FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 1996
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 0-22342
Triad Guaranty Inc.
(Exact name of registrant as specified in its charter)
Delaware 56-1838519
(State of Incorporation) (I.R.S. Employer Identification Number)
101 South Stratford Road, Suite 500
Winston-Salem, North Carolina 27104
(Address of principal executive offices)
(910) 723-1282
(Registrant's telephone number, including area code)
----------------------------------------------------
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 / /
Number of shares of Common Stock, $.01 par value, outstanding as of November 1,
1996: 6,645,361 shares.
<PAGE>
TRIAD GUARANTY INC.
INDEX
Page
Number
Part I. Financial Information:
Item 1. Financial Statements:
Consolidated Balance Sheets as of September 30, 1996 (Unaudited)
and December 31, 1995..........................................3
Consolidated Statements of Income for the Three and Nine Month Periods
Ended September 30, 1996 and 1995 (Unaudited)..................4
Consolidated Statements of Cash Flows for the Nine Month
Periods Ended September 30, 1996 and 1995 (Unaudited)..........5
Notes to Consolidated Financial Statements..............................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................9
Part II. Other Information:
Item 6. Exhibits and Reports on Form 8-K...............................16
Signatures.............................................................16
2
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TRIAD GUARANTY INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
------------- ------------
(Unaudited)
<S> <C> <C>
Assets
Invested assets:
Securities available-for-sale, at fair value:
Fixed maturities ............................................. $ 84,253,890 $ 76,093,199
Equity securities ............................................ 6,977,203 5,659,026
Short-term investments ......................................... 2,414,502 4,226,207
------------ ------------
93,645,595 85,978,432
Cash ............................................................. 377,564 199,241
Real estate acquired in settlement of claims ..................... 134,401 0
Accrued investment income ........................................ 1,186,357 895,657
Deferred policy acquisition costs ................................ 9,728,297 7,576,684
Property and equipment ........................................... 1,623,526 1,340,052
Prepaid reinsurance premium ...................................... 345,188 2,039,240
Reinsurance recoverable .......................................... 75,248 271,106
Other assets ..................................................... 464,090 716,837
------------- ------------
Total assets ..................................................... $107,580,266 $ 99,017,249
============ ============
Liabilities and stockholders' equity Liabilities:
Losses and loss adjustment expenses .......................... $ 5,753,940 $ 4,589,103
Unearned premiums ............................................ 8,588,811 9,086,274
Amounts payable to reinsurer ................................. 0 71,437
Current taxes payable ........................................ 1,600 39,931
Deferred income taxes ........................................ 3,762,161 2,708,572
Unearned ceding commission ................................... 93,713 620,115
Accrued expenses and other liabilities ....................... 1,714,880 1,460,475
------------ ------------
Total liabilities ................................................ 19,915,105 18,575,907
Commitments and contingent liabilities - Note 4
Stockholders' equity:
Preferred stock, par value $.01 per share --- authorized
1,000,000 shares; no shares issued and outstanding .......... -- --
Common stock, par value $.01 per share --- authorized
10,000,000 shares; 6,645,361 issued and outstanding shares
at September 30, 1996 and 4,418,939 at December 31, 1995 .... 66,453 44,189
Additional paid-in capital .................................... 59,346,832 59,141,808
Unrealized gain on available-for-sale securities, net of
income tax liability of $343,383 at September 30, 1996 and
$889,387 at December 31, 1995 ............................. 661,297 1,732,209
Retained earnings ............................................ 27,590,579 19,523,136
------------ ------------
Total stockholders' equity ....................................... 87,665,161 80,441,342
------------ ------------
Total liabilities and stockholders' equity ....................... $107,580,266 $ 99,017,249
============ ============
</TABLE>
See accompanying notes
3
<PAGE>
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
---------------------------- -----------------------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
Premiums written:
Direct ........................................ $ 7,217,239 $ 5,011,362 $ 19,008,390 $ 13,562,164
Assumed ....................................... 4,559 8,273 20,306 26,695
Ceded ......................................... (537,661) (1,023,085) (1,712,620) (2,907,543)
------------ ------------ ------------ ------------
Net premiums written ............................. 6,684,137 3,996,550 17,316,076 10,681,316
Change in unearned premiums ...................... (171,273) (25,164) 438,941 377,092
------------ ------------ ------------ ------------
Earned premiums .................................. 6,512,864 3,971,386 17,755,017 11,058,408
Net investment income ............................ 1,368,002 1,224,345 4,011,300 3,564,780
Realized investment gains ........................ (12,334) 10,284 (153,906) 173,256
