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, 1998
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)
(336) 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 3,
1998: 13,377,536 shares.
<PAGE>
TRIAD GUARANTY INC.
INDEX
Page
Number
Part I. Financial Information:
Item 1. Financial Statements:
Consolidated Balance Sheets as of September 30, 1998 (Unaudited)
and December 31, 1997.....................................................3
Consolidated Statements of Income for the Three and Nine Month
Periods Ended September 30, 1998 and 1997 (Unaudited).....................4
Consolidated Statements of Cash Flow for the Nine Month
Periods Ended September 30, 1998 and 1997 (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
<PAGE>
TRIAD GUARANTY INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
----------- ------------
(Unaudited)
<S> <C> <C>
Assets
Invested assets:
Securities available-for-sale, at fair value:
Fixed maturities .............................. $153,662,429 $ 99,725,487
Equity securities ............................. 11,427,910 11,466,028
Short-term investments .......................... 4,744,018 8,685,842
------------ ------------
$169,834,357 $119,877,357
Cash .............................................. 170,824 8,557
Accrued investment income ......................... 2,332,144 1,460,168
Deferred policy acquisition costs ................. 14,659,504 12,587,355
Property and equipment ............................ 3,105,208 2,524,228
Prepaid reinsurance premium ....................... 16,368 23,263
Reinsurance recoverable ........................... 30,217 49,447
Other assets ...................................... 4,109,781 2,448,685
------------ ------------
Total assets ...................................... $194,258,403 $138,979,060
============ ============
Liabilities and stockholders' equity
Liabilities:
Losses and loss adjustment expenses ........... $ 10,536,147 $ 8,960,411
Unearned premiums ............................. 6,975,250 7,988,342
Current taxes payable ......................... 3,322 3,318
Deferred income taxes ......................... 8,132,759 7,521,874
Long term debt ................................ 34,480,782 --
Accrued interest on debt ...................... 583,722 --
Accrued expenses and other liabilities ........ 3,187,253 2,724,324
------------ ------------
Total liabilities ................................. 63,899,235 27,198,269
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 32,000,000 shares; 13,392,536
shares issued and outstanding at
September 30, 1998 and 13,293,721 at
December 31, 1997 ........................... 133,925 132,937
Additional paid-in capital ..................... 60,417,014 59,369,223
Accumulated other comprehensive income,
net of income tax liability of $2,174,213
at September 30, 1998 and $2,368,998
at December 31, 1997 ........................ 4,043,571 4,405,315
Retained earnings .............................. 65,764,658 47,873,316
------------ ------------
Total stockholders' equity ........................ 130,359,168 111,780,791
------------ ------------
Total liabilities and stockholders' equity ........ $194,258,403 $138,979,060
============ ============
</TABLE>
See accompanying notes
3
<PAGE>
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
-------------------------- -----------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
Premiums written:
Direct ..........................................$ 13,681,365 $ 11,088,559 $ 38,017,064 $ 28,635,704
Assumed ......................................... 1,335 7,150 10,262 23,204
Ceded ........................................... (310,979) (485,041) (788,451) (1,541,755)
------------ ------------ ------------ ------------
Net premiums written ............................... 13,371,721 10,610,668 37,238,875 27,117,153
Change in unearned premiums ........................ 284,247 (232,442) 1,006,197 94,691
------------ ------------ ------------ ------------
Earned premiums .................................... 13,655,968 10,378,226 38,245,072 27,211,844
Net investment income .............................. 2,424,083 1,729,886 6,788,337 4,703,465
Realized investment gains .......................... 307,812 71,616 582,076 77,466
Other income ....................................... 8,609 1,686 9,648 7,716
------------ ------------ ------------ ------------
16,396,472 12,181,414 45,625,133 32,000,491
Losses and expenses:
Losses and loss adjustment expenses ................ 1,714,629 1,554,580 4,297,145 3,938,719
Reinsurance recoveries ............................. 1,508 (34,927) 2,991 (133,320)
------------ ------------ ------------ ------------
Net losses and loss adjustment expenses ............ 1,716,137 1,519,653 4,300,136 3,805,399
Interest expense on debt ........................... 692,388 -- 1,861,578 --
