies to:
WILLIAM W. ROSENBLATT, ESQ.
DEWEY BALLANTINE LLP
1301 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10019-6092
(212) 259-8000
----------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box: [X]
CALCULATION OF REGISTRATION FEE
-------------------------------
<TABLE>
<CAPTION>
=============================================================================================
PROPOSED PROPOSED
MAXIMUM MAXIMUM
OFFERING AGGREGATE
TITLE OF EACH CLASS AMOUNT TO BE PRICE PER OFFERING AMOUNT OF
SECURITIES TO BE REGISTERED REGISTERED SHARE(1) PRICE(1) REGISTRATION FEE
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Series A Cumulative Voting
Preference Shares ............ 562,618 shares $25.00 $14,065,450 $3,910.19
============================================================================================
</TABLE>
(1) Estimated solely for the purpose of computing the registration fee.
Pursuant to Rule 429 under the Securities Act the prospectus filed as part
of this Registration Statement may be used in connection with the securities
covered by Registration Statement 333-7944. This Registration Statement and the
prospectus included herein relates to 562,618 shares of the Registrant's Series
A Cumulative Voting Preference Shares ("Series A Stock") issued as paid-in-kind
dividends with respect to the 2,992,109 shares of Series A Stock previously
registered pursuant to the Registration Statement on Form S-1 of the Registrant
(Registration No. 333-7944, effective August 6, 1998).
----------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE. [GRAPHIC OMITTED]
================================================================================
<PAGE>
SUBJECT TO COMPLETION, DATED OCTOBER 19, 1999
PROSPECTUS
562,618 SHARES OF
SERIES A CUMULATIVE VOTING PREFERENCE SHARES
CGA GROUP, LTD.
----------
This prospectus relates to 562,618 shares of Series A preferred stock of CGA
Group, Ltd., a Bermuda company. There is no public market for Series A preferred
stock and there can be no assurance that an active public or private market for
the Series A preferred stock will develop. We do not intend to list the Series A
preferred stock on a national securities exchange or to apply for quotation of
the Series A preferred stock through the National Association of Securities
Dealers Automated Quotation System.
We have registered the Series A preferred stock for sale by the selling
stockholders identified in this prospectus, and the selling stockholders may
offer the Series A preferred stock from time to time. We will not receive any of
the proceeds from the sale of the Series A preferred stock. We have agreed,
among other things, to bear all expenses (other than underwriting discounts and
commissions) incurred in connection with the registration and sale of the Series
A preferred stock covered by this prospectus.
SEE "RISK FACTORS" BEGINNING ON PAGE 3 FOR A DISCUSSION OF SPECIFIC RISKS
ASSOCIATED WITH AN INVESTMENT IN THE SERIES A PREFERRED STOCK.
----------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
----------
THE DATE OF THIS PROSPECTUS IS __________, 1999.
- ----------------------------Red Herring Language--------------------------------
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. THESE
SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES
IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
- --------------------------------------------------------------------------------
<PAGE>
TABLE OF CONTENTS
PAGE
----
Prospectus Summary ....................................................... 1
Risk Factors ............................................................. 3
Use Of Proceeds .......................................................... 7
Selected Consolidated Financial Data ..................................... 8
Management's Discussion and Analysis of
Financial Condition and Results of Operations .......................... 9
Quantitative and Qualitative Disclosure About Market Risk ................ 16
CGA Group, Ltd. .......................................................... 21
Regulation ............................................................... 30
Management ............................................................... 34
Related Party Transactions ............................................... 40
Selling Stockholders ..................................................... 41
Plan of Distribution ..................................................... 41
Security Ownership of Certain Beneficial Owners and Management ........... 42
Description of Securities ................................................ 46
Certain Tax Considerations ............................................... 53
Legal Matters ............................................................ 62
Experts .................................................................. 62
Enforceability of Civil Liabilities ...................................... 62
Available Information .................................................... 63
Index to Financial Statements and Schedules .............................. F-1
----------
You should rely only on the information contained in this prospectus. We
have not, and the selling stockholders have not, authorized any other person to
provide you with different information. If anyone provides you with different or
inconsistent information, you should not rely on it. We are not, and the selling
stockholders are not, making an offer to sell these securities in any
jurisdiction where the offer or sale is not permitted.
All references to "we," "us," "our" or "CGA Group" in this prospectus mean
CGA Group, Ltd.
<PAGE>
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus.
It may not contain all the information that you should consider before investing
in the Series A preferred stock. You should read the entire prospectus
carefully, including the "Risk Factors" section and the financial statements and
the notes to these statements. See "Glossary of Selected Insurance Terms" for
definitions of insurance terms used in this prospectus.
We have presented all financial information in this prospectus in accordance
with generally accepted accounting principles, unless otherwise specified.
Financial information presented in accordance with statutory accounting
practices is identified as such.
CGA GROUP, LTD.
We are a holding company incorporated in Bermuda with limited liability.
Through our subsidiary Commercial Guaranty Assurance, Ltd., a Bermuda insurance
company, we provide financial guaranty insurance of structured securities,
including commercial real estate backed securities and asset backed securities.
We also provide financial guaranty insurance of other securities, where we have
expertise and where we deem credit enhancement opportunities to be attractive.
We also provide investment management and investment advisory services to
investment vehicles and other clients through our other subsidiary, CGA
Investment Management, Inc., a Delaware corporation that is registered as an
investment adviser with the Securities and Exchange Commission.
The primary clients of Commercial Guaranty Assurance and CGA Investment
Management are St. George Holdings, Ltd., a Cayman Islands company, and its
subsidiaries and Cobalt Holdings LLC, a Delaware limited liability corporation,
and its subsidiaries. In 1998 St. George Holdings and Cobalt Holdings provided
approximately 85% of the total insurance premiums earned by Commercial Guaranty
Assurance, and 91% of the total investment management fees earned by CGA
Investment Management. We expect these percentages to decrease in the future.
We formed Commercial Guaranty Assurance with a view to becoming the market
leader in the commercial real estate segment of the financial guaranty insurance
industry. We use our structured finance and real estate expertise to underwrite
financial guaranties for commercial real estate and other securities to a "zero
loss" underwriting standard. This means that our underwriting guidelines require
that the obligations we insure are structured with sufficient levels of excess
collateral or other security so that we, with a high degree of certainty,
anticipate no losses on each risk we insure. The zero loss underwriting standard
applies without regard to the premium collected on the policies or the
investment income related to the premium collected. Our primary target market is
the large U.S. commercial real estate mortgage market, which we believe is
underserved. We also target select segments of the private asset-backed
securities market.
Customers can purchase Commercial Guaranty Assurance's insurance only
through unaffiliated non-U.S. insurance brokers. Customers include investment
and commercial banks with significant real estate and asset-backed advisory
businesses, and commercial mortgage loan origination and asset-backed
repackaging operations and other participants in the securitization markets.
Our executive offices are located at Craig Appin House, 8 Wesley Street,
Hamilton HM11 Bermuda. Our telephone number at that address is (441) 296-5144.
1
<PAGE>
<TABLE>
<CAPTION>
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
SIX MONTHS SIX MONTHS NINE MONTHS
ENDED ENDED YEAR ENDED ENDED JUNE 21, 1996
JUNE 30, JUNE 30, DECEMBER 31, DECEMBER 31, TO MARCH 31,
1999 1998 1998 1997 1997
------------- ------------- ------------- ------------- -------------
(UNAUDITED) (UNAUDITED) (AUDITED) (AUDITED)
INCOME STATEMENT DATA:
REVENUES
<S> <C> <C> <C> <C> <C>
Gross premiums written .................. $ 7,855,093 $ 3,730,219 $ 49,217,083 $ 773,571 $ --
Ceded premiums .......................... (807,479) (172,467) (39,420,247) -- --
------------- ------------- ------------- ------------- -------------
Net premiums written .................... 7,047,614 3,557,752 9,796,836 773,571 --
Change in unearned premiums ............. (500,072) (837,276) (550,547) (270,576) --
------------- ------------- ------------- ------------- -------------
Net premiums earned ..................... 6,547,542 2,720,476 9,246,289 502,995 --
Net investment income ................... 4,019,724 4,212,895 8,528,122 2,955,601 801
Net realized gains (losses) ............. 130,880 552,381 2,814,132 885,422 --
Management fees ......................... 1,624,055 681,995 3,353,499 -- --
------------- ------------- ------------- ------------- -------------
Total revenues ...................... 12,322,201 8,167,747 23,942,042 4,344,018 801
------------- ------------- ------------- ------------- -------------
EXPENSES
Operating expenses ...................... 6,515,180 7,437,538 14,023,366 6,510,103 11
Policy acquisition costs ................ 315,254 145,587 433,217 53,590 --
Commitment fees ......................... 300,000 297,534 600,000 323,836 --
Excess of loss facility ................. 100,000 100,000 200,000 107,671 --
Losses and loss adjustment expenses
(Net of reinsurance of $67.4 million
in 1998) ............................ 7,750,000 600,000 22,745,000 55,000 --
------------- ------------- ------------- ------------- -------------
Total expenses .................... 14,980,434 8,580,659 38,001,583 7,050,200 11
------------- ------------- ------------- ------------- -------------
Income (loss) before cumulative effect of
change in accounting principle ........ (2,658,233) (412,912) (14,059,541) (2,706,182) 790
Cumulative effect of change in accounting
principle ............................. -- -- (3,928,238) -- --
NET INCOME (LOSS) ......................... (2,658,233) (412,912) (17,987,779) (2,706,182) 790
------------- ------------- ------------- ------------- -------------
Other comprehensive income ................ (5,903,556) (274,916) (710,417) 1,638,092 --
------------- ------------- ------------- ------------- -------------
COMPREHENSIVE INCOME (LOSS) ............... $ (8,561,789) $ (687,828) $ (18,698,196) $ (1,068,090) $ 790
============= ============= ============= ============= =============
Net income (loss) attributable to common
shareholders ............................ $ (11,320,347) $ (10,600,026) $ (38,896,226) $ (12,332,792) $ 790
Basic and diluted income (loss) per common
share ................................... $ (0.61) $ (1.16) $ (4.27) $ (1.89) $ 0.07
============= ============= ============= ============= =============
Weighted average common shares
outstanding ............................. 18,709,501 9,100,000 9,100,000 6,522,313 12,000
============= ============= ============= ============= =============
BALANCE SHEET DATA:
Fixed maturities available for sale
(at fair value) ......................... $ 144,584,244 $ 125,304,617 $ 100,488,537 $ 123,302,763 $ --
Other investments ......................... 5,000,000 -- 30,000,000 -- --
Cash and short-term investments ........... 18,744,457 4,401,305 2,598,140 7,199,106 121,742
Total assets .............................. 229,186,432 143,346,519 215,903,933 142,721,186 133,790
Total liabilities ......................... 66,679,868 5,229,769 95,797,551 3,916,609 121,000
Total mezzanine equity .................... 132,164,254 115,886,915 126,608,249 107,047,101 --
Total shareholders' (deficit) equity ...... 30,342,310 22,229,835 (6,501,867) 31,737,476 12,790
Total liabilities, mezzanine equity, and
shareholders' equity .................... 229,186,432 143,346,519 215,903,933 142,721,186 133,790
</TABLE>
2
<PAGE>
RISK FACTORS
Investing in our Series A preferred stock involves risk. You should
carefully consider the risks and uncertainties described below and elsewhere in
this prospectus before making an investment decision. If any of the following
risks or uncertainties actually occur, our business could be adversely affected.
In this event, the value of our Series A preferred stock could decline, and you
could lose all or a part of your investment.
WE DEPEND ON THE SKILLS OF OUR KEY EMPLOYEES AND NON-BERMUDIAN EMPLOYEES THE
LOSS OF WHOM COULD ADVERSELY AFFECT OUR BUSINESS
We believe that our ability to successfully implement our business
strategy and to operate profitably depends in part on the continued services of
key employees of CGA Group, Commercial Guaranty Assurance and CGA Investment
Management, including:
o Richard A. Price--Chief Executive Officer and President of CGA Group
o James R. Reinhart--Chief Financial Officer of CGA Group and Commercial
Guaranty Assurance
o Geoffrey N. Kauffman--President and Chief Underwriting Officer of
Commercial Guaranty Assurance
o Kem H. Blacker--Managing Director and Chief Operating Officer of CGA
Investment Management
o Michael Miran--Managing Director and General Counsel of CGA Investment
Management
o Jean-Michel Wasterlain--Managing Director of CGA Investment Management
CGA Group and its subsidiaries together have about 40 full-time employees
and depend on a small number of key employees for the production and servicing
of almost all of their business. The inability or unwillingness of these
individuals to continue in their present positions could have a material adverse
effect on our business and financial results and those of CGA Group and its
subsidiaries. Mr. Price and several key employees have entered into employment
agreements, but CGA Group may be unable to retain these employees or quickly
replace them. CGA Group does not maintain key man life insurance policies with
respect to any of its employees.
Under Bermuda law, non-Bermudians generally may not be employed in Bermuda
without the specific permission of governmental authorities. Obtaining this
permission requires a showing that no Bermudian with the minimum qualifications
is available. Although most of the executive officers of CGA Group and
Commercial Guaranty Assurance based in Bermuda are not Bermudian, all of the
non-Bermudian officers have received work permits. It is possible that CGA Group
or Commercial Guaranty Assurance could lose the services of these officers if
their work permits are not renewed, but CGA Group and Commercial Guaranty
Assurance are unaware of any reasons why this might occur.
COMMERCIAL GUARANTY ASSURANCE COULD BE ADVERSELY AFFECTED IF IT LOSES ITS
"TRIPLE-A" CLAIMS PAYING RATING FROM DUFF & PHELPS CREDIT RATING COMPANY
Commercial Guaranty Assurance is rated "Triple-A" for claims-paying ability
by Duff & Phelps Credit Rating Company, a nationally-recognized credit rating
company. "Triple-A" is the highest claims-paying ability rating available from
Duff & Phelps. This "Triple-A" rating is Duff & Phelps' rating of the insurance
provided by Commercial Guaranty Assurance to its clients and is not directed to
the protection of investors in CGA Group's Series A preferred stock or other
securities. The rating reflects Duff & Phelps' current opinion of Commercial
Guaranty Assurance's claims-paying ability, its financial and operating
performance and its ability to meet its obligations to its policyholders. The
rating is not an evaluation of the merits of the Series A preferred stock.
Duff & Phelps could downgrade or withdraw the rating of Commercial Guaranty
Assurance if it fails to continue to meet Duff & Phelps' rating requirements or
if these requirements are changed. A downgrade or withdrawal would have an
adverse effect on the sales of Commercial Guaranty Assurance's products, which,
in turn, would have an adverse effect on CGA Group.
Duff & Phelps and CGA Group have entered into a letter agreement that
o provides that CGA Group and Commercial Guaranty Assurance may not take
actions such as the payment of dividends from Commercial Guaranty Assurance
to CGA Group without obtaining a ratings confirmation from Duff & Phelps;
and
3
<PAGE>
o lists specific steps Commercial Guaranty Assurance must follow in
connection with its issuance of financial guaranty insurance, surety bonds
or similar agreements or instruments to maintain its current rating.
CGA GROUP AND COMMERCIAL GUARANTY ASSURANCE COULD BE ADVERSELY AFFECTED IF THEY
BECOME SUBJECT TO U.S. TAXATION
CGA Group and Commercial Guaranty Assurance are organized and operate in a
manner so that neither company should be subject to United States taxation and
so that U.S. persons who own Series A preferred stock should not be subject to
U.S. federal income tax on CGA Group's undistributed earnings. It is possible
that Commercial Guaranty Assurance could be considered in the future to be
engaged in a U.S. trade or business. If this were to occur, some or all of
Commercial Guaranty Assurance's investment income could become subject to
taxation on a net basis at standard U.S. corporate income tax rates (currently
35%) and it could also become subject to the branch profits tax (30%) on the
amount of net income deemed to have been withdrawn from the U.S. In light of
this risk, Commercial Guaranty Assurance files protective tax returns in the
U.S. reporting no U.S. income, in order to preserve its ability to deduct its
expenses should the Internal Revenue Service successfully challenge Commercial
Guaranty Assurance's position.
In addition, CGA Group and/or Commercial Guaranty Assurance could be
considered or in the future could become "controlled foreign corporations" and
Commercial Guaranty Assurance could generate "related person insurance income."
Any of these results could subject U.S. owners of Series A preferred stock to
current U.S. federal income tax on all or a portion of CGA Group's and/or
Commercial Guaranty Assurance's undistributed earnings. Any of these results
could subject any investors in Series A preferred stock who are allocated this
income and are tax-exempt organizations to unrelated business taxable income.
For a more detailed discussion of the United States tax implications of an
investment in the Series A preferred stock, see "Certain Tax Considerations"
elsewhere in this prospectus.
COMMERCIAL GUARANTY ASSURANCE COULD BE ADVERSELY AFFECTED IF IT BECOMES SUBJECT
TO U.S. OR OTHER NON-BERMUDIAN LICENSING OR INSURANCE REQUIREMENTS
In general, the Bermuda statutes and regulations applicable to Commercial
Guaranty Assurance are less restrictive than those that would be applicable were
it subject to the insurance laws and regulations of any state in the U.S.
Commercial Guaranty Assurance does not write insurance in the U.S., and it
conducts its business to avoid being subject to licensing requirements or
insurance regulations in the U.S. or elsewhere other than in Bermuda.
Although management of Commercial Guaranty Assurance believes that its
current activities comply with all applicable insurance laws and regulations,
insurance regulators in the U.S. or elsewhere could claim that Commercial
Guaranty Assurance is subject to their jurisdiction's licensing requirements
and/or is not in compliance with its insurance laws or regulations. Commercial
Guaranty Assurance's becoming subject to regulation in the U.S. or other
non-Bermudian jurisdiction, or having to modify the manner of conducting its
business, could have a material adverse effect on it, including the added costs
and expenses of licensing and compliance with insurance laws and regulations of
these jurisdictions, or the imposition of fines and penalties.
COMMERCIAL GUARANTY ASSURANCE OPERATES IN AN EXTREMELY COMPETITIVE MARKET AND
MAY NOT BE ABLE TO COMPETE EFFECTIVELY WITH FINANCIAL GUARANTORS THAT ARE RATED
BY MORE THAN ONE U.S. RATING AGENCY, OR WITH U.S.-BASED FINANCIAL GUARANTORS
Commercial Guaranty Assurance's current and prospective competitors in the
financial guaranty insurance business are numerous. Some of Commercial Guaranty
Assurance's competitors have substantially greater financial, technical and
marketing resources, larger customer bases, longer operating histories, greater
name recognition and more established relationships in the industry than
Commercial Guaranty Assurance does. Commercial Guaranty Assurance has a
"Triple-A" claims-paying ability rating from Duff & Phelps, but it does not
have, nor has it requested, claims-paying ability ratings from Standard & Poor's
Ratings Services, Fitch IBCA, Ltd. or Moody's Investors Service, Inc. This
places it at a significant disadvantage in markets where other financial
guarantors currently write insurance, especially the municipal bond market,
because many institutional investors require financial guaranty insurers to have
ratings from at least two of the nationally-recognized rating agencies listed
above.
4
<PAGE>
Also, its inability to negotiate and conclude its policies in the U.S. may be a
competitive disadvantage, in that potential clients of Commercial Guaranty
Assurance, including issuers and investment banks located in the United States,
might not be willing to travel to Bermuda to do business with Commercial
Guaranty Assurance.
AN INVESTMENT IN SERIES A PREFERRED STOCK IS ILLIQUID AND INVESTORS MAY HAVE TO
BEAR THE ECONOMIC RISK OF AN INVESTMENT FOR AN INDEFINITE PERIOD OF TIME
There is no established market for the shares of Series A preferred stock.
The Series A preferred stock is not listed on any national or foreign securities
exchange. Due to this lack of liquidity in the Series A preferred stock,
investors should assume that they may have to bear the economic risk of an
investment in the Series A preferred stock for an indefinite period of time.
COMMERCIAL GUARANTY ASSURANCE COULD BE ADVERSELY AFFECTED IF IT ESTABLISHES
INADEQUATE CLAIM RESERVES AND ACTUAL CLAIMS EXCEED EXPECTATIONS
Due to its relatively recent commencement of operations, Commercial
Guaranty Assurance has a limited operating history from which to estimate
necessary reserves. Reserves are estimates at a given time of what the insurer
ultimately expects to pay on claims, based on facts and circumstances then
known. If Commercial Guaranty Assurance were required to increase its claims
reserves, it would then have to report lower net income in the future.
Furthermore, Commercial Guaranty Assurance's net income would be adversely
affected if actual claims should exceed its claim reserves.
CGA GROUP WILL BE UNABLE TO PAY DIVIDENDS TO HOLDERS OF SERIES A PREFERRED STOCK
IF DUFF & PHELPS DOES NOT APPROVE DIVIDENDS FROM COMMERCIAL GUARANTY ASSURANCE
TO CGA GROUP
CGA Group does not expect to pay dividends to its shareholders other than
the dividends required to be paid on the Series A preferred stock. The dividends
required to be paid by CGA Group on the Series A preferred stock are a key
financial term of the Series A preferred stock. The ability of CGA Group to make
cash distributions and dividends, and to redeem its preferred stock will be
dependent primarily upon receiving dividends and distributions from Commercial
Guaranty Assurance. Commercial Guaranty Assurance's board of directors has
passed a resolution that Commercial Guaranty Assurance will not declare or pay
cash dividends to CGA Group until June 17, 2002. After that date, Commercial
Guaranty Assurance intends to comply with dividend restrictions imposed by Duff
& Phelps in order to maintain its "Triple-A" claims-paying ability rating. In
addition, Commercial Guaranty Assurance has agreed with Duff & Phelps that it
will not declare or pay any dividend, including non-cash dividends, without
first giving Duff & Phelps 20 business days notice and then receiving from Duff
& Phelps a written confirmation that the declaration or payment of the dividend
will not affect Commercial Guaranty Assurance's "Triple-A" rating from Duff &
Phelps. If Duff & Phelps at any time after June 17, 2002 rates the Series A
preferred stock "Triple-B minus" (BBB-) or higher, the dividend rate on the
Series A preferred stock will decrease by 200 basis points (two percent).
YOU MAY NOT BE ABLE TO ENFORCE YOUR LEGAL RIGHTS AGAINST CGA GROUP OR COMMERCIAL
GUARANTY ASSURANCE IN THE UNITED STATES
CGA Group and Commercial Guaranty Assurance are Bermuda companies, and
many of their officers and directors are residents of Bermuda. Most of the
assets of CGA Group, Commercial Guaranty Assurance and these officers and
directors are located outside the United States. Therefore, it may be difficult
for investors to effect service of process within the United States on any of
these parties who reside outside the United States or to recover against them or
their assets in the event of any judgments against them obtained in United
States courts.
COMMERCIAL GUARANTY ASSURANCE'S INSURANCE PORTFOLIO IS INTERDEPENDENT WITH A
SMALL NUMBER OF INTERRELATED COMPANIES THAT COULD BE UNABLE TO PAY INSURANCE
PREMIUMS TO COMMERCIAL GUARANTY ASSURANCE IN THE EVENT THAT COMMERCIAL GUARANTY
ASSURANCE'S CLAIMS PAYING ABILITY RATING IS DOWNGRADED
Approximately 80% of the outstanding principal amount of obligations
insured by Commercial Guaranty Assurance as of March 31, 1999 consisted of
insurance policies which guarantee payment obligations under the
5
<PAGE>
financing arrangements of St. George Holdings, Cobalt Holdings and their
subsidiaries. These guaranteed financing arrangements provide the St. George and
Cobalt companies with the financing to acquire the assets in their investment
portfolios.
The continued ability of the St. George and Cobalt companies to pay their
fees and expenses, including premiums payable to Commercial Guaranty Assurance
and asset management expenses payable to CGA Investment Management, depends on
their general ability to finance their investment activities and to generate
sufficient cash flow from these investment activities. The continued
availability of financing arrangements to these companies is conditional upon
their repayment obligations being guaranteed by Commercial Guaranty Assurance's
Triple-A rated financial guaranty insurance policies. A downgrade of Commercial
Guaranty Assurance by one or more rating agencies would adversely affect the
continued availability of these financing arrangements. The inability of St.
George and Cobalt companies to pay premiums to Commercial Guaranty Assurance and
asset management expenses to CGA Investment Management would significantly
decrease the revenues of Commercial Guaranty Assurance and CGA Investment
Management, and therefore of CGA Group.
THE SECURITIES AND OBLIGATIONS INSURED BY COMMERCIAL GUARANTY ASSURANCE ARE
CONCENTRATED IN THE COMMERCIAL REAL ESTATE SECTOR AND COULD BE ADVERSELY
AFFECTED BY ADVERSE EVENTS IN THE COMMERCIAL REAL ESTATE LOAN MARKET OR BY
ADVERSE EVENTS RELATING TO SPECIFIC REAL ESTATE PROJECTS
About 50% of the securities and obligations insured by Commercial Guaranty
Assurance are backed by pools of commercial real estate loans, and obligations
issued by companies known as real estate investment trusts, which manage real
estate portfolios to earn profits for equityholders. Accordingly, events that
have an adverse effect on these commercial real estate loans and real estate
investment trust obligations could cause defaults on these securities, which
would trigger insurance payments by Commercial Guaranty Assurance and therefore
reduce its net income. Commercial mortgage loans depend for repayment upon the
successful operation of the related real estate project because these loans
typically do not provide for recourse, or for only limited recourse, to the
borrower in the event of non-payment. The successful operation of each real
estate project is subject to the following types of risks:
o general or local economic conditions and property risks, including
structural defects, natural disasters, the conditions of specific industry
segments, competition with other projects and operating costs of the
project
o costs of compliance with laws, including zoning laws and the Americans With
Disabilities Act, and the adverse effect on the returns of a project
o risks relating to commercial mortgage loans, including payments of
principal due on the maturity dates of the loans, making payment dependent
on borrower's ability to refinance the loan or sell the property at a
sufficient price to make the payment
o risks relating to liabilities under state and federal environmental laws
and regulations, which often impose liability for environmental
contamination and clean-up costs, regardless of fault, on secured lenders
and holders of secured debt
THERE MAY BE INADEQUATE MARKET DEMAND FOR FINANCIAL GUARANTY INSURANCE WHICH
COULD HAVE A MATERIAL ADVERSE EFFECT ON THE FINANCIAL CONDITION OR RESULTS OF
OPERATIONS OF COMMERCIAL GUARANTY ASSURANCE
The demand for financial guaranty insurance depends on many factors, most
of which are beyond the control of Commercial Guaranty Assurance. The ability of
issuers of debt obligations to use financial guaranty insurance to obtain a
lower total cost for their debt obligations is affected by a variety of factors,
including:
o the general perception by investors of the financial strength of the
providers of financial guaranty insurance
o the interest rates borne by uninsured obligations
Inadequate demand for financial guaranty insurance would decrease sales of
Commercial Guaranty Assurance's products, and would likely have a material
adverse effect on the financial condition or results of operations of Commercial
Guaranty Assurance.
OUR COMPUTER SYSTEMS AND THOSE OF THIRD PARTIES WITH WHOM WE DO BUSINESS MAY NOT
BE YEAR 2000 COMPLIANT, WHICH MAY CAUSE SYSTEMS FAILURES AND DISRUPTIONS OF
OPERATIONS
Currently, many computer and software products are coded to accept
two-digit entries in the date code field and are unable to distinguish between
the year 1900 and the year 2000. These date code fields will need to accept four
digit
6
<PAGE>
entries to distinguish 21st century dates from 20th century dates. As a result,
many companies' software and computer systems may need to be upgraded or
replaced in order to comply with Year 2000 requirements. Our current computer
and software systems have recently been purchased or leased, as we commenced
operations in June 1997, and therefore we believe that the risk of Year 2000
non-compliance is insignificant as it relates to our computer systems. Although
we are not currently aware of any Year 2000 compliance problems relating to our
own systems that would have a material adverse effect on our business, results
of operations and financial condition, we cannot give you any assurance that we
will not discover Year 2000 compliance problems in these systems that will
require substantial revisions.
In addition, we cannot give you any assurance as to the state of Year 2000
compliance of the software and computers of third parties with whom we do
business, including our customers, suppliers of telecommunications, electric
power suppliers and financial institutions. We have contacted our vendors
regarding the state of their remediation activities for material Year 2000
issues. We do not expect that there will be material disruptions to our business
or material costs to us associated with any Year 2000 disruptions by our
vendors. The cost and timing of third party Year 2000 compliance is not within
our control and we cannot give you any assurances regarding the cost or timing
of these efforts or the potential effects of any failure of these third parties
to comply. The failure by these entities to be Year 2000 compliant could result
in a systemic failure beyond our control, such as a prolonged telecommunications
or electrical failure, and could prevent us from delivering our products and
services to customers.
FORWARD-LOOKING INFORMATION
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. This prospectus or any other written or
oral statements made by or on behalf of CGA Group may include forward-looking
statements which reflect CGA Group'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 these statements. These uncertainties and other factors (which
are described in more detail in this prospectus) include, but are not limited
to,
o financial difficulties encountered by an insured of CGA Group's insurance
company subsidiary,
o uncertainties relating to government and regulatory policies (such as
subjecting CGA Group and/or its subsidiaries to insurance regulation or
taxation in additional jurisdictions),
o the legal environment,
o the uncertainties of the reserving process,
o risks relating to the claims-paying ability rating of CGA Group's insurer
subsidiary,
o loss of the services of any of CGA Group's executive officers,
o changing rates on inflation and other economic conditions,
o ability to collect reinsurance recoverables,
o developments in global financial markets which could affect CGA Group's
investment portfolio, and
o 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, whether as a result of new
information, future events or otherwise.
USE OF PROCEEDS
The registration statement is intended to satisfy certain obligations of
CGA Group under the subscription agreement for the Series A preferred stock. CGA
Group will not receive any proceeds from sales of Series A preferred stock and
has agreed to pay the expenses of the performance of its obligations under the
subscription agreement with respect to the registration statement.
7
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected financial and operating data should be read in
conjunction with the information contained in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Consolidated
Financial Statements of CGA Group and its subsidiaries and the notes to the
Consolidated Financial Statements included elsewhere in this prospectus.
<TABLE>
<CAPTION>
SIX MONTHS SIX MONTHS NINE MONTHS
ENDED ENDED YEAR ENDED ENDED JUNE 21, 1996
JUNE 30, JUNE 30, DECEMBER 31, DECEMBER 31, TO MARCH 31,
1999 1998 1998 1997 1997
------------ ------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED) (AUDITED) (AUDITED)
INCOME STATEMENT DATA:
REVENUES
<S> <C> <C> <C> <C> <C>
Gross premiums written .................. $ 7,855,093 $ 3,730,219 $ 49,217,083 $ 773,571 $ --
Ceded premiums .......................... (807,479) (172,469) (39,420,247) -- --
------------ ------------ ------------ ------------ ------------
Net premiums written .................... 7,047,614 3,557,752 9,796,836 773,571 --
Change in unearned premiums ............. (500,072) (837,276) (550,547) (270,576) --
Net premiums earned ..................... 6,547,542 2,720,476 9,246,289 502,995 --
Net investment income ................... 4,019,724 4,212,895 8,528,122 2,955,601 801
Net realized gains (losses) ............. 130,880 552,381 2,814,132 885,422 --
Management fees ......................... 1,624,055 681,995 3,353,499 -- --
------------ ------------ ------------ ------------ ------------
Total revenues ...................... 12.322,201 8,167,747 23,942,042 4,344,018 801
------------ ------------ ------------ ------------ ------------
EXPENSES
Operating expenses ...................... 6,515,180 7,437,538 14,023,366 6,510,103 11
Acquisition costs ....................... 315,254 145,587 433,217 53,590 --
Commitment fees ......................... 300,000 297,534 600,000 323,836 --
Excess of loss facility ................. 100,000 100,000 200,000 107,671 --
Losses and loss adjustment expenses
(Net of reinsurance of $67.4 million
in 1998) ............................ 7,750,000 600,000 22,745,000 55,000 --
------------ ------------ ------------ ------------ ------------
Total expenses .................... 14,980,434 8,580,659 38,001,583 7,050,200 11
------------ ------------ ------------ ------------ ------------
Income (loss) before cumulative effect of
change in accounting principle ........ (2,658,233) (412,492) (14,059,541) (2,706,182) 790
Cumulative effect of change in accounting
principle ............................. -- -- (3,928,238) -- --
NET INCOME (LOSS) ......................... (2,658,233) (412,912) (17,987,779) (2,706,182) 790
------------ ------------ ------------ ------------ ------------
Other comprehensive income ................ (5,903,556) (274,916) (710,417) 1,638,092 --
------------ ------------ ------------ ------------ ------------
COMPREHENSIVE INCOME (LOSS) ............... $ (8,561,789) $ (687,828) $(18,698,196) $ (1,068,090) $ 790
============ ============ ============ ============ ============
Net income (loss) attributable to common
shareholders ............................ $(11,320,347) $(10,600,026) $(38,896,226) $(12,332,792) $ 790
Basic and diluted income (loss) per common
share ................................... $ (0.61) $ (1.16) $ (4.27) $ (1.89) $ 0.07
============ ============ ============ ============ ============
Weighted average common shares
outstanding ............................. 18,709,501 9,100,000 9,100,000 6,522,313 12,000
============ ============ ============ ============ ============
</TABLE>
8
<PAGE>
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 CGA Group
and the related notes thereto included elsewhere in this prospectus.
GENERAL
CGA Group, Ltd., a holding company, was incorporated in Bermuda on June
21, 1996. The Company has two wholly owned subsidiaries. Commercial Guaranty
Assurance, Ltd. was incorporated in Bermuda on October 22, 1996. Commercial
Guaranty Assurance is licensed as a class 3 insurer under the Insurance Act 1978
of Bermuda. This act authorizes Commercial Guaranty Assurance 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. Commercial Guaranty Assurance has a "Triple-A" "claims
paying ability" rating from Duff & Phelps Credit Rating Company 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. Commercial Guaranty Assurance 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. was incorporated in the state of Delaware
in July 1996 by the founders of CGA Group and was acquired at nominal cost to
CGA Group on June 9, 1997. CGA Investment Management did not commence operations
until after its acquisition by CGA Group. CGA Investment Management is
registered as an investment advisor with the United States Securities and
Exchange Commission under the Investment Advisors Act of 1940, as amended. CGA
Investment Management provides investment management and financial advisory
services primarily to specialized investment vehicles and for the U.S. and
international structured finance markets.
CGA Group and its subsidiaries were inactive until June 17, 1997, on which
date CGA Group's private placement offering was completed and CGA Group was
recapitalized with (a) two classes of preferred stock sold for an aggregate
purchase price of $105 million, (b) common stock sold for an aggregate purchase
price of $45.5 million and (c) conditional commitments to purchase $60 million
of additional preferred stock. On March 31, 1999, CGA Group sold 43,997,863
shares of its Series C preferred stock to existing shareholders for an aggregate
sales price of approximately $51 million. Concurrent with the sale of the Series
C preferred stock, all the outstanding shares of Series B preferred stock were
exchanged for shares of common stock. On April 26, 1999, CGA Group sold 973,483
shares of Series C preferred stock to employees of CGA Group and its
subsidiaries for an aggregate sales price of approximately $1.2 million.