Other income ..................................... 0 256 0 360
------------ ------------ ------------ ------------
7,868,532 5,206,271 21,612,411 14,796,804
Losses and expenses:
Losses and loss adjustment expenses .............. 1,048,633 684,473 2,381,510 1,744,512
Reinsurance recoveries ........................... (35,826) (123,864) (101,085) (337,421)
------------ ------------ ------------ ------------
Net losses and loss adjustment expenses .......... 1,012,807 560,609 2,280,425 1,407,091
Amortization of deferred policy acquisition costs. 816,832 573,182 2,418,039 1,708,574
Other operating expenses (net) ................... 1,840,693 1,144,168 5,216,808 3,440,990
------------ ------------ ------------ ------------
3,670,332 2,277,959 9,915,272 6,556,655
------------ ------------ ------------ ------------
Income before income taxes ....................... 4,198,200 2,928,312 11,697,139 8,240,149
Income taxes:
Current ....................................... 223 4,000 (37,518) 5,000
Deferred ...................................... 1,309,466 918,418 3,645,061 2,562,107
------------ ------------ ------------ ------------
1,309,689 922,418 3,607,543 2,567,107
------------ ------------ ------------ ------------
Net income ....................................... $ 2,888,511 $ 2,005,894 $ 8,089,596 $ 5,673,042
============ ============ ============ ============
Earnings per common and common equivalent share:
Primary ..................................... $.42 $.30 $1.22 $.86
============ ============ ============ ============
Fully diluted ................................ $.42 $.30 $1.18 $.84
============ ============ ============ ============
Shares used in computing earnings per common and common equivalent share:
Primary ..................................... 6,868,787 6,628,409 6,636,757 6,628,409
============ ============ ============ ============
Fully diluted ............................... 6,881,204 6,745,133 6,872,600 6,745,133
============ ============ ============ ============
</TABLE>
See accompanying notes
4
<PAGE>
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30
--------------------------------
1996 1995
---- ----
<S> <C> <C>
Operating activities
Net income ...................................................................... $ 8,089,596 $ 5,673,042
Adjustments to reconcile net income to net cash provided by operating activities:
Loss and unearned premium reserves ........................................... 667,374 277,769
Accrued expenses and other liabilities ....................................... 246,133 136,647
Current taxes payable ........................................................ (38,331) 103
Amounts due to/from reinsurers ............................................... 1,818,475 73,274
Accrued investment income .................................................... (290,700) (88,803)
Policy acquisition costs deferred ............................................ (4,569,653) (2,933,818)
Amortization of policy acquisition costs ..................................... 2,418,039 1,708,574
Net realized investment gains ................................................ 153,906 (173,256)
Provision for depreciation ................................................... 276,541 210,364
Accretion of discount on investments ......................................... (444,646) (429,880)
Amortization of deferred compensation ........................................ 0 112,155
Deferred income taxes ........................................................ 1,539,794 131,758
Unearned ceding commission ................................................... (526,402) (61,773)
Real estate acquired in claim settlement ..................................... (134,401) 0
Other assets ................................................................. 240,047 (190,065)
------------ ------------
Net cash provided by operating activities ....................................... 9,445,772 4,446,091
Investing activities Securities available-for-sale:
Purchases - fixed maturities ................................................ (16,999,911) (7,464,668)
Sales - fixed maturities .................................................... 7,047,623 3,133,921
Purchases - equities ........................................................ (2,595,723) (1,248,913)
Sales - equities ............................................................ 1,824,431 1,097,235
Purchase of property and equipment ............................................ (560,598) (353,954)
------------ ------------
Net cash used in investing activities ........................................... (11,284,178) (4,836,379)
Financing activities
Proceeds from exercise of stock options ......................................... 205,536 --
Retirement of common stock (at cost) ............................................ (512) --
------------ ------------
Net cash provided by financing activities ....................................... 205,024 0
------------ ------------
Net change in cash and short-term investments ................................... (1,633,382) (390,288)
Cash and short-term investments at beginning of period .......................... 4,425,448 2,433,518
------------ ------------
Cash and short-term investments at end of period ................................ $ 2,792,066 $ 2,043,230
============ ============
Supplemental schedule of cash flow information Cash paid during the period for
income taxes and United States
Mortgage Guaranty Tax and Loss Bonds ......................................... $ 1,948,782 $ 2,430,349
============ ============
</TABLE>
See accompanying notes.
