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, 1998
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:
<TABLE>
<CAPTION>
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
<S> <C>
Common Stock, par value $.01 per share New York Stock Exchange, Inc.
7.375% Senior Quarterly Income Debt Securities Due 2097 New York Stock Exchange, Inc.
6.950% Senior Quarterly Income Debt Securities Due 2098 New York Stock Exchange, Inc.
</TABLE>
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 11, 1999 was $1,609,291,128
(based upon the closing price of the registrant's shares on the New York Stock
Exchange on March 11, 1999, which was $53.875). For purposes of the foregoing,
only MediaOne Capital Corporation and Fund American Enterprises Holdings, Inc.
were deemed to be affiliates of the registrant.
At March 11, 1999, there were outstanding 31,533,781 shares of Common
Stock, par value $0.01 per share, of the registrant (includes 1,360,159 shares
of Common Stock owned by a trust on behalf of the Company and excludes 742,520
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, 1998 are incorporated by reference into Part II hereof.
Portions of the registrant's definitive Proxy Statement dated March 26, 1999 in
connection with the Annual Meeting of Shareholders to be held on May 13, 1999
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 7A. Qualitative and Quantitative Disclosures About Market Risk......... 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
1
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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 and municipal obligations. The claims-paying ability of FSA is
rated "triple-A" by the major securities ratings agencies and obligations
dinsured by FSA are generally awarded "triple-A" ratings by reason of such
insurance. 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, 1998, FSA had gross
premiums written of $319.3 million, of which 70% related to insurance of
municipal obligations and 30% related to insurance of asset-backed obligations.
At December 31, 1998, FSA had net insurance in force of $160.0 billion, of which
70% represented insurance of municipal obligations and 30% 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.
FSA owns FSA Insurance Company ("FSAIC"), which in turn owns Financial
Security Assurance International Ltd. ("FSA International"), Financial Security
Assurance (U.K.) Limited ("FSA-UK") and Financial Security Assurance of
Oklahoma, Inc. ("FSA Oklahoma"). FSA International is a Bermuda domiciled
insurance company that primarily provides financial guaranty insurance for
transactions outside United States and European markets as well as reinsurance
to FSA. FSA-UK is a United Kingdom domiciled insurance company that primarily
provides financial guaranty insurance for transactions in the United Kingdom and
other European markets. FSAIC is an Oklahoma domiciled insurance company that
primarily provides reinsurance to FSA. FSA Oklahoma ceased to be an operating
company in 1998. All such insurance company subsidiaries are wholly owned,
except that XL Capital Ltd owns a minority interest in FSA International as
described below.
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 affiliates.
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.
When it commenced operations in 1985, the Company was owned by a number of
large insurance companies and other institutional investors. In 1989, the
Company was acquired by U S WEST Capital Corporation ("U S WEST"), which has
since changed its name to MediaOne Capital Corporation ("MediaOne"). MediaOne is
a subsidiary of MediaOne Group, Inc., with operations and investments in
domestic cable and broadband communications and international broadband and
wireless communication. In 1990, the Company established a strategic
relationship with The Tokio Marine and Fire Insurance Co. Ltd. ("Tokio Marine"),
which acquired a minority interest in the Company. Tokio Marine is a major
Japanese property and casualty insurance company.
In 1994, the Company completed an initial public offering (the "IPO") of
common shares, at which time Fund American Enterprises Holdings, Inc. (together
with its wholly owned subsidiaries, "Fund American") made an investment in the
Company and entered into certain agreements providing, among other things, Fund
American certain rights to acquire additional shares of the Company from the
Company and MediaOne. Pursuant to these agreements, 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. Fund American
primarily operates businesses in insurance and mortgage banking.
In 1998, the Company and XL Capital Ltd ("XL") entered into a joint
venture, establishing two Bermuda domiciled financial guaranty insurance
companies--FSA International and XL Financial Assurance Ltd ("XLFA"). XL owns a
minority interest in FSA International and the Company owns a minority interest
in XLFA. In connection with such joint ventures, XL acquired an interest in the
Company and the Company acquired an interest in XL. XL is a major Bermuda
insurance company.
At December 31, 1998, voting control of the Company was held 32.0% by
MediaOne, 23.1% by Fund American, 6.1% by Tokio Marine, 5.1% by XL and 33.7% by
the public and employees. MediaOne has previously
2
<PAGE>
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. Most of the Company's shares owned by MediaOne are either
subject to stock options held by Fund American or potentially deliverable in
satisfaction of DECS (Debt Exchangeable for Common Stock) securities issued by
MediaOne and maturing in May 1999.
The principal executive offices of the Company are located at 350 Park
Avenue, New York, New York 10022. Subsidiaries of the Company also maintain
offices domestically in San Francisco and Dallas and abroad in London,
Singapore, Bermuda, Paris, Tokyo, Sydney and Madrid.
Industry Overview
Financial guaranty insurance written by FSA typically guarantees scheduled
payments on an issuer's obligations. Upon 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. 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. 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 and municipal obligations. 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 50.8% for the year ending 1998 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 selectively pursues international opportunities and currently operates
in the European and Asia Pacific markets.
Business of FSA
General
The business of FSA is managed by its Management Committee, comprised of
its Chairman, President, Chief Operating Officer, Chief Underwriting Officer,
General Counsel and Chief Financial Officer. FSA is primarily engaged in the
business of writing financial guaranty insurance on asset-backed obligations as
described below.
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 secured by or represent interests in diverse
pools of assets, such as residential mortgage loans, auto loans and credit card
receivables, monoline financial guarantors also insure 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
3
<PAGE>
obligations 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>
Asset-Backed
Volume of Combined Volume
Private-Label Volume of Other Volume Insured by
Residential Public of Monoline
Mortgage Asset-Backed Asset-Backed Insurance
Obligations(1) Obligations(2) Obligations(3) Companies(4)
-------------- -------------- -------------- ------------
(dollars in billions)
<S> <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 74.5
1997.......... 63.3 176.0 239.5 92.6
1998.......... 132.7 178.8 311.5 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, January 16, 1998, and January 8, 1999, 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, January 27,
1997, January 5, 1998, and March 1 , 1999 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: (i) private placement non-residential
asset-backed obligations, (ii) asset-backed commercial paper, and (iii)
non-U.S. obligations.
(4) Information is based on data provided by the Association of Financial
Guaranty Insurors (AFGI).
(5) Not available.
The data set forth in the table above excludes privately placed
non-residential mortgage transactions as well as non-domestic issues. As a
result, the table omits information regarding most "collateralized debt
obligation" securitizations, which represented a significant sector in the
insured asset-backed market in 1998.
The issuance of asset-backed obligations of the type included in the table
experienced substantial growth in each year from 1991 to 1998, with the
exception of 1994. The combined volume of such asset-backed obligations grew
from $99.9 billion in 1991 to $311.5 billion in 1998.
The largest single component of public, non-residential asset-backed
obligations was credit card securitizations in 1991, automobile loan
securitizations in 1992 and 1993, credit card securitizations in 1994, 1995 and
1996, and home equity loan securitizations in 1997 and 1998.
The par value of new asset-backed obligations insured by monoline
financial guaranty insurance companies rose in every year from 1991 through
1997.
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.
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. Issuance
increased in 1997 and 1998 due
4
<PAGE>
to falling interest rates. 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, 1997 and 1998.
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. The percentage of municipal obligations insured
has also increased substantially. From 1989 to 1993, municipal issuance
increased each year. 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, 1997 and 1998, primarily because of lower interest
rates.
The following table sets forth certain information regarding long-term
municipal obligations, issued during the periods indicated:
Insured Municipal Obligations(1)
<TABLE>
<CAPTION>
New Insured
Volume
New New as Percent
Total Insured of New Total
Year Volume Volume Volume
- ---- ------ ------ ------
(dollars in billions)
<S> <C> <C> <C>
1989....................................... $125.0 $ 31.1 24.9%
1990....................................... 127.8 33.5 26.2
1991....................................... 172.4 51.9 30.1
1992....................................... 234.7 80.8 34.4
1993....................................... 292.2 107.9 36.9
1994....................................... 165.0 61.5 37.3
1995....................................... 160.0 68.5 42.8
1996....................................... 185.0 85.7 46.3
1997....................................... 220.7 107.5 48.7
1998....................................... 284.2 144.4 50.8
</TABLE>
- ----------
(1) Information is based on data provided in The Bond Buyer, January 7, 1999.
Volume is expressed in terms of principal insured.
Types of Products
FSA's insurance is employed in both the new issue and secondary markets.
Insurance premium rates take into account the projected return to and risk
assumed by FSA. Critical factors in assessing risk 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 such factors and
subject to FSA's underwriting guidelines. The final premium rate is generally a
function of market factors, including the interest rate savings to the issuer
from the use of insurance.
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<PAGE>
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
mortgage-backed securities and utility first mortgage bonds. Likewise, 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 insures guaranteed investment contracts ("GIC's"), GIC equivalents and
obligations under interest rate, currency and credit default swap transactions,
both alone and in connection with asset-backed and municipal transactions
employing FSA insurance. FSA 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.
FSA also issues surety bonds under its Sure-Bid(R) program, which provides
an alternative to issuers and financial advisors to traditional types of good
faith deposits on competitive municipal bond transactions.
The following table indicates the percentages of par amount (net of
reinsurance) outstanding at December 31, 1998 and 1997 with respect to each type
of asset-backed and municipal program:
Net Par Amount and Percentage Outstanding by Program Type
<TABLE>
<CAPTION>
December 31, 1998
------------------------------------------------------
Asset-Backed Programs Municipal Programs
-------------------------- --------------------------
Percent
of Percent of
Total Net Net Total Net
Net Par Par Par
Par Amount Amount Amount Amount
Outstanding Outstanding Outstanding Outstanding
----------- ----------- ----------- -----------
(dollars in millions)
<S> <C> <C> <C> <C>
New Issue .............. $34,972 93.4% $59,986 90.9%
Secondary Market ....... 2,432 6.5 6,020 9.1
Portfolio Insurance .... 19 0.1 -- 0.0
------- ----- ------- -----
Total .............. $37,423(1) 100.0% $66,006(2) 100.0%
======= ===== ======= =====
<CAPTION>
December 31, 1997
------------------------------------------------------
Asset-Backed Programs Municipal Programs
-------------------------- --------------------------
Percent
of Percent of
Total Net Net Total Net
Net Par Par Par
Par Amount Amount Amount Amount
Outstanding Outstanding Outstanding Outstanding
----------- ----------- ----------- -----------
(dollars in millions)
<S> <C> <C> <C> <C>
New Issue .............. $26,989 95.5% $39,976 87.6%
Secondary Market ....... 1,244 4.4 5,652 12.4
Portfolio Insurance .... 26 0.1 -- 0.0
------- ----- ------- -----
Total .............. $28,259(1) 100.0% $45,628(2) 100.0%
======= ===== ======= =====
</TABLE>
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(1) Excludes $200 million and $231 million par amount outstanding assumed by
FSA under reinsurance agreements at December 31, 1998 and 1997,
respectively.
(2) Excludes $1,044 million and $1,361 million par amount outstanding assumed
by FSA under reinsurance agreements at December 31, 1998 and 1997,
respectively.
6
<PAGE>
Insurance in Force
FSA insures a variety of asset-backed obligations, including obligations
backed by residential mortgage loans, auto loans, other consumer receivables,
corporate bonds, bank loans, government debt and multifamily mortgage loans. FSA
has insured a broad array of municipal obligations. FSA has also insured
investor-owned utility first mortgage bonds. In 1990, FSA ceased writing
insurance backed by commercial mortgage loans, and today retains only minor net
insurance in force in that sector.
FSA has selectively expanded its insured portfolio in a manner intended to
achieve diversification. At December 31, 1998, FSA and its subsidiaries had in
force 631 issues insuring approximately $46.9 billion in gross direct par amount
outstanding of asset-backed obligations and 4,768 issues insuring approximately
$89.3 billion in gross direct par amount outstanding of municipal obligations.
In addition, at December 31, 1998, FSA had assumed pursuant to certain
reinsurance contracts approximately $0.2 billion and $1.2 billion in par amount
outstanding on asset-backed and municipal obligations, respectively, resulting
in a total gross par amount outstanding of approximately $137.6 billion. At such
date, the total net par amount outstanding, determined by reducing the gross par
amount outstanding to reflect reinsurance ceded of approximately $32.9 billion,
was approximately $104.7 billion. Net par data does not distinguish between
quota share and first loss reinsurance. In light of FSA's increasing use of
first loss reinsurance in the asset-backed sector, net par data tends to
overstate FSA's net risk exposure. At December 31, 1998, the weighted average
life of the direct principal insured on these policies was approximately four
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 categories:
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, manufactured housing loans and
credit card receivables.
Government Securities. Obligations primarily backed by government
securities include insured investment funds that invest 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 ("FNMA") and the Federal Home Loan Mortgage Corporation
("Freddie Mac"), 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, and include "collateralized bond
obligations" and "collateralized loan obligations". Corporate obligations
include corporate bonds, bank loan participations, trade receivables, franchise
loans 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.
7
<PAGE>
Commercial Mortgage Portfolio. FSA ceased writing insurance in this sector
in 1990. Obligations backed by commercial mortgages include (a) commercial real
estate obligations primarily backed by commercial real estate, including hotel
properties, office buildings and warehouses, and secured by property cash flow,
property values, first loss letters of credit, cash reserves and other means and
(b) corporate secured obligations secured by mortgages on properties leased to
one or more affiliated corporate tenants, and supported primarily by lease cash
flow and secondarily by property values.
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 categories:
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, moral obligation bonds, resource recovery
bonds and debt issued, guarantied or otherwise supported by non-domestic
national or local governmental entities.
A summary of FSA's insured portfolio at December 31, 1998 is shown below.
Please note that exposure amounts are expressed net of reinsurance but do not
distinguish between quota share reinsurance and first loss reinsurance. In
recent years, FSA has tended to employ quota share reinsurance in the municipal
sector and first loss reinsurance in the asset-backed sector.
8
<PAGE>
Summary of Insured Portfolio at December 31, 1998
<TABLE>
<CAPTION>
Number
of Percent
Issues Net Par Net of Net
In Amount Par and Par and
Force Outstanding Interest Interest
-------- ----------- -------- --------
(dollars in millions)
<S> <C> <C> <C> <C>
Asset-backed obligations
Residential mortgages ......... 339 $ 15,647 $ 20,694 12.9%
Consumer receivables .......... 154 12,539 13,651 8.5
Government securities ......... 30 821 1,345 0.8
Pooled corporate obligations .. 51 6,776 9,155 5.7
Investor-owned utility
obligations ................... 40 757 1,592 1.0
Commercial mortgage portfolio . 9 57 69 0.0
Other asset-backed obligations 8 1,026 1,164 0.9
-------- -------- -------- -----
Total asset-backed
obligations ................. 631 37,623 47,670 29.8
-------- -------- -------- -----
Municipal obligations
General obligation bonds ...... 2,811 25,337 39,665 24.8
Housing revenue bonds ......... 229 2,509 5,066 3.2
Municipal utility revenue bonds 492 9,218 15,772 9.9
Health care revenue bonds ..... 139 5,812 10,473 6.5
Tax-supported (non-general
obligation) bonds ........... 607 14,731 25,205 15.8
Transportation revenue bonds .. 55 2,937 5,532 3.5
Other municipal bonds ......... 435 6,506 10,612 6.5
-------- -------- -------- -----
Total municipal obligations . 4,768 67,050 112,325 70.2
-------- -------- -------- -----
Total ................... 5,399 $104,673 $159,995 100.0%
======== ======== ======== =====
</TABLE>
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,
--------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Asset-backed obligations
Residential mortgages ........ 16% 19% 29% 26% 25%
Consumer receivables ......... 16 24 25 29 23
Government securities ........ 0 2 1 0 0
Pooled corporate obligations . 10 10 1 10 4
Commercial mortgage portfolio 0 0 0 0 0
Investor-owned utility
obligations .................. 0 0 0 0 2
Other asset-backed obligations 2 0 2 1 2
--- --- --- --- ---
Total asset-backed
obligations ................ 44 55 58 66 56
--- --- --- --- ---
Municipal obligations
General obligations bonds .... 22 18 20 11 12
Housing revenue bonds ........ 2 1 1 2 1
Municipal utility revenue
bonds ........................ 9 2 4 4 8
Health care revenue bonds .... 6 4 2 3 4
Tax-supported (non-general
obligation) bonds .......... 10 10 9 6 11
Transportation revenue bonds . 2 2 1 6 1
Other municipal bonds ........ 5 8 5 2 7
--- --- --- --- ---
Total municipal obligations 56 45 42 34 44
--- --- --- --- ---
Total .................. 100% 100% 100% 100% 100%
=== === === === ===
</TABLE>
9
<PAGE>
Terms to Maturity
The table below sets forth the estimated terms to maturity of FSA's
policies at December 31, 1998 and 1997:
Estimated Terms to Maturity of Net Par of Insured Obligations(1)
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
--------------------- ---------------------
(in millions)
Estimated Asset- Asset-
Term to Maturity Backed Municipal Backed Municipal
---------------- ------ --------- ------ ---------
<S> <C> <C> <C> <C>
0 to 5 Years ........... $ 8,468 $ 2,756 $ 7,553 $ 2,230
5 to 10 Years .......... 7,516 7,495 5,637 5,683
10 to 15 Years ......... 5,661 12,427 2,858 8,257
15 to 20 Years ......... 670 20,265 524 14,340
20 Years and Above ..... 15,308 24,107 11,917 16,479
------- ------- ------- -------
Total ................ $37,623 $67,050 $28,489 $46,989
======= ======= ======= =======
</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.
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, 1998:
Asset-Backed -- Original Net Par Amount Per Issue(1)
<TABLE>
<CAPTION>
Percent Percent of
of Total
Number Total Net Par Net Par
Original of Number Amount Amount
Net Par Amount Policies of Issues Outstanding Outstanding
-------------- -------- --------- ----------- -----------
(dollars in millions)
<S> <C> <C> <C> <C>
Less than $10 million ...... 477 37.3% $ 656 1.8%
$10 to $25 million ......... 144 11.2 1,143 3.0
$25 to $50 million ......... 151 11.8 1,801 4.8
$50 million or greater ..... 508 39.7 33,823 90.4
------- ------ ------- ------
Total .................... 1,280 100.0% $37,423 100.0%
======= ====== ======= ======
</TABLE>
- ----------
(1) Does not include $200 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 Percent of
of Total
Number Total Net Par Net Par
Original of Number Amount Amount
Net Par Amount Policies of Issues Outstanding Outstanding
-------------- -------- --------- ----------- -----------
(dollars in millions)
<S> <C> <C> <C> <C>
Less than $10 million ........ 6,644 75.9% $18,190 27.6%
$10 to $25 million ........... 1,252 14.3 13,156 19.9
$25 to $50 million ........... 427 4.9 9,782 14.8
$50 million or greater ....... 434 4.9 24,878 37.7
------- ----- ------- -----
Total ...................... 8,757 100.0% $66,006 100.0%
======= ===== ======= =====
</TABLE>
- ----------
(1) Does not include $1,044 million net par amount outstanding assumed by FSA
and its subsidiaries under reinsurance agreements.
10
<PAGE>
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 considered 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:
Municipal
Insured Portfolio by Jurisdiction
at December 31, 1998
<TABLE>
<CAPTION>
Percent of
Total
Number Net Par Municipal Net
of Amount Par Amount
Jurisdiction Issues Outstanding Outstanding
------------ ------ ----------- -----------
(dollars in millions)
<S> <C> <C> <C>
California ................... 517 $10,233 15.3%
New York ..................... 388 5,836 8.7
Pennsylvania ................. 356 4,821 7.2
Texas ........................ 414 4,128 6.1
Florida ...................... 130 4,091 6.1
New Jersey ................... 275 3,475 5.2
Illinois ..................... 359 3,125 4.7
Massachusetts ................ 126 2,259 3.4
Michigan ..................... 217 2,161 3.2
Wisconsin .................... 252 1,685 2.5
Indiana ...................... 103 1,461 2.2
Minnesota .................... 146 1,340 2.0
All other states ............. 1,453 20,993 31.3
Non-U.S ...................... 32 1,442 2.1
------- ------- -----
Total .................... 4,768 $67,050 100.0%
======= ======= =====
</TABLE>
Issuer Concentration
FSA has adopted underwriting and exposure management policies designed to
limit the net par insured for any one credit. In many cases, FSA uses
reinsurance to limit net exposure to any one credit. At December 31, 1998,
insurance of asset-backed obligations constituted 35.9% of FSA's net par
outstanding and insurance of municipal obligations constituted 64.1% of FSA's
net par outstanding. At such date, FSA's ten largest net insured asset-backed
transactions represented $6.2 billion, or 6.0%, of its total net par amount
outstanding, and FSA's ten largest net insured municipal credits represented
$3.6 billion, or 3.5%, 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, 1998. Please note that exposure amounts are
expressed net of reinsurance but do not distinguish between quota share
reinsurance and first loss reinsurance. In recent years, FSA has tended to
employ quota share reinsurance in the municipal sector and first loss
reinsurance in the asset-backed sector.
11
<PAGE>
Ten Largest Insured Asset-Backed Transactions at December 31, 1998
<TABLE>
<CAPTION>
Net Par
Amount
Transaction Asset Type Outstanding
----------- ---------- -----------
(in millions)
<S> <C> <C>
IMC Home Equity Loan Trust 1998-3........... Residential Mortgages $ 816.5
New Century 1998 - NC5...................... Residential Mortgages 816.0
WFS Financial 1998-C........................ Consumer Receivables 652.5
New Century 1998 - NC7...................... Residential Mortgages 645.7
IMC Home Equity Loan Trust 1998-6........... Residential Mortgages 604.3
PAMCO CLO Series 1997-1..................... Pooled Corporate 577.1
Americredit 1998-D.......................... Consumer Receivables 545.0
WFS Financial 1998-B........................ Consumer Receivables 541.8
Norse CBO................................... Pooled Corporate 530.5
Arcadia Auto Receivable Trust 1998-C........ Consumer Receivables 497.8
--------
Total..................................... $6,227.2
========
</TABLE>
Ten Largest Insured Municipal Credits at December 31, 1998
<TABLE>
<CAPTION>
Net Par
Amount
Credit Obligation Type Outstanding
------ --------------- -----------
(in millions)
<S> <C> <C>
Long Island Power Authority................. Utility Revenue $ 430.7
New York State Dormitory Agency............. Tax-Supported 413.7
Puerto Rico Electric Power Authority........ Utility Revenue 389.5
New York City............................... General Obligation 363.9
Puerto Rico Municipal Finance Agency........ Other Obligation 355.3
Washington State Public Power Supply System. Utility Revenue 344.0
State of New Jersey Pension Obligations..... Tax-Supported 338.2
Florida State Department of Natural Resources Tax-Supported 332.8
State of California......................... General Obligation 323.2
New York City Municipal Water Finance
Authority................................... Utility Revenue 316.6
--------
Total..................................... $3,607.9
========
</TABLE>
Credit Underwriting Guidelines, Standards and Procedures
Financial guaranty insurance written by FSA relies on an assessment of the
adequacy of various payment sources to meet debt service 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 it determines are investment grade without the benefit of FSA's
insurance. To this end, each policy written or reinsured by FSA is designed to
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 premised 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 agreements). 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
12
<PAGE>
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 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 its professional staff of analysts, underwriting
officers, credit officers and 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 by the
chief underwriting officer for the particular sector. 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 and from FSA's Municipal Underwriting
Committee for municipal transactions. 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 FSA's Chief Executive
Officer, President, Chief Operating Officer, Chief Underwriting Officer, Chief
International Underwriting Officer and General Counsel. The Municipal
Underwriting Committee is comprised of FSA's Chief Executive Officer, President,
Chief Municipal Underwriting Officer, an Associate General Counsel for Municipal
Transactions and the Managing Director for Municipal Surveillance. 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. Subject to applicable limits, secondary market and
partial maturity asset-backed transactions 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 larger transactions. Subject to applicable limits,
municipal transactions 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 Research
FSA's Corporate Research Department is comprised of a professional staff
under the direction of the Chief Underwriting Officer. The Corporate Research
Department is responsible for evaluating the credit of entities participating or
providing recourse in obligations insured by FSA. The Corporate Research
Department also provides analysis of relevant industry segments. Members of the
Corporate Research Department generally report their findings directly to the
appropriate underwriting committee in the context of transaction review and
approval.
