<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 31, 1997
REGISTRATION NO. 33-99420
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
POST-EFFECTIVE AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
WFS FINANCIAL 1997-A OWNER TRUST
WFS FINANCIAL AUTO LOANS, INC.
(ORIGINATOR OF THE TRUST DESCRIBED HEREIN)
<TABLE>
<S> <C> <C>
CALIFORNIA 9999 33-0149603
(STATE OR OTHER JURISDICTION OF (PRIMARY SIC (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
23 PASTEUR ROAD
IRVINE, CALIFORNIA 92618
(714) 753-3000
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------
JAMES R. DOWLAN
PRESIDENT
WFS FINANCIAL AUTO LOANS, INC.
23 PASTEUR ROAD
IRVINE, CALIFORNIA 92618
(714) 753-3000
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
------------------------
COPIES TO:
<TABLE>
<S> <C>
ANDREW E. KATZ, ESQ. DALE W. LUM, ESQ.
MITCHELL, SILBERBERG & KNUPP LLP BROWN & WOOD LLP
11377 W. OLYMPIC BOULEVARD 555 CALIFORNIA STREET
LOS ANGELES, CALIFORNIA 90064-1683 SAN FRANCISCO, CALIFORNIA 94104-1715
</TABLE>
------------------------
Approximate date of commencement of proposed sale to the public: As soon as
practicable after this Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<S> <C> <C> <C> <C>
=====================================================================================================
PROPOSED PROPOSED
TITLE OF EACH MAXIMUM MAXIMUM AMOUNT OF
CLASS OF SECURITIES AMOUNT TO BE OFFERING PRICE AGGREGATE REGISTRATION
TO BE REGISTERED REGISTERED PER UNIT OFFERING PRICE FEE*
- ------------------------------------------------------------------------------------------------------------
Auto Receivable Backed Securities....... $500,000,000 100% $500,000,000 $162,424.24
=====================================================================================================
</TABLE>
* Previously paid.
================================================================================
<PAGE> 2
NOTE
THIS POST-EFFECTIVE AMENDMENT NO. 1 TO REGISTRATION STATEMENT IS
BEING FILED TO FILE A COPY OF THE AUDITED FINANCIAL STATEMENTS OF FINANCIAL
SECURITY ASSURANCE INC. FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996, ALONG WITH
AN EXECUTED ACCOUNTANT'S CONSENT THERETO. THOSE FINANCIAL STATEMENTS ARE
EXHIBIT 28 TO THIS POST-EFFECTIVE AMENDMENT NO. 1 TO REGISTRATION STATEMENT,
AND THE CONSENT IS EXHIBIT 23.3.
<PAGE> 3
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
Expenses in connection with the offering of the Securities being registered
hereby are estimated as follows:
<TABLE>
<S> <C>
Registration Fee................................................ $162,424.24
Printing and Engraving.......................................... 50,000.00
Trustees' Fees.................................................. 12,500.00
Accounting Fees................................................. 35,000.00
Legal Fees and Expenses......................................... 80,000.00
Blue Sky Fees and Expenses...................................... 20,000.00
Rating Agency Fees.............................................. 60,000.00
Miscellaneous Fees.............................................. 5,075.76
-----------
Total................................................. $425,000.00
==========
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 317(b) of the California Corporations Code (the "Corporations
Code") provides that a corporation may indemnify any person who was or is a
party or is threatened to be made a party to any "proceeding" (as defined in
Section 317(a) of the Corporations Code), other than an action by or in the
right of the corporation to procure a judgment in its favor, by reason of the
fact that such person is or was a director, officer, employee or other agent of
the corporation (collectively, an "Agent"), against expenses, judgments, fines,
settlements and other amounts actually and reasonably incurred in connection
with such proceeding if the Agent acted in good faith and in a manner the Agent
reasonably believed to be in the best interest of the corporation and, in the
case of a criminal proceeding, had no reasonable cause to believe the conduct
was unlawful.
Section 317(c) of the Corporations Code provides that a corporation shall
have power to indemnify any Agent who was or is a party or is threatened to be
made a party to any threatened, pending or completed action by or in the right
of the corporation to procure a judgment in its favor by reason of the fact that
such person is or was an Agent, against expenses actually and reasonably
incurred by the Agent in connection with the defense or settlement of such
action if the Agent acted in good faith and in a manner such Agent believed to
be in the best interest of the corporation and its shareholders.
Section 317(c) further provides that no indemnification may be made
thereunder for any of the following: (i) in respect of any matter as to which an
Agent shall have been adjudged to be liable to the corporation, unless the court
in which such proceeding is or was pending shall determine that such Agent is
fairly and reasonably entitled to indemnity for expenses, (ii) of amounts paid
in settling or otherwise disposing of a pending action without court approval
and (iii) of expenses incurred in defending a pending action which is settled or
otherwise disposed of without court approval.
Section 317(d) of the Corporations Code requires that an Agent be
indemnified against expenses actually and reasonably incurred to the extent the
Agent has been successful on the merits in the defense of proceedings referred
to in subdivisions (b) or (c) of Section 317.
Except as provided in Section 317(d), and pursuant to Section 317(e),
indemnification under Section 317 shall be made by the corporation only if
specifically authorized and upon a determination that indemnification is proper
in the circumstances because the Agent has met the applicable standard of
conduct, by any of the following: (i) a majority vote of a quorum consisting of
directors who are not parties to the proceeding, (ii) if such a quorum of
directors is not obtainable, by independent legal counsel in a written
II-1
<PAGE> 4
opinion, (iii) approval of the shareholders, provided that any shares owned by
the Agent may not vote thereon, or (iv) the court in which such proceeding is or
was pending.
Pursuant to Section 317(f) of the Corporations Code, the corporation may
advance expenses incurred in defending any proceeding upon receipt of an
undertaking by the Agent to repay such amount if it is ultimately determined
that the Agent is not entitled to be indemnified.
Section 317(h) provides, with certain exceptions, that no indemnification
shall be made under Section 317 where it appears that it would be inconsistent
with a provision of the corporation's articles, bylaws, a shareholder resolution
or an agreement which prohibits or otherwise limits indemnification, or where it
would be inconsistent with any condition expressly imposed by a court in
approving a settlement.
Section 317(i) authorizes a corporation to purchase and maintain insurance
on behalf of an Agent for liabilities arising by reason of the Agent's status,
whether or not the corporation would have the power to indemnify the Agent
against such liability under the provisions of Section 317.
Registrant's Bylaws (the "Bylaws") provide for the indemnification of
officers and directors of the Registrant, to the maximum extent permitted by the
Corporations Code, against expenses, judgments, fines, settlements, and other
amounts actually and reasonably incurred in connection with any proceeding
arising by reason of the fact that such person is or was an officer or director
of the Registrant, and further provides for the advance to such officer or
director of expenses incurred by such officer or director in any such proceeding
to the maximum extent permitted by law. The Bylaws also provide that
Registrant's Board of Directors may provide for the indemnification of, or
advancement of expenses to, other Agents. Registrant's Articles of Incorporation
provide that the liability of directors of the Registrant shall be eliminated to
the fullest extent permissible under California law, but contain no specific
provisions with respect to the indemnification of, or advancement of expenses
to, Agents.
Reference is also made to Section 7 of the Underwriting Agreement among
Donaldson, Lufkin & Jenrette Securities Corporation, the Registrant and WFS (see
Exhibit 1.1), which provides for indemnification of the Registrant under certain
circumstances.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
Not applicable.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
A. EXHIBITS
<TABLE>
<C> <S>
1.1 Form of Underwriting Agreement*
3.1 Articles of Incorporation of WFS Financial Auto Loans, Inc.*
3.2 Bylaws of WFS Financial Auto Loans, Inc.*
4.1 Form of Trust Agreement among WFS Financial Auto Loans, Inc., as Seller, WFS
Investments, Inc., Financial Security Assurance Inc. and Chase Manhattan Bank
Delaware, as Owner Trustee (including form of Certificates)*
4.2 Form of Indenture among WFS Financial 1997-A Owner Trust, Financial Security
Assurance Inc. and Bankers Trust Company, as Indenture Trustee (including
forms of Notes)*
5.1 Opinion of Mitchell, Silberberg & Knupp LLP with respect to legality*
8.1 Opinion of Mitchell, Silberberg & Knupp LLP with respect to tax matters*
10.1 Form of Reinvestment Contract*
10.2 Form of Sale and Servicing Agreement*
10.3 Form of Insurance Agreement*
10.4 Form of Financial Guaranty Insurance Policy (Notes)*
</TABLE>
II-2
<PAGE> 5
<TABLE>
<C> <S>
10.5 Form of Financial Guaranty Insurance Policy (Certificates)*
10.6 Form of Indemnification Agreement*
10.7 Form of Administration Agreement among WFS Financial 1997-A Owner Trust, WFS
Financial Inc, and Bankers Trust Company, as Indenture Trustee*
23.1 Consent of Mitchell, Silberberg & Knupp LLP (included as part of Exhibit
5.1)*
23.2 Consent of Mitchell, Silberberg & Knupp LLP (included as part of Exhibit
8.1)*
23.3 Consent of Coopers & Lybrand, L.L.P.
24.1 Power of Attorney*
25.1 Statement of Eligibility and Qualification of Indenture Trustee
28 Audited Consolidated Financial Statements of Financial Security Assurance
Inc. for the year ended December 31, 1996
</TABLE>
- ---------------
* Previously filed.