RESULTS OF OPERATIONS
June 30, 1999
Total revenues for the quarter ended June 30, 1999 were $6.3 million, of
which $3.5 million was from financial guaranty insurance premiums, $0.5 million
was from investment management and advisory fees and $2.3 million was from
investment income. Total revenues for the quarter ended June 30, 1998 were $5.3
million, of which $1.7 million was from financial guaranty insurance premiums,
$0.5 million was from investment management and advisory fees, $2.3 million was
from investment income and $0.8 million from net realized gains on the sale of
investments.
Net premiums earned were derived from $4.4 million of gross premiums
written, of which $0.4 million were ceded under reinsurance agreements. The 110%
increase in net premiums earned in the quarter ended June 30, 1999 compared to
the quarter ended June 30, 1998 reflects CGA's increased insured exposure. The
net par outstanding insured obligations increased by 41% from $1.3 billion at
June 30, 1998 to $1.8 billion as of June 30, 1999.
Management fees earned by CGA Investment Management remained constant on a
comparable quarter basis although assets under management increased by 68% from
$1.2 billion at June 30, 1998 to $2.0 billion as of June 30, 1999. A portion of
the decrease in management fees earned as a percentage of assets under
management is attributable to several clients of CGA Investment Management
having resecuritized approximately $805 million in assets over the period
between June 30, 1998 and June 30, 1999. The asset management fees payable to
CGA Investment Management in these resecuritization transactions are lower than
the asset management fees payable to CGA Investment Management while these
assets remained in these clients' investment portfolios. In addition, due to the
9
<PAGE>
credit spread widening faced by the capital markets generally in September and
October of 1998, several clients of CGA Investment Management encountered
liquidity difficulties. At the request of these clients, CGA Investment
Management agreed to reduce the amount of the asset management fee.
The amount of Commercial Guaranty Assurance's insured portfolio was $1.8
billion net par as of June 30, 1999. The weighted average term of the insured
securities at June 30, 1999 was approximately 8.5 years. The following table
shows the net par insured obligations at June 30, 1999 and December 31, 1998 by
asset type:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
ASSET TYPE IN 000'S) (IN 000'S)
----------- ---------- ------------
<S> <C> <C>
Auto ................................................... $ 10,540 $ 3,158
Commercial loan obligations/Commercial bond obligations 260,615 189,375
Commercial mortgage-backed securities .................. 379,316 185,754
Corporate asset-backed securities ...................... 87,490 75,000
Credit card receivables ................................ 140,751 185,732
Equipment .............................................. 19,807 27,129
Future flows ........................................... 88,880 39,108
Home equity loans ...................................... 309,304 236,381
Real estate investment trust debt ...................... 211,774 381,777
Real estate investment trust preferred stock ........... 70,000 70,000
Sovereign debt ......................................... 110,000 120,000
Excess of loss reinsurance ............................. 91,250 46,250
Total .................................................. $1,779,727 $1,559,664
---------- ----------
</TABLE>
The following table presents the credit ratings of the above assets, based
on net par outstanding at June 30, 1999 and December 31, 1998:
JUNE 30, DECEMBER 31,
1999 1998
---------- ------------
"AAA" .................................. 4.5% 4%
"AA" ................................... 2.1% 3%
"A" .................................... 18.6% 12%
"BBB" .................................. 63.7% 67%
"BB" ................................... 9.3% 11%
Not rated .............................. 1.8% 3%
Total ................................ 100% 100%
------ ------
Net investment income was $2.3 million for the quarter ended June 30, 1999
and also for the quarter ended June 30, 1998. The value of the investment
portfolio, other investments, and cash was $168.3 million at June 30, 1999
compared to $133.1 million at June 30, 1998, however, the investment allocations
and lower yields on the investments in the current quarter compared to the
quarter ended June 30, 1998 resulted in only a slight increase in investment
income. Cumulative unrealized losses on the investment portfolio as of June 30,
1999 were $5 million.
Operating expenses for the quarter ended June 30, 1999 were $3.2 million
compared to $4.4 million for the quarter ended June 30, 1998. This decrease is
non-recurring as it resulted from CGA Investment Management expensing $1.2
million of client acquisition costs in the second quarter of 1998 that had
previously been capitalized. Operating expenses are primarily personnel, legal,
and administrative in nature.
Total revenues for the six months ended June 30, 1999 were $12.3 million
compared to $8.1 million for the six months ended June 30, 1998. The $4.2
million increase is primarily attributable to the increase in premiums earned
due to the growth in insured par exposure. Net investment income for the six
months ended June 30, 1999 decreased by $0.2 million compared to the same period
in 1998 primarily due to lower yields on Commercial Guaranty Assurance's
investments. Operating expenses for the six months ended June 30, 1999 decreased
by $0.9 million, but would have been $0.3 million higher than the comparable
period in 1998 except for expensing the $1.2 million of client acquisition costs
in the second quarter of 1998 referred to above.
In October 1998, the credit ratings on asset-backed securities which
clients of Commercial Guaranty Assurance had purchased, and that were originated
and serviced by Commercial Financial Services, Inc., were withdrawn by the
10
<PAGE>
three credit rating companies that rated the most recently issued Commercial
Financial Services securities. The withdrawal of the ratings was in response to
allegations of accounting irregularities at Commercial Financial Services. The
rating agencies, investors and insurers commenced investigations into the
allegations. On December 11, 1998, Commercial Financial Services filed a
petition for relief under Chapter 11 of the United States Bankruptcy Code with
the Bankruptcy Court for the Northern District of Oklahoma. The Bankruptcy Court
approved Commercial Financial Services' rejection of the servicing contracts and
other agreements relating to its servicing of the receivables underlying the
Commercial Financial Services securities, effective as of June 23, 1999. As a
result, servicing in respect of the Commercial Financial Services securities was
transferred to the trustees of the respective trusts which issued these
securities (Bankers Trust Company, in the case of the Commercial Financial
Services securities guaranteed by Commercial Guaranty Assurance), as backup
servicers, and their designated sub-servicers.
Clients of Commercial Guaranty Assurance had previously purchased
approximately $212 million face amount of Commercial Financial Services
securities, which exposure was guaranteed by Commercial Guaranty Assurance.
Commercial Guaranty Assurance had obtained reinsurance for about $162 million
face amount of this exposure. In December 1998, Commercial Guaranty Assurance
established a $20.8 million case basis reserve in respect of its exposure on
Commercial Financial Services securities. A case basis reserve is a reserve set
with specific regard to a potential claim or claims, and represents management's
estimate of probable losses on this exposure. In June 1999, CGA made claim
payments on its guarantees in respect of Commercial Financial Services
securities in the aggregate amount of approximately $58.9 million, of which $45
million consisted of payments from its reinsurer and $13.9 million consisted of
Commercial Guaranty Assurance's own funds, paid out of the case basis reserve.
In connection with this claim payment, Commercial Guaranty Assurance and its
reinsurer received from Commercial Guaranty Assurance's clients approximately
$58.9 million par value of Commercial Financial Services bonds. The bonds have
no readily determinable market value and have not been recorded on the books of
Commercial Guaranty Assurance. Until Commercial Guaranty Assurance's exposure on
Commercial Financial Services securities reaches zero, any future interest
payments received on these securities are intended to be used to purchase
additional Commercial Financial Services securities from Commercial Guaranty
Assurance's clients, thereby further reducing Commercial Guaranty Assurance's
exposure.
As a result of these claim payments and interim principal repayments on
the Commercial Financial Services securities, Commercial Guaranty Assurance's
gross exposure in respect of Commercial Financial Services securities has been
reduced to approximately $138.7 million as of June 30, 1999. Of this exposure,
approximately $106 million is covered by reinsurance, leaving Commercial
Guaranty Assurance with a remaining net exposure of approximately $32.7 million.
In June 1999, Commercial Guaranty Assurance added an additional $7.1 million to
its case basis reserve for Commercial Financial Services securities which
brought the reserve up to $14 million. The increase to the reserve was based on
revised collection estimates on the assets underlying the Commercial Financial
Services securities. Aggregate incurred losses for Commercial Financial Services
securities total $27.9 million against par exposure of approximately $46.6
million.
December 31, 1998
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 CGA Group 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 Commercial Guaranty
Assurance to mitigate risks related to its exposure in connection with
guarantees of two credit facilities for St. George Investments I, Ltd. and St.
George Investments III, Ltd. which are used to purchase asset backed and real
estate backed securities. As a result of turmoil in the capital markets during
the month of October 1998, the spreads over treasuries at which investors were
11
<PAGE>
willing to purchase many asset-backed, mortgage-backed and other debt 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
approved 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 Commercial Guaranty Assurance to pay any
remaining balance outstanding under the credit facility. On October 30, 1998
Commercial Guaranty Assurance provided asset specific guarantees and obtained
"cut-through" reinsurance on approximately $382 million par amount of securities
within the two insured investment portfolios. The three parties that provided
this reinsurance and credit support are institutional investors in CGA Group.
The effect of this reinsurance and 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, Commercial Guaranty Assurance received a premium of $38.95 million
from the clients, and ceded an aggregate of $38.7 million to the reinsurer that
provided the cut-through credit enhancement. On April 14, 1999, these credit
support arrangements were cancelled and approximately $29.5 million of premium
was refunded to the clients.
The amount of Commercial Guaranty Assurance'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:
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 --
Real estate investment trust 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%
=== ===
During 1998 the par value of CGA Investment Management's assets under
management increased from $199 million to over $1.8 billion. CGA Investment
Management generally earns a management fee of .25% per annum on the average
market value of the assets under its management. CGA Investment Management 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,
Commercial Guaranty Assurance 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.
12
<PAGE>
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 CGA Investment
Management's clients totaling $1.6 million, and professional fees of $1.3
million.
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 CGA Group to expense
organization costs as incurred. CGA Group 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
CGA Group has two reportable segments, Commercial Guaranty Assurance and
CGA Investment Management. Commercial Guaranty Assurance issues financial
guaranty insurance policies and CGA Investment Management provides investment
management and advisory services. The tables below presents selected financial
information for each of the operating segments:
As of and for the three months ended June 30, 1999:
<TABLE>
<CAPTION>
CGA CGAIM OTHER(a) TOTAL
------------- ------------- ------------- -------------
REVENUES
<S> <C> <C> <C> <C>
Net premiums earned ...... $ 6,547,542 $ -- $ -- $ 6,547,542
Net investment income .... 3,769,116 39,948 210,660 4,019,724
Net realized gains ....... 130,880 -- -- 130,880
Management fees .......... -- 1,624,055 -- 1,624,055
Intersegment revenue ..... -- 118,789 118,356 237,145
-------------
TOTAL REVENUES ........... 12,559,346
EXPENSE ITEMS
Operating expenses ....... 735,090 5,250,217 767,018 6,752,325
Acquisition costs ........ 315,254 -- -- 315,254
Commitment fees .......... 300,000 -- -- 300,000
Excess of loss facility .. 100,000 -- -- 100,000
Losses and loss adjustment
expenses ............... 7,750,000 -- -- 7,750,000
------------- ------------- ------------- -------------
TOTAL EXPENSES ........... -- 15,217,579
NET INCOME ............... 1,247,789 (3,468,021) (438,001) (2,658,233)
ASSETS
Total Assets ............. 186,579,341 2,922,421 31,070,141 220,571,903
============= ============= ============= =============
</TABLE>
- ----------
(a) The "other" segment is comprised of CGA Group, the holding company, which
does not meet any of the quantitative thresholds for determining a
reportable segment.
13
<PAGE>
<TABLE>
<CAPTION>
As of and for the three months ended June 30, 1998:
CGA CGAIM OTHER TOTAL
------------ ------------ ------------- -------------
REVENUES
<S> <C> <C> <C> <C>
Net premiums earned ................................... $ 2,720,476 $ -- $ -- $ 2,720,476
Net investment income ................................. 4,134,921 14,429 63,545 4,212,895
Net realized gains .................................... 552,381 -- -- 552,381
Management fees ....................................... -- 681,995 -- 681,995
------------- ------------- ------------- -------------
TOTAL REVENUES ........................................ 8,167,747
EXPENSE ITEMS
Operating expenses .................................... 627,472 5,838,139 971,927 7,437,538
Acquisition costs ..................................... 145,587 -- -- 145,587
Commitment fees ....................................... 297,534 -- -- 297,534
Excess of loss facility ............................... 100,000 -- -- 100,000
Losses and loss adjustment
expenses ............................................ 600,000 -- -- 600,000
------------- ------------- ------------- -------------
TOTAL EXPENSES ........................................ 8,580,659
NET INCOME ............................................ 5,637,185 (5,165,637) (884,460) (412,912)
ASSETS
Total assets .......................................... 137,813,058 2,278,891 10,777,343 150,869,292
============= ============= ============= =============
As of and for the year ended December 31, 1998.
<CAPTION>
COMMERCIAL CGA
GUARANTEE INVESTMENT
ASSURANCE MANAGEMENT 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, the holding company, which
does not meet any of the quantitative thresholds for determining a
reportable segment.
14
<PAGE>
As of and for the nine months ended December 31, 1997.
<TABLE>
<CAPTION>
COMMERCIAL CGA
GUARANTEE INVESTMENT
ASSURANCE MANAGEMENT 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>
LIQUIDITY AND CAPITAL RESOURCES
The Company capitalized Commercial Guaranty Assurance with $125 million.
On March 31, 1999, CGA Group contributed an additional $27.2 million to
Commercial Guaranty Assurance using proceeds from the sale of CGA Group's Series
C preferred stock. Alliance Capital Management Corporation manages Commercial
Guaranty Assurance'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. CGA Investment Management was initially
capitalized with $3 million. It has required funding from CGA Group since its
commencement of operations totaling $11.5 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.
June 30, 1999
On a consolidated basis, CGA Group used $9.6 million of cash from
operating activities during the six months ended June 30, 1999, compared to
generating $0.5 million for the six months ended June 30, 1998. CGA Group would
have generated $4.2 million from operating activities during the six months
ended June 30, 1999 if the payments related to the Commercial Financial Services
securities had not been incurred.
CGA Group applied $25.1 million of net cash to investing activities during
the six months ended June 30, 1999, compared to $3.3 million in the first six
months of 1998. Cash flows from financing activities in the six months ended
June 30, 1999 resulted from the sale of Series C preferred stock, which raised
net proceeds of $50.9 million.
On April 14, 1999, the credit support arrangements referred to in footnote
6 to the March 31, 1999 financial statements were terminated in their entirety.
In connection with this termination, two subsidiaries of St. George Holdings
received a refund of premium totaling approximately $29.5 million. On April 16,
1999 a portion of these funds were used to repay the $25 million note to
Commercial Guaranty Assurance referred to in footnote 3 to the March 31, 1999
financial statements. Also on April 16, 1999 the $5 million note payable by
Cobalt Holdings to Commercial Guaranty Assurance was sold by Commercial Guaranty
Assurance to CGA Group. The effect of these transactions was to increase claims
paying resources at Commercial Guaranty Assurance by $30 million.
On April 26, 1999, CGA Group sold 973,483 shares of its Series C preferred
stock to employees of CGA Group and its subsidiaries. CGA Group sold the shares
for $1.20 each, for total proceeds of $1.2 million. The shares were 90% financed
by CGA Group at 7% per annum with equal principal installments due annually over
a three-year period commencing April 26, 2000.
CGA Group does not expect to pay cash dividends to its shareholders.
Commercial Guaranty Assurance's Board of Directors has passed a resolution that
Commercial Guaranty Assurance will not declare or pay cash dividends
15
<PAGE>
during its first five years of operations. After this five-year period,
Commercial Guaranty Assurance intends to comply with dividend restrictions, if
any, imposed by Duff & Phelps subject to covenants contained in the subscription
agreements for the various classes of CGA Group's stock. In addition, Commercial
Guaranty Assurance's dividend payments are subject to limitations under
Bermudian insurance regulations that require minimum solvency margins and
liquidity ratios.
Commercial Guaranty Assurance monitors its exposure on a routine basis and
stays in close contact with Duff & Phelps to ensure that its "Triple-A" rating
is maintained. Commercial Guaranty Assurance has a $20 million excess of loss
reinsurance facility agreement and can also arrange reinsurance on an as needed
basis to manage its exposure. CGA Group also has commitments which expire June
17, 2002, from several of its 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 Commercial Guaranty Assurance. The commitments must be funded in the
event that Duff & Phelps notifies CGA Group at least 45 days prior to June 17,
2002 that Commercial Guaranty Assurance's rating will otherwise be downgraded
below a "Triple-A" rating.
December 31, 1998
On a consolidated basis, CGA Group 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 CGA Group moving from the start-up phase
of operations during 1997 to producing cash flow from premiums and management
fees during 1998.
CGA Group 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 CGA Group 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 Commercial Guaranty Assurance'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 CGA Group's private placement offering.
YEAR 2000
CGA Group's primary uses of software systems are for corporate and
investment portfolio accounting, as well as investment underwriting and
analysis. CGA Group's current systems have recently been purchased or leased as
CGA Group commenced operations in June 1997 and are believed to be Year 2000
compliant. Therefore, CGA Group believes that the risk of Year 2000 compliance
is not significant as it relates to its computer software systems. CGA Group has
incurred no material costs to date and expects to incur no material costs in the
future to make its systems Year 2000 compliant.
CGA Group is also in the process of reviewing its exposure to Year 2000
issues resulting from its customers' and vendors' computer systems. CGA Group
has contacted its customers and vendors regarding the state of their remediation
activities for material Year 2000 issues. CGA Group does not expect that there
will be material disruptions to its business or material costs associated with
any Year 2000 disruption by its customers and vendors. However, the cost and
timing of third party Year 2000 compliance is not within CGA Group's control and
no assurances can be given with respect to the cost or timing of these efforts
or the potential effects of any failure to comply. CGA Group will continue to
monitor Year 2000 compliance and formal contingency plans will be formulated if
CGA Group identifies specific areas where there is a substantial risk of Year
2000 problems occurring. No specific areas are identified as of this date.
RECENT ACCOUNTING PRONOUNCEMENTS
On June 15, 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standard No. 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. CGA Group does not believe the application of SFAS 133 will have a
material effect on its consolidated financial statements.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
RISK MANAGEMENT
In the ordinary course of business, CGA Group, through its subsidiaries,
manages a variety of risks. Of these, the primary risk is the credit risk taken
by Commercial Guaranty Assurance in respect of obligations insured by it. Other
16
<PAGE>
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.
CREDIT RISK
The most significant risk to which CGA Group 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 Commercial Guaranty Assurance, but
also in connection with counterparties to interest rate and currency swaps,
credit derivatives, and liquidity providers.
The primary credit risk to which Commercial Guaranty Assurance 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, Commercial Guaranty Assurance 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 of these payments. In the
event the issuer of a Commercial Guaranty Assurance-insured security defaults on
its payment obligations, under its policy Commercial Guaranty Assurance would be
obligated to make all scheduled payments when due for payment. Under its
insurance policies, Commercial Guaranty Assurance 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, Commercial
Guaranty Assurance 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 Commercial Guaranty Assurance.
CREDIT DERIVATIVES
Commercial Guaranty Assurance has exposure to counterparties in respect of
credit derivatives, as described below. Commercial Guaranty Assurance has
entered into default swaps in respect of many of its sovereign and corporate
exposures. Commercial Guaranty Assurance has also guaranteed the payment
obligations of subsidiaries of St. George Holdings and Cobalt Holdings under
default swaps and total rate of return swaps which have been entered into by
these vehicles.
Default Swaps
Default swaps are credit derivatives which enable the owner of a security
to transfer credit risk to another party. Commercial Guaranty Assurance has
entered into default swaps directly with banks and investment banks and has also
guaranteed the obligations of certain subsidiaries of St. George Holdings and
Cobalt Holdings under 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:
o bankruptcy,
o failure to pay,
o repudiation,
o restructuring, and
o cross default or cross-acceleration.
If a credit event occurs, Commercial Guaranty Assurance generally would be
obligated to purchase the reference security at par plus accrued interest. In
some cases, Commercial Guaranty Assurance would have the additional option of
cash settlement, whereby Commercial Guaranty Assurance 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:
o credit risk--a loss may be incurred following a credit event in respect of
the underlying or reference security;
o 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;
o counterparty bankruptcy risk--from Commercial Guaranty Assurance's
perspective, the counterparty's fixed payments would no longer be received;
however, the swap would terminate and Commercial Guaranty Assurance would
no longer have the credit exposure to the reference security;
17
<PAGE>
o liquidity risk--if a credit event occurs, Commercial Guaranty Assurance
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
o 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 Commercial Guaranty Assurance may not be able to do in the required
time period.
Total Rate of Return Swaps
Total rate of return swaps are credit derivatives that are used by
subsidiaries of St. George 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 total rate of return swap's term (typically one year),
the investment vehicle must purchase the underlying bond at the "notional",
which is the amount that had been financed less any principal payments received.
Any market value appreciation or decline is for the investment vehicle's
account.
These swaps are either provided by investment banks selling the bond or
through a swap line provided by institutional lenders to St. George Holdings and
Cobalt Holdings. The total rate of return swap counterparty benefits from a
Commercial Guaranty Assurance 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 Standard & Poor's or Moody's for eligible counterparties.
There are three principal risks associated with total rate of return
swaps:
o 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;
o market value risk--many total rate of return swaps (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
o 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, Commercial Guaranty Assurance would typically guarantee
any payment default by St. George Holdings, Cobalt Holdings or other investment
vehicle under the total rate of return swap, and would thus be liable to cover
any payment default by the investment vehicle under the total rate of return
swap.
LIQUIDITY
The liabilities of many Commercial Guaranty Assurance-insured investment
vehicles (e.g., the subsidiaries of St. George Holdings) do not provide term
funding for the assets owned by these vehicles. This could result in incremental
exposure to Commercial Guaranty Assurance 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. This inability
to refinance could result in a claim against Commercial Guaranty Assurance in
the amount of the market value loss.
As loans, notes and total rate of return swaps (liabilities) of the
Commercial Guaranty Assurance guaranteed investment vehicles mature, the
investment vehicle will attempt to refinance the liability with the existing
lender or issue a new Commercial Guaranty Assurance-insured liability to
refinance the maturing liability. In vehicles such as the subsidiaries of St.
George Holdings, if the 364-day facility is not renewed, the facility will
become a four-year term loan with 25% annual amortization. Currently, for St.
George Investment I (since the facility was not refinanced and 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.
Commercial Guaranty Assurance remains liable for current interest and principal
when due in accordance with the stated amortization schedule on such term loan.
18
<PAGE>
In the event a Commercial Guaranty Assurance-insured liability cannot be
issued to refinance a maturing liability, Commercial Guaranty Assurance will
(a) direct the investment vehicle to sell the related asset with or without
Commercial Guaranty Assurance insurance or
(b) attempt to arrange for the purchase of the asset by another Commercial
Guaranty Assurance-insured investment vehicle. Refinance options for
maturing total rate of return swap include:
(c) refinance or "term out" the full amount of the maturing total rate of
return swap with the existing total rate of return swap counterparty;
(d) refinance the maturing total rate of return swap with the existing total
rate of return swap counterparty or new counterparty at the related
security's market value;
(e) sell the asset with or without a Commercial Guaranty Assurance guaranty;
and
(f) attempt to arrange for the purchase of the asset by another Commercial
Guaranty Assurance-insured investment vehicle. In the case of (b), (c) and
(d), Commercial Guaranty Assurance would be liable for any market value
shortfall not otherwise covered by the terms of the refinancing.
CGA Group had exposure totaling approximately $425 million related to the
timely payment of interest and principal on a loan to St. George Investment I.
The loan is payable in four equal annual installments with the first installment
due November 11, 1999. In order to meet this obligation, CGA Investment
Management, as the advisor to St. George Investments I, advised St. George
Investments I to sell a portion of the underlying securities to special purpose
vehicles that will repackage the securities as follows. Underlying securities
were sold to two newly organized special purpose vehicles, financed by three
classes of certificates. The two most senior classes of certificates,
representing approximately 84% of the total, were purchased by a third party who
is also an institutional investor in CGA Group. CGA Group issued a 5.9% pool
policy related to the underlying pool of securities. This transaction closed in
April, 1999. The proceeds from this sale were sufficient to meet St. George
Investments I's obligations due in November, 1999.
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. The 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. Interest rate swaps
of this type 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. CGA Group 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 investment portfolios of the St. George Holdings and
Cobalt Holdings subsidiaries. Credit derivative contracts with market value
triggers are also subject to credit spread risk.
The following hold true for spread volatility:
o the shorter life of the asset, the lower the credit spread volatility;
o higher rated assets have lower credit spread volatility than lower rated
assets; and
o 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:
o underlying changes in the credit quality of the securities;
o supply/demand equation; and
o 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. CGA Investment Management manages the
19
<PAGE>
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. CGA Investment Management monitors the interest rate risks as agreed
with each client and set forth in the investment guidelines for that client.
Under the client's investment guidelines, each client's investment portfolio
must be managed so as to remain within the parameters of its market risk
category.
Interest Rate Swaps
Commercial Guaranty Assurance-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 Commercial Guaranty Assurance exposed to the marked-to-market
value of the interest rate swap. In general, the investment guidelines for the
St. George and Cobalt investment vehicles require that swap counterparties be
rated not less than "Single-A" by one or more nationally recognized credit
agencies. Several 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.
CGA Group applies a stressed (3-Sigma) expected mark-to-market approach and
aggregates counterparty risks across the Commercial Guaranty
Assurance-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.
Most of the long dated interest rate swaps to which the St. George and
Cobalt investment vehicles 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,
Commercial Guaranty Assurance-guaranteed vehicles have over $700 million of long
dated interest rate swaps with this type of provision.
Spread Deterioration Risk
Several 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 these vehicles' increased funding cost due to
excessive widening of asset-backed commercial paper rates, Commercial Guaranty
Assurance would generally be liable for any shortfall pursuant to the insurance
issued by it.
20
<PAGE>
REINSURANCE
In the ordinary course of its business, Commercial Guaranty Assurance 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 Commercial Guaranty Assurance under these reinsurance
arrangements, Commercial Guaranty Assurance would be liable for such defaulted
amounts. Commercial Guaranty Assurance's exposure to reinsurers was $607.18
million as of December 31, 1998. All of this exposure is with counterparties
which are institutional shareholders (or affiliates of institutional
shareholders) of CGA Group.
Commercial Guaranty Assurance 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. CGA Group and its
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 CGA Group's and its subsidiaries'
counterparties, including contractual provisions intended to reduce exposure by
providing for the offsetting or netting of mutual obligations. CGA Group seeks
to remove or minimize these 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.
CGA GROUP, LTD.
Organized on June 21, 1996 and operating since June 17, 1997, we are a
Bermuda holding company that provides financial guaranty insurance of structured
securities, including commercial real estate backed securities and asset-backed
securities through our primary and wholly-owned subsidiary, Commercial Guaranty
Assurance. We also provide financial guaranty insurance of other securities,
where our senior management team has expertise and credit enhancement
opportunities are deemed attractive.
We also provide investment management and investment advisory services to
investment vehicles and other clients. These services are provided through our
other wholly-owned subsidiary, CGA Investment Management, a Delaware corporation
that is registered as an investment adviser with the Securities and Exchange
Commission under the Investment Advisors Act of 1940, as amended.
The primary clients of Commercial Guaranty Assurance and CGA Investment
Management are St. George Holdings, a Cayman Islands company, and its
subsidiaries and Cobalt Holdings, a Delaware limited liability corporation, and
its subsidiaries. In 1998 the St. George and Cobalt entities provided
approximately 85% of the total premiums earned by Commercial Guaranty Assurance,
and 91% of the total investment management fees earned by CGA Investment
Management. We expect these percentages to decrease in the future.
We formed CGA Group with a view to becoming the market leader in the
commercial real estate segment of the financial guaranty industry. We utilize
our structured finance and real estate expertise to underwrite financial
21
<PAGE>
guaranties for commercial real estate and other securities to a zero loss
underwriting standard. Our primary target market is the large U.S. commercial
real estate mortgage market, which we believe is underserved. We also targets
select segments of the private asset-backed securities market.
Customers can purchase Commercial Guaranty Assurance's insurance only
through unaffiliated non-U.S. insurance brokers. Customers include investment
and commercial banks with significant real estate and asset-backed advisory
businesses, and commercial mortgage loan origination and asset-backed
repackaging operations and other participants in the securitization markets.
FINANCIAL GUARANTY INSURANCE PRODUCTS
Commercial Guaranty Assurance offers four defined product applications
within its primary markets. Within the commercial real estate and asset-backed
markets, We have 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--Commercial Guaranty Assurance insures securities owned
by investment companies (including the St. George and Cobalt
investment vehicles), trusts, conduits or other funds, providing the
insured with the ability to efficiently finance its operations at AAA
rates.
o New Issue Guaranty--Commercial Guaranty Assurance is involved in the
structuring and guaranteeing of new debt securities including
commercial mortgage-backed securities, asset-backed securities,
corporate and government obligations. As securities insured by
Commercial Guaranty Assurance 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--Commercial Guaranty Assurance, 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 Commercial Guaranty Assurance-insured security holders.
o Portfolio Guaranty--Commercial Guaranty Assurance 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 our business strategy in the commercial real estate (including
real estate investment trust) and asset-backed insurance markets, we function
through our subsidiaries as both financial guarantor and as an investment
manager to the St. George and Cobalt investment vehicles and other investment
companies. The St. George and Cobalt investment vehicles purchase securities of
the type that Commercial Guaranty Assurance would be willing to insure. We
expect that by guaranteeing these investment vehicles' financing obligations
secured by the securities purchased by the St. George and Cobalt investment
vehicles in the secondary market, Commercial Guaranty Assurance will be able to
rapidly grow its insured book of business. Commercial Guaranty Assurance has
issued insurance policies which guarantee the payment obligations of the St.
George and Cobalt investment vehicles under their respective financing
arrangements. See below under "CGA Investment Management, Inc.--St. George and
Cobalt."
OVERVIEW OF THE SUBSIDIARIES
Commercial Guaranty Assurance focuses on CGA Group's primary business of
issuing financial guaranty insurance policies, while CGA Investment Management
provides services of investment and collateral management and financial advisory
services including transaction structuring advice.
The main office address of CGA Group and Commercial Guaranty Assurance is
Craig Appin House, 8 Wesley Street, Hamilton HM 11 Bermuda. The main office
address of CGA Investment Management is 17 State Street, New York, New York
10004.
COMMERCIAL GUARANTY ASSURANCE, LTD.
Commercial Guaranty Assurance is an insurance company incorporated on
October 22, 1996 in Bermuda with limited liability. Commercial Guaranty
Assurance commenced operations in June 1997 and is licensed as a Class 3
22
<PAGE>
insurer under the Insurance Act 1978 of Bermuda. Commercial Guaranty Assurance's
claims-paying ability has been rated "Triple-A" by Duff & Phelps Credit Rating
Company, the highest rating assigned by Duff & Phelps. Commercial Guaranty
Assurance's claims-paying ability 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. Commercial Guaranty Assurance
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 Commercial Guaranty Assurance's credit rating is
"Triple-A", all securities and other obligations guaranteed by it are rated
"Triple-A" by Duff & Phelps and, if applicable, Dominion Bond Ratings Service
and Canadian Bond Ratings Service.
Commercial Guaranty Assurance's "Triple-A" rating is supported by an
aggregate of approximately $224 million in claims-paying resources (as of June
30, 1999), consisting of
o approximately $144 million in statutory capital;
o an irrevocable capital commitment on the part of the holders of CGA
Group's Series B preferred stock to purchase an aggregate of $60
million in additional equity securities of CGA Group in the event Duff
& Phelps requires this commitment to be funded in order for Commercial
Guaranty Assurance to maintain its "Triple-A" rating (for a
description of the capital commitment, see Item 12-- "Security
Ownership of Certain Beneficial Owners and Management"); and
o a $20 million excess of loss insurance policy provided by KRE
Reinsurance Ltd., an affiliate of Capital Reinsurance Company (a
shareholder of CGA Group).
On March 31, 1999, CGA Group sold 43,997,863 shares of its Series C
convertible preferred stock to existing investors for net cash proceeds of
$50,996,794.50. CGA Group used approximately $27.2 million of the net proceeds
of the sale to make a capital investment in Commercial Guaranty Assurance, which
capital investment increased Commercial Guaranty Assurance's claims-paying
resources by a corresponding amount.
As a Bermuda domiciled insurance company, Commercial Guaranty Assurance
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.
Commercial Guaranty Assurance'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, Commercial Guaranty
Assurance take place in Bermuda or other locations outside of the United States.
CREDIT ENHANCEMENT BUSINESS
Commercial Guaranty Assurance'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. Commercial Guaranty Assurance primarily insures investment grade
securities in the commercial real estate and asset backed securities markets. It
also insures the liabilities of investment vehicles which invest in structured
securities, including asset-backed securities, commercial mortgage-backed
securities, mortgage backed securities 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 a security defaults on its payment
obligations, the financial guarantor makes the scheduled payments. In this
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 noncancelable.
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 the sum of (a) the annual premium charged to upgrade
23
<PAGE>
the security to "Triple-A" plus (b) 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.
One of Commercial Guaranty Assurance's primary target markets is investment
vehicles which purchase structured securities. Therefore, a substantial portion
of Commercial Guaranty Assurance's guaranty business is generated from advisers
to these types of investment vehicles. These policies typically guaranty the
liabilities issued by the investment vehicle. In these cases, and as a condition
to issuing its policy, Commercial Guaranty Assurance will generally require that
the investment vehicle adopt investment guidelines acceptable to Commercial
Guaranty Assurance.
ZERO-LOSS UNDERWRITING STANDARD
Commercial Guaranty Assurance underwrites all risks insured by it to a
"zero loss" standard--that is, obligations insured by Commercial Guaranty
Assurance are required to be structured with sufficient levels of excess
collateral or other security so that Commercial Guaranty Assurance, to a high
degree of certainty, anticipates no losses on each risk insured without regard
to the premium collected on the policies or the investment income related to the
premiums collected. To this end, each policy written by Commercial Guaranty
Assurance is required to meet the criteria specified in the underwriting
guidelines adopted by its board of directors. Commercial Guaranty Assurance 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 Commercial Guaranty Assurance will not incur losses
with respect to these insured obligations.
Commercial Guaranty Assurance's underwriting guidelines are intended to
provide multiple layers of loss protection. Notes or structured securities
insured by Commercial Guaranty Assurance 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 Commercial Guaranty Assurance against losses. Overcollateralization
or third-party protections may not, however, be required in transactions in
which Commercial Guaranty Assurance is insuring the obligations of highly rated
issuers that typically are regulated or have implied or explicit government
support, or sovereign credits.
Commercial Guaranty Assurance manages its exposure on an ongoing basis and
is closely monitored by Duff & Phelps, Dominion Bond Ratings Service and
Canadian Bond Rating Service to ensure that it is operating in a manner
consistent with its "Triple-A" rating.