13
<PAGE>
Transaction Oversight and Transaction Services
FSA's Transaction Oversight Departments and Transaction Services
Corporation ("TSC") are independent of the analysts and credit officers involved
in the underwriting process. The Asset-Backed and Municipal Transaction
Oversight Departments are responsible for monitoring the performance of
outstanding transactions. TSC, together with the Transaction Oversight
Departments, is responsible for taking remedial actions as appropriate. The
managing directors responsible for the transaction oversight and transaction
services functions report to an Oversight Committee comprised of the Chairman,
the General Counsel, the Chief Underwriting Officer, the Chief Municipal
Underwriting Officer and the Chief Financial Officer. The Transaction Oversight
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, servicers, trustees and other transaction participants. Reviews
of asset-backed transactions often include servicer audits, site visits or
evaluations by third-party appraisers, engineers or other experts retained by
FSA. The Transaction Oversight 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
Transaction Oversight Departments and TSC work together with the Legal
Department and the Corporate Research Department in monitoring these
transactions, negotiating restructurings and pursuing appropriate legal
remedies.
Legal
FSA's Legal Department is comprised of a professional staff of attorneys
and 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 and the Municipal
Underwriting 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 transaction oversight and transaction services functions 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 an 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 its case basis reserves, FSA maintains a general reserve in
order to account for 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
14
<PAGE>
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 or from replenishing amounts applied against new case basis
reserves will result in a charge to earnings at that time. Amounts released from
the general reserve as a result of the runoff of existing net insurance in force
may 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 the present value of its estimated ultimate liability for
losses and loss adjustment expenses with respect to obligations it has insured.
At December 31, 1998 and 1997, FSA's net loss reserves totaled $60.0 million and
$44.8 million, respectively. 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. During 1997, the Company
increased its general reserve by $9.2 million, of which $5.4 million was for new
business originations and $3.8 million was to reestablish the general reserve
for transfers from the general reserves to case basis reserves. During 1997, the
Company transferred $4.5 million from its general reserve to case basis reserves
associated predominantly with certain residential mortgage transactions. The
general reserve was $34.3 million at December 31, 1997. During 1998, the Company
increased its general reserve by $3.9 million, of which $8.0 million was for
originations of new business offset by a $4.1 million decrease in the amount
needed to fund the general loss reserve because of recoveries on certain
commercial mortgage transactions. During 1998, the Company transferred $18.4
million to its general reserve from case basis reserves due to those recoveries
on commercial mortgage transactions. Also during 1998, the Company transferred
$9.4 million from its general reserve to case basis reserves associated
predominantly with certain consumer receivable transactions. Giving effect to
these transfers, the general reserve totaled $47.3 million at December 31, 1998.
Reserves for losses and loss adjustment expenses are discounted at
risk-free rates. The amount of discount taken was approximately $16.0 million
and $19.8 million at December 31, 1998 and 1997, respectively.
Since 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 obligations and almost half of all 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
Assurance Corp. ("Ambac"), Financial Guaranty Insurance Company ("FGIC") and
MBIA Insurance Corp. ("MBIA"). There has been consolidation in the financial
guaranty industry, with Capital Markets Assurance Corp. being acquired by MBIA
and Connie Lee Insurance Company being acquired by Ambac. As a result of this
consolidation, FSA is now the smallest of the major primary financial guaranty
insurers in terms of statutory capital. 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 sponsored commercial paper conduits, bank letter of credit
providers and other credit enhancement, such as cash collateral accounts,
provided by banks, continue to provide significant competition to FSA. In
addition, government sponsored entities, including FNMA and Freddie Mac, have
begun to compete with the monoline financial guaranty insurers in the
mortgage-backed and multifamily sectors.
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
15
<PAGE>
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 and refunded bonds secured by United States
government securities held in escrow or other qualified collateral. 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. Net insurance data does not distinguish
between quota share reinsurance and first loss reinsurance. In light of FSA's
increased use of first loss reinsurance in the asset-backed sector, the data
below may tend to overstate FSA's risk leverage in comparison to its industry
counterparts.
<TABLE>
<CAPTION>
December 31,
------------------------------
1998 1997 1996
---- ---- ----
(dollars in millions)
<S> <C> <C> <C>
Financial guaranty primary insurers, excluding FSA (1)
Leverage ratio ..................................... N/A(2) 149:1 151:1
FSA
Gross insurance in force ........................... $216,564 $158,020 $125,423
Net insurance in force ............................. $159,995 $117,429 $ 93,704
Qualified statutory capital ........................ $ 1,038 $ 782 $ 676
Leverage ratio ..................................... 154:1 150:1 139:1
</TABLE>
- ----------
(1) Financial guaranty primary insurers for which data is included in this
table are Ambac, Capital Markets Assurance Corporation (1997 and 1996),
Connie Lee Insurance Company (1996 only), FGIC and MBIA. 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, 1997 and 1996.
(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
typically but not always 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, to meet state insurance regulatory,
rating agency and internal limits, diversify risks, reduce the need for
additional capital and strengthen financial ratios. At December 31, 1998, FSA
had reinsured approximately 24.2% of its direct principal amount outstanding.
Most of FSA's reinsurance is on a quota share or first-loss basis, with a small
portion being provided on an excess of loss basis. Reinsurance arrangements
typically require FSA to retain a minimum portion of the risks reinsured.
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
either cancelable annually upon 90 days' prior notice by either FSA or the
reinsurer or has a one-year term. In addition, the treaties are
16
<PAGE>
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.
In 1998, FSA's principal ceded reinsurance program consisted of two quota
share treaties, one first-loss treaty and automatic facultative facilities. One
quota share treaty (the "asset-backed treaty") covered all of FSA's approved
regular lines of business, except municipal bond insurance. In 1998, FSA ceded
6.75% of each covered policy under this treaty, up to a maximum of $13.5 million
insured principal per single risk. At its sole option, FSA was entitled to
increase the ceding percentage to 13.5% up to $27 million insured principal per
single risk which is defined by revenue source. The other quota share treaty
(the "municipal treaty") covered FSA's municipal bond insurance business. In
1998, FSA ceded 6% 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 $16 million insured principal per
single risk. At its sole option, FSA was entitled to increase the ceding
percentage to 30% up to $80 million insured principal per single risk. These
cession percentages under both treaties were reduced on smaller-sized
transactions. Under the first-loss treaty, FSA ceded a portion of its first-loss
exposure under specified asset-backed transactions. Under the four automatic
facultative facilities in 1998, FSA at its option could allocate up to a
specified amount for each reinsurer (ranging from $4 million to $40 million
depending on the reinsurer) for each transaction, subject to limits and
exclusions, in exchange for which FSA agreed to cede in the aggregate a
specified percentage of gross par insured by FSA. The two quota share treaties
and automatic facultative facilities allow FSA to withhold a ceding commission
to defray expenses. In 1998, FSA also utilized facultative quota share
first-loss reinsurance on selected transactions.
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 important to FSA, and FSA's reinsurance is
placed with high quality and financially strong reinsurers. FSA's treaty
reinsurers at December 31, 1998 were Asset Guaranty Insurance Company, AXA Re
Finance S.A., Capital Credit Reinsurance Company, Ltd., Capital Reinsurance
Company, Employers Reinsurance Company, Enhance Reinsurance Company, Tokio
Marine and XL Insurance Ltd. In 1998, four reinsurers participated in the
asset-backed quota share treaty and three reinsurers participated in the
municipal quota share treaty and five reinsurers participated in the first-loss
treaty.
FSA, FSAIC, FSA Oklahoma and FSA International have entered into a quota
share reinsurance pooling agreement pursuant to which, after reinsurance
cessions to other reinsurers, the FSA companies share in the net retained risk
insured by each of these companies. Prior to November 1, 1998, FSA, FSAIC and
FSA Oklahoma shared the net retained risk in proportion to their policyholders'
surplus and contingency reserve ("Statutory Capital") 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, 1998, FSA retained 65.63%, FSAIC retained 23.53% and FSA
Oklahoma retained 10.84% of each policy issued by these companies after cessions
to all other reinsurers. Commencing November 1, 1998, FSA Oklahoma ceased to be
a party and FSA International became a party to the agreement, with FSA
International assuming 20% of the business covered by the agreement during a
"ramp-up" period subject to applicable single risk limits. For transactions in
1998 where FSA International retained 20%, FSA's and FSAIC's shares were 58.88%
and 21.12%, respectively. For transactions in 1998 where FSA, FSAIC and FSA
International shared the risk in proportion to their Statutory Capital, the
respective shares were 66.83% for FSA, 23.96% for FSAIC and 9.21% for FSA
International. Following the ramp-up period, FSA, FSAIC and FSA International
will share in business covered by the agreement approximately in proportion to
their Statutory Capital at the end of the prior calendar quarter. 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
ratio exceeds 100%. Under this agreement, FSA-UK ceded to FSA approximately 98%
of its retention after other reinsurance of its policies issued in 1998.
FSA is party to a quota share reinsurance agreement with Commercial
Reinsurance Company ("Commercial Re") pursuant to which Commercial Re assumed
approximately 64.4% of FSA's exposure, on a weighted average
17
<PAGE>
basis, on transactions in FSA's commercial mortgage portfolio. Commercial Re is
owned by MediaOne and Tokio Marine and is engaged exclusively in the business of
reinsuring FSA's commercial mortgage portfolio.
Rating Agencies
The value of the insurance product sold by FSA is generally a function of
the "rating" applied to obligations insured by FSA. The insurance financial
strength, insurer financial strength and claims-paying ability, as the case may
be, of FSA and its operating insurance company subsidiaries is rated "Aaa" by
Moody's Investors Service, Inc. and "AAA" by Standard and Poor's Ratings
Services, Standard & Poor's (Australia) Pty. Ltd., Fitch IBCA, Inc. and Japan
Rating and Investment Information, Inc. Such ratings reflect only the views of
the respective rating agencies, are not recommendations to buy, sell or hold
securities and are subject to revision or withdrawal at any time by such rating
agencies. These rating agencies periodically review the business and financial
condition of FSA, focusing on the insurer's underwriting policies and procedures
and the quality of the obligations insured. Each rating agency performs periodic
assessments of the credits insured by FSA, and the reinsurers and other
providers of capital support to FSA, to confirm that FSA continues to satisfy
such rating agency's capital adequacy criteria necessary to maintain FSA's
"triple-A" 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"), and is also subject to the
insurance laws of the other states in which it is licensed to transact an
insurance business. FSAIC and FSA Oklahoma are Oklahoma domiciled insurance
companies also licensed in New York and subject to the New York Insurance Law.
FSA and its domestic insurance company subsidiaries are required to file
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.
FSA International is a Bermuda domiciled insurance company subject to
applicable requirements of Bermuda law. FSA International maintains its
principal executive offices in Hamilton, Bermuda. FSA International does not
intend to transact business or establish a permanent place of business in the
United States or Europe. FSA-UK is a United Kingdom domiciled insurance company
subject to applicable requirements of English law. FSA-UK maintains its
principal executive offices in London. Pursuant to European Union Directives,
FSA-UK is generally authorized to write business out of its London office in
other member countries of the European Union subject to the satisfaction of
perfunctory registration requirements.
Domestic Insurance Holding Company Laws
The Company and its domestic insurance company subsidiaries (FSA, FSAIC
and FSA Oklahoma) are subject to regulation under insurance holding company
statutes of New York 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 company 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 and
Oklahoma, any acquisition of control of the Company, and thereby indirect
control of FSA, FSAIC and FSA Oklahoma, requires the prior approval of the New
York Superintendent and the Oklahoma Insurance Commissioner. "Control" is
defined as the direct or indirect
18
<PAGE>
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 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 no dividends during 1997. Based upon FSA's statutory
statements for the quarter ended December 31, 1998, the maximum amount available
for payment of dividends by FSA without regulatory approval over the following
12 months is approximately $65.7 million.
19
<PAGE>
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 Bermuda Ministry of Finance regulates FSA International. The United
Kingdom Financial Services Authority regulates FSA-UK. Pursuant to European
Union Directives, FSA-UK has been authorized to provide financial guaranty
insurance for transactions in France and Ireland 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. The Monetary Authority of Singapore regulates activities of
FSA's Singapore office, which is in the process of obtaining a license to
operate as a branch office in Singapore.
Investment Portfolio
FSA manages its investments with the objectives of preserving its triple-A
ratings, capital and claims-paying ability, maintaining a high level of
liquidity and, within these constraints, obtaining a high long-term total
return. FSA's investment portfolio is managed primarily by unaffiliated
professional investment managers, with a portion of its municipal portfolio
managed by its affiliate, FSA Portfolio Management. 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 fixed income
investments by FSA, requiring that at least 95% of such investments must be
rated at least "single A" at acquisition and the overall portfolio must be rated
"double A" on average. Fixed income investments falling below the minimum
quality level are disposed of at such time as management shall deem appropriate.
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 fixed income investments include U.S. Treasury
and agency obligations, corporate bonds, tax-exempt bonds and mortgage
pass-through instruments. The Company and FSA also invest a small portion of
their portfolios in equity securities and/or convertible debt securities.
Furthermore, the Company has investments in various strategic partners,
including XL, XLFA and Fairbanks Capital Holding Corp., which owns a residential
mortgage loan servicer. In addition, the Company has from time to time invested
in sponsors of, or interests in, transactions insured or proposed to be insured
by FSA, none of which investments is material to the Company.
The weighted average maturity of the Company's investment portfolio at
December 31, 1998 was approximately 9.9 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.
The following tables set forth certain information concerning the
investment portfolio of the Company:
Investment Portfolio by Rating
at December 31, 1998(1)
Percent of
Investment
Rating Portfolio
---------------- ----------
AAA(2).......... 69.0%
AA ............. 21.0
A ............. 9.3
BBB............. 0.4
Other........... 0.3
-----
100.0%
=====
- ----------
(1) Ratings are for the long-term fixed income portfolio (95.1% of the entire
investment portfolio as of December 31, 1998) and are based on the higher
of Moody's or S&P ratings available at December 31, 1998.
(2) Includes U.S. Treasury and agency obligations, which comprised 7.9% of the
total portfolio at December 31, 1998.
20
<PAGE>
Summary of Investments
<TABLE>
<CAPTION>
December 31,
-----------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
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 .................... $ 613,324 5.96% $ 453,437 6.52% $ 396,586 6.76%
Tax-exempt bonds ................. 1,041,718 5.26 777,042 5.58 661,831 5.70
---------- ---------- ----------
Total long-term investments ..... 1,655,042 5.51 1,230,479 5.92 1,058,417 6.09
Short-term investments(2) ............ 74,675 4.96 110,308 6.22 56,733 5.43
---------- ---------- ----------
Total investments(3)............. $1,729,717 5.49% $1,340,787 5.95% $1,115,150 6.06%
========== ========== ==========
</TABLE>
- ----------
(1) Yields are stated on a pre-tax basis.
(2) Includes taxable and tax-exempt investments and excludes cash equivalents
of $23.9 million, $22.6 million and $16.9 million, respectively.
(3) Excludes stocks at cost of $64.3 million, $29.4 million and $8.3 million,
respectively.
Investment Portfolio by Security Type
<TABLE>
<CAPTION>
December 31,
-----------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- --------------------
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 .... $ 148,669 $5.14% $ 122,817 $6.20% $ 55,619 $6.63%
Mortgage-backed securities .... 266,770 6.54 195,567 6.62 177,818 6.88
Municipal bonds ............... 1,041,718 5.26 777,042 5.58 661,831 5.70
Asset-backed securities 33,188 7.07 20,961 6.69 71,370 6.82
Corporate securities .......... 164,697 5.34 66,014 5.72 76,760 6.55
Foreign securities ............ -- 48,078 7.62 15,019 6.50
---------- ---------- ----------
Total fixed maturities .... 1,655,042 5.51 1,230,479 5.92 1,058,417 6.09
Short-term investments(2) ..... 74,675 4.96 110,308 6.22 56,733 5.43
---------- ---------- ----------
Total investments(3) ...... $1,729,717 5.49% $1,340,787 5.95% $1,115,150 6.06%
========== ========== ==========
</TABLE>
- ----------
(1) Yields are stated on a pre-tax basis.
(2) Includes taxable and tax-exempt investments and excludes cash equivalents
of $23.9 million, $22.6 million and $16.9 million, respectively.
(3) Excludes stocks at cost of $64.3 million, $24.9 million and $8.3 million,
respectively.
Distribution of Investments by Maturity
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------------------------
1998 1997 1996
----------------------- ----------------------- ------------------------
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) .......... $ 75,677 $ 75,681 $ 114,317 $ 114,315 $ 95,038 $ 95,359
Due after one year
through five years .............. 137,094 139,642 70,283 70,007 57,531 57,712
Due after five years
through ten years ............... 225,259 233,080 208,986 208,170 105,495 105,848
Due after ten years ................. 991,729 1,030,156 730,673 766,912 607,898 620,031
Mortgage-backed securities .......... 266,770 270,500 195,567 197,753 177,818 178,344
Asset-backed securities ............. 33,188 33,656 20,961 21,309 71,370 71,878
---------- ---------- ---------- ---------- ---------- ----------
Total investments(2)............. $1,729,717 $1,782,715 $1,340,787 $1,378,466 $1,115,150 $1,129,172
========== ========== ========== ========== ========== ==========
</TABLE>
- ----------
(1) Includes short-term investments in the amount of $74.7 million, $110.3
million and $56.7 million at December 31, 1998, 1997 and 1996,
respectively, but excludes cash equivalents of $23.9 million, $22.6
million, and $16.9 million, respectively.
(2) Excludes stocks at cost of $64.3 million, $29.4 million and $8.3 million,
respectively.
21
<PAGE>
Mortgage-Backed Securities
Cost and Market Value by Investment Category
<TABLE>
<CAPTION>
December 31, 1998
------------------------------------
Amortized Estimated
Investment Category Par Value Cost Market Value
------------------- --------- ---- ------------
(in thousands)
<S> <C> <C> <C>
Pass-through securities--U.S
Government agency $171,284 $170,069 $171,247
CMO's--U.S. Government agency 32,901 32,489 33,935
CMO's--non-agency 64,003 64,212 65,318
-------- -------- --------
Total mortgage-backed securities $268,188 $266,770 $270,500
======== ======== ========
</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 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, 1998, the Company held sequential pay CMO tranches and
Planned Amortization Classes of CMO's. The CMO's held at December 31, 1998 have
stated maturities ranging from 2 to 37 years, and expected average lives ranging
from 1 to 28 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, 1998, 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, 1998, the Company and its subsidiaries had 232 employees.
None of its employees are covered by collective bargaining agreements. The
Company considers its employee relations to be satisfactory.
Forward-Looking Statements
The Company relies upon the safe harbor for forward looking statements
provided by the Private Securities Litigation Reform Act of 1995. This safe
harbor requires that the Company specify important factors that could cause
actual results to differ materially from those contained in forward-looking
statements made by or on behalf of the Company. Accordingly, forward-looking
statements by the Company and its affiliates are qualified by reference to the
following cautionary statements.
In its filings with the SEC, reports to shareholders, press releases and
other written and oral communications, the Company from time to time makes
forward-looking statements. Such forward-looking statements include, but are not
limited to, (i) projections of revenues, income (or loss), earnings (or loss)
per share, dividends, market share or other financial forecasts, (ii) statements
of plans, objectives or goals of the Company or its management, including those
related to growth in adjusted book value per share or return on equity and (iii)
expected losses on, and adequacy of loss reserves for, insured transactions.
Words such as "believes", "anticipates", "expects", "intends" and "plans" and
similar expressions are intended to identify forward-looking statements but are
not the exclusive means of identifying such statements.
The Company cautions that a number of important factors could cause actual
results to differ materially from the plans, objectives, expectations, estimates
and intentions expressed in forward-looking statements made by the Company.
These factors include: (i) changes in capital requirements or other criteria of
securities rating
22
<PAGE>
agencies applicable to financial guaranty insurers in general or to FSA
specifically; (ii) competitive forces, including the conduct of other financial
guaranty insurers in general; (iii) changes in domestic or foreign laws or
regulations applicable to the Company, its competitors or its clients; (iv) an
economic downturn or other economic conditions (such as a rising interest rate
environment) adversely affecting transactions insured by FSA or its investment
portfolio; (v) inadequacy of loss reserves established by the Company; (vi)
temporary or permanent disruptions in cash flow on structured transactions
attributable to legal challenges to such structures; and (vii) downgrade or
default of one or more of FSA's reinsurers. The Company cautions that the
foregoing list of important factors is not exhaustive. In any event, such
forward-looking statements made by the Company speak only as of the date on
which they are made, and the Company does not undertake any obligation to update
or revise such statements as a result of new information, future events or
otherwise.
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 or its subsidiaries also maintain
leased office space in San Francisco, Dallas, Hamilton (Bermuda), London
(England), Paris (France), Madrid (Spain), Singapore, Sydney (Australia) and
Tokyo (Japan). The Company and its subsidiaries do not own any real property.
Item 3. Legal Proceedings.
In the ordinary course of business, the Company and certain subsidiaries
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 1998.
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 1998
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 February 10, 1999, there were approximately 3,500
holders of the Company's Common Stock, which is listed on the New York Stock
Exchange.
During the fourth quarter of 1998, the Company issued 1,632,653
unregistered shares of Common Stock in reliance upon an exemption from
registration under the Securities Act of 1933 (the "Act") pursuant to Section
4(2) of the Act. Further information about such issuance is contained in Item 5,
"Other Information," of the Company's quarterly report on Form 10-Q for the
quarter ended September 30, 1998.
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 "Five-Year Financial Summary"
on page 16 of the Company's 1998 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 1998 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 7A. Qualitative and Quantitative Disclosures About Market Risks.
Qualitative and quantitative disclosures about market risks is set forth
under the caption "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Results of Operations - Market Risks" on pages 20
and 21 of the Company's 1998 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 1998 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 1998 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 4,
"Section 16(a) Beneficial Ownership Reporting Compliance" on page 16, and
"Executive Officers of the Company" on pages 5 and 6 of the Company's 1999 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 9 through 12, "Report of the Human Resources Committee of the Board of
Directors of Financial Security Assurance Holdings Ltd." on pages 12 through 15,
and "Stock Price Performance" on page 16 of the Company's 1999 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 6
through 9 of the Company's 1999 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 27 through 30 of the Company's 1999 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 1998 Annual
Report to Shareholders the following consolidated financial
statements of Financial Security Assurance Holdings Ltd. and
Subsidiaries:
1998 Annual Report to
Shareholders (Pages)
--------------------
Report of Independent Accountants 25
Consolidated Balance Sheets at
December 31, 1998 and 1997 26
Consolidated Statements of Income
for the Years Ended
December 31, 1998, 1997 and 1996 27
Consolidated Statements of Changes in
Shareholders' Equity for the Years Ended
December 31, 1998, 1997 and 1996 28
Consolidated Statements of Cash Flows
for the Years Ended
December 31, 1998, 1997 and 1996 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, 1998, 1997 and 1996.
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
----------- -------
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.)
4.1 Indenture dated as of September 15, 1997 (the "Senior
QUIDS Indenture") between the Company and First Union
National Bank, as Trustee (the "Senior Debt Trustee").
(Previously filed as Exhibit 2 to the Company's Current
Report on Form 8-K (Commission File No. 1-12644) dated
September 15, 1997 (the "September 1997 Form 8-K"), and
incorporated herein by reference.)
4.1(A) First Supplemental Indenture dated as of November 13,
1998, between the Company and the Senior Debt Trustee.
(Previously filed as Exhibit 6 to the Company's Current
Report on Form 8-K (Commission File No. 1-12644) dated
November 6, 1998 (the "November 1998 Form 8-K"), and
incorporated herein by reference.)
4.1(B) Form of 7.375% Senior Quarterly Income Debt Securities
due 2097. (Previously filed as Exhibit 3 to the
September 1997 Form 8-K, and incorporated herein by
reference.)
4.1(C) Officers' Certificate pursuant to Section 2.01 and 2.03
of the Senior QUIDS Indenture. (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 September 30, 1997, and incorporated herein by
reference.)
4.1(D) Form of 6.950% Senior Quarterly Income Debt Securities
due 2098. (Previously filed as Exhibit 2 to the November
1998 Form 8-K, and incorporated herein by reference.)
4.1(E) Officers' Certificate pursuant to Section 2.01 and 2.03
of the Senior QUIDS Indenture. (Previously filed as
Exhibit 5 to the November 1998 Form 8-K, and
incorporated herein by reference.)
4.1(F) Amended and Restated Trust Indenture dated as of
February 24, 1999 between the Company and the Trustee.
(Previously filed as Exhibit 4.1 to the Company's
Registration Statement on Form S-3 (Reg. No. 33-74165),
and incorporated herein by reference.)
27
<PAGE>
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 August 31, 1998 among FSA,
each of its insurance company affiliates listed on
Schedule I attached thereto, the Banks from time to time
party thereto and Deutsche Bank AG, New York Branch, as
agent. (Previously filed as Exhibit 10 to the Company's
Quarterly Report on Form 10-Q (Commission File No.
1-12644) for the quarterly period ended September 30,
1998, 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.)
10.5+* Amended and Restated Supplemental Executive Retirement
Plan as amended and restated as of February 25, 1999.
