<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
0F THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2000
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the period from ___________________ to
--------------------------------------------------------
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
--------------------------------------------
(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: 38,152,607 shares of common
stock, par value $.10 per share, as of May 9, 2000.
<PAGE>
ENHANCE FINANCIAL SERVICES GROUP INC.
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - March 31, 2000 and December 31, 1999 .................... 3
Consolidated Statements of Income - Three months ended March 31, 2000 and 1999 ........ 4
Consolidated Statement of Shareholders' Equity - Three months ended March 31, 1999..... 5-A
Consolidated Statement of Shareholders' Equity - Three months ended March 31, 2000..... 5-B
Consolidated Statements of Cash Flows - Three months ended March 31, 2000 and 1999..... 6
Notes to Consolidated Financial Statements............................................. 7-9
Independent Accountants' Review Report ................................................ 10
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations ............................... 11-15
Item 3. Quantitative and Qualitative Disclosures About Market Risk................... 16
PART II OTHER INFORMATION
Item 1. Legal Proceedings............................................................ 16
Item 4. Submission of Matters to a Vote of Security Holders.......................... 16
Item 6. Exhibits and reports on Form 8-K............................................. 16
Signature ............................................................................. 16
</TABLE>
Exhibit 4.2.6 Fifth Amendment to the Credit Agreement, dated as of March 31,
2000, among the registrant, Fleet National Bank as lender,
swingline bank and as agent for the Banks, and The Bank of New
York, Bank One, NA (Main Office Chicago) (formerly known as The
First National Bank of Chicago), and Deutsche Bank AG, New York
and/or Cayman Island Branches, as lenders.
Exhibit 15. Letter from Deloitte & Touche LLP regarding unaudited interim
financial information.
Exhibit 27. Financial data schedules
2
<PAGE>
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands except share amounts)
<TABLE>
<CAPTION>
March 31, 2000 December 31, 1999
-------------- -----------------
(unaudited)
<S> <C> <C>
ASSETS
Investments:
Fixed maturities, held to maturity, at amortized cost (market value
$171,924 and $181,474) $ 168,252 $ 177,607
Fixed maturities, available for sale, at market (amortized cost $807,274
and $778,751) 791,516 745,963
Other invested assets 11,287 10,935
Common stock, at market (cost $498) 839 839
Short-term investments 52,744 34,657
----------- -----------
Total Investments 1,024,638 970,001
Cash and cash equivalents 4,198 2,558
Accrued interest and dividends receivable 17,024 18,977
Investment in affiliates 111,955 108,001
Premiums receivable 17,030 22,959
Furniture, fixtures and equipment 10,299 10,206
Deferred policy acquisition costs 123,554 119,213
Federal income taxes recoverable 9,711 6,713
Prepaid federal income tax 24,709 24,797
Deferred income taxes - net 59,708 68,587
Prepaid reinsurance premiums 8,088 8,772
Reinsurance recoverable on unpaid losses 2,273 2,286
Receivable from affiliates 3,544 1,170
Receivable for securities 5,006 --
Goodwill 23,601 24,196
Other assets 91,526 65,496
----------- -----------
TOTAL ASSETS $ 1,536,864 $ 1,453,932
=========== ===========
LIABILITIES, DEFERRED CREDIT AND SHAREHOLDERS' EQUITY
LIABILITIES
Losses and loss adjustment expenses $ 56,187 $ 51,970
Reinsurance payable on paid losses and loss adjustment expenses 6,732 8,997
Deferred premium revenue 353,296 346,088
Accrued profit commissions 2,318 2,554
Long-term debt 75,000 75,000
Short-term debt 138,970 113,941
Payable for securities 11,706 --
Accrued expenses and other liabilities 51,169 41,078
----------- -----------
TOTAL LIABILITIES 695,378 639,628
----------- -----------
DEFERRED CREDIT 132,750 138,000
----------- -----------
SHAREHOLDERS' EQUITY
Common stock-$.10 par value, Authorized-100,000,000 shares,
issued-40,094,404 and 40,007,404 shares 4,009 4,001
Additional paid-in capital 254,063 253,109
Retained earnings 495,774 477,715
Accumulated other comprehensive income (12,524) (25,935)
Treasury stock (32,586) (32,586)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY 708,736 676,304
----------- -----------
TOTAL LIABILITIES, DEFERRED CREDIT AND SHAREHOLDERS' EQUITY $ 1,536,864 $ 1,453,932
=========== ===========
</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)
Three Months Ended March 31,
----------------------------
2000 1999
---- ----
REVENUES
Net premiums written $ 34,147 $ 29,486
Increase in deferred premium revenue (7,892) (5,195)
-------- --------
Premiums earned 26,255 24,291
Net investment income 15,537 13,554
Net realized losses (733) (3,890)
Assignment sales 11,244 8,302
Other income 1,749 2,186
-------- --------
Total revenues 54,052 44,443
-------- --------
EXPENSES
Losses and loss adjustment expenses 5,328 2,757
Policy acquisition costs 9,648 8,875
Profit commissions 431 114
Other operating expenses - insurance 5,122 2,924
- non-insurance 15,560 12,400
-------- --------
Total expenses 36,089 27,070
-------- --------
Income from operations 17,963 17,373
Equity in net income of affiliates 7,838 4,683
Minority interest 264 --
Foreign currency (losses)/gains (26) 13
Interest expense (3,825) (2,444)
-------- --------
Income before income taxes 22,214 19,625
Income tax expense 1,866 1,472
-------- --------
Net income $ 20,348 $ 18,153
======== ========
Basic earnings per share $ 0.53 $ 0.48
======== ========
Diluted earnings per share $ 0.53 $ 0.46
======== ========
Basic weighted average shares outstanding 38,108 37,919
======== ========
Diluted weighted average shares outstanding 38,605 39,192
======== ========
See notes to unaudited consolidated financial statements.