B. FINANCIAL STATEMENT SCHEDULES
Not applicable.
ITEM 17. UNDERTAKINGS.
The undersigned Registrant hereby undertakes as follows:
(a) To provide to the Underwriter at the closing date specified in the
Underwriting Agreement certificates in such denominations and registered in
such names as required by the Underwriter to provide prompt delivery to
each purchaser.
(b) Insofar as indemnification for liabilities arising under the
Securities Act of 1933 (the "Act") may be permitted to directors, officers
and controlling persons of the Registrant pursuant to the foregoing
provisions, or otherwise, the Registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Act and is therefore
unenforceable. In the event that a claim for indemnification against such
liabilities (other than payment by the Registrant of expenses incurred or
paid by a director, officer or controlling person of such Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities
being registered, the Registrant will, unless in the opinion of its counsel
the matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Act and will be governed by the
final adjudication of such issue.
(c) For purposes of determining any liability under the Act, the
information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Act will be deemed to be part of this registration
statement as of the time it was declared effective.
(d) For purpose of determining any liability under the Act, each
post-effective amendment that contains a form of prospectus will be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time will be deemed to
be the initial bona fide offering thereof.
II-3
<PAGE> 6
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Post-Effective Amendment No. 1 to Registration Statement to
be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of Irvine and State of California, on the 31st day of March, 1997.
WFS FINANCIAL AUTO LOANS, INC.,
as originator of
WFS FINANCIAL 1997-A OWNER TRUST
By: /s/ JAMES R. DOWLAN
-------------------------------------
James R. Dowlan
President
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Post-Effective Amendment No. 1 to Registration Statement on Form S-1 has
been signed by the following persons in the capacities and on the dates
indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------------------------------------------- ------------------------------ ----------------
<C> <C> <S>
/s/ JAMES R. DOWLAN President and Chief Executive March 31, 1997
- --------------------------------------------- Officer, Director (Principal
James R. Dowlan Executive Officer)
* Chief Financial Officer March 31, 1997
- --------------------------------------------- (Principal Financial and
Lee A. Whatcott Accounting Officer)
* Director March 31, 1997
- ---------------------------------------------
W. Lee Thyer
* Director March 31, 1997
- ---------------------------------------------
Joy Schaefer
* Director March 31, 1997
- ---------------------------------------------
James R. May
* Director March 31, 1997
- ---------------------------------------------
Jeffrey B. Davis
*By: /s/ JAMES R. DOWLAN
- ---------------------------------------------
James R. Dowlan
Attorney-in-Fact
</TABLE>
II-4
<PAGE> 7
EXHIBIT INDEX
<TABLE>
<CAPTION>
SEQUENTIALLY
NUMBERED
EXHIBIT DESCRIPTION PAGE
- ------------- --------------------------------------------------------------------------- -----
<C> <S> <C>
1.1 Form of Underwriting Agreement*............................................
3.1 Articles of Incorporation of WFS Financial Auto Loans, Inc.*...............
3.2 Bylaws of WFS Financial Auto Loans, Inc.*..................................
4.1 Form of Trust Agreement among WFS Financial Auto Loans, Inc., as Seller,
WFS Investments, Inc., Financial Security Assurance Inc. and Chase
Manhattan Bank Delaware, as Owner Trustee (including form of
Certificates)*.............................................................
4.2 Form of Indenture among WFS Financial 1997-A Owner Trust, Financial
Security Assurance Inc. and Bankers Trust Company, as Indenture Trustee
(including forms of Notes)*................................................
5.1 Opinion of Mitchell, Silberberg & Knupp LLP with respect to legality*......
8.1 Opinion of Mitchell, Silberberg & Knupp LLP with respect to tax matters*...
10.1 Form of Reinvestment Contract*.............................................
10.2 Form of Sale and Servicing Agreement*......................................
10.3 Form of Insurance Agreement*...............................................
10.4 Form of Financial Guaranty Insurance Policy (Notes)*.......................
10.5 Form of Financial Guaranty Insurance Policy (Certificates)*................
10.6 Form of Indemnification Agreement*.........................................
10.7 Form of Administration Agreement among WFS Financial 1997-A Owner Trust,
WFS Financial Inc, and Bankers Trust Company, as Indenture Trustee*........
23.1 Consent of Mitchell, Silberberg & Knupp LLP (included as part of Exhibit
5.1)*......................................................................
23.2 Consent of Mitchell, Silberberg & Knupp LLP (included as part of Exhibit
8.1)*......................................................................
23.3 Consent of Coopers & Lybrand, L.L.P........................................
24.1 Power of Attorney*.........................................................
25.1 Statement of Eligibility and Qualification of Indenture Trustee............
28 Audited Consolidated Financial Statements of Financial Security Assurance
Inc. for the year ended December 31, 1996..................................
</TABLE>
- ---------------
* Previously filed.
<PAGE> 1
EXHIBIT 23.3
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion in Post-Effective Amendment No. 1 to Form S-1 of WFS
Financial Auto Loans, Inc. relating to the WFS Financial 1997-A Owner Trust
(Registration No. 33-99420) of our report dated January 24, 1997 on our audits
of the consolidated financial statements of Financial Security Assurance Inc.
and Subsidiaries as of December 31, 1996 and 1995, and for each of the three
years in the period ended December 31, 1996.
COOPERS & LYBRAND L.L.P.
New York, New York
March 28, 1997
<PAGE> 1
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONTENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
A. 1996 YEAR END FINANCIAL STATEMENTS
Report of Independent Accountants........................................... A-1
Consolidated Balance Sheets as of December 31, 1996 and 1995................ A-2
Consolidated Statements of Income for the Years Ended December 31, 1996,
1995
and 1994.................................................................. A-3
Consolidated Statements of Changes in Shareholder's Equity for the Years
Ended
December 31, 1996, 1995 and 1994.......................................... A-4
Consolidated Statements of Cash Flows for the Years Ended December 31, 1996,
1995 and 1994............................................................. A-5
Notes to Consolidated Financial Statements for the Years Ended December 31,
1996,
1995 and 1994............................................................. A-6-A-24
</TABLE>
The New York State Insurance Department recognizes only statutory
accounting practices for determining and reporting the financial condition and
results of operations of an insurance company, for determining its solvency
under the New York Insurance Law, and for determining whether its financial
condition warrants the payment of a dividend to its stockholders. No
consideration is given by the New York State Insurance Department to financial
statements prepared in accordance with generally accepted accounting principles
in making such determinations.
60
<PAGE> 2
[COOPERS & LYBRAND LETTERHEAD]
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholder and Board of Directors
of Financial Security Assurance Inc.:
We have audited the accompanying consolidated balance sheets of Financial
Security Assurance Inc. and Subsidiaries as of December 31, 1996 and 1995 and
the related consolidated statements of income, changes in shareholder's equity,
and cash flows for each of the three years in the period ended December 31,
1996. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Financial
Security Assurance Inc. and Subsidiaries at December 31, 1996 and 1995, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles.
/s/ Coopers & Lybrand L.L.P.
New York, New York
January 24, 1997
A-1
<PAGE> 3
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1995
------------ ------------
<S> <C> <C>
Bonds at market value (amortized cost of $1,054,678 and
$1,006,084)...................................................... $1,068,677 $1,036,382
Equity investments at market value (cost of $1,000)................ 1,000
Short-term investments............................................. 39,570 14,568
Cash equivalents................................................... 16,129 35,277
------------ ------------
Total investments........................................ 1,125,376 1,086,227
Cash............................................................... 7,517 555
Deferred acquisition costs......................................... 146,233 132,951
Prepaid reinsurance premiums....................................... 151,224 133,548
Reinsurance recoverable on unpaid losses........................... 29,875 61,532
Other assets....................................................... 69,705 61,825
------------ ------------
TOTAL ASSETS............................................. $1,529,930 $1,476,638
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Deferred premium revenue........................................... $ 511,196 $ 463,897
Losses and loss adjustment expenses................................ 72,079 111,759
Deferred federal income taxes...................................... 41,682 43,205
Ceded reinsurance balances payable................................. 12,599 13,664
Payable for securities purchased................................... 14,142 9,516
Accrued expenses and other liabilities............................. 62,900 44,611
------------ ------------
TOTAL LIABILITIES........................................ 714,598 686,652
------------ ------------
COMMITMENTS AND CONTINGENCIES
Common stock (1,000 shares authorized; 660 and 750 shares issued
and outstanding; par value of $22,727 and $20,000 per share)..... 15,000 15,000
Additional paid-in capital......................................... 654,470 681,470
Unrealized gain on investments (net of deferred income tax
provision of $4,899 and $10,604)................................. 9,099 19,694
Accumulated earnings............................................... 136,763 73,822
------------ ------------
TOTAL SHAREHOLDER'S EQUITY............................... 815,332 789,986
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY............... $1,529,930 $1,476,638
========== ==========
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.