5
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1996
(Unaudited)
NOTE 1 -- THE COMPANY
Triad Guaranty Inc. (the "Company") is a holding company which, through its
wholly-owned subsidiary, Triad Guaranty Insurance Corporation ("Triad"),
provides private mortgage insurance coverage in the United States to mortgage
lenders to protect the lender against loss from defaults on low down payment
residential mortgage loans.
NOTE 2 -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three and nine month periods ended
September 30, 1996 are not necessarily indicative of the results that may be
expected for the year ending December 31, 1996. For further information, refer
to the consolidated financial statements and footnotes thereto included in the
Triad Guaranty Inc. annual report on form 10-K for the year ended December 31,
1995.
NOTE 3 -- CONSOLIDATION
The consolidated financial statements include the amounts of Triad Guaranty
Inc. and its wholly-owned subsidiaries, Triad Guaranty Insurance Corporation and
Triad Guaranty Assurance Corporation. All significant intercompany accounts and
transactions have been eliminated.
NOTE 4 -- COMMITMENTS AND CONTINGENT LIABILITIES
REINSURANCE - The Company assumes and cedes certain premiums and losses
from/to reinsurers under various reinsurance agreements. Reinsurance contracts
do not relieve the Company from its obligations to policyholders. Failure of the
reinsurer to honor its obligationcould result in losses to the Company;
consequently, allowances are established for amounts when deemed uncollectible.
6
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
September 30, 1996
(Unaudited)
INSURANCE IN FORCE, DIVIDEND RESTRICTIONS, AND STATUTORY RESULTS - Insurance
regulations limit the writing of mortgage guaranty insurance to an aggregate
amount of insured risk no greater than twenty-five times the total of statutory
capital and surplus and the statutory contingency reserve. The amount of net
risk for insurance in force at September 30, 1996 and December 31, 1995, as
presented below, was computed by applying the various percentage settlement
options to the insurance in force amounts based on the original insured amount
of the loan. Triad's ratio is as follows:
September 30 December 31
1996 1995
Net risk.................................... $1,346,473,056 $869,650,148
=============== =============
Statutory capital and surplus............... $56,313,474 $55,951,158
Statutory contingency reserve............... 31,585,727 22,297,737
Total....................................... $87,899,201 $78,248,895
=============== =============
Risk-to-capital ratio....................... 15.3-to-1 11.1-to-1
=============== =============
Triad is required under the Illinois Insurance Code (the "Code") to
maintain minimum statutory capital and surplus of $5,000,000. In addition, Triad
Guaranty Assurance Corporation is required under the Code to maintain minimum
capital and surplus of $5,000,000. The Code permits dividends to be paid only
out of earned surplus and also requires prior approval of extraordinary
dividends. An extraordinary dividend is any dividend or distribution of cash or
other property the fair value of which, together with that of other dividends or
distributions made within a period of twelve consecutive months, exceeds the
greater of (a) ten percent of Triad's statutory surplus as regards to
policyholders, or (b) Triad's statutory net income for the calendar year
preceding the date of the dividend.
Net income as determined in accordance with statutory accounting practices
was $9,301,518 for the nine months ended September 30, 1996 and $9,337,430 for
the year ended December 31, 1995.
7
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
September 30, 1996
(Unaudited)
None of Triad's equity could be paid out to the parent company in dividends
because the earned surplus of Triad, on a statutory basis, was a deficit of
$2,104,329 and $2,466,645 at September 30, 1996 and December 31, 1995,
respectively.
LOSS RESERVES - The Company establishes loss reserves to provide for the
estimated costs of settling claims with respect to loans reported to be in
default and loans in default which have not been reported to the Company. Due to
the inherent uncertainty in estimating reserves for losses and loss adjustment
expenses, there can be no assurance that the reserves will prove to be adequate
to cover ultimate loss development.
NOTE 5 -- STOCKHOLDERS' EQUITY
On May 23, 1996, the Company's Board of Directors approved a three-for-two
stock split of the Company's Common Stock in the form of a 50% stock dividend on
June 28, 1996. All references to average number of shares outstanding and per
share amounts prior to June 28, 1996 included herein have been restated to
reflect a three-for-two stock split on that date.
