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, 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 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, $.01 par value, outstanding as of November 10,
1997: 13,291,722 shares. Outstanding share amount reflects the registrant's
2-for-1 stock split effective October 28, 1997.
<PAGE>
TRIAD GUARANTY INC.
INDEX
Page
Number
PART I. FINANCIAL INFORMATION:
ITEM 1. FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of September 30, 1997 (Unaudited)
and December 31, 1996..............................................3
Consolidated Statements of Income for the Three and Nine Month
Periods Ended September 30, 1997 and 1996 (Unaudited)..............4
Consolidated Statements of Cash Flows for the Nine Month
Periods Ended September 30, 1997 and 1996 (Unaudited)..............5
Notes to Consolidated Financial Statements..................................6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................10
PART II. OTHER INFORMATION:
Item 6. Exhibits and Reports on Form 8-K...................................17
Signatures.................................................................17
2
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TRIAD GUARANTY INC.
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
1997 1996
------------ ------------
Assets (Unaudited)
Invested assets:
Securities available-for-sale, at fair value:
Fixed maturities .................................$ 99,278,646 $ 87,229,855
Equity securities................................. 10,522,188 7,494,817
Short-term investments.............................. 3,950,109 3,302,125
------------ ------------
$113,750,943 $ 98,026,797
Cash.................................................. 23,293 360,586
Accrued investment income............................. 1,652,154 1,126,642
Deferred policy acquisition costs..................... 11,455,857 10,198,397
Property and equipment................................ 2,322,645 1,705,389
Prepaid reinsurance premium........................... 264,363 300,200
Reinsurance recoverable............................... 189,096 153,274
Other assets.......................................... 1,618,713 531,238
------------ ------------
Total assets..........................................$131,277,064 $112,402,523
============ ============
Liabilities and stockholders' equity Liabilities:
Losses and loss adjustment expenses.................$ 8,282,460 $ 6,305,397
Unearned premiums................................... 8,085,950 8,216,478
Amounts payable to reinsurer........................ 1,145 1,993
Current taxes payable............................... 3,318 1,596
Deferred income taxes............................... 6,694,744 4,276,081
Unearned ceding commission.......................... 72,424 80,573
Accrued expenses and other liabilities.............. 2,147,209 1,840,369
------------ ------------
Total liabilities..................................... 25,287,250 20,722,487
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 20,000,000 shares; 13,291,722
shares issued and outstanding at September 30,
1997 and 6,645,361 at December 31, 1996 - Note 7.. 132,917 66,453
Additional paid-in capital.......................... 59,355,747 59,346,832
Unrealized gain on available-for-sale securities,
net of income tax liability of $1,952,270 at
September 30, 1997 and $823,287 at
December 31, 1996................................ 3,651,385 1,568,800
Retained earnings................................... 42,849,765 30,697,951
------------ ------------
Total stockholders' equity............................ 105,989,814 91,680,036
------------ ------------
Total liabilities and stockholders' equity............$131,277,064 $112,402,523
============ ============
See accompanying notes
3
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TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
---------------------------- ----------------------------
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Revenue:
Premiums written:
Direct ....................................... $ 11,088,559 $ 7,217,239 $ 28,635,704 $ 19,008,390
Assumed ...................................... 7,150 4,559 23,204 20,306
Ceded ........................................ (485,041) (537,661) (1,541,755) (1,712,620)
------------ ------------ ------------ ------------
Net premiums written ............................ 10,610,668 6,684,137 27,117,153 17,316,076
Change in unearned premiums ..................... (232,442) (171,273) 94,691 438,941
------------ ------------ ------------ ------------
Earned premiums ................................. 10,378,226 6,512,864 27,211,844 17,755,017
Net investment income ........................... 1,729,886 1,368,002 4,703,465 4,011,300
Realized investment gains ....................... 71,616 (12,334) 77,466 (153,906)
