SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[x] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934For the fiscal year ended December 31, 1998
[ ] 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
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TRIAD GUARANTY INC.
(Exact name of registrant as specified in its charter)
DELAWARE 56-1838519
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
101 South Stratford Road, Suite 500
Winston-Salem, North Carolina 27104
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (336) 723-1282
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Securities registered pursuant to Section 12(b) of
the Act:
None
Securities registered pursuant to Section 12(g) of
the Act:
Title of each class
Common Stock, par value $.01 per share
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / / .
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
The aggregate market value of the voting stock held by nonaffiliates of the
registrant as of February 16, 1999, computed by reference to the last reported
price at which the stock was sold on such date, was $122,850,797.
The number of shares of the registrant's common stock, par value $.01 per share,
outstanding as of February 16, 1999 was 13,346,869.
Portions of the following documents Part of this Form 10-K into which
are incorporated by reference the document is incorporated by
into this Form 10-K: reference:
TRIAD GUARANTY INC.
Proxy Statement for 1999 Annual Meeting PART III
of Stockholders
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PART I
ITEM 1. BUSINESS.
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 residential
mortgage lenders, including mortgage bankers, mortgage brokers, commercial banks
and savings institutions.
Private mortgage insurance, also known as mortgage guaranty insurance, is
issued in most home purchases and refinancings involving conventional
residential first mortgage loans to borrowers with equity of less than 20%. If
the homeowner defaults, private mortgage insurance reduces, and in some
instances eliminates, the loss to the insured lender. Private mortgage insurance
also facilitates the sale of low down payment mortgage loans in the secondary
mortgage market, principally to the Federal Home Loan Mortgage Corporation
("Freddie Mac") and the Federal National Mortgage Association ("Fannie Mae").
Under risk-based capital regulations applicable to savings institutions, private
mortgage insurance also reduces the capital requirement for such lenders on
residential mortgage loans with equity of less than 20%.
Triad was formed in 1987 as a wholly-owned subsidiary of Primerica
Corporation and began writing private mortgage insurance in 1988. In September
1989, Triad was acquired by Collateral Mortgage, Ltd. ("CML"), a mortgage
banking and real estate lending firm located in Birmingham, Alabama. In 1990,
CML contributed the outstanding stock of Triad to its affiliate, Collateral
Investment Corp. ("CIC"), an insurance holding company.
The Company was incorporated by CIC in Delaware in August 1993 for the
purpose of holding all the outstanding stock of Triad and to undertake the
initial public offering of the Company's Common Stock, which was completed in
November 1993. CIC currently owns 20.0% and CML owns 19.2% of the outstanding
Common Stock of the Company.
The principal executive offices of the Company are located at 101 South
Stratford Road, Suite 500, Winston-Salem, North Carolina 27104. Its telephone
number is (336) 723-1282.
TYPES OF MORTGAGE INSURANCE PRODUCTS
There are two principal types of private mortgage insurance coverage:
"primary" and "pool." The Company offers only primary insurance.
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PRIMARY INSURANCE
Primary insurance provides mortgage default protection on individual loans
and covers unpaid loan principal, delinquent interest and certain expenses
associated with the default and subsequent foreclosure (collectively, the "claim
amount"). The claim amount, to which the appropriate coverage percentage
(typically 15% to 30% as of December 31, 1998) is applied, generally ranges from
110% to 115% of the unpaid principal balance of the loan. The Company's
obligation to an insured lender with respect to a claim is determined by
applying the appropriate coverage percentage to the claim amount. Under its
master policy, the Company has the option of paying the entire claim amount and
taking title to the mortgaged property or paying the coverage percentage in full
satisfaction of its obligations under the insurance written. Primary insurance
can be placed on many types of loan instruments and generally applies to loans
secured by mortgages on owner occupied homes. The Company underwrites primary
insurance on a loan-by-loan basis and on a "delegated underwriting" basis to a
select group of lenders. Mortgage originators who participate in the Company's
delegated program are allowed to issue a certificate of insurance on the loans
it underwrites if certain strict qualifications are met.
The Company offers primary coverage generally ranging from 6% to 35% of the
claim amount with most coverage in the 15% to 30% range as of December 31, 1998.
The coverage percentage provided by the Company is selected by the insured
lender, subject to the Company's underwriting approval, usually in order to
comply with existing Freddie Mac and Fannie Mae requirements to reduce their
loss exposure on loans they purchase to 75% or less of the property's value at
the time the loan is originated. In January 1999, Fannie Mae announced that it
would accept lower coverage percentages from lenders on certain loans for resale
to the secondary market than it previously required. In conjunction with the
announcement, Fannie Mae reduced the coverage requirement so that its loss
exposure on loans processed by its automated underwriting system will be limited
to 80% or less of the property's value at the time of origination. In March
1999, Freddie Mac introduced a similar program.
The Company's premium rates vary depending upon the loan-to-value (LTV)
ratio, loan type, mortgage term, coverage amount and type, which all affect the
perceived risk of a claim on the insured mortgage loan. Generally, premium rates
cannot be changed after the issuance of coverage. The Company, consistent with
industry practice, generally utilizes a nationally based, rather than a regional
or local, premium rate structure.
Mortgage insurance premiums are usually paid by the mortgage borrower to
the mortgage lender or servicer, which in turn remits the premiums to the
mortgage insurer. The Company has three basic types of borrower paid premium
plans. The first is a monthly premium plan under which only one or two months'
premium is paid at the mortgage loan closing. Thereafter level monthly premiums
are collected by the loan servicer for monthly remittance to the Company. The
Company also offers a plan under which the first monthly mortgage insurance
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payment is deferred until the first loan payment is remitted to the Company.
This deferred monthly premium product decreases the amount of cash required from
the borrower at closing, therefore making home ownership more affordable.
Monthly premium plans represented 97% of new insurance written in 1998. Based on
the positive response from mortgage borrowers to the monthly premium plan
product, the Company expects that the percentage of new business written on
monthly premium plans will remain near the current level.
The second type of premium payment plan is an annual premium plan in which
a first-year premium is paid at the mortgage loan closing and annual renewal
payments, which are generally less than the first year premium, are paid
thereafter. Renewal payments are collected monthly from the borrower and held in
escrow by the mortgage lender or servicer for annual remittance in advance of
each renewal year.
The third type of premium payment plan requires a single payment paid at
the loan closing. The single premium payment can be financed by the borrower by
adding it to the principal amount of the mortgage or can be paid in cash at
closing by the borrower.
In addition to the borrower paid plans, the Company has a lender-paid plan
whereby mortgage insurance premiums are charged to the mortgage lender or loan
servicer, which pays the premium to the Company. The lender builds the mortgage
insurance premium into the borrower's interest rate. The Company's lender-paid
plan allows the lender to offer borrowers lower cost mortgages by reducing the
necessary closing costs compared to certain borrower paid plans. The Company's
lender-paid plan has been approved for use by Fannie Mae and Freddie Mac.
POOL INSURANCE
Pool insurance has generally been offered by private mortgage insurers to
lenders as an additional "credit enhancement" for certain mortgage-backed
securities and provides coverage for the full amount of the net loss on each
individual loan included in the pool, subject to a provision limiting aggregate
losses to a specified percentage of the total original balances of all loans in
the pool. Modified pool insurance provides coverage for a specified percentage
of the claim amount for each loan insured, subject to an overall stop-loss
provision applicable to the entire pool of loans insured. The Company does not
offer pool insurance.
RISK SHARING PRODUCTS
In 1997, the Company introduced a mortgage insurance program to enable the
Company to better meet the needs and requirements of larger national lenders.
The program increases the lender's share of the risk of loss on an insured book
of business and provides for a fee to the lender for this increased risk. A
significant portion of Triad's 1998 production resulted from Triad's risk
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sharing programs. In addition, in 1999, the Company began marketing certain
captive reinsurance programs that allow a reinsurance company, generally an
affiliate of the lender, to assume mortgage insurance default losses up to a
maximum exposure. Regulatory and industry issues exist regarding the future of
certain risk sharing programs currently being marketed within the mortgage
insurance industry. The resolution of the regulatory and industry questions
regarding risk sharing programs makes the continued viability of such programs
uncertain. Management is unable to predict the impact of the regulatory issues
on these products.
CANCELLATION OF INSURANCE
Mortgage insurance coverage cannot be canceled by the Company except for
nonpayment of premium or certain material violations of the master policy, and
remains renewable at the option of the insured lender. Generally, mortgage
insurance is renewable at a rate fixed when the insurance on the loan was
initially issued.
Insured lenders may cancel insurance at any time at their option. A
borrower may request that an insured servicer cancel insurance on a mortgage
loan when its loan balance is less than 80% of the property's current value, but
loan servicers are generally restricted in their ability to grant such requests
by secondary market requirements as well as by certain other regulatory
restrictions. Pursuant to recently enacted federal legislation, most loans made
on or after July 29, 1999, are required to have their private mortgage insurance
canceled automatically by the lenders when the outstanding loan amount is 78% or
less of the original property purchase price.
When a borrower refinances a Triad-insured mortgage loan by paying it off
in full with the proceeds of a new mortgage, the insurance on that existing
mortgage is canceled, and insurance on the new mortgage is considered to be new
insurance written. Therefore, continuation of Triad's coverage from a refinanced
loan to a new loan results in both a cancellation of insurance and new insurance
written. The percentage of new insurance written represented by refinanced loans
was 31.7%, 14.0%, and 16.9% in 1998, 1997, and 1996, respectively.
To the extent canceled insurance coverage in areas experiencing economic
growth is not replaced by new insurance in such areas, the percentage of the
Company's book of business in economically weaker areas may increase. This
development may occur during periods of heavy mortgage refinancing. Refinanced
loans in regions experiencing economic growth are less likely to require private
mortgage insurance, while borrowers in economically distressed areas are less
likely to qualify for refinancing because of depreciated real estate values.
Throughout the 1990's, high refinancing activity has occurred because of lower
mortgage interest rates. The percentage of the Company's policies in force at
the end of the previous year that were canceled during the following year was
26.6%, 15.6%, and 14.7% in 1998, 1997, and 1996, respectively. The cancellations
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which have occurred since 1988 have not had a material impact on the geographic
dispersion of the Company's risk in force.
CUSTOMERS
Residential mortgage lenders such as mortgage bankers, mortgage brokers,
commercial banks and savings institutions are the principal customers of the
Company. At December 31, 1998, approximately 55% of the Company's risk in force
came from mortgage bankers, 20% from mortgage brokers, 18% from commercial banks
and 7% from savings institutions. At December 31, 1997, approximately 53% of the
Company's risk in force came from mortgage bankers, 22% from mortgage brokers,
16% from commercial banks and 9% from savings institutions. Although mortgage
lenders are the Company's principal customers, individual mortgage borrowers
generally bear the cost of primary insurance coverage.
To obtain primary insurance from the Company, a mortgage lender must first
apply for and receive a master policy from the Company. The Company's approval
of a lender as a master policyholder is based, among other factors, upon an
evaluation of the lender's financial position and its management's demonstrated
adherence to sound loan origination practices.
The master policy sets forth the terms and conditions of the Company's
mortgage insurance policy. The master policy does not obligate the lender to
obtain insurance from the Company, nor does it obligate the Company to issue
insurance on a particular loan. The master policy provides that the lender must
submit individual loans for insurance to the Company and the loan, subject to
certain stringent criteria, must be approved by the Company to effect coverage
(except in the case of delegated underwriting and when the originator has the
authority to approve coverage within certain guidelines). The Company had 6,214
master policy holders at December 31, 1998, compared to 6,096 at December 31,
1997.
The Company's ten largest customers were responsible for 31.7%, 32.2%, and
23.4% of direct risk in force at December 31, 1998, 1997, and 1996,
respectively. No single customer of the Company (including branches and
affiliates of that customer) accounted for revenues greater than 10% of total
revenues for 1998. The largest single customer of the Company, measured by risk
in force, accounted for 9.5%, 10.2%, and 3.3% at December 31, 1998, 1997, and
1996, respectively.
SALES AND MARKETING
The Company currently markets its insurance products through a field sales
force of thirty-one salaried account executives, three regional sales managers,
six national accounts representatives and an exclusive commissioned general
agency serving a specific geographic market. The Company is licensed to do
business in 44 states and the District of Columbia and has licenses pending in
two states. The Company is actively serving mortgage originators in 38 states
and the District of Columbia.
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In 1998, the Company added to its existing sales force with new
representation in Wisconsin and Southern Florida, and added one new
representative to service the national account market of larger mortgage
lenders. The Company also bought out one of the exclusive general agencies with
which it had a relationship in order to better service the state of Florida.
Currently, the Company is approved to do business with 24 of the top 30 lenders,
up from 21 at year end 1997. The Company will continue to evaluate geographic
expansion opportunities, as well as the need for additional sales
representation.
The success of the Company is dependent upon the services of its account
executives and general agents. For 1998, the Company's commissioned general
agencies produced approximately 20% of the Company's new direct insurance
written while the salaried account executives and the national account
representatives produced the remainder. The loss of the services of any of its
key account executives or the general agency could have a material adverse
effect on the Company's operations.
The Company provides, for a fee, contract underwriting services that enable
customers to improve the efficiency of their operations by outsourcing all or
part of their mortgage loan underwriting. Contract underwriting services have
become increasingly important to lenders as they seek to reduce costs.
Accordingly, contract underwriting significantly contributes to the Company's
mortgage insurance production. The Company provides contract underwriting
services through its own employees as well as independent contractors. The
Company's inability to maintain and provide a sufficient number of qualified
underwriters could have a material adverse effect on the Company's operations.
COMPETITION AND MARKET SHARE
Triad and other private mortgage insurers compete directly with federal and
state governmental and quasi-governmental agencies, principally the Federal
Housing Administration ("FHA"). These agencies sponsor government-backed
mortgage insurance programs which accounted for approximately 44% of high LTV
loans in 1998 and 46% in 1997. In addition to competition from federal agencies,
Triad and other private mortgage insurers face competition from state-supported
mortgage insurance funds. Several of these states (among them, California,
Connecticut, Massachusetts, New York and Vermont) have state housing insurance
funds which are either independent agencies or affiliated with state housing
agencies. Indirectly, the Company also competes with certain mortgage lenders
which forego private mortgage insurance and self-insure against the risk of loss
from defaults on all or a portion of their low down payment mortgage loans.
Fannie Mae and Freddie Mac announced in the first quarter of 1999 that they
would accept lower coverage percentages from lenders on certain loans for resale
to the secondary market than had been previously required. The reduction in the
amount of private mortgage insurance coverage required or the adoption of
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private mortgage insurance substitutes by Fannie Mae or Freddie Mac could
adversely affect the Company's financial condition and results of operations.
Various proposals are being discussed by Congress and certain federal
agencies to reform or modify the FHA. Management is unable to predict the scope
and content of such proposals, or whether any such proposals will be enacted
into law, and if enacted, the effect on the Company.
The private mortgage insurance industry consists of nine active mortgage
insurance companies including Triad, Mortgage Guaranty Insurance Corporation,
General Electric Mortgage Insurance Corporation, PMI Mortgage Insurance Co., CMG
Mortgage Insurance Co., United Guaranty Residential Insurance Company, Republic
Mortgage Insurance Company, and Commonwealth Mortgage Assurance Company (which
contracted to purchase Amerin Corporation during 1998). Triad is the eighth
largest private mortgage insurer based on 1998 market share and, according to
industry data, had a 2.6% share of net new mortgage insurance written during
1998, up from 2.4% in 1997.
Management believes the Company competes with other private mortgage
insurers principally on the basis of personalized and professional service, a
strong management and sales team, and innovative products.
UNDERWRITING PRACTICES
The Company considers effective risk management to be critical to its
long-term financial stability. Market analysis, prudent underwriting, the use of
automated risk evaluation models, auditing and customer service are all
important elements of the Company's risk management process.
UNDERWRITING PERSONNEL
The Company's Vice Presidents of Risk Management and Underwriting report
directly to the President of the Company and the Executive Vice President of
Sales and Marketing, respectively. In addition to a centralized underwriting
department in the home office, the Vice President of Underwriting is responsible
for the Company's regional offices in Georgia, Texas, Illinois, Arizona,
Pennsylvania, Colorado and California. The Vice President of Risk Management is
responsible for assessing the risk factors for the Company and for the quality
control function.
The Company employed an underwriting staff of forty-five at December 31,
1998. The Company's field underwriters and underwriting managers are limited in
their authority to approve programs for certain mortgage loans. The authority
levels are tied to underwriting position, knowledge and experience and relate
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primarily to loan amounts and property type. All loans insured by the Company
are subject to quality control reviews.
RISK MANAGEMENT APPROACH
From its inception in 1988, Triad has adhered to conservative risk
management strategies that were developed, in part, as a result of management's
assessment of the private mortgage insurance industry's loss experience in the
late 1980s. The Company's risk management objective is to build a portfolio of
insurance in force with a claims incidence less than the expected claims rates
on which its premium rates are based. The Company underwrites based on
historical performance of risk factors and utilizes automated underwriting
systems in the risk selection process to assist the underwriter with
decision-making. This process evaluates the following categories of risk:
o MORTGAGE LENDER. The Company reviews each lender's financial
statements and management experience before issuing a master policy.
The Company also tracks the historical risk performance of all
customers that hold a master policy. This information is factored into
the determination of the loan programs that the company will approve
for various lenders. The Company assigns delegated underwriting
authority only to lenders with substantial financial resources and
established records of originating good quality loans.
o PURPOSE AND TYPE OF LOAN. The Company analyzes four general
characteristics of a loan to evaluate its level of risk: (i) LTV
ratio; (ii) purpose of the loan; (iii) type of loan instrument; and
(iv) type of property. The Company seeks only the most basic loan
types with proven track records for which an assessment of risk can be
readily made and the premium received sufficiently offsets that risk.
