SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File No. 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)
(212) 826-0100
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
At July 31, 1998, there were outstanding 29,898,451 shares of Common Stock, par
value $0.01 per share, of the registrant (includes 1,222,652 shares of Common
Stock owned by a trust on behalf of the Company and excludes 2,377,850 shares of
Common Stock actually held in treasury).
<PAGE>
INDEX
PAGE
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Financial Security Assurance Holdings Ltd. and Subsidiaries
Consolidated Balance Sheets - June 30, 1998 and
December 31, 1997 3
Consolidated Statements of Income - Three and six months
ended June 30, 1998 and 1997 4
Consolidated Statement of Changes in Shareholders' Equity
- Six months ended June 30, 1998 5
Consolidated Statements of Cash Flows
- Six months ended June 30, 1998 and 1997 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
PART II OTHER INFORMATION, AS APPLICABLE
Item 4. Submission of Matters to a Vote of Securities Holders 13
Item 5. Other Matters 13
Item 6. Exhibits and Reports on Form 8-K 13
SIGNATURES 14
2
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FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
June 30, December 31,
ASSETS 1998 1997
---- ----
Bonds at market value (amortized cost of
$1,377,623 and $1,230,479) $ 1,417,755 $ 1,268,158
Equity investments at market value (cost
of $25,586 and $29,430) 28,812 30,539
Short-term investments 69,653 132,931
----------- -----------
Total investments 1,516,220 1,431,628
Cash 16,002 12,475
Deferred acquisition costs 179,437 171,098
Prepaid reinsurance premiums 190,946 173,123
Reinsurance recoverable on unpaid losses 3,690 30,618
Receivable for securities sold 7,812 20,623
Other assets 77,240 61,079
----------- -----------
TOTAL ASSETS $ 1,991,347 $ 1,900,644
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deferred premium revenue $ 648,561 $ 595,196
Losses and loss adjustment expenses 66,364 75,417
Deferred federal income taxes 51,421 56,872
Ceded reinsurance balances payable 23,167 11,199
Payable for securities purchased 59,427 72,979
Notes payable 130,000 130,000
Accrued expenses and other liabilities 78,005 76,621
----------- -----------
TOTAL LIABILITIES 1,056,945 1,018,284
----------- -----------
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 693,385 693,851
Accumulated other comprehensive income
(net of deferred income tax provision of
$14,895 and $13,575) 27,662 25,212
Accumulated earnings 279,435 231,124
Deferred equity compensation 27,702 26,181
Less treasury stock at cost (3,506,924
and 3,521,847 shares held) (94,805) (95,031)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY 934,402 882,360
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,991,347 $ 1,900,644
=========== ===========
See notes to condensed consolidated financial statements.
3
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FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Net premiums written (net of premiums ceded
of $27,121, $23,500, $43,512 and $37,427) $ 62,121 $ 67,495 $ 100,068 $ 94,679
Increase in deferred premium revenue (29,669) (39,934) (35,695) (42,344)
--------- --------- --------- ---------
Premiums earned (net of premiums ceded of
$12,581, $10,401, $25,701 and $19,266) 32,452 27,561 64,373 52,335
Net investment income 19,255 17,121 37,938 33,482
Net realized gains 3,939 1,831 6,672 1,333
Other income 126 2,809 356 3,257
--------- --------- --------- ---------
TOTAL REVENUES 55,772 49,322 109,339 90,407
--------- --------- --------- ---------
Expenses:
Losses and loss adjustment expenses (net of
reinsurance recoveries of $(27), $442, $(6,868)
and $884) 1,047 2,156 2,094 4,441
Interest expense 2,408 542 4,842 1,083
Policy acquisition costs 8,527 7,140 16,914 13,349
Other operating expenses 5,587 4,426 11,192 9,210
--------- --------- --------- ---------
TOTAL EXPENSES 17,569 14,264 35,042 28,083
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES 38,203 35,058 74,297 62,324
Provision for income taxes 10,154 9,825 19,802 16,841
--------- --------- --------- ---------
NET INCOME 28,049 25,233 54,495 45,483
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gains arising during period 4,368 15,906 6,787 4,484
Less: reclassification adjustment for gains
included in net income (2,561) (1,190) (4,337) (866)
--------- --------- --------- ---------
Other comprehensive income 1,807 14,716 2,450 3,618
--------- --------- --------- ---------
COMPREHENSIVE INCOME $ 29,856 $ 39,949 $ 56,945 $ 49,101
========= ========= ========= =========
As based upon net income:
Basic earnings per common share $ 0.97 $ 0.84 $ 1.88 $ 1.51
========= ========= ========= =========
Diluted earnings per common share $ 0.92 $ 0.82 $ 1.80 $ 1.48
========= ========= ========= =========
</TABLE>
See notes to condensed consolidated financial statements.