4
<PAGE>
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 1999
(In thousands except share and per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Outstanding Common
Stock Treasury Stock
----------------------- -------------------------
Additional
Paid-in
Shares Amount Shares Amount Capital
------ ------ ------ ------ -------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1998 39,812,937 $3,981 1,950,794 $(32,586) $249,851
Comprehensive income:
Net income for the period -- -- -- -- --
Unrealized foreign currency translation adjustment
(net of tax of $614) -- -- -- -- --
Unrealized gains during the period
(net of tax of $1,768) -- -- -- -- --
Total comprehensive income -- -- -- -- --
Dividends paid ($0.06 per share) -- -- -- -- --
Exercise of stock options 89,495 9 -- -- 1,397
Issuance of common stock (1,500) -- -- -- --
---------- ------ --------- -------- --------
Balance, March 31, 1999 39,900,932 $3,990 1,950,794 $(32,586) $251,248
========== ====== ========= ======== ========
<CAPTION>
Accumulated
Other Comprehensive Income
----------------------------------------
Foreign
Currency Unrealized
Unearned Translation Gains Retained
Compensation Adjustment (Losses) Earnings Total
------------ ---------- -------- -------- -----
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1998 ($493) $ 714 $ 22,965 $ 418,214 $ 662,646
Comprehensive income:
Net income for the period -- -- -- 18,153 --
Unrealized foreign currency translation adjustment
(net of tax of $614) -- (1,140) -- -- --
Unrealized gains during the period
(net of tax of $1,768) -- -- (3,284) -- --
Total comprehensive income -- -- -- -- 13,729
Dividends paid ($0.06 per share) -- -- -- (2,277) (2,277)
Exercise of stock options -- -- -- -- 1,406
Issuance of common stock -- -- -- -- --
----- ------- -------- --------- ---------
Balance, March 31, 1999 $(493) $ (426) $ 19,681 $ 434,090 $ 675,504
===== ======= ======== ========= =========
</TABLE>
See notes to unaudited consolidated financial statements.
5-A
<PAGE>
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2000
(In thousands except share and per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Outstanding Common
Stock Treasury Stock
----------------------- -------------------------
Additional
Paid-in
Shares Amount Shares Amount Capital
------ ------ ------ ------ -------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1999 40,007,404 $4,001 1,950,794 $(32,586) $253,109
Comprehensive income:
Net income for the period -- -- -- -- --
Unrealized gains during the period
(net of tax of $4,095) -- -- -- -- --
Reclassification adjustment for realized losses
included in net income (net of tax $257) -- -- -- -- --
Total comprehensive income -- -- -- -- --
Dividends declared ($0.06 per share) -- -- -- -- --
Exercise of stock options 87,000 8 -- -- 954
---------- ------ --------- -------- --------
Balance, March 31, 2000 40,094,404 $4,009 1,950,794 $(32,586) $254,063
========== ====== ========= ======== ========
<CAPTION>
Accumulated
Other Comprehensive Income
----------------------------------------
Foreign
Currency Unrealized
Unearned Translation Gains Retained
Compensation Adjustment (Losses) Earnings Total
------------ ---------- -------- -------- -----
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1999 ($493) $(2,207) $(23,235) $ 477,715 $ 676,304
Comprehensive income:
Net income for the period -- -- -- 20,348 --
Unrealized gains during the period
(net of tax of $4,095) -- -- 12,935 -- --
Reclassification adjustment for realized losses
included in net income (net of tax $257) -- -- 476 -- --
Total comprehensive income -- -- -- -- 33,759
Dividends declared ($0.06 per share) -- -- -- (2,289) (2,289)
Exercise of stock options -- -- -- -- 962
----- ------- -------- --------- ---------
Balance, March 31, 2000 $(493) $(2,207) $ (9,824) $ 495,774 $ 708,736
===== ======= ======== ========= =========
</TABLE>
See notes to unaudited consolidated financial statements.