A-2
<PAGE> 4
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
REVENUES:
Net premiums written (net of premiums ceded of $55,965,
$33,166 and $28,692, of which $35,299, $20,582 and
$15,999 were ceded to affiliates)..................... $121,000 $ 77,576 $ 77,757
Increase in deferred premium revenue..................... (30,552) (8,229) (12,003)
-------- -------- --------
Premiums earned (net of premiums ceded of $38,723,
$38,013 and $35,051).................................. 90,448 69,347 65,754
Net investment income.................................... 62,728 47,083 45,282
Net realized gains (losses).............................. 1,851 5,032 (3,829)
Other income............................................. 502 4,722 732
-------- -------- --------
TOTAL REVENUES................................... 155,529 126,184 107,939
-------- -------- --------
EXPENSES:
Losses and loss adjustment expenses:
Related to merger..................................... 15,400
Other (net of reinsurance recoveries of ($2,249),
$9,101 and $56,895, of which ($3,084), $7,111 and
$50,839 were ceded to affiliates)................... 6,874 6,258 3,024
Policy acquisition costs................................. 23,829 16,888 15,057
Other operating expenses................................. 14,852 12,352 11,574
-------- -------- --------
TOTAL EXPENSES................................... 45,555 50,898 29,655
-------- -------- --------
INCOME BEFORE INCOME TAXES................................. 109,974 75,286 78,284
-------- -------- --------
Provision (benefit) for income taxes:
Current.................................................. 28,208 23,353 13,338
Deferred................................................. 911 (3,055) 4,682
-------- -------- --------
Total provision.......................................... 29,119 20,298 18,020
-------- -------- --------
NET INCOME....................................... $ 80,855 $ 54,988 $ 60,264
======== ======== ========
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.
A-3
<PAGE> 5
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONAL UNREALIZED
COMMON PAID-IN GAINS ON RETAINED
STOCK CAPITAL INVESTMENTS EARNINGS TOTAL
------- -------- ----------- -------- --------
<S> <C> <C> <C> <C> <C>
BALANCE, December 31, 1993........... $15,000 $497,506 $ 34,892 $ (4,930) $542,468
Net income for the year.............. 60,264 60,264
Dividends paid on common stock....... (17,500) (17,500)
Net change in unrealized loss on
investments (net of deferred income
tax benefit of $30,292)............ (56,256) (56,256)
------- -------- -------- -------- --------
BALANCE, December 31, 1994........... 15,000 497,506 (21,364) 37,834 528,976
Net income........................... 54,988 54,988
Dividends paid on common stock....... (19,000) (19,000)
Net change in unrealized gain on
investments (net of deferred income
taxes of $22,108).................. 41,058 41,058
Capital contribution of CGIC......... 233,964 233,964
Stock repurchase..................... (50,000) (50,000)
------- -------- -------- -------- --------
BALANCE, December 31, 1995........... 15,000 681,470 19,694 73,822 789,986
Net income........................... 80,855 80,855
Dividends paid on common stock....... (18,000) (18,000)
Net change in unrealized loss on
investments (net of deferred income
tax benefit of $5,705)............. (10,595) (10,595)
Stock repurchase..................... (27,000) (27,000)
Adjustment to prior year disposal of
subsidiary......................... 86 86
------- -------- -------- -------- --------
BALANCE, December 31, 1996........... $15,000 $654,470 $ 9,099 $136,763 $815,332
======= ======== ======== ======== ========
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.
A-4
<PAGE> 6
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1996 1995 1994
----------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Premiums received, net............................... $ 124,540 $ 85,481 $ 58,191
Policy acquisition and other operating expenses paid,
net............................................... (49,261) (41,730) (31,696)
Recoverable advances received (paid)................. 10,213 (9,419) (939)
Losses and loss adjustment expenses paid............. (15,473) (4,954) (5,124)
Net investment income received....................... 59,923 40,160 41,429
Federal income taxes received (paid)................. (33,297) (17,295) (14,358)
Interest paid........................................ (22) (38) (72)
Other................................................ 1,330 2,552 (4,314)
----------- --------- ---------
Net cash provided by operating activities.... 97,953 54,757 43,117
----------- --------- ---------
Cash flows from investing activities:
Proceeds from sales of bonds......................... 1,095,929 603,545 790,517
Proceeds from maturities of bonds.................... 2,965 606 55
Purchases of bonds................................... (1,139,129) (685,984) (758,254)
Purchases of property and equipment.................. (2,081) (958) (937)
Cash of contributed subsidiary....................... 199
Net decrease (increase) in short-term investments.... (3,675) 94,727 (58,095)
----------- --------- ---------
Net cash provided by (used for) investing
activities................................. (45,991) 12,135 (26,714)
----------- --------- ---------
Cash flows from financing activities:
Stock repurchase..................................... (27,000) (50,000)
Dividends paid....................................... (18,000) (19,000) (17,500)
----------- --------- ---------
Net cash used for financing activities....... (45,000) (69,000) (17,500)
----------- --------- ---------
Net increase (decrease) in cash........................ 6,962 (2,108) (1,097)
Cash at beginning of year.............................. 555 2,663 3,760
----------- --------- ---------
Cash at end of year.................................... $ 7,517 $ 555 $ 2,663
=========== ========= =========
Reconciliation of net income to net cash flows from
operating activities:
Net income............................................. $ 80,855 $ 54,988 $ 60,264
Decrease (increase) in accrued investment income..... (842) 14 1,773
Increase in deferred premium revenue and related
foreign exchange adjustment....................... 29,622 8,141 12,585
Decrease (increase) in deferred acquisition costs.... (13,282) (10,305) (9,847)
Increase (decrease) in current federal income taxes
payable........................................... (5,090) 6,057 (1,020)
Increase (decrease) in unpaid losses and loss
adjustment expenses............................... (8,023) 14,587 (376)
Increase (decrease) in amounts withheld for others... 52 30 (24,675)
Provision (benefit) for deferred income taxes........ 911 (3,055) 4,682
Net realized losses (gains) on investments........... (1,851) (5,032) 3,829
Depreciation and accretion of bond discount.......... (1,616) (5,564) (4,082)
Change in other assets and liabilities............... 17,217 (5,104) (16)
----------- --------- ---------
Cash provided by operating activities.................. $ 97,953 $ 54,757 $ 43,117
=========== ========= =========
</TABLE>
In addition to the cash received from the contribution of the
subsidiary, the Company also received net assets of $233,765.
In 1996, the Company has recharacterized its cash equivalents
as short-term investments. The amount of cash equivalents
recharacterized were $16,129, $35,277 and $13,457 as of
December 31, 1996, 1995 and 1994, respectively.
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.
A-5
<PAGE> 7
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1. ORGANIZATION AND OWNERSHIP
Financial Security Assurance Inc. (the Company), a wholly owned subsidiary
of Financial Security Assurance Holdings Ltd. (the Parent), is an insurance
company domiciled in the State of New York. The Company is engaged in providing
financial guaranty insurance on asset-backed financings and municipal
obligations. The Company's underwriting policy is to insure asset-backed and
municipal obligations that would otherwise be investment grade without the
benefit of the Company's insurance. The asset-backed obligations insured by the
Company 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 the Company consist primarily of general
obligation bonds that are supported by the issuers' taxing power and special
revenue bonds and other special obligations of states 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
the Company guarantees payment when due of scheduled payments on an issuer's
obligation. In the case of a payment default on an insured obligation, the
Company 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 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. The Company's insured portfolio consists
primarily of asset-backed and municipal obligations originated in the United
States, but the Company has also written and continues to pursue business in
Europe and the Pacific Rim.
At December 31, 1993, the Parent was owned 92.5% by U S WEST and 7.5% by
Tokio Marine. The Parent completed an initial public offering of common shares
on May 13, 1994. In connection with the initial public offering, Fund American
Enterprises Holdings, Inc. (Fund American) acquired an interest in the Parent,
together with rights to acquire additional shares of the Parent from U S WEST
and shares of the Parent's Series A preferred stock. At December 31, 1994, the
Parent was owned 60.9% by U S WEST, 7.7% by Fund American, 7.4% by Tokio Marine
and 24.0% by the public and employees.