Loans having higher LTV ratios are charged a higher premium, as are
other loans which have been shown to carry higher risks, such as
adjustable rate mortgages ("ARMs"). Certain categories of loans are
generally not insured by the Company because such loans are deemed to
have an unacceptable level of risk, including negatively and potential
negatively amortizing ARMs, ARMs with maximum annual and lifetime caps
greater than two and six percentage points, respectively, and loans
for investor properties.
o INDIVIDUAL LOAN AND BORROWER. Except to the extent that the Company's
delegated underwriting program and Freddie Mac's and Fannie Mae's
automated underwriting services are being utilized, the Company
evaluates insurance applications based on its analysis of the
borrower's ability and willingness to repay the mortgage loan and the
characteristics and value of the mortgaged property. The analysis of
the borrower includes reviewing the borrower's housing and total debt
ratios as well as the borrower's Fair, Isaac and Co., Inc. ("FICO")
credit score, as reported by credit rating agencies. Loans may be
submitted under the Stick With Triad program provided the loans meet
the program requirements. Further description of the Stick with Triad
program is located in the Underwriting Process section. Within this
program, the degree to which the borrower must meet certain
underwriting standards, as well as the amount of documentation that is
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required, is a function of the credit score. In the case of delegated
underwriting, compliance with program parameters is monitored by
periodic audits of delegated business. With the automated underwriting
services provided by Freddie Mac and Fannie Mae, lenders are able to
obtain approval for mortgage guaranty insurance with any participating
mortgage insurer. Triad works with both agencies in offering insurance
services through their systems, while monitoring the risk quality of
loans insured through such systems.
o GEOGRAPHIC SELECTION OF RISK. The Company places significant emphasis
on the condition of the regional housing markets in determining its
marketing and underwriting policies. Using both internal and external
data, the Company's risk management department continually monitors
the economic conditions in the Company's active and potential markets.
UNDERWRITING PROCESS
The Company accepts applications for insurance under three basic programs:
the traditional fully documented program, a credit score driven reduced
documentation program, and a delegated underwriting program, which allows a
lender's underwriters to commit insurance to a loan based on strict agreed upon
underwriting guidelines.
The Company utilizes nationwide underwriting guidelines to evaluate the
potential risk of default on mortgage loans submitted for insurance coverage.
These guidelines have evolved over time and take into account the loss
experience of the entire private mortgage insurance industry. They are also
largely influenced by Freddie Mac and Fannie Mae underwriting guidelines. The
Company believes its guidelines are generally consistent with those used by
other private mortgage insurers with respect to the types of loans that the
Company will insure. As a result of the Company's review of regional economies
and housing patterns, specific underwriting guidelines applicable to a given
local, state or regional market will be modified to address concerns in that
market.
Subject to the Company's underwriting guidelines and exception approval
procedures, the Company expects its internal and contract underwriters to
utilize their experience and business judgement in evaluating each loan on its
own merits. Accordingly, the Company's underwriting staff has discretionary
authority to insure loans which deviate in certain minor respects from the
Company's underwriting guidelines. More significant exceptions are subject to
management approval. In all such cases, compensating factors must be identified.
The predominant reason for such deviations involves instances where the
borrower's debt-to-income ratio exceeds the Company's guidelines. To compensate
for exceptions, the Company's underwriters give favorable consideration to such
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factors as excellent borrower credit history, the availability of satisfactory
cash reserves after closing and employment stability.
In addition to the borrower's willingness and ability to repay the loan,
the Company believes that mortgage default risk is affected by a variety of
other factors, including the borrower's employment status. Insured mortgage
loans made to self-employed borrowers are perceived by the Company to have
higher risk of claim, all other factors being equal, than loans to borrowers
employed by third parties. The Company's percentage of risk in force involving
self-employed borrowers was 2.4% and 3.7% at December 31, 1998 and 1997,
respectively.
The Company's Stick With Triad program featuring the Slam Dunk Loan SM
approval process allows selected lenders to submit insurance applications that
do not include all standard documentation. Under this program, Triad issues a
certificate of insurance based on the borrower's FICO credit score or the
approval of the loan through Fannie Mae's or Freddie Mac's automated
underwriting systems. The Company issues a certificate of insurance without the
standard underwriting process if certain program parameters are met and the
borrower has a predetermined minimum credit score. Documentation submission
requirements for non- automated underwritten loans vary depending on the
borrower's credit score. In 1998, the Stick With Triad program represented 59%
of the Company's commitment volume, compared to 60% in 1997. The Company
randomly and through adverse selection audits lenders' files on loans submitted
under this program.
The Company's delegated underwriting program, in addition to the Company's
conservative risk management strategies, utilizes extensive "quality control"
practices including reunderwriting, reappraisal and similar procedures following
issuance of the policy. Standards for type of loan, property type and credit
history of the borrower are established consistent with the Company's risk
strategy. The program has allowed the Company to serve a greater number of the
larger, well established mortgage originators. The Company's delegated
underwriting program accounted for 16% of commitments received in 1998 compared
to 18% in 1997 and 38% in 1996. The decline in the volume of delegated
commitments is a result of the lenders' acceptance of the Company's Stick With
Triad program as well as the increased use of contract-underwriting services.
The performance of loans insured under the delegated underwriting program has
been comparable to the Company's non-delegated business.
The Company utilizes its underwriting skills to provide a contract
underwriting service to its customers. For a fee, Triad underwrites fully
documented underwriting files for secondary market compliance, while at the same
time assessing the file for mortgage insurance, if applicable. In 1996, the
Company began offering Fannie Mae's Desktop Originator and Desktop Underwriter,
as well as the personnel to conduct the underwriting tasks, as a service to its
contract underwriting customers. The Company also offers its contract
underwriting customers direct access to Freddie Mac's Loan Prospector. These
products, which are designed to streamline and reduce costs in the mortgage
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origination process, supply the Company's customers with fast and accurate
service regarding loan compliance and Fannie Mae's or Freddie Mac's decision for
loan purchase or securitization.
OTHER RISK MANAGEMENT
Another important aspect of the Company's risk management is the tracking
of risk exposure in condominium projects. The Company's risk management computer
system tracks the exposure in each project and alerts the underwriter once
predetermined limits are reached. The Company's computer system also identifies
certain exceptions in loan files that deserve special underwriter attention.
The Company uses a comprehensive audit plan designed to determine whether
the underwriting decisions being made are consistent with the policies,
procedures and expectations for quality as set forth by management. All areas of
business activity which involve an underwriting decision are included, with
emphasis on new products, procedures and new master policyholders. The process
used to identify categories of loans selected for an audit begins with the
identification and evaluation of certain defined and verifiable risk elements.
Each loan is then tested against these elements to identify loans which fail to
meet prescribed policies or an identified norm. The procedure allows the Company
management to identify concerns not only at the loan level but also portfolio
concerns which may exist within a given category of business.
CLAIMS-PAYING ABILITY RATINGS
Certain national mortgage lenders and a large segment of the mortgage
securitization market, including Fannie Mae and Freddie Mac, generally will not
purchase high LTV mortgages or mortgage-backed securities unless the private
mortgage insurance coverage on the mortgages has been issued by an insurer with
a claims-paying ability rating of at least "AA-" from Standard & Poor's Rating
Services, a division of the McGraw-Hill Companies, Inc. ("S&P"), Fitch IBCA
("Fitch") or Duff & Phelps Credit Rating Co. ("Duff & Phelps") or a financial
strength rating from Moody's Investor Service ("Moody's") of at least "Aa3."
Fannie Mae and Freddie Mac require mortgage guaranty insurers to maintain two
ratings of "AA-" or better. Private mortgage insurers are not rated by any other
independent nationally-recognized insurance industry rating organization or
agency (such as the A.M. Best Company).
Triad has its claims-paying ability rated by S&P, Fitch and Duff & Phelps.
These ratings are an indication to a mortgage insurer's customers of the
insurer's present financial strength and its capacity to pay future claims.
Ratings are generally considered an important element in a mortgage insurer's
ability to compete for new business. Triad is rated "AA" by S&P, Fitch and Duff
& Phelps. These ratings allow Triad to compete on similar risk-to-capital
guidelines as its competitors. Triad has not sought and does not presently
intend to seek a financial strength rating from Moody's.
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S&P defines insurers rated "AA" as offering excellent financial security
and having the capacity to meet policyholder obligations that is strong under a
variety of economic and underwriting conditions. Fitch defines insurance
companies rated "AA" as having a very strong claims-paying ability and to be
only slightly more susceptible than companies rated "AAA" to exhibiting any
weakening of financial strength due to adverse business and economic
developments. Duff & Phelps defines insurers rated "AA" as having a very high
claims-paying ability with only modest risk which may vary slightly over time
due to economic and/or underwriting conditions. Ratings from S&P, Fitch and Duff
& Phelps are modified with a "+" or "-" sign to indicate the relative position
of a company within its category.
When assigning a claims-paying ability rating, S&P, Fitch, and Duff &
Phelps generally consider: (i) the specific risks associated with the mortgage
insurance industry, such as regulatory climate, market demand, growth and
competition; (ii) management depth, corporate strategy and effectiveness of
operations; (iii) historical operating results and expectations of current and
future performance; and (iv) long-term capital structure, the ratio of debt to
equity, the ratio of risk to capital, near-term liquidity and cash flow levels,
as well as any reinsurance relationships and the claims-paying ability ratings
of such reinsurers. Claims- paying ability ratings are based on factors relevant
to policyholders, agents, insurance brokers, and intermediaries. Such ratings
are not directed to the protection of investors and do not apply to any
securities issued by the Company.
Rating agencies issue claims-paying ability ratings based, in part, upon a
company's performance sensitivity to various economic depression scenarios. In
determining capital levels required to maintain a company's claims-paying
ability rating, the rating agencies allow the use of different forms of capital
including statutory capital, reinsurance and debt. In January 1998 the Company
completed a $35 million private offering of notes due January 15, 2028. The
notes are rated "A" by S&P and "A+" by Fitch. The Company contributed $25
million of the net proceeds from the sale of the notes to Triad. The effect of
the Company's contribution of $25 million to the capital of Triad was to improve
its risk-to- capital ratio and to provide additional capital considered in the
rating agency's depression models.
S&P, Fitch and Duff & Phelps periodically review Triad's claims-paying
ability, as they do with all rated insurers. Ratings can be withdrawn or changed
at any time by a rating agency.
REINSURANCE
The use of reinsurance as a source of capital and as a risk management tool
is well established within the mortgage insurance industry. Reinsurance does not
legally discharge an insurer from its primary liability for the full amount of
13
<PAGE>
the risk it insures, although it does make the reinsurer liable to the primary
insurer. There can be no assurance that the Company's reinsurers will be able to
meet their obligations under the reinsurance agreements.
Certain premiums and losses are assumed from and ceded to other insurance
companies under various quota share reinsurance agreements. The ceding agreement
principally provides the Company with increased capacity to write business and
achieve a more favorable geographic dispersion of risk. In addition, in early
1999, Triad agreed to reinsure portions of the risk written on loans originated
by certain lenders with captive reinsurance companies affiliated with such
lenders.
In January 1996 the Company eliminated quota share reinsurance on new
business and recaptured substantial portions of its coverages on renewal
business. In October 1997 the Company recaptured most of its remaining coverages
on renewal business. The restructured reinsurance program reduced the Company's
quota share cede rate to 0.1% of direct premium written in 1998 compared to 1.7%
in 1997 and 5.3% in 1996. The recapture of business previously ceded resulted in
increased premium revenues for the Company. The Company continues to maintain
$25 million in excess of loss reinsurance designed to protect the Company in the
event of catastrophic levels of losses.
Pursuant to deeper coverage requirements imposed by Fannie Mae and Freddie
Mac, loans eligible for sale to such agencies with a loan-to-value ratio of over
90% require insurance with a coverage percentage of 30%, in contrast to the 25%
coverage previously required. Certain states limit the amount of risk a mortgage
insurer may retain with respect to coverage of an insured loan to 25% of the
claim amount, and, as a result, the deeper coverage portion of such insurance
must be reinsured. Although recent changes by Fannie Mae and Freddie Mac are
expected to reduce how many loans are insured over 25%, the need for reinsurance
channels is not expected to change for Triad. To minimize reliance on third
party reinsurers and to permit the Company to retain the premiums and related
risk on deeper coverage business, Triad reinsures this deeper coverage business
with its wholly-owned subsidiary Triad Guaranty Assurance Corporation ("TGAC").
As of December 31, 1998, TGAC had assumed approximately $72.0 million in risk
from Triad.
DEFAULTS AND CLAIMS
DEFAULTS
The claim process on private mortgage insurance begins with the insurer's
receipt of notification from the lender of a default on an insured's loan.
Default is defined in the primary master policy as the failure by the borrower
to pay, when due, an amount at least equal to the scheduled monthly mortgage
payment under the terms of the mortgage. The master policy requires lenders to
notify the Company of default on a mortgage payment within 10 days of either (i)
14
<PAGE>
the date on which the borrower becomes four months in default or (ii) the date
on which any legal proceeding which affects the loan has been commenced,
whichever occurs first. Notification is required within 45 days of the default
if it occurs when the first payment is due. The incidence of default is affected
by a variety of factors, including change in borrower income, unemployment,
divorce, illness, the level of interest rates and general borrower
creditworthiness. Defaults that are not cured result in a claim to the Company.
Borrowers may cure defaults by making all delinquent loan payments or by selling
the property and satisfying all amounts due under the mortgage.
The following table shows the number of loans insured, related loans in
default, percentage of loans in default (default rate as of the dates
indicated), dollar amount of insured loans in default, dollar amount of direct
risk (gross of reinsurance) with respect to insured loans in default, and
reserves per delinquent loan. Consistent with industry standards, for 1998, the
number of reported loans in default no longer includes defaults of 45 days or
less delinquent.
Default Statistics
<TABLE>
<CAPTION>
December 31
-----------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Number of insured loans in force................... 97,222 82,682 62,334 49,791 41,358
Number of loans in default......................... 518 388 273 206 156
Percentage of loans in default (default rate)...... 0.53% 0.47% 0.44% 0.41% 0.38%
Dollar amount of insured loans in default (000's).. $50,882 $37,828 $25,253 $19,907 $14,356
Dollar amount of direct risk with respect to
insured loans in default (000's)................... $13,216 $9,249 $5,770 $4,071 $2,827
Reserve per delinquent loan........................ $23,442 $23,094 $23,097 $22,277 $20,281
</TABLE>
CLAIMS
Claims result from defaults that are not cured. The frequency of claims
does not directly correlate to the frequency of defaults due in part to the
Company's loss mitigation efforts and the borrower's ability to overcome
temporary financial setbacks. The likelihood that a claim will result from a
default, and the amount of such claim, principally depend on the borrower's
equity at the time of default and the borrower's (or the lender's) ability to
sell the home for an amount sufficient to satisfy all amounts due under the
mortgage, as well as the effectiveness of loss mitigation efforts. Claims are
also affected by local housing prices, interest rates, unemployment levels, the
housing supply and the borrower's desire to avoid foreclosure. During the
default period, the Company works with the insured for possible early disposal
of underlying properties when the chance of the loan reinstating is minimal.
Such dispositions typically result in a reduced claim amount to the Company.
15
<PAGE>
Claim activity is not evenly spread through the coverage period. Relatively
few claims are received during the first two years following issuance of
insurance. A period of rising claims follows, which, based on industry
experience, has historically reached its highest level in the third through
sixth years after the loan origination. Thereafter, the number of claims
received has historically declined at a gradual rate, although the rate of
decline can be affected by economic and other conditions. There can be no
assurance that the historical pattern of claims will continue in the future.
Generally, the Company does not pay a claim for loss under the master
policy if the application for insurance for the loan in question contains
fraudulent information, material omissions or misrepresentations which increase
the risk characteristics of the loan. The Company's master policy also excludes
any cost or expense related to the repair or remedy of any physical damage
(other than "normal wear and tear") to the property collateralizing an insured
mortgage loan. Such physical damage may be caused by accident, natural
occurrence or otherwise.
Under the terms of the master policy, the lender is required to file a
claim with the Company no later than 60 days after it has acquired good and
marketable title to the underlying property through foreclosure. A primary
insurance claim amount includes (i) the amount of unpaid principal due under the
loan; (ii) the amount of accumulated delinquent interest due on the loan
(excluding late charges) to the date of claim filing; (iii) expenses advanced by
the insured under the terms of the master policy, such as hazard insurance
premiums, property maintenance expenses and property taxes to the date of claim
filing; and (iv) certain foreclosure and other expenses, including attorneys
fees. Such claim amount is subject to review and possible adjustment by the
Company. An average of about 12 months elapses from the date of default to a
payment of claim on an uncured default. The Company's experience indicates that
the claim amount on a policy generally ranges from 110% to 115% of the unpaid
principal amount of a foreclosed loan.
Within 60 days after the claim has been filed, the Company has the option
of either (i) paying the coverage percentage specified on the certificate of
insurance (usually 15% to 30% of the claim), with the insured retaining title to
the underlying property and receiving all proceeds from the eventual sale of the
property or (ii) paying 100% of the claim amount in exchange for the lender's
conveyance of good and marketable title to the property to the Company, with the
Company selling the property for its own account. The Company attempts to choose
the claim settlement option which costs the least. In general, the Company
settles claims by paying the coverage percentage of the claim amount. In 1998,
the Company did not exercise the option to acquire any property and did not own
any real estate acquired through claim settlements at December 31, 1998. The
Company did own $141,999 of real estate valued at the lower of cost or net
realizable value as of December 31, 1997.
16
<PAGE>
LOSS MITIGATION
Once a default notice is received, the Company attempts to mitigate its
loss. Through proactive intervention with insured lenders and borrowers, the
Company has been successful in reducing the number and severity of its claims
for loss. Loss mitigation techniques include pre-foreclosure sales, advances to
assist distressed borrowers who have suffered a temporary economic setback, and
the use of new repayment schedules, refinances, loan modifications, forbearance
agreements and deeds-in-lieu of foreclosure. Such mitigation efforts typically
result in a savings to the Company over the percentage coverage amount payable
under the certificate of insurance. Through loss mitigation efforts, the Company
has paid out only 67% of its potential exposure on claims paid through December
31, 1998.
LOSS RESERVES
The Company establishes reserves to provide for the estimated costs of
settling claims with respect to loans reported to be in default and estimates of
loans in default which have not been reported. Consistent with industry
accounting practices, the Company does not establish loss reserves for future
claims on insured loans which are not currently in default. Although the Company
believes that its overall reserve levels at December 31, 1998, are adequate to
meet its future obligations, due to the inherent uncertainty of the reserving
process there can be no assurance that its reserves will prove to be adequate to
cover ultimate loss developments.