5-B
<PAGE>
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended March 31,
----------------------------
2000 1999
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 20,348 $ 18,153
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization, net (2,671) (2,371)
Net realized losses 733 3.890
Equity in net income of affiliates (7,838) (4,683)
Change in assets and liabilities:
Premiums receivable 5,929 4,777
Accrued interest and dividends receivable 1,953 1,532
Accrued expenses and other liabilities 7,802 (6,236)
Deferred policy acquisition costs (4,341) (3,223)
Deferred premium revenue, net 7,892 5,195
Accrued profit commissions (236) (443)
Losses and loss adjustment expenses, net 1,965 1,688
Receivable from affiliates, net (2,374) (39,676)
Payable for securities, net 6,700 2,390
Other, net (21,375) 12,000
Income taxes, net (2,910) (3,429)
--------- ---------
Net cash provided by (used in) operating activities 11,577 (10,436)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (314) (287)
Proceeds from sales and maturities of investments 151,360 92,043
Purchase of investments (168,887) (134,617)
Sales of short-term investments, net (18,087) 37,575
Purchase of other invested assets, net -- (1,586)
Net return of investment in affiliates -- 1,717
--------- ---------
Net cash used in investing activities (35,928) (5,155)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital stock 962 1,405
Short-term debt 25,029 21,487
--------- ---------
Net cash provided by financing activities 25,991 22,892
--------- ---------
Net change in cash and cash equivalents 1,640 7,301
Cash and cash equivalents, beginning of period 2,558 5,542
--------- ---------
Cash and cash equivalents, end of period $ 4,198 $ 12,843
========= =========
</TABLE>
<TABLE>
<CAPTION>
SUPPLEMENTAL DISCLOSURE OF CERTAIN NON-CASH TRANSACTIONS: MARCH 31, 2000
--------------
<S> <C>
Sale of interest in investment in affiliate including accrued interest $ 3,801
========
Consideration received - note receivable $ 3,801
========
</TABLE>
See notes to unaudited consolidated financial statements.
6
<PAGE>
ENHANCE FINANCIAL SERVICES GROUP INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PERIODS ENDED MARCH 31, 2000 AND 1999
(UNAUDITED)
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, 1999 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 three months ended March 31, 2000 may not be indicative of
the results that may be expected for the year ending December 31, 2000.
The Company retained Morgan Stanley Dean Witter & Company in February 2000
to work with the Company to identify and review options to increase shareholder
value. The Company has identified and is implementing initiatives to (1) explore
opportunities to exit and realize value from its non-insurance businesses and
(2) explore opportunities that could maximize shareholder value for the entire
Company. The Company's accounting estimates and assumptions used in the
preparation of its financial statements may be materially affected if the
Company completes a transaction resulting from any of these alternatives.
2. DIVIDENDS DECLARED
In March 2000, Enhance Financial declared a cash dividend of $.06 per share
totaling $2,288,676.
3. COMMON STOCK
During the first quarter of 2000, Enhance Financial made no common stock
repurchases.
4. COMPREHENSIVE INCOME
Total comprehensive income for the three months ended March 31, 2000 and
1999 was $33.8 million and $13.7 million, respectively. Currently, other
comprehensive income represents net income plus changes in unrealized gains and
losses on available for sale securities, foreign currency translation
adjustments and unearned compensation.
7
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PERIODS ENDED MARCH 31, 2000 AND 1999
(UNAUDITED)
5. INCOME TAXES
The Company files a consolidated federal income tax return with its
includable subsidiaries. Subject to the provisions of a tax sharing agreement,
income tax allocation is based upon separate return calculations. The Company
has not recorded a deferred federal income tax liability for the three-month
period ended March 31, 2000 of $5.2 million for the tax benefits associated
with the Company's investment in a portfolio of residual mortgage-backed
securities that consist of residual interests in real estate mortgage
investment conduits ("REMICs"), which was acquired during the second quarter
of 1999, because the Company believes that, through the use of a tax
strategy, the tax law provides a means by which income tax benefits
associated with this portfolio will not result in future tax obligations, and
the Company intends to use such means. For the quarter ended March 31, 2000,
the Company realized $5.2 million of tax benefits from the portfolio of
REMICs and $0.3 million of investment income from the portfolio.
