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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-11356
CMAC Investment Corporation
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 23-2691170
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
</TABLE>
1601 MARKET STREET, PHILADELPHIA, PA 19103
(Address of principal executive offices, including zip code)
(215) 564-6600
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
<TABLE>
<CAPTION>
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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<S> <C>
COMMON STOCK, $.001 PAR VALUE NEW YORK STOCK EXCHANGE
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE
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 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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X].
The following documents have been incorporated by reference in this Form
10-K, as indicated:
<TABLE>
<CAPTION>
PART AND ITEM NUMBER OF FORM 10-K
DOCUMENT INTO WHICH INCORPORATED
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<S> <C>
1. 1997 Annual Report to Stockholders Items 5 through 8 of Part II
2. Proxy Statement for the 1998 Annual Items 10 through 13 of Part III
Meeting of Stockholders
</TABLE>
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date: 22,609,365 shares of Common
Stock, $.001 par value, outstanding on March 25, 1998, and the aggregate market
value of the voting stock held by non-affiliates of the registrant is
1,502,109,687.
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PART I
ITEM 1. BUSINESS
GENERAL
CMAC Investment Corporation (the "Company") provides, through its wholly
owned subsidiary, Commonwealth Mortgage Assurance Company ("CMAC"), private
mortgage insurance coverage in the United States to residential mortgage
lenders. Private mortgage insurance protects lenders from default-related losses
on residential first mortgage loans made to home buyers who make down payments
of less than 20% of the home's purchase price. Private mortgage insurance also
facilitates the sale of such mortgage loans in the secondary mortgage market,
principally to the Federal Home Loan Mortgage Corporation ("Freddie Mac") and
Fannie Mae. CMAC is restricted, generally by state insurance laws and
regulations and the eligibility requirements of Fannie Mae and Freddie Mac, to
providing insurance on residential first mortgage loans only. CMAC currently
offers two principal types of private mortgage insurance coverage: "primary" and
"pool". At December 31, 1997, primary insurance and pool insurance represented
94.4% and 5.6%, respectively, of CMAC's direct risk in force, and this
proportion is not expected to change materially in the future, although the
volume of pool insurance written increased significantly in 1997 and is expected
to continue at similar levels in 1998.
CMAC has been engaged in the mortgage insurance business since 1977. The
Company acquired all of the outstanding common stock of CMAC in October 1992 in
order to facilitate the initial public offering of the Company's common stock.
In the offering, the Company's sole stockholder, Commonwealth Land Title
Insurance Company ("Commonwealth"), then an indirect subsidiary of Reliance
Group Holdings, Inc. ("Reliance"), sold all of the shares of common stock of the
Company owned by it. As a result of the offering, which was completed in
November 1992, the Company became an independent public company.
Primary Insurance
Primary insurance provides mortgage default protection on individual loans
at a specified coverage percentage which is applied to the unpaid loan
principal, delinquent interest and certain expenses associated with the default
and subsequent foreclosure (collectively, the "claim amount"). CMAC's obligation
to an insured lender in respect of a claim is determined by applying the
appropriate coverage percentage to the claim amount. CMAC's "risk" on each
insured loan is the loan amount multiplied by the coverage percentage. Most of
CMAC's current business is written with 30% coverage on loans with a
loan-to-value ("LTV") ratio of 90.01% or higher and 25% coverage on loans with
an LTV ratio between 85.01% and 90%. As of December 31, 1997, approximately 60%
of CMAC's insurance in force has such "deeper coverage". Under its master
policy, CMAC has the option (which is infrequently used) of paying the entire
claim amount and taking title to the mortgaged property, or paying the coverage
percentage in full satisfaction of its obligations under the insurance written.
Pool Insurance
Pool insurance differs from primary insurance in that the exposure on pool
insurance is not limited to a specific coverage percentage on each individual
loan. There is an aggregate exposure limit ("stop loss") on a "pool" of loans
which is generally between 1% and 10% of the initial aggregate loan balance.
Modified pool insurance has a stop loss like pool insurance, but also has
exposure limits on each individual loan. The use of modified pool insurance is
much more limited than traditional pool insurance.
CMAC offers pool insurance on a selected basis to various state housing
finance agencies on the collateral for their bond issues, as a credit
enhancement to mortgage loans included in mortgage-backed securities or in whole
loan sales, and in certain other specific situations. Recently, CMAC has begun
to offer pool insurance on mortgage product sold to Freddie Mac and Fannie Mae
by CMAC's primary insurance customers ("GSE Pool"). This pool insurance has a
very low stop loss, generally 1.0% to 1.5%, and the insured pools contain
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loans with and without primary insurance. Premium rates on this business are
significantly lower than primary insurance rates and therefore the expected
profitability on this business is lower than that of primary insurance. The
volume of such business increased significantly in 1997 due to the strong demand
for this product from CMAC's customers. During 1997, CMAC had pool risk written
of $264.5 million relating specifically to GSE Pool business. It is expected
that CMAC will write a similar amount of such pool insurance in 1998. It is
CMAC's current intention to limit net pool risk in force to approximately 5% of
CMAC's total risk in force. New premiums written for pool insurance were $4.8
million in 1997, $2.1 million in 1996 and $1.6 million in 1995.
Structured Transactions
CMAC, from time to time, engages in structured transactions which may
include either primary insurance, pool insurance or some form of combination. A
structured transaction generally involves insuring a large pool of seasoned
loans or issuing a commitment to insure new loan originations under negotiated
terms. Some structured transactions contain a risk-sharing component under which
the insured assumes a first-loss position or shares in losses in some other
manner. The amount of new premiums written in structured transactions by CMAC in
1997, 1996 and 1995 were $300,000, $400,000 and $1.3 million, respectively.
Revenue Sharing Products
CMAC and the industry have recently begun to offer financial products to
their customers that are designed to allow the customer to participate in the
risks and rewards of the mortgage insurance business. One such product is
captive reinsurance, in which a mortgage lender sets up a mortgage reinsurance
company that assumes part of the risk associated with that lenders' insured book
of business. In most cases, the risk assumed by the reinsurance company is an
excess layer of aggregate losses that would be penetrated only in a situation of
adverse loss development. CMAC had one captive reinsurance agreement in place at
December 31, 1997 and expects to enter into several new agreements in 1998.
Another revenue sharing product is a performance note ("SUPER Note"), which
allows a mortgage lender to invest a portion of capital needed to support its
insured mortgage insurance book and to receive a return on investment that
approximates the return that CMAC achieves on that same book of business. At
December 31, 1997, CMAC had $34,000 of outstanding SUPER Notes and plans to
issue many more in 1998. The aggregate amount of captive reinsurance and SUPER
Note business is not expected to have a material financial impact on CMAC's
balance sheet or financial results in 1998.
CUSTOMERS
Mortgage originators such as mortgage bankers, mortgage brokers, commercial
banks and savings institutions are CMAC's principal customers, although mortgage
borrowers generally bear the cost of primary insurance coverage. CMAC does, on a
limited basis, offer lender-paid mortgage insurance whereby mortgage insurance
premiums are charged to the mortgage lender or loan servicer. On the lender-paid
product, the interest rate to the borrower is usually higher to compensate for
the mortgage insurance premium that the lender is paying. In 1997, approximately
3% of CMAC's primary insurance was done on a lender-paid basis.
To obtain primary insurance from CMAC, a mortgage lender must first apply
for and receive a master policy from CMAC. CMAC's approval of a lender as a
master policyholder is based, among other factors, upon an evaluation of the
lender's financial position and its management's demonstrated adherence to sound
loan origination practices.
The number of primary individual policies in force at December 31, 1997,
1996 and 1995 was 441,605, 382,243 and 321,090, respectively.
CMAC's top 10 customers were responsible for 28.4% of new primary risk
written in 1997 compared to 21.8% and 24.7% for the years ended December 31,
1996 and 1995, respectively. The largest single customer of CMAC (including
branches and affiliates of such customer), measured by risk written, accounted
for 4.9% of new primary risk written during 1997 compared to 4.0% and 4.2% for
the years ended December 31, 1996 and 1995, respectively.
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SALES, MARKETING AND COMPETITION
Sales and Marketing
CMAC employs a field sales force of approximately 100 persons, organized
into three divisions, providing local sales representation throughout the United
States. During 1997, CMAC reorganized by reducing the number of divisions from
six to three and introducing the new position of Area Sales Manager in order to
provide more direct supervision of the field sales force. Each of the three
divisions is supervised by a Divisional Sales Manager who is directly
responsible for several Area Sales Managers. The Area Sales Managers are
responsible for managing a small sales force in different areas within the
division. CMAC sales personnel are compensated by salary, commissions on new
insurance written and a production incentive based on the achievement of various
goals. During 1998, these goals will be related to volume, market share, change
in market share and business quality as measured by CMAC's mortgage scoring
model. In early 1997, CMAC expanded its effort to serve larger national
accounts, which have become a more integral part of the mortgage insurance
market due to consolidation in the mortgage lending industry. Two dedicated
national account positions were created and a more focused effort to support
national accounts was implemented. CMAC intends to keep adding to this effort in
1998 with at least one additional dedicated position.
Competition
CMAC and other private mortgage insurers compete directly with various
federal government agencies, principally the Federal Housing Administration
("FHA"). In addition to competition from federal agencies, CMAC and other
private mortgage insurers face competition from state-supported mortgage
insurance funds.
The private mortgage insurance industry consists of CMAC and seven other
active mortgage insurance companies. During 1997, CMAC was the fifth largest
private mortgage insurer and had, according to industry data, a market share of
new primary mortgage insurance written of 11.2%.
UNDERWRITING PRACTICES
CMAC considers effective risk management to be critical to its long-term
financial stability. Market analysis, prudent underwriting, the use of automated
risk evaluation models, quality control and customer service are all important
elements of CMAC's risk management process.
Underwriting Personnel
In addition to a centralized National Underwriting department in the home
office, each of CMAC's service divisions has a Divisional Service Manager
responsible for evaluating risk and managing all underwriting field staff in the
region. CMAC employs an underwriting and support staff of approximately 321, who
are located in CMAC's 25 service centers. Additionally, CMAC has two agency
operations in place.
Underwriting Process
CMAC has generally accepted applications for primary insurance (other than
in connection with structured transactions) under three basic programs: the
traditional fully documented program, a limited documentation program and the
delegated underwriting program. Programs that involve less than fully documented
file submissions have become more prevalent in recent years. In order to meet
this demand, in the fourth quarter of 1996, CMAC introduced to the marketplace a
new concept in mortgage insurance underwriting and processing. This process is
referred to as "ExpressTrac(sm)". A lender utilizing ExpressTrac can submit
loans to CMAC for insurance with abbreviated levels of documentation based on
the type of loan being submitted for insurance. During 1997, 16% of the
commitments issued for primary insurance were received by CMAC under the
ExpressTrac program. ExpressTrac is not a delegated underwriting program.
Rather, CMAC has agreed to underwrite certain loans with less documentation by
relying upon a scoring model created during 1996 referred to as "Prophet
Score(sm)" (described below). The ExpressTrac program also allows for a
reduction in standard premium rates (4 basis points) for loans having FICO
credit scores
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(described below) of 680 or greater. During 1997, 48% of the commitments issued
by CMAC for primary insurance received this discounted rate.
Delegated Underwriting
CMAC has a delegated underwriting program with certain customers. CMAC's
delegated underwriting program, which was implemented in 1989, currently
involves only lenders that are approved by CMAC's risk management department.
Delegated underwriting programs allow the lender's underwriters to commit CMAC
to insure loans based on agreed upon underwriting guidelines. CMAC routinely
audits loans submitted under these programs. As of December 31, 1997,
approximately 33% of the primary loans on CMAC's books were originated on a
delegated basis and during 1997, 55% of the primary loans insured by CMAC were
originated on a delegated basis. This compares to 20% and 49%, in 1996.
Automated Underwriting
In 1994, CMAC installed an automated underwriting system which uses
artificial intelligence technology to assist its underwriting staff in the
processing of loan files. The system allows the underwriter to eliminate the
rudimentary underwriting steps and to focus on key aspects of the loan file,
with the ultimate goal of increasing underwriting efficiency while maintaining
the same level of risk exposure. During 1995, the system was fully integrated
into the CMAC underwriting process and improved efficiency was realized. In
1996, CMAC further enhanced the automated underwriting system by adding its
Prophet Score model to the automated underwriting systems' decision making
process. Direct connections between the CMAC network and Fannie Mae's Desktop
Underwriter and Freddie Mac's Loan Prospector systems were implemented in
January, 1998.
Mortgage Scoring Models
During the last few years, the use of scoring mechanisms to predict loan
performance has become prevalent in the marketplace, especially with Freddie
Mac's advocacy of the use of credit scores in the mortgage loan underwriting
process. The use of credit scores was pioneered by Fair Isaac and Company and
became popular in the mid-1980s. The FICO model calculates a score based on a
borrower's credit history. This credit score based "scorecard" is used to
predict the future performance of a loan over a one or two year time horizon.
The higher the credit score the lower the likelihood that a borrower will
default on a loan. CMAC's Prophet Score begins with a FICO score then adds
specific additional data regarding the borrower, the loan and the property. It
is this additional mortgage data that expands the integrity of CMAC's Prophet
Score over the entire life of the loan. In addition to the Prophet Score, our
housing analysts regularly review major metropolitan areas to assess the impact
that key indicators such as housing permits, employment trends, and median home
sale prices have on local lending. The healthier the real estate market, the
lower the risk. CMAC refers to this score as a GEOScore. Beginning in October,
1996, the Prophet Score and GEOScore appeared on each insurance commitment that
CMAC issued.
Alternative A Loans
An increasingly popular form of mortgage lending is in the area of
sub-prime loans. Two subsets of this category in which CMAC has recently become
involved are Alternative A loans and A minus loans. Alternative A borrowers have
an equal or better credit profile than CMAC's typical insured borrowers, but
these loans are underwritten with reduced documentation and verification of
information. CMAC typically charges a higher premium rate for this business due
to the reduced documentation, but does not consider this business to be
significantly more risky than its normal primary business. Alternative A loans
made up approximately 1% of primary insured business in 1997. The A minus loan
programs typically have non-traditional credit standards which are less
stringent than standard credit guidelines. This market was created as an avenue
to homeownership for borrowers who had not properly maintained their credit
profile over time. CMAC receives a significantly higher premium for insuring
this product that is commensurate with the additional default risk and is often
a variable rate based on Prophet Score. During 1997, less than 1% of CMAC's
primary insurance written was done on A minus loans. CMAC intends to limit its
participation in the sub-prime market to Alternative A and A minus loans rather
than "B" or "C" (lower credit) loans and to
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limit the business insured to specific targeted lenders with proven good results
and servicing experience in this area.
Contract Underwriting
CMAC utilizes its underwriting skills to provide an outsource contract
underwriting service to its customers. For a fee, CMAC underwrites fully
documented underwriting files for secondary market compliance, while at the same
time assessing the file for mortgage insurance, if applicable. During the fourth
quarter of 1997, CMAC introduced its automated underwriting service on a pilot
basis. This service offers customers access to Fannie Mae's Desktop Underwriter
and Freddie Mac's Loan Prospector. Contract underwriting has increased in
popularity among CMAC's customers over the last few years. During 1997, loans
underwritten via contract underwriting accounted for 29% of applications, 25% of
commitments for insurance and 22% of insurance certificates issued by CMAC. CMAC
often gives recourse to its customers on loans it underwrites for compliance. If
the loan does not meet agreed upon guidelines and is not salable in the
secondary market for that reason, CMAC agrees to remedy the situation either by
placing mortgage insurance coverage on the loan or by purchasing the loan.
During 1997, less than 1% of all loans were subject to these remedies and the
costs associated with these remedies were negligible. There is no assurance that
these low levels will continue in the future.
RATINGS
CMAC, along with other active private mortgage insurers, has its
claims-paying ability and financial strength rated by Standard & Poor's ("S&P"),
Moody's Investors Service, Inc. ("Moody's") and Duff & Phelps Credit Rating
Company ("DCR"). These ratings are an indication to a mortgage insurer's
customers of the insurer's present financial strength and its capacity to honor
its future claims payment obligations. Ratings are generally considered critical
to an insurer's ability to compete for new insurance business. Currently, CMAC
is rated "AA" by S&P and DCR, and "Aa3" by Moody's.
REINSURANCE
CMAC reinsures all direct insurance in force under an excess of loss
reinsurance program which CMAC considers to be an effective catastrophic
reinsurance coverage. This program originally utilized three reinsurers, but
beginning on January 1, 1995, the program was reduced to one reinsurer. The
reinsurer is responsible for 100% of CMAC's covered losses in excess of CMAC's
retention. CMAC's annual retention is determined by a formula which contains
variable components. The estimated 1998 retention is approximately $410 million
of loss. The reinsurer's aggregate annual limit of liability is also determined
by a formula with variable components and is currently estimated to be $80
million. If the reinsurer decides not to renew the reinsurance arrangement and
is not replaced by CMAC, the nonrenewing reinsurer must provide six years of
runoff coverage. There is an overall aggregate limit of liability applicable to
any runoff period equal to four times the annual limit in effect for the
calendar year of such nonrenewal. For 1998, this aggregate limit is estimated to
be $320 million.
The excess of loss reinsurance program also provides restrictions and
limitations on (i) payment of dividends by CMAC; (ii) investments; (iii) mergers
or acquisitions involving other private mortgage insurance companies; and (iv)
reinsurance of exposure retained by CMAC.
In addition, CMAC has entered into a variable quota-share ("VQS") treaty
for primary risk in the 1994 to 1997 origination years and a portion of the pool
risk written in 1997. In this treaty, quota-share loss relief is provided at
varying levels ranging from 7.5% to 15.0% based upon the loss ratio on the
reinsured book. The higher CMAC's loss ratio, the greater the potential
reinsurance relief which protects CMAC in adverse loss situations. A ceding
commission is paid by the reinsurer to CMAC and the agreement is noncancelable
for ten years by either party. As of December 31, 1997, the risk in force
covered by the VQS treaty was approximately $8.7 billion, or approximately 81%
of CMAC's primary risk in force and $100 million, or approximately 17% of CMAC's
pool risk in force. It is CMAC's present intention to reinsure a specific
portion of its pool insurance
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risk in 1998 under a new reinsurance treaty and not cede any additional business
pursuant to the VQS treaty for the 1998 origination year.
DEFAULTS AND CLAIMS
Defaults
The default and claim cycle on loans which have private mortgage insurance
begins with the insurer's receipt from the lender of notification of a default
on an insured loan. The master policy requires lenders to notify CMAC of an
uncured default on a mortgage loan within 75 days (45 days for an uncured
default in the first year of the loan), although many lenders do so earlier. The
recent trend has been earlier notification of defaults by servicers. The
incidence of default is affected by a variety of factors, including change in
borrower income, unemployment, divorce and illness, the level of interest rates
and general borrower creditworthiness. Defaults that are not cured result in
claims to CMAC. Borrowers may cure defaults by making all delinquent loan
payments or by selling the property and satisfying all amounts due under the
mortgage.
The following table shows the number of primary and pool loans insured,
related loans in default and the percentage of loans in default (default rate)
as of the dates indicated:
<TABLE>
<CAPTION>
DEFAULT STATISTICS
DECEMBER 31
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1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
PRIMARY INSURANCE:
Insured loans in force......... 441,605 382,243 321,090 261,750 228,884
Loans in default(1)............ 10,245 9,115 6,734 5,377 5,206
Percentage of loans in
default..................... 2.3% 2.4% 2.1% 2.1% 2.3%
POOL INSURANCE(2):
Insured loans in force......... 236,101 93,531 43,969 31,658 33,691
Loans in default(1)............ 2,114 1,012 595 549 474
Percentage of loans in
default..................... 0.9% 1.1% 1.4% 1.7% 1.4%
</TABLE>
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(1) Loans in default exclude those loans forty-five days past due or less and
loans in default for which CMAC feels it will not be liable for a claim
payment.
(2) Includes traditional and modified pool insurance.
Regions of the United States may experience different default rates due to
varying economic conditions. The following table shows the default rates by CMAC
region as of the dates indicated, including both primary and pool loans.
<TABLE>
<CAPTION>
DEFAULT RATES BY CMAC REGION
DECEMBER 31
------------------------------------
1997 1996 1995 1994 1993
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<S> <C> <C> <C> <C> <C>
North......................................... 2.51% 2.64% 2.56% 2.59% 2.53%
East.......................................... 3.11 3.38 3.34 3.36 3.76
Southeast..................................... 2.35 2.10 1.53 1.51 1.72
Midwest....................................... 1.16 1.28 1.12 0.61 0.92
Southwest..................................... 1.84 1.61 1.38 1.35 1.69
West.......................................... 2.42 2.87 2.52 2.14 2.01
Alaska........................................ 1.02 0.45 0.74 0.67 1.04
</TABLE>
As of December 31, 1997, default rates for CMAC's two largest states
measured by risk in force, California and Florida, were 3.6% and 3.8%,
respectively, compared to 4.0% and 3.2% at December 31, 1996. The increase in
the Florida default rate is due primarily to the increased "affordable housing"
business done in Florida since 1994 and the relatively high default development
on such business.
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Claims
The likelihood that a claim will result from a default and the amount of
such claim depend principally on the borrower's equity at the time of default
and the borrower's (or the lender's) ability to sell the home for an amount
sufficient to satisfy all amounts due under the mortgage, as well as the
effectiveness of loss mitigation efforts. Claims are also affected by local
housing prices, interest rates, unemployment levels and the housing supply.
Claim activity is not evenly spread through the coverage period of a book
of business. Relatively few claims are received during the first two years
following issuance of the policy. This is followed by a period of rising claims
which, based on industry experience, has historically reached its highest level
in the third through fifth years after the year of loan origination. Thereafter,
the number of claims received has historically declined at a gradual rate,
although the rate of decline can be affected by conditions in the economy.
Approximately 62% of CMAC's primary risk in force and most of CMAC's pool risk
in force at December 31, 1997 had not yet reached its anticipated highest claim
frequency years. CMAC's cumulative claim incidence on insurance written,
determined four years after policy issuance, was 2.0% for insurance written in
1991, 1.5% for insurance written in 1992, and 1.5% for insurance written in
1993. Certain "affordable housing" loans insured in 1994 and 1995 have
experienced higher than normal early default and claim rates, although it is too
early to determine how much higher the eventual claim rates on such loans will
be compared to prior books of business. Many of the reasons for these early
defaults have been addressed in the underwriting of such loans in 1996 and 1997.
LOSS MITIGATION
Once a default notice is received, CMAC attempts to mitigate its loss. The
CMAC loan workout department consists of 30 employees, including 17 full-time
workout specialists. Through proactive intervention with insured lenders and
borrowers, CMAC attempts to reduce the number and severity of CMAC's claim
payments. Loss mitigation techniques include pre-foreclosure sales, extensions
of credit to certain borrowers to reinstate insured loans, loan modifications
and deficiency settlements with borrowers. CMAC considers its loss mitigation
efforts to be an effective way to reduce net claim payments.
HOMEOWNERSHIP COUNSELING
In 1995, CMAC established a Homeownership Counseling Center (the "Center")
to work with borrowers receiving insured loans under Community Homebuyer, 97%
loan-to-value ("97s") or other "affordable housing" programs. CMAC considers
this counseling to be very important to the future success of those particular
borrowers with regard to sustaining their mortgage payments. In addition, the
Center counsels such borrowers early in the default process in an attempt to
help cure the loan and assist the borrower in meeting their mortgage obligation.
During 1996, after reviewing results of analyses showing loans counseled by the
Center were performing better than those counseled by others, CMAC took the
proactive step of requiring that counseling on loans it insures be done by the
Center or by a counseling entity that CMAC has reviewed and approved.
