<PAGE>
THIS PROSPECTUS SUPPLEMENT RELATES TO AN EFFECTIVE REGISTRATION STATEMENT UNDER
THE SECURITIES ACT OF 1933, AS AMENDED, AND IS SUBJECT TO COMPLETION OR
AMENDMENT.
<PAGE>
Filed pursuant to Rule 424(b)(5)
Registration Number 33-62451
SUBJECT TO COMPLETION
JANUARY 26, 1996
PROSPECTUS SUPPLEMENT [LOGO]
(To Prospectus Dated December 4, 1995)
7,000,000 DECS-SM-
(DEBT EXCHANGEABLE FOR COMMON STOCK-SM-)
U S WEST, INC.
% EXCHANGEABLE NOTES DUE , 1999
(SUBJECT TO EXCHANGE INTO SHARES OF COMMON STOCK, PAR VALUE $.01 PER SHARE, OF
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.)
The principal amount of each of the % Exchangeable Notes Due ,
1999 (each, a "DECS"), of U S WEST, Inc., a Delaware corporation ("U S WEST"),
being offered hereby will be $ (the last sale price of the common stock, par
value $.01 per share (the "FSA Holdings Common Stock"), of Financial Security
Assurance Holdings Ltd., a New York corporation ("FSA Holdings"), on
, 1996, as reported on the New York Stock Exchange Composite Tape)
(the "Initial Price"). The DECS will mature on , 1999. Interest on
the DECS, at the rate of % of the principal amount per annum, is payable
quarterly on , , and , beginning
, 1996. DECS are not subject to redemption or any sinking fund prior to
maturity.
At maturity (including as a result of acceleration or otherwise), the principal
amount of each DECS will be mandatorily exchanged by U S WEST into a number of
shares of FSA Holdings Common Stock (or, at U S WEST's option under the
circumstances described herein, the cash equivalent) at the Exchange Rate (as
defined herein). The Exchange Rate is equal to, subject to certain adjustments,
(a) if the Maturity Price per share of FSA Holdings Common Stock is greater than
or equal to $ per share of FSA Holdings Common Stock, shares of FSA
Holdings Common Stock per DECS, (b) if the Maturity Price is less than $ but
is greater than the Initial Price, a fractional share of FSA Holdings Common
Stock per DECS so that the value thereof at the Maturity Price equals the
Initial Price and (c) if the Maturity Price is less than or equal to the Initial
Price, one share of FSA Holdings Common Stock per DECS. The "Maturity Price"
means the average Closing Price (as defined herein) per share of FSA Holdings
Common Stock on the 20 Trading Days (as defined herein) immediately prior to
maturity, except as otherwise described herein. Accordingly, the value of the
FSA Common Stock to be received by holders of the DECS (or the cash equivalent)
at maturity will not necessarily equal the principal amount thereof. The DECS
will be unsecured obligations of U S WEST ranking pari passu with all of its
other unsecured and unsubordinated indebtedness. FSA Holdings will have no
obligations with respect to the DECS. See "Description of the DECS."
SEE "RISK FACTORS RELATING TO DECS" BEGINNING ON PAGE S-3 FOR A DISCUSSION OF
CERTAIN FACTORS THAT SHOULD BE CAREFULLY CONSIDERED BY PROSPECTIVE PURCHASERS.
Attached hereto as Appendix A and included as part of this Prospectus Supplement
is a prospectus of FSA Holdings relating to the shares of FSA Holdings Common
Stock that may be received by holders of DECS at maturity. The FSA Holdings
Common Stock is listed on the New York Stock Exchange ("NYSE") under the symbol
"FSA".
For a discussion of certain United States federal income tax consequences for
holders of DECS, see "Certain United States Federal Income Tax Considerations."
"DECS" and "Debt Exchangeable for Common Stock" are service marks of Salomon
Brothers Inc.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS SUPPLEMENT OR THE ACCOMPANYING
<TABLE>
<CAPTION>
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC(1) DISCOUNT U S WEST(1)(2)
Per DECS............................... $ $ $
Total (3).............................. $ $ $
- ---------------------------------------------------------------------------------------
</TABLE>
(1) Plus accrued interest, if any, from , 1996 to the date of
delivery.
(2) Before deducting expenses payable by U S WEST, estimated at $ .
(3) U S WEST has granted to the Underwriters a 30-day option to purchase up to
an aggregate of 1,050,000 additional DECS at the Price to Public, less
Underwriting Discount, solely to cover over-allotments, if any. If the
Underwriters exercise such option in full, the total Price to Public,
Underwriting Discount and Proceeds to U S WEST will be $ ,
$ and $ , respectively. See "Plan of Distribution."
The DECS are offered subject to receipt and acceptance by the Underwriters, to
prior sales and to the Underwriters' right to reject any order in whole or in
part and to withdraw, cancel or modify the offer without notice. It is expected
that delivery of the DECS will be made at the office of Salomon Brothers Inc,
Seven World Trade Center, New York, New York, or through the facilities of The
Depository Trust Company, on or about , 1996.
SALOMON BROTHERS INC
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
LEHMAN BROTHERS
The date of this Prospectus Supplement is , 1996.
<PAGE>
On November 1, 1995, as part of the Recapitalization Plan described herein under
"Recent Development," U S WEST changed its state of incorporation from Colorado
to Delaware through the merger of U S WEST, Inc., a Colorado corporation and U S
WEST's predecessor ("U S WEST Colorado"), with and into U S WEST, with U S WEST
continuing as the surviving corporation. As used herein, unless the context
otherwise requires, references to "U S WEST" shall refer to U S WEST and U S
WEST Colorado, its Colorado predecessor.
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE DECS AND THE
FSA HOLDINGS COMMON STOCK AT LEVELS ABOVE THOSE WHICH MIGHT OTHERWISE PREVAIL IN
THE OPEN MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NEW YORK STOCK
EXCHANGE (WITH RESPECT TO THE FSA HOLDINGS COMMON STOCK) IN THE OVER-THE-COUNTER
MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY
TIME.
S-2
<PAGE>
RISK FACTORS RELATING TO DECS
As described in more detail below, the trading price of the DECS may vary
considerably prior to maturity (including by acceleration or otherwise,
"Maturity") due to, among other things, fluctuations in the market price of FSA
Holdings Common Stock and other events that are difficult to predict and beyond
U S WEST's control.
COMPARISON TO OTHER DEBT SECURITIES; RELATIONSHIP TO FSA HOLDINGS COMMON STOCK
The terms of the DECS differ from those of ordinary debt securities in that
the value of the FSA Holdings Common Stock (or cash equivalent thereof) that a
holder of the DECS will receive upon mandatory exchange of the principal amount
thereof at Maturity (the "Amount Receivable at Maturity") is not fixed, but is
based on the market price of the FSA Holdings Common Stock as specified in the
Exchange Rate (as defined under "Description of the DECS"). There can be no
assurance that the Amount Receivable at Maturity will be equal to or greater
than the principal amount of the DECS. For example, if the Maturity Price of the
FSA Holdings Common Stock is less than the Initial Price, the Amount Receivable
at Maturity will be less than the principal amount paid for the DECS, in which
case an investment in DECS would result in a loss.
In addition, the opportunity for equity appreciation afforded by an
investment in the DECS is less than the opportunity for equity appreciation
afforded by an investment in FSA Holdings Common Stock because the Amount
Receivable at Maturity will only exceed the principal amount of such DECS if the
Maturity Price exceeds the Threshold Appreciation Price (as defined under
"Description of the DECS"), which represents an appreciation of % of the
Initial Price. Moreover, holders of the DECS will only be entitled to receive
upon exchange at Maturity % of any appreciation of the value of FSA Holdings
Common Stock in excess of the Threshold Appreciation Price. Because the market
price of the FSA Holdings Common Stock is subject to market fluctuations, the
Amount Receivable at Maturity may be more or less than the principal amount of
the DECS.
It is impossible to predict whether the price of FSA Holdings Common Stock
will rise or fall. Trading prices of FSA Holdings Common Stock will be
influenced by FSA Holdings's operational results and by complex and interrelated
political, economic, financial and other factors that can affect the capital
markets generally, the stock exchange on which FSA Holdings Common Stock is
traded and the market segment of which FSA Holdings is a part. See the
prospectus relating to FSA Holdings and to FSA Holdings Common Stock attached
hereto as Appendix A and included as part of this Prospectus Supplement. Trading
prices of FSA Holdings Common Stock also may be influenced if U S WEST or
another principal shareholder of FSA Holdings hereafter issues securities with
terms similar to those of the DECS or otherwise transfers shares of FSA Holdings
Common Stock. As of the date hereof, a wholly owned subsidiary of U S WEST held
an aggregate of 15,856,910 shares of FSA Holdings Common Stock, 7,000,000 shares
of which (8,050,000 shares if the Underwriters' over-allotment option is
exercised in full) U S WEST may deliver to holders of the DECS at Maturity.
DILUTION OF FSA HOLDINGS COMMON STOCK
The Amount Receivable at Maturity is subject to adjustment for certain
events arising from stock splits and combinations, stock dividends and certain
other actions of FSA Holdings that modify its capital structure. See
"Description of the DECS -- Dilution Adjustments; Reorganization Events." Such
Amount Receivable at Maturity may not be adjusted for other events, such as
offerings of FSA Holdings Common Stock for cash or in connection with
acquisitions, that may adversely affect the price of FSA Holdings Common Stock
and, because of the relationship of such Amount Receivable at Maturity to the
price of FSA Holdings Common Stock, such other events may adversely affect the
trading price of the DECS. There can be no assurance that FSA Holdings will not
make offerings of FSA Holdings Common Stock or take such other action in the
future or as to the amount of such offerings, if any. In addition, until such
time, if any, as U S WEST shall deliver shares of FSA Holdings Common Stock to
holders of the DECS at Maturity thereof, holders of the DECS will not be
entitled to any rights with respect to FSA Holdings Common Stock (including,
without limitation, voting rights and the rights to receive any dividends or
other distributions in respect thereof).
S-3
<PAGE>
NO OBLIGATION ON THE PART OF FSA HOLDINGS WITH RESPECT TO THE DECS
FSA Holdings has no obligations with respect to the DECS or the Amount
Receivable at Maturity, including any obligation to take the needs of U S WEST
or of holders of the DECS into consideration for any reason. FSA Holdings will
not receive any of the proceeds of the offering of the DECS made hereby and is
not responsible for, and has not participated in, the determination of the time
of, prices for or quantities of DECS to be issued or the determination or
calculation of the Amount Receivable at Maturity. FSA Holdings is not involved
with the administration or trading of the DECS and has no obligations with
respect to the Amount Receivable at Maturity.
POSSIBLE ILLIQUIDITY OF THE SECONDARY MARKET
It is not possible to predict how the DECS will trade in the secondary
market or whether such market will be liquid or illiquid. DECS are novel and
innovative securities and there is currently no secondary market for the DECS.
The DECs will not be listed or traded on any securities exchange or trading
market. Accordingly, pricing information for the DECS may be difficult to obtain
and the liquidity of the DECS may be limited. The Underwriters currently intend,
but are not obligated, to make a market in the DECS. There can be no assurance
that a secondary market will develop or, if a secondary market does develop,
that it will provide the holders of the DECS with liquidity or that it will
continue for the life of the DECS.
UNCERTAINTY OF FEDERAL INCOME TAX CONSEQUENCES
No statutory, judicial or administrative authority directly addresses the
characterization of the DECS or instruments similar to the DECS for U.S. federal
income tax purposes. As a result, significant aspects of the U.S. federal income
tax consequences of an investment in the DECS are not certain. No ruling is
being requested from the Internal Revenue Service with respect to the DECS and
no assurance can be given that the Internal Revenue Service will agree with the
conclusions expressed under "Certain United States Federal Income Tax
Considerations."
S-4
<PAGE>
U S WEST, INC.
U S WEST is a diversified global communications company engaged in the
telecommunications, cable, wireless communications and multimedia content and
services businesses. U S WEST conducts its businesses through two groups: the U
S WEST Communications Group (the "Communications Group") and the U S WEST Media
Group (the "Media Group").
The Communications Group provides telecommunications services to more than
25 million residential and business customers in the states of Arizona,
Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota,
Oregon, South Dakota, Utah, Washington and Wyoming (collectively, the
"Communications Group Region"). Such services include local telephone services,
exchange access services and certain long distance services, as well as various
new services, including Caller ID, voice messaging and high-speed data
networking services. The Communications Group also provides customer premise
equipment and certain communications services to business customers and
governmental agencies both inside and outside the Communications Group Region.
The Media Group is comprised of (i) cable and telecommunications network
businesses outside the Communications Group Region and internationally, (ii)
domestic and international wireless communications network businesses and (iii)
domestic and international multimedia content and services businesses. The Media
Group's cable and telecommunications businesses include domestic cable and
telecommunications businesses and investments outside of the Communications
Group Region, including U S WEST's cable systems in the Atlanta, Georgia
metropolitan area and its interest in Time Warner Entertainment Company, L.P.,
and international cable and telecommunications investments, including U S WEST's
interest in TeleWest plc, the largest provider of combined cable and
telecommunications services in the United Kingdom. The Media Group provides
domestic wireless communications products and services, including cellular
services, to a rapidly growing customer base. U S WEST and AirTouch
Communications, Inc. ("AirTouch") have entered into Phase I of a cellular joint
venture pursuant to which their domestic cellular properties will receive
centralized services from a Wireless Management Company on a contract basis.
Upon consummation of Phase II of the joint venture, the domestic cellular
properties of U S WEST and AirTouch will be combined to form the third largest
cellular company in the United States. The Media Group also provides wireless
communications services internationally through Mercury One-2-One, the world's
first Personal Communications Service, in the United Kingdom. The Media Group's
multimedia content and services businesses develop and package content and
information services, including telephone directories, database marketing and
other interactive services in domestic and international markets. The Media
Group also includes the businesses of U S WEST's capital assets segment,
including U S WEST's interest in FSA Holdings.
RECENT DEVELOPMENT
On November 1, 1995, U S WEST created two classes of common stock that are
intended to reflect separately the performance of the Communications Group and
the Media Group and changed the state of incorporation of U S WEST from Colorado
to Delaware (the "Recapitalization Plan"). The Recapitalization Plan was
effected in accordance with the terms of an Agreement and Plan of Merger, dated
August 17, 1995, between U S WEST Colorado and U S WEST pursuant to which (i) U
S WEST Colorado was merged with and into U S WEST, with U S WEST continuing as
the surviving corporation and (ii) each outstanding share of Common Stock,
without par value, of U S WEST Colorado was converted into one share of U S WEST
Communications Group Common Stock, par value $.01 per share, of U S WEST, which
is intended to reflect separately the performance of the Communications Group,
and one share of U S WEST Media Group Common Stock, par value $.01 per share, of
U S WEST, which is intended to reflect separately the performance of the Media
Group.
The Recapitalization Plan was approved by U S WEST Colorado's shareholders
at a special meeting held on October 31, 1995. Implementation of the
Recapitalization Plan has not resulted in the transfer of any assets from U S
WEST or any of its subsidiaries or altered the legal nature of U S WEST's
obligations to its creditors. Creditors of U S WEST, including the holders of
the DECS, will continue to benefit from the cash flow of the subsidiaries
comprising both the Communications Group and the Media Group, subject to the
satisfaction of obligations by such subsidiaries.
S-5
<PAGE>
The Recapitalization Plan is not expected to have any adverse impact on U S
WEST's credit rating. However, as part of its growth strategy, U S WEST from
time to time engages in discussions regarding acquisitions. U S WEST may fund
any such acquisitions, if consummated, with internally generated funds, debt or
equity. The incurrence of indebtedness to fund such acquisitions and/or the
assumption of indebtedness in connection with such acquisitions could result in
a downgrading of U S WEST's credit rating and, as a result, have an adverse
effect upon the market value of the DECS.
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
FSA Holdings, through its indirect wholly owned subsidiary, Financial
Security Assurance Inc. ("FSA"), is primarily engaged in the business of
providing financial guaranty insurance on asset-backed securities and municipal
bonds. FSA was the first insurance company organized to insure asset-backed
obligations and has been a leading insurer of asset-backed obligations (based on
number of transactions insured) since its inception in 1985. FSA expanded the
focus of its business in 1990 to include financial guaranty insurance of
municipal obligations.
FSA's underwriting policy is to insure asset-backed and municipal
obligations that would otherwise be investment grade without the benefit of
FSA's insurance. The asset-backed obligations insured by FSA are generally
issued in structured transactions and are backed by pools of assets such as
residential mortgage loans, consumer or trade receivables, securities or other
assets having an ascertainable cash flow or market value. The municipal
obligations insured by FSA consist primarily of general obligation bonds that
are supported by the issuers' taxing power and special revenue bonds and other
special obligations of state and local governments that are supported by the
issuers' ability to impose and collect fees and charges for public services or
specific projects. Financial guaranty insurance written by FSA guarantees
payment when due of scheduled payments on an issuer's obligation. In the case of
a payment default on an insured obligation, FSA is generally required to pay the
principal, interest or other amounts due in accordance with the obligation's
original payment schedule or, at its option, to pay such amounts on an
accelerated basis.
FSA Holdings' business strategy is to remain a leading insurer of
asset-backed obligations and to become a more prominent insurer of municipal
obligations. FSA Holdings expects to continue to emphasize a diversified insured
portfolio characterized by insurance of both asset-backed and municipal
obligations, with a broad geographic distribution and a variety of revenue
sources and transaction structures.
In December 1995, FSA Holdings acquired Capital Guaranty Corporation
("Capital Guaranty") in a merger transaction in which Capital Guaranty became a
direct wholly owned subsidiary of FSA Holdings (the "Merger"). Capital Guaranty,
through its wholly owned subsidiary, Capital Guaranty Insurance Company
("CGIC"), provided financial guaranty insurance on municipal bonds. In
connection with the Merger, CGIC, whose principal business is now as a reinsurer
of policies written by FSA, changed its name to "Financial Security Assurance of
Maryland Inc."
For the nine months ended September 30, 1995, FSA had gross premiums written
of $78.3 million, of which 46% related to insurance of municipal obligations and
54% related to insurance of asset-backed obligations. At September 30, 1995, FSA
had net insurance in force of $52.5 billion, of which 59% represented insurance
on municipal obligations and 41% represented insurance on asset-backed
obligations. As of September 30, 1995, pro forma net insurance in force would
have been $71.7 billion, of which 70% represented insurance on municipal
obligations and 30% represented insurance on asset-backed obligations.
At September 30, 1995, FSA Holdings and its subsidiaries had total assets of
$1,137.3 million, an increase of 5.9% from December 31, 1994, and shareholders'
equity of $608.6 million, an increase of 11.6% from December 31, 1994. After
giving pro forma effect to the Merger as if it had occured as of September 30,
1995, total assets would have been $1,463.2 million and shareholders' equity
would have been $751.4 million. For a summary of the results of FSA Holdings for
the three months and year ended December 31, 1995, see "Recent Developments" in
the prospectus of FSA Holdings attached hereto as Appendix A.
S-6
<PAGE>
For additional information about FSA Holdings and Capital Guaranty, see the
prospectus of FSA Holdings attached hereto as Appendix A. FSA Holdings is
subject to the informational requirements of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), and in accordance therewith files
reports, proxy statements and other information with the Securities and Exchange
Commission (the "Commission"). The prospectus of FSA Holdings attached hereto as
Appendix A incorporates the 1994 Annual Reports on Form 10-K of FSA Holdings and
Capital Guaranty, the Quarterly Reports on Form 10-Q of FSA Holdings and Capital
Guaranty for the quarters ended March 31, June 30 and September 30, 1995, the
Current Reports on Form 8-K, dated August 18, 1995 and December 20, 1995, of FSA
Holdings, the Current Reports on Form 8-K, dated August 22, 1995 and December
20, 1995, of Capital Guaranty, the description of the FSA Holdings Common Stock
contained in FSA Holdings' Registration Statement on Form 8-A, declared
effective on May 6, 1994, and all documents filed by FSA Holdings pursuant to
Section 13(a), 13(c), 14 or 15(d) of the Exchange Act subsequent to the date of
such prospectus and prior to the termination of this DECS offering. Such
documents may be inspected and copied at the public reference facilities
maintained by the Commission in Washington, D.C. and at its regional offices and
at the offices of the NYSE, on which the FSA Holdings Common Stock is listed.
Such documents, without exhibits, also may be obtained by writing to the
Secretary of FSA Holdings, Financial Security Assurance Holdings Ltd., 350 Park
Avenue, New York, New York 10022 (telephone number (212) 826-0100). See
"Available Information" and "Incorporation of Certain Documents by Reference" in
the prospectus of FSA Holdings attached hereto as Appendix A.
S-7
<PAGE>
RELATIONSHIP BETWEEN U S WEST AND FSA HOLDINGS
A wholly owned subsidiary of U S WEST currently owns approximately
15,856,910 shares of FSA Holdings Common Stock (50.3% of the outstanding FSA
Holdings Common Stock) and has the right to vote 13,962,970 shares of FSA
Holdings Common Stock (41.7% of the voting power of the outstanding equity of
FSA Holdings). In addition, four of the directors of FSA Holdings are officers
of U S WEST or its affiliates. FSA Holdings is operated as a corporation
independent from U S WEST, and while U S WEST may have some influence over FSA
Holdings, U S WEST does not consider that its ownership of FSA Holdings Common
Stock affords it the power to control the management of FSA Holdings. Moreover,
because U S WEST is not required to retain its current holdings of shares of FSA
Holdings Common Stock in connection with the DECS or otherwise and may sell some
or all of such shares from time to time, there can be no assurance that U S WEST
will have any influence over the actions and decisions taken and made by FSA
Holdings. A principal shareholder of FSA Holdings has a right of first offer
with respect to the shares of FSA Holdings Common Stock which may be delivered
by U S WEST at Maturity. In the event such shareholder exercises such option, U
S WEST may be required to deliver cash at Maturity. For a description of certain
relationships between U S WEST and FSA Holdings, see "Certain Relationships and
Related Transactions" in the prospectus of FSA Holdings attached hereto as
Appendix A.
In connection with the offering of the DECS, FSA Holdings has agreed to
indemnify U S WEST against certain liabilities, including liabilities under the
Securities Act of 1933, as amended (the "Securities Act"), and to pay the
expenses of U S WEST incurred in connection therewith. FSA Holdings has no
obligations with respect to the DECS. See "Risk Factors Relating to DECS -- No
Obligation on the Part of FSA Holdings with Respect to the DECS."
S-8
<PAGE>
CAPITALIZATION
The following table sets forth the unaudited consolidated capitalization of
U S WEST at September 30, 1995, and as adjusted to reflect the application of
the estimated net proceeds from the sale of the DECS (assuming the Underwriters'
over-allotment option is not exercised) and the sale of certain securities by U
S WEST and its affiliates subsequent to September 30, 1995. See "Use of
Proceeds." The table should be read in conjunction with U S WEST's consolidated
financial statements and notes thereto included in the documents incorporated by
reference herein. See "Incorporation of Certain Documents by Reference" in the
accompanying Prospectus.
<TABLE>
<CAPTION>
AT SEPTEMBER 30, 1995
----------------------------
ACTUAL (1) AS ADJUSTED (1)
---------- ---------------
(DOLLARS IN MILLIONS)
<S> <C> <C>
Short-term borrowings....................................... $ 3,640 $ (2)
---------- ---------------
---------- ---------------
Long-term borrowings:
Debentures, notes and other............................... $ 5,144 $ (2)
DECS...................................................... --
---------- ---------------
Total long-term borrowings.................................. $ 5,144 $ (2)
---------- ---------------
Company obligated mandatorily redeemable preferred
securities of subsidiary trust holding solely company
guaranteed debentures...................................... $ 600 $
---------- ---------------
Preferred stock subject to mandatory redemption............. $ 51 $
---------- ---------------
Common shareholders' equity:
Common shares -- no par, 2,000,000,000 authorized;
471,650,698 outstanding................................ $ 8,161 $
Cumulative deficit...................................... (223)
LESOP guarantee......................................... (157)
Foreign currency translation adjustment................. (17)
---------- ---------------
Total common shareholders' equity........................... $ 7,764 $ (3)
---------- ---------------
Total capitalization........................................ $13,559 $ (2)(3)
---------- ---------------
---------- ---------------
<FN>
- ------------------------
(1) Does not give effect to the 10,164,480 shares of common stock, without par
value, of U S WEST Colorado ("Common Stock") that were issuable at
September 30, 1995 upon exercise of exercisable options under U S WEST's
stock option plans or the 9,633,826 shares of Common Stock that were
issuable upon conversion of Liquid Yield Option Notes due 2011 of U S WEST
outstanding at September 30, 1995.
(2) Gives effect to (i) the issuance by U S WEST Capital Funding, Inc. on
October 6, 1995 of $300 million of 6 3/4% Notes Due October 1, 2005, (ii)
the issuance by U S WEST Communications, Inc. on October 13, 1995 of $250
million of 6 3/8% Notes due 2002 and $250 million of 7 1/4% Debentures due
2035, (iii) the issuance by U S WEST Capital Funding, Inc. on October 27,
1995 of $250 million of 6.31% Notes Due November 1, 2005, (iv) the issuance
by U S WEST Communications, Inc. on November 10, 1995 of $250 million of
7.20% Debentures due 2026, (v) the issuance by U S WEST Communications,
Inc. on November 21, 1995 of $250 million of 6.125% Notes due November 21,
2000, (vi) the issuance by U S WEST Communications, Inc. on November 27,
1995 of Swiss Francs 150 million of 4 1/8% Bonds due 2001, (vii) the
issuance by U S WEST Capital Funding, Inc. between November 9, 1995 and
of an aggregate of $ million of medium-term notes bearing
interest ranging from % to % and (viii) the issuance by U S WEST on
December 11, 1995 of 5,430,800 7.625% Exchangeable Notes Due December 15,
1998, and the application of the net proceeds thereof to the reduction of
short-term borrowings.
(3) The Recapitalization Plan has not affected the total common shareholders'
equity or the total capitalization of U S WEST.
</TABLE>
S-9
<PAGE>
SUMMARY FINANCIAL DATA
The summary financial data below should be read in conjunction with the
financial statements and notes thereto included in U S WEST's Annual Report on
Form 10-K for the year ended December 31, 1994 and Form 10-Q for the nine months
ended September 30, 1995. See "Incorporation of Certain Documents by Reference"
in the accompanying Prospectus. The summary financial data at December 31, 1990,
1991, 1992, 1993 and 1994 and for each of the five years ended December 31, 1994
are derived from the consolidated financial statements of U S WEST which have
been audited by Coopers & Lybrand L.L.P., independent certified public
accountants. See "Experts" in the accompanying Prospectus. The summary financial
data at September 30, 1994 and 1995 and for the nine months ended September 30,
1994 and 1995 are derived from the unaudited consolidated financial statements
of U S WEST, which have been prepared on the same basis as U S WEST's audited
consolidated financial statements and, in the opinion of management, contain all
adjustments, consisting of only normal recurring adjustments, necessary for a
fair presentation of the financial position and results of operations for these
periods.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------- ------------------
1990 1991 1992 1993 1994 1994 1995
------- ------- ------- ------- ------- ------- ---------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
FINANCIAL DATA
Sales and other revenues.......................................... $ 9,369 $ 9,528 $ 9,823 $10,294 $10,953 $ 8,114 $ 8,686
Income from continuing operations (1)............................. 1,145 840 1,076 476 1,426 1,017 973
Net income (loss) (2)............................................. 1,199 553 (614) (2,806) 1,426 1,017 964
Total assets...................................................... $22,160 $23,375 $23,461 $20,680 $23,204 $21,388 $ 24,761
Total debt (3).................................................... 5,147 5,969 5,430 7,199 7,938 7,251 8,784
Shareholders' equity.............................................. 9,240 9,587 8,268 5,861 7,382 6,724 7,764
Earnings per common share (continuing operations) (1)............. 2.97 2.09 2.61 1.13 3.14 2.25 2.06
Earnings (loss) per common share.................................. 3.11 1.38 (1.49) (6.69) 3.14 2.25 2.04
Return on common shareholders' equity (4)......................... 13.7% 5.7% 14.4% -- 21.6% 21.0% 16.8%
Percentage of debt to total capital (3)........................... 35.8% 38.4% 39.6% 55.1% 51.8% 51.9% 51.1%
Capital expenditures (3).......................................... $ 2,217 $ 2,425 $ 2,554 $ 2,441 $ 2,820 $ 1,958 $ 2,183
OPERATING DATA
EBITDA (5)........................................................ $ 3,889 $ 3,920 $ 3,963 $ 4,228 $ 4,559 $ 3,443 $ 3,713
Telephone network access lines in service (thousands)............. 12,562 12,935 13,345 13,843 14,336 14,175 14,670
Billed access minutes of use (millions)........................... 38,832 41,701 44,369 48,123 52,275 38,719 42,489
Cellular subscribers.............................................. 219,000 300,000 415,000 601,000 968,000 821,000 1,269,000
Cable television basic subscribers served......................... -- -- -- -- 486,000 481,000 517,000
Employees......................................................... 65,469 65,829 63,707 60,778 61,505 61,167 61,123
Number of common shareholders..................................... 935,530 899,082 867,773 836,328 816,099 823,971 790,692
Weighted average common shares outstanding (thousands)............ 386,012 401,332 412,518 419,365 453,316 451,037 470,076
- ------------------------------
(1) 1993 income from continuing operations was reduced by a restructuring
charge of $610 ($1.46 per share) and $54 ($.13 per share) for the
cumulative effect on deferred taxes of the 1993 federally mandated increase
in income tax rates. 1991 income from continuing operations was reduced by
a restructuring charge of $230 ($.57 per share). 1994 income from
continuing operations includes a gain of $105 ($.23 per share) on the sale
of 24.4 percent of U S WEST's joint venture interest in cable
television/telephone operations in the United Kingdom (TeleWest
Communications plc), a gain of $41 ($.09 per share) on the sale of U S
WEST's paging unit and a gain of $51 ($.11 per share) on the sales of
certain rural telephone exchanges. 1994 first nine months income includes a
gain on the sales of rural telephone exchanges of $31 ($0.07 per share) and
a gain on the sale of paging operations of $41 ($.09 per share). 1995 first
nine months income includes a gain on the sales of rural telephone
exchanges of $70 ($0.14 per share) and expenses associated with the
Recapitalization Plan of $10 ($0.02 per share).
(2) 1992 income includes a charge of $1,793 ($4.35 per share) for the
cumulative effect of change in accounting principles. 1993 net income was
reduced by extraordinary charges of $3,123 ($7.45 per share) for the
discontinuance of Statement of Financial Accounting Standards ("SFAS") No.
71 and $77 ($.18 per share) for the early extinguishment of debt. 1993 net
income also includes a charge of $120 ($.28 per share) for U S WEST's
decision to discontinue the operations of its capital assets segment. 1995
first nine months income includes an extraordinary loss of $9 ($0.02 per
share) for the early extinguishment of debt. Discontinued operations
provided net income (loss) of $54 ($.14 per share), $(287) ($.71 per
share), $103 ($.25 per share) and $38 ($.09 per share) in 1990, 1991, 1992
and 1993, respectively.
(3) Capital expenditures, debt and the percentage of debt to total capital
exclude discontinued operations.
(4) 1992 return on shareholders' equity is based on income before the
cumulative effect of change in accounting principles. 1993 return on
shareholders' equity is not presented. Return on shareholders' equity for
fourth quarter 1993 was 19.9 percent based on income from continuing
operations.
(5) Earnings before interest, taxes, depreciation and amortization ("EBITDA").
EBITDA excludes gains on sales of assets, restructuring charges and other
income. U S WEST considers EBITDA an important indicator of the operational
strength and performance of its businesses. EBITDA, however, should not be
considered as an alternative to operating or net income as an indicator of
the performance of U S WEST's businesses or as an alternative to cash flows
from operating activities as a measure of liquidity, in each case
determined in accordance with generally accepted accounting principles.
</TABLE>
S-10
<PAGE>
PRICE RANGE AND DIVIDEND HISTORY
OF FSA HOLDINGS COMMON STOCK
FSA Holdings Common Stock has been traded on the NYSE under the symbol "FSA"
since May 1994. The following table sets forth the high and low sales prices for
the FSA Holdings Common Stock for the calendar quarters indicated as reported on
the NYSE consolidated transaction system.
<TABLE>
<CAPTION>
SALES PRICES
-------------------- DIVIDENDS
HIGH LOW PAID
-------- -------- ------
<S> <C> <C> <C>
1994
May 6 -- June 30.......................................... $ 22 5/8 $ 20 $0.00
Third Quarter............................................. 22 1/2 20 0.08
Fourth Quarter............................................ 22 3/4 18 3/4 0.08
1995
First Quarter............................................. $ 21 5/8 $ 19 $0.08
Second Quarter............................................ 25 1/2 21 1/2 0.08
Third Quarter............................................. 27 3/4 24 1/4 0.08
Fourth Quarter............................................ 27 24 1/2 0.08
1996
First Quarter (through January 25, 1996).................. $ 25 1/2 $ 24
</TABLE>
As of January 23, 1996, there were 134 holders of record of FSA Holdings
Common Stock and 31,502,025 shares of FSA Holdings Common Stock outstanding.
For a recent sales price of the FSA Holdings Common Stock, see the cover
page of this Prospectus Supplement. See also "Price Range of Common Stock and
Dividends" in the prospectus of FSA Holdings attached hereto as Appendix A.
U S WEST makes no representation as to the amount of dividends, if any, that
FSA Holdings will pay in the future. In any event, holders of the DECS will not
be entitled to receive any dividends that may be payable on the FSA Holdings
Common Stock until such time as U S WEST, if it so elects, delivers FSA Holdings
Common Stock at Maturity of the DECS, and then only with respect to dividends
having a record date on or after the date of delivery of such FSA Holdings
Common Stock. See "Description of the DECS."
USE OF PROCEEDS
The net proceeds to be received by U S WEST from sales of the DECS will be
used for general corporate purposes, including the reduction of short-term and
long-term borrowings and other business opportunities.
S-11
<PAGE>
DESCRIPTION OF THE DECS
The following description of the particular terms of the DECS supplements,
and to the extent inconsistent therewith replaces, the description of the
general terms and provisions of Debt Securities set forth in the Prospectus, to
which description reference is hereby made.
GENERAL
The DECS are a series of Debt Securities (as defined in the Prospectus), to
be issued under an indenture dated as of November 13, 1995, as supplemented by
the First Supplemental Indenture, dated as of December 6, 1995, and the Second
Supplemental Indenture, dated as of , 1996 (the indenture, dated as of
November 13, 1995, as supplemented from time to time, the "Indenture"), between
U S WEST and The First National Bank of Chicago, as Trustee (the "Trustee").
The DECS will be unsecured and will rank on a parity with all other
unsecured and unsubordinated indebtedness of U S WEST. The aggregate number of
DECS to be issued will be 7,000,000 plus such additional number of DECS as may
be issued pursuant to the over-allotment option granted by U S WEST to the
Underwriters (see "Plan of Distribution"). The DECS will mature on ,
1999. In the future U S WEST may issue additional Debt Securities or other
securities with terms similar to those of the DECS.
Each DECS, which will be issued with a principal amount of $ , will
bear interest at the annual rate of % of the principal amount per annum (or
$ per annum) from , 1996, or from the most recent Interest Payment
Date (as defined below) to which interest has been paid or provided for until
the principal amount thereof is exchanged at Maturity pursuant to the terms of
the DECS. Interest on the DECS will be payable quarterly in arrears on ,
, and , commencing , 1996 (each, an "Interest
Payment Date"), to the persons in whose names the DECS are registered at the
close of business on the last day of the calendar month immediately preceding
such Interest Payment Date, provided that interest payable at Maturity shall be
payable to the person to whom the principal is payable. Interest on the DECS
will be computed on the basis of a 360-day year of twelve 30-day months. If an
Interest Payment Date falls on a day that is not a Business Day (as defined
below), the interest payment to be made on such Interest Payment Date will be
made on the next succeeding Business Day with the same force and effect as if
made on such Interest Payment Date, and no additional interest will accrue as a
result of such delayed payment.
At Maturity (including as a result of acceleration or otherwise), the
principal amount of each DECS will be mandatorily exchanged by U S WEST into a
number of shares of FSA Holdings Common Stock at the Exchange Rate (as defined
below). The "Exchange Rate" is equal to, (a) if the Maturity Price (as defined
below) per share of FSA Holdings Common Stock is greater than or equal to $
per share of FSA Holdings Common Stock (the "Threshold Appreciation Price"),
shares of FSA Holdings Common Stock per DECS, (b) if the Maturity Price is
less than the Threshold Appreciation Price but is greater than the Initial
Price, a fractional share of FSA Holdings Common Stock per DECS so that the
value thereof (determined at the Maturity Price) is equal to the Initial Price
and (c) if the Maturity Price is less than or equal to the Initial Price, one
share of FSA Holdings Common Stock per DECS. ACCORDINGLY, THE VALUE OF THE FSA
HOLDINGS COMMON STOCK TO BE RECEIVED BY HOLDERS OF THE DECS (OR, AS DISCUSSED
BELOW, THE CASH EQUIVALENT TO BE RECEIVED IN LIEU OF SUCH SHARES) AT MATURITY
WILL NOT NECESSARILY EQUAL THE PRINCIPAL AMOUNT OF SUCH DECS. The numbers of
shares of FSA Holdings Common Stock per DECS specified in clauses (a) and (c)
above of the Exchange Rate definition are hereinafter referred to as the "Share
Components". Any shares of FSA Holdings Common Stock delivered by U S WEST to
the holders of the DECS that are not affiliated with FSA Holdings shall be free
of any transfer restrictions and the holders of the DECS will be responsible for
the payment of any and all brokerage costs upon the subsequent sale of such
shares. No fractional shares of FSA Holdings Common Stock will be issued at
Maturity as provided under "-- Fractional Shares" below. Although it is U S
WEST's current intention to deliver shares of FSA Holdings Common Stock at
Maturity, U S WEST may at its option deliver cash, in lieu of delivering such
shares of FSA Holdings Common Stock, except where such delivery would violate
applicable state law. The
S-12
<PAGE>
amount of cash deliverable in respect of each DECS shall be equal to the product
of the number of shares of FSA Holdings Common Stock otherwise deliverable in
respect of such DECS on the date of Maturity multiplied by the Maturity Price.
In the event U S WEST elects to deliver cash in lieu of shares at Maturity, it
will be obligated to deliver cash to all holders of DECS except those holders
with respect to whom it has determined delivery of cash may violate applicable
state law and as to whom it will deliver shares of FSA Holdings Common Stock. On
or prior to the seventh Business Day prior to , 1999, U S WEST will
notify The Depository Trust Company and the Trustee and publish a notice in a
daily newspaper of national circulation stating whether the principal amount of
each DECS will be exchanged for shares of FSA Holdings Common Stock or cash;
provided, however, that if U S WEST intends to deliver cash, U S WEST shall have
the right, as a condition to delivery of such cash, to require certification as
to the domicile and residency of each beneficial holder of DECS. Notwithstanding
the foregoing, (i) in the case of certain dilution events, the Exchange Rate
will be subject to adjustment and (ii) in the case of certain reorganization
events, the consideration received by holders of DECS at Maturity will be cash
or other property. See "-- Dilution Adjustments; Reorganization Events" below.
A principal shareholder of FSA Holdings has a right of first offer with
respect to the shares of FSA Common Stock which may be delivered by U S WEST at
Maturity. In the event such shareholder exercises such option, U S WEST may be
required to deliver cash at Maturity.
The "Maturity Price" is defined as the average Closing Price per share of
FSA Holdings Common Stock on the 20 Trading Days immediately prior to (but not
including) the date of Maturity; provided, however, that if there are not 20
Trading Days for the FSA Holdings Common Stock following the 60th calendar day
immediately prior to, but not including, the date of maturity, "Maturity Price"
shall be defined as the market value per share of FSA Holdings Common Stock as
of Maturity as determined by a nationally recognized investment banking firm
retained for such purpose by U S WEST. The "Closing Price" of any security on
any date of determination means the closing sale price (or, if no closing price
is reported, the last reported sale price) of such security (regular way) on the
NYSE on such date or, if such security is not listed for trading on the NYSE on
any such date, as reported in the composite transactions for the principal
United States securities exchange on which such security is so listed, or if
such security is not so listed on a United States national or regional
securities exchange, as reported by the NASDAQ National Market, or, if such
security is not so reported, the last quoted bid price for such security in the
over-the-counter market as reported by the National Quotation Bureau or similar
organization. A "Trading Day" is defined as a day on which the security the
Closing Price of which is being determined (A) is not suspended from trading on
any national or regional securities exchange or association or over-the-counter
market at the close of business and (B) has traded at least once on the national
or regional securities exchange or association or over-the-counter market that
is the primary market for the trading of such security. "Business Day" means any
day that is not a Saturday, a Sunday or a day on which the NYSE, banking
institutions or trust companies in The City of New York are authorized or
obligated by law or executive order to close.
For illustrative purposes only, the following chart shows the number of
shares of FSA Holdings Common Stock or the amount of cash that a holder of DECS
would receive for each DECS at various Maturity Prices. The table assumes that
there will be no adjustments to the Exchange Rate described under "-- Dilution
Adjustments; Reorganization Events" below. There can be no assurance that the
Maturity Price will be within the range set forth below. Given the Initial Price
of $ per DECS and the Threshold Appreciation Price of $ , a DECS holder
would receive at Maturity the following number of shares of FSA Holdings Common
Stock or amount of cash (if U S WEST elects to pay the DECS in cash):
<TABLE>
<CAPTION>
MATURITY PRICE OF NUMBER OF SHARES OF
FSA HOLDINGS FSA HOLDINGS
COMMON STOCK COMMON STOCK AMOUNT OF CASH
- ----------------- --------------------- ----------------
<S> <C> <C>
</TABLE>
Interest on the DECS will be payable, and delivery of FSA Holdings Common
Stock (or, at the option of U S WEST, its cash equivalent) in exchange for the
DECS at Maturity will be made upon surrender of such DECS, at the office or
agency of U S WEST maintained for such purposes; provided, however, that payment
of interest may be made at the option of U S WEST by check mailed to the persons
in whose
S-13
<PAGE>
names the DECS are registered at the close of business on the last day of the
calendar month immediately preceding the relevant Interest Payment Date. See "--
Book-Entry System." Initially such office will be the principal corporate trust
office of First Chicago Trust Company of New York, 14 Wall Street, 8th Fl, New
York, NY 10005.
The DECS will be transferable at any time or from time to time at the
aforementioned office. No service charge will be made to the holder for any such
transfer except for any tax or governmental charge incidental thereto.
The Indenture does not contain any restriction on the ability of U S WEST to
sell, pledge or convey all or any portion of the FSA Holdings Common Stock held
by it or its subsidiaries, and no such shares of FSA Holdings Common Stock will
be pledged or otherwise held in escrow for use at Maturity of the DECS.
Consequently, in the event of a bankruptcy, insolvency or liquidation of U S
WEST or its subsidiaries, the FSA Holdings Common Stock, if any, owned by U S
WEST or its subsidiaries will be subject to the claims of the creditors of U S
WEST or its subsidiaries, respectively. In addition, as described herein, U S
WEST will have the option, exercisable in its sole discretion, to satisfy its
obligations pursuant to the mandatory exchange for the principal amount of each
DECS at Maturity by delivering to holders of the DECS either the number of
shares of FSA Holdings Common Stock specified above or cash in an amount equal
to the product of such number of shares multiplied by the Maturity Price. In the
event of such a sale, pledge or conveyance, a holder of the DECS may be more
likely to receive cash in lieu of FSA Holdings Common Stock. As a result, there
can be no assurance that U S WEST will elect at Maturity to deliver FSA Holdings
Common Stock or, if it so elects, that it will use all or any portion of its
current holdings of FSA Holdings Common Stock to make such delivery.
Consequently, holders of the DECS will not be entitled to any rights with
respect to FSA Holdings Common Stock (including, without limitation, voting
rights and rights to receive any dividends or other distributions in respect
thereof) until such time, if any, as U S WEST shall have delivered shares of FSA
Holdings Common Stock to holders of the DECS at Maturity thereof.
