SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-12644
Financial Security Assurance Holdings Ltd.
(Exact name of registrant as specified in its charter)
New York 13-3261323
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
350 Park Avenue, New York, New York
10022 (Address of principal executive offices, including zip code)
(212) 826-0100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b)of the Act:
Title of each class Name of each exchange on which registered
Common Stock, par value $.01 per share New York Stock Exchange, Inc.
Securities registered pursuant to section 12(g) of the Act:
None
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 voting stock, excluding treasury shares, held
by non-affiliates of the registrant at March 14, 1997 was $1,095,363,846 (based
upon the closing price of the registrant's shares on the New York Stock Exchange
on March 14, 1997, which was $35.375). For purposes of the foregoing, only U S
WEST Capital Corporation and Fund American Enterprises Holdings, Inc. were
deemed to be affiliates of the registrant.
At March 14, 1997, there were outstanding 30,964,349 shares of Common
Stock, par value $0.01 per share, of the registrant (includes 984,629 shares of
Common Stock owned by a trust on behalf of the Company and excludes 1,311,952
shares of Common Stock actually held in treasury).
Documents Incorporated By Reference
Portions of the registrant's Annual Report to Shareholders for the year
ended December 31, 1996 are incorporated by reference into Part II hereof.
Portions of the registrant's definitive Proxy Statement dated March 24, 1997 in
connection with the Annual Meeting of Shareholders to be held on May 8, 1997 are
incorporated by reference into Part III hereof.
<PAGE>
TABLE OF CONTENTS
Page
----
Item 1. Business........................................................ 2
Item 2. Properties...................................................... 23
Item 3. Legal Proceedings............................................... 23
Item 4. Submission of Matters to a Vote of Security Holders............. 23
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters........................................... 24
Item 6. Selected Financial Data......................................... 24
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................... 24
Item 8. Financial Statements and Supplementary Data..................... 24
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...................................... 24
Item 10. Directors and Executive Officers of the Registrant.............. 25
Item 11. Executive Compensation.......................................... 25
Item 12. Security Ownership of Certain Beneficial Owners and Management.. 25
Item 13. Certain Relationships and Related Transactions.................. 25
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. 26
<PAGE>
Item 1. Business.
General
Financial Security Assurance Holdings Ltd. (the "Company"), through its
wholly owned subsidiary, Financial Security Assurance Inc. ("FSA"), is primarily
engaged in the business of providing financial guaranty insurance on
asset-backed securities and municipal bonds. FSA was the first insurance company
organized to insure asset-backed obligations and has been a leading insurer of
asset-backed obligations (based on number of transactions insured) since its
inception in 1985. FSA expanded the focus of its business in 1990 to include
financial guaranty insurance of municipal obligations. For the year ended
December 31, 1996, FSA had gross premiums written of $177.0 million, of which
45% related to insurance of asset-backed obligations and 55% related to
insurance of municipal obligations. At December 31, 1996, FSA had net insurance
in force of $93.7 billion, of which 68% represented insurance of municipal
obligations and 32% represented insurance of asset-backed obligations. FSA is
licensed to engage in the financial guaranty insurance business in all 50
states, the District of Columbia and Puerto Rico.
At December 31, 1993, the Company was owned 92.5% by U S WEST Capital
Corporation ("U S WEST") and 7.5% by The Tokio Marine and Fire Insurance Co.,
Ltd. ("Tokio Marine"). The Company completed an initial public offering (the
"IPO") of common shares on May 13, 1994, at which time Fund American Enterprises
Holdings, Inc. ("Fund American") purchased 2,000,000 shares of the Company's
common stock. In connection with the IPO, the Company, U S WEST and Fund
American entered into certain agreements providing, among other things, Fund
American certain rights to acquire additional shares of the Company from the
Company and U S WEST. Pursuant to these agreements, on September 2, 1994, the
Company issued to Fund American 2,000,000 shares of Series A non-dividend paying
voting convertible preferred stock having a liquidation preference of $700,000.
In December 1995, the Company acquired Capital Guaranty Corporation ("Capital
Guaranty") in a merger transaction in which Capital Guaranty became a direct
wholly owned subsidiary of the Company (the "Merger"). Capital Guaranty through
its wholly owned subsidiary, Capital Guaranty Insurance Corporation ("CGIC"),
provided financial guaranty insurance on municipal bonds. In connection with the
Merger, CGIC, whose principal business is now as a reinsurer of policies written
by FSA, changed its name to Financial Security Assurance of Maryland Inc.
("FSAM"). In May 1996, the Company acquired into treasury 1,000,000 of its
common shares from U S WEST. At December 31, 1996, voting control of the Company
was held 31.0% by U S WEST, 22.3% by Fund American, 5.9% by Tokio Marine and
40.8% by the public and employees. U S WEST has previously announced its
intention to dispose of its remaining interest in the Company as part of its
strategic plan to withdraw from businesses not directly involved in
telecommunications. Substantially all the Company's shares owned by U S WEST are
either subject to stock options held by Fund American or potentially deliverable
in satisfaction of DECS (Debt Exchangeable for Common Stock) securities issued
in May 1996 by U S WEST, Inc.
U S WEST is a subsidiary of U S WEST, Inc., which operates businesses
involved in communications, data solutions, marketing services and capital
assets, including the provision of telephone services in 14 states in the
western and midwestern United States. Fund American is a financial services
holding company whose operating subsidiaries include various insurance companies
and one of the largest mortgage loan servicers in the United States. Tokio
Marine is a major Japanese property and casualty insurance company.
FSA wholly owns FSAM, which in turn wholly owns Financial Security
Assurance of Oklahoma, Inc. ("Oklahoma"). FSAM and Oklahoma provide reinsurance
to FSA.
Financial Security Assurance (U.K.) Limited ("FSA-UK"), a wholly owned
subsidiary of Oklahoma, is authorized to transact an insurance business in the
United Kingdom, and provides financial guaranty insurance for transactions in
the United Kingdom and other European markets.
FSA Portfolio Management Inc. ("FSA Portfolio Management"), a wholly owned
subsidiary of the Company, is engaged in the business of managing the investment
portfolios of the Company and its subsidiaries and of certain third parties.
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<PAGE>
Transaction Services Corporation ("TSC"), a wholly owned subsidiary of the
Company, is engaged in the business of managing workout transactions within the
insured portfolios of the Company and its subsidiaries and of certain third
parties.
Financial Security Assurance International Inc. ("International") is a
non-operating Indiana insurance company subsidiary of FSA. In connection with
the Merger, substantially all the assets in excess of the minimum required
capital of International and all its liabilities were transferred to FSA.
International is now being held by FSA with the intention to sell it to a third
party.
Industry Overview
Financial guaranty insurance written by FSA typically guarantees scheduled
payments on an issuer's obligations. In the case of a payment default on an
insured obligation, FSA is generally required to pay the principal, interest or
other amounts due in accordance with the obligation's original payment schedule
or, at its option, to pay such amounts on an accelerated basis. FSA's
underwriting policy is to insure asset-backed and municipal obligations that
would otherwise be investment grade without the benefit of FSA's insurance. The
asset-backed obligations insured by FSA are generally issued in structured
transactions backed by pools of assets such as residential mortgage loans,
consumer or trade receivables, securities or other assets having an
ascertainable cash flow or market value. The municipal obligations insured by
FSA consist primarily of general obligation bonds supported by the issuers'
taxing power and special revenue bonds and other special obligations of state
and local governments supported by the issuers' ability to impose and collect
fees and charges for public services or specific projects.
The Company's business objective is to remain a leading insurer of
asset-backed obligations and to become a more prominent insurer of municipal
obligations. The Company's acquisition of Capital Guaranty in December 1995
increased the Company's presence in the insured municipal bond sector. The
Company believes that the demand for its financial guaranty insurance will grow
over the long term in response to anticipated growth in insured asset-backed and
municipal obligations. The Company expects continued growth in the insurance of
asset-backed obligations, due in part to the continued expansion of asset
securitization outside of the residential mortgage sector. In the long term, the
Company also expects continued growth in the insurance of municipal obligations,
due in part to increased issuance of municipal bonds to finance repairs and
improvements to the nation's infrastructure and increased municipal bond
purchases by individuals who generally purchase insured obligations. In
addition, the percentage of new domestic municipal bond volume which is insured
has increased each year since 1986, to 46% for the year ending 1996 according to
published sources. Financial guaranty insurance has also begun to be applied to
obligations of municipal issuers located outside of the United States.
The Company expects to continue to emphasize a diversified insured
portfolio characterized by insurance of both asset-backed and municipal
obligations, with a broad geographic distribution and a variety of revenue
sources and transaction structures.
In addition to its domestic business, the Company pursues international
opportunities and currently operates in the European and Pacific Rim markets.
The Company was the first financial guaranty insurance company to insure
asset-backed obligations in international markets. The Company is also party to
a Cooperation Agreement with Tokio Marine, which provides an arrangement to
develop financial guaranty insurance opportunities in Japan.
Business of FSA
Insurance Markets
FSA writes financial guaranty insurance on asset-backed obligations and
municipal obligations, a description of which follows.
Asset-Backed Obligations
Asset-backed obligations are typically issued in connection with structured
financings or securitizations, in which the securities being issued are secured
by or payable from a specific pool of assets having an ascertainable cash flow
or market value and held by a special purpose issuing entity. While most
asset-backed obligations are
3
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secured by or represent interests in diverse pools of assets, such as
residential mortgage loans and credit card and auto loan receivables, monoline
financial guarantors have also insured asset-backed obligations secured by less
diverse payment sources, such as utility mortgage bonds and multifamily real
estate.
In general, asset-backed obligations are payable from cash flow generated
by a pool of assets and take the form of either "pass-through" obligations,
which represent interests in the related assets, or "pay-through" obligations,
which generally are debt obligations collateralized by the related assets. Both
types of asset-backed obligations also generally have the benefit of
overcollateralization, excess cash flow or one or more forms of credit
enhancement to cover credit risks associated with the related assets.
The following table sets forth certain industry information relating to
selected asset-backed obligations for the periods indicated:
New Asset-Backed Obligations
<TABLE>
<CAPTION>
Volume of
Private-Label Volume of Other Combined Asset-Backed Volume
Residential Public Volume Insured by Monoline
Mortgage Asset-Backed of Asset-Backed Insurance
Obligations(1) Obligations(2) Obligations(3) Companies(4)
--------------- ------------------ ------------------ ----------------------
(dollars in billions)
<C> <C> <C> <C> <C>
1991........ $49.3 $50.6 $ 99.9 $ 9.8
1992........ 89.5 51.1 140.6 10.3
1993........ 98.5 61.0 159.5 21.4
1994........ 63.2 75.5 138.7 24.7
1995........ 37.0 108.0 145.0 44.7
1996........ 38.4 151.1 189.5 N/A(5)
</TABLE>
- ----------
(1) Information is from Inside Mortgage Securities, January 8, 1993, January
14, 1994, January 20, 1995, February 2, 1996, and Inside MBS & ABS,
February 14, 1997, and includes all U.S. public and rated private
residential first mortgage-backed transactions, except obligations issued
or guaranteed by government related entities.
(2) Information is from Asset Sales Report, January 18, 1993, January 25, 1993,
January 10, 1994, January 9, 1995, January 22, 1996, and January 27, 1997,
and includes all U.S. public asset-backed obligations (other than
commercial paper transactions) backed by consumer receivables (including
home equity loans), pooled corporate obligations and commercial mortgages.
(3) Combined volume excludes both (i) private placement non-residential
asset-backed obligations and (ii) asset-backed commercial paper.
(4) Information for 1991 through 1992 is based on data provided in the
Association of Financial Guaranty Insurors (AFGI), Report of Combined
Financial Results and New Business Written for the period ended December
31, 1992. Information for 1993 is based on data provided in the AFGI,
Annual Report 1993. Information for 1994 and 1995 is based upon AFGI
reporting for those years.
(5) Not available.
The issuance of asset-backed obligations of the type included in the table
experienced substantial growth in each year over the 1991 to 1996 period, with
the exception of 1994. The combined volume of such asset-backed obligations grew
from $99.9 billion in 1991 to $189.5 billion in 1996.
During 1991, credit card obligations were the largest single component of
public, non-residential asset-backed obligations. Automobile loans were the
largest component in 1992 and 1993. Credit card obligations were the largest
component in 1994 , 1995 and 1996.
The par value of new asset-backed obligations insured by monoline financial
guaranty insurance companies rose in every year from 1991 through 1995.
The growth in the issuance of asset-backed obligations since 1991 has been
due in part to increased capital requirements of commercial banks and insurance
companies and the contraction of credit extended to corporations. Banks have
responded to increased capital requirements by selling certain of their assets,
such as credit card receivables and automobile loans, in securitized structures
to the financial markets. Moreover, many corporations have found securitization
of their assets to be a less costly funding alternative to traditional forms of
borrowing.
4
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Residential mortgage-backed issuance declined in 1994 because interest
rates rose, causing a reduction in mortgage loan refinancings and therefore in
the amount of new loan originations available for securitization. The decline
continued in 1995, as interest rates stabilized, and ended in 1996. In addition,
a substantial amount of residential first mortgage loans were securitized in the
home equity loan sector of the asset-backed market in 1996.
The demand for asset securitizations continues to deepen and broaden as
issuers securitize new classes of assets through increasingly complex
structures. Properly structured credit enhancements are often attractive in
providing market acceptability, liquidity and security.
Municipal Obligations
Municipal obligations include bonds, notes and other evidences of
indebtedness issued by states and their political subdivisions (such as
counties, cities or towns), utility districts, public universities and
hospitals, public housing and transportation authorities and other public and
quasi-public entities. Municipal obligations are supported by the issuer's
taxing power in the case of general obligation bonds, or by the issuer's ability
to impose and collect fees and charges for public services or specific projects
in the case of most special revenue bonds.
Insurance of municipal obligations represents the largest portion of the
financial guaranty insurance business. Since the early 1980s, insured municipal
obligation volume has grown substantially in terms of insurance in force, the
number of municipalities issuing insured obligations and the types of municipal
obligations that are insured. In the 1980s, insured new-issue volume peaked in
1985 in anticipation of tax reform legislation. After passage of the Tax Reform
Act of 1986, new-issue volume declined in 1987, but increased until 1994. The
percentage of municipal obligations insured has also increased substantially
since 1986. The low market interest rates which prevailed during 1993 resulted
in record levels of new issuances and refundings of municipal bonds. As
expected, these record levels of issuances and refundings were not sustained
when interest rates increased. Consequently, the volume of issuances and
refundings of municipal bonds, and opportunities to write insurance for such
bonds, fell significantly in 1994 and modestly in 1995. Both total issuance and
refundings increased in 1996.
The following table sets forth certain information regarding long-term
municipal obligations, issued during the periods indicated:
Insured Municipal Obligations(1)
New Insured
Volume
New New as Percent
Year Total Volume Insured Volume of New Total Volume
---- ------------ -------------- -------------------
(dollars in billions)
1987 ...... $105.0 $19.1 18.2%
1988 ...... 117.3 27.1 23.1
1989 ...... 125.0 31.1 24.9
1990 ...... 127.8 33.5 26.2
1991 ...... 172.4 51.9 30.1
1992 ...... 234.6 80.8 34.4
1993 ...... 291.9 108.0 37.0
1994 ...... 164.6 61.4 37.3
1995 ...... 160.3 68.5 42.7
1996 ...... 184.4 85.2 46.2
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(1) Information is based on data provided in The Bond Buyer, January 27, 1996.
Volume is expressed on the basis of principal value insured.
Types of Products
FSA's insurance is employed in both the new issue and secondary markets.
Insurance premium rates take into account the cost and the projected return to
and the risk assumed by FSA. Critical factors in assessing risk
5
<PAGE>
include the credit quality of the issuer, type of issue, sources of repayment,
transaction structure and term to maturity. Each obligation is evaluated on the
basis of, and the final premium rate is a function of, such factors and subject
to FSA's underwriting guidelines.
In the case of new issues, the insured obligations are sold with FSA
insurance at the time the obligations are issued. For both municipal and
asset-backed obligations, FSA participates in negotiated offerings, where the
investment banker and often the insurer have been selected by the sponsor or
issuer. In addition, FSA participates in competitive offerings, where
underwriting syndicates bid for securities and submit bids that may include
insurance.
In the secondary market, FSA's Triple-A Guaranteed Secondary Securities
(TAGSS(R)) Program provides insurance for uninsured asset-backed obligations
trading in the secondary market. TAGSS-insured securities include utility first
mortgage bonds, sale-leaseback bonds and asset-backed securities supported by
residential mortgages and receivables. FSA's Custody Receipt Program provides
insurance for uninsured municipal obligations trading in the secondary market.
The insurance of obligations outstanding in the secondary market generally
affords a wider secondary market and therefore greater marketability to a given
issue of previously issued obligations. FSA's underwriting guidelines require it
to apply the same underwriting standards on secondary market issues that it does
on new security issues, although the evaluation procedures are typically
abbreviated.
FSA also writes portfolio insurance for securities held by investment
funds, such as unit investment trusts and mutual funds. Such insurance covers
securities either while they are held by the fund or to their maturity, whether
or not held by the fund.
The following table indicates the percentages of par amount (net of
reinsurance) outstanding at December 31, 1996 and 1995 with respect to each type
of asset-backed and municipal program:
Net Par Amount and Percentage Outstanding by Program Type
<TABLE>
<CAPTION>
December 31, 1996
-----------------------------------------------------------
Asset-Backed Programs Municipal Programs
---------------------------- ---------------------------
Percent of Percent of
Net Total Net Par Net Total Net Par
Par Amount Amount Par Amount Amount
Outstanding Outstanding Outstanding Outstanding
----------- ----------- ----------- -----------
(dollars in millions)
<S> <C> <C> <C> <C>
New Issue................. $21,455 93.7% $29,390 85.5%
Secondary Market.......... 1,417 6.2 4,986 14.5
Portfolio Insurance....... 26 0.1 13 0.0
------- ----- ------- -----
Total................ $22,898(2) 100.0% $34,389(3) 100.0%
======= ===== ======= =====
</TABLE>
<TABLE>
<CAPTION>
December 31, 1995
------------------------------------------------------------
Asset-Backed Programs Municipal Programs
---------------------------- ----------------------------
Percent of Percent of
Net Total Net Par Net Total Net Par
Par Amount Amount Par Amount Amount
Outstanding Outstanding Outstanding Outstanding
----------- ----------- ----------- -----------
(dollars in millions)
<S> <C> <C> <C> <C>
New Issue................. $15,343 91.7% $22,560 83.5%
Secondary Market.......... 1,356 8.1 4,451 16.4
Portfolio Insurance....... 33 0.2 14 0.1
------- ----- ------- -----
Total................ $16,732(1) 100.0% $27,025(2) 100.0%
======= ===== ======= =====
</TABLE>
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(1) Excludes $302 million and $331 million par amount outstanding assumed by
FSA under reinsurance agreements at December 31, 1996 and 1995,
respectively.
(2) Excludes $1,605 million and $1,891 million par amount outstanding assumed
by FSA under reinsurance agreements at December 31, 1996 and 1995,
respectively.
Insurance in Force
FSA has insured a variety of asset-backed obligations, including
obligations backed by residential mortgages, consumer receivables, corporate
bonds, bank loans, government debt and commercial mortgages. FSA
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has insured a broad array of municipal obligations. FSA has also insured
investor-owned utility first mortgage bonds.
FSA ceased writing insurance for commercial mortgage transactions in 1990
and announced its withdrawal from this sector of its business in 1992. In
December 1993, in anticipation of the IPO, the Company took certain steps (the
"Restructuring") to reduce its risk of loss from commercial mortgage
transactions previously insured by FSA and its subsidiaries. As part of the
Restructuring, (i) the Company established Commercial Reinsurance Company
("Commercial Re"), a special purpose reinsurance company; (ii) the Company
distributed all the outstanding shares of Commercial Re to the existing
shareholders of the Company in proportion to their ownership interests in the
Company at the time; and (iii) Commercial Re assumed approximately 64.4% of the
exposure of FSA and its subsidiaries, on a weighted average basis, on commercial
mortgage transactions previously insured by FSA and its subsidiaries.
FSA has selectively expanded its insured portfolio in a manner intended to
achieve diversification. At December 31, 1996, FSA and its subsidiaries had in
force 487 issues insuring approximately $32.5 billion in gross direct par amount
outstanding of asset-backed obligations and 2,485 issues insuring approximately
$45.0 billion in gross direct par amount outstanding of municipal obligations.
In addition, at December 31, 1996, FSA had assumed pursuant to certain
reinsurance contracts approximately $0.3 billion and $1.7 billion in par amount
outstanding on asset-backed and municipal obligations, resulting in a total
gross par amount outstanding of approximately $79.5 billion. At such date, the
total net par amount outstanding, determined by reducing the gross par amount
outstanding to reflect reinsurance ceded of approximately $20.3 billion, was
approximately $59.2 billion. At December 31, 1996, the weighted average life of
the direct principal insured on these policies was approximately five and
thirteen years, respectively, for asset-backed and municipal obligations.
Asset-Backed Obligations
FSA's insured portfolio of asset-backed obligations is divided into seven
major areas:
Residential Mortgages. Obligations primarily backed by residential
mortgages generally take the form of conventional pass-through certificates or
pay-through debt securities, but also include commercial paper obligations and
other highly structured products. Residential mortgages backing these insured
obligations include closed-end first mortgages and closed- and open-end second
mortgages or home equity loans on one-to-four family residential properties,
including condominiums and cooperative apartments.
Consumer Receivables. Obligations primarily backed by consumer receivables
include conventional pass-through and pay-through securities as well as more
highly structured transactions. Consumer receivables backing these insured
obligations include automobile loans and leases, credit card receivables, mobile
home loans, timeshare loans and limited partnership investor notes.
Government Securities. Obligations primarily backed by government
securities include insured investment funds that invested in government
securities and insured bonds backed by letters of credit or repurchase
agreements collateralized by government securities. Government securities
include full faith and credit obligations of the United States and obligations
of public and quasi-public agencies of the United States, such as the Federal
National Mortgage Association and the Federal Home Loan Mortgage Corporation, as
well as obligations of non-U.S. sovereigns.
Pooled Corporate Obligations. Obligations primarily backed by pooled
corporate obligations include obligations collateralized by corporate debt
securities or corporate loans and obligations backed by cash flow or market
value of non-consumer indebtedness. Corporate obligations include corporate
bonds, bank loan participations, trade receivables and equity securities.
Investor-Owned Utility Obligations. Obligations backed by investor-owned
utilities include, most commonly, first mortgage bond obligations of for-profit
electric or water utilities providing retail, industrial and commercial service,
and also include sale-leaseback obligation bonds supported by such entities. In
each case, these bonds are secured by a mortgage on property owned by or leased
to an investor-owned utility.
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<PAGE>
Commercial Mortgage Portfolio. FSA ceased writing insurance in this sector
in 1990 and as part of the Restructuring obtained reinsurance from Commercial Re
relating to risk of loss in this sector. Obligations backed by commercial
mortgages are divided into commercial real estate and corporate secured
obligations. Commercial real estate obligations are primarily backed by
commercial real estate, including hotel properties, office buildings and
warehouses and consist of pay-through bonds, pass-through certificates and more
structured products, with credit protection provided by property cash flow,
property values, first loss letters of credit, cash reserves and other means.
Corporate secured obligations generally take the form of bond obligations
secured by mortgages on properties leased to one or more affiliated corporate
tenants, in which the obligations are secured primarily by the lease cash flow
and secondarily by the value of the mortgaged properties
Other Asset-Backed Obligations. Other asset-backed obligations insured by
FSA include bonds or other securities backed by a combination of assets that
include elements of more than one of the categories set forth above.
Municipal Obligations
FSA's insured portfolio of municipal obligations is divided into seven
major areas:
General Obligation Bonds. General obligation bonds are issued by states,
their political subdivisions and other municipal issuers, and are supported by
the general obligation of the issuer to pay from available funds and by a pledge
of the issuer to levy taxes sufficient in an amount to provide for the full
payment of the bonds to the extent other available funds are insufficient.
Housing Revenue Bonds. Housing revenue bonds include both multifamily and
single family housing bonds, with multi-tiered security structures based on the
underlying mortgages, reserve funds, and various other features such as Federal
Housing Administration or private mortgage insurance, bank letters of credit,
and, in some cases, the general obligation of the issuing housing agency or a
state's "moral obligation" (that is, not a legally binding commitment) to make
up deficiencies.
Municipal Utility Revenue Bonds. Municipal utility revenue bonds include
obligations of all forms of municipal utilities, including electric, water and
sewer utilities. Insurable utilities may be organized as municipal enterprise
systems, authorities or joint-action agencies.
Health Care Revenue Bonds. Health care revenue bonds include both long-term
maturities for capital construction or improvements of health care facilities
and medium-term maturities for equipment purchase.
Tax-Supported (Non-General Obligation) Bonds. Tax-supported (non-general
obligation) bonds include a variety of bonds that, though not general
obligations, are supported by the taxing ability of the issuer, such as
tax-backed revenue bonds and lease revenue bonds. Tax-backed revenue bonds may
be secured by a first lien on pledged tax revenues, such as those from special
taxes, including those on retail sales and gasoline, or from tax increments (or
tax allocations) generated by growth in property values within a district. FSA
also insures bonds secured by special assessments, levied against property
owners, which benefit from covenants by the district to levy, collect and
enforce collections and to foreclose on delinquent properties. Lease revenue
bonds or certificates of participation (COPs) may be secured by long-term
obligations or by lease obligations subject to annual appropriation. The
financed project is generally real property or equipment that, in the case of
annual appropriation leases, FSA deems to serve an essential public purpose
(e.g., schools, prisons, courts) or, in the case of long-term leases, is
insulated from the risk of abatement resulting from nontenantability.
Transportation Revenue Bonds. Transportation revenue bonds include a wide
variety of revenue-supported bonds, such as bonds for airports, ports, tunnels,
parking facilities, toll roads and toll bridges.
Other Municipal Bonds. Other municipal bonds insured by FSA include college
and university revenue bonds, resource recovery bonds and debt issued,
guarantied or otherwise supported by the national or local governments of
Australia, Denmark, Finland, France, Italy, Spain and Sweden.
A summary of FSA's insured portfolio at December 31, 1996 is shown below:
8
<PAGE>
Summary of Insured Portfolio at December 31, 1996
<TABLE>
<CAPTION>
Percent
Number of
of Net Par Net Net
Issues In Amount Par and Par and
Force Outstanding Interest Interest
---------- ------------ ----------- ----------
(dollars in millions)
<S> <C> <C> <C> <C>
Asset-backed obligations
Residential mortgages................ 261 $10,987 $15,307 16.3%
Consumer receivables................. 118 7,548 8,316 8.9
Government securities................ 19 1,477 1,629 1.7
Pooled corporate obligations........ 27 1,663 1,918 2.0
Investor-owned utility obligations... 51 791 2,020 2.2
Commercial mortgage portfolio:
Commercial real estate............. 9 113 138 0.1
Corporate secured.................. 3 66 99 0.1
Other asset-backed obligations....... 9 555 669 0.8
---------- ------------ ----------- ----------
Total asset-backed obligations..... 497 23,200 30,096 32.1
---------- ------------ ----------- ----------
Municipal obligations
General obligation bonds............. 1,522 12,523 20,422 21.8
Housing revenue bonds................ 252 1,794 4,116 4.4
Municipal utility revenue bonds...... 296 4,671 8,393 9.0
Health care revenue bonds............ 100 2,854 5,450 5.8
Tax-supported (non-general
obligation) bonds.................. 410 8,805 15,462 16.5
Transportation revenue bonds......... 40 1,479 2,847 3.0
Other municipal bonds................ 263 3,868 6,917 7.4
---------- ------------ ----------- ----------
Total municipal obligations........ 2,883 35,994 63,607 67.9
---------- ------------ ----------- ----------
Total.......................... 3,380 $59,194 $93,703 100.0%
========== ============ =========== ==========
</TABLE>
9
<PAGE>
Obligation Type
The table below sets forth the relative percentages of net par amount
written of obligations insured by FSA by obligation type during each of the last
five years:
Annual New Business Insured by Obligation Type
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------------
Obligation Type 1996 1995 1994 1993 1992
--------------- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Asset-backed obligations
Residential mortgages.................... 29% 26% 25% 14% 18%
Consumer receivables..................... 25 29 23 12 9
Government securities.................... 1 0 0 0 9
Pooled corporate obligations............ 1 10 4 1 4
Commercial Mortgage Portfolio:
Commercial real estate................. 0 0 0 0 0
Corporate secured ..................... 0 0 0 0 0
Investor-owned utility obligations....... 0 0 2 3 0
Other asset-backed obligations 2 1 2 3 1
----------- ----------- --------- --------- --------
Total asset-backed obligations......... 58 66 56 33 41
Municipal obligations
General obligations bonds................ 20 11 12 14 15
Housing revenue bonds.................... 1 2 1 3 4
Municipal utility revenue bonds.......... 4 4 8 10 9
Health care revenue bonds................ 2 3 4 7 8
Tax-supported (non-general
obligation) bonds...................... 9 6 11 17 12
Transportation revenue bonds............. 1 6 1 3 4
Other municipal bonds.................... 5 2 7 13 7
----------- ----------- --------- --------- --------
Total municipal obligations............ 42 34 44 67 59
----------- ----------- --------- --------- --------
Total.............................. 100% 100% 100% 100% 100%
=========== =========== ========= ========= ========
</TABLE>
Terms to Maturity
The table below sets forth the estimated terms to maturity of FSA's
policies at December 31, 1996 and 1995:
Estimated Terms to Maturity of Net Par of Insured Obligations(1)
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
------------------------------ --------------------------------
(in millions)
Estimated Asset- Asset-
Term to Maturity Backed Municipal Backed Municipal
---------------- ------ --------- ------ ---------
<S> <C> <C> <C> <C>
0 to 5 Years............................ $ 7,424 $ 1,571 $ 5,931 $ 3,293
5 to 10 Years........................... 3,920 3,841 3,679 4,713
10 to 15 Years.......................... 1,461 6,272 1,183 4,299
15 to 20 Years.......................... 714 11,433 423 6,986
20 Years and Above...................... 9,681 12,877 5,847 9,625
------------- ------------- ------------- ---------------
Total................................ $23,200 $35,994 $17,063 $28,916
============= ============= ============= ===============
</TABLE>
- ----------
(1) Based on estimates made by the issuers of the insured obligations as of the
original issuance dates of such obligations. Actual maturities could differ
from contractual maturities because borrowers have the right to call or
prepay certain obligations with or without call or prepayment penalties.
10
<PAGE>
Issue Size
The tables below set forth information with respect to the original net par
amount of insurance written per issue insured by FSA at December 31, 1996:
Asset-Backed
Original Net Par Amount Per Issue(1)
<TABLE>
<CAPTION>
Percent of
Percent of Total
Total Net Par Net Par
Original Number Number Amount Amount
Net Par Amount of Policies of Issues Outstanding Outstanding
-------------- ------------- -------------- --------------- ---------------
(dollars in millions)
<S> <C> <C> <C> <C>
Less than $10 million............ 449 43.8% $ 718 3.1%
$10 to $25 million............... 123 12.0 1,156 5.1
$25 to $50 million............... 127 12.4 2,185 9.5
$50 million or greater........... 326 31.8 18,839 82.3
----- ----- ------- -----
Total......................... 1,025 100.0% $22,898 100.0%
===== ===== ======= =====
</TABLE>
- ----------
(1) Does not include $302 million net par amount outstanding assumed by FSA and
its subsidiaries under reinsurance agreements.
Municipal
Original Net Par Amount Per Issue(1)
<TABLE>
<CAPTION>
Percent of
Percent of Total
Total Net Par Net Par
Original Number Number Amount Amount
Net Par Amount of Policies of Issues Outstanding Outstanding
-------------- ------------- -------------- --------------- ---------------
(dollars in millions)
<S> <C> <C> <C> <C>
Less than $10 million............... 3,994 77.0% $10,037 29.2%
$10 to $25 million.................. 707 13.6 7,424 21.6
$25 to $50 million.................. 251 4.8 5,872 17.1
$50 million or greater.............. 237 4.6 11,056 32.1
----- ----- ------- -----
Total............................ 5,189 100.0% $34,389 100.0%
===== ===== ======= =====
</TABLE>
- ----------
(1) Does not include $1,605 million net par amount outstanding assumed by FSA
and its subsidiaries under reinsurance agreements.
Geographic Concentration
In its asset-backed business, FSA considers geographic concentration as a
factor in underwriting insurance covering securitizations of asset pools such as
residential mortgage loans or consumer receivables. However, after the initial
issuance of an insurance policy relating to such securitizations, the geographic
concentration of the underlying assets may change over the life of the policy.
In addition, in writing insurance for other types of asset-backed obligations,
such as securities primarily backed by government or corporate debt, geographic
concentration is not deemed by FSA to be a significant credit factor given other
more relevant measures of diversification such as issuer or industry
diversification.