In determining the liability for unpaid losses related to outstanding
defaults, the Company establishes loss reserves on a case-by-case basis using
historical experience and by making various assumptions and judgements about the
ultimate amount to be paid on loans in default. The amount reserved for any
particular loan is dependent upon the status of the loan as reported by the
servicer of the insured loan. As the default progresses closer to foreclosure,
the amount of loss reserve for that particular loan will be increased, in
stages, to approximately 120% of the Company's exposure, which includes
claims-related expenses. The Company periodically reviews and adjusts its
reserve estimates to address changes in economic conditions as well as
developments in its loss experience.
The Company also establishes reserves to provide for the estimated costs of
settling claims, including legal and other fees, and general expenses of
administering the claims settlement process ("loss adjustment expenses" or
"LAE") and for losses and loss adjustment expenses incurred arising from
defaults which have occurred, but which have not yet been reported to the
insurer ("Incurred But Not Reported" or "IBNR").
The Company's reserving process is based upon the assumption that past
experience, adjusted for the anticipated effect of current economic conditions
and projected future economic trends, provides a reasonable basis for estimating
future events. However, estimation of loss reserves is a difficult and inexact
process. In addition, economic conditions that have affected the development of
17
<PAGE>
the loss reserves in the past may not necessarily affect development patterns in
the future in either a similar manner or degree. 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
developments on loans in default, currently or in the future. The Company's
profitability and financial condition could be adversely affected to the extent
that the Company's estimated reserves are insufficient to cover losses on loans
in default.
The following table represents a reconciliation of the beginning and ending
loss reserves (net of reinsurance) for the periods indicated.
<TABLE>
<CAPTION>
Reconciliation of Losses and Loss Adjustment Expense Reserves
Year Ended December 31
(in thousands)
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Reserve for losses and LAE, net of related reinsurance
recoverables, at beginning of year............................... $ 8,909 $5,974 $3,703 $2,466 $1,805
Add losses and LAE incurred in respect of defaults occurring in:
Current year (1)............................................ 7,953 6,023 4,673 3,191 2,053
Prior years (1) (2)......................................... (944) (846) (1,394) (974) (791)
------- ------ ------ ------ ------
Total incurred losses and LAE.................................... 7,009 5,177 3,279 2,217 1,262
Deduct losses and LAE paid in respect of defaults occurring in:
Current year................................................ 267 210 167 216 86
Prior years................................................. 3,535 2,032 841 764 515
------- ------ ------ ------ ------
Total payments................................................... 3,802 2,242 1,008 980 601
Reserve for losses and LAE, net of the related reinsurance
recoverables, at end of year .................................... 12,116 8,909 5,974 3,703 2,466
Reinsurance recoverables on unpaid losses and LAE, at the end
of year ......................................................... 27 51 331 886 698
------- ------ ------ ------ ------
Reserve for unpaid losses and LAE, before deduction of
reinsurance recoverables on unpaid losses, at end of year........ $12,143 $8,960 $6,305 $4,589 $3,164
======= ====== ====== ====== ======
</TABLE>
(1) Includes loss and LAE reserves relating to loans which are in default but
for which default notices have not been received.
(2) Indicates a cumulative redundancy in loss reserves at the beginning of each
period. Redundancies result from overestimating ultimate claim amounts.
The top section of the above table shows losses incurred on insurance
policies with respect to defaults which occurred in the current and prior
periods. The amount of losses incurred relating to defaults occurring in the
current period represents the estimated amount to be ultimately paid on defaults
18
<PAGE>
occurring in that period. The amount of losses incurred relating to defaults
occurring in prior periods represents an adjustment made in the current period
for defaults which were included in the loss reserve at the end of the prior
period.
The middle section of the above table shows claims paid on insurance
policies with respect to defaults which occurred in the current period and in
prior periods, respectively. Since it takes, on average, about 12 months for a
default which is not cured to eventually develop into a paid claim, most losses
paid relate to defaults occurring in prior periods.
ANALYSIS OF DIRECT RISK IN FORCE
A foundation of the Company's business strategy is proactive risk
selection. The Company analyzes its portfolio in a number of ways to identify
any concentrations of risk or imbalances in risk dispersion. The Company
believes that the quality of its insurance portfolio is affected predominantly
by (i) the quality of loan originations (including the strength of the borrower
and the marketability of the property); (ii) the attributes of loans insured
(including LTV ratio, purpose of the loan, type of loan instrument and type of
underlying property securing the loan); (iii) the seasoning of the loans
insured; (iv) the geographic dispersion of the underlying properties subject to
mortgage insurance; and (v) the quality and integrity of lenders from which the
Company receives loans to insure.
19
<PAGE>
LENDER AND PRODUCT CHARACTERISTICS
The following table reflects the percentage of direct gross risk in force
(as determined on the basis of information available on the date of mortgage
origination) by the categories indicated on December 31, 1998 and 1997:
Direct Risk in Force
December 31
-----------
Product Type: 1998 1997
---- ----
Primary............................................... 100.0% 100.0%
Pool.................................................. 0.0% 0.0%
----- ------
Total................................................. 100.0% 100.0%
====== ======
Direct Primary Risk in Force
December 31
1998 1997
---- ----
Direct Risk in Force (dollars in millions)............ $2,777 $2,231
Lender Concentration:
Top 10 lenders (by original applicant)................ 31.7% 32.2%
LTV:
90.01% to 95.00% (1).................................. 51.4% 52.0%
90.00 and below....................................... 48.6% 48.0%
------ ------
Total................................................. 100.0% 100.0%
====== ======
Loan Type:
Fixed................................................. 92.4% 88.2%
ARM (positive amortization) (2)....................... 7.6% 11.8%
ARM (potential negative amortization) (3)............. 0.0% 0.0%
ARM (scheduled negative amortization) (3)............. 0.0% 0.0%
Other................................................. 0.0% 0.0%
----- ------
Total................................................. 100.0% 100.0%
====== ======
Mortgage Term:
15 years and under.................................... 7.0% 4.3%
Over 15 years......................................... 93.0% 95.7%
------ ------
Total................................................. 100.0% 100.0%
====== ======
Property Type:
Noncondominium (principally single-family detached)... 95.5% 94.9%
Condominium........................................... 4.5% 5.1%
------ ------
Total................................................. 100.0% 100.0%
====== ======
Occupancy Status:
Primary residence..................................... 100.0% 100.0%
Second home........................................... 0.0% 0.0%
Nonowner occupied..................................... 0.0% 0.0%
------ ------
Total................................................. 100.0% 100.0%
====== ======
Mortgage Amount:
$200,000 or less...................................... 93.9% 95.3%
Over $200,000......................................... 6.1% 4.7%
------ ------
Total................................................. 100.0% 100.0%
====== ======
(1) Includes 97s, representing approximately 1% of risk in force at December
31, 1998.
(2) Refers to loans where payment adjustments are the same as mortgage interest
rate adjustments.
(3) Scheduled negative amortization is defined by the Company as the increase
in loan balance that will occur if interest rates do not change. Loans with
potential negative amortization will not have increasing principal balances
unless interest rates increase.
20
<PAGE>
One of the most important determinants of claim incidence is the relative
amount of the borrower's equity in the home (which at the time of origination is
the down payment). For the industry as a whole, historical evidence indicates
that claim incidence on loans having a LTV ratio in excess of 90% is greater
than the claim incidence on loans with LTV ratios equal to or less than 90%. The
Company believes that the higher premium rates it charges on these high LTV
loans adequately reflects the additional risk.
Approximately 1% of the company's risk in force is comprised of the 97% LTV
product ("97s"), which is offered primarily to low and moderate income borrowers
under certain pilot programs. The Company believes that these "affordable
housing" loans have higher risks than its other insured business and has often
attracted borrowers with weak credit histories, generally resulting in higher
loss ratios. In keeping with the Company's established risk strategy, the
Company has not aggressively solicited this segment of the industry. The Company
does not routinely delegate the underwriting of its 97% LTV product.
The Company generally insures only positively amortizing ARMs with maximum
annual and lifetime caps of two and six percentage points, respectively.
Payments on these loans adjust fully with interest rate adjustments. To date,
the performance of the Company's ARM loans has been consistent with that of the
fixed rate portfolio. However, since historical claim frequency data on ARMs has
not yet been tested during a prolonged period of economic stress, there can be
no assurance that claim frequency on ARMs may not eventually be higher,
particularly during a period of rising interest rates combined with decreasing
housing prices. In its normal course of operations, the Company's existing
underwriting policy does not permit coverage of ARMs with "scheduled" or
"potential" negative amortization.
Historical evidence indicates that higher priced properties experience
wider fluctuations in value than moderately priced residences. These
fluctuations exist primarily because there is a much smaller pool of qualified
buyers for higher priced homes which, in turn, reduces the likelihood of
achieving a quick sale at fair market value when necessary to avoid a default.
The Company believes that 15-year mortgages present a lower level of risk
than 30-year mortgages, primarily as a result of the faster amortization and the
more rapid accumulation of borrower equity in the property. Accordingly, the
Company charges lower premium rates on these loans than on comparable 30-year
mortgages.
The Company believes that the risk of claim is also affected by the type of
property securing the insured loan. In management's opinion, loans on
single-family detached housing are subject to less risk of claim incidence than
loans on other types of properties. The Company believes that attached housing
types, particularly condominiums and cooperatives, are a higher risk because in
most areas condominiums and cooperatives tend to be more susceptible to downward
fluctuations in value than single family detached dwellings in the same market.
The term "single-family" applies to all one-to-four unit dwellings and includes
detached and attached townhouse units with fee simple ownership, condominiums
and cooperatives.
21
<PAGE>
Loans on primary residences that were owner occupied at the time of loan
origination constituted almost all of the Company's risk in force at December
31, 1998. Because management believes that loans on nonowner occupied properties
represent a substantially higher risk of claim incidence and are subject to
greater value declines than loans on primary homes, the Company insures these
types of loans only on a case-by-case basis and only after stringent management
review.
The Company's book of business is less mature than that of the private
mortgage insurance industry as a whole, with the Company's direct risk in force
having a weighted average life of 2.4 years at December 31, 1998, and 2.3 years
at December 31, 1997, compared to an estimated industry average of 3.4 years at
December 31, 1998.
The following table shows the percentage of direct risk in force as of
December 31, 1998, for policies written from 1988 through 1998 by the Company,
as well as the cumulative loss ratio (calculated as losses paid divided by
premiums written, in each case for a particular certificate year) which has
developed, through December 31, 1998, for the policies written during the years
indicated and excludes the effects of reinsurance:
Certificate Percent Cumulative Ratio of Losses
Year Direct Risk in Force of Total Paid to Premiums Written(1)
---- -------------------- -------- ---------------------------
(in millions)
1988 $ 1.2 0.0% 14.5%
1989 1.7 0.1 24.2
1990 3.2 0.1 17.4
1991 12.5 0.5 10.6
1992 53.5 1.9 8.0
1993 135.8 4.9 4.9
1994 127.8 4.6 6.7
1995 215.9 7.8 6.2
1996 348.0 12.5 3.6
1997 732.9 26.4 1.4
1998 1,144.9 41.2 0.0
--------- -----
Total $ 2,777.4 100.0%
========= =====
(1) Claim activity is not spread evenly throughout the coverage period of the
book of business. Based on the Company's and the industry's historical
experience, claims incidence is highest in the third through sixth years
after loan origination, and relatively few claims are paid during the first
two years after loan origination. Thus, the cumulative loss experience of
recent certificate years is not indicative of ultimate losses.
22
<PAGE>
GEOGRAPHIC DISPERSION
The following tables reflect the percentage of direct risk in force, net of
reinsurance, on the Company's book of business (by location of property) for the
top ten states and the top ten metropolitan statistical areas ("MSAs") as of
December 31, 1998. The Company continues to diversify its risk in force
geographically. The percentage of the Company's direct risk in force by top ten
states declined to 70.6% for 1998 compared to 73.9% and 77.5% for 1997 and 1996,
respectively. The percentage of the Company's direct risk in force by top ten
MSAs declined to 33.0% for 1998 compared to 36.8% and 41.9% for 1997 and 1996,
respectively.
Top Ten States Top Ten MSAs
-------------- ------------
December 31 December 31
1998 1998
------ ----
Illinois 12.4% Chicago, IL 11.7%
Georgia 10.5 Atlanta, GA 4.8
California 10.1 Los Angeles, CA 3.8
Florida 8.3 San Francisco/Oakland, CA 2.4
Texas 6.4 Houston/Galveston, TX 2.0
North Carolina 5.8 Phoenix, AZ 1.7
Virginia 5.6 Denver, CO 1.7
Pennsylvania 4.3 Charlotte-Gastonia, NC 1.7
Colorado 4.1 Dallas/Forth Worth, TX 1.6
Maryland 3.1 Minneapolis-St. Paul, MN 1.6
----- -----
Total 70.6% Total 33.0%
===== =====
While the Company continues to diversify its risk in force geographically,
a prolonged regional recession, particularly in its high concentration areas,
such as the Southeastern, Western, Middle Atlantic and upper Mid-Western states,
or a prolonged national economic recession, could significantly increase loss
development.
INVESTMENT PORTFOLIO
Income from its investment portfolio is one of the Company's primary
sources of cash flow to support its operations and claims payments. Triad has an
investment advisory agreement with CML for management of its portfolio.
The Company follows an investment policy which requires: (i) 80% of its
investment portfolio (together with cash assets) to consist of cash, short-term
investments and debt securities (including redeemable preferred stocks) which,
at the date of purchase, were rated investment grade by a nationally recognized
rating agency (e.g.,"BBB-" or better by S&P) and (ii) at least 50% of its
23
<PAGE>
investment portfolio (together with cash assets) to consist of cash, cash
equivalents and securities which, at the date of purchase, were rated one of the
two highest investment grades by a nationally recognized rating agency. At
December 31, 1998, the Company's total investment portfolio had a fair market
value of $177.3 million and did not include any real estate or mortgage loans.
Liquidity is sought through cash equivalent investments and through
diversification and investment in publicly traded securities. The Company
attempts to maintain a level of liquidity and a duration in its investment
portfolio consistent with its business outlook and the expected timing,
direction and degree of changes in interest rates. As of December 31, 1998, no
investment in the securities of any single issuer (other than the U.S.
government and its agencies) exceeded 2% of the Company's investment portfolio.
The Company's investment policies and strategies are subject to change
depending upon regulatory, economic and market conditions and the existing or
anticipated financial condition and operating requirements, including the tax
position, of the Company.
The following table shows the results of the Company's investment portfolio
for the periods indicated: Investment Portfolio Results
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Average investments (1)................. $151,711,923 $103,804,750 $89,577,031 $79,253,289 $73,774,699
Pre-tax net investment income........... $9,289,026 $6,234,142 $5,446,672 $4,836,461 $4,180,876
Effective pre-tax yield (1)............. 6.1% 6.0% 6.1% 6.1% 5.7%
Tax-equivalent yield (2)................ 7.9% 8.0% 7.7% 7.5% 7.2%
Pre-tax realized gain (loss) on sale of
investments............................ $880,502 $34,330 $(162,385) $172,992 $(162,723)
</TABLE>
(1) Based on historical cost adjusted for amortization and accretion of premium
and discount.
(2) Based on book value and the Company's marginal tax rate.
24
<PAGE>
The diversification of the Company's investment portfolio at December 31,
1998, is shown in the table below:
Investment Portfolio Diversification
December 31, 1998
---------------------------------------
Amortized Cost Fair Value Percent(1)
-------------- ---------- ----------
Available-for-sale securities:
Fixed maturity securities:
U. S. government obligations.......... $ 8,587,562 $ 8,928,171 5.1%
Mortgage-backed bonds................. 1,359,163 1,411,931 0.8
State and municipal bonds............. 107,535,039 111,753,839 63.0
Industrial & miscellaneous............ 36,386,473 35,297,888 19.9
------------ ------------
Total fixed maturities.............. 153,868,237 157,391,829
Equity securities....................... 11,550,510 14,024,012 7.9
------------ ------------
Total available-for-sale securities. 165,418,747 171,415,841
Short-term investments.................. 5,885,192 5,885,192 3.3
------------ ------------ ------
$171,303,939 $177,301,033 100.0%
============ ============ ======
(1) Percentage of fair value.
The following table shows the scheduled maturities at December 31, 1998, of
the fixed maturity securities held in the Company's investment portfolio:
Investment Portfolio Scheduled Maturity
December 31, 1998
--------------------------
Fair Value Percent
---------- -------
One year or less............................ $ 6,661,101 4.2%
After one year through five years........... 22,877,328 14.5
After five years through ten years.......... 28,895,494 18.4
After ten years though twenty years......... 79,896,775 50.8
After twenty years.......................... 17,649,200 11.2
Mortgage-backed securities (1).............. 1,411,931 0.9
------------ ------
Total................................... $157,391,829 100.0%
============ ======
(1)Substantially all of these securities are guaranteed by U.S. Government
Agencies.
25
<PAGE>
The following table shows the ratings of the Company's investment portfolio
as of December 31, 1998:
Investment Portfolio by S&P Rating
December 31, 1998
Rating(1) Fair Value Percent
Fixed maturities:
U.S. Treasury and U.S. agency bonds... $ 10,340,102 6.6%
AAA................................... 54,639,903 34.7
AA.................................... 25,904,056 16.5
A..................................... 23,703,029 15.1
BBB................................... 22,493,752 14.3
BB.................................... 7,441,892 4.7
B..................................... 5,141,999 3.3
C..................................... 336,375 0.2
D..................................... 78,000 0.0
NR.................................... 7,312,721 4.6
------------- ------
Total fixed maturities........... $ 157,391,829 100.0%
============= ======
Equities:
AAA................................... $ 890,688 6.4%
AA.................................... 924,750 6.6
A..................................... 10,143,710 72.3
BBB................................... 375,938 2.6
BB.................................... 251,250 1.8
B..................................... 1,437,676 10.3
------------- ------
Total equities.................... $ 14,024,012 100.0%
============= ======
Total Portfolio................................ $ 171,415,841
=============
(1) Current ratings assigned by S&P.