10.6+ Amended and Restated 1993 Equity Participation Plan (as
amended and restated on February 26, 1998). (Previously
filed as Exhibit 10.6 to the Company's Annual Report on
Form 10-K (Commission File No. 1-12644) for the fiscal
period ended December 31, 1997 (the "1997 Form 10-K"),
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 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.)
10.10 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.)
28
<PAGE>
10.10(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.)
10.10(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.)
10.11 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.)
10.12 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.)
10.13 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.)
10.14+ 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.)
10.15 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.)
10.16 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.)
10.17 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.)
10.18 Liquidity Facility dated as of December 23, 1993 among
US WEST, Inc., Commercial Re and the Company.
(Previously filed as Exhibit 10.34 to the Form S-1, and
incorporated herein by reference.)
10.19 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.)
10.20 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.)
10.21 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.)
29
<PAGE>
10.21(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.)
10.22* Registration Rights Agreement dated as of November 3,
1998 between the Company and EXEL Limited.
10.23 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.)
10.24 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.)
10.25 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.)
13* Annual Report to Shareholders for the Year Ended
December 31, 1998. 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 PricewaterhouseCoopers LLP.
24* Powers of Attorney. (Previously filed as Exhibit 24 to
the Company's Annual Report on Form 10-K (Commission
File No. 1-12644) for the fiscal period ended December
31, 1996, and incorporated herein by reference, other
than the power of attorney (i) for Mr. Post, which was
filed as Exhibit 24 to the 1997 Form 10-K and
incorporated herein by reference and (ii) for Messrs.
Hama and McCarthy, which are filed herewith.)
27* Financial Data Schedules.
99* Financial Security Assurance Inc. and Subsidiaries 1998
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 filed a Current Report on Form 8-K dated November 6, 1998,
with the Securities and Exchange Commission on November 12, 1998, which
incorporated by reference the documents included as Exhibits thereto into the
Registration Statement relating to the Company's 6.950% Senior Quarterly Income
Debt Securities due 2098.
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: Chairman and Chief Executive Officer
Dated: March 25, 1999
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/ ROBERT P. COCHRAN*
- ----------------------------
Robert P. Cochran Chairman, Chief March 25, 1999
Executive Officer
and Director (Principal
Executive Officer)
/s/ JOHN J. BYRNE*
- ----------------------------
John J. Byrne Vice Chairman of the March 25, 1999
Board and Director
/s/ ROGER K. TAYLOR*
- ----------------------------
Roger K. Taylor President, March 25, 1999
Chief Operating Officer
and Director
/s/ SEAN W. MCCARTHY*
- ----------------------------
Sean W. McCarthy Executive Vice President March 25, 1999
and Director
/s/ JOHN A. HARRISON*
- ----------------------------
John A. Harrison Managing Director March 25, 1999
and Chief Financial
Officer (Principal
Financial Officer)
/s/ JEFFREY S. JOSEPH*
- ----------------------------
Jeffrey S. Joseph Managing Director March 25, 1999
and Controller (Principal
Accounting Officer)
/s/ ROBERT N. DOWNEY*
- ----------------------------
Robert N. Downey Director March 25, 1999
/s/ ANTHONY M. FRANK*
- ----------------------------
Anthony M. Frank Director March 25, 1999
31
<PAGE>
/s/ FUDEJI HAMA*
- ----------------------------
Fudeji Hama Director March 25, 1999
/s/ K. THOMAS KEMP*
- ----------------------------
K. Thomas Kemp Director March 25, 1999
/s/ DAVID O. MAXWELL*
- ----------------------------
David O. Maxwell Director March 25, 1999
/s/ JAMES M. OSTERHOFF*
- ----------------------------
James M. Osterhoff Director March 25, 1999
/s/ JAMES H. OZANNE*
- ----------------------------
James H. Ozanne Director March 25, 1999
/s/ RICHARD A. POST*
- ----------------------------
Richard A. Post Director March 25, 1999
/s/ HOWARD M. ZELIKOW*
- ----------------------------
Howard M. Zelikow Director March 25, 1999
- ----------
* 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
ON FINANCIAL STATEMENT SCHEDULE
To the Shareholders and Board of Directors
of Financial Security Assurance Holdings Ltd.:
Our audits of the consolidated financial statements referred to in our report
dated January 26, 1999 appearing on page 25 of the 1998 Annual Report to
Shareholders of Financial Security Assurance Holdings Ltd. (which report and
consolidated financial statements are incorporated by reference in this Annual
Report on Form 10-K) also included an audit of the financial statement schedule
listed in the index on page 26 of this Form 10-K. In our opinion, this financial
statement schedule presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements.
/s/ PRICEWATERHOUSECOOPERS LLP
-------------------------------
PRICEWATERHOUSECOOPERS LLP
New York, New York
January 26, 1999
33
<PAGE>
Schedule II
Parent Company Condensed Financial Information
Condensed Balance Sheets
(Dollars in thousands)
December 31,
------------------
1998 1997
---- ----
Assets:
Investments and cash $ 59,512 $ 65,044
Investment in subsidiary, at equity in net assets 1,119,235 903,421
Notes receivable from subsidiary 120,000 50,000
Deferred taxes 711 2,178
Other assets 66,544 33,897
---------- ----------
$1,366,002 $1,054,540
========== ==========
Liabilities and Shareholders' Equity:
Notes payable $ 230,000 $ 130,000
Other liabilities 62,566 42,180
Shareholders' equity 1,073,436 882,360
---------- ----------
$1,366,002 $1,054,540
========== ==========
Condensed Statements of Income
(Dollars in thousands)
Year Ended December 31,
-----------------------------
1998 1997 1996
---- ---- ----
Dividends received from subsidiary $ -- $ -- $ 18,000
Other revenue 11,515 3,553 2,741
--------- --------- ---------
Total revenue 11,515 3,553 20,741
Interest and amortization expense (10,590) (2,731) --
Other expenses (1,860) (1,087) (1,187)
Equity in earnings of unconsolidated
affiliate 333 -- --
--------- --------- ---------
(602) (265) 19,554
Equity in undistributed net income of
subsidiary 117,374 100,678 61,697
--------- --------- ---------
Income before income taxes 116,772 100,413 81,251
Income tax benefit (provision) 206 89 (491)
--------- --------- ---------
Net income $ 116,978 $ 100,502 $ 80,760
========= ========= =========
The Parent Company Condensed Financial Information should be read in
conjunction with the Consolidated Financial Statements and Notes to 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,
-------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Other operating expenses recovered, net $ 35,168 $ 4,291 $ 14,700
Dividends from subsidiary -- -- 18,000
Net investment income received 3,510 3,448 3,078
Federal income taxes received (paid) (5,332) 7,237 (1,059)
Interest paid (9,614) (2,716) --
Other (1,089) (3,512) (1,227)
--------- --------- ---------
Net cash provided by operating activities 22,643 8,748 33,492
--------- --------- ---------
Cash flows from investing activities:
Proceeds from sales of bonds 170,513 2,812 21,544
Proceeds from sales of equity investments 73,042 -- --
Purchases of bonds (158,153) (30,224) (3,554)
Purchases of equity investments (92,087) (1,690) (7,336)
Purchases of property and equipment (3) (3) (2)
Investment in subsidiaries (96,788) (31,384) (1,600)
Net decrease (increase) in short-term securities 23,777 (9,890) (15,895)
Other investments (21,502) -- --
--------- --------- ---------
Net cash used for investing activities (101,201) (70,379) (6,843)
--------- --------- ---------
Cash flows from financing activities:
Issuance of notes payable, net 96,850 125,905 --
Surplus notes purchased (70,000) (50,000) --
Dividends paid (12,777) (12,098) (10,536)
Treasury stock, net (23,890) (36,247) (40,610)
Issuance of stock for acquisition of subsidiary 80,000 -- --
Repurchase of stock by subsidiary 8,500 39,500 27,000
Other 533 (5,567) (2,435)
--------- --------- ---------
Net cash provided by (used for) financing activities 79,216 61,493 (26,581)
--------- --------- ---------
Net increase (decrease) in cash 658 (138) 68
Cash at beginning of year (38) 100 32
--------- --------- ---------
Cash at end of year $ 620 $ (38) $ 100
========= ========= =========
Reconciliation of net income to net cash provided
by operating activities:
Net income $ 116,978 $ 100,502 $ 80,760
Equity in undistributed net income of subsidiary (117,374) (100,678) (61,697)
Decrease (increase) in accrued investment income (2,607) (1,394) 264
Increase (decrease) in accrued income taxes (5,137) 6,944 (932)
Provision (benefit) for deferred income taxes (402) 203 365
Net realized gains on investments (5,206) (1,405) (1,128)
Deferred equity compensation 17,765 14,112 5,565
Depreciation and accretion of bond discount (1,077) (1,174) (224)
Minority interest and equity in earnings of
unconsolidated affiliates (333) -- --
Change in other assets and liabilities 20,036 (8,362) 10,519
--------- --------- ---------
Cash provided by operating activities $ 22,643 $ 8,748 $ 33,492
========= ========= =========
</TABLE>
The Parent Company Condensed Financial Information should be read in
conjunction with the Consolidated Financial Statements and Notes to 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.
3. Reclassification
Certain prior-year balances have been reclassified to conform to the 1998
presentation.
36
Exhibit 10.5
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
Supplemental Executive Retirement Plan
As Amended and Restated
as of February 25, 1999
<PAGE>
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
Supplemental Executive Retirement Plan
CONTENTS
Page
----
ARTICLE 1 Purposes of Plan.................................................. 1
ARTICLE 2 Definitions....................................................... 1
ARTICLE 3 Participation..................................................... 3
ARTICLE 4 Restoration of Benefits........................................... 3
ARTICLE 5 Administration and General Provisions............................. 6
i
<PAGE>
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
Supplemental Executive Retirement Plan
ARTICLE 1. Purposes of Plan.
1.1 Financial Security Assurance Inc. adopted the Financial Security Assurance
Inc. Supplemental Executive Retirement Plan (the "Plan"), effective
January 1, 1989, in order to restore the pension benefits of selected
current and future key employees whose benefits under the Financial
Security Assurance Inc. Money Purchase Plan are limited by reason of
certain limitations imposed by Section 401(a)(17), Section 415 and other
provisions of the Internal Revenue Code of 1986, as amended (the "Code").
The Plan was previously amended and restated in its entirety, and adopted
by Financial Security Assurance Holdings Ltd. effective as of January 1,
1995, and subsequently amended on February 12, 1997. The Plan is hereby
amended and restated in its entirety, and adopted by Financial Security
Assurance Holdings Ltd. effective as of February 25, 1999. The benefits,
if any, with respect to any employee who terminated employment prior to
the effective date of any amendment shall be determined in accordance with
the provisions of the Plan as in effect as of such termination date.
ARTICLE 2. Definitions.
For purposes of the Plan, the following terms shall have the meanings set
forth below:
2.1 "Account" shall mean the account established for a Participant under the
Plan to which contributions and earnings are credited.
2.2 "Basic Plan" shall mean the Financial Security Assurance Inc. Money
Purchase Plan as adopted and amended.
2.3 "Beneficiary" shall mean the person or persons designated by the
Participant to receive benefits under the Plan in the event of the
Participant's death. If there is no Beneficiary surviving the Participant,
any death benefit payable hereunder shall be paid to the Participant's
estate.
2.4 "Board" shall mean the Board of Directors of the Company.
2.5 "Code" shall mean the Internal Revenue Code of 1986, as amended from time
to time.
2.6 "COLI" shall mean the corporate owned life insurance purchased by a
Participating Company on a Participant's life pursuant to the Plan.
2.7 "Committee" shall mean the Human Resources Committee of the Board acting
on the majority vote of such Committee.
2.8 "Company" shall mean Financial Security Assurance Holdings Ltd., a New
York corporation.
1
<PAGE>
2.9 "Compensation" shall mean, with respect to each Plan Year, the
Participant's annual base salary, cash bonus, any bonus in lieu of which
an "Equity Bonus" has been granted pursuant to the Company's 1993 Equity
Participation Plan or any successor plan and any amount deferred pursuant
to the Company's Deferred Compensation Plan (other than deferrals related
to "Performance Share" awards); provided, however, that in no case shall
such Compensation exceed $1 million in any Plan Year.
2.10 "Disability" shall mean the Participant's eligibility for disability
benefits under his or her Participating Company's long term disability
plan.
2.11 "Discharge for Cause" shall mean an Employee's termination of employment
by a Participating Company due to such Employee's willful misconduct or
gross negligence in respect of his or her duties of employment with the
Participating Company including, but not limited, to conviction for a
felony or perpetration of a common law fraud which has resulted in or is
likely to result in material economic damage to a Participating Company.
2.12 "Employee" shall mean any individual employed by a Participating Company
on or after January 1, 1989 to whom benefits are payable under the Basic
Plan.
2.13 "Participant" shall mean an Employee who is a member of a select group of
management or highly compensated employees and who has been designated by
the Committee for participation in the Plan pursuant to Section 3.1.
2.14 "Participating Company" shall mean the Company or any subsidiary or
affiliate of the Company employing a Participant.
2.15 "Plan" shall mean the Financial Security Assurance Holdings Ltd.
Supplemental Executive Retirement Plan as set forth herein, previously
known as, and unless specifically provided to the contrary shall include,
the Financial Security Assurance Inc. Supplemental Executive Retirement
Plan.
2.16 "Plan Year" shall mean each calendar year beginning after December 31,
1988.
2.17 "Years of Service" shall mean "Years of Service for Vesting" as defined
under the Basic Plan.
Where used herein, the masculine gender shall be deemed, where applicable,
to include the feminine gender, and references to the singular shall be
deemed, where applicable, to include the plural.
ARTICLE 3. Participation.
3.1 At any time during the Plan Year, the Chief Executive Officer may
recommend an Employee to the Committee for participation in the Plan. Upon
receiving such recommendation, the Committee shall timely act upon it and
shall notify the Employee in the event he or she is designated a
Participant and the date as of which such participation
2
<PAGE>
commences. Unless otherwise determined by the Committee, once an Employee
has been approved by the Committee as a Participant in the Plan, such
Employee shall remain a Participant until all of his or her benefits with
respect to the Plan have been paid or forfeited.
ARTICLE 4. Restoration of Benefits.
4.1 Amount of Restoration of Benefits. Subject to Sections 4.3(b), 4.5 and 5.2
of the Plan, the Account of a Participant who is in service with a
Participating Company on the last day of the Plan Year, and whose pension
benefits under the Basic Plan for such Plan Year are limited by the
application of Section 401(a)(17) of the Code, Section 415 of the Code and
other limits under the Code on the inclusion of deferred amounts for
contribution purposes, shall be credited with an amount equal to the
difference between:
(a) the amount of contribution related to Compensation which would have
been payable to or in respect of the Participant under the Basic
Plan without regard to the maximum annual pension limitation in
Section 415 of the Code or the pensionable compensation limitation
in Section 401(a)(17) of the Code or the exclusion of certain
deferred amounts, and
(b) the amount of contribution related to Compensation actually payable
to or in respect of the Participant under the Basic Plan.
4.2 Vesting. A Participant shall be 100% vested in his or her Account upon
attaining age 55, upon his or her death or Disability while in the employ
of a Participating Company or upon the termination of the Plan pursuant to
Section 5.2. Except as provided in Section 5.4, if a Participant
terminates employment prior to an event specified in the preceding
sentence, such Participant shall be vested in his or her Account in
accordance with the following schedule:
Completed Years of Service Percentage
-------------------------- ----------
Less than 2 0
2 20
3 40
4 60
5 80
6 or more 100
4.3 Crediting of Investment Gain/Loss. As of the last day of each Plan Year,
the Participant's Account shall be credited with an amount determined
pursuant to Section 4.1.
(a) Such Account will be credited with earnings and investment gains and
losses determined by assuming that the Account was invested in such
investments and in such percentages specified by the Participant
based upon such investment vehicles, and in accordance with such
procedures, as specified by the Committee or as delegated by the
Committee for determination.
3
<PAGE>
(b) Notwithstanding paragraph (a) above, if the COLI on a Participant's
life remains in effect (applicable to certain Participants in the
Plan prior to December 31, 1994), the amount credited to the
Participant's Account pursuant to Section 4.1 shall first be used to
pay the premiums on the COLI. Any amount credited pursuant to
Section 4.1 in excess of the amount needed to pay the premiums on
the COLI shall be credited with earnings and investment gains and
losses in the manner provided in paragraph (a) above.
(c) A Participant may request a change in his or her Account's imputed
investments as of the first day of any month by notifying the
Committee, in writing, of such request by the tenth day of the
preceding month. Notwithstanding the above, the Committee has the
discretion to reject a Participant's request of a particular
investment and to credit a rate of return of an investment of its
choosing.
4.4 Form and Timing of Election. Except as otherwise provided herein, payment
of the Participant's vested Account Balance shall be made as soon as
administratively practicable following the Participant's death, Disability
or other termination of employment (a "Distribution Event"). The
Participant may elect (a "Payment Election") that his or her vested
Account Balance be distributed following the Distribution Event in a lump
sum or in installments payable over a specified number of years, not
longer than 15 years; provided, however, that in no event may installment
payments be elected over a number of years that is more than the
Participant's life expectancy or the life expectancy of the designated
primary Beneficiary, whichever is greater, at the time of the Payment
Election. If a Participant elects the installment option, the Participant
must also elect whether installments should be made annually, quarterly or
monthly. A Payment Election may specify different payment options (i) for
different percentages or dollar amounts of a Participant's vested Account
Balance or (ii) in the event of the death or Disability of the
Participant. Distribution will be in the form of a lump sum as soon as
administratively practicable following the Distribution Event, (i) if a
timely Payment Election was not made or (ii) in the event of death or
Disability, if a timely Payment Election to the contrary expressly
applicable in the event of the death or Disability of the Participant was
not made. Payment Elections shall be made on or prior to the date three
months after an Employee becomes a Participant; provided, however, that a
Participant shall be entitled to change his or her Payment Election in
respect of any amounts thereafter contributed or earned on his or her
Account Balance by making a new Payment Election applicable to such future
balances. A Payment Election shall be effective upon submission to the
Committee or its designee, provided that the Committee retains the right,
at its election, to make payments in a lump sum if it elects, in its sole
discretion, to do so notwithstanding any Payment Election requesting an
installment option. Notwithstanding anything to the contrary provided
herein, any distribution to a Participant otherwise payable hereunder
shall be deferred until no later than January 2 in the year following
termination of the Participant's employment with the Company (and its
subsidiaries) to the extent that such distribution, if not so deferred,
would be disallowed as a tax deduction by the Company pursuant to Section
162(m) of the Code (or any successor provision).
4
<PAGE>
4.5 Benefit Restoration With Respect to Certain Bonus Payments. In the event
that a Participating Company accelerates the payment of bonuses for any
Plan Year by paying bonuses which would otherwise be payable in the
following Plan Year, and such payment causes a Participant to be credited
with a lower total contribution under the Basic Plan and the Plan by
virtue of the limitations provided in the Basic Plan and the limitations
on the amount of Compensation provided in Section 2.9 of the Plan, then,
notwithstanding any such limitations, the Committee may, in its
discretion, credit an additional supplemental pension contribution under
the Plan for the Plan Year in which the bonuses were paid on an
accelerated basis up to the amount which would otherwise be lost to the
Participant by virtue of the application of the limitations in the Basic
Plan and in the Plan. The aggregate amounts credited under the Plan, and
the contributions actually payable to or in respect of the Participant
under the Basic Plan, over a two Plan Year period consisting of the Plan
Year into which the bonus was accelerated and the following Plan Year,
shall not be increased by virtue of the application of this Section 4.5.
ARTICLE 5. Administration and General Provisions.
5.1 Administration.
(a) The Plan shall be administered by the Committee in accordance with
the administrative provisions of the Basic Plan. The Committee shall
have full power and authority to interpret, construe and administer
the Plan, and review claims for benefits under the Plan, and the
Committee's interpretations and constructions of the Plan and
actions thereunder shall be binding and conclusive on all persons
and for all purposes.
(b) The Committee shall establish and maintain Plan records and may
arrange for the engagement of such certified public accountants,
actuarial consultants or legal counsel, and make use of such agents
and clerical or other personnel, as they shall require or may deem
advisable for purposes of the Plan. The Committee may rely upon the
written opinion of such counsel and the consultants or accountants
engaged by the Committee and may delegate to any agent or to any
sub-committee or member of the Committee its authority to perform
any act hereunder, including, without limitation, those matters
involving the exercise of discretion, provided that such delegation
shall be subject to revocation at any time by the Committee.
(c) To the maximum extent permitted by applicable law, no member of the
Committee shall be personally liable by reason of any contract or
other instrument executed by him or her in his or her capacity as a
member of the Committee, nor for any mistakes of judgment made in
good faith, and the Company shall indemnify and hold harmless,
directly from its own assets (including the proceeds of any
insurance policy the premiums of which are paid from the Company's
own assets), each member of the Committee and each officer,
employee, or director of the Company to whom any duty or power
relating to the administration or interpretation of the Plan or to
the engagement or control of the assets of the Plan may be delegated
or allocated, against any cost or expense (including counsel fees)
or liability including any sum paid in settlement of a claim with
the approval of the
5
<PAGE>
Company arising out of any act or omission to act in connection with
the Plan.
5.2 Amendment and Termination. The Plan may be amended, suspended or
terminated, in whole or in part, by the Board, but no such action shall
retroactively impair or otherwise adversely affect the rights of any
person to receive benefits under the Plan which have accrued prior to the
date of such action, as determined by the Committee; provided, however,
that the amount of any future contribution payable to or in respect of a
Participant may be reduced by the amount of any increase in the amount of
pension actually payable to the Participant or Beneficiary under the Basic
Plan due to any increases in benefits payable under the Basic Plan
(whether due to changes in Code Sections 401(a)(17) and 415 limitations or
otherwise) subsequent to the Participant's retirement. Anything in Section
4.4 to the contrary notwithstanding, in the event of the termination of
the Plan, the Committee may direct that all Account balances be
distributed in the form of a lump sum distribution.
5.3 Company's Right to Discharge Employees. Nothing contained herein will
confer upon any Participant or other employee the right to be retained in
the employ of any Participating Company, nor will it interfere with the
right of any Participating Company to discharge or otherwise administer
the employment and termination of Participants and other employees without
regard to the existence of the Plan.
5.4 Discharge for Cause. Notwithstanding any other provisions contained in the
Plan, in the event of a Participant's Discharge for Cause, such
Participant and his or her Beneficiary shall forfeit all rights to any
payments under the Plan.
5.5 Sale of Company. Nothing in the Plan shall preclude the Company from
consolidating with or merging into or with, or transferring all or
substantially all its assets to, another corporation which assumes the
Plan and all obligations of the Company hereunder. Under such a
consolidation, merger, or transfer of assets and assumption, the term
"Company" shall refer to such other corporation and the Plan shall
continue in full force and effect.
5.6 Source of Payments. Participants have the status of general unsecured
creditors of the Company and the Plan constitutes a mere promise by the
Company to make benefit payments in the future from its general assets;
provided, however, that such payments shall be reduced by the amount of
any payments made to the Participant or his or her Beneficiary from any
trust or special or separate fund established by the Company to assure
such payments, and if the Company shall make any investments to aid it in
meeting its obligations hereunder, the Participant and his or her
Beneficiary shall have no right, title, or interest whatever in or to any
such investments except as may otherwise be expressly provided in a
separate written instrument relating to such investments. Nothing
contained in the Plan, and no action taken pursuant to its provisions,
shall create or be construed to create a trust of any kind between the
Company and any Participant or Beneficiary. By action of its Board of
Directors, any Participating Company may assume joint and several
liability with the Company with respect to any obligations under the Plan
for Participants employed by the Participating Company.
5.7 Withholding. The Company may withhold from any benefits payable under the
Plan all Federal, state, city or other taxes as shall be required pursuant
to any law or governmental regulation or ruling.
6
<PAGE>
5.8 Expenses. All expenses incurred in administering the Plan will be paid by
the Company and none will be paid by the Participant.
5.9 Assignment. No interest of any Participant or Beneficiary hereunder shall
be subject in any manner to anticipation, alienation, sale, transfer,
assignment, pledge, encumbrance, attachment, or garnishment by creditors
of the Participant or the Participant's Beneficiary. The Plan shall be
binding upon and inure to the benefit of the Company and its successors
and assigns and the Participant, his or her Beneficiary and estate.
5.10 ERISA Status of Plan. The Plan is intended to constitute an "unfunded plan
for management or other highly compensated individuals" as defined in the
Employee Retirement Income Security Act of 1974, as amended from time to
time ("ERISA"), and is subject to certain provisions of ERISA, including
certain requirements relating to reporting, disclosure, enforcement and
claims.
5.11 Applicable Law. The Plan shall be construed, regulated and administered
according to ERISA (to the extent applicable), the Code and the laws of
the State of New York.