INVESTMENT PORTFOLIO
Commercial Guaranty Assurance invests its capital, premiums received from
its insurance business, and earnings on premiums in an investment portfolio.
This investment portfolio is Commercial Guaranty Assurance's primary source of
claims-paying ability. Commercial Guaranty Assurance 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. Commercial Guaranty
Assurance's investment guidelines are consistent with these objectives.
All of Commercial Guaranty Assurance'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 the disposition will not adversely affect the investment portfolio.
Commercial Guaranty Assurance'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 it would generate U.S. source income to Commercial
Guaranty Assurance.
24
<PAGE>
The investment manager for Commercial Guaranty Assurance is Alliance
Capital Management Corporation. Subject to the investment guidelines determined
by Commercial Guaranty Assurance's board of directors, Alliance Capital has
discretion to, among other things, buy, sell, retain, or exchange investments.
Alliance Capital has entered into an investment management agreement with
Commercial Guaranty Assurance, which is terminable by either party upon 30 days'
written notice.
The following tables summarize Commercial Guaranty Assurance's investments
by country and by type of debt security, in each case as of December 31, 1998:
COUNTRY PERCENTAGE TYPE PERCENTAGE
------- ---------- ---- ----------
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 December 31, 1998.
CLAIMS
Even though all risks insured by Commercial Guaranty Assurance are
underwritten to a "zero loss" standard, Commercial Guaranty Assurance is
prepared to deal with claims if any should materialize. Commercial Guaranty
Assurance'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. Commercial Guaranty
Assurance would monitor the progress and ultimate outcome of claims to ensure
that subrogation, salvage and other cost recovery opportunities are fully
explored. Commercial Guaranty Assurance 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, Commercial Guaranty
Assurance may supplement its in-house capabilities in this regard with services
available from other sources. Commercial Guaranty Assurance monitors its
exposure to insured credits on an ongoing basis. In this regard, Commercial
Guaranty Assurance 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
Commercial Guaranty Assurance 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 Commercial Guaranty Assurance.
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 the time that 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. Commercial Guaranty
25
<PAGE>
Assurance reviews its estimates on an ongoing basis and, as experience develops
and new information becomes known, Commercial Guaranty Assurance 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 CGA Group's
earnings would be made in its financial statements for the period in which the
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.,
a credit-card debt collection company, were withdrawn by the three credit rating
companies that rate the securities issued by the trusts. The withdrawal of these
ratings was in response to allegations of accounting and other irregularities at
Commercial Financial Services (CFS). The rating agencies, investors and
insurers, as well as the Securities and Exchange Commission, have commenced an
investigation into these allegations. Clients of Commercial Guaranty Assurance
own approximately $199 million par amount of CFS securities, which exposure has
been guaranteed by Commercial Guaranty Assurance. Commercial Guaranty Assurance
has reinsured approximately $152 million par amount of this exposure, leaving
Commercial Guaranty Assurance with a net exposure of approximately $46.7 million
par amount as of April 30, 1999. Commercial Guaranty Assurance 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 above), Commercial Guaranty
Assurance is generally not required to establish contingency reserves. If
Commercial Guaranty Assurance were to assume reinsurance from a U.S. domiciled
financial guaranty insurer, then Commercial Guaranty Assurance would be required
to maintain contingency reserves, which would be maintained as part of its
general reserves. See "Regulation."
REINSURANCE
On a case by case basis, Commercial Guaranty Assurance may arrange
reinsurance with high quality and financially strong reinsurers. To the extent
that Commercial Guaranty Assurance utilizes reinsurance, it has given Capital
Reinsurance Company, a financial guarantor rated "Triple-A" by Standard & Poor's
Ratings Services and FitchIBCA, Ltd., and Aa2 by Moody's Investors Service, a
right of first offer to provide this reinsurance. The reinsurance of risk does
not relieve Commercial Guaranty Assurance of its original liability to its
policyholders. In the event that a reinsurer was unable to meet its obligations
under a reinsurance contract, Commercial Guaranty Assurance would be liable for
the defaulted amounts.
Commercial Guaranty Assurance has entered into an excess of loss
reinsurance facility agreement in 1997 with KRE Reinsurance Ltd., an affiliate
of Capital Reinsurance Company rated AA by Standard & Poor's 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 Commercial Guaranty Assurance from its inception.
During October, 1998, Commercial Guaranty Assurance took steps to mitigate
risks related to its exposure in connection with guarantees of several client
credit facilities used to purchase asset-backed and real estate backed
securities. As a result of turmoil in the capital markets during this time
period, the spreads over treasuries at which investors were willing to purchase
many types of 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. Many credit facilities
have requirements that lenders' operating ratios, (the portfolio market value
divided by the amount of the loan outstanding) be maintained above approved
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 Commercial Guaranty Assurance to pay any
remaining balance outstanding under the credit facility.
On October 30, 1998, Commercial Guaranty Assurance 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 and St. George Investments III.
The three parties which provided this credit support are institutional investors
in CGA Group. The effect of this third-party credit
26
<PAGE>
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, Commercial Guaranty Assurance 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. Commercial
Guaranty Assurance loaned an aggregate of $30 million to St. George Holdings,
the parent corporation of St. George Investments I and St. George Investments
III) and Cobalt Holdings in order to permit them to provide their subsidiaries
with sufficient funds to pay the premium for such credit support, and to meet
such clients' ongoing liquidity needs. This loan reduced Commercial Guaranty
Assurance's claims-paying resources by $30 million. As a result of these
arrangements, St. George Investments I and St. George Investments III were and
remain to date in full compliance with all loan to value covenants set out in
these companies' credit facilities. On April 14, 1999, these credit support
arrangements were terminated in their entirety. In connection with this
termination, two subsidiaries of St. George Holdings received a refund of
premium totaling approximately $29.5 million. On April 16, 1999, a portion of
these funds was used to repay the $25 million note to Commercial Guaranty
Assurance. Also on April 16, 1999, the $5 million note payable by Cobalt
Holdings to Commercial Guaranty Assurance was assigned by Commercial Guaranty
Assurance to CGA Group. The effect of these transactions was to increase
claims-paying resources at Commercial Guaranty Assurance by $30 million.
CGA Group had exposure totaling approximately $425 million related to the
timely payment of interest and principal on a loan to St. George Investments I.
The loan is payable in four equal annual installments with the first installment
due November 11, 1999. In order to meet this obligation, CGA Investment
Management, as the advisor to St. George Investments I, advised St. George
Investments I to sell a portion of the underlying securities to special purpose
vehicles that will repackage the securities as follows. Underlying securities
were sold to two newly organized special purpose vehicles, financed by three
classes of certificates. The two most senior classes of certificates,
representing approximately 84% of the total, were purchased by a third party who
is also an institutional investor in the CGA Group. CGA Group issued a 5.9% pool
policy related to the underlying pool of securities. This transaction closed in
April, 1999. The proceeds from this sale were sufficient to meet St. George
Investments I's obligations due in November, 1999.
INSURANCE IN FORCE
The following table shows Commercial Guaranty Assurance'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>
Asset-backed securities
(Consumer) $ 456,521,235 29% AAA $ 58,203,887 4%
Asset-backed securities
(Corporate) 345,612,368 22% AA 39,454,116 3%
Commercial mortgage-
backed securities 185,753,755 12% A 180,310,840 12%
Real estate investment
trust debt 381,777,437 24% BBB 1,049,028,508 67%
Real estate investment
trust preferred stock 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.
CGA Investment Management is a Delaware corporation that is registered as
an investment adviser with the Commission under the Investment Advisors Act of
1940, as amended. CGA Investment Management, 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. CGA Investment Management'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
CGA Investment Management acts as investment manager and/or collateral
manager to specialized investment vehicles and other clients, including St.
George Holdings, Cobalt Holdings, and their respective subsidiaries. Its
27
<PAGE>
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. CGA Investment Management
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 CGA Investment Management manages its clients'
assets under agreed upon guidelines and limits.
CGA Investment Management also acts as a financial adviser for its clients,
which include issuers and investment banks, in evaluating structured finance
alternatives and financing structures. CGA Investment Management'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
CGA Investment Management acts as investment manager and/or collateral
manager to specialized finance vehicles, including St. George Holdings, Cobalt
Holdings and their respective subsidiaries, which invest primarily in structured
fixed income securities. In so acting, CGA Investment Management's duties
include some or all of the following:
o 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 related documentation.
o 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.
o Negotiating financing arrangements on behalf of its clients.
o Preparing valuations, reports and other documents as may be required
from time to time by its clients and persons providing financing to
these clients in order to determine compliance with the clients' and
their lenders' policies and procedures.
o Analyzing the performance of assets including recommending the sales
of investments when appropriate.
Initial and ongoing credit reviews are performed by CGA Investment
Management on
o the assets which CGA Investment Management recommends for purchase to
its investment management clients; and
o the counterparties with which CGA Investment Management negotiates
financial hedges or derivative contracts on behalf of its clients.
CGA Investment Management performs market risk management (i.e., interest
rate and currency risk) and operations using systems which integrate front,
middle and back office applications with live feeds from market information
services. CGA Investment Management has developed policies and procedures to
ensure that it manages its clients' assets under agreed upon guidelines and
limits.
FINANCIAL ADVISORY SERVICES
CGA Investment Management 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. CGA Investment
Management charges advisory fees to its clients for its services. CGA Investment
Management's services as financial advisor include the following:
o providing assistance in evaluating, structuring and documenting
structured finance transactions (which could include the purchase of
credit enhancement provided by Commercial Guaranty Assurance); and
o providing assistance in organizing and performing due diligence
relating to financial assets and structured transactions.
28
<PAGE>
REGULATORY STATUS
CGA Investment Management 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
o governs fee arrangements between advisors and clients;
o prohibits fraudulent practices, prohibits the assignment of an
investment advisory contract without the client's consent;
o requires advisors to maintain books and records consistent with rules
that may be promulgated by the Securities and Exchange Commission; and
o authorizes the Securities and Exchange Commission to inspect these
books and records.
ST. GEORGE AND COBALT
St. George Holdings was incorporated in the Cayman Islands as a limited
liability corporation for the purpose of forming subsidiaries which invest in a
wide range of assets, including commercial mortgage-backed securities,
mortgage-backed securities, asset-backed securities and corporate securities.
Cobalt Holdings was organized as a Delaware limited liability company for the
purpose of forming subsidiaries which invest primarily in debt obligations,
preferred stock issued by real estate investment trusts, asset backed securities
backed by portfolios of credit card receivables and other fixed income
securities. The St. George and Cobalt entities fund their respective investment
portfolios through
o lending facilities provided by banks,
o loans provided by commercial paper conduit vehicles,
o the direct issuance of securities in the capital markets, and
o through synthetic purchase arrangements such as total rate of return
swaps, default swaps and repurchase agreements.
CGA Investment Management acts as asset manager for St. George Holdings,
Cobalt Holdings, and their respective subsidiaries. Commercial Guaranty
Assurance has issued insurance policies which guarantee the payment obligations
of the St. George and Cobalt entities under their respective financing
arrangements. These policies generally insure the prompt payment of interest
when due, and principal on maturity, of the respective security. We expect that
the payment obligations of any other subsidiaries of St. George Holdings and
Cobalt Holdings under their respective financing arrangements will similarly be
guaranteed by Commercial Guaranty Assurance.
29
<PAGE>
REGULATION
BERMUDA
THE INSURANCE ACT 1978 AND RELATED REGULATIONS
The Insurance Act 1978 of Bermuda, as amended, and related regulations,
which regulates the business of Commercial Guaranty Assurance, 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,
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 Insurance 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 specific types of insurance.
The registration of an applicant as an insurer is subject to its complying with
the terms of its registration and 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 Insurance 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 Commercial Guaranty
Assurance, are set forth below.
CLASSIFICATION OF INSURERS
The Insurance Act provides for four classes of registration of insurers
carrying on general business. Commercial Guaranty Assurance 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, Commercial Guaranty
Assurance 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 Insurance Act.
CANCELLATION OF INSURER'S REGISTRATION
An insurer's registration may be canceled by the Minister on grounds
specified in the Insurance Act, including failure of the insurer to comply with
its obligations under the Insurance 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, who is the chief administrative
officer under the Insurance 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
30
<PAGE>
normally be a qualified property/casualty actuary, must be approved by the
Minister. Commercial Guaranty Assurance has received an exemption from having to
appoint a loss reserve specialist and to file the annual loss reserve opinion on
the condition that Commercial Guaranty Assurance maintains its claims-paying
ability rating of not less than "Triple-A" by Duff & Phelps.
STATUTORY FINANCIAL STATEMENTS
An insurer must prepare annual statutory financial statements. The
Insurance Act prescribes rules for the preparation and substance of the
statutory financial statements (which include, in statutory form, a balance
sheet, an income statement, and a statement of capital and surplus, and detailed
notes to the statutory financial statements). 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. generally accepted accounting principles 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. generally accepted accounting principles.
Commercial Guaranty Assurance, 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 Insurance 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 Insurance 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 Commercial Guaranty
Assurance is limited under Bermuda insurance regulations. In accordance with
these regulations, Commercial Guaranty Assurance is prohibited from paying
dividends or other distributions unless after the payment the amount by which
its general business assets exceed its general business liabilities is the
greater of the following amounts:
(a) $1,000,000; or
(b) 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
(c) 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.
Commercial Guaranty Assurance 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 the dividend or distribution
Commercial Guaranty Assurance will continue to meet its minimum solvency margin
and minimum liquidity ratio as
31
<PAGE>
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 Commercial
Guaranty Assurance must apply to the Minister for his approval and is obliged to
provide any information in connection with the application as the Minister may
require.
In addition, the fiduciary obligations of members of the board of
directors to creditors, policyholders and shareholders apply to their votes in
respect of dividends, distributions and redemptions.
The above restrictions on distributions by Commercial Guaranty Assurance
to CGA Group will restrict the ability of CGA Group to use the proceeds of the
capital commitments to pay dividends to holders of CGA Group's securities,
because all proceeds from the capital commitments will be contributed by CGA
Group to Commercial Guaranty Assurance. For a description of the capital
commitments, see "Description of Securities".
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 the insurer'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 these types of 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 Commercial Guaranty Assurance is at Craig Appin House, 8 Wesley Street,
Hamilton HM 11 Bermuda and Geoffrey Kauffman, Commercial Guaranty Assurance's
President and Chief Underwriting Officer, is Commercial Guaranty Assurance'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 in this capacity, 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 this type
of "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.
OTHER BERMUDA LAW MATTERS
Although CGA Group and Commercial Guaranty Assurance are incorporated in
Bermuda, each is classified as non-resident of Bermuda for exchange control
purposes by the Bermuda Monetary Authority, Foreign Exchange Control. Because of
its non-resident status, CGA Group 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, CGA Group and Commercial Guaranty Assurance may
not, without the express authorization of the Bermuda legislature or under a
license granted by the Minister, participate in certain types of business
transactions, including:
o 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);
o the taking of mortgages on land in Bermuda in excess of $50,000; or
32
<PAGE>
o the carrying on of business of any kind in Bermuda, except in
furtherance of the business of CGA Group 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, CGA Group and Commercial Guaranty Assurance
are not currently subject to taxes on their income or dividends or to any
foreign exchange controls in Bermuda. In addition there currently is no capital
gains tax in Bermuda.
U.S. AND OTHER
Commercial Guaranty Assurance 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 Commercial Guaranty Assurance, which are not
authorized or admitted to do business within each jurisdiction. With some
exceptions, this type of sale of insurance within a jurisdiction where the
insurer is not admitted to do business is prohibited. We do not intend for
Commercial Guaranty Assurance 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 these activities would require that Commercial
Guaranty Assurance be so authorized or admitted.
We intend that Commercial Guaranty Assurance will not write insurance in
the U.S. We intend for Commercial Guaranty Assurance 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). We have developed operating
guidelines, which include the acceptance of business through insurance brokers
not resident in the U.S., to assist our personnel in conducting business in
conformity with the laws of U.S. jurisdictions. We intend to follow these
guidelines and expect that to the extent that these operating guidelines are
followed, our 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 our activities and claim that we are
subject to their 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
Commercial Guaranty Assurance, by direct placement. The premiums charged by
Commercial Guaranty Assurance do not include any state premium tax. Each insured
is responsible for determining whether it is subject to any state taxes and for
paying these taxes 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 Commercial Guaranty Assurance are currently 4% for insurance premiums
and 1% for reinsurance premiums.
CGA Investment Management has been registered under the United States
Investment Advisers Act of 1940, as amended.
33
<PAGE>
MANAGEMENT
DIRECTORS AND OFFICERS OF THE COMPANY AND THE SUBSIDIARIES
The table below sets forth the names, ages (as of September 30, 1999) and
titles of the persons who are the members of the board of directors of CGA Group
and the executive officers of the CGA Group and its subsidiaries.
<TABLE>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
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 Commercial Guaranty Assurance
Geoffrey N. Kauffman ............................................ 41 President, Commercial Guaranty Assurance
Kem H. Blacker .................................................. 44 Managing Director and Chief Operating Officer,
CGA Investment Management
Michael M. Miran ................................................ 46 Managing Director and General Counsel,
CGA Investment Management
Jean-Michel Wasterlain .......................................... 42 Managing Director, CGA Investment
Management
Jay H. Shidler .................................................. 53 Chairman of the Board of Directors, CGA Group
David M. Barse .................................................. 37 Director, CGA Group
Robert L. Denton ................................................ 47 Director, CGA Group
Richard S. Frary ................................................ 52 Director, CGA Group
Eric A. Gritzmacher ............................................. 51 Director, CGA Group
Alan S. Roseman ................................................. 42 Director, CGA Group
Donald Kramer ................................................... 62 Director, CGA Group
Jeffrey P. Krasnoff ............................................. 44 Director, CGA Group
Michael J. Morrissey ............................................ 52 Director, CGA Group
F. Fuller O'Connor, Jr. ......................................... 39 Director, CGA Group
Paul A. Rubin ................................................... 36 Director, CGA Group
Jay S. Sugarman ................................................. 37 Director, CGA Group
</TABLE>
Our board of directors consists of thirteen members. The board has been
elected in accordance with our bylaws and holds office until the next annual
general meeting of the shareholders of CGA Group. Under our bylaws, the board of
directors has the following composition: the Chairman (currently Jay H.
Shidler), the Chief Executive Officer (currently Richard A. Price), the
Management Member (currently Robert L. Denton) and ten members elected by the
eligible shareholders. In connection with the sale of Series C preferred stock
on March 31, 1999, (see "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Subsequent Events"), 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 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 our bylaws, the board has established four committees. The
compensation committee is comprised of Donald Kramer, Alan S. Roseman (as
chairman), Paul A. Rubin and F. Fuller O'Connor, Jr., and is responsible for
determining compensation for the officers of CGA Group and its subsidiaries and
for authorizing and approving our employee benefits plans. The audit committee
reviews the adequacy and effectiveness of the external auditors and the audit
report, and is composed of Jeffrey P. Krasnoff (as chairman), Michael J.
Morrissey, Paul A. Rubin, Richard S. Frary and David M. Barse. The underwriting
committee is responsible for approving the credit underwriting guidelines for
Commercial Guaranty Assurance and is composed of Donald Kramer, Jay H. Shidler,
Jeffrey P. Krasnoff, Eric A. Gritzmacher (as chairman), F. Fuller O'Connor, Jr.,
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.
34
<PAGE>
The holders of the Series A preferred stock as a class may elect two
additional members of the board of directors if and so long as one or more of
the following events occurs:
o CGA Group fails to pay stock and/or cash dividends on the Series A
preferred stock or other preferred stock as required by it bylaws, or
fails to make payments on permitted debt, if any, and the aggregate
unpaid amounts exceed $5 million in value.
o CGA Group does not pay the redemption price and premium, if any, of
the Series A preferred stock when due.
o CGA Group's noncompliance with any of the restrictions, limitations
and covenants it made to the Series A investors in the Series A
subscription agreement for a period of 60 days after receiving notice
(from holders of 25% of the liquidation value of the Series A
preferred stock) of the noncompliance, unless compliance has been
waived by holders of 50% of the liquidation value of the Series A
preferred stock.
o CGA Group defaults in the performance of, or fails to comply with (and
does not cure within the applicable time period), any obligation
arising under any contract or instrument under which it has issued
preferred stock or incurred permitted debt, and under which the unpaid
amount exceeds $5 million.
o A court of competent jurisdiction enters one or more judgments or
orders against CGA Group, Commercial Guaranty Assurance or CGA
Investment Management in an uninsured aggregate amount over $10
million, and the judgment or order is not discharged, waived, stayed
or satisfied within 45 days, or is the subject of an ongoing appeal
and CGA Group is not obligated to pay the amount while the appeal is
pending.
o CGA Group, Commercial Guaranty Assurance or CGA Investment Management
files for or becomes subject to a bankruptcy, liquidation or
reorganization proceeding.
o Commercial Guaranty Assurance's claims paying ability rating is
downgraded below "Double-A minus" (AA-) by Duff & Phelps for a period
of 45 consecutive days.
CGA Group's bylaws contain provisions for the election of alternate directors.
BIOGRAPHICAL INFORMATION
RICHARD A. PRICE--Director, Chief Executive Officer and President of CGA
Group since July 5, 1996. Until July, 1996, Mr. Price was one of the top
executives at Financial Guaranty Insurance Company, 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. 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 General Electric Capital Corporation 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 asset-backed securities,
mortgage-backed securities 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 joining 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 School of Business.
JAMES R. REINHART--Chief Financial Officer of CGA Group and Commercial
Guaranty Assurance since January 1, 1997. Prior to joining CGA Group, 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
35
<PAGE>
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 Commercial Guaranty Assurance since
June 30, 1998, and Chief Underwriting Officer of Commercial Guaranty Assurance
from January 1, 1997. Prior to joining Commercial Guaranty Assurance, Mr.
Kauffman worked at AMBAC Financial Group, Inc., 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 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 CGA
Investment Management since January 1, 1997. For the twelve years prior to
joining CGA Investment Management, 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 guaranteed investment contract 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.
MICHAEL M. MIRAN--Managing Director and General Counsel of CGA Investment
Management since June 30, 1997. Prior to joining CGA Investment Management, 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, mortgage-backed securities and asset-backed securities 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 CGA Investment Management
since June 1, 1997. Mr. Wasterlain manages CGA Investment Management's real
estate group. Prior to joining CGA Investment Management, 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.
36
<PAGE>
JAY H. SHIDLER--Chairman of the Board of Directors of CGA Group 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 CGA Group 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 CGA Group 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 CGA Group from June 18, 1997 to March 31,
1999, and from September 10, 1999 to present. 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 CGA Group 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 CGA Group 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 President
and Chief Executive Officer 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 CGA Group 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 CGA Group since June 18, 1997. Mr.
Morrissey has served as the Chairman and Chief Executive Officer 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.
F. FULLER O'CONNOR, JR.--Director of CGA Group since September 10, 1999.
Since August 1996, Mr. O'Connor has served as Managing Director of Prudential
Securities, where he specializes in real estate investment banking. From August
1994 to August 1996, he served in the real estate finance group at Chase
Manhattan Bank, where he specialized in commercial mortgage backed securities.
ALAN S. ROSEMAN--Director of CGA Group 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 CGA Group 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.
JAY S. SUGARMAN--Director of CGA Group 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
37
<PAGE>
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.
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 CGA Group for services rendered during the
fiscal year ended December 31, 1998.
SUMMARY COMPENSATION TABLE
<TABLE>
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
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
CGA Investment Management
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,
CGA Investment Management
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
CGA Investment Management
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,
CGA Investment Management
</TABLE>
- --------
(1) Includes housing allowance of $126,385.
(2) Includes housing allowance of $36,750.
(3) Amounts include payments by CGA Group of $50,244 and $68,995 made to
Messrs. Wasterlain and Blacker, respectively, for services rendered prior
to June 17, 1997, pursuant to CGA Group's assumption of these individuals'
employment agreements with CGA Funding, L.P.
(4) Amount includes payment by CGA Group 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 CGA Group's board. All members of CGA Group's
board are reimbursed by CGA Group for transportation to all meetings of the
board of directors 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 CGA Group arising out of the
performance of such duties.
38
<PAGE>
REMUNERATION AND EMPLOYEE AGREEMENTS
LONG-TERM INCENTIVE PLANS
CGA Group adopted a stock warrant plan to promote equity ownership of CGA
Group by selected employees, and the founders and sponsoring investors of CGA
Group and its subsidiaries, to increase their proprietary interest in the
success of CGA Group and/or to encourage them to remain in the employ of CGA
Group and its subsidiaries. On June 17, 1997, 2,342,500 warrants were issued.
Each warrant represents a right to purchase, on or prior to June 17, 2007, one
share of common stock of CGA Group 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 of CGA Group pursuant to the
stock warrant plan vested immediately upon issuance. In addition, the warrants
contain certain adjustments for dilutive events and certain protections for
reorganization, and consolidations or mergers.
401(K) PLAN
CGA Group maintains a qualified retirement plan (401(K) plan) for all its
employees. The amounts contributed by CGA Group during the fiscal year ended
December 31, 1998 for the executive officers named in the above table was
$25,000.
MANAGEMENT CONTRACTS
As of January 1, 1997, CGA Group entered into an employment agreement with
Richard A. Price, as Chief Executive Officer and President of CGA Group, for a
term of three years and subject to annual renewal thereafter. Mr. Price's
employment agreement with CGA Group 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 CGA Group's board of directors.
The employment agreement automatically renews for a one-year period upon the end
of the term of the agreement, unless terminated by CGA Group 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 relocation expenses.
CGA Investment Management 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 CGA Group's board of directors.
Each of these employment agreements automatically renews for a one-year period
upon the anniversary of the agreement, unless terminated by CGA Group 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", the 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 CGA Group,
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 CGA Group shall be indemnified and
secured harmless out of the assets of CGA Group 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. CGA Group 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 CGA Group 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
CGA Group's board of directors has adopted a resolution to the effect that
future transactions between CGA Group 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
39
<PAGE>
pose a conflict of interest with the business of CGA Group. However, to
eliminate any appearance of a conflict, CGA Group, its subsidiaries and its
affiliates have established a policy of not providing insurance guaranties or
investment services to 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 CGA Group, except reimbursements for travel expenses.
Except for the arrangements described below under "Related Party
Transactions", CGA Group does not, and does not permit any of its subsidiaries
to, directly or indirectly, conduct any business with any of the members of the
board of directors or any of their affiliates, unless the transaction or series
of transactions are in the best interests of CGA Group as determined by the
disinterested members of the board of directors and are entered into on an
arms-length basis.
Commercial Guaranty Assurance may not insure risks of stockholders or
their affiliates without bringing the proposed action to the attention of the
board of directors. The decision whether Commercial Guaranty Assurance may
insure risks of this type will be determined by a vote by the board of
directors.
RELATED PARTY TRANSACTIONS
Commercial Guaranty Assurance and Capital Reinsurance Company have entered
into an agreement as of June 4, 1997 which grants Capital Reinsurance Company
the right to make the first offer to provide reinsurance for all insurance
contracts, including contracts of financial guaranty as reinsurance, issued by
Commercial Guaranty Assurance. Capital Reinsurance Company rights under the
right of first offer agreement terminate on the earlier of (a) the date that
Capital Reinsurance Company no longer owns 5% of the common stock of CGA Group
or (b) a public offering of capital stock by CGA Group.
CGA Investment Management has entered into asset management agreements
with each of the existing subsidiaries of St. George Holdings, Cobalt Holdings,
and each of their respective subsidiaries. Pursuant to these agreements, CGA
Investment Management will perform advisory, asset management and related
services for these companies. CGA has guaranteed the payment obligations of
these companies under their financing arrangements, and is expected to guarantee
the payment obligations of any other subsidiaries of St. George Holdings or
Cobalt Holdings which may be established in the future in respect of their
financing obligations. See "The Company--CGA Investment Management, Inc.--St.
George and Cobalt."
In October 1998, Commercial Guaranty Assurance 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 and St. George Investments III.
The three parties which provided such credit support are institutional investors
in the Company. In connection with these arrangements, Commercial Guaranty
Assurance received a premium of $38.95 million from St. George Investments I and
St. George Investments III, and ceded an aggregate of $38.7 million to the three
institutions which provided this credit support. Commercial Guaranty Assurance
loaned $30 million to St. George Holdings (the parent corporation of St. George
Investments I and St. George Investments IIIs) in order to permit St. George
Holdings to provide its subsidiaries with sufficient funds to pay the premium
for this credit support, and to meet its clients' liquidity needs. See "The
Company--Commercial Guaranty Assurance, Ltd.--Reinsurance."
CGA Group pays the holders of its investment units an aggregate of
$600,000 per annum as a fee with respect to the $60 million in capital
commitments. See "Security Ownership of Certain Beneficial Owners and
Management".
CGA Group held a note receivable from its chief executive officer for
$1.25 million which was issued in connection with the June 17, 1997
recapitalization of CGA Group in exchange for 250,000 shares of CGA Group's
common stock. The note was interest-bearing at a rate of 7% compounded
semi-annually. On October 8, 1997, the chief executive officer repaid $1 million
of the note along with the accrued interest thereon. The loan was then repaid in
full on January 31, 1998.
On April 26, 1999, CGA Group sold 973,483 shares of Series C preferred
stock to employees of CGA Group and its subsidiaries. The shares were sold for
$1.20 each, for a total of approximately $1.2 million. The shares were 90%
financed by CGA Group at 7% per annum with equal principal installments due
annually over a three-year period.
40
<PAGE>
SELLING STOCKHOLDERS
The registration statement of which this prospectus is a part has been
filed pursuant to Rule 415 under the Securities Act to afford the holders of
Series A preferred stock listed in the table below the opportunity to sell their
Series A Preferred Stock in a public transaction. By virtue of their ownership
of CGA Group's investment units, several of the selling stockholders, because
they are eligible to do so under CGA Group's bylaws, have elected designees to
the board of directors of CGA Group. See "Management--Directors and Officers of
CGA Group and its subsidiaries" and "Security Ownership of Certain Beneficial
Owners and Management." Share numbers and percentages listed below are as of
September 30, 1999.
<TABLE>
BENEFICIAL OWNERSHIP BENEFICIAL OWNERSHIP
ON THE DATE HEREOF AFTER SALE*
---------------------- NUMBER OF ----------------------
NUMBER OF PERCENT SERIES A NUMBER OF PERCENT
SERIES A OF SHARES SERIES A OF
NAME SHARES CLASS TO BE OFFERED SHARES CLASS
---- ------ ----- ------------- ------ -----
<S> <C> <C> <C> <C> <C>
Putnam Investments (10 funds)(1)(2) ................ 902,325 25.4 902,325 0 0
Oppenheimer (6 funds)(1)(3) ........................ 683,582 19.2 683,582 0 0
Third Avenue Trust on behalf of the
Third Avenue Value Fund Series(5) ................ 601,554 16.9 601,554 0 0
Lennar Capital Services, Inc. (5) .................. 437,491 12.3 437,491 0 0
Olympus Partners (2 funds)(1)(6) ................... 328,121 9.2 328,121 0 0
ACE Limited(5) ..................................... 273,433 7.7 273,433 0 0
Pacific Life Insurance Company
(2 companies)(1)(4)(5) ........................... 273,434 7.7 273,434 0 0
Capital Reinsurance Company(5) ..................... 54,687 1.5 54,687 0 0
</TABLE>
- ---------
* Assumes the sale of all shares of Series A preferred stock offered by the
registration statement of which this prospectus is a part. The selling
stockholders may offer all or only some of such shares.
(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 Putnam
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) The two companies are: Pacific Life Insurance Company and PM Group Life
Insurance Company.
(5) Under CGA Group's bylaws, each of these selling stockholders, by virtue of
its ownership of CGA Group's investment units, has the right to appoint one
director of CGA Group so long as the selling stockholder together with its
affiliates owns the lesser of (a) at least 5% of the shares of common stock
then outstanding or (b) the number of shares of common stock acquired by
the selling stockholder under the subscription agreement for the investment
units. See "Management--Directors and Executive Officers of CGA Group and
its subsidiaries."
(6) The two funds are: Olympus Growth Fund II, L.P. and Olympus Executive Fund,
L.P.
PLAN OF DISTRIBUTION
The shares of Series A preferred stock offered by this prospectus are being
offered directly by the selling stockholders. The sale of the securities may be
effected by the selling stockholders from time to time in transactions in the
over-the-counter market, in negotiated transactions or a combination of these
methods of sale. In each case, these sales could be made at fixed prices which
may be changed, at market prices prevailing at the time of sale, at prices
related to prevailing market prices, or at negotiated prices. The selling
stockholders may effect these transactions by selling securities to or through
broker dealers. Broker-dealers may receive compensation in the form of
underwriting discounts, concessions or commissions from selling stockholders
and/or purchasers of securities for whom these broker-dealers may act as agents
or to whom they sell as principals, or both. The compensation as to a particular
broker-dealer may be in excess of customary commissions. These broker-dealer(s)
may be affiliated with, be customers of, or engage in transactions with or
perform services for one or more of the selling stockholders and/or CGA Group in
the ordinary course of business. CGA Group will keep the registration statement
of which this prospectus is a part or a similar registration statement effective
until the earliest to occur of
41
<PAGE>
o the date that all securities registered pursuant to the registration
statement have been disposed of in accordance with the plan of
disposition indicated in this prospectus,
o the date that all securities registered pursuant to the registration
statement have become saleable pursuant to Rule 144 under the
Securities Act, or
o three years from the date the registration statement was first
declared effective.
At the time a particular offer of the securities is made, to the extent
required, a post-effective amendment will be distributed which will set forth
the number of securities being offered and the terms of the offering. The
post-effective amendment will include the name or names of any underwriters,
dealers or agents, the purchase price paid by any underwriter for the securities
purchased from the selling stockholders, any discounts, commissions and other
items constituting compensation from the selling stockholders and any discounts,
commissions or concessions allowed or reallowed or paid to dealers.
In order to comply with state securities laws, if applicable, the
securities will be sold in these jurisdictions only through registered or
licensed brokers or dealers to the extent required by these laws. In addition,
in some states the securities may not be sold unless they have been registered
or qualified for sale in the applicable state or an exemption from the
registration or qualification requirement is available and is complied with by
CGA Group and the selling stockholder.
The selling stockholders and any broker-dealers, agents or underwriters
that participate with selling stockholders in the distribution of securities may
be deemed to be "underwriters" as defined in the Securities Act. In this event,
all brokerage commissions or discounts and other compensation received by these
selling stockholders, brokers-dealers, agents or underwriters may be deemed
underwriting compensation under the Securities Act. In addition, any of the
securities that qualify for sale pursuant to Rule 144 may be sold under Rule 144
rather than pursuant to the prospectus.
In addition, the selling stockholders and any others engaged in
distribution of securities will be subject to applicable provisions of the
Securities Exchange Act of 1934, as amended, and the rules and regulations
thereunder, including, without limitation, Regulation M, which provisions may
limit the timing of purchases and sales of securities by the selling
stockholders.
