<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 30, 1998
REGISTRATION NO. 333-45229
================================================================================
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 1998-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) 727-1000
(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) 727-1000
(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 this Form is a post-effective amendment filed pursuant to Rule 462(d)
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....... $525,000,000 100% $525,000,000 $154,875.00
============================================================================================================================
</TABLE>
* Previously paid.
================================================================================
<PAGE> 2
NOTE: THIS POST-EFFECTIVE AMENDMENT NO. 1 TO REGISTRATION STATEMENT IS BEING
FILED PURSUANT TO THE "UNDERTAKING REGARDING FINANCIAL SECURITY ASSURANCE INC.
FINANCIAL STATEMENTS" (ITEM 17, UNDERTAKINGS) TO FILE A COPY OF THE AUDITED
FINANCIAL STATEMENTS OF FINANCIAL SECURITY ASSURANCE INC. FOR THE FISCAL YEAR
ENDED DECEMBER 31, 1997, 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............................................ $154,875.00
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.......................................... 4,625.00
-----------
Total............................................. $417,000.00
===========
</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, BancAmerica Robertson
Stephens, 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 1998-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 1998-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, 1997
</TABLE>
- ---------------
* Previously filed.
B. FINANCIAL STATEMENT SCHEDULES
Not applicable.
ITEM 17. UNDERTAKINGS.
The undersigned Registrant hereby undertakes as follows:
(a) To provide to the Underwriters at the closing date specified in
the Underwriting Agreement certificates in such denominations and
registered in such names as required by the Underwriters 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 purposes 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.
Undertaking regarding Financial Security Assurance Inc. financial
statements:
Registrant undertakes to file, no later than March 31, 1998, a
post-effective amendment to its Registration Statement containing the
audited financial statements of Financial Security Assurance Inc. for its
fiscal year ended December 31, 1997, together with a manually executed
accountants' consent thereto.
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 27th day of March, 1998.
WFS FINANCIAL AUTO LOANS, INC.,
as originator of
WFS FINANCIAL 1998-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
--------- ----- ----
<S> <C> <C>
/s/ JAMES R. DOWLAN President and Chief Executive March 27, 1998
- ----------------------------------------------------- Officer, Director (Principal
James R. Dowlan Executive Officer)
* Chief Financial Officer, March 27, 1998
- ----------------------------------------------------- Director
Lee A. Whatcott (Principal Financial and
Accounting Officer)
* Director March 27, 1998
- -----------------------------------------------------
Joy Schaefer
Director March , 1998
- -----------------------------------------------------
James R. May
* Director March 27, 1998
- -----------------------------------------------------
Jeffrey B. Davis
</TABLE>
*By: /s/ JAMES R. DOWLAN
-------------------------------
James R. Dowlan
Attorney-in-Fact
II-4
<PAGE> 7
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION PAGE
------- ----------- ------------
<S> <C> <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 1998-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 1998-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,
1997........................................................
</TABLE>
- ---------------
* Previously filed.
<PAGE> 1
[COOPERS & LYBRAND LETTERHEAD]
CONSENT OF INDEPENDENT ACCOUNTANTS
----------------
We consent to the inclusion in the Post-Effective Amendment No. 1 to Form S-1
of WFS Financial Auto Loans, Inc. relating to the WFS Financial 1998-A Owner
Trust of our report dated January 26, 1998 on our audits of the consolidated
financial statements of Financial Security Assurance Inc. and Subsidiaries as
of December 31, 1997 and 1996, and for each of the three years in the period
ended December 31, 1997.
COOPERS & LYBRAND L.L.P.
New York, New York
March 27, 1998
<PAGE> 1
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
A. 1997 YEAR END FINANCIAL STATEMENTS
Report of Independent Accountants........................... F-2
Consolidated Balance Sheets as of December 31, 1997 and
1996........................................................ F-3
Consolidated Statements of Income for the Years Ended
December 31, 1997, 1996 and 1995............................ F-4
Consolidated Statements of Changes in Shareholder's Equity
for the Years Ended
December 31, 1997, 1996 and 1995............................ F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997,
1996 and 1995............................................... F-6
Notes to Consolidated Financial Statements for the Years
Ended December 31, 1997,
1996 and 1995............................................... F-7
</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.
F-1
<PAGE> 2
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, 1997 and 1996 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,
1997. 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 as of December 31, 1997 and 1996, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.
/s/ COOPERS & LYBRAND L.L.P.