NOTE 6 -- EARNINGS PER SHARE
Primary earnings per common and common equivalent share were computed by
dividing net income by the weighted average number of shares of common stock and
common stock equivalents outstanding during the period. For the purpose of
computing primary earnings per share, the number of common shares was increased
by the number of shares issuable on the exercise of stock options when the
market price of the common stock exceeded the exercise price of the options.
This increase in the number of common shares was reduced by the number of common
shares that are assumed to have been purchased with the proceeds from the
exercise of the options; these purchases were assumed to have been made at the
average price of the common stock during the period. Fully diluted earnings per
share was determined in the same manner as primary earnings per common and
common equivalent share except that the greater of the period-end stock price or
average stock price for the period was used.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION.
RESULTS OF OPERATIONS
Net income for the first nine months of 1996 increased 42.6% to $8.1
million compared to $5.7 million in the first nine months of 1995. Net income
for the third quarter of 1996 increased 44.0% to $2.9 million compared to $2.0
million in the third quarter of 1995. This improvement is attributable to a
60.6% (64.0% in the third quarter) increase in earned premiums, an improved
expense ratio, a 12.5% (11.7% in the third quarter) increase in net investment
income and a continuing low loss ratio.
Net income per share on a fully diluted basis increased 40.0% to $1.18 for
the first nine months of 1996 compared to $0.84 per share for the first nine
months of 1995. Net income per share for the third quarter of 1996 was $0.42 per
share on a fully diluted basis compared to $0.30 per share for the same period
of 1995. Operating earnings per share on a fully diluted basis were $1.19 for
the first nine months of 1996 compared to $0.82 per share for the same period in
1995. Operating earnings exclude realized investment losses of approximately
$154,000 in the first nine months of 1996 and realized investment gains of
approximately $173,000 in the same period of 1995. Realized investment gains or
losses were nominal in the third quarter of 1996 and 1995 and had no effect on
operating earnings for the quarters.
New insurance written was $1.6 billion for the first nine months of 1996
compared to $1.1 billion in the first nine months of 1995, an increase of 45%.
New insurance written in the third quarter of 1996 totaled $576 million compared
to $493 million a year ago. This increase is the result of the continued
penetration of Triad's products in the marketplace coupled with a favorable
interest rate environment for much of 1996, which has caused both refinance and
home buying activities to remain strong for the year. Refinance activity
accounted for 18.8% of new insurance written in the first nine months of 1996
compared to 7.8% of new insurance written in the same period of 1995. Refinance
activity declined slightly in the third quarter of 1996 to 10.1% compared to
11.8% in the third quarter of 1995.
Total direct premiums written were $19.0 million for the first nine months
of 1996, an increase of 40.2% compared to $13.6 million for the first nine
months of 1995. Contributing to this growth were the strong mortgage market, the
requirements of the secondary mortgage market for deeper coverage and the
Company's expansion into new territories. Offsetting the growth somewhat was the
decrease in the annualized persistency rate to 84.3% for the third quarter of
1996 compared to 89.3% for the third quarter of 1995 and 86.4% for all of 1995.
Sales under the Company's monthly premium plan represented 92.7% (93.5% in
the third quarter) of new insurance written in the first nine months of 1996
compared to 80.1% (86.0% in the third quarter) in the same period of 1995. The
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
monthly product spreads the collection of premiums over 12 equal monthly
payments, rather than one payment received in advance as on annual premium
plans. However, renewal premiums on monthly premium plans are greater than the
renewal premiums on a comparable annual premium plan. While in the short term
monthly premium plans decrease the level of written premium, management expects
the ultimate level of written premium on monthly premium plans to exceed the
level of written premium produced by comparable annual premium plans. Management
believes that the percentage of new insurance written under the monthly premium
plan will remain at or slightly above the current level.
Net premiums written increased by 62.1% to $17.3 million in the first nine
months of 1996 compared to $10.7 million for the same period in 1995. Net
premiums written for the third quarter of 1996 were $6.7 million compared to
$4.0 million in 1995, an increase of 67.2%. Earned premiums increased 60.6% to
$17.8 million for the first nine months of 1996 and by 64.0% to $6.5 million in
the 1996 third quarter. This increase in written and earned premium is
attributable to the increase in new insurance written and the change in the
Company's reinsurance program.
Effective January 1, 1996, the Company eliminated its quota share
reinsurance on new business, recaptured substantial portions of its quota share
coverage on renewal business and secured excess of loss reinsurance to protect
against catastrophic losses. These changes have reduced the Company's quota
share cede rate to 5.8% of direct premiums written in the first nine months of
1996 compared to 21.4% in the same period of 1995. Premiums ceded under the
Company's quota share reinsurance agreements for the first nine months of 1996
totaled $1.1 million compared to $2.9 million in the first nine months of 1995.