DILUTION ADJUSTMENTS; REORGANIZATION EVENTS
The Exchange Rate is subject to adjustment if FSA Holdings shall (i) pay a
stock dividend or make a distribution with respect to FSA Holdings Common Stock
in shares of such stock, (ii) subdivide or split its outstanding shares of FSA
Holdings Common Stock, (iii) combine its outstanding shares of FSA Holdings
Common Stock into a smaller number of shares, (iv) issue by reclassification
(other than a reclassification upon a Reorganization Event, described in the
following paragraph) of its shares of FSA Holdings Common Stock any shares of
common stock of FSA Holdings, (v) issue rights or warrants to all holders of FSA
Holdings Common Stock entitling them to subscribe for or purchase shares of FSA
Holdings Common Stock at a price per share less than the market price of the FSA
Holdings Common Stock (other than rights to purchase FSA Holdings Common Stock
pursuant to a plan for the reinvestment of dividends or interest) or (vi) pay a
dividend or make a distribution to all holders of FSA Holdings Common Stock of
evidences of its indebtedness or other assets (excluding any dividends or
distributions referred to in clause (i) above, any shares of common stock issued
pursuant to a reclassification referred to in clause (iv) above or any cash
dividends other than any Extraordinary Cash Dividends (as defined below)) or
issue to all holders of FSA Holdings Common Stock rights or warrants to
subscribe for or purchase any of its securities (other than those referred to in
clause (v) above). In the case of the events referred to in clauses (i), (ii),
(iii) and (iv) above, the Exchange Rate shall be adjusted by adjusting each of
the Share Components of the Exchange Rate in effect immediately prior to such
event so that a holder of any DECS shall be entitled to receive, upon mandatory
exchange of the principal amount of such DECS at Maturity pursuant to either
Share Component of the Exchange Rate, the number of shares of FSA Holdings
Common Stock (or, in the case of a reclassification referred to in clause (iv)
above, the number of shares of other common stock of FSA Holdings issued
pursuant thereto) which such holder of such DECS would have owned or been
entitled to receive immediately following such event had such DECS been
exchanged pursuant to either Share Component of the Exchange Rate immediately
prior to such event or any record date with respect thereto. In the case of the
event referred to in clause (v) above, the Exchange Rate shall be adjusted by
multiplying each of the Share Components of the Exchange Rate in effect
immediately prior to the date of issuance of the rights or warrants referred to
in
S-14
<PAGE>
clause (v) above, by a fraction, of which the numerator shall be the number of
shares of FSA Holdings Common Stock outstanding on the date of issuance of such
rights or warrants, immediately prior to such issuance, plus the number of
additional shares of FSA Holdings Common Stock offered for subscription or
purchase pursuant to such rights or warrants, and of which the denominator shall
be the number of shares of FSA Holdings Common Stock outstanding on the date of
issuance of such rights or warrants, immediately prior to such issuance, plus
the number of additional shares of FSA Holdings Common Stock which the aggregate
offering price of the total number of shares of FSA Holdings Common Stock so
offered for subscription or purchase pursuant to such rights or warrants would
purchase at the market price (determined as the average Closing Price per share
of FSA Holdings Common Stock on the 20 Trading Days immediately prior to the
date such rights or warrants are issued; provided, however, that if there are
not 20 Trading Days for the FSA Holdings Common Stock occurring later than the
60th calendar day immediately prior to, but not including, such date, such
market price shall be determined as the market value per share of FSA Holdings
Common Stock as of such date as determined by a nationally recognized investment
banking firm retained for such purpose by U S WEST), which shall be determined
by multiplying such total number of shares by the exercise price of such rights
or warrants and dividing the product so obtained by such market price. To the
extent that shares of FSA Holdings Common Stock are not delivered after the
expiration of such rights or warrants, the Exchange Rate shall be readjusted to
the Exchange Rate which would then be in effect had such adjustments for the
issuance of such rights or warrants been made upon the basis of delivery of only
the number of shares of FSA Holdings Common Stock actually delivered. In the
case of the event referred to in clause (vi) above, the Exchange Rate shall be
adjusted by multiplying each of the Share Components of the Exchange Rate in
effect on the record date with respect to such dividend or distribution referred
to in clause (vi) above, by a fraction of which the numerator shall be the
market price per share of the FSA Holdings Common Stock on the record date for
the determination of stockholders entitled to receive the dividend or
distribution referred to in clause (vi) above (such market price being
determined as the average Closing Price per share of FSA Holdings Common Stock
on the 20 Trading Days immediately prior to such record date; provided, however,
that if there are not 20 Trading Days for the FSA Holdings Common Stock
occurring later than the 60th calendar day immediately prior to, but not
including, such record date, such market price shall be determined as the market
value per share of FSA Holdings Common Stock as of such record date as
determined by a nationally recognized investment banking firm retained for such
purpose by U S WEST), and of which the denominator shall be such market price
per share of FSA Holdings Common Stock less the fair market value (as determined
by the Board of Directors of U S WEST, whose determination shall be conclusive,
and described in a resolution adopted with respect thereto) as of such record
date of the portion of the assets or evidences of indebtedness so distributed or
of such subscription rights or warrants applicable to one share of FSA Holdings
Common Stock. An "Extraordinary Cash Dividend" means, with respect to any
one-year period, all cash dividends on the FSA Holdings Common Stock during such
period to the extent such dividends exceed on a per share basis 10% of the
average Closing Prices of the FSA Holdings Common Stock over such period (less
any such dividends for which a prior adjustment to the Exchange Rate was
previously made). All adjustments to the Exchange Rate will be calculated to the
nearest 1/10,000th of a share of FSA Holdings Common Stock (or, if there is not
a nearest 1/10,000th of a share, to the next lower 1/10,000th of a share). No
adjustment in the Exchange Rate shall be required unless such adjustment would
require an increase or decrease of at least one percent therein; provided,
however, that any adjustments which by reason of the foregoing are not required
to be made shall be carried forward and taken into account in any subsequent
adjustment. If an adjustment is made to the Exchange Rate pursuant to clauses
(i), (ii), (iii), (iv), (v) or (vi) above, an adjustment shall also be made to
the Maturity Price solely to determine which of clauses (a), (b) or (c) of the
Exchange Rate definition will apply at Maturity. The required adjustment to the
Maturity Price shall be made at Maturity by multiplying the Maturity Price by
the number or fraction determined pursuant to the Exchange Rate adjustment
procedure described above. In the case of the reclassification of any shares of
FSA Holdings Common Stock into any shares of common stock of FSA Holdings other
than FSA Holdings Common Stock, such shares of common stock shall be deemed
S-15
<PAGE>
shares of FSA Holdings Common Stock solely to determine the Maturity Price and
to apply the Exchange Rate at Maturity. Each such adjustment to the Exchange
Rate and the Maturity Price shall be made successively.
In the event of (A) any consolidation or merger of FSA Holdings, or any
surviving entity or subsequent surviving entity of FSA Holdings (an "FSA
Holdings Successor"), with or into another entity (other than a merger or
consolidation in which FSA Holdings is the continuing corporation and in which
the FSA Holdings Common Stock outstanding immediately prior to the merger or
consolidation is not exchanged for cash, securities or other property of FSA
Holdings or another corporation), (B) any sale, transfer, lease or conveyance to
another corporation of the property of FSA Holdings or any FSA Holdings
Successor as an entirety or substantially as an entirety, (C) any statutory
exchange of securities of FSA Holdings or any FSA Holdings Successor with
another corporation (other than in connection with a merger or acquisition) or
(D) any liquidation, dissolution or winding up of FSA Holdings or any FSA
Holdings Successor (any such event, a "Reorganization Event"), each holder of
DECS will receive at Maturity, in lieu of shares of FSA Holdings Common Stock,
as described above, cash in an amount equal to (a) if the Transaction Value (as
defined below) is greater than or equal to the Threshold Appreciation Price,
multiplied by the Transaction Value, (b) if the Transaction Value is less
than the Threshold Appreciation Price but greater than the Initial Price, the
Initial Price and (c) if the Transaction Value is less than or equal to the
Initial Price, the Transaction Value. "Transaction Value" means (i) for any cash
received in any such Reorganization Event, the amount of cash received per share
of FSA Holdings Common Stock, (ii) for any property other than cash or
securities received in any such Reorganization Event, an amount equal to the
market value at Maturity of such property received per share of FSA Holdings
Common Stock as determined by a nationally recognized independent investment
banking firm retained for this purpose by U S WEST and (iii) for any securities
received in any such Reorganization Event, an amount equal to the average
Closing Price per share of such securities on the 20 Trading Days immediately
prior to Maturity multiplied by the number of such securities received for each
share of FSA Holdings Common Stock; provided, however, that in the case of
clause (iii), if there are not 20 Trading Days for such securities occurring
later than the 60th calendar day immediately prior to, but not including, the
date of Maturity, Transaction Value means the market value per share of such
securities as of Maturity as determined by a nationally recognized independent
investment banking firm retained for such purpose by U S WEST. Notwithstanding
the foregoing, in lieu of delivering cash as provided above, U S WEST may at its
option deliver an equivalent value of securities or other property received in
such Reorganization Event, determined in accordance with clause (ii) or (iii)
above, as applicable. If U S WEST elects to deliver securities or other
property, holders of the DECS will be responsible for the payment of any and all
brokerage and other transaction costs upon the sale of such securities or other
property. The kind and amount of securities into which the DECS shall be
exchangeable after consummation of such transaction shall be subject to
adjustment as described in the immediately preceding paragraph following the
date of consummation of such transaction.
No adjustments will be made for certain other events, such as offerings of
FSA Holdings Common Stock by FSA Holdings for cash or in connection with
acquisitions.
U S WEST is required, within ten Business Days following the occurrence of
an event that requires an adjustment to the Exchange Rate or the occurrence of a
Reorganization Event (or, in either case, if U S WEST is not aware of such
occurrence, as soon as practicable after becoming so aware), to provide written
notice to the Trustee and to each holder of DECS of the occurrence of such event
including a statement in reasonable detail setting forth the method by which the
adjustment to the Exchange Rate or change in the consideration to be received by
holders of DECS following the Reorganization Event was determined and setting
forth the revised Exchange Rate or consideration, as the case may be; provided,
however, that, in respect of any adjustment to the Maturity Price, such notice
will only disclose the factor by which the Maturity Price is to be multiplied in
order to determine which clause of the Exchange Rate definition will apply at
Maturity.
S-16
<PAGE>
FRACTIONAL SHARES
No fractional shares of FSA Holdings Common Stock will be issued if U S WEST
exchanges the DECS for shares of FSA Holdings Common Stock. If more than one
DECS shall be surrendered for exchange at one time by the same holder, the
number of full shares of FSA Holdings Common Stock which shall be delivered upon
exchange, in whole or in part, as the case may be, shall be computed on the
basis of the aggregate number of DECS so surrendered at maturity. In lieu of any
fractional share otherwise issuable in respect of all DECS of any holder which
are exchanged at Maturity, such holder shall be entitled to receive an amount in
cash equal to the value of such fractional share at the Maturity Price.
REDEMPTION
The DECS are not subject to redemption prior to Maturity and do not contain
sinking fund or other mandatory redemption provisions. The DECS are not subject
to payment prior to the date of Maturity at the option of the holder.
BOOK-ENTRY SYSTEM
It is expected that the DECS will be issued in the form of one or more
global securities (the "Global Securities") deposited with The Depository Trust
Company (the "Depositary") and registered in the name of a nominee of the
Depositary.
The Depositary has advised U S WEST and the Underwriter as follows: The
Depositary is a limited-purpose trust company organized under the laws of the
State of New York, a member of the Federal Reserve System, a "clearing
corporation" within the meaning of the New York Uniform Commercial Code and a
"clearing agency" registered pursuant to Section 17A of the Exchange Act. The
Depositary was created to hold securities of persons who have accounts with the
Depositary ("participants") and to facilitate the clearance and settlement of
securities transactions among its participants in such securities through
electronic book-entry changes in accounts of the participants, thereby
eliminating the need for physical movement of certificates. Such participants
include securities brokers and dealers, banks, trust companies and clearing
corporations. Indirect access to the Depositary's book-entry system also is
available to others, such as banks, brokers, dealers and trust companies that
clear through or maintain a custodial relationship with a participant, either
directly or indirectly.
Upon the issuance of a Global Security, the Depositary or its nominee will
credit the respective DECS represented by such Global Security to the accounts
of participants. The accounts to be credited shall be designated by the
Underwriter. Ownership of beneficial interests in the Global Securities will be
limited to participants or persons that may hold interests through participants.
Ownership of beneficial interests by participants in such Global Securities will
be shown on, and the transfer of those ownership interests will be effected only
through, records maintained by the Depositary or its nominee for such Global
Securities. Ownership of beneficial interests in such Global Securities by
persons that hold through participants will be shown on, and the transfer of
that ownership interest within such participant will be effected only through,
records maintained by such participant. The laws of some jurisdictions require
that certain purchasers of securities take physical delivery of such securities
in definitive form. Such limits and such laws may impair the ability to transfer
beneficial interests in a Global Security.
So long as the Depositary for a Global Security, or its nominee, is the
registered owner of such Global Security, such depositary or such nominee, as
the case may be, will be considered the sole owner or holder of the DECS for all
purposes under the Indenture. Except as set forth below, owners of beneficial
interests in such Global Securities will not be entitled to have the DECS
registered in their names, will not receive or be entitled to receive physical
delivery of the DECS in definitive form and will not be considered the owners or
holders thereof under the Indenture.
Payment of principal of and any interest on the DECS registered in the name
of or held by the Depositary or its nominee will be made to the Depositary or
its nominee, as the case may be, as the registered owner or the holder of the
Global Security. None of U S WEST, the Trustee, any Paying Agent
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<PAGE>
or any securities registrar for the DECS will have any responsibility or
liability for any aspect of the records relating to or payments made on account
of beneficial ownership interests in a Global Security or for maintaining,
supervising or reviewing any records relating to such beneficial ownership
interests.
U S WEST expects that the Depositary, upon receipt of any payment of
principal or interest in respect of a permanent Global Security, will credit
immediately participants' accounts with payments in amounts proportionate to
their respective beneficial interests in the principal amount of such Global
Security as shown on the records of the Depositary. U S WEST also expects that
payments by participants to owners of beneficial interests in such Global
Security held through such participants will be governed by standing
instructions and customary practices, as is now the case with securities held
for the accounts of customers in bearer form or registered in "street name", and
will be the responsibility of such participants.
A Global Security may not be transferred except as a whole by the Depositary
to a nominee or a successor of the Depositary. If the Depositary is at any time
unwilling or unable to continue as depositary and a successor depositary is not
appointed by U S WEST within ninety days, U S WEST will issue DECS in definitive
registered form in exchange for the Global Security representing such DECS. In
addition, U S WEST may at any time and in its sole discretion determine not to
have any DECS represented by one or more Global Securities and, in such event,
will issue DECS in definitive form in exchange for all of the Global Securities
representing the DECS. Further, if U S WEST so specifies with respect to the
DECS, an owner of a beneficial interest in a Global Security representing DECS
may, on terms acceptable to U S WEST and the Depositary for such Global
Security, receive DECS in definitive form. In any such instance, an owner of a
beneficial interest in a Global Security will be entitled to physical delivery
in definitive form of DECS represented by such Global Security equal in number
to that represented by such beneficial interest and to have such DECS registered
in its name.
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following discussion is based upon the advice of U S WEST's counsel,
Weil, Gotshal & Manges LLP, as to certain of the material U.S. federal income
tax consequences that may be relevant to a citizen or resident of the United
States, a corporation, partnership or other entity created or organized under
the laws of the United States and an estate or trust the income of which is
subject to U.S. federal income taxation regardless of its source (any of the
foregoing, a "U.S. person") who is the beneficial owner of a DECS (a "U.S.
Holder"). All references to "holders" (including U.S. Holders) are to beneficial
owners of the DECS. This summary is based on U.S. federal income tax laws,
regulations, rulings and decisions in effect as of the date of this Prospectus
Supplement (or in the case of certain Treasury regulations now in proposed
form), all of which are subject to change at any time (possibly with retroactive
effect). As the law is technical and complex, the discussion below necessarily
represents only a general summary.
This summary addresses the U.S. federal income tax consequences to holders
who are initial holders of the DECS and who will hold the DECS and, if
applicable, FSA Holdings Common Stock as capital assets. This summary does not
address all aspects of federal income taxation that may be relevant to a
particular holder in light of his or its individual investment circumstances or
to certain types of holders subject to special treatment under the U.S. federal
income tax laws, such as dealers in securities or foreign currency, financial
institutions, insurance companies, tax-exempt organizations and taxpayers
holding the DECS as part of a "straddle", "hedge", "conversion transaction",
"synthetic security", or other integrated investment. Moreover, the effect of
any applicable state, local or foreign tax laws is not discussed.
No statutory, judicial or administrative authority directly addresses the
characterization of the DECS or instruments similar to the DECS for U.S. federal
income tax purposes. As a result, significant aspects of the U.S. federal income
tax consequences of an investment in the DECS are not certain and counsel to U S
WEST is unable to render any opinion with respect to such tax consequences. No
ruling is being requested from the Internal Revenue Service (the "IRS") with
respect to the DECS and no assurance can
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<PAGE>
be given that the IRS will agree with the conclusions expressed herein.
ACCORDINGLY, A PROSPECTIVE INVESTOR (INCLUDING A TAX-EXEMPT INVESTOR) IN THE
DECS SHOULD CONSULT ITS TAX ADVISOR IN DETERMINING THE TAX CONSEQUENCES OF AN
INVESTMENT IN THE DECS, INCLUDING THE APPLICATION OF STATE, LOCAL OR OTHER TAX
LAWS AND THE POSSIBLE EFFECTS OF CHANGES IN FEDERAL OR OTHER TAX LAWS.
Pursuant to the terms of the Indenture, U S WEST and all holders of the DECS
will be obligated to treat the DECS as a unit (the "Unit") consisting of (i) an
exchange note ("Exchange Note") which is a debt obligation with a fixed
principal amount unconditionally payable at Maturity equal to the principal
amount of the DECS, bearing interest at the stated interest rate of the DECS,
and (ii) a forward purchase contract (the "Purchase Contract") pursuant to which
the holder agrees to use the principal payment due on the Exchange Note to
purchase at Maturity the FSA Holdings Common Stock which the holder is entitled
to receive at that time (subject to U S WEST's right to deliver cash in lieu of
the FSA Holdings Common Stock). The Indenture will require that a U.S. Holder
include currently in income payments denominated as interest that are made with
respect to the DECS, in accordance with such holder's method of accounting.
Pursuant to the agreement to treat the DECS as a Unit, a holder will be
required to allocate the purchase price of the DECS between the two components
of the Unit (the Exchange Note and the Purchase Contract) on the basis of their
relative fair market values. The purchase price so allocated will generally
constitute the tax basis for each component. Pursuant to the terms of the
Indenture, U S WEST and the holders agree to allocate the entire purchase price
of the DECS to the Exchange Note. Upon the sale or other disposition of a DECS,
a U.S. Holder generally will be required to allocate the amount realized between
the two components of the DECS on the basis of their then relative fair market
values. A U.S. Holder will recognize gain or loss with respect to each component
equal to the difference between the amount realized on the sale or other
disposition for each such component and the U.S. Holder's tax basis in such
component. Such gain or loss generally will be long-term capital gain or loss if
the U.S. Holder has held the DECS for more than one year at the time of
disposition.
At maturity, pursuant to the agreement to treat the DECS as a Unit, on the
repayment of the Exchange Note, a U.S. Holder will recognize long-term capital
gain or loss equal to any differences between its tax basis and the principal
amount of the Exchange Note. (In general, a holder who purchases the DECS for
the Initial Price and therefore has allocated all of its purchase price to the
Exchange Note should not have gain or loss on repayment because its tax basis
will equal the principal amount.) If U S WEST delivers FSA Holdings Common
Stock, a U.S. Holder will recognize no additional gain or loss on the exchange,
pursuant to the Purchase Contract, of the principal payment due on the Exchange
Note for the FSA Holdings Common Stock. However, a U.S. Holder will recognize
additional gain or loss (which will be short-term capital gain or loss rather
than long-term capital gain or loss) with respect to cash received in lieu of
fractional shares. The amount of such gain or loss recognized by a U.S. Holder
will be equal to the difference between the cash received and the portion of the
principal amount of the Exchange Note allocable to fractional shares. A U.S.
Holder will have a tax basis in such stock equal to the principal amount of the
Exchange Note less the amount of the portion of the principal amount of the
Exchange Note allocable to the fractional shares and will realize capital gain
or loss upon the sale or disposition of such stock. Alternatively, at Maturity,
if U S WEST pays the DECS in cash, a U.S. Holder will have capital gain or loss
equal to any difference between the principal amount of the Exchange Note and
the amount of cash received from U S WEST.
Due to the absence of authority as to the proper characterization of the
DECS, no assurance can be given that the IRS will accept or that a court will
uphold the characterization and tax treatment described above. Proposed Treasury
regulations issued in 1994 with respect to "contingent payment" debt instruments
(the "Proposed Regulations") would provide for a different tax result under some
circumstances for instruments with characteristics similar to the DECS, but the
Proposed Regulations would be effective only for instruments issued 60 days or
more after publication as final regulations. Under the Proposed Regulations, the
amount of interest included in a holder's taxable income for any year would
generally be determined by projecting the amounts of contingent payments and the
yield on the
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<PAGE>
instrument. Taxable interest income would be measured with reference to the
projected yield, which might be less than or greater than the stated interest
rate under the instrument. In the event that the amount of an actual contingent
payment differed from the projected amount of that payment, the difference would
generally increase or reduce taxable interest income, or create a loss. Because
of their prospective effective date, the Proposed Regulations, if finalized in
their current form, would not apply to the DECS. In addition, it is unclear
whether the IRS would view a single instrument that has "principal" that is
entirely contingent as debt for U.S. federal income tax purposes.
Even in the absence of regulations applicable to the DECS, the DECS may be
characterized in a manner that results in tax consequences different from those
reflected in the agreement and described above, including treating the DECS as a
single instrument or treating the Purchase Contract element of the DECS as
itself the combination of a forward contract and one or more options. Under
alternative characterizations of the DECS, it is possible, for example, that (i)
gain may be treated as ordinary income, instead of capital gain, (ii) a U.S.
Holder may be taxable upon the receipt of FSA Holdings Common Stock with a value
in excess of the principal amount of the Exchange Note, rather than upon the
sale of such stock, or (iii) all or part of the interest income on the Exchange
Note may be treated as nontaxable, increasing the gain (or decreasing the loss)
at Maturity or disposition of the DECS (or disposition of the FSA Holdings
Common Stock).
The Revenue Reconciliation Act of 1993 added Section 1258 to the Internal
Revenue Code, which may require certain holders of the DECS who have entered
into hedging transactions or offsetting positions with respect to the DECS to
recognize ordinary income rather than capital gain upon the disposition of the
DECS. In addition, if the DECS is hedged, or is itself a hedge, the timing of
income for the DECS may be affected. Holders should consult their tax advisors
regarding the applicability of this legislation to an investment in the DECS.
NON-UNITED STATES PERSONS
In the case of a holder of the DECS that is not a U.S. person, payments made
with respect to the DECS should not be subject to U.S. withholding tax; PROVIDED
that such holder complies with applicable certification requirements. Any
capital gain realized upon the sale or other disposition of the DECS by a holder
that is not a U.S. person will generally not be subject to U.S. federal income
tax if (i) such gain is not effectively connected with a U.S. trade or business
of such holder and (ii) in the case of an individual, such individual is not
present in the United States for 183 days or more in the taxable year of the
sale or other disposition or the gain is not attributable to a fixed place of
business maintained by such individual in the United States.
BACKUP WITHHOLDING AND INFORMATION REPORTING
A holder of the DECS may be subject to information reporting and to backup
withholding at a rate of 31 percent of certain amounts paid to the holder unless
such holder provides proof of an applicable exemption or a correct taxpayer
identification number, and otherwise complies with applicable requirements of
the backup withholding rules. Any amounts withheld under the backup withholding
rules are not an additional tax and may be refunded or credited against the U.S.
Holder's U.S. federal income tax liability, provided the required information is
furnished to the IRS.
PROPOSED LEGISLATION
On December 7, 1995, the Clinton administration, as part of its budget
proposal, proposed a series of changes to the tax law. One of the proposals
would deny interest deductions to the issuer of a debt instrument issued after
December 7, 1995 which is payable, or at the option of the issuer or a related
party may be payable, in stock of the issuer or related party. U S WEST does not
believe that FSA Holdings is a related party to it within the meaning of the
proposed legislation. However, there can be no assurance that if any legislation
ultimately is enacted, it will not be applicable to the DECS. If such
legislation is applicable to the DECS, the interest deduction attributable to
the DECS would be disallowed. U S WEST does not believe that disallowance of
such interest deduction would have any material adverse effect on U S WEST. In
any event, the proposed legislation would not affect the tax consequences to a
holder of DECS.
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<PAGE>
PLAN OF DISTRIBUTION
Subject to the terms and conditions set forth in the Underwriting Agreement
(the "Underwriting Agreement") among FSA Holdings, U S WEST and the
Underwriters, for whom Salomon Brothers Inc ("Salomon"), Donaldson, Lufkin &
Jenrette Securities Corporation and Lehman Brothers Inc. are acting as
representatives, U S WEST has agreed to sell to the Underwriters, and the
Underwriters have agreed to purchase, the aggregate number of DECS set forth
opposite their names below:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITERS DECS
- --------------------------------------------------------------------------------- -----------
<S> <C>
Salomon Brothers Inc.............................................................
Donaldson, Lufkin & Jenrette Securities Corporation..............................
Lehman Brothers Inc..............................................................
-----------
Total.......................................................................... 7,000,000
-----------
-----------
</TABLE>
In the Underwriting Agreement, the several Underwriters have agreed, subject
to the terms and conditions set forth therein, that the obligations of the
Underwriters are subject to certain conditions precedent and that the
Underwriters will be obligated to purchase all of the DECS offered hereby if any
of the DECS are purchased.
U S WEST has been advised by the Underwriters that they propose to offer the
DECS directly to the public initially at the public offering price set forth on
the cover of this Prospectus Supplement and to certain dealers at such prices
less a concession not in excess of $ per DECS. The Underwriters may allow,
and such dealers may reallow, a concession not in excess of $ per DECS to
other dealers. After the initial public offering, such public offering price and
such concession and reallowance may be changed.
U S WEST and FSA Holdings have agreed not to offer for sale, sell or
contract to sell, or otherwise dispose of, or announce the offering of, without
the prior written consent of Salomon, any shares of FSA Holdings Common Stock or
any securities convertible into or exchangeable for, or warrants to acquire, FSA
Holdings Common Stock for a period of 180 days after the date of this Prospectus
Supplement; provided, however, that such restriction shall not affect the
ability of (i) U S WEST, FSA Holdings or their respective subsidiaries to take
any such actions in connection with the offering of the DECS made hereby or any
exchange at Maturity pursuant to the terms of the DECS, (ii) FSA Holdings to
take any such actions in connection with any employee stock option plan, stock
ownership plan or dividend reinvestment plan of FSA Holdings in effect at the
date of this Prospectus Supplement or (iii) U S WEST to lend shares of FSA
Holdings Common Stock pursuant to the terms of the Securities Loan Agreement (as
defined herein).
In connection with the Offering made hereby, U S WEST or an affiliate
thereof (referred to herein as the "Lender"), and Salomon intend to enter into a
Securities Loan Agreement (the "Securities Loan Agreement") which provides that,
subject to certain restrictions and with the agreement of the Lender, Salomon
may from time to time borrow, return and reborrow shares of FSA Holdings Common
Stock from the Lender (the "Borrowed Securities"); PROVIDED, HOWEVER, that the
number of Borrowed Securities at any time may not exceed 1,600,000 shares,
subject to adjustment to provide antidilution protection. The Securities Loan
Agreement is intended to facilitate market-making activity in the DECS by
Salomon. Salomon may from time to time borrow shares of FSA Holdings Common
Stock under the Securities Loan Agreement to settle short sales of FSA Holdings
Common Stock entered into by Salomon to hedge any long position in the DECS
resulting from its market-making activities. Such sales will be made on the NYSE
or in the over-the-counter market at market prices prevailing at the time of
sale or at prices related to such market prices. Market conditions will dictate
the extent and timing of Salomon's market-making transactions in the DECS and
the consequent need to borrow shares of FSA Holdings Common Stock. The
availability of shares of FSA Holdings Common Stock under the Securities Loan
Agreement, if any, at any time is not assured and any such availability does not
assure market-making activity with respect to the DECS and any market-making
actually engaged in by Salomon may
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<PAGE>
cease at any time. The foregoing description of the Securities Loan Agreement
does not purport to be complete and is qualified in its entirety by reference to
the Securities Loan Agreement, a copy of which is filed as an exhibit to the
Registration Statement of which the accompanying Prospectus forms a part.
U S WEST has granted to the Underwriters an option, exercisable for the
30-day period after the date of this Prospectus Supplement, to purchase up to an
additional 1,050,000 DECS from U S WEST, at the same price per DECS as the
initial DECS to be purchased by the Underwriters. The Underwriters may exercise
such option only for the purpose of covering over-allotments, if any, incurred
in connection with the sale of DECS offered hereby. To the extent that the
Underwriters exercise such option, each Underwriter will have a firm commitment,
subject to certain conditions, to purchase the same proportion of the DECS as
the number of DECS to be purchased and offered by such Underwriter in the above
table bears to the total number of initial DECS to be purchased by the
Underwriters.
The DECS will be a new issue of securities with no established trading
market. The DECS will not be listed or traded on any securities exchange or
trading market. The Underwriters intend to make a market in the DECS, subject to
applicable laws and regulations. However, the Underwriters are not obligated to
do so and any such market-making may be discontinued at any time at the sole
discretion of the Underwriters without notice. Accordingly, no assurance can be
given as to the liquidity of such market.
The Underwriting Agreement provides that U S WEST and FSA Holdings will
indemnify the Underwriters against certain liabilities, including liabilities
under the Securities Act, or contribute to payments the Underwriters may be
required to make in respect thereof.
The Underwriters have from time to time performed various investment banking
and financial advisory services for U S WEST, FSA Holdings and their affiliates,
for which customary compensation has been received.
LEGAL OPINIONS
The validity of the DECS will be passed upon for U S WEST by Weil, Gotshal &
Manges LLP and for the Underwriters by Cleary, Gottlieb, Steen & Hamilton.
Certain tax matters with respect to the DECS also will be passed upon by Weil,
Gotshal & Manges LLP.
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<PAGE>
[LOGO]
PROSPECTUS
$500,000,000
U S WEST, INC.
DEBT SECURITIES
U S WEST, Inc. ("U S WEST"), a Delaware corporation, from time to time may offer
its notes, debentures, or other debt securities (the "Debt Securities"). The
Debt Securities offered pursuant to this Prospectus may be issued in one or more
series and will be limited to $500,000,000 aggregate public offering price.
Certain specific terms of the particular series of Debt Securities will be set
forth in a supplement to this Prospectus (the "Prospectus Supplement") which
will be delivered together with this Prospectus, including, where applicable,
the specific designation, aggregate principal amount, denomination, maturity,
premium, if any, the rate (which may be fixed or variable), time and method of
calculating payment of interest, if any, the place or places where principal of,
premium, if any, and interest, if any, on such Debt Securities will be payable,
optional or mandatory redemption and sinking fund provisions, if any,
conversion, exercise or exchange provisions, if any, and any other specific
terms in respect of the offering and sale of the Debt Securities.
The Debt Securities may be offered and sold through one or more underwriters,
directly by U S WEST, or through dealers or agents. The names of any
underwriters, dealers or agents involved in the distribution of the Debt
Securities in respect of which this Prospectus is being delivered, and any
applicable discounts, commissions or allowances, will be set forth in the
applicable Prospectus Supplement. See "Plan of Distribution" for possible
indemnification arrangements for any underwriters, dealers or agents. Unless
otherwise provided in the Prospectus Supplement relating thereto, the Debt
Securities will not be listed on any securities exchange.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
THIS PROSPECTUS MAY NOT BE USED TO CONSUMMATE SALES OF SECURITIES UNLESS
ACCOMPANIED BY A PROSPECTUS SUPPLEMENT.
THE DATE OF THIS PROSPECTUS IS DECEMBER 4, 1995.
<PAGE>
The Debt Securities will be sold directly, through agents, underwriters or
dealers as designated from time to time, or through a combination of such
methods. If agents or any dealers or underwriters are involved in the sale of
the Debt Securities in respect of which this Prospectus is being delivered, the
names of such agents, dealers or underwriters and any applicable commissions or
discounts will be set forth in or may be calculated from the Prospectus
Supplement with respect to such Debt Securities.
No dealer, salesperson or any other individual has been authorized by U S
WEST to give any information or to make any representation other than those
contained or incorporated by reference in this Prospectus or any accompanying
Prospectus Supplement and, if given or made, such information or representation
must not be relied upon as having been authorized. This Prospectus does not
constitute an offer to sell or a solicitation of an offer to buy any of the
securities offered hereby in any jurisdiction to any person to whom it is
unlawful to make such offer or solicitation in such jurisdiction. 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 U S WEST since the date hereof.
------------------------
U S WEST was incorporated in 1995 under the laws of the State of Delaware in
order to effect the Recapitalization Plan described herein under "Recent
Development." As part of the Recapitalization Plan, U S WEST changed its state
of incorporation from Colorado to Delaware on November 1, 1995 through the
merger of U S WEST, Inc., a Colorado corporation and U S WEST's predecessor ("U
S WEST Colorado"), with and into U S WEST, with U S WEST continuing as the
surviving corporation. As used herein, unless the context otherwise requires,
references to "U S WEST" shall refer to U S WEST and U S WEST Colorado, its
Colorado predecessor.
AVAILABLE INFORMATION
U S WEST is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance
therewith, files reports, proxy statements, and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements, and other information concerning U S WEST can be inspected and
copied at the public reference facilities maintained by the Commission at 450
Fifth Street, N.W., Room 1024, Washington, D.C. 20549, and at the Commission's
Regional Offices at Seven World Trade Center, 13th Floor, New York, New York
10048, and Citicorp Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60601. Copies of such material can be obtained from the Public
Reference Section of the Commission at 450 Fifth Street, N.W., Room 1024,
Washington, D.C. 20549, at prescribed rates. Such reports, proxy statements and
other information concerning U S WEST may also be inspected at the offices of
the New York Stock Exchange, Inc., 20 Broad Street, New York, New York 10005 and
the Pacific Stock Exchange, 301 Pine Street, San Francisco, California 94104,
the securities exchanges on which shares of U S WEST's common stock are listed.
U S WEST has filed with the Commission a registration statement on Form S-3
(herein, together with all amendments and exhibits, referred to as the
"Registration Statement") relating to the Debt Securities under the Securities
Act of 1933, as amended (the "Securities Act"). This Prospectus does not contain
all of the information set forth in the Registration Statement, certain parts of
which are omitted in accordance with the rules and regulations of the
Commission. For further information, reference is hereby made to the
Registration Statement, which is available for inspection and copying as set
forth above. Statements contained in this Prospectus or a Prospectus Supplement
as to the contents of any contract or other document which is filed as an
exhibit to the Registration Statement are not necessarily complete, and each
such statement is qualified in its entirety by reference to the full text of
such contract or document.
2
<PAGE>
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents which have been filed by U S WEST with the
Commission (File No. 1-8611) are incorporated herein by reference: (i) Annual
Report on Form 10-K for the year ended December 31, 1994, (ii) Quarterly Reports
on Form 10-Q for the quarters ended March 31, 1995, June 30, 1995 and September
30, 1995 and (iii) Current Reports on Form 8-K dated January 19, 1995, April 10,
1995, April 18, 1995, May 23, 1995 (as amended by Forms 8-K/A filed on July 12,
1995 and August 24, 1995), June 20, 1995, July 28, 1995, September 22, 1995,
September 28, 1995, October 6, 1995, October 27, 1995 and November 2, 1995.
All documents filed by U S WEST pursuant to Section 13(a), 13(c), 14 or
15(d) of the Exchange Act subsequent to the date of this Prospectus and prior to
the termination of the offering of the Securities shall be deemed to be
incorporated by reference into this Prospectus and to be a part hereof from the
date any such document is filed.
Any statement contained in a document incorporated or deemed to be
incorporated by reference herein shall be deemed to be modified or superseded
for purposes of this Prospectus to the extent that a statement contained herein
or in a Prospectus Supplement (or in any other subsequently filed document which
also is or is deemed to be incorporated by reference herein or therein) modifies
or supersedes such statement. Any such statement so modified or superseded shall
not be deemed, except as so modified or superseded, to constitute a part of this
Prospectus.
U S WEST WILL PROVIDE WITHOUT CHARGE TO EACH PERSON TO WHOM A PROSPECTUS IS
DELIVERED, UPON WRITTEN OR ORAL REQUEST OF SUCH PERSON, A COPY OF ANY OR ALL OF
THE DOCUMENTS WHICH ARE INCORPORATED BY REFERENCE HEREIN, OTHER THAN EXHIBITS TO
SUCH DOCUMENTS (UNLESS SUCH EXHIBITS ARE SPECIFICALLY INCORPORATED BY REFERENCE
INTO SUCH DOCUMENTS). REQUESTS SHOULD BE DIRECTED TO INVESTOR RELATIONS, U S
WEST, INC., 7800 EAST ORCHARD ROAD, ENGLEWOOD, COLORADO 80111 (TELEPHONE NUMBER
(303) 793-6500).
------------------------
3
<PAGE>
U S WEST, INC.
U S WEST is a diversified global communications company engaged in the
telecommunications, cable, wireless communications and multimedia content and
services businesses. U S WEST conducts its businesses through two groups: the U
S WEST Communications Group (the "Communications Group") and the U S WEST Media
Group (the "Media Group"). U S WEST has its principal executive offices at 7800
East Orchard Road, Englewood, Colorado 80111 (telephone number (303) 793-6500).
The Communications Group provides telecommunications services to more than
25 million residential and business customers in the states of Arizona,
Colorado, Idaho, Iowa, Minnesota, Montana, Nebraska, New Mexico, North Dakota,
Oregon, South Dakota, Utah, Washington and Wyoming (collectively, the
"Communications Group Region"). Such services include local telephone services,
exchange access services and certain long distance services, as well as various
new services, including Caller ID, voice messaging and high-speed data
networking services. The Communications Group also provides customer premise
equipment and certain communications services to business customers and
governmental agencies both inside and outside the Communications Group Region.
The Media Group is comprised of (i) cable and telecommunications network and
businesses outside the Communications Group Region and internationally, (ii)
domestic and international wireless communications network businesses and (iii)
domestic and international multimedia content and services businesses. The Media
Group's cable and telecommunications businesses include domestic cable and
telecommunications businesses and investments outside of the Communications
Group Region, including U S WEST's cable systems in the Atlanta, Georgia
metropolitan area and its interest in Time Warner Entertainment Company, L.P.,
and international cable and telecommunications investments, including U S WEST's
interest in TeleWest plc, the largest provider of combined cable and
telecommunications services in the United Kingdom. The Media Group provides
domestic wireless communications products and services, including cellular
services, to a rapidly growing customer base. U S WEST and AirTouch
Communications, Inc. have entered into Phase I of a cellular joint venture
pursuant to which their domestic cellular properties will receive centralized
services from a Wireless Management Company on a contract basis. The Media Group
also provides wireless communications services internationally through Mercury
One-2-One, the world's first Personal Communications Service, in the United
Kingdom. The Media Group's multimedia content and services businesses develop
and package content and information services, including telephone directories,
database marketing and other interactive services in domestic and international
markets.
RECENT DEVELOPMENT
On November 1, 1995, U S WEST created two classes of common stock that are
intended to reflect separately the performance of the Communications Group and
the Media Group and changed the state of incorporation of U S WEST from Colorado
to Delaware (the "Recapitalization Plan"). The Recapitalization Plan was
effected in accordance with the terms of an Agreement and Plan of Merger, dated
as of August 17, 1995, between U S WEST Colorado and U S WEST, pursuant to which
(i) U S WEST Colorado was merged with and into U S WEST, with U S WEST
continuing as the surviving corporation and (ii) each outstanding share of
Common Stock, without par value, of U S WEST was converted into one share of U S
WEST Communications Group Common Stock, par value $.01 per share, of U S WEST,
which is intended to reflect separately the performance of the Communications
Group, and one share of U S WEST Media Group Common Stock, par value $.01 per
share, of U S WEST, which is intended to reflect separately the performance of
the Media Group.
The Recapitalization Plan was approved by U S WEST Colorado's shareholders
at a special meeting held on October 31, 1995. Implementation of the
Recapitalization Plan has not resulted in the transfer of any assets from U S
WEST or any of its subsidiaries or altered the legal nature of U S WEST's
obligations to its creditors, including its obligations under the Debt
Securities. Creditors of U S WEST, including the holders of the Debt Securities,
will continue to benefit from the cash flow of the subsidiaries comprising both
the Communications Group and the Media Group, subject to the satisfaction of
obligations by such subsidiaries. The Recapitalization Plan is not expected to
have any adverse impact on U S WEST's credit rating.
4
<PAGE>
RATIO OF EARNINGS TO FIXED CHARGES
The following table sets forth the ratio of earnings to fixed charges from
continuing operations of U S WEST for the periods indicated. For the purpose of
calculating this ratio, earnings consist of income before income taxes and fixed
charges. Fixed charges include interest on indebtedness (excluding discontinued
operations) and the portion of rentals representative of the interest factor.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
- ----------------------------------------------------- --------------------
1990 1991 1992 1993 1994 1994 1995
- --------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
4.07 3.11 3.85 2.38 4.85 4.88 4.02
</TABLE>
USE OF PROCEEDS
Unless otherwise specified in the Prospectus Supplement, U S WEST will apply
the net proceeds from the sale of the Debt Securities to its general funds to be
used for general corporate purposes, including the reduction of short-term and
long-term borrowings and other business opportunities.
DESCRIPTION OF DEBT SECURITIES
The following description sets forth certain general terms and provisions of
the Debt Securities to which any Prospectus Supplement may relate. The
particular terms and provisions of the series of Debt Securities offered by a
Prospectus Supplement, and the extent to which such general terms and provisions
described below may apply thereto, will be described in the Prospectus
Supplement relating to such series of Debt Securities.
The Debt Securities are to be issued under an Indenture (the "Indenture"),
dated as of November 13, 1995, between U S WEST and The First National Bank of
Chicago, as Trustee (the "Trustee"). The following summaries of certain
provisions of the Debt Securities and the Indenture do not purport to be
complete and are subject to, and are qualified in their entirety by reference
to, all provisions of the Debt Securities and the Indenture, including the
definitions therein of certain terms. Wherever particular sections or defined
terms of the Indenture are referred to, it is intended that such sections or
defined terms shall be incorporated herein by reference.
GENERAL
The Indenture does not limit the aggregate principal amount of Debt
Securities that can be issued thereunder and debt securities may be issued
thereunder up to the aggregate principal amount which may be authorized from
time to time by, or pursuant to a resolution of, U S WEST's Board of Directors
or by a supplemental indenture. Reference is made to the Prospectus Supplement
for the following terms of the particular series of Debt Securities being
offered hereby: (i) the title of the Debt Securities of the series; (ii) any
limit upon the aggregate principal amount of the Debt Securities of the series;
(iii) the date or dates on which the principal of the Debt Securities of the
series will mature; (iv) the rate or rates (or manner of calculations thereof),
if any, at which the Debt Securities of the series will bear interest, the date
or dates from which any such interest will accrue and on which such interest
will be payable, and, with respect to Debt Securities of the series in
registered form, the record date for the interest payable on any interest
payment date; (v) the place or places where the principal of and interest, if
any, on the Debt Securities of the series will be payable; (vi) any redemption
or sinking fund provisions; (vii) if other than the entire principal amount
thereof, the portion of the principal amount of Debt Securities of the series
which will be payable upon declaration of acceleration of the maturity thereof;
(viii) whether the Debt Securities of the series will be issuable in registered
or bearer form or both, any restrictions applicable to the offer, sale or
delivery of Debt Securities in bearer form ("bearer Debt Securities"), and
whether, and the terms upon which, bearer Debt Securities will be exchangeable
for Debt Securities in registered form ("registered Debt Securities") and vice
versa; (ix) whether and under what circumstances U S WEST will pay additional
amounts on the Debt Securities of the series held by a person who is not a U.S.
person (as
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<PAGE>
defined below) in respect of taxes or similar charges withheld or deducted and,
if so, whether U S WEST will have the option to redeem such Debt Securities
rather than pay such additional amounts; (x) whether the Debt Securities will be
denominated or provide for payment in United States dollars or a foreign
currency or units of two or more such foreign currencies; (xi) whether the Debt
Securities of the series will be convertible into or exchangeable or exercisable
for shares of a class of capital stock of U S WEST or any other corporation and
the terms and conditions relating thereto; and (xii) any additional provisions
or other special terms not inconsistent with the provisions of the Indenture,
including any terms which may be required by or advisable under United States
laws or regulations or advisable in connection with the marketing of Debt
Securities of such series. (Sections 2.01 and 2.02.) To the extent not described
herein, principal, premium, if any, and interest will be payable, and the Debt
Securities of a particular series will be transferable, in the manner described
in the Prospectus Supplement relating to such series.
Each series of Debt Securities will constitute unsecured and unsubordinated
indebtedness of U S WEST and will rank on a parity with U S WEST's other
indebtedness. However, since U S WEST is a holding company, the right of U S
WEST and, hence, the right of creditors of U S WEST (including the holders of
the Debt Securities) to participate in any distribution of the assets of any
subsidiaries of U S WEST, whether upon liquidation, reorganization, or
otherwise, is subject to prior claims of creditors of the subsidiary, except to
the extent that claims of U S WEST itself as a creditor of a subsidiary may be
recognized.
