<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
0F THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the period from to
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Commission file number 1-10967
ENHANCE FINANCIAL SERVICES GROUP INC.
------------------------------
(Exact name of registrant as specified in its charter)
New York 13-3333448
--------------------------------- -------------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
335 Madison Avenue, New York, New York 10017
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(Address of principal executive offices)
(Zip Code)
(212) 983-3100
---------------------------------------
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if
changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the proceeding 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 |_|
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date: 37,389,871 shares of
common stock, par value $.10 per share, as of November 11, 1998.
<PAGE>
ENHANCE FINANCIAL SERVICES GROUP INC.
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I FINANCIAL INFORMATION (Unaudited)
Item 1. Financial Statements
Consolidated Balance Sheets - September 30, 1998 and December 31, 1997 ...................... 3
Consolidated Statements of Income - Nine months ended September 30, 1998 and 1997 ........... 4
Consolidated Statement of Shareholders' Equity - Nine months ended September 30 1998 ........ 5
Consolidated Statements of Cash Flows - Nine months ended September 30, 1998 and 1997 ....... 6
Notes to Consolidated Financial Statements .................................................. 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations ...................................... 8-13
PART II OTHER INFORMATION
Item 6. Exhibits ............................................................................ 13
Signature ................................................................................... 14
Exhibit 27 Financial data schedules
</TABLE>
2
<PAGE>
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands except per share amounts)
<TABLE>
<CAPTION>
Sept 30, December 31,
----------- --------------
1998 1997
----------- --------------
(unaudited)
<S> <C> <C>
Assets
Investments:
Fixed maturities, held to maturity, at amortized cost
(market value $206,841 and $219,763) $ 197,096 $ 210,436
Fixed maturities, available for sale, at market
(amortized cost $639,757 and $577,388) 685,344 608,077
Common stock, at market (cost $498) 833 833
Investment in affiliates 61,524 38,862
Other invested assets 23,502 33,045
Short-term investments 35,466 46,832
Cash and cash equivalents 32,039 21,405
----------- --------------
Total Investments 1,035,804 959,490
Premiums and other receivables 32,757 29,958
Accrued interest and dividends receivable 15,684 13,388
Deferred policy acquisition costs 97,949 95,645
Federal income taxes recoverable 3,676 3,366
Prepaid reinsurance premiums 6,749 6,281
Reinsurance recoverable on unpaid losses 2,069 2,688
Receivable for securities 12,356 702
Other assets 69,360 45,975
----------- --------------
TOTAL ASSETS $ 1,276,404 $ 1,157,493
----------- --------------
----------- --------------
Liabilities and Shareholders' Equity
LIABILITIES
Losses and loss adjustment expenses $ 36,785 $ 33,675
Reinsurance payable on paid losses and loss adjustment expenses 8,438 3,479
Deferred premium revenue 299,454 287,535
Accrued profit commissions 2,358 3,768
Current income taxes 4,223 --
Deferred income taxes 74,924 64,680
Long-term debt 75,000 75,000
Short-term debt 68,500 43,500
Payable for securities 7,636 5,318
Accrued expenses and other liabilities 58,553 59,145
----------- --------------
TOTAL LIABILITIES 635,871 576,100
----------- --------------
SHAREHOLDERS' EQUITY
Common stock-$.10 par value
Authorized-100,000,000 shares
Issued-39,244,596 and 38,671,870 shares 3,924 3,867
Additional paid-in capital 236,831 228,507
Retained earnings 400,505 344,402
Unearned compensation (248) --
Unrealized gains 29,556 19,396
Treasury stock (30,035) (14,779)
----------- --------------
TOTAL SHAREHOLDERS' EQUITY 640,533 581,393
----------- --------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,276,404 $ 1,157,493
----------- --------------
----------- --------------
</TABLE>
See notes to unaudited consolidated financial statements.