Other income .................................... 1,686 0 7,716 0
------------ ------------ ------------ ------------
12,181,414 7,868,532 32,000,491 21,612,411
Losses and expenses:
Losses and loss adjustment expenses ............. 1,554,580 1,048,633 3,938,719 2,381,510
Reinsurance recoveries .......................... (34,927) (35,826) (133,320) (101,085)
------------ ------------ ------------ ------------
Net losses and loss adjustment expenses ......... 1,519,653 1,012,807 3,805,399 2,280,425
Amortization of deferred policy acquisition costs 1,049,639 816,832 3,007,082 2,418,039
Other operating expenses (net) .................. 2,704,303 1,840,693 7,371,666 5,216,808
------------ ------------ ------------ ------------
5,273,595 3,670,332 14,184,147 9,915,272
------------ ------------ ------------ ------------
Income before income taxes ...................... 6,907,819 4,198,200 17,816,344 11,697,139
Income taxes:
Current ...................................... 223 223 2,391 (37,518)
Deferred ..................................... 2,169,410 1,309,466 5,595,680 3,645,061
------------ ------------ ------------ ------------
2,169,633 1,309,689 5,598,071 3,607,543
------------ ------------ ------------ ------------
Net income ...................................... $ 4,738,186 $ 2,888,511 $ 12,218,273 $ 8,089,596
============ ============ ============ ============
Earnings per common and common equivalent share:
Primary ...................................... $ .34 $ .21 $ .88 $ .61
============ ============ ============ ============
Fully diluted ................................ $ .34 $ .21 $ .87 $ .59
============ ============ ============ ============
Shares used in computing earnings per common
and common equivalent share:
Primary ...................................... 14,014,582 13,737,574 13,889,126 13,273,514
============ ============ ============ ============
Fully diluted ................................ 14,075,314 13,762,408 14,074,914 13,745,200
============ ============ ============ ============
</TABLE>
See accompanying notes.
4
<PAGE>
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
Nine Months Ended
September 30
---------------------------
1997 1996
---- ----
OPERATING ACTIVITIES
Net income ........................................... $12,218,273 $ 8,089,596
Adjustments to reconcile net income to net cash
provided by operating activities:
Loss and unearned premium reserves ............... 1,846,535 667,374
Accrued expenses and other liabilities ........... 326,267 246,133
Current taxes payable ............................ 1,722 (38,331)
Amounts due to/from reinsurers ................... (833) 1,818,475
Accrued investment income ........................ (525,512) (290,700)
Policy acquisition costs deferred ................ (4,264,541) 4,569,653)
Amortization of policy acquisition costs ......... 3,007,082 2,418,039
Net realized investment gains .................... (77,466) 153,906
Provision for depreciation ....................... 434,894 276,541
Accretion of discount on investments ............. (463,182) (444,646)
Deferred income taxes ............................ 1,289,680 1,539,794
Unearned ceding commission ....................... (8,149) (526,402)
Real estate acquired in claim settlement ......... 0 (134,401)
Other assets ..................................... (1,086,688) 240,047
----------- ------------
Net cash provided by operating activities ........... 12,698,082 9,445,772
INVESTING ACTIVITIES
Securities available-for-sale:
Purchases - fixed maturities .................... (20,254,380) (16,999,911)
Sales - fixed maturities ........................ 10,582,547 7,047,623
Purchases - equities ............................ (3,150,355) (2,595,723)
Sales - equities ................................ 1,469,121 1,824,431
Purchase of property and equipment ................ (1,043,244) (560,598)
----------- ------------
Net cash used in investing activities ............... (12,396,311) (11,284,178)
FINANCING ACTIVITIES
Proceeds from exercise of stock options ............. 8,920 205,536
Retirement of common stock (at cost) ................ 0 (512)
----------- ------------
Net cash provided by financing activities ........... 8,920 205,024
----------- -----------
Net change in cash and short-term investments ....... 310,691 1,633,382)
Cash and short-term investments at
beginning of period................................ 3,662,711 4,425,448
----------- -----------
Cash and short-term investments at end of period .... $ 3,973,402 $ 2,792,066
=========== ============
Supplemental schedule of cash flow information
Cash paid during the period for income
taxes and United States Mortgage Guaranty
Tax and Loss Bonds ................................ $ 4,306,900 $ 1,948,782
============ ============
See accompanying notes.
