SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-Q
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(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____TO____
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CAPITAL RE CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 1-10995 52-1567009
(STATE OR OTHER (COMMISSION FILE NUMBER) (IRS EMPLOYER
JURISDICTION IDENTIFICATION NUMBER)
OF INCORPORATION OR
ORGANIZATION)
1325 AVENUE OF THE AMERICAS
18TH FLOOR
NEW YORK, NEW YORK 10019
(212) 974-0100
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT
WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO (REGISTRANT BECAME SUBJECT TO THE
FILING REQUIREMENTS ON APRIL 8, 1992.)
AS OF NOVEMBER 11, 1998 THERE WERE 31,866,622 OUTSTANDING SHARES OF COMMON
STOCK, PAR VALUE $.01 PER SHARE, OF THE REGISTRANT
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CAPITAL RE CORPORATION AND SUBSIDIARIES
INDEX
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PART I FINANCIAL INFORMATION PAGE
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) CAPITAL RE CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS -SEPTEMBER 30, 1998 (UNAUDITED) AND
DECEMBER 31, 1997 3
CONSOLIDATED STATEMENTS OF INCOME - THREE AND NINE MONTHS 4
ENDED SEPTEMBER 30, 1998 (UNAUDITED) AND SEPTEMBER 30, 1997
(UNAUDITED)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME - THREE AND NINE 5
MONTHS ENDED SEPTEMBER 30, 1998 (UNAUDITED) AND
SEPTEMBER 30, 1997 (UNAUDITED)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY - NINE MONTHS
ENDED SEPTEMBER 30, 1998 (UNAUDITED) 6
CONSOLIDATED STATEMENTS OF CASH FLOWS - NINE MONTHS ENDED
SEPTEMBER 30, 1998 (UNAUDITED) AND SEPTEMBER 30, 1997 (UNAUDITED) 7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 8-9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS 10-26
PART II OTHER INFORMATION
ITEM 3 EXHIBITS AND REPORTS ON FORM 8-K 27-29
SIGNATURES 30
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CAPITAL RE CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(Dollars in thousands except per share amounts)
September 30, December 31,
1998 1997
--------------- ----------------
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Assets
Fixed maturity securities available for sale, at market
(amortized cost: $1,002,120 in 1998 and $887,605 in 1997) $1,064,114 $932,423
Short-term investments, at cost, which approximates market 68,222 75,500
--------------- ----------------
Total Investments 1,132,336 1,007,923
Cash 9,324 14,103
Accrued investment income 14,498 13,761
Deferred acquisition costs 136,111 127,637
Prepaid reinsurance premiums 51,823 59,942
Reinsurance recoverable on ceded losses 7,305 5,527
Funds held under reinsurance agreements 4,532 3,926
Premiums receivable, net 16,851 8,024
Amounts receivable on ceded annuity reserves 55,857 58,635
Investment in affiliates 22,202 21,858
Net assets of discontinued operations 15,369 16,769
Other assets 7,413 7,368
--------------- ----------------
Total Assets $1,473,621 $1,345,473
=============== ================
Liabilities
Deferred premium revenue $393,742 $373,996
Reserve for losses and loss adjustment expenses 43,679 27,986
Annuity benefit reserves 55,857 58,635
Accident and health reserves 16,809 16,367
Profit commission liability 49,422 35,670
Deferred federal income taxes payable 87,682 72,879
Bank note payable 25,000 25,000
Long-term debt 74,847 74,819
Other liabilities 19,518 16,178
--------------- ----------------
Total Liabilities $766,556 $701,530
--------------- ----------------
Company Obligated Mandatorily Redeemable
Preferred Securities of Capital Re LLC 75,000 75,000
Stockholders' Equity
Preferred stock - $.01 par value per share; 25,000,000 shares authorized; no
shares issued and outstanding
in 1998 and 1997 --- ---
Common stock - $.01 par value per share; 75,000,000 shares
authorized, 31,929,119 and 31,826,874 shares issued and
outstanding in 1998 and 1997, respectively 324 322
Additional paid-in capital 226,689 224,999
Retained earnings 369,877 319,253
Treasury stock; 428,000 and 428,000 shares in 1998 and 1997, respectively (4,891) (4,891)
Other Comprehensive Income
Net unrealized gain on fixed maturities securities
available for sale, net of tax 39,934 29,392
Foreign exchange translation 132 (132)
--------------- ----------------
Accumulated Other Comprehensive Income 40,066 29,260
--------------- ----------------
Total Stockholders' Equity 632,065 568,943
--------------- ----------------
Total Liabilities, Preferred Securities of Capital Re LLC and
Stockholders' Equity $1,473,621 $1,345,473
--------------- ----------------
See Accompanying Notes to Unaudited Consolidated Financial Statements
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<CAPTION>
CAPITAL RE CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income
(Dollars in thousands except per share amounts)
Three Months Ended Nine Months Ended
September 30, September 30,
(Unaudited) (Unaudited)
--------------------------- ---------------------------
1998 1997 1998 1997
--------------------------- ---------------------------
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Revenues:
Gross premiums written $41,435 $42,843 $159,367 $132,539
Ceded premiums 810 2,808 2,330 5,549
--------------------------- ---------------------------
Net premiums written 40,625 40,035 157,037 126,990
Decrease/(increase) in deferred premium revenue 5,590 (8,522) (27,866) (38,749)
--------------------------- ---------------------------
Net premiums earned 46,215 31,513 129,171 88,241
Net investment income 16,413 13,931 48,465 41,696
Net realized gain/(loss) 1,848 2,949 4,309 5,543
Fee income 100 73 717 478
Other income 23 25 210 158
Equity income in affiliate 199 302 332 772
--------------------------- ---------------------------
Total Revenues 64,798 48,793 183,204 136,888
--------------------------- ---------------------------
Expenses:
Loss and loss adjustment expenses 21,085 4,770 33,677 10,964
Acquisition costs 12,893 13,194 47,511 38,584
(Increase)/decrease in deferred acquisition costs 774 (2,403) (8,474) (8,487)
Profit commission expense 3,844 1,295 14,432 5,262
Other operating expenses 4,496 3,246 12,352 8,219
Interest expense 1,852 1,819 5,582 5,541
Foreign exchange (gain)/loss (163) 285 (127) 556
Minority interest in Capital Re LLC 1,434 1,434 4,303 4,303
--------------------------- ---------------------------
Total Expenses 46,215 23,640 109,256 64,942
--------------------------- ---------------------------
Income before provision for federal income taxes 18,583 25,153 73,948 71,946
Provision for federal income taxes
Current (721) 3,846 10,600 12,644
Deferred 4,969 2,844 9,056 7,669
--------------------------- ---------------------------
Total provision for federal income taxes 4,248 6,690 19,656 20,313
--------------------------- ---------------------------
Net Income from continuing operations $14,335 $18,463 $54,292 $51,633
Income/(loss) from discontinued operations 135 (207) 158 (132)
Net Income $14,470 $18,256 $54,450 $51,501
=========================== ===========================
Net Income from Continuing Operations
Per Common Share:
Basic $0.45 $0.58 $1.70 $1.63
Diluted $0.44 $0.57 $1.66 $1.59
Net Income Per Common Share:
Basic $0.45 $0.57 $1.71 $1.62
Diluted $0.44 $0.56 $1.66 $1.59
Weighted Average Number of Shares Outstanding
Basic 31,912 31,755 31,871 31,734
Diluted 32,732 32,587 32,730 32,460
Cash dividends per common share $0.04 $0.04 $0.12 $0.11
See Accompanying Notes to Unaudited Consolidated Financial Statements
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CAPITAL RE CORPORATION AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(Dollars in thousands)
Three Months Ended Nine Months Ended
September 30, September 30,
(unaudited) (unaudited)
-------------------------- --------------------------
1998 1997 1998 1997