Amortization of deferred policy acquisition costs .. 1,553,379 1,049,639 4,188,705 3,007,082
Other operating expenses (net) ..................... 3,177,927 2,704,303 9,515,458 7,371,666
------------ ------------ ------------ ------------
7,139,831 5,273,595 19,865,877 14,184,147
------------ ------------ ------------ ------------
Income before income taxes ......................... 9,256,641 6,907,819 25,759,256 17,816,344
Income taxes:
Current ......................................... -- 223 426 2,391
Deferred ........................................ 2,793,250 2,169,410 7,867,488 5,595,680
------------ ------------ ------------ ------------
2,793,250 2,169,633 7,867,914 5,598,071
------------ ------------ ------------ ------------
Net income .........................................$ 6,463,391 $ 4,738,186 $ 17,891,342 $ 12,218,273
============ ============ ============ ============
Earnings per common and
common equivalent share:
Basic ...........................................$ .48 $ .36 $ 1.34 $ .92
============ ============ ============ ============
Diluted .........................................$ .47 $ .34 $ 1.29 $ .89
============ ============ ============ ============
Shares used in computing earnings per
common and common equivalent share:
Basic ........................................... 13,358,409 13,291,244 13,325,656 13,290,885
============ ============ ============ ============
Diluted ......................................... 13,854,330 13,762,476 13,864,865 13,681,225
============ ============ ============ ============
</TABLE>
See accompanying notes.
4
<PAGE>
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30
----------------------------
1998 1997
<S> <C> <C>
Operating activities
Net income ........................................... $ 17,891,342 $ 12,218,273
Adjustments to reconcile net income to net
cash provided by operatingactivities:
Loss and unearned premium reserves ................ 562,644 1,846,535
Accrued expenses and other liabilities ............ 440,186 326,267
Current taxes payable ............................. 4 1,722
Accrued investment income ......................... (871,976) (525,512)
Policy acquisition costs deferred ................. (6,260,854) (4,264,541)
Amortization of policy acquisition costs .......... 4,188,705 3,007,082
Net realized investment gains ..................... (582,076) (77,466)
Provision for depreciation ........................ 560,815 434,894
Amortization of intangible assets ................. 34,795 --
Accretion of discount on investments .............. (739,867) (463,182)
Deferred income taxes ............................. 805,670 1,289,680
Accrued interest on debt .......................... 583,722 --
Real estate acquired in claim settlement .......... 141,999 --
Other assets ...................................... (1,464,865) (1,095,670)
------------ ------------
Net cash provided by operating activities ............ 15,290,244 12,698,082
Investing activities
Securities available-for-sale:
Purchases - fixed maturities ..................... (63,482,701) (20,254,380)
Sales - fixed maturities ......................... 10,760,774 10,582,547
Purchases - equities ............................. (5,119,678) (3,150,355)
Sales - equities ................................. 4,677,949 1,469,121
Purchase of property and equipment ................. (1,134,700) (1,043,244)
------------ ------------
Net cash used in investing activities ................ (54,298,356) (12,396,311)
Financing activities
Proceeds from issuance of long term debt ............. 34,477,899 --
Proceeds from exercise of stock options .............. 750,656 8,920
------------ ------------
Net cash provided by financing activities ............ 35,228,555 8,920
------------ ------------
Net change in cash and short-term investments ........ (3,779,557) 310,691
Cash and short-term investments at beginning
of period ......................................... 8,694,399 3,662,711
------------ ------------
Cash and short-term investments at end of period ..... $ 4,914,842 $ 3,973,402
============ ============
Supplemental schedule of cash flow information
Cash paid during theperiod for:
Income taxes and United States Mortgage Guaranty
Tax and Loss Bonds ............................. $ 6,979,726 $ 4,306,900
Interest .......................................... $ 1,274,972 $ --
Non-cash investing and finance activities:
Exchange of restricted common stock for
intangible asset ............................... $ 298,125 $ --
</TABLE>
See accompanying notes.
5
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
(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, 1998 are not necessarily indicative of the results that may be
expected for the year ending December 31, 1998. 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,
1997.