4
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FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(Dollars in thousands)
<TABLE>
<CAPTION>
Additional Additional Accumulated
Paid-In Paid-In Other Comp- Deferred
Preferred Common Capital - Capital - rehensive Accumulated Equity Treasury
Stock Stock Preferred Common Income Earnings Compensation Stock Total
----- ----- --------- ------ ------ -------- ------------ ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1997 $20 $323 $680 $693,851 $25,212 $231,124 $26,181 $(95,031) $882,360
Net income 54,495 54,495
Net unrealized gain on
investments 2,450 2,450
Dividends paid on common stock
($0.215 per share) (6,184) (6,184)
Deferred equity compensation 7,401 7,401
Deferred equity payout 193 (5,832) 204 (5,435)
Purchase of 4,305 shares of
common stock (242) (242)
Issuance of 10,618 shares of
treasury stock for options
exercised (14) (48) 264 202
Forward share transactions-
settlements with employees
and directors (645) (645)
--- ---- ---- -------- ------- -------- ------- -------- --------
BALANCE, June 30, 1998 $20 $323 $680 $693,385 $27,662 $279,435 $27,702 $(94,805) $934,402
=== ==== ==== ======== ======= ======== ======= ======== ========
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE>
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Six Months Ended June 30,
1998 1997
---- ----
Cash flows from operating activities:
Premiums received, net $ 116,661 $ 98,426
Policy acquisition and other operating expenses
paid, net (43,352) (32,773)
Loss and LAE recovered (paid), net 15,672 (2,332)
Net investment income received 34,742 31,299
Recoverable advances received (paid) 4,561 (443)
Federal income taxes recovered (paid) (30,038) 292
Interest paid (4,820) (1,058)
Other, net 993 3
----------- -----------
Net cash provided by operating activities 94,419 93,414
----------- -----------
Cash flows from investing activities:
Proceeds from sales of bonds 873,081 471,648
Purchases of bonds (1,011,388) (483,183)
Other, net (12,314) 2,586
Purchases of property and equipment (605) (1,687)
Net decrease (increase) in short-term securities 66,759 (57,868)
----------- -----------
Net cash used for investing activities (84,467) (68,504)
----------- -----------
Cash flows from financing activities:
Dividends paid (6,184) (5,775)
Treasury stock (39) (5,153)
Other (202) (654)
----------- -----------
Net cash used for financing activities (6,425) (11,582)
----------- -----------
Net increase in cash 3,527 13,328
Cash at beginning of period 12,475 8,146
----------- -----------
Cash at end of period $ 16,002 $ 21,474
=========== ===========
See notes to condensed consolidated financial statements.
6
<PAGE>
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Six Months Ended June 30, 1998 and 1997
1. ORGANIZATION AND OWNERSHIP
Financial Security Assurance Holdings Ltd. (the Company) is an insurance
holding company domiciled in the State of New York. The Company is primarily
engaged (through its insurance subsidiaries, collectively known as FSA) in the
business of providing financial guaranty insurance on asset-backed and municipal
obligations. At June 30, 1998, the Company was owned 42.1% by MediaOne Capital
Corporation (MediaOne), formerly US WEST Capital Corporation, 12.0% by Fund
American Enterprises Holdings, Inc. (Fund American), 6.7% by The Tokio Marine
and Fire Insurance Co., Ltd. (Tokio Marine) and 39.2% by the public and
employees. These percentages are calculated based upon outstanding shares, which
are reduced by treasury shares as presented in these financial statements.
2. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared in
accordance with instructions to Form 10-Q and, accordingly, do not include all
of the information and disclosures required by generally accepted accounting
principles. These statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's 1997 Annual
Report to Shareholders. The accompanying financial statements have not been
audited by independent accountants in accordance with generally accepted
auditing standards but, in the opinion of management, all adjustments, which
include only normal recurring adjustments, necessary to present fairly the
financial position, results of operations and cash flows at June 30, 1998 and
for all periods presented have been made. The December 31, 1997 condensed
balance sheet data was derived from audited financial statements, but does not
include all disclosures required by generally accepted accounting principles.
