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, 1999
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 1,
1999: 13,302,194 shares.
<PAGE>
TRIAD GUARANTY INC.
INDEX
Page
Number
------
Part I. Financial Information:
Item 1. Financial Statements:
Consolidated Balance Sheets as of September 30, 1999 (Unaudited)
and December 31, 1998.............................................3
Consolidated Statements of Income for the Three and Nine Month
Periods Ended September 30, 1999 and 1998 (Unaudited).............4
Consolidated Statements of Cash Flow for the Nine Month
Periods Ended September 30, 1999 and 1998 (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..................................17
Signatures........................................................... ....17
2
<PAGE>
TRIAD GUARANTY INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- -------------
Unaudited)
<S> <C> <C>
Assets
Invested assets:
Fixed maturities, available-for-sale, at fair value .. $ 160,336,320 $ 157,391,829
Equity securities, available-for-sale, at fair value.. 15,737,966 14,024,012
Short-term investments................................ 7,318,511 5,885,192
Other invested assets................................. 3,092,883 --
------------- -------------
186,485,680 177,301,033
Cash.................................................. 25,471 444,200
Real estate acquired in settlement of claims.......... 145,515 ---
Accrued investment income............................. 2,656,857 2,258,878
Deferred policy acquisition costs..................... 18,983,140 16,015,559
Prepaid federal income tax............................ 32,130,666 25,256,666
Property and equipment................................ 5,355,127 3,446,656
Prepaid reinsurance premium........................... 8,938 14,703
Reinsurance recoverable............................... 39,252 610,817
Other assets.......................................... 6,481,168 5,163,924
------------- -------------
Total assets.......................................... $ 252,311,814 $ 230,512,436
============= =============
Liabilities and stockholders' equity
Liabilities:
Losses and loss adjustment expenses............... $ 14,937,294 $ 12,142,990
Unearned premiums................................. 7,071,916 7,054,737
Current taxes payable............................. 57,867 45,787
Deferred income taxes............................. 39,297,649 33,187,544
Unearned ceding commission........................ 434,603 621,161
Long-term debt.................................... 34,460,717 34,457,080
Accrued interest on debt.......................... 583,722 1,274,972
Accrued expenses and other liabilities............ 4,944,750 4,196,825
------------- -------------
Total liabilities..................................... 101,788,518 92,981,096
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; 13,300,194
shares issued and outstanding at September 30,
1999 and 13,408,869 at December 31, 1998........ 133,002 134,089
Additional paid-in capital........................ 61,814,636 61,538,613
Accumulated other comprehensive income, net
of income tax liability (benefit) of
($1,400,129) at September 30, 1999 and
$2,101,170 at December 31, 1998................. (2,594,491) 3,907,920
Deferred compensation............................. (78,091) ---
Retained earnings................................. 91,248,240 71,950,718
------------- --------------
Total stockholders' equity............................ 150,523,296 137,531,340
------------- --------------
Total liabilities and stockholders' equity............ $ 252,311,814 $ 230,512,436
============= ==============
</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
---------------------------- ---------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
Premiums written:
Direct........................................... $ 17,033,429 $ 13,681,365 $ 48,086,566 $ 38,017,064
Assumed.......................................... 4,238 1,335 13,547 10,262
Ceded............................................ (402,691) (310,979) (1,125,533) (788,451)
------------ ------------ ------------ ------------
Net premiums written................................ 16,634,976 13,371,721 46,974,580 37,238,875
Change in unearned premiums......................... (130,101) 284,247 (22,944) 1,006,197
------------- ------------- ------------ ------------
Earned premiums..................................... 16,504,875 13,655,968 46,951,636 38,245,072
Net investment income............................... 2,657,110 2,424,083 7,743,336 6,788,337
Realized investment gains........................... (33,890) 307,812 998,350 582,076
Other income........................................ 3,500 8,609 12,944 9,648
------------- ------------- ------------ ------------
19,131,595 16,396,472 55,706,266 45,625,133
Losses and expenses:
Losses and loss adjustment expenses................. 1,525,266 1,714,629 5,801,207 4,297,145
Reinsurance recoveries.............................. (6,651) 1,508 (12,551) 2,991
------------- ------------- ------------ ------------
Net losses and loss adjustment expenses............. 1,518,615 1,716,137 5,788,656 4,300,136