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, a wholly-owned subsidiary of Triad
Guaranty Insurance 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 obligation could 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, 1998
(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, 1998 and December 31, 1997,
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,
1998 1997
Net risk ........................... $ 2,599,455,489 $2,231,572,130
=============== ==============
Statutory capital and surplus ...... $ 89,163,345 $ 60,929,830
Statutory contingency reserve ...... 74,379,618 54,766,669
--------------- --------------
Total .............................. $ 163,542,963 $ 115,696,499
=============== ==============
Risk-to-capital ratio .............. 15.9-to-1 19.3-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
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 $24,094,862 for the nine months ended September 30, 1998 and $22,916,215 for
the year ended December 31, 1997.
At September 30, 1998 and December 31, 1997, the amount of Triad's equity
that could be paid out in dividends to stockholders was $5,447,417 and
$2,512,027, respectively, which was the earned surplus of Triad on a statutory
basis on those dates.
7
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
September 30, 1998
(Unaudited)
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
Basic and diluted earnings per share are based on the weighted average
daily number of shares outstanding. For diluted earnings per share, the
denominator includes the dilutive effect of stock options on the
weighted-average shares outstanding. There are no other reconciling items
between the denominator used in basic earnings per share and diluted earnings
per share, and the numerator used in basic earnings per share and diluted
earnings per share is the same for all periods presented.
NOTE 6 - - COMPREHENSIVE INCOME
On January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, Reporting Comprehensive Income. Statement No. 130 establishes
standards for reporting and display of the components of comprehensive income in
financial statements. Comprehensive income is divided into net income and other
comprehensive income. For the Company, other comprehensive income is composed of
unrealized gains or losses on available-for-sale securities, net of income tax.
Prior to adoption of this statement, these amounts were reported as a component
to stockholders' equity. The adoption of this statement had no impact on the
Company's net income or stockholders' equity.
For the three month periods ended September 30, 1998 and 1997, the
Company's comprehensive income was $6.2 million and $6.3 million, respectively.
For the nine month periods ended September 30, 1998 and 1997, the Company's
comprehensive income was $17.5 million and $14.3 million, respectively. Prior
period financial statements have been reclassified to conform to the
requirements of Statement No. 130.
8
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
September 30, 1998
(Unaudited)
NOTE 7 - - LONG TERM DEBT
On January 29, 1998, the Company completed a $35 million private offering
of notes due January 15, 2028. The notes, which represent unsecured obligations
of the Company, bear interest at a rate of 7.9% per annum and are non-callable.
The notes are rated "A" by Standard and Poor's Corporation and "A+" by Fitch
Investors Service. The Company contributed $25 million of the net proceeds from
the sale of the notes to Triad in exchange for a surplus debenture. The Company
will be dependent upon payments under the surplus debenture issued by Triad and
upon possible future dividends from Triad, all of which will be subject to
significant payment restrictions under Illinois insurance laws, to provide funds
for the payment of the Company's obligations under the notes. The Company
retained the balance of the net proceeds of the offering, approximately $9.4
million, which will be available for general corporate purposes, including,
without limitation, investment, payments of principal and interest on the notes
and possible future contributions to the capital of Triad.
9
<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 1998 increased 46.4% to $17.9
million compared to $12.2 million in the first nine months of 1997. Net income
for the third quarter of 1998 increased 36.4% to $6.5 million compared to $4.7
million for the third quarter of 1997. This improvement is attributable to a
40.5% (31.6% in the third quarter) increase in earned premiums, a 44.3% (40.1%
in the third quarter) increase in net investment income and an improved combined
loss and expense ratio.
Net income per share on a diluted basis, which reflects the two-for-one
stock split effective on October 28, 1997, increased 44.5% to $1.29 for the
first nine months of 1998 compared to $0.89 per share for the first nine months
of 1997. Net income per share for the third quarter of 1998 was $0.47 on a
diluted basis compared to $0.34 per share for the same period of 1997. Operating
earnings per share were $1.26 for the first nine months of 1998 compared to
$0.89 for the first nine months of 1997. Operating earnings exclude net realized
gains of approximately $582,000 in the first nine months of 1998 and of
approximately $77,000 in the same period of 1997.
Net new insurance written was $3.3 billion for the first nine months of
1998 as compared to $2.1 billion for the first nine months of 1997, an increase
of 52.5%. For the third quarter, net new insurance written totaled $1.2 billion
in 1998 compared to $817 million in 1997. The Company also produced
approximately $186 million of new insurance written on seasoned loans in the
first nine months of 1998 compared to $951 million in the same period of 1997.