7
Exhibit 10.22
================================================================================
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
and
EXEL LIMITED
Registration Rights Agreement
Dated as of November 3, 1998
================================================================================
<PAGE>
TABLE OF CONTENTS
PAGE
----
SECTION 1 DEFINITIONS..................................................... 1
SECTION 2 DEMAND REGISTRATION............................................. 1
SECTION 3 PIGGYBACK REGISTRATION.......................................... 3
SECTION 4 HOLD-BACK AGREEMENTS; PRESS RELEASES............................ 4
SECTION 5 REGISTRATION PROCEDURES......................................... 4
SECTION 6 REGISTRATION EXPENSES........................................... 8
SECTION 7 INDEMNIFICATION................................................. 9
a. Indemnification by the Company............................. 9
b. Indemnification by EXEL.................................... 10
c. Conduct of Indemnification Proceedings..................... 10
d. Contribution............................................... 11
SECTION 8 PARTICIPATION IN UNDERWRITTEN REGISTRATIONS..................... 11
SECTION 9 TERMINATION..................................................... 12
SECTION 10 AMENDMENTS AND WAIVERS.......................................... 12
SECTION 11 SECRETARY TO RETAIN COPY........................................ 12
SECTION 12 CHOICE OF LAW AND FORUM AND SERVICE OF PROCESS.................. 12
SECTION 13 ARBITRATION..................................................... 12
SECTION 14 ASSIGNMENT...................................................... 14
SECTION 15 NOTICES......................................................... 14
SECTION 16 NO THIRD-PARTY BENEFICIARIES.................................... 15
SECTION 17 ENTIRE AGREEMENT................................................ 15
SECTION 18 HEADINGS........................................................ 15
SECTION 19 COUNTERPARTS.................................................... 15
SECTION 20 SEVERABILITY.................................................... 15
EXHIBIT A DEFINITIONS.....................................................A-1
<PAGE>
REGISTRATION RIGHTS AGREEMENT
REGISTRATION RIGHTS AGREEMENT dated as of November 3, 1998 (this
"Agreement"), among FINANCIAL SECURITY ASSURANCE HOLDINGS LTD., a New York
corporation (the "Company"), and EXEL LIMITED, a Cayman Islands corporation
("EXEL").
WHEREAS, the Company intends to sell to EXEL certain unregistered shares
of common stock ("Common Stock") of the Company and may from time to time issue
to EXEL additional shares of Common Stock pursuant to the Shareholders
Agreement, dated as of the date hereof, among the Company, EXEL and Financial
Security Assurance International Ltd. ("FSAI") (as amended from time to time,
the "FSAI Shareholders Agreement"); and
WHEREAS, the Company intends to provide to EXEL certain registration
rights in respect of the Common Stock;
NOW, THEREFORE, in consideration of the foregoing and for other good and
valuable consideration, the receipt and adequacy of which are hereby
acknowledged, the parties hereto hereby agree as follows:
Section 1. Definitions. Capitalized terms used herein shall have the
meanings provided in Exhibit A hereto, unless the context otherwise requires.
Section 2. Demand Registration.
(a) Except as provided herein and subject to Section 2(c)(ii)
hereof, EXEL may, at any time make a written request to the Company for
registration under the Securities Act of all or part of the Common Stock
it then owns (a "Demand Registration"). Any such request by EXEL shall
specify the aggregate amount of Common Stock to be registered and shall
also specify the intended method of disposition thereof. Within ten
Business Days after receipt of such registration request, the Company
shall commence the preparation of the registration of the Common Stock.
The Company shall include in such registration all Common Stock specified
in the written request; provided, however, that the Company may, upon
written notice to EXEL, delay the effectuation of such Demand Registration
for a reasonable period of time, but not more than 90 days after receipt
of the request for such Demand Registration, (i) as is necessary to
prepare audited financial statements of the company for its most recently
completed fiscal year or other audited financial statements reasonably
required in the Registration Statement, or (ii) if the Company would be
required to divulge in such Registration Statement the existence of any
fact relating to a proposed acquisition, financing or other material
corporate development not otherwise required to be disclosed and
management of the Company shall have in good faith determined that such
disclosure would be materially adverse to the Company. Such notice of
delay shall explain, in reasonable detail, the reasons for such delay. If
the Company shall so delay the effectuation of the Demand Registration,
EXEL may, within 30 days after receipt of the notice of delay, notify the
Company that it is withdrawing its request for registration and such
Demand
<PAGE>
Registration shall be deemed to be withdrawn and such request shall be
deemed not to have been exercised for purposes hereof.
(b) Except as provided by Section 2(d) below and subject to the
hold-back restrictions set forth in Section 4 hereof, EXEL shall be
entitled to three Demand Registrations; provided, however, that (i) only
one Demand Registration may be declared by EXEL in any six-month period
and (ii) if the preferred shares of FSAI owned by the Company are called
by Company pursuant to the Bye-laws of FSAI and EXEL has otherwise
exhausted its right to Demand Registrations hereunder, EXEL shall have the
right to one additional Demand Registration.
(c) (i) The offering of Common Stock pursuant to such Demand
Registration shall be in the form of an Underwritten Offering if requested
by EXEL. If the managing underwriter or underwriters unanimously determine
in good faith that the total amount of Common Stock proposed to be
included in such offering is such as to materially adversely affect the
success of such offering, then the amount of Common Stock shall be reduced
to the extent necessary to reduce the total amount of Common Stock to be
included in such offering to the amount that, in the reasonable opinion of
such managing underwriter or underwriters, can be sold without materially
adversely affecting the success of such offering.
(ii) Notwithstanding anything contained in this Section 2, the
Company shall not be obligated to comply with a Demand Registration if
such registration, in the reasonable judgment of the Company after
consultation with a securities rating agency then rating the Company or
its Subsidiaries or a regulatory authority (having jurisdiction over the
Company or its Subsidiaries), as the case may be, such registration would
(x) impair the debt or claims-paying ability or financial-strength rating
of the Company or its Subsidiaries (including resulting in such rating
being placed on credit watch or under formal review) or (y) materially
increase any capital charge or capital cost of the Company or its
Subsidiaries, or if such regulatory authority otherwise objects to such
offering.
(d) If (i) more than one-third of EXEL's Common Stock sought to be
registered in any Demand Registration is not included in such registration
pursuant to Section 2(c)(i), (ii) a Demand Registration is delayed
pursuant to Section 2(a) hereof and is not effective or otherwise is not
effective within 180 days after EXEL's demand for registration, (iii) if
such registration, after it has become effective, is interfered with by
any stop order, injunction or other order or requirement of the SEC or
other governmental agency or court by reason of an act or omission by the
Company or any of its Subsidiaries or (iv) the conditions to closing
specified in the purchase agreement or underwriting agreement entered into
in connection with such registration are not satisfied because of an act
or omission by the Company or any of its Subsidiaries (other than by
reason of facts or circumstances not within the control of the Company or
any such Subsidiary), then in each such case such Demand Registration
shall not be counted for purposes of calculating the number of demand
rights exercised by EXEL in Section 2(b).
-2-
<PAGE>
(e) Nothing in this Section 2 or in Section 3 hereof shall create
any right in EXEL to require the Company to register any securities other
than Common Stock under the Securities Act.
Section 3. Piggyback Registration.
(a) If the Company at any time proposes to register shares of Common
Stock on its own behalf or on behalf of any holder of Common Stock under
the Securities Act (other than a registration effected solely to implement
an employee benefit plan, a transaction to which Rule 145 promulgated
under the Securities Act is applicable, or a transaction eligible to be
registered on Form S-4 or any successor form), the Company shall give
written notice each such time to EXEL of its intention to do so (which
notice shall include the anticipated filing date of the Registration
Statement and the number of shares proposed to be included in the
Registration Statement). Upon the written request of EXEL given within 5
Business Days after receipt of any such notice by EXEL (stating the number
of shares of Common Stock to be disposed of by EXEL and the intended
method of disposition), the Company shall include the shares of Common
Stock intended to be disposed of in a registration statement under the
Securities Act so as to permit disposition (in accordance with the
reasonable methods in said request) by EXEL of the shares so registered (a
"Piggyback Registration").
(b) Notwithstanding any provision of this Section 3, if the
registration of which the Company gives notice pursuant to Section 3(a) is
for an Underwritten Offering and the managing underwriter or underwriters
determine in good faith that the total number of shares of Common Stock
proposed to be included in such offering is such as to materially
adversely affect the success of such offering, then the priority for
inclusion of Common Stock shall be as follows: (1) if such registration is
or includes a primary registration, (x) first, securities of the Company
proposed to be included in such registration and (y) second, shares of
Common Stock requested to be included in such registration by EXEL and the
other secondary sellers pro-rata in accordance with Section 2(c)(i) or (2)
if such Registration is exclusively a secondary registration, then the
priority for inclusion of shares shall be pro-rata among such secondary
sellers (including EXEL) in accordance with Section 2(c)(i).
(c) If EXEL elects not to participate in any underwriting in which
it had previously requested the registration described in Section 3(a),
EXEL may elect to withdraw therefrom by delivering written notice to the
Company and the managing underwriter or underwriters, if any, 10 Business
Days prior to the planned effective date of such registration.
-3-
<PAGE>
Section 4. Hold-Back Agreements; Press Releases.
(a) EXEL agrees not to effect any public sale or distribution of
securities of the Company, including a sale pursuant to Rule 144 under the
Securities Act (except as part of such Underwritten Registration), during
the 30-day period prior to, other than a sale made in connection with a
Piggyback Registration under Section 3, and during the 180-day period
beginning on, the closing date of each Underwritten Offering made pursuant
to a Registration Statement, unless the managing underwriter or
underwriters agree in writing to waive or shorten any such period for all
sellers of Common Stock. This provision shall not apply to EXEL if there
is a public sale or distribution of securities of the Company subsequent
to such holding period or if EXEL is prevented by applicable statute or
regulation from entering into any such agreement; provided, however, that
EXEL shall undertake, in its request to participate in any such
underwritten offering, not to effect any public sale or distribution of
securities commencing on the date of such offering unless EXEL has
provided 180 days prior written notice of such sale or distribution to the
managing underwriter or underwriters (or such lesser number of days as
then remains in the 180-day period commencing on the closing date of such
offering). The Company agrees to be bound by the foregoing hold-back
agreement and to cause each person to which it grants registration rights
to be so bound, to the same extent as EXEL.
(b) Before EXEL shall disseminate or announce publicly any
information concerning a proposed offering pursuant to Section 2 or 3
hereof that is intended for or may result in public knowledge thereof,
EXEL shall so advise the Company and shall not disseminate or announce
publicly such information without the Company's consent, unless such
information is otherwise publicly available or the dissemination thereof
is required by applicable law.
Section 5. Registration Procedures. In connection with the Company's
Demand Registration or Piggyback Registration obligations pursuant to Sections 2
and 3 hereof, the Company will use its reasonable efforts to effect such Demand
Registration or Piggyback Registration to permit the sale of Common Stock in
accordance with the intended method or methods of distribution thereof, and
pursuant thereto the Company will:
(a) prepare and file with the SEC, as soon as practicable after
receipt of the registration request referred to in Section 2 or 3 hereof,
and use its best efforts to have declared effective, a Registration
Statement relating to the Demand Registration or Piggyback Registration on
any appropriate form under the Securities Act, which form shall be
available for the sale of the Common Stock in accordance with the intended
method or methods of distribution thereof and shall include all financial
statements required by the SEC to be filed therewith, and cooperate and
assist in any filings required to be made with any national stock exchange
or national computerized market system on which the Common Stock is to be
listed or quoted; provided, however, that, before filing a Registration
Statement or Prospectus or any amendments or supplements thereto, the
Company shall furnish to EXEL and the managing underwriter or
underwriters, if any, copies of all such documents proposed to be filed,
which documents shall be
-4-
<PAGE>
subject to the reasonable review of EXEL and the managing underwriter or
underwriters, if any, and the Company shall not file any Registration
Statement or amendment thereto or any Prospectus or any supplement thereto
to which EXEL or the managing underwriter or underwriters, if any, shall
reasonably object in writing;
(b) cause the Prospectus to be supplemented by any required
Prospectus supplement, and as so supplemented to be filed pursuant to Rule
424 under the Securities Act and comply with the provisions of the
Securities Act with respect to the disposition of all Common Stock covered
by such Registration Statement during the applicable period in accordance
with the intended method or methods of distribution by EXEL set forth in
such Registration Statement or supplement to the Prospectus; provided,
however, that any actions taken by the Company in good faith and for valid
business reasons, including, without limitation, the acquisition or
divestiture of assets, shall not violate the foregoing so long as the
Company promptly thereafter complies with the requirements of Section 5(k)
hereof, if applicable;
(c) promptly notify EXEL and the managing underwriter or
underwriters, if any, and (if requested by any such Person) confirm such
notice in writing: (i) when the Registration Statement or any amendment
thereto or the Prospectus or any Prospectus supplement or post-effective
amendment has been filed, and, with respect to the Registration Statement
or any post-effective amendment, when the same has become effective, and
to furnish or make available to EXEL and the underwriter copies thereof,
(ii) of any request by the SEC for amendments or supplements to the
Registration Statement or the Prospectus or for additional information,
(iii) of the issuance by the SEC of any stop order or similar order
suspending the effectiveness of the Registration Statement or the use of
any preliminary Prospectus or Prospectus or the initiation or threatening
of any proceedings for that purpose, (iv) if at any time the
representations and warranties of the Company contemplated by Section 5(1)
hereof cease to be true and correct, (v) of the receipt by the Company of
any notification with respect to the suspension of the qualification of
the Common Stock for offering or sale in any jurisdiction or the
initiation or threatening of any proceeding for such purpose, and (vi) of
the happening of any event that makes any statement made in the
Registration Statement, the Prospectus, or any document incorporated
therein by reference, untrue or that requires the making of any changes in
the Registration Statement, the Prospectus, or any document incorporated
therein by reference in order to make the statements therein not
misleading;
(d) make every reasonable effort to obtain the withdrawal of any
stop order or other order suspending the effectiveness of the Registration
Statement or the use of any preliminary Prospectus or Prospectus, at the
earliest possible moment;
(e) if requested by EXEL or the managing underwriter or
underwriters, if any, incorporate in a Prospectus supplement or
post-effective amendment such
-5-
<PAGE>
information as EXEL or the managing underwriter or underwriters, if any,
reasonably agree should be included therein relating to the plan of
distribution with respect to the Common Stock to be sold by EXEL; and make
all required filings of such Prospectus supplement or post-effective
amendment as soon as notified of the matters to be incorporated in such
Prospectus supplement or post-effective amendment; provided, however, that
the Company shall not be required to take any actions in this Section 5(e)
that are not, in the written opinion of counsel for the Company delivered
to EXEL, in compliance with applicable law;
(f) furnish to EXEL and each managing underwriter or underwriters,
if any, without charge, as many conformed copies as they may reasonably
request of the Registration Statement and any post-effective amendment
thereto, including financial statements and schedules, all documents
incorporated therein by reference and all exhibits (including those
incorporated by reference);
(g) deliver to EXEL and the managing underwriter or underwriters, if
any, without charge, as many copies of the Prospectus (including each
preliminary Prospectus) and any amendment or supplement thereto as such
Persons may reasonably request; it being understood and agreed that the
Company consents to the use of any preliminary Prospectus, Prospectus or
any amendment or supplement thereto by EXEL and the managing underwriter
or underwriters, if any, in connection with the offering and sale of the
Common Stock covered by any preliminary Prospectus or Prospectus or any
amendment or supplement thereto;
(h) prior to any public offering of Common Stock covered by a
Registration Statement, use its best efforts to register or qualify, and
cooperate with EXEL, the managing underwriter or underwriters, if any, and
respective counsel in connection with the registration or qualification
of, such Common Stock for offer and sale under the securities or blue sky
laws of such jurisdictions as EXEL or any such underwriter reasonably
requests in writing and do any and all other acts or things necessary or
advisable to enable the disposition in such jurisdictions of the Common
Stock covered by the Registration Statement; provided, however, that the
Company shall not be required: (1) to qualify generally to do business in
any jurisdiction where it is not then so qualified or (2) to take any
action that would subject it to general service of process in any such
jurisdiction where it is not then so subject or subject the Company to any
tax in any such jurisdiction where it is not then so subject;
(i) (1) cooperate with EXEL and the managing underwriter or
underwriters, if any, to facilitate the timely preparation and delivery of
certificates representing the Common Stock covered by a Registration
Statement to be sold; and (2) enable the Common Stock covered by a
Registration Statement to be in such denominations and registered in such
names as EXEL or the managing underwriter or underwriters may request at
least two Business Days prior to any sale of such Common Stock to the
underwriters;
-6-
<PAGE>
(j) use its best efforts to cause the Common Stock covered by the
applicable Registration Statement to be registered with or approved by
such other governmental agencies or authorities as may be necessary to
enable EXEL or the managing underwriter or underwriters, if any, to
consummate the disposition of such Common Stock; provided, however, that
the Company shall not be required to register the Common Stock covered by
a Registration Statement in any jurisdiction where such registration would
subject the Company to general service of process where it is not then so
subject, or subject the Company to any tax in any such jurisdiction where
it is not then so subject;
(k) upon the occurrence of any event contemplated by Section
5(c)(vi) above, prepare a supplement or post-effective amendment to the
Registration Statement or the related Prospectus or any document
incorporated therein by reference or file any other required document so
that, as thereafter delivered to the purchasers of the Common Stock
covered by a Registration Statement, the Prospectus will not contain an
untrue statement of a material fact or omit to state any material fact
necessary to make the statements therein not misleading;
(l) enter into such customary agreements (including an underwriting
agreement) on terms reasonably acceptable to the Company and use its best
efforts to take all such other actions in order to facilitate the
disposition of the Common Stock covered by the Registration Statement and
in such connection, whether or not an underwriting agreement is entered
into and whether or not the registration is an underwritten registration:
(i) make such representations and warranties to EXEL and the managing
underwriter or underwriters, if any, in form, substance and scope, as are
customarily made by issuers to underwriters in similar underwritten
offerings; (ii) obtain opinions of counsel to the Company and updates
thereof (which counsel and opinions (in form, scope and substance) shall
be reasonably satisfactory to the managing underwriter or underwriters, if
any, and not objected to by EXEL) addressed to EXEL and the managing
underwriter or underwriters, if any, covering the matters customarily
covered in opinions requested in underwritten offerings and such other
matters as may be reasonably requested by EXEL or the underwriters; (iii)
obtain "cold comfort" letters and updates thereof from the Company's
independent public accountants addressed to EXEL and the managing
underwriter or underwriters, if any, such letters to be in customary form
and covering matters of the type customarily covered in "cold comfort"
letters by accountants in connection with primary underwritten offerings;
(iv) if an underwriting agreement is entered into, the same shall set
forth certain indemnification provisions and procedures with respect to
all parties to be indemnified pursuant thereto, which provisions and
procedures shall be normal and customary in the investment banking and/or
financial services industry; provided, however, that EXEL shall not be
required to provide indemnification to any Person beyond the scope of its
indemnity in Section 7(b) hereof; (v) deliver such documents and
certificates as may be reasonably requested by EXEL and the managing
underwriter or underwriters, if any, to evidence compliance with Section
5(k) above and with any customary conditions contained in the underwriting
agreement or other agreement entered into by the Company; and (vi) cause
its directors and management to participate in such
-7-
<PAGE>
"roadshows" or other sales presentations as may be reasonably requested by
EXEL or the managing underwriter or underwriters, if any. Each of the
above shall be done at or before each closing under such underwriting or
similar agreement or as and to the extent required thereunder or
otherwise; and
(m) otherwise use its best efforts to comply with all applicable
rules and regulations of the SEC, and make generally available to holders
of Common Stock covered by a Registration Statement, earnings statements
satisfying the provisions of Section 11(a) of the Securities Act, no later
than 45 days after the end of any 12-month period (or 90 days, if such
period is a fiscal year): (1) commencing at the end of any fiscal quarter
in which Common Stock covered by a Registration Statement is sold to
underwriters in a firm or best efforts underwritten offering, or (2) if
not sold to underwriters in such an offering, beginning with the first
month of the Company's first fiscal quarter commencing after the effective
date of the Registration Statement, which statements shall cover said
12-months periods.
The Company may require EXEL to furnish to the Company such information
regarding the distribution of such securities as the Company may from time to
time reasonably request in writing, and the Company may exclude from the
registration the Common Stock of EXEL if it fails to furnish such information
within a reasonable time after receiving such request.
EXEL agrees that, upon receipt of any notice from the Company of the
happening of any event of the kind described in Section 5(c)(iii), 5(c)(v) or
5(c)(vi) hereof, EXEL will discontinue disposition of Common Stock as promptly
as practicable following receipt of such notice until EXEL receives copies of
the supplemented or amended Prospectus contemplated by Section 5(k) hereof, or
until EXEL is advised in writing by the Company that the use of the Prospectus
may be resumed, and has received copies of any additional or supplemental
filings which are incorporated by reference in the Prospectus, and, if so
directed by the Company, EXEL will deliver to the Company all copies, other than
permanent file copies then in EXEL's possession, of the Prospectus covering such
Common Stock at the time of receipt of such notice.
Section 6. Registration Expenses.
(a) Except as set forth in Section 6(c) hereof, all expenses
incident to the Company's performance of or compliance with this Agreement
pursuant to any Piggyback Registration, including, without limitation all:
(i) registration and filing fees, including fees and expenses associated
with filings required to be made with a national securities exchange or
national computerized market system, (ii) fees and expenses of compliance
with state securities or blue sky laws (including reasonable fees and
disbursements of counsel for underwriters in connection with blue sky
qualifications of the Common Stock covered by the Registration Statement
and determination of eligibility for investment under the laws of such
jurisdictions designated by the managing underwriter or underwriters, if
any), (iii) printing expenses (including expenses of printing certificates
for the Common Stock covered by the Registration Statement in a form
eligible for deposit with Depositary Trust Company and of printing
prospectuses), (iv) fees and disbursements of counsel for the Company, of
all
-8-
<PAGE>
independent public accountants of the Company (including the expenses of
any special audit and "cold comfort" letters required by or incident to
such performance), and of all underwriters, and (v) fees and expenses of
other Persons retained by the Company shall be borne by the Company,
regardless of whether the Registration Statement becomes effective. In
addition to the expenses set forth in Section 6(c), all expenses incident
to the Company's performance of or compliance with this Agreement pursuant
to any Demand Registration including, without limitation, the expenses
described in the first sentence of this Section 6(a) (other than the fees
and disbursements of all independent public accountants of the Company,
which shall be born by the Company) shall be borne by EXEL, whether or not
the Registration Statement becomes effective.
(b) The Company shall, under either a Piggyback or Demand
Registration, pay its internal expenses (including, without limitation,
all salaries and expenses of its officers and employees performing legal
or accounting duties), the expense of any annual audit, rating agency
fees, and the fees and expenses of any Person (other than legal counsel),
including special experts, retained by the Company.
(c) EXEL shall bear the following expenses in connection with any
Demand or Piggyback Registration, regardless or whether the Registration
Statement becomes effective: (i) all discounts, commissions, or fees of
underwriters, selling brokers, dealer managers, or similar securities
industry professionals relating to the distribution of the Common Stock of
EXEL, (ii) all legal and accounting fees and expenses of EXEL and (3) all
taxes of EXEL.
Section 7. Indemnification.
(a) Indemnification by the Company. The Company agrees to indemnify
and hold harmless, to the full extent permitted by law, EXEL, its
officers, directors, and employees, and each Person who controls EXEL
(within the meaning of Section 15 of the Securities Act), from and against
all losses, claims, damages, liabilities, and reasonable expenses arising
out of or based upon any untrue or alleged untrue statement of a material
fact contained in any Registration Statement, Prospectus or preliminary
Prospectus or any omission or alleged omission to state therein a material
fact required to be stated therein or necessary to make the statements
therein not misleading, except insofar as the same are caused by or
contained in any information furnished to the Company in writing by EXEL
or any other holder of Common Stock expressly for use therein; provided,
however, that the Company shall not be liable in any such case to the
extent that any such loss, claim, damage, liability, or expense of EXEL
arises out of or is based upon an untrue statement or alleged untrue
statement or omission or alleged omission made in any such preliminary
Prospectus, if: (1) EXEL or its agents failed to deliver a copy of the
Prospectus to the Person asserting such loss, claim, damage, liability, or
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<PAGE>
expense after the Company had furnished EXEL with a sufficient number of
copies of the same, and (2) the Prospectus corrected such untrue statement
or omission; and provided further that the Company shall not be liable in
any such case to the extent that any such loss, claim, damage, liability,
or expense arises out of or is based upon an untrue statement or alleged
untrue statement or omission or alleged omission in the Prospectus, if
such untrue statement or alleged untrue statement or omission or alleged
omission is corrected in an amendment or supplement to the Prospectus and
EXEL or its agents thereafter fails to deliver such Prospectus as so
amended or supplemented prior to or concurrently with the sale of the
Common Stock covered by a Registration Statement to the Person asserting
such loss, claim, damage, liability, or expenses after the Company had
furnished EXEL with a sufficient number of copies thereof in a manner and
at a time sufficient to permit delivery of the same. The Company will also
indemnify underwriters, selling brokers, dealer managers, and similar
securities industry professionals participating in the distribution, their
officers and directors, and each Person who controls such Persons (within
the meaning of Section 15 of the Securities Act), to the same extent as
provided above with respect to the indemnification of EXEL, if requested.