-------------------------- --------------------------
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Net Income $14,470 $18,256 $54,450 $51,501
Other Comprehensive Income, net of tax:
Change in net unrealized gain on fixed maturities securities
available for sale 10,962 7,224 10,542 5,861
Change in foreign exchange translation 241 (408) 264 (735)
Other Comprehensive Income 11,203 6,816 10,806 5,126
------ ----- ------ -----
Comprehensive Income $25,673 $25,072 $65,256 $56,627
======= ======= ======= =======
See Accompanying Notes to Unaudited Consolidated Financial Statements
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<CAPTION>
CAPITAL RE CORPORATION AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
(Dollars in thousands except share amounts)
Additional
Common Paid-In Retained
Stock Capital Earnings
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Balance, January 1, 1998 ........................................ $322 $224,999 $319,253
Net Income ..................................................... -- -- 54,450
Exercise of stock options, including tax benefit (102,245 shares) 2 1,690 --
Fixed maturities securities available for sale adjustments ...... -- -- --
Foreign exchange translation .................................... -- -- --
Dividend ($.12 per common share) ............................... -- -- (3,826)
-------------------------------------------------------
Balance, September 30, 1998 ..................................... $324 $226,689 $369,877
=======================================================
Net Unrealized
Gain on
Fixed Maturities
Securities Total
Treasury Foreign Exch. Available for Stockholders'
Stock Translation Sale Equity
------------------------------------------------------------
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Balance, January 1, 1998 ........................................ ($4,891) ($132) $29,392 $ 568,943
Net Income ..................................................... -- -- -- 54,450
Exercise of stock options, including tax benefit (102,245 shares) -- -- -- 1,692
Fixed maturities securities available for sale adjustments ...... -- -- 10,542 10,542
Foreign exchange translation .................................... -- 264 -- 264
Dividend ($.12 per common share) ............................... -- -- -- (3,826)
------------------------------------------------------------
Balance, September 30, 1998 ..................................... ($4,891) $ 132 $39,934 $ 632,065
============================================================
See Accompanying Notes to Unaudited Consolidated Financial Statements
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CAPITAL RE CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Dollars in thousands)
Nine Months Ended
September 30,
--------------------------------------
1998 1997
--------------------------------------
Operating Activities:
<S> <C> <C>
Net income $54,450 $51,501
Adjustments to reconcile net income to
net cash provided by operating activities:
Amortization of bond discount on long-term debt 28 28
Net amortization of security premiums (706) 327
Provision for deferred federal income taxes 9,127 7,669
Acquisition costs deferred (47,511) (38,584)
Amortization of deferred acquisition costs 39,037 30,097
Equity Income in affiliates (344) (772)
Change in accrued investment income (737) (56)
Change in premiums receivable, net (11,513) (7,543)
Change in deferred premium revenue, net 27,866 38,749
Change in outstanding loss reserves, net 16,916 283
Net realized (gain) on investments (4,309) (5,543)
Change in ceded balances payable 9,401 3,016
Other 7,690 5,372
Discontinued Operations, Net 4,389 3,015
--------------- ----------------
Net Cash Provided by Operating Activities 103,783 87,559
Investing Activities:
Securities available-for-sale:
Purchases - fixed maturities (591,931) (1,478,783)
Sales-fixed maturities 482,031 1,444,280
Maturities (purchases) of short-term
investments, net 2,537 (79,447)
Investments in Affiliates 0 (11,000)
Other investing activities (436) 33,228
Discontinued Operations, Net 959 383
--------------- ----------------
Net Cash Used in Investing Activities (106,840) (91,339)
Financing Activities:
Net proceeds from exercise of stock options 1,692 1,045
Purchase of treasury stock at cost 0 (1,021)
Dividends paid (3,826) (3,333)
Discontinued Operations, Net 411 (78)
--------------- ----------------
Net Cash Used by Financing Activities (1,723) (3,387)
Decrease in Cash (4,779) (7,167)
Cash at Beginning of Period 14,103 13,306
--------------- ----------------
Cash at End of Period $9,324 $6,139
=============== ================
See Accompanying Notes to Unaudited Consolidated Financial Statements.
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CAPITAL RE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 1998
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements and footnotes have
been prepared in accordance with the instructions to Form 10-Q and the
preparation of unaudited interim financial statements under the Rules and
Regulations of the Securities and Exchange Commission and do not include all the
information and disclosures required by generally accepted accounting
principles. These statements should be read in conjunction with the audited
consolidated financial statements of Capital Re Corporation and Subsidiaries
(the "Corporation") included in the Corporation's 1997 Annual Report on Form
10-K. The accompanying unaudited consolidated financial statements include all
adjustments, consisting only of normal recurring adjustments, necessary to
present fairly the Corporation's financial position and results of operations.
The results of operations for the nine months ended September 30, 1998 may not
be indicative of the results that may be expected for the year ending December
31, 1998.
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standard 130, "Reporting Comprehensive Income" ("FAS 130"). Statement 130
establishes new rules for the reporting and display of comprehensive income and
its components; however, the adoption of this Statement had no impact on the
Corporation income or shareholders' equity. FAS 130 requires unrealized gains or
losses on the Corporation's available-for-sale securities and foreign currency
translation adjustments, which prior to adoption were reported separately in
shareholders' equity to be included in other comprehensive income. Prior year
financial statements have been reclassified to conform to the requirements of
Statement 130. For the three months and nine months ended September 30, 1998 and
1997, total comprehensive income amounted to $25.7 million and $65.3 million,
and $25.1 million and $56.6 million, respectively.
On June 30, 1998, the Corporation completed a two for one stock split of its
outstanding common shares. Prior period financial results have been restated to
reflect the stock split. Additionally, beginning in the third quarter of 1998,
the Company's investment in Lloyd's which was previously consolidated, is
reflected as a discontinued operation based on the Company's intention to pursue
its divestiture. All prior period results have been restated for comparative
purposes.
<PAGE>
2. REINSURANCE
Ceded earned premium for the three and nine months ended September 30, 1998 and
1997 were $3.0 million and $10.4 million, and $6.5 million and $14.1 million,
respectively. Ceded losses for the same periods were ($1.5) million and $1.3
million, and $1.0 million and $2.8 million, respectively.
3. INCOME TAXES
The effective tax rate for the nine months ended September 30, 1998 and 1997 is
lower than the federal corporate tax rate on ordinary income of 35% due
principally to the effect of tax-exempt interest income. Income taxes paid for
the nine months ended September 30, 1998 and 1997 were $16.1 million and $13.2
million, respectively.