Interest expense on debt............................ 692,487 692,388 2,087,404 1,861,578
Amortization of deferred policy acquisition costs... 1,744,618 1,553,379 5,213,879 4,188,705
Other operating expenses (net)...................... 3,815,904 3,177,927 11,094,387 9,515,458
------------- ------------- ------------ ------------
7,771,624 7,139,831 24,184,326 19,865,877
------------- ------------- ------------ ------------
Income before income taxes.......................... 11,359,971 9,256,641 31,521,940 25,759,256
Income taxes:
Current.......................................... (2,144) - - 12,286 426
Deferred......................................... 3,488,049 2,793,250 9,611,404 7,867,488
------------- ------------- ------------ ------------
3,485,905 2,793,250 9,623,690 7,867,914
------------- ------------- ------------ ------------
Net income.......................................... $ 7,874,066 $ 6,463,391 $ 21,898,250 $ 17,891,342
============= ============= ============ ============
Earnings per common and
common equivalent share:
Basic............................................ $.59 $.48 $1.64 $1.34
============= ============= ============ ============
Diluted.......................................... $.58 $.47 $1.61 $1.29
============= ============= ============ ============
Shares used in computing earnings per
common and common equivalent share:
Basic............................................ 13,296,118 13,358,409 13,315,470 13,325,656
============= ============= ============ ============
Diluted.......................................... 13,633,130 13,854,330 13,632,235 13,864,865
============= ============= ============ ============
</TABLE>
See accompanying notes.
4
<PAGE>
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30
----------------------------
1999 1998
---- ----
<S> <C> <C>
Operating activities
Net income................................................ $ 21,898,250 $ 17,891,342
Adjustments to reconcile net income to net
cash provided by operating activities:
Loss and unearned premium reserves..................... 2,811,483 562,644
Accrued expenses and other liabilities................. 544,629 440,186
Current taxes payable.................................. 12,080 4
Accrued investment income.............................. (490,862) (871,976)
Policy acquisition costs deferred...................... (8,181,460) (6,260,854)
Amortization of policy acquisition costs............... 5,213,879 4,188,705
Net realized investment gains ......................... (998,350) (582,076)
Provision for depreciation............................. 539,757 560,815
Amortization of intangible assets...................... 45,443 34,795
Accretion of discount on investments................... (788,322) (739,867)
Deferred income taxes.................................. 9,611,404 7,784,970
Prepaid federal income taxes........................... (6,874,000) (6,979,300)
Accrued interest on debt............................... (691,250) 583,722
Real estate acquired in claim settlement............... (145,515) 141,999
Other assets........................................... (687,457) (1,464,865)
------------ ------------
Net cash provided by operating activities................. 21,819,709 15,290,244
Investing activities
Securities available-for-sale:
Purchases - fixed maturities.......................... (36,005,234) (63,482,701)
Sales - fixed maturities.............................. 24,185,777 10,760,774
Purchases - equities.................................. (4,095,139) (5,119,678)
Sales - equities...................................... 2,989,878 4,677,949
Purchase of other invested assets....................... (3,000,000) --
Purchase of property and equipment...................... (2,450,488) (1,134,700)
------------ ------------
Net cash used in investing activities..................... (18,375,206) (54,298,356)
Financing activities
Proceeds from issuance of long-term debt.................. -- 34,477,899
Purchase and subsequent retirement of common stock........ (2,602,187) --
Proceeds from exercise of stock options................... 172,274 750,656
------------ ------------
Net cash provided by financing activities................. (2,429,913) 35,228,555
------------ ------------
Net change in cash and short-term investments............. 1,014,590 (3,779,557)
Cash and short-term investments at beginning of period.... 6,329,392 8,694,399
------------ ------------
Cash and short-term investments at end of period.......... $ 7,343,982 $ 4,914,842
============ ============
Supplemental schedule of cash flow information
Cash paid during the period for:
Income taxes and United States Mortgage
Guaranty Tax and Loss Bonds.......................... $ 6,874,205 $ 6,979,726
Interest............................................... $ 2,775,017 $ 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, 1999
(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, 1999 are not necessarily indicative of the results that may be
expected for the year ending December 31, 1999. 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,
1998.