Debt Securities of any series may be issued as registered Debt Securities or
bearer Debt Securities or both as specified in the terms of the series. Unless
otherwise indicated in the Prospectus Supplement, Debt Securities will be issued
in denominations of $1,000 and integral multiples thereof, and bearer Debt
Securities will not be offered, sold, resold or delivered to U.S. persons in
connection with their original issuance. For purposes of this Prospectus, "U.S.
person" means a citizen, national or resident of the United States, a
corporation, partnership or other entity created or organized in or under the
laws of the United States, or any political subdivision thereof, or an estate or
trust which is subject to United States federal income taxation regardless of
its source of income.
To the extent set forth in the Prospectus Supplement, except in special
circumstances set forth in the Indenture, interest on bearer Debt Securities
will be payable only against presentation and surrender of the coupons for the
interest installments evidenced thereby as they mature at a paying agency of U S
WEST located outside of the United States and its possessions. (Section
2.05(c).) U S WEST will maintain such an agency for a period of two years after
the principal of such bearer Debt Securities has become due and payable. During
any period thereafter for which it is necessary in order to conform to United
States tax law or regulations, U S WEST will maintain a paying agent outside the
United States and its possessions to which the bearer Debt Securities may be
presented for payment and will provide the necessary funds therefor to such
paying agent upon reasonable notice. (Section 2.04.)
The general provisions of the Indenture do not afford holders of the Debt
Securities protection in the event of a highly-leveraged transaction,
reorganization, merger or similar transaction involving U S WEST that may
adversely affect holders of the Debt Securities.
Bearer Debt Securities and the coupons related thereto will be transferable
by delivery. (Section 2.08(e).)
If appropriate, federal income tax consequences applicable to a series of
Debt Securities will be described in the Prospectus Supplement relating thereto.
GLOBAL SECURITIES
The Debt Securities of a series may be issued in the form of one or more
fully registered global securities (each a "Global Security") that will be
deposited with, or on behalf of, a depositary (the "Depositary") identified in
the Prospectus Supplement relating to such series. Unless and until it is
exchanged for Debt Securities in definitive registered form, a Global Security
may not be transferred
6
<PAGE>
except as a whole by the Depositary for such Global Security to a nominee of
such Depositary or by a nominee of such Depositary to such Depositary or another
nominee of such Depositary or by such Depositary or any such nominee to a
successor of such Depositary or a nominee of such successor.
The specific terms of the depositary arrangements with respect to a series
of Debt Securities will be described in the Prospectus Supplement relating to
such series. U S WEST anticipates that the following provisions will apply to
all depositary arrangements.
Upon the issuance of a Global Security, the Depositary for such Global
Security will credit the accounts held with it with the respective principal
amounts of the Debt Securities represented by such Global Security. Such
accounts shall be designated by the underwriters or agents with respect to such
Debt Securities or by U S WEST if such Debt Securities are offered and sold
directly by U S WEST. Ownership of beneficial interests in a Global Security
will be limited to persons that have accounts with the Depositary for such
Global Security ("participants") or persons that may hold interests through
participants. Ownership of beneficial interests in such Global Security will be
shown on, and the transfer of that ownership will be effected only through,
records maintained by the Depositary for such Global Security or on the records
of participants. The laws of some states require that certain purchasers of
securities take physical delivery of such securities in definitive form. Such
limits and such laws may impair the ability to transfer beneficial interests in
a Global Security.
So long as the Depositary for a Global Security, or its nominee, is the
registered owner of such Global Security, such Depositary or such nominee, as
the case may be, will be considered the sole owner or holder of the Debt
Securities represented by such Global Security for all purposes under the
Indenture governing such Debt Securities. Except as provided below, owners of
beneficial interests in a Global Security will not be entitled to have Debt
Securities of the series represented by such Global Security registered in their
names, will not receive or be entitled to receive physical delivery of Debt
Securities of such series in definitive form and will not be considered the
owners or holders thereof under the Indenture governing such Debt Securities.
Principal, premium, if any, and interest payments on Debt Securities
registered in the name of a Depositary or its nominee will be made to the
Depositary or its nominee, as the case may be, as the registered owner of the
Global Security representing such Debt Securities. Neither U S WEST, the Trustee
for such Debt Securities, any Paying Agent nor the Security Registrar for such
Debt Securities will have any responsibility or liability for any aspect of the
records relating to or payments made on account of beneficial ownership
interests in the Global Security for such Debt Securities or for maintaining,
supervising or reviewing any records relating to such beneficial ownership
interests.
U S WEST expects that the Depositary for a series of Debt Securities issued
in the form of a Global Security, upon receipt of any payment of principal,
premium or interest, will credit immediately participants' accounts with
payments in amounts proportionate to their respective beneficial interests in
the principal amount of the Global Security for such Debt Securities as shown on
the records of such Depositary. U S WEST also expects that payments by
participants to owners of beneficial interests in such Global Security held
through such participants will be governed by standing instructions and
customary practices, as is now the case with securities held for the accounts of
customers in bearer form or registered in "street name," and will be the
responsibility of such participants.
If a Depositary for a series of Debt Securities is at any time unwilling or
unable to continue as depositary and a successor depositary is not appointed by
U S WEST within 90 days, U S WEST will issue Debt Securities of such series in
definitive form in exchange for the Global Security representing such series of
Debt Securities. In addition, U S WEST may at any time and in its sole
discretion determine not to have the Debt Securities of a series represented by
a Global Security and, in such event, will issue Debt Securities of such series
in definitive form in exchange for the Global Security representing such series
of Debt Securities. In either instance, an owner of a beneficial interest in a
Global Security will be entitled to have Debt Securities of the series
represented by such Global Security equal in principal amount to such beneficial
interest registered in its name and will be entitled to physical delivery of
such
7
<PAGE>
Debt Securities in definitive form. Debt Securities of such series so issued in
definitive form will be issued in denominations of $1,000 and integral multiples
thereof and will be issued in registered form only, without coupons.
EXCHANGE OF SECURITIES
To the extent permitted by the terms of a series of Debt Securities
authorized to be issued in registered form and bearer form, bearer Debt
Securities may be exchanged for an equal aggregate principal amount of
registered Debt Securities of the same series and date of maturity in such
authorized denominations as may be requested upon surrender of the bearer Debt
Securities with all unpaid coupons relating thereto, at an agency of U S WEST
maintained for such purpose and upon fulfillment of all other requirements of
such agent. (Section 2.08(b).) As of the date of this Prospectus, United States
Treasury regulations do not permit exchanges of registered Debt Securities for
bearer Debt Securities and, unless such regulations are modified, the terms of a
series of Debt Securities will not permit registered Debt Securities to be
exchanged for bearer Debt Securities.
AMENDMENT AND WAIVER
Subject to certain exceptions, the Indenture may be amended or supplemented
by U S WEST and the Trustee with the consent of the holders of a majority in
principal amount of the outstanding Debt Securities of each series affected by
the amendment or supplement (with each series voting as a class), or compliance
with any provision may be waived with the consent of the holders of a majority
in principal amount of the outstanding Debt Securities of each series affected
by such waiver (with each series voting as a class). However, without the
consent of each Debt Securityholder affected, an amendment or waiver may not (i)
reduce the amount of Debt Securities whose holders must consent to an amendment
or waiver; (ii) change the rate of or change the time for payment of interest on
any Debt Security; (iii) change the principal of or change the fixed maturity of
any Debt Security; (iv) change the terms of any Debt Securities so as to
adversely affect the terms on which such Debt Securities are convertible into,
or exchangeable or exercisable for, shares of a class of capital stock of U S
WEST or any other corporation; (v) waive a default in the payment of the
principal of or interest on any Debt Security; (vi) make any Debt Security
payable in money other than that stated in the Debt Security; or (vii) impair
the right to institute suit for the enforcement of any payment on or with
respect to any Debt Security. (Section 9.02.) The Indenture may be amended or
supplemented without the consent of any Debt Securityholder (i) to cure any
ambiguity, defect or inconsistency in the Indenture, or the Debt Securities of
any series; (ii) to provide for the assumption of all the obligations of U S
WEST under the Debt Securities, any coupons related thereto and the Indenture by
any corporation in connection with a merger, consolidation, transfer or lease of
U S WEST's property and assets substantially as an entirety, as provided for in
the Indenture; (iii) to provide for uncertificated Debt Securities in addition
to or in place of certificated Debt Securities; (iv) to make any change that
does not adversely affect the rights of any Debt Securityholder; (v) to provide
for the issuance of and establish the form and terms and conditions of a series
of Debt Securities endorsed thereon or to establish the form of any
certifications required to be furnished pursuant to the terms of the Indenture
or any series of Debt Securities; or (vi) to add to the rights of Debt
Securityholders. (Section 9.01.)
MERGER
U S WEST may consolidate with or merge into, or transfer or lease its
property and assets substantially as an entirety to, another entity if the
successor entity is a corporation and assumes all the obligations of U S WEST
under the Debt Securities and any coupons related thereto and the Indenture and
if, after giving effect to such transaction, a Default or Event of Default would
not occur or be continuing. Thereafter, all such obligations of U S WEST shall
terminate. (Sections 5.01 and 5.02.)
EVENTS OF DEFAULT
The following events are defined in the Indenture as "Events of Default"
with respect to a series of Debt Securities: (i) default in the payment of
interest on any Debt Security of such series for 90 days; (ii) default in the
payment of the principal of any Debt Security of such series; (iii) failure by U
S WEST for 90 days after notice to it to comply with any of its other agreements
in the Debt Securities of such series,
8
<PAGE>
in the Indenture or in any supplemental indenture; and (iv) certain events of
bankruptcy or insolvency of U S WEST. (Section 6.01.) If an Event of Default
occurs with respect to the Debt Securities of any series and is continuing, the
Trustee or the holders of at least 25% in principal amount of all of the
outstanding Debt Securities of that series may declare the principal (or, if the
Debt Securities of that series are original issue discount Debt Securities, such
portion of the principal amount as may be specified in the terms of that series)
of all the Debt Securities of that series to be due and payable. Upon such
declaration, such principal (or, in the case of original issue discount Debt
Securities, such specified amount) shall be due and payable immediately.
(Section 6.02.)
Securityholders may not enforce the Indenture or the Debt Securities except
as provided in the Indenture. The Trustee may require indemnity satisfactory to
it before it enforces the Indenture or the Debt Securities. (Section 7.01.)
Subject to certain limitations, holders of a majority in principal amount of the
Debt Securities of each series affected (with each series voting as a class) may
direct the Trustee in its exercise of any trust power. (Section 6.05.) The
Trustee may withhold from holders of Debt Securities notice of any continuing
default (except a default in payment of principal or interest) if it determines
that withholding notice is in their interests. (Section 7.05.)
CONCERNING THE TRUSTEE
U S WEST and certain of its affiliates maintain banking relationships in the
ordinary course of business with the Trustee. In addition, the Trustee and
certain of its affiliates serve as trustee, authenticating agent or paying agent
with respect to certain debt securities of U S WEST and its affiliates.
9
<PAGE>
PLAN OF DISTRIBUTION
DISTRIBUTION OF SECURITIES
U S WEST may offer and sell the Debt Securities (i) to or through
underwriting syndicates represented by managing underwriters, (ii) to or through
underwriters without a syndicate, (iii) through dealers, (iv) through agents or
(v) through a combination of any such methods of sale. The Prospectus Supplement
with respect to each series of Debt Securities will set forth the terms of the
offering, including the name or names of any underwriters, dealers or agents,
the purchase price and the net proceeds to U S WEST from such sale, any
underwriting discounts, agency fees and other items constituting underwriters'
or agents' compensation, the initial public offering price and any discounts or
concessions allowed, re-allowed or paid to dealers.
If any underwriters are involved in the offer and sale, the Debt Securities
will be acquired by the underwriters and may be resold by them from time to time
in one or more transactions, including negotiated transactions, at a fixed
public offering price or at varying prices determined at the time of sale.
Unless otherwise set forth in the accompanying Prospectus Supplement, the
obligations of the underwriters to purchase the Debt Securities will be subject
to certain conditions precedent and the underwriters will be obligated to
purchase all the Securities described in such Prospectus Supplement if any are
purchased. Any initial public offering price and any discounts or concessions
allowed or re-allowed or paid to dealers may be changed from time to time.
The Debt Securities may be offered and sold by U S WEST directly or through
an agent or agents designated by U S WEST from time to time. Unless otherwise
indicated in the applicable Prospectus Supplement, any such agent or agents will
be acting on a best efforts basis for the period of its or their appointment.
Any agent participating in the distribution of the Debt Securities may be deemed
to be an "underwriter," as that term is defined in the Securities Act, of the
Securities so offered and sold. The Securities also may be sold to dealers, at
the applicable price to the public set forth in the applicable Prospectus
Supplement relating to a particular series of the Securities, who later resell
to investors. Such dealers may be deemed to be "underwriters" within the meaning
of the Securities Act.
Underwriters, dealers and agents may be entitled, under agreements entered
into with U S WEST, to indemnification by U S WEST against certain liabilities,
including liabilities under the Securities Act.
The place and time of delivery for the Debt Securities in respect of which
this Prospectus is delivered will be set forth in the accompanying Prospectus
Supplement, if appropriate.
DELAYED DELIVERY ARRANGEMENTS
If so indicated in the Prospectus Supplement, U S WEST will authorize
dealers or other persons acting as U S WEST's agents to solicit offers by
certain institutions to purchase Debt Securities from U S WEST pursuant to
contracts providing for payment and delivery on a future date. Institutions with
which such contracts may be made include commercial and savings banks, insurance
companies, pension funds, investment companies, educational and charitable
institutions, and others, but in all cases such institutions must be approved by
U S WEST. The obligations of any purchaser under any such contract will not be
subject to any conditions except that (a) the purchaser of the Debt Securities
shall not at the time of delivery be prohibited from purchasing such securities
under the laws of the jurisdiction to which such purchaser is subject and (b) if
the Debt Securities are also being sold to underwriters, U S WEST shall have
sold to such underwriters the Debt Securities not sold for delayed delivery. The
dealers and such other persons will not have any responsibility in respect of
the validity or performance of such contracts.
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LEGAL OPINIONS
The validity of the Debt Securities will be passed upon by Stephen E. Brilz,
Senior Attorney of U S WEST.
EXPERTS
The consolidated financial statements and the consolidated financial
statement schedule included in U S WEST's Annual Report on Form 10-K for the
year ended December 31, 1994 are incorporated herein by reference in reliance on
the reports of Coopers & Lybrand L.L.P., independent certified public
accountants, given upon the authority of that firm as experts in accounting and
auditing.
The consolidated financial statements of U S WEST and the combined financial
statements of the U S WEST Communications Group and the U S WEST Media Group as
of December 31, 1993 and 1994 and for each of the three years in the period
ended December 31, 1994 included in the Current Report on Form 8-K of U S WEST,
dated September 28, 1995, are incorporated herein by reference in reliance on
the reports of Coopers & Lybrand L.L.P., independent certified public
accountants, given upon the authority of that firm as experts in accounting and
auditing.
The consolidated financial statements of Time Warner Entertainment Company,
L.P. as of December 31, 1994 and 1993 and for each of the three years in the
period ended December 31, 1994, which appear in the Current Report on Form 8-K
of U S WEST, dated May 23, 1995, as amended by Forms 8-K/ A filed on July 12,
1995 and August 24, 1995, are incorporated herein by reference in reliance on
the report of Ernst & Young LLP, independent auditors, given upon the authority
of that firm as experts in accounting and auditing.
The financial statements of Mercury Personal Communications (trading as
Mercury One-2-One) as of March 31, 1995, 1994 and 1993 and for each of the three
years in the period ended March 31, 1994, which appear in the Current Report on
Form 8-K of U S WEST, dated May 23, 1995, as amended by Forms 8-K/A filed on
July 12, 1995 and August 24, 1995, are incorporated herein by reference in
reliance on the report of Arthur Andersen LLP, independent chartered
accountants, given upon the authority of that firm as experts in accounting and
auditing.
The combined financial statements of Georgia Cable Holdings Limited
Partnership and Subsidiary Partnerships as of December 31, 1993 and 1992 and for
each of the years in the two-year period ended December 31, 1993, which appear
in the Current Report on Form 8-K of U S WEST, dated May 23, 1995, as amended by
Forms 8-K/A filed on July 12, 1995 and August 24, 1995, have been incorporated
by reference herein and in the Registration Statement in reliance upon the
report of KPMG Peat Marwick LLP, independent certified public accountants,
incorporated by reference herein, and upon the authority of said firm as experts
in accounting and auditing.
The consolidated financial statements of Wometco Cable Corp. and
subsidiaries as of December 31, 1993 and 1992 and for each of the years in the
two-year period ended December 31, 1993, which appear in the Current Report on
Form 8-K of U S WEST, dated May 23, 1995, as amended by Forms 8-K/ A filed on
July 12, 1995 and August 24, 1995, have been incorporated by reference herein in
reliance upon the report of KPMG Peat Marwick LLP, independent certified public
accountants, incorporated by reference herein and in the Registration Statement,
and upon the authority of said firm as experts in accounting and auditing. The
report on the 1993 consolidated financial statements of Wometco Cable Corp. and
subsidiaries refers to a change in the method of accounting for income taxes in
1993 to adopt the provisions of Financial Accounting Standards Board FASB No.
109 -- Accounting for Income Taxes.
11
<PAGE>
Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. This prospectus shall not constitute an offer to sell or the
solicitation of an offer to buy nor shall there be any sale of these securities
in any State in which such offer, solicitation or sale would be unlawful prior
to registration or qualification under the securities laws of any such State.
<PAGE>
APPENDIX A
SUBJECT TO COMPLETION
JANUARY 26, 1996
PROSPECTUS
[LOGO]
7,000,000 SHARES
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
COMMON STOCK
($.01 PAR VALUE)
This Prospectus relates to shares of common stock, par value $.01 per share (the
"Common Stock"), of Financial Security Assurance Holdings Ltd., a New York
corporation ("FSA Holdings" and, together with its consolidated subsidiaries,
the "Company"), which may be delivered by U S WEST, Inc., a Delaware corporation
("U S WEST"), or an affiliate thereof, at U S WEST's option, pursuant to the
terms of the % Exchangeable Notes due , 1999 (the "Debt
Exchangeable for Common Stock-SM-" or "DECS-SM-") of U S WEST. This Prospectus
is Appendix A to a Prospectus Supplement and Prospectus of U S WEST relating to
the sale of 7,000,000 DECS (the "DECS Prospectus"). See "Prospectus Summary."
FSA Holdings will not receive any of the proceeds from the sale of the DECS or
delivery thereunder of shares of Common Stock to which this Prospectus relates.
U S WEST has granted the underwriters of the DECS a 30-day option to purchase up
to an additional 1,050,000 DECS, which may be exchangeable at their maturity for
additional shares of Common Stock. Such option has been granted solely to cover
over-allotments, if any.
In connection with market-making activities in the DECS, Salomon Brothers Inc
("Salomon") may, subject to certain limitations, from time to time borrow,
return and reborrow up to 1,600,000 shares of Common Stock from U S WEST. See
"Plan of Distribution." Salomon is not under any obligation to engage in any
market-making transactions with respect to the DECS, and any market-making in
the DECS actually engaged in by Salomon may cease at any time.
The Company and U S WEST have agreed not to sell, without the prior written
consent of Salomon, any shares of Common Stock or any securities convertible
into or exchangeable for Common Stock for a period of 180 days after the date of
this Prospectus. See "Plan of Distribution."
The Common Stock is listed for trading on the New York Stock Exchange, Inc. (the
"NYSE") under the symbol "FSA". On January 25, 1996, the last reported sale
price of the Common Stock on the NYSE Composite Tape was $25.00 per share. See
"Price Range of Common Stock and Dividends."
SEE "RISK FACTORS" BEGINNING ON PAGE 9 FOR A DISCUSSION OF CERTAIN FACTORS THAT
SHOULD BE CAREFULLY CONSIDERED BY PROSPECTIVE PURCHASERS.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this Prospectus is , 1996.
<PAGE>
FSA HOLDINGS HAS BEEN ADVISED THAT IN CONNECTION WITH THE OFFERING BY U S
WEST OF THE DECS, THE UNDERWRITERS OF THE DECS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE DECS OR THE
COMMON STOCK OF FSA HOLDINGS AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL
IN THE OPEN MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NYSE (WITH RESPECT
TO THE COMMON STOCK ONLY), IN THE OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH
STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
AVAILABLE INFORMATION
FSA Holdings is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information filed by FSA Holdings may be inspected and
copied at the public reference facilities maintained by the Commission at Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at
the Commission's regional offices at Room 3190, Citicorp Center, 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661; and Seven World Trade
Center, 13th Floor, New York, New York 10048. Copies of such material may be
obtained from the Public Reference Section of the Commission at Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 at prescribed
rates. In addition, material filed by FSA Holdings can be inspected at the
offices of the NYSE, 20 Broad Street, New York, New York 10005.
FSA Holdings has filed with the Commission a Registration Statement on Form
S-3 (the "Registration Statement") under the Securities Act of 1933, as amended
(the "Securities Act"), with respect to the Common Stock offered hereby. This
Prospectus does not contain all of the information set forth in the Registration
Statement and the exhibits and schedules filed as a part thereof, as permitted
by the rules and regulations of the Commission. For further information with
respect to FSA Holdings and the Common Stock, reference is hereby made to such
Registration Statement, including the exhibits and schedules filed as a part
thereof. Statements contained in this Prospectus as to the contents of any
contract or other document referred to herein are not necessarily complete and
where such contract or other document is an exhibit to the Registration
Statement, each such statement is qualified in all respects by the provisions of
such exhibit, to which reference is hereby made for a full statement of the
provisions thereof. The Registration Statement, including the exhibits and
schedules filed as a part thereof, may be inspected without charge at the public
reference facilities maintained by the Commission as set forth in the preceding
paragraph. Copies of these documents may be obtained at prescribed rates from
the Public Reference Section of the Commission at Room 1024, Judiciary Plaza,
450 Fifth Street, N.W., Washington, D.C. 20549.
2
<PAGE>
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents heretofore filed with the Commission (File No.
1-12644) are hereby incorporated by reference in this Prospectus:
1. FSA Holdings' Annual Report on Form 10-K for the year ended December 31,
1994 (which incorporates by reference certain information from FSA Holdings'
Proxy Statement relating to the 1995 Annual Meeting of Shareholders and FSA
Holdings' 1994 Annual Report to Shareholders);
2. FSA Holdings' Quarterly Report on Form 10-Q for the three months ended
March 31, 1995;
3. FSA Holdings' Quarterly Report on Form 10-Q for the three months ended
June 30, 1995;
4. FSA Holdings' Current Report on Form 8-K dated August 18, 1995;
5. FSA Holdings' Quarterly Report on Form 10-Q for the three months ended
September 30, 1995;
6. The description of the Common Stock set forth in FSA Holdings'
Registration Statement on Form 8-A, declared effective on May 6, 1994, and any
amendment or report filed for the purpose of updating such description;
7. FSA Holdings' Current Report on Form 8-K dated December 20, 1995;
8. Annual Report on Form 10-K for the year ended December 31, 1994 of
Capital Guaranty Corporation ("Capital Guaranty"), a wholly owned subsidiary of
FSA Holdings (which incorporates by reference certain information from Capital
Guaranty's Proxy Statement relating to the 1995 Annual Meeting of Shareholders
and Capital Guaranty's 1994 Annual Report to Shareholders);
9. Capital Guaranty's Quarterly Report on Form 10-Q for the three months
ended March 31, 1995;
10. Capital Guaranty's Quarterly Report on Form 10-Q for the three months
ended June 30, 1995;
11. Capital Guaranty's Current Report on Form 8-K dated August 22, 1995;
12. Capital Guaranty's Quarterly Report on Form 10-Q for the three months
ended September 30, 1995; and
13. Capital Guaranty's Current Report on Form 8-K dated December 20, 1995.
All documents filed by FSA Holdings pursuant to Section 13(a), 13(c), 14 or
15(d) of the Exchange Act subsequent to the date of this Prospectus and prior to
the termination of this offering shall be deemed to be incorporated by reference
in this Prospectus and to be a part hereof from the date of filing such
documents.
Any statement contained in a document incorporated by reference herein shall
be deemed to be modified or superseded for purposes of this Prospectus to the
extent that a statement contained herein modifies or supersedes such statement.
Any such statement so modified or superseded shall not be deemed, except as so
modified or superseded, to constitute a part of this Prospectus.
FSA Holdings hereby undertakes to provide without charge to each person to
whom a copy of this Prospectus has been delivered, on the written or oral
request of any such person, a copy of any or all of the documents referred to
above other than exhibits to such documents. Requests for such copies should be
directed to the Secretary of FSA Holdings, Financial Security Assurance Holdings
Ltd., 350 Park Avenue, New York, New York 10022, telephone number (212)
826-0100.
------------------------
"Debt Exchangeable for Common Stock" and "DECS" are service marks of Salomon
Brothers Inc.
3
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE
DETAILED INFORMATION AND FINANCIAL STATEMENTS CONTAINED ELSEWHERE OR
INCORPORATED BY REFERENCE IN THIS PROSPECTUS. FOR DEFINITIONS OF AND ADDITIONAL
INFORMATION CONCERNING CERTAIN TERMS USED IN THIS PROSPECTUS, SEE "GLOSSARY OF
INSURANCE TERMS."
THE COMPANY
FSA Holdings, through its wholly owned subsidiary, Financial Security
Assurance Inc. ("FSA"), is primarily engaged in the business of providing
financial guaranty insurance on asset-backed securities and municipal bonds. FSA
was the first insurance company organized to insure asset-backed obligations and
has been a leading insurer of asset-backed obligations (based on number of
transactions insured) since its inception in 1985. FSA expanded the focus of its
business in 1990 to include financial guaranty insurance of municipal
obligations.
FSA's underwriting policy is to insure asset-backed and municipal
obligations that would otherwise be investment grade without the benefit of
FSA's insurance. The asset-backed obligations insured by FSA are generally
issued in structured transactions and are backed by pools of assets such as
residential mortgage loans, consumer or trade receivables, securities or other
assets having an ascertainable cash flow or market value. The municipal
obligations insured by FSA consist primarily of general obligation bonds that
are supported by the issuers' taxing power and special revenue bonds and other
special obligations of state and local governments that are supported by the
issuers' ability to impose and collect fees and charges for public services or
specific projects. Financial guaranty insurance written by FSA guarantees
payment when due of scheduled payments on an issuer's obligation. In the case of
a payment default on an insured obligation, FSA is generally required to pay the
principal, interest or other amounts due in accordance with the obligation's
original payment schedule or, at its option, to pay such amounts on an
accelerated basis.
The Company's business strategy is to remain a leading insurer of
asset-backed obligations and to become a more prominent insurer of municipal
obligations. The Company expects to continue to emphasize a diversified insured
portfolio characterized by insurance of both asset-backed and municipal
obligations, with a broad geographic distribution and a variety of revenue
sources and transaction structures.
In December 1995, FSA Holdings acquired Capital Guaranty in a merger
transaction in which Capital Guaranty became a direct wholly owned subsidiary of
FSA Holdings (the "Merger"). Capital Guaranty, through its wholly owned
subsidiary, Capital Guaranty Insurance Company ("CGIC"), provided financial
guaranty insurance on municipal bonds. In connection with the Merger, CGIC,
whose principal business is now as a reinsurer of policies written by FSA,
changed its name to Financial Security Assurance of Maryland Inc. ("FSAM").
Except as otherwise expressly provided, the financial and other information
contained in this Prospectus with respect to FSA Holdings and FSA does not give
effect to the Merger. For additional information concerning Capital Guaranty,
see "Capital Guaranty Corporation," "Selected Financial Information of Capital
Guaranty Corporation," and "Incorporation of Certain Documents by Reference."
For the nine months ended September 30, 1995, FSA had gross premiums written
of $78.3 million, of which 46% related to insurance of municipal obligations and
54% related to insurance of asset-backed obligations. At September 30, 1995, FSA
had net insurance in force of $52.5 billion, of which 59% represented insurance
on municipal obligations and 41% represented insurance on asset-backed
obligations. As of September 30, 1995, pro forma net insurance in force would
have been $71.7 billion, of which 70% represented insurance on municipal
obligations and 30% represented insurance on asset-backed obligations.
At September 30, 1995, the Company had total assets of $1,137.3 million, an
increase of 5.9% from December 31, 1994, and shareholders' equity of $608.6
million, an increase of 11.6% from December 31, 1994. After giving pro forma
effect to the Merger as if it had occured as of September 30, 1995, total assets
would have been $1,463.2 million and shareholders' equity would have been $751.4
million. See "Recent Developments" for a summary of FSA Holdings' results for
the quarter and year ended December 31, 1995.
4
<PAGE>
The claims-paying ability of FSA is rated "Aaa" by Moody's Investors
Service, Inc. ("Moody's") and "AAA" by Standard & Poor's Ratings Services
("S&P"), Nippon Investors Services and S&P (Australia) Pty. Ltd.
FSA is licensed to engage in the financial guaranty insurance business in
all 50 states, the District of Columbia and Puerto Rico. The principal executive
offices of FSA Holdings are located at 350 Park Avenue, New York, New York
10022, and its telephone number is (212) 826-0100.
THE OFFERING OF THE DECS
This Prospectus relates to 7,000,000 shares of Common Stock, plus up to an
additional 1,050,000 shares solely to cover over-allotments, which may be
delivered by U S WEST or an affiliate thereof, at U S WEST's option, pursuant to
the terms of the DECS, which are being offered by U S WEST pursuant to the DECS
Prospectus. Such 8,050,000 shares of Common Stock are owned by U S WEST Capital
Corporation, a wholly owned subsidiary of U S WEST ("USWCC"). The Tokio Marine
and Fire Insurance Company, Ltd. ("Tokio Marine") has a right of first offer
with respect to all of the shares of Common Stock owned by USWCC, including the
shares which may be delivered upon maturity of the DECS. For a description of
the relationship between U S WEST and the Company, see "Security Ownership of
Certain Beneficial Owners and Management," "Selling Shareholder" and "Certain
Relationships and Related Transactions."
5
<PAGE>
SUMMARY OF SELECTED CONSOLIDATED FINANCIAL INFORMATION
OF FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
<TABLE>
<CAPTION>
NINE MONTHS
YEARS ENDED DECEMBER 31, ENDED SEPTEMBER 30,
---------------------------------------------------------------- ----------------------------
1990 1991 1992 (1) 1993 (2) 1994 1994 1995
---------- ---------- ---------- ------------- ------------- ------------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT
Gross premiums written...... $ 124,266 $ 110,727 $ 131,131 $ 127,409 $ 106,449 $ 75,144 $ 78,331
Net premiums written........ 101,100 55,910 78,397 65,006 77,757 53,253 54,917
Net premiums earned......... 39,309 60,510 63,857 63,377 65,754 51,674 50,837
Net realized gains
(losses)................... (972) 9,087 29,153 18,292 (3,773) 6,518 1,333
Net investment income....... 31,337 45,059 47,024 47,948 46,592 34,792 36,877
Total revenues.............. 70,466 116,967 142,506 127,654 109,350 93,531 91,752
Losses and loss adjustment
expenses................... 125 9,901 54,623 84,054 3,024 2,270 4,822
Amortization and write-off
of goodwill................ 3,718 3,718 3,718 81,598
Policy acquisition and other
expenses................... 21,648 32,222 31,323 40,459 28,036 21,925 22,526
Income (loss) before income
taxes...................... 44,975 71,126 52,842 (163,866) 78,290 69,336 64,404
Net income (loss)........... 31,270 52,803 43,457 (124,707) 60,375 52,708 46,561
Earnings (loss) per common
share...................... 1.80 2.40 1.90 (5.44) 2.32 2.03 1.80
Cash dividends per common
share...................... 1.65 0.26 0.16 0.08 0.24
SELECTED FINANCIAL RATIOS
GAAP BASIS (3)
Loss ratio.................. 0.3% 16.4% 85.5% 132.6% 4.6% 4.4% 9.5%
Expense ratio............... 54.7 46.0 47.3 62.1 40.5 40.3 42.4
Combined ratio.............. 55.0% 62.4% 132.8% 194.7% 45.1% 44.7% 51.9%
SAP BASIS(3)
Loss ratio.................. 0.4% 18.3% 67.7% 0.7% 28.1% 2.7% 1.7%
Expense ratio............... 36.1 77.6 47.5 52.2 59.1 79.5 49.1
Combined ratio.............. 36.5% 95.9% 115.2% 52.9% 87.2% 82.2% 50.8%
BALANCE SHEET
Total investments........... $ 485,754 $ 659,880 $ 727,455 $ 786,723(4) $ 747,176(4) $ 709,329(4) $ 811,365(4)
Prepaid reinsurance
premiums................... 43,124 71,288 98,225 127,849 121,668 121,891 118,436
Total assets................ 711,588 933,550 1,042,362 1,030,587 1,074,316 991,025 1,137,269
Unearned premiums........... 232,621 256,051 297,073 328,165 334,569 324,175 335,367
Total liabilities........... 282,701 361,811 433,166 488,615 528,880 443,115 528,674
Shareholders' equity........ 428,887 571,739 609,196 541,972 545,436 547,910 608,595
Book value per common
share...................... 22.24 25.00 26.64 20.95 20.92 20.88 23.74
SELECTED FINANCIAL
STATISTICS (3)
Gross insurance in force.... $34,091,000 $45,045,000 $52,592,000 $61,290,000 $65,824,000 $62,686,000 $73,924,000
Net insurance in force...... 27,537,000 33,447,000 37,334,000 41,667,000 45,825,000 43,040,000 52,546,000
Qualified statutory
capital.................... 291,933 420,326 461,443 454,048 465,787 484,906 495,031
Policyholders' leverage
ratio...................... 94:1 80:1 81:1 92:1 98:1 89:1 106:1
ANALYTICAL DATA
Tangible book value per
common share (5)(7)........ 18.35 21.27 23.07 20.95 20.92 20.88 23.74
Adjusted book value per
common share (6)(7)........ 20.45 26.67 28.98 26.15 26.40 25.91 29.77
</TABLE>
- ------------------------------
(1)Results for full year 1992 were adversely affected by $54.6 million of
additional reserves, consisting of case basis reserves for three commercial
mortgage transactions insured by FSA and the establishment of the general
loss reserve.
(2)Results for the year ended December 31, 1993 were adversely affected by $63.7
million in net incurred losses for three commercial mortgage transactions
insured by FSA, $63.0 million of which losses were directly paid by a letter
of credit provided by U S WEST (the "U S WEST Letter of Credit"). The payment
under the U S WEST Letter of Credit was accounted for under generally
accepted accounting principles ("GAAP") as a contribution of capital (net of
related tax effect) and the related losses were reflected as an expense in
FSA's income statement, while for statutory accounting practices ("SAP")
income statement purposes the drawings under the U S WEST Letter of Credit
were netted against such losses. Results were also adversely affected by an
increase of $20.3 million in the nonspecific general loss reserve of FSA for
unidentified losses covering FSA's entire insured portfolio, a write-off of
$78.8 million of goodwill, a restructuring charge of $85.4 million resulting
from the premium payment by FSA to Commercial Reinsurance Company
("Commercial Re") under FSA's reinsurance agreement with Commercial Re and
non-recurring charges of approximately $10.0 million. Gross and net premiums
written were reduced due to the cession of $17.9 million of unearned premiums
from FSA to Commercial Re under such reinsurance agreement.
6
<PAGE>
(3)These ratios and statistics relate solely to FSA. The GAAP loss ratio is
losses and loss adjustment expenses incurred (inclusive of additions to the
general loss reserve) divided by net premium earned. The SAP loss ratio is
losses and loss adjustment expenses incurred (exclusive of additions to the
general loss reserve) divided by net premiums earned. The GAAP expense ratio
is underwriting and operating expenses divided by net premiums earned. The
SAP expense ratio is underwriting and operating expenses divided by net
premiums written. The combined ratio on both a GAAP and SAP basis is the sum
of the applicable loss and expense ratios.
(4)Total investments at December 31, 1993 and 1994 and September 30, 1994 and
1995 included $54.1 million net unrealized gains, $33.7 million net
unrealized losses, $26.0 million net unrealized losses and $11.9 million net
unrealized gains, respectively. In addition, the balance at December 31, 1993
included $24.3 million of funds withheld from the premium ceded by FSA to
Commercial Re, pending deposit of such funds in a trust account satisfying
the requirements of applicable insurance law. Total investments at December
31, 1990, 1991 and 1992 were recorded at amortized cost in accordance with
GAAP and therefore do not include unrealized gains or losses.
(5)Tangible book value per common share is book value per common share less
goodwill per common share.
(6)Adjusted book value per common share, which is tangible book value plus net
unearned premium reserve plus the present value of net future installment
premiums less deferred acquisition costs less tax effect (in each case, on a
per common share basis), is used by management and equity analysts as a
measurement of FSA Holdings' and Capital Guaranty's intrinsic value. Adjusted
book value per common share is not a substitute for GAAP book value per
common share.
(7)Tangible book value per common share and adjusted book value per common share
do not include the effect of unrealized gains on investments for the years
ended December 31, 1990, 1991 and 1992, which were $0.04, $0.71 and $0.60 per
common share, respectively.
7
<PAGE>
SUMMARY OF SELECTED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
OF FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
(UNAUDITED)
The following table presents selected unaudited pro forma consolidated
financial information for FSA Holdings and Capital Guaranty after giving effect
to the Merger. This pro forma information is presented for illustrative purposes
only and is not necessarily indicative of the results that would have been
obtained if the Merger had been consummated on January 1, 1994 (in the case of
income statement items) or September 30, 1995 (in the case of balance sheet
items), or that may be obtained in the future. This pro forma data is derived
from the Unaudited Pro Forma Consolidated Condensed Financial Statements
appearing elsewhere herein and should be read in conjunction with those
statements and the notes thereto. See "Unaudited Pro Forma Consolidated
Condensed Financial Statements."
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, 1994 SEPTEMBER 30, 1995
------------------- --------------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C>
PRO FORMA STATEMENT OF OPERATIONS DATA:
Revenues......................................................... $ 136,114 $ 112,513
Net Income....................................................... 73,627 57,915
Net Income Per Common Share...................................... $ 2.30 $ 1.83
Common Shares Used in Calculation of Above per Common Share
Amount.......................................................... 32,054 31,695
------------------- --------
------------------- --------
<CAPTION>
SEPTEMBER 30, 1995
-------------------
(UNAUDITED)
(IN THOUSANDS,
EXCEPT PER SHARE
DATA)
<S> <C> <C>
PRO FORMA BALANCE SHEET DATA:
Assets........................................................... $ 1,463,180
Debt............................................................. 30,000
Shareholders' Equity
Preferred Stock................................................ 700
Common Stock................................................... 751,426
Book Value per Common Share...................................... $ 23.71
Tangible Book Value per Common Share............................. 23.42
Common Shares Used in Calculation of Above Book Value per Common
Share Amounts................................................... 31,657
</TABLE>
8
<PAGE>
RISK FACTORS
ADEQUACY OF LOSS RESERVES
Like other financial guaranty insurers, FSA does not consider traditional
actuarial approaches used in the property/casualty insurance industry to be
applicable to the determination of its loss reserves because of the absence of a
sufficient number of losses in its financial guaranty insurance activities and
in the financial guaranty industry generally to establish a meaningful
statistical base. In the municipal area, a relatively small percentage of the
total amount of municipal obligations insured by the financial guaranty
insurance industry has experienced defaults in payment in recent years. There
can be no assurance, however, that these low default rates will be indicative of
future rates of default in insured municipal obligations. The statistical base
in the asset-backed area is even more limited than in the municipal area. In
addition, actual loss rates in the asset-backed area may over time prove to be
higher than in the municipal area. Although FSA currently maintains reserves in
an amount believed by its management to be sufficient to pay its estimated
ultimate liability for losses and loss adjustment expenses with respect to
obligations it has insured, there can be no assurance that losses in FSA's
insured portfolio will not exceed the loss reserves. Losses from future
defaults, depending on their magnitude, could have a material adverse effect on
the results of operations and financial condition of FSA Holdings.
CLAIMS-PAYING ABILITY RATINGS
As is customary in the financial guaranty insurance industry, the rating
agencies perform periodic assessments of the credits insured by a financial
guaranty insurer to confirm that such insurer continues to meet the requirements
of the rating agencies for a triple-A rating of the insurer's claims-paying
ability. Although FSA Holdings intends to continue to comply with the criteria
of the rating agencies, no assurance can be given that one or more of the rating
agencies will not reduce or withdraw its triple-A rating of the claims-paying
ability of FSA in the future. FSA's ability to compete with other triple-A rated
financial guarantors, and its results of operations and financial condition,
would be materially adversely affected by a reduction in its ratings.
MARKET AND OTHER FACTORS
The demand for financial guaranty insurance depends upon many factors, some
of which are beyond the control of FSA.
While all the major financial guaranty insurers have triple-A claims-paying
ability ratings from major rating agencies, the marketplace may from time to
time distinguish between financial guarantors on the basis of various factors,
including size, insured portfolio concentration and financial performance. These
distinctions may result in differentials in trading levels for securities
insured by particular financial guarantors which, in turn, may provide a
competitive advantage to those financial guarantors with better trading levels.
Conversely, various investors may lack additional capacity to purchase
securities insured by certain financial guarantors, which may provide a
competitive advantage to guarantors with fewer insured obligations outstanding.
Prevailing interest rate levels affect demand for financial guaranty
insurance to the extent that lower interest rates are accompanied by narrower
spreads between insured and uninsured obligations. The purchase of insurance
during periods of relatively narrower interest rate spreads will generally
provide lower cost savings to the issuer than during periods of relatively wider
spreads. These lower cost savings generally are accompanied by a corresponding
decrease in demand for financial guaranty insurance. However, relatively low
interest rate levels may encourage the issuance of new or the refunding of
existing debt securities by companies and municipalities, which may increase the
demand for financial guaranty insurance.
Credit quality concerns among investors, especially during times of weak
economic conditions, typically result in an increase in demand for financial
guaranty insurance. During such times, investors generally prefer to purchase
higher rated investments, including those that achieve higher ratings through
financial guaranty insurance.
9
<PAGE>
The perceived financial strength of financial guaranty insurers also affects
demand for financial guaranty insurance. Should a major financial guaranty
insurer, or the industry generally, have its claims-paying ability rating
lowered, or suffer for some other reason a deterioration in investor confidence,
demand for financial guaranty insurance would be adversely affected.
In addition, the financial guaranty insurance industry has historically been
and will continue to be subject to the direct and indirect effects of
governmental regulation, including changes in tax laws affecting insurance on
asset-backed and municipal obligations. No assurance can be given that future
legislative or regulatory changes will not adversely affect FSA's business.
COMPETITION AND INDUSTRY CONCENTRATION
FSA faces competition from both other providers of third party credit
enhancement and alternatives to third party credit enhancement. The majority of
asset-backed and municipal obligations are sold without third party credit
enhancement. Accordingly, each transaction proposed to be insured by FSA must
generally compete against an alternative execution which does not employ third
party credit enhancement. FSA also faces competition from other monoline primary
financial guaranty insurers, primarily AMBAC Indemnity Corporation ("AMBAC"),
Capital Markets Assurance Corporation ("CapMAC"), Connie Lee Insurance Company
("Connie Lee"), Financial Guaranty Insurance Company ("FGIC") and MBIA Insurance
Corp. ("MBIA"). Traditional credit enhancers such as bank letter of credit
providers and mortgage pool insurers also provide significant competition to FSA
as providers of credit enhancement for asset-backed obligations. While actions
by securities rating agencies in recent years have significantly reduced the
number of triple-A rated banks that can offer a product directly competitive
with FSA's triple-A guaranty, and recently implemented risk-based capital
guidelines applicable to banks have generally increased costs associated with
letters of credit that compete directly with financial guaranty insurance, bank
letter of credit providers and other credit enhancement, such as cash collateral
accounts, provided by banks, continue to provide significant competition to FSA.
SUBSTANTIAL VOTING CONTROL
Immediately after giving effect to the consummation of the Merger, voting
control of FSA Holdings was held 41.6% by USWCC, 20.9% by Fund American
Enterprises Holdings, Inc. ("Fund American") and 5.7% by Tokio Marine (together,
the "Substantial Shareholders"). Each of the Substantial Shareholders has the
ability to exercise significant influence over the policies and corporate
actions of FSA Holdings. For further information, see "Security Ownership of
Certain Beneficial Owners and Management." Shareholders of FSA Holdings do not
have cumulative voting rights with respect to the election of directors and,
accordingly, any shareholder or group of shareholders holding shares
representing in excess of 50% of the voting shares outstanding of FSA Holdings
would by itself have the power to elect the entire board of directors of FSA
Holdings.