The Company's effective tax rate for the first quarter of 2000 was 8.4%
compared to 7.5% for the comparable period of 1999.
6. RECLASSIFICATIONS
Certain of the 1999 amounts have been reclassified to conform to the
current year presentation.
7. SEGMENT REPORTING
The Company has two reportable segments: insurance and asset-based
businesses. The insurance segment provides credit-related insurance coverage to
meet the needs of customers in a wide variety of domestic and international
markets. The Company's largest insurance business is the provision of
reinsurance to the monoline primary financial guaranty insurers for both
municipal bonds and non-municipal obligations. The Company also provides trade
credit reinsurance, financial responsibility bonds, excess-SIPC insurance and
direct financial guaranty insurance. The asset-based businesses segment deals
primarily with credit-based servicing and securitization of assets in
underserved markets, in particular, the origination, purchase, servicing and
securitization of special assets, including lottery awards, viatical
settlements, structured settlement payments, sub-performing/non-performing and
seller financed residential mortgages and delinquent consumer assets. The
Company's reportable segments are strategic business units that are managed
separately as each business requires different marketing and sales expertise.
The Company evaluates performance based on profit or loss from operating
earnings, which it defines as net income excluding the impact of capital and
foreign exchange gains and losses, and certain non-recurring items, net of
taxes. Summarized financial information concerning the Company's operating
segments is presented in the following tables:
In thousands
<TABLE>
<CAPTION>
March 31, 2000
--------------
Insurance Asset-Based Totals
--------- ----------- ------
<S> <C> <C> <C>
Revenues from external customers $ 27,585 $ 11,663 $ 39,248
Net investment income 15,254 283 15,537
Operating earnings 12,685 10,685 23,370
Segment assets 1,174,460 362,404 1,536,864
In thousands
<CAPTION>
March 31, 1999
--------------
Insurance Asset-Based Totals
--------- ----------- ------
<S> <C> <C> <C>
Revenues from external customers $ 25,679 $ 9,100 $ 34,779
Net investment income 13,554 -- 13,554
Operating earnings 18,721 2,787 21,508
Segment assets 1,191,405 161,536 1,352,941
</TABLE>
8
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PERIODS ENDED MARCH 31, 2000 AND 1999
(UNAUDITED)
The following are reconciliations of reportable segment revenues and profit
to Enhance Financial's consolidated totals:
In thousands
<TABLE>
<CAPTION>
March 31,
---------
2000 1999
-------- --------
<S> <C> <C>
REVENUES
Total revenues from external customers for reportable segments $ 39,248 $ 34,779
Net investment income for reportable segments 15,537 13,554
Realized losses (733) (3,890)
-------- --------
Total consolidated revenues $ 54,052 $ 44,443
======== ========
NET INCOME
Operating earnings for reportable segments $ 23,370 $ 21,508
Capital and foreign exchange losses, net of tax (695) (3,355)
Non recurring expenses, net of tax (2,327) --
-------- --------
Net income $ 20,348 $ 18,153
======== ========
</TABLE>
8. LITIGATION
A complaint was filed against Enhance Financial and Asset Guaranty
Insurance Company ("Asset Guaranty") on April 4, 2000 in the United States
District Court for the District of Maryland by Creditrust Corporation
("Creditrust") and its president alleging that a senior employee of Enhance
Financial had posted messages on an internet message board containing
derogatory, false, misleading, and/or confidential information regarding
Creditrust, in violation of various state and federal common law and statutory
duties. This misconduct alleged was unauthorized and contrary to Company policy,
and the employee identified in the lawsuit no longer works for the Company.
Nonetheless, the complaint alleges that the message board activity was
undertaken on behalf of the Company to further its competitive interests. While
analysis of this matter is ongoing, the Company believes that Creditrust's
claims against Enhance Financial and Asset Guaranty are not well founded and
that the outcome of this litigation will not be material to the Company's
business.
9
<PAGE>
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
To the Board of Directors and Shareholders of
Enhance Financial Services Group Inc.