3
<PAGE>
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
1998 1997 1998 1997
--------- --------- --------- ----------
<S> <C> <C> <C> <C>
Revenues
Net premiums written $ 27,619 $ 25,475 $ 88,582 $ 72,800
(Increase) decrease in deferred premium revenue 1,469 (4,169) (11,452) (10,720)
--------- --------- --------- ----------
Premiums earned 29,088 21,306 77,130 62,080
Net investment income 13,752 12,825 39,991 37,530
Net realized gains/(losses) on sale of investments 2,083 (362) 2,060 (2,433)
Assignment sales 12,718 7,852 35,189 20,292
Other income 1,534 458 4,535 2,244
--------- --------- --------- ----------
Total revenues 59,175 42,079 158,905 119,713
--------- --------- --------- ----------
Expenses
Losses and loss adjustment expenses 4,647 2,740 8,514 6,886
Policy acquisition costs 10,158 7,167 26,826 21,576
Profit commissions 97 174 901 546
Other operating expenses - insurance 3,334 2,949 10,011 7,119
- non-insurance 11,150 7,289 29,839 16,973
--------- --------- --------- ----------
Total expenses 29,386 20,319 76,091 53,100
--------- --------- --------- ----------
Income from operations 29,789 21,760 82,814 66,613
Equity in net income of affiliates 3,167 3,818 9,565 4,070
Foreign currency losses (6) -- (15) (3)
Interest expense (2,190) (2,013) (6,252) (5,287)
--------- --------- --------- ----------
Income before income taxes 30,760 23,565 86,112 65,393
Income tax expense 8,033 6,113 23,633 17,120
--------- --------- --------- ----------
Net income $ 22,727 $ 17,452 $ 62,479 $ 48,273
--------- --------- --------- ----------
--------- --------- --------- ----------
Basic earnings per share $ 0.61 $ 0.47 $ 1.67 $ 1.31
--------- --------- --------- ----------
--------- --------- --------- ----------
Diluted earnings per share $ 0.58 $ 0.45 $ 1.59 $ 1.26
--------- --------- --------- ----------
--------- --------- --------- ----------
Basic weighted average shares outstanding 37,422 37,166 37,484 36,957
--------- --------- --------- ----------
--------- --------- --------- ----------
Diluted weighted average shares outstanding 39,110 38,814 39,255 38,423
--------- --------- --------- ----------
--------- --------- --------- ----------
</TABLE>
See notes to unaudited consolidated financial statements.
4
<PAGE>
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
(In thousands except share amounts)
(unaudited)
<TABLE>
<CAPTION>
Additional
Common Stock Treasury Stock Paid-in Unrealized
--------------------- --------------------
Shares Amount Shares Amount Capital Gains (Losses)
---------- -------- --------- --------- --------- --------------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 38,671,870 $ 3,867 1,284,400 $(14,779) $ 228,507 $ 19,396
Change in unrealized gain 10,160
Dividends paid ($0.17 per share)
Exercise of stock options 564,596 56 8,324
Issuance of common stock 8,130 1
Purchase of treasury stock 546,394 (15,256)
Net income
---------- -------- --------- --------- --------- ---------
Balance, September 30, 1998 39,244,596 $ 3,924 1,830,794 $(30,035) $ 236,831 $ 29,556
---------- -------- --------- --------- --------- ---------
---------- -------- --------- --------- --------- ---------
</TABLE>
<TABLE>
<CAPTION>
Unearned Retained
Compensation Earnings Total
------------- ---------- ---------
<S> <C> <C> <C>
Balance, December 31, 1997 $ -- $ 344,402 $ 581,393
Change in unrealized gain 10,160
Dividends paid ($0.17 per share) (6,376) (6,376)
Exercise of stock options 8,380
Issuance of common stock (248) (247)
Purchase of treasury stock (15,256)
Net income 62,479 62,479
------------- ---------- ---------
Balance, September 30, 1998 $ (248) $ 400,505 $ 640,533
------------- ---------- ---------
------------- ---------- ---------
</TABLE>
See notes to unaudited consolidated financial statements.