New York, New York
January 26, 1998
F-2
<PAGE> 3
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1997 1996
---------- ----------
<S> <C> <C>
Bonds at market value (amortized cost of $1,192,771 and
$1,054,678)............................................... $1,235,441 $1,068,677
Equity investments at market value (cost of $20,405 and
$1,000)................................................... 20,762 1,000
Short-term investments...................................... 103,926 55,699
---------- ----------
Total investments................................. 1,360,129 1,125,376
Cash........................................................ 11,235 7,517
Deferred acquisition costs.................................. 171,098 146,233
Prepaid reinsurance premiums................................ 173,123 151,224
Reinsurance recoverable on unpaid losses.................... 30,618 29,875
Receivable for securities sold.............................. 20,535
Other assets................................................ 72,901 69,705
---------- ----------
TOTAL ASSETS...................................... $1,839,639 $1,529,930
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Deferred premium revenue.................................... $ 595,196 $ 511,196
Losses and loss adjustment expenses......................... 75,417 72,079
Deferred federal income taxes............................... 59,867 41,682
Ceded reinsurance balances payable.......................... 11,199 12,599
Payable for securities purchased............................ 72,979 14,142
Long-term debt.............................................. 50,000
Accrued expenses and other liabilities...................... 77,121 62,900
---------- ----------
TOTAL LIABILITIES................................. 941,779 714,598
---------- ----------
COMMITMENTS AND CONTINGENCIES
Common stock (528 and 660 shares authorized, issued and
outstanding; par value of $28,391 and $22,727 per
share).................................................... 15,000 15,000
Additional paid-in capital.................................. 617,870 654,470
Unrealized gain on investments (net of deferred income tax
provision of $15,059 and $4,899).......................... 27,968 9,099
Accumulated earnings........................................ 237,022 136,763
---------- ----------
TOTAL SHAREHOLDER'S EQUITY........................ 897,860 815,332
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY........ $1,839,639 $1,529,930
========== ==========
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.
F-3
<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,
-------------------------------
1997 1996 1995
-------- -------- -------
<S> <C> <C> <C>
REVENUES:
Net premiums written (net of premiums ceded of $63,513,
$55,965 and $33,166, of which $38,105, $35,299 and
$20,582 were ceded to affiliates)...................... $172,878 $121,000 $77,576
Increase in deferred premium revenue...................... (63,367) (30,552) (8,229)
-------- -------- -------
Premiums earned (net of premiums ceded of $41,198, $38,723
and $38,013)........................................... 109,511 90,448 69,347
Net investment income..................................... 69,643 62,728 47,083
Net realized gains........................................ 6,023 1,851 5,032
Other income.............................................. 10,774 502 4,722
-------- -------- -------
TOTAL REVENUES.................................... 195,951 155,529 126,184
-------- -------- -------
EXPENSES:
Losses and loss adjustment expenses:
Related to merger...................................... 15,400
Other (net of reinsurance recoveries of $3,605,
($2,249) and $9,101, of which $3,199, ($3,084) and
$7,111 were ceded to affiliates)..................... 9,156 6,874 6,258
Policy acquisition costs.................................. 27,962 23,829 16,888
Other operating expenses.................................. 20,717 14,852 12,352
-------- -------- -------
TOTAL EXPENSES.................................... 57,835 45,555 50,898
-------- -------- -------
INCOME BEFORE INCOME TAXES.................................. 138,116 109,974 75,286
-------- -------- -------
Provision (benefit) for income taxes:
Current................................................... 29,832 28,208 23,353
Deferred.................................................. 8,025 911 (3,055)
-------- -------- -------
Total provision............................................. 37,857 29,119 20,298
-------- -------- -------
NET INCOME........................................ $100,259 $ 80,855 $54,988
======== ======== =======
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.
F-4
<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, 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
Net income................................... 100,259 100,259
Net change in unrealized gain on investments
(net of deferred income taxes of
$10,160)................................... 18,869 18,869
Stock repurchase............................. (39,500) (39,500)
Deferred equity payout by Parent............. 2,900 2,900
------- -------- -------- -------- --------
BALANCE, December 31, 1997................... $15,000 $617,870 $ 27,968 $237,022 $897,860
======= ======== ======== ======== ========
</TABLE>
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.