New York, NY 10017
We have reviewed the accompanying consolidated balance sheet of Enhance
Financial Services Group Inc. and subsidiaries (the "Company") as of March
31, 2000, and the related consolidated statements of income, shareholders'
equity and cash flows for the three-month periods ended March 31, 2000 and
1999. These financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to such consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States
of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of the
Company as of December 31, 1999, and the related consolidated statements of
income, shareholders' equity and cash flows for the year then ended (not
presented herein); and in our report dated March 27, 2000, we expressed an
unqualified opinion on those consolidated financial statements. In our opinion,
the information set forth in the accompanying consolidated balance sheet as of
December 31, 1999 is fairly stated, in all material respects, in relation to the
consolidated balance sheet from which it has been derived.
Deloitte & Touche LLP
New York, New York
May 15, 2000
10
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company divides its business operations into two reportable operating
segments: insurance businesses and asset-based businesses.
The insurance businesses of the Company, which are conducted through its
subsidiaries Enhance Reinsurance Company ("Enhance Re") and Asset Guaranty
Insurance Company ("Asset Guaranty" and collectively with Enhance Re, the
"Insurance Subsidiaries"), include principally the reinsurance of financial
guaranties of municipal and asset backed debt obligations issued by monoline
financial guaranty insurers. In addition, the Company is engaged in other
insurance, reinsurance and non-insurance businesses that utilize the Company's
expertise in performing sophisticated analyses of complex, asset-based risks.
The Company's other insurance businesses involve the issuance of direct
financial guaranties of smaller municipal debt obligations, trade credit
reinsurance, financial institutions credit insurance (which includes
excess-SIPC/excess-ICS and related type bonds) and financial responsibility
bonds. Some of these other insurance businesses are conducted by Van-American
Insurance Company ("Van-Am"), a Kentucky-domiciled insurer that writes
reclamation bonds for the coal mining industry, and surety bonds covering the
closure and post-closure obligations of landfill operators. The Company also
provides surety and other credit-based insurance products through its 45%
ownership of SBF Participacoes Ltda.
The Company operates its asset-based businesses primarily through its
consolidated subsidiaries, Singer Asset Finance Company, LLC ("Singer") and
Enhance Life Benefits LLC ("ELB"), and minority owned subsidiaries, Credit-Based
Asset Servicing and Securitization LLC ("C-BASS") and Sherman Financial Group
LLC ("Sherman"). The Company's asset-based businesses include the origination,
purchase, servicing and/or securitization of special assets, including state
lottery awards, structured settlement payments, and viatical settlements;
sub-performing/non-performing and seller-financed residential mortgages, real
estate and subordinated residential mortgage-backed securities; and delinquent
unsecured consumer assets.
The Company has followed a business strategy of maintaining its financial
guaranty business, both primary and reinsurance, and its commitment to intensive
and prudent credit underwriting and conservative investment policies; utilizing
its expertise in underwriting credit risks to expand and develop its other
insurance businesses; and continuing to pursue its asset-based businesses and
diversification efforts utilizing its credit analysis skills in areas that the
Company believes have strong profit and growth potential relative to risk.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2000 VS. THREE MONTHS ENDED MARCH 31, 1999
Interest rates increased between the first quarters of 1999 and 2000,
reducing refundings of bonds in place and also the volume of new issues. In the
first quarter of 2000, municipal new-issue volume was $40.4 billion, a decline
of 30.2% from the same period in 1999. The insured portion of such new issues
was 41.6% and 50.9% during the first quarters of 2000 and 1999, respectively.
Total municipal bond refundings were $3.2 billion in the first quarter of 2000,
approximately 7.9% of new-issue volume, down from 23.7% for the first quarter of
1999 due to higher interest rates.
Gross premiums written in the first quarter of 2000 increased 18.2% to
$35.0 million from $29.6 million in the same period in 1999.
Net premiums written increased 15.6% to $34.1 million in the first quarter
of 2000 from $29.5 million in the same period in 1999. A 123.1% growth in the
direct financial guaranty premium and 52.6% in other insurance premium offset
the 23.6% decrease in municipal reinsurance premiums.
11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following table shows net premiums written by line of business for the
periods presented:
1(ST) Quarter
-----------------------------------------------------------------------------
Net Premiums Written
(dollars in millions) 2000 1999 $ Change % Change
-----------------------------------------------------------------------------
Municipal Reinsurance $ 8.4 $11.0 $(2.6) (23.6)%
Non-Municipal Reinsurance 7.9 6.7 1.2 17.9
Direct Financial Guaranty 8.7 3.9 4.8 123.1
Trade Credit 6.2 6.0 0.2 3.3
Other 2.9 1.9 1.0 52.6
---------------------------------------------
Total $34.1 $29.5 $4.6 15.6%
=============================================
Net premiums earned grew 8.2% to $26.3 million in the first quarter of 2000
from $24.3 million in the first quarter of 1999. The growth in premiums earned
is attributable to increased writings in the direct financial guaranty and
non-municipal reinsurance. Earned premiums from refundings contributed $2.2
million (or 8.4%) of earned premiums in the first quarter of 2000 compared to
$2.0 million (or 8.2%) in the same period in 1999. Deferred premium revenue, net
of prepaid reinsurance premiums, grew to $345.2 million at March 31, 2000 from
$337.3 million at December 31, 1999 and $313.4 at March 31, 1999.