LOSS RESERVES
CMAC establishes reserves to provide for the estimated costs of settling
claims in respect of loans reported to be in default and loans that are in
default which have not yet been reported to CMAC. Consistent with generally
accepted accounting principles and industry accounting practices, CMAC does not
establish loss reserves for future claims on insured loans which are not
currently in default. In determining the liability for unpaid losses related to
reported outstanding defaults, CMAC establishes loss reserves on a case-by-case
basis. The amount reserved for any particular loan is dependent upon the status
of the loan as reported by the servicer of the insured loan, as well as the
economic condition and estimated foreclosure period in the area in which the
default exists. As the default progresses closer to foreclosure, the amount of
loss reserve for that particular loan will be increased, in stages, to
approximately 100% of CMAC's exposure.
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ANALYSIS OF PRIMARY RISK IN FORCE
CMAC's business strategy has been to disperse risk as widely as possible.
CMAC analyzes its portfolio in a number of ways to identify any concentrations
or imbalances in risk dispersion. CMAC believes the quality of its insurance
portfolio is affected significantly by (i) the geographic dispersion of the
properties securing the insured loans; (ii) the quality of loan originations;
(iii) the types of loans insured (including LTV ratio, purpose of the loan, type
of loan instrument and type of underlying property securing the loan); and (iv)
the age of the loans insured.
Geographic Dispersion
The following tables reflect the percentage of direct primary risk in force
on CMAC's book of business (by location of property) for the top ten states and
top 15 metropolitan statistical areas ("MSAs") as of December 31, 1997 and 1996:
<TABLE>
<CAPTION>
TOP TEN STATES 1997 1996
- -------------- ---- ----
<S> <C> <C>
California.................................................. 18.6% 19.8%
New York.................................................... 8.4 8.3
Florida..................................................... 8.3 8.8
Texas....................................................... 5.5 5.8
Georgia..................................................... 5.0 5.0
Pennsylvania................................................ 4.5 4.8
New Jersey.................................................. 4.5 4.4
Arizona..................................................... 4.3 4.3
Maryland.................................................... 2.6 2.7
Tennessee................................................... 2.5 2.6
---- ----
Total............................................. 64.2% 66.5%
==== ====
</TABLE>
<TABLE>
<CAPTION>
TOP FIFTEEN MSAs 1997 1996
- ---------------- ---- ----
<S> <C> <C>
Los Angeles, CA............................................. 5.3% 5.5%
Atlanta, GA................................................. 3.9 4.1
Phoenix, AZ................................................. 3.5 3.5
Philadelphia, PA............................................ 3.2 3.5
New York, NY................................................ 3.0 2.9
Nassau/Suffolk, NY.......................................... 2.7 2.7
Washington, DC-MD-VA........................................ 2.5 2.6
Orange County, CA........................................... 2.2 2.3
Chicago, IL................................................. 2.1 2.1
Riverside-San Bernadino, CA................................. 1.8 1.9
Dallas, TX.................................................. 1.8 1.7
Tampa-St. Petersburg, FL.................................... 1.5 1.7
Boston, MA.................................................. 1.5 1.7
Miami, FL................................................... 1.4 N/A
Ft. Lauderdale, FL.......................................... 1.4 1.4
Oakland, CA................................................. N/A 1.4
---- ----
Total............................................. 37.8% 39.0%
==== ====
</TABLE>
Lender and Product Characteristics
While geographic dispersion is an important component of overall risk
dispersion and it has been a strategy of the Company to reduce its exposure in
the top ten states and top fifteen MSAs, the Company
8
<PAGE> 10
believes the quality of the risk in force should be considered in conjunction
with other elements of risk dispersion, such as product distribution, as well as
CMAC's risk management and underwriting practices.
The following table reflects the percentage of direct risk in force (as
determined on the basis of information available on the date of mortgage
origination) by the categories indicated as of December 31, 1997 and 1996.
DIRECT RISK IN FORCE
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Product Type:
Primary................................................... 94.4% 96.1%
Pool(1)................................................... 5.6 3.9
------- ------
100.0% 100.0%
======= ======
</TABLE>
DIRECT PRIMARY RISK IN FORCE
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Direct Primary Risk in Force (dollars in millions).......... $10,692 $8,352
Lender Concentration:
Top 10 lenders (by original applicant).................... 24.0% 20.7%
Top 20 lenders (by original applicant).................... 33.6% 29.2%
LTV:
95.01% to 97.00%.......................................... 2.6% 2.2%
90.01% to 95.00%.......................................... 45.4 44.1
85.01% to 90.00%.......................................... 46.0 46.7
85.00% and below.......................................... 6.0 7.0
------- ------
Total............................................. 100.0% 100.0%
======= ======
Loan Type:
Fixed..................................................... 82.9% 80.6%
Adjustable rate mortgage ("ARM") (fully indexed)(2)....... 14.7 16.7
ARM (potential negative amortization)(3).................. 2.4 2.7
------- ------
Total............................................. 100.0% 100.0%
======= ======
Mortgage Term:
15 years and under........................................ 3.4% 3.9%
Over 15 years............................................. 96.6 96.1
------- ------
Total............................................. 100.0% 100.0%
======= ======
Property Type:
Non-condominium (principally single-family detached)...... 95.7% 95.2%
Condominium or cooperative................................ 4.3 4.8
------- ------
Total............................................. 100.0% 100.0%
======= ======
Occupancy Status:
Primary residence......................................... 97.2% 97.4%
Second home............................................... 1.1 0.9
Non-owner occupied........................................ 1.7 1.7
------- ------
Total............................................. 100.0% 100.0%
======= ======
</TABLE>
9
<PAGE> 11
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Mortgage Amount:
$200,000 or less.......................................... 88.4% 89.7%
Over $200,000............................................. 11.6 10.3
------- ------
Total............................................. 100.0% 100.0%
======= ======
Loan Purpose:
Purchase.................................................. 84.0% 83.1%
Refinance................................................. 16.0 16.9
------- ------
Total............................................. 100.0% 100.0%
======= ======
</TABLE>
- ---------------
(1) Includes traditional and modified pool insurance.
(2) Refers to loans where payment adjustments are the same as mortgage interest
rate adjustments.
(3) Loans with potential negative amortization will not have increasing
principal balances unless interest rates increase as contrasted with
scheduled negative amortization where an increase in loan balance will occur
even if interest rates do not change.
One of the most important determinants of claim incidence is the relative
amount of borrower's equity in the home, or down payment. The expectation of
claim incidence on loans having an LTV ratio in excess of 90% ("95s") is
approximately two times the expected claim incidence on loans with LTV ratios
equal to or less than 90% and over 85% ("90s"). CMAC believes that the higher
premium rates it charges on 95s adequately reflect the additional risk on these
loans. The industry and CMAC began to insure 97s in 1995. These loans are
expected to have a higher claim incidence than 95s; however, with proper
counseling efforts and by limiting insurance on these loans to sensible
affordable housing programs, it is CMAC's belief that the claim incidence should
not be materially (more than one and one-half times) worse than on 95s, although
this cannot be certain. Early defaults on 97s as compared to other loans have
confirmed CMAC's expectations, although the eventual performance of these loans
cannot yet be accurately projected. Premium rates on 97s are higher than on 95s
to compensate for the additional risk and the higher expected frequency and
severity of claims. The amount of 97s insured in 1997 and 1996 was between 3%
and 4% of the total loans insured each year and the percentage of primary risk
in force on insured 97s went from 2.2% at the end of 1996 to 2.6% at the end of
1997. The percentage of 97s written in 1998 should approximate the 1997 and 1996
figures.
In recent years, CMAC has increased its insurance on mortgages identified
by its customers as "affordable housing" loans. These loans are typically made
to low- and moderate-income borrowers in conjunction with special programs
developed by state or local housing agencies, Fannie Mae or Freddie Mac. Such
programs usually include 95s and 97s and may require certain underwriting
guidelines to be liberalized in order to achieve their objectives. CMAC's
participation in these programs is dependent upon acceptable borrower
counseling. Early default experience on these programs has been worse than non
"affordable housing" loans, however CMAC does not believe the ultimate claims
will materially affect its financial results due to the relatively small amount
of such business combined with higher premium rates and risk-sharing elements.
CMAC's claim frequency on insured ARMs has been higher than on all other
loan types. The Company believes that the risk on ARM loans is greater than on
fixed rate loans due to possible monthly payment increases if interest rates
rise.
The Company believes that 15-year mortgages present a lower level of risk
than 30-year mortgages, primarily as a result of the faster amortization and the
more rapid accumulation of borrower equity in the property. Premium rates for
15-year mortgages are lower to reflect the lower risk.
The Company believes that the risk of claim is also affected by the type of
property securing the insured loan. In the Company's opinion, loans on
single-family detached housing are subject to less risk of claim incidence than
loans on other types of properties. Conversely, loans on attached housing types,
particularly condominiums and cooperatives, are generally considered by the
Company to be a higher risk, due to the
10
<PAGE> 12
higher density of such properties and because a detached unit is the preferred
housing type in most areas. CMAC's more stringent underwriting guidelines on
condominiums and cooperatives reflect this higher expected risk.
The Company believes that the risk of claim on relocation loans and loans
originated by credit unions is extremely low and has begun to offer lower
premium rates on such loans to compensate for the lower risk.
The Company believes that loans on non-owner occupied homes purchased for
investment purposes represent a substantially higher risk of claim incidence,
and are subject to greater value declines than loans on either primary or second
homes. CMAC underwrites loans on non-owner occupied homes more stringently, and
sometimes requires that the investor indemnify CMAC directly for any loss
suffered by CMAC. CMAC also charges a higher premium rate than the rate charged
for insuring loans on owner occupied homes.
The Company believes that higher priced properties experience wider
fluctuations in value than moderately priced residences and that the income of
many people who buy higher priced homes is less stable than that of people with
moderate incomes. Underwriting guidelines for such higher priced properties
reflect this concern.
INVESTMENT PORTFOLIO
The Company's income from its investment portfolio is one of the Company's
primary sources of cash flow to support its operations and claim payments.
The Company follows an investment policy which, at a minimum, requires: (i)
95% of its investment portfolio to consist of cash equivalents and debt
securities (including redeemable preferred stocks) which, at the date of
purchase, were rated investment grade by a nationally recognized rating agency
(e.g., "BBB" or better by S&P), and (ii) at least 50% of its investment
portfolio (together with cash assets) to consist of cash, cash equivalents and
debt securities (including redeemable preferred stocks) which, at the date of
purchase, were rated the highest investment grade by a nationally recognized
rating agency (e.g., "AAA" by S&P). In December 1997, the Company's investment
policy was amended to permit investment in equity securities (including
convertible debt and convertible preferred stock). This equity component is not
permitted to exceed 20% of the total investment portfolio and the Company
intends to begin investing in equity securities in 1998. In addition, all
investments purchased in 1998 will be classified as available for sale in
contrast to the existing portfolio which contains mostly held to maturity
investments.
At December 31, 1997, the Company's investment portfolio had a carrying
value of $596.9 million and a market value of $626.9 million, including $11.0
million of short-term investments. At December 31, 1997, the Company's
investment portfolio did not include any real estate or mortgage loans. It did
include two private placement investment-grade preferred securities with a
carrying value of $2.8 million. At December 31, 1997, 100% of the Company's
investment portfolio (which excludes cash) consisted of cash equivalents and
debt securities (including redeemable preferred stocks) rated investment grade.
The Company's investment policies and strategies are subject to change
depending upon regulatory, economic and market conditions and the then existing
or anticipated financial condition and operating requirements, including the tax
position, of the Company.
11
<PAGE> 13
The diversification of the Company's investment portfolio (other than
short-term investments) at December 31, 1997 is shown in the table below:
INVESTMENT PORTFOLIO DIVERSIFICATION
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-------------------------------------
AMORTIZED
COST FAIR VALUE PERCENT(1)
--------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
Fixed maturities held to maturity:
U.S. government securities(2).................... $ 13,242 $ 13,710 2.7%
State and municipal obligations(3)............... 474,699 504,221 97.3
-------- -------- -----
Total.................................... $487,941 $517,931 100.0%
======== ======== =====
Fixed maturities available for sale:
U.S. government agency securities(2)............. $ 13,605 $ 14,169 14.8%
Redeemable preferred stock(3).................... 78,344 83,793 85.2
-------- -------- -----
Total......................................... $ 91,949 $ 97,962 100.0%
======== ======== =====
</TABLE>
- ---------------
(1) Percentage of amortized cost.
(2) Substantially all of these securities are backed by the full faith and
credit of the U.S. government.
(3) Consists of investment-grade securities.
The following table shows the scheduled maturities of the securities held
in the Company's investment portfolio at December 31, 1997:
INVESTMENT PORTFOLIO SCHEDULED MATURITY(1)
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-------------------------
CARRYING
VALUE PERCENT
-------------- -------
(IN THOUSANDS)
<S> <C> <C>
Short-term investments...................................... $ 11,027 1.9%
Less than one year.......................................... 1,893 0.3
One to five years........................................... 54,892 9.2
Five to ten years........................................... 192,970 32.3
Over ten years.............................................. 238,186 39.9
Mortgage-backed securities(2)............................... 14,169 2.4
Redeemable preferred stock (3).............................. 83,793 14.0
-------- ------
Total............................................. $596,930 100.0%
======== ======
</TABLE>
- ---------------
(1) Actual maturities may differ as a result of calls prior to scheduled
maturity.
(2) Substantially all of these securities are backed by the Government National
Mortgage Association ("GNMA").
(3) No stated maturity date.
12
<PAGE> 14
The following table shows the ratings of the Company's investment portfolio
(other than short-term investments) as of December 31, 1997:
INVESTMENT PORTFOLIO BY S&P RATING
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-------------------------
RATING(1) CARRYING VALUE PERCENT
- --------- -------------- -------
(IN THOUSANDS)
<S> <C> <C>
Fixed maturities:
U.S. government and agency securities..................... $ 27,411 4.7%
AAA....................................................... 363,164 62.0
AA........................................................ 77,909 13.3
A......................................................... 51,782 8.8
BBB....................................................... 22,443 3.8
Not rated(2).............................................. 43,194 7.4
-------- -----
Total............................................. $585,903 100.0%
======== =====
</TABLE>
- ---------------
(1) Current ratings assigned by S&P.
(2) These securities are not rated by S&P, but are rated investment grade by at
least one other nationally recognized securities rating agency.
REGULATION
Direct Regulation
State Regulation
The Company and its insurance subsidiaries are subject to comprehensive,
detailed regulation principally designed for the protection of policyholders,
rather than for the benefit of investors, by the insurance departments in the
various states where the Company and its insurance subsidiaries are licensed to
transact business. Insurance laws vary from state to state, but generally grant
broad supervisory powers to agencies or officials to examine insurance companies
and enforce rules or exercise discretion affecting almost every significant
aspect of the insurance business.
Insurance regulations relate, among other things, to the licensing of
companies to transact business, claims handling, reinsurance requirements,
premium rates and policy forms offered to customers, financial statements,
periodic reporting, permissible investments and adherence to financial standards
relating to surplus, dividends and other criteria of solvency intended to assure
the satisfaction of obligations to policyholders.
Mortgage insurers are generally restricted to writing residential mortgage
guaranty insurance business only. This restriction essentially prohibits CMAC
from using its capital resources in support of other types of insurance or
non-insurance business. The non-insurance businesses of the Company, which
consist of mortgage insurance related services, are not generally subject to
regulation under state insurance laws.
Insurance Holding Company Regulation. All states have enacted legislation
that requires each insurance company in an insurance holding company system to
register with the insurance regulatory authority of its state of domicile and to
furnish to such regulator financial and other information concerning the
operations of companies within the holding company system that may materially
affect the operations, management or financial condition of insurers within the
system.
Because the Company is an insurance holding company and CMAC is a
Pennsylvania insurance company, the Pennsylvania insurance laws regulate, among
other things, certain transactions in the Company's Common Stock and certain
transactions between CMAC, the other insurance subsidiaries and their parent or
affiliates. Specifically, no person may, directly or indirectly, offer to
acquire or acquire "control" of the Company, CMAC or the other insurance
subsidiaries unless such person files a statement and other
13
<PAGE> 15
documents with the Pennsylvania Commissioner of Insurance and obtains the
Commissioner's prior approval. The Commissioner may hold a public hearing on the
matter. "Control" is presumed to exist if 10% or more of CMAC or another of the
Company's insurance subsidiaries' voting securities is owned or controlled,
directly or indirectly, by a person, although the Pennsylvania Commissioner of
Insurance may find that "control" in fact does or does not exist where a person
owns or controls a lesser amount of securities. In addition, material
transactions between CMAC and the Company's other insurance subsidiaries and
their parent or affiliates are subject to certain conditions, including that
they be "fair and reasonable." These restrictions generally apply to all persons
controlling or under common control with CMAC or the Company's other insurance
subsidiaries. Certain transactions between the Company's insurance subsidiaries
and their parent or affiliates may not be entered into unless the Pennsylvania
Commissioner of Insurance is given 30 days prior notification and does not
disapprove the transaction during such 30-day period.
Dividends. The insurance laws of Pennsylvania establish a test limiting
the maximum amount of dividends which may be paid without prior approval by the
Pennsylvania Insurance Commissioner. Under such test, CMAC may pay dividends
during any 12-month period in an amount equal to the greater of: (i) 10% of the
preceding year-end statutory policyholders' surplus or (ii) the preceding year's
statutory net income. In accordance with such restrictions, $93.4 million would
be available for dividends in 1998. However, an amendment to the Pennsylvania
statute, effective in 1994, requires that dividends and other distributions be
paid out of an insurer's unassigned surplus. Because of the unique nature of the
method of accounting for contingency reserves, CMAC has negative unassigned
surplus. Thus, prior approval by the Pennsylvania Insurance commissioner is
required for CMAC to pay dividends or make other distributions so long as CMAC
has negative unassigned surplus. The Pennsylvania Insurance Commissioner has
approved all distributions by CMAC since the passage of this amendment, and
management has every expectation that the Insurance Department will continue to
approve such distributions in the future, provided that the financial condition
of CMAC does not materially change. The State of California has a statute
requiring mortgage insurers to pay dividends or make other distributions out of
unassigned surplus. CMAC and the California Department of Insurance have reached
an understanding under which CMAC will be able to pay dividends or make other
distributions to the Company provided that the financial condition of CMAC does
not materially change.
Risk to Capital. A number of states and Freddie Mac limit a private
mortgage insurer's risk in force to 25 times the insurer's total policyholders'
surplus (which includes the statutory contingency reserve), commonly known as
the "risk-to-capital" requirement. As of December 31, 1997, CMAC's
risk-to-capital ratio was 18.3 to 1, versus 18.4 to 1 in 1996.
Reserves. For statutory reporting, each year CMAC is required to provide
for additions to the contingency reserve in an amount equal to 50% of earned
premiums. Such amounts cannot be withdrawn for a period of 10 years except under
certain circumstances. The contingency reserve, designed to be a reserve against
catastrophic losses, essentially restricts dividends and other distributions by
CMAC. Prior to 1995, CMAC had included the contingency reserve as a component of
policyholders' surplus. The Pennsylvania Insurance Department has determined
that the contingency reserve should be classified as a liability in the
statutory balance sheet rather than as a component of policyholders' surplus. In
response to this determination, commencing in January 1995, CMAC began
classifying the contingency reserve as a liability. At December 31, 1997, CMAC
had policyholders' surplus of $148.1 million and a contingency reserve of $364.4
million.
Premium Rates and Policy Forms. CMAC's premium rates and policy forms are
subject to regulation in every state in which it is licensed to transact
business in order to protect policyholders against the adverse effects of
excessive, inadequate or unfairly discriminatory rates and to encourage
competition in the insurance marketplace. In most states, premium rates and
policy forms must be filed prior to their use. In some states, such rates and
forms must also be approved prior to use. Changes in premium rates are subject
to justification, generally on the basis of the insurer's loss experience,
expenses and future trend analysis. The general default experience in the
mortgage insurance industry may also be considered.
Reinsurance. Certain restrictions apply under the laws of several states
to any licensed company ceding business to an unlicensed reinsurer. Under such
laws, if a reinsurer is not admitted or approved in such states,
14
<PAGE> 16
the company ceding business to the reinsurer cannot take credit in its statutory
financial statements for the risk ceded to such reinsurer absent compliance with
certain reinsurance security requirements. In addition, several states also have
special restrictions on mortgage guaranty insurance. Also, several states limit
the amount of risk a mortgage insurer may retain with respect to coverage on an
insured loan to 25% of the insured's claim amount. Coverage in excess of 25%
(i.e., deep coverage) must be reinsured.
Examination. The Company's insurance subsidiaries are subject to
examination of their affairs by the insurance departments of each of the states
in which they are licensed to transact business.
Federal Regulation
RESPA. The origination or refinance of a federally regulated mortgage loan
is a settlement service, and therefore subject to the Real Estate Settlement
Practices Act of 1974, and the regulations promulgated thereunder (collectively,
"RESPA"). In December 1992, regulations were issued which made clear that
mortgage insurance is also a settlement service, and therefore, that mortgage
insurers are subject to the provisions of Section 8(a) of RESPA, which generally
prohibits persons from accepting anything of value for referring real estate
settlement services to any provider of such services. Although many states
prohibit mortgage insurers from giving rebates, RESPA has been interpreted to
cover many non-fee services as well. HUD's interest in pursuing violations of
RESPA has increased awareness of both mortgage insurers and their customers of
the possible sanctions of this law.
HMDA. Most originators of mortgage loans are required to collect and
report data relating to a mortgage loan applicant's race, nationality, gender,
marital status and census tract to HUD or the Federal Reserve under the Home
Mortgage Disclosure Act of 1975 ("HMDA"). The purpose of HMDA is to detect
possible discrimination in home lending and, through disclosure, to discourage
such discrimination. Mortgage insurers are not required pursuant to any law or
regulation to report HMDA data, although under the laws of several states,
mortgage insurers are currently prohibited from discriminating on the basis of
certain classifications.
The active mortgage insurers, through their trade association, Mortgage
Insurance Companies of America ("MICA"), entered into an agreement with the
Federal Financial Institutions Examinations Council ("FFIEC") to report the same
data on loans submitted for insurance as is required for most mortgage lenders
under HMDA. The first report of HMDA-type data was collected by MICA from its
members for the fourth quarter of 1993 and reported to the FFIEC in the first
quarter of 1994. Subsequent reports of HMDA-type data for the mortgage insurance
industry were submitted by MICA to the FFIEC in March 1995, 1996 and 1997.
Management is not aware of any pending or expected actions by governmental
agencies in response to the reports submitted by MICA to the FFIEC.
MI Cancellation. From time to time, proposals have been advanced in both
houses of Congress which would permit or require cancellation of mortgage
insurance under certain conditions. In 1997, such proposals resulted in one bill
that passed in the House of Representatives and another bill approved by the
Senate. Such proposals would impose certain new requirements, the most
significant of which would require termination of mortgage insurance when a
loan's LTV ratio reaches a specified level, set at 78% in the Senate bill and
80% in the House of Representatives bill. Bills intending to accomplish the same
result have also been introduced in several state legislatures. Such bills
propose the automatic cancellation of mortgage insurance certificates upon the
occurrence of a triggering event such as the reduction of the LTV ratio to a
specified level, the aging of the loan for a specified number of years, or some
combination. Additionally, Fannie Mae has indicated its intention to issue
guidelines to its seller/servicers which would require the automatic
cancellation of mortgage insurance with similar triggering parameters. The
Company cannot predict if or when any of the foregoing legislation or guidelines
will be adopted or effective, but if adopted, and depending upon the nature and
extent of the cancellation parameters required, the persistency of CMAC's
insured loans could be adversely affected. The Company feels that any possible
outcome will have an immaterial impact on CMAC's insured book of business and on
the Company's financial results.
15
<PAGE> 17
Other Direct Regulation
Freddie Mac and Fannie Mae
As the most significant purchasers and sellers of conventional mortgage
loans and beneficiaries of private mortgage insurance, Freddie Mac and Fannie
Mae impose requirements on private mortgage insurers in order for such insurers
to be eligible to insure loans sold to such agencies. Freddie Mac's current
eligibility requirements impose limitations on the type of risk insured,
standards for the geographic and customer diversification of risk, procedures
for claims handling, acceptable underwriting practices and financial
requirements which generally mirror state insurance regulatory requirements.