4. OTHER
Interest paid for the nine months ended September 30, 1998 and 1997 was $4.1
million and $4.0 million, respectively.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Capital Re Corporation (the "Corporation") was incorporated in the State of
Delaware in December 1991, and is the successor by merger to a Maryland
corporation incorporated in 1986. The Corporation is an insurance holding
company and has six wholly owned operating subsidiaries. Capital Reinsurance
Company ("Capital Reinsurance"), domiciled in the State of Maryland, commenced
operations in January 1988. Capital Reinsurance is engaged in the business of
financial guaranty reinsurance, primarily the reinsurance of municipal and
non-municipal bond insurance obligations. Capital Mortgage Reinsurance Company
("Capital Mortgage"), a New York domiciled company, commenced operations in
February 1994. Capital Mortgage reinsures only residential mortgage guaranty
insurance obligations. KRE Reinsurance Ltd. (formerly Capital Mortgage
Reinsurance Company (Bermuda) Ltd.) ("KRE"), a Bermuda domiciled company,
commenced operations in March 1994. KRE is engaged in the business of reinsuring
financial guaranty, mortgage guaranty, financial insurance, trade credit and
other specialty lines of insurance, both as a direct reinsurer of third party
primary insurers and as a retrocessionaire of Capital Reinsurance, Capital
Mortgage, Capital Credit Reinsurance Company Ltd. ("Capital Credit") and Capital
Title Reinsurance Company ("Capital Title"). Capital Credit, also a Bermuda
domiciled insurance company, commenced operations in February 1990. Capital
Credit reinsures trade credit, political risk, and other specialty insurance
lines concentrated in Western Europe and the United States and is a
retrocessionaire of Capital Reinsurance and Capital Mortgage. Capital Title, a
New York domiciled insurance company, commenced operations in March 1996.
Capital Title is engaged in the business of reinsuring title insurance policies.
In November 1996, the Corporation acquired, through a United Kingdom holding
company, Capital Re (UK) Holdings, 100% of the issued shares of Tower Street
Holdings Limited (now known as RGB Holdings, Ltd.), the holding company for RGB
Underwriting Agencies Ltd. ("RGB"). RGB is a managing agency and presently
manages five syndicates operating in the Lloyd's of London ("Lloyd's") insurance
market. In November 1997, RGB Holdings, Ltd. acquired 100% of C.I. de Rougemont
Group Limited, the ultimate holding company for C.I. de Rougemont & Co. Ltd.
("CIDR"), another Lloyd's managing agency. CIDR manages two syndicates, one
marine and the other non-marine. Effective January 1, 1998, the CIDR non-marine
syndicate was merged with the non-marine syndicate of RGB. In connection with
its acquisition of RGB, the Corporation established a corporate name at Lloyd's,
CRC Capital Ltd. ("CRC"), to provide underwriting capacity to the managed
syndicates commencing with the 1997 year of account. CRC currently participates
in a marine, a non-marine and two life syndicates. However, for the three and
nine months ended September 30, 1998, the Corporation is reflecting its
participation in Lloyd's as a discontinued operation since the Company has
commenced a plan of divestiture of its Lloyd's operations, including RGB, CIDR
and CRC. Pending divestiture, the Corporation will continue to support its
commitments to Lloyd's. For comparative purposes, the Corporation has restated
prior period financial statements to reflect Lloyd's as a discontinued
operation.
In December 1996, the Corporation entered into a joint venture with GCR Holdings
Ltd. ("GCR"), to form a Bermuda based insurer, Capital Global Underwriters
Limited ("CGUL"), which specializes in financial lines reinsurance. In April
1997, EXEL Limited ("EXEL") acquired GCR. In March 1998, EXEL sold its share of
CGUL to Bermuda based ACE Limited and CGUL was renamed ACE Capital Re Ltd. The
Corporation, through its subsidiary, KRE, owns a fifty-percent interest in ACE
Capital Re Ltd. and controls 9.9% of its voting stock. The Corporation accounts
for its investment in ACE Capital Re Ltd. under the equity method.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1998 VERSUS THREE MONTHS ENDED
SEPTEMBER 30, 1997
The Company adopted Statement of Financial Accounting Standards No. 128,
"Earnings per Share" ("FAS 128"), as of December 31, 1997. FAS 128 requires the
calculation and presentation on the face of the income statement of basic
earnings per share and, if applicable, diluted earnings per share. Basic
earnings per share is calculated based on the weighted average common shares
outstanding. All potentially dilutive securities such as stock options and
convertible securities are excluded from the basic earnings per share
calculation. In calculating diluted earnings per share, the number of shares is
increased to include all potentially dilutive securities, including stock
options and convertible securities. On June 30, 1998, the Corporation completed
a two for one stock split of its outstanding common shares. Prior period
financial results have been restated to reflect the stock split. Additionally,
as mentioned above, beginning in the third quarter of 1998, the Company's
investment in Lloyd's, which was previously consolidated, is reflected as a
discontinued operation since the Company has commenced a plan of divestiture of
its Lloyd's operations, including RGB, CIDR and CRC. All prior period results
have been restated for comparative purposes.
Net income from continuing operations for the three months ended September 30,
1998 decreased 22.7% to $14.3 million from $18.5 million for the same period of
1997. On a per share basis, basic and diluted net income from continuing
operations decreased to $0.45 and $0.44, respectively, for the three months
ended September 30, 1998 from $0.58 and $0.57, respectively, for the same period
of 1997, or 22.4% and 22.8%, respectively.
Net income including income or (loss) from discontinued operations for the three
months ended September 30, 1998, decreased to $14.5 million from $18.3 million
for the same period of the prior year. On a per share basis, basic and diluted
net income including income or loss from discontinued operations decreased to
$0.45 and $0.44, respectively, for the three months ended September 30, 1998
from $0.57 and $0.56, respectively, for the same period of 1997, or 21.1% and
21.4%, respectively. Net operating income from continuing operations (net income
from continuing operations excluding realized gains and losses and foreign
exchange gains and losses) decreased 22.1% to $13.0 million for the three months
ended September 30, 1998 from $16.7 million for the same period in 1997. On a
per share basis, basic and diluted net operating income from continuing
operations decreased to $0.41 and $0.40, respectively, for the three months
ended September 30, 1998 from $0.53 and $0.51, respectively, for the same period
of 1997, or 22.6% and 21.6%, respectively.
The decrease in third quarter financial results is due to $9.3 million pre-tax
increase in Capital Re's case basis loss reserve for losses arising from the
bankruptcy of the Delaware Valley Obligated Group, a unit of Pittsburgh based
Allegheny Health, Education and Research Foundation ("Allegheny"). The Company
assumed its exposure to Allegheny in the ordinary course under its 1996
reinsurance treaty with MBIA Inc. Under its treaty, the Company has $15 million
in principal outstanding to the hospital system bonds, or approximately 5% of
MBIA's aggregate exposure. The Company expects that the reserve will cover all
anticipated present value losses arising from its exposure to Allegheny. As of
September 30, 1998, the aggregate case basis loss reserve for Allegheny was in
the amount of $10 million. Notwithstanding the Allegheny loss, the Company's
total revenues increased to $64.8 million for the three months ended September
30, 1998 from $48.8 million, or 32.8%, principally on growth in net premiums
earned and net investment income.