5
<PAGE>
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------
1998 1997
---------- ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 62,479 $ 48,273
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization, net (7,476) (6,717)
(Gain) loss on sale of investments, net (2,529) 2,433
Equity in net income of affiliates (9,565) (4,070)
Compensation, restricted stock award program (248) --
Change in assets and liabilities, net of effects from
consolidation of previously unconsolidated affiliate:
Premiums and other receivables (2,799) (1,309)
Accrued interest and dividends receivable (2,296) (1,971)
Accrued expenses and other liabilities (592) 266
Deferred policy acquisition costs (2,304) (6,798)
Deferred premium revenue, net 11,451 10,749
Accrued profit commissions (1,410) 545
Losses and loss adjustment expenses, net 8,688 4,301
Other assets (21,335) (10,631)
Income taxes, net 9,403 1,407
---------- ----------
Net cash provided by operating activities 41,467 36,478
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (1,307) (1,325)
Proceeds from sales and maturities of investments 220,898 452,836
Purchase of investments (269,985) (489,644)
Sales of short-term investments, net 11,366 4,953
Purchases of other invested assets, net 9,543 --
Investment in affiliates (13,097) (6,341)
Cash of previously unconsolidated affilliate -- 147
---------- ----------
Net cash used in investing activities (42,582) (39,374)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Receivable from affiliates -- 636
Capital stock 8,381 6,858
Short-term debt 25,000 7,175
Dividends paid (6,376) (6,137)
Purchase of treasury stock (15,256) (6,006)
---------- ----------
Net cash used in financing activities 11,749 2,526
---------- ----------
Net change in cash and cash equivalents 10,634 (370)
Cash and cash equivalents, beginning of period 21,405 5,385
---------- ----------
Cash and cash equivalents, end of period $ 32,039 $ 5,015
---------- ----------
---------- ----------
</TABLE>
See notes to unaudited consolidated financial statements
6
<PAGE>
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
PERIODS ENDED SEPTEMBER 30, 1998 AND 1997
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q under Rules and
Regulations of the Securities and Exchange Commission and do not include all of
the information and disclosures required by generally accepted accounting
principles. These statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Annual Report on Form
10-K for the year ended December 31, 1997 of Enhance Financial Services Group
Inc. ("Enhance Financial").
The accompanying unaudited consolidated financial statements have not
been audited by independent auditors in accordance with generally accepted
auditing standards. However, in the opinion of management, such financial
statements include all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly the financial position and results of
operations of Enhance Financial and Subsidiaries (collectively the "Company").
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.
2. DIVIDENDS DECLARED
In the first six months of 1998, Enhance Financial declared and paid
cash dividends of $.055 per share. (adjusted for the 2:1 split of the common
stock of Enhance Financial effective June 26, 1998). In September 1998 the
Company declared a dividend of $ .06 per share. The aggregate value of the
dividends declared in 1998 through September 1998 was $6,376,523.
3. COMMON STOCK
On April 8, 1998, the Board of Directors approved a two-for-one stock
split, which was effective on June 26, 1998. An amount equal to the par value of
common shares issued to effect the split was transferred from additional paid-in
capital to the common stock account. This transfer has been reflected in the
consolidated statement of shareholders' equity at January 1, 1998. On June 3,
1998, the Company's shareholders approved an increase in the number of shares of
common stock authorized for issuance to 100 million. All references to number of
common shares and to per-share information in the consolidated financial
statements and related notes have been adjusted to reflect the stock split on a
retroactive basis.
During the first nine months of 1998, Enhance Financial repurchased
546,394 shares of its common stock outstanding at prices ranging from $21.00 to
$34.02 as part of its stock repurchase program, including 106,394 shares
repurchased under a forward purchase agreement.
4. NEW ACCOUNTING STANDARD
The Company adopted Statement of Financial Accounting Standards No. 130
("SFAS 130"), "Reporting Comprehensive Income," during the first quarter of 1998
as required. SFAS 130 establishes standards for reporting and displaying
comprehensive income and its components in a set of financial statements.