The following table shows net premiums earned by line of business for the
periods presented:
1(ST) Quarter
-----------------------------------------------------------------------------
Net Premiums Earned
(dollars in millions) 2000 1999 $ Change % Change
-----------------------------------------------------------------------------
Municipal Reinsurance $ 7.9 $ 8.1 $(0.2) (2.5)%
Non-Municipal Reinsurance 7.0 5.8 1.2 20.7
Direct Financial Guaranty 3.0 2.1 0.9 42.9
Trade Credit 5.2 5.1 0.1 2.0
Other 3.2 3.2 0.0 0.0
---------------------------------------------
Total $26.3 $24.3 $2.0 8.2%
=============================================
Net investment income increased 14.0% to $15.5 million in the first quarter
of 2000 from $13.6 million in the same period in 1999. This increase resulted
primarily from the growth in the Company's fixed maturities portfolio and
short-term investments from $941.0 million at March 31, 1999 to $1,024.6 million
at March 31, 2000. The investment yields on the Company's investment portfolio
were 5.9% and 6.1% for the first quarters of 2000 and 1999, respectively. In
addition, the Company realized $0.7 million of capital losses in the first
quarter of 2000 compared with $3.9 million of capital losses in the first
quarter of 1999. The 2000 capital loss was due to net capital losses on sale of
bonds, whereas the 1999 capital loss includes the recognition of a $4.7 million
pre-tax write down of two holdings in Commercial Financial Services, Inc.
("CFS"). CFS is currently protected under Chapter 11 of the bankruptcy code as
an outgrowth of allegations of improper activities. CFS continues to service the
debt on a current basis, and the Company does not expect any further write-offs.
The Company recognized revenues from disposition of assignments, through
securitization and other sales, of $11.2 million in the first quarter of 2000
compared to $8.3 million in the first quarter of 1999. The increase is
attributable to securitzed transactions by Singer in the states of Florida and
Texas.
Incurred losses and LAE were $5.3 million in the first quarter of 2000
compared to $2.8 million for the same period of 1999. The increase is primarily
due to increases in losses for the Company's trade credit line of business of
$1.0 million, non-specific reserves for $1.0 million and Van Am of $1.2 million.
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The Company's insurance expense ratio was 57.9% in the first quarter of
2000 compared to 49.0% in the first quarter of 1999. The increase in the
insurance operating expense is due to expenses for severance, outplacement and
other assistance related to Company-wide layoffs in the first quarter.
Non-insurance expenses increased to $15.6 million in the first quarter of 2000
from $12.4 million during the same period in 1999. The increase reflects
restructuring costs and expenses associated with the management of the Company's
REMIC investment ($1.2 million), for which no comparable expense was included in
the first quarter of 1999, and increased rent expense. Policy acquisition costs
("PAC") were $9.6 million and $8.9 million for the first quarters of 2000 and
1999, respectively, each representing 36.5% of earned premiums in the respective
periods.
The Company realized income of $7.8 million from its investments in
affiliates in the first quarter of 2000 compared to $4.7 million in the first
quarter of 1999, primarily as a result of increased income from C-BASS.
Interest expense totaled $3.8 million and $2.4 million in the first
quarters of 2000 and 1999, respectively, reflecting the increase in the
Company's short-term debt outstanding.
The Company's first quarter 2000 net income increased 11.5% to $20.3
million from $18.2 million in the first quarter of 1999. First quarter 2000
basic and diluted earnings per share increased 10.4% and 15.2%, respectively, to
$.53 and $.53 from $.48 and $.46 in the first-quarter of 1999. The increase in
net earnings is due to the increase in premiums earned, investment income,
assignment sales and equity earnings partially offset by increased losses and
operating expenses.