The increase in new insurance written was the result of a strong economy,
continued geographic expansion, the penetration of Triad's products in the
marketplace to both new and existing customers and the introduction of new
products. According to industry data, Triad's national market share of net new
insurance written increased to 2.5% for the first nine months of 1998 compared
to 2.4% reported for all of 1997.
The growth in new insurance written also reflects the favorable interest
rate environment in the first nine months of 1998 which caused home buying and
refinance activities to remain strong. Refinance activity was 30.6% of new
insurance written in the first nine months of 1998 compared to 13.0% in the
first nine months of 1997. Total direct insurance in force reached $10.5 billion
at September 30, 1998, compared to $8.8 billion at September 30, 1997, an
increase of 20.1%.
Total direct premiums written were $38.0 million for the first nine months
of 1998, an increase of 32.8% compared to $28.6 million for the first nine
months of 1997. Net premiums written increased by 37.3% to $37.2 million in the
first nine months of 1998 compared to $27.1 million for the same period in 1997.
Earned premiums increased 40.5% to $38.2 million for the first nine months of
1998 from $27.2 million for the first nine months of 1997. This growth in
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
written and earned premium resulted from the increase in new insurance written,
offset by a decline in the Company's persistency rate. The Company's
persistency, or the number of policies remaining in force from one year prior,
was 73.8% at September 30, 1998, compared to 84.2% at December 31, 1997. The
decline in persistency experienced thus far in 1998 will cause future renewal
premiums to be less than would have been expected under higher persistency
conditions. Sales under the Company's monthly premium plan represented 97.5% of
new insurance written in the first three quarters of 1998 compared to 93.5% in
the same period of 1997.
Net investment income for the first nine months of 1998 was $6.8 million, a
44.3% increase over $4.7 million in the first nine months of 1997. Net
investment income for the third quarter of 1998 was $2.4 million, a 40.1%
increase over the third quarter of 1997. This increase in investment income is
the result of growth in the average book value of invested assets by $45.3
million to $146.8 million at September 30, 1998, from $101.5 million at
September 30, 1997. The growth in invested assets is attributable to both the
investment of the proceeds of the Company's $35.0 million debt offering
completed in late January 1998 and the increase in invested assets due to normal
operating cash flow. The yield on average invested assets remained stable at
6.2% for the first nine months of 1997 and 1998, compared to 6.0% for all of
1997. The portfolio's tax-equivalent yield was 7.9% for the first nine months of
1998 and 1997 versus 8.0% for all of 1997. Approximately 69% or $102.7 million
of the Company's fixed maturity portfolio at September 30, 1998, was composed of
state and municipal tax-preferred securities as compared to 67% at September 30,
1997.
The Company's loss ratio (the ratio of incurred losses to earned premiums)
was 11.2% for the first nine months of 1998 compared to 14.0% for the same
period of 1997 and 13.4% for all of 1997. The loss ratio was 12.6% for the third
quarter of 1998 compared to 14.6% for the third quarter of 1997. The Company's
favorable loss ratio reflects the low level of delinquencies compared to the
number of insured loans and the fact that approximately 77% 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.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
During periods of significant refinancing activity, it is possible that
policies on stronger loans may be canceled and on weaker loans may remain in
force, thus potentially increasing the loss ratio on older business. Substantial
increases in production of new business during these periods can offset the
increased loss ratio on the older business.
Net losses and loss adjustment expenses (net of reinsurance recoveries)
increased by 13.0% in the first nine months of 1998 to $4.3 million compared to
$3.8 million in the first nine months of 1997. Net losses and loss adjustment
expenses for the third quarter of 1998 was $1.7 million versus $1.5 million for
the same quarter in 1997. The year to date increase reflects the growing amount
of 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 39.3% to
$4.2 million in the first nine months of 1998 compared to $3.0 million for the
first nine months of 1997. These costs were $1.6 million for the third quarter
of 1998 compared to $1.0 million for the third quarter of 1997, an increase of
48.0%. The increase in amortization reflects both a growing balance of deferred
policy acquisition costs to amortize as the Company builds its total insurance
in force and a higher cancellation rate during the first nine months of 1998.