Total comprehensive income for the nine months ended September 30, 1998
and 1997 was $72.6 million and $55.3 million, respectively. Presently, other
comprehensive income represents net income plus changes in unrealized gains and
losses on available for sale securities.
5. RECLASSIFICATIONS
Certain of the 1997 amounts have been reclassified to conform to the
current year presentation.
7
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
Enhance Financial Services Group Inc. ("Enhance Financial," and
together with its consolidated subsidiaries, the "Company") is a holding company
that, through its subsidiaries, principally Enhance Reinsurance Company and
Asset Guaranty Insurance Company (the "Insurance Subsidiaries"), provides
financial guaranty insurance and reinsurance and other products and services
utilizing the Company's credit-related analytic skills.
The Company acquired a majority ownership interest (increased from a
50% interest) in Singer Asset Finance Company, L.L.C. ("Singer") in March 1997.
The results of Singer have been consolidated since that date.
Results of Operations
Three Months Ended September 30, 1998 vs.
Three Months Ended September 30, 1997
Gross premiums written in the third quarter of 1998 were $28.4 million
compared with $29.3 million in the same period in 1997, representing an decrease
of 3.1%.
Net premiums written increased 8.2% to $27.6 million in the third
quarter of 1998 from $25.5 million in the same period in 1997. Of the Company's
net premiums written in the third quarter of 1998, 41.9%, 16.3% and 41.8% were
derived from the reinsurance of municipal bonds, the reinsurance of
non-municipal obligations and the Company's other insurance lines, respectively,
compared to 27.7%, 26.8% and 45.5% during the same period in 1997.
In the third quarter of 1998, municipal new-issue volume was $59.1
billion, approximately even with the same period in 1997. The insured portion of
such new issues was 57.0% and 51.0% during the third quarters of 1998 and 1997,
respectively. Total municipal bond refundings in the third quarter of 1998
represented approximately 30% of new-issue volume, down from 35% for the third
quarter of 1997.
Earned premiums grew 36.6% to $29.1 million in the third quarter of
1998 from $21.3 million in the third quarter of 1997. Earned premiums from
refundings contributed $5.3 million (or 18.2%) of earned premiums in the third
quarter of 1998 compared to $2.2 million (or 10.3%) in the same period in 1997.
Deferred premium revenue, net of prepaid reinsurance premiums, grew to $292.7
million at September 30, 1998 from $281.3 million at December 31, 1997.
Net investment income increased 7.8% to $13.8 million in the third
quarter of 1998 from $12.8 million in the same period in 1997. This increase
resulted primarily from the growth in the Company's investment portfolio
(excluding investments in affiliates, other invested assets and restricted cash
of Singer) from $834.9 million at September 30, 1997 to $933.7 million at
September 30, 1998. The average yields on the Company's investment portfolio
were 6.2% and 6.4% for the third quarters of 1998 and 1997, respectively. In
addition, the Company realized $2.1 million of capital gains in the third
quarter of 1998 compared with losses of $0.4 million in the third quarter of
1997.
The Company recognized revenues from disposition of assignments,
through securitization and other sales, of $12.7 million in the third quarter of
1998 compared to $7.9 million in the third quarter of 1997.
Incurred losses and LAE increased to $4.6 million in the 1998 third
quarter from $2.7 million in the third quarter of 1997. This increase in the
third-quarter losses is mainly attributable to the addition of $1.6 million to
the non-specific reserve. In the third quarter of 1998 the Company also reduced
the non-specific reserve by $10 million after establishing a $10 million case
reserve for anticipated losses related to reinsurance of Delaware Valley
Obligated Group (DVOG) debt. DVOG is an entity comprising five hospitals and a
medical university in the Philadelphia area that is part of Allegheny Health,
Education and Research Foundation (AHERF), based in Pittsburgh.