FSA seeks to maintain a diversified portfolio of insured municipal
obligations designed to spread its risk across a number of geographic areas. The
table below sets forth those jurisdictions in which municipalities issued an
aggregate of 2% or more of FSA's net par amount outstanding of insured municipal
securities:
11
<PAGE>
Municipal
Insured Portfolio by Jurisdiction
at December 31, 1996
Percent of Total
Net Par Municipal Net
Number Amount Par Amount
Jurisdiction of Issues Outstanding Outstanding
------------ ------------ ---------------- ---------------
(dollars in millions)
California................... 337 $5,669 15.8%
New York..................... 218 3,508 9.7
Florida...................... 96 2,189 6.1
Pennsylvania................. 157 2,106 5.9
Texas........................ 248 1,804 5.0
New Jersey .................. 175 1,733 4.8
Illinois..................... 193 1,320 3.7
Michigan .................... 118 1,145 3.2
Massachusetts................ 84 1,093 3.0
Minnesota.................... 113 1,080 3.0
Louisiana.................... 81 908 2.5
Wisconsin.................... 114 762 2.1
All other states............. 923 11,698 32.5
Non-U.S...................... 26 979 2.7
----- ------- -----
Total................... 2,883 $35,994 100.0%
===== ======= =====
Issuer Concentration
FSA has adopted underwriting and exposure management policies designed to
limit the net insurance in force for any one credit. In many cases, FSA uses
reinsurance to limit net exposure to any one credit. At December 31, 1996,
insurance of asset-backed obligations constituted 32.1% of FSA's net insurance
in force and insurance of municipal obligations constituted 67.9% of FSA's net
insurance in force. At such date, FSA's ten largest insured asset-backed
transactions represented $3.9 billion, or 16.8%, of its total net par amount
outstanding, and FSA's ten largest insured municipal credits represented $2.9
billion, or 8.2%, of its total net par amount outstanding. For purposes of the
foregoing, different issues of asset-backed securities by the same sponsor have
not been aggregated. FSA has, however, adopted underwriting policies
establishing single risk guidelines applicable to asset-backed securities of the
same sponsor. FSA is also subject to certain regulatory limits and rating agency
guidelines on exposure to single credits.
The following tables set forth the net par amount outstanding of FSA's
insurance for the ten largest asset-backed transactions and municipal credits
insured by FSA at December 31, 1996:
Ten Largest Insured Asset-Backed Transactions at December 31, 1996
Net Par
Amount
Transaction Asset Type Outstanding
----------- ---------- -----------
(in millions)
Merit Securities Corp. Series 8......... Residential Mortgages $ 774.8
Aames Home Equity Loan 1996-D........... Residential Mortgages 524.3
Aames Mortgage Trust 1996-C............. Residential Mortgages 435.9
Olympic Auto Receivables Trust 1995-E... Consumer Receivables 376.9
Mid-State Trust II...................... Residential Mortgages 340.7
CICB - Household Credit Cards........... Consumer Receivables 309.1
Olympic Auto Receivables Trust 1996-C... Consumer Receivables 301.9
Olympic Auto Receivables Trust 1995-D... Consumer Receivables 285.4
Olympic Auto Receivables Trust 1996-D... Consumer Receivables 280.9
Securitized Asset Sales Inc. 1993-6..... Residential Mortgages 275.9
--------
Total.............................. $3,905.8
========
12
<PAGE>
Ten Largest Insured Municipal Credits at December 31, 1996
Net Par
Amount
Credit Obligation Type Outstanding
------ --------------- -----------
(in millions)
Washington State Public Power Supply
System................................... Utility Revenue $ 346.0
New York State Medical Care Facilities
Finance Agency........................... Tax-Supported 342.3
State of California........................ General Obligation 327.9
New York City ............................. General Obligation 323.3
Commonwealth of Puerto Rico................ General Obligation 311.5
Puerto Rico Electric Power Authority....... Utility Revenue 286.3
Los Angeles County......................... General Obligation 273.1
Puerto Rico Highway Authority.............. Tax-Supported 257.7
New York City Municipal Water Finance
Authority................................ Utility Revenue 238.8
Vermont Student Assistance Corporation..... Other Municipal Bonds 225.0
--------
Total................................. $2,931.9
========
Credit Underwriting Guidelines, Standards and Procedures
Financial guaranty insurance, as written by FSA, relies on an assessment of
the adequacy of various payment sources to meet debt service payments or other
obligations in a specific transaction without regard to premiums paid or income
from investment of premiums. FSA's underwriting policy is to insure asset-backed
and municipal obligations that would otherwise be investment grade without the
benefit of FSA's insurance. To this end, each policy written or reinsured by FSA
must meet the general underwriting guidelines and specific standards for
particular types of obligations approved by its Board of Directors. In addition,
the Company's Board of Directors has established an Underwriting Committee which
periodically reviews completed transactions to ensure conformity with
underwriting guidelines and standards.
FSA's underwriting guidelines for asset-backed obligations are built on the
concept of multiple layers of protection, and vary by obligation type in order
to reflect different structures and credit support. In this regard, asset-backed
obligations insured by FSA are generally issued in structured transactions and
backed by pools of assets such as consumer or trade receivables, residential
mortgage loans, securities or other assets having an ascertainable cash flow or
market value. In addition, FSA seeks to insure asset-backed obligations that
generally provide for one or more forms of overcollateralization (such as excess
collateral value, excess cash flow or "spread," or reserves) or third-party
protection (such as bank letters of credit, guarantees, net worth maintenance
agreements, indemnity agreements or reinsurance policies). This
overcollateralization or third-party protection need not indemnify FSA against
all loss, but is generally intended to assume the primary risk of financial
loss. Overcollateralization or third-party protection may not, however, be
required in transactions in which FSA is insuring the obligations of certain
highly rated issuers that typically are regulated, have implied or explicit
government support, or are short term, or in transactions in which FSA is
insuring bonds issued to refinance other bonds insured by FSA as to which the
issuer is or may be in default. FSA's general policy has been to insure 100% of
the principal, interest and other amounts due in respect of asset-backed insured
obligations rather than providing partial or first loss coverage sufficient to
convey a triple-A rating on the insured obligations.
FSA's underwriting guidelines for municipal obligations require that the
municipal obligor be rated investment grade by Moody's Investors Service, Inc.
("Moody's") or Standard & Poor's Ratings Services ("S&P") or, in the
alternative, such obligor is considered by FSA to be the equivalent of
investment grade. Where the municipal obligor is a governmental entity with
taxing power or providing an essential public service paid by taxes, assessments
or other charges, supplemental protections may be required if such taxes,
assessments or other charges are not projected to provide sufficient debt
service coverage. Where appropriate, the municipal obligor is required to
provide a rate or charge covenant and a pledge of additional security (e.g.,
mortgages on real property, liens on equipment or revenue pledges) to secure the
obligation.
The rating agencies participate to varying degrees in the underwriting
process. Each asset-backed obligation insured by FSA is reviewed prior to
issuance by both S&P and Moody's to evaluate the risk proposed to be insured. In
the case of municipal obligations, prior rating agency review is a function of
the type of the insured obligation and the risk elements involved. In addition,
substantially all transactions insured by FSA are reviewed by
13
<PAGE>
at least one of the major rating agencies after issuance to confirm continuing
compliance with rating agency standards. The independent review of FSA's
underwriting practices performed by the rating agencies further strengthens the
underwriting process.
The underwriting process that implements these underwriting guidelines and
standards is supported by approximately 78 analysts, underwriting officers and
credit officers and 12 attorneys. Moreover, the approval of senior management is
required for all transactions.
Each underwriting group in the Financial Guaranty Department has a senior
underwriting officer responsible for confirming that each transaction proposed
by the Financial Guaranty Department conforms to the underwriting guidelines and
standards. The evaluation by the senior underwriting officer is reviewed and
approved, in the case of asset-backed transactions, by the Chief Underwriting
Officer, and, in the case of municipal transactions, by the Chief Municipal
Underwriting Officer. This review may take place while the transaction is in its
formative stages, thus facilitating the introduction of further enhancements at
a stage when the transaction is more receptive to change.
Final transaction approval is obtained from FSA's Management Review
Committee for asset-backed transactions, from FSA's Municipal Underwriting
Committee for municipal transactions and from FSA's European Project and
Infrastructure Committee for European project and infrastructure financings.
Approval is usually based upon both a written and an oral presentation by the
underwriting group to the respective committee. The Management Review Committee
is comprised of the President, the Chief Operating Officer, the Chief
Underwriting Officer, the General Counsel, the head of FSA's Financial Guaranty
Department and, on a rotating basis, a senior officer from the Financial
Guaranty Department. The Municipal Underwriting Committee is comprised of the
President, the Chief Operating Officer, the Chief Municipal Underwriting
Officer, the Associate General Counsel for Municipal Transactions and the
Managing Director for Municipal Surveillance. The European Project and
Infrastructure Committee is comprised of the President, the Chief Operating
Officer, the Chief Underwriting Officer, the General Counsel and two managing
directors from the Financial Guaranty Department. Following approval, minor
transaction modifications may be approved by the Chairs of the underwriting
groups. Major changes require the concurrence of the appropriate underwriting
committee. Secondary market and partial maturity asset-backed transactions of
$25.0 million or less of gross principal insured that meet certain credit and
return criteria may be approved by the Chief Underwriting Officer and the head
of the department involved, with a third signature from a member of the
Management Review Committee for transactions greater than $25.0 million and less
than $50.0 million. Municipal transactions of $50.0 million or less of gross
principal insured that meet certain credit and return criteria may be approved
by a committee composed of the Chief Municipal Underwriting Officer or the Head
of Municipal Surveillance, an Associate General Counsel for Municipal
Transactions and any one of certain designated managing directors of the
Municipal Department.
Corporate Underwriting and Research
FSA's Corporate Underwriting and Research Department includes eight
professionals under the direction of the Chief Underwriting Officer. The
Corporate Underwriting and Research Department is responsible for evaluating the
credit of entities participating or providing recourse in obligations insured by
FSA. The Corporate Underwriting and Research Department also provides analysis
of relevant industry segments. Members of the Corporate Underwriting and
Research Department generally report their findings directly to the appropriate
underwriting committee in the context of transaction review and approval.
Surveillance and Transaction Services
FSA's Surveillance and Transaction Services Departments include 20
professionals. The Asset-Backed and Municipal Surveillance Departments are
responsible for monitoring the performance of outstanding transactions. The
Transaction Services Department, together with the Surveillance Departments, are
responsible for taking remedial actions as appropriate. The Surveillance and
Transaction Services Departments are independent of the analysts and credit
officers involved in the underwriting process. The managing directors
responsible for the Surveillance and Transaction Services Departments report to
an Oversight Committee comprised of the President, the General Counsel, the
Chief Underwriting Officer and the Chief Financial Officer. The Surveillance
Departments review each insured transaction to confirm compliance with
transaction covenants, monitor credit and other developments affecting
transaction participants and collateral, and determine the steps, if any,
required to protect the interests of FSA and the holders of FSA-insured
obligations. Reviews for asset-backed transactions typically include an
examination of reports provided by, and (as circumstances warrant) discussions
with, issuers,
14
<PAGE>
servicers or trustees. In some instances, reviews of asset-backed transactions
include servicer audits, site visits or evaluations by third-party appraisers,
engineers or other experts retained by FSA. The Surveillance Departments review
each transaction to determine the level of ongoing attention it will require.
These judgments relate to current credit quality and other factors, including
compliance with reporting or other requirements, legal or regulatory actions
involving transaction participants and liquidity or other concerns that may not
have a direct bearing on credit quality. Transactions with the highest risk
profile are generally subject to more intensive review and, if appropriate,
remedial action. The Surveillance and Transaction Services Departments work
together with the Legal Department and the Corporate Underwriting and Research
Department in monitoring these transactions, negotiating restructurings and
pursuing appropriate legal remedies.
Legal
FSA's Legal Department includes 12 attorneys and six legal assistants under
the direction of the General Counsel. The Legal Department plays a major role in
establishing and implementing legal requirements and procedures applicable to
obligations insured by FSA. Members of the Legal Department serve on the
Management Review Committee, the Municipal Underwriting Committee, and the
European Project and Infrastructure Committee, which provide final underwriting
approval for transactions. An attorney in the Legal Department works together
with a counterpart in the Financial Guaranty Department in determining the legal
and credit elements of each obligation proposed for insurance and in overseeing
the execution of approved transactions. Asset-backed obligations insured by FSA
are ordinarily executed with the assistance of outside counsel working closely
with the Legal Department. Municipal obligations insured by FSA are ordinarily
executed without employment of outside counsel. The Legal Department works
closely with the Surveillance and Transaction Services Departments in addressing
legal issues, rights and remedies, as well as proposed amendments, waivers and
consents, in connection with obligations insured by FSA. The Legal Department is
also responsible for domestic and international regulatory compliance,
reinsurance, secondary market transactions, litigation and other matters.
Loss Reserves
FSA establishes a case basis reserve for the present value of the estimated
loss when, in management's opinion, the likelihood of a future loss is probable
and determinable at the balance sheet date. A case basis reserve for a
particular insured obligation represents FSA's estimate of the present value of
the anticipated shortfall, net of reinsurance, between (i) scheduled payments on
the insured obligations plus anticipated loss adjustment expenses and (ii)
anticipated cash flow from and proceeds to be received on sales of any
collateral supporting the obligation.
In addition to the case basis reserves, FSA maintains a general reserve in
order to account for the unidentified risks inherent in its overall portfolio.
FSA does not consider traditional actuarial approaches used in the
property/casualty insurance industry to be applicable to the determination of
its loss reserves because of the absence of a sufficient number of losses in its
financial guaranty insurance activities and in the financial guaranty industry
generally to establish a meaningful statistical base. The general reserve amount
was calculated by applying a loss factor to the total net par amount of FSA's
insured obligations outstanding over the term of such insured obligations and
discounting the result at a risk-free rate. The loss factor used for this
purpose has been determined based upon an independent rating agency study of
bond defaults and FSA's portfolio characteristics and history. FSA will, on an
ongoing basis, monitor the general reserve and may periodically adjust such
reserve based on FSA's actual loss experience, its future mix of business and
future economic conditions. The general reserve is available to be applied
against future additions or accretions to existing case basis reserves or to new
case basis reserves to be established in the future. To the extent that any such
future additions to case basis reserves are applied from the available general
reserve, there will be no impact on the Company's earnings for that period. To
the extent that additions to case basis reserves for any period exceed the
remaining available general reserve or are not applied from the general reserve,
the excess will be charged against the Company's earnings for that period. Any
addition to the general reserve which results from applying the loss factor to
new par written will also result in a charge to earnings at that time. However,
the release of amounts in the general reserve as a result of the runoff of
existing net insurance in force will be available to be applied against
additions to the general reserve required for new business written.
FSA maintains reserves in an amount believed by its management to be
sufficient to pay its estimated ultimate liability for losses and loss
adjustment expenses with respect to obligations it has insured. At December 31,
1996 and 1995, FSA's net loss reserves totaled $42.2 million and $50.2 million,
respectively. During 1995, the Company increased its general reserve by $6.3
million, of which $3.0 million was for originations of new business and $3.3
million was to reestablish the general reserve following transfers from the
general reserve to case basis
15
<PAGE>
reserves. During 1995, the Company transferred $10.8 million from its general
reserve to case basis reserves associated predominantly with certain residential
mortgage and timeshare receivables transactions. Also in December 1995, FSA
recognized a one-time increase of $15.4 million to the general reserve to
provide for the insured portfolio it had assumed in the Merger in a manner
consistent with the Company's reserving methodology. Prior to the Merger,
Capital Guaranty did not maintain a general reserve. The general reserve was
$31.8 million at December 31, 1995. During 1996, the Company increased its
general reserve by $6.9 million, of which $5.3 million was for new business
originations and $1.6 million was to reestablish the general reserve for
transfers from the general reserves to case basis reserves. During 1996, the
Company transferred $9.0 million from its general reserve to case basis reserves
associated predominantly with certain residential mortgage transactions. The
general reserve was $29.7 million at December 31, 1996
Reserves for losses and loss adjustment expenses are discounted at
risk-free rates. The amount of discount taken was approximately $17.9 million
and $15.3 million at December 31, 1996 and 1995, respectively.
Inasmuch as reserves are necessarily based on estimates and because of the
absence of a sufficient number of losses in its financial guaranty insurance
activities and in the financial guaranty insurance industry generally to
establish a meaningful statistical base, there can be no assurance that the case
basis reserves or the general reserve will be adequate to cover losses in FSA's
insured portfolio.
Competition and Industry Concentration
FSA faces competition from both other providers of third party credit
enhancement and alternatives to third party credit enhancement. The majority of
asset-backed and municipal obligations are sold without third party credit
enhancement. Accordingly, each transaction proposed to be insured by FSA must
generally compete against an alternative execution which does not employ third
party credit enhancement. FSA also faces competition from other monoline primary
financial guaranty insurers, primarily AMBAC Indemnity Corporation, Capital
Markets Assurance Corporation, Financial Guaranty Insurance Company and MBIA
Insurance Corporation. In terms of statutory surplus plus contingency reserves,
FSA is the fourth largest of the five major financial guaranty insurers.
Traditional credit enhancers such as bank letter of credit providers and
mortgage pool insurers also provide significant competition to FSA as providers
of credit enhancement for asset-backed obligations. While actions by securities
rating agencies in recent years have significantly reduced the number of
triple-A rated banks that can offer a product directly competitive with FSA's
triple-A guaranty, and risk-based capital guidelines applicable to banks have
generally increased costs associated with letters of credit that compete
directly with financial guaranty insurance, bank letter of credit providers and
other credit enhancement, such as cash collateral accounts, provided by banks,
continue to provide significant competition to FSA.
Insurance law generally restricts multiline insurance companies, such as
large property/casualty insurers and life insurers, from engaging in the
financial guaranty insurance business other than through separately capitalized
affiliates. Entry requirements include (i) assembling the group of experts
required to operate a financial guaranty insurance business, (ii) establishing
the triple-A claims-paying ability ratings with the credit rating agencies,
(iii) complying with substantial capital requirements, (iv) developing name
recognition and market acceptance with issuers, investment bankers and investors
and (v) organizing a monoline insurance company and obtaining insurance licenses
to do business in the applicable jurisdictions.
FSA's net insurance in force is the outstanding principal, interest and
other amounts to be paid over the remaining life of all obligations insured by
FSA, net of ceded reinsurance, refunded bonds secured by United States
government securities held in escrow or other qualified collateral and.
Qualified statutory capital, determined in accordance with statutory accounting
principles, is the aggregate of policyholders' surplus and contingency reserves
calculated in accordance with statutory accounting principles. Set forth below
are FSA's aggregate gross insurance in force, net insurance in force, qualified
statutory capital and leverage ratio (represented by the ratio of its net
insurance in force to qualified statutory capital) and the average industry
leverage ratio at the dates indicated:
16
<PAGE>
December 31,
--------------------------------------
1996 1995 1994
---- ---- ----
(dollars in millions)
Financial guaranty primary insurers,
excluding FSA (1)
Leverage ratio ................... N/A(2) 146:1 145:1
FSA
Gross insurance in force ............ $125,423 $99,034 $65,824
Net insurance in force .............. $93,704 $75,360 $45,824
Qualified statutory capital ......... $676 $645 $466
Leverage ............................ 139:1 117:1 98:1
- ----------
(1) Financial guaranty primary insurers for which data is included in this
table are AMBAC Indemnity Corporation, Capital Guaranty Insurance Company
(1995 and 1994 only), Capital Markets Assurance Corporation, Connie Lee
Insurance Company, Financial Guaranty Insurance Company and MBIA Insurance
Corporation. Information relating to the financial guaranty primary
insurers is derived from data from statutory accounting financial
information publicly available from each insurer at December 31, 1995 and
1994.
(2) Not available
Reinsurance
Reinsurance is the commitment by one insurance company, the "reinsurer," to
reimburse another insurance company, the "ceding company," for a specified
portion of the insurance risks underwritten by the ceding company in
consideration for a portion of the premiums received. The ceding company also
usually receives ceding commissions to cover costs of business generation.
Because the insured party contracts for coverage solely with the ceding company,
the failure of the reinsurer to perform does not relieve the ceding company of
its obligation to the insured party under the terms of the insurance contract.
Reinsurance Ceded
FSA obtains reinsurance to increase its policy writing capacity, both on an
aggregate risk and a single risk basis, meet state insurance regulatory, rating
agency and internal limits, diversify risks, reduce the need for additional
capital and strengthen financial ratios. At December 31, 1996, FSA had reinsured
approximately 26.2% of its direct principal amount outstanding. Most of FSA's
reinsurance is on a quota share basis, with a small portion being provided on a
first loss or excess of loss per risk basis. Reinsurance arrangements typically
require FSA to retain a specified amount of the risk.
FSA arranges reinsurance on both a facultative (transaction-by-transaction)
and treaty basis. Treaty reinsurance provides coverage for a portion of the
exposure from all qualifying policies issued during the term of the treaty. In
addition, FSA employs "automatic facultative" reinsurance which permits FSA to
apply reinsurance to transactions selected by it subject to certain limitations.
The reinsurer's participation in a treaty is cancelable annually upon 90 days'
prior notice by either FSA or the reinsurer and is cancelable by FSA upon
specified financial deterioration of the reinsurer. As required by applicable
state law, reinsurance agreements may be subject to certain other termination
conditions.
Treaties generally provide coverage for the full term of the policies
reinsured during the annual treaty period, except that, upon a financial
deterioration of the reinsurer and the occurrence of certain other conditions,
FSA generally has the right to reassume all of the business reinsured.
FSA's principal ceded reinsurance program currently consists of three quota
share treaties. One treaty (the "asset-backed treaty") covers all of FSA's
approved regular lines of business, except municipal bond insurance. In 1996,
FSA ceded 11.35% of each covered policy under this treaty, up to a maximum of
$22.7 million insured principal per policy. At its sole option, FSA was entitled
to increase the ceding percentage to 22.7% up to $45.4 million insured principal
per policy. A second treaty (the "municipal treaty") covers FSA's municipal bond
insurance business. In 1996, FSA ceded 10% of each covered policy under this
treaty that is classified by FSA as providing municipal bond insurance as
defined by Article 69 of the insurance laws of New York up to a limit of $26.7
million insured principal per single risk which is defined by revenue source. At
its sole option, FSA was entitled to increase the ceding percentage to 30% up to
$80 million insured principal per single risk. A third treaty (the "teaching
hospital and higher education treaty") covers substantially all teaching
hospital and higher education risks (also covered under the municipal treaty).
In 1996, FSA ceded 5% of its retention (i.e., after cessions of policies under
the municipal treaty) of each covered policy under this treaty, up to limits
that range from $7.5 million to $30 million per single risk. At its sole option,
FSA was entitled to increase the ceding percentage from 5% to 15% of its
retention, subject to the same limits. This third treaty was canceled on a
run-off basis as of December 31, 1996. Under its three automatic facultative
facilities in 1996, FSA at its option could allocate up to $20 - $25 million for
each reinsurer (depending on the reinsurer) for each transaction, subject to
limits and
17
<PAGE>
exclusions, in exchange for which FSA agreed to cede in the aggregate a
specified percentage of gross par insured by FSA. Each of the three treaties and
automatic facultative facilities allowed FSA to withhold a ceding commission to
defray its expenses.
Primary insurers, such as FSA, are required to fulfill their obligations to
policyholders if reinsurers fail to meet their obligations. The financial
condition of reinsurers is therefore evaluated carefully by FSA, and FSA's
reinsurance is placed with high quality and financially strong reinsurers. FSA's
treaty reinsurers at December 31, 1996 were Capital Reinsurance Company,
Compagnie Transcontinentale de Reassurance, Connie Lee Insurance Company,
Enhance Reinsurance Company, Frankona Reinsurance Company and Tokio Marine. In
1996, five reinsurers participated in the asset-backed treaty, three reinsurers
participated in the municipal treaty (including health care and higher
education) and one reinsurer participated in the health care and higher
education treaty.
FSA, FSAM and Oklahoma have entered into a quota share reinsurance pooling
agreement pursuant to which, after reinsurance cessions to other reinsurers,
FSA, FSAM and Oklahoma share in the net retained risk insured by each of these
three companies in proportion to their policyholders' surplus and contingency
reserve as of December 31 of the prior year (with the percentages adjusted
commencing April 1 of each year) through September 30, 1996 and each calendar
quarter thereafter. For the quarter commencing October 1, 1996, FSA retained
64.16%, FSAM retained 24.80% and Oklahoma retained 11.04% of each policy issued
by these companies after cessions to all other reinsurers. FSA-UK and FSA have
entered into a quota share and stop loss reinsurance agreement pursuant to which
(i) FSA-UK reinsures with FSA its retention under its policies after third party
reinsurance based on an agreed-upon percentage that is substantially in
proportion to the policyholders' surplus and contingency reserve of FSA-UK to
the total policyholders' surplus and contingency reserves of FSA and its
subsidiary insurers (including FSA-UK) and (ii) subject to certain limits, FSA
is required to make payments to FSA-UK when FSA-UK's loss ratio and expense
exceeds 100%. Under this agreement, FSA-UK ceded to FSA 98.20% of its retention
after other reinsurance of its policies issued from January 1, 1996 through
March 31, 1996 and 98.23% of policies issued from April 1, 1996 through December
31, 1996.
In connection with the Restructuring, FSA is party to a quota share
reinsurance agreement with Commercial Re pursuant to which Commercial Re assumed
approximately 64.4% of FSA's exposure, on a weighted average basis, on
transactions in FSA's commercial mortgage portfolio.
Rating Agencies
Moody's and S&P periodically review the business and financial condition of
FSA and other companies providing financial guaranty insurance. These rating
agency reviews focus on the insurer's underwriting policies and procedures and
the quality of the obligations insured. The rating agencies frequently perform
assessments of the credits insured by FSA to confirm that FSA continues to meet
the capital adequacy criteria considered necessary by the particular rating
agency to maintain FSA's triple-A claims-paying ability rating. See "Credit
Underwriting Guidelines, Standards and Procedures" above. FSA's ability to
compete with other triple-A rated financial guarantors, and its results of
operations and financial condition, would be materially adversely affected by
any reduction in its ratings.
Insurance Regulatory Matters
General
FSA is licensed to engage in insurance business in all 50 states, the
District of Columbia and Puerto Rico. FSA is subject to the insurance laws of
the State of New York ("New York Insurance Law"), FSAM is subject to the
insurance laws of the State of Maryland and Oklahoma is subject to the insurance
laws of the State of Oklahoma, their respective states of incorporation. Each is
also subject to the insurance laws of the other states in which it is licensed
to transact an insurance business. Each of FSA and its domestic insurance
company subsidiaries are required to file
18
<PAGE>
quarterly and annual statutory financial statements in each jurisdiction in
which they are licensed, and are subject to statutory restrictions concerning
the types and quality of investments and the filing and use of policy forms and
premium rates. FSA's accounts and operations are subject to periodic examination
by the New York Superintendent of Insurance (the "New York Superintendent") (the
last such examination having been conducted in 1995 for the period ended
December 31, 1994) and other state insurance regulatory authorities.
Insurance Holding Company Laws
The Company and its domestic operating insurance company subsidiaries (FSA,
FSAM and Oklahoma) are subject to regulation under insurance holding company
statutes of New York, Maryland and Oklahoma, where these respective insurers are
domiciled, as well as other jurisdictions where these companies are licensed to
do insurance business. The requirements of holding company statutes vary from
jurisdiction to jurisdiction but generally require insurance holding companies
and their insurance subsidiaries to register and file certain reports
describing, among other information, their capital structure, ownership and
financial condition. The holding company statutes also require prior approval of
changes in control, of certain dividends and other intercorporate transfers of
assets and of transactions between insurance companies and their affiliates. The
holding company statutes generally require that all transactions with affiliates
be fair and reasonable and that those exceeding specified limits require prior
notice to or approval by insurance regulators.
Under the insurance holding company laws in effect in New York, Maryland
and Oklahoma, any acquisition of control of the Company, and thereby indirect
control of FSA, FSAM and Oklahoma, requires the prior approval of the New York
Superintendent and the Maryland and Oklahoma Insurance Commissioners. "Control"
is defined as the direct or indirect power to direct or cause the direction of
the management and policies of a person, whether through the ownership of voting
securities, by contract or otherwise. Any purchaser of 10% or more of the
outstanding voting securities of a corporation is presumed to have acquired
control of that corporation and its subsidiaries, although the insurance
regulator may find that "control" in fact does or does not exist when a person
owns or controls either a lesser or greater amount of voting securities.
New York Financial Guaranty Insurance Law
Article 69 ("Article 69") of the New York Insurance Law, a comprehensive
financial guaranty insurance statute, governs all financial guaranty insurers
licensed to do business in New York, including FSA. This statute limits the
business of financial guaranty insurers to financial guaranty insurance and
related lines (such as surety).
Article 69 requires that financial guaranty insurers maintain a special
statutory accounting reserve called the "contingency reserve" to protect
policyholders against the impact of excessive losses occurring during adverse
economic cycles. Article 69 requires a financial guaranty insurer to provide a
contingency reserve (i) with respect to policies written prior to July 1, 1989
in an amount equal to 50% of earned premiums and (ii) with respect to policies
written on and after July 1, 1989, quarterly on a pro rata basis over a period
of 20 years for municipal bonds and 15 years for all other obligations, in an
amount equal to the greater of 50% of premiums written for the relevant category
of insurance or a percentage of the principal guarantied, varying from 0.55% to
2.50%, depending upon the type of obligation guarantied, until the contingency
reserve amount for the category equals the applicable percentage of net unpaid
principal. This reserve must be maintained for the periods specified above,
except that reductions by the insurer may be permitted under specified
circumstances in the event that actual loss experience exceeds certain
thresholds or if the reserve accumulated is deemed excessive in relation to the
insurer's outstanding insured obligations. Financial guaranty insurers are also
required to maintain reserves for losses and loss adjustment expenses on a
case-by-case basis and reserves against unearned premiums.
Article 69 establishes single risk limits for financial guaranty insurers
applicable to all obligations issued by a single entity and backed by a single
revenue source. For example, under the limit applicable to qualifying
asset-backed securities, the lesser of (i) the insured average annual debt
service for a single risk or (ii) the insured unpaid principal (reduced by the
extent to which the unpaid principal of the supporting assets exceeds the
insured unpaid principal) divided by nine, net of qualifying reinsurance and
collateral, may not exceed 10% of the sum of the insurer's policyholders'
surplus and contingency reserve, subject to certain conditions. Under the limit
applicable to municipal obligations, the insured average annual debt service for
a single risk, net of qualifying reinsurance and collateral, may not exceed 10%
of the sum of the insurer's policyholders' surplus and contingency reserve. In
addition, insured principal of municipal obligations attributable to any single
risk, net of qualifying reinsurance and collateral, is limited to 75% of the
insurer's policyholders' surplus and contingency reserve. Single risk limits are
also
19
<PAGE>
specified for other categories of insured obligations, and generally are
more restrictive than those listed for asset-backed or municipal obligations.
Article 69 also establishes aggregate risk limits on the basis of aggregate
net liability insured as compared to statutory capital. "Aggregate net
liability" is defined as outstanding principal and interest of guarantied
obligations insured, net of qualifying reinsurance and collateral. Under these
limits, policyholders' surplus and contingency reserves must not be less than a
percentage of aggregate net liability equal to the sum of various percentages of
aggregate net liability for various categories of specified obligations. The
percentage varies from 0.33% for certain municipal obligations to 4% for certain
non-investment grade obligations.
Dividend Restrictions
FSA's ability to pay dividends is dependent upon FSA's financial condition,
results of operations, cash requirements, rating agency approval and other
related factors and is also subject to restrictions contained in the insurance
laws and related regulations of New York and other states. Under New York State
insurance law, FSA may pay dividends out of earned surplus, provided that,
together with all dividends declared or distributed by FSA during the preceding
12 months, the dividends do not exceed the lesser of (i) 10% of policyholders'
surplus as of its last statement filed with the New York Superintendent of
Insurance or (ii) adjusted net investment income during this period. FSA has
paid dividends of $18.0 million for the year ended December 1996. Based upon
FSA's statutory statements for the quarter ended December 31, 1996 and
considering dividends which can be paid by its subsidiary, the maximum amount
available for payment of dividends by FSA without regulatory approval over the
following 12 months is approximately $45.2 million. As a customary condition for
approving in September 1994 the application of Fund American for a change in
control of FSA, the prior approval of the New York Superintendent was required
for payment of dividends by FSA to the Company for a period of two years
following such change of control. Such prior approval requirement lapsed in
September 1996. In addition, the New York Superintendent has approved the
repurchase by FSA of up to $75 million of its shares from its parent through
December 31, 1998, pursuant to which FSA has repurchased $27 million of its
shares through December 31, 1996. Future share repurchases may not exceed
cumulative statutory net income beginning January 1, 1996.
Financial Guaranty Insurance Regulation in Other Jurisdictions
FSA is subject to laws and regulations of jurisdictions other than the
State of New York concerning the transaction of financial guaranty insurance.
The laws and regulations of these other jurisdictions are generally not more
stringent in any material respect than the New York Insurance Law.
The United Kingdom's Department of Trade and Industry (the "DTI") regulates
FSA-UK. Pursuant to European Union Directives, FSA-UK has since been authorized
to provide financial guaranty insurance for transactions in France, Ireland, and
Spain from its home office in the United Kingdom. FSA has received a
determination from the Australian Insurance and Superannuation Commissioner that
the financial guaranties issued by it with respect to Australian transactions do
not constitute insurance for which a license is required.
Investment Portfolio
FSA manages its investments with the objectives of preserving its capital
and claims-paying ability, maintaining a high level of liquidity and, within
these constraints, obtaining a high long-term total return. The Company's
investment strategy is to emphasize total return rather than current income. To
accomplish its objectives, the Company has established guidelines for eligible
investments by FSA, requiring that each individual investment must be rated at
least "single A" at acquisition and the overall portfolio must be rated "double
A" on average. Investments falling below the minimum quality level are required
to be disposed of at the earliest opportunity that such disposition will not
adversely affect the portfolio. For liquidity purposes, the Company's policy is
to invest FSA assets in investments which are readily marketable with no legal
or contractual restrictions on resale. Eligible investments include U.S.
Treasury and agency obligations, corporate bonds, tax-exempt bonds and mortgage
pass-through instruments. The Company has also invested in an equity fund.