Other operating expenses increased 29.1% to $9.5 million for the first nine
months of 1998 compared to $7.4 million for the same period in 1997. For the
third quarter of 1998, other operating expenses increased to $3.2 million from
$2.7 million in the third quarter of 1997. 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 1998 was 36.8% compared to 38.3% for the first nine
months of 1997 and 37.5% for all of 1997. The expense ratio for the third
quarter of 1998 and 1997 was 35.4%. Contributing to this year-to-date
improvement is the higher level of written premiums in 1998 partially offset by
the increase in expenses.
The effective tax rate for the first nine months of 1998 was 30.5% compared
to 31.4% in the first nine months of 1997. This decrease is the result of the
increase in investment in tax preferred securities and the completion of the
phase-in during 1997 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 as long as yields from new
funds invested in tax-preferred securities remain favorable in relation to fully
taxable securities.
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of operating funds consist primarily of premiums
written and investment income. Operating cash flow is applied primarily to the
payment of claims and expenses.
The Company generated positive cash flow from operating activities for the
first nine months of 1998 of $15.3 million compared to $12.7 million for the
first nine months of 1997. The increase in Triad's operating cash flow reflects
the growth in renewal premiums and insurance written 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.
In January 1998, the Company completed a $35.0 million private offering of
notes due January 15, 2028. The notes, which represent unsecured obligations of
the Company, bear interest at a rate of 7.9% per annum and are non-callable. The
notes are rated "A" by Standard and Poor's Corporation and "A+" by Fitch
Investors Service. The parent company contributed $25.0 million of the net
proceeds to Triad in exchange for a surplus debenture. The parent company is
dependent upon payments under the surplus debenture issued by Triad and upon
possible future dividends from Triad, all of which will be subject to
significant payment restrictions under Illinois insurance laws, to provide funds
for the payment of the Company's obligations under the notes. The parent company
retained the balance of the net proceeds of the offering, approximately $9.4
million, and these proceeds are available for general corporate purposes,
including, without limitation, investment, payments of principal and interest on
the notes and possible future contributions to its subsidiaries.
The parent company's cash flow is dependent on interest income, cash
dividends, revenues from management fees and interest payments under the surplus
debenture 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 as of the end of the preceding fiscal year and limit
the amount of dividends that may be paid without prior approval of the Illinois
Insurance Department. 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 $169.8 million at September 30, 1998,
compared to $119.9 million at December 31, 1997. This increase is attributable
to the investment of proceeds of the $35.0 million debt offering and operating
cash flow. Through investment of a portion of the net proceeds of the note
offering, the Company has increased its investments in higher yielding
non-investment grade securities to approximately 9% of its consolidated
investment portfolio, up from approximately 3% at December 31, 1997. Net
unrealized investment gains were $1.8 million on equity securities and $4.4
13
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
million on fixed maturity securities at September 30, 1998. Fixed maturity
securities and equity securities classified as available for sale totaled $165.1
million at September 30, 1998. Based upon book value, the fixed maturity
portfolio consisted of approximately 69% municipal securities, 23% corporate
securities, 6% U.S. government obligations and 2% mortgage-backed bonds at
September 30, 1998.
The Company's loss reserves increased to $10.5 million at September 30,
1998, compared to $9.0 million at December 31, 1997. 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 $21,500 at September
30, 1998, compared to $23,100 at December 31, 1997. The Company's delinquency
ratio, the ratio of delinquent insured loans to total insured loans, was 0.53%
at September 30, 1998, compared to 0.47% at December 31, 1997.
The Company's unearned premium reserve of $7.0 million at September 30,
1998, decreased from $8.0 million at December 31, 1997. 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. Cancellation activity also can contribute to the decrease in
unearned premiums, whereby older annual premium policies are canceled or
replaced by monthly premium policies.
Total stockholders' equity increased to $130.4 million at September 30,
1998, from $111.8 million at December 31, 1997. This increase resulted from net
income of $17.9 million for the first nine months of 1998 and from additional
paid-in capital of $1.0 million resulting from the exercise of employee stock
options and the issuance of restricted stock in connection with the buyout of
one of the Company's exclusive commissioned general agencies. These increases
were offset somewhat by a decline in net unrealized gains on investments of
about $362,000.