8
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The Company's insurance expense ratio was 46.7% in the third quarter of
1998 compared to 48.3% in the third quarter of 1997. Non-insurance expenses
increased to $11.2 million in the third quarter of 1998 from $7.3 million during
the same period in 1997 reflecting the continued growth in its Singer operations
as well as the growth in expenses associated with the Company's diversification
activities. Policy acquisition costs ("PAC") were $10.2 million and $7.2 million
for the third quarters of 1998 and 1997, respectively, representing 34.9% and
33.6% of earned premiums in those respective periods.
The Company realized income of $3.2 million from its investments in
affiliates in the third quarter of 1998 compared to $3.8 million in the third
quarter of 1997.
Interest expense totaled $2.2 million and $2.0 million in the third
quarters of 1998 and 1997, respectively, reflecting the increase in the
Company's short-term debt outstanding.
The Company's effective tax rate for the third quarter of 1998 was
26.1% compared to 25.9% for the comparable period of 1997.
The Company's 1998 third-quarter net income increased 29.7% to $22.7
million from $17.5 million in the third quarter of 1997. Third-quarter 1998
basic and diluted earnings per share increased 29.8% and 28.9%, respectively,
to $.61 and $.58 from $.47 and $.45 in the third quarter of 1997. This
increase primarily reflects increases in premiums earned, net realized gains
from the sale of investments and growth in the earnings of its Singer
subsidiary. Diluted operating earnings per share, which excludes the impact
of capital and foreign exchange gains and losses, increased 20.0% to $.55 in
the third quarter of 1998 from $.46 in the third quarter of 1997.
The diluted weighted average shares outstanding during the third
quarter of 1998 was 39.1 million compared to 38.8 million during the third
quarter of 1997.
All references to number of common shares and per-share information
reflect the two-for-one stock split which was effective on June 26, 1998.
Nine Months Ended September 30, 1998 vs.
Nine Months Ended September 30, 1997
Gross premiums written in the first nine months of 1998 were $89.4
million compared with $77.5 million in the same period in 1997, representing an
increase of 15.4%.
Net premiums written increased 21.7% to $88.6 million in the first nine
months of 1998 from $72.8 million in the same period in 1997. Of the Company's
net premiums written in the first nine months of 1998, 45.8%, 17.3% and 36.9%
were derived from the reinsurance of municipal bonds, the reinsurance of
non-municipal obligations and the Company's other insurance lines, respectively,
compared to 36.0%, 20.6% and 43.4% during the same period in 1997.
In the first nine months of 1998, municipal new-issue volume was $214.0
billion, a 37% increase over the same period in 1997. The insured portion of
such new issues was 51% during the first nine months of 1998 and 1997,
respectively. Total municipal bond refundings in the first nine months of 1998
represented approximately 30% of new-issue volume, up from 26% for the first
nine months of 1997.
Earned premiums grew 24.2% to $77.1 million in the first nine months of
1998 from $62.1 million in the first nine months of 1997. Earned premiums from
refundings contributed $13.2 million (or 17.1%) of earned premiums in the first
nine months of 1998 compared to $6.6 million (or 10.6%) in the same period in
1997. Deferred premium revenue, net of prepaid reinsurance premiums, grew to
$292.7 million at September 30, 1998 from $281.3 million at December 31, 1997.
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Net investment income increased 6.4% to $40.0 million in the first nine
months of 1998 from $37.6 million in the same period in 1997. This increase
resulted primarily from the growth in the Company's investment portfolio from
$834.9 million at September 30, 1997 to $933.7 million at September 30, 1998.
The average yields on the Company's investment portfolio were 6.2% and 6.3% for
the first nine months of 1998 and 1997, respectively. In addition, the Company
realized $2.4 million of capital losses in the first nine months of 1997
compared with gains of $2.1 in the first nine months of 1998.
The Company recognized revenues from disposition of assignments,
through securitization and other sales, of $35.2 million in the first nine
months of 1998 compared to $20.3 million in the first nine months of 1997. The
amount for the first nine months of 1997 reflects assignment sales for the
period following the Company's acquisition of a majority ownership interest in
Singer in March 1997.