These requirements are subject to change from time to time. Fannie Mae also has
eligibility requirements, although such requirements are not published. CMAC is
an approved mortgage insurer for both Freddie Mac and Fannie Mae.
In 1995, Freddie Mac and Fannie Mae began to require deeper coverage on
certain loans with LTV ratios greater than 85%. The Company believes that this
deeper coverage will not have a material effect on its financial results,
although premiums earned and the provision for losses will increase and the
risk-to-capital ratio will be higher as a result of the increase in risk.
In 1995, CMAC issued a new Master Policy which applies to all business
written after June 1, 1995. Changes in the terms include a broader scope of
coverage for certain environmental and bankruptcy related claims, and somewhat
more limited rights to reject claim payments, neither of which the Company
believes will have a material adverse effect on CMAC's operations or financial
results. The new Master Policy has been approved by Fannie Mae and Freddie Mac,
as well as by all states which require approval of policy forms.
Indirect Regulation
The Company and CMAC are also indirectly, but significantly, impacted by
regulations affecting originators and purchasers of mortgage loans, particularly
Freddie Mac and Fannie Mae, and regulations affecting governmental insurers such
as the FHA and VA. Private mortgage insurers, including CMAC, are highly
dependent upon federal housing legislation and other laws and regulations which
affect the demand for private mortgage insurance and the housing market
generally. For example, legislation which increases the number of persons
eligible for FHA or VA mortgages could have a material adverse effect on the
Company's ability to compete with the FHA or VA.
From time to time, budgets proposed by the President have included
proposals that would raise the FHA single-family loan limit. A similar proposal
is expected to be included in President Clinton's proposed 1998-99 budget. The
Company cannot predict when or if such a proposal will be adopted, but if
adopted, demand for private mortgage insurance may be adversely affected.
Proposals have been advanced which would allow Fannie Mae and Freddie Mac
additional flexibility in determining the amount and nature of alternative
recourse arrangements or other credit enhancements which they could utilize as
substitutes for private mortgage insurance. The Company cannot predict if or
when any of the foregoing legislation or proposals will be adopted, but if
adopted and depending upon the nature and extent of revisions made, demand for
private mortgage insurance may be adversely affected. There can be no assurance
that other federal laws affecting such institutions and entities will not
change, or that new legislation or regulations will not be adopted. In addition,
Fannie Mae and Freddie Mac have entered into, and may in the future seek to
enter into, alternative recourse arrangements or other credit enhancements based
on their existing legislative authority.
Political pressures to simplify the nation's tax code could, among other
things, result in the partial or entire loss of the U.S. federal income tax
deduction for mortgage loan interest, which could result in downward pressure on
housing prices. Any reduction or loss of such deduction could reduce the volume
of low down payment mortgages originated and private mortgage insurance written
and adversely impact mortgage default patterns, and could materially affect the
Company's business.
Recent discussions with the Federal Trade Commission with regard to the
adverse action disclosure provisions of the Fair Credit Reporting Act ("FCRA")
have raised the possibility that CMAC will need to
16
<PAGE> 18
make certain changes to its loan servicing and tracking procedures in order to
give FCRA adverse action notices directly to borrowers. The Company does not
believe that such changes will have a material effect on its operations.
There can be no assurance that the above-mentioned federal laws and
regulations or other federal laws and regulations affecting lenders, private and
governmental mortgage insurers, or purchasers of insured mortgage loans, will
not be amended, or that new legislation or regulations will not be adopted, in
either case, in a manner which will adversely affect the demand for private
mortgage insurance.
YEAR 2000 ISSUE
Many existing computer programs use only two digits to identify a year in
the date field. These programs were designed and developed without considering
the impact of the upcoming change in the century. If not corrected, many
computer applications could fail or create erroneous results by or at the year
2000. The Company has conducted an analysis of its systems and has concluded
that all such systems will be Year 2000 compliant by the end of 1998. "Year 2000
compliant" means fault free performance in the processing of data and date
related data (including, but not limited to, calculating, comparing and
sequencing) by all hardware and software products, individually and in
combination. Fault free performance must include the manipulation of data when
dates are in the 20th or 21st century and must be transparent to the user.
Nevertheless, in the event that third parties with whom the Company transacts
business are not Year 2000 compliant, potential for an adverse effect on the
Company's operations may remain. The Company is taking precautions to minimize
this risk. The Company expects that its Year 2000 compliance program will not
result in any material costs nor have any material impact on its financial
condition.
EMPLOYEES
At December 1997, CMAC had 607 employees, of which approximately one-third
were located at its Philadelphia headquarters facility. CMAC's employees are not
unionized and management considers employee relations to be very good.
ITEM 2. PROPERTIES
The Company leases approximately 59,000 square feet for its corporate
headquarters in Philadelphia under leases which expire in 2003. In addition,
CMAC leases space for its Divisional, Service Center and On-Site offices
throughout the United States comprising approximately 57,000 square feet with
leases expiring between 1997 and 2001. With respect to all facilities, the
Company believes it will be able to obtain satisfactory lease renewal terms.
The Company believes its existing properties are well utilized and are
suitable and adequate for its present circumstances.
The Company maintains a mini-computer network from its corporate data
center located in its headquarters building to support its data processing
requirements for accounting, claims, marketing, risk management, underwriting
and non-insurance operations. In 1997, the Company centralized all computer
operations. All the service centers are linked to the home office in
Philadelphia via a high speed frame-relay network. The centralized environment
is based on the Business Recovery Server (BRS) architecture. The BRS consists of
two geographically dispersed, identical data centers. Each data center is
currently running at 30% of capacity. Either data center is capable of
supporting the entire company. The data centers are linked via a fibre-optic
link allowing simultaneous data updates through disk shadowing. Each center is
part of a separate power grid. This redundant configuration provides disaster
tolerance and automatic back-up, resource sharing and fail-over.
ITEM 3. LEGAL PROCEEDINGS
CMAC is involved in certain litigation arising in the normal course of its
business. CMAC is contesting the allegations in each pending action and
believes, based on current knowledge and after consultation with
17
<PAGE> 19
counsel, that the outcome of such litigation will not have a material adverse
effect on the Company's consolidated financial position and results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of 1996 to a vote of
holders of the Company's common stock.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Information with respect to this item is included on the inside back cover
of the Company's 1997 Annual Report to Stockholders and is incorporated herein
by reference.
ITEM 6. SELECTED FINANCIAL DATA
The information set forth in the tables on page 14 of the Company's 1997
Annual Report to Stockholders under the caption "Selected Financial and
Statistical Data" is hereby incorporated by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information set forth on pages 32 through 35 in the Company's 1997
Annual Report to Stockholders under the caption "Management's Discussion and
Analysis" is hereby incorporated by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated statements of income, of changes in common stockholders'
equity and cash flows for each of the years in the three-year period ended
December 31, 1997, and the related consolidated balance sheets of the Company as
of December 31, 1997 and 1996, together with the related notes thereto and the
independent auditors' report, as well as the unaudited quarterly financial data,
all set forth on pages 15 through 31 of the Company's 1997 Annual Report to
Stockholders, are hereby incorporated by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information on the directors and executive officers of the Registrant
is included in the Company's Proxy Statement for the 1998 Annual Meeting of
Stockholders, and is hereby incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
This information is included in the Company's Proxy Statement for the 1998
Annual Meeting of Stockholders, and is hereby incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This information is included in the Company's Proxy Statement for the 1998
Annual Meeting of Stockholders, and is hereby incorporated by reference.
18
<PAGE> 20
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information is included in the Company's Proxy Statement for the 1998
Annual Meeting of Stockholders, and is hereby incorporated by reference.
PART IV
ITEM 14. FINANCIAL STATEMENT SCHEDULES, EXHIBITS AND REPORTS ON FORM 8-K
(a) 1. Financial statements -- The financial statements listed in the
accompanying Index to Consolidated Financial Statements and
Financial Statement Schedules are filed as part of this Form 10-K.
2. Financial statement schedules -- The financial statement schedules
listed in the accompanying Index to Consolidated Financial
Statements and Financial Statement Schedules are filed as part of
this Form 10-K.
3. Exhibits -- The exhibits listed in the accompanying Index to
Exhibits are filed as part of this Form 10-K.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended December 31,
1997.
19
<PAGE> 21
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
(ITEMS 14(A)1 AND 2)
<TABLE>
<CAPTION>
PAGE
----------------------
ANNUAL
FORM REPORT TO
10-K STOCKHOLDERS*
----- -------------
<S> <C> <C>
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated balance sheets at December 31, 1997 and 1996... -- 15
Consolidated statements of income for each of the three
years in the period ended December 31, 1997............... -- 16
Consolidated statements of changes in common stockholders'
equity for each of the three years in the period ended
December 31, 1997......................................... -- 17
Consolidated statements of cash flows for each of the three
years in the period ended December 31, 1997............... -- 18
Notes to consolidated financial statements.................. -- 19-31
Independent auditors' report................................ -- 31
FINANCIAL STATEMENT SCHEDULES
Independent auditors' report on financial statement
schedules................................................. 24 --
Schedule I -- Summary of investments -- other than
investments in related parties (December 31, 1997).... 25 --
Schedule III -- Condensed financial information of
Registrant (December 31, 1997)........................ 26-30 --
Schedule VI -- Reinsurance (December 31, 1997)......... 31 --
</TABLE>
All other schedules are omitted since the required information is not
present or is not present in amounts sufficient to require submission of the
schedules, or because the information required is included in the consolidated
financial statements and notes thereto.
- ---------------
* Incorporated by reference from the indicated pages of the 1997 Annual Report
to Stockholders.
20
<PAGE> 22
INDEX TO EXHIBITS
(ITEM 14(a)3)
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT
------- -------
<C> <C> <S>
3.1 -- Amended and restated Certificate of Incorporation of the
Company.(2)(Exhibit 3.1)
3.2 -- Amended and restated by-laws of the Company.(4)(Exhibit 3.2)
4.1 -- Specimen certificate for Common Stock.(1)(Exhibit 4.1)
4.2 -- Certificate of Designations relating to $4.125 Preferred
Stock of the Company.(2)(Exhibit 4.2)
4.3 -- Specimen certificate for $4.125 Preferred Stock of the
Company.(1)(Exhibit 4.3)
4.4 -- Standstill and Voting Agreement dated October 27, 1992
between the Company and Reliance Group Holdings,
Inc.(2)(Exhibit 4.4)
10.1 -- Service Agreement dated July 20, 1992, between Commonwealth
Mortgage Assurance Company and Commonwealth Land Title
Insurance Company.(1)(Exhibit 10.1)
10.2 -- Amended Sublease Agreement dated June 15, 1993, between
Commonwealth Mortgage Assurance Company and Commonwealth
Land Title Insurance Company.(3)(Exhibit 10.2)
10.3 -- Tax Indemnification Agreement dated October 28, 1992 among
the Company, Commonwealth Land Title Insurance Company,
Reliance Insurance Company and Reliance Group Holdings,
Inc.(2)(Exhibit 10.3)
10.4 -- Tax Allocation Agreement dated as of April 1, 1992, among
Reliance Insurance Company and certain of its subsidiaries,
including Commonwealth Mortgage Assurance Company.(1)
(Exhibit 10.4)
10.5 -- Employment Agreement dated August 1, 1992, between the
Company and Herbert Wender.(1)(8)(Exhibit 10.5)
10.6 -- Form of Change of Control Agreement dated January 25, 1995,
between the Company and each of Frank P. Filipps, Douglas J.
MacLeod, Harry A. Levine, Paul F. Fischer, C. Robert Quint,
and Thomas J. Shelly, Jr.(5)(8)(Exhibit 10.6)
*10.7 -- Change of Control Agreements dated October 30, 1997, between
the Company and both Howard S. Yaruss and William
Carroll.(8)
10.8 -- CMAC Investment Corporation Pension Plan.(2)(8)
(Exhibit 10.8)
10.9 -- CMAC Investment Corporation Savings Incentive Plan, as
amended and restated through January 1, 1994.(5)(8)
(Exhibit 10.9)
10.10 -- CMAC Investment Corporation 1992 Stock Option Plan as
amended as of January 1, 1995.(5)(8)(Exhibit 10.10)
10.11 -- CMAC Investment Corporation Equity Compensation Plan.
(5)(8)(Exhibit 10.11)
10.12 -- Purchase Agreement dated October 29, 1992 between the
Company and Commonwealth Land Title Insurance Company
regarding $4.125 Preferred Stock.(2)(Exhibit 10.14)
10.13 -- Registration Rights Agreement dated October 27, 1992 between
the Company and Commonwealth Land Title Insurance
Company.(2)(Exhibit 10.15)
10.14 -- Form of Commonwealth Mortgage Assurance Company Master
Policy.(1)(Exhibit 10.16)
10.15 -- Risk-to-Capital Ratio Maintenance Agreement between the
Company and Commonwealth Mortgage Assurance Company
regarding matters relating to Moody's financial strength
rating as amended through October 22, 1993.(3)
(Exhibit 10.15)
10.16 -- Reserve Account Agreement dated August 14, 1992, between the
Company and Commonwealth Mortgage Assurance Company
regarding $4.125 Preferred Stock.(1)(Exhibit 10.18)
10.17 -- First Layer Binder of Reinsurance, effective March 1, 1992,
among Commonwealth Mortgage Assurance Company, Commonwealth
Mortgage Assurance Company of Arizona, AXA Reinsurance SA.
(1)(Exhibit 10.19)
10.18 -- Capital Mortgage Reinsurance Company Variable Quota Share
Reinsurance Agreement, effective January 1, 1994, between
Commonwealth Mortgage Assurance Company and its affiliates
and Capital Mortgage Reinsurance Company.(4)(Exhibit 10.19)
</TABLE>
21
<PAGE> 23
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT
------- -------
<C> <C> <S>
10.19 -- Capital Reinsurance Company Reinsurance Agreement, effective
January 1, 1994, between Commonwealth Mortgage Assurance
Company and Capital Reinsurance Company.(4)(Exhibit 10.20)
10.20 -- Capital Mortgage Reinsurance Company Variable Quota Share
Reinsurance Agreement, effective January 1, 1995, between
Commonwealth Mortgage Assurance Company and its affiliates
and Capital Mortgage Reinsurance Company.(5)(Exhibit 10.20)
10.21 -- Capital Mortgage Reinsurance Company Variable Quota Share
Reinsurance Agreement, effective January 1, 1996, between
Commonwealth Mortgage Assurance Company and its affiliates
and Capital Mortgage Reinsurance Company.(6)(Exhibit 10.21)
10.22 -- Amended form of Commonwealth Mortgage Assurance Company
Master Policy, effective June 1, 1995.(4)(Exhibit 10.22)
10.23 -- Employment Agreement, dated December 30, 1994, between the
Company and James C. Miller.(4)(8)(Exhibit 10.21)
10.24 -- CMAC Investment Corporation 1997 Employee Stock Purchase
Plan.(7)(Exhibit 10)
*13.1 -- 1997 Annual Report of the Company to Stockholders. Except to
the extent incorporated in this Annual Report on 10-K, this
Exhibit is not being "filed" for purposes of Section 18 of
the Securities Exchange Act of 1934 or otherwise.
22.1 -- Subsidiaries of the Company.(1)(Exhibit 22.1)
*24.1 -- Consent of Deloitte & Touche.
*27 -- Financial Data Schedule.
</TABLE>
- ---------------
* Filed herewith.
(1) Incorporated by reference to the exhibit identified in parentheses, filed as
an exhibit in the Registrant's Registration Statement on Form S-1 filed
August 24, 1992 and amendments thereto (File No. 33-51188).
(2) Incorporated by reference to the exhibit identified in parentheses, filed as
an exhibit in the Registrant's Annual Report on Form 10-K filed March 30,
1993.
(3) Incorporated by reference to the exhibit identified in parentheses, filed as
an exhibit in the Registrant's Annual Report on Form 10-K filed March 30,
1994.
(4) Incorporated by reference to the exhibit identified in parentheses, filed as
an exhibit in the Registrant's Annual Report on Form 10-K filed March 30,
1995.
(5) Incorporated by reference to the exhibit identified in parentheses, filed as
an exhibit in the Registrant's Annual Report on Form 10-K filed March 29,
1996.
(6) Incorporated by reference to the exhibit identified in parentheses, filed as
an exhibit in the Registrant's Annual Report on Form 10-k filed March 31,
1997.
(7) Incorporated by reference to the exhibit identified in parentheses, filed as
an exhibit in the Registrant's Registration Statement on Form S-8 filed
November 19, 1997 (File No. 333-40623).
(8) Management contract or compensatory plan or arrangement required to be filed
pursuant to Item 14(c) of Form 10-K.
22
<PAGE> 24
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on March 31, 1998.
CMAC Investment Corporation
By: /s/ FRANK P. FILIPPS
------------------------------------
Frank P. Filipps
(principal executive officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on March 31, 1998 by the following persons on
behalf of the registrant and in the capacities indicated.
<TABLE>
<CAPTION>
NAME TITLE
---- -----
<S> <C>
/s/ HERBERT WENDER Chairman of the Board and Director
- ---------------------------------------------------
Herbert Wender
/s/ FRANK P. FILIPPS President, Chief Executive Officer and Director
- ---------------------------------------------------
Frank P. Filipps
/s/ C. ROBERT QUINT Senior Vice President, Chief Financial Officer
- --------------------------------------------------- (principal accounting officer)
C. Robert Quint
/s/ DAVID C. CARNEY Director
- ---------------------------------------------------
David C. Carney
/s/ CLAIRE M. FAGIN, PH.D., R.N. Director
- ---------------------------------------------------
Claire M. Fagin, Ph.D., R.N.
/s/ JAMES W. JENNINGS Director
- ---------------------------------------------------
James W. Jennings
/s/ JAMES C. MILLER Director
- ---------------------------------------------------
James C. Miller
/s/ RONALD W. MOORE Director
- ---------------------------------------------------
Ronald W. Moore
/s/ ROBERT W. RICHARDS Director
- ---------------------------------------------------
Robert W. Richards
/s/ ANTHONY W. SCHWEIGER Director
- ---------------------------------------------------
Anthony W. Schweiger
</TABLE>
23
<PAGE> 25
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
CMAC Investment Corporation
Philadelphia, Pennsylvania
We have audited the consolidated financial statements of CMAC Investment
Corporation and subsidiaries (the "Company") as of December 31, 1997 and 1996,
and for each of the three years in the period ended December 31, 1997, and have
issued our report thereon dated January 30, 1998; such consolidated financial
statements and report are included in your 1997 Annual Report to Stockholders
and are incorporated herein by reference. Our audits also included the
consolidated financial statement schedules of CMAC Investment Corporation and
subsidiaries, listed in Item 14. These consolidated financial statement
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion based on our audits. In our opinion, such consolidated
financial statement schedules, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly in all
material respects the information set forth therein.
/s/ DELOITTE & TOUCHE LLP
Deloitte & Touche LLP
Philadelphia, Pennsylvania
January 30, 1998
24
<PAGE> 26
CMAC INVESTMENT CORPORATION
SCHEDULE I
SUMMARY OF INVESTMENTS -- OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 1997
<TABLE>
<CAPTION>
AMOUNT
AT WHICH
SHOWN ON
AMORTIZED FAIR THE BALANCE
TYPE OF INVESTMENT COST VALUE SHEET
- ------------------ --------- ----- -----------
(in thousands)
<S> <C> <C> <C>
Fixed Maturities:
Bonds:
United States government and government agencies and
authorities......................................... $ 26,847 $ 27,879 $ 27,411
State and municipal obligations....................... 474,699 504,221 474,699
Redeemable preferred stock............................ 78,344 83,793 83,793
-------- -------- --------
Total fixed maturities..................................... 579,890 615,893 585,903
Short-term investments..................................... 11,027 11,027 11,027
-------- -------- --------
Total investments other than investments in related
parties.................................................. $590,917 $626,920 $596,930
======== ======== ========
</TABLE>
25
<PAGE> 27
CMAC INVESTMENT CORPORATION
SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS
PARENT COMPANY ONLY
<TABLE>
<CAPTION>
DECEMBER 31
--------------------
1997 1996
---- ----
(in thousands)
<S> <C> <C>
Assets
Investments
Fixed maturities held to maturity -- at amortized
cost.................................................. $ 9,734 $ 9,713
Short-term investments................................. 30 491
Cash...................................................... 60 52
Investment in subsidiaries, at equity in net assets....... 461,010 387,014
Federal income taxes...................................... 156 286
Other assets.............................................. 504 247
-------- --------
$471,494 $397,803
======== ========
Liabilities and Stockholders' Equity
Accounts payable -- affiliates............................ $ 995 $ 973
Accounts payable -- other................................. 143 73
Other liabilities......................................... 413 413
-------- --------
1,551 1,459
-------- --------
Preferred stockholder's equity
Redeemable preferred stock, par value $.001 per share;
800,000 shares issued and outstanding at redemption
value.................................................. 40,000 40,000
-------- --------
Common stockholders' equity
Common stock, par value $.001 per share; 80,000,000 shares
authorized; 22,536,674 and 22,395,124 shares,
respectively, issued and outstanding................... 22 22
Additional paid-in capital................................ 179,846 176,431
Retained earnings......................................... 246,166 177,195
Net unrealized gain on investments, net of tax............ 3,909 2,696
-------- --------
429,943 356,344
-------- --------
$471,494 $397,803
======== ========
</TABLE>
See supplementary notes.
26
<PAGE> 28
CMAC INVESTMENT CORPORATION
SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF INCOME
PARENT COMPANY ONLY
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-----------------------------
1997 1996 1995
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Revenues
Equity in undistributed net income of subsidiaries........ $71,249 $62,800 $45,284
Dividends received from subsidiaries...................... 4,300 -- 6,000
Net investment income..................................... 819 776 790
------- ------- -------
76,368 63,576 52,074
------- ------- -------
Expenses
Operating expenses........................................ 1,734 1,693 1,543
------- ------- -------
Pretax income............................................... 74,634 61,883 50,531
Income tax benefit.......................................... 333 338 273
------- ------- -------
Net income.................................................. $74,967 $62,221 $50,804
======= ======= =======
</TABLE>
See supplementary notes.
27
<PAGE> 29
CMAC INVESTMENT CORPORATION
SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
PARENT COMPANY ONLY
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------
1997 1996 1995
---- ---- ----
(in thousands)
<S> <C> <C> <C>
Cash flows from operating activities
Net income............................................... $ 74,967 $ 62,221 $ 50,804
Adjustments to reconcile net income to net cash provided
by operating activities
Equity in undistributed net income of subsidiaries....... (71,249) (62,800) (45,284)
Increase in federal income taxes......................... 130 532 271
Net change in other assets, accounts payable and other
liabilities........................................... (165) 3,955 (3,495)
-------- -------- --------
Net cash provided by operating activities.................. 3,683 3,908 2,296
-------- -------- --------
Cash flows from investing activities
Sales of short-term investments -- net................... 461 4 35
Other.................................................... (21) (19) (18)
-------- -------- --------
Net cash provided by (used in) investing activities........ 440 (15) 17
-------- -------- --------
Cash flows from financing activities
Dividends paid........................................... (5,996) (5,646) (5,511)
Capital contribution..................................... (34) -- --
Proceeds from issuance of common stock................... 1,915 1,581 3,274
-------- -------- --------
Net cash used in financing activities...................... (4,115) (4,065) (2,237)
-------- -------- --------
Increase (decrease) in cash................................ 8 (172) 76
Cash, beginning of year.................................... 52 224 148
-------- -------- --------
Cash, end of year.......................................... $ 60 $ 52 $ 224
======== ======== ========
</TABLE>
See supplementary notes.
28
<PAGE> 30
CMAC INVESTMENT CORPORATION
SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY
SUPPLEMENTARY NOTES
NOTE A
The accompanying Parent Company financial statements should be read in
conjunction with the Consolidated Financial Statements and Notes to Consolidated
Financial Statements appearing on pages 15 through 31 of the CMAC Investment
Corporation 1997 Annual Report to Stockholders.