Certain prior year amounts have been reclassified to conform with the
current year presentation. Specifically, the purchase of United States Mortgage
Guaranty Tax and Loss Bonds have been treated as prepaid federal income taxes
and a reclassification has been made to include this prepaid federal income tax
in the balance sheet as an asset and to restate the corresponding deferred tax
liability. The payment for the tax and loss bonds is essentially a prepayment of
federal income taxes that will become due at a later date. The change had the
effect of increasing both assets and liabilities by $32.1 million at September
30, 1999 and $25.3 million at December 31, 1998. The reclassifications had no
effect on previously reported net income or stockholders' equity.
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
6
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
September 30, 1999
(Unaudited)
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.
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, 1999 and December 31, 1998, 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
1999 1998
Net risk........................ $ 3,116,617,618 $2,776,205,499
================ ==============
Statutory capital and surplus... $ 93,329,426 $ 89,539,785
Statutory contingency reserve... 105,211,136 81,614,277
--------------- --------------
Total........................... $ 198,540,562 $ 171,154,062
================ ==============
Risk-to-capital ratio........... 15.7-to-1 16.2-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
7
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-CONTINUED
September 30, 1999
(Unaudited)
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 $29,136,854 for the nine months ended September 30, 1999 and $31,252,891 for
the year ended December 31, 1998.
At September 30, 1999 and December 31, 1998, the amount of Triad's equity
that could be paid out in dividends to stockholders was $9,613,498 and
$5,823,857, respectively, which was the earned surplus of Triad on a statutory
basis on those dates.
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
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. For the three month periods ended September 30, 1999 and
1998, the Company's comprehensive income was $5.3 million and $6.2 million,
respectively. For the nine month periods ended September 30, 1999 and 1998, the
Company's comprehensive income was $15.4 million and $17.5 million,
respectively.
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 1999 increased 22.4% to $21.9
million compared to $17.9 million in the first nine months of 1998. Net income
for the third quarter of 1999 increased 21.8% to $7.9 million compared to $6.5
million for the third quarter of 1998. This improvement was primarily
attributable to a 22.8% (20.9% in the third quarter) increase in earned
premiums, a 14.1% (9.6% in the third quarter) increase in net investment income,
$1.0 million in realized investment gains, a favorable loss ratio and an
improved expense ratio.
Net income per share on a diluted basis increased 24.5% to $1.61 for the
first nine months of 1999 compared to $1.29 per share for the first nine months
of 1998. Net income per share for the third quarter of 1999 was $0.58 on a
diluted basis compared to $0.47 per share for the same period of 1998. Operating
earnings per share were $1.56 for the first nine months of 1999 compared to
$1.26 for the first nine months of 1998, an increase of 23.4%. Operating
earnings exclude net realized investment gains of approximately $1.0 million and
$582,000 in the first nine months of 1999 and 1998, respectively.
Net new insurance written was $3.5 billion for the first nine months of
1999 as compared to $3.3 billion for the first nine months of 1998, an increase
of 8.0%. For the third quarter, net new insurance written totaled $1.1 billion
in 1999 compared to $1.2 billion in 1998. The Company also produced
approximately $11 million of new insurance written on seasoned loans in the
first nine months of 1999 compared to $186 million in the same period of 1998.
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, which is
calculated based on net new insurance written, was 2.4% for the first nine
months of 1999 compared to 2.5% reported for the first nine months of 1998 and
2.6% for all of 1998.
Refinance activity was 28.3% of new insurance written in the first nine
months of 1999 compared to 30.6% in the first nine months of 1998. Refinance
activity represents 15.2% of new insurance written in the third quarter 1999
compared to 24.8% for the third quarter 1998. This decline in refinance activity
reflects the recent rise in mortgage interest rates. Total direct insurance in
force reached $12.6 billion at September 30, 1999, compared to $10.5 billion at
September 30, 1998, an increase of 19.8%.