26
<PAGE>
REGULATION
DIRECT REGULATION
The Company's insurance subsidiaries are subject to comprehensive, detailed
regulation, principally for the protection of policyholders rather than for the
benefit of investors, by the insurance departments of the various states in
which each insurer is licensed to transact business. Although their scope varies
by state, state insurance laws in general grant broad powers to supervisory
agencies or officials to examine companies and to enforce rules or exercise
discretion touching almost every significant aspect of the insurance business.
These include the licensing of companies to transact business, claims handling
practices, reinsurance requirements, varying degrees of control over premium
rates, the forms and policies offered to customers, financial statements,
periodic financial reporting, permissible investments and adherence to financial
standards relating to statutory surplus, dividends and other criteria of
solvency intended to assure the satisfaction of obligations to policyholders.
All states have enacted legislation that requires each insurance company in
a holding company system to register with the insurance regulatory authority of
its state of domicile and furnish to the regulator financial and other
information concerning the operations of companies within the holding company
system that may materially affect the operations, management or financial
condition of the insurers within the system. Generally, all transactions within
a holding company system between an insurer and its affiliates must be fair and
reasonable and the insurer's statutory policyholders' surplus following any
transaction with an affiliate must be both reasonable in relation to its
outstanding liabilities and adequate for its needs. Most states also regulate
transactions between insurance companies and their parents and/or affiliates.
There can be no assurance that state regulatory requirements will not become
more stringent in the future and have an adverse effect on the Company.
Because the Company is an insurance holding company and Triad is an
Illinois domiciled insurance company, the Illinois insurance laws regulate,
among other things, certain transactions in the Company's Common Stock and
certain transactions between Triad and the Company or affiliates. Specifically,
no person may, directly or indirectly, offer to acquire or acquire beneficial
ownership of more than 10% of any class of outstanding securities of the Company
or its subsidiaries unless such person files a statement and other documents
with the Illinois Director and obtains the Director's prior approval. In
addition, material transactions between Triad and the Company or affiliates are
subject to certain conditions, including that they be "fair and reasonable."
These restrictions generally apply to all persons controlling or under common
control with the insurance companies. "Control" is presumed to exist if 10% or
more of Triad's voting securities is owned or controlled, directly or
indirectly, by a person, although the Illinois Director may find that "control"
in fact does or does not exist where a person owns or controls either a lesser
or greater amount of securities. Other states in addition to Illinois may
regulate affiliated transactions and the acquisition of control of the Company
or its insurance subsidiaries.
27
<PAGE>
Triad is required by Illinois insurance laws to provide for a contingency
reserve in an amount equal to at least 50% of earned premiums. Such reserves
must be maintained for a period of 10 years except in circumstances where high
levels of losses exceed regulatory thresholds. The contingency reserve, designed
to provide a cushion against the effect of adverse economic cycles, has the
effect of reducing statutory surplus and restricting dividends and other
distributions by Triad. At December 31, 1998, Triad had statutory policyholders'
surplus of $89.5 million and statutory contingency reserve of $81.6 million. At
December 31, 1997, Triad had statutory policyholders' surplus of $60.9 million
and a statutory contingency reserve of $54.8 million. Triad's statutory earned
surplus was $5.8 million at year end 1998 versus $2.5 million at year end 1997,
reflecting growth in statutory net income greater than the increase in the
statutory contingency reserve.
The insurance laws of Illinois provide that Triad may pay dividends only
out of statutory earned surplus as of the end of the preceding calendar year and
further establish standards limiting the maximum amount of dividends which may
be paid without prior approval by the Illinois Director. Under such standards,
Triad may pay dividends during any 12-month period equal to the greater of (i)
10% of the preceding year-end statutory policyholders' surplus or (ii) the
preceding year's net income. In addition, insurance regulatory authorities have
broad discretion to limit the payment of dividends by insurance companies. As a
mortgage guaranty insurer, Triad is required by Illinois insurance laws to
provide a contingency reserve. The contingency reserve has the effect of
reducing statutory surplus and restricting dividends and other distributions by
Triad.
Although not subject to a rating law in Illinois, premium rates for
mortgage insurance are subject to regulation in most states to protect
policyholders against the adverse effects of excessive, inadequate or unfairly
discriminatory rates and to encourage competition in the insurance marketplace.
Any increase in premium rates must be justified, generally on the basis of the
insurer's loss experience, expenses and future trend analysis. The general
mortgage default experience may also be considered.
TGAC was organized as a subsidiary of Triad under the insurance laws of the
state of Illinois in December, 1994 and as an Illinois domiciled insurer, is
subject to all Illinois insurance regulatory requirements applicable to Triad.
Triad and TGAC are subject to examination of its affairs by the insurance
departments of each of the states in which it is licensed to transact business.
The Illinois Director periodically conducts a financial examination of insurance
companies domiciled in Illinois. The most recent examination of Triad was issued
by the Illinois Insurance Department on September 6, 1995, and covered the
period January 1, 1991, through December 31, 1994. No material recommendations
were made as a result of this examination. The Illinois Insurance Department
began its examination of Triad and TGAC for the period January 1, 1995, through
December 31, 1998, in March, 1999.
28
<PAGE>
A number of states generally limit the amount of insurance risk which may
be written by a private mortgage insurer to twenty-five times the insurer's
total policyholders' surplus. This restriction is commonly known as the
"risk-to-capital" requirement.
Mortgage insurers are generally restricted by state insurance laws and
regulations to writing residential mortgage guaranty insurance business only.
This restriction generally prohibits Triad from using its capital resources in
support of other types of insurance and restricts its noninsurance business.
However, noninsurance businesses of the Company would not generally be subject
to regulation under state insurance laws.
Regulation of reinsurance varies by state. Except for Illinois, Wisconsin,
New York, Ohio and California, most states have no special restrictions on
reinsurance that would apply to private mortgage insurers other than standard
reinsurance requirements applicable to property and casualty insurance
companies. Certain restrictions, including reinsurance trust fund or letter of
credit requirements, apply under Illinois law to domestic companies and under
the laws of several other states to any licensed company ceding business to
unlicensed reinsurers. If a reinsurer is not admitted or approved, the company
doing business with the reinsurer cannot take credit in its statutory financial
statements for the risk ceded to such reinsurer absent compliance with the
reinsurance security requirements. In addition, some states in which Triad does
business have limited private mortgage insurers to a maximum policy coverage
limit of 25% of the insured's claim amount and require coverages in excess of
25% to be reinsured through another licensed mortgage insurer.
The National Association of Insurance Commissioners ("NAIC") adopted a
risk-based capital ("RBC") formula designed to help regulators identify
property/casualty insurers in need of additional capital. The RBC formula
establishes minimum capital needs based upon risks applicable to individual
insurers, including asset risks, off balance sheet risks (such as guarantees for
affiliates and contingent liabilities), and credit risks (such as reinsurance
ceded and receivables). The NAIC and the Illinois Department of Insurance
currently do not require mortgage guaranty insurers to file RBC analysis in
their annual statements.
As the dominant purchasers and sellers of conventional mortgage loans and
beneficiaries of private mortgage guaranty insurance, Freddie Mac and Fannie Mae
impose requirements on private mortgage insurers in order for such insurers to
be eligible to insure loans sold to such agencies. Freddie Mac's current
eligibility requirements impose limitations on the type of risk insured,
standards for the geographic and customer diversification of risk, procedures
for claims handling, acceptable underwriting practices and financial
requirements which generally mirror state insurance regulatory requirements.
These requirements are subject to change from time to time. Fannie Mae also has
eligibility requirements, although such requirements are not published. Triad is
an approved mortgage insurer for both Freddie Mac and Fannie Mae and meets all
eligibility requirements. There can be no assurance, however, that such
requirements will not change or that Triad will continue to meet such
requirements.
29
<PAGE>
Certain national mortgage lenders and a large segment of the mortgage
securitization market, including Fannie Mae and Freddie Mac, generally will not
purchase mortgages or mortgage-backed securities unless the private mortgage
insurance on the mortgages has been issued by an insurer with a claims-paying
ability rating of at least "AA-" from S&P, Fitch, or Duff & Phelps or a
financial strength rating of at least "Aa3" from Moody's. Fannie Mae and Freddie
Mac require mortgage guaranty insurers to maintain two ratings of "AA-" or
better. Triad has a claims-paying ability rating of "AA" from S&P, Fitch, and
Duff & Phelps. These ratings meet the eligibility requirements of Fannie Mae and
Freddie Mac. S&P, Fitch, and Duff & Phelps include TGAC operations and financial
position with those of Triad in rating Triad's claims-paying ability. There can
be no assurance that Triad's claims-paying ability rating, the method by which
this rating is determined or the eligibility requirements of Fannie Mae and
Freddie Mac will not change.
The Real Estate Settlement and Procedures Act of 1974 ("RESPA") applies to
most residential mortgages insured by Triad, and related regulations provide
that mortgage insurance is a "settlement service" for purposes of loans subject
to RESPA. Subject to limited exceptions, RESPA prohibits persons from accepting
anything of value for referring real estate settlement services to any provider
of such services. Although many states prohibit mortgage insurers from giving
rebates, RESPA has been interpreted to cover many non-fee services as well. The
recently renewed interest of the Department of Housing and Urban Development
("HUD") in investigating transactions for compliance with RESPA has increased
awareness of both mortgage insurers and their customers of the possible
implications of this law.
Most originators of mortgage loans are required to collect and report data
relating to a mortgage loan applicant's race, nationality, gender, marital
status and census tract to HUD or the Federal Reserve under the Home Mortgage
Disclosure Act of 1975 ("HMDA"). The purpose of HMDA is to detect possible
discrimination in home lending and, through disclosure, to discourage such
discrimination. Mortgage insurers are not required pursuant to any law or
regulation to report HMDA data although under the laws of several states
mortgage insurers are currently prohibited from discriminating on the basis of
certain classifications. The active mortgage insurers, through their trade
association, the Mortgage Insurance Companies of America ("MICA"), have entered
into an agreement with the Federal Financial Institutions Examinations Council
("FFIEC") to report the same data on loans submitted for insurance as is
required for most mortgage lenders under HMDA.
INDIRECT REGULATION
The Company, Triad and TGAC are also indirectly, but significantly,
impacted by regulations affecting purchasers of mortgage loans, such as Freddie
Mac and Fannie Mae, and regulations affecting governmental insurers such as the
FHA as well as lenders. Private mortgage insurers, including Triad, are highly
dependent upon federal housing legislation and other laws and regulations which
affect the demand for private mortgage insurance and the housing market
generally. For example, housing legislation enacted in 1992 permits up to 100%
30
<PAGE>
of borrower closing cost to be financed by loans insured by FHA, a significant
increase from the previous 57% limit. Also, in April 1994, HUD reduced the
initial premium (payable at loan origination) for FHA insurance from 3.0% to
2.25%. Effective January 1999, the maximum individual loan amount that the FHA
could insure increased from $170,362 to $208,800. The maximum individual loan
amount the VA can insure presently is $203,000. The maximum loan amounts that
the FHA and VA can insure are subject to adjustment and may increase in the
future. Any future legislation that increases the number of persons eligible for
FHA or VA mortgages could have an adverse effect on the Company's ability to
compete with the FHA or VA.
Pursuant to the Financial Institutions Reform, Recovery, and Enforcement
Act of 1989 ("FIRREA"), the Office of Thrift Supervision ("OTS") issued
risk-based capital rules for savings institutions. These rules establish a lower
capital requirement for a low down payment loan that is insured with private
mortgage insurance, as opposed to remaining uninsured. Furthermore, the
guidelines for real estate lending policies applicable to savings institutions
and commercial banks provide that such institutions should require appropriate
credit enhancement in the form of either mortgage insurance or readily
marketable collateral for any high LTV mortgage. To the extent FIRREA's
risk-based capital rules or the guidelines for real estate lending policies
applicable to savings institutions and commercial banks are changed in the
future, some of the anticipated benefits of FIRREA and the guidelines for real
estate lending policies to the mortgage insurance industry, including Triad, may
be curtailed or eliminated.
In 1995, Fannie Mae and Freddie Mac each introduced their own automated
underwriting system to be used by mortgage originators selling mortgages to
them. These systems, which are provided by Triad as a service to the Company's
contract underwriting customers, streamline the mortgage process and reduce
costs. As a result of the increased acceptance of these products, the process by
which mortgage originators sell loans to Fannie Mae and Freddie Mac is becoming
increasingly automated, a trend which is expected to continue. As a result,
Fannie Mae and Freddie Mac could develop the capability to become the decision
maker regarding selection of a private mortgage insurer for loans sold to them,
a decision traditionally made by the mortgage originator. The Company, however,
is not aware of any plans to do so. The concentration of purchasing power that
would be attained if such development in fact occurred could adversely affect,
from the Company's perspective, the terms on which mortgage insurance is written
on loans sold to Fannie Mae and Freddie Mac.
Additionally, proposals have been advanced which would allow Fannie Mae and
Freddie Mac additional flexibility in determining the amount and nature of
alternative recourse arrangements or other credit enhancements which they could
utilize as substitutes for private mortgage insurance. The Company cannot
predict if or when any of the foregoing legislation or proposals will be
adopted, but if adopted and depending upon the nature and extent of revisions
made, demand for private mortgage insurance may be adversely affected. There can
be no assurance that other federal laws affecting such institutions and entities
will not change, or that new legislation or regulation will not be adopted.
31
<PAGE>
Upon request by an insured, Triad must cancel the mortgage insurance for a
mortgage loan. Fannie Mae and Freddie Mac guidelines, as well as several
existing and proposed state statutes, contain various provisions which give
borrowers the right to request cancellation of mortgage insurance when specified
conditions are met. A bill was enacted by Congress on July 29, 1998, to be
effective on July 29,1999, which will require mortgage lenders to periodically
update borrowers about their private mortgage insurance. Under the legislation,
lenders must inform borrowers that: 1) they have private mortgage insurance; and
2) they may request cancellation when their home equity (loan-to-value or LTV
ratio) has reached 80 percent and other conditions are met. The legislation
further requires lenders to automatically cancel private mortgage insurance when
home equity reaches 78 percent if certain conditions are met. Because most
mortgage borrowers who obtain private mortgage insurance do not achieve 20%
equity in their homes before the homes are sold or the mortgages refinanced, the
Company does not expect to lose a significant amount of its insurance in force
due to the enactment of this bill.
In 1996, the Office of the Comptroller of the Currency ("OCC") granted
permission to national banks to have a reinsurance company as a wholly-owned
operating subsidiary for the purpose of reinsuring mortgage insurance written on
loans originated or purchased by such banks. Several subsequent applications by
banks to offer reinsurance have been approved by the OCC including at least one
request to engage in quota share reinsurance. The OTS, which regulates thrifts
and savings institutions, has recently announced that it would approve
applications for such captive arrangements as well. The reinsurance subsidiaries
of national banks or savings institutions could become significant competitors
of the Company in the future.
EMPLOYEES
As of December 31, 1998, the Company employed 168 persons. Employees are
not covered by any collective bargaining agreement. The Company considers its
employee relations to be satisfactory.
32
<PAGE>
EXECUTIVE OFFICERS
The executive officers of the Company are as follows:
Name Position Age
- ---- -------- ---
William T. Ratliff, III Chairman of the Board of 45
the Company and Triad
Darryl W. Thompson President, Chief Executive 58
Officer and Director of the
Company and Triad
David W. Whitehurst Executive Vice President, 49
Chief Financial Officer,
Treasurer and Director of the
Company; Vice President
and Director of Triad
John H. Williams Executive Vice President and 51
Director of Triad
Ron D. Kessinger Executive Vice President of 44
Triad
Henry B. Freeman Senior Vice President of Triad 49
Earl F. Wall Vice President, Secretary and 41
General Counsel of the
Company and Triad
Michael R. Oswalt Vice President, Controller 37
and Principal Accounting Officer
of the Company and Triad
33
<PAGE>
WILLIAM T. RATLIFF, III has been the Chairman of the Board of the Company
since 1993. Mr. Ratliff has also been Chairman of the Board of Triad since 1989,
President of CIC since 1990 and was President and General Partner of CML from
1987 to 1995. Mr. Ratliff has been Chairman of New South Federal Savings Bank
("New South") since 1986 and President and Director of New South Bancshares,
Inc., New South's parent company, since 1995. From March 1994 until December
1996, Mr. Ratliff served as President of Southwide Life Insurance Corp., of
which he had been Executive Vice President since 1993. Mr. Ratliff joined CML in
1981 after completing his doctoral degree with a study of planning processes in
an insurance company. Previously, he trained and worked as an educator,
counselor and organizational consultant.
DARRYL W. THOMPSON has been the President, Chief Executive Officer and a
Director of the Company since 1993. Mr. Thompson has also been President, Chief
Executive Officer and a Director of Triad since its inception in 1987. From 1986
to 1989, Mr. Thompson also served as President and Chief Executive Officer of
Triad Life Insurance Company, which sold mortgage insurance products. From 1976
to 1985, Mr. Thompson served as Senior Vice President/Southeast Division Manager
of MGIC. Mr. Thompson joined MGIC in 1972.
DAVID W. WHITEHURST has been Executive Vice President, Chief Financial
Officer, Treasurer and a Director of the Company since 1993, and served as
Secretary of the Company from 1993 until 1996. Mr. Whitehurst has also been a
Vice President and Director of Triad since 1989, Executive Vice President of CIC
since 1995 (Vice President from 1990 to 1995), was Chief Financial Officer of
CIC from 1990 through 1995, was Executive Vice President of Southwide Life
Insurance Corp. from 1992 until 1996 and has been a director of New South since
1989. Since January 1997, Mr. Whitehurst has been the President, Treasurer and a
Director of Southland National Insurance Corp. and its subsidiaries. Mr.
Whitehurst joined CML in 1989 and served as Vice President of CML and its
affiliates until 1992, when he began devoting all of his time to CIC and its
affiliates. Mr. Whitehurst is a certified public accountant.
JOHN H. WILLIAMS has been Executive Vice President and a Director of Triad
since its inception in 1987. From 1986 to 1987, Mr. Williams was employed by
Triad Life Insurance Company to develop and organize Triad. From 1978 to 1985,
Mr. Williams was employed by MGIC, most recently serving as Vice President of
Secondary Market Trading.