HOLDING COMPANY STRUCTURE
The operations of FSA Holdings are conducted through FSA. Accordingly, FSA
Holdings' financial condition and results of operations are dependent upon FSA,
whose ability to declare and pay dividends to FSA Holdings is dependent upon
FSA's financial condition, results of operations, cash requirements and other
related factors and is also subject to restrictions contained in the insurance
laws and regulations of New York and other states. See "Price Range of Common
Stock and Dividends," "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources" and
"Insurance Regulatory Matters -- Dividend Restrictions."
SHARES ELIGIBLE FOR FUTURE SALE
At January 24, 1996, the three largest shareholders of FSA Holdings, USWCC,
Fund American and Tokio Marine, together owned approximately 64.3% of the Common
Stock outstanding. U S WEST has the right to cause the delivery of 7,000,000
shares of Common Stock owned by USWCC (plus 1,050,000 shares solely to cover
over-allotments) pursuant to the terms of the DECS. All of the shares of Common
Stock owned by USWCC, Fund American and Tokio Marine will continue to be
tradeable in the open market subject to the volume limitations, manner of sale
and notice requirements of Rule 144 under the Securities
10
<PAGE>
Act or, without such requirements or limitations through the exercise of
registration rights available under agreements with FSA Holdings. See "Certain
Relationships and Related Transactions -- Registration Rights Agreement."
Sales of substantial amounts of Common Stock in the public or private
market, or the perception that such sales could occur, could adversely affect
prevailing market prices of the Common Stock.
IMPACT OF THE DECS ON THE MARKET FOR THE COMMON STOCK
It is not possible to predict accurately how or whether any market that
develops for the DECS will influence the market for the Common Stock. For
example, the price of the Common Stock could become more volatile and could be
depressed by investors' anticipation of the potential distribution into the
market of substantial additional amounts of Common Stock upon the maturity of
the DECS, by possible sales of Common Stock by investors who view the DECS as a
more attractive means of equity participation in FSA Holdings and by hedging or
arbitrage trading activity that may develop involving the DECS and the Common
Stock.
11
<PAGE>
RECENT DEVELOPMENTS
Set forth below is a summary of FSA Holdings' results for the three months
and years ended December 31, 1994 and 1995. In view of the short period between
the date of the Merger, December 20, 1995, and the year-end, December 31, 1995
has been considered the date of the Merger for accounting purposes. As a result,
the accounting for the Merger had no effect on the Statement of Operations Data
presented in this section, except for the recording of the $15.4 million general
reserve provision discussed below. The Merger affected the Balance Sheet Data
presented in this section by increasing total investments by $276,030 thousand,
prepaid insurance premiums by $16,739 thousand, total assets by $329,379
thousand, unearned premiums by $126,047 thousand, total liabilities by $186,572
thousand, shareholders' equity by $142,807 thousand, and by decreasing book
value per share by $0.26 per share; however, adjusted book value per common
share increased by $0.20 per common share (see note 6 of the "Summary of
Selected Consolidated Financial Information of Financial Security Assurance
Holdings Ltd."). (All of these amounts include the effect of providing the $15.4
million general reserve provision discussed below).
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
--------------------- ----------------------
1994 1995 1994 1995
---------- --------- ---------- ----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net premiums earned............................................. $ 14,080 $ 18,510 $ 65,754 $ 69,347
Net investment income........................................... 11,800 12,088 46,592 48,965
Net realized gains.............................................. (10,291) 3,787 (3,773) 5,120
Total revenues.................................................. 15,819 35,521 109,350 127,273
Policy acquisition and other expenses........................... 6,111 8,047 28,036 30,573
Income before income taxes...................................... 8,954 10,638 78,290 75,042
Net income...................................................... 7,667 8,477 60,375 55,038
Earnings per common share....................................... 0.29 0.33 2.32 2.13
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1994 1995
------------ ------------
(DOLLARS IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C> <C>
BALANCE SHEET DATA:
Total investments.................................................................... $ 747,176 $ 1,110,742
Prepaid reinsurance premiums......................................................... 121,668 136,248
Total assets......................................................................... 1,074,316 1,492,962
Unearned premiums.................................................................... 334,569 466,597
Notes Payable........................................................................ 30,000
Total liabilities.................................................................... 528,880 715,015
Shareholders' equity................................................................. 545,436 777,947
Book value per common share.......................................................... 20.92 24.67
</TABLE>
RESULTS OF OPERATIONS
THREE MONTHS AND THE YEAR ENDED DECEMBER 31, 1995 VERSUS THE PRIOR YEAR
Net income for the fourth quarter of 1995 was $18.5 million before a
one-time charge of $10.0 million, or $0.39 per share. The one-time charge
reflected an increase to FSA's general loss reserve consistent with FSA's
established reserving methodology, to provide for the CGIC insured portfolio in
the Merger. CGIC did not maintain a general reserve.
Reported net income for the fourth quarter was $8.5 million, or $0.33 per
share, compared with $7.7 million, or $0.29 per share, for the same period in
1994. For the year, net income was $55.0 million, or $2.13 per share, compared
with $60.4 million, or $2.32 per share in 1994. Both the quarter and the
year-to-
12
<PAGE>
date earnings results were also affected by higher regular additions to FSA's
general loss reserve and by an increase in the effective tax rate on investment
income caused by a repositioning of FSA Holdings' investment portfolio.
On December 20, 1995, Capital Guaranty merged with a subsidiary of FSA
Holdings. In connection with such Merger, CGIC, the principal operating
subsidiary of Capital Guaranty, changed its name to FSAM and became a subsidiary
of FSA. The Merger provided for each Capital Guaranty share to be exchanged for
0.6716 share of Common Stock and cash of $5.69. FSA Holdings issued in the
aggregate 6,051,661 shares of Common Stock. The aggregate cash consideration was
$51.3 million, or approximately 25% of the total merger consideration. The
purchase price, including transaction costs, was approximately $208.6 million.
In the fourth quarter of 1995, FSA (excluding CGIC) insured bonds totaling
$4.6 billion, a 52.1% increase over the same period in 1994. The fourth quarter
asset-backed component rose 60.4% to $2.4 billion. For the year ended December
31, 1995, FSA insured $15.2 billion of securities, a 52.6% increase over 1994,
and the asset-backed portion was $9.8 billion, up 76.9%. For the year ended
December 31, 1995, FSA and CGIC, combined, insured bonds totaling $18.6 billion,
of which $8.7 billion were municipal.
In the municipal bond market, total-market new issuance was approximately
$49.5 billion in the fourth quarter of 1995 and $156.2 billion for the year
ended December 31, 1995, representing an increase of 36% and a decline of 5%
from the respective 1994 levels. Industry insured volume in the primary market
was approximately $24.5 billion for the quarter, an increase over the $13.9
billion insured in 1994. For the year ended December 31, 1995, insured volume
was up approximately 11% to $68.1 billion.
In the fourth quarter of 1995, FSA insured $2.2 billion par of municipal
bonds, as compared with $1.5 billion in the same period of 1994. CGIC insured
$0.7 billion of municipal bonds in the fourth quarter, compared with $0.9
billion in the same period of 1994. For the year ended December 31, 1995, FSA
insured $5.4 billion of municipal bonds (21.9% more than in 1994), of which $3.4
billion were U.S. municipal new issues, representing approximately 5% of 1995
insured municipal new-issue volume. The remainder were secondary-market issues
or were issued by non-U.S. municipalities or government entities. CGIC insured
$3.3 billion of municipal bonds in 1995, including $2.9 billion of U.S.
municipal new issues, representing approximately 4% of the total number of new
issue long-term municipal bonds.
The present value ("PV") of gross premiums originated (which includes the
present value of installment premiums) in the fourth quarter and full-year of
1995 was $43.6 million and $139.1 million, respectively. The asset-backed
portion of fourth quarter PV premiums written grew 110.5% to $23.0 million as
compared with the same period of 1994, primarily because of higher volume. The
municipal portion was $20.6 million in the fourth quarter of 1995. In the fourth
quarter of 1994, FSA's municipal PV premiums written were $21.5 million.
Net income was reduced by the one-time charge associated with the increase
to FSA's general loss reserve of $10.0 million, net of taxes, or $0.39 per
share, provided by FSA Holdings in order to establish reserves for the CGIC
insured portfolio consistent with FSA's reserving methodology. Included in the
$8.5 million of net income for the fourth quarter was the contribution from
refundings and prepayments totalling $2.1 million, or $0.09 per share, and the
contribution from capital gains was $2.5 million, or $0.10 per share.
Fourth quarter operating net income (which excludes the impact of capital
gains or losses) adjusted for the provision to the general loss reserve for CGIC
was $16.0 million, or $0.63 per share, in 1995 and $14.4 million, or $0.55 per
share, in 1994. The increase in the quarter's operating net income relative to
the prior year was due to an increase in the contribution from refundings and
prepayments of $0.06 per share, and a $0.02 per share increase in core net
income (operating net income less the after-tax effect of refundings and
prepayments). Full-year operating net income declined 4.1% to $60.3 million and
operating earnings per share declined 3.0% to $2.34 when compared with 1994. The
year-to-year reduction in operating net income was caused by lower contributions
from refundings and prepayments of $0.2 million and a decline in core net
income.
Fourth quarter core net income, which excludes refundings and prepayments as
well as realized capital gains or losses, was $13.9 million ($0.54 per share),
1.3% higher than in the fourth quarter of 1994, when
13
<PAGE>
core net income was $13.7 million ($0.52 per share). Full year 1995 core net
income declined 4.2% versus the prior year's result of $53.7 million, or $2.08
per share. Full year core net income declined primarily because of higher
additions to FSA's general loss reserve and a higher effective tax rate on
investment income.
Fourth quarter net premiums earned rose 31.5% to $18.5 million due to the
higher level of refundings and prepayments in the fourth quarter of 1995 of $4.4
million, in comparison with $1.1 million in the fourth quarter of 1994.
Refundings and prepayments contributed $2.1 million and $0.6 million to fourth
quarter net income in the respective years. Net premiums earned for full-year
1995 were $69.3 million, a 5.5% increase from the $65.8 million earned in 1994.
Refundings and prepayments contributed $6.6 million and $6.8 million to net
income for 1995 and 1994, respectively.
Net investment income for the fourth quarter of 1995 was $12.1 million, an
increase of 2.5% over the result in 1994. Capital gains were $3.8 million in the
fourth quarter of 1995, an increase of $14.1 million from the $10.3 million in
capital losses recognized in the fourth quarter of 1994.
Net investment income for 1995 was $49.0 million, up 5.1% when compared with
the same period in 1994. Consistent with FSA Holdings' emphasis on total return
rather than current income, FSA Holdings repositioned its portfolio, primarily
during the first half of the year, through the sale of long-dated tax-exempt
securities and purchase of shorter-dated taxable securities. As a result, FSA
Holdings realized $5.1 million in capital gains for the year 1995, compared with
$3.8 million of capital losses for 1994, and FSA Holdings' effective tax rate on
investment income (excluding the effects of capital gains and losses) rose to
21.9% for 1995 from 14.4% for 1994. The after-tax total return for the
investment portfolio during 1995 was 11.6%.
Total policy acquisition and other operating expenses (total operating
expenses) for the fourth quarter of 1995 were $8.0 million, up from $6.1 million
in the fourth quarter of 1994. Total operating expenses for 1995 were higher
than in the same period in 1994 due to higher amortization of deferred
acquisition costs and increased accruals for performance plan payouts, which are
based on FSA Holdings' growth in adjusted book value per share. Total operating
expenses for 1995 were $30.6 million, up from $28.0 million for the same period
in 1994.
Fourth quarter core losses and loss adjustment expenses were $1.4 million in
1995 and $0.8 million in 1994, reflecting additions to the general loss reserve
in both years. Full-year 1995 core losses and loss adjustment expenses were $6.3
million, compared with $3.0 million in 1994. In December 1995, FSA Holdings
recognized a one-time charge of $15.4 million to increase FSA's general loss
reserve to provide for the CGIC insured portfolio in a manner consistent with
FSA's reserving methodology. Also in December 1995, FSA reclassified $9.7
million from the general loss reserve to case reserves associated predominantly
with certain residential mortgage and timeshare receivables transactions. At
December 31, 1995, FSA's unallocated general loss reserve totaled $31.8 million.
USE OF PROCEEDS
All of the shares of Common Stock to which this Prospectus relates may be
delivered by U S WEST, at its option, pursuant to the terms of the DECS, which
are being offered by U S WEST pursuant to the DECS Prospectus. FSA Holdings will
not receive any of the proceeds from the sale of the DECS or delivery thereunder
of the shares of Common Stock to which this Prospectus relates.
14
<PAGE>
PRICE RANGE OF COMMON STOCK AND DIVIDENDS
The following table sets forth for the calendar quarters indicated the high
and low sales prices for the Common Stock, as reported in the NYSE consolidated
transaction system, and the dividends paid per share since May 1994. Prior to
May 1994, the Common Stock was not publicly traded.
<TABLE>
<CAPTION>
SALES PRICES
-------------------- DIVIDENDS
HIGH LOW PAID
-------- -------- ------
<S> <C> <C> <C>
1994
May 6 -- June 30...................... $ 22 5/8 $ 20 $0.00
Third Quarter......................... 22 1/2 20 0.08
Fourth Quarter........................ 22 3/4 18 3/4 0.08
1995
First Quarter......................... $ 21 5/8 $ 19 0.08
Second Quarter........................ 25 1/2 21 1/2 0.08
Third Quarter......................... 27 3/4 24 1/4 0.08
Fourth Quarter........................ 27 24 1/2 0.08
1996
First Quarter (through January 25,
1996)................................ $ 25 1/2 24
</TABLE>
As of January 23, 1996, there were 134 holders of record of the Common Stock
and 31,502,025 shares outstanding.
The amount of dividends payable in the future will be reviewed periodically
by the Board of Directors in light of the Company's earnings, financial
condition and capital and other cash requirements. It is the policy of the Board
of Directors that FSA Holdings retain an adequate portion of its earnings to
support the growth of its business. There is no requirement or assurance that
dividends will be paid.
Most of the operations of FSA Holdings are conducted through FSA. FSA's
ability to declare and pay dividends to Capital Guaranty, which in turn declares
and pays dividends to FSA Holdings, is dependent upon FSA's financial condition,
results of operations, cash requirements and other related factors and is also
subject to restrictions contained in the insurance laws and related regulations
of New York and other states. See "Insurance Regulatory Matters -- Dividend
Restrictions" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources."
FSA Holdings will ordinarily be required to withhold United States federal
income taxes in the amount of 30% of any dividends paid to non-United States
shareholders not otherwise subject to United States federal income taxation,
unless a tax treaty between the United States and the country of the
shareholder's residence provides for withholding at a reduced rate.
15
<PAGE>
UNAUDITED PRO FORMA CONSOLIDATED CONDENSED FINANCIAL INFORMATION
BUSINESS OPERATIONS OF FSA HOLDINGS FOLLOWING THE MERGER
In connection with the Merger, FSA took a number of corporate actions, the
effect of which was to replace Financial Security Assurance International Inc.
("FSAI") with FSAM (formerly CGIC) in the corporate structure of the FSA group
of companies as a subsidiary of FSA, parent of Financial Security Assurance of
Oklahoma, Inc., and participant in the intercompany pooling agreement among the
domestic FSA insurance companies. Such transactions having been completed in
December 1995, FSAI is now an inactive company with no outstanding insurance or
reinsurance obligations, retaining the minimum capital necessary to maintain its
insurance licenses and intended for sale to a third party in 1996. The principal
business of FSAM going forward will be to serve as a reinsurer of policies
issued by FSA or reinsured by FSA from unaffiliated third parties.
FSA Holdings remains headquartered in New York and now has the benefit of a
significant west coast presence through its San Francisco office, the former
office of Capital Guaranty. The San Francisco office will be staffed to
underwrite transactions in coordination with the New York office. In line with
the plan established by FSA Holdings, the majority of the cost savings
associated with the Merger are expected to be brought about by the reduction in
personnel associated with the elimination of duplicative staff from the
accounting, information systems, marketing and human resource functions. FSA
Holdings expects to utilize its current staff levels in New York to support
these functions. In addition, but to a lesser extent, the Merger is also
expected to reduce the costs associated with redundant legal and surveillance
functions. These reductions in personnel are also expected to reduce related
overhead costs such as premises, equipment and similar costs.
The preceding cost savings will result in the reduction of $0.5 million of
policy acquisition costs and $2.5 million in other operating costs as reflected
in the pro forma consolidated condensed statement of operations for the nine
months ended September 30, 1995.
As a result of the reduction in personnel, FSA Holdings expects to establish
a reserve of $4.7 million to cover severance costs. The majority of these costs
are expected to be paid within a year after the effective time of the Merger.
FSA Holdings and Capital Guaranty both have an accounting policy which
establishes case basis loss reserves when, in management's opinion, the
likelihood of a future loss on a specific transaction is probable and
determinable at the balance sheet date. In addition, FSA Holdings establishes a
general loss reserve which is calculated by applying a loss factor to the net
par outstanding over the term of such insured obligations and discounting the
result at risk-free rates. FSA Holdings then establishes case basis reserves out
of the general loss reserve as necessary. FSA Holdings' accounting policy
requires a provision to increase its general loss reserve when business is
written directly, assumed through reinsurance or acquired. Therefore, FSA
Holdings applied FSA's general reserve methodology to CGIC's insured portfolio,
and incurred a $15.4 million pre-tax charge for losses and loss adjustment
expenses. It is management's belief that, over time, the two methodologies would
result in similar total losses, but the timing of loss recognition would be
different.
The pro forma investment portfolio was approximately $1,073 million at
September 30, 1995. This balance has been reduced by the payment of $51.3
million to stockholders of Capital Guaranty and $4.2 million of estimated
transaction costs incurred in connection with the Merger.
FINANCIAL STATEMENTS
The following pro forma consolidated condensed financial statements reflect
the Merger of Capital Guaranty with a subsidiary of FSA Holdings. The Merger
will be accounted for as a "purchase" of Capital Guaranty by FSA Holdings under
GAAP. As such, FSA Holdings will record goodwill for the excess of the cost to
acquire Capital Guaranty over the sum of the amounts assigned to Capital
Guaranty's identifiable assets acquired less liabilities assumed. The pro forma
consolidated condensed financial statements are unaudited and combine the
operations of FSA Holdings and Capital Guaranty for the nine months ended
16
<PAGE>
September 30, 1995 and for the year ended December 31, 1994. The pro forma
consolidated condensed balance sheet assumes the Merger occurred at September
30, 1995. The pro forma consolidated condensed statements of operations assume
the Merger occurred at January 1, 1994.
The historical financial information of FSA Holdings as of and for the nine
months ended September 30, 1995 and for the year ended December 31, 1994 have
been derived from the FSA Holdings financial statements which are incorporated
herein by reference. The historical financial information of Capital Guaranty as
of and for the nine months ended September 30, 1995 and for the year ended
December 31, 1994 have been derived from the Capital Guaranty financial
statements which are incorporated herein by reference. The pro forma
consolidated condensed financial statements should be read in conjunction with
the historical financial statements of FSA Holdings and Capital Guaranty
incorporated herein by reference. See "Available Information" and "Incorporation
of Certain Documents By Reference."
The unaudited pro forma consolidated condensed financial statements have
been included as required by the Commission and are provided for comparative
purposes only. As further discussed in the accompanying notes, the pro forma
financial statements do not purport to be indicative of the financial position
or operating results that would have been achieved had the Merger been
consummated as of the dates indicated and should not be construed as
representative of future financial position or operating results.
17
<PAGE>
PRO FORMA CONSOLIDATED CONDENSED BALANCE SHEET
AS OF SEPTEMBER 30, 1995
UNAUDITED
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
------------------------ ADJUSTMENTS
FSA CAPITAL INCREASE NOTE
HOLDINGS GUARANTY (DECREASE) REFERENCE PRO FORMA
------------ ---------- ------------ ---------- ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
ASSETS
Investments................................. $ 811,365 $ 316,214 $ (51,272) (a) $ 1,072,717
(4,200) (b)
610 (c)
Deferred Acquisition Costs.................. 99,635 29,203 128,838
Prepaid Reinsurance Premiums................ 118,436 17,591 136,027
Reinsurance Recoverable on Unpaid Losses.... 58,212 58,212
Other Assets................................ 49,621 8,620 (300) (d) 67,386
9,445 (e)
------------ ---------- ------------ ------------
TOTAL ASSETS............................ $ 1,137,269 $ 371,628 $ (45,717) $ 1,463,180
------------ ---------- ------------ ------------
------------ ---------- ------------ ------------
LIABILITIES
Unearned Premiums........................... $ 335,367 $ 124,526 $ $ 459,893
Losses and Loss Adjustment
Expenses................................... 97,905 15,400 (f) 113,305
Debt........................................ 30,000 30,000
Other Liabilities........................... 95,402 14,978 (7,572) (g) 108,556
1,000 (h)
4,748 (i)
------------ ---------- ------------ ------------
TOTAL LIABILITIES....................... $ 528,674 $ 169,504 $ 13,576 $ 711,754
------------ ---------- ------------ ------------
------------ ---------- ------------ ------------
SHAREHOLDERS' EQUITY
Preferred Stock............................. $ 20 $ 12 $ (12) (j) $ 20
Common Stock................................ 262 879 (879) (k) 323
61 (l)
Additional Paid in Capital.................. 544,946 152,229 (152,229) (k) 696,929
151,983 (l)
Net Unrealized Gain (Loss) on Investments... 7,759 4,106 (4,106) (k) 7,759
Accumulated Earnings........................ 65,970 44,898 (54,908) (f)(k) 55,960
Deferred Equity Compensation................ 3,812 797 (m) 4,609
Treasury Stock.............................. (14,174) (14,174)
------------ ---------- ------------ ------------
TOTAL STOCKHOLDERS' EQUITY.............. 608,595 202,124 (59,293) 751,426
------------ ---------- ------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY................................. $ 1,137,269 $ 371,628 $ (45,717) $ 1,463,180
------------ ---------- ------------ ------------
------------ ---------- ------------ ------------
Per Common Share Data:
Book Value.................................. $ 23.74 $ 22.39 $ 23.71
Tangible Book Value......................... $ 23.74 $ 22.39 $ 23.42
Common Shares Outstanding................... 25,605 8,794 31,657
</TABLE>
18
<PAGE>
PRO FORMA CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995
UNAUDITED
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
---------------------- ADJUSTMENTS
FSA CAPITAL INCREASE NOTE
HOLDINGS GUARANTY (DECREASE) REFERENCE PRO FORMA
--------- ----------- ------------ ---------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
REVENUES
Premiums Earned.................................... $ 50,837 $ 8,727 $ $ 59,564
Net Investment Income (Loss)....................... 36,877 14,196 (2,742) (n) 48,331
Net Realized Gains................................. 1,333 542 1,875
Other Income....................................... 2,705 38 2,743
--------- ----------- ------------ -----------
TOTAL REVENUES................................. 91,752 23,503 (2,742) 112,513
--------- ----------- ------------ -----------
EXPENSES
Losses and Loss Adjustment Expenses................ 4,822 600 (o) 5,422
Policy Acquisition Costs........................... 12,413 2,639 (460) (p) 14,592
Interest Expense................................... 1,586 255 (q) 1,841
Other Operating Expenses........................... 10,113 3,385 283 (r) 11,300
(2,481) (s)
--------- ----------- ------------ -----------
TOTAL EXPENSES................................. 27,348 7,610 (1,803) 33,155
--------- ----------- ------------ -----------
INCOME BEFORE INCOME TAXES......................... 64,404 15,893 (939) 79,358
Provision for Income Taxes......................... 17,843 3,740 (140) (t) 21,443
--------- ----------- ------------ -----------
NET INCOME (LOSS).................................. $ 46,561 $ 12,153 $ (799) $ 57,915
--------- ----------- ------------ -----------
--------- ----------- ------------ -----------
Weighted Average Common Shares Outstanding......... 25,860 8,794 N/A 31,695
Earnings Per Common Share.......................... $ 1.80 $ 1.35 N/A $ 1.83
</TABLE>
19
<PAGE>
PRO FORMA CONSOLIDATED CONDENSED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1994
UNAUDITED
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
---------------------- ADJUSTMENTS
FSA CAPITAL INCREASE NOTE
HOLDINGS GUARANTY (DECREASE) REFERENCE PRO FORMA
--------- ----------- ------------ ---------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
REVENUES
Premiums Earned.................................... $ 65,754 $ 12,593 $ $ 78,347
Net Investment Income (Loss)....................... 46,592 16,655 (3,656) (n) 59,591
Net Realized Gains (Losses)........................ (3,773) 1,138 (2,635)
Other Income....................................... 777 34 811
--------- ----------- ------------ -----------
TOTAL REVENUES................................. 109,350 30,420 (3,656) 136,114
--------- ----------- ------------ -----------
EXPENSES
Losses and Loss Adjustment Expenses................ 3,024 850 (o) 3,874
Policy Acquisition Costs........................... 15,057 4,707 (339) (p) 19,425
Interest Expense................................... 2,115 340 (q) 2,455
Other Operating Expenses........................... 12,979 4,230 378 (r) 14,525
(3,062) (s)
--------- ----------- ------------ -----------
TOTAL EXPENSES................................. 31,060 11,052 (1,833) 40,279
--------- ----------- ------------ -----------
INCOME BEFORE INCOME TAXES......................... 78,290 19,368 (1,823) 95,835
Provision for Income Taxes......................... 17,915 4,679 (386) (t) 22,208
--------- ----------- ------------ -----------
NET INCOME..................................... $ 60,375 $ 14,689 $ (1,437) $ 73,627
--------- ----------- ------------ -----------
--------- ----------- ------------ -----------
Weighted Average Common Shares Outstanding......... 26,070 8,943 N/A 32,054
Earnings Per Common Share.......................... $ 2.32 $ 1.60 N/A $ 2.30
</TABLE>
20
<PAGE>
NOTES TO UNAUDITED PRO FORMA
CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
The pro forma consolidated condensed financial statements reflect the Merger
of Capital Guaranty with a subsidiary of FSA Holdings. The pro forma financial
statements assume all shares of Capital Guaranty Common Stock, $.10 par value
("Capital Guaranty Common Stock"), are converted, pursuant to the Merger, into
shares of FSA Holdings Common Stock at a per share stock consideration of 0.6716
of a share of FSA Holdings Common Stock (determined based on an average FSA
Holdings Common Stock price of $25.775), per share cash consideration of $5.69
and a total cash consideration (the "Total Cash Consideration") of approximately
$51.3 million.
FSA Holdings management's preliminary allocation of the purchase price was
based upon the estimated fair value of assets acquired and liabilities assumed.
The actual allocation will be based on further studies and valuations as of the
effective time of the Merger and will be primarily affected by the impact of
market interest rates as of the effective time of the Merger upon the valuation
of assets of Capital Guaranty, the effect of the FSA Holdings Common Stock price
as of the effective time of the Merger and the accrual at the effective time of
the Merger of estimated costs to eliminate excess office space and equipment and
to record the estimated liability for severance and other employee termination
costs. The actual adjustments (other than those related to accruals of certain
costs at the effective time of the Merger described above) are not, at the
present time, expected to be significantly different; however, there can be no
assurance that significant differences will not arise.
With the exception of Items (c), (f) and (o) described below, the pro forma
consolidated condensed financial statements do not include adjustments to
conform the accounting policies of Capital Guaranty to those followed by FSA
Holdings. The nature and extent of additional adjustments, if any, will be based
upon further study and analysis and would not be expected to affect
significantly the pro forma financial results.
The following describes the pro forma adjustments reflected in the
accompanying pro forma consolidated condensed financial statements:
(a) To adjust for the Total Cash Consideration paid to holders of
Capital Guaranty Common Stock.
(b) To record the direct out-of-pocket costs of the Merger.
(c) To mark-to-market Capital Guaranty's held to maturity investment
portfolio to conform to FSA Holdings' accounting policy which classifies all
its securities as held for sale.
(d) To record the furniture, fixtures and equipment of Capital Guaranty
at fair value.
(e) To record goodwill for the excess of the cost to acquire Capital
Guaranty over the sum of the amounts assigned to identifiable assets
acquired less liabilities assumed.
(f) At the effective time of the Merger, FSA Holdings applied its
general reserve methodology to CGIC's insured portfolio, which will require
it to incur a $15.4 million pre-tax charge for losses and loss adjustment
expenses.
(g) To record the deferred and current tax liability accounts for all
acquisition adjustments with the exception of goodwill and out-of-pocket
costs of the acquisition.
(h) To establish a reserve for contingent state income tax liabilities.
It is estimated that the contingency will be settled within twelve months
with goodwill being adjusted for the outcome. FSA Holdings does not believe
that the ultimate liability will exceed $1.0 million.
(i) To record estimated liability for severance and other employee
costs expected to result from the Merger.
(j) To reflect the redemption of the Capital Guaranty Preferred Stock.
(k) To eliminate Capital Guaranty's stockholders' equity.
(l) To record the fair value of FSA Holdings Common Stock (at $25.125
per share) issued to acquire Capital Guaranty Common Stock for $152.0
million (6,051,489 shares of FSA Holdings Common Stock issued for 9,010,811
shares of Capital Guaranty Common Stock at a conversion ratio of
21
<PAGE>
0.6716). The purchase price, including transaction costs, of $208.6 million
was equal to the fair value of Common Stock issued to acquire Capital
Guaranty's common stock plus $51.3 million in cash (see note (a)), plus $4.2
million in transaction costs (see note (b)) and $0.8 million for stock
options issued (see note (m)).
(m) To record the excess of the assumed market value ($25.125) over the
grant price with respect to the stock options of FSA Holdings to be given to
Capital Guaranty employees in exchange for their outstanding Capital
Guaranty stock options.
(n) To reflect the reduction of investment income due to the payment of
$51.3 million to shareholders of Capital Guaranty (see note (a)) and $4.2
million of estimated transaction costs (see note (b)) at an assumed interest
rate of 6.59% which was FSA Holdings' investment rate in January 1994.
(o) To record the increase to FSA's general loss reserve for new
business underwritten by CGIC consistent with FSA's general reserve
methodology.
Based on FSA Holdings' detailed plans, it is expected that certain costs and
expenses of the combined companies will be less than the historical expenses due
to the consolidation of certain operations and elimination of duplicative
facilities. The estimated expense reductions are primarily related to the
elimination of duplicative facilities, equipment, personnel and functions.
The pro forma pre-tax expense reductions, based on FSA Holdings' detailed
plans, are estimated to total $5.8 million, of which $2.7 million is a reduction
of policy acquisition costs, for the year ended December 31, 1994 and $4.7
million, of which $2.2 million is a reduction of policy acquisition costs, for
the nine months ended September 30, 1995. Adjustments (p), (s) and (t) reflect
these estimated cost savings.
(p) To adjust amortization policy acquisition costs for the reduction in
expenses.
(q) To reflect dividends on the Capital Guaranty Preferred Stock assumed
to be outstanding after the Merger.
(r) To amortize goodwill over a twenty-five year period.
(s) To reduce expenses due to elimination of duplicative facilities,
personnel and functions net of the effect of costs deferred or amortized.
(t) To record accrued taxes on all adjustments with the exception of
goodwill, amortization and preferred stock dividends.
Adjusted book value per common share, which is tangible book value plus net
unearned premium reserve plus the present value of net future installment
premiums less deferred acquisition costs less tax effect (in each case, on a per
common share basis), is used by management and equity analysts as a measurement
of FSA Holdings' and Capital Guaranty's intrinsic value. Adjusted book value per
common share is not a substitute for GAAP book value per common share. At
September 30, 1995, the historical adjusted book value per common share was
$29.77 for FSA Holdings and $28.13 for Capital Guaranty. The pro forma adjusted
book value per common share at September 30, 1995 would have been $29.89.
22
<PAGE>
SELECTED CONSOLIDATED FINANCIAL INFORMATION OF
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
The following table sets forth selected consolidated historical financial
information of FSA Holdings and has been derived from and should be read in
conjunction with the audited consolidated financial statements of FSA Holdings
for each of the five years ended December 31, 1994 and the unaudited interim
consolidated financial statements of FSA Holdings for the nine-month periods
ended September 30, 1995 and 1994, including the respective notes thereto. See
"Available Information" and "Incorporation of Certain Documents by Reference."
In the opinion of management, all adjustments, consisting of normal recurring
accruals, considered necessary for a fair presentation, have been included in
the unaudited interim data. Interim results for the nine months ended September
30, 1995 are not necessarily indicative of results which may be expected for
future periods, including the year ending December 31, 1995. The financial
information set forth below does not reflect the effects of the consummation in
December 1995 of the Merger. See "Capital Guaranty Corporation," "Selected
Financial Information of Capital Guaranty Corporation," "Incorporation of
Certain Documents by Reference," "Unaudited Pro Forma Consolidated Condensed
Financial Information," and "Recent Developments."
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED DECEMBER 31, ENDED SEPTEMBER 30,
---------------------------------------------------------------------- -------------------------------
1990 1991 1992 (1) 1993 (2) 1994 1994 1995
----------- ----------- ----------- -------------- -------------- -------------- --------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT
Gross premiums written... $ 124,266 $ 110,727 $ 131,131 $ 127,409 $ 106,449 $ 75,144 $ 78,331
Net premiums written..... 101,100 55,910 78,397 65,006 77,757 53,253 54,917
Net premiums earned...... 39,309 60,510 63,857 63,377 65,754 51,674 50,837
Net realized gains
(losses)................ (972) 9,087 29,153 18,292 (3,773) 6,518 1,333
Net investment income.... 31,337 45,059 47,024 47,948 46,592 34,792 36,877
Total revenues........... 70,466 116,967 142,506 127,654 109,350 93,531 91,752
Losses and loss
adjustment expenses..... 125 9,901 54,623 84,054 3,024 2,270 4,822
Amortization and
write-off of goodwill... 3,718 3,718 3,718 81,598
Policy acquisition and
other expenses.......... 21,648 32,222 31,323 40,459 28,036 21,925 22,526
Income (loss) before
income taxes............ 44,975 71,126 52,842 (163,866) 78,290 69,336 64,404
Net income (loss)........ 31,270 52,803 43,457 (124,707) 60,375 52,708 46,561
Earnings (loss) per
common share............ 1.80 2.40 1.90 (5.44) 2.32 2.03 1.80
Cash dividends per common
share................... 1.65 0.26 0.16 0.08 0.24
SELECTED FINANCIAL RATIOS
GAAP BASIS (3)
Loss ratio............... 0.3% 16.4% 85.5% 132.6% 4.6% 4.4% 9.5%
Expense ratio............ 54.7 46.0 47.3 62.1 40.5 40.3 42.4
Combined ratio........... 55.0% 62.4% 132.8% 194.7% 45.1% 44.7% 51.9%
SAP BASIS(3)
Loss ratio............... 0.4% 18.3% 67.7% 0.7% 28.1% 2.7% 1.7%
Expense ratio............ 36.1 77.6 47.5 52.2 59.1 79.5 49.1
Combined ratio........... 36.5% 95.9% 115.2% 52.9% 87.2% 82.2% 50.8%
BALANCE SHEET
Total investments........ $ 485,754 $ 659,880 $ 727,455 $ 786,723(4) $ 747,176(4) $ 709,329(4) $ 811,365(4)
Prepaid reinsurance
premiums................ 43,124 71,288 98,225 127,849 121,668 121,891 118,436
Total assets............. 711,588 933,550 1,042,362 1,030,587 1,074,316 991,025 1,137,269
Unearned premiums........ 232,621 256,051 297,073 328,165 334,569 324,175 335,367
Total liabilities........ 282,701 361,811 433,166 488,615 528,880 443,115 528,674
Shareholders' equity..... 428,887 571,739 609,196 541,972 545,436 547,910 608,595
Book value per common
share................... 22.24 25.00 26.64 20.95 20.92 20.88 23.74
SELECTED FINANCIAL
STATISTICS (3)
Gross insurance in
force................... $34,091,000 $45,045,000 $52,592,000 $61,290,000 $65,824,000 $62,686,000 $73,924,000
Net insurance in force... 27,537,000 33,447,000 37,334,000 41,667,000 45,825,000 43,040,000 52,546,000
Qualified statutory
capital................. 291,933 420,326 461,443 454,048 465,787 484,906 495,031
Policyholders' leverage
ratio................... 94:1 80:1 81:1 92:1 98:1 89:1 106:1
ANALYTICAL DATA
Tangible book value per
common share (5)(7)..... $ 18.35 $ 21.27 $ 23.07 $ 20.95 $ 20.92 $ 20.88 $ 23.74
Adjusted book value per
common share (6)(7)..... 20.45 26.67 28.98 26.15 26.40 25.91 29.77
</TABLE>
- ----------------------------------
(1) Results for full year 1992 were adversely affected by $54.6 million of
additional reserves, consisting of case basis reserves for three commercial
mortgage transactions insured by FSA and the establishment of the general
loss reserve.
(2) Results for the year ended December 31, 1993 were adversely affected by
$63.7 million in net incurred losses for three commercial mortgage
transactions insured by FSA, $63.0 million of which losses were directly
paid by a letter of credit provided by U S WEST (the "U S WEST Letter of
Credit"). The payment under the U S WEST Letter of Credit was accounted for
under GAAP as a contribution of capital (net of related tax effect) and the
related losses were reflected as an expense in FSA's income statement, while
for SAP income statement purposes the drawings under the U S WEST Letter of
Credit were netted against such losses. Results were also adversely affected
by an increase of $20.3 million in FSA's general loss reserve for
unidentified losses
23
<PAGE>
covering FSA's entire insured portfolio, a write-off of $78.8 million of
goodwill, a restructuring charge of $85.4 million resulting from the premium
payment by FSA to Commercial under FSA's reinsurance agreement with
Commercial Re and non-recurring charges of approximately $10.0 million.
Gross and net premiums written were reduced due to the cession of $17.9
million of unearned premiums from FSA to Commercial Re under such
reinsurance agreement.
(3) These ratios and statistics relate solely to FSA. The GAAP loss ratio is
losses and loss adjustment expenses incurred (inclusive of additions to the
general loss reserve) divided by net premium earned. The SAP loss ratio is
losses and loss adjustment expenses incurred (exclusive of additions to the
general loss reserve) divided by net premiums earned. The GAAP expense ratio
is underwriting and operating expenses divided by net premiums earned. The
SAP expense ratio is underwriting and operating expenses divided by net
premiums written. The combined ratio on both a GAAP and SAP basis is the sum
of the applicable loss and expense ratios.
(4) Total investments at December 31, 1993 and 1994 and September 30, 1994 and
1995 included $54.1 million net unrealized gains, $33.7 million net
unrealized losses, $26.0 million net unrealized losses and $11.9 million net
unrealized gains, respectively. In addition, the balance at December 31,
1993 included $24.3 million of funds withheld from the premium ceded by FSA
to Commercial Re, pending deposit of such funds in a trust account
satisfying the requirements of applicable insurance law. Total investments
at December 31, 1990, 1991 and 1992 were recorded at amortized cost in
accordance with GAAP and therefore do not include unrealized gains or
losses.
(5) Tangible book value per common share is book value per common share less
goodwill per common share.
(6) Adjusted book value per common share, which is tangible book value plus net
unearned premium reserve plus the present value of net future installment
premiums less deferred acquisition costs less tax effect (in each case, on a
per common share basis), is used by management and equity analysts as a
measurement of FSA Holdings' and Capital Guaranty's intrinsic value.
Adjusted book value per common share is not a substitute for GAAP book value
per common share.
(7) Tangible book value per common share and adjusted book value per common
share do not include the effect of unrealized gains on investments for the
years ended December 31, 1990, 1991 and 1992, which were $0.04, $0.71 and
$0.60 per common share, respectively.
24
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
MERGER, INITIAL PUBLIC OFFERING AND RESTRUCTURING
In December 1995, FSA Holdings acquired Capital Guaranty pursuant to the
Merger. The Merger consideration consisted of $51.3 million in cash and the
issuance of 6,051,489 shares of Common Stock, including shares issued for
preferred shares converted after September 30, 1995. The purchase price,
including transaction costs, was approximately $208.6 million. As a result of
the Merger, Capital Guaranty became a direct, wholly owned subsidiary of FSA
Holdings. The financial results set forth below do not give effect to the
acquisition of Capital Guaranty. For additional information with respect to
Capital Guaranty, see "Recent Developments," "Capital Guaranty Corporation,"
"Selected Historical Financial Information of Capital Guaranty Corporation" and
"Incorporation of Certain Documents by Reference."
The initial public offering of FSA Holdings (the "IPO") occurred on May 13,
1994, with the sale of 7.5 million common shares listed on the NYSE. Two million
of those shares were acquired by Fund American. In September 1994, Fund American
purchased 50,000 shares of a class of newly created 7% Series B Cumulative
Redeemable Preferred Stock issued by U S WEST and obtained options to purchase
up to 2,560,607 shares of FSA Holdings' stock from USWCC. Fund American also
purchased 2,000,000 shares of FSA Holdings' newly issued, non-dividend paying,
voting, ten-year Series A Convertible Redeemable Preferred Stock, which may be
converted into an equal number of shares of FSA Holdings' common stock at a
conversion price of $29.65 per share (subject, in each case, to anti-dilution).
Under a voting trust agreement with USWCC, Fund American obtained voting rights
equal to 21.0% of FSA Holdings, which reduced U S WEST's voting rights to 49.8%,
at December 31, 1994.
In contemplation of the IPO, in December 1993, FSA Holdings, through its
insurance subsidiary, FSA, significantly reduced its risk of loss from the
commercial mortgage transactions previously insured by FSA. By obtaining quota
share reinsurance for $1.5 billion of outstanding par, FSA reduced its net par
exposure to $0.3 billion. The reinsurance was provided by Commercial Re, an
insurance company organized specifically for this purpose and owned by USWCC and
Tokio Marine. In connection with the Commercial Re cession, FSA Holdings
recognized a special charge of $85.4 million and ceded $17.9 million of its
unearned premium for the premium owed to Commercial Re under the reinsurance
agreement. Also, FSA Holdings sold 3,000,000 shares of Common Stock to USWCC at
$19.68 per share. This capital contribution was used partially to offset the
$78.5 million used by FSA Holdings to capitalize Commercial Re and the premium
payment under the Commercial Re reinsurance agreement (collectively, the
"Restructuring").
In order to present a more complete comparison of 1993 year-end results with
those of 1994, revenue, expense and per-share data affected by the Restructuring
are disclosed for the year ended 1993 on both an historical basis and adjusted
as if the Restructuring had taken place on January 1, 1993.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1995 VERSUS NINE MONTHS ENDED SEPTEMBER 30,
1994
FSA Holdings' 1995 first nine months net income was $46.6 million, compared
with $52.7 million for the same period in 1994, a decrease of 11.7%. The
decrease was due to the following: (i) refundings were lower in 1995
contributing $4.5 million to net income compared with $6.2 million in 1994; (ii)
FSA Holdings increased its general reserve provision by $2.6 million relative to
1994 and (iii) tax rates on investment income increased to 22.3% in 1995 from
13.2% in 1994 as FSA Holdings shifted its focus in managing its investment
portfolio from current earnings to long-term total return and repositioned its
investment portfolio from long-dated tax-exempt securities into shorter term
taxable securities. Therefore, while investment income increased $2.1 million
when the first nine months of 1995 is compared with 1994, the increase in tax
rates on investment income resulted in an increase of $3.6 million in taxes. As
a result of executing this investment strategy, FSA Holdings realized after-tax
capital gains for the first nine months in 1995 of $0.9 million compared with
after-tax realized capital gains of $4.2 million in the prior year.
Operating net income (net income less the after-tax effect of net realized
capital gains or losses) was $44.3 million for the first nine months of 1995
versus $48.5 million for the comparable period in 1994, a
25
<PAGE>
decrease of 8.7%. Core net income (operating net income less the after-tax
effect of refundings and prepayments) was $39.7 million for the first nine
months of 1995 versus $42.3 million for the comparable period in 1994, a
decrease of 6.0%.
The weighted average number of shares of Common Stock outstanding decreased
from 26,044,000 for the first nine months of 1994 to 25,860,000 for the nine
months ended September 30, 1995. This decrease was due to repurchases of FSA
Holdings' stock to fund various equity-based compensation plans. Earnings per
share decreased from $2.03 for the first nine months of 1994 to $1.80 for the
same period in 1995.
Gross premiums written increased 4.2%, to $78.3 million for the first nine
months of 1995 from $75.1 million for the first nine months of 1994. Gross PV of
premiums written for the first nine months of 1995 also increased by 34.3%, to
$95.5 million from the prior year's total of $71.1 million. In the first nine
months of 1995, asset-backed gross PV premiums written were up 103.3% to $57.6
million, as business increased in all sectors relative to PV premiums written in
the first nine months of 1994 of $28.3 million. For the municipal business,
gross PV premiums written in the first nine months decreased 11.4% from $42.8
million in 1994 to $37.9 million in 1995. In the first nine months of 1995, the
estimated total market par volume of municipal new issues was $105.4 billion, a
decrease of 18% from 1994's level and the par insured by the industry decreased
8.5% to $43.4 billion in 1995.