F-5
<PAGE> 6
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1997 1996 1995
----------- ----------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Premiums received, net...................................... $ 171,145 $ 124,540 $ 85,481
Policy acquisition and other operating expenses paid, net... (50,046) (49,261) (41,730)
Recoverable advances received (paid)........................ (7,629) 10,213 (9,419)
Losses and loss adjustment expenses paid.................... (6,463) (15,473) (4,954)
Net investment income received.............................. 63,207 59,923 40,160
Federal income taxes paid................................... (27,080) (33,297) (17,295)
Interest paid............................................... (22) (38)
Other....................................................... 2,142 1,330 2,552
----------- ----------- ---------
Net cash provided by operating activities.......... 145,276 97,953 54,757
----------- ----------- ---------
Cash flows from investing activities:
Proceeds from sales of bonds................................ 1,075,413 1,095,929 603,545
Proceeds from maturities of bonds........................... 32,468 2,965 606
Purchases of bonds.......................................... (1,220,779) (1,139,129) (685,984)
Gain on sale of subsidiaries................................ 9,486
Purchases of property and equipment......................... (2,985) (2,081) (958)
Cash of contributed subsidiary.............................. 199
Net decrease (increase) in short-term investments........... (45,661) (3,675) 94,727
----------- ----------- ---------
Net cash provided by (used for) investing
activities....................................... (152,058) (45,991) 12,135
----------- ----------- ---------
Cash flows from financing activities:
Stock repurchase............................................ (39,500) (27,000) (50,000)
Surplus notes issued........................................ 50,000
Dividends paid.............................................. (18,000) (19,000)
----------- ----------- ---------
Net cash provided by (used for) financing activities........ 10,500 (45,000) (69,000)
----------- ----------- ---------
Net increase (decrease) in cash............................. 3,718 6,962 (2,108)
Cash at beginning of year................................... 7,517 555 2,663
----------- ----------- ---------
Cash at end of year......................................... $ 11,235 $ 7,517 $ 555
----------- ----------- ---------
Reconciliation of net income to net cash flows from
operating activities:
Net income.................................................. $ 100,259 $ 80,855 $ 54,988
Decrease (increase) in accrued investment income............ (1,811) (842) 14
Increase in deferred premium revenue and related foreign
exchange adjustment....................................... 62,101 29,622 8,141
Increase in deferred acquisition costs...................... (24,865) (13,282) (10,305)
Increase (decrease) in current federal income taxes
payable................................................... (519) (5,090) 6,057
Increase (decrease) in unpaid losses and loss adjustment
expenses.................................................. 2,596 (8,023) 14,587
Increase in amounts withheld for others..................... 133 52 30
Provision (benefit) for deferred income taxes............... 11,296 911 (3,055)
Net realized gains on investments........................... (6,023) (1,851) (5,032)
Depreciation and accretion of bond discount................. (1,736) (1,616) (5,564)
Gain on sale of subsidiaries................................ (9,486)
Change in other assets and liabilities...................... 13,331 17,217 (5,104)
----------- ----------- ---------
Cash provided by operating activities....................... $ 145,276 $ 97,953 $ 54,757
=========== =========== =========
</TABLE>
In addition to the cash received from the contribution of the subsidiary, the
Company also received net assets of $233,765.
The accompanying Notes to Consolidated Financial Statements
are an integral part of these statements.
F-6
<PAGE> 7
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1. ORGANIZATION AND OWNERSHIP
Financial Security Assurance Inc. (the Company), an indirect 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 and municipal
obligations. The Company's underwriting policy is to insure asset-backed and
municipal obligations that it determines would be of investment-grade quality
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.
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, Inc. (U S WEST), 7.8% by Fund
American Enterprises Holdings, Inc. (Fund American), 6.1% by The Tokio Marine
and Fire Insurance Co., Ltd. (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. At
December 31, 1997, the Parent was owned 42.1% by U S WEST, 12.0% by Fund
American, 6.7% by Tokio Marine and 39.2% 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 GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities in the Company's consolidated
balance sheets at December 31, 1997 and 1996 and the reported amounts of
revenues and expenses in the consolidated statements of income during the years
ended December 31, 1997, 1996 and 1995. Such estimates and assumptions include,
but are not limited to, losses and loss adjustment expenses and the
F-7
<PAGE> 8
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
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 direct and indirect wholly owned subsidiaries, FSA Insurance Company,
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 1997 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 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.
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 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.
F-8
<PAGE> 9
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
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 $11,025,000 and $17,669,000 at December 31, 1997
and 1996, respectively, were on deposit with state regulatory authorities as
required by insurance regulations.
Consolidated net investment income consisted of the following (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Bonds......................................... $65,149 $61,130 $43,114
Equity securities............................. 376 14
Short-term investments........................ 5,452 3,525 5,705
Investment expenses........................... (1,334) (1,941) (1,736)
------- ------- -------
Net investment income......................... $69,643 $62,728 $47,083
======= ======= =======
</TABLE>
F-9
<PAGE> 10
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
The credit quality of the investment portfolio at December 31, 1997 was as
follows:
<TABLE>
<CAPTION>
PERCENT OF
RATING INVESTMENT PORTFOLIO
------ --------------------
<S> <C>
AAA................................................. 74.9%
AA.................................................. 18.8
A................................................... 6.0
BBB................................................. 0.1
Other............................................... 0.2
</TABLE>
The amortized cost and estimated market value of bonds were as follows (in
thousands):
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
DECEMBER 31, 1997 COST GAINS LOSSES VALUE
----------------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations of
U.S. government corporations and
agencies................................. $ 120,314 $ 800 $ (436) $ 120,678
Obligations of states and political
subdivisions............................. 777,042 40,187 (135) 817,094
Foreign securities......................... 8,252 (562) 7,690
Mortgage-backed securities................. 195,567 2,213 (28) 197,752
Corporate securities....................... 72,388 1,375 (1,093) 72,670
Asset-backed securities.................... 19,208 349 19,557
---------- ------- ------- ----------
Total............................ $1,192,771 $44,924 $(2,254) $1,235,441
========== ======= ======= ==========
</TABLE>
<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>
The change in net unrealized gains (losses) consisted of (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1997 1996 1995
------- -------- -------
<S> <C> <C> <C>
Bonds............................................ $28,671 $(16,299) $63,166
Equity investments............................... 357
------- -------- -------
Change in net unrealized gains (losses)..... $29,028 $(16,299) $63,166
======= ======== =======
</TABLE>
F-10
<PAGE> 11
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
The amortized cost and estimated market value of bonds at December 31, 1997
and 1996, 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, 1997 DECEMBER 31, 1996
------------------------- -------------------------
AMORTIZED ESTIMATED AMORTIZED ESTIMATED
COST MARKET VALUE COST MARKET VALUE
---------- ------------ ---------- ------------
<S> <C> <C> <C> <C>
Due in one year or less....................... $ 4,009 $ 4,007 $ 38,003 $ 38,325
Due after one year through five years......... 65,145 65,776 57,406 57,623
Due after five years through ten years........ 180,530 183,798 105,494 105,849
Due after ten years........................... 728,312 764,551 607,724 619,795
Mortgage-backed securities (stated maturities
of 4 to 39 years)........................... 195,567 197,752 177,818 178,344
Asset-backed securities (stated maturities of
2 to 30 years).............................. 19,208 19,557 68,233 68,741
---------- ---------- ---------- ----------
Total............................... $1,192,771 $1,235,441 $1,054,678 $1,068,677
========== ========== ========== ==========
</TABLE>
Proceeds from sales of bonds during 1997, 1996 and 1995 were
$1,128,416,000, $1,096,568,000 and $587,516,000, respectively. Gross gains of
$11,735,000, $13,420,000 and $12,346,000 and gross losses of $6,014,000,
$11,569,000 and $7,314,000 were realized on sales in 1997, 1996 and 1995,
respectively.