5
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1997
(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, 1997 are not necessarily indicative of the results that may be
expected for the year ending December 31, 1997. 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,
1996.
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 - Triad assumes and cedes certain premiums and losses from/to
reinsurers under various reinsurance agreements. Reinsurance contracts do not
relieve Triad from its obligations to policyholders. Failure of the reinsurer to
honor its obligation could result in losses to Triad; consequently, allowances
are established for amounts when deemed uncollectible.
6
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
September 30, 1997
(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, 1997 and December 31, 1996, 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,
1997 1996
---- ----
Net risk........................... $2,066,871,668 $1,452,824,414
=============== ==============
Statutory capital and surplus...... $ 60,132,542 $ 57,070,475
Statutory contingency reserve...... 49,000,126 35,072,109
--------------- --------------
Total.............................. $ 109,132,668 $ 92,142,584
=============== ==============
Risk-to-capital ratio.............. 18.9-to-1 15.8-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 $16,493,981 for the nine months ended September 30, 1997 and $13,396,769 for
the year ended December 31, 1996.
At September 30, 1997, Triad could pay out to the parent company a dividend
of $1,714,740, representing the earned surplus, on a statutory basis, of Triad
7
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
September 30, 1997
(Unaudited)
on that date. At December 31, 1996, no dividend could be paid out to the parent
company, because the surplus of Triad, on a statutory basis, was a deficit of
$1,347,326.
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 - - EARNINGS PER SHARE
Primary and fully diluted earnings per share are based on the weighted
average daily number of shares outstanding. For both primary and fully diluted
earnings per share, computation of the weighted average daily number of shares
outstanding includes common stock equivalents. Common stock equivalents include
stock options that have a dilutive effect on earnings per share.
NOTE 6 - - NEW ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, Earnings per Share, which is required to be adopted on December 31,
1997. At that time, the Company will be required to change the method currently
used to compute earnings per share and to restate all prior periods. Under the
new requirements for calculating basic earnings per share, the dilutive effect
of stock options will be excluded. The impact of calculating basic earnings per
share is expected to result in an increase in primary earnings per share for the
three and nine month periods ended September 30, 1997 of $ .02 and $ .04 per
share, respectively. For the three and nine month periods ended September 30,
1996, the impact of Statement 128 is not expected to be material. The impact of
Statement 128 on the calculation of fully diluted earnings per share for these
quarters is not expected to be material.
In June 1997, the Financial Accounting Standards Board issued Statement
No. 130, Reporting Comprehensive Income which is effective for fiscal years
beginning after December 31, 1997. The Statement establishes standards for the
reporting and display of comprehensive income and its components in financial
statements. The Company expects to adopt the provisions of Statement No. 130 in
the first quarter of 1998 and will reclassify the financial statements for
earlier periods provided for comparative purposes as required by the Statement.
The application of the new rules will not have an impact on the Company's
financial position or results of operations.
8
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED
September 30, 1997
(Unaudited)
NOTE 7 - - STOCK SPLIT
On September 18, 1997, Triad's Board of Directors declared a two-for-one
stock split in the form of a 100% stock dividend effective October 28, 1997 to
holders of record as of October 10, 1997. The stock split has been recorded as
of September 30, 1997 by a transfer of $66,459 from retained earnings to common
stock, representing a $0.01 par value for each share issued. All per share data
in this report have been restated to reflect the split.
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
Net income for the first nine months of 1997 increased 51% to $12.2 million
compared to $8.1 million in the first nine months of 1996. Net income for the
third quarter of 1997 increased 64% to $4.7 million compared to $2.9 million for
the third quarter of 1996. This improvement is primarily attributable to a 53.3%
(59.3% in the third quarter) increase in earned premiums and also to increased
net investment income and an improved combined loss and expense ratio.
Fully diluted net income per share, which reflects the two-for-one stock
split effective on October 28, 1997, increased 47.5% to $0.87 for the first nine
months of 1997 compared to $0.59 per share for the first nine months of 1996.