RON D. KESSINGER has been Executive Vice President of Insurance Operations
of Triad since June 1996 and was Vice President of Claims and Administration of
Triad from January 1991 to June 1996. From 1985 to 1991, Mr. Kessinger was
employed by Integon Mortgage Guaranty Insurance Corporation, most recently
serving as Vice President of Operations. Prior to joining Integon Mortgage
Guaranty Insurance Corporation, Mr. Kessinger was employed by the parent company
of Integon Mortgage Guaranty Insurance Corporation.
34
<PAGE>
HENRY B. FREEMAN has been Senior Vice President of Risk Management of Triad
since January, 1999 and was Vice President of Risk Management of Triad since its
inception in 1987. From 1981 to 1987, Mr. Freeman was employed by Home Guaranty
Insurance Corporation, where he performed underwriting and claims management
services.
EARL F. WALL has been Vice President and General Counsel of Triad since
January 1996 and Secretary since June 1996. Mr. Wall has been Vice President,
Secretary and General Counsel of the Company since September 1996. From 1982 to
1995, Mr. Wall was employed by Integon in a number of capacities including Vice
President, Associate General Counsel and Director of Integon Life Insurance
Corporation and Georgia International Life Insurance Corporation, Vice President
and General Counsel of Integon Mortgage Guaranty Insurance Corporation, and Vice
President, General Counsel and Director of Marketing One, Inc.
MICHAEL R. OSWALT has been Vice President and Controller of the Company
since March 1994, Vice President of Triad since December 1994, and Controller of
Triad since June 1996. Mr. Oswalt previously served as Vice President and
Controller of CIC and Southwide Life Insurance Corp. from February 1994 until
June 1996. From January 1993 to February 1994, Mr. Oswalt was employed by
Complete Health Services, Inc. where he performed internal audit services. From
1991 to 1993, Mr. Oswalt was employed by Arthur Andersen & Co. Prior to joining
Arthur Andersen & Co., Mr. Oswalt was employed by Deloitte & Touche from 1988 to
1991. Mr. Oswalt is a certified public accountant.
Officers of the Company serve at the discretion of the Board of Directors of the
Company.
ITEM 2. PROPERTIES.
As of December 31, 1998, the Company leases office space in its
Winston-Salem headquarters and its nine underwriting offices located throughout
the country comprising approximately 38,475 square feet under leases expiring
between 1999 and 2002 and which require annual lease payments of $586,348 in
1999. With respect to all facilities, the Company has, or believes it will be
able to obtain, lease renewals on satisfactory terms. The Company believes its
existing properties are well utilized and are suitable and adequate for its
present circumstances.
The Company maintains mid-range and micro-computer systems from its
corporate data center located in its headquarters building to support its data
processing requirements for accounting, claims, marketing, risk management and
underwriting. The Company has in place back-up procedures in the event of
emergency situations.
ITEM 3. LEGAL PROCEEDINGS.
The Company and its subsidiaries, in common with other private mortgage
insurers, are subject to litigation in the normal course of their businesses.
There is no material litigation currently pending against the Company or its
subsidiaries.
35
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock trades on the Nasdaq National Market tier of the
Nasdaq Stock MarketSM under the symbol "TGIC." At December 31, 1998, 13,408,869
shares were issued and outstanding. The following table sets forth the highest
and lowest closing prices of the Company's Common Stock, $0.01 par value, as
reported by Nasdaq during the periods indicated (closing prices have been
restated to reflect the two-for-one stock split on October 28, 1997).
1998 1997
---- ----
High Low High Low
First Quarter........ 42 1/8 30 15 7/8 14
Second Quarter....... 40 3/4 29 3/4 22 11/16 14 3/4
Third Quarter........ 35 7/8 22 3/4 28 1/4 20 1/2
Fourth Quarter ...... 25 3/8 13 1/2 31 26 1/4
As of March 12, 1999, the number of stockholders of record of Company
Common Stock was approximately 159. In addition, there were an estimated 3,300
beneficial owners of shares held by brokers and fiduciaries.
Payments of future dividends are subject to declaration by the Company's
Board of Directors and the amount of such dividend is dependent on the ability
of Triad to pay dividends to the Company. Because of Triad's need to maintain
capital levels required by rating agencies, the Company has no present intention
to pay dividends.
36
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
Year Ended December 31
------------------------------------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Income Statement Data (for period ended): (Dollars in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Premiums written:
Direct....................................... $ 52,974 $ 40,083 $ 26,152 $ 18,890 $ 16,172
Assumed...................................... 13 20 26 34 38
Ceded........................................ (1,090) (1,772) (2,217) (3,924) (4,034
----------- ----------- ----------- ------------ ------------
$ 51,897 $ 38,331 $ 23,961 $ 15,000 $ 12,176
=========== =========== =========== ============ ============
Earned premiums................................... $ 52,822 $ 38,522 $ 24,727 $ 15,478 $ 10,999
Net investment income............................. 9,289 6,234 5,447 4,836 4,181
Realized investments gains (losses)............... 880 34 (162) 173 (163)
Other income...................................... 14 8 -- 1 5
----------- ----------- ----------- ------------ ------------
Total revenues............................... 63,005 44,798 30,012 20,488 15,022
Net losses and loss adjustment expenses........... 7,009 5,177 3,279 2,217 1,262
Interest expense on debt.......................... 2,554 -- -- -- --
Amortization of deferred policy acquisition cost.. 5,955 4,120 3,235 2,289 1,726
Other operating expenses (net of acquisition
cost deferred)............................ 12,435 10,257 7,259 4,753 3,658
----------- ----------- ----------- ------------ ------------
Income before income taxes........................ 35,052 25,244 16,239 11,229 8,376
Income taxes...................................... 10,678 8,002 5,042 3,470 2,594
----------- ----------- ----------- ------------ ------------
Net income........................................ $ 24,374 $ 17,242 $ 11,197 $ 7,759 $ 5,782
=========== =========== =========== ============ ============
Basic earnings per share (1)................. $ 1.83 $ 1.30 $ 0.84 $ 0.59 $ 0.44
Diluted earnings per share (1)............... $ 1.76 $ 1.26 $ 0.83 $ 0.58 $ 0.43
----------- ----------- ----------- ------------ ------------
Weighted average common and common share
equivalents outstanding (1)
Basic ................................... 13,342,749 13,291,160 13,277,853 13,196,067 13,181,459
Diluted.................................. 13,843,382 13,713,538 13,541,551 13,333,014 13,305,786
Balance Sheet Data (at year end):
Total assets................................. $ 205,256 $ 138,979 $ 112,403 $ 99,017 $ 86,664
Total invested assets........................ $ 177,301 $ 119,877 $ 98,027 $ 85,978 $ 75,364
Losses and loss adjustment expenses.......... $ 12,143 $ 8,960 $ 6,305 $ 4,589 $ 3,164
Unearned premiums............................ $ 7,055 $ 7,988 $ 8,216 $ 9,086 $ 9,893
Long-term debt .............................. $ 34,457 $ -- $ -- $ -- $ --
Stockholders' equity......................... $ 137,531 $ 111,781 $ 91,680 $ 80,441 $ 70,108
Statutory Ratios (2):
Loss ratio................................... 13.3% 14.2% 16.0% 14.3% 11.5%
Expense ratio................................ 42.3% 42.5% 49.6% 59.1% 61.8%
----------- ----------- ----------- ------------ ------------
Combined ratio............................... 55.6% 56.7% 65.6% 73.4% 73.3%
=========== =========== =========== ============ ============
GAAP Ratios:
Loss ratio................................... 13.3% 13.4% 13.3% 14.3% 11.5%
Expense ratio................................ 35.4% 37.5% 43.8% 46.9% 44.2%
----------- ----------- ----------- ------------ ------------
Combined ratio............................... 48.7% 50.9% 57.1% 61.2% 55.7%
=========== =========== =========== ============ ============
Other Statutory Data (dollars in millions) (2):
Direct insurance in force.................... $ 11,256.6 $ 9,176.7 $ 6,556.3 $ 5,080.3 $ 4,111.4
Direct risk in force (gross)................. $ 2,777.4 $ 2,231.4 $ 1,515.4 $ 1,090.6 $ 814.1
Risk-to-capital.............................. 16.2:1 19.3:1 15.8:1 11.1:1 8.9:1
</TABLE>
(1) Periods have been restated to reflect the three-for-two stock split on June
28, 1996, and the two-for-one stock split on October 28, 1997.
(2) Based on statutory accounting practices and derived from consolidated
statutory financial statements of Triad.
37
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION.
RESULTS OF OPERATIONS
1998 COMPARED TO 1997
Net income for 1998 increased 41.4% to $24.4 million compared to
$17.2million in 1997. This improvement is attributable to a 37.1% increase in
earned premiums, a 49.0% increase in net investment income, and an improved
combined loss and expense ratio.
Net income per share on a diluted basis increased 40.0% to $1.76 for 1998
compared to $1.26 per share for 1997. Operating earnings per share were $1.72
for 1998 compared to $1.26 for 1997. Operating earnings exclude net realized
gains of approximately $881,000 and $34,000 in 1998 and 1997, respectively.
Net new insurance written was $4.8 billion for 1998 as compared to $2.9
billion for 1997, an increase of 66.2%. For the fourth quarter 1998, net new
insurance written increased 106.2% to $1.5 billion compared to $740 million in
the fourth quarter 1997. The Company also produced approximately $225 million of
new insurance written on seasoned loans in 1998 compared to $950 million in
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 2.6% for all of 1998 and to 2.8% for the fourth
quarter as compared to 2.4% reported for all of 1997.
The growth in new insurance written also reflects the favorable interest
rate environment in 1998 which caused home buying and refinance activities to
remain strong. Refinance activity was 31.7% of new insurance written in 1998
compared to 14.0% in 1997. Total direct insurance in force reached $11.3 billion
at December 31, 1998, compared to $9.2 billion at December 31, 1997, an increase
of 22.7%.
Total direct premiums written were $53.0 million for 1998, an increase of
32.2% compared to $40.1 million for 1997. Net premiums written increased by
35.4% to $51.9 million in 1998 compared to $38.3 million for 1997. Earned
premiums increased 37.1% to $52.8 million for 1998 from $38.5 million for 1997.
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 policies remaining in force from one
year prior, was 73.4% at December 31, 1998, compared to 84.2% at December 31,
1997. The decline in persistency experienced can be expected to cause future
renewal premiums to be lower than would have been expected, which would, in
38
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
turn, have an adverse effect on earnings. Sales under the Company's monthly
premium plan represented 97.3% of new insurance written in 1998 compared to
94.3% in 1997.
Net investment income for 1998 was $9.3 million, a 49.0% increase over $6.2
million in 1997. This increase in investment income is the result of growth in
the average book value of invested assets by $47.9 million to $151.7 million at
December 31, 1998, from $103.8 million at December 31, 1997. The growth in
invested assets is attributable to the investment of the proceeds of the
Company's $35.0 million debt offering, completed in late January 1998, as well
as the increase in invested assets due to normal operating cash flow. The yield
on average invested assets was 6.1% for 1998 compared to 6.0% for 1997. The
portfolio's tax-equivalent yield was 7.9% for 1998 versus 8.0% for 1997.
Approximately 70%, or $107.5 million of the Company's fixed maturity portfolio
at December 31, 1998, was composed of state and municipal tax-preferred
securities as compared to 72%, or $68.7 million, at December 31, 1997.
The Company's loss ratio (the ratio of incurred losses to earned premiums)
was 13.3% for 1998 compared to 13.4% for 1997. The loss ratio was 18.6% for the
fourth quarter of 1998 compared to 12.1% for the fourth 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 78% 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. The increase in the
loss ratio in the fourth quarter of 1998 reflects an increase in delinquent
loans reported in the latter half of 1998 as well as reduced earned premiums due
to lower persistency. 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.
During periods of significant refinancing activity, it is possible that
policies on stronger loans may be canceled and policies 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 35.4% in 1998 to $7.0 million compared to $5.2 million in 1997.
This 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.
39
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
Amortization of deferred policy acquisition costs increased by 44.5% to
$6.0 million in 1998 compared to $4.1 million for 1997. The increase in
amortization reflects an increasing deferred policy acquisition costs asset to
amortize as the Company builds its total insurance in force and a higher
cancellation rate during 1998.
In January 1998, the Company completed a $35.0 million private offering of
notes due January 15, 2028, which bear interest at a rate of 7.9% per annum.
Interest expense relating to this debt was $2.6 million for 1998.
Standard & Poor's Corporation in February 1999 affirmed the "AA" Financial
Strength and counterparty credit rating of Triad. In addition, the "A" issuer
credit rating and senior debt rating of the Company were also affirmed.
Other operating expenses increased 21.2% to $12.4 million for 1998 compared
to $10.3 million for 1997. This increase in expenses is primarily attributable
to advertising, personnel, and 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 1998 was 35.4% compared to 37.5% for 1997. 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 1998 was 30.5% compared to 31.7% for 1997. This
decrease is primarily the result of the increase in investment in tax preferred
securities. 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.
1997 COMPARED TO 1996
Net income for 1997 increased 54.0% to $17.2 million compared to $11.2
million in 1996. This improvement was primarily attributable to a 55.8% increase
in earned premiums, a 14.5% increase in net investment income, and an improved
combined loss and expense ratio.
Net income per share on a diluted basis increased 52.1% to $1.26 for 1997
compared to $0.83 per share for 1996. Operating earnings per share were $1.26
for 1997 compared to $0.84 for 1996, an increase of 50.3%. Operating earnings
exclude net realized investment gains of approximately $34,000 in 1997 and net
realized investment losses of approximately $162,000 in 1996.
40
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
Net new insurance written was $2.9 billion for 1997 as compared to $2.2
billion in 1996, an increase of 30.9%. For the fourth quarter, net new insurance
written increased 32.9% to $740 million in 1997 compared to $557 million in
1996. The Company also produced approximately $950 million of new insurance
written on seasoned loans in 1997. This increase in new insurance written was
the result of continued geographic expansion, the penetration of Triad's
products in the marketplace, and the introduction of new products. According to
industry data, Triad's national market share of new insurance written increased
to 2.4% for 1997 compared to 1.7% for 1996.
The growth in new insurance written also reflected the favorable interest
rate environment in 1997 which caused home buying activities to remain strong.
Refinance activity was 14.0% of new insurance written in 1997 compared to 16.9%
of insurance written in 1996. Total direct insurance in force reached $9.2
billion at December 31, 1997, compared to $6.6 billion at December 31, 1996, an
increase of 40.0%.
Total direct premiums written were $40.1 million for 1997, an increase of
53.3% compared to $26.2 million in 1996. Net premiums written increased by 60.0%
to $38.3 million in 1997 compared to $24.0 million in 1996. Earned premiums
increased 55.8% to $38.5 million for 1997 from $24.7 million in 1996. This
growth in written and earned premium resulted from 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 94.3% of new insurance
written in 1997 compared to 93.0% in 1996. The Company's persistency rate was
84.2% for 1997 compared to 85.3% for 1996.
Net investment income for 1997 was $6.2 million, a 14.5% increase over $5.4
million in 1996. This increase resulted from the growth in the average book
value of invested assets to $103.8 million at December 31, 1997, from $89.6
million at December 31, 1996. The yield on average invested assets was 6.0% for
1997 compared to 6.1% for 1996. This slight decrease was attributable to the
Company's continued investment in lower yielding municipal tax-preferred
securities. The portfolio's tax-equivalent yield was 8.0% for 1997 up from 7.7%
for 1996. Approximately 72%, or $68.7 million, of the Company's fixed maturity
portfolio at December 31, 1997, was composed of state and municipal
tax-preferred securities as compared to 53% at December 31, 1996, and 37% at
December 31, 1995.
The Company's loss ratio was 13.4% for 1997 compared to 13.3% for 1996. The
Company's favorable loss ratio reflected the low level of delinquencies compared
to the number of insured loans and the fact that approximately 73% of the
Company's insurance in force was originated in the previous 36 months.
41
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
Net losses and loss adjustment expenses (net of reinsurance recoveries)
increased by 57.9% in 1997 to $5.2 million compared to $3.3 million in 1996.
This increase reflected 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 27.4% to
$4.1 million in 1997 compared to $3.2 million for 1996. The increase in
amortization reflected a growing balance of deferred policy acquisition costs to
amortize as the Company continued to build its total insurance in force.
Other operating expenses increased 41.3% to $10.3 million for 1997 compared
to $7.3 million for 1996. This increase in expenses was primarily attributable
to advertising, personnel, and facilities and equipment costs required to
support the Company's product development, technology enhancements, geographic
expansion, and increased production.
The expense ratio for 1997 was 37.5% compared to 43.8% for 1996.
Contributing to this improvement was the higher level of written premiums
partially offset by the increase in expenses.
The effective tax rate for 1997 was 31.7% compared to 31.0% in 1996. This
increase was primarily the result of the phase-in of the 35.0% federal statutory
income tax rate applicable to companies with annual taxable income above $10.0
million.
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 1998
of $23.3 million compared to $17.9 million for 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, interest, 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.
42
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
The $35.0 million private offering of notes was completed in January 1998.
The notes are non-callable and represent unsecured obligations of the Company.
They are rated "A" by Standard and Poor's Corporation and "A+" by Fitch IBCA.
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 reimbursed by Triad in the form of
management fees.
In December 1998, the Company announced that its Board of Directors had
authorized the purchase of up to $3.0 million of the Company's outstanding
Common Stock. The parent company will fund the purchase of these shares through
either the sale of parent company invested assets or through dividends from
Triad. Through February 1999, the Company had purchased 131,000 shares of its
common stock for approximately $2.4 million.
Consolidated invested assets were $177.3 million at December 31, 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 8% of its consolidated
investment portfolio, up from approximately 3% at December 31, 1997. Net
unrealized investment gains were $2.5 million on equity securities and $3.5
million on fixed maturity securities at December 31, 1998. Fixed maturity
securities and equity securities, all of which are classified as available for
sale, totaled $171.4 million at December 31, 1998. Based upon book value, the
fixed maturity portfolio at December 31, 1998, consisted of approximately 70%
municipal securities, 24% corporate securities, 5% U.S. government obligations,
and 1% mortgage-backed bonds.
43
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
Fixed maturity securities represent approximately 89% of the Company's
invested assets at December 31, 1998, and the fair value of these fixed rate
securities generally bears an inverse relationship to changes in prevailing
market interest rates. The Company's long-term debt bears interest at a fixed
rate of 7.9% per annum, and as a result, the fair value of this debt is
sensitive to changes in prevailing interest rates. A 10% relative increase or
decrease in market interest rates that affect the Company's financial
instruments would not have a material impact on earnings during the next fiscal
year, and would not materially affect the fair value of the Company's financial
instruments.