To hedge against changes in yields on certain one-year corporate
securities, the Company entered into a series of Eurodollar futures contracts,
which were marked-to-market on a daily basis. These contracts were accounted for
as hedges. At year-end 1996, the net unrealized loss on the contracts, included
in the Company's unrealized gains in the stockholder's equity section, was not
material. The aggregate notional amount of these contracts was $83,728,000 as of
December 31, 1996.
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,
--------------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Balance, beginning of period............... $146,233 $132,951 $ 91,839
-------- -------- --------
Costs deferred during the period:
Ceding commission income................. (18,956) (15,956) (9,836)
Assumed commission expense............... 31 38 55
Premium taxes............................ 5,554 3,718 2,537
Compensation and other acquisition
costs................................. 66,198 49,311 34,437
-------- -------- --------
Total............................ 52,827 37,111 27,193
-------- -------- --------
Costs amortized during the period.......... (27,962) (23,829) (16,888)
-------- -------- --------
Balance of contributed subsidiary.......... 30,807
Balance, end of period..................... $171,098 $146,233 $132,951
======== ======== ========
</TABLE>
5. OTHER OPERATING EXPENSES
Total salary expense and related benefits included in other operating
expenses were $15,355,000, $10,135,000 and $10,976,000 for the years ended
December 31, 1997, 1996 and 1995, respectively.
F-11
<PAGE> 12
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
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 principal and interest have 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 (rather than a general loss reserve) is computed
based on the following statutory requirements:
(i) For all policies written prior to July 1, 1989, an amount equal to
50% of cumulative earned premiums less permitted reductions, plus;
(ii) 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;
- Accruals for deferred compensation are not recognized;
- Purchase accounting adjustments are not recognized;
- Bonds are carried at amortized cost;
- Surplus notes are recognized as surplus rather than a liability.
A reconciliation of the Company's net income for the calendar years 1997,
1996 and 1995 and shareholder's equity at December 31, 1997, 1996 and 1995,
prepared on a GAAP basis, to the amounts reported on a statutory basis, is as
follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
NET INCOME 1997 1996 1995
---------- --------- --------- ---------
<S> <C> <C> <C>
GAAP BASIS...................................... $ 100,259 $ 80,855 $ 54,988
Premium revenue recognition..................... (23,130) (5,518) (4,805)
Losses and loss adjustment expenses incurred.... 4,653 (2,138) 10,871
Deferred acquisition costs...................... (24,865) (12,482) (10,305)
Deferred income tax provision (benefit)......... 8,025 911 (3,055)
Amortization of bonds........................... 56 566 1,195
Accrual of deferred compensation, net........... 26,681 12,737 5,663
Other........................................... (61) 1,404 (1,580)
--------- --------- ---------
STATUTORY BASIS................................. $ 91,618 $ 76,335 $ 52,972
========= ========= =========
</TABLE>
F-12
<PAGE> 13
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
SHAREHOLDER'S EQUITY: 1997 1996 1995
--------------------- --------- --------- ---------
<S> <C> <C> <C>
GAAP BASIS...................................... $ 897,860 $ 815,332 $ 789,986
Premium revenue recognition..................... (74,863) (51,760) (46,248)
Loss and loss adjustment expense reserves....... 34,313 29,660 31,798
Deferred acquisition costs...................... (171,098) (146,233) (132,951)
Contingency reserve............................. (287,694) (227,139) (183,967)
Unrealized gain on investments, net of tax...... (43,027) (14,084) (30,298)
Deferred income taxes........................... 59,867 41,682 43,205
Accrual of deferred compensation................ 41,451 18,390 5,653
Surplus notes................................... 50,000
Other........................................... (12,841) (17,043) (16,492)
--------- --------- ---------
STATUTORY BASIS (SURPLUS)....................... $ 493,968 $ 448,805 $ 460,686
--------- --------- ---------
SURPLUS PLUS CONTINGENCY RESERVE................ $ 781,661 $ 675,944 $ 644,653
========= ========= =========
</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 were 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 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,
--------------------
1997 1996
-------- --------
<S> <C> <C>
Deferred acquisition costs............................. $ 59,884 $ 51,182
Deferred premium revenue adjustments................... 8,424 3,520
Contingency reserve.................................... 38,037 29,492
Unrealized capital gains............................... 16,998 7,915
Market discounts....................................... 2,014 1,955
-------- --------
Total deferred tax liabilities............... 125,357 94,064
-------- --------
Loss and loss adjustment expense reserves.............. (12,009) (10,381)
Deferred compensation.................................. (20,328) (9,791)
Tax credits............................................ (1,789) (7,842)
Tax and loss bonds..................................... (30,520) (22,526)
Other, net............................................. (844) (1,842)
-------- --------
Total deferred tax assets.................... (65,490) (52,382)
-------- --------
Total deferred income taxes............................ $ 59,867 $ 41,682
======== ========
</TABLE>
No valuation allowance was necessary at December 31, 1997 or 1996.