Net income per share for the third quarter of 1997 was $0.34 on a fully diluted
basis compared to $0.21 per share for the same period of 1996. Operating
earnings per share were $0.86 for the first nine months of 1997 compared to
$0.60 for the first nine months of 1996, an increase of 45%. Operating earnings
exclude realized gains of approximately $77,000 in the first nine months of 1997
and realized losses of approximately $154,000 in the same period of 1996.
New insurance written, which includes insurance on new and seasoned loans,
was $3.1 billion for the first nine months of 1997 as compared to $1.6 billion
for the same period of 1996, an increase of 87.9%. For the third quarter, new
insurance written increased 95.8% to $1.1 billion in 1997 compared to $576
million in 1996. This increase in gross new insurance written is the result of
continued geographic expansion and the penetration of Triad's products in the
marketplace including Triad's new risk sharing products. Of the $3.1 billion in
total new insurance production, $952 million was attributable to seasoned loans.
The Company has also benefited from the January 1997 upgrade of Triad's
claims-paying ability rating from "AA-" to "AA" by Standard & Poor's
Corporation. A favorable interest rate environment in the first nine months of
1997 caused home buying activities to remain strong. Refinance activity declined
to 13.0% of new insurance written in the first nine months of 1997 compared to
18.8% of insurance written in the same period of 1996. Total direct insurance in
force reached $8.8 billion at September 30, 1997 compared to $6.2 billion at
September 30, 1996, an increase of 41.8%.
Net new insurance written, which includes coverage on new loans only, was
$2.1 billion for the first nine months of 1997 compared to $1.6 billion for the
same period of 1996, an increase of 30.1%. Management expects almost all of the
production in the remainder of 1997 and 1998 to be comprised of coverage on new
loans. According to industry data, Triad's national market share, which is
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
calculated based on net new insurance written, increased by approximately 47% to
2.5% for the nine months of 1997 compared to 1.7% for the same period of 1996.
Regulatory and industry issues exist regarding the future of certain risk
sharing programs, such as captive reinsurance, currently being marketed within
the mortgage insurance industry. In the first nine months of 1997 a significant
portion of Triad's production, which does not include captive reinsurance,
resulted from Triad's new risk sharing programs. However, the resolution of the
regulatory and industry questions regarding risk sharing programs makes the
continued viability of such programs uncertain.
Total direct premiums written were $28.6 million for the first nine months
of 1997, an increase of 50.6% compared to $19.0 million for the first nine
months of 1996. Net premiums written increased by 56.6% to $27.1 million in the
first nine months of 1997 compared to $17.3 million for the same period in 1996.
Earned premiums increased 53.3% to $27.2 million for the first nine months of
1997 from $17.8 million in the first nine months of 1996. Contributing to this
growth in written and earned premium was the increase in new insurance written,
offset slightly by the decline in the Company's persistency rate. Sales under
the Company's monthly premium plan represented 93.5% of new insurance written in
the first nine months of 1997 compared to 92.7% in the same period of 1996.
Annualized persistency was 84.1% for the first nine months of 1997 compared to
84.3% for the first nine months of 1996.
In the 1996 fourth quarter, Triad introduced its revised Stick With Triad
program featuring the Slam Dunk Loan SM approval process whereby Triad issues a
certificate of insurance based on the borrower's credit score. The popularity,
to a large extent, of this product has reduced customer use of Triad's delegated
underwriting program. Commitments processed through Triad's delegated
underwriting program accounted for 12.9% of commitments received for the first
nine months of 1997, compared to 38.1% in the first nine months of 1996 and
38.0% for all of 1996.
Net investment income for the first nine months of 1997 was $4.7 million, a
17.3% increase over $4.0 million in the first nine months of 1996. This increase
resulted from the growth in average invested assets of $13.4 million to $101.5
million at September 30, 1997 from $88.1 million at September 30, 1996. The
yield on average invested assets increased slightly to 6.2% for the first nine
months of 1997 compared to 6.1% for the same period of 1996. The portfolio's
tax-equivalent yield was 7.9% for the first nine months of 1997 up from 7.7% for
all of 1996. Approximately 67% or $66.5 million of the Company's fixed maturity
portfolio at September 30, 1997 was composed of state and municipal
tax-preferred securities as compared to 53% at December 31, 1996 and 37% at
December 31, 1995.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
The Company's loss ratio (the ratio of incurred losses to earned premiums)
was 14.0% for the first nine months of 1997 compared to 12.8% for the same
period of 1996 and 13.3% for all of 1996. The loss ratio was 14.6% for the third
quarter of 1997 compared to 15.6% for the third quarter of 1996. The Company's
favorable loss ratio reflects the low level of delinquencies compared to the
number of insured loans and the fact that approximately 74% of the Company's
insurance in force was originated in the last 36 months. 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.