Total direct insurance in force reached $6.2 billion at September 30, 1996
compared to $4.9 billion at September 30, 1995, an increase of 27.1%.
In keeping with the Company's established risk strategy, the Company has
not aggressively solicited mortgage insurance under lender guidelines which
allow relaxed credit standards, reduced borrower-paid down payment (e.g., 97%
LTV loans) and expanded underwriting ratios. These products have been especially
popular with borrowers with weak credit histories. Management believes that
successful long term home ownership is not being promoted by the evolution of
many of these programs and that substantially higher loss ratios will result.
The Company does not delegate the underwriting of its 97% LTV product and
continues to maintain underwriting standards which promote successful long-term
home ownership.
The Company's delegated underwriting program accounted for 38.1% of
commitments received for the first nine months of 1996. This program has allowed
Triad to serve a greater number of the country's larger mortgage originators.
Mortgage originators who participate in the Company's delegated program are
allowed to issue a certificate of insurance on the loans it underwrites but must
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
follow strict criteria regarding property type and minimum credit standards. The
Company also performs extensive post-issuance quality control reviews of
certificates issued through each approved mortgage originator under the program.
Management expects the percentage of commitments processed through the Company's
delegated underwriting program to increase.
Net investment income for the first nine months of 1996 was $4.0 million, a
12.5% increase over the first nine months of 1995. Net investment income for the
third quarter of 1996 was $1.4 million, an 11.7% increase over the third quarter
of 1995. This increase resulted from the growth in average invested assets of
$9.8 million to $88.1 million at September 30, 1996 from $78.3 million at
September 30, 1995. The yield on average invested assets was 6.1% for the first
nine months of 1996, compared to 6.1% for the same period of 1995. This yield
reflects the Company's investment strategy to emphasize tax-preferred securities
which yield lower pre-tax rates than similar fully-taxable securities.
Approximately 51% or $42.7 million of the Company's fixed maturity portfolio at
September 30, 1996 was comprised of state and municipal tax-preferred
securities.
In the first nine months of 1996, the Company reported realized investment
losses of $154,000 ($12,000 in the third quarter). This compares to $173,000
($10,000 in the third quarter) of realized investment gains for the first nine
months of 1995. The reported losses for the nine months of 1996 resulted
primarily from the sale of equity securities sold in connection with the
Company's program of selling short-term covered calls and from the sale of
approximately $5 million in mortgage backed securities.
The Company's loss ratio (the ratio of incurred losses to earned premiums)
was 12.8% for the first nine months of 1996 compared to 12.7% for the same
period of 1995 and 14.3% for all of 1995. The loss ratio was 15.6% for the third
quarter of 1996 compared to 14.1% for the same period of 1995. The favorable
ratio reflects the low level of delinquencies compared to the number of insured
loans and the fact that approximately 75.0% of the insurance in force was
originated in the last 36 months. While the Company experienced an increase in
its loss ratio, paid losses continue to remain low at 6.7% and 6.2% of earned
premium for the nine month periods ending September 30, 1996 and September 30,
1995, respectively. Management believes, based upon its experience and industry
data, that claims incidence for it and other private mortgage insurers is
generally highest in the third through sixth years after loan origination.
Although the claims experience on new insurance written in previous years has
been quite favorable, the Company expects its incurred losses to increase as a
greater amount of its insurance in force reaches its anticipated highest claim
frequency years. Due to the inherent uncertainty of future premium levels,
losses, economic conditions and other factors that impact earnings, it is
impossible to predict with any degree of certainty the impact of such higher
claims frequencies on future earnings.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
Net losses and loss adjustment expenses (net of reinsurance recoveries)
increased by 62.1% in the first nine months of 1996 to $2.3 million compared to
$1.4 million in the same period of 1995. Losses and loss adjustment expenses for
the third quarter of 1996 were $1.0 million compared to $561,000 during the
third quarter of 1995. This increase reflects the increase in the Company's
insurance in force and the resulting recognition of a greater amount of
insurance in force reaching its higher claim frequency years. A decrease in
reinsurance recoveries attributable to the Company's restructuring of its
reinsurance program also contributed to the increase in net losses and loss
adjustment expenses.