(b) Indemnification by EXEL. In connection with each Demand and
Piggyback Registration hereunder, EXEL shall furnish to the Company in
writing such information and affidavits as the Company reasonably requests
for use in connection with any Registration Statement or Prospectus, and
agrees to indemnify and hold harmless, to the full extent permitted by
law, the Company, its officers, directors, and employees, and each Person
who directly or indirectly controls the Company (within the meaning of
Section 15 of the Securities Act), from and against any losses, claims,
damages, liabilities, and reasonable expenses resulting from any untrue
statement of a material fact or any omission of a material fact required
to be stated in the Registration Statement or Prospectus or preliminary
Prospectus or necessary to make the statements therein not misleading, to
the extent, but only to the extent, that such untrue statement or omission
is contained in any information or affidavit so furnished by EXEL in
writing to the Company specifically for inclusion in such Registration
Statement or Prospectus. The Company shall be entitled to receive
indemnities from underwriters, selling brokers, dealer managers, and
similar securities industry professionals participating in the
distribution, to the same extent as provided above with respect to
information so furnished in writing by such Persons specifically for
inclusion in any Prospectus or Registration Statement.
(c) Conduct of Indemnification Proceedings. Any Person entitled to
indemnification hereunder shall: (i) give prompt written notice to the
indemnifying party of any written claim with respect to which it seeks
indemnification, and (ii) permit such indemnifying party to assume the
defense of such claim with counsel reasonably satisfactory to the
indemnified party; provided, however, that any Person entitled to
indemnification hereunder shall have the right to employ separate counsel
and to participate in the defense of such claim, but the fees and expenses
of such counsel shall be at the expense of such Person unless: (x) the
indemnifying party has agreed in writing to pay such fees or expenses, or
(y) the indemnifying party shall have failed to assume the defense of such
claim and employ counsel reasonably satisfactory to such Person, or (z) in
the reasonable judgment of any such Person, based upon written advice of
its counsel, a conflict of interest may exist between such Person and the
-10-
<PAGE>
indemnifying party with respect to such claims (in which case, if the
Person notifies the indemnifying party in writing that such Person elects
to employ separate counsel at the expense of the indemnifying party, the
indemnifying party shall not have the right to assume the defense of such
claim on behalf of such Person). If such defense is not assumed by the
indemnifying party, the indemnifying party will not be subject to any
liability for any settlement made without its consent (but such consent
will not be unreasonably withheld). No indemnifying party based on written
advise of counsel will be required to consent to entry of any judgment or
enter into any settlement which does not include as an unconditional term
thereof the giving by the claimant or plaintiff to such indemnified party
of a release from all liability in respect to such claim or litigation. An
indemnifying party who is not entitled to, or elects not to, assume the
defense of a claim will not be obligated to pay the fees and expenses of
more than one counsel (together with appropriate local counsel) for all
parties indemnified by such indemnifying party with respect to such claim,
unless in the reasonable judgment of any indemnified party, based upon
written advice of counsel, a conflict of interest may exist between such
indemnified parties with respect to such claim, in which event the
indemnifying party shall be obligated to pay the fees and expenses of such
additional counsel or counsels.
(d) Contribution. If for any reason the indemnification provided for
in the preceding Sections 7(a) and 7(b) is unavailable to an indemnified
party or insufficient to hold it harmless as contemplated by the preceding
Sections 7(a) and 7(b), then the indemnifying party shall contribute to
the amount paid or payable by the indemnified party as a result of such
loss, claim, damage or liability in such proportion as is appropriate to
reflect not only the relative benefits received by the indemnified party
and the indemnifying party, but also the relative fault of the indemnified
party and the indemnifying party, as well as any other relevant equitable
considerations. No Person guilty of fraudulent misrepresentation (within
the meaning of Section 11(f) of the Securities Act) shall be entitled to
contribution from any Person who was not guilty of such fraudulent
misrepresentation.
Section 8. Participation in Underwritten Registrations.
(a) If any of the Common Stock covered by a Registration Statement
is to be sold in an underwritten offering, the investment banker or
investment bankers and manager or managers that will administer the
offering will be selected by EXEL in the case of a Demand Registration and
otherwise will be selected by the Company.
(b) No Person may participate in any underwritten registration
hereunder unless such Person: (i) agrees to sell such Person's Common
Stock on the basis provided in any underwriting arrangements approved by
the Persons entitled hereunder to approve such arrangements, and (ii)
completes and executes all questionnaires, powers of attorney,
indemnities, underwriting agreement, and other documents required under
the terms of such underwriting arrangements. Nothing in this Section 8
shall be construed to create any additional rights
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<PAGE>
regarding the registration of Common Stock in any Person otherwise than as
set forth herein.
Section 9. Termination. The rights and performance of all the obligations
under this Agreement shall automatically terminate upon the later to occur of
(i) the sale of all Common Stock owned by the EXEL, and (2) termination of the
FSAI Shareholders Agreement in accordance with its terms.
Section 10. Amendments and Waivers. This Agreement may be amended or
modified at any time upon the agreement of the Company and EXEL by an instrument
in writing executed by each such party. In addition, any party may, at its
option, by an instrument in writing, waive or extend the time for the
fulfillment of any condition herein contained to be fulfilled for the benefit of
such party. Waiver by any party of any breach or failure to comply with any
provision of this Agreement by another party shall not be construed as, or
constitute, a continuing waiver of such provisions, or a waiver of any other
breach of or failure to comply with any other provisions of this Agreement.
Section 11. Secretary to Retain Copy. A copy of this Agreement, including
all Exhibits hereto, shall be filed with the Secretary of the Company and the
Secretary shall make it available to EXEL upon request at all reasonable times
during normal business hours.
Section 12. Choice of Law and Forum and Service of Process.
(a) This Agreement shall be governed by and construed in accordance
with New York law, without regard to principles of conflicts of law.
(b) To the extent that an action is required to further, or
otherwise is not inconsistent with, arbitration pursuant to Section 13
hereof, each party hereby irrevocably submits to the exclusive
jurisdiction of any state or federal court of general jurisdiction sitting
in New York, New York, over any action or proceeding arising out of or
relating to this Agreement, and each party hereby irrevocably agrees that
all claims in respect of such action or proceeding may be heard and
determined in such court, except that actions or proceedings to collect on
judgments issued by a New York court may be brought in any jurisdiction
where the losing party has assets. Each party hereby irrevocably waives
the defense of an inconvenient forum to the maintenance of such action or
proceeding. Each party hereby irrevocably waives, to the fullest extent it
may effectively do so, any right to trial by jury of an action or
proceeding arising out of or relating to this Agreement.
(c) Each party hereby agrees that process in any action or
proceeding may be served by registered mail, return receipt requested, or
in any other manner permitted by the rules of the court in which the
action or proceeding may be brought.
Section 13. Arbitration. Except as provided in Section 13(e) below, any
dispute, controversy or claim arising out of or relating to this Agreement or to
any actual or alleged breach, cancellation, termination or invalidity of this
Agreement shall be finally and fully
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<PAGE>
determined in New York, New York, by a Board composed of three arbitrators to be
selected for each controversy as follows:
(a) Any party (a "Party") to an arbitration proceeding hereunder
may, in the event of a dispute, controversy or claim, notify the other
Party or Parties to such dispute, controversy or claim of its desire to
arbitrate the matter, and at the time of such notification the Party
desiring arbitration shall notify any other Party or Parties of the name
of the arbitrator selected by it. The other Party or Parties who has been
so notified shall within forty-five (45) calendar days thereafter select
an arbitrator and notify the Party desiring arbitration of the name of
such second arbitrator. If the Party or Parties notified of a desire for
arbitration shall fail or refuse to nominate the second arbitrator within
forty-five (45) calendar days following the receipt of such notification,
the Party who first served notice of a desire to arbitrate may, within a
period of thirty (30) calendar days following the expiration of such
forty-five (45) day period, apply to a judge of the Supreme Court of the
State of New York for the appointment of a second arbitrator and in such a
case the arbitrator appointed by such a judge shall be deemed to have been
nominated by the Party or Parties who failed to select the second
arbitrator. The two arbitrators, chosen as above provided, shall within
thirty (30) calendar days after the appointment of the second arbitrator
choose a third arbitrator. In the event of the failure of the first two
arbitrators to agree on a third arbitrator within said thirty (30)
calendar day period, either of the Parties may within a period of thirty
(30) calendar days thereafter, after notice to the other Party or Parties,
apply to a judge of the Supreme Court of the State of New York for the
appointment of a third arbitrator and in such case the person so appointed
shall be deemed and shall act as the third arbitrator. Upon acceptance of
the appointment by said third arbitrator, the Board of Arbitration for the
controversy in question shall be deemed fixed. Each arbitrator selected to
serve on the Board of Arbitration shall be an active or retired executive
officer of an insurance or a reinsurance company having no direct or
indirect financial interest in either party or its affiliates and
otherwise free of any actual or potential conflict of interest that might
reasonably prevent such person from acting in a judicious and impartial
manner. All claims, demands, denials of claims and notices pursuant to
this Article shall be given to the addresses of the Parties set forth in
Annex II of the Share Purchase Agreement.
(b) The Board of Arbitration shall fix, by a notice in writing to
the Parties, a reasonable time and place for the hearing and shall follow
the rules and regulations governing the course and conduct of an
arbitration proceeding under the rules of the American Arbitration
Association or its successor organization, including discovery by the
Parties.
(c) The Board of Arbitration shall, within ninety (90) calendar days
following the conclusion of the hearing, render its decision on the matter
or matters in controversy in writing and shall cause a copy thereof to be
served on the Parties thereto. In case the Board of Arbitration fails to
reach a unanimous decision, the decision of the majority of the members of
the Board of Arbitration shall be deemed to be the decision of the Board
of Arbitration and the same shall
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<PAGE>
be final and binding on the Parties thereto. Such decision shall be a
complete defense to any attempted appeal or litigation of such decision in
the absence of serious irregularity. Without limiting the foregoing, the
Parties waive any right to appeal to, and/or seek collateral review of the
decision of the Board of Arbitration by, any court or other body to the
fullest extent permitted by applicable law, including, without limitation,
application or appeal under applicable law.
(d) Any order as to the costs of the arbitration shall be in the
sole discretion of the Board of Arbitration, who may direct to whom and by
whom and in what manner they shall be paid. The Board of Arbitration shall
have no power or authority to order the payment of punitive damages.
(e) Nothing in this Section 13 shall preclude a Party from seeking
an injunction, specific performance or other equitable remedy from any
court of competent jurisdiction.
Section 14. Assignment. Neither this Agreement nor any of the rights,
interests or obligations hereunder shall be assigned by any of the parties
hereto without the prior written consent of the other parties, except by
operation of law; provided, however, that EXEL may assign this Agreement to any
of its direct or indirect subsidiaries without the consent of the Company.
Subject to the preceding sentence, this Agreement will be binding upon, and will
inure to the benefit of and be enforceable by, the parties and their respective
successors and assigns.
Section 15. Notices. All notices and other communications provided for or
permitted hereunder shall be made in writing by hand-delivery, registered
first-class mail, telex, telecopier, or air courier guaranteeing overnight
delivery:
(i) If to the Company:
350 Park Avenue
New York, New York 10022
U.S.A.
Attention: General Counsel
fax: 212-339-0849
(ii) If to EXEL:
Cumberland House
1 Victoria Street
Hamilton HM11, Bermuda
Attention: General Counsel
fax: 441-292-5850
All such notices and communications shall be deemed to have been duly given upon
receipt.
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<PAGE>
Section 16. No Third-Party Beneficiaries. This Agreement is for the
exclusive benefit of the parties hereto and is not intended to confer upon any
other Person any rights or remedies hereunder.
Section 17. Entire Agreement. This Agreement is intended by the parties as
a final expression of their agreement and intended to be a complete and
exclusive statement of the agreement and understanding of the parties hereto in
respect of the subject matter contained herein. There are no restrictions,
promises, warranties, or undertakings, other than those set forth or referred to
herein, with respect to the registration rights granted by the Company with
respect to the Common Stock. This Agreement supersedes all prior agreements and
understandings between the parties with respect to such subject matter.
Section 18. Headings. The headings in this Agreement are for convenience
of reference only and shall not limit or otherwise affect the meaning of any of
the terms or provisions hereof.
Section 19. Counterparts. This Agreement may be executed in any number of
counterparts, each of which shall be deemed to be an original, and all of which,
when taken together, shall constitute one and the same agreement.
Section 20. Severability. If any provision of this Agreement or the
application thereof to any person or circumstances is determined by a court of
competent jurisdiction to be invalid, void or unenforceable, the remaining
provisions hereof, or the application of such provision to persons or
circumstances other than those as to which it has been held invalid or
unenforceable, shall remain in full force and effect and shall in no way be
affected, impaired or invalidated thereby, so long as the economic legal
substance of the transactions contemplated hereby is not affected in any manner
adverse to any party. Upon such determination, the parties shall negotiate in
good faith in an effort to agree upon a suitable and equitable substitute
provision to effect the original intent of the parties.
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<PAGE>
IN WITNESS WHEREOF, the parties have caused this Agreement to be duly
executed and delivered, all of the first data first above written.
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
By: /s/ Bruce E. Stern
--------------------------------------
Name: Bruce E. Stern
Title: Managing Director
EXEL LIMITED
By: /s/ Robert R. Lusardi
--------------------------------------
Name: Robert R. Lusardi
Title: Executive Vice President and
Chief Financial Officer
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<PAGE>
EXHIBIT A
TO REGISTRATION RIGHTS AGREEMENT
DEFINITIONS
"Business Day" means any day on which commercial banks are open for
business in New York, New York.
"Common Stock" means the Common Stock, par value $.01 per share, of the
Company listed on the New York Stock Exchange and any securities listed in
respect thereof, or in a substitution therefor, in connection with any stock
split, dividend, combination, or any reclassification, recapitilization, merger,
consolidation, exchange or other similar reorganization.
"Demand Registration" has the meaning provided in Section 2 hereof.
"Exchange Act" means the Securities Exchange Act of 1934 amended, and the
rules and regulations promulgated thereunder.
"Person" means and individual, partnership, corporation, trust or
unincorporated organization, or a government or agency or political subdivision
thereof or other entity.
"Piggyback Registration" has the meaning provided in Section 3 hereof.
"Prospectus" means the prospectus included in any Registration Statement,
as amended or supplemented by any prospectus supplement with respect to the
terms of the offering of any portion of the Common Stock covered by such
Registration Statement and by all other amendments and supplements to the
prospectus, including post-effective amendments and all material incorporated by
reference in such prospectus.
"Registration Expenses" means the expenses of registration described in
Section 6 hereof.
"Registration Statement" means any registration statement of the Company
that covers any of Common Stock pursuant to the provisions of this Agreement,
including the Prospectus, amendments and supplement to such Registration
Statement, including post-effective amendments, all exhibits and all material
incorporated by reference in such Registration Statement.
"SEC" means the United States Securities and Exchange Commission.
"Securities Act" means the Securities Act of 1933, as amended, and the
rules and regulations promulgated thereunder.
"Underwritten Registration" or "Underwritten Offering" means a
registration in which securities of the Company are sold to an underwriter for
reoffering to the public.
-A-1-
Exhibit 13
[Page 16 of the 1998 Annual Report to Shareholders]
Five-Year Financial Summary
<TABLE>
<CAPTION>
Dollars in millions, except per
share data 1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C>
Summary of Operations (a)
Gross premiums written $319.3 $236.4 $177.0 $110.7 $106.4
Net premiums written 219.9 172.9 121.0 77.6 77.8
Net premiums earned 137.9 109.5 90.4 69.3 65.8
Net investment income 78.8 72.1 65.1 49.0 46.6
Net income (loss) 117.0 100.5 80.8(b) 55.0 60.4
Balance Sheet Data (a)
Total investments 1,874.8 1,431.6 1,154.4 1,110.7 747.2
Total assets 2,405.5 1,900.6 1,537.7 1,490.3 1,074.3
Deferred premium revenue, net 504.6 422.1 360.0 330.3 212.9
Loss and loss adjustment expense
reserve, net 60.0 44.8 42.2 50.2 35.6
Notes payable 230.0 130.0 30.0 30.0 --
Preferred stock 0.7 0.7 0.7 0.7 0.7
Common stockholders' equity 1,072.7 881.7 800.6 777.2 544.7
Per Common Share Data (a)
Earnings (loss) per share (c) 3.82 3.25 2.61 2.13 2.32
Book value per share 35.87 30.66 26.71 24.67 20.92
Dividends paid 0.44 0.41 0.35 0.32 0.16
Additional Data
Qualified statutory capital 1,037.7 781.7 675.9 644.7 465.8
Total claims-paying resources (d) 2,119.6 1,696.1 1,372.3 1,157.1 821.8
Net par outstanding 104,673.0 75,478.0 59,194.0 45,979.0 28,223.0
Net insurance in force
(principal + interest) 159,995.0 117,430.0 93,704.0 75,360.0 45,825.0
Policyholders' leverage
(risk-to-capital ratio) 154:1 150:1 139:1 117:1 98:1
</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 with Capital Guaranty
Corporation.
(c) Represents diluted earnings per share.
(d) Statutory capital + statutory unearned premium reserve + present value of
future net installment premiums + statutory loss reserve + standby line of
credit facility.
<PAGE>
[Page 18 of the 1998 Annual Report to Shareholders]
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Results of Operations
Year Ended December 31, 1998 versus Year Ended December 31, 1997
Adjusted book value per common share of Financial Security Assurance Holdings
Ltd. (the Company) was $47.44 at December 31, 1998, up 19.5% including dividends
since year-end 1997. Excluding realized and unrealized capital gains and losses,
adjusted book value per share rose 17.3% 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.
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, the cost of the
performance share program and other non-recurring adjustments. Core net income
therefore represents the Company's normal operating results on a basis
comparable to that of its industry peers. 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, the cost of the
performance share program and other non-recurring adjustments, if any.
The Company reports core, operating and reported net income per share results in
accordance with SFAS No. 128, which the Company adopted on December 31, 1997.
The standard defines "basic" and "diluted" earnings per share. Basic earnings
per share is based on average basic shares outstanding, which is calculated by
adding shares earned but not issued under the Company's equity bonus and
performance share programs to the average common shares outstanding. Diluted
earnings per share is based on average diluted shares outstanding, which is
calculated by adding shares contingently issuable under stock options, the
performance share program and the Company's convertible preferred stock to the
average basic shares outstanding. Unless otherwise indicated, all earnings per
share results are diluted, and results reported in prior periods have been
restated accordingly.
The Company's 1998 net income was $117.0 million ($3.82 per share), compared
with $100.5 million ($3.25 per share) for 1997, an increase of 16.4%. Core net
income was $107.5 million ($3.51 per share) for 1998, compared with $90.7
million ($2.93 per share) for 1997, an increase of 18.5%. Total core revenues
increased in 1998 by $29.8 million, from $171.6 million for 1997 to $201.4
million for 1998, while total core expenses increased only $7.6 million.
Operating net income was $114.9 million ($3.76 per share) for 1998 versus $95.9
million ($3.10 per share) for 1997, an increase of $19.0 million, or 19.8%.
The Company employs 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,
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 portion of the Company's
premiums is 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
premium payments. For all years prior to 1998, the Company used a fixed discount
rate of 9.5%. At the beginning of 1998, the Company
<PAGE>
[Page 19 of the 1998 Annual Report to Shareholders]
began calculating the discount rate as the average pre-tax yield on its
investment portfolio for the previous three years. This rate for 1998 was 6.31%.
Management intends to revise the discount rate in future years according to the
same formula, in order to reflect interest rates more accurately.
The Company's principal operating subsidiary, Financial Security Assurance Inc.
(FSA), benefited in 1998 from growth of its core markets and a flight to quality
created by volatility in worldwide capital markets. As credit spreads widened
for securities at all levels in the credit spectrum, the value of FSA's guaranty
increased, and the Company was able to increase production volume significantly
while maintaining pricing and underwriting standards. Business was well balanced
across U.S. municipal and asset-backed markets. International activity was
limited during 1998 because the Company found relatively few opportunities with
returns on equity and risk profiles meeting FSA standards.
Gross PV premiums written increased 56.3% to $391.2 million for 1998 from $250.3
million for 1997. (Without the discount rate revision, gross PV premiums written
would have been $379.9 million, an increase of 51.8%.) In 1998, the Company
insured $58.6 billion par value of bonds, a 58.2% increase over par insured in
1997.
Asset-backed market conditions were favorable. Securitization volume was strong,
credit spreads widened, and competition from uninsured executions decreased as
demand fell for subordinated debt and residuals. As a result, FSA found a larger
number of appropriate transactions to guarantee and was able to expand its
product lines. In addition to maintaining strong production in the consumer and
residential mortgage finance sectors, FSA significantly increased its volume of
structured financings, such as collateralized debt obligations. Asset-backed
gross PV premiums written were $162.7 million in 1998, compared with $111.0
million in 1997, an increase of 46.6%. FSA's asset-backed par insured increased
20.8% to $23.5 billion.
FSA also increased its municipal bond insurance volume, returns and market
share, aided by higher market volume for new municipal bonds, increased market
penetration by bond insurance and strong trading value for FSA-insured bonds.
For the municipal business, gross PV premiums written increased to $228.5
million for 1998 from $139.3 million for 1997, an increase of 64.1%. FSA's
municipal par insured increased 99.6% to $35.1 billion. Municipal par increased
more than municipal PV premiums written because of a reduction in international
transactions, which generally have high premium rates, and a decrease in the
average lives of domestic general obligations. In addition, the capital charges
assigned by Standard & Poor's to measure risk in FSA's municipal transactions,
which began the year at the lowest level of risk in the industry, decreased
further during the year because of the higher quality of the new business
insured.
FSA's gross premiums written increased 35.1% to $319.3 million for 1998 from
$236.4 million for 1997. Net premiums written were $219.9 million during 1998,
an increase of 27.2% when compared with the 1997 result. Gross premiums written
grew at a faster pace than net premiums written due to the Company's greater use
of reinsurance to expand capacity for large transactions and certain successful
securitization programs. Reinsurance cessions totaled 31.1% of 1998 gross
premiums written, compared with 26.9% in 1997. Net premiums earned in 1998 were
$137.9 million, compared with $109.5 million in 1997, an increase of 25.9%.
Premiums earned from refundings and prepayments were $15.8 million for 1998 and
$11.3 million for 1997, contributing $7.4 million and $5.2 million,
respectively, to after-tax earnings. Before the effects of refundings and
prepayments, net premiums earned grew 24.3% over the comparable 1997 result. No
assurance can be given that refundings and prepayments will continue at the
level experienced in 1998 or 1997.
Net investment income was $78.8 million for 1998 and $72.1 million for 1997, an
increase of 9.3%. This increase was due primarily to higher invested balances as
a result of new business writings and proceeds from debt issued in the fourth
quarter of 1998. The Company's effective tax rate on investment income was 17.6%
for 1998, compared with 19.9% for 1997. In 1998, the Company realized $20.9
million in net capital gains, compared with $11.5 million in 1997. Capital
<PAGE>
[Page 20 of the 1998 Annual Report to Shareholders]
gains and losses are a by-product of the normal investment management process
and will vary substantially from period to period.
Other income was $0.5 million for 1998, compared with $9.3 million for 1997.
Other income in 1997 was largely due to the sale of two insurance subsidiaries
to realize the value of their redundant insurance licenses. All of the
subsidiaries' insurance policy obligations were assumed by FSA.
Interest expense in 1998 was $10.6 million, an increase of $6.2 million when
compared with 1997 results. The increase was due to the Company's increase in
debt outstanding. For further discussion, see Liquidity and Capital Resources
below.
The provision for losses and loss adjustment expenses in 1998 was $4.0 million,
compared with $9.2 million in 1997, representing additions to the Company's
general reserve. During 1998, the Company transferred $18.4 million to its
general reserve from case basis reserves due to recoveries on certain commercial
mortgage transactions. This recovery allowed for a decrease of $4.1 million in
the amount needed to fund the general reserve for originations of new business
in 1998. Also during 1998, the Company transferred $9.4 million from its general
reserve to case basis reserves due primarily to anticipated claims on two
sub-prime auto loan programs. The additions to the general reserve represent
management's estimate of the amount required to cover the present value of the
net cost of claims adequately. The Company will, on an ongoing basis, monitor
these reserves and may periodically adjust such reserves, upward or downward,
based on the Company's actual loss experience, its future mix of business, and
future economic conditions. At December 31, 1998, the Company's general reserve
was $47.3 million.