Net premiums written were $54.9 million for the first nine months of 1995,
an increase of 3.1% when compared with the same period in 1994. Net premiums
written increased at a slower pace than gross premiums written due to higher
reinsurance cessions than in the previous year.
Net premiums earned for the first nine months of 1995 were $50.8 million,
compared with $51.7 million for the same period in 1994, a decrease of 1.6%.
Premiums earned from refundings and prepayments were $9.3 million for the first
nine months of 1995 and $13.2 million for the same period in 1994, contributing
$4.5 million and $6.2 million to after-tax earnings. Net premiums earned for the
period grew 7.8% relative to 1994 when the effects of refundings and prepayments
are eliminated. While prepayments may continue throughout the remainder of the
year, no assurances can be given that they will continue at the same level that
was experienced in the first nine months of 1995.
Net investment income was $36.9 million for the first nine months of 1995
and $34.8 million for the comparable period in 1994, an increase of 6.0%, and
has been affected by a general decline in market interest rate levels and by a
higher effective tax rate on investment income. Over the past year, FSA Holdings
has repositioned its investment portfolio from long-dated tax-exempt securities
into shorter-term taxable securities, resulting in the tax rate on investment
income increasing from 13.2% in the first nine months of 1994 to 22.3% in the
first nine months of 1995. Net capital gains realized by FSA Holdings were $1.3
million for the first nine months of 1995 as compared with $6.5 million for the
same period in 1994. Realized capital gains and losses are the by-product of FSA
Holdings' investment strategy and may vary substantially from period to period.
The provisions for losses and loss adjustment expenses during the first nine
months of 1995 and 1994 were $4.8 million and $2.3 million, respectively,
representing additions to FSA Holdings' general loss reserve.
Total policy acquisition and other operating expenses were $22.5 million for
the first nine months of 1995 compared with $21.9 million for the same period in
1994, an increase of 2.8%. Eliminating the effect of refundings and prepayments,
total policy acquisition and other operating expenses would have increased 10.0%
due to higher amortization of deferred acquisition costs and higher compensation
costs in 1995.
Income before income taxes for the first nine months of 1995 was $64.4
million, down from $69.3 million, or 7.1%, for the same period in 1994.
FSA Holdings' effective tax rate for the first nine months of 1995 was 27.7%
compared with 24.0% for the same period in 1994. The increase in effective tax
rates was due to taxable interest income contributing a higher proportion of
pre-tax income in the first nine months of 1995 compared to the first nine
months of 1994.
26
<PAGE>
YEAR ENDED DECEMBER 31, 1994 VERSUS YEAR ENDED DECEMBER 31, 1993
Because a large part of FSA's business is in the asset-backed market, where
installment premiums are typical, gross premiums written has limited use as an
indicator of current-year originations. To gauge more accurately year-to-year
changes in originations, management uses the PV of premiums written, which
captures both upfront and installment premiums from current originations only.
To calculate PV premiums, management estimates the life of each transaction that
has installment premiums and discounts the future installment payments at an
annual rate of 9.5%, a rate FSA Holdings has used consistently since it began
calculating PV premiums.
Both gross premiums written and gross PV premiums written declined in 1994,
primarily because FSA Holdings wrote less municipal bond insurance. Gross
premiums written were $106.4 million during 1994, compared with $127.4 million
during 1993, a decrease of 16.5%. Gross PV premiums written during 1994 were
$103.5 million, versus $130.7 million during 1993, a decrease of 20.8%
While FSA Holdings' municipal insured par volume was down 40.3% to $4.4
billion, the overall municipal new issue market and the insured portion of this
market had even greater declines of 44% each. Gross PV premiums written for the
municipal business decreased only 30.1%, to $64.2 million in 1994, as a result
of deliberate effort by FSA Holdings to maintain average premium rates rather
than reduce prices to increase volume.
Partially offsetting the decrease in municipal par volume was an increase in
FSA Holdings' asset-backed par volume for 1994, which totaled $5.6 billion, up
29.7% from 1993. Asset-backed premiums increased only slightly, however, because
premium rates were lower and transactions closed in 1994 generally had shorter
average lives. Gross PV premiums written for the asset-backed business were
$39.3 million in 1994, an increase of $0.5 million from the prior year.
Net premiums written were $77.8 million for 1994, compared with $65.0
million for 1993, an increase of 19.6%. Net premiums written for 1993 were
reduced $17.9 million by the cession of premiums to Commercial Re in connection
with the Restructuring. Adjusting for this cession, net premiums written would
have been $82.9 million for 1993, resulting in a decrease in 1994 of 6.2%. The
percentage decrease in net premiums written was less than that for gross
premiums written due to a reduction in FSA Holdings' need for facultative
reinsurance during 1994. FSA Holdings uses facultative reinsurance, in addition
to its reinsurance treaties, to comply with internal and external guidelines
limiting FSA Holdings' exposure to single risks and portfolio concentrations.
Net premiums earned for 1994 were $65.8 million, compared with $63.4 million
for 1993, an increase of 3.8%. This increase in net premiums earned was
primarily due to a greater recognition of premium earnings from refunded and
prepaid obligations than occurred in 1993, offset by a reduction during 1994 for
the effects of premiums ceded to Commercial Re. Adjusting for this cession, net
premiums earned would have been $58.1 million for 1993, resulting in an increase
of 13.3% when 1993 is compared with 1994. Net premiums earned from refunded or
prepaid obligations were $14.2 million and $10.4 million during 1994 and 1993,
respectively, contributing $6.8 million and $5.1 million to net income for the
respective periods.
Net investment income for 1994 was $46.6 million, compared with $47.9
million for 1993. If net investment income were adjusted as of January 1, 1993,
to reflect funds utilized in the Restructuring, net investment income for 1993
would have been $42.2 million, and 1994 results would have reflected an increase
of 10.5%. Consistent with FSA Holdings' emphasis on total return rather than
current income, management repositioned the investment portfolio during 1994 by
selling long-dated tax-exempt securities and buying shorter-dated taxable
securities. This repositioning caused the following changes: (i) the investment
yield decreased from an average yield of 6.53% for 1993 to an average yield of
6.50% for 1994 as FSA Holdings shortened the duration of its portfolio; (ii) FSA
Holdings realized capital losses of $3.8 million during 1994, compared with
capital gains of $18.3 million for 1993; and (iii) FSA Holdings' operating
effective tax rate (excluding the effect of capital gains and losses, losses and
loss adjustment expenses, and restructuring charges) increased from 19.8% for
1993 to 23.4% for 1994. Investment and cash equivalent balances were $747.2
million at December 31, 1994, versus $786.7 million at December 31, 1993, a
27
<PAGE>
decrease of $39.5 million or 5.0%. Because FSA Holdings designated its entire
investment portfolio as held for sale, it is required to mark-to-market its
investment portfolio, causing the reported investment balance to decline $87.5
million from year-end 1993 to year-end 1994.
Other income was $0.8 million for 1994, compared with a loss of $2.0 million
for 1993, due primarily to a $2.8 million write-down to net realizable value in
1993 of FSA Holdings' interest in the residual cash flow of the assets
collateralizing an insured transaction. FSA Holdings had received this interest
in connection with the insured transaction.
Losses and loss adjustment expenses for 1994 were $3.0 million, compared
with $84.1 million for 1993. The losses and loss adjustment expenses in 1994
were due to the increase in FSA Holdings' general reserve. Of the $84.1 million
in 1993, $63.7 million related to additional case basis reserves for three
transactions in FSA Holdings' commercial mortgage portfolio, and the remaining
$20.3 million related primarily to an increase in the general reserve to reflect
the potential for loss in the commercial mortgage portfolio. The increase to the
general reserve attributable to business underwritten in 1993 was $2.6 million.
Total operating expenses (total expenses less goodwill, restructuring
charges and losses and loss adjustment expenses) were $28.0 million for 1994,
compared with $40.5 million for 1993. Had the Restructuring been in effect
during 1993 and the effects of approximately $7.2 million in non-recurring
charges eliminated, total operating expenses would have been $28.5 million. The
details of the non-recurring charges in 1993 are discussed in "Results of
Operations -- Year Ended December 31, 1993 Versus Year Ended December 31, 1992."
Current direct costs (total operating expenses excluding the effects of deferral
and amortization of policy acquisition costs, interest expense and ceding
commission income) for 1994 were $45.7 million, compared with $55.3 million in
1993, or a decrease of 17.3%. This decrease was due to the $7.2 million in
non-recurring charges during 1993 and $3.4 million lower surveillance costs
during 1994 as a result of the Restructuring. The percentage of fixed costs
(those costs that are unrelated to the acquisition of business, such as the cost
of surveillance, accounting, EDP and administration) to total current direct
costs decreased to 27.2% for 1994 from 44.0% for 1993, and would have been 38.1%
in 1993 excluding the non-recurring charges discussed above. Compensation
expenses were $29.6 million and $33.5 million for 1994 and 1993, respectively,
representing 64.7% and 60.5%, respectively, of total current direct costs.
Federal income tax expense increased by $57.1 million, from a $39.2 million
federal income tax benefit for 1993 to a $17.9 million federal income tax
expense for 1994. The benefit in 1993 was due to the restructuring charge and to
loss and loss adjustment expenses. FSA Holdings' effective tax rate was 23.9% in
1993 and 22.9% in 1994.
YEAR ENDED DECEMBER 31, 1993 VERSUS YEAR ENDED DECEMBER 31, 1992
Gross premiums written were $127.4 million for 1993, compared with $131.1
million in 1992, a decrease of 2.8%. The amount of gross PV premiums written for
1993 was $130.7 million, versus $136.0 million for 1992, a decrease of 3.9%.
These premiums were attributable to $11.7 billion of gross par amount of
obligations insured during 1993, compared with $8.8 billion for 1992. Gross PV
premiums written for the asset-backed business were $38.8 million in 1993, a
decrease of $8.9 million or 18.7% from the prior year. The decrease in
asset-backed business was primarily the result of a decrease in the consumer
receivables and pooled corporate obligations sectors, partially offset by
increases in the residential mortgages and investor-owned utilities sectors.
Gross PV premiums written for the municipal business increased 4.0% to $91.8
million for 1993 from $88.3 million for 1992.
Net premiums written were $65.0 million for 1993, compared with $78.4
million for 1992, a decrease of 17.1%. Net premiums written for 1993 were
reduced by $17.9 million due to the cession of premiums under the Commercial Re
reinsurance agreement in connection with the Restructuring. Adjusting for this
cession, net premiums written would have been $82.9 million for 1993, an
increase of 5.7% compared with 1992.
Net premiums earned for 1993 were $63.4 million, compared with $63.9 million
for 1992, a decrease of 0.7%. This decrease in net premiums earned was primarily
due to a greater recognition of premium earnings from refunded and prepaid
obligations in 1992 and to the premiums ceded under the Commercial Re
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reinsurance agreement in 1993 in connection with the Restructuring. Adjusting
for this cession, net premiums earned would have been $58.1 million for 1993,
compared with $57.4 million for 1992, an increase of 1.2%. Net premiums earned
from refunded or prepaid obligations were $10.4 million and $13.7 million for
1993 and 1992, respectively.
Net investment income for 1993 was $47.9 million, compared with $47.0
million for 1992. Investment balances were $774.6 million at December 31, 1993,
versus $713.5 million at December 31, 1992, an increase of $61.2 million or
8.6%. However, $54.1 million of this increase was due to FSA Holdings' adoption
of Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" (SFAS No. 115). Under SFAS No. 115,
FSA Holdings designated its entire investment portfolio as held for sale and was
required to value it at market. The $54.1 million represented FSA Holdings' net
unrealized gains in its investment portfolio at December 31, 1993. In addition,
$24.3 million of the premium paid to Commercial Re was retained by FSA Holdings
on a funds withheld basis, pending deposit of such funds in a trust account
satisfying the requirements of applicable insurance law. The average yield on
the investment portfolio decreased from 6.94% for 1992 to 6.53% for 1993. This
decrease was due to FSA investing new cash and proceeds from security sales in
lower-yielding securities as market rates declined in this period. Net realized
capital gains were $18.3 million for the year ended December 31, 1993, compared
with $29.2 million for the same period in 1992. The ability of FSA Holdings to
continue sustaining significant levels of realized capital gains is dependent
upon the general interest rate environment, as well as whether the recognition
of capital gains is consistent with FSA Holdings' portfolio management
objectives at the time. There is no assurance that realized gains will continue
at a level similar to that of recent years. If net investment income were
adjusted as of January 1, 1992, to reflect funds used in the Restructuring, net
investment income for 1993 and 1992 would have been $42.2 million and $41.1
million, respectively.
Other income was $2.5 million for 1992, compared with a loss of $2.0 million
for 1993, due primarily to a $2.8 million write-down to net realizable value in
1993 of FSA Holdings' interest, received in connection with an insured
transaction, in the residual cash flow of the assets collateralizing the insured
transaction.
Losses and loss adjustment expenses for 1993 were $84.1 million, compared
with $54.6 million for 1992. Of the $84.1 million, $63.7 million related to
additional case basis reserves for three transactions in the commercial mortgage
portfolio, and the remaining $20.3 million primarily related to an increase in
the general loss reserve to reflect the potential for loss in the commercial
mortgage portfolio. Increases to the general loss reserve attributable to
business underwritten in 1993 and 1992 were $2.6 million and $1.7 million,
respectively. Had the Commercial Re reinsurance agreement been in effect during
these periods, losses and loss adjustment expenses would have been $35.3 million
and $25.7 million for 1993 and 1992, respectively, resulting from Commercial
Re's assumption of losses and loss adjustment expenses. U S WEST, under a letter
of credit, paid directly $63.0 million of losses and loss adjustment expenses in
1993. This payment by U S WEST was treated for GAAP purposes as a capital
contribution and therefore was shown as losses incurred with an increase (net of
tax) of $41.8 million to paid-in capital, thereby protecting FSA Holdings'
equity. Net losses and loss adjustment expenses paid, net of the U S WEST letter
of credit payments, were $43.4 million in 1993, compared with $6.0 million in
1992.
Total operating expenses (total expenses less goodwill, restructuring
charges and losses and loss adjustment expenses) were $40.5 million for 1993,
compared with $31.3 million for 1992, reflecting an increase of 29.2%. The
increase in total operating expenses from 1992 to 1993 was primarily the result
of a non-recurring pre-tax charge of approximately $7.2 million in 1993
resulting from (i) the acceleration of the amortization of deferred general
liquidity facility fees of $2.1 million and $0.2 million of legal fees, (ii) a
$2.9 million accrual for salary and related benefits primarily due to a
settlement for terminated employees in the FSA Profit Participation Plan, and
(iii) a $2.0 million expense relating to the acceleration of deferred
acquisition expenses as a result of the non-recurring charges. Excluding these
non-recurring charges, total operating expenses rose 6.4%. Current direct costs
(total operating expenses excluding the effects of deferral and amortization of
policy acquisition costs, interest expense and ceding commission income) for
1993 were $55.3 million, compared with $52.7 million in 1992, an increase of
4.9%. This increase was primarily due to $2.9 million of increased personnel
costs and an increase of $2.1 million in liquidity fees (as
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part of the non-recurring charges discussed above), partially offset by lower
other expenses. The percentage of fixed costs (those costs that are unrelated to
the acquisition of business, such as the costs of surveillance, accounting, EDP
and administration) to total current direct costs increased from 30.5% for 1992
to 44.0% for 1993 and would have been 38.1% excluding the non-recurring charges
discussed above. Compensation expenses were $33.5 million and $30.5 million for
1993 and 1992, respectively, representing 60.5% and 57.9%, respectively, of
total current direct costs, excluding the effects of ceding commissions and
deferral and amortization of policy acquisition costs. Had the Restructuring
been in effect during these periods, total operating expenses would have been
$35.7 million and $26.0 million for 1993 and 1992, respectively.
Federal income tax expense decreased by $48.6 million, from a $9.4 million
federal income tax expense for 1992 to a $39.2 million federal income tax
benefit for 1993. This decrease was due to lower levels of taxable income in
1993 as a result of increased losses and loss adjustment expenses. FSA Holdings'
effective tax rate was 17.8% in 1992 and 23.9% in 1993.
Net income was $43.5 million for 1992, compared with a net loss of $124.7
million for 1993. The decline was due to $84.1 million of losses and loss
adjustment expenses incurred, an $85.4 million restructuring charge and a $78.8
million write-off of goodwill. The foregoing goodwill write-off occurred in
connection with U S WEST'S intention to dispose of its interest in FSA Holdings.
In June 1993, U S WEST wrote off the remaining goodwill recorded in connection
with the acquisition of FSA Holdings to reflect its investment in FSA Holdings
at net realizable value. Accordingly, FSA Holdings' financial statements for
1993 reflect a $78.8 million write-off of the goodwill that had represented the
excess of the purchase price paid by U S WEST over FSA Holdings' net tangible
and identifiable intangible assets at the time of acquisition by U S WEST.
LIQUIDITY AND CAPITAL RESOURCES
FSA Holdings' consolidated invested assets and cash equivalents at September
30, 1995, net of unsettled securities transactions, was $785.4 million, a 10.8%
increase from the December 31, 1994 balance of $708.7 million. This increase is
the result of a change in the market value of the investment portfolio, which
included an unrealized loss position of $33.4 million at December 31, 1994 and
an unrealized gain position of $11.9 million at September 30, 1995, as well as
net cash generated from operations.
Because most operations of FSA Holdings are conducted through FSA, the
liquidity of FSA Holdings, both on a short-term basis (less than twelve months)
and on a long-term basis (twelve months or longer), will be largely dependent
upon the ability of FSA to declare and pay dividends to Capital Guaranty, which
in turn declares and pays dividends to FSA Holdings, and upon external
financings.
FSA's ability to pay dividends is dependent upon FSA's financial condition,
results of operations, cash requirements and other related factors and is also
subject to restrictions contained in the insurance laws and related regulations
of New York (the "New York Insurance Law") and other states. Under New York
Insurance Law, FSA may declare and distribute dividends from its earned surplus,
subject to maintenance of a minimum capital requirement. Approval of the
Superintendent of the New York State Insurance Department (the "New York
Superintendent") is required if a dividend, together with all dividends declared
or distributed by FSA during the preceding twelve months, exceeds the lesser of
(i) 10% of policyholders' surplus shown on its last statement filed with the New
York Superintendent or (ii) adjusted net investment income, as defined, for the
same period. At December 31, 1994 and September 30, 1995, FSA had $16.9 million
and $33.6 million, respectively, available for the payment of dividends over the
following 12 months under such limitations. However, as a customary condition
for approving the application of Fund American for a change in control of FSA,
the prior approval of the New York Superintendent is required for any payment of
dividends by FSA to FSA Holdings for a period of two years following such change
in control. Such approval was provided for the payment of $17.5 million in
dividends by FSA to FSA Holdings in 1994 and $14.0 million during the first nine
months of 1995 in the ordinary course of business. At September 30, 1995 and
December 31, 1994, FSA Holdings had an investment portfolio of $14.3 million and
$17.7 million, respectively.
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The primary use of funds by FSA Holdings is the payment of dividends to its
shareholders, which amounted to $4.2 million in 1994 and $6.2 million for the
first nine months of 1995. Dividends paid prior to 1994 are not comparable, as
FSA Holdings was not publicly held.
FSA's primary uses of funds are to pay operating expenses and to pay
dividends to Capital Guaranty. Capital Guaranty's primary uses of funds are to
pay debt service on $30 million of outstanding notes and to pay dividends to FSA
Holdings. FSA's funds may also be required in order to satisfy claims under
insurance policies in the event of a default by an issuer of an insured
obligation and the unavailability or exhaustion of other liquidity sources in
the transaction, such as the cash flow and collateral underlying such
obligations. FSA seeks to structure asset-backed transactions to address
liquidity risks through the addition of other liquidity sources to transactions.
The insurance policies issued by FSA provide, in general, that payment of
principal, interest and other amounts insured by FSA may not be accelerated by
the holder of the obligation but are paid by FSA in accordance with the
obligation's original payment schedule or, at FSA's option, on an accelerated
basis. These policy provisions prohibiting acceleration of certain claims are
mandatory under Article 69 of the New York Insurance Law and serve to reduce
FSA's liquidity requirements.
FSA Holdings believes that FSA's operating liquidity needs, both on a
short-term basis and long-term basis, can be funded exclusively from its
operating cash flow. FSA has a number of sources of liquidity that it expects to
have available to pay claims on a short- and long-term basis: the cash flow from
its written premiums, its investment portfolio and the earnings thereon, its
lines of credit, its reinsurance arrangements with third-party reinsurers and
capital market transactions.
FSA's investment portfolio, net of unsettled securities transactions, had a
market value of approximately $771.0 million and $690.9 million at September 30,
1995 and December 31, 1994, respectively. FSA's portfolio has been classified as
available-for-sale. FSA manages its investments with the objectives of
preserving its capital and claims-paying ability, maintaining a high level of
liquidity and, within these constraints, obtaining a high long-term total
return.
In order to provide additional sources of liquidity to fund claims under
policies, FSA has a $150 million credit facility with a syndicate of banks
headed by Swiss Bank Corporation, New York Branch, as agent. Principal amounts
drawn under this credit facility will mature at the expiration of the facility.
Restrictive covenants under this credit facility include requirements that FSA's
retained risk in certain business segments not exceed certain percentages of
total insurance in force, and that FSA not insure any transaction if doing so
would result in the loss of its Triple-A rating. FSA has complied with all
covenants under this credit facility. To date, FSA has not borrowed under this
credit facility, which will expire in 1998, unless extended.
In August 1994, FSA entered into a $186.9 million facility agreement with
Canadian Global Funding Corporation and Hambros Bank Limited. Pursuant to the
agreement, FSA can arrange for Canadian Global Funding Corporation to purchase
designated FSA-insured securities. Securities purchased under the agreement must
mature on or before August 30, 2004, and must be guaranteed as to principal and
interest by FSA. Restrictions on FSA's ability to arrange such financing include
requirements that FSA has paid all amounts owed under the agreement and that FSA
not be rated below investment grade by Moody's or S&P. As of September 30, 1995,
$100.9 million of this facility remained available for the purchase of
designated securities.
Reinsurance arrangements provide a further source of liquidity to FSA. FSA
is a party to many reinsurance agreements that include advance claims provisions
which require the reinsurer to reimburse FSA in advance for anticipated claims.
These advance claims provisions allow FSA to pay the reinsured portion of claims
with funds provided by its reinsurers rather than with FSA's own funds.
FSA may also access liquidity through the capital markets. Insured
refundings or refinancings of outstanding insured bonds may be employed in the
future in both distress and non-distress situations, including the refunding of
defaulted obligations prior to maturity as a means of mitigating or eliminating
loss. Such advance refundings permit the refunding issuer to access the capital
markets when market conditions are viewed favorably, rather than bear the risk
that less favorable market conditions may be present at maturity of the insured
obligations. Certain transactions in the commercial mortgage portfolio present a
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liquidity risk to FSA in that the underlying assets may need to be sold or
refinanced by the issuer in order to repay the principal amount of FSA-insured
securities at maturity. As a result of the Restructuring, a substantial majority
of the liquidity risk inherent in the commercial mortgage portfolio has been
assumed by Commercial Re.
On November 10, 1994, FSA Holdings announced the appointment of an
independent trustee authorized to purchase shares of FSA Holdings' Common Stock
in open market transactions, at times and prices determined by the trustee.
These purchases are intended to fund future obligations relating to equity
bonuses, performance shares and stock options under FSA Holdings' 1993 Equity
Participation Plan. At September 30, 1995, the total number of shares purchased
was 527,622 at a cost of $12.0 million.
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FINANCIAL GUARANTY INDUSTRY OVERVIEW
GENERAL
Financial guaranty insurance provides an unconditional and irrevocable
guaranty to the holder of a debt obligation of full and timely payment of
principal and interest. Financial guaranty insurance is primarily offered on
municipal and asset-backed debt obligations. In the event of a default under the
obligation, the insurer has recourse against the issuer and/or any related
collateral (which is a more common component in the case of insured asset-backed
obligations or other non-municipal debt) for amounts paid under the terms of the
policy. Payments under the insurance policy may not be accelerated by the holder
of the debt obligation. Generally, absent payment in full at the option of the
insurer, in the event of a default under an insured obligation the holder
continues to receive payments of principal and interest on schedule, as if no
default had occurred. Each subsequent purchaser of the obligation generally
receives the benefit of such guaranty.
Financial guaranty insurance benefits both issuers and investors. The
principal economic value of financial guaranty insurance to an issuer of an
obligation is the savings in interest costs resulting from the difference
between the interest rates on an insured obligation and the interest rate on the
same obligation on an uninsured basis. Investors benefit from the greater
marketability of the insured obligation and a reduction in the risk of loss
associated with an issuer's default, as well as greater retention of value of
their investment should the issuer experience adversity. See "Risk Factors --
Market and Other Factors" for a discussion of factors affecting the demand for
and supply of financial guaranty insurance.
The premium for financial guaranty insurance is paid by the issuer of the
obligation either in full at the inception of the policy or, in installments on
an annual basis. Premium rates are typically calculated as a percentage of
either the principal amount of the debt or total exposure (principal and
interest). Rate setting reflects such factors as the credit strength of the
issuer, type of issue, sources of income, collateral pledged, restrictive
covenants, maturity, prevailing market spreads between insured and uninsured
obligations and competition from other insurers, other providers of credit
enhancement and alternatives to credit enhancement.
Premiums are generally non-refundable and are recognized as income over the
life of the insured obligation. This long and relatively predictable earnings
pattern is characteristic of the financial guaranty insurance industry and
provides a relatively stable source of future revenues to financial guaranty
insurers.
In addition to FSA, there are currently five principal primary U.S.
financial guaranty insurers: AMBAC, CapMAC, Connie Lee, FGIC and MBIA.
FINANCIAL GUARANTY MARKET
The primary financial guaranty insurance market consists of two main
sectors: municipal bond insurance and insurance on asset-backed securities.
MUNICIPAL BOND MARKET. Municipal bond insurance provides credit enhancement
of bonds, notes and other evidences of indebtedness issued by states and their
political subdivisions (for example, counties, cities or towns), utility
districts, public universities and hospitals, public housing and transportation
authorities and other public and quasi-public entities. Municipal bonds are
supported by the issuer's taxing power in the case of general obligation or
special tax-supported bonds or by its ability to impose and collect fees and
charges for public services or specific projects in the case of most revenue
bonds. Insurance provided to the municipal bond market has been and continues to
be the major source of revenue for the financial guaranty insurance industry.
The volume of municipal bonds issued in 1994, $164.9 billion, represented a
substantial decline from the $292.0 billion issued in the prior year. This
decline was due to the substantial and rapid increase in interest rates, which
caused a reduction in refunding issues to the point where they represented only
23% of total issuance compared to 51% in 1993. Bonds issued for new money
purposes, however, increased to $116.0 billion in 1994 from the 1993 level of
$97.0 billion. The insured volume of municipal bonds in 1994 declined to $61.2
billion from the 1993 level of $107.9 billion, representing 37% of total
municipal bonds issued in both years.
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In the first nine months of 1995, $105.4 billion of municipal bonds were
issued, of which $78.5 billion was for new money purposes. The insured portion
of such new issues amounted to 41% in the nine-month period.
The following table sets forth certain information regarding new-issue long
term (over one year) municipal bonds and new-issue insured long term municipal
bonds, in each case issued during the years indicated:
<TABLE>
<CAPTION>
NEW INSURED
MUNICIPAL VOLUME
NEW TOTAL NEW INSURED AS PERCENT OF NEW
MUNICIPAL MUNICIPAL TOTAL MUNICIPAL
YEAR VOLUME VOLUME VOLUME
- ----------------------------------------------- ----------- ------------- ---------------------
(IN BILLIONS)
<S> <C> <C> <C>
1986........................................... $ 151.3 $ 24.8 16.4%
1987........................................... 105.4 21.6 20.5
1988........................................... 117.8 30.5 25.9
1989........................................... 125.0 30.6 24.5
1990........................................... 128.1 33.5 26.2
1991........................................... 174.1 52.0 29.9
1992........................................... 235.0 80.8 34.4
1993........................................... 292.0 107.9 37.0
1994........................................... 164.9 61.2 37.1
</TABLE>
- ------------------------
Figures are based upon estimated data provided by The Bond Buyer, November 7,
1995.
In addition to insurance of new issues, financial guaranty insurers have
provided insurance to certain investment vehicles, usually unit investment
trusts or mutual funds, which invest in outstanding issues of municipal bonds.
Although the insurer in such circumstances typically does not have the authority
to restructure the documents of an outstanding issue to conform to its preferred
format, it generally does apply stricter underwriting criteria in determining
which issuers qualify for insurance. Issues with no reserve funds or other
factors usually deemed important in assessing risk of non-payment will be
insured only if the underlying creditworthiness of the issuer is stronger than
usual.
ASSET-BACKED SECURITIES MARKET. Asset-backed transactions or
securitizations constitute a form of structured financing distinguishable from
unsecured debt issues by being supported by a specific pool of assets having an
ascertainable cash flow or market value that is held by the issuing entity,
rather than relying on the general unsecured creditworthiness of the issuer of
the obligation. While most asset-backed securities represent interests in pools
of assets, such as residential and commercial mortgages and credit card and auto
loan receivables, monoline financial guarantors have also insured asset-backed
securities secured by one or a few assets, such as utility mortgage bonds and
multifamily housing bonds.
The asset-backed securities market experienced very substantial growth in
this decade, with new issuances increasing from approximately $25 billion in
1989 to approximately $75 billion in 1994 and approximately $73 billion in the
nine months ended September 30,1995. Securities backed by credit card
receivables were the fastest growing segment of the market in 1993 and 1994 and
constituted the largest single component of the market in 1994. The principal
amount of asset-backed securities insured by monoline financial guarantors grew
from $6.7 billion in 1989 to an estimated $27.4 billion in 1994.
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BUSINESS
GENERAL
FSA Holdings, through its indirect wholly owned subsidiary, FSA, is
primarily engaged in the business of providing financial guaranty insurance on
asset-backed securities and municipal bonds. FSA Holdings and FSA were each
incorporated in 1984 under the laws of the State of New York. FSA received its
New York State insurance license and commenced operations in 1985. FSA is
licensed to engage in the financial guaranty insurance business in all 50
states, the District of Columbia and Puerto Rico. FSAM, a wholly owned
subsidiary of FSA, and Financial Security Assurance of Oklahoma, Inc.
("Oklahoma"), a wholly owned subsidiary of FSAM, provide reinsurance to FSA.
Financial Security Assurance (U.K.) Limited ("FSA-UK"), a wholly owned
subsidiary of Oklahoma, provides financial guaranty insurance for transactions
in the United Kingdom, France and Ireland. FSA Portfolio Management Inc. ("FSA
Portfolio Management") is a wholly owned subsidiary of FSA Holdings organized in
December 1992 to provide investment management services to FSA and to third
parties. Transaction Services Corporation is a wholly owned subsidiary of FSA
Holdings organized in December 1995 to provide transaction management and
workout services to FSA and third parties.
In December 1995, FSA Holdings acquired Capital Guaranty in a merger
transaction pursuant to which Capital Guaranty became a direct wholly owned
subsidiary of FSA Holdings. Except as otherwise expressly provided, the
information set forth in this section with respect to FSA Holdings and FSA does
not reflect the effects of such acquisition. For additional information
concerning Capital Guaranty, see "Capital Guaranty Corporation," "Selected
Financial Information of Capital Guaranty Corporation" and "Incorporation of
Certain Documents by Reference."
Financial guaranty insurance written by FSA guarantees payment when due of
scheduled payments on an issuer's obligations. In the case of a payment default
on an insured obligation, FSA is generally required to pay only the principal,
interest or other amounts due in accordance with the obligation's original
payment schedule or, at FSA's option, on an accelerated basis.
The claims-paying ability of FSA is rated "Aaa" by Moody's and "AAA" by S&P,
Nippon Investors Services and S&P (Australia) Pty. Ltd. FSA was the first
insurance company organized to insure asset-backed obligations and has been a
leading insurer of asset-backed obligations (based on number of transactions
insured) since its inception in 1985. FSA expanded the focus of its business in
1990 to include financial guaranty insurance of municipal obligations. For the
year ended December 31, 1994 and the nine months ended September 30, 1995, FSA
had gross premiums written of $106.4 million and $78.3 million, respectively, of
which 64% and 46.1% respectively, related to insurance of municipal obligations
and 36% and 53.9%, respectively, related to insurance of asset-backed
obligations. At December 31, 1994 and September 30, 1995, FSA had net insurance
in force of $45.8 billion and $52.5 billion, respectively, of which 62% and 59%,
respectively, represented insurance on municipal obligations and 38% and 41%,
respectively, represented insurance of asset-backed obligations.
The Company's business strategy is to remain a leading insurer of
asset-backed obligations and to become a more prominent insurer of municipal
obligations. The Company believes that the demand for its financial guaranty
insurance will grow over the long term in response to anticipated growth in
insured asset-backed and municipal obligations. The Company expects continued
growth in the insurance of asset-backed obligations due in part to the continued
expansion of asset securitization to meet the liquidity needs and increasingly
more stringent capital requirements of financial institutions. In the long term,
the Company also expects growth in the insurance of municipal obligations due in
part to increased issuance of municipal bonds to finance repairs and
improvements to the nation's infrastructure and increased municipal bond
purchases by individuals who generally purchase insured obligations. In 1995,
however, there was a substantial decline in the issuance of municipal bonds, and
there can be no assurance as to when, if ever, that trend will be reversed. The
percentage of new domestic municipal bond volume which is insured, however, has
increased each year since 1986, to 37.1% in 1994 and to 41% for the nine months
ended September 30, 1995. The Company expects to continue to emphasize a
diversified insured portfolio
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characterized by insurance of both asset-backed and municipal obligations, with
a broad geographic distribution and a variety of revenue sources and transaction
structures. The Company's acquisition of Capital Guaranty was intended to
increase the Company's presence in the insured municipal bond sector.
TYPES OF PRODUCTS
FSA's insurance is employed in both the new issue and secondary markets.
Insurance premium rates take into account the cost and the projected return to
and the risk assumed by FSA. Critical factors in assessing risk include the
credit quality of the issuer, type of issue, sources of repayment, transaction
structure and term to maturity. Each obligation is evaluated in accordance with,
and the final premium rate is a function of, such factors and subject to FSA's
underwriting guidelines. See "-- Credit Underwriting Guidelines, Standards and
Procedures."
In the case of new issues, the insured obligations are initially sold with
FSA insurance. For both municipal and asset-backed obligations, FSA participates
in negotiated offerings, where the investment banker and often the insurer have
been selected by the sponsor or issuer. In addition, FSA participates in
competitive offerings, where underwriting syndicates bid for securities and
submit bids that may include insurance.
In the secondary market, FSA's Triple-A Guaranteed Secondary Securities
(TAGSS-Registered Trademark-) Program provides insurance for uninsured
asset-backed obligations trading in the secondary market. TAGSS insured
securities have included utility first mortgage bonds, sale-leaseback bonds and
asset-backed securities supported by residential mortgages and receivables.
FSA's Custody Receipt Program provides insurance for uninsured municipal
obligations trading in the secondary market. The insurance on obligations
outstanding in the secondary market generally affords a wider secondary market
and therefore greater marketability to a given issue of previously issued
obligations. Premiums for secondary market insurance are payable either in full
at the time of policy issuance or over the life of the obligation. FSA's
underwriting guidelines require it to apply the same underwriting standards on
secondary market issues that it does on new security issues, although the
evaluation procedures are typically abbreviated.
FSA also writes portfolio insurance for securities held by investment funds
such as unit investment trusts and mutual funds. Such insurance covers
securities either while they are held by the fund or to their maturity, whether
or not held by the fund.
As of December 31, 1994 and September 30, 1995, FSA's insurance on new
issues with respect to asset-backed obligations represented approximately 92.5%
and 91.5%, respectively, of the aggregate net par amount outstanding with
respect to such obligations, (excluding $88.8 million and $80.0 million par
amount outstanding assumed by FSA under reinsurance agreements at December 31,
1994 and September 30, 1995, respectively) and its insurance on new issues with
respect to municipal obligations as of such dates represented approximately
80.8% and 79.1%, respectively, of the aggregate net par amount outstanding with
respect to such obligations (excluding $735.5 million and $628.0 million par
amount outstanding assumed by FSA under reinsurance agreements at December 31,
1994 and September 30, 1995, respectively).
INSURANCE IN FORCE
FSA has insured a variety of asset-backed obligations, including obligations
backed by residential mortgages, consumer receivables, corporate bonds, bank
loans, government debt and commercial mortgages. FSA has also insured
investor-owned utility first mortgage bonds. FSA has insured a broad array of
municipal obligations.
FSA ceased writing insurance for commercial mortgage transactions in 1990
and announced its withdrawal from this sector of its business in 1992. In
December 1993, in anticipation of the IPO, the Company undertook the
Restructuring to reduce its risk of loss from commercial mortgage transactions
previously insured by FSA and its subsidiaries. As part of the Restructuring,
(i) the Company established Commercial Re, a newly formed reinsurance company;
(ii) the Company distributed all the outstanding shares of Commercial Re to the
existing shareholders of the Company in proportion to their ownership
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<PAGE>
interests in the Company at the time; and (iii) Commercial Re assumed
approximately 64.4% of the exposure of FSA and its subsidiaries, on a weighted
average basis, on commercial mortgage transactions previously insured by FSA and
its subsidiaries.
FSA has selectively expanded its insured portfolio in a manner intended to
achieve diversification. At December 31, 1994, FSA had in force 332 issues
insuring approximately $18.8 billion in gross direct par amount outstanding of
asset-backed obligations and 1,086 issues insuring approximately $20.8 billion
in gross direct par amount outstanding of municipal obligations. In addition, at
December 31, 1994, FSA had assumed pursuant to certain reinsurance contracts
approximately $88.8 million and $735.5 million in par amount outstanding on
asset-backed and municipal obligations, resulting in a total gross par amount
outstanding of approximately $40.3 billion. At such date, the total net par
amount outstanding, determined by reducing the gross par amount outstanding to
reflect reinsurance ceded of approximately $12.1 billion, was approximately
$28.2 billion. At December 31, 1994, the weighted average life of the direct
principal insured on these policies was approximately seven and fourteen years,
respectively, for asset-backed and municipal obligations.
ASSET-BACKED OPERATIONS
FSA's insured portfolio of asset-backed obligations is divided into seven
major areas:
RESIDENTIAL MORTGAGES. Obligations primarily backed by residential
mortgages generally take the form of conventional pass-through certificates or
pay-through debt securities, but also include commercial paper obligations and
other highly structured products. Residential mortgages backing these insured
obligations include closed-end first mortgages and closed- and open-end second
mortgages or home equity loans on one-to-four family residential properties,
including condominiums and cooperative apartments.
CONSUMER RECEIVABLES. Obligations primarily backed by consumer receivables
include conventional pass-through and pay-through securities as well as more
highly structured transactions. Consumer receivables backing these insured
obligations include automobile loans and leases, credit card receivables, mobile
home loans, timeshare loans and limited partnership investor notes.
GOVERNMENT SECURITIES. Obligations primarily backed by government
securities include insured investment funds that include government securities
and insured bonds backed by letters of credit or repurchase agreements
collateralized by government securities. Government securities include full
faith and credit obligations of the United States and obligations of public and
quasi-public agencies of the United States, such as the Federal National
Mortgage Association and the Federal Home Loan Mortgage Corporation, as well as
obligations of non-U.S. sovereigns.
POOLED CORPORATE OBLIGATIONS. Obligations primarily backed by pooled
corporate obligations include obligations collateralized by corporate debt
securities or corporate loans and obligations backed by cash flow or market
value of non-consumer assets. Corporate obligations include corporate bonds,
bank loan participations, trade receivables and equity securities.
COMMERCIAL MORTGAGE PORTFOLIO. FSA ceased writing insurance in this sector
in 1990 and as part of the Restructuring obtained reinsurance from Commercial Re
relating to risk of loss in this category. Obligations backed by commercial
mortgages are divided into commercial real estate and corporate secured.
Commercial real estate obligations are primarily backed by commercial real
estate including hotel properties, office buildings and warehouses and consist
of pay-through bonds, pass-through certificates and more structured products,
with credit protection provided by property cash flow, property values, first
loss letters of credit, cash reserves and other means. Corporate secured
obligations generally take the form of bond obligations secured by mortgages on
properties leased to one or more affiliated corporate tenants, in which the
obligations are secured primarily by the lease cash flow and secondarily by the
value of the mortgaged properties. Lease obligors on these transactions include
major food and clothing retailers, and properties securing these transactions
include retail and warehouse facilities.
37
<PAGE>
INVESTOR-OWNED UTILITY OBLIGATIONS. Obligations backed by investor-owned
utilities include, most commonly, first mortgage bond obligations of for-profit
electric or water utilities providing retail, industrial and commercial service,
and also include sale-leaseback obligation bonds issued by such entities. In
each case, these bonds are secured by a mortgage on property owned by or leased
to an investor-owned utility.
OTHER ASSET-BACKED OBLIGATIONS. Other asset-backed obligations insured by
FSA include bonds or other securities backed by a combination of assets that
include elements of more than one of the categories set forth above.
MUNICIPAL OBLIGATIONS
FSA's insured portfolio of municipal obligations is divided into eight major
areas:
GENERAL OBLIGATION BONDS. General obligation bonds are issued by states,
their political subdivisions and other municipal issuers, and are supported by
the general obligation of the issuer to pay from available funds and by a pledge
of the issuer to levy taxes sufficient in an amount to provide for the full
payment of the bonds to the extent other available funds are insufficient.
HOUSING REVENUE BONDS. Housing revenue bonds include both multifamily and
single family housing bonds, with multi-tiered security structures based on the
underlying mortgages, reserve funds, and various other features such as Federal
Housing Administration or private mortgage insurance, bank letters of credit,
and, in some cases, the general obligation of the issuing housing agency or a
state's "moral obligation" (that is, not a legally binding commitment) to make
up deficiencies.
MUNICIPAL UTILITY REVENUE BONDS. Municipal utility revenue bonds include
obligations of all forms of municipal utilities, including electric, water and
sewer utilities. Insurable utilities may be organized as municipal enterprise
systems, authorities or joint-action agencies.
HEALTH CARE REVENUE BONDS. Health care revenue bonds include both long-term
maturities for capital construction or improvements of health care facilities
and medium-term maturities for equipment purchase.
INTERNATIONAL MUNICIPAL BONDS. International municipal bonds include U.K.
housing authority obligations and debt issued or guarantied by the governments
of Australia, Denmark, France, Italy and Sweden and various local governments of
Australia, France and Spain.
TAX-SUPPORTED (NON-GENERAL OBLIGATION) BONDS. Tax-supported (non-general
obligation) bonds include a variety of bonds that, though not general
obligations, are supported by the taxing ability of the issuer, such as
tax-backed revenue bonds and lease revenue bonds. Tax-backed revenue bonds may
be secured by a first lien on pledged tax revenues, such as those from special
taxes, including those on retail sales and gasoline, or from tax increments (or
tax allocations) generated by growth in property values within a district. FSA
also insures bonds secured by special assessments, levied against property
owners, which benefit from covenants by the district to levy, collect and
enforce collections and to foreclose on delinquent properties. Lease revenue
bonds or certificates of participation (COPs) may be secured by long-term
obligations or by lease obligations subject to annual appropriation. The
financed project is generally real property or equipment that, in the case of
annual appropriation leases, FSA deems to serve an essential public purpose
(e.g., schools, prisons, courts) or, in the case of long-term leases, is
insulated from the risk of abatement resulting from nontenantability.
TRANSPORTATION REVENUE BONDS. Transportation revenue bonds include a wide
variety of revenue-supported bonds, such as bonds for airports, ports, tunnels,
parking facilities, toll roads and toll bridges.
OTHER MUNICIPAL BONDS. Other municipal bonds insured by FSA include college
and university revenue bonds and resource recovery bonds.