The weighted average maturity of the Company's investment portfolio at
December 31, 1996 was approximately 11.5 years. The Company's current investment
strategy is to invest in quality readily marketable instruments of intermediate
average duration so as to generate stable investment earnings with minimal
market value or credit risk.
20
<PAGE>
The following tables set forth certain information concerning the
investment portfolio of FSA:
Investment Portfolio by Rating
at December 31, 1996(1)
Percent of
Investment
Rating Portfolio
---------------------------------------- -------------------
AAA(2) .............................. 68.8%
AA .................................. 19.7
A ................................... 11.5
-----
100.0%
=====
- ----------
(1) Ratings are for the fixed income portfolio (91.9% of the entire investment
portfolio as of December 31, 1996) and are based on the higher of Moody's
or S&P ratings available at December 31, 1996.
(2) Includes U.S. Treasury and agency obligations, which comprised 5.0% of the
total portfolio at December 31, 1996.
Summary of Investments
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------------------------
1996 1995 1994
----------------------- --------------------------- --------------------------
Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average
Investment Category Cost Yield(1) Cost Yield(1) Cost Yield(1)
------------------- ----------- ---------- ------------- --------- ----------- ---------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Long-term investments:
Taxable bonds.............. $ 396,586 6.76% $383,790 7.00% $284,226 7.95%
Tax-exempt bonds........... 661,831 5.70 643,624 5.62 390,384 6.52
----------- -------------- ----------
Total long-term investments 1,058,417 6.09 1,027,414 6.13 674,610 7.13
Short-term investments(2)....... 56,733 5.43 14,567 5.97 92,449 5.91
----------- -------------- ----------
Total investments(3)...... $1,115,150 6.06% $1,041,981 6.13% $767,059 6.98%
=========== ============== ==========
</TABLE>
- ----------
(1) Yields are stated on a pre-tax basis.
(2) Includes taxable and tax-exempt investments and excludes cash equivalents
of $16.9 million, $38.1 million and $13.5 million, respectively.
(3) Excludes stocks with a market value of $8.3 million, $0 and $0,
respectively.
21
<PAGE>
Investment Portfolio by Security Type
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------------------------------------
1996 1995 1994
-------------------------- -------------------------- --------------------------
Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average
Investment Category Cost Yield(1) Cost Yield(1) Cost Yield(1)
------------------- ------------- --------- ------------- ---------- ---------- ----------
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
U.S. government securities... $ 55,619 6.63% $ 45,139 6.27% $ 7,036 8.09%
Mortgage-backed securities... 177,818 6.88 265,213 7.15 179,205 8.13
Municipal bonds.............. 661,831 5.70 643,624 5.62 390,384 6.52
Asset-backed securities...... 71,370 6.82 43,493 6.83 81,449 7.52
Corporate securities......... 76,760 6.55 1,254 6.86 -- --
Foreign securities........... 15,019 6.50 28,691 7.04 16,536 8.00
------------ ------------- -----------
Total fixed maturities.. 1,058,417 6.09 1,027,414 6.13 674,610 7.13
Short-term investments(2).... 56,733 5.43 14,567 5.97 92,449 5.91
------------ ------------- -----------
Total investments(3).... $1,115,150 6.06% $1,041,981 6.13% $767,059 6.98%
============ ============= ===========
</TABLE>
- ----------
(1) Yields are stated on a pre-tax basis.
(2) Includes taxable and tax-exempt investments and excludes cash equivalents
of $16.9 million, $38.1 million and $13.5 million, respectively.
(3) Excludes stocks of $8.3 million, $0 and $0, respectively.
Distribution of Investments by Maturity
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------------------------------
1996 1995 1994
-------------------------- ---------------------- --------------------------
Estimated Estimated Estimated
Amortized Market Amortized Market Amortized Market
Investment Category Cost Value Cost Value Cost Value
------------------- ---------- ------------- ---------- --------- ----------- ---------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Due in one year or less(1)...... $ 95,038 $ 95,359 $ 17,343 $ 17,345 $ 93,950 $ 93,942
Due after one year through five
years ........................ 57,531 57,712 26,036 26,375 30,209 29,520
Due after five years through
ten years..................... 105,495 105,848 157,161 162,573 36,140 36,453
Due after ten years............. 607,898 620,031 532,735 551,239 346,106 322,973
Mortgage-backed securities...... 177,818 178,344 265,213 271,087 179,205 169,846
Asset-backed securities......... 71,370 71,878 43,493 44,024 81,449 80,926
----------- -------------- ------------ ------------- ------------ ------------
Total investments(2)....... $1,115,150 $1,129,172 $1,041,981 $1,072,643 $767,059 $733,660
=========== ============== ============ ============= ============ ============
</TABLE>
- ----------
(1) Includes short-term investments in the amount of $56.8 million, $14.6
million and $92.4 million at December 31, 1996, 1995 and 1994,
respectively, but excludes cash equivalents of $16.9 million, $38.1
million, and $13.5 million, respectively.
(2) Excludes stocks of $8.3 million, $0 and $0, respectively.
Mortgage-Backed Securities
Cost and Market Value by Investment Category
<TABLE>
<CAPTION>
December 31, 1996
----------------------------------------------------------
Amortized Estimated
Investment Category Par Value Cost Market Value
------------------- --------- ---- ------------
(in thousands)
<S> <C> <C> <C>
Pass-through securities--U.S. Government
agency $ 102,024 $ 103,377 $ 103,851
CMO's--U.S. Government agency 6,000 5,893 6,128
CMO's--non-agency 70,025 68,548 68,365
--------- --------- ---------
Total mortgage-backed securities $ 178,049 $ 177,818 $ 178,344
========= ========= =========
</TABLE>
The Company's investments in mortgage-backed securities consisted of
pass-through certificates and collateralized mortgage obligations ("CMO's")
which are secured by mortgage loans guarantied or insured by
22
<PAGE>
agencies of the federal government. These securities are highly liquid with
readily determinable market prices. The Company also held triple-A rated CMO's
which are not guarantied by government agencies. Secondary market quotations are
available for these securities, although they are not as liquid as the
government agency-backed securities.
At December 31, 1996, the Company held sequential pay CMO tranches and
Planned Amortization Classes (PAC) of CMO's. The CMO's held at December 31, 1996
have stated maturities ranging from 22 to 30 years, and expected average lives
ranging from 1.3 to 19.4 years based on anticipated prepayments of principal.
None of the Company's holdings of CMO's is subject to extraordinary interest
rate sensitivity. At December 31, 1996, the Company did not own any
interest-only stripped mortgage securities or inverse floating rate CMO
tranches.
Mortgage-backed securities differ from traditional fixed income bonds
because they are subject to prepayments at par value without penalty at the
borrower's option. Prepayment rates on mortgage-backed securities are influenced
primarily by the general level of prevailing interest rates, with prepayments
increasing when prevailing interest rates are lower than the rates on the
underlying mortgages. When prepayments occur, the proceeds must be re-invested
at then current market rates, which are generally below the yield on the prepaid
securities. Prepayments on mortgage-backed securities purchased at a premium to
par will result in a loss to the Company to the extent of the unamortized
premium.
Employees
At December 31, 1996, the Company and its subsidiaries had 202 employees.
None of its employees are covered by collective bargaining agreements. The
Company considers its employee relations to be satisfactory.
Item 2. Properties.
The principal executive offices of the Company and FSA are located at 350
Park Avenue, New York, New York 10022. The principal executive offices, which
consist of approximately 53,000 square feet of office space, are under lease
agreements which expire in 2005. The Company's telephone number at its principal
executive offices is (212) 826-0100. FSA also maintains leased office space in
San Francisco, Dallas, London (England), Paris (France), Madrid (Spain) and
Sydney (Australia). The Company and its subsidiaries do not own any real
property.
Item 3. Legal Proceedings.
In the ordinary course of business, certain subsidiaries of the Company
have become party to certain litigation. The Company believes that these matters
will be resolved with no material financial impact on the Company.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of the Company's shareholders during
the fourth quarter of 1996.
23
<PAGE>
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Information relating to the principal market on which the Company's common
stock is tradable, the high and low sales prices per share for each quarterly
period for the past two years and the frequency and amount of any cash dividends
declared in the past two years is set forth on page 48 of the Company's 1996
Annual Report to Shareholders and such information is incorporated herein by
reference. Information concerning restrictions on the payment of dividends is
set forth in Item 1 above under the caption "Insurance Regulatory Matters --
Dividend Restrictions." At March 24, 1997, there were approximately 2,600
holders of the Company's Common Stock, which is listed on the New York Stock
Exchange.
Item 6. Selected Financial Data.
Selected financial data for the Company and its subsidiaries for each of
the last five years is set forth under the caption "Financial Highlights" on
page 16 of the Company's 1996 Annual Report to Shareholders. Such information is
incorporated herein by reference and should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto contained on pages 26 to
44 of such Annual Report.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Management's Discussion and Analysis of Financial Condition and Results of
Operations is set forth under the caption "Management's Discussion and Analysis
of Financial Condition and Results of Operations" on pages 18 through 24 of the
Company's 1996 Annual Report to Shareholders. Such information is incorporated
herein by reference and should be read in conjunction with the Consolidated
Financial Statements and the Notes thereto contained on pages 26 to 44 of such
Annual Report.
Item 8. Financial Statements and Supplementary Data.
The 1996 Consolidated Financial Statements, together with the Notes thereto
and the Report of Independent Accountants thereon, are set forth on pages 25
through 44 of the Company's 1996 Annual Report to Shareholders. Such information
is incorporated herein by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
24
<PAGE>
Part III
Item 10. Directors and Executive Officers of the Registrant.
Information relating to the Company's directors and executive officers is
set forth under the captions "Election of Directors" on pages 1 through 5,
"Section 16(a) Beneficial Ownership Reporting Compliance" on page 16, and
"Executive Officers of the Company" on pages 6 and 7 of the Company's 1997 Proxy
Statement. Such information is incorporated herein by reference.
Item 11. Executive Compensation.
Information relating to compensation of the Company's directors and
executive officers is set forth under the captions "Executive Compensation" on
pages 10 through 12, "Report of the Human Resources Committee of the Board of
Directors of Financial Security Assurance Holdings Ltd." on pages 13 through 16,
and "Stock Price Performance" on page 17 of the Company's 1997 Proxy Statement.
Such information is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Information relating to security ownership of certain beneficial owners of
the Company's equity securities and by the Company's directors and executive
officers is set forth under the caption "Ownership of the Company" on pages 7
through 10 of the Company's 1997 Proxy Statement. Such information is
incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions.
Information relating to certain relationships and related transactions is
set forth under the captions "Compensation Committee Interlocks and Insider
Participation" on page 16 and "Certain Relationships and Related Transactions"
on pages 18 through 22 of the Company's 1997 Proxy Statement. Such information
is incorporated herein by reference.
25
<PAGE>
Part IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) Financial Statements and Financial Statement Schedules and Exhibits.
1. Financial Statements
The Registrant has incorporated by reference from the 1996 Annual
Report to Shareholders the following consolidated financial statements
of Financial Security Assurance Holdings Ltd. and Subsidiaries:
1996 Annual Report to
Shareholders (Pages)
Report of Independent Accountants 25
Consolidated Balance Sheets at
December 31, 1996 and 1995 26
Consolidated Statements of Income
for the Years Ended
December 31, 1996, 1995 and 1994 27
Consolidated Statements of Changes in
Shareholders' Equity for the Years Ended
December 31, 1996, 1995 and 1994 28
Consolidated Statements of Cash Flows
for the Years Ended
December 31, 1996, 1995 and 1994 29
Notes to Consolidated Financial Statements 30-44
2. Financial Statement Schedules
The following financial statement schedule is filed as part of this
Report.
Schedule Title
-------- -----
II Condensed Financial Statements of the Registrant
for the Years Ended December 31, 1996, 1995 and 1994.
The report of the Registrant's independent auditors with respect to
the above listed financial statement schedule is set forth on page 33
of this Report.
All other schedules are omitted because they are either inapplicable
or the required information is presented in the consolidated financial
statements of the Company or the notes thereto.
26
<PAGE>
3. Exhibits
The following are annexed as exhibits to this Report:
Exhibit No. Exhibit
----------- -------
2.1 Agreement and Plan of Merger dated as of August 18, 1995
among the Company, FSACG Inc. and Capital Guaranty
Corporation. (Previously filed as Exhibit 2.1 to the
Company's Registration Statement on Form S-4 (Reg. No.
33-99626), as such Registration Statement has been amended,
and incorporated herein by reference.)
3.1 Restated Certificate of Incorporation of the Company.
(Previously filed as Exhibit 3.1 to the Company's Annual
Report on Form 10-K (Commission File No. 1-12644) for the
fiscal period ended December 31, 1994 (the "1994 Form
10-K"), and incorporated herein by reference.)
3.1(A) Certificate of Amendment of the Amended and Restated
Certificate of Incorporation of the Company. (Previously
filed as Exhibit 3.1(A) to the Company's Registration
Statement on Form S-1 (Reg. No. 33-70230), as such
Registration Statement has been amended (the "Form S-1"),
and incorporated herein by reference.)
3.2 Amended and Restated By-laws of the Company, as amended and
restated on February 14, 1996. (Previously filed as Exhibit
5 to the Company's Quarterly Report on Form 10-Q (Commission
File No. 1-12644) for the quarterly period ended March 31,
1996 (the "March 31, 1996 10-Q"), and incorporated herein by
reference.)
4 Specimen Certificate representing shares of Common Stock.
(Previously filed as Exhibit 4 to the Form S-1, and
incorporated herein by reference.)
4(A) Specimen Certificate representing shares of Series A
Convertible Redeemable Preferred Stock. (Previously filed as
Exhibit 4(A) to the Form S-1, and incorporated herein by
reference.)
9 Voting Trust Agreement dated as of September 2, 1994 among
Fund American, U S WEST Capital Corporation ("USWCC") and
First Chicago Trust Company of New York, as voting trustee.
(Previously filed as Exhibit 9 to the 1994 Form 10-K, and
incorporated herein by reference.)
10.1 Credit Agreement dated as of November 23, 1994 among FSA,
Various Banks and Swiss Bank Corporation, New York Branch,
as agent. (Previously filed as Exhibit 10.2(B) to the 1994
Form 10-K, and incorporated herein by reference.)
10.2 Facility Agreement dated as of August 30, 1994, among FSA,
Canadian Global Funding Corporation and Hambros Bank
Limited. (Previously filed as Exhibit 2 to the Company's
Quarterly Report on Form 10-Q (Commission File No. 1-12644)
for the quarterly period ended September 30, 1994, and
incorporated herein by reference.)
10.3 Credit Agreement dated as of April 30, 1996, among FSA,
Financial Security Assurance of Maryland Inc., Financial
Security Assurance of Oklahoma, Inc., the Banks signatory
thereto and Bayerische Landesbank Girozentrale, New York
Branch, as Agent. (Previously filed as Exhibit 2 to the
Company's Quarterly Report on Form 10-Q (Commission File No.
1-12644) for the quarterly period ended June 30, 1996, and
incorporated herein by reference.)
27
<PAGE>
10.4+ Money Purchase Pension Plan and Trust Agreement dated as of
January 1, 1989 between FSA and Transamerica, with Adoption
Agreement No. 001 and Addendum. (Previously filed as Exhibit
10.7 to the Form S-1, and incorporated herein by reference.)
10.5+ Supplemental Executive Retirement Plan as amended and
restated as of January 1, 1995. (Previously filed as Exhibit
10.8(A) to the 1994 Form 10-K, and incorporated herein by
reference.)
10.6+ Amended and Restated 1993 Equity Participation Plan (as
amended and restated December 20, 1995). (Previously filed
as Exhibit 10.9(B) to the Company's Annual Report on Form
10-K (Commission File No. 1-12644) for the fiscal period
ended December 31, 1995 (the "1995 Form 10-K"), and
incorporated herein by reference.)
10.6(A)+ Amended and Restated 1993 Equity Participation Plan (as
amended and restated on February 14, 1996). (Previously
filed as Exhibit No. 4 to the March 31, 1996 10-Q, and
incorporated herein by reference.)
10.7+ Deferred Compensation Plan (Effective as of June 1, 1995).
(Previously filed as Exhibit No. 3 to the Company's
Quarterly Report on Form 10-Q (Commission File No. 1-12644)
for the quarterly period ended June 30, 1995 (the "June 30,
1995 10-Q"), and incorporated herein by reference.)
10.8+ Severance Policy for Senior Management (Effective as of
February 8, 1995). (Previously filed as Exhibit No. 3 to the
March 31, 1996 10-Q, and incorporated herein by reference.)
10.9+ Employment Agreement dated as of December 20, 1995 between
the Company and Michael Djordjevich. (Previously filed as
Exhibit 10.13 to the 1995 Form 10-K, and incorporated herein
by reference.)
10.10 Deconsolidation Agreement dated May 13, 1994 among U S WEST,
Inc., USWCC, the Company, FSA, International and Oklahoma.
(Previously filed as Exhibit 10.16 to the 1994 Form 10-K,
and incorporated herein by reference.)
10.11 Cooperation Agreement dated as of December 27, 1990 among
Tokio Marine, the Company and FSA. (Previously filed as
Exhibit 10.17 to the Form S-1, and incorporated herein by
reference.)
10.12 Tokio Marine Stockholders Agreement dated December 27, 1990
among Tokio Marine, the Company and USWCC. (Previously filed
as Exhibit 10.18 to the Form S-1, and incorporated herein by
reference.)
10.12(A) Letter Agreement dated as of September 2, 1994 concerning
the Tokio Marine Stockholders Agreement between U S WEST,
Inc., and the Company. (Previously filed as Exhibit 10.18(A)
to the 1994 Form 10-K, and incorporated herein by
reference.)
10.12(B) Amendment No. 1 dated December 23, 1993 to Tokio Marine
Stockholders Agreement. (Previously filed as Exhibit 10.19
to the Form S-1, and incorporated herein by reference.)
10.13 Master Reinsurance Placement Memorandum dated December 27,
1991 between Tokio Marine and FSA. (Previously filed as
Exhibit 10.20 to the Form S-1, and incorporated herein by
reference.)
28
<PAGE>
10.14 Amended and Restated Interests and Liabilities Contract
concerning the Quota Share Treaty effective as of January 1,
1991 among Tokio Marine and FSA and its identified
subsidiaries and affiliates, with Amendment No. 1 thereto.
(Previously filed as Exhibit 10.21(A) to the 1994 Form 10-K,
and incorporated herein by reference.)
10.15 Amended and Restated Interests and Liabilities Contract
concerning the Municipal Bond Insurance Quota Share Treaty
effective as of January 1, 1991 among Tokio Marine, FSA and
its identified subsidiaries and affiliates, with Amendment
No. 1 thereto. (Previously filed as Exhibit 10.22(A) to the
1994 Form 10-K, and incorporated herein by reference.)
10.16 Investment Management Agreement dated as of December 1, 1995
between FSA Portfolio Management Inc. and Charter Indemnity
Company. (Previously filed as Exhibit 10.23 to the 1995 Form
10-K, and incorporated herein by reference.)
10.17 Investment Management Agreement dated as of December 1, 1995
between FSA Portfolio Management Inc. and Northern County
Mutual Insurance Company. (Previously filed as Exhibit 10.24
to the 1995 Form 10-K, and incorporated herein by
reference.)
10.18 Investment Management Agreement dated as of December 1, 1995
between FSA Portfolio Management Inc. and Valley Insurance
Company. (Previously filed as Exhibit 10.25 to the 1994 Form
10-K, and incorporated herein by reference.)
10.19+ Promissory Note between the Company and Sean W. McCarthy
dated December 20, 1993. (Previously filed as Exhibit
10.30(A) to the Form S-1, and incorporated herein by
reference.)
10.20 Quota Share Reinsurance Agreement dated December 22, 1993,
among Commercial Re, FSA and International. (Previously
filed as Exhibit 10.17 to the Form S-1, and incorporated
herein by reference.)
10.21 Share Purchase Agreement dated as of December 23, 1993 among
Commercial Re, U S WEST and the Company. (Previously filed
as Exhibit 10.32 to the Form S-1, and incorporated herein by
reference.)
10.22 Federal Income Tax Allocation Agreement dated as of December
23, 1993 among Commercial Re, U S WEST and the Company.
(Previously filed as Exhibit 10.33 to the Form S-1, and
incorporated herein by reference.)
10.23 Liquidity Facility dated as of December 23, 1993 among U S
WEST, Inc., Commercial Re and the Company. (Previously filed
as Exhibit 10.34 to the Form S-1, and incorporated herein by
reference.)
10.24 Investment Management Agreement dated as of December 23,
1993 among FSA Portfolio Management, Commercial Re and the
Company. (Previously filed as Exhibit 10.35 to the Form S-1,
and incorporated herein by reference.)
10.25 Agreement for Management and the Provision of Personnel,
Property and Services dated as of December 23, 1993 between
Commercial Re and the Company. (Previously filed as Exhibit
10.36 to the Form S-1, and incorporated herein by
reference.)
29
<PAGE>
10.26 Securities Purchase Agreement among U S WEST, Inc., USWCC,
Fund American and the Company (including Exhibit A thereto).
(Previously filed as Exhibit 10.38 to the Form S-1, and
incorporated herein by reference.)
10.26(A) Amendment dated as of May 6, 1994 to Securities Purchase
Agreement among U S WEST, Inc., USWCC, Fund American and the
Company. (Previously filed as Exhibit 10.38(A) to the 1994
Form 10-K, and incorporated herein by reference.)
10.27 Registration Rights Agreement dated as of May 13, 1994 among
the Company, USWCC and Fund American. (Previously filed as
Exhibit 10.39 to the 1994 Form 10-K, and incorporated herein
by reference.)
10.28 Fund American Shareholders Agreement dated as of September
2, 1994 among USWCC, Fund American and the Company.
(Previously filed as Exhibit 10.40 to the 1994 Form 10-K,
and incorporated herein by reference.)
10.29 Five-Year Option dated as of September 2, 1994. (Previously
filed as Exhibit 10.41 to the 1994 Form 10-K, and
incorporated herein by reference.)
10.30 Ten-Year Option dated as of September 2, 1994. (Previously
filed as Exhibit 10.42 to the 1994 Form 10-K, and
incorporated herein by reference.)
10.31 Insurance Indemnification and Insurance Agreement dated as
of May 20, 1994, between U S WEST, Inc. and the Company.
(Previously filed as Exhibit 10.43 to the 1994 Form 10-K,
and incorporated herein by reference.)
10.31(A) Letter dated May 23, 1995 from the Company to U S WEST, Inc.
amending Insurance Indemnification and Insurance Agreement
dated as of May 20, 1994, between U S WEST, Inc. and the
Company. (Previously filed as Exhibit 10.43(A) to the 1995
Form 10-K, and incorporated herein by reference.)
10.31(B) Letter dated November 28, 1995 from the Company to U S WEST,
Inc. amending Insurance Indemnification and Insurance
Agreement dated as of May 20, 1994, between U S WEST, Inc.
and the Company. (Previously filed as Exhibit 10.43(B) to
the 1995 Form 10-K, and incorporated herein by reference.)
13 Annual Report to Shareholders for the Year Ended December
31, 1996. Such report is furnished for the information of
the Securities and Exchange Commission only and, except for
those portions thereof which are expressly incorporated by
reference in the Annual Report on Form 10-K, is not to be
deemed filed as part of this Report.
21 List of Subsidiaries.
23 Consent of Coopers & Lybrand L.L.P.
24 Powers of Attorney.
99 Financial Security Assurance Inc. and Subsidiaries 1996
Consolidated Financial Statements and Report of Independent
Accountants.
- ----------
+ Management contract or compensatory plan or arrangement required to be
filed as an exhibit to this Form 10-K pursuant to Item 14(c).
(b) Reports on Form 8-K
The Company did not file any Reports on Form 8-K during the fourth quarter
of 1996.
30
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
FINANCIAL SECURITY ASSURANCE
HOLDINGS LTD. (Registrant)
By: /s/ ROBERT P. COCHRAN
--------------------------------------
Name: Robert P. Cochran
Title: President and Chief Executive Officer
Dated: March 24, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signature Title Date
----------------- ----------------- -----------------
/s/ JOHN J. BYRNE*
- ----------------------------
John J. Byrne Chairman of the Board March 24, 1997
and Director
/s/ ROBERT P. COCHRAN*
- ----------------------------
Robert P. Cochran President, Chief March 24, 1997
Executive Officer
and Director (Principal
Executive Officer)
/s/ ROGER K. TAYLOR*
- ----------------------------
Roger K. Taylor Managing Director, March 24, 1997
Chief Operating
Officer and Director
/s/ JOHN A. HARRISON*
- ----------------------------
John A. Harrison Managing Director March 24, 1997
and Chief Financial
Officer (Principal
Financial Officer)
/s/ JEFFREY S. JOSEPH*
- ----------------------------
Jeffrey S. Joseph Managing Director March 24, 1997
and Controller (Principal
Accounting Officer)
/S/ MICHAEL DJORDJEVICH*
- ----------------------------
Michael Djordjevich Director March 24, 1997
/s/ ROBERT N. DOWNEY*
- ----------------------------
Robert N. Downey Director March 24, 1997
/s/ ANTHONY M. FRANK*
- ----------------------------
Anthony M. Frank Director March 24, 1997
/s/ TOSHIKI KANEDA*
- ----------------------------
Toshiki Kaneda Director March 24, 1997
31
<PAGE>
/s/ K. THOMAS KEMP*
- ----------------------------
K. Thomas Kemp Director March 24, 1997
/s/ DAVID O. MAXWELL*
- ----------------------------
David O. Maxwell Director March 24, 1997
/s/ JAMES M. OSTERHOFF*
- ----------------------------
James M. Osterhoff Director March 24, 1997
/s/ JAMES H. OZANNE*
- ----------------------------
James H. Ozanne Director March 24, 1997
/s/ STAATS M. PELLETT, JR.*
- ----------------------------
Staats M. Pellett, Jr. Director March 24, 1997
/s/ RICHARD A. POST*
- ----------------------------
Richard A. Post Director March 24, 1997
/s/ ALLAN L. WATERS*
- ----------------------------
Allan L. Waters Director March 24, 1997
/s/ HOWARD M. ZELIKOW*
- ----------------------------
Howard M. Zelikow Director March 24, 1997
- ----------
* Robert P. Cochran, by signing his name hereto, does hereby sign this Annual
Report on Form 10-K on behalf of each of the Directors and Officers of the
Registrant named above after whose typed names asterisks appear pursuant to
powers of attorney duly executed by such Directors and Officers and filed with
the Securities and Exchange Commission as exhibits to this Report.
By: /s/ ROBERT P. COCHRAN
--------------------------------
Robert P. Cochran,
Attorney-in-fact
32
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors
of Financial Security Assurance Holdings Ltd.:
Our report on the consolidated financial statements of Financial Security
Assurance Holdings Ltd. and Subsidiaries has been incorporated by reference in
this Form 10-K from page 25 of the 1996 Annual Report to Shareholders of
Financial Security Assurance Holdings Ltd. and Subsidiaries. In connection with
our audits of such financial statements, we have also audited the related
financial statement schedule listed in the index on page 26 of this Form 10-K.
In our opinion, the financial statement schedule, referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
COOPERS & LYBRAND L.L.P.
New York, New York
January 24, 1997
33
<PAGE>
Schedule II
Parent Company Condensed Financial Information
Condensed Balance Sheets
(Dollars in thousands)
December 31,
------------------------
1996 1995
---- ----
Assets:
Investments $ 29,040 $ 24,515
Investments in subsidiary, at equity in
net assets 785,332 759,986
Deferred taxes 515 1,269
Other assets 6,772 1,109
-------- --------
$821,659 $786,879
======== ========
Liabilities and Shareholders' Equity:
Other liabilities $ 20,399 $ 8,932
Shareholders' equity 801,260 777,947
-------- --------
$821,659 $786,879
======== ========
Condensed Statements of Income
(Dollars in thousands)
Year Ended December 31,
---------------------------------------
1996 1995 1994
---- ---- ----
Dividends received from subsidiary $18,000 $ 19,000 $17,500
Other revenue 3,469 1,089 748
------- -------- -------
Total revenue 21,469 20,089 18,248
Total expenses 3,672 1,333 741
------- -------- -------
17,797 18,756 17,507
Equity in undistributed net income
of subsidiary 62,855 35,988 42,764
------- -------- -------
Income before income taxes 80,652 54,744 60,271
Income tax benefit 108 294 104
------- -------- -------
Net income $80,760 $55,038 $60,375
======= ======= =======
The Parent Company Condensed Financial Information should be read in conjunction
with the Consolidated Financial Statements and Notes to the Consolidated
Financial Statements as incorporated by reference in Item 8 (Financial
Statements and Supplementary Data).
34
<PAGE>
Schedule II
Parent Company Condensed Financial Information (Continued)
Condensed Statements of Cash Flows
(Dollars in thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Other operating expenses paid, net $16,995 $ 10 $ (237)
Dividends from subsidiary 18,000 19,000 17,500
Net investment income received 3,610 1,779 979
Federal income taxes received (paid) (1,298) 1,405 (764)
Interest and liquidity fees paid (2,093) (57) (506)
Other (5,583) 12,973 319
------- -------- -------
Net cash provided by operating activities 29,631 35,110 17,291
------- -------- -------
Cash flows from investing activities:
Proceeds from sales of bonds 21,544 21,257 18,119
Purchases of bonds (10,895) (27,815) (27,158)
Purchases of property and equipment (107) (41) (44)
Payment for purchase of subsidiary, net of cash acquired (11,646)
Net decrease (increase) in short-term securities (14,911) (38,038) (3,457)
------- -------- -------
Net cash provided by (used for) investing activities (4,369) (56,283) (12,540)
------- -------- -------
Cash flows from financing activities:
Issuance of common stock 7,126
Return of capital 27,000 50,000
Dividends paid (10,536) (8,275) (4,150)
Treasury stock (41,660) (14,444) (3,730)
Issuance of preferred stock 700
Payment of management notes (5,624) (2,811)
------- -------- -------
Net cash provided by (used for) financing activities (25,196) 21,657 (2,865)
------- -------- -------
Net increase (decrease) in cash 66 484 1,886
Cash and cash equivalents at beginning of year 563 79 (1,807)
------- -------- -------
Cash and cash equivalents at end of year $ 629 $ 563 $ 79
======= ======== =======
Reconciliation of net income to net cash provided by
operating activities:
Net income (loss) $80,760 $55,038 $60,375
Equity in undistributed net loss (income) of subsidiary (62,855) (35,988) (42,764)
Decrease (increase) in accrued investment income 264 110 (340)
Increase (decrease) in accrued income taxes (2,278) 1,240 (4,969)
Provision (benefit) for deferred income taxes 873 (128) 4,101
Net realized losses (gains) on investments (1,338) (88) (56)
Deferred equity compensation 5,565 5,735
Depreciation and accretion of bond discount (119) (171) 50
Change in other assets and liabilities 8,759 9,362 894
------- -------- -------
Cash provided by operating activities $29,631 $ 35,110 $17,291
======= ======== =======
</TABLE>
The Parent Company Condensed Financial Information should be read in conjunction
with the Consolidated Financial Statements and Notes to the Consolidated
Financial Statements as incorporated by reference in Item 8 (Financial
Statements and Supplementary Data).
35
<PAGE>
SCHEDULE II
Financial Security Assurance Holdings Ltd. (Parent Company)
Notes To Condensed Financial Statements
1. Condensed Financial Statements
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. These condensed financial
statements should be read in conjunction with the Company's consolidated
financial statements and the notes thereto.
2. Significant Accounting Policies
The Parent Company carries its investments in subsidiaries under the equity
method.
36
<PAGE>
EXHIBIT INDEX
Exhibit
No. Exhibit
- ------- -------
2.1 Agreement and Plan of Merger dated as of August 18, 1995 among the
Company, FSACG Inc. and Capital Guaranty Corporation. (Previously
filed as Exhibit 2.1 to the Company's Registration Statement on Form
S-4 (Reg. No. 33-99626), as such Registration Statement has been
amended, and incorporated herein by reference.)
3.1 Restated Certificate of Incorporation of the Company. (Previously
filed as Exhibit 3.1 to the Company's Annual Report on Form 10-K
(Commission File No. 1-12644) for the fiscal period ended December 31,
1994 (the "1994 Form 10-K"), and incorporated herein by reference.)
3.1(A) Certificate of Amendment of the Amended and Restated Certificate of
Incorporation of the Company. (Previously filed as Exhibit 3.1(A) to
the Company's Registration Statement on Form S-1 (Reg. No. 33-70230),
as such Registration Statement has been amended (the "Form S-1"), and
incorporated herein by reference.)
3.2 Amended and Restated By-laws of the Company, as amended and restated
on February 14, 1996. (Previously filed as Exhibit 5 to the Company's
Quarterly Report on Form 10-Q (Commission File No. 1-12644) for the
quarterly period ended March 31, 1996 (the "March 31, 1996 10-Q"), and
incorporated herein by reference.)
4 Specimen Certificate representing shares of Common Stock. (Previously
filed as Exhibit 4 to the Form S-1, and incorporated herein by
reference.)
4(A) Specimen Certificate representing shares of Series A Convertible
Redeemable Preferred Stock. (Previously filed as Exhibit 4(A) to the
Form S-1, and incorporated herein by reference.)
9 Voting Trust Agreement dated as of September 2, 1994 among Fund
American, U S WEST Capital Corporation ("USWCC") and First Chicago
Trust Company of New York, as voting trustee. (Previously filed as
Exhibit 9 to the 1994 Form 10-K, and incorporated herein by
reference.)
10.1 Credit Agreement dated as of November 23, 1994 among FSA, Various
Banks and Swiss Bank Corporation, New York Branch, as agent.
(Previously filed as Exhibit 10.2(B) to the 1994 Form 10-K, and
incorporated herein by reference.)