Total policy acquisition and other operating expenses (excluding the cost of the
performance share program, which was $17.4 million for 1998 and $11.5 million
for 1997, and interest expense) were $45.6 million in 1998, compared with $38.0
million in 1997, an increase of $7.6 million. Further excluding the effect of
refundings, total policy acquisition and other operating expenses were $41.2
million in 1998, compared with $34.7 million in 1997, an increase of $6.5
million. The increase resulted from greater amortization of deferred acquisition
costs due to a higher level of core premiums earned, along with higher personnel
costs. The Company's core expense ratio fell to 33.8% from 35.3% in 1997.
Income before income taxes for 1998 was $159.7 million, up 15.3% from $138.5
million for 1997.
The Company's effective tax rate for 1998 was 26.8%, compared with 27.4% for
1997.
The weighted average number of diluted shares of common stock outstanding
decreased from 30,913,000 for 1997 to 30,599,000 for 1998. This decrease was
primarily due to stock repurchases by the Company to fund obligations under
employee benefit plans, partially offset by an increase in the dilutive effect
of the Company's convertible preferred stock and shares unissued or contingently
issuable for employee benefit plans.
Market Risk
The main objective in managing the Company's investment portfolio is to maximize
the total return while minimizing investment credit risks. Investment strategies
are based on many factors, including the Company's tax position, fluctuation in
interest rates, regulatory and rating agency criteria and other market factors.
Investment decisions are carried out by one internal investment manager and
three external investment managers for the fixed-income investments and four
external managers for the equity portfolio. These investment decisions are based
on guidelines established by management and approved by the board of directors.
Market risk represents the potential for loss due to adverse changes in the fair
value of financial instruments. The market risks related to financial
instruments of the Company relate primarily to its investment portfolio, of
which 91% is invested in fixed-income securities. Changes in interest rates
affect the value of the Company's fixed-income portfolio. As interest rates
rise, the fair value of fixed-income securities decreases. Sensitivity to
interest rate movements can be estimated by projecting a hypothetical increase
in interest rates of 1.0%. Based on market values and
<PAGE>
[Page 21 of the 1998 Annual Report to Shareholders]
interest rates at year-end 1998, this hypothetical increase in interest rates
would result in an after-tax decrease of $73.4 million in the net fair value of
the Company's fixed-income portfolio. Since the Company is able to hold these
investments to maturity, absent an unusually large demand for funds, it does not
expect to recognize any material adverse impact to income or cash flows under
the above scenario.
The Company's investment portfolio holdings are primarily U.S.
dollar-denominated fixed-income securities, including municipal bonds, U.S.
government bonds, and mortgage-backed, asset-backed and corporate securities. In
calculating the sensitivity to interest rates for the taxable securities, U.S.
Treasury rates are changed instantaneously by 1.0%, and the option-adjusted
spreads of the securities are held constant. Tax-exempt securities are subjected
to a change in the Municipal Triple-A Obligation curve that would be equivalent
to a 1.0% taxable interest rate change based on year-end taxable/tax-exempt
ratios. The simulation for tax-exempts calculates duration by taking into
account the applicable call date if the bond is at a premium or the maturity
date if the bond is at a discount.
Year 2000 Readiness Disclosure
The Company established its Year 2000 (Y2K) committee in 1997. The committee has
investigated potential effects on FSA of the Y2K problem arising from the
inability of some computers to properly recognize dates in the year 2000 and
later. The Company has examined its hardware, software, network and customer and
vendor interdependencies in FSA's information systems and has found no material
problems with any mission-critical FSA systems. It has conducted appropriate
tests on its larger hardware and networking components, personal computers and
material systems software, and all such systems are considered to be Y2K
compliant. By mid-1999, the Company expects to have completed verification of
Y2K compliance with outside vendors from which the Company purchases software.
These are generally large vendors with active Y2K programs. The cost of the
Company's Y2K compliance has been immaterial.
FSA's financial guaranty policies do not contain an exclusion for Y2K problems.
Each guaranty policy is customized for its individual transaction, so the actual
policy and other transaction documents should be consulted regarding questions
about the effect of Y2K problems of specific parties on specific policies. For
example, if an issuer fails to make an insured payment due to a Y2K problem,
FSA's insurance policy generally would cover such failure. On the other hand, if
the issuer made the payment and the trustee failed to distribute it to
bondholders due to a Y2K problem, FSA's insurance policy generally would not
cover such failure. To investigate whether certain entities connected with
transactions it insures have Y2K problems that could affect insured payments,
FSA has surveyed the servicers and trustees for FSA-insured asset-backed
transactions and has also surveyed certain companies that operate in a trustee,
paying agent or securities depository capacity for a large component of FSA's
public finance book of business. Responses to date have generally indicated
active Y2K testing and remediation programs. FSA plans to query the companies
again in 1999 to measure their progress. FSA provides additional information
about its Y2K compliance program on its website at www.fsa.com/y2k.
Year Ended December 31, 1997 versus Year Ended December 31, 1996
The Company's 1997 net income was $100.5 million ($3.25 per share), compared
with $80.8 million ($2.61 per share) for 1996, an increase of 24.4%. Core net
income was $90.7 million ($2.93 per share) for 1997, compared with $78.4 million
($2.54 per share) for 1996, an increase of 15.7%. Total core revenues increased
in 1997 by $26.1 million, from $145.5 million for 1996 to $171.6 million for
1997, while total core expenses increased only $8.8 million. Operating net
income was $95.9 million ($3.10 per share) for 1997 versus $82.2 million ($2.66
per share) for 1996, an increase of $13.7 million, or 16.7%.
The markets in which FSA participates expanded during 1997, and FSA's own
production was well balanced across those markets. Gross premiums written
increased 33.6% to $236.4 million for 1997 from $177.0 million for 1996. Gross
PV premiums written increased 10.6% to $250.3 million for 1997 from $226.3
million for 1996. In 1997, asset-backed gross PV premiums written were $111.0
million, compared with $125.8 million in 1996, a decrease of 11.8%. This
decrease was attributable to several large, high-premium transactions executed
in the pooled corporate obligations sector in 1996. Volume from FSA-insured
consumer and residential mortgage securiti-
<PAGE>
[Page 22 of the 1998 Annual Report to Shareholders]
zation programs remained strong during 1997, although FSA avoided certain
residential mortgage sectors where returns or credit characteristics were
unattractive. In addition, FSA guaranteed a number of profitable pooled
corporate transactions in such areas as collateralized bond obligations,
collateralized loan obligations and trade receivables. For the municipal
business, gross PV premiums written increased to $139.3 million for 1997 from
$100.5 million for 1996, an increase of 38.6% due to higher volume in the
municipal new-issue market, increased market penetration by bond insurance, and
greater market share for FSA aided by strong trading value for FSA-insured
bonds.
In 1997, the Company insured par value of bonds totaling $37.1 billion, a 19.3%
increase over par insured in 1996. FSA's asset-backed component increased 3.0%
to $19.5 billion while its municipal sector increased 44.5% to $17.6 billion.
Net premiums written were $172.9 million during 1997, an increase of 42.9% when
compared with the 1996 result. Net premiums written grew at a faster pace than
gross premiums written due to the Company's efforts to reduce its reinsurance
selectively, ceding 26.9% of its 1997 gross premiums written, compared with
31.6% in 1996. Net premiums earned in 1997 were $109.5 million, compared with
$90.4 million in 1996, an increase of 21.1%. Premiums earned from refundings and
prepayments were $11.3 million for 1997 and $10.3 million for 1996, contributing
$5.2 million and $3.8 million, respectively, to after-tax earnings. Before the
effects of refundings and prepayments, net premiums earned grew 22.5% over the
comparable 1996 result.
Net investment income was $72.1 million for 1997 and $65.1 million for 1996, an
increase of 10.8%. This increase was due primarily to higher invested balances
as a result of new business writings and proceeds from debt issued in the fourth
quarter. The Company's effective tax rate on investment income was 19.9% for
1997, compared with 20.0% for 1996. In 1997, the Company realized $11.5 million
in net capital gains, compared with $3.2 million in 1996. Capital gains and
losses are a by-product of the normal investment management process and will
vary substantially from period to period.
Other income was $9.3 million for 1997, compared with $0.3 million for 1996.
This increase was due to the sales of two insurance subsidiaries, which realized
the value of their redundant insurance licenses. All of the subsidiaries'
insurance policy obligations were assumed by FSA.
Interest expense in 1997 was $4.4 million, an increase of $2.2 million when
compared with the 1996 result. The increase was due to the Company's increase in
debt outstanding. For further discussion, see Liquidity and Capital Resources
below.
The provision for losses and loss adjustment expenses in 1997 was $9.2 million,
compared with $6.9 million in 1996, representing additions to the Company's
general loss reserve. During 1997, the Company transferred $4.5 million from its
general reserve to case basis reserves associated predominantly with certain
residential mortgage transactions. 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. At
December 31, 1997, the Company's general loss reserve was $34.3 million.
Total policy acquisition and other operating expenses (excluding the cost of the
performance share program, which was $11.5 million for 1997 and $5.3 million for
1996, and interest expense) were $38.0 million in 1997, compared with $34.8
million in 1996, an increase of 9.0%. Further excluding the effect of
refundings, total policy acquisition and other operating expenses were $34.7
million in 1997, compared with $30.4 million in 1996, an increase of 14.1%. The
increase resulted from greater amortization of deferred acquisition costs due to
a higher level of core premiums earned, along with higher personnel costs and
bank facility fees.
Income before income taxes for 1997 was $138.5 million, up 26.2% from $109.8
million for 1996.
The Company's effective tax rate for 1997 was 27.4%, compared with 26.4% for
1996.
The weighted average number of diluted shares of common stock outstanding
increased to 30,913,000 for 1997 from 30,895,000 for 1996. This increase was
primarily due to an increase in the dilutive effect of the Company's convertible
preferred stock, partially offset by shares repurchased by the Company to fund
obligations under employee benefit plans and to close out a portion of its
forward purchase arrangement.
<PAGE>
[Page 23 of the 1998 Annual Report to Shareholders]
Liquidity and Capital Resources
The Company's consolidated invested assets and cash equivalents at December 31,
1998, net of unsettled security transactions, were $1,770.6 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 $58.0 million at December 31, 1998, compared with an
unrealized gain position of $38.8 million at December 31, 1997. At December 31,
1998, the Company had, at the holding company level, an investment portfolio of
$59.5 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 its receipt of
dividends from, or payment on convertible surplus notes by, 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 no
dividends in 1998. Based upon FSA's statutory statements for the quarter ended
December 31, 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 $65.7 million. In
addition, the Company holds $120 million of convertible surplus notes of FSA.
Payments of principal or interest on such notes may be made with the approval of
the New York Insurance Department.
In 1998, FSA repurchased $8.5 million of its shares from its parent,
representing the balance remaining of $75.0 million that had been approved for
repurchase by the New York Insurance Department.
Dividends paid by the Company to its shareholders increased to $12.8 million in
1998 from $12.1 million in 1997 and to $0.44 per common share in 1998 from
$0.405 in 1997. In addition to paying dividends, the Company uses funds to make
debt service payments and to repurchase shares of the Company's common stock to
fund employee benefit plans. During 1998, the Company purchased $23.9 million of
its stock for employee benefit plans. During the fourth quarter of 1998, the
Company issued $100.0 million of 6.950% Senior Quarterly Income Debt Securities
due November 1, 2098 and callable on or after November 1, 2003. The proceeds
from this issuance were used to augment the capital in its insurance company
subsidiaries and for general corporate purposes. The Company also has
outstanding $130.0 million of 7.375% Senior Quarterly Income Debt Securities due
September 30, 2097 and callable on or after September 18, 2002. These securities
were issued during 1997.
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 two financial institutions (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 1998 and 1997 were $0.7 million and $2.1 million,
respectively, and were charged to additional paid-in cap-
<PAGE>
[Page 24 of the 1998 Annual Report to Shareholders]
ital. By the fourth quarter of 1997, 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 December 31, 1998, 562,200 Forward Shares remained in the
program. Of these, 33,078 shares were held for the benefit of the Company as a
result of the repurchase of Forward Shares from employees and directors, and
529,122 shares continued to be held for the benefit of employees and directors.
On November 3, 1998, the Company and XL Capital Ltd (XL), which was named EXEL
Limited until February 1999, closed a transaction to create two new
Bermuda-based financial guaranty insurance companies. Each of the new companies
has initially been capitalized with approximately $100 million. One company,
Financial Security Assurance International Ltd., is an indirect subsidiary of
FSA, and the other company, XL Financial Assurance Ltd, is a subsidiary of XL.
The Company has a minority interest in the XL subsidiary, and XL has a minority
interest in the FSA indirect subsidiary. In conjunction with forming the new
companies, the Company and XL swapped $80 million of their respective common
shares, with the Company delivering to XL 1,632,653 common shares out of
treasury. The Company concurrently sold, at no gain or loss, $60 million of the
XL shares to an unrelated third party in order to fund, in part, its investment
in Financial Security Assurance International Ltd.
FSA's primary uses of funds are to pay operating expenses and to pay dividends
to its parent. FSA's funds are also required to satisfy 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 payment 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 by
matching insured payments with available cash flow or other payment sources. 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.
FSA has a credit arrangement, aggregating $150.0 million at December 31, 1998,
that is provided by commercial banks and intended for general application to
transactions insured by FSA and its insurance company subsidiaries. At December
31, 1998, there were no borrowings under this arrangement, which expires on
November 23, 1999, unless extended. 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 $186.9 million, of which
$45.0 million was unutilized at December 31, 1998.
FSA has a standby line of credit commitment in the amount of $240.0 million with
a group of international Aaa/AAA-rated banks 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 $230.0 million or 5.75% of
average annual debt service of the covered portfolio. 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 in the covered portfolio, including certain installment
premiums and other collateral. This commitment has a term beginning on April 30,
1998 and expiring on April 30, 2005 and contains an annual renewal provision
subject to approval by the banks. No amounts have been utilized under this
commitment as of December 31, 1998.
The Company has no plans for material capital expenditures within the next
twelve months.
<PAGE>
[Page 25 of the 1998 Annual Report to Shareholders]
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors
of Financial Security Assurance Holdings Ltd.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows present fairly, in all material respects, the financial position of
Financial Security Assurance Holdings Ltd. and Subsidiaries (the Company) at
December 31, 1998 and 1997, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles. 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 of these statements in accordance with
generally accepted auditing standards which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
By: /S/ PRICEWATERHOUSECOOPERS LLP
------------------------------
PRICEWATERHOUSECOOPERS LLP
New York, New York
January 26, 1999
<PAGE>
[Page 26 of the 1998 Annual Report to Shareholders]
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
December 31, December 31,
ASSETS 1998 1997
----------- -----------
<S> <C> <C>
Bonds at market value (amortized cost of $1,655,042 and $1,230,479) $1,708,040 $1,268,158
Equity investments at market value (cost of $64,292 and $29,430) 68,243 30,539
Short-term investments 98,554 132,931
----------- -----------
Total investments 1,874,837 1,431,628
Cash 3,490 12,475
Deferred acquisition costs 199,559 171,098
Prepaid reinsurance premiums 217,096 173,123
Reinsurance recoverable on unpaid losses 3,907 30,618
Receivable for securities sold 1,655 20,623
Investment in unconsolidated affiliates 29,496 --
Other assets 75,440 61,079
----------- -----------
TOTAL ASSETS $2,405,480 $1,900,644
=========== ===========
LIABILITIES AND MINORITY INTEREST AND SHAREHOLDERS' EQUITY
Deferred premium revenue $721,699 $ 595,196
Losses and loss adjustment expenses 63,947 75,417
Deferred federal income taxes 54,007 56,872
Ceded reinsurance balances payable 31,502 11,199
Payable for securities purchased 105,859 72,979
Notes payable 230,000 130,000
Minority interest 20,388 --
Accrued expenses and other liabilities 104,642 76,621
----------- -----------
TOTAL LIABILITIES AND MINORITY INTEREST 1,332,044 1,018,284
----------- -----------
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 730,567 693,851
Accumulated other comprehensive income (net of deferred income tax
provision of $20,288 and $13,575) 37,678 25,212
Accumulated earnings 335,325 231,124
Deferred equity compensation 43,946 26,181
Less treasury stock at cost (2,372,839 and 3,521,847 shares held) (75,103) (95,031)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY 1,073,436 882,360
----------- -----------
TOTAL LIABILITIES AND MINORITY INTEREST AND
SHAREHOLDERS' EQUITY $2,405,480 $1,900,644
=========== ===========
</TABLE>
The accompanying Notes to Consolidated
Financial Statements are an integral part of these statements.
<PAGE>
[Page 27 of the 1998 Annual Report to Shareholders]
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
REVENUES: 1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net premiums written $219,853 $172,878 $121,000
Increase in deferred premium revenue (81,926) (63,367) (30,552)
--------- --------- ---------
Premiums earned 137,927 109,511 90,448
Net investment income 78,823 72,085 65,064
Net realized gains 20,890 11,522 3,189
Other income 474 9,303 297
--------- --------- ---------
TOTAL REVENUES 238,114 202,421 158,998
--------- --------- ---------
EXPENSES:
Losses and loss adjustment expenses 3,949 9,156 6,874
Policy acquisition costs 35,439 27,962 23,829
Other operating expenses 38,136 26,804 18,524
--------- --------- ---------
TOTAL EXPENSES 77,524 63,922 49,227
--------- --------- ---------
Minority interest and equity in earnings of unconsolidated
affiliates (844) -- --
--------- --------- ---------
INCOME BEFORE INCOME TAXES 159,746 138,499 109,771
--------- --------- ---------
Provision (benefit) for income taxes:
Current 52,346 30,960 27,227
Deferred (9,578) 7,037 1,784
--------- --------- ---------
Total provision 42,768 37,997 29,011
--------- --------- ---------
NET INCOME 116,978 100,502 80,760
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during
period (net of deferred income tax provision
(benefit) of $14,024, $12,701 and $(4,708)) 26,045 23,587 (8,744)
Less: reclassification adjustment for gains included
in net income (net of deferred income tax provision
of $7,311, $4,033 and $1,116) (13,579) (7,489) (2,073)
--------- --------- ---------
Other comprehensive income (loss) 12,466 16,098 (10,817)
--------- --------- ---------
COMPREHENSIVE INCOME $129,444 $116,600 $ 69,943
========= ========= =========
As based upon net income:
Basic earnings per common share $ 4.02 $ 3.35 $ 2.64
========= ========= =========
Diluted earnings per common share $ 3.82 $ 3.25 $ 2.61
========= ========= =========
</TABLE>
The accompanying Notes to Consolidated
Financial Statements are an integral part of these statements.
<PAGE>
[Page 28 of the 1998 Annual Report to Shareholders]
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
Preferred Common Capital - Capital - (Loss) on Accumulated
Stock Stock Preferred Common Investments Earnings
----- ----- --------- ------ ----------- --------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1995 $ 20 $323 $680 $ 696,253 $ 19,931 $ 72,410
Net income for the year 80,760
Net change in accumulated comprehensive
income (net of deferred
income tax benefit of $5,823) (10,817)
Dividends paid on common
stock ($0.35 per share) (10,536)
Deferred equity compensation
Purchase of 1,529,131 shares of
common stock
Other common stock transactions (1,135)
Adjustment to prior-year disposal of
subsidiary 87
------- ---- ---- --------- -------- ---------
BALANCE, December 31, 1996 20 323 680 695,118 9,114 142,721
Net income for the year 100,502
Net change in accumulated comprehensive
income (net of deferred
income taxes of $8,667) 16,098
Dividends paid on common stock
($0.405 per share) (12,099)
Deferred equity compensation
Deferred equity payout 187
Purchase of 162,573 shares of
common stock
Issuance of 125,106 shares of treasury
stock for options exercised 688
Forward share transactions:
Settlements with employees and directors (2,142)
Settlements with counterparties
------- ---- ---- --------- -------- ---------
BALANCE, December 31, 1997 20 323 680 693,851 25,212 231,124
Net income for the year 116,978
Net change in accumulated comprehensive
income (net of deferred
income taxes of $6,713) 12,466
Dividends paid on common stock
($0.44 per share) (12,777)
Deferred equity compensation
Deferred equity payout 750
Purchase of 496,940 shares of
common stock
Issuance of 1,632,653 shares of treasury
stock for XL stock 36,721
Issuance of 13,295 shares of treasury
stock for options exercised (22)
Forward share transactions-settlements
with employees and directors (733)
------- ---- ---- --------- -------- ---------
BALANCE, December 31, 1998 $ 20 $323 $680 $ 730,567 $ 37,678 $ 335,325
======= ==== ==== ========= ======== =========
<CAPTION>
Deferred
Equity Treasury
Compensation Stock Total
------------ ----- -----
<S> <C> <C> <C>
BALANCE, December 31, 1995 $ 6,504 $(18,174) $ 777,947
Net income for the year 80,760
Net change in accumulated comprehensive
income (net of deferred
income tax benefit of $5,823) (10,817)
Dividends paid on common
stock ($0.35 per share) (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)
Adjustment to prior-year disposal of
subsidiary 87
-------- -------- -----------
BALANCE, December 31, 1996 12,069 (58,785) 801,260
Net income for the year 100,502
Net change in accumulated comprehensive
income (net of deferred
income taxes of $8,667) 16,098
Dividends paid on common stock
($0.405 per share) (12,099)
Deferred equity compensation 17,781 17,781
Deferred equity payout (3,287) 56 (3,044)
Purchase of 162,573 shares of
common stock (5,434) (5,434)
Issuance of 125,106 shares of treasury
stock for options exercised (382) 3,042 3,348
Forward share transactions:
Settlements with employees and directors (2,142)
Settlements with counterparties (33,910) (33,910)
-------- -------- -----------
BALANCE, December 31, 1997 26,181 (95,031) 882,360
Net income for the year 116,978
Net change in accumulated comprehensive
income (net of deferred
income taxes of $6,713) 12,466
Dividends paid on common stock
($0.44 per share) (12,777)
Deferred equity compensation 23,970 23,970
Deferred equity payout (6,371) 204 (5,417)
Purchase of 496,940 shares of
common stock (23,907) (23,907)
Issuance of 1,632,653 shares of treasury
stock for XL stock 43,279 80,000
Issuance of 13,295 shares of treasury
stock for options exercised 166 352 496
Forward share transactions-settlements
with employees and directors (733)
-------- -------- -----------
BALANCE, December 31, 1998 $ 43,946 $(75,103) $ 1,073,436
======== ======== ===========
</TABLE>
The accompanying Notes to Consolidated
Financial Statements are an integral part of these statements.
<PAGE>
[Page 29 of the 1998 Annual Report to Shareholders]
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Premiums received, net $ 247,229 $ 171,145 $ 124,540
Policy acquisition and other operating expenses
paid, net (53,306) (43,279) (32,266)
Recoverable advances received (paid) 1,473 (7,629) 10,213
Losses and loss adjustment expenses recovered
(paid) 10,989 (6,463) (15,473)
Net investment income received 70,146 65,662 63,533
Federal income taxes paid (54,020) (19,797) (34,595)
Interest paid (9,614) (5,158) (2,115)
Other (1,623) (2,017) (4,253)
----------- ----------- -----------
Net cash provided by operating activities 211,274 152,464 109,584
----------- ----------- -----------
Cash flows from investing activities:
Proceeds from sales of bonds 1,908,098 1,074,658 1,117,473
Proceeds from sales of equity investments 93,613 3,568 --
Proceeds from maturities of bonds -- 32,468 2,965
Purchases of bonds (2,257,947) (1,229,612) (1,141,688)
Purchases of equity investments (128,475) (24,662) (8,336)
Net gain on sale of subsidiaries -- 7,986 --
Purchases of property and equipment (1,168) (3,097) (2,188)
Net decrease (increase) in short-term
investments 39,513 (55,551) (18,586)
Other investments (14,610) -- --
----------- ----------- -----------
Net cash used for investing activities (360,976) (194,242) (50,360)
----------- ----------- -----------
Cash flows from financing activities:
Issuance of notes payable, net 96,850 125,905 --
Repayment of notes payable -- (30,000) --
Dividends paid (12,777) (12,099) (10,536)
Treasury stock, net (23,686) (36,246) (41,660)
Issuance of stock for acquisition of subsidiary 80,000 -- --
Other 330 (1,453) --
----------- ----------- -----------
Net cash provided by (used for) financing
activities 140,717 46,107 (52,196)
----------- ----------- -----------
Net increase (decrease) in cash (8,985) 4,329 7,028
Cash at beginning of year 12,475 8,146 1,118
----------- ----------- -----------
Cash at end of year $ 3,490 $ 12,475 $ 8,146
=========== =========== ===========
</TABLE>
Continued
The accompanying Notes to Consolidated
Financial Statements are an integral part of these statements.