NOTE B
CMAC Investment Corporation (the "Company") was incorporated in December,
1991 in order to hold the capital stock of Commonwealth Mortgage Assurance
Company ("CMAC"). In the fourth quarter of 1992, a merger among controlled
subsidiaries of CMAC was consummated with the effect that the Company acquired
all of the outstanding stock of CMAC, and CMAC's sole stockholder, Commonwealth
Land Title Insurance Company ("Commonwealth"), then an indirect wholly owned
subsidiary of Reliance Group Holdings, Inc., acquired all of the outstanding
capital stock of the Company.
In the fourth quarter of 1992, the initial public offering of the Company's
common stock (the "Offering") was consummated. In the Offering, Commonwealth
sold all of the 7,000,000 shares owned by it, and the Company issued and sold
3,950,000 shares. In addition, the Company issued and sold 800,000 shares of
$4.125 Preferred Stock to Commonwealth. Aggregate proceeds to the Company from
the sale of common stock were approximately $67,200,000 and from the sale of
preferred stock were $40,000,000.
The preferred stock, issued in connection with the Offering, is entitled to
cumulative annual dividends of $4.125 per share, payable quarterly in arrears.
The preferred stock is redeemable at the option of the Company at $54.125 per
share on or after August 15, 2002, and declining to $50.00 per share on or after
August 15, 2005 (plus in each case accumulated and unpaid dividends), or is
subject to mandatory redemption at a redemption price of $50.00 per share plus
accumulated and unpaid dividends based upon specified annual sinking fund
requirements from 2002 to 2011.
The Company is a holding company whose principal source of income is
dividends from CMAC. The ability of CMAC to pay dividends on its common stock is
restricted by certain provisions of the insurance laws of the Commonwealth of
Pennsylvania, its state of domicile. The insurance laws of Pennsylvania
establish a test limiting the maximum amount of dividends which may be paid by
an insurer without prior approval by the Pennsylvania Insurance Commissioner.
Under such test, CMAC may pay dividends during any 12-month period in an amount
equal to the greater of (i) 10% of the preceding year-end statutory
policyholders' surplus or (ii) the preceding year's statutory net income. In
accordance with such restrictions, $93,390,000 would be available for dividends
in 1998. However, an amendment to the Pennsylvania statute, effective in 1994,
requires that dividends and other distributions be paid out of an insurer's
unassigned surplus. Because of the unique nature of the method of accounting for
contingency reserves, CMAC has negative unassigned surplus. Thus, prior approval
by the Pennsylvania Insurance Commissioner is required for CMAC to pay dividends
or make other distributions so long as CMAC has negative unassigned surplus. The
Pennsylvania Insurance Commissioner has approved all distributions by CMAC since
the passage of this amendment and management has every expectation that the
Commissioner of Insurance will continue to approve such distributions in the
future, provided that the financial condition of CMAC does not materially
change.
The State of California has a statute requiring mortgage insurers to pay
dividends or make other distributions out of unassigned surplus. CMAC and the
California Department of Insurance have reached an understanding under which
CMAC will be able to pay dividends or make other distributions to the Company
provided that the financial condition of CMAC does not materially change.
In addition, CMAC's current excess of loss reinsurance arrangement
prohibits the payment of any dividend which would have the effect of reducing
its total policyholders' surplus (which includes contingency
29
<PAGE> 31
CMAC INVESTMENT CORPORATION
SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
PARENT COMPANY ONLY
SUPPLEMENTARY NOTES (CONTINUED)
reserve) below $85,000,000. As of December 31, 1997, CMAC's total policyholders'
surplus was $512,469,000.
The Company and CMAC have entered into an agreement pursuant to which the
Company has agreed to establish and, for so long as any shares of $4.125
Preferred Stock remain outstanding, maintain a reserve account in an amount
equal to three years of dividend payments on the outstanding shares of $4.125
Preferred Stock (currently $9.9 million), and not to pay dividends on the common
stock at any time when the amount in the reserve account is less than three
years of dividend payments on the shares of $4.125 Preferred Stock then
outstanding. This agreement between the Company and CMAC provides that the
holders of the $4.125 Preferred Stock are entitled to enforce the agreement's
provisions as if such holders were signatories to the agreement.
The Company may not pay any dividends on shares of common stock unless the
Company has paid all accrued dividends on and has complied with all sinking fund
and redemption obligations relating to its outstanding shares of $4.125
Preferred Stock.
NOTE C
On October 15, 1996, the Board of Directors authorized a stock split, paid
on December 2, 1996, in the form of a dividend of one additional share of the
Company's common stock for each share owned by stockholders of record on
November 7, 1996. The dividend was accounted for as a two-for-one stock split
and par value remained at $.001 per share.
Accordingly, all references to common share and per-share data have been
adjusted to give effect to the stock split.
30
<PAGE> 32
CMAC INVESTMENT CORPORATION
SCHEDULE VI -- REINSURANCE
MORTGAGE INSURANCE PREMIUMS EARNED
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
ASSUMED PERCENTAGE
CEDED TO FROM OF AMOUNT
GROSS OTHER OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
------ --------- --------- ------ ----------
(in thousands)
<S> <C> <C> <C> <C> <C>
1997................................ $258,148 $20,619 $181 $237,710 0.08%
======== ======= ==== ========
1996................................ $203,042 $15,268 $147 $187,921 0.08%
======== ======= ==== ========
1995................................ $145,139 $ 8,185 $180 $137,134 0.13%
======== ======= ==== ========
</TABLE>
31
<PAGE> 33
(Recycle LOGO)
This document has been printed entirely on recycled paper.
<PAGE> 34
EXHIBIT INDEX
EXHIBITS, INCLUDING THOSE INCORPORATED BY REFERENCE.
The following is a list of exhibits filed as part of this Annual
Report on Form 10-K. Where so indicated by footnote, exhibits which were
previously filed are incorporated by reference. For exhibits incorporated by
reference, the location of the exhibit in the previous filing is indicated in
parentheses. The page numbers listed refer to the page numbers where such
exhibits are located using the sequential numbering system specified by Rules
0-3 and 403.
EXHIBIT PAGE
NUMBER EXHIBIT
- ------- -------
3.1 Amended and restated Certificate of Incorporation of the
Company.(2)(Exhibit 3.1)
3.2 Amended and restated by-laws of the Company. (4) (Exhibit 3.2)
4.1 Specimen certificate for Common Stock.(1)(Exhibit 4.1)
4.2 Certificate of Designations relating to $4.125 Preferred Stock
of the Company.(2)(Exhibit 4.2)
4.3 Specimen certificate for $4.125 Preferred Stock of the
Company.(1)(Exhibit 4.3)
4.4 Standstill and Voting Agreement dated October 27, 1992 between
the Company and Reliance Group Holdings, Inc.(2)(Exhibit 4.4)
10.1 Service Agreement dated July 20, 1992, between Commonwealth
Mortgage Assurance Company and Commonwealth Land Title
Insurance Company.(1)(Exhibit 10.1)
10.2 Amended Sublease Agreement dated June 15, 1993, between
Commonwealth Mortgage Assurance Company and Commonwealth Land
Title Insurance Company.(3)(Exhibit 10.2)
10.3 Tax Indemnification Agreement dated October 28, 1992 among the
Company, Commonwealth Land Title Insurance Company, Reliance
Insurance Company and Reliance Group Holdings, Inc.(2)(Exhibit
10.3)
10.4 Tax Allocation Agreement dated as of April 1, 1992, among
Reliance Insurance Company and certain of its subsidiaries,
including Commonwealth Mortgage Assurance Company.(1)(Exhibit
10.4)
10.5 Employment Agreement dated August 1, 1992, between the Company
and Herbert Wender.(1)(8)(Exhibit 10.5)
10.6 Form of Change of Control Agreement dated January 25, 1995,
between the Company and each of Frank P. Filipps, Douglas J.
MacLeod, Harry A. Levine, Paul F. Fischer, C. Robert Quint and
Thomas J. Shelly, Jr. (5)(8) (Exhibit 10.6)
*10.7 Change of Control Agreements dated October 30, 1997, between
the Company and both Howard S. Yaruss and William Carroll. (8)
<PAGE> 35
EXHIBIT PAGE
NUMBER EXHIBIT
- ------- -------
10.8 CMAC Investment Corporation Pension Plan.(2)(8) (Exhibit 10.8)
10.9 CMAC Investment Corporation Savings Incentive Plan, as amended
and restated through January 1, 1994.(5)(8)(Exhibit 10.9)
10.10 CMAC Investment Corporation 1992 Stock Option Plan as amended
as of January 1, 1995. (5)(8)(Exhibit 10.10)
10.11 CMAC Investment Corporation Equity Compensation Plan. (5)(8)
(Exhibit 10.11)
<PAGE> 36
EXHIBIT PAGE
NUMBER EXHIBIT
- ------- -------
10.12 Purchase Agreement dated October 29, 1992 between the Company
and Commonwealth Land Title Insurance Company regarding $4.125
Preferred Stock.(2)(Exhibit 10.14)
10.13 Registration Rights Agreement dated October 27, 1992 between
the Company and Commonwealth Land Title Insurance
Company.(2)(Exhibit 10.15)
10.14 Form of Commonwealth Mortgage Assurance Company Master
Policy.(1)(Exhibit 10.16)
10.15 Risk-to-Capital Ratio Maintenance Agreement between the
Company and Commonwealth Mortgage Assurance Company regarding
matters relating to Moody's financial strength rating as
amended through October 22, 1993.(3) (Exhibit 10.15)
10.16 Reserve Account Agreement dated August 14, 1992, between the
Company and Commonwealth Mortgage Assurance Company regarding
$4.125 Preferred Stock.(1)(Exhibit 10.18)
10.17 First Layer Binder of Reinsurance, effective March 1, 1992,
among Commonwealth Mortgage Assurance Company, Commonwealth
Mortgage Assurance Company of Arizona, AXA Reinsurance
SA.(1)(Exhibit 10.19)
10.18 Capital Mortgage Reinsurance Company Variable Quota Share
Reinsurance Agreement, effective January 1, 1994, between
Commonwealth Mortgage Assurance Company and its affiliates and
Capital Mortgage Reinsurance Company. (4)(Exhibit 10.19)
10.19 Capital Reinsurance Company Reinsurance Agreement, effective
January 1, 1994, between Commonwealth Mortgage Assurance
Company and Capital Reinsurance Company. (4) (Exhibit 10.20)
10.20 Capital Mortgage Reinsurance Company Variable Quota Share
Reinsurance Agreement, effective January 1, 1995, between
Commonwealth Mortgage Assurance Company and its affiliates and
Capital Mortgage Reinsurance Company. (5)(Exhibit 10.20)
10.21 Capital Mortgage Reinsurance Company Variable Quota Share
Reinsurance Agreement, effective January 1, 1996, between
Commonwealth Mortgage Assurance Company and its affiliates and
Capital Mortgage Reinsurance Company. (6) (Exhibit 10.21)
10.22 Amended form of Commonwealth Mortgage Assurance Company Master
Policy, effective June 1, 1995. (4)(Exhibit 10.22)
10.23 Employment Agreement, dated December 30, 1994, between the
Company and James C. Miller. (4)(8)(Exhibit 10.21)
10.24 CMAC Investment Corporation 1997 Employee Stock Purchase Plan.
(7) (Exhibit 10)
42
<PAGE> 37
EXHIBIT PAGE
NUMBER EXHIBIT
- ------- -------
*13.1 1997 Annual Report of the Company to Stockholders. Except to
the extent incorporated in this Annual Report on 10-K, this
Exhibit is not being "filed" for purposes of Section 18 of the
Securities Exchange Act of 1934 or otherwise.
22.1 Subsidiaries of the Company.(1)(Exhibit 22.1)
*24.1 Consent of Deloitte & Touche.
*27 Financial Data Schedule.
* Filed herewith.
(1) Incorporated by reference to the exhibit identified in parentheses,
filed as an exhibit in the Registrant's Registration Statement on Form
S-1 filed August 24, 1992 and amendments thereto (File No. 33-51188).
(2) Incorporated by reference to the exhibit identified in parentheses,
filed as an exhibit in the Registrant's Annual Report on Form 10-K
filed March 30, 1993.
(3) Incorporated by reference to the exhibit identified in parentheses,
filed as an exhibit in the Registrant's Annual Report on Form 10-K
filed March 30, 1994.
(4) Incorporated by reference to the exhibit identified in parentheses,
filed as an exhibit in the Registrant's Annual Report on Form 10-K
filed March 30, 1995.
(5) Incorporated by reference to the exhibit identified in parentheses,
filed as an exhibit in the Registrant's Annual Report on Form 10-K
filed March 29, 1996.
(6) Incorporated by reference to the exhibit identified in parentheses,
filed as an exhibit in the Registrant's Annual Report on Form 10-K
filed March 31, 1997.
(7) Incorporated by reference to the exhibit identified in parentheses,
filed as an exhibit in the Registrant's Registration Statement on Form
S-8 filed November 19, 1997. (File No.333-40623).
(8) Management contract or compensatory plan or arrangement required to be
filed pursuant to Item 14(c) of Form 10-K.
<PAGE> 1
EXHIBIT 10.7
AGREEMENT
THIS AGREEMENT made and entered into this 30th day of October, 1997 by and
between CMAC INVESTMENT CORPORATION, a corporation organized and existing under
the laws of the state of Delaware (hereinafter referred to as the "Company") and
HOWARD S. YARUSS (hereinafter referred to as the "Employee").
WHEREAS, the Employee is presently employed by the Company as its SENIOR VICE
PRESIDENT, SECRETARY AND GENERAL COUNSEL; and
WHEREAS, the Board of Directors of the Company (the "Board") recognizes that, as
is the case with many publicly-held corporations, the possibility of a change in
control of the Company exists and that such possibility, and the uncertainty and
questions it may raise among management, may result in the departure or
distraction of key management personnel to the detriment of the Company; and
WHEREAS, the Board has determined that appropriate steps should be taken to
reinforce and encourage the continued attention and dedication of key members of
the Company's management to their assigned duties without distraction in the
face of potentially disturbing circumstances arising from the possibility of a
change in control of the Company; and
WHEREAS, in order to induce the Employee to remain in the employ of the Company,
the Company agrees that the Employee shall receive the compensation set forth in
this Agreement as a cushion against the financial and career impact on the
Employee in the event that Employee's employment with the Company is terminated
subsequent to a "Change of Control" (as that term is defined in Section 1
hereof).
NOW, THEREFORE, in consideration of the foregoing and the mutual covenants and
agreements hereinafter set forth and intending to be legally bound hereby, the
parties hereto agree as follows:
1. DEFINITIONS. When used in this Agreement, the following terms shall have the
specific meanings shown in this Section unless the context of any provision of
this Agreement clearly requires otherwise:
(a) "Affiliate" and "Associate" shall have the respective meanings
ascribed to such terms in Rule 12b-2 of the General Rules and Regulations under
the Securities Exchange Act of 1934, as amended (the "Exchange Act").
(b) "Beneficial Owner" of any securities shall mean:
(i) that such Person or any of such Person's Affiliates or
Associates, directly or indirectly, has the right to acquire (whether such right
is exercisable immediately or only after the passage of time) pursuant to any
agreement, arrangement or understanding (whether or not in
<PAGE> 2
writing) or upon the exercise of conversion rights, exchange rights, rights,
warrants or options, or otherwise; provided, however, that a Person shall not be
deemed the "Beneficial Owner" of securities tendered pursuant to a tender or
exchange offer made by such Person or any of such Person's Affiliates or
Associates until such tendered securities are accepted for payment, purchase or
exchange;
(ii) that such Person or any of such Person's Affiliates or
Associates, directly or indirectly, has the right to vote or dispose of or has
"beneficial ownership" of (as determined pursuant to Rule 13d-3 of the General
Rules and Regulations under the Exchange Act), including without limitation,
pursuant to any agreement, arrangement or understanding (whether or not in
writing); provided, however, that a Person shall not be deemed the "Beneficial
Owner" of any security under this subsection (ii) as a result of an oral or
written agreement, arrangement or understanding to vote such security if such
agreement, arrangement or understanding (A) arises solely from a revocable proxy
given in response to a public proxy or consent solicitation made pursuant to, an
in accordance with, the applicable provisions of the General Rules and
Regulations under the Exchange Act, and (B) is not then reportable by such
Person on Schedule 13D under the Exchange Act (or any comparable successor
report); or
(iii) where voting securities are beneficially owned, directly
or indirectly, by any other Person (or any Affiliate or Associate thereof) with
which such Person (or any of such Person's Affiliates or Associates) has any
agreement, arrangement or understanding (whether or not in writing) for the
purpose of acquiring, holding, voting (except pursuant to a revocable proxy
described in the proviso to subsection (ii) above) or disposing of any voting
securities of the Company;
provided, however, that nothing in this subsection (b) shall cause a Person
engaged in business as an underwriter of securities to be the "Beneficial Owner"
of any securities acquired through such Person's participation in good faith in
a firm commitment underwriting until expiration of forty (40) days after the
date of such acquisition.
(c) "Change of Control" shall be deemed to have taken place if (i) any
Person (except for the Employee or his family, the Company or any employee
benefit plan of the Company or of any Affiliate, any Person or entity organized,
appointed or established by the Company for or pursuant to the terms of any such
employee benefit plan), together with all Affiliates and Associates of such
Person, shall become the Beneficial Owner in the aggregate of 20% or more of the
shares of the Company then outstanding and entitled to vote for directors
generally, (ii) any Person (except the Employee and his family), together with
all Affiliates and Associates of such Person purchases substantially all of the
assets of the Company, or (iii) during any twenty-four (24) month period,
individuals who at the beginning of such period constituted the Board cease for
any reason to constitute a majority thereof, unless the election, or the
nomination for election by the Company's stockholders, of at least seventy-five
percent (75%) of the directors who were not directors at the beginning of such
period was approved by a vote of at least seventy-five percent (75%) of the
directors in office at the time of such election or nomination who were
directors at the beginning of
2
<PAGE> 3
such period.
(d) "Person" shall mean any individual, firm, corporation, partnership
or other entity.
(e) "Subsidiary" shall have the meaning ascribed to such term in Rule
12b-2 of the General Rules and Regulations under the Exchange Act.
(f) "Termination Date" shall mean the date of receipt of the Notice of
Termination described in Section 2 hereof or any later date specified therein,
as the case may be.
(g) "Termination of Employment" shall mean the termination of the
Employee's actual employment relationship with the Company.
(h) "Termination following a Change of Control" shall mean a
Termination of Employment within two years after a Change of Control either:
(i) initiated by the Company for any reason other than (a) the
Employee's continuous illness, injury or incapacity for a period of twelve
consecutive months or (b) for "cause", which shall mean misappropriation of
funds, habitual insobriety, substance abuse, conviction of a crime involving
moral turpitude, or gross negligence in the performance of duties, which gross
negligence has had a material adverse effect on the business, operations,
assets, properties or financial condition of the Company and its Subsidiaries
taken as a whole; or
(ii) initiated by the Employee upon the occurrence of one or
more of the following:
(A) any failure of the Company to comply with and satisfy
any of the conditions of this Agreement;
(B) any change resulting in a significant reduction by
the Company of the authority, duties or responsibilities of the Employee;
(C) any removal by the Company of the Employee from the
employment grade, compensation level or officer positions which the Employee
holds as of the effective date hereof, except in connection with promotions to a
higher office;
(D) the requirement that the Employee undertake business
travel (or commuting in excess of fifty miles each way) to an extent
substantially greater than is reasonable and customary for the position the
Employee holds.
2. NOTICE OF TERMINATION. Any Termination following a Change of Control shall be
communicated by a Notice of Termination to the other party hereto given in
accordance with Section 14 hereof. For purposes of this Agreement, a "Notice of
Termination" means a written notice which
3
<PAGE> 4
(i) indicates the specific termination provision in this Agreement relied upon,
(ii) briefly summarizes the facts and circumstances deemed to provide a basis
for termination of the Employee's employment under the provision so indicated,
and (iii) if the Termination Date is other than the date of receipt of such
notice, specifies the Termination Date (which date shall not be more than
fifteen days after the giving of such notice).
3. BENEFITS UPON CHANGE OF CONTROL.
(a) In the event of a Change of Control (i) any stock options
previously granted to the Employee under any Company stock option or equity
compensation plan which have not yet vested shall become vested, and (ii) any
restricted stock previously granted to the Employee under any Company equity
compensation plan which has not yet vested or become freely transferable shall
become vested and freely transferable.
(b) In the event of the Employee's Termination following a Change of
Control the Company shall pay to the Employee, within fifteen days after the
Termination Date, an amount in cash equal to 2.0 times (i) the Employee's then
current annual base compensation, plus (ii) the Employee's then current target
bonus eligibility.
(c) In the event of the Employee's Termination following a Change of
Control, the Employee shall be entitled to continued participation in the
Company's life, disability, accident and health insurance plans for a period not
to exceed thirty-six (36) months following the termination.
4. OTHER PAYMENTS. The payment due under Section 3 hereof shall be in addition
to and not in lieu of any payments or benefits due to the Employee under any
other plan, policy or program of the Company except that no payments shall be
due to the Employee under the Company's then current severance pay plan for
employees, if any.
5. ESTABLISHMENT OF TRUST. The Company has or will establish an irrevocable
trust fund (hereinafter referred to as the "Trust Fund") pursuant to a trust
agreement to hold assets contributed to satisfy its obligations under this
Agreement. Funding of such trust fund shall be subject to the Company's
discretion, as set forth in the trust agreement establishing the Trust Fund.
Notwithstanding the foregoing:
(a) Upon a Change of Control of the Company, the Chief Financial
Officer of the Company, or his authorized representative (hereinafter referred
to collectively as the "Treasurer"), shall immediately remit to the Trustee of
the Trust Fund as a contribution to the applicable trust established as part of
the Trust Fund for the benefit of the Employee the amount due under this
Agreement and not yet contributed to the Trustee as well as an amount estimated
to be sufficient to pay all fees and expenses that may thereafter become due.
The Trustee shall be under no duty to determine the sufficiency, or to enforce
the making, of such contributions.
(b) In the event that the Chairman of the Board determines that a
Change of Control of
4
<PAGE> 5
the Company is imminent, the Treasurer shall make the payments to the Trustee
specified in paragraph (i) above. If a Change of Control of the Company shall
not have occurred within ninety (90) days of the contribution made pursuant to
this Section 5 and the Board adopts a resolution to the effect that, for
purposes of this Agreement, a Change of Control of the Company is not imminent,
any amounts added to the Trust Fund pursuant to this Section, together with any
earnings thereon, shall be paid by the Trustee to the Company.
6. ENFORCEMENT.
(a) In the event that the Company shall fail or refuse to make payment
of any amounts due the Employee under Sections 3 and 4 hereof within the
respective time periods provided therein, the Company shall pay to the Employee,
in addition to the payment of any other sums provided in this Agreement,
interest, compounded daily, on any amount remaining unpaid from the date payment
is required under Section 3 and 4, as appropriate, until paid to the Employee,
at the rate from time to time announced by PNC Bank, or its successor, as its
"prime rate" plus 2%, each change in such rate to take effect on the effective
date of the change in such prime rate.
(b) It is the intent of the parties that the Employee not be required
to incur any expenses associated with the enforcement of his rights under this
Agreement by arbitration, litigation or other legal action because the cost and
expense thereof would substantially detract from the benefits intended to be
extended to the Employee hereunder. Accordingly, the Company shall pay the
Employee on demand the amount necessary to reimburse the Employee in full for
all expenses (including attorney's fees and legal expenses) incurred by the
Employee in enforcing any of the obligations of the Company under this
Agreement.
7. NO MITIGATION. The Employee shall not be required to mitigate the amount of
any payment or benefit provided for in this Agreement by seeking other
employment or otherwise, nor shall the amount of any payment or benefit provided
for herein be reduced by any compensation earned by other employment or
otherwise.
8. NON-EXCLUSIVITY OF RIGHTS. Nothing in this Agreement shall prevent or limit
the Employee's continuing or future participation in or rights under any
benefit, bonus, incentive or other plan or program provided by the Company or
any of its Subsidiaries or Affiliates and for which the Employee may qualify;
provided, however, that with respect to a Termination following a Change of
Control, the Employee hereby waives the Employee's right to receive any payments
under any severance pay plan or similar program applicable to other employees of
the Company, and agrees to accept the payment provided in Section 3(b) above in
lieu of any other severance pay plan or similar program.