The results of operations for the periods ended June 30, 1998 and 1997 are not
necessarily indicative of the operating results for the full year.
3. COMPREHENSIVE INCOME
The Company adopted Statement of Financial Accounting Standards (SFAS) No.
130, Reporting Comprehensive Income, which requires that all components of other
comprehensive income be classified by their nature in a financial statement and
accumulated balances of other comprehensive income be displayed separately from
retained earnings and additional paid-in capital in the equity section of a
balance sheet. The Company is disclosing this information in its statements of
income. Comprehensive income is defined as the change in shareholders' equity
during a period from transactions and other events and circumstances from
non-owner sources and includes net income and all changes in shareholders'
equity except those from investments by owners and distributions to owners. This
statement did not change the current accounting treatment for components of
comprehensive income such as changes in unrealized gains or losses on securities
available for sale.
4. RECENTLY ISSUED ACCOUNTING STANDARD
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities (FAS No. 133). FAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. FAS
No. 133 is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999. The impact of FAS No. 133 on the Company has not yet been
determined.
7
<PAGE>
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations
1998 and 1997 Second Quarter Results
The Company's 1998 second quarter net income was $28.0 million, compared with
$25.2 million for the same period in 1997, an increase of 11.2%. Core net income
(operating net income less the after-tax effect of refundings and prepayments)
was $26.3 million, compared with $22.0 million for the same period in 1997, an
increase of 19.5%. Total core revenues in the second quarter of 1998 increased
$6.7 million, from $41.6 million in 1997 to $48.3 million in 1998, while total
core expenses increased only $2.4 million. Operating net income (net income less
the after-tax effect of net realized capital gains or losses and the cost of the
performance share program and other non-operating items) was $28.0 million for
the second quarter of 1998 versus $23.6 million for the comparable period in
1997, an increase of $4.4 million or 18.7%.
There are 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 a present value, as well as up-front premiums, but only
for business originated in the period. At the beginning of 1998, the Company
revised the discount rate used to estimate gross PV premiums written in order to
more accurately reflect current interest rates. The new discount rate of 6.3%
represents the average pre-tax yield on the Company's investment portfolio for
the previous three years. The Company intends to revise the discount rate in
future years according to the same formula. For business written prior to 1998,
the discount rate remains 9.5% in all years. The change to the new discount rate
has no effect on current or future earned premiums. 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. Regardless of the
measure used, quarter to quarter comparisons are of limited significance because
originations fluctuate from quarter to quarter but historically have not
exhibited a seasonal pattern.
Gross premiums written decreased 1.9%, from $91.0 million for the second quarter
of 1997 to $89.2 million for the second quarter of 1998. Gross PV premiums
written increased 23.0%, to $107.3 million in 1998 from $87.2 million in the
second quarter of 1997. The decrease in gross premiums written came from several
large, high-premium European transactions closed in the second quarter of 1997,
whereas the increase in gross PV premiums written was due primarily to municipal
transactions. In the second quarter of 1998, asset-backed gross PV premiums
written were $35.8 million, as compared with $38.9 million in 1997, a decrease
of 8.1%. For the municipal business, gross PV premiums written in the second
quarter increased from $48.3 million in 1997 to $71.5 million in 1998, an
increase of 48.0%.
In the second quarter of 1998, the Company insured par value of bonds totaling
$17.1 billion, an 80.6% increase over the same period in 1997. FSA's second
quarter asset-backed component rose 44.9% to $6.6 billion while its municipal
sector rose 113.9% to $10.5 billion.
Net premiums written were $62.1 million for the second quarter of 1998, a
decline of 8.0% when compared with 1997. Net premiums earned for the second
quarter of 1998 were $32.5 million, compared with $27.6 million in the second
quarter of 1997, an increase of 17.7%. Premiums earned from refundings and
prepayments were $3.5 million for the second quarter of 1998 and $3.3 million
for the same period of 1997, contributing $1.6 million and $1.5 million,
respectively, to after-tax earnings. Net premiums earned for the quarter grew
19.2% relative to the same period in 1997 when the effects of refundings and
prepayments are eliminated.