38
<PAGE>
SUMMARY OF INSURANCE PORTFOLIO
<TABLE>
<CAPTION>
AT SEPTEMBER
AT DECEMBER 31, 1994 30, 1995
-------------------------------------------------------------------------- -------------
NUMBER OF NUMBER NET PAR PERCENT NET PAR AND
ISSUES SINCE OF ISSUES NET PAR AND INTEREST OF NET PAR INTEREST
INCEPTION IN FORCE OUTSTANDING OUTSTANDING AND INTEREST OUTSTANDING
--------------- ----------- ------------ ------------- --------------- -------------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
ASSET-BACKED OBLIGATIONS
Residential mortgages...... 168 150 $ 4,836 $ 7,008 15.3% $ 9,427
Consumer receivables....... 87 54 2,479 2,741 6.0 4,626
Government securities...... 35 19 2,017 2,142 4.7 1,715
Pooled corporate
obligations............... 49 23 1,686 2,076 4.5 2,570
Commercial mortgage
portfolio:
Commercial real estate... 11 9 156 184 0.4 --
Corporate secured........ 6 5 118 172 0.4 --
Investor-owned utility
obligations............... 93 67 786 2,154 4.7 1,848
Other asset-backed
obligations............... 12 5 797 822 1.8 1,574
------ ----------- ------------ ------------- ------ -------------
Total asset-backed
obligations............. 461 332 12,875 17,299 37.8 21,760
------ ----------- ------------ ------------- ------ -------------
MUNICIPAL OBLIGATIONS
General obligation bonds... 862 394 3,650 6,245 13.6 6,643
Housing revenue bonds...... 371 200 1,622 3,671 8.0 3,437
Municipal utility revenue
bonds..................... 323 169 2,169 4,018 8.8 4,545
Health care revenue bonds.. 64 50 1,594 3,151 6.9 3,154
International municipal.... 15 14 438 923 2.0 1,310
Tax-supported (non-general
obligation) bonds......... 265 142 3,426 6,055 13.2 6,964
Transportation revenue
bonds..................... 78 36 720 1,429 3.1 1,864
Other municipal bonds...... 248 81 1,729 3,033 6.6 2,869
------ ----------- ------------ ------------- ------ -------------
Total municipal
obligations............. 2,226 1,086 15,348 28,525 62.2 30,786
------ ----------- ------------ ------------- ------ -------------
Total.................... 2,687 1,418 $ 28,223 $ 45,824 100.0% $ 52,546
------ ----------- ------------ ------------- ------ -------------
------ ----------- ------------ ------------- ------ -------------
<CAPTION>
PERCENT OF
NET PAR AND
INTEREST
---------------
<S> <C>
ASSET-BACKED OBLIGATIONS
Residential mortgages...... 17.9%
Consumer receivables....... 8.8
Government securities...... 3.3
Pooled corporate
obligations............... 4.9
Commercial mortgage
portfolio:
Commercial real estate... --
Corporate secured........ --
Investor-owned utility
obligations............... 3.5
Other asset-backed
obligations............... 3.0
------
Total asset-backed
obligations............. 41.4
------
MUNICIPAL OBLIGATIONS
General obligation bonds... 12.6
Housing revenue bonds...... 6.5
Municipal utility revenue
bonds..................... 8.6
Health care revenue bonds.. 6.0
International municipal.... 2.5
Tax-supported (non-general
obligation) bonds......... 13.3
Transportation revenue
bonds..................... 3.5
Other municipal bonds...... 5.6
------
Total municipal
obligations............. 58.6
------
Total.................... 100.0%
------
------
</TABLE>
- ------------------------------
September 30, 1995 pro forma net par and interest would have been $71,685
million, with municipal obligations representing 70% of the insured portfolio
and asset-backed obligations representing 30%.
39
<PAGE>
OBLIGATION TYPE
The table below sets forth the relative percentages of net par amount
written of obligations insured by FSA by security type during each of the last
five years and for the nine months ended September 30, 1995 (adjusted as if the
Restructuring had occurred at January 1, 1990):
NEW BUSINESS INSURED BY OBLIGATION TYPE
(AS ADJUSTED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
SECURITY TYPE 1990 1991 1992 1993 1994
- ----------------------------------------------------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
ASSET-BACKED OBLIGATIONS
Residential mortgages.............................. 19% 24% 18% 14% 25%
Consumer receivables............................... 9 12 9 12 23
Government securities.............................. 17 9 9 0 0
Pooled corporate obligations....................... 18 2 4 1 4
Commercial Mortgage Portfolio:
Commercial real estate(1)........................ 0 0 0 0 0
Corporate secured(2)............................. 1 0 0 0 0
Investor-owned utility obligations................. 1 2 0 3 2
Other asset-backed obligations..................... 1 0 1 3 2
--- --- --- --- ---
Total asset-backed obligations................... 66 49 41 33 56
--- --- --- --- ---
MUNICIPAL OBLIGATIONS
General obligations bonds.......................... 13 11 15 13 10
Housing revenue bonds.............................. 2 25 4 3 1
Municipal utility revenue bonds.................... 1 1 9 10 8
Health care revenue bonds.......................... 3 4 8 7 4
International municipal............................ 0 0 0 3 3
Tax-supported (non-general obligation) bonds....... 12 8 12 17 11
Transportation revenue bonds....................... 3 0 4 3 1
Other municipal bonds.............................. 0 2 7 11 6
--- --- --- --- ---
Total municipal obligations...................... 34 51 59 67 44
--- --- --- --- ---
Total............................................ 100% 100% 100% 100% 100%
--- --- --- --- ---
--- --- --- --- ---
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30,
SECURITY TYPE 1995
- ----------------------------------------------------- -----------------
<S> <C>
ASSET-BACKED OBLIGATIONS
Residential mortgages.............................. 32%
Consumer receivables............................... 32
Government securities.............................. 0
Pooled corporate obligations....................... 7
Commercial Mortgage Portfolio:
Commercial real estate(1)........................ 0
Corporate secured(2)............................. 0
Investor-owned utility obligations................. 0
Other asset-backed obligations..................... 3
---
Total asset-backed obligations................... 74
---
MUNICIPAL OBLIGATIONS
General obligations bonds.......................... 6
Housing revenue bonds.............................. 0
Municipal utility revenue bonds.................... 5
Health care revenue bonds.......................... 2
International municipal............................ 1
Tax-supported (non-general obligation) bonds....... 7
Transportation revenue bonds....................... 3
Other municipal bonds.............................. 2
---
Total municipal obligations...................... 26
---
Total............................................ 100%
---
---
</TABLE>
- ------------------------
(1) On an historical basis, relative percentages of net par amount written of
commercial real estate obligations insured for 1990, 1991, 1992, 1993, 1994
and the nine months ended September 30, 1995 were 2%, 0%, 0%, 0%, 0% and 0%,
respectively.
(2) On an historical basis, relative percentages of net par amount written of
corporate secured obligations insured for 1990, 1991, 1992, 1993, 1994 and
the nine months ended September 30, 1995 were 9%, 0%, 0%, 0%, 0% and 0%,
respectively.
Pro forma new business written for the nine months ended September 30, 1995
would have consisted of 44% municipal obligations and 56% asset backed
obligations.
GEOGRAPHIC CONCENTRATION
In its asset-backed business, FSA considers geographic concentration as a
factor in underwriting insurance covering securitizations of asset pools such as
residential mortgages or consumer receivables. However, after the initial
issuance of an insurance policy relating to such securitizations, the geographic
concentration of the underlying assets may change over the life of the policy.
In addition, in writing insurance
40
<PAGE>
for other types of asset-backed obligations, such as securities primarily backed
by government or corporate debt, geographic concentration is not deemed by FSA
to be a significant credit factor given other more relevant measures of
diversification such as issuer or industry diversification.
FSA seeks to maintain a diversified portfolio of insured municipal
obligations designed to spread its risk across a number of geographic areas. The
table below sets forth those states in which municipalities issued an aggregate
of 2% or more of FSA's net par amount outstanding at December 31, 1994 and
September 30, 1995 of insured municipal securities:
MUNICIPAL
INSURED PORTFOLIO BY STATE
<TABLE>
<CAPTION>
AT DECEMBER 31, 1994
------------------------------------------ AT SEPTEMBER 30, 1995
PERCENT OF -----------------------------
TOTAL PERCENT OF
NET PAR MUNICIPAL NET NET PAR TOTAL MUNICIPAL
NUMBER AMOUNT PAR AMOUNT AMOUNT NET PAR AMOUNT
STATE OF ISSUES OUTSTANDING OUTSTANDING OUTSTANDING OUTSTANDING
- ----------------------------------------- ----------- ------------ --------------- ------------ ---------------
<S> <C> <C> <C> <C> <C>
California............................... 118 $ 1,751 11.4% $ 2,082 12.4%
Florida.................................. 77 1,595 10.4 1,678 10.0
New York................................. 53 1,549 10.1 1,632 9.7
New Jersey............................... 75 1,171 7.6 1,157 6.9
Pennsylvania............................. 58 801 5.2 861 5.1
Louisiana................................ 56 775 5.0 759 4.5
Michigan................................. 43 637 4.2 663 4.0
Massachusetts............................ 27 635 4.2 515 3.1
Texas.................................... 101 557 3.6 644 3.9
Illinois................................. 49 281 1.8 456 2.7
Maine.................................... 6 387 2.5 400 2.4
All other states......................... 404 4,240 27.7 4,584 27.3
Non-U.S.(1).............................. 19 969 6.3 1,336 8.0
----- ------------ ----- ------------ -----
Total.................................... 1,086 $ 15,348 100.0% $ 16,767 100.0%
----- ------------ ----- ------------ -----
----- ------------ ----- ------------ -----
</TABLE>
- ------------------------
(1) Non-U.S. includes international and Puerto Rico.
ISSUER CONCENTRATION
FSA has adopted underwriting and exposure management policies designed to
limit the net insurance in force for any one credit. In many cases, FSA uses
reinsurance to limit net exposure to any one credit. At December 31, 1994,
insurance of asset-backed obligations constituted 37.8% of FSA's net insurance
in force and insurance of municipal obligations constituted 62.2% of FSA's net
insurance in force. As of such date, FSA's ten largest insured asset-backed
transactions represented $2.6 billion, or 9.4%, of its total net par amount
outstanding, and FSA's ten largest insured municipal credits represented $2.0
billion, or 7.1%, of its total net par amount outstanding. FSA is also subject
to certain regulatory limits and rating agency guidelines on exposure to single
credits.
41
<PAGE>
The following tables set forth the net par amount outstanding of FSA's
insurance for the ten largest asset-backed transactions and municipal credits
insured by FSA at September 30, 1995:
TEN LARGEST INSURED ASSET-BACKED TRANSACTIONS AT SEPTEMBER 30, 1995
<TABLE>
<CAPTION>
TRANSACTION ASSET TYPE
- ---------------------------------------------------------------- --------------------------- NET PAR
AMOUNT
OUTSTANDING
------------
(IN
MILLIONS)
<S> <C> <C>
Olympic Auto Receivables Trust 1995-D Consumer Receivables $ 481.0
Mid-State Trust II Residential Mortgages 378.1
Western Financial 1995-4 Grantor Trust Consumer Receivables 331.5
HFC Home Equity Loan Asset-Backed Certificates Series 1991-2 Residential Mortgages 330.4
Merit Securities Corp. Series 4 Residential Mortgages 322.6
Securitized Asset Sales Inc 1993-6 Residential Mortgages 312.2
First Source Financial LLP CP Pooled Corporate 300.6
Credit Lyonnais Pooled Corporate 265.5
Western Financial 1995-3 Grantor Trust Consumer Receivables 256.5
Olympic Auto Receivables Trust 1994-B Consumer Receivables 256.5
------------
Total $ 3,234.9
------------
------------
</TABLE>
TEN LARGEST INSURED MUNICIPAL CREDITS AT SEPTEMBER 30, 1995
<TABLE>
<CAPTION>
CREDIT OBLIGATION TYPE
- ---------------------------------------------------------------- --------------------------- NET PAR
AMOUNT
OUTSTANDING
------------
(IN
MILLIONS)
<S> <C> <C>
Maine Health and Higher Education Other Municipal Bonds $ 230.2
Vermont Student Assistance Corporation Other Municipal Bonds 225.0
Commonwealth of Puerto Rico General Obligation 215.3
Florida State Department of Natural Resources Tax-Supported 212.5
State of California General Obligation 208.6
New York State Medical Care Facilities Finance Agency Tax-Supported 198.8
Washington Public Power Supply System Utility Revenue 194.7
Lower Colorado River Authority Utility Revenue 194.4
Washington, D.C General Obligation 173.7
Los Angeles County General Obligation 168.8
------------
Total $ 2,022.0
------------
------------
</TABLE>
CREDIT UNDERWRITING GUIDELINES, STANDARDS AND PROCEDURES
Financial guaranty insurance, as written by FSA, relies on an assessment of
the adequacy of various payment sources to meet debt service payments or other
obligations in a specific transaction without regard to premiums paid or income
from investment of premiums. FSA's underwriting policy is to insure asset-backed
and municipal obligations that would otherwise be investment grade without the
benefit of FSA's insurance. To this end, each policy written or reinsured by FSA
must meet the general underwriting guidelines and specific standards for
particular types of obligations approved by its Board of Directors. In addition,
the Company's Board of Directors has established an Underwriting Committee which
periodically reviews completed transactions to ensure conformity with
underwriting guidelines and standards.
FSA's underwriting guidelines for asset-backed obligations are built on the
concept of multiple layers of protection, and vary by obligation type in order
to reflect different structures and credit support. In this regard, asset-backed
obligations insured by FSA are generally issued in structured transactions and
backed by pools of assets such as consumer or trade receivables, residential
mortgage loans, securities or
42
<PAGE>
other assets having an ascertainable cash flow or market value. In addition, FSA
seeks to insure asset-backed obligations that generally provide for one or more
forms of overcollateralization (such as excess collateral values, excess cash
flow or "spread," or reserves) or third-party protection (such as bank letters
of credit, guarantees, net worth maintenance agreements, indemnity agreements or
reinsurance policies). This overcollateralization or third-party protection need
not indemnify FSA against all loss, but is generally intended to assume the
primary risk of financial loss. Overcollateralization or third-party protection
may not, however, be required in transactions in which FSA is insuring the
obligations of certain highly rated issuers that typically are regulated or have
implied or explicit government support or in transactions in which FSA is
insuring bonds issued to refinance other bonds insured by FSA as to which the
issuer is or may be in default. FSA's general policy has been to insure 100% of
the principal, interest and other amounts due in respect of asset-backed insured
obligations rather than providing partial or first loss coverage sufficient to
convey a triple-A rating on the insured obligations.
FSA's underwriting guidelines for municipal obligations require that the
municipal obligor be rated investment grade by Moody's or S&P or, in the
alternative, such obligor is considered by FSA to be the equivalent of
investment grade. Where the municipal obligor is a governmental entity with
taxing power or providing an essential public service paid by taxes, assessments
or other charges, supplemental protections may be required if such taxes,
assessments or other charges are not projected to provide sufficient debt
service coverage. Where appropriate, the municipal obligor is required to
provide a rate or charge covenant and a pledge of additional security (e.g.,
mortgages on real property, liens on equipment or revenue pledges) to secure the
obligation.
The rating agencies participate to varying degrees in the underwriting
process. Each asset-backed obligation insured by FSA is reviewed prior to
issuance by both S&P and Moody's to evaluate the risk proposed to be insured. In
the case of municipal obligations, prior rating agency review is a function of
the type of the insured obligation and the risk elements involved. In addition,
substantially all transactions insured by FSA are reviewed by at least one of
the major rating agencies after issuance to confirm continuing compliance with
rating agency standards. The independent review of FSA's underwriting practices
performed by the rating agencies further strengthens the underwriting process.
The underwriting process that implements these underwriting guidelines and
standards is supported by approximately 61 analysts, underwriting officers and
credit officers and ten attorneys. Moreover, the approval of senior management
is required for all transactions.
Each underwriting group in the Financial Guaranty Department has a senior
underwriting officer responsible for confirming that each transaction proposed
by the Financial Guaranty Department conforms to the underwriting guidelines and
standards. The evaluation by the senior underwriting officer is reviewed and
approved, in the case of asset-backed transactions, by the Chief Underwriting
Officer, and, in the case of municipal transactions, by the Chief Municipal
Underwriting Officer. This review may take place while the transaction is in its
formative stages, thus facilitating the introduction of further enhancements at
a stage when the transaction is more receptive to change.
Final transaction approval is obtained from FSA's Management Review
Committee for asset-backed transactions and from FSA's Municipal Underwriting
Committee for municipal transactions. Approval is usually based upon both a
written and an oral presentation by the underwriting group to the respective
committee. The Management Review Committee is comprised of the President, the
Chief Operating Officer, the Chief Underwriting Officer, the General Counsel
and, on a rotating basis, a senior officer from the Financial Guaranty
Department. The Municipal Underwriting Committee is comprised of the President,
the Chief Operating Officer, the Chief Municipal Underwriting Officer, the
Associate General Counsel for Municipal Transactions, the Managing Director for
the Financial Guaranty Group and a senior officer from the Financial Guaranty
Department. Following approval, minor transaction modifications may be approved
by the Chairs of the underwriting groups. Major changes require the concurrence
of the Management Review Committee or the Municipal Underwriting Committee, as
applicable. Secondary market and partial maturity asset-backed transactions of
$25.0 million or less of gross principal insured that meet certain credit and
return criteria may be approved by the Chief Underwriting Officer. Municipal
transactions of $25.0 million or
43
<PAGE>
less of gross principal insured that meet certain credit and return criteria may
be approved by a committee composed of the Chief Municipal Underwriting Officer,
the Associate General Counsel for Municipal Transactions and the municipal
analyst for the transaction.
CORPORATE UNDERWRITING AND RESEARCH
FSA's Corporate Underwriting and Research Department includes nine
professionals under the direction of the Chief Underwriting Officer. The
Corporate Underwriting and Research Department is responsible for evaluating the
credit of entities participating or providing recourse in obligations insured by
FSA. The Corporate Underwriting and Research Department also provides analysis
of relevant industry segments. Members of the Corporate Underwriting and
Research Department generally report their findings directly to the Management
Review Committee or Municipal Underwriting Committee in the context of
transaction review and approval.
INSURED PORTFOLIO MANAGEMENT
FSA's Insured Portfolio Management Department includes 19 professionals
under the direction of a managing director. The Insured Portfolio Management
Department is responsible for monitoring the performance of outstanding
transactions and taking remedial actions as appropriate. The Insured Portfolio
Management Department is independent of the analysts and credit officers
involved in the underwriting process. The managing director responsible for the
Insured Portfolio Management Department reports to an Oversight Committee
comprised of such managing director, the President, the General Counsel, the
Chief Underwriting Officer and the Chief Financial Officer. The Insured
Portfolio Management Department reviews each insured transaction to confirm
compliance with transaction covenants, monitors credit and other developments
affecting transaction participants and collateral and determines the steps, if
any, required to protect the interests of FSA and the holders of FSA-insured
obligations. Reviews for asset-backed transactions typically include an
examination of reports provided by, and (as circumstances warrant) discussions
with, issuers, servicers or trustees. In some instances, reviews of asset-backed
transactions include servicer audits, site visits or evaluations by third-party
appraisers, engineers or other experts retained by FSA. The Insured Portfolio
Management Department reviews each transaction to determine the level of ongoing
attention it will require. These judgments relate to current credit quality and
other factors, including compliance with reporting or other requirements, legal
or regulatory actions involving transaction participants and liquidity or other
concerns that may not have a direct bearing on credit quality. Transactions with
the highest risk profile are generally subject to more intensive review and, if
appropriate, remedial action. The Insured Portfolio Management Department works
together with the Legal Department and the Corporate Underwriting and Research
Department in monitoring these transactions, negotiating restructurings and
pursuing appropriate legal remedies.
LEGAL
FSA's Legal Department includes ten attorneys and six legal assistants under
the direction of the General Counsel. The Legal Department plays a major role in
establishing and implementing legal requirements and procedures applicable to
obligations insured by FSA. Members of the Legal Department serve on both the
Management Review Committee and the Municipal Underwriting Committee, which
provide final underwriting approval for transactions. An attorney in the Legal
Department works together with a counterpart in the Financial Guaranty
Department in determining the legal and credit elements of each obligation
proposed for insurance and in overseeing the execution of approved transactions.
Asset-backed obligations insured by FSA are ordinarily executed with the
assistance of outside counsel working closely with the Legal Department.
Municipal obligations insured by FSA are ordinarily executed without employment
of outside counsel. The Legal Department works closely with the Insured
Portfolio Management Department in addressing legal issues, rights and remedies,
as well as proposed amendments, waivers and consents, in connection with
obligations insured by FSA. The Legal Department is also responsible for
domestic and international regulatory compliance, reinsurance, secondary market
transactions, litigation and other matters.
44
<PAGE>
LOSS RESERVES
FSA establishes a case basis reserve for 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 case basis reserve for a
particular insured obligation represents FSA's estimate of the present value of
the anticipated shortfall, net of reinsurance, between (i) scheduled payments on
the insured obligations plus the anticipated loss adjustment expenses and (ii)
the anticipated cash flow from and proceeds to be received on sales of any
collateral supporting the obligation.
In addition to the case basis reserves, FSA established a general loss
reserve in December 1992, in order to account for the identified risks inherent
in its overall portfolio. FSA does not consider traditional actuarial approaches
used in the property/casualty insurance industry to be applicable to the
determination of its loss reserves because of the absence of a sufficient number
of losses in its financial guaranty insurance activities and in the financial
guaranty industry generally to establish a meaningful statistical base. The
general loss reserve amount is calculated by applying a loss factor to the total
net par amount outstanding of FSA's insured obligations outstanding over the
term of such insured obligations and discounting the result at a risk-free rate.
The loss factor used for this purpose has been determined based upon an
independent rating agency study of bond defaults and FSA's portfolio
characteristics and history. FSA monitors the general loss reserve on an ongoing
basis and may periodically adjust such reserve based on FSA's actual loss
experience, its future mix of business and future economic conditions. The
general loss reserve is available to be applied against future additions or
accretions to existing case basis reserves or to new case basis reserves to be
established in the future. To the extent that any such future additions to case
basis reserves are applied from the available general loss reserve, there will
be no impact on the Company's earnings for that period except to the extent that
increases to FSA's general loss reserve are implemented to replenish that
reserve. To the extent that additions to case basis reserves for any period
exceed the remaining available general loss reserve or are not applied from the
general loss reserve, the excess will be charged against the Company's earnings
for that period. Any addition to the general loss reserve which results from
applying the loss factor to new par written will also result in a charge to
earnings at that time. However, the release of amounts in the general loss
reserve as a result of the runoff of existing net insurance in force will be
available to be applied against additions to the general loss reserve required
for new business written.
FSA maintains reserves in an amount believed by its management to be
sufficient to pay its estimated ultimate liability for losses and loss
adjustment expenses with respect to obligations it has insured. At September 30,
1995 and December 31, 1994, FSA's net loss reserves totaled $39.7 million and
$35.6 million, respectively. In 1994, losses of $3.0 million were incurred to
increase the general loss reserve for new business written in 1994 and $16.9
million was transferred from the general loss reserve to case basis reserves for
projected losses on certain transactions, the majority of which were in the
Company's discontinued commercial mortgage portfolio. Giving effect to this
transfer, FSA's unallocated general loss reserve totaled $20.9 million at
December 31, 1994. In the first nine months of 1995, losses of $4.8 million were
incurred to increase the general loss reserve. At September 30, 1995, the
general reserve totaled $24.9 million.
Inasmuch as reserves are necessarily based on estimates and because of the
absence of a sufficient number of losses in its financial guaranty insurance
activities and in the financial guaranty insurance industry generally to
establish a meaningful statistical base, there can be no assurance that the case
basis reserves or the general loss reserve will be adequate to cover losses in
FSA's insured portfolio.
COMPETITION AND INDUSTRY CONCENTRATION
FSA faces competition from both other providers of third party credit
enhancement and alternatives to third party credit enhancement. The majority of
asset-backed and municipal obligations are sold without third party credit
enhancement. Accordingly, each transaction proposed to be insured by FSA must
generally compete against an alternative execution which does not employ third
party credit enhancement. FSA also faces competition from other monoline primary
financial guaranty insurers, primarily AMBAC, CapMAC, Connie Lee, FGIC and MBIA.
In terms of statutory surplus plus contingency reserves, FSA is the
45
<PAGE>
fourth largest of the six major financial guaranty insurers. Traditional credit
enhancers such as bank letter of credit providers and mortgage pool insurers
also provide significant competition to FSA as providers of credit enhancement
for asset-backed obligations. While actions by securities rating agencies in
recent years have significantly reduced the number of triple-A rated banks that
can offer a product directly competitive with FSA's triple-A guaranty, and
recently implemented risk-based capital guidelines applicable to banks have
generally increased costs associated with letters of credit that compete
directly with financial guaranty insurance, bank letter of credit providers and
other credit enhancement, such as cash collateral accounts, provided by banks,
continue to provide significant competition to FSA.
Insurance law generally restricts multiline insurance companies, such as
large property/casualty insurers and life insurers, from engaging in the
financial guaranty insurance business other than through separately capitalized
affiliates. Entry requirements include (i) assembling the group of experts
required to operate a financial guaranty insurance business, (ii) establishing
the triple-A claims-paying ability ratings with the credit rating agencies,
(iii) complying with substantial capital requirements, (iv) developing name
recognition and market acceptance with issuers, investment bankers and investors
and (v) organizing a monoline insurance company and obtaining insurance licenses
to do business in the applicable jurisdictions.
FSA's net insurance in force is the outstanding principal, interest and
other amounts to be paid over the remaining life of all obligations insured by
FSA, net of ceded reinsurance, refunded bonds secured by United States
government securities held in escrow or other qualified collateral, defeased
policy obligations and redemptions and repayments. Qualified statutory capital,
determined in accordance with statutory accounting principles, is the aggregate
of policyholders' surplus and contingency reserves calculated in accordance with
statutory accounting principles. Set forth below are FSA's aggregate gross
insurance in force, net insurance in force, qualified statutory capital and
leverage ratio (represented by the ratio of its net insurance in force to
qualified statutory capital) and the average industry leverage ratio at the
dates indicated:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1992 1993 1994
--------- --------- ---------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
FINANCIAL GUARANTY PRIMARY INSURERS, EXCLUDING FSA (1)
Leverage ratio.............................................. 140:1 140:1 145:1
FSA
Gross insurance in force.................................... $ 52,592 $ 61,290 $ 65,824
Net insurance in force...................................... 37,334 41,667 45,824
Qualified statutory capital................................. 461 454 466
Leverage ratio.............................................. 81:1 92:1 98:1
</TABLE>
- ------------------------
(1) Financial guaranty primary insurers for which data is included in this table
are AMBAC, CapMAC, CGIC, Connie Lee, FGIC and MBIA. Information relating to
the financial guaranty primary insurers is derived from data from the
Association of Financial Guaranty Insurors and from statutory accounting
financial information publicly available from each insurer at December 31,
1992, 1993 and 1994.
REINSURANCE
Reinsurance is the commitment by one insurance company, the "reinsurer," to
reimburse another insurance company, the "ceding company," for a specified
portion of the insurance risks underwritten by the ceding company in
consideration for a portion of the premiums received. The ceding company also
usually receives ceding commissions to cover costs of business generation.
Because the insured party contracts for coverage solely with the ceding company,
the failure of the reinsurer to perform does not relieve the ceding company of
its obligation to the insured party under the terms of the insurance contract.
46
<PAGE>
REINSURANCE CEDED
FSA obtains reinsurance to increase its policy writing capacity, both on an
aggregate risk and a single risk basis, to meet state insurance regulatory,
rating agency and internal limits, to diversify risks, to reduce the need for
additional capital and to strengthen financial ratios. At December 31, 1995, FSA
had reinsured approximately 26.9% of its direct principal amount outstanding
(excluding policies issued by FSAM). Most of FSA's reinsurance is on a quota
share basis, with a small portion being provided on a first loss or excess of
loss per risk basis. Reinsurance arrangements typically require FSA to retain a
specified amount of the risk.
FSA arranges reinsurance on both a facultative (transaction-by-transaction)
and treaty basis. Treaty reinsurance provides coverage for a portion of the
exposure from all qualifying policies issued during the term of the treaty. The
reinsurer's participation in a treaty is cancelable annually upon 90 days' prior
notice by either FSA or the reinsurer and is cancelable by FSA upon specified
financial deterioration of the reinsurer. As required by applicable state law,
reinsurance agreements may be subject to certain other termination conditions.
Treaties generally provide coverage for the full term of the policies
reinsured during the annual treaty period, except that, upon a financial
deterioration of the reinsurer and the occurrence of certain other conditions,
FSA generally has the right to reassume all of the business reinsured.
FSA's principal ceded reinsurance program currently consists of three quota
share treaties. One treaty (the "asset-backed treaty") covers all of FSA's
approved regular lines of business, except municipal bond insurance. In 1995,
FSA ceded 14.5% of each covered policy under this treaty, up to a maximum of $29
million insured principal per policy. At its sole option, FSA was entitled to
increase the ceding percentage to 21.75% up to $42.5 million insured principal
per policy. A second treaty (the "municipal treaty") covers FSA's municipal bond
insurance business. In 1995, FSA ceded 14% of each covered policy under this
treaty that is classified by FSA as providing municipal bond insurance as
defined by Article 69 of the insurance laws of New York up to a limit of $37.3
million insured principal per single risk which is defined by revenue source. At
its sole option, FSA was entitled to increase the ceding percentage to 30% up to
$80 million insured principal per single risk. A third treaty (the "teaching
hospital and higher education treaty") covers substantially all teaching
hospital and higher education risks (also covered under the municipal treaty).
In 1995, FSA ceded 5% to 15% (depending on the type of obligation) of its
retention (i.e., after cessions of policies under the municipal treaty) of each
covered policy under this treaty, up to limits that range from $7.5 million to
$30 million per single risk. At its sole option, FSA was entitled to increase
the ceding percentage from 15% up to 30% (depending on the type of obligation)
of its retention, subject to the same limits. Each of the three treaties allowed
FSA to withhold a ceding commission to defray its expenses.
Primary insurers, such as FSA, are required to fulfill their obligations to
policyholders if reinsurers fail to meet their obligations. The financial
condition of reinsurers is therefore evaluated carefully by FSA, and FSA's
reinsurance is placed with high quality and financially strong reinsurers. FSA's
treaty reinsurers at December 31, 1995 were Abeille Reassurances, Capital
Reinsurance Company ("Capital Re"), Compagnie Transcontinentale de Reassurance,
Connie Lee Insurance Company, Enhance Reinsurance Company ("Enhance"), Frankona
Reinsurance Company, Tokio Marine and Trade Indemnity plc. In 1994, nine
reinsurers participated in the asset-backed treaty, three reinsurers
participated in the municipal treaty (including health care and higher
education) and one reinsurer participated in a health care and higher education
treaty.
FSA, FSAM and Oklahoma have entered into a quota share reinsurance pooling
agreement pursuant to which, after reinsurance cessions to other reinsurers,
FSA, FSAM and Oklahoma share in the net retained risk insured by each of these
three companies in proportion to their policyholders' surplus and contingency
reserve as of December 31 of the prior year (with the percentages adjusted
commencing April 1 of each year). For the year commencing April 1, 1995, FSA
retained 60.48%, FSAM (as assignee of FSAI in the case of policies issued prior
to December 20, 1995) retained 27.03% and Oklahoma (as assignee of the prior
Oklahoma with respect to policies issued prior to June 29, 1995) retained 12.49%
of each policy issued by these companies after cessions to all other reinsurers.
FSA-UK and FSA have entered into a quota share and stop loss reinsurance
agreement pursuant to which (i) FSA-UK reinsures with FSA its retention under
its
47
<PAGE>
policies after other reinsurance based on an agreed-upon percentage that is
substantially in proportion to the policyholders' surplus and contingency
reserve of FSA-UK to the total policyholders' surplus and contingency reserves
of FSA and its subsidiary insurers (including FSA-UK) and (ii) subject to
certain limits, FSA is required to make payments to FSA-UK when FSA-UK's loss
ratio exceeds 100%. Under this agreement, FSA-UK ceded to FSA 98% of its
retention after other reinsurance of its policies issued in 1994.
In connection with the Restructuring, FSA is party to a quota share
reinsurance agreement with Commercial Re pursuant to which Commercial Re assumed
approximately 64.4% of FSA's exposure, on a weighted average basis, on
transactions in FSA's commercial mortgage portfolio.
RATING AGENCIES
Moody's and S&P periodically review the business and financial condition of
FSA and other companies providing financial guaranty insurance. These rating
agency reviews focus on the insurer's underwriting policies and procedures and
the quality of the obligations insured. The rating agencies frequently perform
assessments of the credits insured by FSA to confirm that FSA continues to meet
the capital allocation criteria considered necessary by the particular rating
agency to maintain FSA's triple-A claims-paying ability rating. See "Credit
Underwriting Guidelines, Standards and Procedures" above. FSA's ability to
compete with other triple-A rated financial guarantors, and its results of
operations and financial condition, would be materially adversely affected by
any reduction in its ratings.
INVESTMENT PORTFOLIO
FSA manages its investments with the objectives of preserving its capital
and claims-paying ability, maintaining a high level of liquidity and, within
these constraints, obtaining a high long-term total return. During 1994, FSA
Holdings changed its investment strategy to emphasize total return rather than
current income. To accomplish its objectives, FSA Holdings has established
guidelines for eligible investments, requiring that each individual investment
must be rated at least "single A" at acquisition and the overall portfolio must
be rated "double A" on average. Investments falling below the minimum quality
level are required to be disposed of at the earliest opportunity that such
disposition will not adversely affect the portfolio. For liquidity purposes, FSA
Holdings' policy is to invest in investments which are readily marketable with
no legal or contractual restrictions on resale. Eligible investments include
U.S. Treasury and agency obligations, corporate bonds, tax-exempt bonds and
mortgage pass-through instruments.
The weighted average maturity of FSA Holdings' investment portfolio at
December 31, 1994 was approximately 12.9 years. FSA Holdings' current investment
strategy is to invest in quality readily marketable instruments of intermediate
average duration so as to generate stable investment earnings with minimal
market value or credit risk.
The following tables set forth certain information concerning the investment
portfolio of FSA:
INVESTMENT PORTFOLIO BY RATING(1)
<TABLE>
<CAPTION>
PERCENT OF PERCENT OF
INVESTMENT INVESTMENT
PORTFOLIO AT PORTFOLIO AT
RATING DECEMBER 31, 1994 SEPTEMBER 30, 1995
- ------------------------------------------------------------- --------------------- ---------------------
<S> <C> <C>
AAA (2)...................................................... 56.9% 64.1%
AA........................................................... 26.1 27.3
A............................................................ 17.0 8.6
----- -----
100.0% 100.0%
----- -----
----- -----
</TABLE>
- ------------------------
(1) Ratings are based on the higher of Moody's or S&P ratings available at
December 31, 1994 and September 30, 1995, respectively.
(2) Includes U.S. Treasury and agency obligations, which comprised 13.7% and
33.0% of the total portfolio at December 31, 1994 and September 30, 1994,
respectively.
48
<PAGE>
SUMMARY OF INVESTMENTS
<TABLE>
<CAPTION>
DECEMBER 31, 1994 SEPTEMBER 30, 1995
------------------------- -------------------------
WEIGHTED WEIGHTED
AMORTIZED AVERAGE AMORTIZED AVERAGE
INVESTMENT CATEGORY COST YIELD (1) COST YIELD (1)
- ----------------------------------------------------------------- ---------- ------------- ---------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Long-term investments:
Taxable bonds.................................................. $ 284,226 7.95% $ 333,183 7.42%
Tax-exempt bonds............................................... 390,384 6.52 411,008 5.90
---------- ----------
Total long-term investments.................................. 674,610 7.13 744,191 6.58
Short-term investments (2)....................................... 92,449 5.91 32,949 5.95
---------- ----------
Total investments............................................ $ 767,059 6.98% $ 777,140 6.55%
---------- ----------
---------- ----------
</TABLE>
- ------------------------
(1) Yields are stated on a pre-tax basis.
(2) Includes taxable and tax-exempt investments and excludes cash equivalents of
$13.5 million, and $22.3 million, respectively.
INVESTMENT PORTFOLIO BY SECURITY TYPE
<TABLE>
<CAPTION>
DECEMBER 31, 1994 SEPTEMBER 30, 1995
------------------------- -------------------------
WEIGHTED WEIGHTED
AMORTIZED AVERAGE AMORTIZED AVERAGE
INVESTMENT CATEGORY COST YIELD (1) COST YIELD (1)
- ----------------------------------------------------------------- ---------- ------------- ---------- -------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
U.S. government securities....................................... $ 7,036 8.09% $ 34,027 7.03%
Mortgage-backed securities....................................... 179,205 8.13 247,621 7.48
Municipal bonds.................................................. 390,384 6.52 411,008 5.90
Asset-backed securities.......................................... 81,449 7.52 24,603 7.65
Other securities................................................. 16,536 8.00 26,942 7.15
---------- ----------
Total fixed maturities....................................... 674,610 7.13 744,201 6.58
Short-term investments(2)........................................ 92,449 5.91 32,939 5.95
---------- ----------
Total investments............................................ $ 767,059 6.98% $ 777,140 6.55%
---------- ----------
---------- ----------
</TABLE>
- ------------------------
(1) Yields are stated on a pre-tax basis.
(2) Includes taxable and tax-exempt investments and excludes cash equivalents of
$13.5 million and $22.3 million, respectively.
DISTRIBUTION OF INVESTMENTS BY MATURITY
<TABLE>
<CAPTION>
DECEMBER 31, 1994 SEPTEMBER 30, 1995
---------------------- ----------------------
ESTIMATED ESTIMATED
AMORTIZED MARKET AMORTIZED MARKET
INVESTMENT CATEGORY COST VALUE COST VALUE
- --------------------------------------------------------------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Due in one year or less (1).................................... $ 93,950 $ 93,942 $ 33,419 $ 33,145
Due after one year through five years.......................... 30,209 29,520 23,070 23,341
Due after five years through ten years......................... 36,140 36,453 132,627 136,120
Due after ten years............................................ 346,106 322,973 315,800 319,702
Mortgage-backed securities..................................... 179,205 169,846 247,621 251,724
Asset-backed securities........................................ 81,449 80,926 24,603 25,045
---------- ---------- ---------- ----------
Total investments.......................................... $ 767,059 $ 733,660 $ 777,140 $ 789,077
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
- ------------------------
(1) Includes short-term investments in the amount of $92.4 million and $32.9
million at December 31, 1994 and September 30, 1995, respectively, but
excludes cash equivalents of $13.5 million and $22.3 million, respectively.
49
<PAGE>
CAPITAL GUARANTY CORPORATION
In December 1995, FSA Holdings consummated the Merger, pursuant to which
Capital Guaranty became a direct wholly owned subsidiary of FSA Holdings.
Capital Guaranty was incorporated in June 1986 under the laws of the State of
Maryland. Capital Guaranty is an insurance holding company that insured
municipal bonds through its wholly owned subsidiary, CGIC. Following the Merger,
the name of CGIC was changed to FSAM, and its principal business is now to
reinsure policies issued by FSA or reinsured by FSA from unaffiliated third
parties. CGIC is authorized to write financial guaranty insurance in all 50
states, the District of Colombia, Puerto Rico, Guam and the U.S. Virgin Islands.
Municipal bond insurance written by CGIC guarantees payment to the investor when
due of principal and interest on the bond insured. CGIC sought to maintain a
diversified insurance portfolio which spreads its exposure to loss based upon a
number of criteria including issue size, type of bond, geographic area and
issuer. CGIC derived its revenues primarily from insurance premiums earned over
the life of the insured obligation and from investment income.
CGIC has earned triple-A claims-paying ability ratings, the highest ratings
available from Moody's and S&P. For additional information concerning Capital
Guaranty and CGIC, see "Incorporation of Certain Documents by Reference."
TYPE OF PRODUCTS
CGIC's insurance was employed in both the new issue and secondary markets.
CGIC participated in both negotiated offerings, where the investment banker and
often the insurer were selected by the sponsor of the issuer, and competitive
offerings, where underwriting syndicates bid for securities and submitted bids
that may have included insurance.
Insurance on municipal bonds which are already issued and trading in the
secondary market is typically purchased by either a dealer or an institution to
facilitate the sale of municipal bonds in its portfolio. The insurance generally
increases the sale price of bonds (by an amount greater than the cost of the
policy) and affords a wider secondary market, and therefore greater
marketability. As with new issues, the premium is payable at the time of policy
issuance. CGIC employed the same underwriting standards on secondary market
issues that it did on newly issued municipal bond issues and primarily insured
the same bond categories as in the competitive bid market.
As of December 31, 1994, 81.3% of the aggregate net par amount of CGIC's
insurance outstanding insured was new issues.
INSURANCE IN FORCE
CGIC provided financial guarantees for municipal bond issues in the primary
and secondary markets. Financial guaranty insurance of the type written by CGIC
guaranteed to the holder of the underlying obligation the timely payment of
principal and interest on the obligation in accordance with the obligation's
original debt service schedule. Accordingly, payments under the insurance policy
cannot be accelerated by the bondholder in the case of a payment on the insured
obligation.
CGIC sought to maintain a diversified insurance portfolio designed to spread
its risk according to a variety of criteria, including issue size, type of bond,
geographic area, and issuer.
Since its formation in 1986, CGIC wrote 1,467 policies on 625 municipal
credits, of which 1,123 policies on 523 credits remained outstanding as of
December 31, 1994. A separate policy was generally written to cover each
separate bond issue. CGIC defined "credits" as any group of issues by the same
municipal issuer and supported by the same revenue source. At December 31, 1994,
CGIC's total insured debt service exposure, net of reinsurance of $2.4 billion,
was $15.8 billion and the net par amount outstanding of municipal securities
insured by CGIC was $8.4 billion. At December 31, 1994, the weighted average
remaining life of CGIC's insurance in force was 13.6 years and the average issue
size by net par amount outstanding insured by CGIC was $7.5 million.
Approximately $6.8 billion, or 81.3%, of CGIC's net par insurance in force
at December 31, 1994, was comprised of primary policies underwritten and issued
by CGIC (or issued by United States Fidelity and
50
<PAGE>
Guaranty Company and reinsured in full or assumed by CGIC, principally in
connection with its formation and initial operations). The remainder of CGIC's
net par insurance in force at December 31, 1994 was comprised of reinsurance
assumed, most of which was assumed from Capital Re under an excess of loss
facility pursuant to which CGIC is responsible for a layer of losses in excess
of a specified minimum exposure retained by Capital Re. The exposure retained on
each individual credit by Cap Re ranged from $40.0 million to $57.5 million par
amount and associated interest depending upon the bond category reinsured.
CGIC's maximum exposure was $75.0 million par amount and associated interest for
each individual credit insured. Such reinsurance assumed generally carried lower
S&P weighted average capital charge than the remainder of CGIC's in force
business. This excess of loss facility was terminated on a run-off basis on
January 1, 1992.
TYPE OF OBLIGATIONS
CGIC's insured portfolio was divided into eight major areas: General
Obligations, Special Revenue, Utilities, Leases, Healthcare, Asset-backed,
Colleges/Universities and Housing/Structured. The table below sets forth CGIC's
insured portfolio as of December 31, 1994 and September 30, 1995 by bond type:
SUMMARY OF INSURANCE PORTFOLIO
<TABLE>
<CAPTION>
AT DECEMBER 31, 1994 AT SEPTEMBER 30, 1995
---------------------------------------- ----------------------------------------
NET PAR % OF TOTAL NET NET PAR % OF TOTAL NET
NUMBER OF AMOUNT PAR AMOUNT NUMBER OF AMOUNT PAR AMOUNT
ISSUES OUTSTANDING OUTSTANDING ISSUES OUTSTANDING OUTSTANDING
--------- ----------- -------------- --------- ----------- --------------
(IN (IN
MILLIONS) MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
General Obligation...................... 478 $2,976 35% 650 $ 3,878 37%
Special Revenue......................... 126 1,613 19 168 2,025 20
Utilities............................... 193 1,390 17 216 1,565 15
Leases.................................. 237 1,317 16 287 1,611 16
Healthcare.............................. 43 706 8 49 855 8
Asset-backed............................ 20 220 3 20 210 2
Colleges/Universities................... 19 133 2 27 215 2
Housing/Structured...................... 7 32 -- 7 31 --
--------- ----------- ----- --------- ----------- -----
Total................................. 1,123 $8,387 100.0% 1,424 $10,390 100.0%
--------- ----------- ----- --------- ----------- -----
--------- ----------- ----- --------- ----------- -----
</TABLE>
General obligation bonds, which are supported by the full faith and credit
and taxing power of state and local government issuers, and utility revenue
bonds, which are supported primarily by a pledge of revenues imposed and
collected by state and local public entities for the provision of essential
services, generally represent a lower credit risk than other types of municipal
bonds. Due to CGIC's focus on these lower risk-weighted obligations and
financial guaranty reinsurance business assumed on an excess of loss basis from
Capital Re, CGIC's management believed that CGIC continued to have the lowest
weighted average capital charge under S&P's risk-weighted system of any
municipal bond insurer at December 31, 1994. S&P's risk-weighted system assigns
capital charges based on bond category (without considering differences among
issuers within a category) and average annual debt service, and takes into
account third-party capital support such as reinsurance. Accordingly, the fact
that CGIC had the lowest weighted average capital charge indicated that, on the
basis of S&P's capital allocation methodology, CGIC's insured portfolio had the
lowest risk profile of any of the municipal bond insurers (based on S&P's bond
categories).