On December 20, 1995, a subsidiary of the Parent merged (the Merger) with
Capital Guaranty Corporation (CGC). The Merger provided for each CGC share to be
exchanged for 0.6716 share of the Parent's common stock and cash of $5.69. The
Parent issued in the aggregate 6,051,661 common shares and paid aggregate cash
consideration of $51,300,000. In conjunction with the Merger, the Parent
contributed (the Contribution) the common stock of Capital Guaranty Insurance
Company (CGIC), a subsidiary of CGC, to the Company. As a result of the
Contribution, the Company's net assets increased by $233,964,000. Net premiums
written by CGIC in 1995 prior to the Contribution were $26,070,000. At December
31, 1995, the Parent was owned 50.3% by U S WEST, 7.8% by Fund American, 6.1% by
Tokio Marine and 35.8% by the public and employees. At December 31, 1996, the
Parent was owned 40.4% by U S WEST, 11.5% by Fund American, 6.4% by Tokio Marine
and 41.7% by the public and employees.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying financial statements have been prepared in accordance with
generally accepted accounting principles (GAAP), which differ in certain
material respects from the accounting practices prescribed or permitted by
insurance regulatory authorities (see Note 6). The preparation of financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of
A-6
<PAGE> 8
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
contingent assets and liabilities in the Company's consolidated balance sheets
at December 31, 1996 and 1995 and the reported amounts of revenues and expenses
in the consolidated statements of income during the years ended December 31,
1996, 1995 and 1994. Such estimates and assumptions include, but are not limited
to, losses and loss adjustment expenses and the deferral and amortization of
deferred policy acquisition costs. Actual results may differ from those
estimates. Significant accounting policies under GAAP are as follows:
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries, Financial Security Assurance of Maryland Inc.
(which was named Capital Guaranty Insurance Corporation until the Merger),
Financial Security Assurance International Inc., Financial Security Assurance of
Oklahoma, Inc. and Financial Security Assurance (U.K.) Limited (collectively,
the Subsidiaries). All intercompany accounts and transactions have been
eliminated. Certain prior-year balances have been reclassified to conform with
the 1996 presentation. The Merger, and the related Contribution to the Company,
were accounted for on a purchase accounting basis. In view of the short period
between the date of the Merger, December 20, 1995, and the year-end, the date of
the Contribution for accounting purposes is considered to be December 31, 1995.
As a result, the accounting for the Contribution has no effect on the Company's
consolidated statement of income for the year ended December 31, 1995, except
for the recording of $15,400,000 in losses and loss adjustment expenses to
increase the Company's general reserve to provide for the insured portfolio
assumed by the Company as a result of the Contribution (see Note 16).
INVESTMENTS
Investments in debt securities designated as available for sale are carried
at market value. Any resulting unrealized gain or loss is reflected as a
separate component of shareholder's equity, net of applicable deferred income
taxes. All of the Company's long-term investments are classified as available
for sale.
Bond discounts and premiums are amortized on the effective yield method
over the remaining terms of the securities acquired. For mortgage-backed
securities, and any other holdings for which prepayment risk may be significant,
assumptions regarding prepayments are evaluated periodically and revised as
necessary. Any adjustments required due to the resultant change in effective
yields are recognized in current income. Short-term investments, which are those
investments with a maturity of more than three months but less than one year at
time of purchase, are carried at market value, which approximates cost. Realized
gains or losses on sale of investments are determined on the basis of specific
identification. Investment income is recorded as earned.
To manage adverse movements in interest rates, the Company uses exchange
traded futures and options. These contracts are designated as hedges of specific
identified securities and any gains or losses on these hedges are deferred and
included as part of the Company's unrealized gains or losses in stockholder's
equity until the disposition of the hedged assets. The Company will discontinue
to account for these contracts as hedges if there ceases to be a high
correlation between the change in price of the hedged assets and the hedge.
Cash equivalents represent amounts deposited in money market funds and
investments with a maturity at time of purchase of three months or less.
PREMIUM REVENUE RECOGNITION
Gross and ceded premiums are earned in proportion to the amount of risk
outstanding over the expected period of coverage. Deferred premium revenue and
prepaid reinsurance premiums represent that portion of
A-7
<PAGE> 9
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
premium which is applicable to coverage of risk to be provided in the future on
policies in force. When an insured issue is retired or defeased prior to the end
of the expected period of coverage, the remaining deferred premium revenue and
prepaid reinsurance premium, less any amount credited to a refunding issue
insured by the Company, are recognized.
LOSSES AND LOSS ADJUSTMENT EXPENSES
A case basis reserve for unpaid losses and loss adjustment expenses is
recorded at the present value of the estimated loss when, in management's
opinion, the likelihood of a future loss is probable and determinable at the
balance sheet date. The estimated loss on a transaction is discounted using
current risk-free rates.
The general reserve is calculated by applying a loss factor to the total
net par amount outstanding of the Company's insured obligations outstanding over
the term of such insured obligations and discounting the result at risk-free
rates. The loss factor used for this purpose has been determined based upon an
independent rating agency study of bond defaults and the Company's portfolio
characteristics and history. The general 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.
Management of the Company periodically evaluates its estimates for losses
and loss adjustment expenses and establishes reserves that management believes
are adequate to cover the ultimate net cost of claims; the reserves are
necessarily based on estimates, and there can be no assurance that the ultimate
liability will not differ from such estimates. The Company will, on an ongoing
basis, monitor these reserves and may periodically adjust such reserves based on
the Company's actual loss experience, its future mix of business, and future
economic conditions.
DEFERRED ACQUISITION COSTS
Deferred acquisition costs comprise those expenses that vary with and are
primarily related to the production of business, including commissions paid on
reinsurance assumed, compensation and related costs of underwriting and
marketing personnel, certain rating agency fees, premium taxes and certain other
underwriting expenses, reduced by ceding commission income on premiums ceded to
reinsurers. Deferred acquisition costs and the cost of acquired business are
amortized over the period in which the related premiums are earned.
Recoverability of deferred acquisition costs is determined by considering
anticipated losses and loss adjustment expenses.
FEDERAL INCOME TAXES
The provision for income taxes consists of an amount for taxes currently
payable and a provision for tax consequences deferred to future periods
reflected at current income tax rates.
3. INVESTMENTS
Bonds at amortized cost of $17,669,000 and $11,969,000 at December 31, 1996
and 1995, respectively, were on deposit with state regulatory authorities as
required by insurance regulations.
A-8
<PAGE> 10
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Consolidated net investment income consisted of the following (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Long-term bonds............................... $61,130 $43,114 $46,517
Equity securities............................. 14
Short-term investments and cash equivalents... 3,525 5,705 778
Investment expenses........................... (1,941) (1,736) (2,013)
------- ------- -------
Net investment income......................... $62,728 $47,083 $45,282
======= ======= =======
</TABLE>
The credit quality of the investment portfolio at December 31, 1996 was as
follows:
<TABLE>
<CAPTION>
PERCENT OF
RATING INVESTMENT PORTFOLIO
------------------------------------ --------------------
<S> <C>
AAA................................. 69.9%
AA.................................. 20.0
A................................... 10.1
</TABLE>
The amortized cost and estimated market value of long-term bonds were as
follows (in thousands):
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
DECEMBER 31, 1996 COST GAINS LOSSES VALUE
- --------------------------------------------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations of
U.S. government corporations and
agencies................................... $ 55,319 $ 1,103 $ (557) $ 55,865
Obligations of states and political
subdivisions............................... 661,657 15,164 (2,887) 673,934
Foreign securities........................... 15,019 196 (70) 15,145
Mortgage-backed securities................... 177,818 1,432 (906) 178,344
Corporate securities......................... 76,632 335 (319) 76,648
Asset-backed securities...................... 68,233 680 (172) 68,741
---------- ------- ------- ----------
Total.............................. $1,054,678 $ 18,910 $ (4,911) $1,068,677
========== ======= ======= ==========
</TABLE>
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
DECEMBER 31, 1995 COST GAINS LOSSES VALUE
- --------------------------------------------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations of
U.S. government corporations and
agencies................................... $ 44,873 $ 2,231 $ -- $ 47,104
Obligations of states and political
subdivisions............................... 635,872 20,112 (330) 655,654
Foreign securities........................... 28,691 1,909 (17) 30,583
Mortgage-backed securities................... 262,936 5,949 (51) 268,834
Corporate securities......................... 1,254 51 1,305
Asset-backed securities...................... 32,458 444 32,902
---------- ------- ------- ----------
Total.............................. $1,006,084 $ 30,696 $ (398) $1,036,382
========== ======= ======= ==========
</TABLE>
A-9
<PAGE> 11
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
The change in net unrealized gains (losses) consisted of (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1996 1995 1994
-------- ------- --------
<S> <C> <C> <C>
Long-term bonds............................................. $(16,299) $63,166 $(86,564)
Short-term investments...................................... 16
-------- ------- --------
Change in net unrealized gains (losses)................... $(16,299) $63,166 $(86,548)
======== ======= ========
</TABLE>
The amortized cost and estimated market value of long-term bonds at
December 31, 1996 and 1995, by contractual maturity, are shown below (in
thousands). Actual maturities could differ from contractual maturities because
borrowers have the right to call or prepay certain obligations with or without
call or prepayment penalties.