8
<PAGE>
Net investment income was $19.3 million for the second quarter of 1998 and $17.1
million for the comparable period in 1997, an increase of 12.5%. The Company's
effective tax rate on investment income was 20.1% for the second quarter of 1997
compared with 17.8% for the same period in 1998. In the second quarter of 1998,
the Company realized $3.9 million in net capital gains as compared with net
capital gains of $1.8 million for the same period in 1997. Capital gains and
losses are a by-product of the normal investment management process and will
vary substantially from period to period.
The provision for losses and loss adjustment expenses during the second quarter
of 1998 was $1.0 million compared with $2.2 million in 1997, representing
additions to the Company's general loss reserve. The additions to the general
loss reserve represent management's estimate of the amount required to
adequately cover the net cost of claims. 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. At June 30, 1998, the unallocated balance in the Company's
general loss reserve was $54.2 million.
Total policy acquisition and other operating expenses (excluding the cost of the
performance share program of $3.8 million for the second quarter of 1998
compared with $1.8 million for the same period of 1997) were $10.3 million for
the second quarter of 1998 compared with $9.7 million for the same period in
1997, an increase of 5.9%. Excluding the effects of refundings, total policy
acquisition and other operating expenses were $9.3 million for the second
quarter of 1998 compared with $8.8 million for the same period in 1997, an
increase of 5.9%. The increase was the result of higher DAC amortization due to
a higher level of premiums earned, personnel costs and bank facility fees.
During the second quarter of 1997, the Company realized a $2.6 million net gain
from the sale of a subsidiary, net of certain previously capitalized expenses.
The subsidiary was sold because its insurance licenses were no longer required.
Income before income taxes for the second quarter of 1998 was $38.2 million, up
from $35.1 million, or 9.0%, for the same period in 1997.
The Company's effective tax rate for the second quarter of 1998 was 26.6%
compared with 28.0% for the same period in 1997.
The weighted average number of diluted shares of common stock outstanding
decreased to 30,371,000 for the quarter ended June 30, 1998, from 30,725,000
during the second quarter of 1997. This decrease was due to shares the Company
repurchased to fund obligations under employee benefit plans and to close out a
portion of its forward share purchase arrangement, as discussed in previous
filings, partially offset by an increase in the dilutive effect of its
convertible preferred stock and shares issuable under its performance share
program. Diluted earnings per share increased to $0.92 for the second quarter of
1998 from $0.82 for the same period in 1997.
The Company has assessed its internal operating systems and software for Year
2000 compliance. Management does not expect that the arrival of the Year 2000
will require any material upgrade to its internal systems or software. The
Company has completed its survey of Year 2000 readiness of trustees, servicers,
issuers and other parties in FSA-insured transactions. While such other parties
have not informed the Company of any material issues regarding Year 2000
readiness, there can be no assurance that each such party will be Year 2000
compliant. Failure by an issuer or servicer in an FSA-insured transaction to be
Year 2000 compliant may result in unanticipated claims upon FSA. While FSA
generally would be entitled to reimbursement for any such claims paid, the
liquidity exposure to FSA from such claims could be material. Failure by a
trustee in an FSA-insured transaction to make payments to insured
securityholders due to failure by the trustee to be Year 2000 compliant
generally would not entitle the trustee to make claims upon FSA.
1998 and 1997 First Six Months Results
The Company's 1998 first half net income was $54.5 million, compared with $45.5
million for the same period in 1997, an increase of 19.8%. Core net income was
$51.0 million, compared with $42.6 million for the same period in 1997, an
increase of 19.7%. Total core revenues in the first half of 1998 increased $13.6
million, from $80.9 million in 1997 to $94.5 million in 1998, while total core
expenses increased only $4.9 million. Operating net income was
9
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$54.8 million for the first half of 1998 versus $45.2 million for the comparable
period in 1997, an increase of $9.6 million or 21.2%.
Gross premiums written increased 8.7%, to $143.6 million for the first half of
1998 from $132.1 million for the first half of 1997. Also, gross PV premiums
written increased 21.8%, to $158.0 million in 1998 from $129.7 million in the
first half of 1997. In the first half of 1998, asset-backed gross PV premiums
written were $51.9 million, as compared with $60.2 million in 1997, a decrease
of 13.7% attributable to large, high premium transactions in the first quarter
of 1997. For the municipal business, gross PV premiums written in the first half
increased to $106.1 million in 1998 from $69.5 million in 1997, an increase of
52.6%.