Incurred losses and LAE were $8.5 million and $6.9 million in the first
nine months of 1998 and 1997, respectively. This increase in the losses is
mainly attributable to a net contribution of $1.6 million to the non-specific
reserve. In the third quarter of 1998 the Company also reduced the non-specific
reserve by $10 million to offset a $10 million case reserve established for
anticipated losses related to reinsurance of Delaware Valley Obligated Group
(DVOG) debt. DVOG is an entity comprising five hospitals and a medical
university in the Philadelphia area that is part of Allegheny Health, Education
and Research Foundation (AHERF), based in Pittsburgh
The Company's insurance-expense ratio was 48.9% in the first nine
months of 1998 compared to 47.1% in the first nine months of 1997. PAC were
$26.8 million and $21.6 million for the first nine months of 1998 and 1997,
respectively, representing 34.8% of earned premiums in each period.
Non-insurance expenses increased to $29.8 million in the first nine
months of 1998 from $17.0 million during the same period in 1997 reflecting the
continued growth in the Singer operations, which expenses are included on a
consolidated basis since March 1997, as well as the growth in expenses
associated with the Company's diversification activities.
The Company realized income of $9.6 million from its investments in
affiliates in the first nine months of 1998 compared to $4.1 million in the
first nine months of 1997. The 1997 amounts include the Company's share of
the net income of Singer prior to the purchase of its majority interest in
March 1997, from which time the results of Singer have been consolidated.
Interest expense totaled $6.3 and $5.3 million in the first nine months
of 1998 and 1997, respectively, reflecting the increase in the Company's
short-term debt outstanding over the period.
The Company's effective tax rate for the first nine months of 1998 was
27.4% compared to 26.2% for the comparable period of 1997.
The Company's net income in the first nine months of 1998 increased
29.4% to $62.5 million from $48.3 million in the first nine months of 1997.
Basic earnings per share increased 27.5% to $1.67 in the first nine months of
1998 from $1.31 in the first nine months of 1997. Diluted earnings per share
increased 26.2% to $1.59 from $1.26. These increases primarily reflect
increases in premiums earned, net realized gains from the sale of investments
and growth in the earnings of its Singer subsidiary. Diluted operating
earnings per share, which excludes the impact of capital and foreign exchange
gains and losses, increased 20.0% to $1.56 in the first nine months of 1998
from $1.30 in the first nine months of 1997.
The diluted weighted average shares outstanding during the first nine
months of 1998 was 39.3 million compared to 38.4 million for the first nine
months of 1997.
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
All references to number of common shares and to per-share information
reflect the two-for-one stock split which was effective on June 26, 1998.
Liquidity and Capital Resources
As a holding company, Enhance Financial funds the payment of its
operating expenses, principal and interest on its debt obligations, dividends
to its shareholders and the repurchase of Common Stock primarily from
dividends and other payments from the Insurance Subsidiaries; manages cash
flows associated with the Company's diversification activities and draws on
its line of credit provided under the credit agreement described below.
Payments of dividends to Enhance Financial by the Insurance Subsidiaries are
subject to restrictions relating to statutory capital and surplus and net
investment income. During the first nine months of 1998 the Insurance
Subsidiaries paid dividends of $18.5 million to Enhance Financial. As of
September 30, 1998, the maximum amount of dividends remaining available from
the Insurance Subsidiaries without prior approval of the insurance regulatory
authorities was $15.4 million.
The Company's cash flow from operations for the first nine months of
1998 was $41.5 million compared to $36.5 million for the same period in 1997.
The Company's investment portfolio increased to $933.7 million at September 30,
1998 from $891.6 million at December 31, 1997 principally as a result of the
cash flows from operations and declining interest rates which increased the mark
to market for the period.