The Company's loss reserves increased to $12.1 million at December 31,
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 $23,400 at December 31,
1998, compared to $23,100 at December 31, 1997. The Company's delinquency ratio,
the ratio of reported delinquent insured loans to total insured loans, was 0.53%
at December 31, 1998, compared to 0.47% at December 31, 1997. Beginning with
year end 1998, the Company began reporting only delinquencies that are greater
than 45 days delinquent to conform with the industry standard. Previously, the
Company reported all delinquencies, including those 45 days or less past due.
The change had no material impact on the Company's loss reserves.
The Company's unearned premium reserve of $7.1 million at December 31,
1998, decreased from $8.0 million at December 31, 1997. This decline is
primarily attributable 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 $137.5 million at December 31,
1998, from $111.8 million at December 31, 1997. This increase resulted primarily
from net income of $24.4 million for 1998, the tax benefit and additional
paid-in capital of $1.9 million relating to 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
$497,000 and the retirement of 15,000 shares of the Company's Common Stock
purchased during October 1998 for $297,000.
Triad's total statutory policyholders' surplus increased to $89.5 million
at December 31, 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 $31.3 million,
offset primarily by a decrease in unrealized investment gains of $925,000 and an
44
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION -- CONTINUED
increase in the statutory contingency reserve of $26.8 million. Triad's
statutory earned surplus was $5.8 million at December 31, 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. Approximately $1.9
million and $2.8 million of the statutory earned surplus for 1998 and 1997,
respectively, was attributable to unrealized gains. The balance in the statutory
contingency reserve was $81.6 million at December 31, 1998, compared to $54.8
million at December 31, 1997.
The Company 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 $1.8 million in capitalized costs have
been incurred for the project thus far through December 31, 1998) and that the
project will be funded through cash flow from operations.
Substantially all of the Company's existing computer systems which are
integral to its business were originally developed to be year 2000 compliant or
are being reprogrammed. The Company plans to reprogram its existing computer
systems, as necessary, and complete testing of the Company's existing system by
March 31, 1999. As of December 31, 1998, the Company is approximately 90%
complete in the review and testing of its existing computer systems for 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.
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
December 31, 1998, Triad's risk-to-capital ratio was 16.2-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.
45
<PAGE>
ITEM 7. 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; 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.
46
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Financial Statements and Supplementary Data are presented in a separate
section of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information regarding directors and nominees for directors of the Company
is included in the Company's Proxy Statement for the 1999 Annual Meeting of
Stockholders, and is hereby incorporated by reference.
For information regarding the executive officers of the Company, reference
is made to the section entitled "Executive Officers of the Company" in Part I,
Item 1 of this Report.
ITEM 11. EXECUTIVE COMPENSATION.
This information is included in the Company's Proxy Statement for the 1999
Annual Meeting of Stockholders, and is hereby incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
This information is included in the Company's Proxy Statement for the 1999
Annual Meeting of Stockholders, and is hereby incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
This information is included in the Company's Proxy Statement for the 1999
Annual Meeting of Stockholders, and is hereby incorporated by reference.
47
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT
SCHEDULES, AND REPORTS ON FORM 8-K.
(a) (1) and (2) The response to this portion of Item 14 is submitted as a
separate section of this report.
(a) (3) Listing of Exhibits-- The response to this portion of Item 14 is
submitted as a separate section of this report.
(b) Reports on Form 8-K.
No reports on form 8-K were filed during the quarter ended December
31, 1998.
(c) Exhibits-- The response to this portion of Item 14 is submitted as a
separate section of this report.
(d) Financial Statement Schedules-- The response to this portion of Item
14 is submitted as a separated section of this report.
48
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on the 18th day of
March, 1999.
By /s/ Darryl W. Thompson
-----------------------------
Darryl W. Thompson
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on the 18th day of March, 1999 by the following
persons on behalf of the Registrant in the capacities indicated.
SIGNATURE TITLE
/s/ William T. Ratliff, III Chairman of the Board
- ---------------------------
William T. Ratliff, III
/s/ Darryl W. Thompson President, Chief Executive Officer and
- --------------------------- Director
Darryl W. Thompson
/s/ David W. Whitehurst Executive Vice President, Chief Financial
- --------------------------- Officer, Treasurer and Director
David W. Whitehurst
/s/ Michael R. Oswalt Vice President and Controller, Principal
- --------------------------- Accounting Officer
Michael R. Oswalt
/s/ Robert T. David Director
- ---------------------------
Robert T. David
/s/ Raymond H. Elliott Director
- ---------------------------
Raymond H. Elliott
49
<PAGE>
ANNUAL REPORT ON FORM 10-K
ITEM 8, ITEM 14(a)(1) and (2), (3), (c) and (d)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
INDEX TO EXHIBITS
FINANCIAL STATEMENTS
FINANCIAL STATEMENT SCHEDULES
CERTAIN EXHIBITS
YEAR ENDED DECEMBER 31, 1998
TRIAD GUARANTY INC.
WINSTON-SALEM, NORTH CAROLINA
50
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
(Item 14(a) 1 and 2)
CONSOLIDATED FINANCIAL STATEMENTS Page
- --------------------------------- ----
Report of Independent Auditors......................................... 54
Consolidated Balance Sheets at December 31, 1998 and 1997.............. 55 - 56
Consolidated Statements of Income for each of the three years
in the period ended December 31, 1998............................... 57
Consolidated Statements of Changes in Stockholders' Equity for
each of the three years in the period ended December 31, 1998....... 58
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 1998............................... 59
Notes to Consolidated Financial Statements............................. 60 - 77
FINANCIAL STATEMENT SCHEDULES
- -----------------------------
Schedules at and for each of the three years in the period ended December 31,
1998
Schedule I - Summary of investments - other than investments
in related parties............................................... 78
Schedule II - Condensed financial information of Registrant......... 79 - 83
Schedule IV - Reinsurance........................................... 84
All other schedules are omitted since the required information is not present or
is not present in amounts sufficient to require submission of the schedules, or
because the information required is included in the consolidated financial
statements and notes thereto.
51
<PAGE>
INDEX TO EXHIBITS
(ITEM 14(A) 3)
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------ ----------------------
3.1 Certificate of Incorporation of the Registrant, as amended (7)(Exhibit
3.1)
3.2 By-Laws of the Registrant (1) (Exhibit 3(b))
4.1 Form of Common Stock certificate (1)(Exhibit 4(a))
4.2 Indenture Between Triad Guaranty Inc. and Banker's Trust Co.(8)
(Exhibit 4.2)
10.1 1993 Long-Term Stock Incentive Plan (1)(3) (Exhibit 10(a)
10.2 Proportional Reinsurance Agreement between Triad Guaranty Insurance
Corporation and PMI Mortgage Insurance Co. (1) (Exhibit 10(b))
10.3 Agreement for Administrative Services among Triad Guaranty Insurance
Corporation and Collateral Investment Corp. and Collateral Mortgage,
Ltd. (1)(Exhibit 10(c))
10.4 Investment Advisory Agreement between Triad Guaranty Insurance
Corporation and Collateral Mortgage, Ltd. (1) (Exhibit 10(d))
10.6 Registration Agreement among the Registrant, Collateral Investment
Corp. and Collateral Mortgage, Ltd. (2) (Exhibit 10.6)
10.7 Employment Agreement between the Registrant and Darryl W. Thompson
(2)(3) (Exhibit 10.7)
10.8 Employment Agreement between the Registrant and John H.Williams (2)(3)
(Exhibit 10.8)
10.10 Employment Agreement between the Registrant and Henry B.Freeman (2)(3)
(Exhibit 10.10)
10.11 Employment Agreement between the Registrant and Ron D.Kessinger (2)(3)
(Exhibit 10.11)
10.13 Proportional Reinsurance Agreement between Triad Guaranty Insurance
Corporation and PMI Mortgage Insurance Co. (4) (Exhibit 10.13)
10.15 Excess of Loss Reinsurance Agreement between Triad Guaranty
Insurance Corporation and National Union Fire Insurance
Company of Pittsburgh, PA.(5) (Exhibit 10.15)
10.16 Economic Value Added Incentive Bonus Program (Senior Management)
(6) (Exhibit 10.16)
52
<PAGE>
10.17 Amendment to Employment Agreement between the Registrant and Darryl W.
Thompson (3)(6) (Exhibit 10.17)
10.18 Amendment to Employment Agreement between the Registrant and John H.
Williams (3)(6) (Exhibit 10.18)
10.19 Amendment to Employment Agreement between the Registrant and Henry B.
Freeman (3)(6) (Exhibit 10.19)
10.20 Amendment to Employment Agreement between the Registrant and Ron D.
Kessinger (3)(6) (Exhibit 10.20)
21.1 Subsidiaries of the Registrant (6) (Exhibit 21.1)
*23.1 Consent of Ernst & Young LLP (Exhibit 23.1)
*27.1 Financial Data Schedule (Exhibit 27.1)
- -----------------
* Filed Herewith.
(1) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the Registrant's Registration Statement on Form S-1 filed
October 22, 1993 and amendments thereto.
(2) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the 1993 Form 10-K.
(3) Denotes management contract or compensatory plan of arrangement required to
be filed as an exhibit to this report pursuant to Item 601 of Regulation
S-K.
(4) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the 1994 Form 10-K.
(5) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the 1995 Form 10-K.
(6) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the 1996 Form 10-K.
(7) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the June 30, 1997 Form 10-Q.
(8) Incorporated by reference to the exhibit identified in parentheses, filed
as an exhibit in the 1997 Form 10-K.
53
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Triad Guaranty Inc.
We have audited the accompanying consolidated balance sheets of Triad Guaranty
Inc. and subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Triad Guaranty
Inc. and subsidiaries at December 31, 1998 and 1997, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998 in conformity with generally accepted
accounting principles.
Ernst & Young LLP
January 20, 1999
54
<PAGE>
Triad Guaranty Inc.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31
1998 1997
-----------------------------------
Assets
<S> <C> <C>
Invested assets:
Securities available-for-sale, at fair value:
Fixed maturities (amortized cost:
1998-$153,868,237; 1997-$95,756,136) $157,391,829 $ 99,725,487
Equity securities (cost: 1998-$11,550,510;
1997-$8,666,815) 14,024,012 11,466,028
Short-term investments 5,885,192 8,685,842
-----------------------------------
177,301,033 119,877,357
Cash 444,200 8,557
Accrued investment income 2,258,878 1,460,168
Deferred policy acquisition costs 16,015,559 12,587,355
Property and equipment, at cost less
accumulated depreciation
(1998-$2,292,770; 1997-$1,563,289) 3,446,656 2,524,228
Reinsurance recoverable 610,817 49,447
Other assets 5,178,627 2,471,948
-----------------------------------
Total assets $205,255,770 $138,979,060
===================================
</TABLE>
55
<PAGE>
<TABLE>
<CAPTION>
December 31
1998 1997
--------------------------------
Liabilities and stockholders' equity
<S> <C> <C>
Liabilities:
Losses and loss adjustment expenses $ 12,142,990 $ 8,960,411
Unearned premiums 7,054,737 7,988,342
Current taxes payable 45,787 3,318
Deferred income taxes 7,930,878 7,521,874
Unearned ceding commission 621,161 -
Long-term debt 34,457,080 -
Accrued interest on debt 1,274,972 -
Accrued expenses and other liabilities 4,196,825 2,724,324
--------------------------------
Total liabilities 67,724,430 27,198,269
Commitments and contingencies (Note 5 and 7)
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, 13,408,869
at December 31, 1998 and 13,293,721 at
December 31, 1997 issued and outstanding shares 134,089 132,937
Additional paid-in capital 61,538,613 59,369,223
Accumulated other comprehensive income, net
of income tax liability of $2,101,170 at
December 31, 1998 and $2,368,998 at
December 31, 1997 3,907,920 4,405,315
Retained earnings 71,950,718 47,873,316
--------------------------------
Total stockholders' equity 137,531,340 111,780,791
--------------------------------
Total liabilities and stockholders' equity $205,255,770 $138,979,060
================================
</TABLE>
See accompanying notes.
56
<PAGE>
<TABLE>
<CAPTION>
Triad Guaranty Inc.
Consolidated Statements of Income
Year ended December 31
1998 1997 1996
-------------------------------------------------
<S> <C> <C> <C>
Revenue:
Premiums written:
Direct $52,973,589 $40,082,507 $26,151,650
Assumed 13,052 20,061 26,222
Ceded (1,089,955) (1,772,039) (2,216,417)
-------------------------------------------------
Net premiums written 51,896,686 38,330,529 23,961,455
Change in unearned premiums 925,045 191,163 766,286
------------------------------------------------
Earned premiums 52,821,731 38,521,692 24,727,741
Net investment income 9,289,026 6,234,142 5,446,672
Net realized investment gains (losses) 880,502 34,330 (162,385)
Other income 13,652 7,716 -
------------------------------------------------
63,004,911 44,797,880 30,012,028
Losses and expenses:
Losses and loss adjustment expenses 7,005,420 5,317,812 3,444,354
Reinsurance recoveries 3,198 (140,734) (165,224)
------------------------------------------------
Net losses and loss adjustment expenses 7,008,618 5,177,078 3,279,130
Interest expense on debt 2,554,126 - -
Amortization of deferred policy
acquisition costs 5,954,915 4,120,469 3,234,876
Other operating expenses (net of
acquisition costs deferred) 12,434,890 10,256,815 7,259,271
------------------------------------------------
27,952,549 19,554,362 13,773,277
------------------------------------------------
Income before income taxes 35,052,362 25,243,518 16,238,751
Income taxes:
Current 38,928 2,613 (37,292)
Deferred 10,639,361 7,999,081 5,079,077
------------------------------------------------
10,678,289 8,001,694 5,041,785
------------------------------------------------
Net income $24,374,073 $17,241,824 $11,196,966
================================================
Earnings per common and common
equivalent share:
Basic $1.83 $1.30 $.84
Diluted 1.76 1.26 .83
================================================
Shares used in computing earnings per
common and common equivalent share:
Basic 13,342,749 13,291,160 13,277,853
Diluted 13,843,382 13,713,538 13,541,551
================================================
</TABLE>
See accompanying notes.
57
<PAGE>
<TABLE>
<CAPTION>
Triad Guaranty Inc.
Consolidated Statements of Changes in Stockholders' Equity
Accumulated Other
Additional Comprehensive
Common Paid-In Income Retained
Stock Capital Earnings Total
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995 $ 44,189 $59,141,808 $1,732,209 $19,523,136 $ 80,441,342
Net income - - - 11,196,966 11,196,966
Other comprehensive income - net of tax:
Change in unrealized gain - - (163,409) - (163,409)
-----------------
Comprehensive income - - - - 11,033,557
Issuance of 11,316 shares of common stock
under stock option plans 113 205,536 - - 205,649
Three-for-two stock split effected in
the form of a 50% stock dividend 22,151 - - (22,151) -
Retirement of common stock - (512) - - (512)
--------------------------------------------------------------------------------
Balance at December 31, 1996 66,453 59,346,832 1,568,800 30,697,951 91,680,036
Net income - - - 17,241,824 17,241,824
Other comprehensive income - net of tax:
Change in unrealized gain - - 2,836,515 - 2,836,515
-----------------
Comprehensive income - - - - 20,078,339
Issuance of 2,499 shares of common stock
under stock option plans 25 22,391 - - 22,416
Two-for-one stock split effected in the
form of a 100% stock dividend 66,459 - - (66,459) -
--------------------------------------------------------------------------------
Balance at December 31, 1997 132,937 59,369,223 4,405,315 47,873,316 111,780,791
Net income - - - 24,374,073 24,374,073
Other comprehensive income - net of tax:
Change in unrealized gain - - (497,395) - (497,395)
-----------------
Comprehensive income - - - - 23,876,678
Issuance of 122,648 shares of common stock
under stock option plans 1,227 954,629 - - 955,856
Tax effect of exercise of non-qualified
stock options - 916,711 - - 916,711
Purchase and subsequent retirement of
15,000 shares of common stock (150) - - (296,671) (296,821)
Issuance of 7,500 shares of restricted 75 298,050 - - 298,125
stock
================================================================================
Balance at December 31, 1998 $134,089 $61,538,613 $3,907,920 $71,950,718 $137,531,340
================================================================================
</TABLE>
See accompanying notes.
58
<PAGE>
<TABLE>
<CAPTION>
Triad Guaranty Inc.
Consolidated Statements of Cash Flows
Year ended December 31
1998 1997 1996
----------------------------------------------------
Operating activities
<S> <C> <C> <C>
Net income $24,374,073 $17,241,824 $11,196,966
Adjustments to reconcile net income to net
cash provided by operating activities:
Loss and unearned premium reserves 2,248,974 2,426,878 846,498
Accrued expenses and other liabilities 1,450,310 901,991 362,459
Current taxes payable 42,469 1,722 (38,335)
Amounts due to/from reinsurer (547,469) 378,771 1,787,428
Accrued investment income (798,710) (333,526) (230,985)
Accrued interest on debt 1,274,972 - -
Policy acquisition costs deferred (9,383,119) (6,509,427) (5,856,589)
Amortization of policy acquisition costs 5,954,915 4,120,469 3,234,876
Net realized investment (gains) losses (880,502) (34,330) 162,385
Provision for depreciation 750,097 621,050 394,282
Accretion of bond discounts (1,013,820) (620,762) (591,336)
Deferred income taxes 1,593,543 1,700,081 1,573,810
Unearned ceding commission 621,161 (80,573) (539,542)
Other assets (2,559,112) (1,914,971) 171,949
Other operating activities 192,489 - -
----------------------------------------------------
Net cash provided by operating activities 23,320,271 17,899,197 12,473,866
Investing activities
Securities available-for-sale:
Purchases - fixed maturities (74,664,883) (25,487,708) (19,823,655)
Sales - fixed maturities 17,449,277 16,186,544 8,036,070
Purchases - equities (7,507,782) (3,835,769) (2,732,179)
Sales - equities 5,591,607 1,678,286 1,838,226
Purchases of property and equipment (1,665,430) (1,431,278) (760,202)
----------------------------------------------------
Net cash used in investing activities (60,797,211) (12,889,925) (13,441,740)
Financing activities
Proceeds from issuance of long-term debt 34,452,898 - (512)
Retirement of common stock (296,821) - -
Proceeds from exercise of stock options 955,856 22,416 205,649
----------------------------------------------------
Net change by financing activities 35,111,933 22,416 205,137
Net change in cash and short-term investments (2,365,007) 5,031,688 (762,737)
Cash and short-term investments at beginning of year 8,694,399 3,662,711 4,425,448
----------------------------------------------------
Cash and short-term investments at end of year $ 6,329,392 $ 8,694,399 $ 3,662,711
====================================================
Supplemental schedule of cash flow information
Cash paid during the period for:
Income taxes and United States Mortgage Guaranty
Tax and Loss Bonds $ 8,963,726 $ 6,299,891 $ 3,348,000
Interest $ 1,274,972
Non-cash investing and finance activities:
Exchange of restricted common stock for
intangible assets $ 298,125 - -
</TABLE>
See accompanying notes.