Total direct premiums written were $48.1 million for the first nine months
of 1999, an increase of 26.5% compared to $38.0 million for the first nine
months of 1998. Total direct premiums written increased 24.5% in the third
quarter of 1999 compared to the third quarter of 1998. Net premiums written
increased by 26.1% to $47.0 million for the first nine months of 1999 compared
9
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED
to $37.2 million for the same period in 1998. Net premiums written for the third
quarter of 1999 increased 24.4% compared to the third quarter of 1998. Earned
premiums increased 22.8% to $47.0 million for the first nine months of 1999 from
$38.2 million for the first nine months of 1998. For the third quarter of 1999,
earned premiums increased 20.9% compared to the same period of 1998. This growth
in 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 percentage of insurance remaining in force from one year
prior, was 68.0% at September 30, 1999, compared to 70.0% at December 31, 1998
and 73.8% at September 30, 1998. Persistency for the quarter improved to an
annualized rate of 79.6% reflecting the trend of rising interest rates and
declining cancellations.
Net investment income for the first nine months of 1999 was $7.7 million, a
14.1% increase over $6.8 million for the same period in 1998. Net investment
income for the third quarter of 1999 was $2.7 million, a 9.6% increase over the
third quarter of 1998. This increase in investment income is the result of
growth in the average book value of invested assets by $33.5 million to $180.3
million at September 30, 1999, from $146.8 million at September 30, 1998. The
growth in average invested assets is attributable to normal operating cash flow.
The yield on average invested assets declined to 5.7% for the first nine months
of 1999 compared to 6.2% for the same period of 1998 reflecting the Company's
continued investment strategy to emphasize tax preferred securities which yield
lower pre-tax rates than similar fully taxable securities. The portfolio's
tax-equivalent yield was 7.8% for the first nine months of 1999 and 7.9% for the
first nine months of 1998. Approximately 73% or $120.7 million of the Company's
fixed maturity portfolio at September 30, 1999, was composed of state and
municipal tax-preferred securities as compared to 69% at September 30, 1998.
The Company's loss ratio (the ratio of incurred losses to earned premiums)
was 12.3% for the first nine months of 1999 as compared to 11.2% for the same
period of 1998 and 13.3% for all of 1998. The loss ratio was 9.2% for the third
quarter of 1999 compared to 12.6% for the third quarter of 1998. The Company's
favorable loss ratio reflects the low level of delinquencies compared to the
number of insured loans and the fact that approximately 79% 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.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED
During periods of significant refinancing activity, it is possible that
policies on stronger loans may lapse and that 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 34.6% in the first nine months of 1999 to $5.8 million compared to
$4.3 million in the first nine months of 1998. Net losses and loss adjustment
expenses for the third quarter of 1999 and 1998 were $1.5 million and $1.7
million, respectively. 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 24.5% to
$5.2 million in the first nine months of 1999 compared to $4.2 million for the
first nine months of 1998. These costs were $1.7 million for the third quarter
of 1999 compared to $1.6 for the third quarter of 1998, an increase of 12.3%.
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 due to refinance activity during the first nine
months of 1999.
Other operating expenses increased 16.6% to $11.1 million for the first
nine months of 1999 as compared to $9.5 million for the same period in 1998. For
the third quarter of 1999, other operating expenses increased to $3.8 million
from $3.2 million in the third quarter of 1998. 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 1999 was 34.7% compared to 36.8% for the first nine
months of 1998 and 35.4% for all of 1998. The expense ratio for the third
quarter of 1999 improved to 33.4% from 35.4% reported a year earlier.
Contributing to this improvement is the higher level of written premiums in the
first nine months of 1999 partially offset by the increase in expenses.
The effective tax rate for the first nine months of 1999 and 1998 was
30.5%. 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.
11
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - 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, interest, expenses, and taxes.
The Company generated positive cash flow from operating activities for the
first nine months of 1999 of $21.8 million compared to $15.3 million for the
first nine months of 1998. 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, interest, and other expenses.
The Company's business does not routinely require significant capital
expenditures other than for enhancements to its computer systems and
technological capabilities. 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 interest income and payments
from Triad including cash dividends, management fees, and interest payments
under surplus notes. 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 reimbursed by Triad in the form of management fees.
Consolidated invested assets were $186.5 million at September 30, 1999,
including $176.1 million classified as available-for-sale. Net unrealized
investment gains were $2.1 million on equity securities and net unrealized
investment losses were $6.0 million on fixed maturity securities at September
30, 1999. The fixed maturity portfolio consisted of approximately 73% municipal
securities, 22% corporate securities, 4% U.S. government obligations, and 1%
mortgage-backed bonds at September 30, 1999.