For the three-month period ended March 31, 2000, the Company realized $5.2
million of tax benefits from the portfolio of residential mortgage-backed
securities that consist of residual interests in real estate mortgage investment
conduits ("REMICs") acquired in April 1999. With respect to the acquired tax
benefits, as of March 31, 2000, the Company has recorded a $132.8 million
deferred tax asset and a related deferred credit. The deferred tax asset is
reduced and the deferred credit is amortized to income (as a reduction of
current tax expense) as the tax benefits are realized (approximately $5.2
million for the three-month period ended March 31, 2000). In addition, for the
three-month period ended March 31, 2000, the Company realized $0.3 million of
investment income from the portfolio. At March 31, 2000, the Company did not
record a deferred federal income tax liability of $5.2 million for tax losses of
$15.0 million associated with the portfolio because the tax law provides a
means, through the use of a particular tax strategy which the Company intends to
use, by which income tax benefits associated with this portfolio will not result
in future tax obligations. The tax strategy involves numerous assumptions and
requires that certain steps occur in a specific order. Although the Company
believes that the assumptions are reasonable and that the Company can cause the
required steps to occur in the proper order, certain of the assumptions and
steps are outside the control of the Company and therefore there is no assurance
that all the assumptions will be satisfied or all of the steps will occur in the
proper order. In addition, this tax strategy is based on current law and there
is no assurance that new laws, regulations or court decisions will not be
enacted or occur that render the tax strategy ineffective. If (i) the Company
were to dispose of the portfolio other than in accordance with its currently
anticipated tax strategy, (ii) the Company were to determine that the Company
would be unable or it would be unadvisable to utilize the tax strategy, (iii)
current tax law were to change, or (iv) there were an unfavorable determination
by the IRS regarding the Company's tax strategy, the Company may be required to
record a deferred federal income tax liability for and/or recapture all or a
significant portion of the tax losses associated with the portfolio that the
Company previously recognized (an aggregate of $19.6 million as of March 31,
2000).
The diluted weighted average shares outstanding during the first quarter of
2000 were 38.6 million compared to 39.2 million during the first quarter of
1999.
Singer and ELB combined contributed net income of $.03 per share in the
first quarter of 2000 compared to a net loss of $.03 per share during the
comparable period in 1999. C-BASS contributed $.19 per share to Enhance
Financial's first quarter 2000 net income, compared to $.09 per share during the
comparable period in 1999. Sherman had a $.01 per share loss, compared to $.02
per share loss during the comparable period in 1999.
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 (as defined below).
Payments of dividends by the Insurance Subsidiaries are subject to
restrictions relating to statutory capital and surplus and net investment
income. During the first quarter of 2000, Enhance Financial received $5.5
million in dividends from Enhance Re ($4.5 million) and Asset Guaranty ($1.0
million). As of March 31, 2000, the maximum amount of dividends that may be paid
in the subsequent quarter ending June 30, 2000 from the Insurance Subsidiaries
without prior approval of the insurance regulatory authorities is $12.4 million.
Payments of dividends by Enhance Financial to its shareholders are further
restricted by the terms of the credit agreement. At March 31, 2000, the maximum
amount of the dividends that may be paid in the second quarter (6/30/00) by
Enhance Financial to its shareholders in compliance with the terms of such
agreement is $5.7 million. In the first quarter of 2000, Enhance Financial
declared cash dividends of $.06 per share, aggregating $2,288,676.
13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
As of March 31, 2000, the statutory policyholders' surplus of Enhance Re
and Asset Guaranty was $221.5 million and $87.4 million, respectively, compared
to the minimum $68.4 million required by each under the Insurance Law and
compared to $214.8 million and $90.6 million at December 31, 1999, respectively.
The Company's cash flow provided by operations for the first quarter of
2000 was $11.6 million compared to cash flow used for operations of $10.4
million for the same period in 1999. The increase in cash flow provided from
operations of $22.0 million for the same period in 1999 was primarily due to a
favorable change in accrued interest and expense of $1.1 million, an increase in
accrued expenses of $14.0 million, and an increase in deferred premium revenue
of $2.7 million. The carrying value of the Company's investment portfolio (total
investments plus cash and cash equivalents) increased to $1,028.8 million at
March 31, 2000 from $972.6 million at December 31, 1999 primarily as a result of
the cash flows from operations and a decrease in unrealized losses.
Enhance Financial is party to a credit agreement (amended March 31, 2000)
(the "Credit Agreement") with major commercial banks providing for borrowing by
Enhance Financial of up to $150 million to be used for general corporate
purposes, of which $50 million is due May 30, 2000 and the balance of $100
million is due June 27, 2000. The Credit Agreement provides for a revolving
credit facility under which individual advances may be converted, at Enhance
Financial's discretion, into a four-year term loan. The total outstanding under
the Credit Agreement at March 31, 2000 is $137 million. The Credit Agreement
requires that the proceeds from asset sales be applied toward repayment of
amounts outstanding.