59
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. ACCOUNTING POLICIES
NATURE OF BUSINESS
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.
BASIS OF PRESENTATION
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles, which vary in some respects from
statutory accounting practices which are prescribed or permitted by the various
insurance departments.
CONSOLIDATION
The consolidated financial statements include the amounts of Triad Guaranty Inc.
and its wholly-owned subsidiaries, Triad Guaranty Insurance Corporation
("Triad") and Triad Guaranty Assurance Corporation ("TGAC"), a wholly-owned
subsidiary of Triad Guaranty Insurance Corporation. All significant intercompany
accounts and transactions have been eliminated.
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
INVESTMENTS
Securities classified as "available-for-sale" are carried at fair value, and
unrealized gains and losses on such securities are reported as a separate
component of accumulated other comprehensive income. The Company does not have
any securities classified as "held-to-maturity" or "trading".
60
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. ACCOUNTING POLICIES (CONTINUED)
Fair value generally represents quoted market value prices for securities traded
in the public market or prices analytically determined using bid or closing
prices for securities not traded in the public marketplace. Realized investment
gains or losses are determined on a specific identification basis and are
included in net income. Short-term investments are defined as short-term, highly
liquid investments both readily convertible to known amounts of cash and having
maturities of three months or less upon acquisition by the Company.
DEFERRED POLICY ACQUISITION COSTS
The costs of acquiring new business, principally commissions and certain policy
underwriting and issue costs, which generally vary with and are primarily
related to the production of new business, are deferred. Amortization of such
policy acquisition costs is charged to expense in proportion to premium revenue
recognized over the estimated policy life. The Company reviews the persistency
of policies in force and makes appropriate adjustments to reflect policy
cancellations.
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost and is amortized principally on a
straight-line basis over the estimated useful lives of depreciable assets.
Property and equipment primarily consists of furniture and equipment and
computer hardware and software.
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
Reserves are provided for the estimated costs of settling claims in respect of
loans reported to be in default and estimates of loans in default which have not
been reported to the Company. Consistent with industry accounting practices, the
Company does not establish loss reserves for future claims on insured loans
which are not currently in default. Loss reserves are established by management
using historical experience and by making various assumptions and judgments
about the ultimate amount to be paid on loans in default. The estimates are
continually reviewed and, as adjustments to these liabilities become necessary,
such adjustments are reflected in current operations.
61
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. ACCOUNTING POLICIES (CONTINUED)
REINSURANCE
Certain premiums and losses are assumed from and ceded to other insurance
companies under various reinsurance agreements. Reinsurance premiums, claim
reimbursement and reserves related to reinsurance business are accounted for on
a basis consistent with those used in accounting for the original policies
issued and the terms of the reinsurance contracts. The Company receives a ceding
commission in connection with ceded reinsurance. The ceding commission is earned
on a monthly pro rata basis in the same manner as the premium and is recorded as
a reduction of other operating expenses. The reinsurance treaties provide for
profit commissions on ceded reinsurance based on the loss ratio associated with
the business ceded.
INCOME TAXES
The Company uses the asset and liability method of accounting for income taxes.
Under the asset and liability method, deferred tax assets, net of any valuation
allowance, and deferred tax liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled, and the effect on deferred
tax assets and liabilities of a change in tax rates is recognized in income in
the period that includes the enactment date.
INCOME RECOGNITION
The Company writes policies that are guaranteed renewable contracts at the
borrower's option on single premium, annual premium, and monthly premium bases.
For annual payment policies, the first year premium exceeds the renewal premium.
The Company does not have the option to reunderwrite these contracts. Premiums
written on annual policies are earned on a monthly pro rata basis. Single
premium policies covering more than one year are amortized over the estimated
policy life in accordance with the expiration of risk. Premiums written on a
monthly basis are generally earned in the month that coverage is provided.
STOCK OPTIONS
The Company grants stock options for a fixed number of shares to employees with
an exercise price equal to or greater than the fair value of the shares at the
date of grant. The Company accounts for stock option grants in accordance with
APB Opinion No. 25, Accounting for Stock Issued to Employees, and, accordingly,
recognizes no compensation expense for the stock option grants.
62
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. ACCOUNTING POLICIES (CONTINUED)
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 employee 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.
STOCK SPLITS
The Company had a three-for-two stock split in 1996 in the form of a 50% stock
dividend. The Company also had a two-for-one stock split in 1997 in the form of
a 100% stock dividend. All earnings per share amounts and stock option
information prior to the stock splits were restated to reflect post-split
amounts.
COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board issued Statement No. 130,
Reporting Comprehensive Income. The Statement establishes standards for the
reporting and display of comprehensive income and its components in financial
statements. The Company adopted the provisions of Statement No. 130 in the first
quarter of 1998 and reclassified the financial statements for earlier periods
provided for comparative purposes as required by the Statement. The application
of the new rules had no impact on the Company's financial position or results of
operations.
Currently, the only element of other comprehensive income applicable to the
Company is changes in unrealized gains and losses on securities classified as
available-for-sale, which are displayed in the following table, along with
related tax effects.
1998 1997 1996
------------------------------------------
Unrealized gains (losses) arising
during the period, before taxes $ 115,278 $4,398,198 $(413,783)
Income taxes (40,347) (1,539,369) 144,824
------------------------------------------
Unrealized gains (losses) arising
during the period, net of taxes 74,931 2,858,829 (268,959)
------------------------------------------
Less: Reclassification adjustment
Gains (losses) realized in net
income 880,502 34,330 (162,385)
Income taxes (308,176) (12,016) 56,835
------------------------------------------
Reclassification adjustment for gains
(losses) realized in net income 572,326 22,314 (105,550)
------------------------------------------
Other comprehensive income - change
in unrealized gains $(497,395) $2,836,515 $(163,409)
==========================================
63
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. INVESTMENTS
The amortized cost and the fair value of investments are as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------------------------------------------------------
<S> <C> <C> <C> <C>
At December 31, 1998
Available-for-sale securities:
Fixed maturity securities:
Corporate $ 36,386,473 $ 599,664 $1,688,249 $ 35,297,888
U.S. Government 8,587,562 340,609 - 8,928,171
Mortgage-backed 1,359,163 52,768 - 1,411,931
State and municipal 107,535,039 4,317,425 98,625 111,753,839
--------------------------------------------------------------
Total 153,868,237 5,310,466 1,786,874 157,391,829
Equity securities 11,550,510 3,027,626 554,124 14,024,012
--------------------------------------------------------------
Total $165,418,747 $8,338,092 $2,340,998 $171,415,841
==============================================================
At December 31, 1997
Available-for-sale securities:
Fixed maturity securities:
Corporate $ 12,260,852 $ 475,211 $ 38,842 $ 12,697,221
U.S. Government 9,823,960 374,877 1,406 10,197,431
Mortgage-backed 4,679,115 127,190 4,950 4,801,355
State and municipal 68,789,100 3,039,784 9,529 71,819,355
Public utilities 203,109 7,016 - 210,125
---------------------------------------------------------------
Total 95,756,136 4,024,078 54,727 99,725,487
Equity securities 8,666,815 2,810,028 10,815 11,466,028
---------------------------------------------------------------
Total $104,422,951 $6,834,106 $ 65,542 $111,191,515
===============================================================
</TABLE>
The amortized cost and estimated fair value of investments in fixed maturity
securities, at December 31, 1998, are summarized by stated maturity as follows:
Available-for-Sale
-----------------------------------
Amortized Fair
Cost Value
-----------------------------------
Maturity:
One year or less $ 6,583,097 $ 6,661,101
After one year through five years 22,091,536 22,877,328
After five years through ten years 28,707,282 28,895,494
After ten years 95,127,159 97,545,975
Mortgage-backed securities 1,359,163 1,411,931
===================================
Total $153,868,237 $157,391,829
===================================
64
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. INVESTMENTS (CONTINUED)
Realized gains and losses on sales of investments are as follows:
Year ended December 31
1998 1997 1996
------------------------------------------
Securities available-for-sale:
Fixed maturity securities:
Gross realized gains $307,255 $ 35,274 $ 28,425
Gross realized losses (73,329) (270,818) (48,112)
Equity securities:
Gross realized gains 707,695 360,066 86,607
Gross realized losses (91,425) (117,810) (106,244)
Other investments:
Gross realized gains 30,306 42,520 30,509
Gross realized losses - (14,902) (153,570)
------------------------------------------
Net realized gains (losses) $880,502 $ 34,330 $(162,385)
==========================================
Net unrealized appreciation (depreciation) on fixed maturity securities changed
by $(445,759) $2,809,249, and $(1,228,326), in 1998, 1997 and 1996,
respectively; the corresponding amounts for equity securities were $(325,711),
$1,571,472 and $961,475.
Major categories of the Company's net investment income are summarized as
follows:
Year ended December 31
1998 1997 1996
------------------------------------------
Income:
Fixed maturities $8,625,387 $5,849,084 $5,260,073
Preferred stocks 280,032 114,610 37,858
Common stocks 256,918 279,640 236,715
Cash and short-term investments 494,565 212,033 122,461
------------------------------------------
9,656,902 6,455,367 5,657,107
Expenses 367,876 221,225 210,435
------------------------------------------
Net investment income $9,289,026 $6,234,142 $5,446,672
==========================================
At December 31, 1998 and 1997, investments with an amortized cost of $6,314,934
and $6,404,051, respectively, were on deposit with state insurance departments
to satisfy regulatory requirements.
65
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. DEFERRED POLICY ACQUISITION COSTS
An analysis of deferred policy acquisition costs is as follows:
Year ended December 31
1998 1997 1996
------------------------------------------
Balance at beginning of year $12,587,355 $10,198,397 $ 7,576,684
Acquisition costs deferred:
Sales compensation 6,353,311 4,265,208 3,330,059
Underwriting and issue expenses 3,029,808 2,244,219 2,526,530
------------------------------------------
9,383,119 6,509,427 5,856,589
Amortization of acquisition expenses 5,954,915 4,120,469 3,234,876
------------------------------------------
Net increase 3,428,204 2,388,958 2,621,713
------------------------------------------
Balance at end of year $16,015,559 $12,587,355 $10,198,397
==========================================
66
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. RESERVE FOR UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity for the reserve for unpaid losses and loss adjustment expenses for
1998, 1997 and 1996 are summarized as follows:
1998 1997 1996
----------------------------------------
Reserve for losses and loss
adjustment expenses at January 1,
net of reinsurance recoverables $8,909,121 $5,974,664 $ 3,703,251
Incurred losses and loss adjustment
expenses net of reinsurance
recoveries (principally in respect
of default notices occurring in):
Current year 7,953,412 6,022,700 4,673,130
Redundancy on prior years (944,794) (845,622) (1,394,000)
----------------------------------------
Total incurred losses and loss
adjustment expenses 7,008,618 5,177,078 3,279,130
Loss and loss adjustment expense
payments net of reinsurance
recoveries (principally in respect
of default notices occurring in):
Current year 266,983 210,493 166,717
Prior years 3,534,822 2,032,128 841,000
----------------------------------------
Total loss and loss adjustment
expense payments 3,801,805 2,242,621 1,007,717
----------------------------------------
Reserve for losses and loss
adjustment expenses at December 31,
net of reinsurance recoverables
of $27,056, $51,290 and $330,733
in 1998, 1997 and 1996, respectively $12,115,934 $8,909,121 $ 5,974,664
========================================
The foregoing reconciliation shows a redundancy in reserves has emerged for each
of the years presented. These redundancies resulted principally from settling
case-basis reserves for amounts less than expected or reducing incurred but not
reported reserves on default notices occurring in prior years.
67
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. COMMITMENTS
The Company leases certain office facilities and equipment under operating
leases. Rental expense for all leases was $902,866, $835,596 and $609,215 for
1998, 1997, and 1996, respectively. Future minimum payments under noncancellable
operating leases at December 31, 1998 are as follows:
1999 $ 904,525
2000 813,412
2001 715,827
2002 294,286
2003 43,456
-----------
$2,771,506
===========
6. FEDERAL INCOME TAXES
Triad purchases ten-year non-interest bearing United States Mortgage Guaranty
Tax and Loss Bonds in lieu of paying federal income taxes. At December 31, 1998
and 1997, Triad was obligated to purchase approximately $154,000 and $425,000,
respectively, of United States Mortgage Guaranty Tax and Loss Bonds.
Income tax expense differed from the amounts computed by applying the Federal
statutory income tax rate to income before taxes as follows:
1998 1997 1996
------------------------------------------
Income tax computed at
statutory rate $12,268,326 $ 8,835,231 $5,683,563
Increase (decrease) in
taxes resulting from:
Tax-exempt interest (1,559,067) (1,002,062) (751,407)
Other (30,970) 168,525 109,629
------------------------------------------
Income tax expense $10,678,289 $ 8,001,694 $5,041,785
==========================================
68
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. FEDERAL INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant portions
of deferred tax assets and deferred tax liabilities at December 31, 1998 and
1997 are presented below.
1998 1997
--------------------------------
DEFERRED TAX LIABILITIES
Statutory contingency reserve $25,605,001 $17,370,996
Deferred policy acquisition costs 5,605,446 4,405,574
Unrealized investment gain 2,101,170 2,368,998
Other 861,296 686,937
--------------------------------
Total deferred tax liabilities 34,172,913 24,832,505
DEFERRED TAX ASSETS
United States Mortgage Guaranty Tax and
Loss Bonds 25,256,666 16,293,366
Unearned premiums 536,397 611,467
Losses and loss adjustment expenses 341,449 250,599
Other 107,523 155,199
--------------------------------
Total deferred tax assets 26,242,035 17,310,631
--------------------------------
Net deferred tax liability $ 7,930,878 $ 7,521,874
================================
69
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. INSURANCE IN FORCE, DIVIDEND RESTRICTION, AND STATUTORY RESULTS
Approximately 60% of Triad's net risk in force is concentrated in seven states
including 12% in Illinois, 11% in Georgia, 10% in California, 8% in Florida, 7%
in Texas, 6% in Virginia, and 6% in North Carolina. While Triad continues to
diversify its risk in force geographically, a prolonged recession in its high
concentration areas could result in higher incurred losses and loss adjustment
expenses for Triad.
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 December 31, 1998 and 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:
1998 1997
---------------------------------------
Net risk $2,776,205,499 $2,231,572,130
=======================================
Statutory capital and surplus $ 89,539,785 $ 60,929,830
Contingency reserve 81,614,277 54,766,669
---------------------------------------
Total $ 171,154,062 $ 115,696,499
=======================================
Risk-to-capital ratio 16.2 to 1 19.3 to 1
=======================================
Triad and TGAC are each required under the Illinois Insurance Code (the "Code")
to maintain minimum statutory 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 market 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 statutory
surplus as regards policyholders, or (b) statutory net income for the calendar
year preceding the date of the dividend. Net income as determined in accordance
with statutory accounting practices was $31,252,891, $22,916,215, and
$13,369,769 for the years ended December 31, 1998, 1997 and 1996, respectively.
At December 31, 1998, the amount of the Company's equity that can be paid out in
dividends to the stockholders is $5,823,857, which is the earned surplus of
Triad on a statutory basis.
70
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. RELATED PARTY TRANSACTIONS
The Company and Triad pay affiliated companies for management, investment, and
other services. The total expense incurred for such items was $336,143, $284,660
and $303,555 in 1998, 1997 and 1996, respectively. In addition, in 1998, Triad
began providing certain investment accounting, reporting, and maintenance
functions for an affiliate. Income earned during 1998 for such services was
$12,309. Management believes that the income and expenses incurred for such
services approximate costs that the Company and affiliates would have incurred
if those services had been provided by unaffiliated third parties.
9. EMPLOYEE BENEFIT PLAN
Substantially all employees participate in the Company's 401(k) Profit Sharing
Plan. Under the plan, employees elect to defer a portion of their wages, with
the Company matching deferrals at the rate of 50% of the first 8% of the
employee's salary deferred. The Company contributed $225,797, $151,134, and
$123,699 for the years ended December 31, 1998, 1997 and 1996, respectively, to
the plan.
10. REINSURANCE
Certain premiums and losses are assumed from and ceded to other insurance
companies under various reinsurance agreements. The ceding agreement principally
provides Triad with increased capacity to write business and achieve a more
favorable geographic dispersion of risk.
Effective January 1, 1996, Triad eliminated quota share reinsurance on new
business and recaptured substantial portions of its coverage on renewal
business. Triad received approximately $1,100,000 and re-established reserves,
unearned premiums, and deferred acquisition costs for the previously ceded
business with no effect on income. Also, effective January 1, 1996, Triad
obtained $25.0 million in excess of loss reinsurance designed to provide
reinsurance protection in case of catastrophic levels of losses.
71
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. REINSURANCE (CONTINUED)
Effective October 1, 1997, Triad recaptured most of the remaining coverage on
renewal business. Triad received approximately $168,000 and re-established
reserves, unearned premiums, and deferred acquisition costs for the previously
ceded business with no effect on income.