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1995
------------------------- -------------------------
ESTIMATED ESTIMATED
AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Due in one year or less................... $ 38,003 $ 38,325 $ 2,776 $ 2,778
Due after one year through five years..... 57,406 57,623 25,735 26,075
Due after five years through ten years.... 105,494 105,849 157,161 162,573
Due after ten years....................... 607,724 619,795 525,018 543,220
Mortgage-backed securities (stated
maturities of 16 to 30 years)........... 177,818 178,344 262,936 268,834
Asset-backed securities (stated maturities
of 2 to 5 years)........................ 68,233 68,741 32,458 32,902
---------- ---------- ---------- ----------
Total................................... $1,054,678 $1,068,677 $1,006,084 $1,036,382
========== ========== ========== ==========
</TABLE>
Proceeds from sales of long-term bonds during 1996, 1995 and 1994 were
$1,096,568,000, $587,516,000 and $808,143,000, respectively. Gross gains of
$13,420,000, $12,346,000 and $13,919,000 and gross losses of $11,569,000,
$7,314,000 and $17,748,000 were realized on sales in 1996, 1995 and 1994,
respectively.
To hedge against changes in yields on certain one-year corporate
securities, the Company has entered into a series of Eurodollar futures
contracts, which are marked-to-market on a daily basis. These contracts are
accounted for as a hedge. As of year-end, the net unrealized loss on the
contracts, included in the Company's unrealized gains in stockholder's equity
section, is not material. The aggregate notional amount of these contracts is
$83,728,000 as of December 31, 1996.
A-10
<PAGE> 12
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
4. DEFERRED ACQUISITION COSTS
Acquisition costs deferred for amortization against future income and the
related amortization charged to expenses are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Balance, beginning of period............................... $132,951 $ 91,839 $ 81,992
-------- -------- --------
Costs deferred during the period:
Ceding commission income................................... (15,956) (9,836) (8,476)
Assumed commission expense................................. 38 55 84
Premium taxes.............................................. 3,718 2,537 2,589
Compensation and other acquisition costs................... 49,311 34,437 30,707
-------- -------- --------
Total............................................ 37,111 27,193 24,904
-------- -------- --------
Costs amortized during the period.......................... (23,829) (16,888) (15,057)
-------- -------- --------
Balance of contributed subsidiary.......................... 30,807
--------
Balance, end of period..................................... $146,233 $132,951 $ 91,839
======== ======== ========
</TABLE>
5. OTHER OPERATING EXPENSES
Total salary expense and related benefits included in other operating
expenses were $10,135,000, $10,976,000 and $9,187,000 for the years ended
December 31, 1996, 1995 and 1994, respectively.
6. STATUTORY ACCOUNTING PRACTICES
GAAP for the Company differs in certain significant respects from
accounting practices prescribed or permitted by insurance regulatory
authorities. The principal differences result from the following statutory
accounting practices:
- Upfront premiums on municipal business are recognized as earned when
related risk has expired rather than over the expected coverage period;
- Acquisition costs are charged to operations as incurred rather than as
related premiums are earned;
- A contingency reserve is computed based on the following statutory
requirements (rather than establishing a general loss reserve):
a. For all policies written prior to July 1, 1989, an amount equal to
50% of cumulative earned premiums less permitted reductions, plus;
b. For all policies written on or after July 1, 1989, an amount equal
to the greater of 50% of premiums written for each category of insured
obligation or a designated percent of principal guaranteed for that
category. These amounts are provided each quarter as either 1/60th or
1/80th of the total required for each category, less permitted reductions;
- Certain assets designated as "non-admitted assets" are charged directly
to statutory surplus but are reflected as assets under GAAP;
- Federal income taxes are provided only on taxable income for which income
taxes are currently payable;
A-11
<PAGE> 13
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
- Accruals for deferred compensation are not recognized;
- Purchase accounting adjustments are not recognized;
- Bonds are carried at amortized cost.
A reconciliation of the Company's net income for the calendar years 1996,
1995 and 1994 and shareholder's equity at December 31, 1996, 1995 and 1994,
prepared on a GAAP basis, to the amounts reported on a statutory basis, is as
follows (in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Net Income (Loss):
GAAP BASIS......................................... $ 80,855 $ 54,988 $ 60,264
Premium revenue recognition........................ (5,518) (4,805) (5,425)
Losses and loss adjustment expenses incurred....... (2,138) 10,871 (13,908)
Deferred acquisition costs......................... (12,482) (10,305) (9,847)
Deferred income tax provision (benefit)............ 911 (3,055) 4,682
Amortization of bonds.............................. 566 1,195 520
Accrual of deferred compensation................... 12,737 5,663 (9,062)
Other.............................................. 1,404 (1,580) (274)
-------- -------- --------
STATUTORY BASIS.................................... $ 76,335 $ 52,972 $ 26,950
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Shareholder's Equity:
GAAP BASIS......................................... $815,332 $789,986 $528,976
Premium revenue recognition........................ (51,760) (46,248) (29,891)
Loss and loss adjustment expense reserves.......... 29,660 31,798 20,927
Deferred acquisition costs......................... (146,233) (132,951) (91,839)
Contingency reserve................................ (227,139) (183,967) (121,414)
Unrealized loss (gain) on investments, net of
tax.............................................. (14,084) (30,298) 32,868
Deferred income taxes.............................. 41,682 43,205 10,222
Accrual of deferred compensation................... 18,390 5,653
Other.............................................. (17,043) (16,492) (5,475)
-------- -------- --------
STATUTORY BASIS (SURPLUS).......................... $448,805 $460,686 $344,374
======== ======== ========
SURPLUS PLUS CONTINGENCY RESERVE................... $675,944 $644,653 $465,788
======== ======== ========
</TABLE>
7. FEDERAL INCOME TAXES
For periods prior to May 13, 1994, the date of initial public offering when
the Parent became less than 80% owned by U S WEST, the Parent, the Company and
its Subsidiaries joined with U S WEST and its subsidiaries in filing a
consolidated federal income tax return. For the Company, under a written tax
sharing agreement with U S WEST, the allocation of income taxes was based upon
separate return calculations which provided that benefits or liabilities created
by the Company are allocated to the Company regardless of whether the benefits
were usable or additional liabilities were incurred in the U S WEST tax returns.
For periods subsequent to May 12, 1994, the Parent and all members of its group
elected to file consolidated
A-12
<PAGE> 14
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
federal tax returns. The calculation of each member's tax benefit or liability
by the Company was controlled by a tax sharing agreement that based the
allocation of such benefit or liability upon a separate return calculation.
The cumulative balance sheet effects of deferred tax consequences are (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1996 1995
-------- --------
<S> <C> <C>
Deferred acquisition costs............................. $ 51,182 $ 46,533
Deferred premium revenue adjustments................... 3,520 2,905
Contingency reserve.................................... 29,492 11,542
Unrealized capital gains............................... 7,915 14,950
Market discounts....................................... 1,955 900
-------- --------
Total deferred tax liabilities............... 94,064 76,830
-------- --------
Loss and loss adjustment expense reserves.............. (10,381) (11,129)
Deferred compensation.................................. (9,791) (5,529)
Tax credits............................................ (7,842) (3,795)
Tax and loss bonds..................................... (22,526) (11,116)
Other, net............................................. (1,842) (2,056)
-------- --------
Total deferred tax assets.................... (52,382) (33,625)
-------- --------
Total deferred income taxes............................ $ 41,682 $ 43,205
======== ========
</TABLE>
No valuation allowance was necessary at December 31, 1996 or 1995.
A reconciliation of the effective tax rate with the federal statutory rate
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
---- ---- -----
<S> <C> <C> <C>
Tax at statutory rate................................ 35.0% 35.0% 35.0%
Tax-exempt interest.................................. (8.9) (8.3) (12.0)
Other................................................ 0.4 0.3
---- ---- ----
Provision for income taxes........................... 26.5% 27.0% 23.0%
==== ==== ====
</TABLE>
8. DIVIDENDS AND CAPITAL REQUIREMENTS
Under New York Insurance Law, the Company may pay a dividend without the
prior approval of the Superintendent of the New York State Insurance Department
only from earned surplus subject to the maintenance of a minimum capital
requirement, and the dividend, which together with all dividends declared or
distributed by it during the preceding twelve months, may not exceed the lesser
of 10% of its policyholders' surplus shown on its last filed statement, or
adjusted net investment income, as defined, for such twelve-month period. As of
December 31, 1996, the Company had $45,184,000 available for the payment of
dividends over the next twelve months. As a customary condition for approving
the application of Fund American for a change in control of the Company, the
prior approval of the Superintendent of the New York State Insurance Department
was required for any payment of dividends by the Company to the Parent for a
period of two years following such changed control. Such approval was provided
for the payment of dividends by the Company to the Parent in 1996, 1995 and 1994
in the ordinary course of business. Such prior approval requirement lapsed in
September 1996. In addition, the New York Superintendent has approved the
repurchase by the Company
A-13
<PAGE> 15
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
of up to $75,000,000 of its shares from the Parent through December 31, 1998,
pursuant to which the Company has repurchased $27,000,000 of its shares through
December 31, 1996. Future share repurchases may not exceed cumulative statutory
net income beginning January 1, 1996.