In the first half of 1998, the Company insured par value of bonds totaling $26.2
billion, a 60.9% increase over the same period in 1997. FSA's first half
asset-backed sector rose 7.8% to $9.6 billion while its municipal sector rose
124.4% to $16.6 billion.
Net premiums written were $100.1 million for the first half of 1998, an increase
of $5.4 million, or 5.7%, when compared with 1997. Net premiums earned for the
first half of 1998 were $64.4 million, compared with $52.3 million in the first
half of 1997, an increase of 23.0%. Premiums earned from refundings and
prepayments were $8.2 million for the first half of 1998 and $5.6 million for
the same period of 1997, contributing $3.8 million and $2.6 million,
respectively, to after-tax earnings. Net premiums earned for the first half grew
20.2% relative to the same period in 1997 when the effects of refundings and
prepayments are eliminated.
Net investment income was $37.9 million for the first half of 1998 and $33.5
million for the comparable period in 1997, an increase of 13.3%. The Company's
effective tax rate on investment income was 19.5% for the first half of 1997
compared with 18.1% in 1998. In the first half of 1998, the Company realized
$6.7 million in net capital gains as compared with $1.3 million for the same
period in 1997. Capital gains and losses are a by-product of the normal
investment management process and will vary substantially from period to period.
The provision for losses and loss adjustment expenses during the first half of
1998 was $2.1 million compared with $4.4 million for the same period in 1997,
representing additions to the Company's general loss reserve.
Total policy acquisition and other operating expenses (excluding the cost of the
performance share program of $7.1 million for the first half of 1998 compared
with $3.5 million for the same period of 1997) were $21.0 million for the first
half of 1998 compared with $19.1 million for the same period in 1997, an
increase of 10.0%. Excluding the effects of refundings, total policy acquisition
and other operating expenses were $18.7 million for the first half of 1998
compared with $17.5 million for the same period in 1997, an increase of 6.8%.
Income before income taxes for the first half of 1998 was $74.3 million, up from
$62.3 million, or 19.2%, for the same period in 1997.
The Company's effective tax rate for the first half of 1998 was 26.7% compared
with 27.0% for the same period in 1997.
The weighted average number of diluted shares of common stock outstanding
decreased from 30,716,000 during the first six months of 1997 to 30,297,000, for
the six months ended June 30, 1998. Diluted earnings per share increased to
$1.80 for the first six months of 1998 from $1.48 for the same period in 1997.
Liquidity and Capital Resources
The Company's consolidated invested assets and cash equivalents at June 30,
1998, net of unsettled security transactions, was $1,464.6 million, compared
with the December 31, 1997, balance of $1,379.3 million. These balances include
the change in the market value of the investment portfolio, which had an
unrealized gain position of $43.4 million at June 30, 1998 and $38.8 million at
December 31, 1997.
At June 30, 1998, the Company had, at the holding company level, an investment
portfolio of $63.9 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 and to declare and pay dividends will largely depend
upon the receipt of dividends from and payments on surplus notes by FSA and upon
external financings.
10
<PAGE>
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 no
dividends in 1997. Based upon FSA's statutory statements for the quarter ended
June 30, 1998, 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 $51.3 million. In
addition, the Company holds a $50 million surplus note of FSA. Payments of
principal or interest on such note may be made with the approval of the New York
Insurance Department. The New York Superintendent has approved the repurchase by
FSA of up to $75.0 million of its shares from its parent, all of which have been
repurchased as of June 30, 1998.
Dividends paid by the Company to its shareholders increased to $6.2 million in
the first half of 1998 from $5.8 million in the comparable period of 1997 and to
$0.215 per common share in 1998 from $0.190 in 1997. In addition to paying
dividends, the Company uses funds to make debt service payments and to fund
employee benefit plans.
The Company has outstanding $130.0 million of 7-3/8% Senior Quarterly Income
Debt Securities due September 30, 2097 and callable without premium or penalty
on or after September 18, 2002.