Net losses and loss adjustment expenses (net of reinsurance recoveries)
increased by 66.9% in the first nine months of 1997 to $3.8 million compared to
$2.3 million in the first nine months of 1996. Losses and loss adjustment
expenses for the third quarter of 1997 were $1.5 million compared to $1.0
million for the third quarter of 1996. 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.
Amortization of deferred policy acquisition costs increased by 24.4% to
$3.0 million in the first nine months of 1997 compared to $2.4 million for the
first nine months of 1996. These costs were $1.0 million for the third quarter
of 1997 compared to $817,000 for the third quarter of 1996, an increase of
28.5%. 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 $7.4 million for the first nine
months of 1997 compared to $5.2 million for the same period in 1996. For the
third quarter of 1997, other operating expense increased to $2.7 million from
$1.8 million in the third quarter of 1996. This increase in expenses is
primarily attributable to advertising, personnel, facilities and equipment costs
required to support the Company's product development, technology enhancements,
geographic expansion and increased production.
The expense ratio (ratio of underwriting expenses to net premiums written)
for the first nine months of 1997 was 38.3% compared to 44.1% for the first nine
months of 1996 and 43.8% for all of 1996. The expense ratio for the third
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
quarter of 1997 improved to 35.4% from 39.8% reported a year earlier.
Contributing to this improvement is the higher level of written premiums
partially offset by the increase in expenses.
The effective tax rate for the first nine months of 1997 was 31.4% compared
to 30.8% in the first nine months of 1996. This increase is primarily the result
of 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 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.
The Company generated positive cash flow from operating activities for the
first nine months of 1997 of $12.7 million compared to $9.4 million for the
first nine months of 1996. The increase in Triad's operating cash flow reflects
the growth in insurance written and insurance in force that has more than offset
the increases in claims paid and other expenses.
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. Triad
had an earned surplus of $1.7 million at September 30, 1997 and a deficit of
$1.3 million at December 31, 1996. Triad has no immediate plans to pay a cash
dividend to the parent company. The Illinois Insurance Department permits
expenses of the parent company to be paid by Triad in the form of management
fees.
Consolidated invested assets were $113.8 million at September 30, 1997,
including a total of $109.8 million in fixed maturity securities and equity
securities classified as available- for-sale. Net unrealized investment gains on
13
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
equity securities were $2.3 million and on fixed maturity securities were $3.3
million at September 30, 1997.
Approximately 7.5% or $7.2 million of the Company's fixed maturity
portfolio at September 30, 1997 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, 1997 was $3.3 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 loss reserves increased to $8.3 million at September 30, 1997
compared to $6.3 million at December 31, 1996. 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 reserves per delinquent loan were $22,600 at September 30, 1997
and $23,100 at December 31, 1996. The Company's delinquency ratio, the ratio of
delinquent insured loans to total insured loans, was 0.46% at September 30, 1997
compared to 0.44% at December 31, 1996.
The Company's unearned premium reserve of $8.1 million at September 30,
1997 decreased from $8.2 million at December 31, 1996. This decline is
attributable primarily to the continued production of the monthly premium
product, which produces little unearned premium compared to annual and single
premium products. Refinance activity is also responsible for the decrease in
unearned premiums, whereby older annual premium policies are replaced by monthly
premium policies.
14
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
Total stockholders' equity increased to $106.0 million at September 30,
1997 from $91.7 million at December 31, 1996. This increase resulted from net
income of $12.2 million for the first nine months of 1997 and an increase,
during 1997, in net unrealized gains on invested assets classified as
available-for-sale of $2.1 million (net of income tax).