51
<PAGE>
GEOGRAPHIC CONCENTRATION
CGIC had a geographically diversified portfolio that generally reflected
national issuance patterns. The table below sets forth a geographic analysis of
CGIC's portfolio as of December 31, 1994 and September 30, 1995.
INSURED PORTFOLIO BY STATE
<TABLE>
<CAPTION>
AT DECEMBER 31, 1994 AT SEPTEMBER 30, 1995
--------------------------------------------- --------------------------------------------
NET PAR % OF TOTAL NET NET PAR % OF TOTAL NET
NUMBER OF AMOUNT PAR AMOUNT NUMBER OF AMOUNT PAR AMOUNT
ISSUES OUTSTANDING OUTSTANDING ISSUES OUTSTANDING OUTSTANDING
----------- ------------- ----------------- ----------- ------------ -----------------
(IN MILLIONS) (IN
MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
California........................ 151 $ 1,497 18% 201 $ 1,980 19%
New York.......................... 254 944 11 307 996 10
Pennsylvania...................... 60 699 8 72 765 7
Texas............................. 73 499 6 124 793 8
Minnesota......................... 63 483 6 90 775 7
Illinois.......................... 32 293 4 37 298 3
Puerto Rico....................... 103 291 3 125 322 3
Iowa.............................. 19 267 3 27 357 3
Missouri.......................... 33 236 3 51 338 3
Michigan.......................... 23 235 3 31 269 3
Other (1)......................... 520 2,943 35 569 3,497 34
----- ------ ----- ----- ------------ -----
Total........................... 1,331(2) $ 8,387 100.0% 1,634 $ 10,390 100.0%
----- ------ ----- ----- ------------ -----
----- ------ ----- ----- ------------ -----
</TABLE>
- ------------------------
(1) Consists of those states in which CGIC had an exposure of less than 3.0% of
its total net par amount outstanding.
(2) This total differs from those in the previous tables because certain bond
insurance policies provide coverage in more than one state.
ISSUER CONCENTRATION
CGIC had adopted underwriting and reinsurance policies designed to limit the
net insurance in force for any one municipal credit. Such policies relied
primarily on the single risk limits set forth under the New York financial
guaranty insurance law, which specify that, for each bond issued by a single
entity and backed by a single revenue source (i) the insured average annual debt
service, net of reinsurance and collateral, may not exceed 10% of the aggregate
of the insurer's policyholders' surplus and contingency reserves, and (ii) the
insured unpaid principal, net of reinsurance and collateral, may not exceed 75%
of the aggregate of the insurer's policyholders' surplus and contingency
reserves. In addition, CGIC's underwriting and reinsurance policies took into
account rating agency guidelines on maximum exposure to single credits and
CGIC's internal policies regarding diversification of its portfolio based on
geography and bond category. CGIC's largest single credit exposure at December
31, 1994 was in connection with general obligation bonds issued by the City of
New York, which is rated A- by S&P and A by Moody's. The total net par amount
insured was $148.0 million for a total net exposure of $327.4 million including
both unpaid principal and interest. The average net exposure per issue at
December 31, 1994 was $14.0 million.
REINSURANCE CEDED
As of December 31, 1994, CGIC had retained 87.3% of its $9.6 billion gross
par amount outstanding
and had ceded 12.7% to certain facultative and excess of loss reinsurers. State
insurance laws and regulations, as well as S&P and Moody's, impose minimum
capital requirements on financial guaranty companies which limit the aggregate
amount of insurance that may be written by an insurer as well as the amount of
exposure to any single revenue stream. CGIC used reinsurance as a means of
managing its exposure to single issuers and classes of credits in order to
comply with regulatory and rating agency requirements and internal underwriting
and portfolio management criteria.
52
<PAGE>
In general, CGIC conducted its reinsurance on a facultative basis under
which selected portions of CGIC's liabilities were ceded on an issue-by-issue
basis. Most of such reinsurance was ceded on a proportional basis. CGIC had, in
a few instances, participated in non-proportional reinsurance arrangements.
These arrangements were effected on an excess of loss basis and involve the
retention by CGIC of a first loss exposure (liability for all losses related to
a particular risk up to a stated dollar amount).
As a primary insurer, CGIC was required to honor its obligations to its
policyholders whether or not its reinsurers performed their obligations under
their reinsurance agreements with CGIC. The surveillance group of CGIC monitored
the financial positions of its reinsurers, both independently and through the
use of rating agency evaluations, on a regular basis. Moreover, the reinsurance
agreements typically entered into by CGIC provided CGIC with the right to
replace a reinsurer which had been downgraded or to demand that collateral
support be provided by such reinsurer. CGIC's primary reinsurers were Enhance
Reinsurance Company and Capital Re. In addition, CGIC ceded certain transactions
to USF&G, Continental Insurance Company, Hannover Ruckversicherungs AG and
Connie Lee.
CREDIT FACILITY
CGIC had a $25.0 million seven-year stand-by irrevocable limited recourse
credit facility with an international bank, as agent. The line provided
liquidity to CGIC in the event claims from municipal obligations exceeded
specified levels. Repayment of any amounts drawn under the facility was limited
primarily to the amount of any recoveries of claims paid. The credit facility
had no direct correlation to CGIC's underwriting guidelines since losses were
not anticipated and underwriting guidelines were designed to achieve an ultimate
zero-loss underwriting result. This credit facility was terminated upon the
consummation of the Merger.
INVESTMENTS AND INVESTMENT POLICY
Capital Guaranty's primary investment criteria were quality and liquidity,
with yield secondary. The investment objective was a total return greater than
the Lehman 50/50 Intermediate/Long-Term, Government/Corporate Index adjusted to
an after-tax basis. At December 31, 1994, 89.4% of the portfolio was invested in
Triple-A rated and U.S. Government securities, and 10.3% in Double-A rated
securities. At that date, cash and short-term instruments accounted for 16.1% of
Capital Guaranty's total invested assets. The average portfolio quality was AAA,
overall duration was 5 1/4 years and average maturity was 8 years.
The Investment Committee of the Board of Directors of Capital Guaranty,
established in 1994, set policy, monitored performance and ratified
transactions. Senior management carried out the policy and oversaw day-to-day
portfolio management by an independent investment management firm.
The following tables summarize the composition of CGIC's investment
portfolio:
INVESTMENT PORTFOLIO BY S&P RATING (1)
AS OF DECEMBER 31, 1994
<TABLE>
<CAPTION>
RATING FAIR VALUE % OF PORTFOLIO
- ---------------------------------------- -------------- --------------
(IN THOUSANDS)
<S> <C> <C>
AAA and Short-term investments.......... $246,238 89.4%
AA...................................... 28,389 10.3
A....................................... 743 .3
-------------- -----
Total................................... $275,370 100.0%
-------------- -----
-------------- -----
</TABLE>
- ------------------------
(1) Ratings are based on S&P ratings.
53
<PAGE>
SUMMARY OF INVESTMENT PORTFOLIO
<TABLE>
<CAPTION>
AT DECEMBER 31, 1994 AT SEPTEMBER 30, 1995
------------------------------ ------------------------------
WEIGHTED WEIGHTED
AVERAGE BOOK AVERAGE BOOK
YIELD YIELD
FAIR VALUE TO MATURITY FAIR VALUE TO MATURITY
---------- ----------------- ---------- -----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Taxable
Short term...................................... $ 44,453 5.3% $ 12,118 5.6%
Long term....................................... 98,616 7.0 128,520 7.5
Tax Exempt
Long term....................................... 132,301 5.6 176,186 5.7
---------- --- ---------- ---
Total......................................... $ 275,370 6.1% $ 316,824 6.4
---------- --- ---------- ---
---------- --- ---------- ---
</TABLE>
INVESTMENT PORTFOLIO BY SECURITY TYPE
<TABLE>
<CAPTION>
AT DECEMBER 31, 1994 AT SEPTEMBER 30, 1995
------------------------------ ------------------------------
WEIGHTED WEIGHTED
AVERAGE BOOK AVERAGE BOOK
CATEGORY FAIR VALUE YIELD TO MATURITY FAIR VALUE YIELD TO MATURITY
- -------------------------------------------------- ---------- ----------------- ---------- -----------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
U.S. government obligations....................... $ 58,410 6.5% $ 43,799 6.8%
Mortgage-backed securities........................ 23,646 8.7 68,379 8.1
Municipal obligations............................. 132,301 5.6 176,186 5.7
Corporate securities.............................. 16,560 6.4 16,342 6.6
---------- --- ---------- ---
Total long-term investments....................... 230,917 6.2 304,706 6.5
Short-term investments............................ 44,453 5.3 12,118 5.6
---------- --- ---------- ---
Total investments............................. $ 275,370 6.1% $ 316,824 6.4%
---------- --- ---------- ---
---------- --- ---------- ---
</TABLE>
INVESTMENT PORTFOLIO BY MATURITY
<TABLE>
<CAPTION>
AT DECEMBER 31, 1994 AT SEPTEMBER 30, 1995
---------------------------------- -------------------------------
MATURITY FAIR VALUE % OF PORTFOLIO (1) FAIR VALUE % OF PORTFOLIO
- ----------------------------------------------- ------------- ------------------- ---------- -------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Due in one year or less........................ $ 52,576 19.1% $ 22,132 7.0%
Due after one year through five years.......... 35,671 12.9 25,546 8.0
Due after five years through ten years......... 57,240 20.8 61,410 19.4
Due after ten years............................ 106,237 38.6 139,358 44.0
------------- ----- ---------- -----
251,724 91.4 248,446 78.4
Mortgage-backed securities..................... 23,646 8.6 68,378 21.6
------------- ----- ---------- -----
Total Investments.......................... $ 275,370(1) 100.0% $ 316,824 100.0%
------------- ----- ---------- -----
------------- ----- ---------- -----
</TABLE>
- ------------------------
(1) The weighted average maturity of the Company's investment portfolio at
December 31, 1994 was 8.0 years.
54
<PAGE>
SELECTED CONSOLIDATED FINANCIAL INFORMATION
OF CAPITAL GUARANTY CORPORATION
The following table sets forth selected consolidated historical financial
information of Capital Guaranty and has been derived from and should be read in
conjunction with the audited consolidated financial statements of Capital
Guaranty for each of the five fiscal years ended December 31, 1994 and the
unaudited interim consolidated financial statements of Capital Guaranty for the
nine-month periods ended September 30, 1995 and September 30, 1994, including
the respective notes thereto. See "Available Information" and "Incorporation of
Certain Documents by Reference." In the opinion of management, all adjustments,
consisting of normal recurring accruals, considered necessary for a fair
presentation, have been included in the unaudited interim data. Interim results
for the nine months ended September 30, 1995 are not necessarily indicative of
results which may be expected for future periods, including the year ending
December 31, 1995.
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER
YEAR ENDED DECEMBER 31, 30,
--------------------------------------------------------------------- -----------
1990 1991 1992 1993 1994 1994
------------- ------------- ----------- ------------- ----------- -----------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT
Gross premiums written................ $ 23,520 $ 24,955 $ 24,747 $ 26,544 $ 24,671 $ 15,598
Net premiums written.................. 13,754 22,296 23,662 17,439 23,885 15,134
Net premiums earned................... 6,752 10,282 12,097 18,743 12,598 10,136
Net realized investment gains......... 16 2,676 1,553 1,218 1,138 663
Net investment income................. 12,821 12,874 13,710 14,957 16,655 12,330
Total revenues........................ 19,674 26,064 27,512 34,977 30,420 23,155
Income before income taxes and
cumulative effect of change in
accounting for income taxes.......... 7,787(1) 19,026 21,397 25,949 19,368 14,360
Income tax............................ 1,703(1) 5,650 7,321 8,475 4,679 3,554
Cumulative effect of change in
accounting for income taxes (2)...... 425
Net income............................ 6,084(1) 13,376 14,076 17,899 14,689 10,806
Net income per common share: (3)
Income before cumulative effect of
accounting change.................... $ 0.62(1) $ 1.47 $ 1.59 $ 1.96 $ 1.60 $ 1.17
Cumulative effect of accounting
change............................... 0.00 0.00 0.00 0.05 0.00 0.00
------------- ------------- ----------- ------------- ----------- -----------
Net income per common share........... $ 0.62(1) $ 1.47 $ 1.59 $ 2.01 $ 1.60 $ 1.17
------------- ------------- ----------- ------------- ----------- -----------
------------- ------------- ----------- ------------- ----------- -----------
Weighted average common shares
outstanding.......................... 9,199 8,857 8,659 8,741 8,943 8,993
SELECTED FINANCIAL RATIOS
GAAP BASIS (4)
Loss ratio............................ 0% 0% 0% 0% 0% 0%
Expense ratio......................... 176(1) 68 51 42 71 71
Combined ratio........................ 176(1) 68 51 42 71 71
SAP BASIS(4)
Loss ratio............................ 0% 0% 0% 0% 0% 0%
Expense ratio......................... 96 44 31 34 46 53
Combined ratio........................ 96 44 31 34 46 53
BALANCE SHEET
Cash and investments.................. $ 165,108 $ 184,295 $ 206,000 $ 278,488(5) $ 282,400 $ 276,506
Total assets.......................... 206,865 231,604 252,844 331,364(5) 334,387 327,753
Unearned premiums (6)................. 61,883 73,897 85,462 84,159 95,451 89,156
Senior notes payable.................. -- -- -- 30,000 30,000 30,000
Other liabilities..................... 6,704 11,716 9,942 13,059 8,690 9,822
Total liabilities..................... 83,358 101,778 109,112 145,636 151,061 145,943
Total stockholders' equity............ 123,507 129,826 143,732 185,728(5) 183,326 181,810
Total capitalization.................. 123,507 129,826 143,732 215,728(5) 213,326 211,810
Book value per common share........... N/A N/A N/A 19.79 20.25 20.08
SELECTED FINANCIAL STATISTICS
Gross insurance in force.............. $10,470,000 $12,944,000 $14,248,000 $15,398,000 $18,126,000 $16,868,000
Net insurance in force................ 8,646,000 10,919,000 12,365,000 12,929,000 15,764,000 14,588,000
Qualified statutory capital........... 113,000 118,000 133,000 191,000 197,000 193,000
Policyholders' leverage ratio......... 76:1 92:1 93:1 68:1 80:1 76:1
ANALYTICAL DATA
Adjusted book value per common share
(7).................................. N/A N/A N/A 24.02 25.30 24.75
<CAPTION>
1995
-----------
<S> <C>
INCOME STATEMENT
Gross premiums written................ $ 22,299
Net premiums written.................. 20,211
Net premiums earned................... 8,727
Net realized investment gains......... 542
Net investment income................. 14,196
Total revenues........................ 23,503
Income before income taxes and
cumulative effect of change in
accounting for income taxes.......... 15,893
Income tax............................ 3,740
Cumulative effect of change in
accounting for income taxes (2)......
Net income............................ 12,153
Net income per common share: (3)
Income before cumulative effect of
accounting change.................... $ 1.35
Cumulative effect of accounting
change............................... 0.00
-----------
Net income per common share........... $ 1.35
-----------
-----------
Weighted average common shares
outstanding.......................... 8,794
SELECTED FINANCIAL RATIOS
GAAP BASIS (4)
Loss ratio............................ 0%
Expense ratio......................... 69
Combined ratio........................ 69
SAP BASIS(4)
Loss ratio............................ 0%
Expense ratio......................... 37
Combined ratio........................ 37
BALANCE SHEET
Cash and investments.................. $ 316,465
Total assets.......................... 371,628
Unearned premiums (6)................. 106,935
Senior notes payable.................. 30,000
Other liabilities..................... 14,978
Total liabilities..................... 169,504
Total stockholders' equity............ 202,124
Total capitalization.................. 232,124
Book value per common share........... 22.39
SELECTED FINANCIAL STATISTICS
Gross insurance in force.............. $21,571,000
Net insurance in force................ 19,139,000
Qualified statutory capital........... 205,000
Policyholders' leverage ratio......... 94:1
ANALYTICAL DATA
Adjusted book value per common share
(7).................................. 28.13
</TABLE>
55
<PAGE>
(1) Reflects expenses incurred in connection with the repurchase and
accruals of vested units issued to management pursuant to a performance stock
rights plan. Without the effect of such expenses, income before taxes, net
income and net income per common share would have been $14.3 million, $10.4
million and $1.09, respectively, and Capital Guaranty's expense ratio and
combined ratio would have been 80%.
(2) Reflects the adoption of Statement of Financial Accounting Standards
("SFAS") No. 109, "Accounting for Income Taxes," effective January 1, 1993. As
permitted by SFAS No. 109, Capital Guaranty elected not to restate the financial
statements of any prior years.
(3) Net income per common share and the weighted average number of common
shares outstanding have been calculated giving effect to recapitalization
transactions which occurred subsequent to December 31, 1992. See Notes 1 and 6
to Capital Guaranty's 1994 consolidated financial statements. Assumed conversion
of the Capital Guaranty Preferred Stock resulted in a $0.01 dilutive effect for
the year ended December 31, 1993.
(4) The GAAP loss ratio represents loss and loss adjustment expenses
incurred divided by net premiums earned. The GAAP expense ratio represents
underwriting and operating expenses divided by net premiums earned. The GAAP
combined ratio represents the total of the loss and expense ratios. The
statutory loss ratio represents loss and loss adjustment expenses incurred
divided by statutory net premiums earned. The statutory expense ratio represents
statutory underwriting and operating expenses divided by statutory net premiums
written. The statutory combined ratio represents the total of the statutory loss
and expense ratios.
(5) Reflects the adoption of SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" at December 31, 1993, resulting in an
increase in cash and investments and total assets of $9.0 million and
stockholders' equity and total capitalization of $5.9 million.
(6) Deferred premium revenue is presented net of prepaid reinsurance
premiums.
(7) Adjusted book value per common share, which is book value plus net
unearned premium reserve plus the present value of net future installment
premiums less deferred acquisition costs less tax effect (in each case, on a per
common share basis), is used by management and equity analysts as a measurement
of FSA Holdings' and Capital Guaranty's intrinsic value. Adjusted book value per
common share is not a substitute for GAAP book value per common share.
56
<PAGE>
INSURANCE REGULATORY MATTERS
GENERAL
FSA is licensed to engage in insurance business in all 50 states, the
District of Columbia and Puerto Rico. FSA is subject to the insurance laws of
the New York Insurance Law, FSAM is subject to the insurance laws of the State
of Maryland, International is subject to the insurance laws of the State of
Indiana, Oklahoma is subject to the insurance laws of the State of Oklahoma, and
FSA-UK is subject to the insurance laws of the United Kingdom, their respective
jurisdictions of incorporation. Each is also subject to the insurance laws of
the other states in which it is licensed to transact an insurance business. Each
of FSA and its domestic insurance subsidiaries are required to file periodic
statutory financial statements in each jurisdiction in which they are licensed,
and are subject to statutory restrictions concerning the types and quality of
investments and the filing and use of policy forms and premium rates. In
addition, FSA's accounts and operations are subject to periodic examination by
the New York Superintendent (the last such examination having been conducted in
1995 for the period ended December 31, 1994) and other state insurance
regulatory authorities.
INSURANCE HOLDING COMPANY AND OTHER LAWS
FSA Holdings and its domestic insurance subsidiaries (FSA, FSAM,
International and Oklahoma) are subject to regulation under insurance holding
company statutes of New York, Maryland, Indiana and Oklahoma, where these
respective insurers are domiciled, as well as other jurisdictions where these
companies are licensed to do insurance business. The requirements of holding
company statutes vary from jurisdiction to jurisdiction but generally require
insurance holding companies and their insurance subsidiaries to register and
file certain reports describing, among other information, their capital
structure, ownership and financial condition. The holding company statutes also
require prior approval of changes in control, of certain dividends and other
intercorporate transfers of assets and of transactions between insurance
companies and their affiliates. The holding company statutes generally require
that all transactions with affiliates be fair and reasonable and that those
exceeding specified limits require prior notice to or approval by insurance
regulators.
Under the laws in effect in New York, Maryland, Indiana and Oklahoma, any
acquisition of control of FSA Holdings, and thereby indirect control of FSA,
FSAM, International and Oklahoma, requires the prior approval of the New York
Superintendent and the Maryland, Indiana and Oklahoma Insurance Commissioners. A
similar law applies to the United Kingdom, requiring approval of the United
Kingdom Department of Trade and Industry (the "DTI") for any change of control
of FSA-UK. "Control" is defined as the direct or indirect power to direct or
cause the direction of the management and policies of a person, whether through
the ownership of voting securities, by contract or otherwise. Any purchaser of
10% or more of the outstanding voting securities of a corporation is presumed to
have acquired control of that corporation and its subsidiaries, although the
insurance regulator may find that "control" in fact does or does not exist when
a person owns or controls either a lesser or greater amount of voting
securities.
NEW YORK FINANCIAL GUARANTY INSURANCE LAW
In 1989, New York enacted Article 69 ("Article 69") of the New York
Insurance Law, a comprehensive financial guaranty insurance statute, which
governs all financial guaranty insurers licensed to do business in New York,
including FSA. This statute limits the business of financial guaranty insurers
to financial guaranty insurance and related lines (such as surety).
Article 69 requires that financial guaranty insurers maintain a special
statutory accounting reserve called the "contingency reserve" to protect
policyholders against the impact of excessive losses occurring during adverse
economic cycles. Article 69 requires a financial guaranty insurer to provide a
contingency reserve (i) with respect to policies written prior to July 1, 1989
in an amount equal to 50% of earned premiums and (ii) with respect to policies
written on and after July 1, 1989, quarterly on a pro rata basis over a period
of 20 years for municipal bonds and 15 years for all other obligations, in an
amount equal to the greater of 50% of premiums written for the relevant category
of insurance or a percentage of the principal guarantied, varying from 0.55% to
2.50%, depending upon the type of obligation guarantied, until the
57
<PAGE>
contingency reserve amount for the category equals the applicable percentage of
net unpaid principal. This reserve must be maintained for the periods specified
above, except that reductions by the insurer may be permitted under specified
circumstances in the event that actual loss experience exceeds certain
thresholds or if the reserve accumulated is deemed excessive in relation to the
insurer's outstanding insured obligations. Financial guaranty insurers are also
required to maintain reserves for losses and loss adjustment expenses on a
case-by-case basis and reserves against unearned premiums.
Article 69 establishes single risk limits for financial guaranty insurers
applicable to all obligations issued by a single entity and backed by a single
revenue source. For example, under the limit applicable to qualifying
asset-backed securities, the lesser of (i) the insured average annual debt
service for a single risk or (ii) the insured unpaid principal (reduced by the
extent to which the unpaid principal of the supporting assets exceeds the
insured unpaid principal) divided by nine, net of qualifying reinsurance and
collateral, may not exceed 10% of the sum of the insurer's policyholders'
surplus and contingency reserve, subject to certain conditions. Under the limit
applicable to municipal obligations, the insured average annual debt service for
a single risk, net of qualifying reinsurance and collateral, may not exceed 10%
of the sum of the insurer's policyholders' surplus and contingency reserve. In
addition, insured principal of municipal obligations attributable to any single
risk, net of qualifying reinsurance and collateral, is limited to 75% of the
insurer's policyholders' surplus and contingency reserve. Single risk limits are
also specified for other categories of insured obligations, and generally are
more restrictive than those listed for asset-backed or municipal obligations.
Article 69 also establishes aggregate risk limits on the basis of aggregate
net liability insured as compared to statutory capital. "Aggregate net
liability" is defined as outstanding principal and interest of guarantied
obligations insured, net of qualifying reinsurance and collateral. Under these
limits, policyholders' surplus and contingency reserves must not be less than a
percentage of aggregate net liability equal to the sum of various percentages of
aggregate net liability for various categories of specified obligations. The
percentage varies from 0.33% for certain municipal obligations to 4% for certain
non-investment grade obligations.
DIVIDEND RESTRICTIONS
Pursuant to the New York Insurance Law, FSA may declare dividends, subject
to any restriction in its certificate of incorporation, out of its earned
surplus. "Earned surplus" is defined as the portion of policyholders' surplus
that represents the net earnings, gains or profits, after deduction of all
losses, that have not been distributed to shareholders as dividends, or
transferred to stated capital or capital surplus or applied to other purposes
permitted by law, but does not include unrealized appreciation or depreciation
of assets. FSA may not declare or distribute any dividend to shareholders which,
together with all dividends declared or distributed by it during the preceding
12 months, exceeds the lesser of (i) 10% of policyholders' surplus as of its
last statement on file with the New York Superintendent or (ii) adjusted net
investment income during such period unless, upon prior application therefor,
the New York Superintendent approves a greater dividend distribution based upon
his finding that FSA will retain sufficient policyholders' surplus to support
its obligations and writings. "Adjusted net investment income" is defined as net
investment income for the 12 months immediately preceding the declaration or
distribution of the current dividend increased by the excess, if any, of net
investment income over dividends declared or distributed during the period
commencing 36 months prior to the declaration or distribution of the current
dividend and ending 12 months prior thereto.
Approval of the New York Superintendent was required in connection with the
purchase by Fund American of Common Stock in 1994. As a customary condition to
approving the change in control, any dividend payment by FSA to FSA Holdings
during the two year period following such change in control requires the prior
approval of the New York Superintendent. Such approval was provided for the
payment of dividends by FSA to FSA Holdings in 1994 and 1995 in the ordinary
course of business.
58
<PAGE>
FINANCIAL GUARANTY INSURANCE REGULATION IN OTHER JURISDICTIONS
FSA is subject to laws and regulations of jurisdictions other than the State
of New York concerning the transaction of financial guaranty insurance. The laws
and regulations of these other jurisdictions are generally not more stringent in
any material respect than the New York Insurance Law.
In May 1994, the DTI issued an insurance license to FSA-UK. Pursuant to
European Community Directives, FSA-UK has since been authorized to provide
financial guaranty insurance for transactions in France and Ireland from its
home office in the United Kingdom. Previously, the London office of FSA operated
as a marketing and sales office with underwriting activities conducted through
FSA Holdings' New York office under a no-action response by the DTI to FSA
Holdings' filings. FSA has received a determination from the Australian
Insurance and Superannuation Commissioner that the financial guaranties issued
by it with respect to Australian transactions do not constitute insurance for
which a license is required.
ACCOUNTING
GENERAL
The consolidated financial statements of FSA Holdings are prepared in
accordance with GAAP. For reporting to certain regulatory authorities, the
financial statements of FSA, FSAM, International and Oklahoma are prepared in
accordance with SAP, which consist of recording transactions and preparing
financial statements in accordance with the rules and procedures prescribed or
permitted by state regulatory authorities.
REVENUE RECOGNITION
Premiums for financial guaranty insurance policies are either payable up
front in full on the date the policy is written (as is primarily the case with
policies on municipal obligations) or on an installment basis over the life of
the policy (as is primarily the case with policies on asset-backed obligations).
FSA Holdings defers recognition of the premium received from an insurance policy
in which premiums are payable up front by crediting the premium to its unearned
premium reserve and amortizing the premium over the life of the underlying
insured obligation. FSA Holdings recognizes installment premiums as revenue over
the period to which such premiums apply. FSA Holdings credits installment
premiums as unearned premium reserve in the period in which such premiums are
due to FSA Holdings and recognizes revenue from the amortization of the premiums
over the period, generally one year or less, to which such premiums apply. The
revenue that FSA Holdings recognizes from its insurance premiums for each period
is its net premiums earned for that period.
When an insured issue has been refunded, the remaining unearned premiums on
the refunded issue in excess of the unearned premiums attributable to the
refunding issue (the "new issue") are recognized at that time, as the risk to
FSA on the refunded issue is considered to have been eliminated. If the new
issue is not insured by FSA, the entire amount of the remaining unearned premium
on the refunded issue is recognized as revenue when FSA receives proper
notification and documentation that the refunding has occurred. In the case of
the refunding, redemption or other prepayment of an insured obligation as to
which the premiums are payable in installments, FSA is generally not entitled to
receive further premiums in respect of the policy covering such obligation to
the extent prepaid.
DEFERRED ACQUISITION COSTS
In accordance with GAAP, in order to match expenses with revenues, FSA
defers certain policy acquisition costs and amortizes them over the period in
which the related premiums are earned. Deferred acquisition costs comprise those
expenses, generally incurred at the commencement of the term of the insurance
policy, that vary with and are primarily related to the production of new or
renewal business, including allocated amounts of salaries and related costs of
underwriting and marketing personnel, rating agency fees, premium taxes, legal
fees, underwriting report costs and association dues, offset by reinsurance
commissions received on premiums ceded to reinsurers. See the Consolidated
Balance Sheets included with the Consolidated Financial Statements of the
Company incorporated herein by reference for the amounts of unearned premiums
and deferred acquisition costs.
59
<PAGE>
RESERVES
RESERVES UNDER GAAP
Under GAAP, FSA Holdings defers recognition of the premium received from an
up front insurance policy by crediting the premium to its unearned premium
reserve and amortizing the premium over the life of the underlying insured
obligation. FSA Holdings' unearned premium reserve, net of reinsurance, at
September 30, 1995 and December 31, 1994 was $216.9 million and $212.9 million,
respectively.
FSA establishes a case basis reserve for losses and related loss adjustment
expenses when, in its judgment, a particular insured obligation is in default or
a default and subsequent loss is probable, and the amount of the loss can be
reasonably estimated by FSA. FSA does not consider traditional actuarial
approaches used in the property/casualty insurance industry to be applicable to
the determination of its loss reserves because of the absence of a sufficient
number of losses in its financial guaranty insurance activities and in the
financial guaranty industry generally to establish a meaningful statistical
base. A case basis reserve for a particular insured obligation represents FSA's
estimate of the present value of the anticipated shortfall, net of reinsurance,
between (i) scheduled payments on the insured obligations plus the anticipated
loss adjustment expenses and (ii) the anticipated cash flow from and proceeds to
be received on sales of any collateral supporting the obligation. For a
description of the specific case basis reserves established by FSA, see
"Business -- Credit Underwriting Guidelines, Standards and Procedures -- Loss
Reserves."
In addition to the case basis reserves, FSA established in December 1992 the
general loss reserve, which was $20.9 million at December 31, 1994, in order to
account for the identified risks inherent in its overall portfolio. The general
loss reserve amount was calculated by applying a loss factor to the total net
par amount outstanding of FSA's insured obligations outstanding over the term of
such insured obligations and discounting the result at a risk-free rate. The
loss factor used for this purpose has been determined based upon an independent
rating agency study of bond defaults and FSA's portfolio characteristics and
history. FSA will on an ongoing basis monitor the general loss reserve and may
periodically adjust such reserve based on FSA's actual loss experience, its
future mix of business and future economic conditions. The general loss reserve
is available to be applied against future additions or accretions to existing
case basis reserves or to new case basis reserves to be established in the
future. To the extent that any such future additions to case basis reserves are
less than the available general loss reserve, there will be no impact on FSA
Holdings' earnings for that period. If additions to case basis reserves for any
period exceed the remaining available general loss reserve, the excess will be
charged against FSA Holdings' earnings for that period. Any addition to the
general loss reserve which results from applying the loss factor to new par
written will also result in a charge to earnings at that time. However, the
release of amounts in the general loss reserve as a result of the runoff of
existing net insurance in force will be available to be applied against
additions to the general loss reserve required for new business written.
FSA maintains reserves in an amount believed by its management to be
sufficient to pay its estimated ultimate liability for losses and loss
adjustment expenses with respect to obligations it has insured. At September 30,
1995 and December 31, 1994, FSA's net loss reserves totaled $39.7 million and
$35.6 million, respectively.
RESERVES UNDER SAP
FSA establishes an unearned premium reserve relating to premiums received by
FSA but unearned. These premiums are generally earned in accordance with
regulatory requirements over the term of the obligations to which the premiums
relate. At September 30, 1995 and December 31, 1994, FSA Holdings' SAP unearned
premium reserve, net of reinsurance, was $250.5 million and $242.8 million,
respectively.
The New York Insurance Law requires that financial guaranty insurers
maintain both a reserve for known incurred losses (similar to GAAP case basis
loss reserves discussed above) and a special SAP reserve called the "contingency
reserve" to protect policyholders against the impact of excessive losses
occurring during adverse economic cycles. At December 31, 1994, FSA had a
statutory contingency reserve totalling $121.4 million.
60
<PAGE>
DIRECTORS AND EXECUTIVE OFFICERS
Set forth below is certain information concerning directors and executive
officers of FSA Holdings. Each director holds office (subject to FSA Holdings'
by-laws) until the next annual meeting of shareholders and until his or her
successor has been elected and qualified. The management of FSA Holdings is
conducted by a Management Committee, the permanent members of which are Messrs.
Cochran, Taylor, Brain, Brewer, Harrison, McCarthy and Stern. The information
concerning the directors has been furnished by them to FSA Holdings.
<TABLE>
<CAPTION>
NAME AGE (1) POSITION WITH FSA
- ------------------------- ------------- -------------------------------------------------------------
<S> <C> <C>
John J. Byrne 63 Chairman of the Board and Director
Robert P. Cochran 46 President, Chief Executive Officer and Director
Roger K. Taylor 44 Managing Director, Chief Operating Officer and Director
Joshua Brain 39 Managing Director and head of Insured Portfolio Management of
FSA
Russell B. Brewer II 38 Managing Director and Chief Underwriting Officer of FSA
John A. Harrison 52 Managing Director and Chief Financial Officer
Sean W. McCarthy 36 Managing Director and head of Financial Guaranty Department
of FSA
Bruce E. Stern 41 Managing Director, General Counsel and Secretary
Robert N. Downey 60 Director
Barbara M. Japha 42 Director
K. Thomas Kemp 55 Director
Kozo Kusakari 53 Director
David O. Maxwell 65 Director
Richard D. McCormick 55 Director
James M. Osterhoff 59 Director
James H. Ozanne 52 Director
Richard A. Post 37 Director
Allan L. Waters 38 Director
</TABLE>
- ------------------------
(1) As of January 25, 1996
MR. BYRNE has been Chairman of the Board of Directors and a director of FSA
Holdings since May 1994. He has also been Chairman of the Board of Directors and
Chief Executive Officer of Fund American since 1985 and President of Fund
American since 1990. From 1989 through 1990, Mr. Byrne was Chairman of the Board
of Directors of Fireman's Fund Insurance Company ("Fireman's Fund"). Prior to
joining Fireman's Fund, Mr. Byrne was Chairman and Chief Executive Officer of
GEICO Corporation. Mr. Byrne is also Chairman of Fund American Enterprises, Inc.
("FAE"), a subsidiary of Fund American, and a director of Source One Mortgage
Services Corporation ("Source One"), a subsidiary of FAE. Mr. Byrne is a
director of Terra Nova (Bermuda) Holdings Ltd., Mid America Apartment
Communities and Zurich Reinsurance, Ltd.
MR. COCHRAN has been President and Chief Executive Officer of FSA Holdings
and of FSA since August 1990. Mr. Cochran has been Chairman of FSA since July
1994, and a director of FSA Holdings since August 1990 and of FSA since July
1988. From September 1990 until December 1993, Mr. Cochran was a
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<PAGE>
director of USWCC. Prior to August 1990, Mr. Cochran was Managing Director,
Financial Guaranty Department of FSA. Prior to joining FSA Holdings in 1985, Mr.
Cochran was managing partner of the Washington, D.C. office of the Kutak Rock
law firm. Mr. Cochran is a director of Fund American and of White Mountains
Insurance Holdings, Inc.
MR. TAYLOR has been director of FSA Holdings since February 1995. Mr. Taylor
has been Chief Operating Officer of FSA Holdings since May 1993. Mr. Taylor has
been a Managing Director of FSA since January 1991 and was a consultant to FSA
from January 1990 to January 1991. He was a director of FSA Holdings from August
1993 until August 1994 and has been a director of FSA since January 1992. Prior
to joining FSA, Mr. Taylor was Executive Vice President of Financial Guaranty
Insurance Company, a financial guaranty insurer. Mr. Taylor is also a director
of Source One Mortgage Services Corporation.
MR. BRAIN has been a Managing Director of FSA since March 1989 and head of
its Insured Portfolio Management Department since July 1992. He has been a
director of FSA since September 1993. Prior to joining FSA in March 1989, Mr.
Brain was an attorney with Cleary, Gottlieb, Steen & Hamilton.
MR. BREWER has been a Managing Director of FSA since March 1989 and the
Chief Underwriting Officer of FSA since September 1990. He has been a director
of FSA since September 1993. From March 1989 to August 1991, Mr. Brewer was
Managing Director, Asset Finance Group, of FSA. Prior to joining FSA in 1986,
Mr. Brewer was an Associate Director of Moody's.
MR. HARRISON has been a Managing Director and the Chief Financial Officer of
FSA since August 1991 and the Chief Financial Officer of FSA Holdings since
February 1993. He has been a director of FSA since September 1993. From April
1987 through August 1991, Mr. Harrison was Chief Financial Officer of Citibank,
N.A. -U.S. Consumer Banking Group, and prior thereto was Managing Director, Real
Estate Finance Group, of Merrill Lynch & Co. Inc.
MR. MCCARTHY has been a Managing Director of FSA since March 1989 and head
of its Financial Guaranty Department since April 1993. He has been a director of
FSA since September 1993. Prior to joining FSA in 1988, Mr. McCarthy was a Vice
President of PaineWebber Incorporated.
MR. STERN has been a Managing Director, the Secretary and the General
Counsel of FSA Holdings since April 1993. Since April 1993, he has been the
Secretary of FSA, and since March 1989, he has been a Managing Director of FSA.
He has been a director of FSA since August 1990. Prior to joining FSA as General
Counsel in 1987, Mr. Stern was an attorney with Cravath, Swaine & Moore.
MR. DOWNEY has been director of FSA Holdings since August 1994. Mr. Downey
has been a limited partner since 1990, and a general partner from 1976 until
1990, of Goldman, Sachs & Co. At Goldman, Sachs & Co., Mr. Downey served as head
of the Municipal Bond Department and Vice Chairman of the Fixed Income Division.
Mr. Downey was a Director of the Securities Industry Association from 1987
through 1991 and served as its Chairman in 1990 and Vice Chairman in 1988 and
1989.
MS. JAPHA has been director of FSA Holdings since May 1994. Ms. Japha has
been Vice President -- Business Development of U S WEST Communications Group
since October 1995. From May 1995 to October 1995, Ms. Japha served as Vice
President -- Law and Human Resources of U S West Communications Group. Prior to
that time, Ms. Japha served as Vice President -- Law and Associate General
Counsel, General Corporation Section, U S WEST since 1994, and has been employed
as counsel by U S WEST in other positions since 1989. Prior to joining U S WEST,
Ms. Japha was Assistant Vice President and Legal Counsel, of Columbia Savings, a
Federal Savings and Loan Association.
MR. KEMP has been director of FSA Holdings since August 1994. Mr. Kemp has
served as Executive Vice President, Treasurer and Secretary of Fund American
since 1993 and Vice President, Treasurer and Secretary since 1991. Since 1994,
Mr. Kemp has served as President and Chief Executive Officer of White Mountains
Holdings, Inc., a subsidiary of Fund American. Mr. Kemp was a Vice President of
Fireman's Fund from 1990 to January 1991. Prior to joining Fireman's Fund, Mr.
Kemp was President of Resolute Reinsurance Company. Mr. Kemp is a director of
Fund American, FAE, Main Street America Holdings, Inc., White Mountains
Holdings, Inc. and White Mountains Insurance Company.
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<PAGE>
MR. KUSAKARI has been director of FSA Holdings and FSA since June 1991. Mr.
Kusakari has been General Manager of the Guarantee and Credit Underwriting
Department of Tokio Marine since June 1993. From June 1990 through May 1993, he
was General Manager of the Credit & Guarantee Insurance Division and Non-Marine
Underwriting Department of Tokio Marine. From June 1988 through May 1990, Mr.
Kusakari was General Manager of the Credit & Guarantee Insurance Division of
Tokio Marine.
MR. MAXWELL has been director of FSA Holdings since August 1994. Mr. Maxwell
was Chairman of the Board and Chief Executive Officer of Federal National
Mortgage Association from 1981 until his retirement in 1991. Mr. Maxwell is a
director of Hechinger Company, Potomac Electric Power Company (PEPCO) and
SunAmerica Inc.
MR. MCCORMICK has been director of FSA Holdings since August 1994. Mr.
McCormick has been Chairman of U S WEST since May 1992 and President and Chief
Executive Officer of U S WEST since January 1991. He was President and Chief
Operating Officer of U S WEST from 1986 to 1991. Mr. McCormick is a director of
Norwest Corp. and UAL, Inc.
MR. OSTERHOFF has been director of FSA Holdings since April 1992. Mr.
Osterhoff was a director of FSA from September 1993 until July 1994. He was
Executive Vice President and Chief Financial Officer of U S WEST from December
1991 until September 1995. Prior to joining U S WEST, Mr. Osterhoff was Vice
President -- Finance and Chief Financial Officer of Digital Equipment Corp., a
computer manufacturer. Mr. Osterhoff is a director of GenCorp.
MR. OZANNE has been director of FSA Holdings since December 1989. Mr. Ozanne
was a director of FSA from December 1989 until July 1994. He was Chairman and
Director of Nations Financial Holdings Corporation from January 1994 through
January 2, 1996. During December 1993, Mr. Ozanne served as President and Chief
Operating Officer of Nations Financial Capital Corporation. He was President and
Chief Executive Officer of USWCC from September 1989 until December 1993. Prior
to joining USWCC, Mr. Ozanne was Executive Vice President of General Electric
Capital Corporation, a financial services company.
MR. POST has been director of FSA Holdings since April 1994. Mr. Post was a
director of FSA from April 1994 until July 1994. In addition, he has been
President of USWCC and U S WEST Financial Services Inc. since December 1993,
President of U S WEST Real Estate Inc. since September 1993 and Vice President
- -- Capital Assets of U S WEST since August 1993, and prior thereto was employed
by U S WEST in a number of other positions. Effective January 1996, Mr. Post
will assume additional responsibilities as Vice President -- Commercial
Development of U S WEST Media Group. In addition, Mr. Post has been a director
of a number of U S WEST-affiliated companies.
MR. WATERS has been director of FSA Holdings since August 1994. Mr. Waters
has been Senior Vice President and Chief Financial Officer of Fund American
since December 1993. He was Vice President and Controller of FAE from 1991 to
1993 and has been a member of the Fund American organization (formerly the
Fireman's Fund organization) since 1985. Mr. Waters is also a director of FAE,
Source One, White Mountains Insurance Holdings, Inc. and White Mountains
Insurance Company.
In addition, pursuant to the Merger, U S WEST and Fund American agreed to
cause the Board of Directors to be increased by four members, and to elect
Messrs. Michael Djordjevich, Anthony Frank, Howard Zelikow and Staats Pellett,
Jr. to fill the vacancies created by such increase. Each of Messrs. Djordjevich,
Frank, Zelikow and Pellet ceased to serve as a director and officer, as the case
may be, of Capital Guaranty and its affiliates upon consummation of the Merger.
Set forth below is certain information concerning Messrs. Djordjevich, Frank,
Zelikow and Pellet.
MR. DJORDJEVICH has been Vice Chairman of FSA Holdings since December 1995.
Prior to December 1995, he was President and Chief Executive Officer of Capital
Guaranty, CGIC and Capital Guaranty Service Corporation ("CGSC") from 1986 until
the consummation of the Merger and Chairman of the Board of Directors of all
three companies from 1992 until the consummation of the Merger.
MR. FRANK was a director of Capital Guaranty from February 1994 until the
consummation of the Merger. He has been Chairman of Acrogen, Inc., a
biotechnology company, since 1992. Mr. Frank was Postmaster
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<PAGE>
General of the United States from 1988 to 1992 and, prior to that, he served as
Chairman of the Board and Chief Executive Officer of First Nationwide Bank from
1971 to 1988. Mr. Frank has also been a director of Charles Schwab Inc., Bedford
Properties Inc., Irvine Apartment Communities, Inc., Living Centers of America,
Inc., General American Investors, Inc., Temple-Inland, Inc. and Crescent Real
Estate Equities.
MR. ZELIKOW was a director of Capital Guaranty from February 1994 until the
consummation of the Merger. He has been a management and financial consultant
doing business at ZKA Associates since 1987 and has been a member of Kayne
Anderson Investment Management, Inc. since 1988. Mr. Zelikow has been a director
of Victoria Financial Corporation from 1991 to the present and a director of
Nobel Insurance Limited from 1989 to 1993.
MR. PELLETT was a director of Capital Guaranty from February 1994 until the
consummation of the Merger. He was Senior Vice President of Bessemer Trust
Company N.A. ("Bessemer"), a federally chartered bank engaged in investment
management, fiduciary and other financial services. Mr. Pellett was at Bessemer
from 1976 to January 1996. He also served as a Public Member of the Municipal
Securities Rulemaking Board.