In May 1996, the Company repurchased 1,000,000 shares of its common stock from
MediaOne for a purchase price of $26.50 per share. At the same time, the Company
also entered into forward agreements with two banks (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 (i) to
purchase the Forward Shares from the Counterparties for a price equal to $26.50
per share plus carrying costs or (ii) to 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 and risk
of 750,000 of these shares available for subscription by certain of the
Company's employees and directors. When an individual participant exercises
Forward Shares under the subscription program, the Company settles with the
participant but does not necessarily close out the corresponding Forward Share
position with the Counterparties. The cost of these settlements during 1997 was
$2.1 million and was charged to additional paid-in capital. By the fourth
quarter of 1997, such exercises by participants had increased the number of
shares allocated to the Company from 1,000,000 shares to 1,187,800 shares.
During the fourth quarter of 1997, the Company exercised rights under the
forward agreements, purchasing 1,187,800 Forward Shares for a total cost of
$33.9 million. At June 30, 1998, as a result of the Company's exercise, the
repurchased shares were held as treasury stock, and 562,200 shares remained in
the program. As a result of the repurchase of Forward Shares from employees and
directors, 28,000 shares are held for the benefit of the Company and 534,200
shares continue to be held for the benefit of the employees and directors.
FSA's primary uses of funds are to pay operating expenses, to pay dividends to
its parent and to repurchase stock from its parent. 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.
11
<PAGE>
A group of international Aaa/AAA-rated banks make available to FSA a standby
irrevocable limited recourse line of credit, which was increased from $125.0
million to $240.0 million during 1997. This credit facility 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. The facility expires on April 30, 2005 unless extended.
The Company has a credit arrangement aggregating $150.0 million at June 30,
1998, which is provided by commercial banks and intended for general application
to transactions insured by FSA. At June 30, 1998, there were no borrowings under
this arrangement, which expires on November 23, 1999. 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.
Under the agreement, FSA can arrange financing for transactions subject to
certain conditions. The amount of this facility was $186.9 million, of which
$54.3 million was unutilized at June 30, 1998.
The Company has no plans for material capital expenditures within the next
twelve months.
Forward-Looking Statements
This quarterly report contains forward-looking statements regarding, among other
things, the Company's plans and prospects. Important factors, including general
market conditions and the competitive environment, could cause actual results to
differ materially from those described in such forward-looking statements.
Certain of these factors are described in more detail under the heading
"Forward-Looking Statements" in Item 1 of the Company's Annual Report on Form
10-K for the year ended December 31, 1997. Forward-looking statements in this
report are expressly qualified by all such factors. The Company undertakes no
obligation to revise or update any forward-looking statements to reflect changes
in events or expectations or otherwise.
12
<PAGE>
PART II
OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Securities Holders
The Company's Annual Meeting of Shareholders was held on Thursday, May 14,
1998. At the 1998 Annual Meeting, shareholders elected all 12 nominees for
director and approved the Company's selection of Coopers & Lybrand L.L.P. (now
PricewaterhouseCoopers LLP) as independent auditors for the year ending December
31, 1998. The number of votes cast with respect to each director nominee were as
follows:
Nominee Number of Shares Voted For Number of Shares Withheld
------- -------------------------- -------------------------
John J. Byrne 29,973,501 24,455
Robert P. Cochran 29,973,501 24,455
Robert N. Downey 29,973,769 24,187
Anthony M. Frank 28,517,733 1,480,223
Toshiki Kaneda 29,973,836 24,120
K. Thomas Kemp 29,973,836 24,120
David O. Maxwell 29,973,501 24,455
James M. Osterhoff 29,973,501 24,455
James H. Ozanne 29,973,836 24,120
Richard A. Post 29,973,836 24,120
Roger K. Taylor 29,973,501 24,455
Howard M. Zelikow 29,973,836 24,120
The selection of PricewaterhouseCoopers LLP was ratified by 29,978,804 shares;
1,237 shares were voted against ratification and holders of 17,915 shares
abstained from voting on this matter.
Item 5. Other Matters
In accordance with new Rule 14a-4(c)(1) under the Securities Exchange Act
of 1934, management proxies for the Company's 1999 Annual Meeting of
Shareholders may use their discretionary voting authority with respect to any
proposal presented at the meeting by a shareholder who does not provide the
Company with written notice of such proposal before February 14, 1999.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
(1) Financial statements of Financial Security Assurance Inc. for
the quarterly period ended June 30, 1998.