CGA Group agreed to register the securities under the Securities Act and
to indemnify and hold the selling stockholders harmless against certain
liabilities under the Securities Act that could arise in connection with the
sale by the selling stockholders of the securities.
See "Selling Stockholders".
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following tables set forth certain information regarding the ownership
of CGA Group's securities of
o each person known by the CGA Group to own beneficially five percent or
more of the outstanding shares of any class of CGA Group's voting
securities;
o each of CGA Group's directors;
o each of CGA Group's executive officers; and
o all directors and executive officers of CGA Group as a group.
None of the directors or executive officers of CGA Group own beneficially any
shares of CGA Group's Series A preferred stock.
42
<PAGE>
SERIES A PREFERRED STOCK (as of September 30, 1999).
<TABLE>
NUMBER OF SHARES
NAME AND ADDRESS OF BENEFICIAL OWNER(1) BENEFICIALLY OWNED PERCENT OF CLASS
- --------------------------------------- ------------------ ----------------
<S> <C> <C>
Putnam Investments
One Post Office Square, Boston, MA 02109 .......................... 902,325 25.4
Oppenheimer Funds
Two World Trade Center, 34th Floor, New York, NY 10048 ............ 683,582 19.2
Third Avenue Trust on behalf of the
Third Avenue Value Fund Series
767 Third Ave., New York, NY 10017 ................................ 601,554 16.9
Lennar Capital Services, Inc.
760 N.W. 107th Ave., Suite 300, Miami, FL 33172 ................... 437,491 12.3
Olympus Partners .................................................... 328,121 9.2
Pacific Life Insurance Company
700 Newport Center Drive, Newport Beach, CA 92660 ................. 273,434 7.7
ACE Limited
Suite 653, 48 Par-La Ville Road, Hamilton, HM11, Bermuda .......... 273,433 7.7
Capital Reinsurance Company
1325 Avenue of the Americas, New York, NY 10019 ................... 54,687 1.5
</TABLE>
- -----------
(1) See the footnotes to the table on page 41 above entitled "Selling
Stockholders."
SERIES C PREFERRED STOCK (as of September 30, 1999).
<TABLE>
NUMBER OF SHARES
BENEFICIALLY
NAME AND ADDRESS OF BENEFICIAL OWNER(1) OWNED PERCENT OF CLASS
- --------------------------------------- ----- ----------------
<S> <C> <C>
Pacific Life Insurance Company
700 Newport Center Drive, Newport Beach, CA 92660 ................. 10,553,309 12.5
Morgan Guaranty Trusts (2 trusts)(2), (3)
522 Fifth Avenue, New York, NY 10036 .............................. 5,636,684 11.1
Third Avenue Trust
767 Third Ave., New York, NY 10017 ................................ 6,045,667 10.7
Olympus Partners
Metro Centre, One Station Place, Stamford, CT 06902 ............... 5,454,882 10.7
ACE Limited
Suite 653, 48 Par-La Ville Road, Hamilton, HM11, Bermuda .......... 5,978,543 10.7
Lennar CGA Holdings, Inc.
760 N.W. 107th Ave., Suite 400, Miami, FL 33172 ................... 5,224,666 8.6
</TABLE>
- -----------
(1) See the footnotes to the table on page 41 above entitled "Selling
Stockholders."
(2) These parties are investment managers with discretion for various funds
under their control.
(3) 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.
43
<PAGE>
COMMON STOCK (as of September 30, 1999).
<TABLE>
NUMBER OF SHARES PERCENT
NAME OF BENEFICIAL OWNER* BENEFICIALLY OWNED OF CLASS
- ------------------------- ------------------ --------
<S> <C> <C>
Third Avenue Value Fund(1)
767 Third Avenue, New York, NY 10017 ........................... 3,387,395 11.4
Olympus Partners (2)
Metro Centre, One Station Place, Stamford, CT 06902 ............ 3,366,634 11.3
Pacific Life Insurance Company(3)
700 Newport Center Drive, Newport Beach, CA 92660 .............. 3,362,472 11.3
Capital Reinsurance Company(4)
1325 Avenue of the Americas, New York, NY 10019 ................ 3,345,857 11.2
Morgan Guaranty Trust
522 Fifth Avenue, New York, NY 10036 ........................... 2,959,783 9.9
ACE Limited(5)
Suite 653, 48 Par-La Ville Road, Hamilton, HM11, Bermuda ....... 2,885,087 9.7
Lennar CGA Holdings, Inc.(6)
760 N.W. 107th Ave., Suite 400, Miami, FL 33172 ................ 2,324,673 7.8
The Equitable Life Assurance Society of the United States
1290 Avenue of the Americas, New York, NY 10104 ................ 1,909,548 6.4
CGA Firemark Venture Fund I, LLC
c/o The Firemark Group, 67 Park Place, Morristown, NJ 07960 .... 1,432,454 4.8
</TABLE>
- -----------
* See also the footnotes to the tables on pages 41 and 42.
SECURITY OWNERSHIP OF DIRECTORS AND NAMED EXECUTIVE OFFICERS
(AS OF SEPTEMBER 30, 1999)
None of the directors or officers of CGA Group own shares of CGA Group
Series A preferred stock.
The percentages listed in the right column of the table below assume
29,781,369 shares of common stock, comprised of 28,005,648 shares of common
stock, investor warrants (held by the holders of Series A preferred stock) to
purchase 270,000 shares of common stock, sponsor and founder warrants to
purchase 847,729 shares of common stock and vested employee warrants to purchase
657,992 shares of common stock and employee warrants to purchase 328,996 shares
of common stock which vested on June 17, 1999.
<TABLE>
NUMBER OF
SHARES OF NUMBER OF
SERIES C PERCENT SHARES OF PERCENT OF
PREFERRED STOCK OF CLASS COMMON STOCK CLASS
--------------- -------- ------------ -----
<S> <C> <C> <C> <C>
David M. Barse (7) ..................................... 0 0 0 0
Robert L. Denton (8) ................................... 32,801 * 165,607 *
Richard S. Frary ....................................... 0 0 0 0
Eric A. Gritzmacher (9) ................................ 0 0 0 0
Donald Kramer (10) ..................................... 0 0 0 0
Jeffrey P. Krasnoff (11) ............................... 0 0 0 0
Michael J. Morissey (13) ............................... 0 0 0 0
Richard A. Price (13) .................................. 0 0 531,706 1.8
Alan S. Roseman (14) ................................... 0 0 0 0
Paul A. Rubin (15) ..................................... 0 0 0 0
F. Fuller O'Connor, Jr. (16) ........................... 0 0 0 0
Jay H. Shidler (17) .................................... 0 0 937,913 3.1
Jay S. Sugarman (18) ................................... 0 0 0 0
Kem H. Blacker (19) .................................... 0 0 132,232 *
Jean-Michel Wasterlain (20) ............................ 0 0 98,730 *
Michael M. Miran (21) .................................. 0 0 27,161 *
Landon D. Parsons (22) ................................. 0 0 18,073 *
Directors and Named Executive
Officers as a group .................................. 32,801 * 1,911,422 6.1
</TABLE>
- -----------
* Less than one percent.
44
<PAGE>
(1) Includes 3,341,703 shares of common stock and warrants to purchase 45,692
shares of common stock.
(2) Includes 3,341,711 shares of common stock and warrants to purchase 24,923
shares of common stock.
(3) Includes 3,341,703 shares of common stock and warrants to purchase 20,769
shares of common stock.
(4) Includes 3,341,703 shares of common stock and warrants to purchase 4,154
shares of common stock.
(5) Includes 2,864,318 shares of common stock and warrants to purchase 20,769
shares of common stock.
(6) Includes 2,291,442 shares of common stock and warrants to purchase 33,231
shares of common stock.
(7) Excludes 3,341,703 shares of common stock, warrants to purchase 20,769
shares of common stock, 601,554 shares of Series A preferred stock and
6,045,667 shares of Series C preferred stock held of record by Third Avenue
Trust, for which Mr. Barse, a Director of CGA Group, serves as President
and Chief Operating Officer. Mr. Barse disclaims beneficial ownership of
these securities held by Third Avenue Trust.
(8) 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, and includes 32,801
shares of Series C preferred stock owned by Ms. Denton.
(9) Excludes 3,341,703 shares of common stock, warrants to purchase 20,769
shares of common stock, 273,434 shares of Series A preferred stock and
10,553,309 shares of Series C preferred stock held of record by Pacific
Life Insurance Company for which Mr. Gritzmacher, a Director of CGA Group,
serves as Vice President, and its affiliates. Mr. Gritzmacher disclaims
beneficial ownership of these securities held of record by such entities.
(10) Excludes 2,864,318 shares of common stock, warrants to purchase 20,769
shares of common stock, 273,433 shares of Series A preferred stock and
5,978,543 shares of Series C preferred stock held of record by ACE Limited,
for which Mr. Kramer, a Director of CGA Group, serves as director. Mr.
Kramer disclaims beneficial ownership of these securities held of record by
ACE Limited.
(11) Excludes 2,291,442 shares of common stock, warrants to purchase 33,231
shares of common stock and 5,224,666 shares of Series C preferred stock
held of record by Lennar CGA Holdings Inc. and 437,491 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 these securities held of record by Lennar CGA
Holdings, Inc.
(12) Excludes 1,432,154 shares of common stock and 1,818,303 shares of Series C
preferred stock held of record by CGA Firemark Venture Fund I, LLC. Mr.
Morrissey, a Director of CGA Group, 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 these securities held
of record by CGA Firemark Venture Fund I, LLC.
(13) Includes 148,544 shares of common stock and warrants to purchase 383,162
shares of common stock.
(14) Excludes 3,341,703 shares of common stock, warrants to purchase 4,154
shares of common stock and 54,687 shares of Series A preferred stock held
of record by Capital Reinsurance Company, for which Mr. Roseman, a Director
of CGA Group, serves as General Counsel, Executive Vice President and
Secretary of Capital Reinsurance Company. Mr. Roseman disclaims beneficial
ownership of these securities held of record by Capital Reinsurance
Corporation.
(15) Excludes 3,341,711 shares of common stock, 328,121 shares of Series A
preferred stock and 5,454,882 shares of Series C preferred stock held of
record by Olympus Growth Fund II, L.P. and Olympus Executive Fund, L.P. Mr.
Rubin, a Director of CGA Group, is a partner of Olympus Partners, an
affiliate of these two funds. Mr. Rubin disclaims beneficial ownership of
these securities held of record by such entities.
(16) Excludes 954,770 shares of common stock and 1,818,303 shares of Series C
preferred stock held of record by Prudential Securities Group, Inc., for
which Mr. O'Connor, a Director of CGA Group, serves as managing director.
Mr. O'Connor disclaims beneficial ownership of these securities held of
record by Prudential Securities Group, Inc.
(17) Includes 7,720 shares of common stock, warrants to purchase 7,227 shares of
common stock and 14,875 shares of Series C preferred stock held of record
by Shidler/CGA Corp., 3,741 shares of common stock, warrants to purchase
3,502 shares of common stock and 7,208 shares of Series C preferred stock
held of record by Shidler Equities Corp., and 529,869 shares of common
stock, warrants to purchase 385,854 shares of common stock and 316,780
shares of Series C preferred stock held by Shidler Equities, L.P.
(18) Excludes 954,770 shares of common stock and 1,818,303 shares of Series C
preferred stock held of record by Starwood CGA, LLC. Mr. Sugarman, a
Director of CGA Group, is President and Chief Executive Officer of Starwood
Financial Trust, an affiliate of Starwood CGA, LLC. Mr. Sugarman disclaims
beneficial ownership of these securities held of record by Starwood CGA,
LLC.
(19) Includes 20,000 shares of common stock and warrants to purchase 112,232
shares of common stock.
(20) Includes 17,000 shares of common stock and warrants to purchase 81,730
shares of common stock.
(21) Includes 12,000 shares of common stock and warrants to purchase 15,161
shares of common stock.
(22) Includes 5,000 shares of common stock and warrants to purchase 13,073
shares of common stock.
45
<PAGE>
DESCRIPTION OF SECURITIES
CGA Group's authorized capital stock consists of 268,012,000 shares of
common stock, 10,000,000 shares of Series A preferred stock, 10,000,000 shares
of Series B preferred stock and 52,000,000 shares of Series C preferred stock.
As of September 30, 1999, there were 3,554,627 shares of Series A preferred
stock, no shares of Series B preferred stock, 44,971,346 shares of Series C
preferred stock and 28,005,648 shares of common stock issued and outstanding.
SERIES A PREFERRED STOCK
GENERAL
CGA Group has issued 3,554,627 shares of its Series A preferred stock,
each share having a $.01 par value. As described below, the shares of Series A
preferred stock have a mandatory redemption period of ten years. CGA Group also
has an optional redemption after June 17, 2002 as described more fully below.
See "--Optional Redemption." The Series A preferred stock ranks senior to all
other classes of CGA Group's capital stock.
DIVIDENDS
Each share of Series A preferred stock is entitled to dividends in an
amount equal to 13.75% per annum based on a $25 stated value. In addition, if
any time after June 17, 2002, the Series A preferred stock is rated investment
grade (a rating of BBB- or higher from Duff & Phelps, or the then-equivalent
rating in the event Duff & Phelps changes its rating designations), this
dividend rate will decrease by 200 basis points. The Series A preferred
dividends are fully cumulative, compound quarterly and accrue quarterly (based
on the actual number of days elapsed over a year of 360 days) until redemption.
Subject to Bermuda law, the payment of accrued Series A preferred dividends will
be as, if and when any dividends are declared by CGA Group's board of directors.
The Series A preferred dividends accrued prior to June 17, 2002 will be paid in
kind, and the Series A preferred dividends accruing after that date will be paid
in cash at a rate of 11.75% per annum, and, to the extent that the dividends
accrue in excess of a rate of 11.75% per annum, the excess, if any, will be paid
in cash to the extent CGA Group receives assurance from Duff & Phelps that the
cash payment will not adversely affect Commercial Guaranty Assurance's AAA
rating; otherwise the excess will be paid in kind or in cash as determined by
CGA Group.
If an event of non-compliance (as defined under "--Events of
Non-Compliance" below) occurs, the dividend rate shall be increased by 250 basis
points so long as the event of non-compliance is continuing.
DIVIDEND PREFERENCE
So long as any Series A preferred stock remains outstanding, no dividends
(other than dividends payable in shares of stock ranking junior to the Series A
preferred stock) may be declared or paid or set apart for payment on, nor may
any distribution be made to, any class of stock of CGA Group ranking junior to
or on parity with the Series A preferred stock.
MANDATORY REDEMPTION
CGA Group will be obligated to redeem the Series A preferred stock, in
whole, on June 17, 2007 at a redemption price per share equal to 100% of the
stated value of the Series A preferred stock, together with accrued and unpaid
Series A preferred dividends, if any.
After June 17, 1997, each holder of Series A preferred stock has the right
to require CGA Group to redeem all of the holder's shares of Series A preferred
stock upon the occurrence of a change of control of CGA Group at a redemption
price equal to the sum of (i) 101% of $25 (the stated value of the Series A
preferred stock) and accrued and unpaid non-cash dividends on the Series A
preferred stock through the date of the redemption, and (ii) accrued and unpaid
cash dividends on the Series A preferred stock through the date of the
redemption.
OPTIONAL REDEMPTION
CGA Group and the holders of the Series A preferred stock agreed on March
1, 1999 that the Series A preferred stock shall be redeemable in cash at the
election of CGA Group, in whole or in part at any time and from time to time at
a redemption price equal to the stated value of the Series A preferred stock per
share plus accrued but unpaid dividends through the date of the redemption, pro
rata from all holders of Series A preferred stock.
46
<PAGE>
The Series A holders (and any future transferees) have irrevocably waived
any right to receive any redemption premium or other additional amount in
respect of any optional redemption of the Series A preferred stock by CGA Group.
Under to the March 1, 1999 Agreement, if CGA Group at any time completes a
public offering of shares of its common stock, which public offering has been
registered with the Securities and Exchange Commission and has resulted in net
proceeds to CGA Group of not less than $50 million, then CGA Group shall utilize
the net proceeds to redeem the shares of Series A preferred stock, on a pro rata
basis from all holders of Series A preferred stock.
At any time prior to June 17, 2000 and upon ten days' prior written notice
to the holders, up to 35% of the Series A preferred stock is redeemable in cash
at the election of CGA Group with the proceeds of one or more public offerings
of CGA Group's capital stock registered with the Securities and Exchange
Commission, at any time or from time to time, at a redemption price equal to the
sum of (a) 120% of the sum of $25 and accrued and unpaid non-cash dividends
through the date of the redemption and (b) accrued and unpaid cash dividends
thereon through the date of the redemption.
LIQUIDATION PREFERENCE
If CGA Group voluntarily or involuntarily liquidates, dissolves or
winds-up, the holders of the Series A preferred stock will be entitled to
receive, after all creditors of CGA Group have been paid, a liquidation
preference per share equal to $25, together with all accrued and unpaid Series A
preferred dividends through the date of the liquidation, dissolution or winding
up, out of the assets of CGA Group before any distribution is made to the
holders of any security ranking junior to or on parity with the Series A
preferred stock.
VOTING RIGHTS AND BOARD REPRESENTATION
The holders of Series A preferred stock are entitled to exercise seven
votes per share, constituting an aggregate of 18.2 million votes (representing,
as of June 17, 1997, approximately 41% of the total number of votes that the
holders of CGA Group voting capital stock may cast). Each additional issuance of
Series A preferred stock in excess of 2,600,000 shares (including paid-in-kind
dividends) will proportionally dilute the per share voting rights attributable
to the then-outstanding shares of Series A Preferred Stock for so long as the
excess exists.
The holders of the Series A preferred stock are not entitled to elect any
members of CGA Group board of directors, except as provided in "--Penalties for
Non-Compliance" below.
CGA Group's bylaws limit the direct and indirect voting power of each U.S.
person so that, unless an event of non-compliance has occurred (see below under
"Events of Non-Compliance") and is continuing, no U.S. person will own, directly
or indirectly, stock that controls 10% or more of the total combined voting
power of all classes of stock of CGA Group entitled to vote.
LIMITATION ON COMPANY INDEBTEDNESS AND PREFERRED STOCK
Under the subscription agreement for the Series A preferred stock, CGA
Group will not, directly or indirectly, incur any indebtedness or issue any
preferred stock unless (a) no event of non-compliance (and no event that, with
notice, lapse of time or both, would be an event of non-compliance) shall have
occurred and be continuing at the time or would occur as a consequence of the
incurrence of such indebtedness or issuance of preferred stock and (b) the
indebtedness or preferred stock is specifically permitted under the Series A
subscription agreement. This covenant will not restrict CGA Group's ability to
incur obligations under insurance, reinsurance or retrocession contracts or
other arrangements by which a person guarantees financial or credit risks in
each case entered into in the ordinary course of business. This covenant also
will not restrict CGA Group's ability to incur obligations with respect to
letters of credit or similar instruments or credit facilities for the purpose of
securing insurance, reinsurance or retrocessional obligations entered into in
the ordinary course of business, to the extent that these letters of credit or
similar instruments or credit facilities are not drawn upon, or if drawn upon,
the drawing is reimbursed not later than the 30th business day following a
demand for reimbursement. This covenant also will not restrict CGA Group's
ability to issue the Series B preferred stock pursuant to the commitments.
LIMITATION ON RESTRICTED SUBSIDIARY INDEBTEDNESS AND PREFERRED STOCK
Under the subscription agreement, CGA Group will not permit Commercial
Guaranty Assurance or CGA Investment Management to incur, directly or
indirectly, any indebtedness or to issue any preferred stock unless (a) no
47
<PAGE>
event of non-compliance shall have occurred and be continuing at the time or
would occur as a consequence of the incurrence of the indebtedness or issuance
of such preferred stock and (b) the indebtedness or preferred stock is
specifically permitted. This covenant will not restrict the ability of
Commercial Guaranty Assurance or CGA Investment Management to incur, directly or
indirectly, insurance obligations.
OTHER RESTRICTIONS AND LIMITATIONS ON CGA GROUP AND ITS SUBSIDIARIES
The subscription agreement for the Series A preferred stock also
restricts:
o the ability of CGA Group and its subsidiaries to pay dividends or
distributions in respect of their shares of capital stock, other
than dividends or distributions payable solely to CGA Group or a
subsidiary of CGA Group;
o the ability of CGA Group and its subsidiaries to make intercompany
loans or advances, or to make intercompany transfers of assets or
properties;
o the ability of CGA Group and its subsidiaries to sell assets or
shares of capital stock at less than their fair market value, as
determined by the board of directors of CGA Group;
o the ability of CGA Group and its subsidiaries to enter into
encumbrances or restrictions (except as required by law or
regulation) relating to the payment of dividends or redemptions, the
making of intercompany loans or advances, or intercompany transfers
of assets or properties;
o the ability of CGA Group to amend or modify the terms of the
commitments to purchase Series B preferred stock without the written
consent of the holders of 90% of the outstanding shares of Series A
preferred stock;
o the ability of CGA Group and its subsidiaries to enter into any
transaction with or for the benefit of any of their respective
affiliates on terms less favorable to CGA Group or the subsidiary
than those that could be obtained in a comparable arms-length
transaction with an unrelated third party, unless approved by CGA
Group board of directors (including approval by a majority of the
disinterested directors);
o the ability of CGA Group or any of its subsidiaries to merge,
amalgamate or consolidate with any other entity.
EVENTS OF NON-COMPLIANCE
Under the subscription agreement, events of non-compliance with respect to
the Series A preferred stock include:
o failure of CGA Group to pay dividends on the Series A preferred
stock under the terms of CGA Group's bylaws, provided that the
unpaid amount is in excess of $5 million;
o failure by CGA Group to pay the redemption price and premium, if
any, in respect of the Series A Preferred Stock when due upon
mandatory or optional redemption, required purchase or otherwise;
o failure by CGA Group or its subsidiaries to pay amount in respect of
indebtedness or preferred stock when due, provided that the unpaid
amount exceeds $5 million individually or in the aggregate;
o the entry by a court of competent jurisdiction of one or more
judgments or orders against the Company or any of its subsidiaries
in an uninsured aggregate amount in excess of $10 million, which
judgment or order is not discharged or waived within 45 days or
subject to an appeal during which the Company is not obligated to
pay the amount;
o the making by CGA Group or any of its subsidiaries of a general
assignment for the benefit of creditors, or the consent to the
appointment of a receiver or trustee, or the occurrence of an event
of bankruptcy, insolvency or reorganization;
o a downgrade of Commercial Guaranty Assurance's claims-paying ability
rating below a "Double A minus' (AA-) rating by Duff & Phelps for a
period of 45 consecutive days.
PENALTIES FOR NON-COMPLIANCE
If any of the above events of non-compliance has occurred, then, for so
long as the event of non-compliance remains uncured and is continuing:
48
<PAGE>
o the size of the board of directors of CGA Group will be increased by
two members, and the holders of the Series A preferred stock as a
class will be entitled to appoint at least two members of the board;
o the dividend rate on the Series A preferred stock will be increased
by 250 basis points (2.5%); and
o no class of stock of CGA Group ranking junior to or on parity with
the Series A Preferred Stock may be redeemed.
REPORTING
CGA Group is required by the Series A subscription agreement to furnish to
the holders of the Series A preferred stock, within 15 days after it files them
with the Securities and Exchange Commission, copies of the annual and quarterly
reports and the information, documents and other reports that CGA Group is
required to file with the Securities and Exchange Commission under Sections 13
and 15(d) of the Exchange Act. Notwithstanding that CGA Group may not be
required to remain subject to the reporting requirements of Section 13 and 15(d)
of the Exchange Act, to the extent permitted by the Exchange Act, CGA Group
shall continue to file with the Securities and Exchange Commission and provide
the holders of the Series A preferred stock with the annual reports and the
information, documents and other reports that are specified in Section 13 and
15(d) of the Exchange Act. In the event that CGA Group is not permitted to file
such reports, documents and information with the Securities and Exchange
Commission, CGA Group will provide substantially similar information with
respect to itself and its subsidiaries to the holders of the Series A preferred
stock as if CGA Group were subject to the reporting requirements of the Section
13 and 15(d) of the Exchange Act.
WAIVER AND AMENDMENT
The consent of the holders of a majority of the outstanding shares of the
Series A preferred stock is required with respect to waivers and amendments
which do not affect the payment terms of the Series A preferred stock or the
amount of Series A preferred stock holders who must consent to any amendment or
the relative ranking of the Series A preferred stock. The latter waiver and
amendments may be made only with the consent of the holders of 90% of the
outstanding aggregate liquidation value of Series A preferred stock.
WARRANTS
In addition to Series A preferred stock, the purchaser of each of the
2,600,000 shares of Series A preferred stock issued on June 17, 1997 acquired
for no additional consideration, one warrant for each share of Series A
preferred stock purchased. Each warrant represents a right to purchase, on or
prior to June 17, 2007, .1038462 shares of common stock at an exercise price of
$.01 per share of common stock, for an aggregate total of 270,000 shares of
common stock. The Warrants contain certain adjustments for dilutive events and
protections for reorganizations, consolidations, or mergers.
SERIES B PREFERRED STOCK
GENERAL
On June 4, 1997, CGA Group issued 1,600,000 investment units. Each
investment unit consisted of 1 share of Series B preferred stock, 4.8925 shares
of common stock and a commitment to purchase 1.5 additional shares of Series B
preferred stock. Accordingly, CGA Group issued 1,600,000 shares of its Series B
preferred stock, with a par value of $.01 per share. CGA Group also obtained
commitments to purchase an additional 2,400,000 shares of Series B preferred
stock, as described below under "Commitments." The Series B preferred stock
ranks junior to the Series A preferred stock and the Series C preferred stock
and senior to the common stock.
On March 31, 1999, in connection with the sale by CGA Group of 43,997,863
shares of Series C preferred stock, all of the issued and outstanding shares of
Series B preferred stock were converted into shares of common stock at a
conversion ratio of 11.816 shares of common stock per share of Series B
preferred stock. The conversion ratio was based on an assumed value of $3.00 per
share of common stock. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Subsequent Events." As of the date of this
prospectus, no shares of Series B preferred stock are issued and outstanding.
DIVIDENDS
The Series B preferred stock is entitled to dividends in an amount equal
to 7% per annum based on a $25 stated value. The Series B preferred dividends
are fully cumulative, compound quarterly and accrue quarterly (based on the
49
<PAGE>
actual number of days elapsed over a year of 360 days) until redemption.
Subject to Bermuda law, the payment of accrued Series B preferred dividends is
payable in cash or in kind as, if and when dividends are declared by CGA Group's
board of directors, provided that, so long as any Series A preferred stock is
outstanding, no dividends other than dividends payable in shares of Series B
preferred stock may be declared or paid or set apart for payment on the Series B
preferred stock.
DIVIDEND PREFERENCE
Any obligation of CGA Group with regard to the Series B preferred
dividends does not affect the payment by CGA Group of the Series A preferred
dividends when these dividends become due. As long as any Series B preferred
stock remains outstanding, no dividends (other than dividends payable in shares
of stock ranking junior to the Series B preferred stock) may be declared as paid
or set apart for payment on, nor may any distribution be made to, any class of
stock that ranks junior to the Series B preferred stock.
MANDATORY REDEMPTION
The Company is obligated to redeem the issued and outstanding Series B
preferred stock, if any, in whole, at a redemption price per share equal to $25,
together with accrued and unpaid dividends, if any, upon the earliest of June
17, 2012, a sale, merger or amalgamation of CGA Group and a qualified public
offering; provided, however, that so long as CGA Group is in default in respect
of any obligation to redeem or pay dividends in respect of the Series A
preferred stock, CGA Group may not redeem any Series B preferred stock.
REDEMPTION PREFERENCE
If CGA Group defaults on any payment due upon the mandatory redemption of
the Series B preferred stock and the default is not cured, (a) no class of stock
ranking junior to the Series B preferred stock may be redeemed; (b) no dividends
(other than dividends payable in stock ranking junior to the Series B preferred
stock) may be declared or paid or set apart for payment on, nor may any
distribution be made, to, any class of stock ranking junior to the Series B
preferred stock; and (c) no dividends on shares ranking on parity with the
Series B preferred stock may be paid or set apart for payment.
LIQUIDATION PREFERENCE
If CGA Group voluntarily or involuntarily liquidates, dissolves or
winds-up, the holders of the Series B preferred stock, if any, will be entitled
to receive, after all creditors of CGA Group have been paid and the Series A
preferred liquidation preference and Series C liquidation preference have been
satisfied, a liquidation preference per share equal to $25, plus all accrued and
unpaid dividends to the date of such liquidation, dissolution or winding up, out
of the assets of CGA Group before any distribution is made to the holders of any
stock of CGA Group ranking junior to the Series B preferred stock.
In the event that the assets available for distribution to the holders of
the Series B preferred stock and stock ranking on a parity with the Series B
preferred stock are insufficient to pay the respective preferential amounts in
full, these assets will be distributed ratably in proportion to the preferential
amounts payable thereon.
VOTING RIGHTS
Except as otherwise required by Bermuda law, the holders of the Series B
preferred stock are entitled to exercise five votes per share on all matters
presented to CGA Group's shareholders. As more fully described below under
"Certain Tax Considerations", CGA Group's bylaws attempt to limit the direct and
indirect voting power of each holder of CGA Group's stock so that no U.S. person
will be entitled to votes representing 10 percent or more of CGA Group's voting
power.
BOARD REPRESENTATION RIGHTS
Prior to a qualified public offering, the holders of Series B preferred
stock are entitled to elect at least eight directors to CGA Group's board of
directors. Following a qualified public offering, certain holders of Series B
preferred stock may maintain special rights to designate members of the board.
REGISTRATION RIGHTS
There are no demand or piggyback registration rights with respect to the
Series B preferred stock.
50
<PAGE>
SERIES C PREFERRED STOCK
GENERAL
On March 31, 1999, CGA Group sold to existing shareholders an aggregate of
43,997,863 shares of Series C preferred stock for net cash proceeds of
$50,996,794.50. On April 26, 1999, CGA Group sold 973,483 shares of Series C
preferred stock to employees of CGA Group and its subsidiaries, for a total of
approximately $1.2 million. The Series C preferred stock ranks junior to the
Series A preferred stock and senior to the Series B preferred stock and the
common stock.
DIVIDENDS
The holders of shares of Series C preferred stock are not entitled to
receive any dividends with respect to such shares.
REDEMPTION
CGA Group will redeem the Series C preferred stock in the event of a sale
of CGA Group or a merger, consolidation or amalgamation with another entity
which results in the owners of all of CGA Group's capital stock prior to the
transaction owning securities with less than 50% of the then-outstanding voting
power of the surviving entity following the transaction. The redemption will
only be made if and to the extent that the consideration paid for each share of
Series C preferred stock in connection with the sale, merger or other
transaction is less than the liquidation value of the Series C preferred stock.
The liquidation value of the Series C preferred stock is the stock's stated
value, $1.50 per share, plus an amount equal to 7.00% per annum of the stated
value, compounded annually from March 31, 1999 through the closing date of the
liquidation.
On the maturity date of the Series C preferred stock, March 31, 2009, the
Series C preferred stock shall, at the option of CGA Group, be redeemed for cash
in an amount per share equal to the liquidation value described in the preceding
paragraph or converted into shares of CGA Group's common stock as described
below.
No later than 10 days prior to the maturity date, CGA Group shall give
notice to the holders of Series C preferred stock of the impending maturity of
the shares, of whether CGA Group intends to redeem the shares for cash or shares
of common stock, and of the then-applicable Series C liquidation value or number
of shares of common stock into which a share of Series C preferred stock is then
convertible. Any redemption of Series C preferred stock shall be made pro rata
from among the registered holders of the shares then issued and outstanding and
with ten calendar days' prior notice to such registered holders.
CONVERSION
The shares of Series C preferred stock shall automatically be converted
into shares of common stock at the earlier to occur of March 31, 2009, or the
issuance by CGA Group in one or a series of related transactions either
privately or through registered public offerings (other than pursuant to
acquisitions, mergers or other business combinations or pursuant to stock option
plans, stock purchase plans or other employee benefit plans or arrangements) of
equity securities resulting in aggregate gross proceeds to CGA Group of at least
$50,000,000 and at a price per share determined by a majority of the board of
directors to be fair and reasonable, at the conversion ratios set forth in the
appendices to CGA Group's bylaws. Upon the issuance by CGA Group of new equity
in this manner, each share of Series C preferred stock shall be converted into a
number of shares of common stock determined by dividing $1.50 by the conversion
price.
Series C preferred stock may be converted into shares of common stock at
any time at the option of the holder at the then-applicable conversion price.
The conversion price shall be adjusted from time to time in accordance with the
terms of the appendices to CGA Group's bylaws in order to reflect dividends,
stock splits, distributions, issuances of securities entitling subscribers to
purchase shares of common stock for less than the conversion price, or other
changes in CGA Group's capital structure.
LIQUIDATION PREFERENCE
If CGA Group voluntarily or involuntarily liquidates, dissolves or
winds-up, the holders of the Series C preferred stock will be entitled to
receive, after all creditors of CGA Group have been paid and the Series A
preferred
51
<PAGE>
liquidation preference has been satisfied, a liquidation preference per share
equal to (a) the stated value of the Series C preferred stock, U.S. $1.50 per
share, subject to adjustment in the event of any share split or combination with
respect to these shares plus (b) an amount equal to 7.00% per annum of the
stated value, which amount shall calculated based on the actual number of days
elapsed over a year of 360 days from March 31, 1999 through the date of such
liquidation and shall be compounded annually.
In the event that the assets available for distribution to the holders of
the Series C preferred stock and stock ranking on parity with the Series C
preferred stock are insufficient to pay the respective preferential amounts in
full, the assets will be distributed ratable in proportion to the preferential
amounts payable thereon.
VOTING RIGHTS
Except as otherwise required by Bermuda law, the holders of Series C
preferred stock are entitled to exercise one vote per share on all matters
presented to CGA Group's shareholders. As more fully described below under
"Certain Tax Considerations", CGA Group's bylaws attempt to limit the direct and
indirect voting power of each holder of CGA Group's stock so that no U.S. person
will be entitled to votes representing 10 percent or more of CGA Group's voting
power.
BOARD REPRESENTATION RIGHTS
Prior to a qualified public offering, the holders of Series C preferred
stock are entitled, as a class, to elect two members of CGA Group's board of
directors.
REGISTRATION RIGHTS
There are no demand or piggyback registration rights with respect to the
Series C preferred stock.
COMMON STOCK
GENERAL
On June 17, 1997, CGA Group issued 9,100,000 shares of its common stock,
each share having a $.01 par value, representing 7,827,957 shares to the
investment unit investors and 1,272,043 shares to CGA Group's sponsoring
investors. On March 31, 1999, all of the issued and outstanding shares of CGA
Group's Series B preferred stock were converted into shares of common stock at a
conversion ratio of 11.816 shares of common stock per share of Series B
preferred stock. The conversion ratio was based on an assumed value of $3.00 per
share of common stock. As a result of the conversion, 18,905,648 new shares of
common stock were issued. As of the date of this Prospectus, 28,005,648 shares
of common stock were issued and outstanding. The common stock is perpetual in
duration.