Gross premiums written decreased 3.3% to $41.4 million for the three months
ended September 30, 1998 from $42.8 million for the same period of 1997. The
slight decline in total gross premiums written in the third quarter 1998 was, in
part, the result of several large municipal transactions reinsured in the third
quarter of 1997. In addition, mortgage guaranty reinsurance premium declined due
to an increased level in mortgage prepayments caused by lower interest rates as
well as the Company's shift away from assuming quota share reinsurance business
to assuming structured excess of loss reinsurance business. The decrease in
total gross premiums written was partially offset by growth in non-municipal
bond reinsurance business. This growth was due to a significant increase in
premiums written in the credit default swaps sector of that business. The
Company has expanded its traditional municipal and nonmunicipal financial
guaranty bond reinsurance lines of business to include credit default swaps. A
credit default swap is a transaction whereby a counterparty pays a periodic fee
in fixed basis points on a notional amount in return for a contingent payment by
the company in the case of one or more defined credit events on one or more
third party reference securities or loans. A credit event is defined as failure
to pay, bankruptcy, cross acceleration (accompanied by a failure to pay),
repudiation, restructuring, or similar nonpayment event. Credit default swap
premium grew to $2.2 million for the three months ended September 30, 1998 from
$0.2 million in the prior year.
In 1997, the Company added a financial reinsurance line of business. This line
consists of structured, finite risk, financial transactions involving the
reinsurance of annuity and accident and health reserves. Gross premiums written
from financial lines increased to $2.8 million for the three months ended
September 30, 1998 from $2.6 million for the same period of 1997. The following
table shows gross premiums written by line of business for the three months
ended September 30, 1998 and September 30, 1997.
GROSS PREMIUMS WRITTEN
THREE MONTHS ENDED
SEPTEMBER 30,
1998 1997
---- ----
(dollars in millions)
MUNICIPAL $7.8 $13.5
NON-MUNICIPAL 6.2 3.4
FINANCIAL LINES 2.8 2.6
MORTGAGE 13.1 16.4
TITLE 1.5 1.1
CREDIT AND SPECIALTY 10.0 5.8
------ -------
$41.4 $42.8
Net premiums written increased by 1.5% to $40.6 million for the three months
ended September 30, 1998 from $40.0 million for the same period in 1997. The
following table shows net premiums written by line of business for the three
months ended September 30, 1998 and September 30, 1997.
NET PREMIUMS WRITTEN
THREE MONTHS ENDED
SEPTEMBER 30,
1998 1997
---- ----
(dollars in millions)
MUNICIPAL $7.1 $13.5
NON-MUNICIPAL 6.2 3.3
FINANCIAL LINES 2.8 0.0
MORTGAGE 13.1 16.3
TITLE 1.4 1.1
CREDIT AND SPECIALTY 10.0 5.8
------ -------
$40.6 $40.0
For the three months ended September 30, 1998, net premiums earned increased
46.7% to $46.2 million from $31.5 million for the comparable 1997 period. This
increase was primarily due to growth in net premiums earned in the municipal,
non-municipal (including credit default swaps), credit and specialty, and
financial lines of business. For the three months ended September 30, 1998, net
refunded earned premium increased to $6.6 from $1.9 million for the comparable
period in 1997. Excluding the effects of net refunded municipal earned premium,
net premiums earned increased 33.8% to $39.6 million for the three months ended
September 30, 1998 from $29.6 million for the three months ended September 30,
1997. A refunding extinguishes the Corporation's reinsurance liability for the
refunded obligation and the Corporation then recognizes revenue equal to the
remaining related deferred premium revenue. Net premiums earned from credit
default swaps, which are earned as written, increased to $2.2 million for the
three months ended September 30, 1998 from $0.2 million in the prior year. For
the three months ended September 30, 1998 and 1997, ceded earned premium was
$3.0 million and $6.5 million, respectively. The following table shows net
premiums earned by line of business for the three months ended September 30,
1998 and September 30, 1997.
NET PREMIUMS EARNED
THREE MONTHS ENDED
SEPTEMBER 30,
1998 1997
---- ----
(dollars in millions)
MUNICIPAL $12.8 $ 8.0
NON-MUNICIPAL 6.8 3.4
FINANCIAL LINES 2.8 0.0
MORTGAGE 13.7 14.0
TITLE 1.5 1.0
CREDIT AND SPECIALTY 8.6 5.1
------- -------
$46.2 $31.5
For the three months ended September 30, 1998, net investment income increased
18.0% to $16.4 million from $13.9 million for the comparable period in 1997.
Growth in investment income was primarily attributable to a larger investment
portfolio caused by an increase in invested assets from positive operating cash
flows during the twelve months ended September 30, 1998. In addition, the
Corporation recognized net realized gains of $1.8 million for the three months
ended September 30, 1998 compared to $2.9 million for same period in 1997.
Loss and loss adjustment expenses increased to $21.1 million from $4.8 million
for the three months ended September 30, 1998 and 1997, respectively. The
increase in losses recorded for the three months ended September 30, 1998 was
primarily attributable to the $9.3 million Allegheny loss, as well as expected
loss development commensurate with the growth in net premiums earned. Ceded
losses for the three months ended September 30, 1998 and 1997 were ($1.5)
million and $1.0 million, respectively. The loss ratio was 45.6% for the three
months ended September 30, 1998 compared to 15.1 % for the prior year. Excluding
the Allegheny loss, the loss ratio for the three months ended September 30, 1998
was 25.5%.
Total expenses, including loss and loss adjustment expenses, increased 95.8% to
$46.2 million for the three months ended September 30, 1998 from $23.6 million
for the same period of 1997. This increase was primarily attributable to the
Allegheny loss as well as the amortization of acquisition expenses associated
with the increased level of premiums earned and normal expected loss development
from the credit, mortgage and financial lines business. In addition, the
increase in expenses was attributable to an increase in overhead to support
growth in the Company's lines of businesses. The expense ratio for the three
months ended September 30, 1998 and 1997 was 47.6% and 48.7%, respectively. The
combined ratio, excluding expenses associated with non-insurance operations,
increased to 93.2% for the three months ended September 30, 1998 from 63.8% for
the comparable 1997 period. This increase is a result of the Allegheny loss as
well as the Corporation's diversification strategy, which is producing more
business from lines with relatively higher combined ratios than that of the
financial guaranty reinsurance business. For the three months ended September
30, 1998, the combined ratios excluding the Allegheny loss was 73.1%.
For the three months ended September 30, 1998, the total federal tax provision
decreased to $4.2 million from $6.7 million for the same period in 1997. In
addition, the effective tax rate decreased to 22.9% for the three months ended
September 30, 1998 from 26.6% for the same period of 1997.
NINE MONTHS ENDED SEPTEMBER 30, 1998 VERSUS NINE MONTHS ENDED
SEPTEMBER 30, 1997
Net income from continuing operations for the nine months ended September 30,
1998 increased 5.2% to $54.3 million from $51.6 million for the same period of
1997. On a per share basis, basic and diluted net income from continuing
operations increased to $1.70 and $1.66, respectively, for the nine months ended
September 30, 1998 from $1.63 and $1.59, respectively, for the same period of
1997, or 4.3% and 4.4%, respectively.
Net income including income or loss from discontinued operations for the nine
months ended September 30, 1998, increased to $54.5 million from $51.5 million
for the same period of the prior year. On a per share basis, basic and diluted
net income including income or loss from discontinued operations decreased to
$1.71 and $1.66, respectively, for the three months ended September 30, 1998
from $1.62 and $1.59, respectively, for the same period of 1997 or 5.6% and
4.4%, respectively.
Net operating income from continuing operations (net income from continuing
operations excluding realized gains and losses and foreign exchange gains and
losses) increased 6.2% to $51.4 million for the nine months ended September 30,
1998 from $48.4 million for the same period in 1997. On a per share basis, basic
and diluted net operating income from continuing operations increased to $1.61
and $1.57, respectively, for the nine months ended September 30, 1998 from $1.52
and $1.49, respectively, for the same period of 1997, or 5.9% and 5.4%,
respectively.