Triad's total statutory policyholders' surplus increased to $60.1 million
at September 30, 1997 from $57.1 million at December 31, 1996. This increase
resulted from statutory net income of $16.5 million and unrealized gains of $1.1
million offset primarily by an increase in the statutory contingency reserve of
$13.9 million. Triad's statutory earned surplus was $1.7 million at September
30, 1997 compared to a deficit of $1.3 million at December 31, 1996, reflecting
growth in statutory net income greater than the increase in the statutory
contingency reserve. The balance in the statutory contingency reserve was $49.0
million at September 30, 1997 compared to $35.1 million at December 31, 1996.
The Company expects to incur aggregate capital costs of approximately $2.0
million in 1997 and 1998 to upgrade and enhance its computer systems and
technological capabilities. The Company expects to fund such expenditures with
cash flow from operations. As a part of this effort, management has initiated a
program to prepare the Company's computer systems and applications to be year
2000 compliant. The Company expects to incur internal staff costs as well as
consulting and other expenses related to infrastructure and facilities
enhancement necessary to prepare the systems for the year 2000. Most of the
modifications will be made as part of the Company's capital upgrade to its
computer systems throughout the remainder of 1997 and 1998.
Triad's ability to write insurance depends on the adequacy of its statutory
capital in relation to risk in force. A significant reduction of capital or a
significant increase in risk may impair Triad's ability to write additional
insurance. Freddie Mac and Fannie Mae require Triad to maintain a
risk-to-capital ratio of no more than 25-to-1. A number of states also generally
limit Triad's risk-to-capital ratio to 25-to-1. As of September 30, 1997 Triad's
risk-to-capital ratio was 18.9-to-1, and as of December 31, 1996 was 15.8-to-1,
as compared to 19.4-to-1 for the industry as a whole at December 31, 1996, the
latest industry data available. Management believes its risk-to-capital ratio
can increase up to approximately 20-to-1 without an adverse effect on its
claims-paying ability ratings. With increasing production, management and the
Board of Directors are evaluating the Company's needs and alternatives for
additional capital for Triad. Management anticipates initiating a private
placement offering of up to $35 million in the fourth quarter of 1997.
15
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
NEW ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, Earnings per Share, which is required to be adopted on December 31,
1997. At that time, the Company will be required to change the method currently
used to compute earnings per share and to restate all prior periods. Under the
new requirements for calculating basic earnings per share, the dilutive effect
of stock options will be excluded. The impact of calculating basic earnings per
share is expected to result in an increase in primary earnings per share for the
three and nine month periods ended September 30, 1997 of $ 0.02 and $0.04 per
share, respectively. For the three and nine month periods ended September 30,
1996, the impact of Statement 128 is not expected to be material. The impact of
Statement 128 on the calculation of fully diluted earnings per share for these
quarters is not expected to be material.
In June 1997, the Financial Accounting Standards Board issued Statement No.
130, Reporting Comprehensive Income which is effective for fiscal years
beginning after December 31, 1997. The Statement establishes standards for the
reporting and display of comprehensive income and its components in financial
statements. The Company expects to adopt the provisions of Statement No. 130 in
the first quarter of 1998 and will reclassify the financial statements for
earlier periods provided for comparative purposes as required by the Statement.
The application of the new rules will not have an impact on the Company's
financial position or results of operations.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Management's Discussion and Analysis and this Report contain forward
looking statements relating to future plans, expectations and performance which
involve various risks and uncertainties, including but not limited to the
following: interest rates may increase 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
or rates; the amount of new insurance written could be affected by changes in
federal housing legislation, including changes in the Federal Housing
Administration loan limits and coverage requirements of Freddie Mac and Fannie
Mae; the Company's performance may be impacted by changes in the performance of
the financial markets and general economic conditions. Economic downturns in
regions where Triad's risk is more concentrated could have a particularly
adverse affect on Triad's financial condition and loss development. 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.