Amortization of deferred policy acquisition costs increased by 41.5% to
$2.4 million in the first nine months of 1996 compared to $1.7 million for the
first nine months of 1995. These costs were $817,000 for the third quarter of
1996 compared to $573,000 for the third quarter of 1995, an increase of 42.5%.
The increase in amortization reflects a growing balance of deferred policy
acquisition costs to amortize as the Company builds its total insurance in
force.
Other operating expenses increased to $5.2 million for the first nine
months of 1996 compared to $3.4 million for the same period in 1995. For the
third quarter of 1996, other operating expenses increased to $1.8 million from
$1.1 million in the third quarter of 1995. This increase in expenses is
primarily attributable to personnel, facilities and equipment costs required to
support Triad's geographic expansion and increased production coupled with a
reduction in ceding commissions earned following changes in the Company's quota
share reinsurance program. Ceding commissions paid to the Company are reported
as a reduction in other operating expenses and decreased to $461,000 in the
first nine months of 1996 compared to $1.2 million in the first nine months of
1995. For the third quarter of 1996 ceding commissions were $128,000 compared to
$374,000 in the third quarter of 1995.
The Company provides contract underwriting as a service to lenders and to
provide a means of generating new mortgage insurance business. Expenses relating
to providing contract underwriting services are reported in other operating
expenses. The Company began reporting revenue related to contract underwriting
as other income in the first half of 1996. Management views, however, contract
underwriting revenue to be an offset to the costs incurred to provide this
service to lenders. Accordingly, the Company began reporting the revenue
associated with contract underwriting services as a reduction in expense, rather
than income, in the 1996 third quarter.
The Company's expense ratio (ratio of underwriting expenses to net premiums
written) for the first nine months of 1996 was 44.1% compared to 48.2% for the
first nine months of 1995 and 46.9% for all of 1995. For the third quarter of
1996 the expense ratio was 39.8% compared to 43.0% for the same period of 1995.
Contributing to this improvement is the higher level of written premiums offset
somewhat by the increase in expenses.
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
The effective tax rate for the first nine months of 1996 was 30.8% compared
to 31.2% in the first nine months of 1995. This reduction is the result of
increased investments in tax-preferred securities offset somewhat by the
phase-in of the 35% Federal statutory income tax rate applicable to companies
with annual taxable income above $10 million. Management expects the Company's
effective tax rate to remain about the same or increase only slightly as long as
yields from new funds invested in tax-preferred securities remain favorable in
relation to fully taxable securities.
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of operating funds consist primarily of premiums
written and investment income. Operating funds are applied primarily to the
payment of claims and expenses.
Triad generated positive cash flow from operating activities for the first
nine months of 1996 of $9.4 million compared to $4.4 million for the first nine
months of 1995. The increase in Triad's operating cash flow is attributable to
growth in production and the impact of the Company's restructuring of its
reinsurance agreements which resulted in the recapture of premiums previously
ceded.
The Company's business does not routinely require significant capital
expenditures. Positive cash flows are invested pending future payments of claims
and expenses. Cash flow shortfalls, if any, could be funded through sales of
short term investments and other investment portfolio securities.
The parent company's cash flow is dependent on cash dividends and revenues
from management fees from Triad. The insurance laws of the State of Illinois
impose certain restrictions on dividends from Triad. These restrictions, based
on statutory accounting practices, include requirements that dividends may be
paid only out of statutory earned surplus and limit the amount of dividends that
may be paid without prior approval of the Illinois Insurance Department. Because
of Triad's rapid growth in written premiums and the requirement to add amounts
to the statutory contingency reserve equal to at least 50% of earned premiums
(which reduces statutory earned surplus), Triad reported a deficit in statutory
earned surplus of $2.1 million at September 30, 1996 and $2.5 million at
December 31, 1995. Accordingly, Triad may not presently pay cash dividends to
the parent company. The Illinois Insurance Department permits expenses of the
parent company to be charged to Triad in the form of management fees.
Consolidated invested assets were $93.6 million at September 30, 1996,
including $91.2 million in fixed maturity and equity securities all of which are
classified as available-for-sale. Net unrealized investment gains on fixed
maturity securities were $166,000 and unrealized investment gains on equity
securities totaled $833,000 at September 30, 1996.
13
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
Approximately 19% or $16.4 million of the Company's fixed maturity
portfolio at September 30, 1996 was composed of mortgage-backed securities,
substantially all of which are guaranteed by U.S. Government Agencies. Certain
mortgage-backed securities are subject to significant prepayment risk due to the
fact that, in periods of declining interest rates, mortgages may be repaid more
rapidly than scheduled as borrowers refinance higher rate mortgages to take
advantage of lower rates. As a result, holders of mortgage-backed securities may
receive large prepayments on their investments which must be reinvested at then
current rates.