The Company maintains a credit facility providing for borrowings to be
used for general corporate purposes. During the second quarter of 1998, the
Company entered into a new unsecured credit agreement with four major commercial
banks for up to $100 million of borrowings, an increase of $25 million over the
previous agreement (which was terminated). As of September 30, 1998, the Company
had $68.5 million outstanding under the credit agreement.
In July 1996, the Company formed Credit-Based Asset Servicing and
Securitization LLC ("C-BASS"), a joint venture in which the Enhanced Financial
and Mortgage Guaranty Insurance Company each own a 48% interest. Through
September 30, 1998 the Company had contributed $36.1 million to C-BASS
(including its 100% interest in Litton Loan Servicing Inc.) and expects that
it will provide additional funding. In January 1998 the Company guarantied
repayment of up to $25 million of the amount outstanding under a $50 million
unsecured revolving credit facility that C-BASS obtained from a major
commercial bank. The outstanding principal under the facility is currently
due no later than January 29, 1999.
In the first six months of 1998, Enhance Financial declared and paid
cash dividends of $.055 per share (adjusted for the 2:1 split of the common
stock of Enhance Financial effective June 26, 1998). Enhanced Financial
declared a dividend of $ .06 per share in September, which was paid in
October. The aggregate dividends declared through September 1998 were
$6,376,523.
YEAR 2000
As the Year 2000 approaches, management is assessing the Company's
potential exposure to the so called "millenium bug" and the effects the
century date change may have on its electronic systems and those of its
significant business partners. Since certain computer programs were written
using two digits rather than four to define the applicable year, computing
devices and systems may recognize a date using the two digits "00" as 1900
rather than the year 2000. Those that do not recognize a date correctly could
generate erroneous data and/or cause systems to fail.
As part of its firm-wide Year 2000 Project, the Company has
established a Year 2000 Task Force consisting of senior management of the
Company, led by the Chief Information Officer and General Counsel of Enhance.
It has also retained an independent information technology consulting firm
and outside legal counsel to provide assistance with Year 2000 compliance and
has adequate staff to administer the Project. The progress of the Company's
Year 2000 Project is being monitored by the Audit Committee of the board of
directors.
11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The Year 2000 Project covers both computer systems and
infrastructure ("IT systems") as well as other systems and equipment which
utilize embedded microchips ("non-IT systems"). It also considers the
readiness of significant third parties on whom the Company depends such as
clients, vendors and service providers. The Year 2000 Project has six phases:
Project Development and Resource Mobilization, Assessment, Remediation,
Testing, Contingency Planning and Implementation. The status of each phase is
as follows: Project Development and Resource Mobilization is substantially
complete; Assessment began in the third quarter of 1997 and is expected to be
completed by the end of the first quarter of 1999; Remediation and Testing of
IT systems, by the Company with the assistance of independent contractors,
began in the fourth quarter of 1997 and are expected to be substantially
complete by the end of the second quarter of 1999; Contingency Planning will
begin in the first quarter of 1999 and is expected to be complete by the end
of the third quarter of 1999; and Implementation of contingency plans will be
made as and when needed.
Based on the assessment of its major IT systems, the Company expects
that all necessary remediation and testing will be completed in a timely
manner to insure that it is substantially Year 2000 compliant. As part of its
third-party due diligence, the Company is assessing the Year 2000 compliance
of all major products and services purchased from vendors and service
providers of non-IT components and systems. The failure of IT and non-IT
systems associated with cash management, servicing, communications and
building facilities would in varying degrees have a material adverse effect
on the Company. Such failures could disrupt the Company's ability to conduct
normal business operations, including financial transactions such as payment
of claims or debts, collecting or funding of receivables and selling of
commercial paper. The consequences of such failures could include business
interruption, lost revenue and illiquidity. The magnitude of the financial
impact of such potential failures is not known at this time. The Year 2000
Project includes provision for contingency planning for systems and
facilities that will generally involve processing that does not rely upon
computer systems and will utilize additional staff as needed. The Company
expects to complete its contingency plans and arrangements by the end of the
third quarter of 1999.