10.2 Facility Agreement dated as of August 30, 1994, among FSA, Canadian
Global Funding Corporation and Hambros Bank Limited. (Previously filed
as Exhibit 2 to the Company's Quarterly Report on Form 10-Q
(Commission File No. 1-12644) for the quarterly period ended September
30, 1994, and incorporated herein by reference.)
10.3 Credit Agreement dated as of April 30, 1996, among FSA, Financial
Security Assurance of Maryland Inc., Financial Security Assurance of
Oklahoma, Inc., the Banks signatory thereto and Bayerische Landesbank
Girozentrale, New York Branch, as Agent. (Previously filed as Exhibit
2 to the Company's Quarterly Report on Form 10-Q (Commission File No.
1-12644) for the quarterly period ended June 30, 1996, and
incorporated herein by reference.)
10.4+ Money Purchase Pension Plan and Trust Agreement dated as of January 1,
1989 between FSA and Transamerica, with Adoption Agreement No. 001 and
Addendum. (Previously filed as Exhibit 10.7 to the Form S-1, and
incorporated herein by reference.)
1
<PAGE>
Exhibit
No. Exhibit
- ------- -------
10.5+ Supplemental Executive Retirement Plan as amended and restated as of
January 1, 1995. (Previously filed as Exhibit 10.8(A) to the 1994 Form
10-K, and incorporated herein by reference.)
10.6+ Amended and Restated 1993 Equity Participation Plan (as amended and
restated December 20, 1995). (Previously filed as Exhibit 10.9(B) to
the Company's Annual Report on Form 10-K (Commission File No. 1-12644)
for the fiscal period ended December 31, 1995 (the "1995 Form 10-K"),
and incorporated herein by reference.)
10.6(A)+ Amended and Restated 1993 Equity Participation Plan (as amended and
restated on February 14, 1996). (Previously filed as Exhibit No. 4 to
the March 31, 1996 10-Q, and incorporated herein by reference.)
10.7+ Deferred Compensation Plan (Effective as of June 1, 1995). (Previously
filed as Exhibit No. 3 to the Company's Quarterly Report on Form 10-Q
(Commission File No. 1-12644) for the quarterly period ended June 30,
1995 (the "June 30, 1995 10-Q"), and incorporated herein by
reference.)
10.8+ Severance Policy for Senior Management (Effective as of February 8,
1995). (Previously filed as Exhibit No. 3 to the March 31, 1996 10-Q,
and incorporated herein by reference.)
10.9+ Employment Agreement dated as of December 20, 1995 between the Company
and Michael Djordjevich. (Previously filed as Exhibit 10.13 to the
1995 Form 10-K, and incorporated herein by reference.)
10.10 Deconsolidation Agreement dated May 13, 1994 among U S WEST, Inc.,
USWCC, the Company, FSA, International and Oklahoma. (Previously filed
as Exhibit 10.16 to the 1994 Form 10-K, and incorporated herein by
reference.)
10.11 Cooperation Agreement dated as of December 27, 1990 among Tokio
Marine, the Company and FSA. (Previously filed as Exhibit 10.17 to the
Form S-1, and incorporated herein by reference.)
10.12 Tokio Marine Stockholders Agreement dated December 27, 1990 among
Tokio Marine, the Company and USWCC. (Previously filed as Exhibit
10.18 to the Form S-1, and incorporated herein by reference.)
10.12(A) Letter Agreement dated as of September 2, 1994 concerning the Tokio
Marine Stockholders Agreement between U S WEST, Inc., and the Company.
(Previously filed as Exhibit 10.18(A) to the 1994 Form 10-K, and
incorporated herein by reference.)
10.12(B) Amendment No. 1 dated December 23, 1993 to Tokio Marine Stockholders
Agreement. (Previously filed as Exhibit 10.19 to the Form S-1, and
incorporated herein by reference.)
10.13 Master Reinsurance Placement Memorandum dated December 27, 1991
between Tokio Marine and FSA. (Previously filed as Exhibit 10.20 to
the Form S-1, and incorporated herein by reference.)
10.14 Amended and Restated Interests and Liabilities Contract concerning the
Quota Share Treaty effective as of January 1, 1991 among Tokio Marine
and FSA and its identified subsidiaries and affiliates, with Amendment
No. 1 thereto. (Previously filed as Exhibit 10.21(A) to the 1994 Form
10-K, and incorporated herein by reference.)
10.15 Amended and Restated Interests and Liabilities Contract concerning the
Municipal Bond Insurance Quota Share Treaty effective as of January 1,
1991 among Tokio Marine, FSA and its
2
<PAGE>
Exhibit
No. Exhibit
- ------- -------
identified subsidiaries and affiliates, with Amendment No. 1 thereto.
(Previously filed as Exhibit 10.22(A) to the 1994 Form 10-K, and
incorporated herein by reference.)
10.16 Investment Management Agreement dated as of December 1, 1995 between
FSA Portfolio Management Inc. and Charter Indemnity Company.
(Previously filed as Exhibit 10.23 to the 1995 Form 10-K, and
incorporated herein by reference.)
10.17 Investment Management Agreement dated as of December 1, 1995 between
FSA Portfolio Management Inc. and Northern County Mutual Insurance
Company. (Previously filed as Exhibit 10.24 to the 1995 Form 10-K, and
incorporated herein by reference.)
10.18 Investment Management Agreement dated as of December 1, 1995 between
FSA Portfolio Management Inc. and Valley Insurance Company.
(Previously filed as Exhibit 10.25 to the 1994 Form 10-K, and
incorporated herein by reference.)
10.19+ Promissory Note between the Company and Sean W. McCarthy dated
December 20, 1993. (Previously filed as Exhibit 10.30(A) to the Form
S-1, and incorporated herein by reference.)
10.20 Quota Share Reinsurance Agreement dated December 22, 1993, among
Commercial Re, FSA and International. (Previously filed as Exhibit
10.17 to the Form S-1, and incorporated herein by reference.)
10.21 Share Purchase Agreement dated as of December 23, 1993 among
Commercial Re, U S WEST and the Company. (Previously filed as Exhibit
10.32 to the Form S-1, and incorporated herein by reference.)
10.22 Federal Income Tax Allocation Agreement dated as of December 23, 1993
among Commercial Re, U S WEST and the Company. (Previously filed as
Exhibit 10.33 to the Form S-1, and incorporated herein by reference.)
10.23 Liquidity Facility dated as of December 23, 1993 among U S WEST, Inc.,
Commercial Re and the Company. (Previously filed as Exhibit 10.34 to
the Form S-1, and incorporated herein by reference.)
10.24 Investment Management Agreement dated as of December 23, 1993 among
FSA Portfolio Management, Commercial Re and the Company. (Previously
filed as Exhibit 10.35 to the Form S-1, and incorporated herein by
reference.)
10.25 Agreement for Management and the Provision of Personnel, Property and
Services dated as of December 23, 1993 between Commercial Re and the
Company. (Previously filed as Exhibit 10.36 to the Form S-1, and
incorporated herein by reference.)
10.26 Securities Purchase Agreement among U S WEST, Inc., USWCC, Fund
American and the Company (including Exhibit A thereto). (Previously
filed as Exhibit 10.38 to the Form S-1, and incorporated herein by
reference.)
10.26(A) Amendment dated as of May 6, 1994 to Securities Purchase Agreement
among U S WEST, Inc., USWCC, Fund American and the Company.
(Previously filed as Exhibit 10.38(A) to the 1994 Form 10-K, and
incorporated herein by reference.)
10.27 Registration Rights Agreement dated as of May 13, 1994 among the
Company, USWCC and Fund American. (Previously filed as Exhibit 10.39
to the 1994 Form 10-K, and incorporated herein by reference.)
3
<PAGE>
Exhibit
No. Exhibit
- ------- -------
10.28 Fund American Shareholders Agreement dated as of September 2, 1994
among USWCC, Fund American and the Company. (Previously filed as
Exhibit 10.40 to the 1994 Form 10-K, and incorporated herein by
reference.)
10.29 Five-Year Option dated as of September 2, 1994. (Previously filed as
Exhibit 10.41 to the 1994 Form 10-K, and incorporated herein by
reference.)
10.30 Ten-Year Option dated as of September 2, 1994. (Previously filed as
Exhibit 10.42 to the 1994 Form 10-K, and incorporated herein by
reference.)
10.31 Insurance Indemnification and Insurance Agreement dated as of May 20,
1994, between U S WEST, Inc. and the Company. (Previously filed as
Exhibit 10.43 to the 1994 Form 10-K, and incorporated herein by
reference.)
10.31(A) Letter dated May 23, 1995 from the Company to U S WEST, Inc. amending
Insurance Indemnification and Insurance Agreement dated as of May 20,
1994, between U S WEST, Inc. and the Company. (Previously filed as
Exhibit 10.43(A) to the 1995 Form 10-K, and incorporated herein by
reference.)
10.31(B) Letter dated November 28, 1995 from the Company to U S WEST, Inc.
amending Insurance Indemnification and Insurance Agreement dated as of
May 20, 1994, between U S WEST, Inc. and the Company. (Previously
filed as Exhibit 10.43(B) to the 1995 Form 10-K, and incorporated
herein by reference.)
13* Annual Report to Shareholders for the Year Ended December 31, 1996.
Such report is furnished for the information of the Securities and
Exchange Commission only and, except for those portions thereof which
are expressly incorporated by reference in the Annual Report on Form
10-K, is not to be deemed filed as part of this Report.
21* List of Subsidiaries.
23* Consent of Coopers & Lybrand L.L.P.
24* Powers of Attorney.
99* Financial Security Assurance Inc. and Subsidiaries 1996 Consolidated
Financial Statements and Report of Independent Accountants.
- ----------
+ Management contract or compensatory plan or arrangement required to be
filed as an exhibit to this Form 10-K pursuant to Item 14(c).
* Filed herewith.
(b) Reports on Form 8-K
The Company did not file any Reports on Form 8-K during the fourth quarter
of 1996.
4
EXHIBIT 13
[page 16 of 1996 Annual Report]
Selected Financial Data
<TABLE>
<CAPTION>
Dollars in millions, except per
share data 1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C>
Summary of Operations (a)
Gross premiums written $ 177.0 $ 110.7 $ 106.4 $ 127.4 $ 131.1
Net premiums written 121.0 77.6 77.8 65.0 78.4
Net premiums earned 90.4 69.3 65.8 63.4 63.9
Net investment income 65.1 49.0 46.6 47.9 47.0
Net income (loss) 80.8 (b) 55.0 60.4 (c) (124.7) 43.5
Balance Sheet Data (a)
Total investments 1,154.4 1,110.7 747.2 786.7 727.5
Total assets 1,537.7 1,490.3 1,074.3 1,031.0 1,042.4
Deferred premium revenue, net 360.0 330.3 212.9 200.3 198.8
Loss and loss adjustment expense
reserve, net 42.2 50.2 35.6 36.0 58.7
Preferred stock 0.7 0.7 0.7 - -
Common stockholders' equity 800.6 777.2 544.7 542.0 609.2
Per Common Share Data (a)
Earnings (loss) per share 2.64 2.13 2.32 (5.44) 1.90
Book value per share 26.71 24.67 20.92 20.95 (d) 26.64
Dividends paid 0.35 0.32 0.16 (e) - (e) 0.26
Additional Data
Qualified statutory capital 675.9 644.7 465.8 454.0 461.4
Total claims-paying resources (f) 1,359.8 1,138.7 807.1 767.3 769.6
Net par outstanding 59,194.0 45,979.0 28,223.0 24,659.0 21,363.0
Net insurance in force
(principal + interest) 93,704.0 75,360.0 45,825.0 41,667.0 37,334.0
Policyholders' leverage
(risk-to-capital ratio) 139:1 117:1 98:1 92:1 81:1
</TABLE>
(a) Prepared according to generally accepted accounting principles (GAAP).
(b) Includes the effect of a one-time general reserve charge of $15.4 million
($10.0 million after taxes) related to the Merger.
(c) Includes restructuring charge, goodwill and other non-recurring charges
totaling $193.8 million after tax, as discussed in prior Annual Reports.
(d) Prior to 1993, book value per share does not include unrealized gains and
losses, net of taxes, in accordance with SFAS No. 115.
(e) Dividends prior to 1994 are not comparable because the Company was not
publicly held.
(f) Statutory capital + statutory unearned premium reserve + present value of
future net installment premiums.
<PAGE>
[pages 18 - 24 of 1996 Annual Report]
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1996 VERSUS YEAR ENDED DECEMBER 31, 1995
The 1996 results of Financial Security Assurance Holdings Ltd. (the
Company) were positively affected by the Merger on December 20, 1995 of Capital
Guaranty Corporation with a subsidiary of the Company. Capital Guaranty
Corporation's operating subsidiary, Capital Guaranty Insurance Company (CGIC),
became a subsidiary of Financial Security Assurance Inc. (FSA) and changed its
name to Financial Security Assurance of Maryland Inc. The Merger provided for
each Capital Guaranty Corporation share to be exchanged for 0.6716 share of the
Company's common stock and cash of $5.69. The Company issued in the aggregate
6,051,661 common shares and aggregate cash of $51.3 million. The transaction
value of the Merger, including transaction costs, was $208.6 million. The Merger
was accounted for on a purchase accounting basis. In view of the short period
between the date of the Merger and year-end 1995, the date of the Merger for
accounting purposes is considered to be December 31, 1995. As a result, the
accounting for the Merger has no effect on 1995 results of operations, except
for the recording of a $15.4 million general loss reserve provision discussed
below.
The Company's adjusted book value per common share at December 31, 1996 was
$34.53, up 12.0%, including dividends, since year-end 1995. Excluding realized
and unrealized capital gains and losses, adjusted book value per share rose
12.9%, including dividends. Adjusted book value per common share is used by
management and some equity analysts as a proxy for the Company's intrinsic
value, exclusive of franchise value. It is defined as book value plus net
deferred premium revenue plus the present value of future net installment
premiums less deferred acquisition costs less tax effect. Adjusted book value is
not a substitute for GAAP book value per common share.
The Company discusses its financial results by breaking out various levels
of its income statement in order to present a better analysis of underlying
trends. Core net income represents net income before the after-tax effects of
refundings and prepayments, net realized capital gains and losses, and other
non-recurring adjustments. Core net income therefore represents the Company's
normal operating results. Operating net income is core net income plus the
after-tax effect of refundings and prepayments. This distinction between core
and operating net income is important because higher-than-normal volumes of
refundings and prepayments disproportionately increase earned premiums and could
suggest a stronger earnings trend than the pace of originations would warrant.
Net income, as reported, is operating net income plus the after-tax effects of
capital gains and losses and other non-recurring adjustments, if any.
The Company's net income for 1996 was $80.8 million, compared with $55.0
million for the same period in 1995, an increase of 46.7%. The increase was
primarily attributable to higher core net income due to the Merger and lower
provisions to the Company's general reserve for losses, partially offset by
lower refundings and prepayments and lower capital gains. Earnings per share
increased to $2.64 for 1996 from $2.13 for the same period in 1995.
Operating net income was $78.7 million ($2.58 per share) for 1996 versus
$60.3 million ($2.34 per share) for the comparable period in 1995, an increase
of 30.5%. Core net income was $74.9 million ($2.45 per share) for 1996 versus
$53.7 million ($2.08 per share) for the comparable period in 1995, an increase
of 39.6%.
The Company considers two measures of gross premiums originated for a given
period. Gross premiums written captures premiums collected in the period,
whether collected up front for business originated in the period, or in
installments for business originated in prior periods. An alternative measure,
the gross present value of premiums written (gross PV premiums written) reflects
future installment premiums discounted to their present value, as well as
upfront premiums, but only for business originated in the period. The Company
considers gross PV premiums written to be the better indicator of a given
period's origination activity because a substantial part of the Company's
premiums are collected in installments, a practice typical of the asset-backed
business. To calculate PV premiums, management estimates the life of each
transaction that has installment premiums and discounts the future installment
payments at an annual rate of 9.5%, a rate the Company has used consistently
since it began calculating PV premiums.
In a favorable operating environment, in which all of FSA's markets grew in
size, FSA's overall insurance originations reached record levels in 1996. Gross
PV premiums written increased 62.6% to $226.3 million from $139.1 million for
1995. The $125.8 million of asset-backed gross PV premiums written in 1996 was
70.4% higher than the $73.9 million written in 1995. Asset-backed production
increased due to strong volume from FSA-insured securitization programs, as well
as the execution of several large, high-premium transactions in the pooled
corporate obligations sector. Asset-backed volume reached these levels even
though FSA exercised restraint in certain highly competitive asset sectors,
particularly the home equity loan sector, in order to maintain credit quality
and acceptable returns on capital. For the municipal business, gross PV premiums
increased 53.9% to $100.5 million in 1996 from $65.3 million in 1995, due to the
Merger and increased demand for FSA-insured bonds.
Gross premiums written increased 59.8% to $177.0 million for 1996 from
$110.7 million for 1995.
<PAGE>
In 1996, the Company insured bonds totaling $31.1 billion, a 104.2%
increase over the same period in 1995. Compared with the combined FSA and
Capital Guaranty production in 1995, the increase would have been 68.8%. FSA's
1996 asset-backed par insured rose 91.9% to $18.9 billion while its municipal
par insured rose 126.9% to $12.2 billion. Although par originated grew faster
than PV premiums originated, average returns on equity exceeded the Company's
target rate in both the municipal and asset-backed markets. The Company
calculates a return on equity for each transaction based on a risk-weighted
allocation of capital.
Net premiums written were $121.0 million for 1996, an increase of 56.0%
when compared with 1995. The increase in net premiums written was less than that
of gross premiums written because the Company ceded increased amounts on a
facultative basis for the asset-backed business in 1996 in order to maintain the
diversity of risk in the Company's insured portfolio. This level of reinsurance
may not continue at the same rate.
Net premiums earned for 1996 were $90.4 million, compared with $69.3
million for 1995, an increase of 30.4%. Net premiums earned from refundings and
prepayments were $10.3 million for 1996 and $13.8 million for the same period in
1995, contributing $3.8 million and $6.6 million to after-tax earnings. Core net
premiums earned, which exclude the effects of refundings and prepayments, grew
44.3% (21.4% compared with the combined FSA and Capital Guaranty 1995 results).
No assurance can be given that refundings and prepayments will continue at the
level experienced in 1996 or 1995.
Net investment income was $65.1 million for 1996 and $49.0 million for the
comparable period in 1995, an increase of 32.9%. The increase in investment
income is primarily due to additional invested assets acquired in the Merger.
The Company's effective tax rate on investment income decreased to 20.0% for
1996 from 21.9% for 1995 as the holdings of tax-exempt securities increased. The
Company realized $3.2 million of net capital gains for 1996, compared with
realized net capital gains of $5.1 million and the net gain on the sale of a
subsidiary of $2.2 million for the same period in 1995.
The provisions for core losses and loss adjustment expenses for 1996 were
$6.9 million, compared with $6.3 million for 1995, representing additions to the
Company's general loss reserve. During 1996, the Company reclassified $9.0
million from its general reserve to case basis reserves. These case basis
reserves were associated predominantly with certain residential mortgage
transactions. Giving effect to all the 1996 events, the general reserve totaled
$29.7 million at December 31, 1996. In 1995, the Company also recognized a
one-time charge of $15.4 million to increase its general reserve to provide for
the Capital Guaranty portfolio in a manner consistent with FSA's general
reserving methodology. The additions to the general reserve represent
management's estimate of the amount required to cover the net cost of claims
adequately. The Company will, on an ongoing basis, monitor these reserves and
may periodically adjust such reserves based on the Company's actual loss
experience, its future mix of business, and future economic conditions.
Total policy acquisition and other operating expenses were $40.2 million
for 1996, compared with $30.6 million for the same period in 1995, an increase
of 31.5%. Eliminating the effect of refundings and prepayments, core policy
acquisition and other operating expenses would have increased 32.5%. The
increase was primarily the result of higher deferred acquisition cost
amortization, due to a higher level of premiums earned, and increased accruals
for performance plan payouts, due to the addition of another plan year to the
accrual base.
Income before income taxes for 1996 was $109.8 million, up from $75.0
million, or 46.3%, for the same period in 1995.
The Company's effective tax rate for 1996 was 26.4%, compared with 26.7%
for the same period in 1995.
The weighted average number of shares of common stock outstanding increased
to 30,547,000 for 1996 from 25,797,000 for 1995. This increase was due to the
issuance of new shares in the Merger, partially offset by a repurchase of shares
as discussed below in "Liquidity and Capital Resources."
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1995 VERSUS YEAR ENDED DECEMBER 31, 1994
The Company's adjusted book value per common share at December 31, 1995 was
$31.16, up 19.4%, including dividends, since year-end 1994.
The Company's 1995 net income was $55.0 million, compared with $60.4
million for 1994, a decrease of 8.8%. The decrease was due primarily to the
one-time charge of $15.4 million, or $10.0 million after taxes, to increase the
general reserve to provide for the CGIC insured portfolio acquired in the
Merger. As an independent company prior to the Merger, CGIC had not maintained a
general reserve. This one-time increase to the general reserve was consistent
with FSA's established reserving methodology. The decrease in earnings was
partially offset by (i) higher capital gains, which contributed $3.3 million to
net income for 1995, compared with capital losses of $2.5 million for 1994; and
(ii) the realization of a net after-tax gain of $1.4 million on the sale of a
subsidiary after writing off certain previously capitalized expenses.
Operating net income was $60.3 million for 1995 versus $62.8 million for
1994. This 4.1% decrease can be traced to lower contributions from refundings of
$0.2 million and a decline in core net income to $53.7 million for 1995 from
$56.0 million for 1994. The 4.2% decline in core net income resulted primarily
from higher additions to the Company's general loss reserve and a higher
effective tax rate on investment income, both of which are discussed below.
<PAGE>
The weighted average number of shares of common stock outstanding decreased
to 25,797,000 for 1995 from 26,070,000 for 1994 because the Company repurchased
stock to fund various equity-based compensation plans. Earnings per share for
the year decreased to $2.13 for 1995 from $2.32 for 1994.
Overall business origination was strong in 1995. Gross PV premiums written
for the year 1995 increased by 34.4% to $139.1 million from the prior year's
result of $103.5 million. Almost all the growth came from asset-backed business,
where originations increased in all major product lines. Asset-backed gross PV
premiums written grew 88.1% to $73.8 million in 1995, compared with $39.3
million the prior year. FSA insured asset-backed obligations with an aggregate
gross par amount of $9.8 billion for 1995 and $5.6 billion for 1994.
For the municipal business, gross PV premiums written in 1995 increased
1.7% to $65.3 million in 1995 from $64.2 million in 1994. Although FSA
participated selectively in the municipal market in order to mitigate the
effects of price competition and thereby achieved acceptable returns, municipal
gross par insured increased at a faster rate than PV premiums, to $5.4 billion
for 1995 from $4.4 billion for 1994. While the estimated total market par volume
of municipal new issues was $156.2 billion, a decrease of 5% from the 1994
level, the par insured by the financial guaranty industry grew to $68.1 billion
in 1995, 11% higher than in the prior year. The Company believes that the
increased penetration of municipal bond insurance reflects both increased
investor demand for insurance and efforts by some bond insurers to increase
volume by reducing premiums.
Gross premiums written increased 4.0% to $110.7 million for 1995 from
$106.4 million for 1994. Net premiums written were $77.6 million for 1995,
approximately equal to the $77.8 million written for 1994. Net premiums written
were flat despite the increase in gross premiums written because the Company
ceded more business under facultative reinsurance on asset-backed and
international business to meet its internal single-risk limits.
Net premiums earned for 1995 were $69.3 million, compared with $65.8
million for 1994, an increase of 5.5%. Premiums earned from refundings and
prepayments were $13.8 million for 1995 and $14.2 million for 1994, contributing
$6.6 million and $6.8 million, respectively, to after-tax earnings. Core net
premiums earned for the year grew 7.9% relative to the 1994 result.
Net investment income was $49.0 million for 1995 and $46.6 million for
1994, an increase of 5.1%, and was adversely affected by a general decline in
market interest rate levels. Net capital gains realized by the Company were $5.1
million for 1995, compared with a loss of $3.8 million for 1994. Realized
capital gains and losses are by-products of the Company's investment strategy
and may vary substantially from period to period. Over the past year, the
Company has repositioned its investment portfolio from long-dated tax-exempt
securities into shorter-term taxable securities, resulting in the tax rate on
investment income increasing to 21.9% for 1995 from 14.4% for 1994. The
investment portfolio at December 31, 1995 had unrealized gains of $30.7 million,
compared with unrealized losses of $33.4 million at December 31, 1994.
The provisions for core losses and loss adjustment expenses during 1995 and
1994 were $6.3 million and $3.0 million, respectively, representing additions to
the Company's general loss reserve. In December, FSA recognized the one-time
charge of $15.4 million to increase its general reserve to provide for the
Capital Guaranty insured portfolio in a manner consistent with FSA's reserving
methodology. Also during 1995, FSA reclassified $10.8 million from the general
reserve to case reserves associated predominantly with certain residential
mortgage and timeshare receivables transactions. At December 31, 1995, the
balance in the Company's general loss reserve was $31.8 million.
Total policy acquisition and other operating expenses were $30.6 million
for 1995, compared with $28.0 million for 1994, an increase of 9.1%. Core policy
acquisition and other operating expenses were 11.2% higher due to higher
amortization of deferred acquisition costs and increased accruals for
performance-based compensation plans.
Other income increased to $3.8 million for 1995 from $0.8 million for 1994.
This increase was primarily the result of a $2.2 million net gain recognized
from a sale of one of the Company's insurance subsidiaries, whose licenses were
no longer required, net of a write-off of certain previously capitalized costs.
Income before income taxes for 1995 was $75.0 million, down 4.1% from $78.3
million for 1994.
The Company's effective tax rate for 1995 was 26.7%, compared with 22.9%
for 1994. The increase in effective tax rates was due to taxable interest income
contributing a higher proportion of pre-tax income for 1995 than for 1994.
LIQUIDITY AND CAPITAL RESOURCES
The Company's consolidated invested assets and cash equivalents at December
31, 1996, net of unsettled security transactions, was $1,140.0 million, compared
with the December 31, 1995 balance of $1,103.6 million. These balances include
the change in the market value of the investment portfolio, which had an
unrealized gain position of $30.7 million at December 31, 1995, compared with an
unrealized gain position of $14.0 million at December 31, 1996.
At December 31, 1996, the Company had, at the holding company level, an
investment portfolio of $28.7 million available to fund the liquidity needs of
its activities outside of its insurance operations. Because the majority of the
Company's operations are conducted through FSA, the long-term ability of the
Company to service its debt
<PAGE>
and to declare and pay dividends will be largely dependent upon the receipt of
dividends from FSA and upon external financings.
FSA's ability to pay dividends is dependent upon FSA's financial condition,
results of operations, cash requirements, rating agency approval and other
related factors and is also subject to restrictions contained in the insurance
laws and related regulations of New York and other states. Under New York State
insurance law, FSA may pay dividends out of earned surplus, provided that,
together with all dividends declared or distributed by FSA during the preceding
12 months, the dividends do not exceed the lesser of (i) 10% of policyholders'
surplus as of its last statement filed with the New York Superintendent of
Insurance or (ii) adjusted net investment income during this period. FSA paid
dividends of $18.0 million in 1996. Based upon FSA's statutory statements for
the quarter ended December 31, 1996, and considering dividends that can be paid
by its subsidiary, the maximum amount available for payment of dividends by FSA
without regulatory approval over the following 12 months is approximately $45.2
million. As a customary condition for approving, in September 1994, the
application of Fund American for a change in control of FSA, the prior approval
of the New York Superintendent was required for payment of dividends by FSA to
the Company for a period of two years following such change of control. The
prior approval requirement lapsed in September 1996. In addition, the New York
Superintendent has approved the repurchase by FSA of up to $75.0 million of its
shares from the Company through December 31, 1998, pursuant to which FSA has
repurchased $27.0 million of its shares through December 31, 1996. Future share
repurchases may not exceed cumulative statutory net income beginning January 1,
1996.
The primary use of funds by the Company is the payment of dividends to its
shareholders, which totaled $10.5 million in 1996 and $8.3 million in 1995.
Dividends paid were greater in 1996 because of the higher number of shares
outstanding, as a result of the Merger, and an increase in dividends declared to
$0.35 per common share in 1996 from $0.32 in 1995. Other uses of funds are the
annual debt service of $2.1 million on $30.0 million of senior notes assumed by
the Company as a result of the Merger, and repurchases of the Company's common
stock to fund employee benefit plans. In connection with the Merger, FSA
repurchased a portion of its shares from the Company for $50.0 million in
December 1995. These funds replenished funds used by the Company to meet the
cash consideration required by the Merger agreement. During 1995, the Company
also paid current and former members of management $5.6 million in satisfaction
of notes that were received by them in connection with the sale of their
interests in the Company as a part of the Company's acquisition by U S WEST in
1989.
FSA's primary uses of funds are to pay operating expenses, to pay dividends
to the Company and to repurchase stock from the Company. FSA's funds are also
required to satisfy future claims, if any, under insurance policies in the event
of default by an issuer of an insured obligation and the unavailability or
exhaustion of other liquidity sources in the transaction, such as the cash flow
or collateral underlying the obligations. FSA seeks to structure asset-backed
transactions to address liquidity risks through inclusion of such other
liquidity sources in transactions. The insurance policies issued by FSA provide,
in general, that payments of principal, interest and other amounts insured by
FSA may not be accelerated by the holder of the obligation but are paid by FSA
in accordance with the obligation's original payment schedule or, at FSA's
option, on an accelerated basis. These policy provisions prohibiting
acceleration of certain claims are mandatory under Article 69 of the New York
Insurance Law and serve to reduce FSA's liquidity requirements.
The Company believes that FSA's expected operating liquidity needs, both on
a short- and long-term basis, can be funded from its operating cash flow. In
addition, FSA has a number of sources of liquidity that are available to pay
claims on a short- and long-term basis: cash flow from written premiums, FSA's
investment portfolio and earnings thereon, reinsurance arrangements with
third-party reinsurers, liquidity lines of credit with banks, and capital market
transactions.
On April 30, 1996, FSA entered into an agreement with an international
Aaa/AAA-rated bank for a $125.0 million credit facility, which expires on
January 31, 2003, unless extended. This facility is a standby irrevocable
limited recourse line of credit that provides liquidity and credit support to
FSA in the event losses from municipal obligations in FSA's insured portfolio
exceed specified limits. Repayment of amounts drawn under the line will be
limited primarily to recoveries of losses related to such municipal obligations.
In May 1996, the Company repurchased 1.0 million shares of its common stock
from U S WEST for a purchase price of $26.50 per share. At the same time, the
Company also entered into forward agreements with National Westminster Bank Plc
and Canadian Imperial Bank of Commerce (the Counterparties) in respect of 1.75
million shares (the Forward Shares) of the Company's common stock. Under the
forward agreements, the Company has the obligation either to (i) purchase the
Forward Shares from the Counterparties for a price equal to $26.50 per share
plus carrying costs or (ii) direct the Counterparties to sell the Forward
Shares, with the Company receiving any excess or making up any shortfall between
the sale proceeds and $26.50 per share plus carrying costs in cash or additional
shares, at its option. The Company made the economic benefit of 750,000 of these
shares available for subscription by certain employees and its board of
directors. If the Company were to settle these Forward Shares at the Company's
December 31, 1996 market price of $32.875, it would receive approximately
171,000 shares, net of the portion allocable to employees and directors.
<PAGE>
In connection with the Merger, the Company assumed $30.0 million of senior
notes payable of Capital Guaranty Corporation. Interest on these notes is paid
semiannually at the rate of 7.05% per annum. These notes are due in three equal
installments of $10.0 million beginning in 2001 and ending in 2003.
The Company has no material plans for capital expenditures within the next
twelve months.
<PAGE>
[page 25 of 1996 Annual Report]
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors
of Financial Security Assurance Holdings Ltd.:
We have audited the accompanying consolidated balance sheets of Financial
Security Assurance Holdings Ltd. and Subsidiaries as of December 31, 1996 and
1995 and the related consolidated statements of income, changes in shareholders'
equity, and cash flows for each of the three years in the period ended December
31, 1996. 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 Financial Security
Assurance Holdings Ltd. and Subsidiaries at December 31, 1996 and 1995, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles.
COOPERS & LYBRAND L.L.P.
New York, New York
January 24, 1997
<PAGE>
[page 26 of 1996 Annual Report]
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
December 31, December 31,
ASSETS 1996 1995
----------- -----------
<S> <C> <C>
Bonds at market value (amortized cost of $1,058,417 and $1,027,414) $ 1,072,439 $ 1,058,076
Equity investments at market value (cost of $8,336) 8,336 --
Short-term investments 56,733 14,567
Cash equivalents 16,908 38,099
---------- ----------
Total investments 1,154,416 1,110,742
Cash 8,146 1,118
Deferred acquisition costs 146,233 132,951
Prepaid reinsurance premiums 151,224 133,548
Reinsurance recoverable on unpaid losses 29,875 61,532
Other assets 47,848 50,371
---------- ----------
TOTAL ASSETS $1,537,742 $1,490,262
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deferred premium revenue $ 511,196 $ 463,897
Losses and loss adjustment expenses 72,079 111,759
Deferred federal income taxes 41,167 41,936
Ceded reinsurance balances payable 12,599 13,664
Payable for securities purchased 14,390 9,516
Notes payable 30,000 30,000
Accrued expenses and other liabilities 55,051 41,543
---------- ----------
TOTAL LIABILITIES 736,482 712,315
---------- ----------
COMMITMENTS AND CONTINGENCIES
Preferred stock (3,000,000 shares authorized; 2,000,000
issued and outstanding; par value of $.01 per share) 20 20
Common stock (50,000,000 shares authorized; 32,276,301
issued; par value of $.01 per share) 323 323
Additional paid-in capital - preferred 680 680
Additional paid-in capital - common 695,118 696,253
Unrealized gain on investments (net of deferred income tax
provision of $4,908 and $10,731) 9,114 19,931
Accumulated earnings 142,721 72,410
Deferred equity compensation 12,069 6,504
Less treasury stock at cost (2,303,407 and 774,276 shares held) (58,785) (18,174)
---------- ----------
TOTAL SHAREHOLDERS' EQUITY 801,260 777,947
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,537,742 $1,490,262
========== ==========
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an
integral part of these statements.