<PAGE>
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(Dollars in thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Reconciliation of net income to net cash flows from
operating activities:
Net income $ 116,978 $ 100,502 $ 80,760
Increase in accrued investment income (3,613) (2,504) (578)
Increase in deferred premium revenue and related
foreign exchange adjustment 82,530 62,101 29,622
Increase in deferred acquisition costs (28,461) (24,865) (13,282)
Increase (decrease) in current federal income
taxes payable (1,674) 7,891 (7,368)
Increase (decrease) in unpaid losses and loss
adjustment expenses 15,240 2,596 (8,023)
Increase in amounts withheld for others 82 133 52
Provision (benefit) for deferred income taxes (9,578) 10,309 1,784
Net realized gains on investments (20,890) (11,522) (3,189)
Deferred equity compensation 17,765 14,299 5,565
Depreciation and accretion of bond discount (4,523) (2,802) (1,735)
Minority interest and equity in earnings of
unconsolidated affiliates 844 -- --
Net gain on sale of subsidiaries -- (7,986) --
Change in other assets and liabilities 46,574 4,312 25,976
--------- --------- ---------
Cash provided by operating activities $ 211,274 $ 152,464 $ 109,584
========= ========= =========
</TABLE>
The accompanying Notes to Consolidated
Financial Statements are an integral part of these statements.
<PAGE>
[Pages 30 - 44 of the 1998 Annual Report to Shareholders]
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
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 company subsidiaries) in providing financial
guaranty insurance on asset-backed and municipal obligations. The Company's
underwriting policy is to insure asset-backed and municipal obligations that it
determines would be of investment-grade quality 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 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 Asia Pacific region.
At December 31, 1996, the Company was owned 40.4% by U S WEST Capital
Corporation (U S WEST), 11.5% by Fund American Enterprises Holdings, Inc. (Fund
American), 6.4% by The Tokio Marine and Fire Insurance Co., Ltd. (Tokio Marine)
and 41.7% by the public and employees. At December 31, 1997, the Company was
owned 42.1% by U S WEST, 12.0% by Fund American, 6.7% by Tokio Marine and 39.2%
by the public and employees. On November 3, 1998, the Company issued 1,632,653
common shares out of treasury to XL Capital Ltd (XL), which was named EXEL
Limited until February 1999, in exchange for $80,000,000 of XL's common stock in
conjunction with the creation of a new subsidiary (see Note 7). At December 31,
1998, the Company was owned 40.5% by MediaOne Capital Corporation (MediaOne),
formerly U S WEST, 11.6% by Fund American, 6.4% by Tokio Marine, 5.5% by XL and
36.0% 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. 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
5). 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, 1998 and 1997 and the reported amounts of
revenues and expenses in the consolidated statements of income during the years
ended December 31, 1998, 1997 and 1996. 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:
<PAGE>
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its direct and indirect subsidiaries, FSA Portfolio Management Inc.,
Transaction Services Corporation, Financial Security Assurance Inc. (FSA), FSA
Insurance Company, Financial Security Assurance International Ltd., 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 1998 presentation.
Investments
Investments in debt securities designated as available for sale are
carried at market value. Equity investments 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. Except as
specified in Note 20, 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 resulting change in effective
yields are recognized in current income. Short-term investments, which are those
investments with a maturity of 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.
The Company holds derivative securities, including U.S. Treasury bond
futures contracts and call option contracts, that are not accounted for as
hedges and are marked-to-market on a daily basis. Any gains or losses are
included in capital gains or losses.
Investments in unconsolidated affiliates are carried on the equity basis
(see Note 20).
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 the portion of premium that 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 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.
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 present value of 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.
<PAGE>
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
In 1997, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 128, Earnings Per Share (EPS), specifying the computation,
presentation and disclosure requirements for EPS (see Note 18). The new standard
defines "basic" and "diluted" earnings per share. Basic earnings per share are
based on average basic shares outstanding, which is calculated by adding shares
earned but not issued under the Company's equity bonus and performance share
programs to the average common shares outstanding. Diluted earnings per share
are based on average diluted shares outstanding, which is calculated by adding
shares contingently issuable under stock options, the performance share program
and the Company's convertible preferred stock to the average basic shares
outstanding. All earnings per share have been restated to reflect the adoption
of SFAS No. 128.
Segment Reporting
In 1997, the Financial Accounting Standards Board issued SFAS No. 131,
Disclosure about Segments of an Enterprise and Related Information, establishing
standards for the way that public business enterprises report information about
operating segments in annual and interim financial statements and requiring
presentation of a measure of profit or loss, certain specific revenue and
expense items and segment assets. The Company has no reportable operating
segments as a monoline financial guaranty insurer.
3. INVESTMENTS
Bonds at amortized cost of $11,481,000 and $11,025,000 at December 31,
1998 and 1997, 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,
-----------------------
1998 1997 1996
-------- -------- --------
Bonds $ 71,888 $ 65,422 $ 61,740
Equity investments 1,075 1,393 928
Short-term investments 8,391 7,206 3,966
Investment expenses (2,531) (1,936) (1,570)
-------- -------- --------
Net investment income $ 78,823 $ 72,085 $ 65,064
======== ======== ========
<PAGE>
The credit quality of the fixed-income investment portfolio at December
31, 1998 was as follows:
Percent of Fixed-Income
Rating Investment Portfolio
-------- -----------------------
AAA 66.0%
AA 20.4
A 12.9
BBB 0.4
Other 0.3
The amortized cost and estimated market value of bonds were as follows (in
thousands):
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
December 31, 1998 Cost Gains Losses Value
- ----------------- ---- ----- ------ -----
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies $ 148,669 $ 2,432 $ (336) $ 150,765
Obligations of states and political
subdivisions 1,041,718 42,265 (637) 1,083,346
Mortgage-backed securities 266,770 3,920 (190) 270,500
Corporate securities 164,697 5,539 (463) 169,773
Asset-backed securities 33,188 494 (26) 33,656
---------- ---------- ---------- ----------
Total $1,655,042 $ 54,650 $ (1,652) $1,708,040
========== ========== ========== ==========
December 31, 1997
- -----------------
U.S. Treasury securities and obligations
of U.S. government corporations
and agencies $ 122,817 $ 799 $ (454) $ 123,162
Obligations of states and political
subdivisions 777,042 40,187 (135) 817,094
Foreign securities 48,078 -- (6,126) 41,952
Mortgage-backed securities 195,567 2,213 (27) 197,753
Corporate securities 66,014 1,375 (501) 66,888
Asset-backed securities 20,961 349 (1) 21,309
---------- ---------- ---------- ----------
Total $1,230,479 $ 44,923 $ (7,244) $1,268,158
========== ========== ========== ==========
</TABLE>
The change in net unrealized gains (losses) consisted of (in thousands):
Year Ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
Bonds $ 15,319 $ 23,657 $(16,640)
Equity investments 2,842 1,109 --
Other 1,017 -- --
-------- -------- --------
Change in net unrealized gains (losses) $ 19,178 $ 24,766 $(16,640)
======== ======== ========
<PAGE>
The amortized cost and estimated market value of bonds at December 31,
1998, 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>
Estimated
Amortized Market
Cost Value
---------- ----------
<S> <C> <C>
Due in one year or less $ 1,002 $ 1,006
Due after one year through five years 137,094 139,642
Due after five years through ten years 225,259 233,080
Due after ten years 991,729 1,030,156
Mortgage-backed securities (stated maturities of 1 to 30 years) 266,770 270,500
Asset-backed securities (stated maturities of 25 to 30 years) 33,188 33,656
---------- ----------
Total $1,655,042 $1,708,040
========== ==========
</TABLE>
Proceeds from sales of bonds during 1998, 1997 and 1996 were
$1,889,130,000, $1,127,749,000 and $1,118,112,000, respectively. Gross gains of
$28,322,000, $12,627,000 and $15,335,000 and gross losses of $8,585,000,
$1,433,000 and $12,146,000 were realized on sales in 1998, 1997 and 1996,
respectively.
Proceeds from sales of equity investments during 1998 and 1997 were
$93,613,000 and $3,568,000, respectively. Gross gains of $2,684,000 and $33,000
and gross losses of $1,331,000 and $7,000 were realized on sales in 1998 and
1997, respectively.
The Company held open positions in U.S. Treasury bond futures contracts
with an aggregate notional amount of $57,700,000 and $33,300,000 as of December
31, 1998 and 1997, respectively. The Company also held open positions in
Eurodollar futures contracts with an aggregate notional amount of $1,000,000 as
of December 31, 1998. Such positions are marked-to-market on a daily basis and,
for the years ended December 31, 1998, 1997 and 1996, resulted in net realized
gains of $883,000, $190,000 and $923,000, respectively, which are 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,
-----------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Balance, beginning of period $ 171,098 $ 146,233 $ 132,951
--------- --------- ---------
Costs deferred during the period:
Ceding commission income (27,693) (18,956) (15,956)
Assumed commission expense 22 31 38
Premium taxes 8,081 5,554 3,718
Compensation and other acquisition costs 83,490 66,198 49,311
--------- --------- ---------
Total 63,900 52,827 37,111
--------- --------- ---------
Costs amortized during the period (35,439) (27,962) (23,829)
--------- --------- ---------
Balance, end of period $ 199,559 $ 171,098 $ 146,233
========= ========= =========
</TABLE>
<PAGE>
5. 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 principal and interest have 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 (rather than a general reserve) is computed based
on the following statutory requirements:
(i) For all policies written prior to July 1, 1989, an amount equal
to 50% of cumulative earned premiums less permitted reductions, plus;
(ii) 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;
- Surplus notes are recognized as surplus rather than a liability.
A reconciliation of net income for the calendar years 1998, 1997 and 1996
and shareholders' equity at December 31, 1998 and 1997, 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: 1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
GAAP BASIS $ 116,978 $ 100,502 $ 80,760
Non-insurance companies net loss (gain) 3,839 (243) 95
Premium revenue recognition (16,411) (23,130) (5,518)
Losses and loss adjustment expenses incurred 12,938 4,653 (2,138)
Deferred acquisition costs (28,461) (24,865) (12,482)
Deferred income tax provision (benefit) (8,039) 8,025 911
Amortization of bonds -- 56 566
Accrual of deferred compensation, net 33,268 26,681 12,737
Other 100 (61) 1,404
--------- --------- ---------
STATUTORY BASIS $ 114,212 $ 91,618 $ 76,335
========= ========= =========
</TABLE>
<PAGE>
December 31,
--------------------
Shareholders' Equity: 1998 1997
---- ----
GAAP BASIS $ 1,073,436 $ 882,360
Non-insurance companies liabilities, net 31,155 15,500
Premium revenue recognition (91,297) (74,863)
Loss and loss adjustment expense reserves 47,250 34,313
Deferred acquisition costs (199,559) (171,098)
Contingency reserve (367,454) (287,694)
Unrealized gain on investments, net of tax (55,851) (43,027)
Deferred income taxes 56,672 59,867
Accrual of deferred compensation 70,022 41,451
Surplus notes 120,000 50,000
Other (14,118) (12,841)
----------- -----------
STATUTORY BASIS SURPLUS $ 670,256 $ 493,968
=========== ===========
SURPLUS PLUS CONTINGENCY RESERVE $ 1,037,710 $ 781,661
=========== ===========
6. FEDERAL INCOME TAXES
The Company and its Subsidiaries (except Financial Security Assurance
International Ltd.) file a consolidated federal income tax return. The
calculation of each member's tax benefit or liability is controlled by a tax
sharing agreement that bases 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,
------------
1998 1997
--------- ---------
Deferred acquisition costs $ 69,079 $ 59,884
Deferred premium revenue adjustments 10,354 8,424
Unrealized capital gains 21,134 15,618
Contingency reserves 46,260 38,037
--------- ---------
Total deferred tax liabilities 146,827 121,963
--------- ---------
Loss and loss adjustment expense reserves (16,613) (12,009)
Deferred compensation (36,066) (21,503)
Tax and loss bonds (38,726) (30,520)
Other, net (1,415) (1,059)
--------- ---------
Total deferred tax assets (92,820) (65,091)
--------- ---------
Total deferred income taxes $ 54,007 $ 56,872
========= =========
No valuation allowance was necessary at December 31, 1998 or 1997.
A reconciliation of the effective tax rate with the federal statutory rate
follows:
Year Ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
Tax at statutory rate 35.0% 35.0% 35.0%
Tax-exempt interest (8.5) (7.9) (8.9)
Other 0.3 0.3 0.3
---- ---- ----
Provision for income taxes 26.8% 27.4% 26.4%
==== ==== ====
<PAGE>
7. SHAREHOLDERS' EQUITY
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 holders of 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 one of its majority-owned
subsidiaries.
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 two financial institutions
(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. At the same time it
entered into the forward agreements, 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 1998 and
1997 was $733,000 and $2,142,000, respectively, 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
purchased 1,187,800 Forward Shares for $33,910,000 by exercising rights under
the forward agreements. At December 31, 1998, 562,200 Forward Shares remained in
the program. Of these, 33,078 shares were held for the benefit of the Company as
a result of the repurchase of Forward Shares from employees and directors, and
529,122 shares continued to be held for the benefit of employees and directors.
On November 3, 1998, the Company and XL closed a transaction to create two
new Bermuda-based financial guaranty insurance companies. Each of the new
companies has been initially capitalized with approximately $100,000,000. One
company, Financial Security Assurance International Ltd., is an indirect
subsidiary of FSA, and the other company, XL Financial Assurance Ltd, is a
subsidiary of XL. The Company has a minority interest in the XL subsidiary, and
XL has a minority interest in the FSA indirect subsidiary. In conjunction with
forming the new companies, the Company and XL swapped $80,000,000 of their
respective common shares, with the Company delivering to XL 1,632,653 common
shares out of treasury. The Company concurrently sold, at no gain or loss,
$60,000,000 of the XL shares to an unrelated third party in order to fund, in
part, its investment in Financial Security Assurance International Ltd.
8. 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, 1998, FSA had $65,726,000 available for the payment
of dividends over the next twelve months. In addition, the Company holds
$120,000,000 of surplus notes of FSA. Payments of principal or interest on such
notes may be made with the approval of the New York Insurance Department.
In 1998, FSA repurchased $8,500,000 of its shares from its parent,
representing the balance remaining of $75,000,000 that had been approved for
repurchase by the New York Insurance Department.
<PAGE>
9. CREDIT ARRANGEMENTS AND ADDITIONAL CLAIMS-PAYING RESOURCES
FSA has a credit arrangement aggregating $150,000,000 at December 31,
1998, which is provided by commercial banks and intended for general application
to transactions insured by the Subsidiaries. At December 31, 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 and Hambros Bank Limited. Under the
agreement, which expires in August 2004, FSA can arrange financing for
transactions subject to certain conditions. The amount of this facility was
$186,911,000, of which $44,974,000 was unutilized at December 31, 1998.
FSA has a standby line of credit commitment in the amount of $240,000,000
with a group of international Aaa/AAA-rated banks 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 $230,000,000 or 5.75% of
average annual debt service of the covered portfolio. 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 in the covered portfolio, including certain installment
premiums and other collateral. This commitment has a term beginning on April 30,
1997 and expiring on April 30, 2004 and contains an annual renewal provision
subject to approval by the banks. No amounts have been utilized under this
commitment as of December 31, 1998.
On September 18, 1997, the Company issued $130,000,000 of 7.375% Senior
Quarterly Income Debt Securities (Senior QUIDS) due September 30, 2097 and
callable without premium or penalty on or after September 18, 2002. Interest on
these notes is paid quarterly beginning on December 31, 1997. Debt issuance
costs of $4,320,000 are being amortized over the life of the debt. The Company
used the proceeds to repay $30,000,000 of outstanding notes, to augment capital
in the Subsidiaries, to repurchase Forward Shares (see Note 7) and for general
corporate purposes.
On November 13, 1998, the Company issued $100,000,000 of 6.95% Senior
QUIDS due November 1, 2098 and callable without premium or penalty on or after
November 1, 2003. Interest is paid quarterly beginning on February 1, 1999. Debt
issuance costs of $3,375,000 are being amortized over the life of the debt. The
Company used the proceeds to augment capital in the Subsidiaries and for general
corporate purposes.
10. 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 $2,584,000, $2,535,000 and $2,215,000 for the years ended
December 31, 1998, 1997 and 1996, 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.
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 December 1995. The 1993 Equity
Participation Plan also contains provisions that permit the Human Resources
Committee to pay all or a portion of employees' 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 performance shares, stock options and equity bonus awards is
acquired by the Company through open-market purchases by a trust established for
such purpose.
Performance shares are awarded under the Company's 1993 Equity
Participation Plan. The Plan authorizes the discretionary grant of performance
shares by the Human Resources Committee to key employees of the Company and its
subsidiaries. The number of shares of the Company's common stock earned for each
performance share depends upon the attainment by the Company of certain growth
rates of adjusted book value per outstanding share over a three-year period. At
each payout date, each performance share is adjusted to pay out from zero up to
two common shares. No common shares are paid out if
<PAGE>
the compound annual growth rate of the Company's adjusted book value per
outstanding share was less than 7%. Two common shares per performance share are
paid out if the compound annual growth rate was 19% or greater. Payout
percentages are interpolated for compound annual growth rates between 7% and
19%.
Performance shares granted under the 1993 Equity Participation Plan were
as follows:
<TABLE>
<CAPTION>
Outstanding Granted Earned Forfeited Outstanding Market
at Beginning During During During at End Price at
of Year the Year the Year the Year of Year Grant Date
------- -------- -------- -------- ------- ----------
<S> <C> <C> <C> <C> <C>
1996 1,109,150 282,490 -- 17,300 1,374,340 $25.2500
1997 1,374,340 253,057 201,769 59,253 1,366,375 35.5000
1998 1,366,375 273,656 229,378 26,145 1,384,508 46.0625
</TABLE>
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 $40,862,000,
$29,500,000 and $13,741,000 for the years ended December 31, 1998, 1997 and
1996, 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 shareholders' 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 SFAS No. 123.
Had the compensation cost for the Company's performance shares been determined
based upon the provisions of SFAS No. 123, there would have been no effect on
the Company's reported net income and earnings per share.
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 and other employee benefit
plans and are presented as treasury stock in these financial statements. During
1998, 1997 and 1996, the total number of shares purchased by the trust was
496,940, 162,573 and 529,131, respectively, at a cost of $23,907,000, $5,434,000
and $14,111,000, respectively. In 1996, 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 under its defined contribution plans, to its employees, nor does it provide
post-employment benefits to former employees other than under its severance
plans.
11. 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,
-----------------------
1999 $ 2,489
2000 2,327
2001 2,014
2002 1,739
2003 1,739
Thereafter 3,333
-------
Total $13,641
=======
Rent expense for the years ended December 31, 1998, 1997 and 1996 was
$4,372,000, $4,067,000 and $3,816,000, 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.
<PAGE>
12. REINSURANCE
The Subsidiaries reinsure portions of their risks with affiliated (see
Note 14) and unaffiliated reinsurers under quota share and first-loss treaties
and on a facultative basis. The Subsidiaries' principal ceded reinsurance
program consisted in 1998 of two quota share treaties, one first-loss treaty and
four automatic facultative facilities. One treaty covered all of the
Subsidiaries' approved regular lines of business, except U.S. municipal
obligation insurance. Under this treaty in 1998, the Subsidiaries ceded 6.75% of
each covered policy, up to a maximum of $13,500,000 insured principal per
policy. At their sole option, the Subsidiaries could have increased, and in
certain instances did increase, the ceding percentage to 13.5% up to $27,000,000
of each covered policy. A second treaty covered the Subsidiaries' U.S. municipal
obligation insurance business. Under this treaty in 1998, the Subsidiaries ceded
6% of each covered policy that is classified by the Subsidiaries as providing
U.S. municipal bond insurance as defined by Article 69 of the New York Insurance
Law up to a limit of $16,000,000 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. These cession percentages under both treaties were reduced on
smaller-sized transactions. The first-loss treaty applied to qualifying U.S.
mortgage-backed transactions. Under the four automatic facultative facilities in
1998, the Subsidiaries at their option could allocate up to a specified amount
for each reinsurer (ranging from $4,000,000 to $40,000,000 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 quota share
treaties and automatic facultative facilities allowed the Subsidiaries to
withhold a ceding commission to defray their expenses. The Subsidiaries also
employed non-treaty quota share and first-loss facultative reinsurance on
various transactions in 1998.
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,
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Written premiums ceded $ 99,413 $ 63,513 $ 55,965
Written premiums assumed 935 1,352 1,873
Earned premiums ceded 55,939 41,713 38,723
Earned premiums assumed 4,271 5,121 6,020
Loss and loss adjustment expense payments ceded 22,619 2,862 29,408
Loss and loss adjustment expense payments assumed 3 2 3
Incurred (recovered) losses and loss adjustment
expenses ceded (4,673) 3,605 (2,249)
Incurred (recovered) losses and loss adjustment
expenses assumed (139) 161 38
</TABLE>
December 31,
------------
1998 1997
---- ----
Principal outstanding ceded $32,914,844 $24,547,361
Principal outstanding assumed 1,360,916 1,670,468
Deferred premium revenue ceded 217,096 173,123
Deferred premium revenue assumed 10,799 14,128
Loss and loss adjustment expense reserves ceded 3,907 30,618
Loss and loss adjustment expense reserves assumed 723 865
<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, 1998 and 1997 (net of amounts ceded to other
insurers) and the terms to maturity are as follows:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
----------------- -----------------
Terms to Maturity Asset-Backed Municipal Asset-Backed Municipal
- ----------------- ------------ --------- ------------ ---------
<S> <C> <C> <C> <C>
0 to 5 Years $ 8,468 $ 2,756 $ 7,553 $ 2,230
5 to 10 Years 7,516 7,495 5,637 5,683
10 to 15 Years 5,661 12,427 2,858 8,257
15 to 20 Years 670 20,265 524 14,340
20 Years and Above 15,308 24,107 11,917 16,479
------- ------- ------- -------
Total $37,623 $67,050 $28,489 $46,989
======= ======= ======= =======
</TABLE>
The principal amount ceded as of December 31, 1998 and 1997 and the terms
to maturity are as follows (in millions):
December 31, 1998 December 31, 1997
----------------- -----------------
Terms to Maturity Asset-Backed Municipal Asset-Backed Municipal
------- ------- ------- -------
0 to 5 Years $ 2,727 $ 1,157 $ 3,828 $ 965
5 to 10 Years 1,859 2,143 2,118 1,693
10 to 15 Years 1,116 3,022 553 2,078
15 to 20 Years 591 4,852 257 3,005
20 Years and Above 3,230 12,218 3,373 6,677
------- ------- ------- -------
Total $ 9,523 $23,392 $10,129 $14,418
======= ======= ======= =======
The Company limits its exposure to losses from writing financial
guarantees by underwriting investment-grade obligations, diversifying its
portfolio and maintaining rigorous collateral requirements on asset-backed
obligations, as well as through reinsurance. 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 1998 1997 1998 1997
- ------------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
Residential mortgages $15,647 $12,928 $ 3,324 $ 3,665
Consumer receivables 12,539 10,659 3,663 4,601
Government securities 821 787 267 120
Pooled corporate obligations 6,776 3,004 1,388 540
Commercial mortgage portfolio:
Commercial real estate 15 98 49 418
Corporate secured 42 55 314 481
Investor-owned utility obligations 757 643 464 229
Other asset-backed obligations 1,026 315 54 75
------- ------- ------- -------
Total asset-backed obligations $37,623 $28,489 $ 9,523 $10,129
======= ======= ======= =======
</TABLE>
<PAGE>
The asset-backed insured portfolio, which aggregated $47,146,604,000
principal before reinsurance at December 31, 1998, was collateralized by assets
with an estimated fair value of $53,754,485,000. At December 31, 1997, it
aggregated $38,618,244,000 principal before reinsurance and was collateralized
by assets with an estimated fair value of $44,382,716,000. Such estimates of
fair value are calculated at the inception of each insurance policy and are
changed only in proportion to changes in exposure. At December 31, 1998, the
estimated fair value of collateral and reserves over the principal insured
averaged from 110% for commercial real estate to 181% for corporate secured
obligations. At December 31, 1997, the estimated fair value of collateral and
reserves over the principal insured averaged from 100% for commercial real
estate to 172% 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 1998 1997 1998 1997
- --------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
General obligation bonds $25,337 $17,101 $ 4,517 $ 3,182
Housing revenue bonds 2,509 1,770 1,108 955
Municipal utility revenue bonds 9,218 5,892 5,489 2,294
Health care revenue bonds 5,812 3,924 3,348 2,175
Tax-supported bonds (non-general obligation) 14,731 11,210 5,238 3,526
Transportation revenue bonds 2,937 1,972 2,154 1,041
Other municipal bonds 6,506 5,120 1,538 1,245
------- ------- ------- -------
Total municipal obligations $67,050 $46,989 $23,392 $14,418
======= ======= ======= =======
</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, 1998:
<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 517 $10,233 15.3% $ 3,103
New York 388 5,836 8.7 4,137
Pennsylvania 356 4,821 7.2 834
Texas 414 4,128 6.1 1,441
Florida 130 4,091 6.1 1,616
New Jersey 275 3,475 5.2 1,486
Illinois 359 3,125 4.7 628
Massachusetts 126 2,259 3.4 976
Michigan 217 2,161 3.2 511
Wisconsin 252 1,685 2.5 228
Indiana 103 1,461 2.2 162
Minnesota 146 1,340 2.0 191
All Other States 1,453 20,993 31.3 6,812
Non-U.S 32 1,442 2.1 1,267
----- ------- ----- -------
Total 4,768 $67,050 100.0% $23,392
===== ======= ===== =======
</TABLE>
<PAGE>
14. RELATED PARTY TRANSACTIONS
The Subsidiaries ceded premiums of $23,838,000, $21,216,000 and
$19,890,000 to Tokio Marine for the years ended December 31, 1998, 1997 and
1996, respectively. The amounts included in prepaid reinsurance premiums at
December 31, 1998 and 1997 for reinsurance ceded to Tokio Marine were
$62,422,000 and $53,603,000, respectively. Reinsurance recoverable on unpaid
losses ceded to Tokio Marine was $612,000 and $613,000 at December 31, 1998 and
1997, respectively. The Subsidiaries ceded losses and loss adjustment expenses
of $603,000, $1,095,000 and $232,000 to Tokio Marine for the years ended
December 31, 1998, 1997 and 1996, respectively. The Subsidiaries ceded premiums
of $7,297,000 and $15,000 to X.L. Insurance Company, Ltd., a subsidiary of XL,
for the years ended December 31, 1998 and 1997, respectively. The amounts
included in prepaid reinsurance premiums at December 31, 1998 and 1997 for
reinsurance ceded to X.L. Insurance Company, Ltd. were $5,306,000 and $6,000,
respectively.