Included in the Company's fixed maturity portfolio of mortgage backed
securities at September 30, 1996 was $5.3 million invested in planned
amortization class ("PAC") collateralized mortgage obligations ("CMOs"). PACs
are tranches of CMOs specifically designed to amortize in a more predictable
manner and to protect against prepayments as interest rates decline. In periods
of declining interest rates, prepayments are first applied to the non-PAC
tranches of the CMO, creating improved call protection for the PAC tranche. Only
after all non-PAC tranches have been paid off are prepayments applied to the PAC
tranche. In periods of increasing interest rates, prepayments are first applied
to the PAC tranche, thus reducing extension risk for PACs. As a result, PACs
have a more stable cash flow than most other mortgage securities because they
have better call protection and less extension risk. All principal balances
invested in CMOs by the Company are U.S. Government agency sponsored or
guaranteed.
The Company's reinsurance recoverable of $75,000 and prepaid reinsurance
premium of $345,000 at September 30, 1996 decreased from $271,000 and $2.0
million, respectively, at December 31, 1995. These decreases primarily reflect
the recapture of previously ceded losses and unearned premiums as part of the
Company's restructuring of its reinsurance program.
The Company's loss reserves increased to $5.8 million at September 30, 1996
compared to $4.6 million at December 31, 1995. This growth is the result of the
increases in new insurance written and the maturing of the Company's risk in
force. Consistent with industry practices, the Company does not establish loss
reserves for future claims on insured loans which are not currently in default.
The Company's delinquency ratio, the ratio of delinquent insured loans to total
insured loans, was 0.42% at September 30, 1996 compared to 0.41% at December 31,
1995.
The Company's unearned premium reserve of $8.6 million at September 30,
1996 decreased from $9.1 million at December 31, 1995. This decline is
attributable primarily to the continued high production of the monthly premium
product, which produces little unearned premium compared to annual and single
premium products. Also, the Company has experienced a higher level of refinance
activity in the first nine months of 1996 whereby older annual premium policies
are replaced by monthly premium policies resulting in a decline in the unearned
premium reserve.
14
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
Total stockholders' equity increased to $87.7 million at September 30, 1996
from $80.4 million at December 31, 1995. This increase resulted from net income
of $8.1 million for the first nine months of 1996 and from additional paid-in
capital of $205,000 resulting from the exercise of employee stock options and
the issuance of common stock under the Company's stock incentive plan. This was
partially offset by a decrease in net unrealized gains on invested assets
classified as available-for-sale of $1.1 million (net of income tax).
Triad's total statutory policyholders' surplus increased to $56.3 million
at September 30, 1996 from $56.0 million at December 31, 1995. This increase is
primarily related to statutory net income for the first nine months of 1996 of
$9.3 million and an unrealized investment gain of $691,000 offset by an increase
in the contingency reserve of $9.3 million. Triad's deficit in statutory earned
surplus was $2.1 million at September 30, 1996 reduced from $2.5 million at
December 31, 1995. The balance in the contingency reserve was $31.6 million at
September 30, 1996 compared to $22.3 million at December 31, 1995.
The Company has no current plans for any significant capital expenditures.
The Company's ability to write insurance depends on the adequacy of its
capital in relation to its risk in force. A significant reduction of capital may
impair the Company's ability to write new insurance. In spite of higher limits
permitted by the secondary mortgage market and state insurance laws, management
believes its risk to capital ratio can increase up to the approximate current
industry level of 20-to-1 without an adverse effect on its claims-paying ability
ratings. As of September 30, 1996, Triad's risk-to-capital ratio was 15.3-to-1
compared to 11.1-to-1 at December 31, 1995.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Management's Discussion and Analysis and this Report contain forward
looking statements which involve various risks and uncertainties, including but
not limited to the following: interest rates may increase or decrease from their
current levels; housing transactions and mortgage issuance may decrease for many
reasons including changes in interest rates or economic conditions; the
Company's market share may change as a result of changes in underwriting
criteria or competitive products; the Company's performance may be impacted by
changes in the performance of the financial markets and general economic
conditions. Accordingly actual results may differ from those set forth in the
forward looking statements. Attention is also directed to other risk factors set
forth in documents filed by the Company with the Securities and Exchange
Commission.