F-13
<PAGE> 14
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
A reconciliation of the effective tax rate with the federal statutory rate
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Tax at statutory rate.............................. 35.0% 35.0% 35.0%
Tax-exempt interest................................ (7.9) (8.9) (8.3)
Other.............................................. 0.3 0.4 0.3
---- ---- ----
Provision for income taxes......................... 27.4% 26.5% 27.0%
==== ==== ====
</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, 1997, the Company had $49,846,000 available for the payment of
dividends over the next twelve months. In addition, the New York Superintendent
has approved the repurchase by the Company of up to $75,000,000 of its shares
from the Parent through December 31, 1998, pursuant to which the Company has
repurchased $66,500,000 of its shares through December 31, 1997.
9. CREDIT ARRANGEMENTS AND ADDITIONAL CLAIMS-PAYING RESOURCES
The Company has a credit arrangement aggregating $150,000,000 at December
31, 1997, which is provided by commercial banks and intended for general
application to transactions insured by the Company and the Subsidiaries. At
December 31, 1997, there were no borrowings under this arrangement, which
expires on November 23, 1999. 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, 1997.
The Company has a standby line of credit commitment in the amount of
$240,000,000 with a group of international Aaa/AAA-rated banks 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
$230,000,000 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, 1997 and expiring on April 30,
2004 and contains an annual renewal provision subject to approval by the banks.
No amounts have been utilized under this commitment as of December 31, 1997.
On September 21, 1997, the Company borrowed $50,000,000 from its Parent in
the form of Surplus Notes. These notes carried a simple interest rate of 5.0%
per annum. Principal of and interest on the Surplus Notes may be paid at any
time at the option of the Company, subject to prior approval of the New York
Insurance Department and compliance with the conditions to such payments as
contained in the New York Insurance Laws. These notes have no stated maturity.
F-14
<PAGE> 15
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
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
$2,312,000, $1,977,000 and $1,784,000 for the years ended December 31, 1997,
1996 and 1995, 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 closing of 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.
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 performance shares, stock options and equity
bonus awards is 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. During 1997, employees acquired 125,106 shares
subject to options at an average strike price of
F-15
<PAGE> 16
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
$22.32 per share and with an average market price of $41.47 per share. In
addition, options to purchase 20,194 shares were forfeited during 1997. Giving
effect to such exchange and subsequent awards, at December 31, 1997, there were
outstanding 1,366,375 performance shares and options to purchase 56,656 shares
of common stock.
Performance shares granted under the 1993 Equity Participation Plan were as
follows:
<TABLE>
<CAPTION>
OUTSTANDING GRANTED EARNED FORFEITED OUTSTANDING MARKET
AT BEGINNING DURING THE DURING THE DURING AT END PRICE AT
OF YEAR YEAR YEAR THE YEAR OF YEAR GRANT DATE
------------ ---------- ---------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
1995...................... 1,025,500 83,650 1,109,150 $19.250
1996...................... 1,109,150 282,490 17,300 1,374,340 25.250
1997...................... 1,374,340 253,057 201,769 59,253 1,366,375 35.500
</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
$28,439,000, $12,737,000 and $5,663,000 for the years ended December 31, 1997,
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. The Company recognized a benefit for the difference between
the market value of the Parent's common stock and the cost of the stock when it
was purchased by the independent trustee (which amount was reimbursed by the
Company to its Parent) for shares distributed under the performance share plan.
This benefit was recorded by the Company as a capital contribution which totaled
$2,900,000 in 1997. In 1996, the Parent 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, there would have been no
effect on the Company's reported net income.
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 1997, 1996 and 1995,
the total number of shares purchased by this trust was 162,573, 529,131 and
591,714, respectively, at a cost of $5,434,000, $14,111,000 and $14,444,000,
respectively. In 1996 and 1995, 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.