DIVIDENDS
The common stock is not entitled to dividends as long as any shares of
Series A preferred stock or Series B preferred stock remain outstanding.
Thereafter, the common stock is entitled to any net profits of CGA Group, when,
as and if declared as dividends by the board of directors.
LIQUIDATION
If CGA Group voluntarily or involuntarily liquidates, dissolves or
winds-up, the holders of the common stock are entitled, after all creditors of
CGA Group have been paid and the Series A preferred liquidation preference, the
Series B preferred liquidation preference and the Series C liquidation
preference have been satisfied, to share ratably in the remaining assets of CGA
Group together with common stock.
VOTING RIGHTS
Except as otherwise required by Bermuda law, the holders of common stock
are entitled to exercise two votes per share on all matters presented to CGA
Group's shareholders. As more fully described below under "Certain Tax
Considerations", CGA Group's bylaws attempt to limit the direct and indirect
voting power of each holder of CGA Group's stock so that no U.S. person will be
entitled to votes representing 10 percent or more of CGA Group's voting power.
OTHER RIGHTS
The holders of the common stock have registration rights, preemption
rights, first refusal rights, tag-along rights and drag-along rights with
respect to the common stock, as set forth in CGA Group's shareholders agreement
attached as an exhibit to the registration statement of which this prospectus is
a part.
52
<PAGE>
INVESTOR WARRANTS
CGA Group's sponsoring investors and founders hold 785,229 warrants. Each
investor warrant represents a right to purchase, on or prior to June 16, 2007,
one share of common stock at an exercise price of $2.12 per share. The investor
warrants contain adjustments for dilutive events and protections for
reorganizations, consolidations, or mergers.
COMMITMENTS
GENERAL
In connection with their purchase of investment units, the unit investors
irrevocably committed to purchase an aggregate of $60 million of Series B
preferred stock, at a purchase price of $25 per share, in the event that CGA
Group receives written notice from Duff & Phelps that Duff & Phelps will reduce
its claims-paying ability rating of Commercial Guaranty Assurance below
"Triple-A", and the events that have led to the notice of the proposed downgrade
have not been cured within 45 days to the satisfaction of Duff & Phelps.
COMMITMENT FEE
CGA Group is required to pay annually in advance a commitment fee to each
unit investor equal to one percent of the unit investor's then-aggregate
commitment amount.
COMMITMENT SUPPORT
In order to secure their commitments, each unit investor not rated
"Double-A" or higher delivered to CGA Group a five-year letter of credit from a
bank rated at least "Double-A" or a one-year letter of credit from a bank rated
at least "Double-A" to be renewed annually for five years, ,or other form of
credit support as will not give rise to a downgrading of Commercial Guaranty
Assurance's rating by Duff & Phelps. Each unit investor is also subject to
maintenance requirements with respect to its rating on the letter of credit.
Failure to renew a one-year letter of credit prior to expiration will give rise
to the right of CGA Group to draw down on the letter of credit.
COMMITMENT BY CGA GROUP TO COMMERCIAL GUARANTY ASSURANCE
On June 17, 1997, CGA Group entered into a commitment agreement with
Commercial Guaranty Assurance to contribute to Commercial Guaranty Assurance,
through the purchase of equity securities of Commercial Guaranty Assurance or
otherwise, the proceeds of the sale of any Series B preferred stock to the unit
investors pursuant to the commitments. CGA Group has assigned its rights to the
unit investors' commitments to support such commitment to Commercial Guaranty
Assurance.
VOTING RIGHTS
The unit investors are not entitled to any rights, including voting or
consent rights, of a shareholder of CGA Group with respect to their commitments.
Each share of Series B preferred stock issued pursuant to the commitments will
have proportional voting rights based on the number of shares of Series B
preferred stock issued and outstanding at that time. See "Description of
Securities--Series B Preferred Stock--Voting Rights."
GOVERNING LAW
The shares of Series A preferred stock are governed by the laws of
Bermuda, without regard to the principles of conflicts of law.
CONSENT TO JURISDICTION AND SERVICE
CGA Group has appointed CT Corporation System as its agent for service of
process in any suit, action or proceeding with respect to the Series A preferred
stock and for actions brought under the United States federal or state
securities laws brought in any United States federal or state court located in
the City of New York and submits, to such jurisdiction.
CERTAIN TAX CONSIDERATIONS
The following summary of the taxation of CGA Group, Commercial Guaranty
Assurance, CGA Investment Management and the taxation of shareholders of CGA
Group describes the material U.S. federal and Bermuda tax
53
<PAGE>
consequences as of the date of this prospectus and is for general information
only. The tax treatment of a holder of securities for U.S. federal, state, local
and non-U.S. tax purposes may vary depending on the holder's particular status.
The description of U.S. federal income tax law set forth below with respect to
the taxation of CGA Group, Commercial Guaranty Assurance, CGA Investment
Management, and shareholders of CGA Group is based upon the advice of Dewey
Ballantine LLP. The description of Bermuda tax law set forth below is based upon
the advice of Conyers Dill & Pearman, Bermuda. Because of their inherently
factual nature, no opinion has been given by Dewey Ballantine to investors with
respect to
o whether CGA Group or Commercial Guaranty Assurance will have a
permanent establishment in the U.S. or will be engaged in a U.S.
trade or business,
o any factual or accounting matters or
o the existence or amounts of Related Person Insurance Income
("RPII").
All statements in this prospectus with respect to these matters and information
with respect to facts, determinations or conclusions relating to the business or
activities of Commercial Guaranty Assurance and CGA Investment Management have
been provided by the management of CGA Group.
Investors have been advised and again are urged to consult their own tax
advisors concerning the U.S. federal, state, and local and non-U.S. tax
consequences to them of owning securities.
There is a limited income tax treaty between Bermuda and the United States
(the Bermuda Insurance Enterprises and Mutual Assistance Tax Treaty), which
affects the taxation of insurance company income only. In form the treaty
provides for reciprocal waiver of taxation by both countries with respect to
certain income derived by an insurance company. However, since Bermuda does not
currently tax this type of income, the treaty, in effect, currently operates
unilaterally with respect to the imposition of taxes. The treaty is, however,
reciprocal with respect to mutual assistance in tax matters.
TAXATION OF CGA GROUP AND ITS SUBSIDIARIES
BERMUDA
CGA Group and Commercial Guaranty Assurance have received from the
Minister of Finance of Bermuda an assurance under The Exempted Undertakings Tax
Protection Act, 1966 of Bermuda. The tax assurance states that in the event of
there being enacted in Bermuda any legislation imposing tax computed on profits
or income, or computed on any capital asset, gain or appreciation, or any tax in
the nature of estate duty or inheritance tax, then the imposition of this type
of tax shall not be applicable to CGA Group or Commercial Guaranty Assurance or
to any of their operations or the shares, debentures or other obligations of CGA
Group and Commercial Guaranty Assurance until March 28, 2016. This assurance
does not prevent the application of any such tax payable in accordance with the
provisions of the Land Tax Act 1967 of Bermuda or otherwise payable in relation
to the property leased to CGA Group or Commercial Guaranty Assurance. Commercial
Guaranty Assurance will be required to pay certain registration fees as an
insurer under the act and each of Commercial Guaranty Assurance and CGA Group
will be required to pay certain annual Bermuda government fees. In addition, all
entities employing individuals in Bermuda are required to pay a payroll tax to
the Bermuda government.
Currently there is no Bermuda withholding tax on dividends paid by CGA
Group or Commercial Guaranty Assurance.
U.S.
CGA Group and CGA. CGA Group is a pure holding company and does not engage
in any business activity; hence, it is not engaged in a trade or business in the
U.S. Commercial Guaranty Assurance operates its business in a manner that
management believes should not result in its being treated as engaged in a trade
or business within the U.S. Consequently, management does not expect Commercial
Guaranty Assurance to be obligated to pay U.S. federal income tax. However,
because the determination of whether a foreign corporation is engaged in a trade
or business in the U.S. is inherently factual and there are no definitive
standards for making such determination, there can be no assurance that the
Internal Revenue Service will not contend that Commercial Guaranty Assurance is
engaged in a trade or business in the U.S.
54
<PAGE>
Ordinarily, a foreign corporation deemed to be engaged in a trade or
business in the U.S. will be subject to U.S. income tax, including, potentially,
the branch profits tax, on its net income that is effectively connected with the
conduct of that trade or business, unless the corporation is entitled to relief
under an income tax treaty. This type of income tax would be imposed on
effectively connected net income and would be computed in a manner generally
analogous to that applied to the net income of a domestic corporation. However,
if a foreign corporation does not timely file a U.S. federal income tax return,
even if its failure to do so is based upon a good faith determination that it
was not engaged in a trade or business in the U.S., it is not entitled to
deductions and credits allocable to its effectively connected income. Moreover,
penalties may be assessed for failure to file these tax returns. Commercial
Guaranty Assurance files "protective" U.S. federal income tax returns so that if
it were held to be engaged in a trade or business in the U.S., it would be
allowed to deduct expenses and utilize credits allocable to income determined to
be effectively connected with this trade or business and would not be subject to
a failure to file penalty. The maximum U.S. income tax rates currently are 35%
for a corporation's effectively connected net income and 30% for the branch
profits tax. The branch profits tax, which is based on net income after
subtracting the regular corporate tax and making certain other adjustments, is
imposed on the amount of net income deemed to have been withdrawn from the U.S.
The maximum combined corporate net income and branch profits tax rate is
approximately 54.5%.
Under the tax treaty described above, a Bermuda corporation that meets
certain eligibility requirements (described below) and that is predominantly
engaged in the insurance business will not be subject to U.S. federal income tax
on its business profits effectively connected with a U.S. federal trade or
business provided that the trade or business is not conducted through a
permanent establishment in the U.S. This is known as the "No PE Exemption".
Management believes that Commercial Guaranty Assurance qualifies for the No PE
Exemption; however, because the determination of whether a trade or business is
being conducted through a permanent establishment is inherently factual,
management cannot assure the exemption's availability. In order to meet the
eligibility requirements of the tax treaty, (a) more than 50% of Commercial
Guaranty Assurance's stock must be beneficially owned, directly or indirectly,
by individuals who are Bermuda residents or U.S. citizens or residents, and (b)
Commercial Guaranty Assurance's income must not be used in substantial part,
directly or indirectly, to make disproportionate distributions to, or to meet
certain liabilities to, individuals who are not Bermuda residents or U.S.
citizens or residents. Management monitored the sale of securities made pursuant
to the offering of the Series A preferred stock and warrants, the offering of
the investment units and the offering of the Series C preferred stock to ensure
that Commercial Guaranty Assurance would meet the tax treaty's eligibility
requirement after the completion of each of these offerings. Thus, absent a
misrepresentation by any of the purchasers of CGA Group's securities, CGA Group,
and hence Commercial Guaranty Assurance, meets the eligibility requirements of
the tax treaty. However, there can be no assurance that Commercial Guaranty
Assurance will continue to meet these requirements in the future.
The No PE Exemption may only apply to net premium income; thus, reliance
on the No PE Exemption may not preclude the U.S. from taxing a Bermuda
corporation that is predominantly engaged in the insurance business in the U.S.
on its non-premium effectively connected income. Accordingly, even if the No PE
Exemption is available to Commercial Guaranty Assurance, if Commercial Guaranty
Assurance is determined to be engaged in a trade or business in the U.S., the
U.S. may be able to tax any of its income (other than net premium income) that
is effectively connected with the conduct of that trade or business. In general,
income is effectively connected with the conduct of a U.S. trade or business
only if it is derived from U.S. sources. However, under special rules applicable
to foreign insurance companies engaged in an insurance business in the U.S., a
minimum amount of investment income (whether or not derived from U.S. sources),
determined by a formula, is deemed to be effectively connected with the conduct
of that U.S. trade or business (and, as previously indicated, may not be
protected from U.S. taxation by the No PE Exemption). Thus, if Commercial
Guaranty Assurance is determined to be engaged in a trade or business in the
U.S., a portion of its investment income may be subject to U.S. taxation, and
this could be so even though Commercial Guaranty Assurance does not, and does
not intend in the future to, invest in securities that generate U.S. source
income.
A foreign corporation not engaged in a trade or business in the U.S. is
subject to U.S. federal income tax at the rate of 30% on its "fixed or
determinable annual or periodical gains, profits and income" derived from
sources within the U.S. (for example, dividends and certain interest income).
Thus, even if Commercial Guaranty Assurance is not engaged in a trade or
business in the U.S., it could be subject to the 30% tax on this type of income,
depending upon the types of instruments in which it invests. As noted above,
however, Commercial Guaranty Assurance does not invest, and does not intend in
the future to invest, in securities that generate U.S. source income.
55
<PAGE>
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 currently applicable to
these premiums are four percent for direct insurance premiums and one percent
for reinsurance premiums. Management anticipates that a substantial portion of
Commercial Guaranty Assurance's premium income will be U.S. source income and
therefore subject to the excise tax. The excise tax would not apply, however, if
Commercial Guaranty Assurance were determined to be engaged in a trade or
business in the U.S. and ineligible for the No PE Exemption.
CGA Investment Management. As a U.S. corporation, CGA Investment
Management is subject to U.S. taxation at regular corporate tax rates, generally
35%. If CGA Investment Management were to distribute dividends to CGA Group,
these dividends would be subject to a 30% withholding tax. Because Commercial
Guaranty Assurance and CGA Investment Management are related parties for
purposes of the Internal Revenue Code's transfer pricing rules, under these
rules the IRS could allocate additional income to CGA Investment Management if
it were to determine that under circumstances involving unrelated parties
dealing at arms length CGA Investment Management would have earned income in
connection with Commercial Guaranty Assurance policies issued to CGA Investment
Management's customers, which was instead being shifted to Commercial Guaranty
Assurance. In such case, the reallocated income would be taxed as income to CGA
Investment Management at regular corporate rates and also might be subject to a
30% withholding tax. Nonetheless, there is no reason to believe that the various
fees are not at arm's length.
TAXATION OF HOLDERS OF SERIES A PREFERRED STOCK
BERMUDA TAXATION
Under current Bermuda law, dividends paid by Commercial Guaranty Assurance
to CGA Group and by CGA Group to the holders of its securities are not subject
to Bermuda withholding tax. If Bermuda were to enact a withholding tax on
dividends, which is not expected to be the case, the tax treaty as currently
written would not protect U.S. holders from the imposition of such tax with
respect to distributions from CGA Group.
U.S. TAXATION
The following summary addresses only certain U.S. federal income tax
consequences with respect to Series A preferred stock acquired by investors and
held as capital assets and does not deal with the tax consequences applicable to
all categories of investors, some of which (such as broker-dealers, investors
who hold Series A preferred stock as part of hedging or conversion transactions
and investors whose functional currency is not the U.S. dollar) may be subject
to special rules. Current investors in Series A preferred stock have been
advised and prospective investors in Series A preferred stock are again advised
to consult their own tax advisers with respect to their particular circumstances
and with respect to the effects of U.S. federal, state, local or other
countries' tax laws to which they may be subject.
U.S. HOLDERS
The following discussion summarizes certain U.S. federal income tax
consequences relating to the acquisition, ownership and disposition of Series A
preferred stock by a beneficial owner thereof that is
o a citizen or resident of the U.S.;
o a U.S. domestic corporation; or
o otherwise subject to U.S. federal income taxation on a net income
basis.
Dividends. Distributions with respect to the Series A preferred stock,
whether in cash or in additional shares, will be treated as ordinary dividend
income to the extent of CGA Group's current or accumulated earnings and profits
as determined for U.S. federal income tax purposes. Except in limited
circumstances not expected to be applicable here, these dividends will not be
eligible for the dividends received deduction generally allowed to U.S.
corporations. Distributions in excess of CGA Group's current and accumulated
earnings and profits will first be applied to reduce the holder's tax basis in
the Series A preferred stock, and any amounts distributed in excess of such tax
basis will be treated as gain from the sale or exchange of Series A preferred
stock. However, as discussed below, this treatment would be subject to certain
modifications if CGA Group is considered a "controlled foreign corporation".
Under existing rules and regulations, undeclared dividends are not taxable
until declared even if those dividends are cumulative and must be paid when the
shares are redeemed, as a result of a call, put or mandatory redemption
56
<PAGE>
obligation. It is possible, however, that this rule could be changed so that in
some circumstances these undeclared dividends would be currently taxable. If
this type of change were to occur, it is not possible to say whether it would
apply to the Series A preferred stock, although if it were to apply it is likely
that it would apply prospectively. This change could be made by regulation and
therefore does not require Congressional action.
Redemption of Series A Preferred Stock. A redemption of Series A preferred
stock for cash will be taxable as a distribution in exchange for the stock.
Generally, a redemption will result in capital gain or loss equal to the
difference between the amount of cash received and the stockholder's tax basis
in the stock redeemed and will be long-term if the stock was owned for more than
one year. However, any portion of the redemption price attributable to declared
but unpaid dividends or dividend arrearages will be taxable as a dividend to the
extent of earnings and profits.
Under certain circumstances, cash received in redemption of preferred
stock that is not attributable to dividend arrearages or declared but unpaid
dividends may nevertheless also be taxable as a dividend, rather than as an
exchange. This type of a result could obtain in the event that CGA Group redeems
less than the full amount of a stockholder's shares of Series A preferred stock
under one of its early redemption options. However, when, taking into account
all classes of stock in CGA Group, a stockholder either
o completely terminates its interest (other than as a creditor) in the
redeeming company (taking into account the attribution rules
prescribed by the Internal Revenue Code);
o experiences a substantial reduction in its interest in corporate
management and earnings as a result of the redemption and is a
minority shareholder after the redemption; or
o is a less than one percent stockholder and experiences any reduction
in its interest, the redemption proceeds will instead be treated as
an exchange and generally will give rise to capital gain or loss.
Redemption Premium. The Internal Revenue Code requires that in certain
circumstances the excess of the redemption price of preferred stock over its
issue price (a redemption premium) be included in income, prior to receipt, as a
constructive dividend. However, this provision should not apply to the Series A
preferred stock because the redemption price is not expected to exceed the issue
price by more than a de minimis amount, which will be the case if redemption
occurs at maturity. These rules could, however, apply in the event that the fair
market value of any distributed shares of Series A preferred stock is less than
$25.00 on the date of distribution.
Controlled Foreign Corporations. Each U.S. 10% Shareholder (as described
below) of a controlled foreign corporation must include in gross income for U.S.
federal income tax purposes its pro rata share of the controlled foreign
corporation's "subpart F income," whether or not such income is distributed by
the controlled foreign corporation to such shareholder. Any U.S. corporation,
citizen, resident, partnership, estate or trust that owns, directly or
indirectly through foreign persons, or is considered to own, 10 percent or more
of the total combined voting power of all classes of stock of the foreign
corporation will be considered to be a "U.S. 10% shareholder." Subpart F income
includes insurance income and "fixed or determinable annual or periodical"
income. A foreign insurance company, such as Commercial Guaranty Assurance, will
be treated as a controlled foreign corporation only if U.S. 10% shareholders
collectively own more than 25 percent of the total combined voting power or
total value of the corporation's stock for an uninterrupted period of 30 days or
more during any tax year. In the case of all other foreign corporations, such as
CGA Group, the test is generally the same except that more than 50 percent is
substituted for more than 25 percent.
Except as provided below, CGA Group's bylaws attempt to limit the direct
and indirect voting power of each holder of CGA Group's stock so that no U.S.
person, other than a holder of Series A preferred stock during an event of
non-compliance, will be entitled to votes representing 10 percent or more of CGA
Group's voting power. In addition, CGA Group's bylaws provide that CGA Group's
voting rights in Commercial Guaranty Assurance will be exercised in accordance
with the proportional voting rights of the shareholders of CGA Group so that no
U.S. person will be entitled indirectly to votes representing 10% or more of
Commercial Guaranty Assurance's voting power. Accordingly, management expects
that neither CGA Group nor Commercial Guaranty Assurance is or will become a
controlled foreign corporation. However, given the Internal Revenue Code's broad
constructive ownership rules, it is possible that stock in CGA Group owned by
one or more persons will be attributed to another person that also owns stock in
CGA Group and could result in a person inadvertently becoming a U.S. 10%
shareholder and/or CGA Group becoming a controlled foreign corporation, which in
turn could cause Commercial Guaranty Assurance to also become a controlled
foreign corporation. In addition, if an event of non-compliance occurs, one or
more holders of the
57
<PAGE>
Series A preferred stock could become a U.S. 10% shareholder because upon the
happening of one of these events, the holders of the Series A preferred stock as
a class have the right to appoint additional directors to the board.
Accordingly, in this case, it is possible that each of CGA Group and Commercial
Guaranty Assurance could become a controlled foreign corporation. Nonetheless,
so long as a shareholder of CGA Group is not itself a U.S. 10% Shareholder and,
as expected (and explained below), Commercial Guaranty Assurance does not have
related person insurance income that is currently taxable to U.S. shareholders,
the classification of CGA Group or Commercial Guaranty Assurance as a controlled
foreign corporation will have no adverse effect on such shareholder. Therefore,
U.S. persons who might directly or through attribution acquire stock possessing
10 percent or more of the combined voting power of CGA Group should consider the
possible application of the controlled foreign corporation rules.
Related Person Insurance Income Rules. Certain provisions of the Internal
Revenue Code will apply to off-shore insurance companies such as Commercial
Guaranty Assurance, if
o at least 25% of the value or voting power of an insurance company's
stock is held (directly or indirectly through foreign entities) by
U.S. persons (which includes all U.S. shareholders, not just U.S.
10% shareholders),
o at least 20% of an insurance company's gross insurance income is
related person insurance income (as described below) and
o at least 20% of the voting power or the value of an insurance
company's stock is owned, directly or indirectly, by related U.S.
persons or persons which are insured or reinsured (directly or
indirectly) by the insurance company or persons "related" to such
insureds or reinsureds (the "RPII CFC Rule").
Related person insurance income is income (investment income and premium income)
from the direct or indirect insurance or reinsurance of any U.S. person who
holds (directly or indirectly through foreign entities) such insurance company's
stock or a person "related" to such a U.S. holder of the insurance company's
stock. Generally, the term "related" person for this purpose means someone who
controls or is controlled by the U.S. person or someone who is controlled by the
same person or persons that control such U.S. person. "Control" exists where a
person owns more than 50% in value or voting power of a corporation's stock,
after applying certain constructive ownership rules.
Commercial Guaranty Assurance takes such steps as are necessary to ensure
that less than 20% of Commercial Guaranty Assurance's gross insurance income is
related person insurance income and that less than 20% of the voting power or
value of CGA Group's stock is owned by persons insured or reinsured (directly or
indirectly) by Commercial Guaranty Assurance or "related" to such insureds or
reinsureds.
Commercial Guaranty Assurance may insure risks on behalf of St. George
and/or Cobalt without creating related person insurance income, provided no U.S.
person owns directly or constructively more than 50% of the vote or value of St.
George Holdings' or Cobalt Holdings', and hence each of their subsidiaries',
stock. Upon the initial distributions of the securities of St. George and
Cobalt, respectively, no U.S. person owned directly or constructively more than
50% of the vote or value of these companies' securities. Moreover, St. George
Holdings' and Cobalt Holdings' governing documents each contain restrictions on
the sale of such securities that should effectively preclude any U.S. person
from owning more than 50% of the vote or value of either the securities of St.
George Holdings or the securities of Cobalt Holdings. Therefore, management
expects that no related person insurance income will result from insuring
investments of St. George and/or Cobalt.
In light of the foregoing, management believes that less than 20% of the
gross insurance income of Commercial Guaranty Assurance for any taxable year
will constitute related person insurance income. However, if 20% or more of the
gross insurance income of Commercial Guaranty Assurance for any taxable year
were to constitute related person insurance income and 20% or more of the voting
power or value of Commercial Guaranty Assurance stock is held, directly or
indirectly, by U.S. insureds or reinsureds or by persons related to Commercial
Guaranty Assurance, each direct and indirect U.S. holder of securities would be
taxable currently on its allocable share of Commercial Guaranty Assurance's
related person insurance income regardless of whether the holder is a "U.S. 10%
Shareholder" and regardless of whether the holder is an insured or related to an
insured. For this purpose, all of Commercial Guaranty Assurance's related person
insurance income would be allocated solely to U.S. holders, but no holder would
be allocated related person insurance income in excess of its ratable share of
Commercial Guaranty Assurance's total income.
In order to determine how much related person insurance income, if any,
Commercial Guaranty Assurance has earned in each fiscal year, management asks
its policyholders whether they or any persons related to them own shares
58
<PAGE>
of CGA Group and are U.S. persons. In addition, after each fiscal year ends,
Commercial Guaranty Assurance sends a letter to each person who was a
policyholder during that year asking the policyholder to represent whether
during the year it was a U.S. person owning stock of CGA Group or was related to
such a person. There can be no assurance that this procedure will enable CGA
Group to identify all of Commercial Guaranty Assurance's income which may be
considered related person insurance income. For any taxable year in which CGA
Group determines that Commercial Guaranty Assurance's gross related person
insurance income is 20% or more of Commercial Guaranty Assurance's gross
insurance income for the year, CGA Group may also seek information from its
shareholders as to whether beneficial owners of its shares at the end of the
year are U.S. persons. To the extent CGA Group is unable to determine whether a
beneficial owner of shares is a U.S. person, CGA Group may assume that the owner
is not a U.S. person for purposes of apportioning related person insurance
income, thereby increasing the per share related person insurance income amount
for all other shareholders who are known to be U.S. persons.
Information Reporting. If Commercial Guaranty Assurance meets the related
person insurance income controlled foreign corporation Rule in a given tax year,
each U.S. person who is a shareholder of CGA Group on the last day of CGA
Group's fiscal year must attach a Form 5471 to the shareholder's income tax or
information return for the period which includes that date. In the event that
Commercial Guaranty Assurance's gross related person insurance income
constitutes 20% or more of its gross insurance income (which is not anticipated)
and no other exception applies that would prevent Commercial Guaranty Assurance
from being subject to the related person insurance income controlled foreign
corporation Rule, CGA Group intends to provide Form 5471 to its U.S.
shareholders for attachment to their returns. The amount of the related person
insurance income inclusions may be subject to adjustment based upon subsequent
IRS examination. A tax-exempt organization will be required to attach Form 5471
to its information return in the circumstances described above. See "Unrelated
Business Taxable Income of tax-exempt Shareholders" below. Failure to file Form
5471 may result in penalties.
In addition, U.S. persons who at any time own 10% or more in vote or value
of the total outstanding shares of CGA Group have an independent obligation to
file Form 5471 with respect to such shares, and should consult with their tax
advisor regarding this and other possible reporting requirements.
Unrelated Business Taxable Income of Tax-Exempt Shareholders. Subpart F
insurance income (which includes related person insurance income) allocable to
U.S. tax-exempt organizations is likely to be treated as unrelated business
taxable income. Under a look-through rule, this type of income is treated as if
it were directly received by the tax-exempt organization and therefore will be
considered income from an unrelated business. While the look-through rule
generally will not apply to subpart F insurance income attributable to insurance
of the tax-exempt organization's own risks or those of certain of its
affiliates, it is unlikely that this subpart F insurance income will be so
traced. Rather, since subpart F insurance income is allocated to all U.S. 10%
shareholders, and related person insurance income, if there is any, is allocated
to all U.S. persons who own stock, it is likely that any subpart F insurance
income that is allocated to a tax exempt shareholder, will be attributable to
risks other than its own or those of its affiliates. Nonetheless, to the extent
any tax-exempt shareholder is allocated exempt subpart F insurance income and
that income is so traceable, the income should not be unrelated business taxable
income. Investors are advised to consult their own tax advisors regarding the
application of this rule.
Dispositions of Series A Preferred Stock by U.S. Persons, Generally.
Subject to the discussions below relating to "Disposition of Series A Preferred
Stock by U.S. Persons Who are Not U.S. 10% Shareholders" and "Disposition of
Series A Preferred Stock by U.S. 10% Shareholders," U.S. persons will, upon the
sale or exchange of Series A preferred stock, generally recognize gain or loss
for federal income tax purposes equal to the excess of the amount realized upon
such sale or exchange over the person's federal income tax basis for such Series
A preferred stock. However, in certain circumstances described below, gain may
be recharacterized, in whole or in part, as a dividend.
Disposition of Series A Preferred Stock by U.S. Persons Who are Not U.S.
10% Shareholders. As noted above, in the case of a U.S. person who owns Series A
preferred stock but is not a U.S. 10% shareholder, related person insurance
income may be allocable to such holder's securities in CGA Group during the
period of ownership but not taxed to him because less than 20 percent of CGA
Group's securities are owned by persons generating related person insurance
income or less than 20 percent of Commercial Guaranty Assurance's gross
insurance income is related person insurance income. Upon the holder's sale or
exchange of Series A preferred stock at a gain, however, there is a reasonable
likelihood that an amount of the gain equal to the holder's allocable share of
untaxed related person insurance income will be taxable as a dividend. Moreover,
the IRS has an arguable position that the amount of gain so taxed as a dividend
will be equal to all the earnings and profits allocable to the U.S. holder
during the period that such
59
<PAGE>
holder held the Series A preferred stock (whether or not Commercial Guaranty
Assurance has related person insurance income). Dewey Ballantine believes that
this position would not be correct, but due to the absence of clarifying
regulations, there can be no assurance that the IRS will not take this position.
If the IRS were to take this position and were to prevail, for individuals, this
would mean that the amount of gain taxed as a dividend would bear tax at the
rates applicable to ordinary income rather than at the currently lower rates
applicable to long-term capital gain. The rates applicable to corporate
shareholders would not be affected, however, since corporations pay tax on
capital gains at the same rates as they pay on ordinary income.
If, as Dewey Ballantine believes, only the untaxed related person
insurance income would be subject to dividend characterization, the selling
shareholder nevertheless has the burden of showing the amount of untaxed related
person insurance income allocable to the Series A preferred stock sold. CGA
Group keeps records showing what it believes to be the untaxed related person
insurance income allocable to each share of Series A preferred stock and will,
upon reasonable request, provide any owner or prior owner of Series A preferred
stock with such information.
Disposition of Series A Preferred Stock by U.S. 10% Shareholders. To the
extent that the income of Commercial Guaranty Assurance is taxable currently to
a U.S. 10% shareholder as subpart F income (which includes related person
insurance income), gain from the sale of Series A preferred stock by such U.S.
10% shareholder will not be recharacterized as a dividend, except to the extent
of such U.S. 10% shareholder's allocable share of subpart F income in the year
of sale.
Uncertainty as to Application of Related Person Insurance Income.
Regulations interpreting the related person insurance income provisions of the
Internal Revenue Code exist only in proposed form. It is not certain whether
these regulations will be adopted in their proposed form or what changes might
ultimately be made thereto when they are finalized, or whether any such changes,
as well as any interpretation or application of the related person insurance
income rules by the IRS, the courts or otherwise, might have retroactive effect.
In addition, there can be no assurance that the IRS will not challenge any
determinations by CGA Group or Commercial Guaranty Assurance as to the amount,
if any, of related person insurance income that should be includible in the
income of a holder of Series A preferred stock or that the amounts of the
related person insurance income inclusions will not be subject to adjustment
based upon subsequent IRS examination. Accordingly, the meaning of the related
person insurance income provisions and the application thereof to CGA Group and
its subsidiaries is uncertain. Each U.S. person which currently owns Series A
preferred stock has been advised, and each such person which is considering an
investment in Series A preferred stock is again advised, to consult a tax
advisor as to the implications of related person insurance income on its
investment.
Foreign Tax Credit. Because it is believed that currently U.S. persons own
at least 50 percent of CGA Group's stock and this ownership distribution is
anticipated to continue in the future, only a portion of both the dividends paid
by CGA Group (including any gain from the sale of Series A preferred stock that
is treated as a dividend) and any subpart F income of its subsidiaries
(including related person insurance income of Commercial Guaranty Assurance) may
be treated as foreign source income for purposes of computing a shareholder's
U.S. foreign tax credit limitation. CGA Group will consider providing
shareholders with information regarding the portion of this subpart F income or
dividend inclusions constituting foreign source income to the extent this
information is reasonably available. It is likely that substantially all of this
income that is foreign source will constitute either "passive" or "financial
services" income for foreign tax credit limitation purposes. Thus, U.S.
shareholders with excess foreign tax credits may not be able to utilize these
excess foreign tax credits to reduce U.S. tax on this income.
Passive Foreign Investment Companies. Special U.S. federal income tax
rules apply to foreign corporations that are "passive foreign investment
companies." In general, a foreign corporation will be a passive foreign
investment company if 75 percent or more of its income constitutes "passive
income" or 50 percent or more of its assets produce passive income. In the case
of a company that is a passive foreign investment company, its shareholders who
are U.S. persons would be subject to a penalty tax at the time of their sale of,
or receipt of an "excess distribution" with respect to their securities unless
they elected to be treated as a "qualified electing fund", in which case they
would be currently taxable on their share of each year's income. In general, a
shareholder receives an "excess distribution" if the amount of the distribution
is more than 125 percent of the average distribution with respect to their stock
during the three preceding taxable years (or shorter period during which the
taxpayer held the stock). In general, the penalty tax is equivalent to an
interest charge on taxes that are deemed due but not paid during the period that
the shareholder owned the shares, computed by assuming that the excess
distribution or gain (in the case of a sale) with respect to the securities was
received in equal portions and taxed at the highest applicable tax rate
60
<PAGE>
throughout the holder's period of ownership. The interest charge is equal to the
applicable rate imposed on underpayments of U.S. federal income tax for such
period.
The passive foreign investment company statutory provisions contain an
express exception from the definition of passive income for income "derived in
the active conduct of an insurance business by a corporation which is
predominantly engaged in an insurance business." This exception is intended to
ensure that income derived by a bona fide insurance company is not treated as
passive income, except to the extent this income is attributable to financial
reserves in excess of the reasonable needs of the insurance business.
The passive foreign investment company statutory provisions contain a
look-through rule which states that for purposes of determining whether a
foreign corporation is a passive foreign investment company such foreign
corporation shall be treated as if it received "directly its proportionate share
of the income" and as if it "held its proportionate share of the assets" of any
other corporation in which it owns at least 25 percent of the value of its
stock. Because CGA Group is expected to own all of the outstanding stock of
Commercial Guaranty Assurance and CGA Investment Management, the look-through
rule should apply to treat CGA Group as owning the assets and receiving the
income of Commercial Guaranty Assurance and CGA Investment Management directly
for purposes of determining whether CGA Group is a passive foreign investment
company in any given year.
In management's view, CGA Group, through its principal subsidiary,
Commercial Guaranty Assurance, will be predominantly engaged in an insurance
business and will not have financial reserves in excess of the reasonable needs
of Commercial Guaranty Assurance's insurance business. While no explicit
guidance is provided by the statutory language and regulations on these
provisions have not been issued, Dewey Ballantine believes that under the
look-through rule CGA Group should be deemed to own the assets and to have
received the income of Commercial Guaranty Assurance, its insurance subsidiary,
directly for purposes of determining whether CGA Group qualifies for the above
insurance exception. This interpretation of the look-through rule is consistent
with the legislative intention generally to exclude bona fide insurance
companies from the application of the passive foreign investment company
provisions; however, until definitive regulations are issued there can be no
assurance that the look through rule will be applied in this fashion.