9. NO SET-OFF. The Company's obligation to make the payments provided for in
this Agreement and otherwise to perform its obligations hereunder shall not be
affected by any circumstances, including, without limitation, any set-off,
counterclaim, recoupment, defense or other right which the Company may have
against the Employee or others.
5
<PAGE> 6
10. TAXES. Any payment required under this Agreement shall be subject to all
requirements of law with regard to the withholding of taxes, filing, making of
reports and the like, and the Company shall use its best efforts to satisfy
promptly all such requirements.
11. ADJUSTMENT FOR TAXES. In the event that either the Company's independent
public accountants or the Internal Revenue Service determine that any payment,
coverage, benefit or benefit acceleration provided to the Employee, whether
specifically provided for in this Agreement or otherwise, is subject to the
excise tax imposed by Section 4999 (or any successor provision) ("Section 4999")
of the Code, the Company, within thirty (30) days thereafter, shall pay to the
Executive, in addition to any other payment, coverage or benefit due and owing
hereunder, an amount determined by multiplying the rate of excise tax then
imposed by Section 4999 by the amount of the "excess parachute payment" received
by the Executive (determined without regard to any payments made to the
Executive pursuant to this paragraph) and dividing the product so obtained by
the amount obtained by subtracting the aggregate local, estate and Federal
income tax rate applicable to the receipt by the Employee of the "excess
parachute payment" (taking into account the deductibility for Federal income tax
purposes of the payment of state and local income taxes thereon) from the amount
obtained by subtracting from 1.00 the rate of excise tax then imposed by Section
4999 of the Code, it being the Company's intention that the Employee's net after
tax position be identical to that which would have obtained had Sections 280G
and 4999 not been a part of the Code.
12. TERM OF AGREEMENT. The term of this Agreement shall be for 3 years from the
date hereof and shall be automatically renewed for successive one-year periods
unless the Company notifies the Employee in writing that this Agreement will not
be renewed at least sixty (60) days prior to the end of the current term;
provided, however, that (i) after a Change of Control during the term of this
Agreement, this Agreement shall remain in effect until all of the obligations of
the parties hereunder are satisfied or have expired, and (ii) this Agreement
shall terminate if, prior to a Change of Control, the employment of the Employee
with the Company or any of its Subsidiaries, as the case may be, shall terminate
for any reason, or if the Employee shall cease to be an Employee.
13. SUCCESSOR COMPANY. The Company shall require any successor or successors
(whether direct or indirect, by purchase, merger, consolidation or otherwise) to
all or substantially all of the business and/or assets of the Company, by
agreement in form and substance satisfactory to the Employee, to acknowledge
expressly that this Agreement is binding upon and enforceable against the
Company in accordance with the terms hereof, and to become jointly and severally
obligated with the Company to perform this Agreement in the same manner and to
the same extent that the Company would be required to perform if no such
succession or successions had taken place. Failure of the Company to obtain such
agreement prior to the effectiveness of any such succession shall be a breach of
this Agreement. As used in this Agreement, the Company shall mean the Company as
hereinbefore defined and any successor or successors to its business and/or
assets, jointly and severally.
6
<PAGE> 7
14. NOTICE. All notices and other communications required or permitted hereunder
or necessary or convenient herewith shall be in writing and shall be delivered
personally or mailed by registered or certified mail, return receipt requested,
or by overnight express courier service, as follows:
If to the Company, to:
CMAC Investment Corporation
1601 Market Street
Philadelphia, PA 19103
Attention: Corporate Secretary
If to the Employee, to:
Howard S. Yaruss
328 South Smedley Street
Philadelphia, PA 19104
or to such other names or addresses as the Company or the Employee, as the case
may be, shall designate by notice to the other party hereto in the manner
specified in this Section 14; provided, however, that if no such notice is given
by the Company following a Change of Control, notice at the last address of the
Company or to any successor pursuant to Section 13 hereof shall be deemed
sufficient for the purposes hereof. Any such notice shall be deemed delivered
and effective when received in the case of personal delivery; five days after
deposit, postage prepaid, with the U.S. Postal Service in the case of registered
or certified mail; or on the next business day in the case of an overnight
express courier service.
15. GOVERNING LAW. This Agreement shall be governed by and construed by and
interpreted under the laws of the Commonwealth of Pennsylvania without giving
effect to any conflict of laws provisions.
16. CONTENTS OF AGREEMENTS, AMENDMENT AND ASSIGNMENT.
(a) This Agreement supersedes all prior agreements and sets forth the
entire understanding between the parties hereto with respect to the subject
matter hereof and cannot be changed, modified, extended or terminated except
upon written amendment executed by the Employee and approved by the Board and
executed on the Company's behalf by a duly authorized officer. The provisions of
this Agreement may provide for payments to the Employee under certain
compensation or bonus plans under circumstances where such plans would not
provide for the payment thereof. It is the specific intention of the parties
that the provisions of this Agreement shall supersede any provisions to the
contrary in such plans, and such plans shall be deemed to have been amended to
correspond with this Agreement without further action by the Company or the
Board.
(b) Nothing in this Agreement shall be construed as giving the Employee any
right to be
7
<PAGE> 8
retained in the employ of the Company.
(c) All of the terms and provisions of this Agreement shall be binding
upon and inure to the benefit of and be enforceable by the respective heirs,
representatives, successors and assigns of the parties hereto, except that the
duties and responsibilities of the Employee and the Company hereunder shall not
be assignable in whole or in part by the Company.
17. SEVERABILITY. If any provision of this Agreement or application thereof to
anyone or under any circumstances shall be determined to be invalid or
unenforceable, such invalidity or unenforceability shall not affect any other
provisions or applications of this Agreement which can be given effect without
the invalid or unenforceable provision or application.
18. REMEDIES CUMULATIVE; NO WAIVER. No right conferred upon the Employee by this
Agreement is intended to be exclusive of any other right or remedy, and each and
every such right or remedy shall be cumulative and shall be in addition to any
other right or remedy given hereunder or now or hereafter existing at law or in
equity. No delay or omission by the Employee in exercising any right, remedy or
power hereunder or existing at law or in equity shall be construed as a waiver
thereof, including, without limitation, any delay by the Employee in delivering
a Notice of Termination pursuant to Section 2 hereof after an event has occurred
which would, if the Employee had resigned, have constituted a Termination
following a Change of Control pursuant to this Agreement.
19. MISCELLANEOUS. All section headings are for convenience only. This Agreement
may be executed in several counterparts, each of which is an original. It shall
not be necessary in making proof of this Agreement or any counterpart hereof to
produce or account for any of the other counterparts.
IN WITNESS WHEREOF, the undersigned, intending to be legally bound, have
executed this Agreement as of the date first above written.
CMAC INVESTMENT CORPORATION
By: /s/ Frank P. Filipps /s/ Howard S. Yaruss
---------------------------- -------------------------
Frank P. Filipps, President Howard S. Yaruss
Attest: [ILLEGIBLE SIGNATURE]
-------------------------
8
<PAGE> 9
AGREEMENT
THIS AGREEMENT made and entered into this 30th day of October, 1997 by and
between CMAC INVESTMENT CORPORATION, a corporation organized and existing under
the laws of the state of Delaware (hereinafter referred to as the "Company") and
WILLIAM W. CARROLL, JR. (hereinafter referred to as the "Employee").
WHEREAS, the Employee is presently employed by the Company as its NATIONAL SALES
MANAGER; and
WHEREAS, the Board of Directors of the Company (the "Board") recognizes that, as
is the case with many publicly-held corporations, the possibility of a change in
control of the Company exists and that such possibility, and the uncertainty and
questions it may raise among management, may result in the departure or
distraction of key management personnel to the detriment of the Company; and
WHEREAS, the Board has determined that appropriate steps should be taken to
reinforce and encourage the continued attention and dedication of key members of
the Company's management to their assigned duties without distraction in the
face of potentially disturbing circumstances arising from the possibility of a
change in control of the Company; and
WHEREAS, in order to induce the Employee to remain in the employ of the Company,
the Company agrees that the Employee shall receive the compensation set forth in
this Agreement as a cushion against the financial and career impact on the
Employee in the event that Employee's employment with the Company is terminated
subsequent to a "Change of Control" (as that term is defined in Section 1
hereof).
NOW, THEREFORE, in consideration of the foregoing and the mutual covenants and
agreements hereinafter set forth and intending to be legally bound hereby, the
parties hereto agree as follows:
1. DEFINITIONS. When used in this Agreement, the following terms shall have the
specific meanings shown in this Section unless the context of any provision of
this Agreement clearly requires otherwise:
(a) "Affiliate" and "Associate" shall have the respective meanings ascribed
to such terms in Rule 12b-2 of the General Rules and Regulations under the
Securities Exchange Act of 1934, as amended (the "Exchange Act").
(b) "Beneficial Owner" of any securities shall mean:
(i) that such Person or any of such Person's Affiliates or Associates,
directly or indirectly, has the right to acquire (whether such right is
exercisable immediately or only after the passage of time) pursuant to any
agreement, arrangement or understanding (whether or not in
<PAGE> 10
writing) or upon the exercise of conversion rights, exchange rights, rights,
warrants or options, or otherwise; provided, however, that a Person shall not be
deemed the "Beneficial Owner" of securities tendered pursuant to a tender or
exchange offer made by such Person or any of such Person's Affiliates or
Associates until such tendered securities are accepted for payment, purchase or
exchange;
(ii) that such Person or any of such Person's Affiliates or
Associates, directly or indirectly, has the right to vote or dispose of or has
"beneficial ownership" of (as determined pursuant to Rule 13d-3 of the General
Rules and Regulations under the Exchange Act), including without limitation,
pursuant to any agreement, arrangement or understanding (whether or not in
writing); provided, however, that a Person shall not be deemed the "Beneficial
Owner" of any security under this subsection (ii) as a result of an oral or
written agreement, arrangement or understanding to vote such security if such
agreement, arrangement or understanding (A) arises solely from a revocable proxy
given in response to a public proxy or consent solicitation made pursuant to, an
in accordance with, the applicable provisions of the General Rules and
Regulations under the Exchange Act, and (B) is not then reportable by such
Person on Schedule 13D under the Exchange Act (or any comparable successor
report); or
(iii) where voting securities are beneficially owned, directly
or indirectly, by any other Person (or any Affiliate or Associate thereof) with
which such Person (or any of such Person's Affiliates or Associates) has any
agreement, arrangement or understanding (whether or not in writing) for the
purpose of acquiring, holding, voting (except pursuant to a revocable proxy
described in the proviso to subsection (ii) above) or disposing of any voting
securities of the Company;
provided, however, that nothing in this subsection (b) shall cause a Person
engaged in business as an underwriter of securities to be the "Beneficial Owner"
of any securities acquired through such Person's participation in good faith in
a firm commitment underwriting until expiration of forty (40) days after the
date of such acquisition.
(c) "Change of Control" shall be deemed to have taken place if (i) any
Person (except for the Employee or his family, the Company or any employee
benefit plan of the Company or of any Affiliate, any Person or entity organized,
appointed or established by the Company for or pursuant to the terms of any such
employee benefit plan), together with all Affiliates and Associates of such
Person, shall become the Beneficial Owner in the aggregate of 20% or more of the
shares of the Company then outstanding and entitled to vote for directors
generally, (ii) any Person (except the Employee and his family), together with
all Affiliates and Associates of such Person purchases substantially all of the
assets of the Company, or (iii) during any twenty-four (24) month period,
individuals who at the beginning of such period constituted the Board cease for
any reason to constitute a majority thereof, unless the election, or the
nomination for election by the Company's stockholders, of at least seventy-five
percent (75%) of the directors who were not directors at the beginning of
such period was approved by a vote of at least seventy-five percent (75%) of the
directors in office at the time of such election or nomination who were
directors at the beginning of
2
<PAGE> 11
such period.
(d) "Person" shall mean any individual, firm, corporation, partnership
or other entity.
(e) "Subsidiary" shall have the meaning ascribed to such term in Rule
12b-2 of the General Rules and Regulations under the Exchange Act.
(f) "Termination Date" shall mean the date of receipt of the Notice of
Termination described in Section 2 hereof or any later date specified therein,
as the case may be.
(g) "Termination of Employment" shall mean the termination of the
Employee's actual employment relationship with the Company.
(h) "Termination following a Change of Control" shall mean a Termination
of Employment within two years after a Change of Control either:
(i) initiated by the Company for any reason other than (a) the
Employee's continuous illness, injury or incapacity for a period of twelve
consecutive months or (b) for "cause", which shall mean misappropriation of
funds, habitual insobriety, substance abuse, conviction of a crime involving
moral turpitude, or gross negligence in the performance of duties, which gross
negligence has had a material adverse effect on the business, operations,
assets, properties or financial condition of the Company and its Subsidiaries
taken as a whole; or
(ii) initiated by the Employee upon the occurrence of one or more of
the following:
(A) any failure of the Company to comply with and satisfy any
of the conditions of this Agreement;
(B) any change resulting in a significant reduction by the
Company of the authority, duties or responsibilities of the Employee;
(C) any removal by the Company of the Employee from the
employment grade, compensation level or officer positions which the Employee
holds as of the effective date hereof, except in connection with promotions to a
higher office;
(D) the requirement that the Employee undertake business travel
(or commuting in excess of fifty miles each way) to an extent substantially
greater than is reasonable and customary for the position the Employee holds.
2. NOTICE OF TERMINATION. Any Termination following a Change of Control shall be
communicated by a Notice of Termination to the other party hereto given in
accordance with Section 14 hereof. For purposes of this Agreement, a "Notice of
Termination" means a written notice which
3
<PAGE> 12
(i) indicates the specific termination provision in this Agreement relied upon,
(ii) briefly summarizes the facts and circumstances deemed to provide a basis
for termination of the Employee's employment under the provision so indicated,
and (iii) if the Termination Date is other than the date of receipt of such
notice, specifies the Termination Date (which date shall not be more than
fifteen days after the giving of such notice).
3. BENEFITS UPON CHANGE OF CONTROL.
(a) In the event of a Change of Control (i) any stock options
previously granted to the Employee under any Company stock option or equity
compensation plan which have not yet vested shall become vested, and (ii) any
restricted stock previously granted to the Employee under any Company equity
compensation plan which has not yet vested or become freely transferable shall
become vested and freely transferable.
(b) In the event of the Employee's Termination following a Change of
Control the Company shall pay to the Employee, within fifteen days after the
Termination Date, an amount in cash equal to 2.0 times (i) the Employee's then
current annual base compensation, plus (ii) the Employee's then current target
bonus eligibility.
(c) In the event of the Employee's Termination following a Change of
Control, the Employee shall be entitled to continued participation in the
Company's life, disability, accident and health insurance plans for a period not
to exceed thirty-six (36) months following the termination.
4. OTHER PAYMENTS. The payment due under Section 3 hereof shall be in addition
to and not in lieu of any payments or benefits due to the Employee under any
other plan, policy or program of the Company except that no payments shall be
due to the Employee under the Company's then current severance pay plan for
employees, if any.
5. ESTABLISHMENT OF TRUST. The Company has or will establish an irrevocable
trust fund (hereinafter referred to as the "Trust Fund") pursuant to a trust
agreement to hold assets contributed to satisfy its obligations under this
Agreement. Funding of such trust fund shall be subject to the Company's
discretion, as set forth in the trust agreement establishing the Trust Fund.
Notwithstanding the foregoing:
(a) Upon a Change of Control of the Company, the Chief Financial
Officer of the Company, or his authorized representative (hereinafter referred
to collectively as the "Treasurer"), shall immediately remit to the Trustee of
the Trust Fund as a contribution to the applicable trust established as part of
the Trust Fund for the benefit of the Employee the amount due under this
Agreement and not yet contributed to the Trustee as well as an amount estimated
to be sufficient to pay all fees and expenses that may thereafter become due.
The Trustee shall be under no duty to determine the sufficiency, or to enforce
the making, of such contributions.
(b) In the event that the Chairman of the Board determines that a
Change of Control of
4
<PAGE> 13
the Company is imminent, the Treasurer shall make the payments to the Trustee
specified in paragraph (i) above. If a Change of Control of the Company shall
not have occurred within ninety (90) days of the contribution made pursuant to
this Section 5 and the Board adopts a resolution to the effect that, for
purposes of this Agreement, a Change of Control of the Company is not imminent,
any amounts added to the Trust Fund pursuant to this Section, together with any
earnings thereon, shall be paid by the Trustee to the Company.
6. ENFORCEMENT.
(a) In the event that the Company shall fail or refuse to make payment of any
amounts due the Employee under Sections 3 and 4 hereof within the respective
time periods provided therein, the Company shall pay to the Employee, in
addition to the payment of any other sums provided in this Agreement, interest,
compounded daily, on any amount remaining unpaid from the date payment is
required under Section 3 and 4, as appropriate, until paid to the Employee, at
the rate from time to time announced by PNC Bank, or its successor, as its
"prime rate" plus 2%, each change in such rate to take effect on the effective
date of the change in such prime rate.
(b) It is the intent of the parties that the Employee not be required to
incur any expenses associated with the enforcement of his rights under this
Agreement by arbitration, litigation or other legal action because the cost and
expense thereof would substantially detract from the benefits intended to be
extended to the Employee hereunder. Accordingly, the Company shall pay the
Employee on demand the amount necessary to reimburse the Employee in full for
all expenses (including attorney's fees and legal expenses) incurred by the
Employee in enforcing any of the obligations of the Company under this
Agreement.
7. NO MITIGATION. The Employee shall not be required to mitigate the amount of
any payment or benefit provided for in this Agreement by seeking other
employment or otherwise, nor shall the amount of any payment or benefit provided
for herein be reduced by any compensation earned by other employment or
otherwise.
8. NON-EXCLUSIVITY OF RIGHTS. Nothing in this Agreement shall prevent or limit
the Employee's continuing or future participation in or rights under any
benefit, bonus, incentive or other plan or program provided by the Company or
any of its Subsidiaries or Affiliates and for which the Employee may qualify;
provided, however, that with respect to a Termination following a Change of
Control, the Employee hereby waives the Employee's right to receive any payments
under any severance pay plan or similar program applicable to other employees of
the Company, and agrees to accept the payment provided in Section 3(b) above in
lieu of any other severance pay plan or similar program.
9. NO SET-OFF. The Company's obligation to make the payments provided for in
this Agreement and otherwise to perform its obligations hereunder shall not be
affected by any circumstances, including, without limitation, any set-off,
counterclaim, recoupment, defense or other right which the Company may have
against the Employee or others.
5
<PAGE> 14
10. TAXES. Any payment required under this Agreement shall be subject to all
requirements of law with regard to the withholding of taxes, filing, making of
reports and the like, and the Company shall use its best efforts to satisfy
promptly all such requirements.
11. ADJUSTMENT FOR TAXES. In the event that either the Company's independent
public accountants or the Internal Revenue Service determine that any payment,
coverage, benefit or benefit acceleration provided to the Employee, whether
specifically provided for in this Agreement or otherwise, is subject to the
excise tax imposed by Section 4999 (or any successor provision) ("Section 4999")
of the Code, the Company, within thirty (30) days thereafter, shall pay to the
Executive, in addition to any other payment, coverage or benefit due and owing
hereunder, an amount determined by multiplying the rate of excise tax then
imposed by Section 4999 by the amount of the "excess parachute payment" received
by the Executive (determined without regard to any payments made to the
Executive pursuant to this paragraph) and dividing the product so obtained by
the amount obtained by subtracting the aggregate local, estate and Federal
income tax rate applicable to the receipt by the Employee of the "excess
parachute payment" (taking into account the deductibility for Federal income tax
purposes of the payment of state and local income taxes thereon) from the amount
obtained by subtracting from 1.00 the rate of excise tax then imposed by Section
4999 of the Code, it being the Company's intention that the Employee's net after
tax position be identical to that which would have obtained had Sections 280G
and 4999 not been a part of the Code.
12. TERM OF AGREEMENT. The term of this Agreement shall be for 3 years from the
date hereof and shall be automatically renewed for successive one-year periods
unless the Company notifies the Employee in writing that this Agreement will not
be renewed at least sixty (60) days prior to the end of the current term;
provided, however, that (i) after a Change of Control during the term of this
Agreement, this Agreement shall remain in effect until all of the obligations of
the parties hereunder are satisfied or have expired, and (ii) this Agreement
shall terminate if, prior to a Change of Control, the employment of the Employee
with the Company or any of its Subsidiaries, as the case may be, shall terminate
for any reason, or if the Employee shall cease to be an Employee.
13. SUCCESSOR COMPANY. The Company shall require any successor or successors
(whether direct or indirect, by purchase, merger, consolidation or otherwise) to
all or substantially all of the business and/or assets of the Company, by
agreement in form and substance satisfactory to the Employee, to acknowledge
expressly that this Agreement is binding upon and enforceable against the
Company in accordance with the terms hereof, and to become jointly and severally
obligated with the Company to perform this Agreement in the same manner and to
the same extent that the Company would be required to perform if no such
succession or successions had taken place. Failure of the Company to obtain such
agreement prior to the effectiveness of any such succession shall be a breach of
this Agreement. As used in this Agreement, the Company shall mean the Company as
hereinbefore defined and any successor or successors to its business and/or
assets, jointly and severally.
6
<PAGE> 15
14. NOTICE. All notices and other communications required or permitted hereunder
or necessary or convenient herewith shall be in writing and shall be delivered
personally or mailed by registered or certified mail, return receipt requested,
or by overnight express courier service, as follows:
If to the Company, to:
CMAC Investment Corporation
1601 Market Street
Philadelphia, PA 19103
Attention: Corporate Secretary
If to the Employee, to:
William W. Carroll, Jr.
140 Nandina Circle
Ponte Vedra Beach, FL 32082
or to such other names or addresses as the Company or the Employee, as the case
may be, shall designate by notice to the other party hereto in the manner
specified in this Section 14; provided, however, that if no such notice is given
by the Company following a Change of Control, notice at the last address of the
Company or to any successor pursuant to Section 13 hereof shall be deemed
sufficient for the purposes hereof. Any such notice shall be deemed delivered
and effective when received in the case of personal delivery; five days after
deposit, postage prepaid, with the U.S. Postal Service in the case of registered
or certified mail; or on the next business day in the case of an overnight
express courier service.
15. GOVERNING LAW. This Agreement shall be governed by and construed by and
interpreted under the laws of the Commonwealth of Pennsylvania without giving
effect to any conflict of laws provisions.
16. CONTENTS OF AGREEMENTS, AMENDMENT AND ASSIGNMENT.
(a) This Agreement supersedes all prior agreements and sets forth the entire
understanding between the parties hereto with respect to the subject matter
hereof and cannot be changed, modified, extended or terminated except upon
written amendment executed by the Employee and approved by the Board and
executed on the Company's behalf by a duly authorized officer. The provisions of
this Agreement may provide for payments to the Employee under certain
compensation or bonus plans under circumstances where such plans would not
provide for the payment thereof. It is the specific intention of the parties
that the provisions of this Agreement shall supersede any provisions to the
contrary in such plans, and such plans shall be deemed to have been amended to
correspond with this Agreement without further action by the Company or the
Board.
(b) Nothing in this Agreement shall be construed as giving the Employee any
right to be
7
<PAGE> 16
retained in the employ of the Company.
(c) All of the terms and provisions of this Agreement shall be binding
upon and inure to the benefit of and be enforceable by the respective heirs,
representatives, successors and assigns of the parties hereto, except that the
duties and responsibilities of the Employee and the Company hereunder shall not
be assignable in whole or in part by the Company.
17. SEVERABILITY. If any provision of this Agreement or application thereof to
anyone or under any circumstances shall be determined to be invalid or
unenforceable, such invalidity or unenforceability shall not affect any other
provisions or applications of this Agreement which can be given effect without
the invalid or unenforceable provision or application.