F-16
<PAGE> 17
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Future minimum rental payments are as follows (in thousands):
<TABLE>
<S> <C>
Year Ended December 31, 1998............................... $ 2,477
1999....................................................... 2,440
2000....................................................... 2,301
2001....................................................... 2,014
2002....................................................... 1,739
Thereafter................................................. 5,071
-------
Total............................................ $16,042
=======
</TABLE>
Rent expense for the years ended December 31, 1997, 1996 and 1995 was
$3,708,000, $3,383,000 and $3,493,000, 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 1997 of
two quota share treaties and three automatic facultative facilities. One treaty
covered all of the Company's approved regular lines of business, except U.S.
municipal obligation insurance. Under this treaty in 1997, the Company ceded
9.75% of each covered policy, up to a maximum of $19,500,000 insured principal
per policy. At its sole option, the Company could have increased, and in certain
instances did increase, the ceding percentage to 19.5% up to $39,000,000 of each
covered policy. A second treaty covered the Company's U.S. municipal obligation
insurance business. Under this treaty in 1997, the Company ceded 9% of each
covered policy that is classified by the Company as providing U.S. municipal
bond insurance as defined by Article 69 of the New York Insurance Law up to a
limit of $24,000,000 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 35% up to $93,333,000 per single risk. These
cession percentages under both treaties were reduced on smaller-sized
transactions. Under the three automatic facultative facilities in 1997, the
Company at its option could allocate up to a specified amount for each reinsurer
(ranging from $4,000,000 to $50,000,000 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 treaties and automatic facultative facilities allowed
the Company to withhold a ceding commission to defray their expenses. The
Company also employed non-treaty, quota share facultative reinsurance on various
transactions in 1997 in keeping with prior practices. In 1997, the Company also
implemented facultative first- loss reinsurance on selected asset-backed
transactions.
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.
F-17
<PAGE> 18
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Amounts reinsured were as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Written premiums ceded........................... $63,513 $55,965 $33,166
Written premiums assumed......................... 1,352 1,873 1,684
Earned premiums ceded............................ 41,713 38,723 38,013
Earned premiums assumed.......................... 5,121 6,020 2,759
Loss and loss adjustment expense payments
ceded.......................................... 2,862 29,408 3,060
Loss and loss adjustment expense payments
assumed........................................ 2 3 3
Incurred losses and loss adjustment expenses
ceded.......................................... 3,605 (2,249) 9,101
Incurred losses and loss adjustment expenses
assumed........................................ 161 38 81
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1997 1996
----------- -----------
<S> <C> <C>
Principal outstanding ceded....................... $24,547,361 $20,292,615
Principal outstanding assumed..................... 1,670,468 1,995,752
Deferred premium revenue ceded.................... 173,123 151,224
Deferred premium revenue assumed.................. 14,128 18,929
Loss and loss adjustment expense reserves ceded... 30,618 29,875
Loss and loss adjustment expense reserves
assumed......................................... 865 705
</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, 1997 and 1996 (net of amounts ceded to other
insurers of $10,129 and $9,601 of asset-backed and $14,418 and $10,691 of
municipal, respectively) and the terms to maturity are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
------------------------- -------------------------
TERMS TO MATURITY ASSET-BACKED MUNICIPAL ASSET-BACKED MUNICIPAL
----------------- ------------ --------- ------------ ---------
<S> <C> <C> <C> <C>
0 to 5 Years................. $ 7,553 $ 2,230 $ 7,424 $ 1,571
5 to 10 Years................ 5,637 5,683 3,920 3,841
10 to 15 Years............... 2,858 8,257 1,461 6,272
15 to 20 Years............... 524 14,340 714 11,433
20 Years and Above........... 11,917 16,479 9,681 12,877
------- ------- ------- -------
Total.............. $28,489 $46,989 $23,200 $35,994
======= ======= ======= =======
</TABLE>
The principal amount ceded as of December 31, 1997 and 1996 and the terms
to maturity are as follows (in millions):
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
------------------------ ------------------------
TERMS TO MATURITY ASSET-BACKED MUNICIPAL ASSET-BACKED MUNICIPAL
----------------- ------------ --------- ------------ ---------
<S> <C> <C> <C> <C>
0 to 5 Years............................... $ 3,828 $ 965 $3,695 $ 769
5 to 10 Years.............................. 2,118 1,693 2,413 1,192
10 to 15 Years............................. 553 2,078 452 1,479
15 to 20 Years............................. 257 3,005 302 2,345
20 Years and Above......................... 3,373 6,677 2,739 4,906
------- ------- ------ -------
Total............................ $10,129 $14,418 $9,601 $10,691
======= ======= ====== =======
</TABLE>
F-18
<PAGE> 19
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