Growth in net premiums earned to $129.2 million from $88.2 million, or 46.5%,
and growth in net investment income to $48.5 million from $41.7 million, or
16.3%, partially offset by the $10 million pre-tax Allegheny loss were the
principal causes of the increase in the Company's financial results for the nine
months ended September 30, 1998.
Gross premiums written increased 20.3% to $159.4 million for the nine months
ended September 30, 1998 from $132.5 million for the same period of 1997. Gross
premiums written increased primarily because of growth in the non-municipal line
of business which includes credit default swaps, the credit and specialty line
of business as well as from the financial lines line of business. Credit default
swap premiums amounted to $4.3 million for the nine months ended September 30,
1998 compared to $0.3 million in the same period of the prior year. The
following table shows gross premiums written by line of business for the nine
months ended September 30, 1998 and 1997.
GROSS PREMIUMS WRITTEN
NINE MONTHS ENDED
SEPTEMBER 30,
1998 1997
---- ----
(dollars in millions)
MUNICIPAL $46.5 $43.2
NON-MUNICIPAL 18.4 10.6
FINANCIAL LINES 8.4 2.6
MORTGAGE 54.4 56.8
TITLE 3.4 2.5
CREDIT AND SPECIALTY 28.3 16.8
------ ------
$159.4 $132.5
Net premiums written increased by 23.6% to $157.0 million for the nine months
ended September 30, 1998 from $127.0 million for the same period in 1997. This
increase is commensurate with the increase in gross premiums written explained
above. The following table shows net premiums written by line of business for
the nine months ended September 30, 1998 and September 30, 1997.
<PAGE>
NET PREMIUMS WRITTEN
NINE MONTHS ENDED
SEPTEMBER 30,
1998 1997
---- ----
(dollars in millions)
MUNICIPAL $44.5 $40.6
NON-MUNICIPAL 18.4 10.6
FINANCIAL LINES 8.4 0.0
MORTGAGE 54.2 56.5
TITLE 3.4 2.5
CREDIT AND SPECIALTY 28.1 16.8
------ ------
$157.0 $127.0
For the nine months ended September 30, 1998, net premiums earned increased
46.5% to $129.2 million from $88.2 million for the comparable 1997 period. This
increase was primarily due to growth in net premiums earned across all product
lines of business. For the nine months ended September 30, 1998, net refunded
earned premium increased to $14.5 from $4.3 million for the comparable period in
1997. Excluding the effects of net municipal refunded earned premium, net
premiums earned increased 36.7% to $114.7 million for the nine months ended
September 30, 1998 from $83.9 million for the nine months ended September 30,
1997. A refunding extinguishes the Corporation's reinsurance liability for the
refunded obligation and the Corporation then recognizes revenue equal to the
remaining related deferred premium revenue. Net premiums earned from credit
default swaps, which are earned as written, increased to $4.3 million for the
three months ended September 30, 1998 from $0.3 million in the prior year. For
the nine months ended September 30, 1998 and 1997, ceded earned premium was
$10.4 million and $14.1 million, respectively. The following table shows net
premiums earned by line of business for the nine months ended September 30, 1998
and September 30, 1997.
NET PREMIUMS EARNED
NINE MONTHS ENDED
SEPTEMBER 30,
1998 1997
---- ----
(dollars in millions)
MUNICIPAL $32.0 $22.2
NON-MUNICIPAL 15.6 8.8
FINANCIAL LINES 8.4 0.0
MORTGAGE 46.3 41.4
TITLE 3.8 2.4
CREDIT AND SPECIALTY 23.1 13.4
------ ------
$129.2 $88.2
For the nine months ended September 30, 1998, net investment income increased
16.3% to $48.5 million from $41.7 million for the comparable period in 1997.
Growth in investment income was primarily attributable to a larger investment
portfolio caused by an increase in invested assets from positive operating cash
flows during the twelve months ended September 30, 1998. In addition, the
Corporation recognized net realized gains of $4.3 million for the nine months
ended September 30, 1998 compared to $5.5 million for same period in 1997.
Loss and loss adjustment expenses increased to $33.7 million from $11.0 million
for the nine months ended September 30, 1998 and 1997, respectively. The
increase in losses recorded for the nine months ended September 30, 1998 were
primarily attributable to the $10.0 million Allegheny loss, as well as expected
loss development in the financial lines, mortgage and credit and specialty
reinsurance lines of business. Ceded losses for the nine months ended September
30, 1998 and 1997 were $1.3 million and $2.8 million, respectively. For the nine
months ended September 30, 1998, the loss ratio was 26.1% compared to 12.4% for
the same period of 1997. Excluding the Allegheny loss, the loss ratio for the
nine months ended September 30, 1998 was 18.3%.
Total expenses, including loss and loss adjustment expenses, increased 68.4% to
$109.3 million for the nine months ended September 30, 1998 from $64.9 million
for the same period of 1997. This increase was primarily attributable to the
Allegheny loss as well as the amortization of acquisition expenses associated
with the increased level of premiums earned across all lines of business and
normal loss development from the credit and specialty, mortgage and financial
line lines of business. In addition, the increase in expenses was attributable
to an increase in overhead to support growth in the Company's lines of
businesses. For the nine months ended September 30, 1998 the expense ratio
increased slightly to 51.0% from 49.4% from the prior year. The combined ratio,
excluding expenses associated with non-insurance operations, increased to 77.1%
for the nine months ended September 30, 1998 from 61.8% for the comparable 1997
period. This increase is related to the Allegheny loss as well as an expected
result of the Corporation's diversification strategy, which is producing more
business from lines with relatively higher combined ratios than that of the
financial guaranty reinsurance business. Excluding the Allegheny loss, the
combined ratio for the nine months ended September 30, 1998 was 69.3%.
For the nine months ended September 30, 1998, the total federal tax provision
decreased to $19.7 million from $20.3 million for the same period in 1997. In
addition, the effective tax rate decreased to 26.6% for the nine months ended
September 30, 1998 from 28.2% for the same period of 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Corporation relies on dividends from Capital Reinsurance and Capital Credit
to fund its payment of dividends on its capital stock and interest on its
outstanding debt. The major sources of liquidity for Capital Reinsurance are
funds generated from reinsurance premiums, net investment income and maturing
investments. Capital Reinsurance is domiciled in the State of Maryland, and,
under Maryland insurance law, the amount of the surplus of Capital Reinsurance
available for distribution as dividends is subject to certain statutory
restrictions. The amount available for distribution from Capital Reinsurance
during 1998 with notice to, but without prior approval of, the Maryland
Insurance Commissioner is limited to 10% of Capital Reinsurance's policyholders'
surplus as of December 31, 1997, or approximately $34.6 million. For the nine
months ended September 30, 1998, Capital Reinsurance paid $5.0 million in
dividends to the Corporation.
Capital Credit's major sources of liquidity are funds generated from reinsurance
premiums, net investment income and maturing investments. Capital Credit is a
Bermuda domiciled insurer whose distributions are governed by Bermuda law. Under
Bermuda law and the by-laws of Capital Credit, dividends may be paid out of the
profits of the company (defined as accumulated realized profits less accumulated
realized losses). Distributions to shareholders may also be paid out of Capital
Credit's surplus limited by requirements that such company must at all times (i)
maintain the minimum share capital required under Bermuda law and (ii) have
relevant assets in an amount equal to or greater than 75% of relevant
liabilities, all as defined under Bermuda law. Capital Credit paid its first
dividend to the Corporation in October 1998 in the amount of $4.0 million.