<PAGE>
[page 27 of 1996 Annual Report]
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
REVENUES:
Net premiums written (net of premiums ceded of
$55,965, $33,166 and $28,692, of which
$35,299, $20,582 and $15,999 were ceded to
affiliates) $121,000 $ 77,576 $ 77,757
Increase in deferred premium revenue (30,552) (8,229) (12,003)
-------- --------- ---------
Premiums earned (net of premiums ceded of
$38,723, $38,013 and $35,051) 90,448 69,347 65,754
Net investment income 65,064 48,965 46,592
Net realized gains (losses) 3,189 5,120 (3,773)
Other income 297 3,841 777
-------- --------- ---------
TOTAL REVENUES 158,998 127,273 109,350
-------- --------- ---------
EXPENSES:
Losses and loss adjustment expenses:
Related to Merger -- 15,400 --
Other (net of reinsurance recoveries of
($2,249), $9,101 and $56,895, of which
($3,084), $7,111 and $50,839 were ceded
to affiliates) 6,874 6,258 3,024
Policy acquisition costs 23,829 16,888 15,057
Other operating expenses 18,524 13,685 12,979
-------- --------- ---------
TOTAL EXPENSES 49,227 52,231 31,060
-------- --------- ---------
INCOME BEFORE INCOME TAXES 109,771 75,042 78,290
-------- --------- ---------
Provision (benefit) for income taxes:
Current 27,227 23,187 9,132
Deferred 1,784 (3,183) 8,783
-------- --------- ---------
Total provision 29,011 20,004 17,915
-------- --------- ---------
NET INCOME $ 80,760 $ 55,038 $ 60,375
-------- --------- ---------
Weighted average common shares outstanding 30,547 25,797 26,070
-------- --------- ---------
Earnings per common share $ 2.64 $ 2.13 $ 2.32
======== ========= =========
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an
integral part of these statements.
<PAGE>
[page 28 of 1996 Annual Report]
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Additional Additional Unrealized
Paid-In Paid-In Gain Deferred
Preferred Common Capital- Capital- (Loss) on Accumulated Equity Treasury
Stock Stock Preferred Common Investments Earnings Compensation Stock Total
----- ----- --------- ------ ----------- -------- ------------ ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1993 $ -- $259 $ -- $537,143 $35,148 (30,578) $ -- $ -- $541,972
Issuance of 2,000,000 shares
of preferred stock 20 680 700
Issuance of employees'
restricted stock 3 7,123 7,126
Net income for the year 60,375 60,375
Net change in unrealized loss
on investments (net of deferred (56,857) (56,857)
income tax benefit of $30,616)
Dividends paid on common
stock ($0.16 per share) (4,150) (4,150)
Purchase of 182,562 shares of
common stock (3,730) (3,730)
--- ---- ---- -------- ----- -------- ------- -------- --------
BALANCE, December 31, 1994 20 262 680 544,266 (21,709) 25,647 (3,730) 545,436
Net income for the year 55,038 55,038
Net change in unrealized gain
on investments (net of deferred 41,640 41,640
income taxes of $22,421)
Issuance of common stock -
6,051,661 shares 61 151,987 152,048
Dividends paid on common
stock ($0.32 per share) (8,275) (8,275)
Deferred equity compensation 6,504 6,504
Purchase of 591,714 shares of
common stock (14,444) (14,444)
--- ---- ---- -------- ----- -------- ------- -------- --------
BALANCE, December 31, 1995 20 323 680 696,253 19,931 72,410 6,504 (18,174) 777,947
Net income for the year 80,760 80,760
Net change in unrealized loss
on investments (net of deferred (10,817) (10,817)
income tax benefit of $5,823)
Dividends paid on common
stock ($0.35 per share) (10,536) (10,536)
Deferred equity compensation 5,565 5,565
Purchase of 1,529,131 shares
of common stock (40,611) (40,611)
Other common stock transactions (1,135) (1,135)
Adjustment to prior year
disposal of subsidiary 87 87
--- ---- ---- -------- ----- -------- ------- -------- --------
BALANCE, December 31, 1996 $20 $323 $680 $695,118 9,114 $142,721 $12,069 $(58,785) $801,260
=== ==== ==== ======== ===== ======== ======= ======== ========
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an
integral part of these statements.
<PAGE>
[page 29 of 1996 Annual Report]
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Premiums received, net $ 124,540 $ 85,481 $ 58,191
Policy acquisition and other operating expenses
paid, net (32,266) (36,067) (24,807)
Recoverable advances received (paid) 10,213 (9,419) (939)
Losses and loss adjustment expenses paid (15,473) (4,954) (5,124)
Net investment income received 63,533 41,939 42,408
Federal income taxes paid (34,595) (15,890) (15,122)
Interest paid (2,115) (95) (578)
Other (4,253) 9,872 (3,995)
----------- --------- ---------
Net cash provided by operating activities 109,584 70,867 50,034
----------- --------- ---------
Cash flows from investing activities:
Proceeds from sales of bonds 1,117,473 624,802 810,006
Proceeds from maturities of bonds 2,965 606 55
Purchases of bonds (1,150,024) (713,799) (786,782)
Purchases of property and equipment (2,188) (999) (981)
Payment for purchase of subsidiary, net of cash
acquired -- (11,447) --
Net decrease (increase) in short-term
investments (18,586) 56,689 (61,552)
----------- --------- ---------
Net cash used for investing activities (50,360) (44,148) (39,254)
----------- --------- ---------
Cash flows from financing activities:
Dividends paid (10,536) (8,275) (4,150)
Treasury stock (41,660) (14,444) (3,730)
Issuance of preferred stock -- -- 700
Payment of management notes -- (5,624) (2,811)
----------- --------- ---------
Net cash used for financing activities (52,196) (28,343) (9,991)
----------- --------- ---------
Net increase (decrease) in cash 7,028 (1,624) 789
Cash at beginning of year 1,118 2,742 1,953
----------- --------- ---------
Cash at end of year $ 8,146 $ 1,118 $ 2,742
=========== ========= =========
</TABLE>
Continued
<PAGE>
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(Dollars in thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Reconciliation of net income to net cash flows
from operating activities:
Net income $ 80,760 $55,038 $60,375
Decrease (increase) in accrued investment income (578) 124 1,433
Increase in deferred premium revenue and related
foreign exchange adjustment 29,622 8,141 12,585
Increase in deferred acquisition costs (13,282) (10,305) (9,847)
Increase (decrease) in current federal income
taxes payable (7,368) 7,297 (5,989)
Increase (decrease) in unpaid losses and loss
adjustment expenses (8,023) 14,587 (376)
Increase (decrease) in amounts withheld for others 52 30 (24,675)
Provision (benefit) for deferred income taxes 1,784 (3,183) 8,783
Net realized losses (gains) on investments (3,189) (5,120) 3,773
Deferred equity compensation 5,565 5,735 --
Depreciation and accretion of bond discount (1,735) (5,735) (4,032)
Change in other assets and liabilities 25,976 4,258 8,004
-------- ------- -------
Cash provided by operating activities $109,584 $70,867 $50,034
======== ======= =======
</TABLE>
Additional common stock was issued in relation to the Merger in 1995.
In 1996, the Company has recharacterized its cash equivalents as short-term
investments. The amounts of cash equivalents recharacterized were $16,908,
$38,099 and $13,516 as of December 31, 1996, 1995 and 1994, respectively.
The accompanying Notes to Consolidated Financial Statements are an
integral part of these statements.
<PAGE>
[pages 30-44 of 1996 Annual Report]
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1. ORGANIZATION AND OWNERSHIP
Financial Security Assurance Holdings Ltd. (the Company) is a holding
company incorporated in the State of New York. The Company is principally
engaged (through its insurance subsidiaries) in providing financial guaranty
insurance on asset-backed financings and municipal obligations. The Company's
underwriting policy is to insure asset-backed and municipal obligations that
would otherwise be investment grade without the benefit of the Company's
insurance. The asset-backed obligations insured by the Company are generally
issued in structured transactions and are backed by pools of assets such as
residential mortgage loans, consumer or trade receivables, securities or other
assets having an ascertainable cash flow or market value. The municipal
obligations insured by the Company consist primarily of general obligation bonds
that are supported by the issuers' taxing power and of special revenue bonds and
other special obligations of states and local governments that are supported by
the issuers' ability to impose and collect fees and charges for public services
or specific projects. Financial guaranty insurance written by the Company
guarantees payment when due of scheduled payments on an issuer's obligation. In
the case of a payment default on an insured obligation, the Company is generally
required to pay the principal, interest or other amounts due in accordance with
the obligation's original payment schedule or, at its option, to pay such
amounts on an accelerated basis.
The Company expects to continue to emphasize a diversified insured
portfolio characterized by insurance of both asset-backed and municipal
obligations, with a broad geographic distribution and a variety of revenue
sources and transaction structures. The Company's insured portfolio consists
primarily of asset-backed and municipal obligations originated in the United
States, but the Company has also written and continues to pursue business in
Europe and the Pacific Rim.
At December 31, 1993, the Company was owned 92.5% by U S WEST Capital
Corporation, a wholly owned subsidiary of U S WEST, Inc. (U S WEST) and 7.5% by
The Tokio Marine and Fire Insurance Co., Ltd. (Tokio Marine). The Company
completed an initial public offering of common shares on May 13, 1994. In
connection with the initial public offering, Fund American Enterprises Holdings,
Inc. (Fund American) acquired an interest in the Company, together with rights
to acquire additional shares of the Company from U S WEST and 2,000,000 shares
of the Company's Series A non-dividend paying, voting, convertible preferred
stock having a liquidation preference of $700,000 (see Note 8). At December 31,
1994, the Company was owned 60.9% by U S WEST, 7.7% by Fund American, 7.4% by
Tokio Marine and 24.0% by the public and employees.
On December 20, 1995, a subsidiary of the Company merged (the Merger) with
Capital Guaranty Corporation (CGC). The Merger provided for each CGC share to be
exchanged for 0.6716 share of the Company's common stock and cash of $5.69. The
Company issued in the aggregate 6,051,661 common shares and paid aggregate cash
consideration of $51,300,000. At December 31, 1995, the Company was owned 50.3%
by U S WEST, 7.8% by Fund American, 6.1% by Tokio Marine and 35.8% by the public
and employees. At December 31, 1996, the Company was owned 40.4% by U S WEST,
11.5% by Fund American, 6.4% by Tokio Marine and 41.7% by the public and
employees.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying financial statements have been prepared in accordance with
generally accepted accounting principles (GAAP), which, for the insurance
company subsidiaries, differ in certain material respects from the accounting
practices prescribed or permitted by insurance regulatory authorities (see Note
6). The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities in the Company's consolidated
balance sheets at December 31, 1996 and 1995 and the reported amounts of
revenues and expenses in the consolidated statements of income during the years
ended December 31, 1996, 1995 and 1994. Such estimates and assumptions include,
but are not limited to, losses and loss adjustment expenses and the deferral and
<PAGE>
amortization of deferred policy acquisition costs. Actual results may differ
from those estimates. Significant accounting policies under GAAP are as follows:
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries, FSA Portfolio Management Inc., CGC,
Transaction Services Corporation, and Financial Security Assurance Inc. (FSA)
and its wholly owned subsidiaries, Financial Security Assurance of Maryland Inc.
(which was named Capital Guaranty Insurance Company until the Merger), Financial
Security Assurance International Inc., Financial Security Assurance of Oklahoma,
Inc. and Financial Security Assurance (U.K.) Limited (collectively, the
Subsidiaries). All intercompany accounts and transactions have been eliminated.
Certain prior-year balances have been reclassified to conform to the 1996
presentation. The Merger was accounted for on a purchase accounting basis. In
view of the short period between the date of the Merger, December 20, 1995, and
the year-end, the date of the Merger for accounting purposes is considered to be
December 31, 1995. As a result, the accounting for the Merger has no effect on
the Company's consolidated statement of income for the year ended December 31,
1995, except for recording of $15,400,000 in losses and loss adjustment expenses
to increase FSA's general reserve to provide for the insured portfolio assumed
by FSA in the Merger (see Notes 17 and 19).
Investments
Investments in debt securities designated as available for sale are carried
at market value. Any resulting unrealized gain or loss is reflected as a
separate component of shareholders' equity, net of applicable deferred income
taxes. All of the Company's long-term investments are classified as available
for sale.
Bond discounts and premiums are amortized on the effective yield method
over the remaining terms of the securities acquired. For mortgage-backed
securities, and any other holdings for which prepayment risk may be significant,
assumptions regarding prepayments are evaluated periodically and revised as
necessary. Any adjustments required due to the resultant change in effective
yields are recognized in current income. Short-term investments, which are those
investments with a maturity of more than three months but less than one year at
time of purchase, are carried at market value, which approximates cost. Realized
gains or losses on sale of investments are determined on the basis of specific
identification. Investment income is recorded as earned.
To manage adverse movements in interest rates, the Company uses exchange
traded futures and options. Primarily, these contracts are designated as hedges
of specific identified securities and any gains or losses on these hedges are
deferred and included as part of the Company's unrealized gains or losses in
stockholder's equity until the disposition of the hedged assets. The Company
will discontinue to account for these contracts as hedges if there ceases to be
a high correlation between the change in price of the hedged assets and the
hedge. Other derivative positions, also in exchange traded futures contracts,
that are not accounted for as hedges are marked-to-market on a daily basis, and
any gains or losses are included in capital gains or losses.
Cash equivalents represent amounts deposited in money market funds and
investments with a maturity at time of purchase of three months or less.
Premium Revenue Recognition
Gross and ceded premiums are earned in proportion to the amount of risk
outstanding over the expected period of coverage. Deferred premium revenue and
prepaid reinsurance premiums represent that portion of premium which is
applicable to coverage of risk to be provided in the future on policies in
force. When an insured issue is retired or defeased prior to the end of the
expected period of coverage, the remaining deferred premium revenue and prepaid
reinsurance premium, less any amount credited to a refunding issue insured by
the Company, are recognized.
Losses and Loss Adjustment Expenses
A case basis reserve for unpaid losses and loss adjustment expenses is
recorded at the present value of the estimated loss when, in management's
opinion, the likelihood of a future loss is probable and determinable at the
balance sheet date. The estimated loss on a transaction is discounted using
current risk-free rates.
The general reserve is calculated by applying a loss factor to the total
net par amount outstanding of the Company's insured obligations outstanding over
the term of such insured obligations and discounting the result at risk-free
rates. The loss factor used for this purpose has been determined based upon an
independent rating agency study of bond defaults and the Company's portfolio
characteristics and history. The general reserve is available to be applied
against future additions or accretions to existing case basis reserves or to new
case basis reserves to be established in the future.
<PAGE>
Management of the Company periodically evaluates its estimates for losses
and loss adjustment expenses and establishes reserves that management believes
are adequate to cover the ultimate net cost of claims; the reserves are
necessarily based on estimates, and there can be no assurance that the ultimate
liability will not differ from such estimates. The Company will, on an ongoing
basis, monitor these reserves and may periodically adjust such reserves based on
the Company's actual loss experience, its future mix of business, and future
economic conditions.
Deferred Acquisition Costs
Deferred acquisition costs comprise those expenses that vary with and are
primarily related to the production of business, including commissions paid on
reinsurance assumed, compensation and related costs of underwriting and
marketing personnel, certain rating agency fees, premium taxes and certain other
underwriting expenses, reduced by ceding commission income on premiums ceded to
reinsurers. Deferred acquisition costs and the cost of acquired business are
amortized over the period in which the related premiums are earned.
Recoverability of deferred acquisition costs is determined by considering
anticipated losses and loss adjustment expenses.
Federal Income Taxes
The provision for income taxes consists of an amount for taxes currently
payable and a provision for tax consequences deferred to future periods
reflected at current income tax rates.
Earnings per Common Share
Earnings per common share is determined by dividing net income by the
weighted average number of common shares outstanding.
3. INVESTMENTS
Bonds at amortized cost of $17,669,000 and $11,969,000 at December 31, 1996
and 1995, respectively, were on deposit with state regulatory authorities as
required by insurance regulations.
Consolidated net investment income consisted of the following (in
thousands):
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Long-term bonds $61,740 $43,789 $47,024
Equity investments 928 -- --
Short-term investments and
cash equivalents 3,966 6,070 935
Investment expenses (1,570) (894) (1,367)
------- ------- -------
Net investment income $65,064 $48,965 $46,592
======= ======= =======
The credit quality of the investment portfolio at December 31, 1996 was
as follows:
Percent of
Rating Investment Portfolio
------------------------------ ----------------------
AAA 68.8%
AA 19.7
A 11.5
<PAGE>
The amortized cost and estimated market value of long-term bonds were as
follows (in thousands):
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
December 31, 1996 Cost Gains Losses Value
- ----------------- ---- ----- ------ -----
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies $ 55,619 $ 1,103 $ (557) $ 56,165
Obligations of states and political
subdivisions 661,831 15,208 (2,870) 674,169
Foreign securities 15,019 197 (71) 15,145
Mortgage-backed securities 177,818 1,432 (906) 178,344
Corporate securities 76,760 381 (403) 76,738
Asset-backed securities 71,370 680 (172) 71,878
---------- ------- -------- ----------
Total $1,058,417 $19,001 $(4,979) $1,072,439
========== ======= ======= ==========
December 31, 1995
- -----------------
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies $ 45,139 $ 2,232 $ -- $ 47,371
Obligations of states and political
subdivisions 643,624 20,412 (330) 663,706
Foreign securities 28,691 1,909 (17) 30,583
Mortgage-backed securities 265,213 5,949 (75) 271,087
Corporate securities 1,254 51 -- 1,305
Asset-backed securities 43,493 531 -- 44,024
---------- ------- ----- ----------
Total $1,027,414 $31,084 $(422) $1,058,076
========== ======= ===== ==========
</TABLE>
The change in net unrealized gains (losses) consisted of (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Long-term bonds $(16,640) $64,061 $(87,490)
Short-term investments -- -- 17
-------- ------- --------
Change in net unrealized gains (losses) $(16,640) $64,061 $(87,473)
======== ======= ========
</TABLE>
<PAGE>
The amortized cost and estimated market value of long-term bonds at
December 31, 1996 and 1995, by contractual maturity, are shown below (in
thousands). Actual maturities could differ from contractual maturities because
borrowers have the right to call or prepay certain obligations with or without
call or prepayment penalties.
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
----------------- -----------------
Estimated Estimated
Amortized Market Amortized Market
Cost Value Cost Value
---- ----- ---- -----
<S> <C> <C> <C> <C>
Due in one year or less $ 38,305 $ 38,626 $ 2,776 $ 2,778
Due after one year through five years 57,531 57,712 26,036 26,375
Due after five years through ten years 105,495 105,848 157,161 162,573
Due after ten years 607,898 620,031 532,735 551,239
Mortgage-backed securities (stated
maturities of 16 to 30 years) 177,818 178,344 265,213 271,087
Asset-backed securities (stated
maturities of 2 to 5 years) 71,370 71,878 43,493 44,024
---------- ---------- ---------- ----------
Total $1,058,417 $1,072,439 $1,027,414 $1,058,076
========== ========== ========== ==========
</TABLE>
Proceeds from sales of long-term bonds during 1996, 1995 and 1994 were
$1,118,112,000, $608,773,000 and $826,261,000, respectively. Gross gains of
$15,335,000, $12,434,000 and $14,031,000 and gross losses of $12,146,000,
$7,314,000 and $17,804,000 were realized on sales in 1996, 1995 and 1994,
respectively.
To hedge against changes in yields on certain one-year corporate
securities, the Company has entered into a series of Eurodollar futures
contracts, which are marked-to-market on a daily basis. These contracts are
accounted for as a hedge. As of year-end, the net unrealized loss on the
contracts, included in the Company's unrealized gains in stockholders' equity
section, is not material. The aggregate notional amount of these contracts is
$83,728,000 as of December 31, 1996.
The Company holds open positions in U.S. Treasury bond futures contracts
with an aggregate notional amount of $20,600,000 as of December 31, 1996. These
positions are marked-to-market on a daily basis, and for the year ended December
31, 1996, the Company reported a net realized gain of $923,000, which is
included in gross realized capital gains above.
4. DEFERRED ACQUISITION COSTS
Acquisition costs deferred for amortization against future income and the
related amortization charged to expenses are as follows (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Balance, beginning of period $132,951 $ 91,839 $81,992
-------- -------- -------
Costs deferred during the period:
Ceding commission income (15,956) (9,836) (8,476)
Assumed commission expense 38 55 84
Premium taxes 3,718 2,537 2,589
Compensation and other acquisition costs 49,311 34,437 30,707
-------- -------- -------
Total 37,111 27,193 24,904
-------- -------- -------
Costs amortized during the period (23,829) (16,888) (15,057)
-------- -------- -------
Balance of acquired subsidiary -- 30,807 --
-------- -------- -------
Balance, end of period $146,233 $132,951 $91,839
======== ======== =======
</TABLE>
<PAGE>
5. OTHER OPERATING EXPENSES
Total salary expense and related benefits included in other operating
expenses were $14,596,000, $12,046,000 and $10,369,000 for the years ended
December 31, 1996, 1995 and 1994, respectively.
6. STATUTORY ACCOUNTING PRACTICES
GAAP for the Subsidiaries differs in certain significant respects from
accounting practices prescribed or permitted by insurance regulatory
authorities. The principal differences result from the following statutory
accounting practices:
- Upfront premiums on municipal business are recognized as earned when
related risk has expired rather than over the expected coverage period;
- Acquisition costs are charged to operations as incurred rather than as
related premiums are earned;
- A contingency reserve is computed based on the following statutory
requirements (rather than establishing a general loss reserve):
a. For all policies written prior to July 1, 1989, an amount equal to
50% of cumulative earned premiums less permitted reductions, plus;
b. For all policies written on or after July 1, 1989, an amount equal
to the greater of 50% of premiums written for each category of insured
obligation or a designated percentage of principal guaranteed for that
category. These amounts are provided each quarter as either 1/60th or
1/80th of the total required for each category, less permitted reductions;
- Certain assets designated as "non-admitted assets" are charged directly
to statutory surplus but are reflected as assets under GAAP;
- Federal income taxes are provided only on taxable income for which income
taxes are currently payable;
- Accruals for deferred compensation are not recognized;
- Purchase accounting adjustments are not recognized;
- Bonds are carried at amortized cost.
A reconciliation of net income for the calendar years 1996, 1995 and 1994
and shareholders' equity at December 31, 1996, 1995 and 1994, reported by the
Company on a GAAP basis, to the amounts reported by the Subsidiaries on a
statutory basis, is as follows (in thousands):
<TABLE>
<CAPTION>
Net Income: 1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
GAAP BASIS $80,760 $55,038 $60,375
Non-insurance companies net loss (gain) 95 (50) (111)
Premium revenue recognition (5,518) (4,805) (5,425)
Losses and loss adjustment expenses incurred (2,138) 10,871 (13,908)
Deferred acquisition costs (12,482) (10,305) (9,847)
Deferred income tax provision (benefit) 911 (3,055) 4,682
Amortization of bonds 566 1,195 520
Accrual of deferred compensation 12,737 5,663 (9,062)
Other 1,404 (1,580) (274)
------- ------- -------
STATUTORY BASIS $76,335 $52,972 $26,950
======= ======= =======
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------
Shareholders' Equity: 1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
GAAP BASIS $801,260 $777,947 $545,436
Non-insurance companies liabilities (assets), net 14,072 12,039 (16,460)
Premium revenue recognition (51,760) (46,248) (29,891)
Loss and loss adjustment expense reserves 29,660 31,798 20,927
Deferred acquisition costs (146,233) (132,951) (91,839)
Contingency reserve (227,139) (183,967) (121,414)
Unrealized loss (gain) on investments, net of tax (14,084) (30,298) 32,868
Deferred income taxes 41,682 43,205 10,222
Accrual of deferred compensation 18,390 5,653 --
Other (17,043) (16,492) (5,475)
-------- -------- --------
STATUTORY BASIS (SURPLUS) $448,805 $460,686 $344,374
======== ======== ========
SURPLUS PLUS CONTINGENCY RESERVE $675,944 $644,653 $465,788
======== ======== ========
</TABLE>
7. FEDERAL INCOME TAXES
For periods prior to May 13, 1994, the date of the initial public offering
when the Company became less than 80% owned by U S WEST, the Company and its
Subsidiaries joined with U S WEST and its subsidiaries in filing a consolidated
federal income tax return. Under a U S WEST practice, an income tax benefit or
liability was allocated to the Company to the extent that benefits were usable
or additional liabilities were incurred by U S WEST due to the Company's
inclusion in the U S WEST tax returns. For each year since the Company's
acquisition by U S WEST, the Company's resulting income tax provision has been
the same as if the allocation of taxes were based on a separate return
calculation. For the Subsidiaries, under a separate tax sharing agreement with U
S WEST, the allocation of income taxes was based upon separate return
calculations which provided that benefits or liabilities created by the
Subsidiaries are allocated to the Subsidiaries regardless of whether the
benefits were usable or additional liabilities were incurred in the U S WEST tax
returns. For periods subsequent to May 12, 1994, the Company and all members of
its group elected to file consolidated federal income tax returns. The
calculation of each member's tax benefit or liability was controlled by a tax
sharing agreement that based the allocation of such benefit or liability upon a
separate return calculation.
The cumulative balance sheet effects of deferred tax consequences are (in
thousands):
December 31,
------------
1996 1995
---- ----
Deferred acquisition costs $51,182 $46,533
Deferred premium revenue adjustments 3,520 2,905
Unrealized capital gains 7,952 15,077
Contingency reserves 30,893 11,542
Market discounts 1,950 913
------- -------
Total deferred tax liabilities 95,497 76,970
------- -------
Loss and loss adjustment expense reserves (10,381) (11,129)
Deferred compensation (10,730) (6,046)
Tax credits (7,861) (3,813)
Tax and loss bonds (22,526) (11,116)
Other, net (2,832) (2,930)
------- -------
Total deferred tax assets (54,330) (35,034)
------- -------
Total deferred income taxes $41,167 $41,936
======= =======
No valuation allowance was necessary at December 31, 1996 or 1995.
<PAGE>
A reconciliation of the effective tax rate with the federal statutory rate
follows:
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Tax at statutory rate 35.0% 35.0% 35.0%
Tax-exempt interest (8.9) (8.5) (12.3)
Other 0.3 0.2 0.2
---- ---- ----
Provision for income taxes 26.4% 26.7% 22.9%
==== ==== ====
8. SHAREHOLDERS' EQUITY
Pursuant to the Supplemental Restricted Stock Plan, on May 13, 1994, awards
of outstanding units to existing employees under the FSA Profit Participation
Plan were valued at $0.20 per dollar of award ($0.70 per dollar of award in the
case of 1994 regular units granted thereunder) and, at the election of each
outstanding employee, were exchanged for restricted shares of common stock
valued at the initial public offering price of $20.00 per share. In exchange for
an accrued balance of approximately $7.1 million in such Profit Participation
Plan, the Company issued 356,345 shares of restricted stock (see Note 11).
On September 2, 1994, the Company issued to Fund American 2,000,000 shares
of Series A, non-dividend paying, voting, convertible preferred stock having an
aggregate liquidation preference of $700,000. The preferred stock is
convertible, at the option of the holder upon payment of the conversion price
therefor, into an equal number of shares of common stock (subject to
anti-dilutive adjustment). The conversion price per share (subject to
anti-dilutive adjustment) is $29.65. The preferred stock will be redeemed (if
then outstanding) on May 13, 2004 at a redemption price of $0.35 per share. Fund
American is entitled to one vote per share of preferred stock, voting together
as a single class with the Common Stock on all matters upon which holders of
Common Stock are entitled to vote. As the holder of the preferred stock, Fund
American is not entitled to receive dividends or other distributions of any kind
payable to shareholders of the Company, except that, in the event of the
liquidation, dissolution or winding up of the Company, it is entitled to receive
out of the assets of the Company available therefor, before any distribution or
payment is made to the holders of common stock or to any other class of capital
stock of the Company ranking junior to the Company's preferred stock,
liquidation payments in the amount of $0.35 per share. Fund American may not
transfer the preferred stock, except to a majority-owned subsidiary.
On December 20, 1995, CGC merged with a subsidiary of the Company. The
Merger provided for each CGC share to be exchanged for 0.6716 share of the
Company's common stock and cash of $5.69. The Company issued in the aggregate
6,051,661 common shares and paid aggregate cash consideration of $51,300,000.
In May 1996, the Company repurchased 1,000,000 shares of its common stock
from U S WEST for a purchase price of $26.50 per share. At the same time, the
Company also entered into forward agreements with National Westminster Bank Plc
and Canadian Imperial Bank of Commerce (the Counterparties) in respect of
1,750,000 shares (the Forward Shares) of the Company's common stock. Under the
forward agreements, the Company has the obligation either to: (a) purchase the
Forward Shares from the Counterparties for a price equal to $26.50 per share
plus carrying costs or (b) direct the Counterparties to sell the Forward Shares,
with the Company receiving any excess or making up any shortfall between the
sale proceeds and $26.50 per share plus carrying costs in cash or additional
shares, at its option. Simultaneous with the Company entering into the forward
agreements, the Company made the economic benefit of 750,000 of these shares
available for subscription by certain employees and its board of directors. If
the Company were to settle these Forward Shares, at the Company's December 31,
1996 market price of $32.875, it would receive approximately 171,000 shares, net
of the portion allocable to employees and directors.
<PAGE>
9. DIVIDENDS AND CAPITAL REQUIREMENTS
Under New York Insurance Law, FSA may pay a dividend to the Company without
the prior approval of the Superintendent of the New York State Insurance
Department only from earned surplus subject to the maintenance of a minimum
capital requirement. In addition, the dividend, together with all dividends
declared or distributed by FSA during the preceding twelve months, may not
exceed the lesser of 10% of its policyholders' surplus shown on FSA's last filed
statement, or adjusted net investment income, as defined, for such twelve-month
period. As of December 31, 1996, FSA had $45,184,000 available for the payment
of dividends over the next twelve months. As a customary condition for approving
the application of Fund American for a change in control of FSA, the prior
approval of the Superintendent of the State of New York Insurance Department was
required for any payment of dividends by FSA to the Company for a period of two
years following such changed control. Such approval was provided for the payment
of dividends by FSA to the Company in 1996, 1995 and 1994 in the ordinary course
of business. Such prior approval requirement lapsed in September 1996. In
addition, the New York Superintendent has approved the repurchase by FSA of up
to $75,000,000 of its shares from the Company through December 31, 1998,
pursuant to which FSA has repurchased $27,000,000 of its shares through December
31, 1996. Future share repurchases may not exceed cumulative statutory net
income beginning January 1, 1996.
10. CREDIT ARRANGEMENTS AND ADDITIONAL CLAIMS-PAYING RESOURCES
The Company has a credit arrangement aggregating $150,000,000 at December
31, 1996, which is provided by commercial banks and intended for general
application to transactions insured by the Subsidiaries. At December 31, 1996,
there have been no borrowings under this arrangement. In addition, there are
credit arrangements assigned to specific insured transactions. In August 1994,
FSA entered into a facility agreement with Canadian Global Funding Corporation
and Hambros Bank Limited. Under the agreement, FSA can arrange financing for
transactions subject to certain conditions. The amount of this facility was
$186,911,000, of which $100,911,000 was unutilized at December 31, 1996.
FSA has a standby line of credit commitment in the amount of $125,000,000
with an international Aaa/AAA-rated bank to provide loans to FSA after it has
incurred, during the term of the facility, cumulative municipal losses (net of
any recoveries) in excess of the greater of $200,000,000 or 5.75% of average
annual debt service. The obligation to repay loans made under this agreement is
a limited recourse obligation payable solely from, and collateralized by, a
pledge of recoveries realized on defaulted insured obligations including certain
installment premiums and other collateral. This commitment has a term beginning
on April 30, 1996 and expiring on January 31, 2003 and contains an annual
renewal provision subject to approval by the bank.
In connection with the Merger, the Company assumed $30,000,000 of CGC's
senior notes. Interest on these notes is paid semiannually at the rate of 7.05%
per annum. Repayment of these notes is due in three equal installments of
$10,000,000 beginning in 2001 and ending in 2003.
11. EMPLOYEE BENEFIT PLANS
The Subsidiaries maintain both a qualified and a non-qualified
non-contributory defined contribution pension plan for the benefit of all
eligible employees. The Subsidiaries' contributions are based upon a fixed
percentage of employee compensation. Pension expense, which is funded as
accrued, amounted to $2,215,000, $1,898,000 and $1,965,000 for the years ended
December 31, 1996, 1995 and 1994, respectively.
The Subsidiaries have an employee retirement savings plan for the benefit
of all eligible employees. The plan permits employees to contribute a percentage
of their salaries up to limits prescribed by the Internal Revenue Service (IRS
Code, Section 401(k)). The Subsidiaries' contributions are discretionary, and
none have been made.