9. CREDIT ARRANGEMENTS AND ADDITIONAL CLAIMS-PAYING RESOURCES
The Company has a credit arrangement aggregating $150,000,000 at December
31, 1996, which is provided by commercial banks and intended for general
application to transactions insured by the Company and the Subsidiaries. At
December 31, 1996, there have been no borrowings under this arrangement. In
addition, there are credit arrangements assigned to specific insured
transactions. In August 1994, the Company entered into a facility agreement with
Canadian Global Funding Corporation and Hambros Bank Limited. Under the
agreement, the Company can arrange financing for transactions subject to certain
conditions. The amount of this facility was $186,911,000, of which $100,911,000
was unutilized at December 31, 1996.
The Company has a standby line of credit commitment in the amount of
$125,000,000 with an international Aaa/AAA-rated bank to provide loans to the
Company after it has incurred, during the term of the facility, cumulative
municipal losses (net of any recoveries) in excess of the greater of
$200,000,000 or 5.75% of average annual debt service. The obligation to repay
loans made under this agreement is a limited recourse obligation payable solely
from, and collateralized by, a pledge of recoveries realized on defaulted
insured obligations including certain installment premiums and other collateral.
This commitment has a term beginning on April 30, 1996 and expiring on January
31, 2003 and contains an annual renewal provision subject to approval by the
bank.
10. EMPLOYEE BENEFIT PLANS
The Company maintains both a qualified and a non-qualified non-contributory
defined contribution pension plan for the benefit of all eligible employees. The
Company's contributions are based upon a fixed percentage of employee
compensation. Pension expense, which is funded as accrued, amounted to
$1,977,000, $1,784,000 and $1,888,000 for the years ended December 31, 1996,
1995 and 1994, respectively.
The Company has an employee retirement savings plan for the benefit of all
eligible employees. The plan permits employees to contribute a percentage of
their salaries up to limits prescribed by the Internal Revenue Service (IRS
Code, Section 401(k)). The Company's contributions are discretionary, and none
have been made.
During 1991, the Company established the Profit Participation Plan as a
long-term incentive compensation plan for the benefit of certain of its
employees. Prior to the initial public offering, the Parent adopted a
Supplemental Restricted Stock Plan. Pursuant to this plan, awards of outstanding
units to existing employees under the Profit Participation Plan were valued at
$0.20 per dollar of award ($0.70 per dollar of award in the case of 1994 regular
units granted thereunder) and, at the election of each outstanding employee,
were exchanged for restricted shares of the Parent's common stock valued at the
initial public offering price of $20.00 per share. All employees of the Company,
including all senior executives, exchanged their outstanding interests in the
Profit Participation Plan for restricted shares of the Parent's common stock at
the public offering price under the Supplemental Restricted Stock Plan. In
settlement of an accrued balance of $7,126,000 in such Profit Participation
Plan, the Company purchased 356,345 shares of restricted stock from the Parent
and awarded the shares to employees. The stock was restricted because ownership
of the shares by employees required continued employment; the shares vested
ratably over a three-year period on July 1, 1994, 1995 and 1996.
A-14
<PAGE> 16
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Pursuant to the 1993 Equity Participation Plan, 1,810,780 shares of the
Parent's common stock, subject to anti-dilutive adjustment, were reserved for
awards of options, restricted shares of common stock, and performance shares to
employees for the purpose of providing, through the grant of long-term
incentives, a means to attract and retain key personnel and to provide to
participating officers and other key employees long-term incentives for
sustained high levels of performance. Shares available under the 1993 Equity
Participation Plan were increased from 1,810,780 to 2,110,780 in May 1995. The
1993 Equity Participation Plan also contains provisions that permit the Human
Resources Committee to pay all or a portion of an employee's bonuses in the form
of shares of the Parent's common stock credited to the employees at a 15%
discount from current market value and paid to employees five years from the
date of award. Up to an aggregate of 10,000,000 shares may be allocated to such
equity bonuses. Common stock to pay equity bonus awards will be acquired by the
Parent through open-market purchases by a trust established for such purpose.
During 1994, under the Parent's 1993 Equity Participation Plan, the Parent
granted to officers and employees, in respect of future performance,
non-qualified options to purchase an aggregate of 1,099,000 shares of the
Parent's common stock, of which 39,000 were forfeited and 1,060,000 were still
outstanding at December 31, 1994, substantially all of which have an exercise
price of $20.00 per share. (As described below, 1,025,500 of these options will
be converted to performance shares.) The foregoing options vest, subject to
continuation of employment and other terms of the option grants, at the rate of
20% per year, for five one-year periods, with the first period ending on July 1,
1994. Such options expire ten years after the effective dates of their grant. In
the fourth quarter of 1994, holders of outstanding stock options under the 1993
Equity Participation Plan were offered the right to exchange such stock options
for an equal number of performance shares under such Plan. Also, as a result of
the Merger, the Parent granted 169,956 of stock options with strike prices
ranging from $18.63 to $23.53 per share to employees of CGC in exchange for
outstanding stock options of CGC. Giving effect to such exchange, at December
31, 1996, there were outstanding 1,374,340 performance shares and 201,956
options to purchase shares of common stock.
Performance shares granted under the 1993 Equity Participation Plan were as
follows:
<TABLE>
<CAPTION>
OUTSTANDING
AT GRANTED FORFEITED OUTSTANDING MARKET
BEGINNING DURING DURING AT END PRICE AT
OF YEAR THE YEAR THE YEAR OF YEAR GRANT DATE
----------- --------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C>
1994............... 1,025,500 1,025,500 $ 21.875
1995............... 1,025,500 83,650 1,109,150 19.250
1996............... 1,109,150 282,490 17,300 1,374,340 25.250
</TABLE>
The Company applies APB Opinion 25 and related Interpretations in
accounting for the Parent's performance shares. The Company estimates the final
cost of these performance shares and accrues for this expense over the
performance period. The accrued expense for the performance shares was
$12,737,000 and $5,663,000 for the years ended December 31, 1996 and 1995,
respectively. In tandem with this accrued expense, the Parent estimates those
performance shares that it expects to settle in stock and records this amount in
stockholders' equity as deferred compensation. The remainder of the accrual,
which represents the amount of performance shares that the Parent estimates it
will settle in cash, is recorded in accrued expenses and other liabilities. In
1996, the Company adopted disclosure provisions of FASB Statement 123. Had the
compensation cost for the Parent's performance shares been determined based upon
fair value at the grant dates for the awards consistent with the method of FASB
Statement 123, the effect on the Company's net income and earnings per share
would have been immaterial.
A-15
<PAGE> 17
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
In November 1994, the Parent appointed an independent trustee authorized to
purchase shares of the Parent's 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 the 1993 Equity Participation Plan. During 1996, 1995 and 1994,
the total number of shares purchased by this trust was 529,131, 591,714 and
182,562, respectively, at a cost of $14,111,000, $14,444,000 and $3,730,000,
respectively. The Parent also repurchased stock from its employees in
satisfaction of withholding taxes on shares distributed under its restricted
stock plan.
The Company does not currently provide post-retirement benefits, other than
pensions to its employees, nor does it provide post-employment benefits to
former employees.
11. COMMITMENTS AND CONTINGENCIES
The Company leases office space and equipment under non-cancelable
operating leases, which expire at various dates through 2005.
Future minimum rental payments are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------
<S> <C>
1996............................................... $ 2,257
1997............................................... 2,267
1998............................................... 2,229
1999............................................... 2,169
2000............................................... 2,014
Thereafter......................................... 6,810
-------
Total.................................... $17,746
=======
</TABLE>
Rent expense for the years ended December 31, 1996, 1995 and 1994 was
$3,383,000, $3,493,000 and $3,430,000, respectively.
During the ordinary course of business, the Company and its Subsidiaries
have become parties to certain litigation. Management believes that these
matters will be resolved with no material financial impact on the Company.