Capital Mortgage is subject to the dividend restrictions imposed under New York
insurance law. Accordingly, dividends may only be declared and distributed out
of earned surplus (as defined under New York insurance law). Additionally, no
dividend may be declared or distributed by Capital Mortgage in an amount which,
together with all dividends declared or distributed by Capital Mortgage during
the preceding twelve months, exceeds the lesser of 10% of such company's surplus
to policyholders as shown by its last Annual Statutory Statement on file with
the New York insurance department, or 100% of adjusted net investment income (as
defined under New York insurance law) during such period, unless, upon prior
application, the New York Superintendent of Insurance approves a greater
dividend distribution based upon his finding that Capital Mortgage will retain
sufficient surplus to support its obligations and writings. KRE's dividends and
distributions to its sole shareholder, Capital Mortgage, are governed by Bermuda
law and are subject to the same restrictions as those for Capital Credit
described in the preceding paragraph. To date, Capital Mortgage and KRE have not
declared nor paid any dividends. The maximum dividend payable by Capital
Mortgage during 1998 is $0 since its earned surplus was ($0.4) million as of
December 31, 1997.
Capital Title is subject to the New York insurance laws and regulations
governing title insurers. Accordingly, dividends may only be declared and
distributed out of earned surplus as defined under New York insurance law and
only if such dividends do not reduce the company's surplus to less than 50% of
its outstanding capital shares, i.e., the value of its outstanding common
equity. Additionally, no dividend may be declared or distributed in an amount
which, together with all dividends declared or distributed by the company during
the preceding twelve months, exceeds 10% of the company's outstanding capital
shares, unless, after deducting such dividends, it has a surplus at least equal
to 50% of its statutory reinsurance reserve or a surplus at least equal to
$250,000, whichever is greater. During 1997, Capital Title paid a dividend in
the amount of $1.1 million to its immediate parent, KRE. As of December 31,
1997, Capital Title's maximum amount payable as a dividend during 1998 is
approximately $1.3 million.
In January 1994, the Corporation formed and capitalized, through the purchase of
common shares, Capital Re LLC. Capital Re LLC exists solely for the purpose of
issuing preferred and common shares and lending the proceeds of such issuance to
the Corporation to fund its business operations. In January 1994, Capital Re LLC
issued $75.0 million of company obligated mandatorily redeemable preferred
securities, the proceeds of which were loaned to the Corporation. The
Corporation has, among other undertakings, unconditionally guaranteed all
legally declared and unpaid dividends of Capital Re LLC. The company obligated
mandatorily redeemable preferred securities were issued at $25 par value per
share and pay monthly dividends at a rate of 7.65% per annum.
In June 1997, Capital Reinsurance invested approximately $11.0 million for a
minority ownership interest in CGA Group, Ltd. ("CGA"). CGA was formed to
provide financial guaranty insurance ("Policies") of structured securities,
including commercial real estate and asset backed transactions. CGA's initial
capitalization consisted of $150.5 million of paid-in capital and $60 million of
committed capital. Capital Re's investment consists of an aggregate of $10.0
million in B Preferred Stock and Common Stock of CGA and $1.0 million in A
Preferred Stock. In connection with its investment in the B Preferred Stock,
Capital Reinsurance has a commitment to invest an additional $7.5 million (the
"Capital Commitments") in CGA to the extent that such investment would be
necessary in order for CGA's operating subsidiary, Commercial Guaranty
Assurance, Ltd. ("CG Assurance") to maintain its triple-A rating from Duff &
Phelps Credit Rating Company ("D&P"). Additionally, KRE has a $20 million
outstanding excess of loss reinsurance agreement with CG Assurance which
responds when CG Assurance credit losses under Policies reach certain
catastrophic levels (including Policies issued in favor of the funding banks
described below). Also in June 1997, Capital Reinsurance invested $0.1 million
in St. George Holdings Ltd. ("St. George").
As part of its business plan, through its operating subsidiaries (the "St.
George Investment Subsidiaries"), St. George purchases investment grade,
asset-backed securities to be held to maturity, selectively resold, or
repackaged with CG Assurance Policies and then resold (the "Managed
Portfolios"). The securities purchases are funded by bank loans advanced to the
St. George Investment Subsidiaries. CG Assurance issues Policies to secure
repayment to the funding banks. Under certain of the bank loan agreements, the
St. George Investment Subsidiaries are required to provide additional collateral
to the extent the market values of the Managed Portfolios fall below certain
thresholds. Failure to satisfy the collateral requirements may result in the
liquidation of the Managed Portfolios and, to the extent that proceeds from
liquidation are insufficient to repay the bank loans, then the St. George
Investment Subsidiaries must pay any shortfall. If the St. George Investment
Subsidiaries cannot pay the amount then due, then CG Assurance is obligated to
pay such amounts under its Policies issued in favor of the funding banks.
Due to unprecedented market conditions relating to credit spreads during the
third quarter of 1998, the market values of the Managed Portfolios declined. As
of September 30, 1998, the market values of the Managed Portfolios with
collateral threshold triggers were not then below the collateral threshold
triggers. Subsequent to September 30, market values further declined through
mid-October and, as of October 18, 1998, CG Assurance's management prepared an
estimate of market values of the Managed Portfolios, which indicated that if
such market values were validated at the October 30, 1998 valuation date
provided for in the bank loan agreements, substantial collateral would be
required in the case of the Managed Portfolios subject to the collateral
threshold triggers. As a result, certain institutional investors in CGA provided
credit enhancements on various securities in the Managed Portfolios in the
aggregate principal amount of $382 million. Of that aggregate amount, Capital
Reinsurance credit enhanced $74.6 million of investment-grade asset-backed
securities. Capital Reinsurance also credit enhanced the two other institutional
investors that provided credit enhancement on the Securities in the Managed
Portfolios. Capital Reinsurance was paid a market rate premium for providing the
reinsurance support. Market values of the Managed Portfolios have improved since
October and, currently, the market values of the Managed Portfolios are above
the relevant collateral threshold triggers. Throughout this period, CG Assurance
was, and continues to be, rated triple-A by D&P.
In February and July, 1998, KRE Reinsurance assumed from CG Assurance three
issues of asset-backed securities (the "Securities") issued by Commercial
Financial Services Inc. ("CFS"), a leader in the acquisition, securitization and
collection of charged off credit card loans. At the time they were reinsured,
the Securities were rated investment grade. On October 22, 1998, the Company
became aware of possible irregularities relating to the Securities when Standard
& Poor's Corporation ("S&P") announced the suspension of its single A rating on
the Securities due to the lack of sufficient information material to the
continued maintenance of its rating. S&P suspended its rating in the context of
allegations that CFS may have been involved in improper conduct, including
substantial sales to an affiliate of assets which were backing certain of its
outstanding obligations. Based on the allegations, and with insufficient
information to the contrary, D&P, Fitch ICBA and Moody's Investors Service
Company also downgraded or withdrew their ratings on the Securities. In the
Company's third quarter earnings release, the Company reported that it had
outstanding principal exposure of approximately $155.8 million to the
Securities. CFS has engaged outside legal counsel and an independent accounting
firm to assist in an internal inquiry into the allegations of improper conduct.