(b) Reports on Form 8-K
None
13
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
By /s/ John A. Harrison
---------------------------------------------------------
August 13, 1998 John A. Harrison
Managing Director & Chief Financial Officer
(Chief Accounting Officer)
14
<PAGE>
Exhibit Index
Exhibit No. Exhibit
- ----------- -------
1. Financial statements of Financial Security Assurance Inc. for the
quarterly period ended June 30, 1998
EXHIBIT 1
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
Condensed Consolidated Financial Statements
June 30, 1998
<PAGE>
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Six Months Ended June 30, 1998 and 1997
INDEX
FINANCIAL STATEMENTS:
Condensed Consolidated Balance Sheets 1
Condensed Consolidated Statements of Income 2
Condensed Consolidated Statements of Cash Flows 3
Notes to Condensed Consolidated Financial Statements 4
The New York State Insurance Department recognizes only statutory accounting
practices for determining and reporting the financial condition and results of
operations of an insurance company, for determining its solvency under the New
York Insurance Law, and for determining where its financial condition warrants
the payment of a dividend to its stockholders. No consideration is given by the
New York State Insurance Department to financial statements prepared in
accordance with generally accepted accounting principles in making such
determinations.
<PAGE>
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
June 30, December 31,
ASSETS 1998 1997
---- ----
<S> <C> <C>
Bonds at market value (amortized cost
of $1,329,490 and $1,192,771) $1,369,513 $1,235,441
Equity investments at market value (cost
of $16,367 and $20,405) 17,361 20,762
Short-term investments 62,900 103,926
---------- ----------
Total investments 1,449,774 1,360,129
Cash 13,863 11,235
Deferred acquisition costs 179,437 171,098
Prepaid reinsurance premiums 190,946 173,123
Reinsurance recoverable on unpaid losses 3,690 30,618
Receivable for securities sold 7,769 20,535
Other assets 86,379 72,901
---------- ----------
TOTAL ASSETS $1,931,858 $1,839,639
========== ==========
LIABILITIES AND SHAREHOLDER'S EQUITY
Deferred premium revenue $ 648,561 $ 595,196
Losses and loss adjustment expenses 66,364 75,417
Deferred federal income taxes 52,520 59,867
Ceded reinsurance balances payable 23,167 11,199
Payable for securities purchased 59,342 72,979
Long-term debt 50,000 50,000
Accrued expenses and other liabilities 82,279 77,121
---------- ----------
TOTAL LIABILITIES 982,233 941,779
---------- ----------
Common stock (500 and 528 shares authorized, issued and
outstanding; par value of $30,000 and $28,391 per share) 15,000 15,000
Additional paid-in capital 614,067 617,870
Accumulated other comprehensive income (net of deferred
income tax provision of $14,076 and $15,059) 26,140 27,968
Accumulated earnings 294,418 237,022
---------- ----------
TOTAL SHAREHOLDER'S EQUITY 949,625 897,860
---------- ----------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $1,931,858 $1,839,639
========== ==========
</TABLE>
See notes to condensed consolidated financial statements.
1
<PAGE>
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands)
Six Months Ended June 30,
-------------------------
1998 1997
---- ----
REVENUES:
Net premiums written (net of premiums ceded of
$43,512 and $37,427) $ 100,068 $ 94,679
Increase in deferred premium revenue (35,695) (42,344)
----------- -----------
Premiums earned (net of premiums ceded of
$25,701 and $19,266) 64,373 52,335
Net investment income 36,022 32,886
Net realized gains 8,478 1,384
Other income 265 4,537
----------- -----------
TOTAL REVENUES 109,138 91,142
----------- -----------
EXPENSES:
Losses and loss adjustment expenses (net of
reinsurance recoveries of $(6,868) and $2,438) 2,094 4,441
Policy acquisition costs 16,914 13,349
Other operating expenses 11,372 8,387
----------- -----------
TOTAL EXPENSES 30,380 26,177
----------- -----------
INCOME BEFORE INCOME TAXES 78,758 64,965
Provision for income taxes 21,363 17,766
----------- -----------
NET INCOME 57,395 47,199
----------- -----------
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains arising during period 3,683 3,677
Less: reclassification adjustment for
gains included in net income (5,511) (900)
----------- -----------
Other comprehensive income (1,828) 2,777
----------- -----------
COMPREHENSIVE INCOME $ 55,567 $ 49,976
=========== ===========
See notes to condensed consolidated financial statements.