<PAGE>
During 1991, the Subsidiaries established the Profit Participation Plan as
a long-term incentive compensation plan for the benefit of certain of its
employees. Prior to the initial public offering, the Company adopted a
Supplemental Restricted Stock Plan. Pursuant to this plan, awards of outstanding
units to existing employees under the Profit Participation Plan were valued at
$0.20 per dollar of award ($0.70 per dollar of award in the case of 1994 regular
units granted thereunder) and, at the election of each outstanding employee,
were exchanged for restricted shares of common stock valued at the initial
public offering price of $20.00 per share. All employees of the Company,
including all senior executives, exchanged their outstanding interests in the
Profit Participation Plan for restricted shares of common stock at the public
offering price under the Supplemental Restricted Stock Plan. In exchange for an
accrued balance of $7,126,000 in such Profit Participation Plan, the Company
issued 356,345 shares of restricted stock. This transaction was treated as a
non-cash financing transaction for cash flow purposes. The stock was restricted
because ownership of the shares by employees required continued employment; the
shares vested ratably over a three-year period on July 1, 1994, 1995 and 1996.
Pursuant to the 1993 Equity Participation Plan, 1,810,780 shares of common
stock, subject to anti-dilutive adjustment, were reserved for awards of options,
restricted shares of common stock, and performance shares to employees for the
purpose of providing, through the grant of long-term incentives, a means to
attract and retain key personnel and to provide to participating officers and
other key employees long-term incentives for sustained high levels of
performance. Shares available under the 1993 Equity Participation Plan were
increased from 1,810,780 to 2,110,780 in May 1995. The 1993 Equity Participation
Plan also contains provisions that permit the Human Resources Committee to pay
all or a portion of an employee's bonuses in the form of shares of common stock
credited to the employees at a 15% discount from current market value and paid
to employees five years from the date of award. Up to an aggregate of 10,000,000
shares may be allocated to such equity bonuses. Common stock to pay equity bonus
awards will be acquired by the Company through open-market purchases by a trust
established for such purpose.
During 1994, under the Company's 1993 Equity Participation Plan, the
Company granted to officers and employees, in respect of future performance,
non-qualified options to purchase an aggregate of 1,099,000 shares of common
stock, of which 39,000 were forfeited and 1,060,000 were still outstanding at
December 31, 1994, substantially all of which have an exercise price of $20.00
per share. (As described below, 1,025,500 of these options were converted to
performance shares.) The foregoing options vest, subject to continuation of
employment and other terms of the option grants, at the rate of 20% per year,
for five one-year periods, with the first period ending on July 1, 1994. Such
options expire ten years after the effective dates of their grant. In the fourth
quarter of 1994, holders of outstanding stock options under the 1993 Equity
Participation Plan were offered the right to exchange such stock options for an
equal number of performance shares under such Plan. Also, as a result of the
Merger, the Company granted 169,956 of stock options with strike prices ranging
from $18.63 to $23.53 per share to employees of CGC in exchange for outstanding
stock options of CGC. Giving effect to such exchange and subsequent awards, at
December 31, 1996, there were outstanding 1,374,340 performance shares and
201,956 options to purchase shares of common stock.
Performance shares granted under the 1993 Equity Participation Plan were as
follows:
Outstanding Granted Forfeited Outstanding Market
at Beginning During During at End Price at
of Year the Year the Year of Year Grant Date
------- -------- -------- ------- ----------
1994 -- 1,025,500 -- 1,025,500 $21.875
1995 1,025,500 83,650 -- 1,109,150 19.250
1996 1,109,150 282,490 17,300 1,374,340 25.250
The Company applies APB Opinion 25 and related Interpretations in
accounting for its performance shares. The Company estimates the final cost of
these performance shares and accrues for this expense over the performance
period. The accrued expense for the performance shares was $13,741,000 and
$5,744,000 for the years ended December 31, 1996 and 1995, respectively. In
tandem with this accrued expense, the Company estimates those performance shares
that it expects to settle in stock and records this amount in stockholders'
equity as deferred compensation. The remainder of the accrual, which represents
the amount of performance shares that the Company estimates it will settle in
cash, is recorded in accrued expenses and other liabilities. In 1996, the
Company adopted disclosure provisions of FASB Statement 123. Had the
compensation cost for the Company's performance shares been determined based
upon fair value at the grant dates for the awards consistent with the method of
FASB Statement 123, the effect on the Company's net income and earnings per
share would have been immaterial.
<PAGE>
In November 1994, the Company appointed an independent trustee authorized
to purchase shares of the Company's common stock in open market transactions, at
times and prices determined by the trustee. These purchases are intended to fund
future obligations relating to equity bonuses, performance shares and stock
options under the 1993 Equity Participation Plan. During 1996, 1995 and 1994,
the total number of shares purchased by the trust was 529,131, 591,714 and
182,562, respectively, at a cost of $14,111,000, $14,444,000 and $3,730,000,
respectively. The Company also repurchased stock from its employees in
satisfaction of withholding taxes on shares distributed under its restricted
stock plan.
The Company does not currently provide post-retirement benefits, other than
pensions, to its employees, nor does it provide post-employment benefits to
former employees.
12. COMMITMENTS AND CONTINGENCIES
The Company and its Subsidiaries lease office space and equipment under
non-cancelable operating leases, which expire at various dates through 2005.
Future minimum rental payments are as follows (in thousands):
Year Ended December 31,
-----------------------
1997 $ 2,257
1998 2,267
1999 2,229
2000 2,169
2001 2,014
Thereafter 6,810
-------
Total $17,746
=======
Rent expense for the years ended December 31, 1996, 1995 and 1994 was
$3,816,000, $3,712,000 and $3,535,000, respectively.
During the ordinary course of business, the Subsidiaries have become
parties to certain litigation. Management believes that these matters will be
resolved with no material financial impact on the Company.
13. REINSURANCE
The Subsidiaries reinsure portions of their risks with affiliated (see Note
15) and unaffiliated reinsurers under quota share treaties and on a facultative
basis. The Subsidiaries' principal ceded reinsurance program consisted in 1996
of three quota share treaties and three automatic facultative facilities. One
treaty covers all of the Subsidiaries' approved regular lines of business,
except municipal obligation insurance. Under this treaty in 1996, the
Subsidiaries ceded 11.35% of each covered policy, up to a maximum of $22,700,000
insured principal per policy. At their sole option, the Subsidiaries could have
increased, and in certain instances did increase, the ceding percentage to 22.7%
up to $45,400,000 of each covered policy. A second treaty covers the
Subsidiaries' municipal obligation insurance business. Under this treaty in
1996, the Subsidiaries ceded 10% of each covered policy that is classified by
the Subsidiaries as providing municipal bond insurance as defined by Article 69
of the New York Insurance Law up to a limit of $26,667,000 per single risk,
which is defined by revenue source. At their sole option, the Subsidiaries could
have increased, and in certain instances did increase, the ceding percentage to
30% up to $80,000,000 per single risk. Under the third treaty in 1996, the
Subsidiaries ceded 5% of their retention (i.e., after cessions of policies under
the municipal obligation insurance treaty) covering substantially all teaching
hospital and higher education risks, up to limits that range from $7,500,000 to
$30,000,000 per single risk (depending on the type of obligation). At their sole
option, the Subsidiaries could have increased, and in certain instances did
increase, the ceding percentage from 5% to 15% of their retention, subject to
the same limits. This third treaty was canceled on a run-off basis as of
December 31, 1996. Under the three automatic facultative facilities in 1996, the
Subsidiaries at their option could allocate up to $20,000,000 or $25,000,000 for
each reinsurer (depending on the reinsurer) for each transaction, subject to
limits and exclusions, in exchange for which the Subsidiaries agreed to cede in
the aggregate a specified percentage of gross par insured by the Subsidiaries.
Each of the three treaties and automatic facultative facilities allows the
Subsidiaries to withhold a ceding commission to defray their expenses.
<PAGE>
In the event (which management considers to be highly unlikely) that any or
all of the reinsuring companies were unable to meet their obligations to the
Subsidiaries, the Subsidiaries would be liable for such defaulted amounts. The
Subsidiaries have also assumed reinsurance of municipal obligations from
unaffiliated insurers.
Amounts reinsured were as follows (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Written premiums ceded $55,965 $33,166 $28,692
Written premiums assumed 1,873 1,684 1,973
Earned premiums ceded 38,723 38,013 35,051
Earned premiums assumed 6,020 2,759 7,059
Loss and loss adjustment expense payments
ceded 29,408 3,060 1,483
Loss and loss adjustment expense payments
assumed 3 3 3
Incurred losses and loss adjustment expenses ceded (2,249) 9,101 56,895
Incurred losses and loss adjustment expenses
assumed 38 81 137
</TABLE>
December 31,
------------
1996 1995
---- ----
Principal outstanding ceded $20,292,615 $14,355,664
Principal outstanding assumed 1,995,752 2,347,122
Deferred premium revenue ceded 151,224 133,548
Deferred premium revenue assumed 18,929 5,027
Loss and loss adjustment expense reserves ceded 29,875 61,532
Loss and loss adjustment expense reserves assumed 705 670
14. OUTSTANDING EXPOSURE AND COLLATERAL
The Company's policies insure the scheduled payments of principal and
interest on asset-backed and municipal obligations. The principal amount insured
(in millions) as of December 31, 1996 and 1995 (net of amounts ceded to other
insurers of $9,601 and $6,093 of asset-backed and $10,691 and $8,263 of
municipal, respectively) and the terms to maturity are as follows:
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
----------------- -----------------
Terms to Maturity Asset-Backed Municipal Asset-Backed Municipal
- ----------------- ------------ --------- ------------ ---------
<S> <C> <C> <C> <C>
0 to 5 Years $ 7,424 $ 1,571 $ 5,931 $ 3,293
5 to 10 Years 3,920 3,841 3,679 4,713
10 to 15 Years 1,461 6,272 1,183 4,299
15 to 20 Years 714 11,433 423 6,986
20 Years and Above 9,681 12,877 5,847 9,625
- ------------ ------- ------- ------- -------
Total $23,200 $35,994 $17,063 $28,916
======= ======= ======= =======
</TABLE>
<PAGE>
The principal amount ceded as of December 31, 1996 and 1995 and the terms
to maturity are as follows (in millions):
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
----------------- -----------------
Terms to Maturity Asset-Backed Municipal Asset-Backed Municipal
- ----------------- ------------ --------- ------------ ---------
<S> <C> <C> <C> <C>
0 to 5 Years $3,695 $ 769 $2,297 $1,103
5 to 10 Years 2,413 1,192 1,503 1,775
10 to 15 Years 452 1,479 403 1,020
15 to 20 Years 302 2,345 126 1,514
20 Years and Above 2,739 4,906 1,764 2,851
------ --------- ------ ------
Total $9,601 $10,691 $6,093 $8,263
====== ======= ====== ======
</TABLE>
The Company limits its exposure to losses from writing financial guarantees
by underwriting investment-grade obligations, by diversifying its portfolio and
by maintaining rigorous collateral requirements on asset-backed obligations. The
gross principal amounts of insured obligations in the asset-backed insured
portfolio are backed by the following types of collateral (in millions):
<PAGE>
<TABLE>
<CAPTION>
Net of Amounts Ceded Ceded
December 31, December 31,
------------ ------------
Types of Issues 1996 1995 1996 1995
- --------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
Residential mortgages $10,987 $ 6,740 $3,077 $1,909
Consumer receivables 7,548 5,105 3,735 1,320
Government securities 1,477 1,651 449 263
Pooled corporate obligations 1,663 1,819 852 732
Commercial mortgage portfolio:
Commercial real estate 113 148 463 640
Corporate secured 66 98 619 801
Investor-owned utility obligations 791 821 266 292
Other asset-backed obligations 555 681 140 136
------- -------- ------ ------
Total asset-backed obligations $23,200 $17,063 $9,601 $6,093
======= ======= ====== ======
</TABLE>
<PAGE>
The asset-backed insured portfolio, which aggregated $32.8 billion
principal before reinsurance at December 31, 1996, was collateralized by assets
with an estimated fair value of $38.3 billion. At December 31, 1995, it
aggregated $23.2 billion principal before reinsurance and was collateralized by
assets with an estimated fair value of $28.0 billion. Such estimates of the
collateral's fair value, which is reduced as exposure expires, are based upon
information at the inception of the insurance policy. At December 31, 1996, the
estimated fair value of collateral and reserves over the principal insured
averaged from 100% for commercial real estate to 168% for corporate secured
obligations. At December 31, 1995, the estimated fair value of collateral and
reserves over the principal insured averaged from 100% for commercial real
estate to 164% for corporate secured obligations. Collateral for specific
transactions is generally not available to pay claims related to other
transactions. The amounts of losses ceded to reinsurers are determined net of
collateral.
The gross principal amount of insured obligations in the municipal insured
portfolio includes the following types of issues (in millions):
<TABLE>
<CAPTION>
Net of Amounts Ceded Ceded
December 31, December 31,
------------ ------------
Types of Issues 1996 1995 1996 1995
- --------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
General obligation bonds $12,523 $ 8,738 $ 2,423 $1,764
Housing revenue bonds 1,794 1,674 1,033 685
Municipal utility revenue bonds 4,671 3,873 1,472 1,107
Health care revenue bonds 2,854 2,587 2,049 1,718
Tax-supported bonds (non-general obligation) 8,805 7,090 2,152 1,741
Transportation revenue bonds 1,479 1,365 436 293
Other municipal bonds 3,868 3,589 1,126 955
------- -------- -------- ------
Total municipal obligations $35,994 $28,916 $10,691 $8,263
======= ======= ======= ======
</TABLE>
<PAGE>
In its asset-backed business, the Company considers geographic
concentration as a factor in underwriting insurance covering securitizations of
pools of such assets as residential mortgages or consumer receivables. However,
after the initial issuance of an insurance policy relating to such
securitization, the geographic concentration of the underlying assets may not
remain fixed over the life of the policy. In addition, in writing insurance for
other types of asset-backed obligations, such as securities primarily backed by
government or corporate debt, geographic concentration is not deemed by the
Company to be significant given other more relevant measures of diversification
such as issuer or industry.
The Company seeks to maintain a diversified portfolio of insured municipal
obligations designed to spread its risk across a number of geographic areas. The
following table sets forth, by state, those states in which municipalities
located therein issued an aggregate of 2% or more of the Company's net par
amount outstanding of insured municipal securities as of December 31, 1996:
<TABLE>
<CAPTION>
Net Par Percent of Total Ceded Par
Number Amount Municipal Net Par Amount
State of Issues Outstanding Amount Outstanding Outstanding
----- --------- ----------- ------------------ -----------
(in millions) (in millions)
<S> <C> <C> <C> <C>
California 337 $ 5,669 15.8% $ 1,091
Florida 96 2,189 6.1 772
New York 218 3,508 9.7 1,733
Pennsylvania 157 2,106 5.9 551
New Jersey 175 1,733 4.8 461
Louisiana 81 908 2.5 379
Michigan 118 1,145 3.2 361
Minnesota 113 1,080 3.0 102
Massachusetts 84 1,093 3.0 393
Illinois 193 1,320 3.7 210
Texas 248 1,804 5.0 412
Wisconsin 114 762 2.1 186
All Other States 923 11,698 32.5 3,413
Non-U.S. 26 979 2.7 627
----- ------- ----- -------
Total 2,883 $35,994 100.0% $10,691
===== ======= ===== =======
</TABLE>
15. RELATED PARTY TRANSACTIONS
The Subsidiaries ceded premiums of $19,890,000, $13,061,000 and $6,609,000
to Tokio Marine for the years ended December 31, 1996, 1995 and 1994,
respectively. The amounts included in prepaid reinsurance premiums at December
31, 1996 and 1995 for reinsurance ceded to Tokio Marine were $44,634,000 and
$33,382,000, respectively. Reinsurance recoverable on unpaid losses ceded to
Tokio Marine was $477,000 and $323,000 at December 31, 1996 and 1995,
respectively.
The Subsidiaries ceded premiums of $15,409,000, $7,522,000 and $9,390,000
on a quota share basis to affiliates of U S WEST for the years ended December
31, 1996, 1995 and 1994, respectively, of which $372,000, $629,000 and
$1,838,000, respectively, were ceded to Commercial Reinsurance Company
(Commercial Re). The amounts included in prepaid reinsurance premiums for
reinsurance ceded to these affiliates were $49,649,000 and $39,918,000 at
December 31, 1996 and 1995, respectively, of which $8,728,000 and $10,720,000,
respectively, were ceded to Commercial Re. The amounts of reinsurance
recoverable on unpaid losses ceded to these affiliates at December 31, 1996 and
1995 were $23,473,000 and $55,024,000, respectively, of which $19,170,000 and
$42,918,000, respectively, were ceded to Commercial Re. The Commercial Re
reinsurance agreement was subject to, and received, the non-disapproval of the
State of New York Insurance Department due to its nature as an affiliate
transaction. FSA has taken credit for the reinsurance ceded to Commercial Re.
<PAGE>
16. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following estimated fair values have been determined by the Company
using available market information and appropriate valuation methodologies.
However, considerable judgment is necessary to interpret the data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amount the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
Long-term bonds -- The carrying amount of long-term bonds represents fair
value. The fair value of long-term bonds is based upon quoted market price.
Short-term investments -- The carrying amount is fair value, which
approximates cost due to the short maturity of these instruments.
Cash and cash equivalents, receivable for investments sold and payable for
investments purchased -- The carrying amount approximates fair value because of
the short maturity of these instruments.
Deferred premium revenue, net of prepaid reinsurance premiums -- The
carrying amount of deferred premium revenue, net of prepaid reinsurance
premiums, represents the Company's future premium revenue, net of reinsurance,
on policies where the premium was received at the inception of the insurance
contract. The fair value of deferred premium revenue net of prepaid reinsurance
premiums is an estimate of the premiums that would be paid under a reinsurance
agreement with a third party to transfer the Company's financial guaranty risk,
net of that portion of the premium retained by the Company to compensate it for
originating and servicing the insurance contract.
Installment premiums -- Consistent with industry practice, there is no
carrying amount for installment premiums since the Company will receive premiums
on an installment basis over the term of the insurance contract. Similar to
deferred premium revenue, the fair value of installment premiums is the
estimated present value of the future contractual premium revenues that would be
paid under a reinsurance agreement with a third party to transfer the Company's
financial guaranty risk, net of that portion of the premium retained by the
Company to compensate it for originating and servicing the insurance contract.
Losses and loss adjustment expenses, net of reinsurance recoverable on
unpaid losses -- The carrying amount is fair value, which is the present value
of the expected cash flows for specifically identified claims and potential
losses in the Company's insured portfolio.
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
----------------- -----------------
(In thousands) Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
<S> <C> <C> <C> <C>
Assets:
Long-term bonds $1,072,439 $1,072,439 $1,058,076 $1,058,076
Short-term investments 56,733 56,733 14,567 14,567
Cash and cash equivalents 25,054 25,054 39,217 39,217
Receivable for securities sold -- -- 2,326 2,326
Liabilities:
Deferred premium revenue, net of
prepaid reinsurance premiums 359,972 251,980 330,349 263,618
Losses and loss adjustment expenses,
net of reinsurance recoverable on
unpaid losses 42,204 42,204 50,227 50,227
Notes payable 30,000 30,000 30,000 30,000
Payable for investments purchased 14,390 14,390 9,516 9,516
Off-balance-sheet instruments:
Installment premiums -- 102,988 -- 82,212
</TABLE>
<PAGE>
17. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The Company's liability for losses and loss adjustment expenses consists of
the case basis and general reserves. Activity in the liability for losses and
loss adjustment expenses is summarized as follows (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Balance at January 1 $111,759 $ 91,130 $36,094
Less reinsurance recoverable 61,532 55,491 79
-------- --------- -------
Net balance at January 1 50,227 35,639 36,015
Incurred losses and loss adjustment expenses:
Current year 5,300 3,000 3,024
Prior years 1,574 3,258 --
Related to Merger -- 15,400 --
Paid losses and loss adjustment expenses:
Current year -- -- (3,397)
Prior years (14,897) (7,070) (3)
-------- --------- -------
Net balance December 31 42,204 50,227 35,639
Plus reinsurance recoverable 29,875 61,532 55,491
-------- --------- -------
Balance at December 31 $ 72,079 $111,759 $91,130
======== ========= =======
</TABLE>
In 1994, the Company increased its general reserve by $3,024,000 for
origination of new business and transferred $16,932,000 of the general reserve
to its case basis reserves for projected losses on certain transactions, the
majority of which are in its discontinued commercial mortgage portfolio.
During 1995, the Company increased its general reserve by $6,258,000, of
which $3,000,000 was for originations of new business and $3,258,000 was to
reestablish the general reserve for transfers from general reserves to case
basis reserves. During 1995, the Company transferred $10,788,000 from its
general reserve to case basis reserves associated predominantly with certain
residential mortgage and timeshare receivables transactions. Also in December
1995, FSA recognized a one-time increase of $15,400,000 to the general reserve
to provide for the insured portfolio it had assumed in the Merger with CGC in a
manner consistent with the Company's reserving methodology. Prior to the Merger,
CGC did not maintain a general reserve. Giving effect to all the 1995 events,
the general reserve totaled $31,798,000 at December 31, 1995.
During 1996, the Company increased its general reserve by $6,874,000, of
which $5,300,000 was for originations of new business and $1,574,000 was to
reestablish the general reserve for transfers from general reserves to case
basis reserves. During 1996, the Company transferred $9,012,000 from its general
reserve to case basis reserves associated predominantly with certain residential
mortgage and timeshare receivables transactions. Giving effect to these
transfers, the general reserve totaled $29,660,000 at December 31, 1996.
Reserves for losses and loss adjustment expenses are discounted at
risk-free rates. The amount of discount taken was approximately $17,944,000,
$15,276,000 and $14,588,000 at December 31, 1996, 1995 and 1994, respectively.
<PAGE>
18. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
(In thousands, except share data) First Second Third Fourth Full Year
----- ------ ----- ------ ---------
<S> <C> <C> <C> <C> <C>
1996
Gross premiums written $52,580 $44,762 $38,994 $40,630 $176,966
Net premiums written 34,139 30,726 28,449 27,686 121,000
Net premiums earned 22,734 19,750 21,637 26,327 90,448
Net investment income 15,682 15,986 16,467 16,929 65,064
Losses and loss adjustment expenses 1,625 1,530 1,482 2,237 6,874
Income before taxes 26,234 25,211 22,948 35,378 109,771
Net income 19,544 18,748 17,210 25,258 80,760
Earnings per common share 0.62 0.61 0.58 0.83 2.64
1995
Gross premiums written $26,792 $29,649 $21,890 $32,412 $110,743
Net premiums written 19,557 20,792 14,568 22,659 77,576
Net premiums earned 15,215 15,330 20,292 18,510 69,347
Net investment income 12,354 12,311 12,212 12,088 48,965
Losses and loss adjustment expenses 1,700 1,605 1,517 16,836 21,658
Income before taxes 14,414 21,652 28,338 10,638 75,042
Net income 10,805 15,484 20,272 8,477 55,038
Earnings per common share 0.42 0.59 0.79 0.33 2.13
</TABLE>
19. PRO FORMA RESULTS OF ACQUISITION (UNAUDITED)
The unaudited consolidated results of operations (in thousands) on a pro
forma basis as though the Merger had been consummated on January 1, 1994, and
excluding the effect of the one-time general reserve charge in 1995 of $15,400,
are as follows:
December 31,
------------
1995 1994
---- ----
Total revenues $157,150 $136,046
Total expenses 44,239 39,561
Earnings per common share 2.53 2.31
The pro forma information is presented for informational purposes only and
is not necessarily indicative of the operating results that would have occurred
had the Merger been consummated as of January 1, 1994, nor are they necessarily
indicative of future operating results.
<PAGE>
[page 48 of 1996 Annual Report]
Common Stock Data
<TABLE>
<CAPTION>
Market Price
----------------------------------------------------
Dividends per Share High Low Close
<S> <C> <C> <C> <C>
1995
Quarter ended March 31 $0.080 $21.500 $19.000 $21.500
Quarter ended June 30 $0.080 25.500 21.500 25.000
Quarter ended September 30 $0.080 27.750 24.250 25.375
Quarter ended December 31 $0.080 27.000 24.750 24.875
1996
Quarter ended March 31 $0.080 26.750 24.000 25.375
Quarter ended June 30 $0.080 28.375 25.375 27.375
Quarter ended September 30 $0.095 30.000 25.750 29.500
Quarter ended December 31 $0.095 32.875 27.625 32.875
</TABLE>
EXHIBIT 21
SUBSIDIARIES
OF
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
Capital Guaranty Corporation (incorporated in the State of Maryland)
FSA Portfolio Management Inc. (incorporated in the State of New York)
Financial Security Assurance Inc. (incorporated in the State of New York)
Financial Security Assurance of Maryland Inc.
(incorporated in the State of Maryland)
Financial Security Assurance International Inc.
(incorporated in the State of Indiana)
Financial Security of Oklahoma, Inc. (incorporated in the State of Oklahoma)
Financial Security Assurance (U.K.) Limited
(incorporated in the United Kingdom)
Transaction Services Corp. (incorporated in the State of New York)
Exhibit 23
CONSENT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors
of Financial Security Assurance Holdings Ltd.:
We consent to the incorporation by reference in the Registration Statements, as
amended, of Financial Security Assurance Holdings Ltd. and Subsidiaries on Form
S-8 (File No. 33-78784), Form S-3 (File No. 33-80769) and Form S-4 (File No.
33-99626) of:
1. Our report dated January 24, 1997 on our audits of the consolidated
financial statements of Financial Security Assurance Holdings Ltd. and
Subsidiaries as of December 31, 1996 and 1995, and for each of three
years in the period ended December 31, 1996, which report is incorporated
by reference in this Annual Report on Form 10-K for the fiscal year ended
December 31, 1996;
2. Our report dated January 24, 1997 on our audits of the financial
statement schedule of Financial Security Assurance Holdings Ltd. and
Subsidiaries, which report is included in this Annual Report on Form 10-K
for the fiscal year ended December 31, 1996; and
3. Our report dated January 24, 1997 on our audits of the consolidated
financial statements of Financial Security Assurance Inc. and
Subsidiaries as of December 31, 1996 and 1995, and for each of the
three years in the period ended December 31, 1996, which report is
included in exhibit 99 to this Annual Report on Form 10-K for the fiscal
year ended December 31, 1996.
/s/ Coopers & Lybrand L.L.P.
COOPERS & LYBRAND L.L.P.
New York, New York
March 24, 1997
EXHIBIT 24
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
POWER-OF-ATTORNEY
The undersigned, as a Director of Financial Security Assurance Holdings Ltd., a
New York corporation (the "Company"), does hereby constitute and appoint each of
Robert P. Cochran, Roger K. Taylor and Bruce E. Stern to be his agent and
attorney-in-fact, with the power to act fully hereunder and with full power of
substitution to act in the name and on behalf of the undersigned, (i) to sign in
the name and on behalf of the undersigned, as Director of the Company, and file
with the Securities and Exchange Commission, an Annual Report on Form 10-K for
each fiscal year for which the Company is required to file such an Annual
Report, and any amendments or supplements thereto, and (ii) to execute and
deliver any instruments, certificates or other documents which he shall deem
necessary or proper in connection with the filing of each such Annual Report on
Form 10-K, and any such amendment or supplement thereto, and generally to act
for and in the name of the undersigned with respect to each such filing as fully
as could the undersigned if then personally present and acting. The foregoing
Power-of-Attorney shall be in full force and effect for so long as the
undersigned shall be a Director of the Company, unless and until revoked by
written instrument delivered to the General Counsel of the Company.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on the
date set forth below.
Dated: March 7, 1997 /s/ JOHN J. BYRNE
---------------------------------
John J. Byrne
<PAGE>
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
POWER-OF-ATTORNEY
The undersigned, as a Director and the President and Chief Executive Officer of
Financial Security Assurance Holdings Ltd., a New York corporation (the
"Company"), does hereby constitute and appoint each of Robert P. Cochran, Roger
K. Taylor and Bruce E. Stern to be his agent and attorney-in-fact, with the
power to act fully hereunder and with full power of substitution to act in the
name and on behalf of the undersigned, (i) to sign in the name and on behalf of
the undersigned, as Director and as President and Chief Executive Officer
(Principal Executive Officer) of the Company, and file with the Securities and
Exchange Commission, an Annual Report on Form 10-K for each fiscal year for
which the Company is required to file such an Annual Report, and any amendments
or supplements thereto, and (ii) to execute and deliver any instruments,
certificates or other documents which he shall deem necessary or proper in
connection with the filing of each such Annual Report on Form 10-K, and any such
amendment or supplement thereto, and generally to act for and in the name of the
undersigned with respect to each such filing as fully as could the undersigned
if then personally present and acting. The foregoing Power-of-Attorney shall be
in full force and effect for so long as the undersigned shall be a Director and
the President and Chief Executive Officer of the Company, unless and until
revoked by written instrument delivered to the General Counsel of the Company.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on the
date set forth below.
Dated: March 7, 1997 /s/ ROBERT P. COCHRAN
-----------------------------------
Robert P. Cochran
<PAGE>
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
POWER-OF-ATTORNEY
The undersigned, as a Director of Financial Security Assurance Holdings Ltd., a
New York corporation (the "Company"), does hereby constitute and appoint each of
Robert P. Cochran, Roger K. Taylor and Bruce E. Stern to be his agent and
attorney-in-fact, with the power to act fully hereunder and with full power of
substitution to act in the name and on behalf of the undersigned, (i) to sign in
the name and on behalf of the undersigned, as Director of the Company, and file
with the Securities and Exchange Commission, an Annual Report on Form 10-K for
each fiscal year for which the Company is required to file such an Annual
Report, and any amendments or supplements thereto, and (ii) to execute and
deliver any instruments, certificates or other documents which he shall deem
necessary or proper in connection with the filing of each such Annual Report on
Form 10-K, and any such amendment or supplement thereto, and generally to act
for and in the name of the undersigned with respect to each such filing as fully
as could the undersigned if then personally present and acting. The foregoing
Power-of-Attorney shall be in full force and effect for so long as the
undersigned shall be a Director of the Company, unless and until revoked by
written instrument delivered to the General Counsel of the Company.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on the
date set forth below.
Dated: March 7, 1997 /s/ MICHAEL DJORDJEVICH
-----------------------------------
Michael Djordjevich
<PAGE>
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
POWER-OF-ATTORNEY
The undersigned, as a Director of Financial Security Assurance Holdings Ltd., a
New York corporation (the "Company"), does hereby constitute and appoint each of
Robert P. Cochran, Roger K. Taylor and Bruce E. Stern to be his agent and
attorney-in-fact, with the power to act fully hereunder and with full power of
substitution to act in the name and on behalf of the undersigned, (i) to sign in
the name and on behalf of the undersigned, as Director of the Company, and file
with the Securities and Exchange Commission, an Annual Report on Form 10-K for
each fiscal year for which the Company is required to file such an Annual
Report, and any amendments or supplements thereto, and (ii) to execute and
deliver any instruments, certificates or other documents which he shall deem
necessary or proper in connection with the filing of each such Annual Report on
Form 10-K, and any such amendment or supplement thereto, and generally to act
for and in the name of the undersigned with respect to each such filing as fully
as could the undersigned if then personally present and acting. The foregoing
Power-of-Attorney shall be in full force and effect for so long as the
undersigned shall be a Director of the Company, unless and until revoked by
written instrument delivered to the General Counsel of the Company.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on the
date set forth below.
Dated: March 7, 1997 /s/ ROBERT N. DOWNEY
-----------------------------------
Robert N. Downey
<PAGE>
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
POWER-OF-ATTORNEY
The undersigned, as a Director of Financial Security Assurance Holdings Ltd., a
New York corporation (the "Company"), does hereby constitute and appoint each of
Robert P. Cochran, Roger K. Taylor and Bruce E. Stern to be his agent and
attorney-in-fact, with the power to act fully hereunder and with full power of
substitution to act in the name and on behalf of the undersigned, (i) to sign in
the name and on behalf of the undersigned, as Director of the Company, and file
with the Securities and Exchange Commission, an Annual Report on Form 10-K for
each fiscal year for which the Company is required to file such an Annual
Report, and any amendments or supplements thereto, and (ii) to execute and
deliver any instruments, certificates or other documents which he shall deem
necessary or proper in connection with the filing of each such Annual Report on
Form 10-K, and any such amendment or supplement thereto, and generally to act
for and in the name of the undersigned with respect to each such filing as fully
as could the undersigned if then personally present and acting. The foregoing
Power-of-Attorney shall be in full force and effect for so long as the
undersigned shall be a Director of the Company, unless and until revoked by
written instrument delivered to the General Counsel of the Company.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on the
date set forth below.
Dated: March 7, 1997 /s/ ANTHONY M. FRANK
-----------------------------------
Anthony M. Frank
<PAGE>
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
POWER-OF-ATTORNEY
The undersigned, as a Director of Financial Security Assurance Holdings Ltd., a
New York corporation (the "Company"), does hereby constitute and appoint each of
Robert P. Cochran, Roger K. Taylor and Bruce E. Stern to be his agent and
attorney-in-fact, with the power to act fully hereunder and with full power of
substitution to act in the name and on behalf of the undersigned, (i) to sign in
the name and on behalf of the undersigned, as Director of the Company, and file
with the Securities and Exchange Commission, an Annual Report on Form 10-K for
each fiscal year for which the Company is required to file such an Annual
Report, and any amendments or supplements thereto, and (ii) to execute and
deliver any instruments, certificates or other documents which he shall deem
necessary or proper in connection with the filing of each such Annual Report on
Form 10-K, and any such amendment or supplement thereto, and generally to act
for and in the name of the undersigned with respect to each such filing as fully
as could the undersigned if then personally present and acting. The foregoing
Power-of-Attorney shall be in full force and effect for so long as the
undersigned shall be a Director of the Company, unless and until revoked by
written instrument delivered to the General Counsel of the Company.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on the
date set forth below.