The information currently available to the Company indicates that the assets
backing the Securities reinsured by the Company are performing in accordance
with expectations. As of September 30, 1998, no provision for losses has been
made and, until adequate information is provided, the Company will not be able
to determine whether losses, if any, will be incurred.
In December 1997, the Corporation's Board of Directors authorized an increase of
the quarterly common stock dividend rate to $0.04 per share, or $0.16 annually.
For the nine months ended September 30, 1998, common dividends were declared and
paid in the amount of $3.8 million or $0.12 per share.
Cash flows from operations for the nine months ended September 30, 1998 and
1997, consisting of reinsurance premiums collected net of expenses,
investment income and income taxes, were $103.8 million and $87.5 million,
respectively. The Corporation believes that current levels of cash flow
from operations provide the Corporation with sufficient liquidity to
meet its operating needs. The Corporation's non-operating cash outflows
are primarily dedicated to (i)fixed-income investment activity, (ii) the
payment of dividends on its common shares, (iii) payments of interest on
long-term debt and (iv) the payment of its loan obligations to Capital Re LLC.
At September 30, 1998, cash and investments approximated $1.14 billion, an
increase of $110.0 million, or 10.7%, from $1.03 billion at December 31, 1997.
In managing its investment portfolio, the Corporation places a high priority on
quality and liquidity. As of September 30, 1998, the entire investment portfolio
was invested in highly rated fixed income securities.
At September 30, 1998, approximately $179.6 million, or 15.7%, of the
Corporation's investment portfolio was comprised of mortgage-backed securities
("MBS"). Of the MBS portfolio, approximately $153.1 million, or 85.2%, is backed
by agencies or entities sponsored by the U.S. government as to the full amount
of principal and interest. As of September 30, 1998, the entire MBS portfolio
was invested in triple A rated securities.
Prepayment risk is an inherent risk of holding MBS. However, the degree of
prepayment risk is particular to the type of MBS held. The Corporation limits
its exposure to prepayments by purchasing less volatile types of MBS. As of
September 30, 1998, $3.7 million, or approximately 2.0%, of the MBS portfolio
was invested in collateralized mortgage obligations ("CMOs") which are
characterized as planned amortization class CMOs ("PACs"). PACs are securities
whose cash flows are designed to remain constant over a variety of mortgage
prepayment environments. Other classes in the CMO security are structured to
accept the volatility of mortgage prepayment changes, thereby insulating the PAC
class. Of the remaining MBS portfolio, $175.9 million, or 98.0%, was invested in
mortgage-backed pass-throughs or sequential CMOs. Pass-throughs are securities
in which the monthly cash flows of principal and interest (both scheduled and
prepayments) generated by the underlying mortgages are distributed on a pro-rata
basis to the holders of securities. A sequential MBS is structured to divide the
CMO security into sequentially ordered classes. Receipt of principal payments
within classes is contingent on the retirement of all previously paying classes.
Generally, interest payments are made currently on all classes. While these
securities are more sensitive to prepayment risk than PACs, they are not
considered highly volatile securities. While the Corporation may consider
investing in any tranche of a sequential MBS, the individual security's
characteristics (duration, relative value, underlying collateral, etc.) along
with aggregate portfolio risk management determine which tranche of sequential
MBS will be purchased. At September 30, 1998, the Corporation had no securities
such as interest only securities, principal only securities, or MBS purchased at
a substantial premium to par that have the potential for loss of a significant
portion of the original investment due to changes in the prepayment rate of the
underlying loans supporting the security.
On January 22, 1998, the Corporation extended its existing agreement with
Deutsche Bank AG for the provision of a $25.0 million liquidity facility (the
"DB Liquidity Facility") which is available for general corporate purposes. The
DB Liquidity Facility was extended for one year and is scheduled to expire on
January 22, 1999. Capital Reinsurance also renewed an agreement on January 27,
1998 with Deutsche Bank AG for a credit facility (the "DB Credit Facility") of
up to $75.0 million specifically designed to provide rating agency qualified
capital to further support Capital Reinsurance's claims-paying resources. This
agreement expires January 27, 2005. The Corporation has not borrowed under
either the DB Liquidity Facility or the DB Credit Facility.
In addition, on August 20, 1996, the Corporation entered into a credit agreement
with Chase Manhattan Bank for the provision of a $25.0 million credit facility
(the "Chase Facility") which is available for general corporate purposes.
Furthermore, on August 26, 1996, the Corporation utilized $16 million of the
Chase Facility for purposes of paying subordinated notes which came due.
Interest on the bank note issued under the Chase Facility is payable quarterly
based upon the Corporation's chosen interest rate option under the terms of the
Chase Facility. In November 1996, the Corporation utilized the remaining $9
million of the Chase Facility for purposes of acquiring RGB.
On November 5, 1998, Moody's Investor Service ("Moody's") placed the Aaa
insurance financial strength rating of Capital Reinsurance and the Aa3 senior
long-term debt rating of the Company on review for possible downgrade. The "a1"
preferred stock rating of Capital Re LLC was also placed on review for possible
downgrade. Moody's stated that the review was prompted by recent changes in the
mix of financial guaranty reinsurance business being assumed by the Company,
through its various subsidiaries, in response to competitive pressure on the
Company's core financial guaranty franchise. This action by Moody's had no
effect on the Company's financial statements as of September 30, 1998.
The Company is analyzing the need to raise additional equity capital to support
its business. This analysis is ongoing and there can be no assurance that the
Company's ultimate decision will be to raise additional capital or whether such
capital can be raised when desired or on terms acceptable to the Company.
THE YEAR 2000
The Company is actively pursuing its Year 2000 analysis and preparation. The
Year 2000 issue involves potential complications related to computer systems,
machinery and electronics which contain computer code, whether in software or
imbedded within microchips, that recognize years in two digit code, e.g. "98"
for the year 1998. Software or microchips that recognize the Year 2000 as "00"
or any year thereafter in its two digit equivalent, threatens date sensitive
calculations by potentially misapplying the date (e.g. "00" could be applied as
1900 rather than 2000). Any coding that causes a date recognition error of this
sort is commonly referred to as a Year 2000 "bug".
STATE OF READINESS
The Company has assembled a team comprised of officers and employees of the
finance and information systems departments to oversee the Company's readiness
for the Year 2000. The group has already completed the first phase of their
analysis in which a comprehensive list of all the Company's own information
technology systems and general technology was prepared. Additionally, the
Company's clients and vendors were reviewed and a listing prepared of those with
information systems or other technology upon which the Company may rely and
which may be affected by the Year 2000 "bug". The Company has made inquiry as to
Year 2000 readiness with these clients and vendors and has received responses
from a majority of them. It is currently evaluating these responses. However,
all of the Company's ceding companies that have thus far responded report that
they expect to be Year 2000 compliant by year-end 1998. The Company is now
performing testing and remediation, as necessary, on its information technology
systems, its general systems and any other technology that may be affected by
the Year 2000 "bug". This process is not yet complete, but is expected to be
completed by mid-1999.
The following is a summary of the Company's internal readiness status:
o IN-HOUSE APPLICATIONS: Two-thirds of the key in-house applications
have been tested and are Year 2000 compliant. The remainder will be
tested by year-end 1998.
o ACCOUNTING SOFTWARE: Vendors for the major accounting software
packages used by the Company have stated that the
software versions the Company uses are Year 2000 compliant.
o ADMINISTRATION/HUMAN RESOURCES; OPERATING SYSTEM SOFTWARE;
NETWORK/LAN UTILITIES; DESKTOP HARDWARE WILL BE COMPLIANT BY UPGRADES
OR ENHANCEMENTS: will be compliant in the fourth quarter of 1998.
o GENERAL OFFICE SERVICES: These systems will all be
upgraded by mid-1999.