The purchase of United States Mortgage Guaranty Tax and Loss bonds have
been treated as prepaid federal income taxes. The company began classifying this
prepaid federal income tax in the balance sheet as an asset and restated the
corresponding deferred tax liability as of September 30, 1999 and December 31,
1998. The payment for the tax and loss bonds is essentially a prepayment of
federal income taxes that will become due at a later date. The
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED
change had the effect of increasing both assets and liabilities by $32.1 million
at September 31, 1999 and $25.3 million at December 31, 1998.
The Company's loss reserves increased to $14.9 million at September 30,
1999, compared to $12.1 million at December 31, 1998. 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 $21,600 at September
30, 1999, compared to $23,400 at December 31, 1998. The Company's delinquency
ratio, the ratio of reported delinquent insured loans to total insured loans,
was 0.65% at September 30, 1999, compared to 0.53% at December 31, 1998.
Total stockholders' equity increased to $150.5 million at September 30,
1999, from $137.5 million at December 31, 1998. This increase resulted primarily
from net income of $21.9 million for the first nine months of 1999 offset by a
decrease in net unrealized gains on invested assets classified as
available-for-sale of $6.5 million (net of income tax) and the retirement of
146,000 shares of the Company's stock purchased for $2.6 million.
Triad's total statutory policyholders' surplus increased to $93.3 million
at September 30, 1999, from $89.5 million at December 31, 1998. This increase
resulted primarily from statutory net income of $29.1 million offset by an
increase in the statutory contingency reserve of $23.6 million. Triad's
statutory earned surplus was $9.6 million at September 30, 1999, compared to
$5.8 million at December 31, 1998, reflecting growth in statutory net income and
unrealized gains on equity securities greater than the increase in the statutory
contingency reserve. Approximately $1.3 and $1.9 million of the statutory earned
surplus for September 30, 1999, and December 31, 1998, respectively, was
attributable to unrealized gains. The balance in the statutory contingency
reserve was $105.2 million at September 30, 1999, compared to $81.6 million at
December 31, 1998.
The Company is undertaking modifications and upgrades to enhance its
computer systems and technological capabilities. The Company expects to incur
approximately $4.5 million for this system conversion and upgrade (approximately
$3.7 million in capitalized costs have been incurred for the project through
September 30, 1999) and is funding the project through cash flow from
operations.
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, 1999, and December 31, 1998, Triad's risk-to-capital ratio was
15.7-to-1 and 16.2-to-1, respectively, as compared to 14.8-to-1 for the industry
as a whole at December 31,1998, the latest industry data available.
13
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED
YEAR 2000 ISSUE
The Company is dependent on processes that have been automated and are
completely handled by computers. In the past, some computer programs were
written using only two digits to identify a year in the date field. Although
this has worked well it could present problems as companies move into the year
2000 due to the fact that the two digits "00" may be read as "1900" rather than
"2000". This technical problem may cause computer programs to fail or create
erroneous results.
In 1997, the Company began conducting a review and analysis of all computer
hardware and software and created a plan to address potential problems relating
to Year 2000 concerns. Due to the fact that Triad began operations less than
twelve years ago, the Company's hardware and software represent, for the most
part, relatively new technology. As computer programs have been created, in many
cases, programmers have had the foresight to include a 4-digit year. Many
programs and equipment have only recently been added to the existing
configuration. The Company has concluded its assessment of potential Year 2000
issues and believes that its internal exposure to Year 2000 concerns are
minimal.
STATE OF READINESS. The Company defines 'Year 2000 Compliant' to mean that
hardware and software will continue to work accurately and without failure
before, during and after the date changes to January 1, 2000 with neither
functionality nor performance being affected by the date change. With this as
the Company's goal, the plan developed to ensure that the Company is Year 2000
compliant has six major steps: 1) define possible problem areas, 2) research
potential issues, 3) make corrections, 4) conduct preliminary tests, 5)
implement final changes, 6) review and complete testing. As a part of this plan,
the Company maintains communication with its strategic business partners and
customers to advise of its progress and subsequent completion of its compliance
testing.
The first step involves identifying every aspect of the Company's business
that may be computerized or may interface with a process that is computerized.