Dated: March 7, 1997 /s/ TOSHIKI KANEDA
-----------------------------------
Toshiki Kaneda
<PAGE>
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
POWER-OF-ATTORNEY
The undersigned, as a Director of Financial Security Assurance Holdings Ltd., a
New York corporation (the "Company"), does hereby constitute and appoint each of
Robert P. Cochran, Roger K. Taylor and Bruce E. Stern to be his agent and
attorney-in-fact, with the power to act fully hereunder and with full power of
substitution to act in the name and on behalf of the undersigned, (i) to sign in
the name and on behalf of the undersigned, as Director of the Company, and file
with the Securities and Exchange Commission, an Annual Report on Form 10-K for
each fiscal year for which the Company is required to file such an Annual
Report, and any amendments or supplements thereto, and (ii) to execute and
deliver any instruments, certificates or other documents which he shall deem
necessary or proper in connection with the filing of each such Annual Report on
Form 10-K, and any such amendment or supplement thereto, and generally to act
for and in the name of the undersigned with respect to each such filing as fully
as could the undersigned if then personally present and acting. The foregoing
Power-of-Attorney shall be in full force and effect for so long as the
undersigned shall be a Director of the Company, unless and until revoked by
written instrument delivered to the General Counsel of the Company.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on the
date set forth below.
Dated: March 7, 1997 /s/ K. THOMAS KEMP
-----------------------------------
K. Thomas Kemp
<PAGE>
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
POWER-OF-ATTORNEY
The undersigned, as a Director of Financial Security Assurance Holdings Ltd., a
New York corporation (the "Company"), does hereby constitute and appoint each of
Robert P. Cochran, Roger K. Taylor and Bruce E. Stern to be his agent and
attorney-in-fact, with the power to act fully hereunder and with full power of
substitution to act in the name and on behalf of the undersigned, (i) to sign in
the name and on behalf of the undersigned, as Director of the Company, and file
with the Securities and Exchange Commission, an Annual Report on Form 10-K for
each fiscal year for which the Company is required to file such an Annual
Report, and any amendments or supplements thereto, and (ii) to execute and
deliver any instruments, certificates or other documents which he shall deem
necessary or proper in connection with the filing of each such Annual Report on
Form 10-K, and any such amendment or supplement thereto, and generally to act
for and in the name of the undersigned with respect to each such filing as fully
as could the undersigned if then personally present and acting. The foregoing
Power-of-Attorney shall be in full force and effect for so long as the
undersigned shall be a Director of the Company, unless and until revoked by
written instrument delivered to the General Counsel of the Company.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on the
date set forth below.
Dated: March 7, 1997 /s/ DAVID O. MAXWELL
-----------------------------------
David O. Maxwell
<PAGE>
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
POWER-OF-ATTORNEY
The undersigned, as a Director of Financial Security Assurance Holdings Ltd., a
New York corporation (the "Company"), does hereby constitute and appoint each of
Robert P. Cochran, Roger K. Taylor and Bruce E. Stern to be his agent and
attorney-in-fact, with the power to act fully hereunder and with full power of
substitution to act in the name and on behalf of the undersigned, (i) to sign in
the name and on behalf of the undersigned, as Director of the Company, and file
with the Securities and Exchange Commission, an Annual Report on Form 10-K for
each fiscal year for which the Company is required to file such an Annual
Report, and any amendments or supplements thereto, and (ii) to execute and
deliver any instruments, certificates or other documents which he shall deem
necessary or proper in connection with the filing of each such Annual Report on
Form 10-K, and any such amendment or supplement thereto, and generally to act
for and in the name of the undersigned with respect to each such filing as fully
as could the undersigned if then personally present and acting. The foregoing
Power-of-Attorney shall be in full force and effect for so long as the
undersigned shall be a Director of the Company, unless and until revoked by
written instrument delivered to the General Counsel of the Company.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on the
date set forth below.
Dated: March 7, 1997 /s/ JAMES M. OSTERHOFF
-----------------------------------
James M. Osterhoff
<PAGE>
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
POWER-OF-ATTORNEY
The undersigned, as a Director of Financial Security Assurance Holdings Ltd., a
New York corporation (the "Company"), does hereby constitute and appoint each of
Robert P. Cochran, Roger K. Taylor and Bruce E. Stern to be his agent and
attorney-in-fact, with the power to act fully hereunder and with full power of
substitution to act in the name and on behalf of the undersigned, (i) to sign in
the name and on behalf of the undersigned, as Director of the Company, and file
with the Securities and Exchange Commission, an Annual Report on Form 10-K for
each fiscal year for which the Company is required to file such an Annual
Report, and any amendments or supplements thereto, and (ii) to execute and
deliver any instruments, certificates or other documents which he shall deem
necessary or proper in connection with the filing of each such Annual Report on
Form 10-K, and any such amendment or supplement thereto, and generally to act
for and in the name of the undersigned with respect to each such filing as fully
as could the undersigned if then personally present and acting. The foregoing
Power-of-Attorney shall be in full force and effect for so long as the
undersigned shall be a Director of the Company, unless and until revoked by
written instrument delivered to the General Counsel of the Company.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on the
date set forth below.
Dated: March 7, 1997 /s/ JAMES H. OZANNE
-----------------------------------
James H. Ozanne
<PAGE>
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
POWER-OF-ATTORNEY
The undersigned, as a Director of Financial Security Assurance Holdings Ltd., a
New York corporation (the "Company"), does hereby constitute and appoint each of
Robert P. Cochran, Roger K. Taylor and Bruce E. Stern to be his agent and
attorney-in-fact, with the power to act fully hereunder and with full power of
substitution to act in the name and on behalf of the undersigned, (i) to sign in
the name and on behalf of the undersigned, as Director of the Company, and file
with the Securities and Exchange Commission, an Annual Report on Form 10-K for
each fiscal year for which the Company is required to file such an Annual
Report, and any amendments or supplements thereto, and (ii) to execute and
deliver any instruments, certificates or other documents which he shall deem
necessary or proper in connection with the filing of each such Annual Report on
Form 10-K, and any such amendment or supplement thereto, and generally to act
for and in the name of the undersigned with respect to each such filing as fully
as could the undersigned if then personally present and acting. The foregoing
Power-of-Attorney shall be in full force and effect for so long as the
undersigned shall be a Director of the Company, unless and until revoked by
written instrument delivered to the General Counsel of the Company.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on the
date set forth below.
Dated: March 7, 1997 /s/ STAATS PELLETT, JR.
-----------------------------------
Staats Pellett, Jr.
<PAGE>
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
POWER-OF-ATTORNEY
The undersigned, as a Director of Financial Security Assurance Holdings Ltd., a
New York corporation (the "Company"), does hereby constitute and appoint each of
Robert P. Cochran, Roger K. Taylor and Bruce E. Stern to be his agent and
attorney-in-fact, with the power to act fully hereunder and with full power of
substitution to act in the name and on behalf of the undersigned, (i) to sign in
the name and on behalf of the undersigned, as Director of the Company, and file
with the Securities and Exchange Commission, an Annual Report on Form 10-K for
each fiscal year for which the Company is required to file such an Annual
Report, and any amendments or supplements thereto, and (ii) to execute and
deliver any instruments, certificates or other documents which he shall deem
necessary or proper in connection with the filing of each such Annual Report on
Form 10-K, and any such amendment or supplement thereto, and generally to act
for and in the name of the undersigned with respect to each such filing as fully
as could the undersigned if then personally present and acting. The foregoing
Power-of-Attorney shall be in full force and effect for so long as the
undersigned shall be a Director of the Company, unless and until revoked by
written instrument delivered to the General Counsel of the Company.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on the
date set forth below.
Dated: March 7, 1997 /s/ RICHARD A. POST
-----------------------------------
Richard A. Post
<PAGE>
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
POWER-OF-ATTORNEY
The undersigned, as a Director and the Chief Operating Officer of Financial
Security Assurance Holdings Ltd., a New York corporation (the "Company"), does
hereby constitute and appoint each of Robert P. Cochran, Roger K. Taylor and
Bruce E. Stern to be his agent and attorney-in-fact, with the power to act fully
hereunder and with full power of substitution to act in the name and on behalf
of the undersigned, (i) to sign in the name and on behalf of the undersigned, as
Director and the Chief Operating Officer of the Company, and file with the
Securities and Exchange Commission, an Annual Report on Form 10-K for each
fiscal year for which the Company is required to file such an Annual Report, and
any amendments or supplements thereto, and (ii) to execute and deliver any
instruments, certificates or other documents which he shall deem necessary or
proper in connection with the filing of each such Annual Report on Form 10-K,
and any such amendment or supplement thereto, and generally to act for and in
the name of the undersigned with respect to each such filing as fully as could
the undersigned if then personally present and acting. The foregoing
Power-of-Attorney shall be in full force and effect for so long as the
undersigned shall be a Director and the Chief Operating Officer of the Company,
unless and until revoked by written instrument delivered to the General Counsel
of the Company.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on the
date set forth below.
Dated: March 7, 1997 /s/ ROGER K. TAYLOR
-----------------------------------
Roger K. Taylor
<PAGE>
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
POWER-OF-ATTORNEY
The undersigned, as a Director of Financial Security Assurance Holdings Ltd., a
New York corporation (the "Company"), does hereby constitute and appoint each of
Robert P. Cochran, Roger K. Taylor and Bruce E. Stern to be his agent and
attorney-in-fact, with the power to act fully hereunder and with full power of
substitution to act in the name and on behalf of the undersigned, (i) to sign in
the name and on behalf of the undersigned, as Director of the Company, and file
with the Securities and Exchange Commission, an Annual Report on Form 10-K for
each fiscal year for which the Company is required to file such an Annual
Report, and any amendments or supplements thereto, and (ii) to execute and
deliver any instruments, certificates or other documents which he shall deem
necessary or proper in connection with the filing of each such Annual Report on
Form 10-K, and any such amendment or supplement thereto, and generally to act
for and in the name of the undersigned with respect to each such filing as fully
as could the undersigned if then personally present and acting. The foregoing
Power-of-Attorney shall be in full force and effect for so long as the
undersigned shall be a Director of the Company, unless and until revoked by
written instrument delivered to the General Counsel of the Company.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on the
date set forth below.
Dated: March 7, 1997 /s/ ALLAN L. WATERS
-----------------------------------
Allan L. Waters
<PAGE>
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
POWER-OF-ATTORNEY
The undersigned, as a Director of Financial Security Assurance Holdings Ltd., a
New York corporation (the "Company"), does hereby constitute and appoint each of
Robert P. Cochran, Roger K. Taylor and Bruce E. Stern to be his agent and
attorney-in-fact, with the power to act fully hereunder and with full power of
substitution to act in the name and on behalf of the undersigned, (i) to sign in
the name and on behalf of the undersigned, as Director of the Company, and file
with the Securities and Exchange Commission, an Annual Report on Form 10-K for
each fiscal year for which the Company is required to file such an Annual
Report, and any amendments or supplements thereto, and (ii) to execute and
deliver any instruments, certificates or other documents which he shall deem
necessary or proper in connection with the filing of each such Annual Report on
Form 10-K, and any such amendment or supplement thereto, and generally to act
for and in the name of the undersigned with respect to each such filing as fully
as could the undersigned if then personally present and acting. The foregoing
Power-of-Attorney shall be in full force and effect for so long as the
undersigned shall be a Director of the Company, unless and until revoked by
written instrument delivered to the General Counsel of the Company.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on the
date set forth below.
Dated: March 7, 1997 /s/ HOWARD ZELIKOW
-----------------------------------
Howard Zelikow
<PAGE>
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
POWER-OF-ATTORNEY
The undersigned, as a Managing Director and the Chief Financial Officer of
Financial Security Assurance Holdings Ltd., a New York corporation (the
"Company"), does hereby constitute and appoint each of Robert P. Cochran, Roger
K. Taylor and Bruce E. Stern to be his agent and attorney-in-fact, with the
power to act fully hereunder and with full power of substitution to act in the
name and on behalf of the undersigned, (i) to sign in the name and on behalf of
the undersigned, as Managing Director and Chief Financial Officer (Principal
Financial Officer) of the Company, and file with the Securities and Exchange
Commission, an Annual Report on Form 10-K for each fiscal year for which the
Company is required to file such an Annual Report, and any amendments or
supplements thereto, and (ii) to execute and deliver any instruments,
certificates or other documents which he shall deem necessary or proper in
connection with the filing of each such Annual Report on Form 10-K, and any such
amendment or supplement thereto, and generally to act for and in the name of the
undersigned with respect to each such filing as fully as could the undersigned
if then personally present and acting. The foregoing Power-of-Attorney shall be
in full force and effect for so long as the undersigned shall be a Managing
Director and the Chief Financial Officer of the Company, unless and until
revoked by written instrument delivered to the General Counsel of the Company.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on the
date set forth below.
Dated: March 7, 1997 /s/ JOHN A. HARRISON
-----------------------------------
John A. Harrison
<PAGE>
Annual Reports on Form 10-K of
Financial Security Assurance Holdings Ltd.
POWER-OF-ATTORNEY
The undersigned, as a Managing Director and the Controller of Financial Security
Assurance Holdings Ltd., a New York corporation (the "Company"), does hereby
constitute and appoint each of Robert P. Cochran, Roger K. Taylor and Bruce E.
Stern to be his agent and attorney-in-fact, with the power to act fully
hereunder and with full power of substitution to act in the name and on behalf
of the undersigned, (i) to sign in the name and on behalf of the undersigned, as
Managing Director and Controller (Principal Accounting Officer) of the Company,
and file with the Securities and Exchange Commission, an Annual Report on Form
10-K for each fiscal year for which the Company is required to file such an
Annual Report, and any amendments or supplements thereto, and (ii) to execute
and deliver any instruments, certificates or other documents which he shall deem
necessary or proper in connection with the filing of each such Annual Report on
Form 10-K, and any such amendment or supplement thereto, and generally to act
for and in the name of the undersigned with respect to each such filing as fully
as could the undersigned if then personally present and acting. The foregoing
Power-of-Attorney shall be in full force and effect for so long as the
undersigned shall be a Managing Director and the Controller of the Company,
unless and until revoked by written instrument delivered to the General Counsel
of the Company.
IN WITNESS WHEREOF, the undersigned has executed this Power-of-Attorney on the
date set forth below.
Dated: March 7, 1997 /s/ JEFFREY S. JOSEPH
-----------------------------------
Jeffrey S. Joseph
EXHIBIT 99
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
Consolidated Financial Statements and
Report of Independent Accountants
December 31, 1996
<PAGE>
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AND REPORT OF INDEPENDENT ACCOUNTANTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
REPORT OF INDEPENDENT ACCOUNTANTS 1
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets 2
Consolidated Statements of Income 3
Consolidated Statements of Changes in Shareholder's Equity 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 7
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholder and Board of Directors
of Financial Security Assurance Inc.:
We have audited the accompanying consolidated balance sheets of Financial
Security Assurance Inc. and Subsidiaries as of December 31, 1996 and 1995 and
the related consolidated statements of income, changes in shareholder's equity,
and cash flows for each of the three years in the period ended December 31,
1996. 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 Financial Security
Assurance Inc. and Subsidiaries at December 31, 1996 and 1995, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles.
COOPERS & LYBRAND L.L.P.
New York, New York
January 24, 1997
<PAGE>
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
ASSETS December 31, December 31,
1996 1995
---------- ----------
<S> <C> <C>
Bonds at market value (amortized cost of $1,054,678 and
$1,006,084) $1,068,677 $1,036,382
Equity investments at market value (cost of $1,000) 1,000
Short-term investments 39,570 14,568
Cash equivalents 16,129 35,277
---------- ----------
Total investments 1,125,376 1,086,227
Cash 7,517 555
Deferred acquisition costs 146,233 132,951
Prepaid reinsurance premiums 151,224 133,548
Reinsurance recoverable on unpaid losses 29,875 61,532
Other assets 69,705 61,825
---------- ----------
TOTAL ASSETS $1,529,930 $1,476,638
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Deferred premium revenue $ 511,196 $ 463,897
Losses and loss adjustment expenses 72,079 111,759
Deferred federal income taxes 41,682 43,205
Ceded reinsurance balances payable 12,599 13,664
Payable for securities purchased 14,142 9,516
Accrued expenses and other liabilities 62,900 44,611
---------- ----------
TOTAL LIABILITIES 714,598 686,652
---------- ----------
COMMITMENTS AND CONTINGENCIES
Common stock (1,000 shares authorized; 660 and 750 shares issued
and outstanding; par value of $22,727 and $20,000 per share) 15,000 15,000
Additional paid-in capital 654,470 681,470
Unrealized gain on investments (net of deferred income tax
provision of $4,899 and $10,604) 9,099 19,694
Accumulated earnings 136,763 73,822
---------- ----------
TOTAL SHAREHOLDER'S EQUITY 815,332 789,986
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $1,529,930 $1,476,638
========== ==========
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an
integral part of these statements.
2
<PAGE>
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
REVENUES:
Net premiums written (net of premiums ceded of
$55,965, $33,166 and $28,692,
of which $35,299, $20,582 and $15,999 were
ceded to affiliates) $121,000 $ 77,576 $ 77,757
Increase in deferred premium revenue (30,552) (8,229) (12,003)
-------- --------- ---------
Premiums earned (net of premiums ceded of
$38,723, $38,013 and $35,051) 90,448 69,347 65,754
Net investment income 62,728 47,083 45,282
Net realized gains (losses) 1,851 5,032 (3,829)
Other income 502 4,722 732
-------- --------- ---------
TOTAL REVENUES 155,529 126,184 107,939
-------- --------- ---------
EXPENSES:
Losses and loss adjustment expenses:
Related to merger 15,400
Other (net of reinsurance recoveries of
($2,249), $9,101 and $56,895, of which
($3,084), $7,111 and $50,839 were ceded
to affiliates) 6,874 6,258 3,024
Policy acquisition costs 23,829 16,888 15,057
Other operating expenses 14,852 12,352 11,574
-------- --------- ---------
TOTAL EXPENSES 45,555 50,898 29,655
-------- --------- ---------
INCOME BEFORE INCOME TAXES 109,974 75,286 78,284
-------- --------- ---------
Provision (benefit) for income taxes:
Current 28,208 23,353 13,338
Deferred 911 (3,055) 4,682
-------- --------- ---------
Total provision 29,119 20,298 18,020
-------- --------- ---------
NET INCOME $ 80,855 $ 54,988 $ 60,264
======== ========= =========
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an
integral part of these statements.
3
<PAGE>
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY
(Dollars in thousands)
<TABLE>
<CAPTION>
Additional Unrealized
Common Paid-In Gains on Retained
Stock Capital Investments Earnings Total
----- ------- ----------- -------- -----
<S> <C> <C> <C> <C> <C>
BALANCE, December 31, 1993 $15,000 $497,506 $34,892 $ (4,930) $542,468
Net income for the year 60,264 60,264
Dividends paid on common stock (17,500) (17,500)
Net change in unrealized loss on
investments (net of deferred income
tax benefit of $30,292) (56,256) (56,256)
------- -------- ------- --------- --------
BALANCE, December 31, 1994 15,000 497,506 (21,364) 37,834 528,976
Net income 54,988 54,988
Dividends paid on common stock (19,000) (19,000)
Net change in unrealized gain on
investments (net of deferred income
taxes of $22,108) 41,058 41,058
Capital contribution of CGIC 233,964 233,964
Stock repurchase (50,000) (50,000)
------- -------- ------- --------- --------
BALANCE, December 31, 1995 15,000 681,470 19,694 73,822 789,986
Net income 80,855 80,855
Dividends paid on common stock (18,000) (18,000)
Net change in unrealized loss on
investments (net of deferred income
tax benefit of $5,705) (10,595) (10,595)
Stock repurchase (27,000) (27,000)
Adjustment to prior year disposal of
subsidiary 86 86
------- -------- ------- -------- --------
BALANCE, December 31, 1996 $15,000 $654,470 $ 9,099 $136,763 $815,332
======= ======== ======= ======== ========
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an integral
part of these statements.
4
<PAGE>
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Premiums received, net $ 124,540 $ 85,481 $ 58,191
Policy acquisition and other operating expenses
paid, net (49,261) (41,730) (31,696)
Recoverable advances received (paid) 10,213 (9,419) (939)
Losses and loss adjustment expenses paid (15,473) (4,954) (5,124)
Net investment income received 59,923 40,160 41,429
Federal income taxes received (paid) (33,297) (17,295) (14,358)
Interest paid (22) (38) (72)
Other 1,330 2,552 (4,314)
----------- --------- ---------
Net cash provided by operating activities 97,953 54,757 43,117
----------- --------- ---------
Cash flows from investing activities:
Proceeds from sales of bonds 1,095,929 603,545 790,517
Proceeds from maturities of bonds 2,965 606 55
Purchases of bonds (1,139,129) (685,984) (758,254)
Purchases of property and equipment (2,081) (958) (937)
Cash of contributed subsidiary 199
Net decrease (increase) in short-term
investments (3,675) 94,727 (58,095)
----------- --------- ---------
Net cash provided by (used for) investing
activities (45,991) 12,135 (26,714)
----------- --------- ---------
Cash flows from financing activities:
Stock repurchase (27,000) (50,000)
Dividends paid (18,000) (19,000) (17,500)
----------- --------- ---------
Net cash used for financing activities (45,000) (69,000) (17,500)
----------- --------- ---------
Net increase (decrease) in cash 6,962 (2,108) (1,097)
Cash at beginning of year 555 2,663 3,760
----------- --------- ---------
Cash at end of year $ 7,517 $ 555 $ 2,663
=========== ========= =========
</TABLE>
Continued
The accompanying Notes to Consolidated Financial Statements are an
integral part of these statements.
5
<PAGE>
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(Dollars in thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Reconciliation of net income to net cash flows
from operating activities:
Net income $80,855 $54,988 $60,264
Decrease (increase) in accrued investment income (842) 14 1,773
Increase in deferred premium revenue and related
foreign exchange adjustment 29,622 8,141 12,585
Decrease (increase) in deferred acquisition costs (13,282) (10,305) (9,847)
Increase (decrease) in current federal income
taxes payable (5,090) 6,057 (1,020)
Increase (decrease) in unpaid losses and loss
adjustment expenses (8,023) 14,587 (376)
Increase (decrease) in amounts withheld for others 52 30 (24,675)
Provision (benefit) for deferred income taxes 911 (3,055) 4,682
Net realized losses (gains) on investments (1,851) (5,032) 3,829
Depreciation and accretion of bond discount (1,616) (5,564) (4,082)
Change in other assets and liabilities 17,217 (5,104) (16)
------- ------- -------
Cash provided by operating activities $97,953 $54,757 $43,117
======= ======= =======
</TABLE>
In addition to the cash received from the contribution of the subsidiary, the
Company also received net assets of $233,765.
In 1996, the Company has recharacterized its cash equivalents as short-term
investments. The amounts of cash equivalents recharacterized were $16,129,
$35,277 and $13,457 as of December 31, 1996, 1995 and 1994, respectively.
The accompanying Notes to Consolidated Financial Statements are an
integral part of these statements.
6
<PAGE>
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1. ORGANIZATION AND OWNERSHIP
Financial Security Assurance Inc. (the Company), a wholly owned subsidiary
of Financial Security Assurance Holdings Ltd. (the Parent), is an insurance
company domiciled in the State of New York. The Company is engaged in providing
financial guaranty insurance on asset-backed financings and municipal
obligations. The Company's underwriting policy is to insure asset-backed and
municipal obligations that would otherwise be investment grade without the
benefit of the Company's insurance. The asset-backed obligations insured by the
Company are generally issued in structured transactions and are backed by pools
of assets such as residential mortgage loans, consumer or trade receivables,
securities or other assets having an ascertainable cash flow or market value.
The municipal obligations insured by the Company consist primarily of general
obligation bonds that are supported by the issuers' taxing power and special
revenue bonds and other special obligations of states and local governments that
are supported by the issuers' ability to impose and collect fees and charges for
public services or specific projects. Financial guaranty insurance written by
the Company guarantees payment when due of scheduled payments on an issuer's
obligation. In the case of a payment default on an insured obligation, the
Company is generally required to pay the principal, interest or other amounts
due in accordance with the obligation's original payment schedule or, at its
option, to pay such amounts on an accelerated basis.
The Company expects to continue to emphasize a diversified insured
portfolio characterized by insurance of both asset-backed and municipal
obligations, with a broad geographic distribution and a variety of revenue
sources and transaction structures. The Company's insured portfolio consists
primarily of asset-backed and municipal obligations originated in the United
States, but the Company has also written and continues to pursue business in
Europe and the Pacific Rim.
At December 31, 1993, the Parent was owned 92.5% by U S WEST and 7.5% by
Tokio Marine. The Parent completed an initial public offering of common shares
on May 13, 1994. In connection with the initial public offering, Fund American
Enterprises Holdings, Inc. (Fund American) acquired an interest in the Parent,
together with rights to acquire additional shares of the Parent from U S WEST
and shares of the Parent's Series A preferred stock. At December 31, 1994, the
Parent was owned 60.9% by U S WEST, 7.7% by Fund American, 7.4% by Tokio Marine
and 24.0% by the public and employees.
On December 20, 1995, a subsidiary of the Parent merged (the Merger) with
Capital Guaranty Corporation (CGC). The Merger provided for each CGC share to be
exchanged for 0.6716 share of the Parent's common stock and cash of $5.69. The
Parent issued in the aggregate 6,051,661 common shares and paid aggregate cash
consideration of $51,300,000. In conjunction with the Merger, the Parent
contributed (the Contribution) the common stock of Capital Guaranty Insurance
Company (CGIC), a subsidiary of CGC, to the Company. As a result of the
Contribution, the Company's net assets increased by $233,964,000. Net premiums
written by CGIC in 1995 prior to the Contribution were $26,070,000. At December
31, 1995, the Parent was owned 50.3% by U S WEST, 7.8% by Fund American, 6.1% by
Tokio Marine and 35.8% by the public and employees. At December 31, 1996, the
Parent was owned 40.4% by U S WEST, 11.5% by Fund American, 6.4% by Tokio Marine
and 41.7% by the public and employees.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying financial statements have been prepared in accordance with
generally accepted accounting principles (GAAP), which differ in certain
material respects from the accounting practices prescribed or permitted by
insurance regulatory authorities (see Note 6). The preparation of financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities in
the Company's consolidated balance sheets at December 31, 1996 and 1995 and the
reported amounts of revenues and expenses in
7
<PAGE>
the consolidated statements of income during the years ended December 31, 1996,
1995 and 1994. Such estimates and assumptions include, but are not limited to,
losses and loss adjustment expenses and the deferral and amortization of
deferred policy acquisition costs. Actual results may differ from those
estimates. Significant accounting policies under GAAP are as follows:
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries, Financial Security Assurance of Maryland Inc.
(which was named Capital Guaranty Insurance Corporation until the Merger),
Financial Security Assurance International Inc., Financial Security Assurance of
Oklahoma, Inc. and Financial Security Assurance (U.K.) Limited (collectively,
the Subsidiaries). All intercompany accounts and transactions have been
eliminated. Certain prior-year balances have been reclassified to conform with
the 1996 presentation. The Merger, and the related Contribution to the Company,
were accounted for on a purchase accounting basis. In view of the short period
between the date of the Merger, December 20, 1995, and the year-end, the date of
the Contribution for accounting purposes is considered to be December 31, 1995.
As a result, the accounting for the Contribution has no effect on the Company's
consolidated statement of income for the year ended December 31, 1995, except
for the recording of $15,400,000 in losses and loss adjustment expenses to
increase the Company's general reserve to provide for the insured portfolio
assumed by the Company as a result of the Contribution (see Note 16).
Investments
Investments in debt securities designated as available for sale are carried
at market value. Any resulting unrealized gain or loss is reflected as a
separate component of shareholder's equity, net of applicable deferred income
taxes. All of the Company's long-term investments are classified as available
for sale.
Bond discounts and premiums are amortized on the effective yield method
over the remaining terms of the securities acquired. For mortgage-backed
securities, and any other holdings for which prepayment risk may be significant,
assumptions regarding prepayments are evaluated periodically and revised as
necessary. Any adjustments required due to the resultant change in effective
yields are recognized in current income. Short-term investments, which are those
investments with a maturity of more than three months but less than one year at
time of purchase, are carried at market value, which approximates cost. Realized
gains or losses on sale of investments are determined on the basis of specific
identification. Investment income is recorded as earned.
To manage adverse movements in interest rates, the company uses exchange
traded futures and options. These contracts are designated as hedges of specific
identified securities and any gains or losses on these hedges are deferred and
included as part of the Company's unrealized gains or losses in stockholders'
equity until the disposition of the hedged assets. The Company will discontinue
to account for these contracts as hedges if there ceases to be a high
correlation between the change in price of the hedged assets and the hedge.
Cash equivalents represent amounts deposited in money market funds and
investments with a maturity at time of purchase of three months or less.
Premium Revenue Recognition
Gross and ceded premiums are earned in proportion to the amount of risk
outstanding over the expected period of coverage. Deferred premium revenue and
prepaid reinsurance premiums represent that portion of premium which is
applicable to coverage of risk to be provided in the future on policies in
force. When an insured issue is retired or defeased prior to the end of the
expected period of coverage, the remaining deferred premium revenue and prepaid
reinsurance premium, less any amount credited to a refunding issue insured by
the Company, are recognized.
Losses and Loss Adjustment Expenses
A case basis reserve for unpaid losses and loss adjustment expenses is
recorded at the present value of the estimated loss when, in management's
opinion, the likelihood of a future loss is probable and determinable at the
balance sheet date. The estimated loss on a transaction is discounted using
current risk-free rates.
The general reserve is calculated by applying a loss factor to the total
net par amount outstanding of the Company's insured obligations outstanding over
the term of such insured obligations and discounting the result at risk-free
rates. The loss factor used for this purpose has been determined based upon an
independent rating agency study of bond defaults and the Company's portfolio
characteristics and history. The general reserve is available to be applied
against future additions or accretions to existing case basis reserves or to new
case basis reserves to be established in the future.
8
<PAGE>
Management of the Company periodically evaluates its estimates for losses
and loss adjustment expenses and establishes reserves that management believes
are adequate to cover the ultimate net cost of claims; the reserves are
necessarily based on estimates, and there can be no assurance that the ultimate
liability will not differ from such estimates. The Company will, on an ongoing
basis, monitor these reserves and may periodically adjust such reserves based on
the Company's actual loss experience, its future mix of business, and future
economic conditions.
Deferred Acquisition Costs
Deferred acquisition costs comprise those expenses that vary with and are
primarily related to the production of business, including commissions paid on
reinsurance assumed, compensation and related costs of underwriting and
marketing personnel, certain rating agency fees, premium taxes and certain other
underwriting expenses, reduced by ceding commission income on premiums ceded to
reinsurers. Deferred acquisition costs and the cost of acquired business are
amortized over the period in which the related premiums are earned.
Recoverability of deferred acquisition costs is determined by considering
anticipated losses and loss adjustment expenses.
Federal Income Taxes
The provision for income taxes consists of an amount for taxes currently
payable and a provision for tax consequences deferred to future periods
reflected at current income tax rates.
3. INVESTMENTS
Bonds at amortized cost of $17,669,000 and $11,969,000 at December 31, 1996
and 1995, respectively, were on deposit with state regulatory authorities as
required by insurance regulations.
Consolidated net investment income consisted of the following (in
thousands):
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Long-term bonds $61,130 $43,114 $46,517
Equity securities 14
Short-term investments and
cash equivalents 3,525 5,705 778
Investment expenses (1,941) (1,736) (2,013)
------- ------- -------
Net investment income $62,728 $47,083 $45,282
======= ======= =======
The credit quality of the investment portfolio at December 31, 1996 was
as follows:
Percent of
Rating Investment Portfolio
------------------------------ ----------------------
AAA 69.9%
AA 20.0
A 10.1
9
<PAGE>
The amortized cost and estimated market value of long-term bonds were as
follows (in thousands):
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
December 31, 1996 Cost Gains Losses Value
- ----------------- ---- ----- ------ -----
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies $ 55,319 $ 1,103 $ (557) $ 55,865
Obligations of states and political
subdivisions 661,657 15,164 (2,887) 673,934
Foreign securities 15,019 196 (70) 15,145
Mortgage-backed securities 177,818 1,432 (906) 178,344
Corporate securities 76,632 335 (319) 76,648
Asset-backed securities 68,233 680 (172) 68,741
---------- ------- ------- ----------
Total $1,054,678 $18,910 $(4,911) $1,068,677
========== ======= ======= ==========
</TABLE>
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
December 31, 1995 Cost Gains Losses Value
- ----------------- ---- ----- ------ -----
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies $ 44,873 $ 2,231 $ - $ 47,104
Obligations of states and political
subdivisions 635,872 20,112 (330) 655,654
Foreign securities 28,691 1,909 (17) 30,583
Mortgage-backed securities 262,936 5,949 (51) 268,834
Corporate securities 1,254 51 1,305
Asset-backed securities 32,458 444 32,902
---------- ------- ------- ----------
Total $1,006,084 $30,696 $ (398) $1,036,382
========== ======= ======= ==========
</TABLE>
The change in net unrealized gains (losses) consisted of (in thousands):
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Long-term bonds $(16,299) $63,166 $(86,564)
Short-term investments 16
-------- ------- --------
Change in net unrealized gains (losses) $(16,299) $63,166 $(86,548)
======== ======= ========
10
<PAGE>
The amortized cost and estimated market value of long-term bonds at
December 31, 1996 and 1995, by contractual maturity, are shown below (in
thousands). Actual maturities could differ from contractual maturities because
borrowers have the right to call or prepay certain obligations with or without
call or prepayment penalties.