16
<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, 1997
/s/ Michael R. Oswalt
-----------------------------
Michael R. Oswalt
Vice President and Controller,
Principal Accounting Officer
17
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
------ -----------
11 Statement Re Computation of Net Income per Share
27 Financial Data Schedule
18
EXHIBIT 11
TRIAD GUARANTY INC.
STATEMENT RE COMPUTATION OF NET INCOME PER SHARE
Three and Nine Month Periods Ended September 30, 1997 and 1996
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
1997 1996 1997 1996
----------- ----------- ----------- -----------
PRIMARY NET INCOME PER SHARE
- -----------------------------
<S> <C> <C> <C> <C>
Weighted average common
shares outstanding................ 13,291,244 13,290,722 13,290,844 13,273,514
Net shares to be issued upon
exercise of dilutive stock options
after applying treasury stock
method............................ 723,338 446,852 598,282 0
----------- ----------- ----------- -----------
Adjusted shares outstanding......... 14,014,582 13,737,574 13,889,126 13,273,514
=========== =========== =========== ===========
Net income.......................... $ 4,738,186 $ 2,888,511 $12,218,273 $ 8,089,596
=========== =========== =========== ===========
Primary net income per share........ $.34 $.21 $.88 $.61
=========== =========== =========== ===========
FULLY DILUTED NET INCOME PER SHARE
- ----------------------------------
Weighted average common
shares outstanding................. 13,291,244 13,290,722 13,290,844 13,273,514
Net shares to be issued upon
exercise of dilutive stock options
after applying treasury stock
method............................. 784,070 471,686 784,070 471,686
------------ ----------- ----------- -----------
Adjusted shares outstanding......... 14,075,314 13,762,408 14,074,914 13,745,200
============ =========== =========== ===========
Net income.......................... $ 4,738,186 $ 2,888,511 $12,218,273 $ 8,089,596
============ =========== =========== ===========
Fully diluted net income per
share............................... $.34 $.21 $.87 $.59
============ ============ ============ ===========
</TABLE>
19
<PAGE>
EXHIBIT 11
<TABLE>
<CAPTION>
Three months ended Nine months Ended
September 30, September 30,
------------------------- ------------------------
1997 1996 1997 1996
----------- ----------- ----------- -----------
ADDITIONAL PRIMARY COMPUTATION
- ------------------------------
<S> <C> <C> <C> <C>
Weighted average common
shares outstanding 13,291,244 13,290,722 13,290,844 13,273,514
Net shares to be issued upon
exercise of dilutive stock options
after applying treasury stock
method 723,338 446,852 598,282 368,786
----------- ------------ ----------- -----------
Adjusted shares outstanding 14,014,582 13,737,574 13,889,126 13,642,300
=========== ============ =========== ===========
Net income $ 4,738,186 $ 2,888,511 $12,218,273 $ 8,089,596
=========== ============ =========== ===========
Primary net income per share $.34 $.21 $.88 $.59(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%.
20
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary information extracted from Form 10-Q for
the nine months ended September 30, 1997, 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-31-1997
<PERIOD-END> SEP-30-1997
<DEBT-HELD-FOR-SALE> 99,278,646
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 10,522,188
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 113,750,943
<CASH> 23,293
<RECOVER-REINSURE> 29,416
<DEFERRED-ACQUISITION> 11,455,857
<TOTAL-ASSETS> 131,277,064
<POLICY-LOSSES> 8,282,460
<UNEARNED-PREMIUMS> 8,085,950
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 0
0
0
<COMMON> 132,917
<OTHER-SE> 105,856,897
<TOTAL-LIABILITY-AND-EQUITY> 131,277,064
27,211,844
<INVESTMENT-INCOME> 4,703,465
<INVESTMENT-GAINS> 77,466
<OTHER-INCOME> 7,716
<BENEFITS> 3,805,399
<UNDERWRITING-AMORTIZATION> 3,007,082
<UNDERWRITING-OTHER> 7,371,666
<INCOME-PRETAX> 17,816,344
<INCOME-TAX> 5,598,071
<INCOME-CONTINUING> 12,218,273
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 12,218,273
<EPS-PRIMARY> 0.88
<EPS-DILUTED> 0.87
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