Triad's total statutory policyholders' surplus increased to $89.2 million
at September 30, 1998, from $60.9 million at December 31, 1997. This increase
resulted from the Company's contribution to Triad of $25.0 million of note
proceeds through a surplus debenture and statutory net income of $24.1 million,
offset primarily by a decrease in unrealized gains on equity securities of $1.7
million and an increase in the statutory contingency reserve of $19.6 million.
Triad's statutory earned surplus was $5.4 million at September 30, 1998,
compared to $2.5 million at December 31, 1997, reflecting growth in statutory
net income greater than the increase in the statutory contingency reserve. The
balance in the statutory contingency reserve was $74.4 million at September 30,
1998, compared to $54.8 million at December 31, 1997.
14
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
Substantially all of the Company's existing computer systems which are
integral to its business were originally developed to be year 2000 compliant or
will be reprogrammed. The Company plans to reprogram its existing computer
systems, as necessary, and complete testing of the Company's existing system by
December 31, 1998. As of September 30, 1998, the Company is approximately 80%
complete in the review and testing of its existing computer systems for the Year
2000 compliance. Year 2000 compliance costs incurred relating to the Company's
existing computer systems are being expensed and are immaterial. Some of the
Company's computer systems integral to its business interface with computer
systems of third parties. Virtually all transactions with systems operated by
third parties involve nationally recognized service bureaus and government
sponsored entities such as Freddie Mac and Fannie Mae. The Company is working
with these third parties to coordinate any necessary testing of year 2000
related system interfaces. As a result, the Company does not anticipate that
year 2000 compliance issues arising from interfaces with third-party systems
will have a material impact on its operations.
The Company also is undertaking modifications and upgrades to enhance its
computer systems and technological capabilities. The Company expects that
aggregate costs of approximately $2.8 million will be expended for this system
conversion and upgrade (approximately $1.4 million in capitalized costs has been
incurred for the project thus far through September 30, 1998) and that the
project will be funded through cash flow from operations. As a part of this
systems enhancement effort, which should be completed in the first quarter of
1999, management has initiated a program to insure that these new systems and
applications are year 2000 compliant. Internal staff costs, consulting and other
expenses necessary to insure that the new systems are year 2000 compliant will
be made as part of the Company's capital upgrade to its computer systems
throughout the remainder of 1998 and 1999.
Triad's ability to write insurance depends on the maintenance of its
claims-paying ability ratings and the adequacy of its 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. A number of
states also generally limit Triad's risk-to-capital ratio to 25-to-1. As of
September 30, 1998, Triad's risk-to-capital ratio was 15.9-to-1, as compared to
19.3-to-1 at December 31, 1997, and 17.8-to-1 for the industry as a whole at
December 31, 1997, the latest industry data available.
15
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION - - CONTINUED
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; rating agencies may revise methodologies for determining the Company's
claims-paying ability ratings and may revise or withdraw the assigned ratings at
any time; 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
----------- -----------
27 Financial Data Schedule
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 12, 1998
/s/ Michael R. Oswalt
----------------------
Michael R. Oswalt
Vice President and Controller,
Principal Accounting Officer
17
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary information extracted from Form 10-Q for
the nine months ended September 30, 1998, 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-31-1998
<PERIOD-END> SEP-30-1998
<DEBT-HELD-FOR-SALE> 153,662,429
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 11,427,910
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 169,834,357
<CASH> 170,824
<RECOVER-REINSURE> 4,986
<DEFERRED-ACQUISITION> 14,659,504
<TOTAL-ASSETS> 194,258,403
<POLICY-LOSSES> 10,536,147
<UNEARNED-PREMIUMS> 6,975,250
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 34,480,782
0
0
<COMMON> 133,925
<OTHER-SE> 130,225,243
<TOTAL-LIABILITY-AND-EQUITY> 194,258,403
38,245,072
<INVESTMENT-INCOME> 6,788,337
<INVESTMENT-GAINS> 582,076
<OTHER-INCOME> 9,648
<BENEFITS> 4,300,136
<UNDERWRITING-AMORTIZATION> 4,188,705
<UNDERWRITING-OTHER> 9,515,458
<INCOME-PRETAX> 25,759,256
<INCOME-TAX> 7,867,914
<INCOME-CONTINUING> 17,891,342
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 17,891,342
<EPS-PRIMARY> 1.34
<EPS-DILUTED> 1.29
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>