The Company has not had to defer any of its expected information technology or
other technology installations, updates or enhancements in order to accommodate
its Year 2000 review and remediation work.
COSTS
Due to the youthfulness of the Company's information technology and other
systems, testing and remediation has been fairly uncomplicated. Moreover, none
of the Company's technology ismainframe computer based. Mainframes traditionally
use older coding methodologies and, thus, are more likely to be double digit
dated coded. No external consultants have been retained. Internal information
technology personnel have overseen and implemented the testing and remediation
of the systems and technology. The amount of additional time allocable to
employees' efforts have been nominal. All system upgrade costs incurred would
have been incurred by the Company as part of routine software upgrades and all
patches have been provided without any material cost to the Company. The Company
does not expect any material additional costs and expects that, including the
cost allocation of internal personnel, the overall testing and remediation will
be less than $50,000 as originally anticipated. The costs are being funded
through operating cash flows and will be expensed as incurred.
THE RISK OF THE COMPANY'S YEAR 2000 ISSUES
A Year 2000 "bug" issue may manifest itself as (i) a failure of the Company's
software, systems and general technology, (ii) a failure of a client or vendor's
software or systems which would impact the Company, and (iii) insurance claims
against the Company due to Year 2000 issues. The likelihood that a failure of
the Company's software and systems would have a material affect on the business
of the Company is minimal. The information technology and other systems are not
critical to the carrying-on of the Company's business. Additionally, all
critical accounting, financial reporting and human resources functions can be
maintained on a manual basis for a period of time without materially impeding
the operations of the Company. Similarly, a failure of clients and vendors to
properly provide data or services will also not materially affect the Company's
ability to continue its operations. Such a failure would likely be temporary and
could be compensated for in the short-term by using manual alternatives to
tracking business with our clients or vendors. Reinsurance losses pose the most
reasonably likely worst case scenario for the Company arising out of Year 2000
"bugs". The issue would originate with a default on debt service obligations of
bond issuers due to the issuer's own Year 2000 "bug" difficulties. In the event
of such a default, the Company's clients, the ceding companies, will be required
to make debt service payments on behalf of the defaulting issuers. The Company
will have to make prompt payment to its clients for its agreed upon portion of
such losses. Such defaults by bond issuers would generally be of a technical
nature, arising out of temporary inabilities to process payments or calculate
payment amounts. Additionally, the defaulted debt service obligations would
generally not require our clients, the ceding insurers, to make debt service
payments on behalf of the issuers for a prolonged period. Once issuers or
payment agents have cured any errors, they would resume debt service payment and
reimburse the insurers for all payments made. Hence, the reasonable worst case
scenario for the Company under such circumstances would involve liquidity
pressure which should ease quickly. There is no way to quantify the potential
exposure under this scenario as there has never been any event similar to the
Year 2000. Consequently, it is difficult to make assumptions based on the
Company's business. However, as the Company's operating units affected by such
an occurrence already meet the rating agency stress test requirements designed
to simulate depression-era conditions, the Company believes it can withstand
temporary defaults of that magnitude based on the Year 2000 "bug".
CONTINGENCY PLANS
The Company does not have a prescribed contingency plan relative to Year 2000
"bug" issues. The Company does not predict that a failure of its information
technology systems will materially affect daily operations or have an immediate
impact on the Company's ability to conduct business. All internal financial
reporting of the Company may be conducted by hand. As for any failure of a bond
issuer that has been reinsured by the Company, the Company expects to handle
such matters in the ordinary course of business. As the Company is a reinsurer,
payments are requested in bulk by the Company's ceding insurers, and payment of
reinsurance proceeds would be made in bulk. The Company is not required to make
payment to individual bond obligees. Ultimately, all recovery efforts in the
event of any Year 2000 "bug" related event can either be handled internally, or
would require the intervention of hardware, software or other technology
vendors. The Company maintains a list of the appropriate contacts at such
vendors in the event such a need arises.
<PAGE>
PART II - OTHER INFORMATION
Item 3 - EXHIBITS AND REPORTS ON FORM 8-K
(A) THE FOLLOWING IS ANNEXED AS AN EXHIBIT:
EXHIBIT
NUMBER DESCRIPTION
------ -----------
11 STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
(UNAUDITED)
(B) REPORTS ON FORM 8-K: NONE
<PAGE>
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION PAGE
- - ------ ----------- ----
11 STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS (UNAUDITED) 29
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CAPITAL RE CORPORATION
Date: November 11, 1998 By /s/ David A. Buzen
----------------------------
David A. Buzen
Executive Vice President and
Chief Financial Officer
Date: November 11, 1998 By /s/ Alan S. Roseman
----------------------------
Alan S. Roseman
Senior Vice President,
General Counsel and Secretary
<TABLE>
<CAPTION>
CAPITAL RE CORPORATION AND SUBSIDIARIES
Exhibit 11 Statement Re: Computation of Per Share Earnings
(Unaudited)
(Dollars in thousands except per share amounts)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ----------------------------
1998 1997 1998 1997
------------------------------ ----------------------------
Earnings per common share (Basic and Diluted)
<S> <C> <C> <C> <C>
Net Income 14,470 18,256 54,450 51,501
Basic weighted average shares outstanding during the period 31,912 31,755 31,871 31,734
Potentially dilutive employee stock options 820 832 859 726
------------- ------------- ------------- -------------
Diluted weighted average shares outstanding during the period 32,732 32,587 32,730 32,460
============= ============= ============= =============
Basic earnings per common share $0.45 $0.57 $1.71 $1.62
============= ============= ============= =============
Diluted earnings per common share $0.44 $0.56 $1.66 $1.59
============= ============= ============= =============
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-mos
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1998
<DEBT-HELD-FOR-SALE> 1,132,336
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 0
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 1,132,336
<CASH> 9,324
<RECOVER-REINSURE> 7,305
<DEFERRED-ACQUISITION> 136,111
<TOTAL-ASSETS> 1,473,621
<POLICY-LOSSES> 43,679
<UNEARNED-PREMIUMS> 393,742
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 99,847
324
75,000
<COMMON> 0
<OTHER-SE> 631,741
<TOTAL-LIABILITY-AND-EQUITY> 1,473,621
157,037
<INVESTMENT-INCOME> 48,465
<INVESTMENT-GAINS> 4,309
<OTHER-INCOME> 1,259
<BENEFITS> 33,677
<UNDERWRITING-AMORTIZATION> 39,037
<UNDERWRITING-OTHER> 12,352
<INCOME-PRETAX> 73,948
<INCOME-TAX> 19,656
<INCOME-CONTINUING> 54,292
<DISCONTINUED> 158
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 54,450
<EPS-PRIMARY> 1.71
<EPS-DILUTED> 1.66
<RESERVE-OPEN> 22,555
<PROVISION-CURRENT> 18,548
<PROVISION-PRIOR> 7,388
<PAYMENTS-CURRENT> 293
<PAYMENTS-PRIOR> 9,176
<RESERVE-CLOSE> 39,022
<CUMULATIVE-DEFICIENCY> 0<F1>
<FN>
Not Applicable for mortgage guaranty and specialty reinsurer
</FN>
</TABLE>