2
<PAGE>
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Six Months Ended June 30,
-------------------------
1998 1997
---- ----
Cash flows from operating activities:
Premiums received, net $ 116,661 $ 98,426
Policy acquisition and other operating
expenses paid, net (41,315) (33,988)
Recoverable advances received (paid) 4,561 (443)
Loss and LAE recovered (paid), net 15,672 (2,332)
Net investment income received 31,989 29,487
Federal income taxes paid (30,584) (6,152)
Other, net (3,597) 1,370
----------- -----------
Net cash provided by operating activities 93,387 86,368
----------- -----------
Cash flows from investing activities:
Proceeds from sales of bonds 818,324 470,721
Purchases of bonds (943,776) (482,437)
Other 4,086
Purchases of property and equipment (550) (1,638)
Net decrease (increase) in short-term securities 43,743 (56,935)
----------- -----------
Net cash used for investing activities (82,259) (66,203)
----------- -----------
Cash flows from financing activities:
Stock repurchase (8,500) (7,000)
----------- -----------
Net cash used for financing activities (8,500) (7,000)
----------- -----------
Net increase in cash 2,628 13,165
Cash at beginning of period 11,235 7,517
----------- -----------
Cash at end of period $ 13,863 $ 20,682
=========== ===========
See notes to condensed consolidated financial statements.
3
<PAGE>
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997
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 primarily engaged in
the business of providing financial guaranty insurance on asset-backed and
municipal obligations.
2. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have been
prepared by the Company and are unaudited. In the opinion of management, all
adjustments, which include only normal recurring adjustments, necessary to
present fairly the financial position, results of operations and cash flows at
June 30, 1998 and for all periods presented, have been made.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. These statements should be read in
conjunction with the Company's December 31, 1997 consolidated financial
statements and notes thereto. The year-end condensed balance sheet was derived
from audited financial statements, but does not include all disclosures required
by generally accepted accounting principles. The results of operations for the
periods ended June 30, 1998 and 1997 are not necessarily indicative of the
operating results for the full year.
3. COMPREHENSIVE INCOME
The Company adopted Statement of Financial Accounting Standards (SFAS) No.
130, Reporting Comprehensive Income, which requires that all components of other
comprehensive income be classified by their nature in a financial statement and
accumulated balances of other comprehensive income be displayed separately from
retained earnings and additional paid-in capital in the equity section of a
balance sheet. The Company is disclosing this information in its statements of
income. Comprehensive income is defined as the change in shareholders' equity
during a period from transactions and other events and circumstances from
non-owner sources and includes net income and all changes in shareholders'
equity except those from investments by owners and distributions to owners. This
statement did not change the current accounting treatment for components of
comprehensive income such as changes in unrealized gains or losses on securities
available for sale.
4. RECENTLY ISSUED ACCOUNTING STANDARD
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities (FAS No. 133). FAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and hedging activities. It requires
that an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value. FAS
No. 133 is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999. The impact of FAS No. 133 on the Company has not yet been
determined.
4
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
Financial Security Assurance Holdings Ltd.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<DEBT-HELD-FOR-SALE> 1,487,408
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 28,812
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 1,516,220
<CASH> 16,002
<RECOVER-REINSURE> 3,690
<DEFERRED-ACQUISITION> 179,437
<TOTAL-ASSETS> 1,991,347
<POLICY-LOSSES> 66,364
<UNEARNED-PREMIUMS> 648,561
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 130,000
0
700
<COMMON> 693,708
<OTHER-SE> 239,994
<TOTAL-LIABILITY-AND-EQUITY> 1,991,347
64,373
<INVESTMENT-INCOME> 37,938
<INVESTMENT-GAINS> 6,672
<OTHER-INCOME> 356
<BENEFITS> 2,094
<UNDERWRITING-AMORTIZATION> 16,914
<UNDERWRITING-OTHER> 16,034
<INCOME-PRETAX> 74,297
<INCOME-TAX> 19,802
<INCOME-CONTINUING> 54,495
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 54,495
<EPS-PRIMARY> 1.88
<EPS-DILUTED> 1.80
<RESERVE-OPEN> 75,417
<PROVISION-CURRENT> 2,094
<PROVISION-PRIOR> (11,147)
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 66,364
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