If, however, the look-through rule does not apply to CGA Group with
respect to the income and assets of Commercial Guaranty Assurance in the manner
described above, then CGA Group might be a passive foreign investment company.
Moreover, there is a risk that the Commercial Guaranty Assurance Fund Guaranty
would be viewed as equity in St. George, in which event Commercial Guaranty
Assurance would be viewed as owning virtually all of the equity of St. George
and/or Cobalt. This risk arises because St. George and Cobalt intend that
Commercial Guaranty Assurance-guaranteed borrowing will provide 99% of the funds
used to acquire their respective investment portfolios and for the collateral
value of their respective investment portfolios and that Commercial Guaranty
Assurance's Fund Guaranty will represent the principal credit support for
lenders and counterparties of St. George and Cobalt. If the Commercial Guaranty
Assurance Fund Guaranty were to be viewed as equity, the "look through" rule
would apply to treat Commercial Guaranty Assurance as if it owned virtually all
of St. George's and/or Cobalt's assets and earned virtually all of St. George's
and/or Cobalt's income, and since both such assets and income would be passive,
this might result in CGA Group becoming a passive foreign investment company.
Fund Guaranty to the availability of the
Moreover, if Commercial Guaranty Assurance were considered to own
substantially all of St. George's and/or Cobalt's equity, there is also a risk
that Commercial Guaranty Assurance's premium income from St. George and/or
Cobalt would not be viewed as insurance income. Nonetheless, there are
substantial arguments against treating Commercial Guaranty Assurance as owning
substantially all of St. George's and/or Cobalt's equity by reason of the
insurance that it writes for such companies, with one of the strongest being
that the premiums that Commercial Guaranty Assurance will charge St. George and
Cobalt for insurance will be based upon the same criteria as those used to
determine the premium charged to unrelated third parties and therefore should be
viewed as an arm's length premium.
It is the opinion of Dewey Ballantine that Commercial Guaranty Assurance
should not be viewed as holding equity in St. George and/or Cobalt and therefore
the look through rules should not apply with respect to St. George's or Cobalt's
assets or income and the premiums derived by Commercial Guaranty Assurance from
St. George and Cobalt should be viewed as active income derived from the
insurance business. However, given the relatively small amount of equity in St.
George and Cobalt the importance of the Commercial Guaranty Assurance Fund
Guaranty to the availability of the loan facility, the fact that initially all
of the equity securities of St. George Holdings and limited
61
<PAGE>
partnership interests in Cobalt Holdings will be held by shareholders of CGA
Group and the absence of authority directly on point, there is some risk that
the IRS could successfully treat Commercial Guaranty Assurance as owning most of
St. George's and Cobalt's equity and apply the look-through rule to cause
Commercial Guaranty Assurance to be characterized as a passive foreign
investment company. Therefore, each U.S. person which owns Series A preferred
stock and each U.S. person which is considering an investment in the Series A
preferred stock and is not a tax-exempt entity (which is unaffected by the
passive foreign investment company rules under existing law) is again advised to
consult a tax advisor as to the effects of the passive foreign investment
company rules.
NON-U.S. HOLDERS
Persons that are not U.S. persons generally will be subject to U.S.
federal income tax on dividend distributions with respect to, and gain realized
from the sale or exchange of, Series A preferred stock only if the dividends or
gains are effectively connected with the conduct of a trade or business within
the U.S. Management believes that nonresident alien individuals will not be
subject to U.S. federal income or estate tax with respect to Series A preferred
stock of CGA Group.
ALL HOLDERS OF SERIES A PREFERRED STOCK
Management does not expect CGA Group to pay dividends on the Series A
preferred stock through paying agents or custodians located in the U.S., but if
such were the case, the U.S. custodian or payor would be required to satisfy
certain information reporting requirements. In addition, in this case, a holder
of Series A preferred stock could be subject to backup withholding at the rate
of 31 percent with respect to dividends paid to these persons, unless the holder
(a) is a corporation or comes within other exempt categories and, when required,
demonstrates this fact, or (b) provides a taxpayer identification number,
certifies as to no loss of exemption from backup withholding and otherwise
complies with applicable requirements of the backup withholding rules. The
backup withholding tax is not an additional tax and may be credited against a
holder's regular U.S. federal income tax liability. No backup withholding would
occur if CGA Group were to directly pay any dividends on the Series A preferred
stock or were to use a non-U.S. paying agent or custodian to do so.
Except as discussed above with respect to backup withholding, dividends
paid by CGA Group will not be subject to a U.S. withholding tax.
The tax considerations could be different if certain of the structures
described above that are intended to mitigate negative tax consequences were to
be modified or eliminated, as the board of directors and shareholders will have
the authority to do.
LEGAL MATTERS
The validity of the Series A preferred stock will be passed upon as to
matters of Bermuda law by Conyers, Dill & Pearman, and as to matters of United
States tax law, by Dewey Ballantine LLP, New York, New York.
EXPERTS
The financial statements of CGA Group as of and for the year ended
December 31, 1998, for the nine months ended December 31, 1997 and for the
period from June 21, 1996 to March 31, 1997 included in this prospectus and
elsewhere in this registration statement have been audited by
PricewaterhouseCoopers, independent accountants as indicated in their report
with respect thereto and are included in this prospectus in reliance upon the
authority of PricewaterhouseCoopers as experts in accounting and auditing.
ENFORCEABILITY OF CIVIL LIABILITIES
As a Bermuda corporation, substantially all the assets of CGA Group are
located outside the United States. Accordingly, any judgment obtained in the
United States against CGA Group may not be collectible within the United States.
CGA Group will consent to service of process in the City of New York, Borough of
Manhattan, for claims relating to the validity, or seeking enforcement, of CGA
Group's obligations under the terms of the Series A preferred stock. CGA Group
has appointed CT Corporation System as its authorized agent upon which process
may be served in any such action. See "Description Of Securities--Governing Law;
Consent To Jurisdiction and Service."
62
<PAGE>
Accordingly, it may be difficult for investors to effect service within the
United States upon CGA Group with respect to other claims pertaining to the
Series A preferred stock, including claims predicated upon the civil liability
provisions of the securities laws of the United States. Moreover, it may be
difficult for investors to enforce outside the United States judgments against
CGA Group obtained in the United States in any actions pertaining to the Series
A preferred stock, particularly with respect to actions to which CGA Group has
not consented to service of process in the United States such as those
predicated upon the civil liability provisions of the securities laws of the
United States. In addition, some of CGA Group's directors and executive
officers, and certain of the experts named herein, are residents of Bermuda. As
a result, it may be difficult for investors to effect service within the United
States upon such persons or to realize in the United States upon judgments of
courts in the United States, including judgments predicated upon civil liability
under United States securities laws. CGA Group has been informed by its Bermuda
counsel, Conyers Dill & Pearman, that the United States and Bermuda do not
currently have a treaty providing for reciprocal recognition and enforcement of
judgments of U.S. courts in civil and commercial matters and that a final
judgment for the payment of money rendered by any federal or state court in the
United States based on civil liability, whether or not predicated solely upon
the U.S. federal securities laws, would, therefore, not be automatically
enforceable in Bermuda. CGA Group has also been advised by Conyers Dill &
Pearman that a final and conclusive judgment obtained in federal or state courts
in the United States under which a sum of money is payable as compensatory
damages (i.e., not being a sum claimed by a revenue authority for taxes or other
charges of a similar nature by a governmental authority, or in respect of a fine
or penalty or multiple or punitive damages) may be the subject of an action on a
debt in the Supreme Court of Bermuda under the common law doctrine of
obligation. This type of action should be successful upon proof that the sum of
money is due and payable, and without having to prove the facts supporting the
underlying judgment, as long as (a) the court that gave the judgment was
competent to hear the action in accordance with private international law
principles as applied by the courts in Bermuda and (b) the judgment is not
contrary to public policy in Bermuda, was not obtained by fraud or in
proceedings contrary to natural justice of Bermuda and is not based on an error
in Bermuda law. A Bermuda court may impose civil liability on CGA Group or its
directors or officers in a suit brought in the Supreme Court of Bermuda against
CGA Group or such persons with respect to a violation of U.S. federal securities
laws, provided that the facts surrounding the violation would constitute or give
rise to a cause of action under Bermuda law.
AVAILABLE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 under the Securities Act with respect to the shares of
Series A preferred stock offered hereby. This prospectus does not contain all
the information set forth in the registration statement and the exhibits and
schedules to the registration statement. For additional information with respect
to us and the Series A preferred stock offered hereby, reference is made to the
registration statement and the exhibits and schedules filed with the
registration statement. Statements contained in this prospectus as to the
contents of any contract or any other document referred to are not necessarily
complete, and in each instance reference is made to the copy of such contract or
document filed as an exhibit to the registration statement, each of these
statement being qualified in all respects by the reference. A copy of the
registration statement may be inspected without charge at the offices of the
Securities and Exchange Commission in Washington, D.C. 20549 and copies of all
or any part of the registration statement may be obtained from the Public
Reference Section of the Securities and Exchange Commission maintained at Suite
1300, 7 World Trade Center, New York, New York 10048 and Suite 1400, Citicorp
Center, 500 West Madison Street, Chicago, Illinois 60661-2511, at prescribed
rates.
63
<PAGE>
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
<TABLE>
PAGE
----
<S> <C>
Financial Statements of CGA Group, Ltd.
Report of Independent Auditors on Financial Statements.............................. F-2
Consolidated Balance Sheets at December 31, 1998 and 1997........................... F-3
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 ................................................................ F-4
Consolidated Statements of Mezzanine Equity for the year ended December 31, 1998
and the nine months ended December 31, 1997 ...................................... F-5
Consolidated Statements of Shareholders' Equity for the year ended December 31,
1998 and the nine months ended December 31, 1997.................................. F-6
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................................................................. F-7
Notes to Consolidated Financial Statements for the year ended December 31, 1998..... F-8
Unaudited Consolidated Balance Sheets -- June 30, 1999 and December 31, 1998........ F-22
Unaudited Consolidated Statements of Operations -- Three Months and Six Months
Ended June 30, 1999 and June 30, 1998............................................. F-23
Unaudited Consolidated Statements of Changes in Mezzanine Equity -- Six Months
Ended June 30, 1999 and the Year Ended December 31, 1998.......................... F-24
Unaudited Consolidated Statements of Changes in Shareholders' Equity -- Six
Months Ended June 30, 1999 and the Year Ended December 31, 1998................... F-25
Unaudited Consolidated Statements of Cash Flows -- Six Months Ended June 30, 1999
and 1998 ......................................................................... F-26
Notes to Unaudited Consolidated Financial Statements for the Six Months Ended
June 30, 1999 .................................................................... F-27
Financial Schedule(s)
</TABLE>
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.
F-1
<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
F-2
<PAGE>
CGA GROUP, LTD.
CONSOLIDATED BALANCE SHEETS
(EXPRESSED IN U.S. DOLLARS)
<TABLE>
<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.
F-3
<PAGE>
CGA GROUP, LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
(EXPRESSED IN U.S. DOLLARS)
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED JUNE 21, 1996
DECEMBER 31, DECEMBER 31, TO MARCH 31,
1998 1997 1997
------------ ------------ ------------
REVENUES
<S> <C> <C> <C>
Gross premiums written ............................ $ 49,217,083 $ 773,571 $ --
Ceded premiums .................................... (39,420,247) -- --
------------ ------------ ------------
Net premiums written .............................. 9,796,836 773,571 --
Change in unearned premiums ....................... (550,547) (270,576) --
------------ ------------ ------------
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
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
CGA GROUP, LTD.
CONSOLIDATED STATEMENTS OF MEZZANINE EQUITY
(EXPRESSED IN U.S. DOLLARS)
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31,
1998 1997
------------- -------------
MEZZANINE EQUITY
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
============= =============
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
CGA GROUP, LTD.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(EXPRESSED IN U.S. DOLLARS)
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31,
1998 1997
------------ ------------
SHAREHOLDERS' EQUITY
COMMON STOCK
<S> <C> <C>
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.
F-6
<PAGE>
CGA GROUP, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(EXPRESSED IN U.S. DOLLARS)
<TABLE>
<CAPTION>
NINE MONTHS JUNE 21, 1996
YEAR ENDED ENDED TO
DECEMBER 31 DECEMBER 31 MARCH 31,
1998 1997 1997
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C> <C> <C>
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.
F-7
<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, a holding company, was incorporated in Bermuda on June 21,
1996. CGA Group has two wholly owned subsidiaries. Commercial Guaranty
Assurance, Ltd. was incorporated in Bermuda on October 22, 1996. Commercial
Guaranty Assurance is licensed as a class 3 insurer under the Insurance Act 1978
of Bermuda, 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. Commercial
Guaranty Assurance has a "Triple-A" "claims paying ability" rating from Duff &
Phelps Credit Rating Company 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. Commercial Guaranty Assurance
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. was incorporated in
Delaware, U.S.A. in July 1996 by the founders of CGA Group and was acquired at
nominal cost to CGA Group on June 9, 1997. CGA Investment Management did not
commence operations until after its acquisition by CGA Group. CGA Investment
Management is registered as an investment advisor with the United States
Securities and Exchange Commission under the Investment Advisors Act of 1940, as
amended. CGA Investment Management provides investment management and financial
advisory services primarily to specialized investment vehicles and for the U.S.
and international structured finance markets. CGA Investment Management and its
employees are based in New York City, New York.
The primary clients of Commercial Guaranty Assurance and CGA Investment
Management are St. George Holdings, Ltd. and Cobalt Holdings, Ltd. and their
respective subsidiaries. In 1998 they provided approximately 85% of the total
premiums earned by Commercial Guaranty Assurance, and 91% of the total
investment management fees earned by CGA Investment Management. These
percentages are expected to decrease in the future.
Operations commenced following the completion of CGA Group's private
placement offering which occurred on June 17, 1997. The initial capitalization
of CGA Group 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 CGA Group
completed its recapitalization.
As part of the recapitalization on June 17, 1997, CGA Group issued 2.6
million shares of Series A preferred stock, par value $.01 per share, for a
price of $25 per share. The shares of Series A preferred stock are entitled to 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 a total of 270,000
shares of common stock at an exercise price of $.01 per share. The warrants were
valued at $4.99 per share and were accounted for as additional paid-in-capital
to the common stock.
As part of the recapitalization, on June 17, 1997, CGA Group issued 1.6
million shares of Series B cumulative voting preferred stock, par value $.01 per
share, for a price of $25 per share. The shares of Series B preferred stock were
entitled to a 20% quarterly compounding dividend paid in additional shares of
Series B preferred stock. The shares of Series B preferred stock were sold to
investors as part of investment units which also included commitments to
purchase an additional $60 million of Series B preferred stock in the aggregate
upon the occurrence of certain funding events, in order to maintain Commercial
Guaranty Assurance's "Triple-A" rating from Duff & Phelps. CGA Group pays a
$600,000 annual fee to the holders of the investment units for their
commitments. The investment units also included an aggregate of 7,827,957 shares
of common stock out of a total of 9,100,000 million shares of common stock
issued pursuant to the recapitalization 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. The exercise price on
these warrants is subject to
F-8
<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)
reduction based on the sales price of additional common stock or equivalents. A
reduction in the exercise price occurred on March 31, 1999 from $5.00 to $2.12
as a result of the Series B preferred stock conversion and Series C preferred
stock issuance. An additional 1,494,771 warrants have been authorized for
issuance to certain employees which each represent the right to purchase one
share of common stock on or prior to June 17, 2007 at an exercise price of $5
per share.
2. SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared on the basis of
accounting principles generally accepted in the United States of America (GAAP)
and include the accounts of CGA Group, Commercial Guaranty Assurance, and CGA
Investment Management. 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
Commercial Guaranty Assurance'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. CGA Group evaluates the recoverability of deferred
acquisition costs whenever changes in circumstances warrant. If it is determined
that an impairment exists, the excess of the unamortized balance over deferred
acquisition costs will be charged to earnings.
c) Reinsurance
In the ordinary course of business, Commercial Guaranty Assurance 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 Commercial Guaranty Assurance of its original liability to its
policyholders. In the event that a reinsurer was unable to meet its obligations
under the existing reinsurance contracts, Commercial Guaranty Assurance 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 Commercial Guaranty Assurance's insured
obligations over the expected term of such insured obligations.
F-9
<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)
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. CGA Group 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 4 regarding subsequent
events.
e) Organization expenses
Organization costs consisted of expenses incurred to form CGA Group 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, CGA Group expensed
the remaining unamortized organization costs which is reflected in the financial
statements as a change in accounting principle. (See footnote (2.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.
CGA Group 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
CGA Group computes loss per share in accordance with Statement of
Financial Accounting Standard (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) Comprehensive income
The FASB issued Statement of Financial Accounting Standard (SFAS) No. 130,
"Reporting Comprehensive Income", effective for fiscal years beginning after
December 15, 1997. This statement requires CGA Group to report in the financial
statements, in addition to net income, comprehensive income and its components.
Comprehensive income for CGA Group is comprised solely of changes in unrealized
appreciation or depreciation on marketable investments. CGA Group has adopted
SFAS 130 in these consolidated financial statements.
F-10
<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)
j) Segments
The FASB issued Statement of Financial Accounting Standard (SFAS) No. 131,
"Disclosures about Segments of an Enterprise and Related Information", which CGA
Group has adopted in these consolidated financial 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 CGA Group's
investment management and insurance operations.
k) 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 CGA Group to expense
organization costs as incurred. On July 1, 1998, CGA Group expensed the
remaining unamortized organization costs which is reflected in the financial
statements as a change in accounting principle.
3. NOTE RECEIVABLE
CGA Group held a note receivable from CGA Group's chief executive officer
for $1.25 million which was issued in connection with the June 17, 1997
recapitalization in exchange for 250,000 shares of CGA Group'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>
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>
F-11
<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>
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 St. George
Holdings which is the parent company of certain clients of CGA Investment
Management. 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 St.
George Holdings and its subsidiaries with cash to manage their liquidity and to
pay for additional financial guaranty insurance.
F-12
<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 Commercial Guaranty Assurance'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. This type of 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., a credit-card debt
collection company, were withdrawn by the three credit rating companies that
rate the
F-13
<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)
most recently issued Commercial Financial Services securities. The withdrawal of
the ratings was in response to allegations of accounting irregularities at
Commercial Financial Services. The rating agencies, investors and insurers have
commenced an investigation into the allegations. Clients of CGA Investment
Management own approximately $155 million par of the Commercial Financial
Services securities and Commercial Guaranty Assurance has insured the credit
facilities used to finance their purchase. Commercial Guaranty Assurance had
previously reinsured approximately $138 million par of this exposure. In
addition, Commercial Guaranty Assurance has exposure of approximately $46
million par to Commercial Financial Services securities through a financial
guaranty policy issued to a client that purchased the securities for their own
account. Commercial Guaranty Assurance previously reinsured approximately $16
million par of this exposure. In summary, Commercial Guaranty Assurance has
exposure to a total of $201 million par of Commercial Financial Services issued
securities, of which $154 million par has been reinsured, leaving a net exposure
of approximately $47 million par. Commercial Guaranty Assurance estimates the
loss on its net exposure of the Commercial Financial Services 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, Commercial Guaranty Assurance 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 Commercial Guaranty Assurance under the existing
reinsurance agreements, Commercial Guaranty Assurance would be liable for such
defaulted amounts. Commercial Guaranty Assurance also has a $20 million excess
of loss reinsurance facility. As of December 31, 1998, prepaid reinsurance of
approximately $1.3 million was associated with a single reinsurer.
As stated above in note seven, Commercial Guaranty Assurance has reinsured
approximately $154 million par of its total exposure to $201 million par of
Commercial Financial Services issued securities, leaving a net exposure of
approximately $47 million par. Commercial Guaranty Assurance has reinsurance
recoverable of $67.4 million relating to the Commercial Financial Services
securities as of December 31, 1998.
Also during October, 1998, Commercial Guaranty Assurance 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 Commercial
Guaranty Assurance to pay any remaining balance outstanding under the credit
facility.
During October, 1998 two of CGA Investment Management's clients worked
with Commercial Guaranty Assurance to reduce the impact of any future spread
widening on their operating ratios. Commercial Guaranty Assurance 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. Commercial
Guaranty Assurance 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 CGA Group who
has contracted with two other shareholders of CGA Group to participate in the
above described credit arrangements.
F-14
<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
========== ==========
CGA Group'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 CGA Group 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. CGA Group 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. CGA Group
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 CGA Group 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 CGA Group followed by Series B preferred
stock and then CGA Group's common stock.
10. COMMON STOCK
The number of shares of common stock of CGA Group 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
F-15
<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 ended December 31, 1998 and the period ended December 31,
1997.
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31,
1998 1997
------------ ------------
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) $ --
============ ========
CGA Group 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 CGA Group 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.
CGA Group 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, CGA 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 exercised 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.
F-16
<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
Commercial Guaranty Assurance principally insures structured securities
including asset-backed securities, mortgage-backed securities and commercial
mortgage-backed securities. Commercial Guaranty Assurance'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, Commercial Guaranty Assurance'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)
---------- ----------
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 --
Real estate investment trust 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
CGA Group has two reportable segments: Commercial Guaranty Assurance and
CGA Investment Management (see description of each segment in Note 1). CGA Group
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. Commercial Guaranty Assurance provides financial guaranty insurance.
CGA Investment Management 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.
F-17
<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>
F-18
<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 CGA Group's consolidated totals in the financial statements.
Depreciation expense is included in operating expenses.
1998 1997
------------- -------------
REVENUES
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
============= =============
14. CONTINGENCIES AND COMMITMENTS
a) CGA Group has exposure totaling approximately $425 million related to the
timely payment of interest and principal on a loan to St. George Investment I,
Ltd. The loan is payable in four equal annual installments with the first
installment due November 11, 1999. In order to meet this obligation, CGA
Investment Management, as the advisor to St. George Investment I, has advised
St. George Investment I 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 84% of the total, would be held by a
third party who is also an institutional investor in CGA Group. CGA Group 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 St.
George Investment I's obligations due in November, and CGA Investment Management
would advise St. George Investment I 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 St. George Investment I is not otherwise able to meet their debt
obligation, the lender may call on CGA Group's loan guaranty for the shortfall.
CGA Group may then liquidate the underlying collateral to subrogate losses paid.
b) Lease commitments
CGA Group rents office space in Hamilton, Bermuda under an operating lease
which expires in 2000. CGA Investment Management 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
CGA Group and Commercial Guaranty Assurance, 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
F-19
<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)
amended, of Bermuda, that generally protects them from incurring taxation by
Bermuda tax authorities until March 28, 2016. Since CGA Group and Commercial
Guaranty Assurance are not engaged in a trade or business in the U.S. there
should be no U.S. income taxes due, however, Commercial Guaranty Assurance does
file protective U.S. income tax returns. CGA Investment Management 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 (Bermuda), amendments thereto and related
regulations, Commercial Guaranty Assurance 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 relates to deferred acquisition costs and prepaid expenses
of CGA Group. There were no statutory restrictions on payment of dividends from
the retained earnings of CGA Group 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 (SFAS) No. 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. CGA Group 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 CGA Group 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, resolutions to the following effect were among those
approved:
o That the authorized share capital of CGA Group 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 CGA Group create a new series of preferred stock, the `Series C
preferred stock' and offer up to $63 million of such stock to the
existing holders of CGA Group's common stock and Series B preferred
stock.
o Concurrent with the closing of the sale of Series C preferred stock,
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 CGA Group 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 capital
F-20
<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)
commitments of the holders of CGA Group's investment units or
otherwise will not be greater than 7% per annum, that any Series B
preferred stock shall rank junior to the Series C preferred stock in
all respects, and that any Series B preferred stock shall not be
entitled to voting rights.
o That the number of directors of CGA Group 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.
CGA Group 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.
Unaudited Subsequent Event
On April 14, 1999, clients of CGA received gross proceeds of approximately
$551 million from the sale of securities that had been financed using credit
facilities insured by CGA. CGA issued new financial guaranty insurance related
to the sale resulting in approximately $163 million of new exposure. The effect
of the transaction was to reduce CGA's risk-in-force by approximately $375
million. The sellers will use the proceeds of this transaction to meet their
respective obligations under various financing arrangements, as well as to
provide cash for investment activities in the normal course of their business.
The financial statements do not include any adjustments that might result from
this transaction.
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>
F-21
<PAGE>
CGA GROUP, LTD.
CONSOLIDATED BALANCE SHEETS
(EXPRESSED IN U.S. DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
------------- -------------
ASSETS
<S> <C> <C>
Fixed maturity securities available for sale at fair value
(amortized cost: $149,560,124 and $99,560,861) ................ $ 144,584,244 $ 100,488,537
Other investments ............................................. 5,000,000 30,000,000
Cash and short-term investments ............................... 18,744,457 2,598,140
Premiums receivable ........................................... 2,535,342 3,228,497
Management fees receivable .................................... 400,577 1,093,411
Accrued investment income ..................................... 3,621,906 3,679,763
Deferred acquisition costs .................................... 3,930,577 3,202,557
Prepaid reinsurance premiums .................................. 1,264,330 1,286,782
Reinsurance recoverable ....................................... 44,936,126 67,400,000
Other assets .................................................. 4,168,873 2,926,246
------------- -------------
Total assets ............................................ $ 229,186,432 $ 215,903,933
============= =============
LIABILITIES
Deferred premium revenue ...................................... $ 1,432,311 $ 821,124
Reserve for losses and loss adjustment expenses ............... 61,605,054 90,200,000
Reinsurance balances payable .................................. 378,544 420,660
Accrued costs and expenses .................................... 3,263,959 4,355,767
------------- -------------
Total liabilities ....................................... 66,679,868 95,797,551
------------- -------------
MEZZANINE EQUITY
Preferred stock, $.01 par value, 72,000,000 shares authorized:
Series A .................................................... 81,202,282 75,291,100
Series B .................................................... -- 51,317,149
Series C .................................................... 50,961,972 --
------------- -------------
Total mezzanine equity .................................. 132,164,254 126,608,249
------------- -------------
SHAREHOLDERS' EQUITY
Common stock, $.01 par value, 268,000,000 and 20,000,000 shares
authorized, 28,005,648 and 9,100,000 issued and outstanding. 280,057 91,000
Additional paid-in-capital .................................... 96,019,011 42,486,057
Accumulated other comprehensive income (loss) ................. (4,975,880) 927,676
Retained deficit .............................................. (60,980,878) (50,006,600)
------------- -------------
Total shareholders' (deficit) equity .................... 30,342,310 (6,501,867)
------------- -------------
Total liabilities and shareholders' equity .............. $ 229,186,432 $ 215,903,933
============= =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-22
<PAGE>
CGA GROUP, LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
(EXPRESSED IN U.S. DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
---------------------------- ----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
REVENUES
<S> <C> <C> <C> <C>
Gross premiums written ................. $ 4,387,861 $ 1,780,226 $ 7,855,093 $ 3,730,219
Ceded premiums ......................... (387,854) (172,467) (807,479) (172,467)
------------ ------------ ------------ ------------
Net premiums written ................... 4,000,007 1,607,759 7,047,614 3,557,752
Change in unearned premiums ............ (534,511) 41,582 (500,072) (837,276)
------------ ------------ ------------ ------------
Net premiums earned .................... 3,465,496 1,649,341 6,547,542 2,720,476
Net investment income .................. 2,348,222 2,324,640 4,019,724 4,212,895
Net realized gains (losses) ............ (20,686) 794,575 130,880 552,381
Management fees ........................ 478,796 492,939 1,624,055 681,995
------------ ------------ ------------ ------------
Total Revenues ..................... 6,271,828 5,261,495 12,322,201 8,167,747
------------ ------------ ------------ ------------
EXPENSES
Operating expenses ..................... 3,238,902 4,366,129 6,515,180 7,437,538
Policy acquisition costs ............... 167,116 92,342 315,254 145,587
Commitment fees ........................ 152,055 149,589 300,000 297,534
Excess of loss facility ................ 50,000 50,000 100,000 100,000
Losses and loss adjustment expenses .... 7,450,000 405,000 7,750,000 600,000
------------ ------------ ------------ ------------
Total expenses ..................... 11,058,073 5,063,060 14,980,434 8,580,659
------------ ------------ ------------ ------------
(4,786,245) 198,435 (2,658,233) (412,912)
NET INCOME (LOSS)
Paid in kind dividends-- preferred stock (2,8 55,100) (4,909,681) (8,316,045) (9,635,722)
Accretion-- preferred stock ............ (147,966) (198,103) (346,069) (551,392)
------------ ------------ ------------ ------------
NET LOSS ATTRIBUTABLE TO COMMON
SHAREHOLDERS ......................... $ (7,789,311) $ (4,909,349) $(11,320,347) $(10,600,026)
Basic and diluted loss per common share $ (0.28) $ (0.54) $ (0.61) $ (1.16)
============ ============ ============ ============
Weighted average shares outstanding .... 28,005,648 9,100,000 18,709,501 9,100,000
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-23
<PAGE>
CGA GROUP, LTD.
CONSOLIDATED STATEMENTS OF MEZZANINE EQUITY
(EXPRESSED IN U.S. DOLLARS)
(UNAUDITED)
SIX MONTHS YEAR ENDED
ENDED DECEMBER 31,
JUNE 30, 1999 1998
------------- --------------
MEZZANINE EQUITY
SERIES A PREFERRED STOCK
Balance--beginning of period ................. $ 32,119 $ 27,965
Stock issued ................................. -- --
Pay-in-kind dividends paid ................... 2,246 4,154
------------- -------------
Balance--end of period ....................... 34,365 32,119
------------- -------------
ADDITIONAL PAID-IN-CAPITAL--SERIES A PREFERRED
Balance--beginning of period ................. 75,258,981 65,504,534
Fair value of warrants ....................... -- (1,347,300)
Pay-in-kind dividends paid ................... 5,613,004 10,379,765
Accretion to redemption value ................ 228,566 514,273
Accretion on warrants ........................ 67,366 207,709
------------- -------------
Balance--end of period ....................... 81,167,917 75,258,981
------------- -------------
TOTAL SERIES A PREFERRED STOCK ............... $ 81,202,282 $ 75,291,100
============= =============
SERIES B PREFERRED STOCK
Balance--beginning of period ................. $ 16,000 $ 16,000
Pay-in-kind dividends paid ................... 6,687 --
Stock exchanged for common stock ............. (22,687) --
------------- -------------
Balance--end of period ....................... -- 16,000
------------- -------------
ADDITIONAL PAID-IN-CAPITAL--SERIES B PREFERRED
Balance--beginning of period ................. 37,284,985 37,059,371
Pay-in-kind dividends paid ................... 16,710,271 --
Accretion to redemption value ................ 50,137 225,614
Unaccreted issuance costs .................... 2,648,879 --
Stock exchanged for common stock ............. (56,694,272) --
------------- -------------
Balance--end of period ....................... -- 37,284,985
------------- -------------
PAY-IN-KIND DIVIDENDS ACCRUED--SERIES B
Balance--beginning of period ................. 14,016,164 4,439,231
Dividends accrued ............................ 2,700,795 9,576,933
Dividends paid ............................... (16,716,959) --
------------- -------------
Balance--end of period ....................... -- 14,016,164
------------- -------------
TOTAL SERIES B PREFERRED STOCK ............... $ -- $ 51,317,149
============= =============
SERIES C CONVERTIBLE PREFERRED STOCK
Balance--beginning of period ................. $ -- $ --
Stock issued (44,971,346 shares) ............. 449,713 --
------------- -------------
Balance--end of period ....................... 449,713 --
------------- -------------
ADDITIONAL PAID-IN-CAPITAL--SERIES C PREFERRED
Balance--beginning of period ................. -- --
Stock issued ................................. 51,715,259 --
Issuance costs ............................... (1,203,000) --
------------- -------------
Balance--end of period ....................... 50,512,259 --
------------- -------------
TOTAL SERIES C CONVERTIBLE PREFERRED STOCK ... $ 50,961,972 $ --
============= =============
TOTAL MEZZANINE EQUITY ....................... $ 132,164,254 $ 126,608,249
============= =============
The accompanying notes are an integral part of these financial statements.
F-24
<PAGE>
CGA GROUP, LTD.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(EXPRESSED IN U.S. DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR ENDED
JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
SHAREHOLDERS' EQUITY
COMMON STOCK
<S> <C> <C>
Balance--beginning of period ............................ $ 91,000 $ 91,000
Stock issued (18,905,648 shares) ........................ 189,057 --
------------ ------------
Balance--end of period .................................. 280,057 91,000
------------ ------------
ADDITIONAL PAID-IN-CAPITAL--COMMON STOCK
Balance--beginning of period ............................ 42,486,057 42,086,353
Stock issued ............................................ 56,527,902 --
Fair value of warrants .................................. -- 1,347,300
Accretion of Series A Preferred Stock to redemption value (228,566) (514,273)
Accretion of Series B Preferred Stock to redemption value (50,137) (225,614)
Accretion on warrants ................................... (67,366) (207,709)
Unaccreted issuance costs (Series B) .................... (2,648,879) --
------------ ------------
Balance--end of period .................................. 96,019,011 42,486,057
------------ ------------
ACCUMULATED OTHER COMPREHENSIVE INCOME
Balance--beginning of period ............................ 927,676 1,638,092
Decrease during the period .............................. (5,903,556) (710,416)
------------ ------------
Balance--end of period .................................. (4,975,880) 927,676
------------ ------------
RETAINED EARNINGS (DEFICIT)
Balance--beginning of period ............................ (50,006,600) (12,057,969)
Net loss ................................................ (2,658,233) (17,987,779)
Series A pay-in-kind dividends .......................... (5,615,250) (10,383,919)
Series B pay-in-kind dividends .......................... (2,700,795) (9,576,933)
------------ ------------
Balance--end of period .................................. (60,980,878) (50,006,600)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY (DEFICIT) .................... $ 30,342,310 $ (6,501,867)
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-25
<PAGE>
CGA GROUP, LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(EXPRESSED IN U.S. DOLLARS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 1999 JUNE 30, 1998
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C> <C>
Net loss .............................................................. $ (2,658,233) $ (412,912)
Adjustments to reconcile loss to net cash used in operating activities:
Amortization of investments ......................................... 224,970 1,374,914
Depreciation expense ................................................ 252,863 168,127
Realized gain on sale of investments ................................ (130,880) (552,381)
Realized loss on sale of fixed assets ............................... -- 26,282
Changes in assets and liabilities:
Premiums receivable ................................................. 693,155 (1,099,837)
Management fees receivable .......................................... 692,834 --
Accrued investment income ........................................... 57,857 1,404,271
Deferred acquisition costs .......................................... (728,020) (1,692,894)
Prepaid reinsurance premiums ........................................ 22,452 --
Reinsurance recoverable ............................................. 22,463,874 --
Other assets ........................................................ (1,420,701) (504,145)
Organization costs .................................................. -- 493,115
Deferred premium revenue ............................................ 611,187 837,277
Reserve for losses and loss adjustment expenses ..................... (28,594,946) 600,000
Reinsurance balances payable ........................................ (42,116) 172,467
Accrued costs and expenses .......................................... (1,091,808) (296,584)
------------ ------------
Net cash provided by (used in) operating activities ................... (9,647,512) 517,700
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Cost of fixed maturity investments acquired ........................... (71,185,421) (76,545,764)
Proceeds from sale of fixed maturity investments ...................... 46,092,067 73,479,977
Purchases of fixed assets ............................................. (74,789) (499,714)
Note receivable ....................................................... -- 250,000
------------ ------------
Net cash used in investing activities ................................. (25,168,143) (3,315,501)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds on issuance of Series C Preferred Stock ...................... 52,164,972 --
Issuance costs of Series C Preferred Stock ............................ (1,203,000) --
------------ ------------
Net cash provided by financing activities ............................. 50,961,972 --
------------ ------------
NET INCREASE (DECREASE) IN CASH AND SHORT-TERM INVESTMENTS ............ 16,146,317 (2,797,801)
CASH AND SHORT-TERM INVESTMENTS--BEGINNING OF PERIOD .................. 2,598,140 7,199,106
------------ ------------
CASH AND SHORT-TERM INVESTMENTS--END OF PERIOD ........................ $ 18,744,457 $ 4,401,305
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-26
<PAGE>
CGA GROUP, LTD.