18. REMEDIES CUMULATIVE; NO WAIVER. No right conferred upon the Employee by this
Agreement is intended to be exclusive of any other right or remedy, and each and
every such right or remedy shall be cumulative and shall be in addition to any
other right or remedy given hereunder or now or hereafter existing at law or in
equity. No delay or omission by the Employee in exercising any right, remedy or
power hereunder or existing at law or in equity shall be construed as a waiver
thereof, including, without limitation, any delay by the Employee in delivering
a Notice of Termination pursuant to Section 2 hereof after an event has occurred
which would, if the Employee had resigned, have constituted a Termination
following a Change of Control pursuant to this Agreement.
19. MISCELLANEOUS. All section headings are for convenience only. This Agreement
may be executed in several counterparts, each of which is an original. It shall
not be necessary in making proof of this Agreement or any counterpart hereof to
produce or account for any of the other counterparts.
IN WITNESS WHEREOF, the undersigned, intending to be legally bound, have
executed this Agreement as of the date first above written.
CMAC INVESTMENT CORPORATION
By: /s/ Frank P. Phillips /s/ William W. Carroll, Jr.
--------------------------- ----------------------------
Frank P. Filipps, President William W. Carroll, Jr.
Attest: /s/ Howard S. Yaruss
-----------------------
8
<PAGE> 1
CMAC
1997
FINANCIAL
SECTION
CMAC Investment Corporation and Subsidiaries 13
<PAGE> 2
SELECTED FINANCIAL AND STATISTICAL DATA
(IN MILLIONS, EXCEPT PER-SHARE AMOUNTS AND RATIOS)
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF INCOME
Premiums earned ..................................... $ 237.7 $ 187.9 $ 137.1 $ 106.1 $ 81.6
Net investment income ............................... 33.8 30.0 25.9 22.6 20.9
Total revenues ...................................... 277.3 222.6 165.6 130.5 107.1
Provision for losses ................................ 117.1 91.9 57.8 38.6 29.1
Policy acquisition costs and other operating expenses 57.7 48.1 39.6 35.6 29.9
Pretax income ....................................... 102.5 82.6 68.2 56.4 48.2
Net income .......................................... 75.0 62.2 50.8 41.1 35.8(1)
Net income per share(2)(3) .......................... $ 3.06 $ 2.55 $ 2.09 $ 1.70 $ 1.47(1)
Average shares outstanding(2)(3) .................... 23.4 23.1 22.7 22.2 22.2
CONSOLIDATED BALANCE SHEET
Assets .............................................. $ 704.6 $ 592.7 $ 499.1 $ 410.2 $ 375.1
Investments ......................................... 596.9 513.2 437.5 358.7 327.0
Unearned premiums ................................... 49.3 53.4 56.1 61.9 60.6
Reserve for losses .................................. 148.6 108.2 67.3 46.7 40.7
Redeemable preferred stock .......................... 40.0 40.0 40.0 40.0 40.0
Common stockholders' equity ......................... 429.9 356.3 298.6 239.7 212.9
Book value per share ................................ $ 19.08 $ 15.91 $ 13.42 $ 10.91 $ 9.71
STATUTORY RATIOS
Loss ratio .......................................... 50.6% 50.6% 44.3% 37.7% 38.6%
Expense ratio ....................................... 21.2 23.2 28.5 27.6 27.6
- -------------------------------------------------------------------------------------------------------------------------------
Combined ratio ...................................... 71.8% 73.8% 72.8% 65.3% 66.2%
===============================================================================================================================
OTHER STATUTORY DATA
New primary insurance written ....................... $ 13,707 $ 12,301 $ 10,607 $ 9,354 $ 8,718
Direct primary insurance in force ................... 46,900 39,438 32,362 25,809 21,444
Direct primary risk in force ........................ 10,010 8,352 6,672 5,031 4,134
Direct pool risk in force ........................... 594 342 223 167 137
</TABLE>
(1) Includes $1.7 million ($0.08 per share) from the cumulative effect of
changes in accounting principles.
(2) Diluted net income per share and share information per Statement of
Financial Accounting Standards No. 128, "Earnings Per Share." See note 1.
(3) All share and per-share data for prior periods have been restated to reflect
the stock split. See note 1.
14 CMAC Investment Corporation and Subsidiaries
<PAGE> 3
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(IN THOUSANDS, EXCEPT SHARE AMOUNTS) December 31
--------------------
1997 1996
<S> <C> <C>
ASSETS
Investments
Fixed maturities held to maturity - at amortized cost
(fair value $517,931 and $409,675) ...................... $487,941 $393,296
Fixed maturities available for sale - at fair value
(amortized cost $91,949 and $110,519) ................... 97,962 114,666
Short-term investments ................................... 11,027 5,196
Cash ...................................................... 2,364 3,189
Deferred policy acquisition costs ......................... 25,025 23,900
Provisional losses recoverable ............................ 31,325 18,199
Other assets .............................................. 48,971 34,302
- -----------------------------------------------------------------------------------
$704,615 $592,748
===================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Unearned premiums ......................................... $ 49,332 $ 53,384
Reserve for losses ........................................ 148,628 108,206
Deferred federal income taxes ............................. 6,541 5,266
Accounts payable and accrued expenses ..................... 30,171 29,548
- -----------------------------------------------------------------------------------
234,672 196,404
- -----------------------------------------------------------------------------------
Preferred stockholder's equity
Redeemable preferred stock, par value $.001 per share;
800,000 shares issued and outstanding -
at redemption value ..................................... 40,000 40,000
- -----------------------------------------------------------------------------------
Commitments and contingencies
Common stockholders' equity
Common stock, par value $.001 per share; 80,000,000 shares
authorized; 22,536,674 and 22,395,124 shares,
respectively, issued and outstanding .................... 22 22
Additional paid-in capital ............................... 179,846 176,431
Retained earnings ........................................ 246,166 177,195
Net unrealized gain on investments, net of tax ........... 3,909 2,696
- -----------------------------------------------------------------------------------
429,943 356,344
- -----------------------------------------------------------------------------------
$704,615 $592,748
===================================================================================
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
15
<PAGE> 4
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
(IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS) Year Ended December 31
--------------------------------------
1997 1996 1995
REVENUES
<S> <C> <C> <C>
Net premiums written ................ $ 233,026 $ 183,676 $ 131,689
Decrease in unearned premiums ....... 4,684 4,245 5,445
- --------------------------------------------------------------------------------
Premiums earned ..................... 237,710 187,921 137,134
Net investment income ............... 33,787 30,011 25,952
Gain on sales of investments, net ... 806 868 260
Other income ........................ 5,007 3,796 2,288
- --------------------------------------------------------------------------------
277,310 222,596 165,634
- --------------------------------------------------------------------------------
EXPENSES
Provision for losses ................ 117,149 91,894 57,803
Policy acquisition costs ............ 31,287 26,850 23,356
Other operating expense ............. 26,381 21,277 16,290
- --------------------------------------------------------------------------------
174,817 140,021 97,449
- --------------------------------------------------------------------------------
Pretax income ........................ 102,493 82,575 68,185
Provision for income taxes ........... (27,526) (20,354) (17,381)
- --------------------------------------------------------------------------------
Net income ........................... $ 74,967 $ 62,221 $ 50,804
================================================================================
Basic net income per share ........... $ 3.19 $ 2.64 $ 2.15
================================================================================
Diluted net income per share ......... $ 3.06 $ 2.55 $ 2.09
================================================================================
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
16 CMAC Investment Corporation and Subsidiaries
<PAGE> 5
CONSOLIDATED STATEMENTS OF CHANGES IN COMMON STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
NET
UNREALIZED
ADDITIONAL GAIN (LOSS) ON
COMMON PAID-IN RETAINED INVESTMENTS,
STOCK CAPITAL EARNINGS NET OF TAX TOTAL
-----------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(IN THOUSANDS)
Balance, January 1, 1995 .......... $ 11 $ 160,391 $ 86,523 $ (7,177) $ 239,748
Net income ........................ -- -- 50,804 -- 50,804
Net unrealized gain on investments,
net of tax ....................... -- -- -- 10,301 10,301
Issuance of common stock .......... -- 3,274 -- -- 3,274
Dividends ......................... -- -- (5,511) -- (5,511)
- -------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 ........ 11 163,665 131,816 3,124 298,616
Net income ........................ -- -- 62,221 -- 62,221
Net unrealized loss on investments,
net of tax ....................... -- -- -- (428) (428)
Issuance of common stock .......... -- 1,581 -- -- 1,581
Two-for-one stock split ........... 11 11,185 (11,196) -- --
Dividends ......................... -- -- (5,646) -- (5,646)
- -------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 ........ 22 176,431 177,195 2,696 356,344
Net income ........................ -- -- 74,967 -- 74,967
Net unrealized gain on investments,
net of tax ....................... -- -- -- 1,213 1,213
Issuance of common stock .......... -- 3,415 -- -- 3,415
Dividends ......................... -- -- (5,996) -- (5,996)
- -------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 ........ $ 22 $ 179,846 $ 246,166 $ 3,909 $ 429,943
=======================================================================================================
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
17
<PAGE> 6
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31
----------------------------------
(IN THOUSANDS) 1997 1996 1995
<S> <C> <C> <C>
Cash flows from operating activities
Net income ................................................ $ 74,967 $ 62,221 $ 50,804
Adjustments to reconcile net income to net cash provided
by operating activities
Gain on sales of investments, net ........................ (806) (868) (260)
Decrease in unearned premiums ............................ (4,052) (2,731) (5,747)
Amortization of deferred policy acquisition costs ........ 31,287 26,850 23,356
Increase in deferred policy acquisition costs ............ (32,412) (29,400) (27,855)
Increase in reserve for losses ........................... 40,422 40,905 20,635
Increase (decrease) in deferred federal income taxes ..... 622 (308) 678
Increase in provisional losses recoverable ............... (13,126) (10,026) (5,324)
Net change in other assets, accounts payable and
accrued expenses ........................................ (3,366) (2,166) 2,835
- --------------------------------------------------------------------------------------------------
Net cash provided by operating activities .................. 93,536 84,477 59,122
- --------------------------------------------------------------------------------------------------
Cash flows from investing activities
Proceeds from sales of investments available for sale ..... 18,995 8,974 14,071
Proceeds from redemptions of investments available for sale 13,076 12,389 7,799
Proceeds from redemptions of investments held to maturity . 4,945 890 5,906
Purchases of investments available for sale ............... (12,814) (19,755) (27,046)
Purchases of investments held to maturity ................. (98,875) (78,876) (56,479)
Purchases of short-term investments, net .................. (5,831) (245) (326)
(Purchase) sale of real estate owned ...................... (6,330) (700) 134
Other ..................................................... (4,946) (3,546) (1,224)
- --------------------------------------------------------------------------------------------------
Net cash used in investing activities ...................... (91,780) (80,869) (57,165)
- --------------------------------------------------------------------------------------------------
Cash flows from financing activities
Dividends paid ............................................ (5,996) (5,646) (5,511)
Proceeds from issuance of common stock .................... 3,415 1,581 3,274
- --------------------------------------------------------------------------------------------------
Net cash used in financing activities ...................... (2,581) (4,065) (2,237)
- --------------------------------------------------------------------------------------------------
Decrease in cash ........................................... (825) (457) (280)
Cash, beginning of year .................................... 3,189 3,646 3,926
- --------------------------------------------------------------------------------------------------
Cash, end of year .......................................... $ 2,364 $ 3,189 $ 3,646
==================================================================================================
Supplemental disclosures of cash flow information
Income taxes paid ......................................... $ 25,750 $ 19,250 $ 18,500
- --------------------------------------------------------------------------------------------------
Interest paid ............................................. $ -- $ 70 $ 114
- --------------------------------------------------------------------------------------------------
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
18 CMAC Investment Corporation and Subsidiaries
<PAGE> 7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
CMAC Investment Corporation (the "Company") was incorporated in December 1991 in
order to hold the capital stock of Commonwealth Mortgage Assurance Company
("CMAC"). In the fourth quarter of 1992, a merger among controlled subsidiaries
of CMAC was consummated with the effect that the Company acquired all of the
outstanding stock of CMAC, and CMAC's sole stockholder, Commonwealth Land Title
Insurance Company ("Commonwealth"), then an indirect wholly owned subsidiary of
Reliance Group Holdings, Inc. ("Reliance"), acquired all of the outstanding
capital stock of the Company.
In the fourth quarter of 1992, an initial public offering of the Company's
common stock (the "Offering") was consummated. In this Offering, Commonwealth
sold all of the 7,000,000 shares owned by it, and the Company issued and sold
3,950,000 shares. In addition, the Company issued and sold 800,000 shares of
$4.125 Preferred Stock to Commonwealth. Aggregate proceeds to the Company from
the sale of common stock were approximately $67,200,000 and from the sale of
preferred stock were $40,000,000.
CMAC and its subsidiaries provide private mortgage insurance and risk
management services to mortgage lending institutions located throughout the
United States. Consistent with the private mortgage insurance industry, CMAC's
highest state concentration of risk is in California. Private mortgage insurance
protects lenders from default-related losses on residential first mortgage loans
made to home buyers who make down payments of less than 20 percent of the
purchase price and facilitates the sale of these mortgages in the secondary
market.
The consolidated financial statements are prepared in accordance with
generally accepted accounting principles and include the accounts of all
subsidiaries. All material intercompany balances and transactions have been
eliminated in consolidation.
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company to make estimates and
assumptions that affect the reported amounts of assets and liabilities as of the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Insurance Premiums
Premiums written on an annual and multiyear basis are initially deferred as
unearned premiums and earned over the policy term, and premiums written on a
monthly basis are primarily earned as they are received. Annual premiums are
amortized on a monthly, straight-line basis. Multiyear premiums are amortized
over the terms of the contracts in accordance with the expiration of risk. Ceded
premiums written are initially set up as prepaid reinsurance and are amortized
in accordance with direct premiums earned.
Reserve for Losses
The reserve for losses consists of the estimated cost of settling claims on
defaults reported and defaults that have occurred but have not been reported.
Consistent with generally accepted accounting principles and industry accounting
practices, CMAC does not establish loss reserves for future claims on insured
loans that are not currently in default. In determining the liability for unpaid
losses related to reported outstanding defaults, CMAC establishes loss reserves
on a case-by-case basis. The amount reserved for any particular loan is
dependent upon the status of the loan as reported by the servicer of the insured
loan as well as the economic condition and estimated foreclosure period in the
area in which the default exists. As the default progresses closer to
foreclosure, the amount of loss reserve for that particular loan is increased,
in stages, to approximately 100 percent of CMAC's exposure and that adjustment
is included in current operations.
Deferred Policy Acquisition Costs
Costs associated with the acquisition of mortgage insurance business, consisting
of compensation, premium taxes and other policy issuance and underwriting
expenses, are initially deferred. The costs related to annual and multiyear
policies are amortized on a basis consistent with the recognition of income
while costs related to monthly policies are amortized over a period of two
years.
Income Taxes
Deferred income taxes are provided for the temporary difference between the
financial reporting basis and the tax basis of the Company's assets and
liabilities using enacted tax rates applicable to future years.
19
<PAGE> 8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
- --------------------------------------------------------------------------------
Investments
The Company is required to group its investment portfolio in three categories:
held to maturity, available for sale, and trading securities. Debt securities
for which the Company has the positive intent and ability to hold to maturity
are classified as held to maturity and reported at amortized cost. Debt and
equity securities purchased and held principally for the purpose of selling them
in the near term are classified as trading securities and reported at fair
value, with unrealized gains and losses included in earnings. The Company had no
trading securities in its portfolio at December 31, 1997 or 1996. All other
investments are classified as available for sale and are reported at fair value,
with unrealized gains and losses (net of tax) reported in a separate component
of stockholders' equity. Realized gains and losses are determined on a specific
identification method and are included in income.
Fair Values of Financial Instruments
The following methodology was used by the Company in estimating the fair value
disclosures for its financial instruments: fair values for fixed maturity
securities (including redeemable preferred stock) are based on quoted market
prices, dealer quotes, and prices obtained from independent pricing services.
The carrying amounts reported on the balance sheet for cash and short-term
investments approximate their values.
Accounting for Stock-Based Compensation
The Company accounts for stock-based compensation in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation". SFAS 123 requires expanded disclosures of stock-based
compensation arrangements with employees and encourages, but does not require
the recognition of compensation expense for the fair value of stock options and
other equity instruments granted as compensation to employees for fiscal years
beginning after December 15, 1995. The Company has chosen to continue to account
for stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," ("APB 25") and related interpretations. Accordingly, compensation
cost for stock options is measured as the excess, if any, of the quoted market
price of the Company's stock at the date of the grant over the amount an
employee must pay to acquire the stock.
Net Income Per Share
In March 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No.
128, "Earnings Per Share". SFAS 128 requires the Company to disclose both
"basic" earnings per share and "diluted" earnings per share for annual and
interim periods ending after December 15, 1997. Basic net income per share is
based on the weighted average number of common shares outstanding, while diluted
net income per share is based on the weighted average number of common shares
outstanding and common share equivalents that would arise from the exercise of
stock options. On October 15, 1996, the Board of Directors authorized a stock
split, payable December 2, 1996, in the form of a dividend of one additional
share of the Company's common stock for each share owned by stockholders of
record on November 7, 1996. The dividend was accounted for as a two-for-one
stock split and the par value of the common stock remained at $.001 per share.
Accordingly, all references to common per-share data have been adjusted to give
effect to the stock split. The calculation of the basic and diluted net income
per share, after giving effect to the stock split, was as follows (in thousands,
except per-share amounts):
<TABLE>
<CAPTION>
1997 1996 1995
-----------------------------------------
<S> <C> <C> <C>
Net income ..................... $ 74,967 $ 62,221 $ 50,804
Preferred stock
dividend
adjustment .................... (3,300) (3,300) (3,300)
- --------------------------------------------------------------------------------
Adjusted
net income .................... $ 71,667 $ 58,921 $ 47,504
- --------------------------------------------------------------------------------
Average diluted
stock options
outstanding ................... 1,526.6 1,494.3 1,435.6
Average exercise
price per share ............... $ 16.64 $ 14.21 $ 12.37
Average market
price per share -
diluted basis ................. $ 44.66 $ 29.73 $ 21.45
Average
common shares
outstanding ................... 22,471 22,340 22,112
Increase in shares
due to exercise of
options - diluted
basis ......................... 945 770 608
Adjusted shares
outstanding -
diluted ....................... 23,416 23,110 22,720
Net income per
share - basic ................. $ 3.19 $ 2.64 $ 2.15
================================================================================
Net income
per share - diluted ........... $ 3.06 $ 2.55 $ 2.09
================================================================================
</TABLE>
20 CMAC Investment Corporation and Subsidiaries
<PAGE> 9
- --------------------------------------------------------------------------------
Accounting Principles Issued and Not Yet Adopted
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income",
which requires an entity to present, as a component of comprehensive income, the
amounts from transactions and other events which are currently excluded from the
statement of income and are recorded directly to stockholders' equity. Also, in
June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information", which requires an entity to disclose
information in a manner consistent with internally used information and requires
more detailed disclosures of operating and reporting segments than are currently
in practice. Both statements are effective for fiscal years beginning after
December 15, 1997. The adoption of these statements, which concern disclosure
standards only, is not required until 1998. The adoption will not have any
impact on the Company's financial position or results of operations.
- --------------------------------------------------------------------------------
2. INVESTMENTS
Fixed maturity investments at December 31, 1997 and 1996 consisted of (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1997
--------------------------------------------
GROSS GROSS
AMORTIZED FAIR UNREALIZED UNREALIZED
COST VALUE GAINS LOSSES
<S> <C> <C> <C> <C>
Fixed maturities held to maturity at amortized cost:
Bonds and notes:
United States government ......................... $ 13,242 $ 13,710 $ 468 $ --
State and municipal obligations .................. 474,699 504,221 29,758 236
- ----------------------------------------------------------------------------------------------------
$487,941 $517,931 $ 30,226 $ 236
====================================================================================================
Fixed maturities available for sale:
Mortgage-backed securities ........................ $ 13,605 $ 14,169 $ 565 $ 1
Redeemable preferred stock ........................ 78,344 83,793 7,546 2,097
- ----------------------------------------------------------------------------------------------------
$ 91,949 $ 97,962 $ 8,111 $ 2,098
====================================================================================================
<CAPTION>
DECEMBER 31, 1996
--------------------------------------------
GROSS GROSS
AMORTIZED FAIR UNREALIZED UNREALIZED
COST VALUE GAINS LOSSES
<S> <C> <C> <C> <C>
Fixed maturities held to maturity at amortized cost:
Bonds and notes:
United States government ......................... $ 15,197 $ 15,610 $ 413 $ --
State and municipal obligations .................. 378,099 394,065 16,408 442
- ----------------------------------------------------------------------------------------------------
$393,296 $409,675 $ 16,821 $ 442
====================================================================================================
Fixed maturities available for sale:
Mortgage-backed securities ........................ $ 18,678 $ 19,355 $ 683 $ 6
Redeemable preferred stock ........................ 91,841 95,311 3,920 450
- ----------------------------------------------------------------------------------------------------
$110,519 $114,666 $ 4,603 $ 456
====================================================================================================
</TABLE>
21
<PAGE> 10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
The contractual maturities of fixed maturity investments are as follows (in
thousands): DECEMBER 31, 1997
-----------------------
AMORTIZED FAIR
COST VALUE
<S> <C> <C>
Fixed maturities:
1998 ........................................................... $ 1,892 $ 1,913
1999-2002 ...................................................... 76,461 79,392
2003-2007 ...................................................... 262,288 279,761
2008 and thereafter ............................................ 147,300 156,865
Mortgage-backed securities ..................................... 13,605 14,169
Redeemable preferred stock ..................................... 78,344 83,793
- ----------------------------------------------------------------------------------------------------------
$ 579,890 $ 615,893
==========================================================================================================
<CAPTION>
Net investment income consisted of (in thousands):
YEAR ENDED DECEMBER 31
-------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Investment income:
Fixed maturities ............................................... $ 32,892 $ 29,190 $ 25,478
Short-term investments ......................................... 440 348 270
Other .......................................................... 642 688 515
- ----------------------------------------------------------------------------------------------------------
33,974 30,226 26,263
Investment expenses ............................................. (187) (215) (311)
- ----------------------------------------------------------------------------------------------------------
$ 33,787 $ 30,011 $ 25,952
==========================================================================================================
<CAPTION>
Net gain on sales of investments consisted of (in thousands):
YEAR ENDED DECEMBER 31
-------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Gains on sales and redemptions of investments available for sale ... $ 828 $ 873 $ 475
Losses on sales and redemptions of investments available for sale .. (15) (2) (212)
Losses on redemptions of investments held to maturity .............. (7) (3) (3)
- ----------------------------------------------------------------------------------------------------------
$ 806 $ 868 $ 260
==========================================================================================================
<CAPTION>
Net unrealized appreciation (depreciation) on investments consisted of
(in thousands): YEAR ENDED DECEMBER 31
-------------------------------------
1997 1996 1995
<S> <C> <C> <C>
Fixed maturities held to maturity ............................... $ 13,611 $ (2,847) $ 28,590
==========================================================================================================
Fixed maturities available for sale ............................. $ 1,866 $ (659) $ 15,847
Deferred tax (provision) benefit ................................ (653) 231 (5,546)
- ----------------------------------------------------------------------------------------------------------
$ 1,213 $ (428) $ 10,301
==========================================================================================================
</TABLE>
22 CMAC Investment Corporation and Subsidiaries
<PAGE> 11
- --------------------------------------------------------------------------------
Securities on deposit with various state insurance commissioners amounted to
$4,318,000 at December 31, 1997 and $4,319,000 at December 31, 1996.
The Company adopted Financial Accounting Series Special Report, "A Guide to
Implementation of Statement 115 on Accounting for Certain Investments in Debt
and Equity Securities" (the "Implementation Guide"), effective November 30,
1995. Concurrent with the adoption of the Implementation Guide, the Company
reassessed the appropriateness of the classification of its securities. In
accordance with this reassessment, the Company determined to transfer certain
securities from held to maturity to available for sale.