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
----------------- -----------------
Estimated Estimated
Amortized Market Amortized Market
Cost Value Cost Value
---- ----- ---- -----
<S> <C> <C> <C> <C>
Due in one year or less $ 38,003 $ 38,325 $ 2,776 $ 2,778
Due after one year through five years 57,406 57,623 25,735 26,075
Due after five years through ten years 105,494 105,849 157,161 162,573
Due after ten years 607,724 619,795 525,018 543,220
Mortgage-backed securities (stated
maturities of 16 to 30 years) 177,818 178,344 262,936 268,834
Asset-backed securities (stated
maturities of 2 to 5 years) 68,233 68,741 32,458 32,902
---------- ---------- ---------- ----------
Total $1,054,678 $1,068,677 $1,006,084 $1,036,382
========== ========== ========== ==========
</TABLE>
Proceeds from sales of long-term bonds during 1996, 1995 and 1994 were
$1,096,568,000, $587,516,000 and $808,143,000, respectively. Gross gains of
$13,420,000, $12,346,000 and $13,919,000 and gross losses of $11,569,000,
$7,314,000 and $17,748,000 were realized on sales in 1996, 1995 and 1994,
respectively.
To hedge against changes in yields on certain one-year corporate
securities, the Company has entered into a series of Eurodollar futures
contracts, which are marked-to-market on a daily basis. These contracts are
accounted for as a hedge. As of year-end, the net unrealized loss on the
contracts, included in the Company's unrealized gains in stockholder's equity
section, is not material. The aggregate notional amount of these contracts is
$83,728,000 as of December 31, 1996.
4. DEFERRED ACQUISITION COSTS
Acquisition costs deferred for amortization against future income and the
related amortization charged to expenses are as follows (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Balance, beginning of period $132,951 $ 91,839 $81,992
-------- --------- -------
Costs deferred during the period:
Ceding commission income (15,956) (9,836) (8,476)
Assumed commission expense 38 55 84
Premium taxes 3,718 2,537 2,589
Compensation and other acquisition costs 49,311 34,437 30,707
-------- --------- -------
Total 37,111 27,193 24,904
-------- --------- -------
Costs amortized during the period (23,829) (16,888) (15,057)
-------- --------- -------
Balance of contributed subsidiary 30,807
---------
Balance, end of period $146,233 $132,951 $91,839
======== ========= =======
</TABLE>
5. OTHER OPERATING EXPENSES
Total salary expense and related benefits included in other operating
expenses were $10,135,000, $10,976,000 and $9,187,000 for the years ended
December 31, 1996, 1995 and 1994, respectively.
11
<PAGE>
6. STATUTORY ACCOUNTING PRACTICES
GAAP for the Company differs in certain significant respects from
accounting practices prescribed or permitted by insurance regulatory
authorities. The principal differences result from the following statutory
accounting practices:
- Upfront premiums on municipal business are recognized as earned when
related risk has expired rather than over the expected coverage period;
- Acquisition costs are charged to operations as incurred rather than as
related premiums are earned;
- A contingency reserve is computed based on the following statutory
requirements (rather than establishing a general loss reserve):
a. For all policies written prior to July 1, 1989, an amount equal to
50% of cumulative earned premiums less permitted reductions, plus;
b. For all policies written on or after July 1, 1989, an amount equal
to the greater of 50% of premiums written for each category of insured
obligation or a designated percent of principal guaranteed for that
category. These amounts are provided each quarter as either 1/60th or
1/80th of the total required for each category, less permitted reductions;
- Certain assets designated as "non-admitted assets" are charged directly
to statutory surplus but are reflected as assets under GAAP;
- Federal income taxes are provided only on taxable income for which income
taxes are currently payable;
- Accruals for deferred compensation are not recognized;
- Purchase accounting adjustments are not recognized;
- Bonds are carried at amortized cost.
A reconciliation of the Company's net income for the calendar years
1996, 1995 and 1994 and shareholder's equity at December 31, 1996, 1995 and
1994, prepared on a GAAP basis, to the amounts reported on a statutory
basis, is as follows (in thousands):
1996 1995 1994
---- ---- ----
Net Income (Loss):
GAAP BASIS $80,855 $54,988 $60,264
Premium revenue recognition (5,518) (4,805) (5,425)
Losses and loss adjustment expenses incurred (2,138) 10,871 (13,908)
Deferred acquisition costs (12,482) (10,305) (9,847)
Deferred income tax provision (benefit) 911 (3,055) 4,682
Amortization of bonds 566 1,195 520
Accrual of deferred compensation 12,737 5,663 (9,062)
Other 1,404 (1,580) (274)
------- ------- -------
STATUTORY BASIS $76,335 $52,972 $26,950
======= ======= =======
12
<PAGE>
December 31,
------------
Shareholder's Equity: 1996 1995 1994
---- ---- ----
GAAP BASIS $815,332 $789,986 $528,976
Premium revenue recognition (51,760) (46,248) (29,891)
Loss and loss adjustment expense reserves 29,660 31,798 20,927
Deferred acquisition costs (146,233) (132,951) (91,839)
Contingency reserve (227,139) (183,967) (121,414)
Unrealized loss (gain) on investments,
net of tax (14,084) (30,298) 32,868
Deferred income taxes 41,682 43,205 10,222
Accrual of deferred compensation 18,390 5,653
Other (17,043) (16,492) (5,475)
-------- -------- --------
STATUTORY BASIS (SURPLUS) $448,805 $460,686 $344,374
======== ======== ========
SURPLUS PLUS CONTINGENCY RESERVE $675,944 $644,653 $465,788
======== ======== ========
7. FEDERAL INCOME TAXES
For periods prior to May 13, 1994, the date of initial public offering when
the Parent became less than 80% owned by U S WEST, the Parent, the Company and
its Subsidiaries joined with U S WEST and its subsidiaries in filing a
consolidated federal income tax return. For the Company, under a written tax
sharing agreement with U S WEST, the allocation of income taxes was based upon
separate return calculations which provided that benefits or liabilities created
by the Company are allocated to the Company regardless of whether the benefits
were usable or additional liabilities were incurred in the U S WEST tax returns.
For periods subsequent to May 12, 1994, the Parent and all members of its group
elected to file consolidated federal tax returns. The calculation of each
member's tax benefit or liability by the Company was controlled by a tax sharing
agreement that based the allocation of such benefit or liability upon a separate
return calculation.
The cumulative balance sheet effects of deferred tax consequences are (in
thousands):
December 31,
------------
1996 1995
---- ----
Deferred acquisition costs $51,182 $46,533
Deferred premium revenue adjustments 3,520 2,905
Contingency reserve 29,492 11,542
Unrealized capital gains 7,915 14,950
Market discounts 1,955 900
------- -------
Total deferred tax liabilities 94,064 76,830
------- -------
Loss and loss adjustment expense reserves (10,381) (11,129)
Deferred compensation (9,791) (5,529)
Tax credits (7,842) (3,795)
Tax and loss bonds (22,526) (11,116)
Other, net (1,842) (2,056)
------- -------
Total deferred tax assets (52,382) (33,625)
------- -------
Total deferred income taxes $41,682 $43,205
======= =======
No valuation allowance was necessary at December 31, 1996 or 1995.
13
<PAGE>
A reconciliation of the effective tax rate with the federal statutory rate
follows:
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
Tax at statutory rate 35.0% 35.0% 35.0%
Tax-exempt interest (8.9) (8.3) (12.0)
Other 0.4 0.3
---- ---- ----
Provision for income taxes 26.5% 27.0% 23.0%
===== ===== =====
8. DIVIDENDS AND CAPITAL REQUIREMENTS
Under New York Insurance Law, the Company may pay a dividend without the
prior approval of the Superintendent of the New York State Insurance Department
only from earned surplus subject to the maintenance of a minimum capital
requirement, and the dividend, which together with all dividends declared or
distributed by it during the preceding twelve months, may not exceed the lesser
of 10% of its policyholders' surplus shown on its last filed statement, or
adjusted net investment income, as defined, for such twelve-month period. As of
December 31, 1996, the Company had $45,184,000 available for the payment of
dividends over the next twelve months. As a customary condition for approving
the application of Fund American for a change in control of the Company, the
prior approval of the Superintendent of the New York State Insurance Department
was required for any payment of dividends by the Company to the Parent for a
period of two years following such changed control. Such approval was provided
for the payment of dividends by the Company to the Parent in 1996, 1995 and 1994
in the ordinary course of business. Such prior approval requirement lapsed in
September 1996. In addition, the New York Superintendent has approved the
repurchase by the Company of up to $75,000,000 of its shares from the Parent
through December 31, 1998, pursuant to which the Company has repurchased
$27,000,000 of its shares through December 31, 1996. Future share repurchases
may not exceed cumulative statutory net income beginning January 1, 1996.
9. CREDIT ARRANGEMENTS AND ADDITIONAL CLAIMS-PAYING RESOURCES
The Company has a credit arrangement aggregating $150,000,000 at December
31, 1996, which is provided by commercial banks and intended for general
application to transactions insured by the Company and the Subsidiaries. At
December 31, 1996, there have been no borrowings under this arrangement. In
addition, there are credit arrangements assigned to specific insured
transactions. In August 1994, the Company entered into a facility agreement with
Canadian Global Funding Corporation and Hambros Bank Limited. Under the
agreement, the Company can arrange financing for transactions subject to certain
conditions. The amount of this facility was $186,911,000, of which $100,911,000
was unutilized at December 31, 1996.
The Company has a standby line of credit commitment in the amount of
$125,000,000 with an international Aaa/AAA-rated bank to provide loans to the
Company after it has incurred, during the term of the facility, cumulative
municipal losses (net of any recoveries) in excess of the greater of
$200,000,000 or 5.75% of average annual debt service. The obligation to repay
loans made under this agreement is a limited recourse obligation payable solely
from, and collateralized by, a pledge of recoveries realized on defaulted
insured obligations including certain installment premiums and other collateral.
This commitment has a term beginning on April 30, 1996 and expiring on January
31, 2003 and contains an annual renewal provision subject to approval by the
bank.
10. EMPLOYEE BENEFIT PLANS
The Company maintains both a qualified and a non-qualified non-contributory
defined contribution pension plan for the benefit of all eligible employees. The
Company's contributions are based upon a fixed percentage of employee
compensation. Pension expense, which is funded as accrued, amounted to
$1,977,000, $1,784,000 and $1,888,000 for the years ended December 31, 1996,
1995 and 1994, respectively.
14
<PAGE>
The Company has an employee retirement savings plan for the benefit of all
eligible employees. The plan permits employees to contribute a percentage of
their salaries up to limits prescribed by the Internal Revenue Service (IRS
Code, Section 401(k)). The Company's contributions are discretionary, and none
have been made.
During 1991, the Company established the Profit Participation Plan as a
long-term incentive compensation plan for the benefit of certain of its
employees. Prior to the closing of the Initial Public Offering (see Note 15),
the Parent adopted a Supplemental Restricted Stock Plan. Pursuant to this plan,
awards of outstanding units to existing employees under the Profit Participation
Plan were valued at $0.20 per dollar of award ($0.70 per dollar of award in the
case of 1994 regular units granted thereunder) and, at the election of each
outstanding employee, were exchanged for restricted shares of the Parent's
common stock valued at the initial public offering price of $20.00 per share.
All employees of the Company, including all senior executives, exchanged their
outstanding interests in the Profit Participation Plan for restricted shares of
the Parent's common stock at the public offering price under the Supplemental
Restricted Stock Plan. In settlement of an accrued balance of $7,126,000 in such
Profit Participation Plan, the Company purchased 356,345 shares of restricted
stock from the Parent and awarded the shares to employees. The stock was
restricted because ownership of the shares by employees required continued
employment; the shares vested ratably over a three-year period on July 1, 1994,
1995 and 1996.
Pursuant to the 1993 Equity Participation Plan, 1,810,780 shares of the
Parent's common stock, subject to anti-dilutive adjustment, were reserved for
awards of options, restricted shares of common stock, and performance shares to
employees for the purpose of providing, through the grant of long-term
incentives, a means to attract and retain key personnel and to provide to
participating officers and other key employees long-term incentives for
sustained high levels of performance. Shares available under the 1993 Equity
Participation Plan were increased from 1,810,780 to 2,110,780 in May 1995. The
1993 Equity Participation Plan also contains provisions that permit the Human
Resources Committee to pay all or a portion of an employee's bonuses in the form
of shares of the Parent's common stock credited to the employees at a 15%
discount from current market value and paid to employees five years from the
date of award. Up to an aggregate of 10,000,000 shares may be allocated to such
equity bonuses. Common stock to pay equity bonus awards will be acquired by the
Parent through open-market purchases by a trust established for such purpose.
During 1994, under the Parent's 1993 Equity Participation Plan, the Parent
granted to officers and employees, in respect of future performance,
non-qualified options to purchase an aggregate of 1,099,000 shares of the
Parent's common stock, of which 39,000 were forfeited and 1,060,000 were still
outstanding at December 31, 1994, substantially all of which have an exercise
price of $20.00 per share. (As described below, 1,025,500 of these options will
be converted to performance shares.) The foregoing options vest, subject to
continuation of employment and other terms of the option grants, at the rate of
20% per year, for five one-year periods, with the first period ending on July 1,
1994. Such options expire ten years after the effective dates of their grant. In
the fourth quarter of 1994, holders of outstanding stock options under the 1993
Equity Participation Plan were offered the right to exchange such stock options
for an equal number of performance shares under such Plan. Also, as a result of
the Merger, the Parent granted 169,956 of stock options with strike prices
ranging from $18.63 to $23.53 per share to employees of CGC in exchange for
outstanding stock options of CGC. Giving effect to such exchange, at December
31, 1996, there were outstanding 1,374,340 performance shares and 201,956
options to purchase shares of common stock.
Performance shares granted under the 1993 Equity Participation Plan were as
follows:
Outstanding Granted Forfeited Outstanding Market
at Beginning During During at End Price at
of Year the Year the Year of Year Grant Date
------- -------- -------- ------- ----------
1994 1,025,500 1,025,500 $21.875
1995 1,025,500 83,650 1,109,150 19.250
1996 1,109,150 282,490 17,300 1,374,340 25.250
15
<PAGE>
The Company applies APB Opinion 25 and related Interpretations in
accounting for the Parent's performance shares. The Company estimates the final
cost of these performance shares and accrues for this expense over the
performance period. The accrued expense for the performance shares was
$12,737,000 and $5,663,000 for the years ended December 31, 1996 and 1995,
respectively. In tandem with this accrued expense, the Parent estimates those
performance shares that it expects to settle in stock and records this amount in
stockholders' equity as deferred compensation. The remainder of the accrual,
which represents the amount of performance shares that the Parent estimates it
will settle in cash, is recorded in accrued expenses and other liabilities. In
1996, the Company adopted disclosure provisions of FASB Statement 123. Had the
compensation cost for the Parent's performance shares been determined based upon
fair value at the grant dates for the awards consistent with the method of FASB
Statement 123, the effect on the Company's net income and earnings per share
would have been immaterial.
In November 1994, the Parent appointed an independent trustee authorized to
purchase shares of the Parent's common stock in open market transactions, at
times and prices determined by the trustee. These purchases are intended to fund
future obligations relating to equity bonuses, performance shares and stock
options under the 1993 Equity Participation Plan. During 1996, 1995 and 1994,
the total number of shares purchased by this trust was 529,131, 591,714 and
182,562, respectively, at a cost of $14,111,000, $14,444,000 and $3,730,000,
respectively. The Parent also repurchased stock from its employees in
satisfaction of withholding taxes on shares distributed under its restricted
stock plan.
The Company does not currently provide post-retirement benefits, other than
pensions to its employees, nor does it provide post-employment benefits to
former employees.
11. COMMITMENTS AND CONTINGENCIES
The Company leases office space and equipment under non-cancelable
operating leases, which expire at various dates through 2005.
Future minimum rental payments are as follows (in thousands):
Year Ended December 31,
-----------------------
1997 $ 2,257
1998 2,267
1999 2,229
2000 2,169
2001 2,014
Thereafter 6,810
-------
Total $17,746
=======
Rent expense for the years ended December 31, 1996, 1995 and 1994 was
$3,383,000, $3,493,000 and $3,430,000, respectively.
During the ordinary course of business, the Company and its Subsidiaries
have become parties to certain litigation. Management believes that these
matters will be resolved with no material financial impact on the Company.
16
<PAGE>
12. REINSURANCE
The Company reinsures portions of its risks with affiliated (see Note 14)
and unaffiliated reinsurers under quota share treaties and on a facultative
basis. The Company's principal ceded reinsurance program consisted in 1996 of
three quota share treaties and three automatic facultative facilities. One
treaty covers all of the Company's approved regular lines of business, except
municipal obligation insurance. Under this treaty in 1996, the Company ceded
11.35% of each covered policy, up to a maximum of $22,700,000 insured principal
per policy. At its sole option, the Company could have increased, and in certain
instances did increase, the ceding percentage to 22.7% up to $45,400,000 of each
covered policy. A second treaty covers the Company's municipal obligation
insurance business. Under this treaty in 1996, the Company ceded 10% of each
covered policy that is classified by the Company as providing municipal bond
insurance as defined by Article 69 of the New York Insurance Law up to a limit
of $26,667,000 per single risk, which is defined by revenue source. At its sole
option, the Company could have increased, and in certain instances did increase,
the ceding percentage to 30% up to $80,000,000 per single risk. Under the third
treaty in 1996, the Company ceded 5% of its retention (i.e., after cessions of
policies under the municipal obligation insurance treaty) covering substantially
all teaching hospital and higher education risks, up to limits that range from
$7,500,000 to $30,000,000 per single risk (depending on the type of obligation).
At its sole option, the Company could have increased, and in certain instances
did increase, the ceding percentage from 5% to 15% of its retention, subject to
the same limits. This third treaty was canceled on a run-off basis as of
December 31, 1996. Under the three automatic facultative facilities in 1996, the
Company at its option could allocate up to $20,000,000 or $25,000,000 for each
reinsurer (depending on the reinsurer) for each transaction, subject to limits
and exclusions, in exchange for which the Company agreed to cede in the
aggregate a specified percentage of gross par insured by the Company. Each of
the three treaties and automatic facultative facilities allows the Company to
withhold a ceding commission to defray its expenses.
In the event (which management considers to be highly unlikely) that any or
all of the reinsuring companies were unable to meet their obligations to the
Company, the Company would be liable for such defaulted amounts. The Company has
also assumed reinsurance of municipal obligations from unaffiliated insurers.
Amounts reinsured were as follows (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Written premiums ceded $55,965 $33,166 $28,692
Written premiums assumed 1,873 1,684 1,973
Earned premiums ceded 38,723 38,013 35,051
Earned premiums assumed 6,020 2,759 7,059
Loss and loss adjustment expense payments
ceded 29,408 3,060 1,483
Loss and loss adjustment expense payments
assumed 3 3 3
Incurred losses and loss adjustment expenses ceded (2,249) 9,101 56,895
Incurred losses and loss adjustment expenses
assumed 38 81 137
</TABLE>
December 31,
------------
1996 1995
---- ----
Principal outstanding ceded $20,292,615 $14,355,664
Principal outstanding assumed 1,995,752 2,347,122
Deferred premium revenue ceded 151,224 133,548
Deferred premium revenue assumed 18,929 5,027
Loss and loss adjustment expense reserves ceded 29,875 61,532
Loss and loss adjustment expense reserves assumed 705 670
17
<PAGE>
13. OUTSTANDING EXPOSURE AND COLLATERAL
The Company's policies insure the scheduled payments of principal and
interest on asset-backed and municipal obligations. The principal amount insured
(in millions) as of December 31, 1996 and 1995 (net of amounts ceded to other
insurers of $9,601 and $6,093 of asset-backed and $10,691 and $8,263 of
municipal, respectively) and the terms to maturity are as follows:
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
----------------- -----------------
Terms to Maturity Asset-Backed Municipal Asset-Backed Municipal
- ----------------- ------------ --------- ------------ ---------
<C> <C> <C> <C> <C>
0 to 5 Years $ 7,424 $ 1,571 $ 5,931 $ 3,293
5 to 10 Years 3,920 3,841 3,679 4,713
10 to 15 Years 1,461 6,272 1,183 4,299
15 to 20 Years 714 11,433 423 6,986
20 Years and Above 9,681 12,877 5,847 9,625
------- ------- ------- -------
Total $23,200 $35,994 $17,063 $28,916
======= ======= ======= =======
</TABLE>
The principal amount ceded as of December 31, 1996 and 1995 and the terms
to maturity are as follows (in millions):
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
----------------- -----------------
Terms to Maturity Asset-Backed Municipal Asset-Backed Municipal
- ----------------- ------------ --------- ------------ ---------
<C> <C> <C> <C> <C>
0 to 5 Years $3,695 $ 769 $2,297 $1,103
5 to 10 Years 2,413 1,192 1,503 1,775
10 to 15 Years 452 1,479 403 1,020
15 to 20 Years 302 2,345 126 1,514
20 Years and Above 2,739 4,906 1,764 2,851
------ -------- ------ ------
Total $9,601 $10,691 $6,093 $8,263
====== ======= ====== ======
</TABLE>
The Company limits its exposure to losses from writing financial guarantees
by underwriting investment-grade obligations, by diversifying its portfolio and
by maintaining rigorous collateral requirements on asset-backed obligations. The
gross principal amounts of insured obligations in the asset-backed insured
portfolio are backed by the following types of collateral (in millions):
<TABLE>
<CAPTION>
Net of Amounts Ceded Ceded
December 31, December 31,
------------ ------------
Types of Collateral 1996 1995 1996 1995
- ------------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
Residential mortgages $10,987 $ 6,740 $3,077 $1,909
Consumer receivables 7,548 5,105 3,735 1,320
Government securities 1,477 1,651 449 263
Pooled corporate obligations 1,663 1,819 852 732
Commercial mortgage portfolio:
Commercial real estate 113 148 463 640
Corporate secured 66 98 619 801
Investor-owned utility obligations 791 821 266 292
Other asset-backed obligations 555 681 140 136
------- -------- ------ ------
Total asset-backed obligations $23,200 $17,063 $9,601 $6,093
======= ======= ====== ======
</TABLE>
18
<PAGE>
The asset-backed insured portfolio, which aggregated $32.8 billion
principal before reinsurance at December 31, 1996, was collateralized by assets
with an estimated fair value of $38.3 billion. At December 31, 1995, it
aggregated $23.2 billion principal before reinsurance and was collateralized by
assets with an estimated fair value of $28.0 billion. Such estimates of the
collateral's fair value, which is reduced as exposure expires, are based upon
information at the inception of the insurance policy. At December 31, 1996, the
estimated fair value of collateral and reserves over the principal insured
averaged from 100% for commercial real estate to 168% for corporate secured
obligations. At December 31, 1995, the estimated fair value of collateral and
reserves over the principal insured averaged from 100% for commercial real
estate to 164% for corporate secured obligations. Collateral for specific
transactions is generally not available to pay claims related to other
transactions. The amounts of losses ceded to reinsurers are determined net of
collateral.
The gross principal amount of insured obligations in the municipal insured
portfolio includes the following types of issues (in millions):
<TABLE>
<CAPTION>
Net of Amounts Ceded Ceded
December 31, December 31,
------------ ------------
Types of Issues 1996 1995 1996 1995
- --------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
General obligation bonds $12,523 $ 8,738 $ 2,423 $1,764
Housing revenue bonds 1,794 1,674 1,033 685
Municipal utility revenue bonds 4,671 3,873 1,472 1,107
Health care revenue bonds 2,854 2,587 2,049 1,718
Tax-supported bonds (non-general obligation) 8,805 7,090 2,152 1,741
Transportation revenue bonds 1,479 1,365 436 293
Other municipal bonds 3,868 3,589 1,126 955
------- -------- -------- ------
Total municipal obligations $35,994 $28,916 $10,691 $8,263
======= ======= ======= ======
</TABLE>
In its asset-backed business, the Company considers geographic
concentration as a factor in underwriting insurance covering securitizations of
pools of such assets as residential mortgages or consumer receivables. However,
after the initial issuance of an insurance policy relating to such
securitization, the geographic concentration of the underlying assets may not
remain fixed over the life of the policy. In addition, in writing insurance for
other types of asset-backed obligations, such as securities primarily backed by
government or corporate debt, geographic concentration is not deemed by the
Company to be significant given other more relevant measures of diversification
such as issuer or industry.
The Company seeks to maintain a diversified portfolio of insured municipal
obligations designed to spread its risk across a number of geographic areas. The
following table sets forth, by state, those states in which municipalities
located therein issued an aggregate of 2% or more of the Company's net par
amount outstanding of insured municipal securities as of December 31, 1996:
<TABLE>
<CAPTION>
Net Par Percent of Total Ceded Par
Number Amount Municipal Net Par Amount
State of Issues Outstanding Amount Outstanding Outstanding
----- --------- ----------- ------------------ -----------
(in millions) (in millions)
<S> <C> <C> <C> <C>
California 337 $ 5,669 15.8% $ 1,091
Florida 96 2,189 6.1 772
New York 218 3,508 9.7 1,733
Pennsylvania 157 2,106 5.9 551
New Jersey 175 1,733 4.8 461
Louisiana 81 908 2.5 379
Michigan 118 1,145 3.2 361
Minnesota 113 1,080 3.0 102
Massachusetts 84 1,093 3.0 393
Illinois 193 1,320 3.7 210
Texas 248 1,804 5.0 412
Wisconsin 114 762 2.1 186
All Other States 923 11,698 32.5 3,413
Non-U.S. 26 979 2.7 627
----- ------- ---- -------
Total 2,883 $35,994 100.0% $10,691
===== ======= ===== =======
</TABLE>
19
<PAGE>
14. RELATED PARTY TRANSACTIONS
Allocable expenses are shared by the Company and its Parent on a basis
determined principally by estimates of respective usage as stated in an expense
sharing agreement. The agreement is subject to the provisions of the New York
Insurance Law. Amounts included in other assets at December 31, 1996 and 1995
are $4,205,000 and $3,322,000, respectively, for unsettled expense allocations
due from the Parent.
The Company ceded premiums of $19,890,000, $13,061,000 and $6,609,000 to
Tokio Marine for the years ended December 31, 1996, 1995 and 1994, respectively.
The amounts included in prepaid reinsurance premiums at December 31, 1996 and
1995 for reinsurance ceded to Tokio Marine were $44,634,000 and $33,382,000,
respectively. Reinsurance recoverable on unpaid losses ceded to Tokio Marine was
$477,000 and $323,000 at December 31, 1996 and 1995, respectively.
The Company ceded premiums of $15,409,000, $7,522,000 and $9,390,000 on a
quota share basis to affiliates of U S WEST for the years ended December 31,
1996, 1995 and 1994, respectively, of which $372,000, $629,000 and $1,838,000,
respectively, were ceded to Commercial Reinsurance Company (Commercial Re). The
amounts included in prepaid reinsurance premiums for reinsurance ceded to these
affiliates were $49,649,000 and $39,918,000 at December 31, 1996 and 1995,
respectively, of which $8,728,000 and $10,720,000, respectively, were ceded to
Commercial Re. The amounts of reinsurance recoverable on unpaid losses ceded to
these affiliates at December 31, 1996 and 1995 were $23,473,000 and $55,024,000,
respectively, of which $19,170,000 and $42,918,000, respectively, were ceded to
Commercial Re. The Commercial Re reinsurance agreement was subject to, and
received, the non-disapproval of the State of New York Insurance Department due
to its nature as an affiliate transaction. The Company has taken credit for the
reinsurance ceded to Commercial Re.
15. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following estimated fair values have been determined by the Company
using available market information and appropriate valuation methodologies.
However, considerable judgment is necessary to interpret the data to develop the
estimates of fair value. Accordingly, the estimates presented herein are not
necessarily indicative of the amount the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
Long-term bonds -- The carrying amount of long-term bonds represents fair
value. The fair value of long-term bonds is based upon quoted market price.
Short-term investments -- The carrying amount is fair value, which
approximates cost due to the short maturity of these instruments.
Cash and cash equivalents, receivable for investments sold and payable for
investments purchased -- The carrying amount approximates fair value because of
the short maturity of these instruments.
Deferred premium revenue, net of prepaid reinsurance premiums -- The
carrying amount of deferred premium revenue, net of prepaid reinsurance
premiums, represents the Company's future premium revenue, net of reinsurance,
on policies where the premium was received at the inception of the insurance
contract. The fair value of deferred premium revenue net of prepaid reinsurance
premiums is an estimate of the premiums that would be paid under a reinsurance
agreement with a third party to transfer the Company's financial guaranty risk,
net of that portion of the premium retained by the Company to compensate it for
originating and servicing the insurance contract.
Installment premiums -- Consistent with industry practice, there is no
carrying amount for installment premiums since the Company will receive premiums
on an installment basis over the term of the insurance contract. Similar to
deferred premium revenue, the fair value of installment premiums is the
estimated present value of the future contractual premium revenues that would be
paid under a reinsurance agreement with a third party to transfer
20
<PAGE>
the Company's financial guaranty risk, net of that portion of the premium
retained by the Company to compensate it for originating and servicing the
insurance contract.
Losses and loss adjustment expenses, net of reinsurance recoverable on
unpaid losses -- The carrying amount is fair value, which is the present value
of the expected cash flows for specifically identified claims and potential
losses in the Company's insured portfolio.
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
----------------- -----------------
(In thousands) Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
<S> <C> <C> <C> <C>
Assets:
Long-term bonds $1,068,677 $1,068,677 $1,036,382 $1,036,382
Short-term investments 39,570 39,570 14,568 14,568
Cash and cash equivalents 23,646 23,646 35,832 35,832
Receivable for securities sold 2,326 2,326
Liabilities:
Deferred premium revenue, net of
prepaid reinsurance premiums 359,972 251,980 330,349 263,618
Losses and loss adjustment expenses,
net of reinsurance recoverable on
unpaid losses 42,204 42,204 50,227 50,227
Payable for investments purchased 14,142 14,142 9,516 9,516
Off-balance-sheet instruments:
Installment premiums 102,988 82,212
</TABLE>
16. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
The Company's liability for losses and loss adjustment expenses consists of
the case basis and general reserves. Activity in the liability for losses and
loss adjustment expenses is summarized as follows (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Balance at January 1 $111,759 $ 91,130 $36,094
Less reinsurance recoverable 61,532 55,491 79
-------- --------- -------
Net balance at January 1 50,227 35,639 36,015
Incurred losses and loss adjustment expenses:
Current year 5,300 3,000 3,024
Prior years 1,574 3,258
Related to Merger 15,400
Paid losses and loss adjustment expenses:
Current year (3,397)
Prior years (14,897) (7,070) (3)
-------- --------- -------
Net balance December 31 42,204 50,227 35,639
Plus reinsurance recoverable 29,875 61,532 55,491
-------- --------- -------
Balance at December 31 $ 72,079 $ 111,759 $91,130
======== ========= =======
</TABLE>
In 1994, the Company increased its general reserve by $3,024,000 for
origination of new business and transferred $16,932,000 of the general reserve
to its case basis reserves for projected losses on certain transactions, the
majority of which are in its discontinued commercial mortgage portfolio.
21
<PAGE>
During 1995, the Company increased its general reserve by $6,258,000, of
which $3,000,000 was for originations of new business and $3,258,000 was to
reestablish the general reserve for transfers from general reserves to case
basis reserves. During 1995, the Company transferred $10,788,000 from its
general reserve to case basis reserves associated predominantly with certain
residential mortgage and timeshare receivables transactions. Also in December
1995, FSA recognized a one-time increase of $15,400,000 to the general reserve
to provide for the insured portfolio it had assumed in the Merger with CGC in a
manner consistent with the Company's reserving methodology. Prior to the Merger,
CGC did not maintain a general reserve. Giving effect to all the 1995 events,
the general reserve totaled $31,798,000 at December 31, 1995.
During 1996, the Company increased its general reserve by $6,874,000, of
which $5,300,000 was for originations of new business and $1,574,000 was to
reestablish the general reserve for transfers from general reserves to case
basis reserves. During 1996, the Company transferred $9,012,000 from its general
reserve to case basis reserves associated predominantly with certain residential
mortgage and timeshare receivables transactions. Giving effect to these
transfers, the general reserve totaled $29,660,000 at December 31, 1996.
Reserves for losses and loss adjustment expenses are discounted at
risk-free rates. The amount of discount taken was approximately $17,944,000,
$15,276,000 and $14,588,000 at December 31, 1996, 1995 and 1994, respectively.
22
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<DEBT-HELD-FOR-SALE> 1,146,080
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 8,336
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 1,154,416
<CASH> 8,146
<RECOVER-REINSURE> 29,875
<DEFERRED-ACQUISITION> 146,233
<TOTAL-ASSETS> 1,537,742
<POLICY-LOSSES> 72,079
<UNEARNED-PREMIUMS> 511,196
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 30,000
0
700
<COMMON> 695,441
<OTHER-SE> 105,119
<TOTAL-LIABILITY-AND-EQUITY> 1,537,742
90,448
<INVESTMENT-INCOME> 65,064
<INVESTMENT-GAINS> 3,189
<OTHER-INCOME> 297
<BENEFITS> 6,874
<UNDERWRITING-AMORTIZATION> 23,829
<UNDERWRITING-OTHER> 18,524
<INCOME-PRETAX> 109,771
<INCOME-TAX> 29,011
<INCOME-CONTINUING> 80,760
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 80,760
<EPS-PRIMARY> 2.64
<EPS-DILUTED> 2.64
<RESERVE-OPEN> 50,227
<PROVISION-CURRENT> 5,300
<PROVISION-PRIOR> 1,574
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 14,897
<RESERVE-CLOSE> 42,204
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