NOTES TO UNAUDITED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED JUNE 30, 1998
(EXPRESSED IN U.S. DOLLARS)
1. GENERAL
The interim consolidated financial statements, which include the accounts
of CGA Group, Ltd. and its subsidiaries, have been prepared on the basis of
accounting principles generally accepted in the United States of America and, in
the opinion of management, reflect all adjustments (consisting of normal
recurring accruals) necessary for a fair presentation of results for these
periods. The results of operations and cash flows for any interim period are not
necessarily indicative of results for the full year. These financial statements
should be read in conjunction with the consolidated financial statements, and
related notes thereto, included in the CGA Group's 1998 Annual Report on Form
10-K.
CGA Group, a holding company, was incorporated in Bermuda on June 21,
1996. CGA Group has two wholly owned subsidiaries. Commercial Guaranty
Assurance, Ltd. was incorporated in Bermuda on October 22, 1996. Commercial
Guaranty Assurance is licensed as a class 3 insurer under the Insurance Act 1978
of Bermuda, 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. Commercial
Guaranty Assurance has a "Triple-A" "claims paying ability" rating from Duff &
Phelps Credit Rating Company 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. Commercial Guaranty Assurance
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. was incorporated in
Delaware, U.S.A. in July 1996 by the founders of CGA Group and was acquired at
nominal cost to CGA Group on June 9, 1997. CGA Investment Management did not
commence operations until after its acquisition by CGA Group. CGA Investment
Management is registered as an investment advisor with the United States
Securities and Exchange Commission under the Investment Advisors Act of 1940, as
amended. CGA Investment Management provides investment management and financial
advisory services primarily to specialized investment vehicles and for the U.S.
and international structured finance markets. CGA Investment Management and its
employees are based in New York City, New York.
The primary clients of Commercial Guaranty Assurance and CGA Investment
Management are St. George Holdings, Ltd. and Cobalt Holdings, Ltd. and their
respective subsidiaries. In 1998 they provided approximately 85% of the total
premiums earned by Commercial Guaranty Assurance, and 91% of the total
investment management fees earned by CGA Investment Management. These
percentages are expected to decrease in the future.
Operations commenced following the completion of CGA Group's private
placement offering which occurred on June 17, 1997. The initial capitalization
of CGA Group 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 CGA Group
completed its recapitalization.
As part of the recapitalization on June 17, 1997, CGA Group issued 2.6
million shares of Series A preferred stock, par value $.01 per share, for a
price of $25 per share. The shares of Series A preferred stock are entitled to 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 a total of 270,000
shares of common stock at an exercise price of $.01 per share. The warrants were
valued at $4.99 per share and were accounted for as additional paid-in-capital
to the common stock.
As part of the recapitalization, on June 17, 1997, CGA Group issued 1.6
million shares of Series B cumulative voting preferred stock, par value $.01 per
share, for a price of $25 per share. The shares of Series B preferred stock were
entitled to a 20% quarterly compounding dividend paid in additional shares of
Series B preferred stock. The shares of Series B preferred stock were sold to
investors as part of investment units which also included commitments to
purchase an additional $60 million of Series B preferred stock in the aggregate
upon the occurrence of certain
F-27
<PAGE>
CGA GROUP, LTD.
NOTES TO UNAUDITED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1998
(EXPRESSED IN U.S. DOLLARS)
funding events, in order to maintain Commercial Guaranty Assurance's "Triple-A"
rating from Duff & Phelps. CGA Group pays a $600,000 annual fee to the holders
of the investment units for their commitments. The investment units also
included an aggregate of 7,827,957 shares of common stock out of a total of
9,100,000 million shares of common stock issued pursuant to the recapitalization
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. The exercise price on
these warrants is subject to reduction based on the sales price of additional
common stock or equivalents. A reduction in the exercise price occurred on March
31, 1999 from $5.00 to $2.12 as a result of the Series B preferred stock
conversion and Series C preferred stock issuance. An additional 1,494,771
warrants have been authorized for issuance 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.
On March 31, 1999 CGA Group sold 43,997,863 shares of Series C convertible
cumulative voting preferred stock to existing shareholders for an aggregate
sales price of $50,996,795. Concurrent with the sale of the Series C preferred
stock, the outstanding 1,600,000 of Series B preferred stock and the 668,678
shares of Series B preferred stock declared as pay-in-kind dividends thereon,
totaling 2,268,678 shares valued at $56,716,950, were exchanged for 18,905,648
shares of common stock based on an exchange price of $3 per share of common
stock.
On April 26, 1999 CGA Group sold 973,483 shares of Series C preferred
stock to employees of CGA Group and its subsidiaries. The shares were sold for
$1.20 each for an aggregate sales price of $1,168,179. CGA Group received cash
proceeds of $122,218 and the remaining $1,045,961 was financed by CGA Group by
granting employee loans up to a maximum of 90% of the purchase price of the
shares. The employee loans were granted in the form of promissory notes which
bear interest at a rate of 7% per annum and are repayable in three equal
installments on April 26, 2000, April 26, 2001 and April 26, 2002.
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 CGA Group, Commercial Guaranty Assurance, and CGA
Investment Management. 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
Commercial Guaranty Assurance'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. CGA
F-28
<PAGE>
CGA GROUP, LTD.
NOTES TO UNAUDITED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1998
(EXPRESSED IN U.S. DOLLARS)
Group evaluates the recoverability of deferred acquisition costs whenever
changes in circumstances warrant. If it is determined that an impairment exists,
the excess of the unamortized balance over deferred acquisition costs will be
charged to earnings.
c) Reinsurance
In the ordinary course of business, Commercial Guaranty Assurance 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 Commercial Guaranty Assurance of its original liability to its
policyholders. In the event that a reinsurer was unable to meet its obligations
under the existing reinsurance contracts, Commercial Guaranty Assurance would be
liable for the 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) Reserve for losses and loss adjustment expenses
A case basis reserve for unpaid losses and loss adjustment expenses may be
recorded at the present value of the 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 Commercial Guaranty Assurance's insured
obligations over the expected term of the insured obligations.
Management believes that the current level of the reserve is adequate to
cover the ultimate net cost of claims. The reserve is necessarily an estimate
and there can be no assurance that the ultimate liability will not differ from
this estimate. CGA Group will monitor the reserve on an ongoing basis and may
periodically adjust the reserve based on actual loss experience, the future mix
of business and economic conditions.
The reserve for losses is reflected on the balance sheet gross of any
losses recoverable from reinsurers.
e) 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
shareholder's 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.
f) 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.
g) Loss per common share
In 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 128 "Earnings per share." This statement
requires CGA Group to report basic earnings per share and
F-29
<PAGE>
CGA GROUP, LTD.
NOTES TO UNAUDITED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1998
(EXPRESSED IN U.S. DOLLARS)
diluted 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. CGA Group adopted this statement in 1998.
h) Comprehensive Income
The FASB issued Statement of Financial Accounting Standard No. 130
"Reporting Comprehensive Income", effective for fiscal years beginning after
December 15, 1997. This statement requires CGA Group to report in the financial
statements, in addition to net income, comprehensive income and its components.
Comprehensive income for CGA Group is comprised solely of changes in unrealized
appreciation or depreciation on fixed maturity securities. CGA Group adopted
this statement in 1998.
i) 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 CGA Group to expense
organization costs as incurred. On July 1, 1998, CGA Group expensed the
remaining unamortized organization costs, which is reflected in the financial
statements as a change in accounting principle.
3. OTHER INVESTMENTS
Other investments are comprised of a $5 million note from Cobalt Holdings
LLC, a Delaware limited liability corporation which is also the parent company
of certain clients of CGA Investment Management. 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. The Cobalt Holdings note matures in
July, 2013 and may be prepaid without penalty.
4. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS
JUNE 30, DECEMBER 31,
1999 1998
---------- ----------
Other Assets
Other prepaid expenses $ 228,938 $ 222,752
Prepaid commitment fees 576,164 276,164
Fixed assets, net of depreciation 1,425,527 1,603,600
Deposits 352,080 280,000
Accounts receivable 378,000 368,730
Other 1,208,164 175,000
---------- ----------
Total Other Assets $4,168,873 $2,926,246
========== ==========
5. LOSSES AND LOSS EXPENSES
The reserve for losses and loss adjustment expenses (LAE) is established
in an amount equal to Commercial Guaranty Assurance's estimate of general and
case basis reserves 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. A case basis reserve is based on the present value of the
expected loss and LAE. The general reserve 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.
F-30
<PAGE>
CGA GROUP, LTD.
NOTES TO UNAUDITED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1998
(EXPRESSED IN U.S. DOLLARS)
The provision for losses and LAE is comprised of the following at June 30,
1999 and December 31, 1998:
JUNE 30, DECEMBER 31,
1999 1998
----------- -----------
Case basis reserve ................. $58,955,054 $88,200,000
General reserve .................... 2,650,000 2,000,000
----------- -----------
Total reserve for losses and LAE $61,605,054 $90,200,000
=========== ===========
The activity in the provision for losses and LAE is as follows:
SIX MONTHS
ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
1999 1998
------------ ------------
Reserve for losses and LAE
Balance at January 1 ........................... $ 90,200,000 $ 55,000
Less reinsurance recoverables ................ 67,400,000 --
------------ ------------
Net Balance at beginning of period ............. 22,800,000 55,000
Net losses and loss expenses incurred .......... 7,750,000 22,745,000
Net losses and loss expenses paid .............. (13,881,072) --
------------ ------------
Net reserve for losses and LAE
Balance at end of period ..................... 16,668,928 22,800,000
Reinsurance recoverable ........................ 44,936,126 67,400,000
------------ ------------
Reserve for losses and LAE, gross of reinsurance
recoverable
Balance at end of period ....................... $ 61,605,054 $ 90,200,000
============ ============
In October 1998, the credit ratings on asset-backed securities which
clients of Commercial Guaranty Assurance had purchased, and that were originated
and serviced by Commercial Financial Services, Inc., a credit-card debt
collection company, were withdrawn by the three credit rating companies that
rated the most recently issued Commercial Financial Services securities. The
withdrawal of the ratings was in response to allegations of accounting
irregularities at Commercial Financial Services. The rating agencies, investors
and insurers commenced investigations into the allegations. On December 11,
1998, Commercial Financial Services filed a petition for relief under Chapter 11
of the United States Bankruptcy Code with the Bankruptcy Court for the Northern
District of Oklahoma. The Bankruptcy Court approved Commercial Financial
Services' rejection of the servicing contracts and other agreements relating to
its servicing of the receivables underlying the Commercial Financial Services
securities, effective as of June 23, 1999. As a result, servicing in respect of
the Commercial Financial Services securities was transferred to the trustees of
the respective trusts which issued the securities (Bankers Trust Company, in the
case of the Commercial Financial Services securities guaranteed by Commercial
Guaranty Assurance), as backup servicers, and their designated sub-servicers.
Clients of Commercial Guaranty Assurance had previously purchased
approximately $212 million face amount of Commercial Financial Services
securities, which exposure was guaranteed by Commercial Guaranty Assurance.
Commercial Guaranty Assurance had obtained reinsurance for about $162 million
face amount of this exposure. In December 1998, Commercial Guaranty Assurance
established a $20.8 million case basis reserve in respect of its exposure on
Commercial Financial Services securities, representing management's estimate of
probable losses on this exposure. In June 1999, Commercial Guaranty Assurance
made claim payments on its guarantees in respect of Commercial Financial
Services securities in the aggregate amount of approximately $58.9 million, of
which $45 million consisted of payments from its reinsurer and $13.9 million
consisted of Commercial Guaranty Assurance's own funds, paid out of the case
basis reserve. In connection with this claim payment, Commercial Guaranty
Assurance and its reinsurer received approximately $58.9 million par value of
Commercial Financial Services bonds.
F-31
<PAGE>
CGA GROUP, LTD.
NOTES TO UNAUDITED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1998
(EXPRESSED IN U.S. DOLLARS)
The bonds have no readily determinable market value and have not been recorded
on the books of Commercial Guaranty Assurance. Until Commercial Guaranty
Assurance's exposure on Commercial Financial Services securities reaches zero,
any future interest payments received on these securities are intended to be
used to purchase additional Commercial Financial Services securities from
Commercial Guaranty Assurance's clients, thereby further reducing Commercial
Guaranty Assurance's exposure.
As a result of these claim payments and interim principal repayments on
the Commercial Financial Services securities, Commercial Guaranty Assurance's
gross exposure in respect of Commercial Financial Services securities has been
reduced to approximately $138.7 million as of June 30, 1999. Of this exposure,
approximately $106 million is covered by reinsurance, leaving Commercial
Guaranty Assurance with a remaining net exposure of approximately $32.7 million.
In June 1999, Commercial Guaranty Assurance added an additional $7.1 million to
its case basis reserve for Commercial Financial Services securities, which
brought the reserve up to $14 million. The increase to the reserve was based on
revised collection estimates on the assets underlying the Commercial Financial
Services securities. Aggregate incurred losses for Commercial Financial Services
securities total $27.9 million against par exposure of approximately $46.6
million.
6. REINSURANCE
In the ordinary course of business, Commercial Guaranty Assurance 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 Commercial Guaranty Assurance under the existing
reinsurance agreements, Commercial Guaranty Assurance would be liable for the
defaulted amounts. Commercial Guaranty Assurance also has a $20 million excess
of loss reinsurance facility. As of June 30, 1999 prepaid reinsurance of
approximately $1.26 million was associated with a single reinsurer. As stated
above, Commercial Guaranty Assurance has reinsured a portion of its exposure to
asset-backed securities originated and serviced by Commercial Financial
Services.
In October, 1998 Commercial Guaranty Assurance provided credit support on
approximately $382 million of securities within 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. Commercial Guaranty Assurance 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.
On April 14, 1999, these credit support arrangements were cancelled and
approximately $29.5 million of premium was refunded to the clients.
7. MEZZANINE EQUITY
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
----------- -----------
<S> <C> <C>
Series A: 3,436,501 and 3,211,890 shares issued and
outstanding ............................................ $ 34,365 $ 32,119
Additional paid in capital ............................... 81,167,917 75,258,981
----------- -----------
Total Series A preferred stock ........................... $81,202,282 $75,291,100
=========== ===========
Series B: nil and 1,600,000 shares issued and outstanding $ -- $ 16,000
Additional paid in capital and pay-in-kind dividends ..... -- 51,301,149
----------- -----------
Total Series B preferred stock ........................... $ -- $51,317,149
=========== ===========
Series C: 44,971,346 and nil shares issued and outstanding $ 449,713 $ --
Additional paid in capital ............................... 50,512,259 --
----------- -----------
Total Series C preferred stock ........................... $50,961,972 $ --
=========== ===========
</TABLE>
F-32
<PAGE>
CGA GROUP, LTD.
NOTES TO UNAUDITED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1998
(EXPRESSED IN U.S. DOLLARS)
CGA Group'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 CGA Group at any time.
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 Series A and Series B preferred stock were each recorded at fair
value. 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.
The Series A preferred stock, the Series B preferred stock and the Series
C preferred stock are voting securities, and are entitled to 7 votes per share,
5 votes per share and 1 vote per share, respectively, on all matters presented
to the security holders of CGA Group for their approval. The Series A preferred
stock ranks senior in liquidation preference to all other classes of capital
stock of CGA Group, followed by the Series C preferred stock, the Series B
preferred stock and the common stock of CGA Group, respectively.
On March 31, 1999 all issued and outstanding shares of Series B preferred
stock were converted into shares of common stock, at a conversion ratio of
11.816 shares of common stock per share of Series B preferred stock. The
conversion ratio was based on an assumed value of $3.00 per share of common
stock. As a result of the conversion, 18,905,648 new shares of common stock were
issued. No shares of Series B preferred stock are currently issued and
outstanding. If the $60 million of Series B preferred stock commitments are
called, new shares will be issued with pay-in-kind dividends yielding 7%.
The 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, are
mandatorily convertible into shares of common stock upon the occurrence of
certain events at the conversion rate specified in CGA Group's Bye-Laws, and are
subject to redemption by CGA Group for cash upon the occurrence of certain
events at the redemption rate specified in CGA Group's Bye-laws. The Series C
preferred stock does not earn dividends.
8. COMMON STOCK
The number of common shares outstanding as of June 30, 1999 and the year
ended December 31, 1998 were as follows:
1999 1998
---------- ---------
Issued and outstanding ................ 28,005,648 9,100,000
Weighted average number of shares ..... 18,709,501 9,100,000
The common stock of CGA Group carries 2 votes per share on all matters
presented to the security holders of CGA Group for their approval.
F-33
<PAGE>
CGA GROUP, LTD.
NOTES TO UNAUDITED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1998
(EXPRESSED IN U.S. DOLLARS)
9. LOSS PER COMMON SHARE
The following table sets forth the computation of basic and diluted loss
per share for the periods ended June 30, 1999 and 1998.
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 1999 JUNE 30, 1998
------------- -------------
Basic loss per share ("EPS") Numerator:
Net loss ................................ $ (2,658,233) $ (412,912)
Series A--Pay-in-kind dividends paid .... (5,615,250) (4,889,380)
Series A--Pay-in-kind dividends accrued . -- (191,320)
Series A--Accretion to redemption value . (228,566) (285,707)
Series A--Accretion on warrants ......... (67,366) (140,344)
Series B--Pay-in-kind dividends accrued . (2,700,795) (4,555,022)
Series B--Accretion to redemption value . (50,137) (125,341)
Net Loss Available to Common Shareholders $(11,320,347) $(10,600,026)
------------ ------------
Denominator:
Weighted Average Shares Outstanding ..... 18,709,501 9,100,000
------------ ------------
Basic EPS ............................... $ (0.61) $ (1.16)
============ ============
Diluted Loss Per Share Numerator ........ $(11,320,347) $(10,600,026)
------------ ------------
Denominator ............................. 18,709,501 9,100,000
------------ ------------
Diluted EPS ............................. $ (0.61) $ (1.16)
============ ============
CGA Group 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 CGA Group 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 March 31, 1999. These
warrants are exercisable at any time on or prior to June 17, 2007 at an exercise
price of $.01 per share of common stock evidenced thereby.
CGA Group also issued 847,729 warrants to certain investors and members of
management on June 17, 1997. Each warrant represents the right to purchase one
share of common stock on or prior to June 17, 2007. The exercise price of the
warrants was lowered from $5 per share to $2.12 per share in connection with the
Series B preferred stock conversion into common stock and the issuance of the
Series C preferred stock. All of the warrants were outstanding as of June 30,
1999. In addition, CGA Group has authorized 1,494,771 warrants for issuance to
certain employees. These warrants 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 warrants vest ratably over a four-year period and expire if
not exercised within thirty days of the employee's termination of employment. As
of June 30, 1999, there were 1,315,984 warrants outstanding of which 657,992
warrants were exercisable. As of December 31, 1998 there were 1,348,129 warrants
outstanding of which 337,032 warrants were exercisable.
F-34
<PAGE>
CGA GROUP, LTD.
NOTES TO UNAUDITED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1998
(EXPRESSED IN U.S. DOLLARS)
10. INSURANCE IN FORCE
The following table shows the net par outstanding of insured obligations,
net of reinsurance, at June 30, 1999 and December 31, 1998 by asset type:
1999 1998
ASSET TYPE (IN 000'S) (IN 000'S)
---------- ---------- ----------
Auto ...................................... $ 10,540 $ 3,158
CLO's/CBO's ............................... 260,615 189,375
Commercial mortgage-backed securities ..... 379,316 185,754
Corporate asset-backed securities ......... 87,490 75,000
Credit card receivables ................... 140,751 185,732
Equipment ................................. 19,807 27,129
Future flows .............................. 88,880 39,108
Home equity loans ......................... 309,304 236,381
REIT Debt ................................. 211,774 381,777
REIT Preferred ............................ 70,000 70,000
Sovereign debt ............................ 110,000 120,000
XOL Reinsurance ........................... 91,250 46,250
---------- ----------
Total ..................................... $1,779,727 $1,559,664
========== ==========
The following table presents the credit ratings of the above assets, based
on net par outstanding at June 30, 1999 and December 31, 1998:
1999 1998
---- ----
"AAA" .................................. 4.5% 4%
"AA" ................................... 2.1% 3%
"A" .................................... 18.6% 12%
"BBB" .................................. 63.7% 67%
"BB" ................................... 9.3% 11%
Not rated .............................. 1.8% 3%
---- ----
Total .............................. 100% 100%
==== ====
11. OTHER COMPREHENSIVE INCOME
Other comprehensive income is comprised of unrealized gains and losses on
investments. Accumulated other comprehensive income is as follows:
<TABLE>
<CAPTION>
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
<S> <C> <C>
Unrealized appreciation (depreciation) on
investments
Balance--beginning of period ............................. $ 927,676 $1,638,092
Decrease during period ................................... (5,903,556) (710,416)
----------- ----------
Balance--end of period ................................... $(4,975,880) $ 927,676
=========== ==========
</TABLE>
12. SEGMENT REPORTING
CGA Group has two reportable segments: Commercial Guaranty Assurance and
CGA Investment Management (see description of each segment in Note 1). CGA
Group's management has identified the operating segments on
F-35
<PAGE>
CGA GROUP, LTD.
NOTES TO UNAUDITED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1998
(EXPRESSED IN U.S. DOLLARS)
the basis that they are separate legal entities and that each entity carries on
a different type of business. Commercial Guaranty Assurance provides financial
guaranty insurance and CGA Investment Management provides investment management
services. The accounting policies of each of the segments are the same as those
described in the summary of significant accounting policies.
The table below presents financial information for each of the operating
segments. As of and for the six months ended June 30, 1999:
<TABLE>
<CAPTION>
CGA CGAIM OTHER (A) TOTAL
------------- ------------- ------------- -------------
REVENUES
<S> <C> <C> <C> <C>
Net premiums earned ............... $ 6,547,542 $ -- $ -- $ 6,547,542
Net investment income ............. 3,769,116 39,948 210,660 4,019,724
Net realized gains ................ 130,880 -- -- 130,880
Management fees ................... -- 1,624,055 -- 1,624,055
Intersegment revenue .............. -- 118,789 118,356 237,145
TOTAL REVENUES .................... 12,559,346
EXPENSE ITEMS
Operating expenses ................ 735,090 5,250,217 767,018 6,752,325
Acquisition costs ................. 315,254 -- -- 315,254
Commitment fees ................... 300,000 -- -- 300,000
Excess of loss facility ........... 100,000 -- -- 100,000
Losses and loss adjustment expenses 7,750,000 -- -- 7,750,000
TOTAL EXPENSES .................... -- 15,217,579
NET INCOME ........................ 1,247,789 (3,468,021) (438,001) (2,658,233)
------------- ------------- ------------- -------------
ASSETS
Total assets ...................... $ 186,579,341 $ 2,922,421 $ 31,070,141 $ 220,571,903
============= ============= ============= =============
</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.
F-36
<PAGE>
CGA GROUP, LTD.
NOTES TO UNAUDITED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1998
(EXPRESSED IN U.S. DOLLARS)
As of and for the six months ended June 30, 1998:
<TABLE>
<CAPTION>
CGA CGAIM OTHER TOTAL
------------- ------------- ------------- -------------
REVENUES
<S> <C> <C> <C> <C>
Net premiums earned ............... $ 2,720,476 $ -- $ -- $ 2,720,476
Net investment income ............. 4,134,921 14,429 63,545 4,212,895
Net realized gains ................ 552,381 -- -- 552,381
Management fees ................... -- 681,995 -- 681,995
TOTAL REVENUES .................... 8,167,747
EXPENSE ITEMS
Operating expenses ................ 627,472 5,838,139 971,927 7,437,538
Acquisition Costs ................. 145,587 -- -- 145,587
Commitment Fees ................... 297,534 -- -- 297,534
Excess of loss facility ........... 100,000 -- -- 100,000
Losses and loss adjustment expenses 600,000 -- -- 600,000
TOTAL EXPENSES .................... 8,580,659
Net Income ........................ 5,637,185 (5,165,637) (884,460) (412,912)
------------- ------------- ------------- -------------
ASSETS
Total Assets ...................... $ 137,813,058 $ 2,278,891 $ 10,777,343 $ 150,869,292
============= ============= ============= =============
</TABLE>
The following are reconciliations of reportable segment revenues, expenses
and assets to CGA Group's consolidated totals in the financial statements.
Depreciation expense is included in operating expenses.
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 1999 JUNE 30, 1998
------------- -------------
REVENUES
Total revenues for reportable segments ....... $ 12,559,346 $ 8,167,747
Elimination of intersegment revenues ......... (237,145) --
------------- -------------
Total consolidated revenues .................. $ 12,322,201 $ 8,167,747
============= =============
EXPENSES
Total expenses for reportable segments ....... $ 15,217,579 $ 8,580,659
Elimination of intersegment operating expenses (237,145) --
------------- -------------
Total consolidated expenses .................. $ 14,980,434 $ 8,580,659
============= =============
ASSETS
Total assets for reportable segments ......... $ 220,571,903 $ 150,869,292
Intercompany loans ........................... (11,122,336) (7,522,773)
Other intercompany balances .................. (2,863,135) --
------------- -------------
Total consolidated assets .................... $ 206,586,432 $ 143,346,519
============= =============
13. TAXATION
CGA Group and Commercial Guaranty Assurance, 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 CGA Group and Commercial Guaranty
Assurance are not engaged in a trade or business in the U.S.
F-37
<PAGE>
CGA GROUP, LTD.
NOTES TO UNAUDITED FINANCIAL STATEMENTS--(CONTINUED)
FOR THE SIX MONTHS ENDED JUNE 30, 1998
(EXPRESSED IN U.S. DOLLARS)
there should be no U.S. income taxes due, however, Commercial Guaranty Assurance
does file protective U.S. income tax returns. CGA Investment Management is
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 2013 and 2012,
respectively.
14. STATUTORY FINANCIAL DATA
Under The Insurance Act of 1978 (Bermuda), amendments thereto and related
regulations, CGA Group 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 June 30, 1999
and December 31, 1998 were $143,746,566 and $114,681,031 respectively. Statutory
net income for the six months ended June 30, 1999 was $519,769 and statutory net
loss for the year ended December 31, 1998 was $11,264,214. The principal
differences between capital and surplus and statutory net income and
shareholders' equity and income as reported in conformity with GAAP relates to
deferred acquisition costs and prepaid expenses of CGA Group. There were no
statutory restrictions on payment of dividends from the retained earnings of CGA
Group as the required level of solvency was met by the common stock in issue.
15. COMPARATIVE FINANCIAL INFORMATION
The comparative figures for the year ended December 31, 1998 are based on
audited financial statements as of that date.
F-38
<PAGE>
================================================================================
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THIS OFFERING OTHER THAN THOSE CONTAINED IN
THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION AND
REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY CGA GROUP,
LTD. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL,
UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN
THE AFFAIRS OF CGA GROUP, LTD. SINCE THE DATE HEREOF OR THAT THE INFORMATION
CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THIS DATE. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO
BUY ANY SECURITIES OTHER THAN THE REGISTERED SECURITIES TO WHICH IT RELATES.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN
OFFER TO BUY SUCH SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR
SOLICITATION IS UNLAWFUL.
562,618 SHARES
CGA GROUP, LTD.
SERIES A
PREFERRED STOCK
-------------
PROSPECTUS
-------------
______ __, 1999
================================================================================
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table lists the expenses incurred in connection with the
distribution of the securities being registered hereby, all of which shall be
borne by the Company:
Commission Registration Fees ............................ $ 26,520
Transfer Agent Fees ..................................... --
Printing Costs .......................................... 50,000
Legal Fees and Expenses ................................. 150,000
Accounting Fees and Expenses ............................ 20,000
Miscellaneous ........................................... 10,000
--------
Total ........................................... $256,520
========
Other than the Commission registration fees, all of the foregoing are
estimates and subject to future contingencies.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
The bye-laws of CGA Group provide that directors, alternate directors and
other officers for the time being acting in relation to any of the affairs of
CGA Group, as well as their heirs, executors and administrators, shall be
indemnified and secured harmless out of the assets of CGA Group from and against
all actions, costs, charges, losses, damages and expenses which they or any of
them, their heirs, executors or administrators, shall or may incur or sustain by
or by reason of any act done, concurred in or omitted in or about the execution
of them duty, or supposed duty, or in their respective offices or trusts, and
none of them shall be answerable for the acts, receipts, neglects or defaults of
the others of them or for joining in any receipts for the sake of conformity, or
for any bankers or other persons with whom any money or effects belonging to CGA
Group shall or may be lodged or deposited for safe custody, or for insufficiency
or deficiency of any security upon which any moneys of or belonging to CGA Group
shall be placed out on or invested, or for any other loss, misfortune or damage
which may happen in the execution of their respective offices or trusts, or in
relation thereto, provided that the indemnity shall not extend to any matter in
respect of any fraud or dishonesty which may attach to any of said persons.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
During the past three years, the Registrant has issued the following
equity securities that were not registered under the Securities Act of 1933, as
amended (the "Securities Act"):
On June 17, 1997, the Registrant redeemed its initial capitalization of
12,000 shares of common stock, par value of $1.00 per share, and effected the
following transactions:
(i) The Registrant issued to accredited investors 2.6 million shares
of Series A preferred stock for aggregate cash consideration of
$65,000,000. In addition, for no additional consideration, the Registrant
issued to the Series A Preferred Stockholders warrants which represent the
right to purchase a total of 270,000 shares of common stock, par value
$.01 per share, of the Company. The principal underwriter for this
offering of the Series A preferred stock was Donaldson, Lufkin & Jenrette
Securities Corporation.
(ii) The Registrant issued to accredited investors 1.6 million
investment units for aggregate consideration of $140 million, consisting
of $80 million in cash and $60 million in commitments. Each investment
unit consists of one share of Series B preferred stock, 4.8925 shares of
common stock and a commitment to purchase 1.5 additional shares of Series
B preferred stock upon the occurrence of certain events. The principal
underwriter for the offering of the investment units was Salomon Brothers
Inc.
(iii) The Registrant sold 1,272,043 shares of common stock to the
sponsoring investors and certain members of management for an aggregate
consideration of $6,360,215. The Registrant issued to such investors,
II-1
<PAGE>
for no additional consideration, 847,729 warrants, which each represent
the right to purchase one share of Common Stock on or prior to June 16,
2007, at an exercise price of $5 per share.
(iv) The Registrant issued an additional 1,494,771 warrants, for no
consideration, to certain employees of the Company, which each represent
the right to purchase one share of common stock at an exercise price of $5
per share. The employees' warrants will vest ratably over a four-year
period and expire if not exercised within thirty days of the employee's
termination of employment.
On March 31, 1999, the Registrant sold to certain existing shareholders of
the Registrant an aggregate of 43,997,863 shares of Series C preferred stock for
net cash proceeds of $50,996,794.50. The sale was made pursuant to the terms of
the Series C Convertible Cumulative Voting Preferred Stock Subscription
Agreement which is filed as an Exhibit to this Registration Statement. Pursuant
to the terms of the Series C Subscription Agreement, 31,997,863 shares of Series
C preferred stock were sold at $1.50 per share pursuant to the basic
subscription privilege (and overallotments with respect thereto) and 12,000,000
shares of Series C preferred stock were sold at $0.25 per share pursuant to the
additional allotment privilege (and overallotments with respect thereto). 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 net proceeds from the transaction will be used
for general corporate purposes and to make capital investments in Commercial
Guaranty Assurance.
In connection with the consummation of the transactions contemplated by
the Series C preferred stock Subscription Agreement, on March 31, 1999 all
issued and outstanding shares of Series B preferred stock were converted into
shares of common stock, at a conversion ratio of 11.816 shares of Common Stock
per share of Series B preferred stock. The conversion ratio was based on an
assumed value of $3.00 per share of common stock. As a result of the conversion,
18,905,648 new shares of common stock were issued.
On April 26, 1999, the Company sold 973,483 shares of Series C preferred
stock to employees of the Registrant and its subsidiaries. The shares were sold
for $1.20 each, for a total of approximately $1.2 million. The shares were 90%
financed by the Registrant at 7% per annum with equal principal installments due
annually over a three-year period.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
All financial statement schedules are omitted because they are either not
applicable, not required, or because the information required therein is
included in the financial statements or the notes thereto.
EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------ -----------
3.1* Memorandum of Association and Certificate of
Incorporation of CGA Group, Ltd.
3.2* Amended and Restated Bye-laws of CGA Group, Ltd. dated
as of March 31, 1999.
3.3* Amended and Restated Appendices to the Amended and
Restated Bye-laws of CGA Group, Ltd. dated as of March
31, 1999.
4.1* CGA Group, Ltd. Shareholders Agreement dated as of June
12, 1997, as amended and restated as of March 31, 1999.
5.1* Opinion of Dewey Ballantine LLP as to certain United
States tax matters
5.2* Opinion of Conyers Dill & Pearman as to the legality of
the securities being registered and as to certain
matters of law of Bermuda
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
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.
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
10.4* Right of First Refusal Agreement dated as of June 17,
1997, by and between CGA Group, Ltd. and Capital
Reinsurance Company
II-2
<PAGE>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.5* Discretionary Investment Advisory Agreement, dated as of
December 18, 1996 between Alliance Capital Management
L.P. and Commercial Guaranty Assurance, Ltd.
10.6* Investment Management Agreement dated as of December 27,
1996, between J.P. Morgan Investment Management Inc. and
Commercial Guaranty Assurance, Ltd.
10.7* Letter Agreement, dated June 17, 1997 between CGA Group,
Ltd. and DCR (and attachments)
10.8* Employee Warrant Agreement
10.9* CGA Group, Ltd. Employee Stock Warrant Plan
10.10* CGA Group, Ltd. Sponsoring Investors and Founders Stock
Warrant Plan
10.11* Excess of Loss Agreement, dated as of June 12, 1997, by
and between CGA Group, Ltd. and KRE Reinsurance Ltd.