12. REINSURANCE
The Company reinsures portions of its risks with affiliated (see Note 14)
and unaffiliated reinsurers under quota share treaties and on a facultative
basis. The Company's principal ceded reinsurance program consisted in 1996 of
three quota share treaties and three automatic facultative facilities. One
treaty covers all of the Company's approved regular lines of business, except
municipal obligation insurance. Under this treaty in 1996, the Company ceded
11.35% of each covered policy, up to a maximum of $22,700,000 insured principal
per policy. At its sole option, the Company could have increased, and in certain
instances did increase, the ceding percentage to 22.7% up to $45,400,000 of each
covered policy. A second treaty covers the Company's municipal obligation
insurance business. Under this treaty in 1996, the Company ceded 10% of each
covered policy that is classified by the Company as providing municipal bond
insurance as defined by Article 69 of the New York Insurance Law up to a limit
of $26,667,000 per single risk, which is defined by revenue source. At its sole
option, the Company could have increased, and in certain instances did increase,
the ceding percentage to 30% up to $80,000,000 per single risk. Under the third
treaty in 1996, the Company ceded 5% of its retention (i.e., after cessions of
policies under the municipal obligation insurance treaty) covering substantially
A-16
<PAGE> 18
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
all teaching hospital and higher education risks, up to limits that range from
$7,500,000 to $30,000,000 per single risk (depending on the type of obligation).
At its sole option, the Company could have increased, and in certain instances
did increase, the ceding percentage from 5% to 15% of its retention, subject to
the same limits. This third treaty was canceled on a run-off basis as of
December 31, 1996. Under the three automatic facultative facilities in 1996, the
Company at its option could allocate up to $20,000,000 or $25,000,000 for each
reinsurer (depending on the reinsurer) for each transaction, subject to limits
and exclusions, in exchange for which the Company agreed to cede in the
aggregate a specified percentage of gross par insured by the Company. Each of
the three treaties and automatic facultative facilities allows the Company to
withhold a ceding commission to defray its expenses.
In the event (which management considers to be highly unlikely) that any or
all of the reinsuring companies were unable to meet their obligations to the
Company, the Company would be liable for such defaulted amounts. The Company has
also assumed reinsurance of municipal obligations from unaffiliated insurers.
Amounts reinsured were as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Written premiums ceded........................................ $55,965 $33,166 $28,692
Written premiums assumed...................................... 1,873 1,684 1,973
Earned premiums ceded......................................... 38,723 38,013 35,051
Earned premiums assumed....................................... 6,020 2,759 7,059
Loss and loss adjustment expense payments ceded............... 29,408 3,060 1,483
Loss and loss adjustment expense payments assumed............. 3 3 3
Incurred losses and loss adjustment expenses ceded............ (2,249) 9,101 56,895
Incurred losses and loss adjustment expenses assumed.......... 38 81 137
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1996 1995
----------- -----------
<S> <C> <C>
Principal outstanding ceded....................................... $20,292,615 $14,355,664
Principal outstanding assumed..................................... 1,995,752 2,347,122
Deferred premium revenue ceded.................................... 151,224 133,548
Deferred premium revenue assumed.................................. 18,929 5,027
Loss and loss adjustment expense reserves ceded................... 29,875 61,532
Loss and loss adjustment expense reserves assumed................. 705 670
</TABLE>
13. OUTSTANDING EXPOSURE AND COLLATERAL
The Company's policies insure the scheduled payments of principal and
interest on asset-backed and municipal obligations. The principal amount insured
(in millions) as of December 31, 1996 and 1995 (net of
A-17
<PAGE> 19
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
amounts ceded to other insurers of $9,601 and $6,093 of asset-backed and $10,691
and $8,263 of municipal, respectively) and the terms to maturity are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1995
-------------------------- --------------------------
TERMS TO MATURITY ASSET-BACKED MUNICIPAL ASSET-BACKED MUNICIPAL
- --------------------------------------------- ------------ --------- ------------ ---------
<S> <C> <C> <C> <C>
0 to 5 Years................................. $ 7,424 $ 1,571 $ 5,931 $ 3,293
5 to 10 Years................................ 3,920 3,841 3,679 4,713
10 to 15 Years............................... 1,461 6,272 1,183 4,299
15 to 20 Years............................... 714 11,433 423 6,986
20 Years and Above........................... 9,681 12,877 5,847 9,625
------- ------- ------- -------
Total.............................. $ 23,200 $35,994 $ 17,063 $28,916
======= ======= ======= =======
</TABLE>
The principal amount ceded as of December 31, 1996 and 1995 and the terms
to maturity are as follows (in millions):
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1995
-------------------------- --------------------------
TERMS TO MATURITY ASSET-BACKED MUNICIPAL ASSET-BACKED MUNICIPAL
- --------------------------------------------- ------------ --------- ------------ ---------
<S> <C> <C> <C> <C>
0 to 5 Years................................. $ 3,695 $ 769 $ 2,297 $ 1,103
5 to 10 Years................................ 2,413 1,192 1,503 1,775
10 to 15 Years............................... 452 1,479 403 1,020
15 to 20 Years............................... 302 2,345 126 1,514
20 Years and Above........................... 2,739 4,906 1,764 2,851
------- ------- ------- -------
Total.............................. $ 9,601 $10,691 $ 6,093 $ 8,263
======= ======= ======= =======
</TABLE>
The Company limits its exposure to losses from writing financial guarantees
by underwriting investment-grade obligations, by diversifying its portfolio and
by maintaining rigorous collateral requirements on asset-backed obligations. The
gross principal amounts of insured obligations in the asset-backed insured
portfolio are backed by the following types of collateral (in millions):
<TABLE>
<CAPTION>
NET OF AMOUNTS
CEDED CEDED
DECEMBER 31, DECEMBER 31,
------------------- -----------------
TYPES OF COLLATERAL 1996 1995 1996 1995
- ------------------------------------------------------ ------- ------- ------ ------
<S> <C> <C> <C> <C>
Residential mortgages................................. $10,987 $ 6,740 $3,077 $1,909
Consumer receivables.................................. 7,548 5,105 3,735 1,320
Government securities................................. 1,477 1,651 449 263
Pooled corporate obligations.......................... 1,663 1,819 852 732
Commercial mortgage portfolio:
Commercial real estate.............................. 113 148 463 640
Corporate secured................................... 66 98 619 801
Investor-owned utility obligations.................... 791 821 266 292
Other asset-backed obligations........................ 555 681 140 136
------- ------- ------ ------
Total asset-backed obligations.............. $23,200 $17,063 $9,601 $6,093
======= ======= ====== ======
</TABLE>
The asset-backed insured portfolio, which aggregated $32.8 billion
principal before reinsurance at December 31, 1996, was collateralized by assets
with an estimated fair value of $38.3 billion. At December 31, 1995, it
aggregated $23.2 billion principal before reinsurance and was collateralized by
assets with an estimated fair value of $28.0 billion. Such estimates of the
collateral's fair value, which is reduced as exposure
A-18
<PAGE> 20
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
expires, are based upon information at the inception of the insurance policy. At
December 31, 1996, the estimated fair value of collateral and reserves over the
principal insured averaged from 100% for commercial real estate to 168% for
corporate secured obligations. At December 31, 1995, the estimated fair value of
collateral and reserves over the principal insured averaged from 100% for
commercial real estate to 164% for corporate secured obligations. Collateral for
specific transactions is generally not available to pay claims related to other
transactions. The amounts of losses ceded to reinsurers are determined net of
collateral.
The gross principal amount of insured obligations in the municipal insured
portfolio includes the following types of issues (in millions):
<TABLE>
<CAPTION>
NET OF AMOUNTS CEDED
CEDED DECEMBER 31, DECEMBER 31,
------------------- ------------------
TYPES OF ISSUES 1996 1995 1996 1995
- ----------------------------------------------------- ------- ------- ------- ------
<S> <C> <C> <C> <C>
General obligation bonds............................. $12,523 $ 8,738 $ 2,423 $1,764
Housing revenue bonds................................ 1,794 1,674 1,033 685
Municipal utility revenue bonds...................... 4,671 3,873 1,472 1,107
Health care revenue bonds............................ 2,854 2,587 2,049 1,718
Tax-supported bonds (non-general obligation)......... 8,805 7,090 2,152 1,741
Transportation revenue bonds......................... 1,479 1,365 436 293
Other municipal bonds................................ 3,868 3,589 1,126 955
------- ------- ------- ------
Total municipal obligations................ $35,994 $28,916 $10,691 $8,263
======= ======= ======= ======
</TABLE>
In its asset-backed business, the Company considers geographic
concentration as a factor in underwriting insurance covering securitizations of
pools of such assets as residential mortgages or consumer receivables. However,
after the initial issuance of an insurance policy relating to such
securitization, the geographic concentration of the underlying assets may not
remain fixed over the life of the policy. In addition, in writing insurance for
other types of asset-backed obligations, such as securities primarily backed by
government or corporate debt, geographic concentration is not deemed by the
Company to be significant given other more relevant measures of diversification
such as issuer or industry.