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 1997 1996 1997 1996
------------------- -------- -------- ------- ------
<S> <C> <C> <C> <C>
Residential mortgages........................ $12,928 $10,987 $ 3,665 $3,077
Consumer receivables......................... 10,659 7,548 4,601 3,735
Government securities........................ 787 1,477 120 449
Pooled corporate obligations................. 3,004 1,663 540 852
Commercial mortgage portfolio:
Commercial real estate.................. 98 113 418 463
Corporate secured....................... 55 66 481 619
Investor-owned utility obligations........... 643 791 229 266
Other asset-backed obligations............... 315 555 75 140
------- ------- ------- ------
Total asset-backed obligations..... $28,489 $23,200 $10,129 $9,601
======= ======= ======= ======
</TABLE>
The asset-backed insured portfolio, which aggregated $38,618,244,000
principal before reinsurance at December 31, 1997, was collateralized by assets
with an estimated fair value of $44,382,716,000. At December 31, 1996, it
aggregated $32,792,722,000 principal before reinsurance and was collateralized
by assets with an estimated fair value of $38,323,180,000. Such estimates of
fair value are calculated at the inception of each insurance policy and are
changed only in proportion to changes in exposure. At December 31, 1997, the
estimated fair value of collateral and reserves over the principal insured
averaged from 100% for commercial real estate to 172% for corporate secured
obligations. 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. 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 1997 1996 1997 1996
--------------- ------- ------- ------- -------
<S> <C> <C> <C> <C>
General obligation bonds.................... $17,101 $12,523 $ 3,182 $ 2,423
Housing revenue bonds....................... 1,770 1,794 955 1,033
Municipal utility revenue bonds............. 5,892 4,671 2,294 1,472
Health care revenue bonds................... 3,924 2,854 2,175 2,049
Tax-supported bonds (non-general
obligation)............................... 11,210 8,805 3,526 2,152
Transportation revenue bonds................ 1,972 1,479 1,041 436
Other municipal bonds....................... 5,120 3,868 1,245 1,126
------- ------- ------- -------
Total municipal obligations....... $46,989 $35,994 $14,418 $10,691
======= ======= ======= =======
</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
F-19
<PAGE> 20
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
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 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, 1997:
<TABLE>
<CAPTION>
NET PAR PERCENT OF TOTAL CEDED PAR
NUMBER AMOUNT MUNICIPAL NET PAR AMOUNT
STATE OF ISSUES OUTSTANDING AMOUNT OUTSTANDING OUTSTANDING
----- --------- ------------- ------------------ -------------
(IN MILLIONS) (IN MILLIONS)
<S> <C> <C> <C> <C>
California........................... 403 $ 7,832 16.7% $ 1,929
New York............................. 281 4,307 9.2 2,163
Pennsylvania......................... 231 3,125 6.6 650
New Jersey........................... 207 2,730 5.8 1,260
Florida.............................. 103 2,669 5.7 817
Texas................................ 294 2,472 5.3 669
Illinois............................. 274 1,851 3.9 254
Massachusetts........................ 101 1,460 3.1 553
Michigan............................. 147 1,417 3.0 409
Minnesota............................ 129 1,152 2.5 111
Wisconsin............................ 179 1,138 2.4 206
All Other States..................... 1,190 15,575 33.1 4,528
Non-U.S.............................. 29 1,261 2.7 869
----- ------- ----- -------
Total...................... 3,568 $46,989 100.0% $14,418
===== ======= ===== =======
</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, 1997 and 1996
are $4,702,000 and $4,205,000, respectively, for unsettled expense allocations
due from the Parent.
The Company ceded premiums of $21,216,000, $19,890,000 and $13,061,000 to
Tokio Marine for the years ended December 31, 1997, 1996 and 1995, respectively.
The amounts included in prepaid reinsurance premiums at December 31, 1997 and
1996 for reinsurance ceded to Tokio Marine were $53,603,000 and $44,634,000,
respectively. Reinsurance recoverable on unpaid losses ceded to Tokio Marine was
$613,000 and $477,000 at December 31, 1997 and 1996, respectively.
The Company ceded premiums of $16,890,000, $15,409,000 and $7,522,000 on a
quota share basis to affiliates of U S WEST for the years ended December 31,
1997, 1996 and 1995, respectively, of which $351,000, $372,000 and $629,000,
respectively, were ceded to Commercial Reinsurance Company (Commercial Re). The
amounts included in prepaid reinsurance premiums for reinsurance ceded to these
affiliates were $51,980,000 and $49,649,000 at December 31, 1997 and 1996,
respectively, of which $5,554,000 and $8,728,000, respectively, were ceded to
Commercial Re. The amounts of reinsurance recoverable on unpaid losses ceded to
these affiliates at December 31, 1997 and 1996 were $24,195,000 and $23,473,000,
respectively, of which $20,335,000 and $19,170,000, respectively, were ceded to
Commercial Re. The
F-20
<PAGE> 21
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
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.
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.
Bonds -- The carrying amount of bonds represents fair value. The fair value
of 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, 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 premiums retained by the Company to compensate it for
originating and servicing the insurance contracts.
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.