10.12* Employment Agreement, as of January 1, 1997, by and
between CGA Group, Ltd. and Richard A. Price
10.13* Employment Agreement, as of January 1, 1997, by and
between CGAIM and Jean-Michel Wasterlain.
10.14* Employment Agreement, as of June 30, 1997, by and
between CGAIM and Michael M. Miran.
10.15* Employment Agreement, as of January 1, 1997, by and
between CGAIM and Kem H. Blacker.
10.16* Employment Agreement, as of August 1, 1997, by and
between CGAIM 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.
10.18* Series C Convertible Cumulative Voting Preferred Stock
Subscription Agreement, dated as of March 31, 1999.
10.19* Agreement dated as of March 1, 1999 by and among CGA
Group, Ltd. and the holders of the Series C Preferred
Stock.
10.20 Restricted Stock Purchase Agreement and Promissory Note,
dated as of April 26, 1999, between CGA Group, Ltd. and
the employees thereof listed in Exhibit B thereto.
10.21 CGA Group, Ltd. Chief Financial Officer's Certificate as
to Adjustment to Exercise Price of Warrants Issued
Pursuant to the Sponsoring Investors and Founders Stock
Warrant Plan, dated May 18, 1999.
21.1 Subsidiaries of CGA Group, Ltd.
23.1** Consent of Dewey Ballantine LLP
23.2** Consent of Conyers Dill & Pearman
23.3 Consent of PricewaterhouseCoopers
24.1* Power of Attorney (included in signature page to
Registration Statement)
- ---------
* Previously filed.
** Included in the respective opinions.
ITEM 22. UNDERTAKINGS
The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this registration statement;
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the aggregate,
II-3
<PAGE>
represent a fundamental change in the information set forth in the
registration statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum offering range
may be reflected in the form of prospectus filed with the Commission
pursuant to Rule 424(b) if, in the aggregate, the changes in volume and
price represent no more than a 20 percent change in the maximum aggregate
offering price set forth in the "Calculation of Registration Fee" table in
the effective registration statement.
(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement;
(2) That insofar as indemnification for liabilities arising under
the Securities Act of 1933 may be permitted to directors, officers and
controlling persons of the Registrant pursuant to the foregoing
provisions, or otherwise, the Registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant in
the successful defense of any action, suit or proceeding) is asserted by
such director, officer or controlling person in connection with the
securities being registered, the Registrant will, unless in the opinion of
its counsel the matter has been settled by controlling precedent, submit
to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue;
(3) For purposes of determining any liability under the Securities
Act of 1933, the information omitted from the form of prospectus filed as
part of this registration statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the Registrant pursuant to Rule
424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be
part of this registration statement as of the time it was declared
effective.
(4) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof; and
(5) To remove from registration by means of a post-effective
amendment any of the securities being registered which remain unsold at
the termination of the offering.
II-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in Hamilton, Bermuda, on October 19,
1999.
CGA GROUP, LTD.
By: /S/ RICHARD A. PRICE
------------------------------------
RICHARD A. PRICE
Chief Executive Officer and President
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed below on October 19, 1999 by the
following persons in the capacities indicated. Each person whose signature
appears below hereby appoints and constitutes Richard A. Price or James R.
Reinhart, and each of them, as his attorney-in-fact, with full power of
substitution, for him or her in any and all capacities, to execute in the name
and on behalf of such person any amendment to this Registration Statement
(including any post-effective amendment) and to file the same, with exhibits
thereto, and other documents in connection therewith, making such changes in
this Registration Statement as the person so acting deems appropriate, hereby
ratifying and confirming all that said attorney-in-fact, or his or her
substitute may do or cause to be done by virtue hereof.
SIGNATURE TITLE
--------- -----
/s/ RICHARD PRICE Chief Executive Officer,
-------------------------- President and Director
RICHARD PRICE
/s/ JAY SHIDLER* Chairman
--------------------------
JAY SHIDLER
/s/ JAMES REINHART* Chief Financial Officer
--------------------------
JAMES REINHART
/s/ ROBERT DENTON* Director
--------------------------
ROBERT DENTON
/s/ DAVID BARSE* Director
--------------------------
DAVID BARSE
/s/ RICHARD FRARY* Director
--------------------------
RICHARD FRARY
/s/ ERIC GRITZMACHER* Director
--------------------------
ERIC GRITZMACHER
/s/ DONALD KRAMER* Director
--------------------------
DONALD KRAMER
II-5
<PAGE>
SIGNATURE TITLE
--------- -----
/s/ JEFF KRASNOFF* Director
--------------------------
JEFF KRASNOFF
/s/ MICHAEL MORRISSEY* Director
--------------------------
MICHAEL MORRISSEY
/s/ ALAN S. ROSEMAN* Director
--------------------------
ALAN S. ROSEMAN
/s/ PAUL RUBIN* Director
--------------------------
PAUL RUBIN
/s/ F. Fuller O'Connor, Jr.* Director
--------------------------
F. FULLER O'CONNOR, JR.
/s/ JAY SUGARMAN* Director
--------------------------
JAY SUGARMAN
*By: /s/ RICHARD PRICE
--------------------------
(RICHARD PRICE, ATTORNEY-IN-FACT**)
** By authority of Power of Attorney filed with this Registration Statement on
Form S-1.
II-6
Exhibit 10.20
RESTRICTED STOCK PURCHASE AGREEMENT
RESTRICTED STOCK PURCHASE AGREEMENT (this "Agreement"), dated as of
April 26, 1999 ("Effective Date"), between CGA Group, Ltd., a Bermuda
corporation ("Seller"), and [____________] ("Purchaser").
WHEREAS, the Board of Directors of Seller has directed that Seller offer
to sell to Purchaser an aggregate of [_______] shares of its Series C
Convertible Cumulative Voting Preference Shares, par value $.01 per share (the
"Series C Preferred Stock"), on the terms and subject to the conditions set
forth herein;
WHEREAS, Purchaser is employed by Seller or a Subsidiary of Seller and
desires to purchase the shares of Series C Preferred Stock so offered on the
terms and subject to the conditions set forth herein; and
WHEREAS, concurrently herewith, Purchaser has executed and delivered a
promissory note to seller dated as of the date hereof.
NOW, THEREFORE, to implement the foregoing and in consideration of the
mutual agreements contained herein, the parties hereto agree as follows:
SECTION 1. PURCHASE OF SERIES C PREFERRED STOCK
(a) Purchase and Sale of Shares. Subject to the terms set forth
in this Agreement, and in reliance upon the representations, warranties and
agreements of Purchaser contained herein, Seller hereby agrees to sell to
Purchaser, and Purchaser agrees to purchase, a total of [___________] shares of
Series C Preferred Stock (the "Purchased Shares"), at a price of $1.20 per
share, which represents an aggregate purchase price of $_______ (the "Purchase
Price"), with such transaction to occur on the Purchase Date (as defined below).
(b) Purchase Loan. On the Purchase Date (as defined below),
Seller will make a loan to Purchaser (the "Loan") in the amount of $ _______ for
the purpose of financing a portion of the aggregate Purchase Price payable by
Purchaser (maximum 90% of Purchase Price). The Loan will be evidenced by a
promissory note to be executed and delivered by Purchaser (a "Note")
substantially in the form of EXHIBIT A hereto.
(c) Closing of the Purchase and Sale; Payment for Shares. The
closing of the transactions contemplated hereby shall take place at the offices
of Seller on April 26, 1999, or at such time, date and place as Seller and
Purchaser shall mutually agree (the "Purchase Date"). At the closing, Purchaser
shall pay the Purchase Price to Seller, by executing and delivering the Note and
by payment of $_________ in cash or by cash equivalent acceptable to the
Company, and as promptly as reasonably practicable thereafter, Seller shall
deliver to Purchaser a duly executed certificate representing the Purchased
Shares.
(d) Voting and Dividend Rights. Purchaser will have all voting
rights with respect to the
<PAGE>
Purchased Shares. Cash dividends and distributions payable with respect to the
Purchased Shares shall be the property of the Purchaser. Any other interests of
Purchaser with respect to the Purchased Shares shall be determined as otherwise
set forth in this Agreement, including the vesting provisions of Section 2
below.
SECTION 2. VESTING
(a) Vesting and Transfer Restrictions. The Purchased Shares will
be subject to the vesting and transfer restrictions to the extent set forth in
this Section 2 (such Purchased Shares are sometimes referred to herein as
"Unvested Shares" during the period that such restrictions apply and as "Vested
Shares" after such restrictions have expired). Until the lapsing of the vesting
restrictions set forth in this Section 2, Unvested Shares may not be sold,
transferred, pledged, encumbered or otherwise disposed of by Purchaser (except
by will or by the laws of descent and distribution) and shall be subject to the
Call Option set forth in Section 3 hereof.
(b) Vesting Events. The Purchased Shares shall become Vested
Shares (i) immediately on the Purchase Date for the number of shares represented
by the cash payment made by the Purchaser and (ii) on each date that the
Purchaser makes a principal payment on the Note, for the number of shares
represented on such repayment (based on the Purchase Price per share)
Notwithstanding the foregoing, the Purchased Shares that are Unvested Shares
shall become earlier vested upon an Involuntary Termination or a Change in
Control, each as defined below in this Section 2.
(c) Termination of Employment.
(i) Involuntary Termination. In the event of termination
of employment of Purchaser prior to vesting of any Purchased Shares either (a)
by Seller without Cause (as defined below) or (b) upon the Disability (as
defined below) or death of Purchaser (each such event, an "Involuntary
Termination"), the vesting and transfer restrictions of this Section 2 on any
Unvested Shares shall immediately lapse, and such shares shall become Vested
Shares.
(1) For purposes hereof, the term "Cause" shall
mean (i) the willful failure by the Purchaser to substantially perform his or
her duties as an employee of the Seller (other than due to death or Disability)
after reasonable notice to the Purchaser of such failure, (ii) the Purchaser's
engaging in serious misconduct that is injurious to the Seller in any way,
including, without limitation, by way of damage to its business reputation or
standing, or (iii) the Purchaser having been convicted of, or entered a plea of
nolo contendere to, a crime that constitutes a felony or involving moral
turpitude. Notwithstanding the foregoing, in the event a Purchaser is party to
an employment (or similar) agreement with the Company or any Subsidiary (as
defined below) that defines the term "cause," such definition shall apply for
purpose of this Agreement.
(2) For purposes hereof, the term "Disability"
shall mean the total and permanent disability of the Purchaser, as determined by
the Board of Directors ("Board") in its sole discretion.
(ii) Voluntary Termination. In the event of any
termination of the employment of Purchaser prior to vesting of any Purchased
Shares for any reason other than an Involuntary Termination (each such event, a
"Voluntary Termination"), Seller shall have a Call
2
<PAGE>
Option under Section 3 on the Unvested Shares of Purchaser, and may accelerate
the principal and interest due under the Note (in accordance with its terms).
(3) For purposes hereof, "Subsidiary" shall mean
Commercial Guaranty Assurance, Ltd. and CGA Investment Management, Inc.
(d) Change in Control. In the event that a Change in Control (as
defined below) of Seller occurs prior to vesting of any Purchased Shares, the
vesting and transfer restrictions of this Section 2 will automatically lapse
with respect to all Unvested Shares. For purposes hereof, a "Change in Control"
shall be deemed to have occurred upon the occurrence of one of the following
events:
(i) The consummation of the acquisition by any person (as
such term is defined in Section 13(d) or 14(d) of the Securities Exchange Act of
1934 (the "Exchange Act")) of beneficial ownership (within the meaning of Rule
13d-3 promulgated under the Exchange Act) of more than fifty percent (50%) of
the combined voting power of the then outstanding voting securities of the
Seller;
(ii) The cessation, for any reason, by the individuals
who, as of the Closing Date, are members of the Board to constitute a majority
of such Board, unless the designation of any new individual as a director is
pursuant to the right to designate a director granted to certain members under
the By-laws of Seller, and such new director shall be considered as a member of
such Board; or
(iii) Approval by stockholders of: (1) a merger or
consolidation if the stockholders of the Seller immediately before such merger
or consolidation do not, as a result of such merger or consolidation, own,
directly or indirectly, more than fifty percent (50%) of the combined voting
power of the then outstanding voting securities of the entity resulting from
such merger or consolidation; (2) an agreement for the sale or other disposition
of all or substantially all of the assets of Seller other than an agreement for
such sale or disposition to a corporation which, immediately prior to such sale
or disposition, is owned directly or indirectly by the stockholders of Seller in
materially the same proportion as their ownership of stock immediately prior to
such sale or disposition.
For purposes hereof, the term "Change in Control" shall not mean the
following:
(a) An initial public offering of the capital stock of the
Company resulting in net proceeds to the Company of at least $50 million;
(b) A merger of the Company with, or acquisition of the Company
by, any other entity if such merger or acquisition, as applicable, is approved
by the Board or any other recapitalization or change in capital structure,
whether public or private, of the Company, in each case, after which, and for a
period of one year following any such transaction, the Purchaser holds the same
position as set forth in his employment agreement with the Company (or, in the
case of a Purchaser who is not employed pursuant to an employment agreement, has
the same position, duties and responsibilities as existed prior to any such
transaction), has the same chain of command, reports to the same individual or
individuals, and suffers no material change in his employment.
3
<PAGE>
Notwithstanding anything to the contrary contained above, a Change in
Control shall not be deemed to occur solely because more than fifty percent
(50%) of the combined voting power of the then outstanding securities is, or all
or substantially all of the assets of the Company are, acquired by: (i) a
trustee or other fiduciary holding securities under one or more employee benefit
plans maintained for employees of the Company; or (ii) any corporation which,
immediately prior to such acquisition, is owned directly or indirectly by the
stockholders of the Company in materially the same proportion as their ownership
of stock immediately prior to such acquisition.
SECTION 3. CALL OPTION ON UNVESTED SHARES
(a) Voluntary Termination. If Purchaser shall no longer be
employed by Seller by reason of a Voluntary Termination, then Seller, by written
notice (the "Call Notice") to Purchaser (or his legal representative), shall
have the right and option (the "Call Option"), but not the obligation, to
purchase all or any portion of the Purchased Shares that remain Unvested Shares,
at the repurchase price set forth in Section 3(b) hereof, for a period of ninety
(90) days following the effective date of such termination. If Seller exercises
such right, Purchaser shall have the obligation to sell such Purchased Shares
specified in the Call Notice, at the Repurchase Price (as set forth below) of
such repurchased shares. Notwithstanding anything herein to the contrary, Seller
may assign its rights under this Section 3 to any of its Subsidiaries.
(b) Repurchase Price. For purposes of this Section 3, Seller may
repurchase Unvested Shares at a per share repurchase price equal to the sum of
(A) 1.20 per share, plus (B) any accrued but unpaid interest on the Note through
the closing of the Call Option, calculated on a per share basis (subject to any
applicable tax withholding requirements in the event such repurchase price
exceeds the fair market value of the shares on the closing of the Call Option).
Payment of the repurchase price may be made, in the discretion of Seller, in
cash, cash equivalent, by offset of the corresponding principal amount due under
the Note upon a Voluntary Termination, or by a combination of the foregoing
forms of payment. Any amount of appreciation equal to the excess of fair market
value at such time and the Purchaser's original purchase price shall be
forfeited by Purchaser to Seller, and Purchaser shall have no rights whatsoever
with respect thereto.
(c) Closing. The closing of any purchase under this Section 3
shall be held at the principal offices of Seller on the 30th day after the date
of the Call Notice, or at such other time and place as Seller and Purchaser
agree upon. At such closing, Purchaser shall deliver or cause the delivery of
certificates representing the Purchased Shares to be sold, duly endorsed for
transfer and accompanied by all requisite stock transfer taxes, and, except as
specifically provided herein, such Purchased Shares shall be free and clear of
any liens, claims, options, charges, encumbrances or rights of others arising
through the action or inaction of Purchaser, and Purchaser shall so represent
and warrant, and further represent and warrant that he is the beneficial owner
of such Purchased Shares. Seller shall deliver at the closing payment for such
Purchased Shares by check.
SECTION 4. SHAREHOLDERS AGREEMENT
As a condition of this Agreement and the Purchaser's right to
acquire the Purchased Shares hereunder, the Purchaser shall be required to
execute and agree to be bound by the terms and conditions of the CGA Group, Ltd.
Shareholders Agreement dated as of June 12, 1997, as amended and restated as of
March 31, 1999, as such Shareholders Agreement applies to holders of Series C
4
<PAGE>
Preferred Stock, and the Company agrees that Purchaser shall be afforded the
rights and privileges set forth in such Shareholders Agreement with respect to
the Purchased Shares upon their conversion into Company common stock.
SECTION 5. ISSUANCE OF SHARES; RIGHTS AS A STOCKHOLDER
(a) Stock Certificates. Stock certificates representing the
Purchased Shares shall be registered in the name of Purchaser.
(b) Legends. Certificates representing Purchased Shares to which
the provisions of this Agreement apply shall bear the following legends:
THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR UNDER
ANY STATE SECURITIES LAWS, AND MAY NOT BE SOLD OR TRANSFERRED
EXCEPT IN COMPLIANCE WITH SAID ACT AND THE RULES AND REGULATIONS
THEREUNDER AND APPLICABLE STATE SECURITIES LAWS.
THIS CERTIFICATE AND THE SHARES OF STOCK AND ALL RIGHTS HEREBY
REPRESENTED ARE SUBJECT TO THE TERMS, CONDITIONS AND RESTRICTIONS
SET FORTH IN THE RESTRICTED STOCK PURCHASE AGREEMENT DATED APRIL
26, 1999 AND THE SHAREHOLDERS AGREEMENT DATED JUNE 12, 1997, AS
AMENDED AND RESTATED AS OF MARCH 31, 1999, AND MAY NOT BE SOLD OR
TRANSFERRED EXCEPT IN ACCORDANCE WITH THE TERMS AND CONDITIONS OF
SUCH AGREEMENTS, COPIES OF WHICH ARE ON FILE AT THE OFFICES OF
CGA GROUP, LTD.
(c) Rights as a Stockholder. Except as otherwise provided in this
Agreement, Purchaser shall have the same rights and privileges as any other
stockholder holding the same class of stock, including, without limitation, the
right to vote the Purchased Shares and to receive distributions and dividends on
such Purchased Shares. Purchaser's rights as a shareholder are subject to the
making of provision for the payment or withholding of any taxes to be withheld
pursuant to any applicable law in respect of the receipt or lapse of forfeiture
with respect to such shares.
SECTION 6. REPRESENTATIONS AND WARRANTIES
(a) Representations and Warranties of Seller. Seller represents
and warrants to Purchaser that:
5
<PAGE>
(i) Seller is a corporation duly organized, validly
existing and in good standing under the laws of Bermuda, and has the requisite
corporate power and authority to execute and deliver this Agreement and to
perform its obligations hereunder.
(ii) The execution, delivery and performance of this
Agreement, and the delivery of the Purchased Shares have been duly authorized by
all necessary corporate action on the part of Seller.
(iii) This Agreement has been duly executed and delivered
by Seller and constitutes the legal, valid and binding obligations of Seller,
enforceable against Seller in accordance with its terms, except as enforcement
thereof may be limited by bankruptcy, insolvency or other similar laws affecting
the enforcement of creditors of creditors rights in general or general
principles of equity.
(b) Representations and Warranties of Purchaser. Purchaser
represents and warrants to Seller that:
(i) Purchaser is acquiring the Purchased Shares for his or
her own account and not with a view to distributing or reselling the Purchased
Shares in any transaction that would be in violation of any federal or state
securities laws;
(ii) Purchaser (a) is familiar with the business of
Seller, (b) has had an opportunity to discuss with representatives of Seller the
condition of and prospects for the continued operation of Seller and such other
matters as he deemed appropriate in considering whether to acquire the Purchased
Shares and (c) has been provided access to all available information about
Seller requested by him;
(iii) Purchaser understands that the Purchased Shares have
not been registered under the Act, or registered or qualified under the
securities laws of any state, and that she may not sell or otherwise transfer
the Purchased Shares unless the Purchased Shares are subsequently registered
under the Act and registered or qualified under applicable state securities
laws, or unless an exemption is available that permits such sale or transfer
without such registration and qualification;
(iv) Purchaser's intention is not to transfer, sell or
otherwise dispose of any Purchased Shares prior to the registration thereof
other than through a transaction that would not require registration of such
shares under the Act; and
(v) this Agreement has been duly executed and delivered by
Purchaser and constitutes the legal, valid and binding obligation of Purchaser,
enforceable against Purchaser in accordance with its terms, except as
enforcement thereof may be limited by bankruptcy, insolvency or other similar
laws affecting the enforcement of creditors' rights in general or general
principles of equity.
SECTION 7. MISCELLANEOUS
(a) Withholding of Taxes; Notice of 83 (b) Election. Seller shall
have the right to require Purchaser to pay to Seller the amount of any taxes
that are required to be withheld with
6
<PAGE>
respect to Purchaser's Purchased Shares, including any such taxes required to be
withheld in connection with (i) any dividend or distribution in respect of the
Purchased Shares, (ii) any conversion of Unvested Shares to Vested Shares, or
(iii) any sale of Purchased Shares. Purchaser shall promptly notify Seller if
Purchaser makes an election under section 83(b) of the Internal Revenue Code.
(b) Governing Law. This Agreement and the rights and obligations
of the parties hereto shall be governed by, and construed and enforced in
accordance with, the laws of the State of New York, without giving effect to the
conflicts of laws principles thereof.
(c) Specific Performance. The parties hereto acknowledge that
there will be no adequate remedy at law for a violation of any of the provisions
of this Agreement and that, in addition to any other remedies that may be
available, all of the provisions of this Agreement shall be specifically
enforceable in accordance with their respective terms.
(d) Severability. The invalidity or unenforceability of any
provision of this Agreement in any jurisdiction shall not affect the validity or
enforceability of the remainder of this Agreement in that jurisdiction or the
validity or enforceability of this Agreement, including that provision, in any
other jurisdiction.
(e) Notice. All notices and other communications hereunder shall
be in writing and, unless otherwise provided herein, shall be deemed to have
been given when received by the party to whom such notice is to be given at its
address set forth below, or such other address for the party as shall be
specified by notice given pursuant hereto:
If to Seller:
CGA Group, Ltd.
Craig Appin House
8 Wesley Street
Hamilton HM 11 Bermuda
Attn: James Reinhart
If to Purchaser:
-------------------------
-------------------------
-------------------------
(f) Binding Effect. This Agreement shall inure to the benefit of
and shall be binding upon the parties hereto and their respective heirs, legal
representatives, successors and assigns.
(g) Amendment and Modification. This Agreement may be amended,
modified or supplemented only by written agreement of the party against whom
enforcement of such amendment, modification or supplement is sought.
7
<PAGE>
(h) Headings; Execution in Counterparts. The headings and
captions contained herein are for convenience only and shall not control or
affect the meaning or construction of any provision hereof. This Agreement may
be executed in any number of counterparts, each of which shall be deemed to be
an original and all of which together shall constitute one and the same
instrument.
(i) No Rights to Employment. Nothing in this Agreement shall
constitute an offer of employment to Purchaser or be construed to require Seller
to continue Purchaser in the employ of Seller for any stated period of time.
(j) Entire Agreement. This Agreement and the Note constitute the
entire agreement, and supersedes all prior agreements and understandings, oral
and written, between the parties hereto with respect to the subject matter
hereof.
IN WITNESS WHEREOF, Purchaser and Seller have executed this
Restricted Stock Award Agreement as of the date first above written.
CGA GROUP, LTD.
By:
-------------------------------
Name:
Title:
PURCHASER
----------------------------------
8
<PAGE>
EXHIBIT A
TO EXHIBIT 10.20
[FORM OF]
PROMISSORY NOTE
$________________ April 26, 1999
FOR VALUE RECEIVED, the undersigned, __________________, an individual
residing at __________________, ("Maker"), hereby promises to pay to the order
of CGA Group, Ltd., a company with limited liability formed under the laws of
Bermuda (together with its successors and permitted assigns, the "Holder"), at
the Holder's address at Craig Appin House, 8 Wesley Street, Hamilton HM 11,
Bermuda, or at such other place as Holder may designate from time to time, the
principal sum of _________________ ($_________) in legal and lawful money of the
United States of America, together with accrued interest thereon as set forth in
Section 1 hereof, which interest shall accrue on the outstanding principal from
and including the date hereof, but excluding the date on which the principal and
all accrued interest are paid in full. The principal of this Note, together with
all accrued interest thereon, shall be due and payable in three equal
installments on April 26, 2000, April 26, 2001 and April 26, 2002, respectively
(or, if any such day is not a business day in each of New York, New York and
Hamilton, Bermuda, then on the next succeeding business day) ("Installment
Dates").
This Note is issued in connection with the CGA Group, Ltd. Restricted
Stock Purchase Agreement dated as of April 26, 1999 between Maker and Holder
(the "Agreement").
Section 1. INTEREST. This Note shall accrue interest at the rate of 7%
per annum. Interest shall be payable on each Installment Date.
Section 2. PREPAYMENTS. Maker may, at his option, prepay the principal
amount of this Note, and all accrued interest thereon, at any time and from time
to time, in whole or in part and without penalty.
Section 3. ACCELERATION. The Holder will have the right to accelerate
the principal and interest due under this Note if any of the following events
(such event, an "Event of Default") occurs:
(a) During the period that any Purchased Shares remain Unvested Shares
under the Agreement, a termination of the employment of Maker occurs by reason
of a Voluntary Termination (as defined in the Agreement), effective ninety (90)
days after the effective date of such termination, or such earlier or later date
that is the closing date of the Holder's Call Option under the Agreement, as to
the Unvested Shares repurchased under the Call Option;
(b) Maker shall fail to pay any principal or interest amount due under
this Note on any Installment Date on or prior to such Installment Date;
9
<PAGE>
(c) Maker shall fail to perform, observe or comply with any other
covenant, agreement, or condition contained in this Note and such failure
continues for a period of ten (10) days following written notice to Maker from
Holder of the continuation of such failure; or
(d) Maker (i) shall generally not, or be unable to, or shall admit in
writing his inability to, pay his debts as such debts become due; (ii) shall
make an assignment for the benefit of creditors, petition or apply to any
tribunal for the appointment of a custodian, receiver, or trustee for himself or
a substantial part of his assets; (iii) shall commence any proceeding under any
bankruptcy, reorganization, arrangement or readjustment of debt law or statute
of any jurisdiction, whether now or hereafter in effect; (iv) shall have had any
such petition or application filed or any such proceeding shall have been
commenced, against him, in which an adjudication or appointment is made or order
for relief is entered, or which petition, application or proceeding remains
undismissed or unstayed for a period of thirty (30) days or more; (v) shall be
the subject of any proceeding under which his assets may be subject to seizure,
forfeiture or divestiture; (vi) by any act or omission shall indicate his
consent to, approval of or acquiescence in any such petition, application or
proceeding or order for relief or the appointment of a custodian, receiver or
trustee for all or any substantial part of his property; or (vii) shall suffer
any such custodianship, receivership, or trusteeship to continue undischarged
for a period of thirty (30) days or more.
Upon the existence of an Event of Default, Holder may (i) declare this
Note outstanding, all interest thereon, and all other amounts payable at any
time or from time to time under this Note to be forthwith due and payable,
whereupon the Note, all such interest, and all such amounts due at any time and
from time to time under this Note shall become and be forthwith due and payable,
without presentment, demand, protest, or further notice of any kind, all of
which are hereby expressly waived by Maker; and/or (ii) exercise any rights and
remedies provided by law.
Section 4. COLLECTION COSTS AND EXPENSES. If there is an Event of
Default, Maker shall pay all costs and expenses incurred by Holder, including
reasonable attorneys' fees and expenses, in connection with the enforcement and
collection of this Note.
Section 5. GOVERNING LAW. This Note shall be governed by and construed
in accordance with the laws of the State of New York (without giving effect to
its conflict of law principles).
Section 6. WAIVER AND AMENDMENT. Maker hereby waives presentment, demand
for payments, notice of dishonor, protest and notice of protest and any and all
other notices or demands in connection with this Note. No delay or omission on
the part of Holder in exercising any right hereunder shall operate as a waiver
of such right or of any other right under this Note. A waiver on one occasion
shall not be construed as a bar to or waiver of any such right and/or remedy on
any future occasion. Any provision of this Note may be amended upon the express
written agreement thereto of Maker and Holder at the time of such amendment.
Section 7. HEADINGS; CONSTRUCTION. The headings of the sections of this
Note are inserted for convenience only and shall not be deemed to constitute a
part hereof; words used herein of any gender shall be construed to include any
other gender where appropriate, and
10
<PAGE>
words used herein that are either singular or plural shall be construed to
include the other where appropriate.
Section 8. NOTICES. Any notice or other communication permitted or
required to be given hereunder to the Holder shall be given to the Holder in
accordance with the Agreement. Any notice or other communication permitted or
required to be given hereunder to the Maker shall be given to the Maker at the
registered offices of CGA Group, Ltd. as set forth in the Agreement, or to such
other address as given to the Holder by the Maker in writing and agreed to by
the Maker.
Section 9. LOST NOTE. Upon receipt by Maker of evidence satisfactory to
it of the loss, theft, destruction or mutilation of this Note, and (in the case
of loss, theft or destruction) of indemnity satisfactory to it, and upon
reimbursement to Maker of all reasonable expenses incidental thereto, and upon
surrender and cancellation of such Note, if mutilated, Maker will deliver in
lieu of such Note a new note for the unpaid principal amount thereof and
carrying the same rights to interest on the unpaid principal.
Section 10. SEVERABILITY. Any provision of this Note which is prohibited
or unenforceable in any jurisdiction shall, as to such jurisdiction, be
ineffective to the extent of such prohibition or unenforceability without
invalidating the remaining provisions hereof, and any such prohibition or
unenforceability in any jurisdiction shall not invalidate or render
unenforceable such provision in any other jurisdiction.
IN WITNESS WHEREOF, the undersigned has executed this Note on the date
first above written.
----------------------------------
[Name]
11
<PAGE>
EXHIBIT B
TO EXHIBIT 10.20
<TABLE>
CGA Group, Ltd.
Employee Stock Purchase Plan Participants
Closed April 26, 1999
<CAPTION>
Total Total Down Loan
Shares Cost Payment Amount
------------------------ ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
1 Aseron Ross $ 15,000.00 $ 18,000.00 $ 1,800.00 16,200.00
2 Avidan Martin 50,000.00 60,000.00 6,000.00 54,000.00
3 Blacker Kem 41,667.00 50,000.40 5,000.04 45,000.36
4 Borg Joshua 20,000.00 24,000.00 2,400.00 21,600.00
5 Bourdeau Isabelle 45,000.00 54,000.00 5,400.00 48,600.00
6 Coon Andy 25,000.00 30,000.00 3,000.00 27,000.00
7 Coyle James 35,000.00 42,000.00 4,200.00 37,800.00
8 Egler Gerri 20,000.00 24,000.00 2,400.00 21,600.00
9 Faber Carol 20,000.00 24,000.00 2,400.00 21,600.00
10 Fishbone Scott 30,000.00 36,000.00 3,600.00 32,400.00
11 Lang Yan-Meng 5,000.00 6,000.00 6,000.00 --
12 Liabotis Elizabeth 15,000.00 18,000.00 1,800.00 16,200.00
13 Manion Peter 8,500.00 10,200.00 1,020.00 9,180.00
14 McGovern Geraldine 10,000.00 12,000.00 1,200.00 10,800.00
15 Miran Michael 100,000.00 120,000.00 12,000.00 108,000.00
16 Parsons Landon 83,334.00 100,000.80 10,000.08 90,000.72
17 Price Richard 308,316.00 369,979.20 36,997.92 332,981.28
18 Pridgen Tracy 25,000.00 30,000.00 3,000.00 27,000.00
19 Riordan Brian 15,000.00 18,000.00 1,800.00 16,200.00
20 Steffelin Edward 41,666.00 49,999.20 4,999.92 44,999.28
21 Stuhlemmer Eric 15,000.00 18,000.00 1,800.00 16,200.00
22 Wasterlain Jean-Michel 40,000.00 48,000.00 4,800.00 43,200.00
23 Yung Ron 5,000.00 6,000.00 600.00 5,400.00
----------- ------------- ----------- -------------
Totals $973,483.00 $1,168,179.60 $122,217.96 $1,045,961.64
=========== ============= =========== =============
</TABLE>
12
CGA GROUP, LTD.
CHIEF FINANCIAL OFFICER'S CERTIFICATE
As to Adjustment to Exercise Price of Warrants Issued
Pursuant to the Sponsoring Investors and Founders Stock Warrant Plan
This Chief Financial Officer's Certificate is delivered pursuant to Sections 14
and 15 of the CGA Group, Ltd. Sponsoring Investors and Founders Stock Warrant
Plan dated as of June 17, 1997 (the "Warrant Agreement"). Capitalized terms used
but not otherwise defined herein shall have the meanings ascribed to them in the
Warrant Agreement.
The undersigned, being the duly appointed, qualified and acting
Chief Financial Officer of CGA Group, Ltd. (the "Company"), DOES HEREBY CERTIFY,
in the name and on behalf of the Company, that:
1. On March 31, 1999, the Company converted 2,268,678 shares of
the Company's Series B Preferred Stock into an aggregate of 18,905,648 shares of
the Company's Common Stock.
2. On March 31, 1999, the Company sold to investors 43,997,863
shares of the Company's Series C Preferred Stock for aggregate proceeds of
$50,996,794.50. The shares of Series C Preferred Stock are convertible into
shares of the Company's Common Stock on a one-for-one basis at the holder's
option at any time, and are mandatorily convertible into shares of the Company's
Common Stock on a one-for-one basis upon the occurrence of certain events.
3. On April 16, 1999, the Company sold to certain of its
employees an aggregate of 973,483 shares of the Company's Series C Preferred
Stock for aggregate proceeds of $1,168,179.60.
4. As of the date of this Certificate there are 28,005,648 shares
of Common Stock and 44,971,346 shares of Series C Preferred Stock issued and
outstanding, respectively. Assuming the conversion of all such shares of Series
C Preferred Stock into shares of Common Stock, there are 72,976,994 shares of
Common Stock deemed to be issued and outstanding.
5. Immediately prior to March 31, 1999, each Warrant entitled the
holder thereof to purchase from the Company, on or prior to June 16, 2007, one
share of Common Stock for an exercise price of $5.00.
6. As a result of the transactions listed above, the Purchase
Price of the Warrants has been adjusted so that each Warrant now entitles the
holder thereof to purchase from the Company, on or prior to June 16, 2007, one
share of Common Stock for an exercise price of $2.12.
IN WITNESS WHEREOF, the undersigned has executed this Chief
Financial Officer's Certificate this 18th day of May, 1999
By: /s/ JAMES R. REINHART
------------------------------------------------
Name: James R. Reinhart
Title: Chief Financial Officer, CGA Group, Ltd.
Commercial Guaranty Assurance, Ltd. (Bermuda)
CGA Investment Management, Inc. (Delaware)