Since 1997, the Company has invested in a major initiative to
replace and upgrade its technology. This project, which is ongoing,
addresses, among other matters, many of the Year 2000 issues of the Company's
internal IT systems. The Company has expended approximately $2 million on
this project, which, accordingly, includes a portion of the cost of Year 2000
compliance. Additional expenditures for Year 2000 compliance, which will be
funded through operating cash flow, are expected to total approximately $1.5
million. Such cost estimates are based upon information which is currently
available and may change as the Year 2000 Project proceeds. However, the cost
of Year 2000 compliance is not expected to affect materially the financial
condition of the Company.
The Company is communicating with third parties with which it has
material dealings to determine the status of their Year 2000 readiness.
Management is unable at this time to conclude whether all such third parties
will successfully address their Year 2000 issues, and how their failure to do
so, if any, would impact the Company. Management has determined that the
following consequences to the Company could result from the failure of such
third parties to successfully address their Year 2000 issues: Obligors of
insured issues (see also next paragraph) - increased credit risk, claims,
loss of premiums and renewals; Primaries and Reinsurers - increased credit
risk, uncollected claims, premium loss, impaired liquidity; Counterparties
and Issuers of Obligations - investment portfolio downgrade, loss of income
and/or principal; Financial Institutions and Lenders - impaired liquidity,
loss of income and/or principal; Vendors and Service Providers - interrupted
power, building access, telecommunications, flow of goods, security and
professional and technical services.
The insurance policies issued or reinsured by the insurers of the
Company do not contain specific exclusions for Year 2000-related defaults.
Generally, a default by an obligor insured or reinsured by the insurers would
be covered in such case. Although the insurers would expect to eventually
recover the amounts paid in claims for Year 2000-related defaults by
obligors, the coincidence of several such unanticipated claims could result
in short-term liquidity risk for the insurers. Failure of a trustee or paying
agent for an obligor insured by the insurers to make payment on a obligation
as a result of a Year 2000-related event (or otherwise) would generally not
be covered by policies insured or reinsured and no such claims are expected.
However, since industry custom in this area has not been established, the
Company is investigating whether its insured obligors as well as their
trustees, paying agents and other related parties will be Year 2000 compliant
and it will establish
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
appropriate contingency plans based upon the results of this inquiry and the
developing understanding of how such potential claims will be addressed by the
financial guaranty industry as a whole.
In addition to other risks in connection with the Year 2000, general
uncertainty among market participants could cause a decline in business
activity and revenue in 1999 and 2000, as companies address their Year 2000
issues. The Company cannot predict the magnitude of such possible decline or
the impact that it may have on its financial results for those years, but it
has undertaken a thorough review of third party risks inherent in Year 2000
issues, and it is working with the industry group allied with its core
business to identify and address credit and other business issues related to
Year 2000. The Company is also assessing potential effects of unexpected
failures in local, national or international systems, including power,
communication and transportation systems, on which the normal conduct of
business depends, and it will establish contingency plans to deal with such
failures, although there can be no assurance that such plans can be effective
in such circumstances. The failure of the efforts of the Company or its
significant third parties to address material Year 2000 issues could result
in the disruption of the Company's normal business activity and have a
material adverse effect on the Company. While the Company does not believe
that Year 2000 issues will have such an impact, there can be no assurance,
due to the uncertain nature of potential Year 2000 problems and the Company's
lack of control over some of them, that all Year 2000 issues will be foreseen
and corrected in a timely fashion.
Part II: Other Information
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 6. Exhibits and reports on Form 8-K
(a) Exhibits
Exhibit 27. Financial data schedules.
(b) Reports on Form 8-K
None.
13
<PAGE>
SIGNATURE
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 tbe
undersigned thereunto duly authorized.
Date: November l6, 1998 ENHANCE FINANCIAL SERVICES GROUP INC.
By: /s/ Arthur Dubroff
----------------------------------------
Arthur Dubroff
Executive Vice President (duly authorized officer)
and Principal Financial Officer
14
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