Research includes contacting hardware and software vendors/suppliers. Each
vendor/supplier has been required to present evidence of Year 2000 compliance
for all hardware and software licensed for use by the Company. In a few cases,
the Company's equipment was not compliant and replacements/upgrades have been
initiated.
In late 1997, the Company began testing its operating software and programs
written in-house. The review of this internal software was completed and
modifications were made and tested. The Company has worked with all interfacing
partners and customers to test both Triad's changes and the changes implemented
by its business partners and customers. Telecommunication equipment and other
peripherals not normally associated with computer systems have also been
14
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED
verified and tested. The Company has complied with requirements put forth by the
government sponsored enterprises ("GSEs") and has been an active participant in
the MBA Year 2000 Readiness Project. As a result of the testing and reviews, the
Company believes that its major systems are Year 2000 compliant.
COSTS. For the most part, the Company's existing computer systems were
originally developed to be Year 2000 compliant. The current hardware and
software have not required a significant overhaul to become Year 2000 compliant.
As part of the Company's Year 2000 compliance plan, internal personnel and
outside resources were used to address the identified hardware and software
issues necessary to ensure compliance. Expenses relating to the Year 2000
compliance testing are expensed as incurred and are immaterial.
RISKS. Should any of the Company's efforts to become Year 2000 compliant
prove to be inadequate or ineffective, possible interruptions to critical
business operations could occur. Many of the critical business functions involve
processes that can be accomplished through multiple methods. While the Company's
primary method of operation involves the transmission and receipt of electronic
data, it also has the capability to handle most of its processes manually.
Should there be a Year 2000 problem with the electronic transmission process,
the Company expects that it would be able to substitute manual processing until
the electronic means could be recovered. For instance, loan and claim
submissions are primarily non-electronic. All internal processes have been
thoroughly tested; however, should a problem occur, non-complex subsystems are
available which should allow for quick recovery. The Company's internal analysts
and developers who have been integral in the testing of the Company's systems
are expected to be available to assist in handling any disruptions. The Company
also relies on many external parties to provide critical pieces to its business
functions. Although these external parties have verified their individual Year
2000 compliance, the Company could potentially be adversely affected if their
computer systems are disrupted by the Year 2000 problem.
Contingency Plans. The Company's contingency plan is designed to limit, as
much as possible, the disruption that a failure relating to Year 2000 concerns
could cause. The Company is assessing all critical business functions, weighing
whether or not each can be delayed, and prioritizing their degree of impact.
Because the Company's business processes go well beyond the automated functions,
all employees are involved in the contingency planning process. As part of the
contingency plan, the Company is performing employee skill assessments, updating
documentation, cross training employees and developing methods to manually
handle processes that may fail electronically. Special Year 2000 employee
guidelines are being created to convey to all Company employees the
expectations, responsibilities, and authority levels necessary. The Company is
also reviewing alternate communication methods and reevaluating security
measures of current systems. The Company's development, testing and assessment
of its contingency plan will continue through 1999.
15
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS - 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; decreases in persistency, which are affected by loan refinancings in
periods of low interest rates, may have an adverse effect on earnings; 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 effect
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, 1999
/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, 1999, 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-31-1999
<PERIOD-END> SEP-30-1999
<DEBT-HELD-FOR-SALE> 160,336,320
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 15,737,966
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 186,485,680
<CASH> 25,471
<RECOVER-REINSURE> 1,250
<DEFERRED-ACQUISITION> 18,983,140
<TOTAL-ASSETS> 252,311,814
<POLICY-LOSSES> 14,937,294
<UNEARNED-PREMIUMS> 7,071,916
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 34,460,717
0
0
<COMMON> 133,002
<OTHER-SE> 150,390,294
<TOTAL-LIABILITY-AND-EQUITY> 252,311,814
46,951,636
<INVESTMENT-INCOME> 7,743,336
<INVESTMENT-GAINS> 998,350
<OTHER-INCOME> 12,944
<BENEFITS> 5,788,656
<UNDERWRITING-AMORTIZATION> 5,213,879
<UNDERWRITING-OTHER> 11,094,387
<INCOME-PRETAX> 31,521,940
<INCOME-TAX> 9,623,690
<INCOME-CONTINUING> 21,898,250
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 21,898,250
<EPS-BASIC> 1.64
<EPS-DILUTED> 1.61
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