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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding ownership of
FSA Holdings' equity at December 21, 1995 as to (a) each person known by FSA
Holdings to beneficially own, within the meaning of the Exchange Act, 5% or more
of the outstanding shares of the Common Stock or Preferred Stock, (b) each
director and nominee for director of FSA Holdings, (c) each of the five most
highly compensated executive officers of FSA Holdings and (d) all such executive
officers and directors of FSA Holdings as a group. The table provides
information regarding actual, beneficial and voting ownership. In connection
with the IPO, the Company, Fund American and U S WEST entered into certain
arrangements affecting such ownership, which are summarized in Notes (3) and (4)
to the following table.
<TABLE>
<CAPTION>
NUMBER OF SHARES OWNED (1)
-----------------------------------------
VOTING
ACTUAL BENEFICIAL (2) POWER (3)
5% SHAREHOLDERS, DIRECTORS AND ------------------- ------------------- ---------
EXECUTIVE OFFICERS NUMBER PERCENT NUMBER PERCENT PERCENT
- ------------------------------------------------------------ ---------- ------- ---------- ------- ---------
<S> <C> <C> <C> <C> <C>
U S WEST Capital Corporation................................ 15,856,910 50.3% 15,856,910 50.3% 41.7%
c/o U S WEST, Inc.
7800 East Orchard Road
Englewood, Colorado 80111 (4)(5)
Fund American Enterprises Holdings, Inc..................... 2,460,200 7.8 7,020,807 22.3 19.0
The 1820 House
Main Street
Norwich, Vermont 05055 (5)(6)
The Tokio Marine and Fire Insurance Co., Ltd................ 1,929,000 6.1 1,929,000 6.1 5.8
2-1, Marunouchi 1-Chome
Chiyoda-ku, Tokyo 100 Japan
Oppenheimer Group, Inc...................................... 1,352,820 4.3 1,352,820 4.3 4.0
Oppenheimer Tower,
World Financial Center,
New York, New York 10281
Russell B. Brewer II........................................ 5,010 * 61,222 * *
John J. Byrne (6)........................................... 15,000 * 15,000 * *
Robert P. Cochran........................................... 46,954 * 238,457 * *
Robert N. Downey............................................ 50,000 * 50,000 * *
Barbara M. Japha............................................ -- * -- * *
K. Thomas Kemp (6).......................................... 1,600 * 1,600 * *
Kozo Kusakari............................................... -- * -- * *
David O. Maxwell............................................ 6,000 * 6,000 * *
Sean W. McCarthy............................................ 6,984 * 80,841 * *
Richard D. McCormick........................................ 1,000 * 1,000 * *
James M. Osterhoff.......................................... 1,000 * 1,000 * *
James H. Ozanne............................................. 3,000 * 3,000 * *
Richard A. Post............................................. 200 * 200 * *
Bruce E. Stern.............................................. 4,672 * 62,010 * *
Roger K. Taylor............................................. 19,726 * 138,647 * *
Allan L. Waters............................................. 2,000 * 2,000 * *
All executive officers and directors as a group (18
persons)................................................... 168,206 * 775,588 2.5% *%
</TABLE>
- --------------------------
* Indicates less than 1%
(1) In the case of USWCC, Fund American, Tokio Marine and Oppenheimer Group,
Inc., number of shares owned is based on Schedules 13D or 13G filed by such
entities with the Commission. Percents are calculated (a) based on
31,502,025 shares of Common Stock outstanding (excluding 677,722 shares held
by or for the account of FSA Holdings and its subsidiaries), at January 23,
1996 and (b) in accordance with Rule 13d-3 of the Exchange Act with regard
to beneficial ownership, but including (i)
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<PAGE>
vested and unvested performance shares with each performance share treated
as one share of Common Stock, (ii) unvested restricted stock, (iii) equity
bonus shares and (iv) vested stock options exercisable within 60 days, in
each case awarded under plans described in note (2) below.
(2) A person is deemed to have "beneficial ownership" of any shares as of a
given date which such person has the right to acquire within 60 days after
such date. In computing the percentage of outstanding shares held by each
person named above on a given date, any security which such person has the
right to acquire within 60 days after such date is deemed to be outstanding,
but is not deemed to be outstanding for the purpose of computing the
percentage ownership of any other person. Please see Notes (3) and (4) below
for additional information regarding shares beneficially owned by Fund
American. Shares beneficially owned by executive officers include (a)
unvested restricted shares issued to them under the Company's Supplemental
Restricted Stock Plan, (b) equity bonuses awarded under the FSA Holdings'
1993 Equity Partnership Plan and (c) vested and unvested performance shares
awarded under the Company's 1993 Equity Participation Plan assuming such
performance shares are paid out as one share of Common Stock for each
performance share. The table includes shares subject to vested and unvested
performance shares, and equity bonus awards, in the following amounts:
Robert P. Cochran -- 64,000 vested and 96,000 unvested performance shares,
and 8,071.81 equity bonus shares; Roger K. Taylor -- 40,000 vested and
60,000 unvested performance shares, and 4,967.28 equity bonus shares;
Russell B. Brewer II -- 20,000 vested and 30,000 unvested performance
shares, and 1,552.27 equity bonus shares; Sean W. McCarthy -- 26,000 vested
and 39,000 unvested performance shares, and 2,638.86 equity bonus shares;
Bruce E. Stern -- 20,000 vested and 30,000 unvested performance shares, and
2,980.37 equity bonus shares; all executive officers and directors as a
group -- 210,000 vested and 315,000 unvested performance shares, and
24,681.14 equity bonus shares.
(3) Under a voting trust agreement among Fund American, USWCC and The First
National Bank of Chicago, as voting trustee thereunder (the "Voting
Trustee"), 1,893,940 shares of Common Stock deliverable upon the exercise in
full of an option granted by USWCC to Fund American were deposited into a
voting trust administered by the Voting Trustee, and Fund American has the
right to direct the voting of such shares prior to the exercise of the
option (the "Voting Trust Agreement"). In addition, at any time that Fund
American owns at least 35% of the issued and then outstanding shares of
Common Stock (including, for this purpose, the 1,893,940 shares subject to
such option), in order that the Company be considered a majority owned
subsidiary of Fund American, USWCC will deposit into the voting trust an
additional number of shares, to the extent USWCC beneficially owns such
shares, so that Fund American will be able to vote 50.1% of the then issued
and outstanding shares of Common Stock. Percents are calculated based upon
(a) 31,502,025 shares of Common Stock outstanding (excluding 677,722 shares
held by or for the account of FSA Holdings) and (b) 2,000,000 shares of
Series A Convertible Redeemable Preferred Stock of FSA Holdings (the
"Preferred Stock") outstanding at January 23, 1996.
(4) All of such shares are subject to the Fund American Shareholders Agreement
(as hereinafter defined) and the Tokio Marine Stockholders Agreement (as
hereinafter defined). See "Certain Relationships and Related Transactions --
Fund American Shareholders Agreement" and "-- Tokio Marine Stockholders
Agreement." 7,000,000 of such shares (plus an additional 1,050,000 if the
underwriters of the DECS exercise their over-allotment option) may be
delivered by U S WEST or USWCC, at U S WEST's option, upon maturity of the
DECS.
(5) On December 21, 1995, Fund American owned (subject, in each case, to
anti-dilutive adjustment): (a) 2,000,000 shares of Preferred Stock,
constituting all the issued and outstanding Preferred Stock on such date,
which are convertible into an equal number of shares of Common Stock at the
conversion price of $29.65 per share; (b) an option, which expires on May
13, 1999 and entitles Fund American to purchase up to 666,667 shares of
Common Stock from USWCC at an exercise price of $23.50 per share; (c) an
option, which expires on November 2, 2004 and entitles Fund American to
purchase up to 1,893,940 shares of Common Stock from USWCC at an exercise
price of $26.40 per share; and (d) certain voting rights with respect to
certain shares of Common Stock as described in Note (3) above. If Fund
American were to exercise both such options, USWCC's actual and beneficial
ownership would be reduced to 13,296,303 shares, or 42.2%.
(6) Mr. Byrne is the Chairman, President and Chief Executive Officer, and a
major shareholder, of Fund American, and Mr. Kemp is Executive Vice
President, Treasurer and Secretary of Fund American. Messrs. Byrne and Kemp
disclaim beneficial ownership of Common Stock and Preferred Stock held by
Fund American.
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<PAGE>
SELLING SHAREHOLDER
This Prospectus relates to 7,000,000 shares of Common Stock, plus up to an
additional 1,050,000 shares solely to cover over-allotments, which may be
delivered by U S WEST or an affiliate thereof, at U S WEST's option, pursuant to
the terms of the DECS, which are being offered by U S WEST pursuant to the DECS
Prospectus. Such 8,050,000 shares of Common Stock are owned by USWCC, a
wholly-owned subsidiary of U S WEST. In addition to the 8,050,000 shares of
Common Stock which may be delivered upon maturity of the DECS, USWCC owns
7,806,910 shares of Common Stock. All or a portion of the shares of Common Stock
owned by USWCC are subject to the Fund American Shareholders Agreement and the
Tokio Marine Stockholders Agreement. See "Certain Relationships and Related
Transactions -- Fund American Shareholders Agreement" and "-- Tokio Marine
Stockholders Agreement."
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<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
FUND AMERICAN, U S WEST AND FSA HOLDINGS RELATIONSHIPS
In May 1994, Fund American purchased 2,000,000 shares of Common Stock
directly from USWCC, and USWCC simultaneously consummated an initial public
offering of an additional 5,500,000 shares of Common Stock (plus 582,385 shares
of Common Stock pursuant to the underwriters' over-allotment option), at a price
of $20.00 per share. In September 1994, Fund American completed the second stage
(the "Second Closing") of its investment in FSA Holdings and acquired: (i)
50,000 shares of preferred stock, par value $1.00 per share, designated as
Series B Cumulative Redeemable Preferred Stock of U S WEST, Inc., a Colorado
corporation and U S WEST's predecessor (the "U S WEST Preferred Stock"); (ii)(A)
options to acquire 666,667 shares of Common Stock from USWCC at an exercise
price of $23.50 per share beginning November 13, 1994 and ending May 13, 1999
(the "Five-Year Option") and (B) options to acquire 1,893,940 shares of Common
Stock from USWCC at an exercise price of $26.40 per share beginning November 13,
1994 and ending September 2, 2004 (the "Ten-Year Option" and together with the
Five-Year Option, the "USWCC Options"); the number of shares and price per share
contained in the USWCC Options are, in each case, subject to anti-dilutive
adjustment); and (iii) 2,000,000 shares of the Series A Convertible Redeemable
Preferred Stock of FSA Holdings from FSA Holdings which are convertible into an
equal number of shares of Common Stock at a price of $29.65 per share beginning
November 13, 1994 and ending on the redemption date thereof, May 13, 2004. On
November 1, 1995, the U S WEST Preferred Stock was converted into 50,000 shares
of preferred stock, par value $1.00 per share, designated as Series C Cumulative
Redeemable Preferred Stock, of U S WEST, in connection with the implementation
of a recapitalization plan by U S WEST. The USWCC Options and the Preferred
Stock remain outstanding and their terms have not since been amended.
The aggregate purchase price paid by Fund American at the Second Closing was
$50,700,000 in cash, consisting of $50,000,000 paid for the U S WEST Preferred
Stock and the USWCC Options and $700,000 paid for the Preferred Stock. According
to the Schedule 13-D filed by Fund American, the source of such funds was
current assets of Fund American, and no part of such funds is or was represented
by funds or other consideration borrowed or otherwise obtained for the purpose
of acquiring, holding, trading or voting such securities.
In connection with the Second Closing, FSA Holdings entered into a
Registration Rights Agreement with USWCC and Fund American (the "Registration
Rights Agreement"). Under this Agreement, at any time prior to May 13, 2004,
each of Fund American and USWCC is entitled to four demand registrations and the
right to register certain shares on a "piggyback" basis at the expense of FSA
Holdings on an unlimited number of occasions if FSA Holdings proposes to have a
public offering of Common Stock. FSA Holdings has agreed to indemnify Fund
American and USWCC for certain liabilities, including liabilities under the
Securities Act, or to contribute to payments Fund American or USWCC may be
required to make in respect thereof, in connection with sales by such person of
Common Stock in a registration statement prepared by FSA Holdings under the
Registration Rights Agreement. The shares of Common Stock offered hereby are
being registered pursuant to a demand registration exercised by USWCC in
accordance with the terms of the Registration Rights Agreement.
FUND AMERICAN SHAREHOLDERS AGREEMENT
In connection with the Second Closing, Fund American entered into (i) a
Voting Trust Agreement with USWCC and The First National Bank of Chicago, as
voting trustee thereunder, and (ii) the Shareholders Agreement (the "Fund
American Shareholders Agreement") with USWCC and FSA Holdings. Pursuant to the
Voting Trust Agreement, Fund American has the right to direct the voting of the
1,893,940 shares of Common Stock deliverable upon the exercise in full of the
Ten-Year Option prior to the exercise of the Ten-Year Option. In addition, under
certain circumstances, Fund American may require USWCC to deposit additional
shares into the voting trust, to the extent USWCC beneficially owns such shares,
so that Fund American will be able to vote 50.1% of the then issued and
outstanding shares of Common Stock.
The Fund American Shareholders Agreement provides that Fund American and U S
WEST will use their best efforts to cause the Board of Directors of FSA Holdings
to consist of 11 directors and the persons
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<PAGE>
nominated to serve on the Board of Directors to include (i) seven persons
designated by Fund American, four of whom must be approved by U S WEST in the
exercise of its sole discretion, (ii) two independent directors (within the
meaning of the rules of the NYSE), (iii) the President-Chief Executive Officer
of FSA Holdings and (iv) one person who is a senior employee of Tokio Marine,
for the period that such person is required to be designated as a director of
FSA Holdings in accordance with the Tokio Marine Stockholders Agreement referred
to below under "Certain Relationships and Related Transactions -- Tokio Marine
Stockholders Agreement." Fund American and U S WEST have agreed to use their
best efforts to cause Mr. Byrne to be Chairman of the Board of FSA Holdings (as
long as he is able to serve) and he will be deemed to be a designee not
requiring approval of U S WEST.
The Securities Purchase Agreement provides that from and after the 1996
annual meeting of shareholders of FSA Holdings and thereafter, or from an
earlier date in certain events, the parties will use their best efforts to cause
the Board of Directors of FSA Holdings to consist of 11 directors and the
persons nominated to serve on the Board of Directors to include (i) two
independent directors (within the meaning of the rules of the NYSE), (ii) the
President-Chief Executive Officer of FSA Holdings, (iii) one person who is a
senior employee of Tokio Marine, for the period that such person is required to
be designated as a director of FSA Holdings in accordance with the Tokio Marine
Stockholders Agreement, and (iv) seven persons designated by Fund American, of
whom U S WEST must approve a number based on the "voting power" held by Fund
American and U S WEST as of the date of the nominations as set forth in the
following table:
<TABLE>
<CAPTION>
FUND AMERICAN VOTING POWER AS A
PERCENTAGE OF FUND AMERICAN AND DESIGNEES TO BE APPROVED
U S WEST COMBINED VOTING POWER BY U S WEST
- ------------------------------------------------------------------ -----------------------------
<S> <C>
0% through 14.29%................................................. 6
Above 14.29% through 28.58%....................................... 5
Above 28.58% through 50.00%....................................... 4
Above 50.00% through 57.16%....................................... 3
Above 57.16% through 71.45%....................................... 2
Above 71.45% through 90.00%....................................... 1
Above 90.00%...................................................... 0
</TABLE>
FSA Holdings, U S WEST and Fund American are free to alter the foregoing
arrangements and have in fact provided for (a) three (rather than two)
independent directors, (b) the inclusion of FSA Holdings' Chief Operating
Officer as a director, for a total of thirteen directors (rather than eleven)
and (c) the inclusion of four nominees of Capital Guaranty as required pursuant
to the terms of the Merger, for a total of 17 directors.
Under the Fund American Shareholders Agreement, "voting power" means the
number of shares held outright by a party or its affiliates, except that shares
of Common Stock deliverable to Fund American upon exercise of the Ten-Year
Option, and any additional shares deposited by U S WEST in the voting trust
described above, will be deemed to be owned by Fund American and not by U S
WEST, provided that the votes attributed to the Preferred Stock will be excluded
from Fund American's "voting power." The Fund American Shareholders Agreement
requires Fund American and U S WEST to vote all shares of Common Stock over
which they exercise voting control in favor of the election of all persons
nominated as provided in such agreement.
The Fund American Shareholders Agreement terminates upon the earliest to
occur of (i) the cessation of the existence of FSA Holdings, (ii) September 2,
1997, (iii) the consent of U S WEST and Fund American, (iv) the sale,
disposition or other transfer of any shares of Common Stock by U S WEST that
causes U S WEST to own outright (excluding shares of Common Stock deliverable to
Fund American and its majority owned subsidiaries upon exercise of the Ten-Year
Option) less than 15% of the outstanding shares of Common Stock, or (v) such
time as U S WEST, Fund American and their permitted transferees own less than
50% of the outstanding shares of Common Stock.
U S WEST, FSA HOLDINGS AND FSA RELATIONSHIPS
In December 1993, FSA Holdings completed the Restructuring, which
significantly reduced its risk of loss from its insured portfolio of obligations
backed by commercial mortgages (the "Commercial Mortgage
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<PAGE>
Portfolio"). As part of the Restructuring, FSA obtained reinsurance from
Commercial Re in respect of the Commercial Mortgage Portfolio. Commercial Re is
an insurance company organized for the purpose of the Restructuring that is
owned approximately 91.6% by USWCC and 8.4% by Tokio Marine. Various agreements
were entered into among FSA Holdings, Commercial Re and U S WEST in connection
with the Restructuring, all of which remains in force and have not since been
amended. These agreements include (i) a quota share reinsurance agreement, (ii)
an investment management agreement providing for the management by FSA Portfolio
Management of Commercial Re's investment portfolio and other matters in exchange
for a fee initially ranging from 15 to 30 basis points per annum on the market
value of Commercial Re's investment portfolio and (iii) a management agreement
pursuant to which FSA Holdings provides management services to Commercial Re,
including regulatory compliance and accounting services, for a fixed fee of
$100,000 per annum.
So long as USWCC may be deemed to control FSA Holdings, FSA Holdings is
subject to the Modification of Final Judgment (the "Judgment") entered in 1984
in connection with the settlement of the legal action entitled UNITED STATES V.
WESTERN ELECTRIC COMPANY, INC. Pursuant to the Judgment, American Telephone and
Telegraph Company divested itself of its interest in the seven regional
operating companies, including U S WEST. The Judgment prohibits FSA Holdings
from entering into certain activities or obtaining an ownership interest in or
exercising control over any entity that engages in such activities. FSA Holdings
has not engaged, and does not intend to engage, in any of such activities and,
accordingly, the Judgment has not had, and is not expected to have, any material
effect on the business of FSA Holdings.
Since its acquisition of FSA Holdings, U S WEST has provided insurance
coverage for FSA Holdings under insurance policies issued to U S WEST, including
worker's compensation, property and general liability, business interruption,
directors and officer's liability and fiduciary liability coverage. FSA Holdings
pays an allocated share of the premiums for such coverages which are lower than
those FSA Holdings would have to pay were it separately covered for such
matters. FSA Holdings' allocated share of such premiums for 1994 was $0.2
million. In May 1994, U S WEST and FSA Holdings entered into an Insurance
Indemnification and Insurance Agreement that requires U S WEST to continue to
include FSA Holdings and its subsidiaries as insureds under certain insurance
policies until December 31, 1997, subject to earlier termination at the election
of either party.
TOKIO MARINE, FSA HOLDINGS AND FSA RELATIONSHIPS
Tokio Marine, FSA Holdings and FSA entered into a Cooperation Agreement
dated as of December 27, 1990 (the "Cooperation Agreement") in connection with
Tokio Marine's investment in FSA Holdings. The Cooperation Agreement contains
reinsurance provisions (discussed below) and reciprocal marketing provisions.
The Cooperation Agreement also entitles Tokio Marine to select one director of
FSA Holdings and of FSA and to place up to three of its employees in FSA's New
York offices. The term of the Cooperation Agreement is automatically renewed on
an annual basis for successive one-year terms unless notice is given, subject to
earlier termination by one party upon default by the other, prior to December 31
of the prior year. Pursuant to the Cooperation Agreement, FSA has entered into a
Master Reinsurance Placement Memorandum (the "Memorandum") dated December 27,
1990 by which FSA has agreed to cede and Tokio Marine has agreed to accept
reinsurance equal to 10% of the principal amount of new business written by FSA
in each calendar year, with the cessions to be composed of treaty participations
and facultative cessions, including an automatic facility by which FSA at its
option may cede up to $25.0 million per policy on a quota share basis subject to
certain condition. Pursuant to the Memorandum, Tokio Marine participates in
FSA's non-municipal and municipal treaties and has provided facultative
reinsurance to FSA. FSA Holdings ceded premiums of $14.2 million and $6.6
million to Tokio Marine for the years ended December 31, 1993 and 1994,
respectively. In the opinion of the management of FSA Holdings and FSA, the
terms of the Cooperation Agreement and reinsurance with Tokio Marine are no less
favorable to FSA than the terms that could be obtained from unaffiliated
parties.
TOKIO MARINE STOCKHOLDERS AGREEMENT
Pursuant to a Stockholders Agreement dated December 27, 1990, as amended
(the "Tokio Marine Stockholders Agreement"), among Tokio Marine, FSA Holdings
and USWCC, USWCC has agreed to vote
70
<PAGE>
all stock in FSA Holdings owned by it to nominate and to elect a senior employee
of Tokio Marine designated by Tokio Marine to the Board of Directors of FSA
Holdings as long as Tokio Marine owns at least 5% (9.9% in the event the
Cooperation Agreement is terminated as a result of a breach by Tokio Marine) of
FSA Holdings' outstanding Common Stock or the Cooperation Agreement is in
effect. As long as such conditions are met, to the extent permitted by law, FSA
Holdings has agreed to cause a senior employee of Tokio Marine to be nominated
as a director of FSA Holdings. So long as Tokio Marine owns any Common Stock,
USWCC has agreed to use commercially reasonable efforts to cause the maximum
cash dividends to be paid each year with respect to the Common Stock of FSA
Holdings which can be paid without violating applicable law, causing the rating
agencies to lower or consider lowering the triple-A claims-paying ability
ratings of FSA or reducing the cash of FSA Holdings and its subsidiaries below
the amount needed to satisfy their reasonably anticipated business needs.
The Tokio Marine Stockholders Agreement contains certain restrictions on the
ability of Tokio Marine, USWCC and FSA Holdings to sell or otherwise transfer
any stock of FSA Holdings or any subsidiary of FSA Holdings (and, under certain
circumstances, the stock of USWCC), or all or substantially all of the assets of
FSA Holdings or FSA, including a right of first offer in the event of a proposed
sale of Common Stock by USWCC or Tokio Marine. Under such right of first offer,
Tokio Marine will have the right to purchase all of the shares of Common Stock
owned by USWCC which may be delivered upon maturity of the DECS. Certain of the
rights granted to Tokio Marine under the Tokio Marine Stockholders Agreement may
make it more difficult for USWCC to sell additional shares of Common Stock or
for FSA Holdings to dispose of certain assets or raise funds from the sale of
Common Stock and therefore might be deemed to restrict a change of control of
FSA Holdings.
REINSURANCE AGREEMENTS WITH ENHANCE REINSURANCE COMPANY
Enhance, a subsidiary of Enhance Financial Services Group Inc. ("Enhance
Financial") which was 31.5% owned by a subsidiary of U S WEST at September 30,
1995, provides reinsurance to FSA by participating in the asset-backed and
municipal reinsurance treaties and through facultative cessions. On December 11,
1995, U S WEST issued 5,430,800 of its 7.625% Exchangeable Notes due December
15, 1998 (the "Enhance DECS"). At maturity of the Enhance DECS, U S WEST may, at
its option, deliver to holders of the Enhance DECS the shares of common stock of
Enhance Financial owned by U S WEST's subsidiary. If U S WEST so elects to
deliver such shares, the interest of U S WEST in Enhance Financial will be
significantly reduced.
For 1994, FSA ceded to Enhance 4% of the principal amount of new business
written in the asset-backed area (which FSA may increase to 6%), subject to
certain treaty limitations and exclusions, and 5% of the principal amount of new
business written in the municipal area (which FSA may increase to 10%), subject
to certain treaty limitations and exclusions. Asset Guaranty Insurance Company
("Asset Guaranty"), which is also a subsidiary of Enhance Financial, previously
participated in the asset-backed treaty and assumed reinsurance through
facultative cessions. Pursuant to reinsurance agreements in effect in prior
years with Enhance and Asset Guaranty, FSA Holdings ceded to Enhance and Asset
Guaranty premiums of $13.4 million, $10.0 million and $7.6 million for the years
ended December 31, 1992, 1993 and 1994, respectively. In the opinion of the
management of FSA Holdings, the terms of the existing reinsurance agreements
with Enhance are no less favorable to FSA and its subsidiaries than the terms
that could be obtained from unaffiliated parties.
OTHER RELATIONSHIPS
In connection with the 1989 acquisition of FSA by U S WEST, FSA Holdings
issued promissory notes and incurred other obligations to Mr. Cochran and to
several former members of the management of FSA Holdings, in exchange for all
their common stock of FSA Holdings. In addition, certain amounts of deferred
compensation were included in the notes and obligations to several of these
individuals. The aggregate principal amounts owed to Mr. Cochran and to certain
former members of management in the aggregate, at January 1, 1995, were $620,107
and $5,003,532, respectively. The respective principal balances were paid in two
equal installments on January 3, 1995 and March 31, 1995.
71
<PAGE>
In February 1992, FSA Holdings provided a loan in the principal amount of
$630,000 to Mr. Sean W. McCarthy, a Managing Director of FSA, in connection with
his relocation to New York City at the request of FSA Holdings. In December
1993, the loan agreement was amended to (i) reduce the principal balance by
$141,173 (an amount equal to the loss on the sale of his home in connection with
such relocation) and (ii) allow for the repayment of the remaining principal
balance of $362,827.06 at December 31, 1993 over a ten-year period in equal
installments at an interest rate of 5.27% per annum. Installment payments were
made in January 1995 and January 1996.
72
<PAGE>
PLAN OF DISTRIBUTION
Subject to the terms and conditions set forth in the Underwriting Agreement
(the "Underwriting Agreement") among FSA Holdings, U S WEST and the
Underwriters, for whom Salomon, Donaldson, Lufkin & Jenrette Securities
Corporation and Lehman Brothers Inc. are acting as representatives, U S WEST has
agreed to sell to the Underwriters, and the Underwriters have agreed to
purchase, the aggregate number of DECS set forth opposite their names below:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITERS DECS
- ------------------------------------------------------------------------------------------- -----------
<S> <C>
Salomon Brothers Inc.......................................................................
Donaldson, Lufkin & Jenrette Securities Corporation........................................
Lehman Brothers Inc. ......................................................................
-----------
Total.................................................................................... 7,000,000
-----------
-----------
</TABLE>
In the Underwriting Agreement, the several Underwriters have agreed, subject
to the terms and conditions set forth therein, that the obligations of the
Underwriters are subject to certain conditions precedent and that the
Underwriters will be obligated to purchase all of the DECS offered pursuant to
the DECS Prospectus if any of the DECS are purchased.
U S WEST has been advised by the Underwriters that they propose to offer the
DECS directly to the public initially at the public offering price set forth on
the cover of the DECS Prospectus and to certain dealers at such prices less a
concession not in excess of $ per DECS. The Underwriters may allow, and
such dealers may reallow, a concession not in excess of $ per DECS to other
dealers. After the initial public offering, such public offering price and such
concession and reallowance may be changed.
U S WEST and FSA Holdings have agreed not to offer for sale, sell or
contract to sell, or otherwise dispose of, or announce the offering of, without
the prior written consent of Salomon, any shares of Common Stock or any
securities convertible into or exchangeable for, or warrants to acquire, Common
Stock for a period of 180 days after the date of this Prospectus; provided,
however, that such restriction shall not affect the ability of (i) U S WEST, FSA
Holdings or their respective subsidiaries to take any such actions in connection
with the offering of the DECS made pursuant to the DECS Prospectus or any
exchange at maturity pursuant to the terms of the DECS, (ii) FSA Holdings to
take any such actions in connection with any employee stock option plan, stock
ownership plan or dividend reinvestment plan of FSA Holdings in effect at the
date of this Prospectus or (iii) U S WEST to lend shares of Common Stock
pursuant to the terms of the Securities Loan Agreement (as defined herein).
In connection with the DECS Offering, U S WEST or an affiliate thereof
(referred to herein as the "Lender"), and Salomon intend to enter into a
Securities Loan Agreement (the "Securities Loan Agreement") which provides that,
subject to certain restrictions and with the agreement of the Lender, Salomon
may from time to time borrow, return and reborrow shares of Common Stock from
the Lender (the "Borrowed Securities"); PROVIDED, HOWEVER, that the number of
Borrowed Securities at any time may not exceed 1,600,000 shares, subject to
adjustment to provide antidilution protection. The Securities Loan Agreement is
intended to facilitate market-making activity in the DECS by Salomon. Salomon
may from time to time borrow shares of Common Stock under the Securities Loan
Agreement to settle short sales of Common Stock entered into by Salomon to hedge
any long position in the DECS resulting from its market-making activities. Such
sales will be made on the NYSE or in the over-the-counter market at market
prices prevailing at the time of sale or at prices related to such market
prices. Market conditions will dictate the extent and timing of Salomon's
market-making transactions in the DECS and the consequent need to borrow shares
of Common Stock. The availability of shares of Common Stock under the Securities
Loan Agreement, if any, at any time is not assured and any such availability
does not assure market-making activity with respect to the DECS and any
market-making actually engaged in by Salomon may cease at any time. The
foregoing description of the Securities Loan Agreement does not purport to be
complete and is qualified in its entirety by reference to the Agreement, a copy
of which is filed as an exhibit to the Registration Statement of which the
Prospectus is a part.
73
<PAGE>
U S WEST has granted to the Underwriters an option, exercisable for the
30-day period after the date of the DECS Prospectus, to purchase up to an
additional 1,050,000 DECS from U S WEST, at the same price per DECS as the
initial DECS to be purchased by the Underwriters. The Underwriters may exercise
such option only for the purpose of covering over-allotments, if any, incurred
in connection with the sale of DECS offered pursuant to the DECS Prospectus. To
the extent that the Underwriters exercise such option, each Underwriter will
have a firm commitment, subject to certain conditions, to purchase the same
proportion of the DECS as the number of DECS to be purchased and offered by such
Underwriter in the above table bears to the total number of initial DECS to be
purchased by the Underwriters.
The DECS will be a new issue of securities with no established trading
market. The Underwriters intend to make a market in the DECS, subject to
applicable laws and regulations. However, the Underwriters are not obligated to
do so and any such market-making may be discontinued at any time at the sole
discretion of the Underwriters without notice. Accordingly, no assurance can be
given as to the liquidity of such market.
At U S WEST's option, upon maturity of the DECS, shares of Common Stock may
be delivered by U S WEST or USWCC pursuant to the terms of the DECS. For a
description of the terms of such exchange, see the DECS Prospectus.
The Underwriting Agreement provides that U S WEST and FSA Holdings will
indemnify the Underwriters against certain liabilities, including liabilities
under the Securities Act, or contribute to payments the Underwriters may be
required to make in respect thereof.
The Underwriters have from time to time performed various investment banking
and financial advisory services for U S WEST, FSA Holdings and their respective
affiliates, for which customary compensation has been received.
EXPERTS
FINANCIAL STATEMENTS
The consolidated financial statements of FSA Holdings and its subsidiaries
as of December 31, 1994 and 1993 and for each of the three years in the period
ended December 31, 1994, incorporated by reference in FSA Holdings' Annual
Report (Form 10-K), have been audited by Coopers & Lybrand L.L.P., independent
auditors, as set forth in their report thereon included therein and incorporated
herein by reference. Such consolidated financial statements are incorporated
herein by reference in reliance upon such report given upon the authority of
such firm as experts in accounting and auditing.
The consolidated financial statements of Capital Guaranty and its
subsidiaries as of December 31, 1994 and 1993, and for each of the three years
in the period ended December 31, 1994, incorporated by reference in Capital
Guaranty's Annual Report (Form 10-K), have been audited by Ernst & Young LLP,
independent auditors, as set forth in their report thereon included therein and
incorporated herein by reference. Such consolidated financial statements are
incorporated herein by reference in reliance upon such report given upon the
authority of such firm as experts in accounting and auditing.
LEGAL MATTERS
The validity of the Common Stock being offered hereby will be passed upon
for FSA Holdings by Bruce E. Stern, Esq., General Counsel of FSA Holdings.
74
<PAGE>
GLOSSARY OF INSURANCE TERMS
<TABLE>
<S> <C>
Acquisition costs................. All expenses incurred that are primarily related to
acquiring new insurance policies.
Asset-backed debt obligation or
asset-backed debt security....... A debt instrument that is supported by a pool of assets,
such as automobile loans or single family mortgage
loans. The payments on the assets produce the revenue
stream that services the interest and principal on the
asset-backed debt obligation.
Capacity.......................... The measure of an insurer's financial strength to issue
contracts of insurance, usually determined by the
largest amount acceptable on a given risk or, in certain
other situations, by the maximum volume of business it
is prepared to accept.
Cede.............................. To pass on to a reinsurer all or part of the insurance
written by an insurer (the ceding insurer) with the
object of reducing the possible liability of the latter.
"Cessions" is the noun equivalent of the verb "cede."
Ceded premiums.................... Premiums transferred under reinsurance policies in
connection with the transfer by an insurance company of
a portion of its insured risk to another insurer (the
reinsurer).
Ceding commission................. The consideration paid by an assuming company to a
ceding company to cover acquisition costs related to
business assumed under a reinsurance or retrocession
contract.
Ceding company.................... An insurance company that cedes a portion of its insured
risk to a reinsurer.
Combined ratio.................... The sum of the loss ratio and the expense ratio on
either a SAP or a GAAP basis, as the case may be.
Contingency reserve............... A reserve used in SAP accounting designed to protect
policyholders against the effect of excessive losses
occurring during adverse economic cycles.
Credit enhancement................ Use of a financial guaranty to upgrade the credit
quality of a security such as by the use of an insurance
policy or letter of credit.
Credit rating..................... An alphabetic system used by major rating agencies to
categorize the creditworthiness of an issuer of a
specific obligation. A credit rating of BBB or Baa or
better is considered an investment grade rating, meaning
the securities have been analyzed and are regarded as
having adequate capacity to provide timely payment of
debt service. A credit rating below BBB or Baa is
considered a speculative grade rating, meaning there is
a greater vulnerability to default.
Deferred acquisition cost......... Those expenses, generally incurred at the commencement
of the term of the insurance policy, that vary with and
are primarily related to the production of new or
renewal business, including: salaries and related costs
of underwriting and marketing, rating agency fees,
premium taxes, and certain other underwriting expenses
offset by reinsurance commissions received on premiums
ceded to reinsurers.
</TABLE>
75
<PAGE>
<TABLE>
<S> <C>
Earned premium.................... The portion of net premiums that is recognized as income
during a given period. The amount of earned premium in a
given period is determined differently under SAP and
under GAAP.
Excess of loss reinsurance........ A form of non-proportional reinsurance which, subject to
a specified limit, indemnifies the ceding company
against loss in excess of a specified deductible with
respect to claims under a policy. This form of insurance
is also known as stop-loss insurance.
Expense ratio..................... On a SAP basis, the ratio of underwriting and operating
expenses divided by net premiums written. On a GAAP
basis, the ratio of underwriting and operating expenses
to net premium earned.
Facultative reinsurance........... Involves individual risks offered to the reinsurer which
the latter is under no obligation to accept.
Financial guaranty................ The promise to make payments to the holders of a debt,
loan or other similar financial instrument in the event
the borrower or underlying obligor fails to do so.
GAAP.............................. Generally accepted accounting principles as defined by
the American Institute of Certified Public Accountants,
the Financial Accounting Standards Board and other
recognized accounting literature.
GAAP expense ratio................ The quotient derived by dividing underwriting and
operating expenses by net premiums earned.
Gross insurance in force.......... The sum of all liabilities insured under insurance and
reinsurance policies in force. Gross insurance in force
in the case of a financial guaranty insurance policy is
the sum of all unpaid principal, interest and other
obligations, in respect of the obligations insured,
assuming payment at maturity in accordance with the
terms of such obligations, net of refunded bonds secured
by United States government securities held in escrow or
other qualified collateral and net of defeased policy
obligations and redemptions and repayments.
Gross par amount insured.......... The aggregate principal amount of obligations insured.
Gross par amount outstanding...... The outstanding principal amount of insured obligations,
net of refunded bonds secured by United States
government securities held in escrow or other qualified
collateral and net of defeased policy obligations.
Gross premiums written............ All premiums arising from policies issued directly by
the primary insurance company to its policyholders plus
assumed premiums.
Guarantor......................... The entity, such as an insurance company, that promises
to pay on an obligation in the event the obligor fails
to do so.
Incurred losses................... Losses which have already occurred and which have or
will result in a claim under the terms of an insurance
policy or a reinsurance agreement.
Insurance in force or exposure.... Principal outstanding and interest to be paid over the
remaining life of a given obligation in respect of
obligations insured and reinsured by the Company, net of
refunded debt obligations, retrocessions, redemptions
and repayments.
</TABLE>
76
<PAGE>
<TABLE>
<S> <C>
Issuer............................ A municipality or corporation or other entity that is
the obligor on a debt issuance to the capital markets.
Leverage ratio.................... The ratio of insurance in force to qualified statutory
capital.
Loss adjustment expenses or LAE... All of the costs associated with the settlement of
claims, except the claim payment itself.
Loss ratio........................ On a SAP basis, the ratio of losses and loss adjustment
expenses incurred (exclusive of additions to the general
loss reserve) to net premiums earned. On a GAAP basis,
the ratio of losses and loss adjustment expenses
incurred (inclusive of additions to the general loss
reserve) to net premiums earned.
Loss reserve...................... For an individual loss, an estimate of the amount the
insurer expects to pay for the reported claim. For total
losses, estimates of expected payments for reported and
unreported claims. May include amounts for loss
adjustment expenses. See "Incurred losses."
Monoline financial guaranty
insurer.......................... A property/casualty insurer which operates in areas of
bond insurance and closely related lines, and which has
no exposure resulting from other general
property/casualty lines of business. Monoline financial
guaranty insurer traditionally referred to a writer of
municipal bond insurance, but currently includes, as
well, insurers of asset-backed debt obligations.
Net insurance in force............ The gross insurance in force under outstanding insurance
and reinsurance policies issued by the insurer, net of
ceded reinsurance.
Net par amount outstanding........ Gross par amount outstanding, net of ceded reinsurance.
Net premiums earned............... Premiums earned, net of earned premiums ceded to
reinsurers.
Net premiums written.............. Gross premiums written, net of premiums ceded to
reinsurers.
Obligor........................... The entity required to make payments under a debt, loan
or other similar financial instrument.
Policyholders' surplus............ The amount remaining after all liabilities, including
loss and contingency reserves, are subtracted from all
assets, applying SAP.
Premiums earned................... The premiums written during a period plus the unearned
premiums at the beginning of the period less the
unearned premiums at the end of the period.
Proportional reinsurance.......... A generic term describing all forms of reinsurance in
which the reinsurer shares a proportional part of the
original losses and premiums of the reinsured.
Qualified statutory capital....... The aggregate of policyholders' surplus and contingency
reserves, calculated in accordance with SAP.
Quota share....................... A form of proportional reinsurance under which the
ceding insurer transfers to the reinsurer a specified
percentage of each risk within a defined category or
insurance business written by the insurer in return for
a similar percentage of the premium applicable thereto.
</TABLE>
77
<PAGE>
<TABLE>
<S> <C>
Reinsurance....................... The procedure whereby an insurer transfers ("cedes") to
another insurer a portion of the risk insured and a
portion of the related premiums. Reinsurance can be
effected by a "treaty," where reinsurance automatically
covers a portion of all risks of a defined category,
amount and type, or by "facultative" reinsurance, where
reinsurance is negotiated on a contract-by-contract
basis.
Residual value insurance.......... Insurance that guaranties a minimum value for an asset
or pool of assets at a particular point in time, such as
at the expiration date of a lease with respect to such
asset or assets.
SAP............................... Statutory Accounting Practices consisting of recording
transactions and preparing financial statements in
accordance with the rules and procedures prescribed or
permitted by state regulatory authorities.
Surety............................ A line of insurance in which the obligor promises to
perform the obligations of a third party under a
contractual agreement should the third party fail to do
so. A surety is similar in form to a financial guaranty,
the essential difference being that financial guaranties
apply to third-party obligations which are of a
financial nature.
Treaty reinsurance................ Reinsurance written on a treaty basis instead of
facultatively. A reinsurance treaty is a reinsurance
agreement between the ceding company and the reinsurer,
usually for one year or longer, which stipulates the
technical particulars applicable to the reinsurance of
some class or classes of business.
Underwriting...................... The insurer's or reinsurer's process of reviewing
submissions for insurance coverage, deciding whether to
accept all or part of the coverage requested and
determining the applicable premiums; also refers to the
acceptance of such coverage.
Unearned premiums................. The portion of premium attributable to the unexpired
period of policies that has been collected by an insurer
but has not yet been recognized as earned premiums and
accounted for as revenues.
</TABLE>
78
<PAGE>
NO DEALER, SALESPERSON OR ANY OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE
MADE HEREUNDER SHALL UNDER ANY CIRCUMSTANCES CREATE AN IMPLICATION THAT THERE
HAS BEEN NO CHANGE IN THE FACTS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OR
SOLICITATION BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION
IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS
NOT QUALIFIED TO DO SO OR TO ANYONE TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR
SOLICITATION.
--------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Available Information.......................... 2
Incorporation of Certain Documents by
Reference..................................... 3
Prospectus Summary............................. 4
Risk Factors................................... 9
Recent Developments............................ 12
Use of Proceeds................................ 14
Price Range of Common Stock and Dividends...... 15
Unaudited Pro Forma Consolidated Condensed
Financial Information......................... 16
Selected Historical Consolidated Financial
Information of Financial Security Assurance
Holdings Ltd.................................. 23
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.................................... 25
Financial Guaranty Industry Overview........... 33
Business....................................... 35
Capital Guaranty Corporation................... 50
Selected Historical Consolidated Financial
Information of Capital Guaranty Corporation... 55
Insurance Regulatory Matters................... 57
Accounting..................................... 59
Directors and Executive Officers............... 61
Security Ownership of Certain Beneficial Owners
and Management................................ 65
Selling Shareholder............................ 67
Certain Relationships and Related
Transactions.................................. 68
Plan of Distribution........................... 73
Experts........................................ 74
Legal Matters.................................. 74
Glossary of Insurance Terms.................... 75
</TABLE>
7,000,000 SHARES
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
COMMON STOCK
($.01 PAR VALUE)
[LOGO]
PROSPECTUS
DATED , 1996
<PAGE>
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS SUPPLEMENT OR THE PROSPECTUS, IN CONNECTION WITH THE OFFER CONTAINED
IN THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS, AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY U S WEST OR ANY UNDERWRITER. NEITHER THE DELIVERY OF THIS PROSPECTUS
SUPPLEMENT AND THE PROSPECTUS NOR ANY SALE MADE HEREUNDER AND THEREUNDER SHALL
UNDER ANY CIRCUMSTANCES CREATE AN IMPLICATION THAT THERE HAS BEEN NO CHANGE IN
THE AFFAIRS OF U S WEST SINCE THE DATE HEREOF. THIS PROSPECTUS SUPPLEMENT AND
THE PROSPECTUS ARE NOT AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY
SECURITY IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH OFFER OR
SOLICITATION.
-------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
PROSPECTUS SUPPLEMENT
Risk Factors Relating to DECS................. S-3
U S WEST, Inc................................. S-5
Recent Development............................ S-5
Financial Security Assurance Holdings Ltd..... S-6
Relationship Between U S WEST and FSA
Holdings.................................... S-8
Capitalization................................ S-9
Summary Financial Data........................ S-10
Price Range and Dividend History of FSA
Holdings Common Stock....................... S-11
Use of Proceeds............................... S-11
Description of the DECS....................... S-12
Certain United States Federal Income Tax
Considerations.............................. S-18
Plan of Distribution.......................... S-21
Legal Opinions................................ S-22
PROSPECTUS
Available Information......................... 2
Incorporation of Certain Documents by
Reference................................... 3
U S WEST, Inc................................. 4
Recent Development............................ 4
Ratio of Earnings to Fixed Charges............ 5
Use of Proceeds............................... 5
Description of Debt Securities................ 5
Plan of Distribution.......................... 10
Legal Opinions................................ 11
Experts....................................... 11
Appendix A
</TABLE>
7,000,000 DECS-SM-
(DEBT EXCHANGEABLE FOR
COMMON STOCK-SM-)
U S WEST, INC.
% EXCHANGEABLE NOTES
DUE , 1999
[LOGO]
SALOMON BROTHERS INC
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
LEHMAN BROTHERS
PROSPECTUS SUPPLEMENT
DATED , 1996