Reinsurance activity for the years ended December 31, 1998, 1997, and 1996 is as
follows:
1998 1997 1996
-----------------------------------------
Earned premiums ceded $1,098,515 $1,809,012 $2,319,927
Losses ceded (3,198) 140,734 165,224
Earned premiums assumed 15,500 19,804 29,012
Losses assumed 50,241 67,903 99,910
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 deemed
uncollectible. Triad evaluates the financial condition of its reinsurers and
monitors credit risk arising from similar geographic regions, activities, or
economic characteristics of its reinsurers to minimize its exposure to
significant losses from reinsurer insolvency.
11. LONG-TERM STOCK INCENTIVE PLAN
In August 1993, the Company adopted the 1993 Long-Term Stock Incentive Plan (the
"Plan"). Under the Plan, certain directors, officers, and key employees are
eligible to be granted various stock-based awards. The number of shares of
common stock which may be issued or sold or for which options or stock
appreciation rights may be granted under the Plan is 2,100,000 shares.
72
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. LONG-TERM STOCK INCENTIVE PLAN (CONTINUED)
Information concerning the stock option plan is summarized below.
Weighted
Number of Option Average
Shares Price Exercise Price
---------------------------------------------
1996
Outstanding, beginning of year 797,850 $ 4.58 - 8.92 $ 6.13
Granted 239,256 8.84 - 15.13 11.47
Exercised 33,948 5.34 - 6.94 6.06
Canceled 9,462 5.96 - 11.49 9.56
Outstanding, end of year 993,696 4.58 - 15.13 7.38
Exercisable, end of year 738,229 4.58 - 11.49 6.54
1997
Outstanding, beginning of year 993,696 4.58 - 15.13 7.38
Granted 184,550 14.81 - 38.27 20.13
Exercised 2,999 4.58 - 8.92 7.47
Outstanding, end of year 1,175,247 4.58 - 38.27 9.39
Exercisable, end of year 887,462 4.58 - 15.13 6.91
1998
Outstanding, beginning of year 1,175,247 4.58 - 38.27 9.39
Granted 126,675 22.50 - 49.08 42.52
Exercised 122,648 4.58 - 20.07 7.79
Canceled 667 14.81 14.81
Outstanding, end of year 1,178,607 4.58 - 49.08 13.11
Exercisable, end of year 934,027 4.58 - 49.08 9.05
73
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. LONG-TERM STOCK INCENTIVE PLAN (CONTINUED)
Information concerning stock options outstanding and exercisable at December 31,
1998 is summarized below.
Outstanding Exercisable
- ---------------------------------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Number of Exercise Remaining Number of Exercisable
Shares Option Price Price Life Shares Price
- ---------------------------------------------------- --------------------------
675,150 $4.58 - $8.92 $6.17 5.2 675,150 $6.17
240,698 10.17 - 17.00 12.28 7.3 194,329 12.06
138,084 20.07 - 29.44 21.09 8.2 39,414 21.07
63,900 37.75 - 39.75 38.98 9.2 7,630 37.86
60,775 41.94 - 49.08 48.11 9.1 17,504 49.08
============ ---------
1,178,607 934,027
============ =========
At December 31, 1998, 1,818,905 shares of the Company's common stock were
reserved, and 640,298 shares were available for issuance under the Plan.
The options issued under the Plan in 1998, 1997, and 1996 vest over three years.
Certain of the options will immediately vest in the event of a change in control
of the Company. Options granted under the Plan terminate no later than 10 years
following the date of grant.
Pro forma information required by Financial Accounting Standards Board Statement
No. 123, "Accounting for Stock-Based Compensation", has been estimated as if the
Company had accounted for stock-based awards under the fair value method of that
Statement. The fair value of options granted in 1996, 1997, and 1998 was
estimated at the date of the grant using a Black-Scholes option pricing model
with the following weighted-average input assumptions: risk-free interest rate
of 6.2% for 1996, 5.7% for 1997, and 5.1% for 1998; dividend yield of 0.0%;
expected volatility of .20 for 1996, .29 for 1997, and .40 for 1998; and a
weighted-average expected life of the option of seven years.
74
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. LONG-TERM STOCK INCENTIVE PLAN (CONTINUED)
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's stock options have characteristics significantly different from
those of traded options and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its employee stock options.
The following table summarizes the fair value of options granted in 1998, 1997,
and 1996.
Weighted-Average Weighted-Average
Exercise Price Fair Value
Type of Option 1998 1997 1996 1998 1997 1996
- ----------------------------- ------------------------ -----------------------
Stock Price = Exercise Price $37.87 $18.65 $11.44 $13.42 $5.73 $3.16
Stock Price < Exercise Price $49.08 $20.78 $11.48 $11.29 $3.88 $1.70
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. Had compensation
expense for stock options been recognized using the fair value method on the
grant date, net income and earnings per share on a pro forma basis would have
been (in thousands except for earnings per share information):
1998 1997 1996
--------------------------------------------
Net Income - as reported $24,374 $17,242 $11,197
Net Income - pro forma $23,779 $16,937 $11,054
Earnings per share - as reported:
Basic $ 1.83 $ 1.30 $ 0.84
Diluted $ 1.76 $ 1.26 $ 0.83
Earnings per share - pro forma:
Basic $ 1.78 $ 1.28 $ 0.83
Diluted $ 1.72 $ 1.24 $ 0.82
The preceding effects of applying Statement 123 are not likely to be indicative
of the effects on net income and earnings per share in future years due to the
vesting period of awards granted in these years.
75
<PAGE>
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. LONG-TERM DEBT
In January of 1998, the Company completed a $35.0 million private offering of
notes due January 15, 2028. Proceeds from the offering, net of debt issue costs
of $547,102, totaled $34,542,898. The notes, which represent unsecured
obligations of the Company, bear interest at a rate of 7.9% per annum and are
non-callable.
13. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying values and fair values of financial instruments as of December 31,
1998 and 1997 are summarized below.
<TABLE>
<CAPTION>
1998 1997
----------------------------- ---------------------------------
Carrying Fair Carrying Fair
Value Value Value Value
----------------------------- ---------------------------------
<S> <C> <C> <C> <C>
Financial Assets
Fixed maturities available-
for-sale $157,391,829 $157,391,829 $99,725,487 $99,725,487
Equity securities
available-for-sale 14,024,012 14,024,012 11,466,028 11,466,028
Financial Liabilities
Long-term debt 34,457,080 38,468,000 - -
</TABLE>
The fair values of cash and short-term investments approximate their carrying
values due to their short-term maturity or availability.
The fair values of fixed maturity securities and equity securities have been
determined using quoted market prices for securities traded in the public market
or prices using bid or closing prices for securities not traded in the public
marketplace. These fair values are disclosed in Note 2.
The fair value of the Company's long-term debt is estimated using discounted
cash flow analysis, based on the Company's current incremental borrowing rates
for similar types of borrowing arrangements.
76
<PAGE>
14. UNAUDITED QUARTERLY FINANCIAL DATA
The following is a summary of the unaudited quarterly results of operations for
the years ended December 31, 1998 and 1997 (in thousands except per share data):
1998 Quarter
-----------------------------------------------
First Second Third Fourth Year
-----------------------------------------------
Net premiums written $11,335 $12,532 $13,372 $14,658 $51,897
Earned premiums 11,930 12,659 13,656 14,577 52,822
Net investment income 2,039 2,326 2,424 2,501 9,290
Net losses incurred 1,477 1,107 1,716 2,709 7,009
Underwriting and other expenses
4,841 5,301 5,423 5,379 20,944
Net income 5,383 6,045 6,463 6,483 24,374
Basic earnings per share .40 .45 .48 .48 1.83
Diluted earnings per share .39 .44 .47 .47 1.76
1997 Quarter
-----------------------------------------------
First Second Third Fourth Year
-----------------------------------------------
Net premiums written $7,379 $9,128 $10,611 $11,213 $38,331
Earned premiums 7,849 8,985 10,378 11,310 38,522
Net investment income 1,472 1,502 1,730 1,530 6,234
Net losses incurred 1,196 1,090 1,520 1,371 5,177
Underwriting and other expenses
3,095 3,530 3,754 3,998 14,377
Net income 3,447 4,033 4,738 5,024 17,242
Basic earnings per share .26 .30 .36 .38 1.30
Diluted earnings per share .25 .30 .34 .36 1.26
77
<PAGE>
SCHEDULE I
SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES
TRIAD GUARANTY INC.
DECEMBER 31, 1998
Amount at
Which Shown
Amortized Fair in Balance
Type of Investment Cost Value Sheet
----------------------------------
(dollars in thousands)
Fixed maturity securities, available-for-sale:
Bonds:
U.S. Government obligations................ $ 8,588 $ 8,928 $ 8,928
Mortgage-backed securities................. 1,359 1,412 1,412
State and municipal bonds.................. 107,535 111,754 111,754
Corporate bonds............................ 36,135 35,043 35,043
Public utilities........................... 251 255 255
-------- -------- --------
Total........................................ 153,868 157,392 157,392
-------- -------- --------
Equity securities, available-for-sale:
Common stocks:
Public utilities......................... 857 1,395 1,395
Bank, Trust, and Insurance............... 793 1,347 1,347
Industrial & miscellaneous............... 5,257 6,540 6,540
Preferred Stock ............................. 4,644 4,742 4,742
-------- -------- --------
Total....................................... 11,551 14,024 14,024
-------- -------- --------
Short-term investments.......................... 5,885 5,885 5,885
-------- -------- --------
Total investments other than investments in
related parties................................. $171,304 $177,301 $177,301
======== ======== ========
78
<PAGE>
Schedule II - Condensed Financial Information of Registrant
Condensed Balance Sheets
Triad Guaranty Inc.
(Parent Company)
December 31
1998 1997
---- ----
(dollars in thousands)
Assets:
Fixed maturities- available-for-sale.............. $ 9,439 $ ---
Equity securities- available-for-sale............. 271 ---
Notes receivable from subsidiary.................. 25,000 ---
Investment in subsidiaries........................ 136,369 111,200
Cash and short-term investments................... 943 562
Accrued investment income......................... 1,225 ---
Deferred income taxes............................. 86 ---
Other assets...................................... --- 56
-------- --------
Total assets...................................... $173,333 $111,818
======== ========
Liabilities and stockholders' equity:
Liabilities:
Current taxes payable............................. $ 45 $ 3
Long-term debt.................................... 34,457 ---
Accrued interest on long-term debt................ 1,275 ---
Accrued expenses and other liabilities............ 25 35
-------- --------
Total liabilities................................. 35,802 38
Stockholders' equity:
Common stock...................................... 134 133
Additional paid-in capital........................ 61,538 59,369
Accumulated other comprehensive income............ 3,908 4,405
Retained earnings................................. 71,951 47,873
-------- --------
Total stockholders' equity........................... 137,531 111,780
-------- --------
Total liabilities and stockholders' equity........... $173,333 $111,818
======== ========
See notes to condensed financial statements.
79
<PAGE>
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF INCOME
TRIAD GUARANTY INC.
(PARENT COMPANY)
Year Ended December 31
----------------------
1998 1997 1996
---- ---- ----
(dollars in thousands)
Revenues:
Net investment income........................ $ 2,787 $ 22 $ 17
Realized investment gains.................... 14 --- ---
------- -------- -------
2,801 22 17
------- ------- -------
Expenses:
Interest on long-term debt................... 2,554 --- ---
Operating expenses........................... 5 6 6
------- ------- -------
2,559 6 6
------- ------- -------
Income before federal income taxes
and equity in undistributed income
of subsidiaries.............................. 242 16 11
Federal income tax expense...................... 80 2 151
------- ------- -------
Income (loss) before equity in
undistributed income of subsidiaries......... 162 14 (140)
Equity in undistributed income of
subsidiaries................................. 24,213 17,228 11,337
------- ------- -------
Net income...................................... $24,375 $17,242 $11,197
======= ======= =======
See notes to condensed financial statements.
80
<PAGE>
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED STATEMENTS OF CASH FLOWS
TRIAD GUARANTY INC.
(PARENT COMPANY)
Year Ended December 31
----------------------
1998 1997 1996
---- ---- ----
Operating Activities (dollars in thousands)
Net income........................................ $ 24,375 $17,242 $11,197
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed income of subsidiaries. (24,213) (17,228) (11,337)
Accrued investment income...................... (1,225) --- ---
Other assets................................... 56 (40) 20
Deferred income taxes.......................... 42 --- 151
Current tax payable............................ 42 2 ---
Accrued interest on long-term debt............. 1,275 --- ---
Accretion of discount on investments........... (130) --- ---
Amortization of debt issue costs............... 4 --- ---
Realized investment gain on securities......... (14) --- ---
Accrued expenses and other liabilities......... (10) 30 (15)
-------- ------- -------
Net cash provided by operating activities......... 202 6 16
Investing Activities
Securities available-for-sale:
Fixed Maturities:
Purchases................................... (13,909) --- ---
Sales....................................... 4,276 --- ---
Equities
Purchases................................... (300) --- ---
Issuance of Surplus Note to subsidiary......... (25,000) --- ---
-------- ------- -------
Net cash used in investing activities (34,933) --- ---
Financing Activities
Proceeds from issuance of long term debt....... 34,453 --- ---
Proceeds from exercise of stock options........ 956 22 206
Retirement of common stock..................... (297) --- ---
-------- ------- -------
Net cash provided by financing activities......... 35,112 22 206
-------- ------- ------
Increase in cash and short-term investments....... 381 28 222
Cash and short-term investments at beginning
of year....................................... 562 534 312
-------- ------- -------
Cash and short-term investments at end of year.... $ 943 $ 562 $ 534
======== ======= =======
See notes to condensed financial statements.
81
<PAGE>
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
TRIAD GUARANTY INC.
(PARENT COMPANY)
SUPPLEMENTARY NOTES
NOTE 1
In the parent company financial statements, the Company's investment in its
subsidiaries is stated at cost plus equity in undistributed earnings of the
subsidiaries. The Company's share of net income of its subsidiaries is included
in income using the equity method. The accompanying Parent Company financial
statements should be read in conjunction with the Consolidated Financial
Statements and Notes to Consolidated Financial Statements included as part of
this Form 10-K.
NOTE 2
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 3
The amortized cost and the fair value of investments held by the parent
company are as follows (dollars in thousands):
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
AT DECEMBER 31, 1998
Available-for-sale Securities:
Fixed Maturity Securities:
Corporate................... $ 9,777 $113 $451 $9,439
------ ---- ---- ------
Total.................... 9,777 113 451 9,439
Equity Securities............. 300 -- 29 271
------ ---- ---- ------
Total.................... $10,077 $113 $480 $9,710
======= ==== ==== ======
82
<PAGE>
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
TRIAD GUARANTY INC.
(PARENT COMPANY)
SUPPLEMENTARY NOTES
NOTE 3 (CONTINUED)
Major categories of the parent company's investment income are summarized
as follows (dollars in thousands):
Year Ended December 31
----------------------
1998 1997 1996
---- ---- ----
Income:
Fixed Maturities.................. $ 679 $-- $--
Equity Securities................. 17 -- --
Cash and short-term investments... 71 22 417
Note receivable from subsidiary... 2,052 -- --
------ --- ----
Total............................. 2,819
Expenses............................. 32 -- --
------ --- ----
Net investment income................ $2,787 $22 $ 17
====== === ====
NOTE 4
In January of 1998, the Company completed a $35 million private offering of
notes due January 15, 2028. Proceeds from the offering, net of debt issue costs
of $547,102, totaled $34,542,898. The notes, which represent unsecured
obligations of the Company, bear interest at a rate of 7.9% per annum and are
non-callable.
83
<PAGE>
SCHEDULE IV - REINSURANCE
TRIAD GUARANTY INC.
MORTGAGE INSURANCE PREMIUM EARNED
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Percentage
Ceded To Assumed of Amount
Gross Other From Other Net Assumed
Amount Companies Companies Amount to Net
--------------------------------------------------------
(dollars in thousands)
1998................ $53,905 $1,099 $16 $52,822 0.0%
======= ====== === =======
1997................ $40,311 $1,809 $20 $38,522 0.1%
======= ====== === =======
1996................ $27,019 $2,320 $29 $24,728 0.1%
======= ====== === =======
84
EXHIBIT 23.1
Exhibit 23 - Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 33-75668) pertaining to the 1993 Long-Term Stock Incentive Plan of Triad
Guaranty Inc., the Registration Statement (Form S-8 No. 33-96550) pertaining to
the Triad Guaranty Inc. 401(k) Profit Sharing Plan, and the Registration
Statement (Form S-8 No. 33-69967) pertaining to the Employee Stock Purchase Plan
of Triad Guaranty Inc. of our report dated January 20, 1999, with respect to the
consolidated financial statements included in this Annual Report (Form 10-K) of
Triad Guaranty Inc., and our report included in the following paragraph with
respect to the financial statement schedules.
Our audits also included the financial statement schedules of Triad Guaranty
Inc. listed in Item 14(a). These schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion based on our
audits. In our opinion, the financial statement schedules referred to above,
when considered in relation to the basic financial statements taken as a whole,
present fairly in all material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
- -----------------------
Raleigh, North Carolina
March 24, 1999
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary information extracted from Form 10-K for the
twelve months ended December 31, 1998, and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 157,391,829
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 14,024,012
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 177,301,033
<CASH> 444,200
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 16,015,559
<TOTAL-ASSETS> 205,255,770
<POLICY-LOSSES> 12,142,990
<UNEARNED-PREMIUMS> 7,054,737
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 34,457,080
0
0
<COMMON> 134,089
<OTHER-SE> 137,397,251
<TOTAL-LIABILITY-AND-EQUITY> 205,255,770
52,821,731
<INVESTMENT-INCOME> 9,289,026
<INVESTMENT-GAINS> 880,502
<OTHER-INCOME> 13,652
<BENEFITS> 7,008,618
<UNDERWRITING-AMORTIZATION> 5,954,915
<UNDERWRITING-OTHER> 12,434,890
<INCOME-PRETAX> 35,052,362
<INCOME-TAX> 10,678,289
<INCOME-CONTINUING> 24,374,073
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 24,374,073
<EPS-PRIMARY> 1.83
<EPS-DILUTED> 1.76
<RESERVE-OPEN> 8,909,121
<PROVISION-CURRENT> 7,953,412
<PROVISION-PRIOR> (944,794)
<PAYMENTS-CURRENT> 266,983
<PAYMENTS-PRIOR> 3,534,822
<RESERVE-CLOSE> 12,115,934
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