Information regarding the transferred securities at November 30, 1995 was as
follows (in thousands):
<TABLE>
<CAPTION>
AMORTIZED NET UNREALIZED
COST GAINS
---------------------------
<S> <C> <C>
Fixed maturities:
Bonds and notes:
Mortgage-backed
securities ............................ $29,896 $ 1,329
================================================================================
</TABLE>
- --------------------------------------------------------------------------------
3. REINSURANCE
CMAC utilizes reinsurance to reduce net risk in force to meet regulatory risk to
capital requirements and to comply with the regulatory maximum policy coverage
percentage limitation of 25 percent. Although the use of reinsurance does not
discharge an insurer from its primary liability to the insured, the reinsuring
company assumes the related liability. Included in other assets are amounts
recoverable from reinsurers pertaining to unpaid claims, claims incurred but not
reported and unearned premiums (prepaid reinsurance). Reinsurance recoverable on
unpaid and incurred but not reported claims was $1,033,000 at December 31, 1996.
Prepaid reinsurance premiums were $8,077,000 and $7,445,000 at December 31, 1997
and 1996, respectively.
The effect of reinsurance on premiums written and earned is as follows for
the years ended December 31 (in thousands):
<TABLE>
<CAPTION>
Premiums written: 1997 1996 1995
--------------------------------------------
<S> <C> <C> <C>
Direct ..................... $ 254,134 $ 200,228 $ 139,469
Assumed .................... 143 181 152
Ceded ...................... (21,251) (16,733) (7,932)
- --------------------------------------------------------------------------------
Net premiums written ....... $ 233,026 $ 183,676 $ 131,689
================================================================================
Premiums earned:
Direct ..................... $ 258,148 $ 203,042 $ 145,139
Assumed .................... 181 147 180
Ceded ...................... (20,619) (15,268) (8,185)
- --------------------------------------------------------------------------------
Net premiums earned ........ $ 237,710 $ 187,921 $ 137,134
================================================================================
</TABLE>
The 1997, 1996 and 1995 figures included $18,847,000, $13,659,000 and
$6,845,000 for premiums written and $18,759,000, $13,494,000 and $6,444,000 for
premiums earned, respectively, for reinsurance ceded under variable quota share
treaties entered into in 1997, 1996, 1995 and 1994 covering the books of
business originated in those years. The 1997, 1996 and 1995 figures included
$1,801,000, $2,398,000, and $350,000 for premiums written and $1,211,000,
$1,072,000 and $891,000 for premiums earned, respectively, of reinsurance ceded
under an excess of loss reinsurance program that was entered into in 1992.
Provisional losses recoverable of $31,325,000 and $18,199,000 for 1997 and 1996,
respectively, represent amounts due from the reinsurer relating to losses
incurred under the variable quota share treaties entered into in 1997, 1996,
1995 and 1994 covering the books of business originated in those years.
23
<PAGE> 12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
- --------------------------------------------------------------------------------
4. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
As described in note 1, CMAC establishes reserves to provide for the estimated
costs of settling claims in respect of loans reported to be in default and loans
that are in default which have not yet been reported to CMAC.
The following table presents information relating to the liability for
unpaid claims and related expenses (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------------------------------------
<S> <C> <C> <C>
Balance at January 1 ................................................. $ 108,206 $ 67,301 $ 46,666
Less reinsurance recoverables ........................................ 1,033 481 193
- --------------------------------------------------------------------------------------------------------------
Net balance at January 1 ............................................. 107,173 66,820 46,473
- --------------------------------------------------------------------------------------------------------------
Add losses and LAE incurred in respect of default notices received in:
Current year ........................................................ 112,188 95,298 54,521
Prior years ......................................................... 4,961 (3,404) 3,282
- --------------------------------------------------------------------------------------------------------------
Total incurred ....................................................... 117,149 91,894 57,803
- --------------------------------------------------------------------------------------------------------------
Deduct losses and LAE paid in respect of default notices received in:
Current year ........................................................ 14,371 14,774 8,518
Prior years ......................................................... 61,323 36,767 28,938
- --------------------------------------------------------------------------------------------------------------
Total paid ........................................................... 75,694 51,541 37,456
- --------------------------------------------------------------------------------------------------------------
Net balance at December 31 ........................................... 148,628 107,173 66,820
Plus reinsurance recoverables ........................................ -- 1,033 481
- --------------------------------------------------------------------------------------------------------------
Balance at December 31 ............................................... $ 148,628 $ 108,206 $ 67,301
==============================================================================================================
</TABLE>
As a result of changes in estimates of insured events in prior years, the
provision for losses and loss adjustment expenses (net of reinsurance recoveries
of $6,504,000, $2,913,000 and $1,243,000 in 1997, 1996 and 1995, respectively)
increased by $4,961,000 in 1997 due primarily to higher than anticipated losses
on certain "affordable housing" program loans insured in 1994 and 1995 and
higher than anticipated losses in California, decreased by $3,404,000 in 1996
due primarily to lower than anticipated claim payments as compared to the
amounts reserved and increased by $3,282,000 in 1995 due primarily to higher
than anticipated losses in California.
- --------------------------------------------------------------------------------
5. REDEEMABLE PREFERRED STOCK
Preferred stock is entitled to cumulative annual dividends of $4.125 per share,
payable quarterly in arrears. The preferred stock is redeemable at the option of
the Company at $54.125 per share on or after August 15, 2002, and declining to
$50.00 per share on or after August 15, 2005 (plus in each case accumulated and
unpaid dividends), or is subject to mandatory redemption at a redemption price
of $50.00 per share plus accumulated and unpaid dividends based upon specified
annual sinking fund requirements from 2002 to 2011.
24 CMAC Investment Corporation and Subsidiaries
<PAGE> 13
- --------------------------------------------------------------------------------
6. INCOME TAXES
Deferred income taxes at the end of each period are determined by applying
enacted statutory tax rates applicable to the years in which the taxes are
expected to be paid or recovered. Deferred income taxes reflect the net tax
effects of temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts for income tax
purposes. The effect on deferred taxes of a change in the tax rate is recognized
in earnings in the period that includes the enactment date.
Provision for income taxes includes a net deferred tax provision in 1997,
1996 and 1995 of $21,622,000, $18,143,000 and $11,177,000, respectively. Of the
1997, 1996 and 1995 provisions, $21,916,000, $18,455,000 and $10,247,000,
respectively, were due to a deduction related to the purchase of U.S. government
non-interest-bearing tax and loss bonds as allowed by federal tax regulations,
with the 1997, 1996 and 1995 purchase deduction offset by $4,060,000, $2,636,000
and $5,653,000, respectively, of alternative minimum tax adjustments. All other
amounts arose principally from differences in accounting for deferred policy
acquisition costs and insurance reserve tax adjustments required as a result of
the Tax Reform Act of 1986.
The significant components of the Company's net deferred tax assets and
liabilities are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31
--------------------------
1997 1996
--------------------------
<S> <C> <C>
Deferred tax assets:
Unearned premiums ........................... $ 2,043 $ 1,677
Loss reserves ............................... 3,346 2,705
Other ....................................... 664 706
- --------------------------------------------------------------------------------
6,053 5,088
- --------------------------------------------------------------------------------
Deferred tax liabilities:
Deferred policy acquisition costs ........... (8,761) (8,368)
Net unrealized gain on investments .......... (2,105) (1,452)
Other ....................................... (1,728) (534)
- --------------------------------------------------------------------------------
(12,594) (10,354)
- --------------------------------------------------------------------------------
Net deferred tax liability ................... $ (6,541) $ (5,266)
================================================================================
</TABLE>
The reconciliation of taxes computed at the statutory tax rate of 35 percent for
1997, 1996 and 1995 to the provision for income taxes is as follows (in
thousands):
<TABLE>
<CAPTION>
1997 1996 1995
----------------------------------
<S> <C> <C> <C>
Provision for income taxes computed at the statutory tax rate ...... $ 35,873 $ 28,901 $ 23,865
Change in tax provision resulting from:
Tax-exempt municipal bond interest and dividends received deduction
(net of proration) ............................................... (8,472) (8,498) (6,955)
Other, net ........................................................ 125 (49) 471
- ----------------------------------------------------------------------------------------------------------
Provision for income taxes ......................................... $ 27,526 $ 20,354 $ 17,381
==========================================================================================================
</TABLE>
25
<PAGE> 14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
- --------------------------------------------------------------------------------
7. STOCKHOLDERS' EQUITY AND DIVIDEND RESTRICTIONS
The Company is a holding company whose principal source of income is dividends
from CMAC. The ability of CMAC to pay dividends on its common stock is
restricted by certain provisions of the insurance laws of the Commonwealth of
Pennsylvania, its state of domicile. The insurance laws of Pennsylvania
establish a test limiting the maximum amount of dividends that may be paid by an
insurer without prior approval by the Pennsylvania Insurance Commissioner. Under
such test, CMAC may pay dividends during any 12-month period in an amount equal
to the greater of (i) 10 percent of the preceding year-end statutory
policyholders' surplus or (ii) the preceding year's statutory net income. In
accordance with such restrictions, $93,390,000 would be available for dividends
in 1998. However, an amendment to the Pennsylvania statute, effective in 1994,
requires that dividends and other distributions be paid out of an insurer's
unassigned surplus. Because of the unique nature of the method of accounting for
contingency reserves, CMAC has negative unassigned surplus. Thus, prior approval
by the Pennsylvania Insurance Commissioner is required for CMAC to pay dividends
or make other distributions so long as CMAC has negative unassigned surplus. The
Pennsylvania Insurance Commissioner has approved all distributions by CMAC since
the passage of this amendment, and management has every expectation that the
Commissioner of Insurance will continue to approve such distributions in the
future, provided that the financial condition of CMAC does not materially
change.
The State of California has a statute requiring mortgage insurers to pay
dividends or make other distributions out of unassigned surplus. CMAC and the
California Department of Insurance have reached an understanding under which
CMAC will be able to pay dividends or make other distributions to the Company,
provided that the financial condition of CMAC does not materially change.
The Company and CMAC have entered into an agreement, pursuant to which the
Company has agreed to establish and, for as long as any shares of $4.125
Preferred Stock remain outstanding, maintain a reserve account in an amount
equal to three years of dividend payments on the outstanding shares of $4.125
Preferred Stock (currently $9,900,000), and not to pay dividends on the common
stock at any time when the amount in the reserve account is less than three
years of dividend payments on the shares of $4.125 Preferred Stock then
outstanding. This agreement between the Company and CMAC provides that the
holders of the $4.125 Preferred Stock are entitled to enforce the agreement's
provisions as if such holders were signatories to the agreement.
The Company may not pay any dividends on shares of common stock unless the
Company has paid all accrued dividends on, and has complied with all sinking
fund and redemption obligations relating to, its outstanding shares of $4.125
Preferred Stock.
CMAC's current reinsurance arrangement prohibits the payment of any dividend
that would have the effect of reducing its statutory total policyholders'
surplus (which includes contingency reserve) below $85,000,000. As of December
31, 1997, CMAC had $512,469,000 of total policyholders' surplus.
CMAC, domiciled in Pennsylvania, prepares its statutory financial statements
in accordance with the accounting practices prescribed or permitted by the
Commonwealth of Pennsylvania Insurance Department. Prescribed statutory
accounting practices include a variety of publications of the National
Association of Insurance Commissioners ("NAIC") as well as state laws,
regulations and general administrative rules. Permitted statutory accounting
practices encompass all accounting practices not so prescribed. CMAC is required
under the NAIC Model Act to provide for a contingency reserve in an amount equal
to 50 percent of earned premiums. Such amounts cannot be withdrawn for a period
of 10 years except under certain circumstances. Prior to 1995, CMAC had
classified its contingency reserve as a separate component of policyholders'
surplus. As of December 31, 1994, this practice increased statutory
policyholders' surplus by $159,302,000 over what it would have been had the
prescribed accounting practice been followed. The Pennsylvania Insurance
Department has determined that the contingency reserve should be classified as a
liability in the statutory balance sheet rather than as a separate component of
policyholders' surplus. In response to this determination, commencing in January
1995, CMAC began classifying the contingency reserve as a liability.
CMAC's statutory policyholders' surplus at December 31, 1997 and 1996 was
$148,087,000 and $142,113,000, respectively. CMAC's statutory net income for
1997, 1996 and 1995 was $93,390,000, $75,344,000 and $56,219,000, respectively.
26 CMAC Investment Corporation and Subsidiaries
<PAGE> 15
- --------------------------------------------------------------------------------
8. RELATED PARTY TRANSACTIONS
In July 1992, the Company and Commonwealth entered into a sublease agreement for
office space, which provided for payments equal to Commonwealth's cost,
including base rent and a pass-through of certain building expenses. In August
1993, substantially all of this subleased space was leased back to Commonwealth
at a market rental rate. The sublease expired May 31, 1996. The net amount paid
for the subleased space was $95,000 and $227,000 in 1996 and 1995, respectively.
Prior to the Offering, CMAC was included in the consolidated federal tax
return filed by Reliance, and CMAC was a party to a tax-sharing agreement with
Commonwealth. The tax-sharing agreement was terminated upon completion of the
Offering; however, CMAC has reimbursed Reliance for federal income taxes
attributable to CMAC's 1992 operations through the completion of the Offering as
though the tax-sharing agreement were still in effect. CMAC has agreed to
reimburse Reliance for federal income taxes, if any (together with any related
interest or penalties), attributable to CMAC for periods during which CMAC was a
member of Reliance's consolidated group. Reliance has agreed to limit the amount
of such reimbursement, if any, by CMAC to $1,853,000, the amount included in the
federal tax liability account on the Company's June 30, 1992 balance sheet (plus
the amount of the tax benefit, if any, obtained by the Company from making such
reimbursement). In addition, CMAC has agreed to reimburse Reliance for any
future federal income taxes (plus post-closing date interest) resulting from
CMAC's operations while a member of Reliance's consolidated group if CMAC could
be benefited by a related adjustment to CMAC's federal income taxes in an amount
calculated as if CMAC were entitled to such benefit. Reliance will reimburse
CMAC for any future federal income taxes resulting from CMAC's operations while
a member of Reliance's consolidated group which actually decrease Reliance's
consolidated federal income taxes.
- --------------------------------------------------------------------------------
9. STOCK-BASED COMPENSATION
In November 1992, the Company's Board of Directors adopted the CMAC Investment
Corporation 1992 Stock Option Plan (the "Stock Option Plan"), which provides for
the granting of nonqualified stock options, either alone or together with stock
appreciation rights. Originally up to 500,000 shares were subject to stock
options. This amount was amended by a vote of the stockholders to 900,000 in May
1993. These options may be granted to directors, officers, and key employees of
the Company at prices that are not less than 90 percent of fair market value on
the date the options are granted, although all options have been granted with an
exercise price equal to the fair value of the Company's stock at the date of
grant. Accordingly, no compensation expense has been recognized for the
Company's stock-based compensation plans. Each stock option is exercisable for a
period of ten years from the date of the grant and is subject to a vesting
schedule as approved by the Company's Stock Option and Compensation Committee.
In May 1995, the CMAC Investment Corporation Equity Compensation Plan was
instituted by a vote of the stockholders. This plan provides for the granting of
nonqualified stock options, under terms similar to those in the Stock Option
Plan, or other forms of equity-based compensation. The aggregate number of
shares that may be issued under this new plan is 1,100,000, which brought the
total number of shares subject to stock options or other forms of equity-based
compensation to 2,000,000. Effective with the stock split in December 1996, all
share totals within the plans were doubled, bringing the total number of shares
subject to stock options or other forms of equity-based compensation to
4,000,000.
27
<PAGE> 16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
- --------------------------------------------------------------------------------
Information regarding the Stock Option Plan and Equity Compensation Plan is as
follows, after giving effect to the stock split:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
NUMBER OF EXERCISE PRICE
SHARES PER SHARE
---------------------------
<S> <C> <C>
Outstanding, January 1, 1995 .................... 1,592,324 $ 12.02
Granted ........................................ 296,800 22.40
Exercised ...................................... (254,112) 10.80
Cancelled ...................................... (6,932) 13.22
- --------------------------------------------------------------
Outstanding, December 31, 1995 .................. 1,628,080 14.10
Granted ........................................ 9,000 24.69
Exercised ...................................... (122,658) 10.22
Cancelled ...................................... (62,300) 16.52
- --------------------------------------------------------------
Outstanding, December 31, 1996 .................. 1,452,122 14.39
Granted ........................................ 343,100 43.21
Exercised ...................................... (126,970) 11.35
Cancelled ...................................... (27,250) 19.57
- --------------------------------------------------------------
Outstanding, December 31, 1997 .................. 1,641,002 20.56
==============================================================
Exercisable, December 31, 1997 .................. 770,952 12.67
==============================================================
Available for grant, December 31, 1997 .......... 1,810,450
==============================================================
</TABLE>
The Company applies APB 25 in accounting for its stock-based compensation
plans. Had compensation cost for the Company's stock option plans been
determined based upon the fair value at the grant date for awards under these
plans consistent with the methodology prescribed under SFAS 123, the Company's
net income and earnings per share would have been reduced by approximately
$1,460,000 ($0.06 per share), $1,026,000 ($0.04 per share) and $58,000 in 1997,
1996 and 1995, respectively. The pro forma effect on net income for 1997, 1996
and 1995 is not representative of the pro forma effect on net income in future
years, because it does not take into consideration pro forma compensation
expense related to grants made prior to 1995.
The weighted average fair values of the stock options granted during 1997,
1996 and 1995 were $22.97, $18.25 and $16.68, respectively. The fair value of
each stock option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions used for grants:
<TABLE>
<CAPTION>
1997 1996 1995
----------------------------------
<S> <C> <C> <C>
Expected life (years) ................ 8.03 9.06 8.96
Risk-free interest rate .............. 6.29% 5.26% 5.53%
Volatility ........................... 37.06% 64.44% 64.44%
Dividend yield ....................... 0.29% 0.32% 0.32%
</TABLE>
The following table summarizes information concerning currently outstanding and
exercisable options at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------- ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$9.00 - $13.50 399,552 4.93 $ 9.13 398,552 $ 9.11
$13.94 - $14.69 622,950 6.42 14.62 288,050 14.61
$22.13 - $32.50 426,200 8.34 25.95 85,350 22.86
$39.00 - $52.94 192,300 9.85 43.32 -- --
--------- ---------
1,641,002 770,952
========= =========
</TABLE>
In July 1997, the Company's Board of Directors adopted the CMAC Investment
Corporation 1997 Employee Stock Purchase Plan (the "ESPP"), subject to
shareholder approval at the Company's 1998 Annual Meeting. A total of 200,000
shares of the Company's authorized but unissued common stock have been made
available under the ESPP, which allows eligible employees to purchase shares of
the Company's common stock at a discount of 15 percent off the stock's fair
market value on the offering date or purchase date, whichever is lower.
28 CMAC Investment Corporation and Subsidiaries
<PAGE> 17
- --------------------------------------------------------------------------------
10. BENEFIT PLANS
The Company maintains a noncontributory defined benefit pension plan covering
substantially all full-time employees that is similar to the pension plan of
Commonwealth that covered all of the Company's employees prior to the Offering.
The new plan did not require an asset transfer, and all eligible Company
employees are entitled to benefits from both plans. Retirement benefits are a
function of the years of service and the level of compensation. Assets of the
plan consist primarily of balanced mutual funds. The components of net pension
cost for the years ended December 31, 1997, 1996 and 1995 are as follows (in
thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------------------------------------
<S> <C> <C> <C>
Service cost benefits earned
during the year .................. $ 540 $ 479 $ 321
Interest cost on projected
benefit obligation ............... 264 213 146
Return on plan assets ............. (318) (132) $(183)
Net amortization
and deferral ..................... 235 123 191
- --------------------------------------------------------------------------------
Net pension cost .................. $ 721 $ 683 $ 475
================================================================================
</TABLE>
The projected benefit obligation that arose when the new plan was
consummated is approximately $675,000. This obligation is being amortized into
pension expense over the longer of the expected remaining service life of
eligible employees or 15 years.
A reconciliation of the funded status of the plan with the accrued pension
cost included in accounts payable and accrued expenses at December 31, 1997 and
1996 is as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
---------------------------
<S> <C> <C>
Actual present value of benefit obligations:
Vested ................................... $ 1,133 $ 1,004
Nonvested ................................ 552 349
Participants in pay status ............... 184 --
- --------------------------------------------------------------------------------
Accumulated benefit obligation ........... 1,869 1,353
Effect of anticipated future
compensation levels ..................... 2,830 1,983
- --------------------------------------------------------------------------------
Projected benefit obligation ............. 4,699 3,336
Plan assets at fair value ................ (2,501) (1,684)
- --------------------------------------------------------------------------------
Projected benefit obligation in
excess of plan assets ................... 2,198 1,652
Unrecognized net loss .................... (1,006) (606)
Unrecognized prior service cost .......... (393) (448)
- --------------------------------------------------------------------------------
Accrued pension cost ..................... $ 799 $ 598
================================================================================
</TABLE>
Assumptions used to determine net pension cost and the actuarial present
value of the projected benefit obligation for 1997, 1996 and 1995 were as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
-----------------------------------
<S> <C> <C> <C>
Discount rates .................... 7.25% 7.50% 7.50%
Long-term rates of return
on assets ........................ 8.50% 8.50% 8.50%
Rates of increase in
compensation levels .............. 6.00% 6.00% 6.00%
Cost of living increases .......... 4.50% 4.50% 4.50%
</TABLE>
The Company also provides a nonqualified deferred compensation plan covering
certain key executives designated by the Board of Directors. Under this plan,
participants are eligible to receive benefits in addition to those paid under
the defined benefit pension plan if their base compensation is in excess of the
current IRS compensation limitation for the defined benefit pension plan.
Retirement benefits under the nonqualified plan are a function of the years of
service and the level of compensation and are reduced by any benefits paid under
the defined benefit plan. The components of net periodic pension cost in 1997
and a reconciliation of the plan's funded status to the amounts included in
accounts payable and accrued expenses as of December 31, 1997, are as follows
(in thousands):
<TABLE>
<S> <C>
Service cost benefits earned during the year .................... $ 49
Interest cost on expected benefit obligation .................... 16
Net amortization and deferral ................................... 14
- --------------------------------------------------------------------------------
Net pension cost ................................................ $ 79
================================================================================
Accumulated benefit obligation .................................. $ 33
Effect of anticipated future compensation levels ................ 259
- --------------------------------------------------------------------------------
Projected benefit obligation .................................... 292
Unrecognized net loss ........................................... (12)
Unrecognized net prior service cost ............................. (201)
- --------------------------------------------------------------------------------
Accrued pension cost ............................................ $ 79
================================================================================
</TABLE>
The actuarial assumptions used to determine net pension cost and the
actuarial present value of the projected benefit obligation for 1997 were as
follows:
<TABLE>
<S> <C>
Discount rates ................................................. 7.25%
Long-term rates of return on assets ............................ 8.00%
Rates of increase in compensation levels ....................... 6.00%
Cost of living increases ....................................... 4.00%
</TABLE>
29
<PAGE> 18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
- --------------------------------------------------------------------------------
In addition to providing pension benefits, the Company will provide certain
health care and life insurance benefits to retired employees. The Company
accounts for such benefits under SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions," and accrues the estimated costs of
retiree medical and life benefits over the period during which employees render
the service that qualifies them for benefits. The components of net periodic
postretirement benefit costs in 1997, 1996 and 1995 and a reconciliation of the
plan's funded status to the amounts included in accounts payable and accrued
expenses as of December 31, 1997 and 1996 are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
----------------------------------------
<S> <C> <C> <C>
Service cost ...................... $ 18 $ 18 $ 14
Interest cost ..................... 20 16 13
Amortization of gain .............. (9) (10) (13)
Amortization of prior
service cost ..................... (11) (11) (11)
- --------------------------------------------------------------------------------
Net periodic postretirement
benefit cost ..................... $ 18 $ 13 $ 3
================================================================================
<CAPTION>
1997 1996
-------------------------
<S> <C> <C>
Accumulated postretirement
benefit obligation............... $ 306 $ 237
Unrecognized net gain............. 149 195
Unrecognized prior service cost... 161 172
- --------------------------------------------------------------------------------
Accrued postretirement
benefit cost..................... $ 616 $ 604
================================================================================
</TABLE>
The actuarial assumptions used in calculations relating to SFAS106 were a
discount rate of 7.75 percent and 7.5 percent, respectively, at January 1, 1997
and 1996 for determination of net periodic postretirement benefit cost and a
discount rate of 7.25 percent and 7.75 percent, respectively, at December 31,
1997 and 1996 for disclosure.