The Company seeks to maintain a diversified portfolio of insured municipal
obligations designed to spread its risk across a number of geographic areas. The
following table sets forth, by state, those states in
A-19
<PAGE> 21
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
which municipalities located therein issued an aggregate of 2% or more of the
Company's net par amount outstanding of insured municipal securities as of
December 31, 1996:
<TABLE>
<CAPTION>
NET PAR CEDED PAR
AMOUNT AMOUNT
OUTSTANDING PERCENT OF TOTAL OUTSTANDING
NUMBER OF ----------- MUNICIPAL NET PAR -----------
STATE ISSUES AMOUNT OUTSTANDING
--------------------------------- --------- (IN ------------------ (IN
MILLIONS) MILLIONS)
<S> <C> <C> <C> <C>
California....................... 337 $ 5,669 15.8% $ 1,091
Florida.......................... 96 2,189 6.1 772
New York......................... 218 3,508 9.7 1,733
Pennsylvania..................... 157 2,106 5.9 551
New Jersey....................... 175 1,733 4.8 461
Louisiana........................ 81 908 2.5 379
Michigan......................... 118 1,145 3.2 361
Minnesota........................ 113 1,080 3.0 102
Massachusetts.................... 84 1,093 3.0 393
Illinois......................... 193 1,320 3.7 210
Texas............................ 248 1,804 5.0 412
Wisconsin........................ 114 762 2.1 186
All Other States................. 923 11,698 32.5 3,413
Non-U.S.......................... 26 979 2.7 627
----- ------- ----- -------
Total.................. 2,883 $35,994 100.0% $10,691
===== ======= ===== =======
</TABLE>
14. RELATED PARTY TRANSACTIONS
Allocable expenses are shared by the Company and its Parent on a basis
determined principally by estimates of respective usage as stated in an expense
sharing agreement. The agreement is subject to the provisions of the New York
Insurance Law. Amounts included in other assets at December 31, 1996 and 1995
are $4,205,000 and $3,322,000, respectively, for unsettled expense allocations
due from the Parent.
The Company ceded premiums of $19,890,000, $13,061,000 and $6,609,000 to
Tokio Marine for the years ended December 31, 1996, 1995 and 1994, respectively.
The amounts included in prepaid reinsurance premiums at December 31, 1996 and
1995 for reinsurance ceded to Tokio Marine were $44,634,000 and $33,382,000,
respectively. Reinsurance recoverable on unpaid losses ceded to Tokio Marine was
$477,000 and $323,000 at December 31, 1996 and 1995, respectively.
The Company ceded premiums of $15,409,000, $7,522,000 and $9,390,000 on a
quota share basis to affiliates of U S WEST for the years ended December 31,
1996, 1995 and 1994, respectively, of which $372,000, $629,000 and $1,838,000,
respectively, were ceded to Commercial Reinsurance Company (Commercial Re). The
amounts included in prepaid reinsurance premiums for reinsurance ceded to these
affiliates were $49,649,000 and $39,918,000 at December 31, 1996 and 1995,
respectively, of which $8,728,000 and $10,720,000, respectively, were ceded to
Commercial Re. The amounts of reinsurance recoverable on unpaid losses ceded to
these affiliates at December 31, 1996 and 1995 were $23,473,000 and $55,024,000,
respectively, of which $19,170,000 and $42,918,000, respectively, were ceded to
Commercial Re. The Commercial Re reinsurance agreement was subject to, and
received, the non-disapproval of the State of New York Insurance Department due
to its nature as an affiliate transaction. The Company has taken credit for the
reinsurance ceded to Commercial Re.
A-20
<PAGE> 22
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
15. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following estimated fair values have been determined by the Company
using available market information and appropriate valuation methodologies.
However, considerable judgment is necessary to interpret the data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amount the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
Long-term bonds -- The carrying amount of long-term bonds represents fair
value. The fair value of long-term bonds is based upon quoted market price.
Short-term investments -- The carrying amount is fair value, which
approximates cost due to the short maturity of these instruments.
Cash and cash equivalents, receivable for investments sold and payable for
investments purchased -- The carrying amount approximates fair value because of
the short maturity of these instruments.
Deferred premium revenue, net of prepaid reinsurance premiums -- The
carrying amount of deferred premium revenue, net of prepaid reinsurance
premiums, represents the Company's future premium revenue, net of reinsurance,
on policies where the premium was received at the inception of the insurance
contract. The fair value of deferred premium revenue net of prepaid reinsurance
premiums is an estimate of the premiums that would be paid under a reinsurance
agreement with a third party to transfer the Company's financial guaranty risk,
net of that portion of the premium retained by the Company to compensate it for
originating and servicing the insurance contract.
Installment premiums -- Consistent with industry practice, there is no
carrying amount for installment premiums since the Company will receive premiums
on an installment basis over the term of the insurance contract. Similar to
deferred premium revenue, the fair value of installment premiums is the
estimated present value of the future contractual premium revenues that would be
paid under a reinsurance agreement with a third party to transfer the Company's
financial guaranty risk, net of that portion of the premium retained by the
Company to compensate it for originating and servicing the insurance contract.
A-21
<PAGE> 23
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Losses and loss adjustment expenses, net of reinsurance recoverable on
unpaid losses -- The carrying amount is fair value, which is the present value
of the expected cash flows for specifically identified claims and potential
losses in the Company's insured portfolio.
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1995
------------------------- -------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
---------- ---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Assets:
Long-term bonds......................... $1,068,677 $1,068,677 $1,036,382 $1,036,382
Short-term investments.................. 39,570 39,570 14,568 14,568
Cash and cash equivalents............... 23,646 23,646 35,832 35,832
Receivable for securities sold.......... 2,326 2,326
Liabilities:
Deferred premium revenue, net of prepaid
reinsurance premiums................. 359,972 251,980 330,349 263,618
Losses and loss adjustment expenses, net
of reinsurance recoverable on unpaid
losses............................... 42,204 42,204 50,227 50,227
Payable for investments purchased....... 14,142 14,142 9,516 9,516
Off-balance-sheet instruments:
Installment premiums.................... 102,988 82,212
</TABLE>
16. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The Company's liability for losses and loss adjustment expenses consists of
the case basis and general reserves. Activity in the liability for losses and
loss adjustment expenses is summarized as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1996 1995 1994
-------- -------- -------
<S> <C> <C> <C>
Balance at January 1........................ $111,759 $ 91,130 $36,094
Less reinsurance recoverable................ 61,532 55,491 79
-------- -------- -------
Net balance at January 1.................... 50,227 35,639 36,015
Incurred losses and loss adjustment
expenses:
Current year.............................. 5,300 3,000 3,024
Prior years............................... 1,574 3,258
Related to Merger......................... 15,400
Paid losses and loss adjustment expenses:
Current year.............................. (3,397)
Prior years............................... (14,897) (7,070) (3)
-------- -------- -------
Net balance December 31..................... 42,204 50,227 35,639
Plus reinsurance recoverable................ 29,875 61,532 55,491
-------- -------- -------
Balance at December 31............ $ 72,079 $111,759 $91,130
======== ======== =======
</TABLE>
In 1994, the Company increased its general reserve by $3,024,000 for
origination of new business and transferred $16,932,000 of the general reserve
to its case basis reserves for projected losses on certain transactions, the
majority of which are in its discontinued commercial mortgage portfolio.
A-22
<PAGE> 24
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
During 1995, the Company increased its general reserve by $6,258,000, of
which $3,000,000 was for originations of new business and $3,258,000 was to
reestablish the general reserve for transfers from general reserves to case
basis reserves. During 1995, the Company transferred $10,788,000 from its
general reserve to case basis reserves associated predominantly with certain
residential mortgage and timeshare receivables transactions. Also in December
1995, FSA recognized a one-time increase of $15,400,000 to the general reserve
to provide for the insured portfolio it had assumed in the Merger with CGC in a
manner consistent with the Company's reserving methodology. Prior to the Merger,
CGC did not maintain a general reserve. Giving effect to all the 1995 events,
the general reserve totaled $31,798,000 at December 31, 1995.
During 1996, the Company increased its general reserve by $6,874,000, of
which $5,300,000 was for originations of new business and $1,574,000 was to
reestablish the general reserve for transfers from general reserves to case
basis reserves. During 1996, the Company transferred $9,012,000 from its general
reserve to case basis reserves associated predominantly with certain residential
mortgage and timeshare receivables transactions. Giving effect to these
transfers, the general reserve totaled $29,660,000 at December 31, 1996.
Reserves for losses and loss adjustment expenses are discounted at
risk-free rates. The amount of discount taken was approximately $17,944,000,
$15,276,000 and $14,588,000 at December 31, 1996, 1995 and 1994, respectively.
A-23