F-21
<PAGE> 22
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
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, 1997 DECEMBER 31, 1996
----------------------- -----------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
---------- ---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Assets:
Bonds................................. $1,235,441 $1,235,441 $1,068,677 $1,068,677
Short-term investments................ 103,926 103,926 39,570 39,570
Cash.................................. 11,235 11,235 23,646 23,646
Receivable for securities sold........ 20,535 20,535
Liabilities:
Deferred premium revenue, net of
prepaid reinsurance premiums....... 422,073 295,451 359,972 251,980
Losses and loss adjustment expenses,
net of reinsurance recoverable on
unpaid losses...................... 44,799 44,799 42,204 42,204
Notes payable......................... 50,000 50,000
Payable for investments purchased..... 72,979 72,979 14,142 14,142
Off-balance-sheet instruments:
Installment premiums.................. 116,888 102,988
</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,
-----------------------------
1997 1996 1995
------- -------- --------
<S> <C> <C> <C>
Balance at January 1............................ $72,079 $111,759 $ 91,130
Less reinsurance recoverable.................... 29,875 61,532 55,491
------- -------- --------
Net balance at January 1........................ 42,204 50,227 35,639
Incurred losses and loss adjustment expenses:
Current year.................................. 5,400 5,300 3,000
Prior years................................... 3,756 1,574 3,258
Related to Merger............................. 15,400
------- -------- --------
Paid losses and loss adjustment expenses:
Current year.................................. (2,850)
Prior years................................... (3,711) (14,897) (7,070)
------- -------- --------
Net balance December 31......................... 44,799 42,204 50,227
Plus reinsurance recoverable.................... 30,618 29,875 61,532
------- -------- --------
Balance at December 31................ $75,417 $ 72,079 $111,759
======= ======== ========
</TABLE>
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
F-22
<PAGE> 23
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
transactions. Also in December 1995, the Company 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.
During 1997, the Company increased its general reserve by $9,156,000, of
which $5,400,000 was for originations of new business and $3,756,000 was to
reestablish the general reserve for transfers from general reserves to case
basis reserves. During 1997, the Company transferred $4,503,000 from its general
reserve to case basis reserves associated predominantly with certain residential
mortgage transactions. Giving effect to these transfers, the general reserve
totaled $34,313,000 at December 31, 1997.
Reserves for losses and loss adjustment expenses are discounted at
risk-free rates. The amount of discount taken was approximately $19,779,000,
$17,944,000 and $15,276,000 at December 31, 1997, 1996 and 1995, respectively.
17. RECENTLY ISSUED ACCOUNTING STANDARDS
In February 1997, the Securities and Exchange Commission (SEC) issued
Financial Reporting Release No. 48, Disclosure of Accounting Policies for
Derivative Financial Instruments and Derivative Commodity Instruments and
Disclosure of Quantitative and Qualitative Information about Market Risk
Inherent in Derivative Financial Instruments, Other Financial Instruments, and
Derivative Commodity Instruments (FRR No. 48).
FRR No. 48 amends rules and forms for registrants and requires
clarification and expansion of existing disclosures for derivative financial
instruments, other financial instruments and derivative commodity instruments,
as defined therein. The amendments require enhanced disclosure with respect to
these derivative instruments in the footnotes to the financial statements.
Additionally, the amendments expand existing disclosure requirements to include
quantitative and qualitative discussions with respect to market risk inherent in
market-risk-sensitive instruments such as equity and fixed-maturity securities,
as well as derivative instruments.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
Reporting Comprehensive Income. SFAS No. 130 establishes standards for reporting
and display of comprehensive income and its components (revenues, expenses,
gains and losses) in a full set of general-purpose financial statements.
Comprehensive income is defined as the change in stockholders' equity during a
period from transactions and other events and circumstances from non-owner
sources and includes net income and all changes in stockholders' equity except
those resulting from investments by owners and distributions to owners.
SFAS No. 130 requires that an enterprise (i) classify items of other
comprehensive income by their nature in a financial statement and (ii) display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement of
financial position.
SFAS No. 130 is effective for fiscal years beginning after December 15,
1997. Reclassification of financial statements for earlier periods provided for
comparative purposes is required.
F-23
<PAGE> 24
FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
Also in June 1997, the Financial Accounting Standards Board issued SFAS No.
131, Disclosure about Segments of an Enterprise and Related Information. SFAS
No. 131 establishes standards for the way that public business enterprises
report information about operating segments in annual and interim financial
statements and requires presentation of a measure of profit or loss, certain
specific revenue and expense items and segment assets. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers, superseding most of SFAS No. 14, Financial Reporting for
Segments of a Business Enterprise.
SFAS No. 131 requires that a public business enterprise report financial
and descriptive information about its reportable operating segments. Generally,
financial information is required to be reported on the basis that is used
internally for evaluating segment performance and deciding how to allocate
resources to segments. The enterprise must report information about revenues
derived, major customers, and countries in which it earns revenues and holds
assets, regardless of whether that information is used in making operating
decisions. However, SFAS No. 131 does not require an enterprise to report
information that is not prepared for internal use if reporting would be
impracticable.
SFAS No. 131 is effective for financial statements for periods beginning
after December 15, 1997. SFAS No. 131 need not be applied to interim financial
statements in the initial year of its application, but comparative information
for interim periods in the initial year of application is to be reported in
financial statements of the interim periods in the third year of application.
The Company is in the process of determining the effect of these standards
on its financial statements.
F-24