15
<PAGE>
PART II
Item 1. Legal Proceedings - None
Item 2. Changes in Securities - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - None
Item 6. a. Exhibits
Exhibit No. Description
----------- -----------
11 Statement Re Computation of Net Income
per share
27 Financial Data Schedule
b. Reports on Form 8-K - None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TRIAD GUARANTY INC.
-------------------
Date: November 13, 1996
/s/ Michael R. Oswalt
---------------------
Michael R. Oswalt
Vice President and Controller,
Principal Accounting Officer
16
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
------ -----------
11 Statement Re. Computation of Net Income per Share
27 Financial Data Schedule
17
EXHIBIT 11
TRIAD GUARANTY INC.
STATEMENT RE COMPUTATION OF NET INCOME PER SHARE
Three and Nine Month Periods Ended September 30, 1996 and 1995
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
PRIMARY NET INCOME PER SHARE
Weighted average common
shares outstanding ............... 6,645,361 6,628,409 6,636,757 6,628,409
Net shares to be issued upon
exercise of dilutive stock options
after applying treasury stock
method ........................... 223,426 0 0 0
---------- ---------- ---------- ----------
Adjusted shares outstanding ........ 6,868,787 6,628,409 6,636,757 6,628,409
========== ========== ========== ==========
Net income ......................... $2,888,511 $2,005,894 $8,089,596 $5,673,042
========== ========== ========== ==========
Primary net income per share ....... $ .42 $ .30 $ 1.22 $ .86
========== ========== ========== ==========
FULLY DILUTED NET INCOME PER SHARE
Weighted average common
shares outstanding ............... 6,645,361 6,628,409 6,636,757 6,628,409
Net shares to be issued upon
exercise of dilutive stock options
after applying treasury stock
method ........................... 235,843 116,724 235,843 116,724
---------- ---------- ---------- ----------
Adjusted shares outstanding ........ 6,881,204 6,745,133 6,872,600 6,745,133
========== ========== ========== ==========
Net income ......................... $2,888,511 $2,005,894 $8,089,596 $5,673,042
========== ========== ========== ==========
Fully diluted net income per
Share............................... $.42 $.30 $1.18 $.84
========== =========== ========== ==========
</TABLE>
18
<PAGE>
EXHIBIT 11 -- CONTUINED
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
ADDITIONAL PRIMARY COMPUTATION
Weighted average common
shares outstanding ............... 6,645,361 6,628,409 6,636,757 6,628,409
Net shares to be issued upon
exercise of dilutive stock options
after applying treasury stock
method ........................... 223,426 84,756 184,393 36,124
---------- ---------- ---------- ----------
Adjusted shares outstanding ........ 6,868,787 6,713,165 6,821,150 6,664,533
========== ========== ========== ==========
Net income ......................... $2,888,511 $2,005,894 $8,089,596 $5,673,042
========== ========== ========== ==========
Primary net income per share ....... $ .42 $ .30 (a) $ 1.19 (a) $ .85 (a)
========== ========== ========== ==========
</TABLE>
(a) This calculation is submitted in accordance with Regulation S-K item
601(b)(11) although not required by footnote 2 to paragraph 14 of APB
Opinion No. 15 because it results in dilution of less than 3%.
19
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary information extracted from Form 10-Q for
the nine months ended September 30, 1996, and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> SEP-30-1996
<DEBT-HELD-FOR-SALE> 84,253,890
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 6,977,203
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 93,645,595
<CASH> 377,564
<RECOVER-REINSURE> 10,816
<DEFERRED-ACQUISITION> 9,728,297
<TOTAL-ASSETS> 107,580,266
<POLICY-LOSSES> 5,753,940
<UNEARNED-PREMIUMS> 8,588,811
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 66,453
<OTHER-SE> 87,665,161
<TOTAL-LIABILITY-AND-EQUITY> 107,580,266
17,755,017
<INVESTMENT-INCOME> 4,011,300
<INVESTMENT-GAINS> (153,906)
<OTHER-INCOME> 0
<BENEFITS> 2,280,425
<UNDERWRITING-AMORTIZATION> 2,418,039
<UNDERWRITING-OTHER> 5,216,808
<INCOME-PRETAX> 11,697,139
<INCOME-TAX> 3,607,543
<INCOME-CONTINUING> 8,089,596
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,089,596
<EPS-PRIMARY> 1.22
<EPS-DILUTED> 1.18
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