The Company and Mortgage Guaranty Insurance Company ("MGIC") each own 46%
interests in C-BASS. The Company had contributed $55.5 million to C-BASS from
its inception in 1996 through March 31, 2000 and expects that it will provide
additional funding with MGIC on a pari passu basis with MGIC.
In December 1998, the Company and MGIC formed Sherman, a joint venture in
which the Company and MGIC, each own 45% interests. The Company has committed to
contribute a total of $20.2 million to Sherman, of which $9.1 million has been
contributed as of March 31, 2000, including $1.6 million in cash and the
Company's contribution of the assets or equity in the subsidiaries of Alegis
Group Inc. The Company expects that it will provide additional funding in
addition to its original contribution to Sherman from time to time. In May 1999,
the Company guaranteed repayment by Sherman of up to 50% of the amount
outstanding under a $50 million revolving credit facility that Sherman obtained
from a major commercial bank. As of March 31, 2000, the outstanding principal
balance under the facility was approximately $47.0 million, of which the Company
has guaranteed $23.5 million.
In July 1998, the Company acquired an 80% ownership interest in AGS
Financial LLC. The Company is obligated to pay $3.1 million, as and when needed,
of which $2.1 million has been paid as of March 31, 2000.
Based on the cash flow of the Company in recent years, the Company's
current financial condition and the Company's expectation as to its net premium
written, the Company does not expect the dividends from the Insurance
Subsidiaries and other subsidiaries in 2000 will provide adequate liquidity to
enable Enhance Financial to meet its debt obligations, its general overhead
expenses, its expenditures for capital improvements and its commitments to fund
the operations of its asset-based businesses. The Company for the short term has
increased bank borrowings and proposes to address the situation in the longer
term, both for 2000 and thereafter, through a combination of capital market
transactions and the sale of assets. The success of this effort will depend on
numerous factors, many beyond the Company's control, including general capital
market conditions, interest rate environment, and insurance regulatory
constraints, and there can be no assurance that the Company will be successful
in resolving the situation in a manner that will not involve substantial
expense, dilution to its shareholders and/or a restructuring of the Company.
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
In August 1999, Moody's Investor Service, Inc. ("Moody's") downgraded
Enhance Financial's senior long-term debt rating from Aa3 to A2. In February
2000, Moody's placed such debt rating under review for possible further
downgrade. The Company does not believe that the August 1999 downgrade has had
or should have a material adverse effect on the Company. However, the downgrade
could result in increased cost to Enhance Financial for borrowing funds or
otherwise raising capital. Similarly, any additional downgrade of senior
long-term debt rating of Enhance Financial could increase the cost of borrowing
funds or otherwise raising capital, or could make certain types of borrowings or
capital unavailable to the Company, which could have a material adverse effect
on the Company.
The Company retained Morgan Stanley Dean Witter & Company in February to
work with the Company to identify and review options to increase shareholder
value. The Company has identified and is implementing initiatives to (1) explore
opportunities to exit and realize value from its non-insurance businesses and
(2) explore opportunities that could maximize shareholder value for the entire
Company.
15
<PAGE>
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.
As of March 31, 2000 there have been no material changes in the Company's
market risk exposure as described in the Management's Discussion and Analysis
contained in the Company's Annual Report on Form 10-K for the year ended
December 31, 1999.
PART II: OTHER INFORMATION
ITEM 1. Legal Proceedings.
A complaint was filed against Enhance Financial and Asset Guaranty on April
4, 2000 by Creditrust in the United States District Court for the District of
Maryland. See Note 8 to Notes to Consolidated Financial Statements Periods Ended
March 31, 2000 and 1999 (unaudited).
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
ITEM 6. Exhibits and reports on Form 8-K.
(a) Exhibits
Exhibit 4.2.6. Fifth Amendment to the Credit Agreement, dated as
of March 31, 2000, among the registrant, Fleet
National Bank as lender, swingline bank and as
agent for the Banks, and The Bank of New York,
Bank One, NA (Main Office Chicago) (formerly known
as The First National Bank of Chicago), and
Deutsche Bank AG, New York and/or Cayman Island
Branches, as lenders.
Exhibit 15. Letter from Deloitte & Touche LLP regarding
unaudited interim financial information.
Exhibit 27. Financial data schedules.
(b) Reports on Form 8-K
None.
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 the
undersigned thereunto duly authorized.
Date: September 20, 2000 ENHANCE FINANCIAL SERVICES GROUP INC.
By: /s/ Richard P. Lutenski
------------------------------------
Richard P. Lutenski
Executive Vice President (duly
authorized officer) and Chief
Financial Officer
16