The Company also maintains a Savings Incentive Plan, which covers
substantially all full-time employees, to which participants can contribute up
to 15 percent of their base earnings as pre-tax contributions. The Company will
match at least 25 percent of the first 5 percent of base earnings contributed in
any given year. These matching funds are subject to certain vesting
requirements.
The expense to the Company for matching funds for the years ended December
31, 1997, 1996 and 1995 was $544,000, $474,000 and $485,000, respectively.
11. COMMITMENTS AND CONTINGENCIES
CMAC is involved in certain litigation arising in the normal course of its
business. CMAC is contesting the allegations in each pending action and
believes, based on current knowledge and consultation with counsel, that the
outcome of such litigation will not have a material adverse effect on the
Company's consolidated financial position or results of operations.
CMAC utilizes its underwriting skills to provide an outsource contract
underwriting service to its customers. CMAC often gives recourse to its
customers on loans it underwrites for compliance. If the loan does not meet
agreed upon guidelines and is not salable in the secondary market for that
reason, CMAC agrees to remedy the situation either by placing mortgage insurance
coverage on the loan or by purchasing the loan. During 1997, less than 1 percent
of all loans were subject to these remedies and the costs associated with these
remedies were negligible.
The Company and CMAC shared a $5,000,000 discretionary line of credit to be
used for general corporate purposes. There were no draws against this line of
credit during 1997 or 1996, and it was revoked in early 1998.
The Company leases office space for use in its underwriting, sales, loan
workout and administrative support operations. Net rental expense in connection
with these leases totaled $1,990,000, $1,468,000 and $1,432,000 in 1997, 1996
and 1995, respectively. The commitment for noncancelable operating leases in
future years is as follows (in thousands):
<TABLE>
<S> <C>
1998.............................................................. $ 1,775
1999.............................................................. 1,480
2000.............................................................. 1,323
2001.............................................................. 1,138
2002.............................................................. 942
2003.............................................................. 630
- --------------------------------------------------------------------------------
$ 7,288
================================================================================
</TABLE>
30 CMAC Investment Corporation and Subsidiaries
<PAGE> 19
- --------------------------------------------------------------------------------
12. QUARTERLY FINANCIAL DATA (UNAUDITED)
(IN THOUSANDS, EXCEPT PER-SHARE INFORMATION)
<TABLE>
<CAPTION>
1997 QUARTER
--------------------------------------------------------
FIRST SECOND THIRD FOURTH YEAR
--------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net premiums written ................ $ 47,084 $ 56,638 $ 60,591 $ 68,713 $233,026
Net premiums earned ................. 54,312 57,772 61,354 64,272 237,710
Net investment income ............... 8,084 8,428 8,426 8,849 33,787
Provision for losses ................ 26,753 28,266 30,194 31,936 117,149
Policy acquisition and other expenses 13,384 14,084 14,681 15,519 57,668
Net income .......................... 17,284 18,562 19,288 19,833 74,967
Net income per share(1) ............. $ 0.71 $ 0.76 $ 0.78 $ 0.81 $ 3.06
Average shares outstanding(1) ....... 23,263 23,462 23,522 23,569 23,416
<CAPTION>
1996 QUARTER
--------------------------------------------------------
FIRST SECOND THIRD FOURTH YEAR
--------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net premiums written ................ $ 40,237 $ 41,847 $ 46,351 $ 55,241 $183,676
Net premiums earned ................. 41,946 45,851 48,698 51,426 187,921
Net investment income ............... 7,117 7,348 7,623 7,923 30,011
Provision for losses ................ 20,026 21,912 23,808 26,148 91,894
Policy acquisition and other expenses 11,435 12,181 12,056 12,455 48,127
Net income .......................... 14,427 15,271 15,957 16,566 62,221
Net income per share(1)(2) .......... $ 0.59 $ 0.63 $ 0.65 $ 0.68 $ 2.55
Average shares outstanding(1)(2) .... 23,002 23,074 23,128 23,237 23,110
</TABLE>
(1) Diluted net income per share and average shares outstanding per SFAS No.
128, "Earnings Per Share." See note 1.
(2) All share and per-share data for prior periods have been restated to reflect
the stock split. See note 1.
- --------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
CMAC Investment Corporation
Philadelphia, Pennsylvania
We have audited the accompanying consolidated balance sheets of CMAC Investment
Corporation and subsidiaries (the "Company") as of December 31, 1997 and 1996,
and the related consolidated statements of income, changes in common
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of CMAC Investment Corporation and
subsidiaries at December 31, 1997 and 1996, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1997 in conformity with generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
Philadelphia, Pennsylvania
January 30, 1998
31
<PAGE> 20
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
1997 COMPARED TO 1996
Net income for 1997 was $75.0 million, a 20.5% increase compared to $62.2
million for 1996. This improvement was a result of significant growth in
premiums earned and net investment income, partially offset by a higher
provision for losses, policy acquisition costs and other operating expenses.
New primary insurance written during 1997 was $13.7 billion, an 11.4%
increase compared to $12.3 billion for 1996. This increase reflected a market
share increase which was primarily due to CMAC's continued focus on large,
national primary insurance customers and continued geographic expansion into
markets previously under represented by CMAC such as the Northwest and Midwest.
The increase resulted despite a 4.4% decline in new insurance written volume in
the private mortgage insurance industry in 1997. CMAC's market share of the
industry increased to 11.2% in 1997, compared to 9.6% for 1996, and for the
fourth quarter of 1997, CMAC's market share was 12.1%. Additionally, in 1997,
CMAC wrote an increased amount of pool insurance which represented an addition
to risk of $277.5 million as compared to $108.9 million in 1996. Most of this
pool insurance volume related to a group of structured transactions composed
primarily of Fannie Mae- and Freddie Mac-eligible conforming mortgage loans that
are geographically dispersed throughout the United States and that have lower
average loan-to-value ratios than CMAC's primary business. Under a pool
insurance transaction, the exposure to CMAC on each individual loan is uncapped;
however, the aggregate stop-loss percentage (typically 1.0% to 1.5% of the
initial aggregate loan balance in the Fannie Mae/Freddie Mac transactions) is
the most that can be paid out in losses before the insurer's exposure
terminates. The Company expects its pool insurance activity to continue at this
same level in 1998 due to its demand in the marketplace. Premium rates on such
pool insurance are significantly lower than on primary insurance loans due to
the low stop-loss levels, which limit the overall risk exposure to CMAC, and the
focus of such product on high quality primary insurance customers. Nonetheless,
this pool insurance has contributed to the increase in earned premiums during
1997. Standard & Poor's has recently determined that the capital requirements to
support such pool insurance will be significantly more stringent than on primary
insurance due to the low premium rates and CMAC has reviewed its capital levels
to ensure compliance with these requirements. The average stop-loss on pool
insurance written during 1997 was 1.5%.
Refinanced loans represented 17.0% of new primary insurance written during
1997 as compared to 16.5% in 1996. However, for the fourth quarter of 1997,
refinanced loans represented 21.8% of new primary insurance written as compared
to only 13.4% for the fourth quarter of 1996 as lower interest rates in the
third quarter of 1997 caused refinance activity to increase significantly in the
fourth quarter. These lower interest rates should cause refinancing activity at
the beginning of 1998 to continue at a higher rate although strong housing
prices have caused a large percentage of the refinanced loans to be done without
private mortgage insurance at an LTV of 80% or below. The persistency rate,
which is defined as the percentage of policies in force that are renewed in any
given year, was 84.2% for 1997 as compared to 83.9% for 1996. This increase was
consistent with the slight decline in the level of refinancing activity during
1997. The persistency rate for 1998 should be significantly lower than in 1997
due to the increase in refinancing activity at the end of 1997.
The majority of CMAC's business in 1997 reflected the deeper insurance
coverage required by Fannie Mae and Freddie Mac beginning in 1995. That
coverage, which is 25% on loans written with an LTV between 85.01% and 90% and
30% on loans with LTVs greater than 90%, results in higher premiums and losses
than the older coverages of 22% and 17%, respectively, but should not materially
affect the Company's financial results. Approximately 60% of CMAC's direct
primary insurance in force had such deeper coverage at the end of 1997. Monthly
premium plans, which allow borrowers to pay premiums on a monthly basis rather
than annually in advance, accounted for 93.8% of CMAC's primary new insurance
written in 1997 as compared to 91.6% in 1996. Although this program reapportions
the cash flow from an insured loan over the life of the loan, there should be no
material financial effect from its widespread use. At the end of 1995, the
industry and CMAC introduced a variation of the monthly premium plan in which
the borrower does not need to pay any mortgage insurance premium at closing and
under which some portion of the first month's premium can be deferred or
forgiven. During 1997, business written under this program was approximately 31%
of CMAC's total as compared to 11% in 1996.
Net premiums earned in 1997 were $237.7 million, a 26.5% increase compared
to $187.9 million for 1996. This increase reflected a continuation of high
persistency levels, the insurance in force growth resulting from strong new
insurance volume, increased premium rates on deeper coverages and higher
LTV-insured products during 1997, and the increase in pool insurance written
during 1997. The strong volume and high persistency led to an increase in direct
primary insurance in force during 1997 of 18.9%, from $39.4 billion at December
31, 1996 to $46.9 billion at December 31, 1997. Direct pool risk in force also
grew to $593.9 million at December 31, 1997 from $341.9 million at
32 CMAC Investment Corporation and Subsidiaries
<PAGE> 21
- --------------------------------------------------------------------------------
the end of 1996, an increase of 73.7% for the year. Primary new insurance
written on loans with LTVs greater than 90% represented 42.1% of the total
amount written in 1997 as compared to 45.5% in 1996.
Net investment income for 1997 was $33.8 million, a 12.6% increase compared
to $30.0 million in 1996. This increase was a result of continued growth in
invested assets primarily due to positive operating cash flows of $93.5 million,
offset slightly by a small decrease in investment yields. The Company's pre-tax
investment yield declined from 6.2% at December 31, 1996 to 6.0% at December 31,
1997. The Company has continued to invest new operating cash flow in
tax-advantaged securities, primarily municipal bonds. The Company has modified
its investment policy to allow the purchase of equities, which includes both
common stock and convertible securities, beginning in 1998. The policy limits
the common equity exposure to 20% of the investment portfolio's market value.
There should be no material effect on operating cash flows or investment yields
as a result of this change in investment policy.
The provision for losses was $117.1 million in 1997, an increase of 27.5%
compared to $91.9 million in 1996. This increase reflected the significant
growth and maturation of CMAC's book of business over the past several years,
the continued adverse experience of California loans, and the relatively poor
experience of certain "affordable housing" program loans insured starting in
1994. Although the ultimate performance of the books of business that originated
since 1994 cannot yet be determined, it appears that the ultimate loss levels
will be higher than average, due in part to the presence of these "affordable
housing" loans. CMAC's overall default rate at December 31, 1997 was 1.8% as
compared to 2.1% at December 31, 1996. The number of defaults rose from 10,127
at December 31, 1996 to 12,359 at December 31, 1997 and the average loss reserve
per loan in default rose from $10,685 at the end of 1996 to $12,026 at December
31, 1997. This increase in average loss reserve per default reflected the
Company's continued implementation of a more conservative reserve calculation
for certain loans in default perceived as having a higher risk of claim
incidence. In addition, an increase in the coverage percentage on loans
originated beginning in 1995 has necessitated a higher reserve balance on loans
in a default status due to the increased ultimate exposure on these loans. The
default rate in California was 3.6% (including pool) at December 31, 1997 as
compared to 4.0% at December 31, 1996 and claims paid in California during 1997
were $48.2 million, representing approximately 57.0% of total claims as compared
to 61.9% in 1996. The "affordable housing" early default experience is a result
of insuring certain loans in which the borrowers' principal and interest
reserves and other credit factors were not as strong as on prior years' books of
business. Certain underwriting changes were implemented near the end of 1996 to
compensate for the factors that contributed to the early default experience on
these "affordable housing" loans; however, it is too early to determine the
impact of such changes. The Company believes that many loan servicers have
changed the timing of reporting loans in default, which has continued to result
in an incremental increase in the number of loans in default. This change allows
for earlier intervention with borrowers in default, which might lead to a higher
cure rate for such loans.
Underwriting and other operating expenses were $57.7 million for 1997, an
increase of 19.8% compared to $48.1 million for 1996. These expenses consisted
of policy acquisition expenses, which relate directly to the acquisition of new
business, and other operating expenses, which primarily represent overhead and
administrative costs.
Policy acquisition costs were $31.3 million in 1997, an increase of 16.5%
compared to $26.9 million in 1996. This reflects the increase in sales- and
underwriting-related expenses relating to the Company's continued market share
expansion and the development of the Company's marketing infrastructure needed
to support a focus on larger, national mortgage lenders in order to take
advantage of the widespread consolidation occurring in the mortgage lending
industry. Other operating expenses for 1997 were $26.4 million, an increase of
24.0% compared to $21.3 million for 1996. Much of the increase continued to
result from an expansion of the Company's technology efforts and an increase in
expenses associated with the company's ancillary services, specifically contract
underwriting. Some of these additional contract underwriting expenses were
correspondingly offset by increases to other income, which rose 31.9% from $3.8
million in 1996 to $5.0 million in 1997, although the main purpose of the
contract underwriting effort is to support the sales effort by generating
incremental mortgage insurance business. During 1997, loans underwritten via
contract underwriting accounted for 29% of applications, 25% of insurance
commitments, and 22% of certificates issued by CMAC as compared to 35% of
applications, 21% of commitments and 18% of certificates in 1996. In 1998, these
percentages are expected to decrease due to the increase in refinancing activity
and strong housing prices which may result in a decrease in loans needing
private mortgage insurance. However, the total volume of loans underwritten via
contract underwriting is expected to increase which will result in an increase
in other operating expenses without a direct corresponding increase in mortgage
insurance business. Changing market conditions have caused the cost of contract
underwriting to increase during 1997 due to the short-
33
<PAGE> 22
MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
- --------------------------------------------------------------------------------
age of available resources and this is expected to continue into 1998 as
refinancing activity continues at a higher rate.
The effective tax rate for 1997 was 26.9% as compared to 24.6% for 1996.
Operating income was 54.9% of net income in 1997 as compared to 51.8% in 1996,
thus resulting in the increase in the effective tax rate for 1997.
1996 COMPARED TO 1995
Net income for 1996 was $62.2 million, an increase of 22.5% compared to $50.8
million for 1995. This improvement reflected significant increases in premiums
earned and net investment income, partially offset by increases in the provision
for losses, policy acquisition costs and other operating expenses.
Net primary insurance written during 1996 was $12.3 billion, an increase of
16.0% compared to $10.6 billion for 1995. This increase was primarily due to an
overall increase of 16.1% in the private mortgage insurance market during 1996,
which was aided by strong levels of refinancing during the first six months of
the year brought about by relatively low interest rates. CMAC's market share of
the industry remained constant at 9.6% in 1996. CMAC's market share in the
fourth quarter of 1996 was 10.2%. In addition to the net primary insurance
written, CMAC significantly increased its net pool insurance written during 1996
to $6.1 billion as compared to $1.4 billion for 1995. Most of the pool insurance
written in 1996 related to one transaction that is geographically dispersed
throughout the United States and has a very low stop-loss level.
Refinancing represented 16.5% of CMAC's new primary insurance written in
1996 as compared to 11.0% in 1995. Higher interest rates toward the end of the
second quarter of 1996 caused refinance activity to slow significantly in the
third and fourth quarters. The persistency rate was 86.0% as compared to 86.5%
for 1995. This slight decrease was consistent with the higher level of
refinancing activity experienced in the first half of 1996.
The majority of CMAC's business in 1996 reflected the deeper insurance
coverage required by Fannie Mae and Freddie Mac. Monthly premium plans accounted
for 91.6% of CMAC's primary new insurance written in 1996 as compared to 82.4%
in 1995. Although this program reapportions the cash flow from an insured loan
over the life of the loan, there should be no material financial effect from its
widespread use. In addition, CMAC wrote approximately 11% of its business under
a variation of the monthly premium program in which the borrower does not need
to pay any mortgage insurance premium at closing and under which some portion of
the first month's premium can be deferred or forgiven.
Net premiums earned in 1996 were $187.9 million, an increase of 37.0%
compared to $137.1 million in 1995. This increase reflected the growth in
insurance in force resulting from strong new insurance volume and a continuation
of high persistency levels and increased premium rates on deeper coverages and
higher LTV-insured products during 1996. Direct primary insurance in force grew
from $32.4 billion at December 31, 1995 to $39.4 billion at December 31, 1996, a
21.9% increase during the year. Direct pool insurance in force also grew to $9.1
billion at December 31, 1996 from $3.5 billion at December 31, 1995, an increase
of 161.9% for the year. Primary new insurance written on loans with LTVs greater
than 90% represented 45.5% of the total amount written in 1996 as compared to
48.2% in 1995.
Net investment income was $30.0 million in 1996, an increase of 15.6%
compared to $26.0 million in 1995. This increase was a result of the continued
growth in invested assets due to positive cash flows from operations of $84.5
million, offset slightly by a decrease in investment yields. The Company's
pre-tax investment yield declined from 6.3% at December 31, 1995 to 6.2% at
December 31, 1996. The Company has continued to invest new operating cash flow
in tax-advantaged securities, primarily municipal bonds.
The provision for losses was $91.9 million in 1996, an increase of 59.0%
compared to $57.8 million in 1995. This increase reflected the significant
growth and maturation of CMAC's book of business over the past several years,
the continued adverse experience of California loans, and the relatively poor
early experience of "affordable housing" program loans insured in 1994 and 1995.
Although the ultimate performance of the books of business that originated in
1994 and 1995 cannot yet be determined, it appears that the ultimate loss levels
will be higher than average, mainly due to the presence of these "affordable
housing" loans. CMAC's overall default rate at December 31, 1996 was 2.1% as
compared to 2.0% at December 31, 1995. The number of defaults rose from 7,329 a
year ago to 10,127 at December 31, 1996 and the average loss reserve per default
rose from $9,183 at December 31, 1995 to $10,685 at December 31, 1996. This
increase in average loss reserve per default reflected the Company's continued
implementation of a more conservative reserve calculation for certain loans in
default perceived as having a higher risk of claim incidence. The default rate
in California rose from 3.3% at December 31, 1995 to 4.0% at December 31, 1996
and claims paid in California represented approximately 61.9% of the total
claims paid in 1996 as compared to 56.0% in 1995.
Underwriting and other operating expenses were $48.1 million for 1996, an
increase of 21.4% compared to $39.6 million for 1995. These expenses consisted
of policy acquisition expenses, which relate directly to the acquisition of new
business, and other operating expenses, which primarily represent overhead and
administrative costs.
34 CMAC Investment Corporation and Subsidiaries
<PAGE> 23
- --------------------------------------------------------------------------------
Policy acquisition costs were $26.9 million, a 15.0% increase compared to
$23.4 million in 1995. This reflects the increase in volume of new insurance
written, and increases in sales- and underwriting-related expenses incurred in
an effort to continue a broad geographic coverage. Other operating expenses were
$21.3 million for 1996 as compared to $16.3 million in 1995, an increase of
30.6%. Much of the increase continued to result from an expansion of the
Company's technology efforts and a significant increase in expenses associated
with the Company's ancillary services, specifically contract underwriting. Some
of these additional contract underwriting expenses were correspondingly offset
by increases to other income although the main purpose of the contract
underwriting effort is to support the sales effort by generating incremental
mortgage insurance business. During 1996, loans underwritten via contract
underwriting accounted for 35% of applications, 21% of insurance commitments and
18% of certificates issued by CMAC.
The effective tax rate for 1996 was 24.6%, a decrease compared to 25.5% for
1995. This decrease was due in part to the growing percentage of tax-advantaged
securities in the Company's investment portfolio.
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of funds consist primarily of premiums and investment
income. Funds are applied primarily to the payment of CMAC's claims and
operating expenses. The Company generated positive cash flows from operating
activities in 1997, 1996 and 1995 of $93.5 million, $84.5 million and $59.1
million, respectively. The significant increases in operating cash flows reflect
the growth in insurance written and insurance-in-force that has more than offset
any increases in claims paid and other expenses. Positive cash flows are
invested pending future payments of claims and other expenses; cash flow
shortfalls, if any, are funded primarily through sales of short-term investments
and other investment portfolio securities.
Total investments were $596.9 million at December 31, 1997, including $11.0
million of short-term investments with maturities of 90 days or less and $27.4
million of U.S. Treasury equivalents and government agency securities. At
December 31, 1997, virtually all of the Company's investments consisted of money
market and investment-grade, readily marketable, fixed-income securities,
concentrated in maturities of greater than 10 years.
Loss reserves increased from $108.2 million at December 31, 1996 to $148.6
million at December 31, 1997. This increase in loss reserves due to newly
reported defaults, new loans in default that were not reported, and increases to
loss reserves on existing defaults was a result of continued adverse California
experience as well as the continued growth of the in-force insurance book. In
addition, CMAC experienced abnormally high early defaults on the 1994 and 1995
origination year books of business, which reflected the increase in "affordable
housing" program loans insured in that period. Unearned premiums decreased from
$53.4 million at December 31, 1996 to $49.3 million at December 31, 1997,
reflecting the continued widespread use of the monthly premium product, which
does not produce unearned premium.
Stockholders' equity, which includes redeemable preferred stock of $40.0
million, increased to $469.9 million at December 31, 1997, an increase of 18.6%
from $396.3 million at December 31, 1996. This increase resulted primarily from
net income for 1997 of $75.0 million and a $1.2 million increase (net of tax) in
the market value of securities available for sale, offset by $6.0 million of
dividends.
CMAC upgraded and enhanced its computer systems and technological
capabilities in 1997 through the purchase of $1.3 million of computer equipment.
This upgraded computer system was needed to support CMAC's newly structured
centralized processing operations as well as the redesigned disaster recovery
plan that was implemented in conjunction with the centralized system.
The Company believes that CMAC will have sufficient funds to satisfy its
claims payments and operating expenses and to pay dividends to the Company for
at least the next 12 months. The Company also believes that it will be able to
satisfy its long-term (more than 12 months) liquidity needs with cash flow from
CMAC. As a holding company, the Company conducts its principal operations
through CMAC. The Company's ability to pay dividends on the $4.125 Preferred
Stock is dependent upon CMAC's ability to pay dividends or make other
distributions to the Company. Based on the Company's current intention to pay
quarterly common stock dividends of approximately $0.03 per share, the Company
will require distributions from CMAC of $6.0 million annually to pay the
dividends on the outstanding shares of $4.125 Preferred Stock and common stock.
There are regulatory and contractual limitations on the payment of dividends or
other distributions. (See note 7 to the Consolidated Financial Statements.) The
Company does not believe that these restrictions will prevent the payment by
CMAC or the Company of these anticipated dividends or distributions in the
foreseeable future.
35
<PAGE> 1
Exhibit 24.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the Registration Statements of
CMAC Investment Corporation on Form S-8 (Registration Nos. 33-57872, 33-67366,
33-98106 and 333-40623) of our report dated January 30, 1998, appearing in this
Annual Report on Form 10-K of CMAC Investment Corporation for the year ended
December 31, 1997.
/s/ Deloitte & Touche LLP
- ------------------------------
DELOITTE & TOUCHE LLP
Philadelphia, Pennsylvania
March 30, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S 1997 ANNUAL REPORT TO STOCKHOLDERS.
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<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
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40,000
0
<COMMON> 22
<OTHER-SE> 429,921
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<INCOME-PRETAX> 102,493
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<EPS-PRIMARY> 3.19
<EPS-DILUTED> 3.06
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