The Subsidiaries ceded premiums of $25,862,000, $16,890,000 and
$15,409,000 on a quota share basis to affiliates of MediaOne (Enhance
Reinsurance Company, Asset Guaranty Insurance Company and Commercial Reinsurance
Company) for the years ended December 31, 1998, 1997 and 1996, respectively. The
amounts included in prepaid reinsurance premiums for reinsurance ceded to these
affiliates were $61,088,000 and $51,980,000 at December 31, 1998 and 1997,
respectively. The amounts of reinsurance recoverable on unpaid losses ceded to
these affiliates at December 31, 1998 and 1997 were $1,755,000 and $24,195,000,
respectively. The Subsidiaries ceded losses and loss adjustment expenses
(recoveries) of $(11,956,000), $2,105,000 and $(3,316,000) to these affiliates
for the years ended December 31, 1998, 1997 and 1996, respectively.
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.
Bonds -- The carrying amount of bonds represents fair value. The fair
value of 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, receivable for investments sold and payable for investments
purchased -- The carrying amount approximates fair value because of the short
maturity of these instruments.
Investments in unconsolidated affiliates -- The carrying amount is fair
value due to accounting for these investments on the equity basis.
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 premiums retained by the Company to compensate it for
originating and servicing the insurance contracts.
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.
<PAGE>
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, 1998 December 31, 1997
----------------- -----------------
Carrying Estimated Carrying Estimated
(In thousands) Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
<S> <C> <C> <C> <C>
Assets:
Bonds $1,708,040 $1,708,040 $1,268,158 $1,268,158
Short-term investments 98,554 98,554 132,931 132,931
Cash 3,490 3,490 12,475 12,475
Receivable for securities sold 1,655 1,655 20,623 20,623
Investment in unconsolidated affiliates 29,496 29,496 -- --
Liabilities:
Deferred premium revenue, net of
prepaid reinsurance premiums 504,603 417,130 422,073 347,855
Losses and loss adjustment expenses,
net of reinsurance recoverable on
unpaid losses 60,040 60,040 44,799 44,799
Notes payable 230,000 232,736 130,000 131,612
Payable for investments purchased 105,859 105,859 72,979 72,979
Off-balance-sheet instruments:
Installment premiums -- 163,239 -- 116,888
</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,
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Balance at January 1 $ 75,417 $ 72,079 $ 111,759
Less reinsurance recoverable 30,618 29,875 61,532
--------- --------- ---------
Net balance at January 1 44,799 42,204 50,227
Incurred losses and loss adjustment expenses:
Current year 8,049 5,400 5,300
Prior years (4,100) 3,756 1,574
Recovered (paid) losses and loss adjustment expenses:
Current year (192) (2,850) --
Prior years 11,484 (3,711) (14,897)
--------- --------- ---------
Net balance December 31 60,040 44,799 42,204
Plus reinsurance recoverable 3,907 30,618 29,875
--------- --------- ---------
Balance at December 31 $ 63,947 $ 75,417 $ 72,079
========= ========= =========
</TABLE>
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 a portion of the general reserve that had previously been
transferred 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.
<PAGE>
During 1997, the Company increased its general reserve by $9,156,000, of
which $5,400,000 was for originations of new business and $3,756,000 was to
reestablish a portion of the general reserve that had previously been
transferred to case basis reserves. During 1997, the Company transferred
$4,503,000 from its general reserve to case basis reserves associated
predominantly with certain residential mortgage transactions. Giving effect to
these transfers, the general reserve totaled $34,313,000 at December 31, 1997.
During 1998, the Company increased its general reserve by $3,949,000, of
which $8,049,000 was for originations of new business offset by a $4,100,000
decrease in the amount needed to fund the general loss reserve because of
recoveries on certain commercial mortgage transactions. During 1998, the Company
transferred $18,403,000 to its general reserve from case basis reserves due to
those recoveries on commercial mortgage transactions. Also during 1998, the
Company transferred $9,414,000 from its general reserve to case basis reserves
associated predominantly with certain consumer receivable transactions. Giving
effect to these transfers, the general reserve totaled $47,251,000 at December
31, 1998.
Reserves for losses and loss adjustment expenses are discounted at
risk-free rates. The amount of discount taken was approximately $16,029,000,
$19,779,000 and $17,944,000 at December 31, 1998, 1997 and 1996, respectively.
17. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
(In thousands, except share data) First Second Third Fourth Full Year
----- ------ ----- ------ ---------
<S> <C> <C> <C> <C> <C>
1998
Gross premiums written $ 54,338 $ 89,242 $ 77,024 $ 98,662 $319,266
Net premiums written 37,947 62,121 54,462 65,323 219,853
Net premiums earned 31,921 32,452 32,618 40,936 137,927
Net investment income 18,683 19,255 19,710 21,175 78,823
Losses and loss adjustment expenses 1,047 1,047 1,046 809 3,949
Income before taxes 36,094 38,203 42,450 42,999 159,746
Net income 26,446 28,049 30,988 31,495 116,978
Basic earnings per common share 0.91 0.97 1.08 1.06 4.02
Diluted earnings per common share 0.88 0.92 1.03 1.01 3.82
1997
Gross premiums written $ 41,111 $ 90,995 $ 42,470 $ 61,815 $236,391
Net premiums written 27,184 67,495 28,911 49,288 172,878
Net premiums earned 24,774 27,561 27,204 29,972 109,511
Net investment income 16,361 17,121 17,920 20,683 72,085
Losses and loss adjustment expenses 2,285 2,156 2,426 2,289 9,156
Income before taxes 27,266 35,058 37,896 38,279 138,499
Net income 20,250 25,233 27,225 27,794 100,502
Basic earnings per common share 0.67 0.84 0.91 0.93 3.35
Diluted earnings per common share 0.66 0.82 0.88 0.90 3.25
</TABLE>
<PAGE>
18. EARNINGS PER SHARE
In 1997, the Company adopted SFAS No. 128 specifying the
computation, presentation and disclosure requirements for EPS. The new standard
defines "basic" and "diluted" earnings per share. Basic earnings per share are
based on average basic shares outstanding, which is calculated by adding shares
earned but not issued under the Company's equity bonus and performance share
programs to the average common shares outstanding. Diluted earnings per share
are based on average diluted shares outstanding, which is calculated by adding
shares contingently issuable under stock options, the performance share program
and the Company's convertible preferred stock to the average basic shares
outstanding. The calculations of average basic and diluted common shares
outstanding are as follows (in thousands):
Year Ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
Average common shares outstanding 28,854 29,858 30,547
Shares earned but unissued under stock-based
compensation plans 248 170 80
------ ------ ------
Average basic common shares outstanding 29,102 30,028 30,627
Shares contingently issuable under:
Stock-based compensation plans 622 395 268
Convertible preferred stock 875 490 --
------ ------ ------
Average diluted common shares outstanding 30,599 30,913 30,895
19. RECENTLY ISSUED ACCOUNTING STANDARD
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities. SFAS 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. SFAS No. 133 is effective January 1, 2000.
The Company is in the process of determining the effect of these standards
on its financial statements, but management does not believe that it will have a
material effect on the Company's financial condition.
20. INVESTMENTS IN UNCONSOLIDATED AFFILIATES
The Company accounts for investments in two companies on the equity basis.
In June 1998, the Company invested $10,000,000 to purchase a 25% interest in
Fairbanks Capital Holding Corp., which buys, sells and services residential
mortgages. In November 1998, the Company invested $19,900,000 to purchase a
19.9% interest in XL Financial Assurance Ltd, a financial guaranty insurance
subsidiary of XL (see Note 7). In 1998, the Company recognized equity losses of
$548,000 and goodwill amortization of $240,000 on its Fairbanks Capital Holding
Corp. investment and equity income of $332,000 on its XL Financial Assurance Ltd
investment.
21. MINORITY INTEREST IN SUBSIDIARY
In November 1998, the Company sold to XL, for $20,000,000, a 20% interest
in Financial Security Assurance International Ltd., FSA's newly formed
Bermuda-based financial guaranty subsidiary (see Note 7). This interest is in
the form of Cumulative Participating Voting Preferred Shares, which in total
have a minimum fixed dividend of $1,000,000 per annum. For the period ended
December 31, 1998, the Company recognized minority interest of $388,000.
<PAGE>
[Page 48 of the 1998 Annual Report to Shareholders]
Common Stock Data
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
New York Stock Exchange Price
- --------------------------------------------------------------------------------------
Dividends paid per share High Low Close
======================================================================================
<S> <C> <C> <C> <C>
1997
Quarter ended March 31 $0.0950 $36.7500 $32.7500 $33.1250
Quarter ended June 30 $0.0950 39.2500 31.5000 38.9375
Quarter ended September 30 $0.1075 46.9375 38.7500 46.5000
Quarter ended December 31 $0.1075 48.6875 40.3125 48.2500
- --------------------------------------------------------------------------------------
1998
Quarter ended March 31 $0.1075 $56.4375 $44.0000 $54.6250
Quarter ended June 30 $0.1075 60.3750 54.6250 58.7500
Quarter ended September 30 $0.1125 61.1250 45.2500 48.7500
Quarter ended December 31 $0.1125 56.7500 38.8750 54.2500
- --------------------------------------------------------------------------------------
</TABLE>
Annual dividend information for the years 1994 through 1998 appears in the
Five-Year Financial Summary on page 16. The Company estimates that it has
approximately 3,500 shareholders.
Exhibit 21
SUBSIDIARIES
OF
FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.
Financial Security Assurance Inc. (incorporated in the State of New York)
FSA Insurance Company (incorporated in the State of Oklahoma)
Financial Security Assurance International Ltd. (incorporated in Bermuda)
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)
FSA Portfolio Management Inc. (incorporated in the State of New York)
Exhibit 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Registration Statements, as
amended, of Financial Security Assurance Holdings Ltd. on Form S-8 (File No.
33-78784) (1993 Equity Participation Plan), Form S-8 (File No. 33-92648)
(Deferred Compensation Plan), Form S-3 (File No. 33-80769) (in connection with
USW DECS and Forward Shares), Form S-3 (File No. 333-34181) (Debt Securities and
Common Stock) and Form S-3 (File No. 333-74165) (Debt Securities, Common Stock
and Stock Purchase Contracts) of:
1. Our report dated January 26, 1999 on our audits of the consolidated
balance sheets of Financial Security Assurance Holdings Ltd. and
Subsidiaries as of December 31, 1998 and 1997, 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, 1998, which report is incorporated by reference in this
Annual Report on form 10-K for the fiscal year ended December 31,
1998;
2. Our report dated January 26, 1999 on our audit of the financial
statement schedule relating to the consolidated financial statements
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, 1998; and
3. Our report dated January 26, 1999 on our audits of the consolidated
balance sheets of Financial Security Assurance Inc. and Subsidiaries
as of December 31, 1998 and 1997, 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, 1998,
which report is included in exhibit 99 to this Annual Report on form
10-K for the fiscal year ended December 31, 1998.
/s/ PRICEWATERHOUSECOOPERS LLP
------------------------------
PRICEWATERHOUSECOOPERS LLP
New York, New York
March 23, 1999
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: February 25, 1999 /s/ Fudeji Hama
---------------------
Fudeji Hama
<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 3, 1999 /s/ Sean W. McCarthy
-------------------------
Sean W. McCarthy
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-END> Dec-31-1998
<DEBT-HELD-FOR-SALE> 1,806,594
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 68,243
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 1,874,837
<CASH> 3,490
<RECOVER-REINSURE> 3,907
<DEFERRED-ACQUISITION> 199,559
<TOTAL-ASSETS> 2,405,480
<POLICY-LOSSES> 63,947
<UNEARNED-PREMIUMS> 721,699
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 230,000
0
700
<COMMON> 730,890
<OTHER-SE> 341,846
<TOTAL-LIABILITY-AND-EQUITY> 2,405,480
137,927
<INVESTMENT-INCOME> 78,823
<INVESTMENT-GAINS> 20,890
<OTHER-INCOME> 474
<BENEFITS> 3,949
<UNDERWRITING-AMORTIZATION> 35,439
<UNDERWRITING-OTHER> 38,980
<INCOME-PRETAX> 159,746
<INCOME-TAX> 42,768
<INCOME-CONTINUING> 116,978
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 116,978
<EPS-PRIMARY> 0
<EPS-DILUTED> 3.82
<RESERVE-OPEN> 75,417
<PROVISION-CURRENT> 8,049
<PROVISION-PRIOR> (8,192)
<PAYMENTS-CURRENT> 729
<PAYMENTS-PRIOR> 10,598
<RESERVE-CLOSE> 63,947
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
Exhibit 99
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
Consolidated Financial Statements and
Report of Independent Accountants
December 31, 1998
<PAGE>
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AND REPORT OF INDEPENDENT ACCOUNTANTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
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.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, changes in shareholder's equity, and cash
flows present fairly, in all material respects, the financial position of
Financial Security Assurance Inc. and Subsidiaries (the Company) at December 31,
1998 and 1997, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
New York, New York
January 26, 1999
1
<PAGE>
FINANCIAL SECURITY ASSURANCE INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
December 31, December 31,
ASSETS 1998 1997
---- ----
<S> <C> <C>
Bonds at market value (amortized cost of $1,631,094
and $1,192,771) $1,683,928 $1,235,441
Equity investments at market value (cost of $34,250 and
$20,405) 37,268 20,762
Short-term investments 92,241 103,926
---------- ----------
Total investments 1,813,437 1,360,129
Cash 2,729 11,235
Deferred acquisition costs 199,559 171,098
Prepaid reinsurance premiums 217,096 173,123
Reinsurance recoverable on unpaid losses 3,907 30,618
Receivable for securities sold 1,656 20,535
Other assets 105,379 72,901
---------- ----------
TOTAL ASSETS $2,343,763 $1,839,639
========== ==========
LIABILITIES AND MINORITY INTEREST AND SHAREHOLDER'S EQUITY
Deferred premium revenue $ 721,699 $ 595,196
Losses and loss adjustment expenses 63,947 75,417
Deferred federal income taxes 56,672 59,867
Ceded reinsurance balances payable 31,502 11,199
Payable for securities purchased 105,749 72,979
Long-term debt 120,000 50,000
Minority interest 20,388
Accrued expenses and other liabilities 119,215 77,121
---------- ----------
TOTAL LIABILITIES AND MINORITY INTEREST 1,239,172 941,779
---------- ----------
COMMITMENTS AND CONTINGENCIES
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 694,788 617,870
Accumulated other comprehensive income (net of deferred
income tax provision of $19,904 and $15,059) 36,964 27,968
Accumulated earnings 357,839 237,022
---------- ----------
TOTAL SHAREHOLDER'S EQUITY 1,104,591 897,860
---------- ----------
TOTAL LIABILITIES AND MINORITY INTEREST AND
SHAREHOLDER'S EQUITY $2,343,763 $1,839,639
========== ==========
</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,
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
REVENUES:
Net premiums written $ 219,853 $ 172,878 $ 121,000
Increase in deferred premium revenue (81,926) (63,367) (30,552)
--------- --------- ---------
Premiums earned 137,927 109,511 90,448
Net investment income 76,023 69,643 62,728
Net realized gains 21,667 6,023 1,851
Other income 381 10,774 502
--------- --------- ---------
TOTAL REVENUES 235,998 195,951 155,529
--------- --------- ---------
EXPENSES:
Losses and loss adjustment expenses 3,949 9,156 6,874
Policy acquisition costs 35,439 27,962 23,829
Other operating expenses 28,502 20,717 14,852
--------- --------- ---------
TOTAL EXPENSES 67,890 57,835 45,555
--------- --------- ---------
Minority interest (388)
---------
INCOME BEFORE INCOME TAXES 167,720 138,116 109,974
--------- --------- ---------
Provision (benefit) for income taxes:
Current 54,942 29,832 28,208
Deferred (8,039) 8,025 911
--------- --------- ---------
Total provision 46,903 37,857 29,119
--------- --------- ---------
NET INCOME 120,817 100,259 80,855
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising
during period (net of deferred income tax
provision (benefit) of $12,428, $12,268
and $(5,057)) 23,080 22,784 (9,392)
Less: reclassification adjustment for gains
included in net income (net of deferred
income tax provision
of $7,583, $2,108 and $648) (14,084) (3,915) (1,203)
--------- --------- ---------
Other comprehensive income (loss) 8,996 18,869 (10,595)
--------- --------- ---------
COMPREHENSIVE INCOME $ 129,813 $ 119,128 $ 70,260
========= ========= =========
</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>
Unrealized
Additional Gain
Common Paid-In (Loss) on Retained
Stock Capital Investments Earnings Total
----- ------- ----------- -------- -----
<S> <C> <C> <C> <C> <C>
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 accumulated
comprehensive income
(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
Net income 100,259 100,259
Net change in accumulated
comprehensive income
(net of deferred income
taxes of $10,160) 18,869 18,869
Stock repurchase (39,500) (39,500)
Deferred equity payout by Parent 2,900 2,900
--------- ----------- --------- --------- -----------
BALANCE, December 31, 1997 15,000 617,870 27,968 237,022 897,860
Net income 120,817 120,817
Net change in accumulated
comprehensive income
(net of deferred income
taxes of $4,844) 8,996 8,996
Stock repurchase (8,500) (8,500)
Capital contribution from Parent 80,000 80,000
Deferred equity payout by Parent 5,418 5,418
--------- ----------- --------- --------- -----------
BALANCE, December 31, 1998 $ 15,000 $ 694,788 $ 36,964 $ 357,839 $ 1,104,591
========= =========== ========= ========= ===========
</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,
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Premiums received, net $ 247,229 $ 171,145 $ 124,540
Policy acquisition and other operating
expenses paid, net (81,559) (50,046) (49,261)
Recoverable advances received (paid) 1,473 (7,629) 10,213
Losses and loss adjustment expenses
recovered (paid) 10,989 (6,463) (15,473)
Net investment income received 67,268 63,207 59,923
Federal income taxes paid (52,210) (27,080) (33,297)
Interest paid (22)
Other (877) 2,142 1,330
----------- ----------- -----------
Net cash provided by operating
activities 192,313 145,276 97,953
----------- ----------- -----------
Cash flows from investing activities:
Proceeds from sales of bonds 1,735,585 1,071,845 1,095,929
Proceeds from sales of equity investments 22,571 3,568
Proceeds from maturities of bonds 32,468 2,965
Purchases of bonds (2,098,264) (1,196,117) (1,139,129)
Purchases of equity investments (37,034) (24,662)
Gain on sale of subidiaries 9,486
Purchases of property and equipment (1,071) (2,985) (2,081)
Net decrease (increase) in short-term
investments 15,857 (45,661) (3,675)
Other investments 20,037
----------- ----------- -----------
Net cash provided by (used for)
investing activities (342,319) (152,058) (45,991)
----------- ----------- -----------
Cash flows from financing activities:
Stock repurchase (8,500) (39,500) (27,000)
Surplus notes issued 70,000 50,000
Capital contribution 80,000
Dividends paid (18,000)
----------- ----------- -----------
Net cash provided by (used for)
financing activities 141,500 10,500 (45,000)
----------- ----------- -----------
Net increase (decrease) in cash (8,506) 3,718 6,962
Cash at beginning of year 11,235 7,517 555
----------- ----------- -----------
Cash at end of year $ 2,729 $ 11,235 $ 7,517
=========== =========== ===========
</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,
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Reconciliation of net income to net cash
flows from operating activities:
Net income $ 120,817 $ 100,259 $ 80,855
Increase in accrued investment income (3,939) (1,811) (842)
Increase in deferred premium revenue and
related foreign exchange adjustment 82,530 62,101 29,622
Increase in deferred acquisition costs (28,461) (24,865) (13,282)
Increase (decrease) in current federal
income taxes payable 2,732 (519) (5,090)
Increase (decrease) in unpaid losses and
loss adjustment expenses 15,240 2,596 (8,023)
Increase in amounts withheld for others 81 133 52
Provision (benefit) for deferred income
taxes (8,039) 11,296 911
Net realized gains on investments (21,667) (6,023) (1,851)
Depreciation and accretion of bond
discount (3,540) (1,736) (1,616)
Gain on sale of subsidiaries (9,486)
Minority interest 388
Change in other assets and liabilities 36,171 13,331 17,217
--------- --------- ---------
Cash provided by operating activities $ 192,313 $ 145,276 $ 97,953
========= ========= =========
</TABLE>
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, 1998, 1997 AND 1996
1. ORGANIZATION AND OWNERSHIP
Financial Security Assurance Inc. (the Company), an indirect 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 and municipal
obligations. The Company's underwriting policy is to insure asset-backed and
municipal obligations that it determines would be of investment-grade quality
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 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 Asia Pacific region.
At December 31, 1996, the Parent was owned 40.4% by U S WEST Capital
Corporation (U S WEST), 11.5% by Fund American Enterprises Holdings, Inc. (Fund
American), 6.4% by The Tokio Marine and Fire Insurance Co., Ltd. (Tokio Marine)
and 41.7% by the public and employees. At December 31, 1997, the Parent was
owned 42.1% by U S WEST, 12.0% by Fund American, 6.7% by Tokio Marine and 39.2%
by the public and employees. At December 31, 1998, the Parent was owned 40.5% by
MediaOne Capital Corporation (MediaOne), formerly U S WEST, 11.6% by Fund
American, 6.4% by Tokio Marine, 5.5% by XL Capital Ltd (XL) and 36.0% 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 5). The preparation of financial
statements in conformity with GAAP 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, 1998 and 1997 and the reported amounts of
revenues and expenses in the consolidated statements of income during the years
ended December 31, 1998, 1997 and 1996. 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 direct and indirect subsidiaries, FSA Insurance Company, Financial
Security Assurance International Ltd., 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 1998
presentation.
7
<PAGE>
Investments
Investments in debt securities designated as available for sale are
carried at market value. Equity investments 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 resulting change in effective
yields are recognized in current income. Short-term investments, which are those
investments with a maturity of 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.
The Company holds derivative securities, including U.S. Treasury bond
futures contracts and call option contracts, that are not accounted for as
hedges and are marked-to-market on a daily basis. Any gains or losses are
included in capital gains or losses.
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 the portion of premium that 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 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.
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 present value of 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.
8
<PAGE>
Segment Reporting
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 131, Disclosure about Segments of an
Enterprise and Related Information, establishing standards for the way that
public business enterprises report information about operating segments in
annual and interim financial statements and requiring presentation of a measure
of profit or loss, certain specific revenue and expense items and segment
assets. The Company has no reportable operating segments as a monoline financial
guaranty insurer.
3. INVESTMENTS
Bonds at amortized cost of $11,481,000 and $11,025,000 at December 31,
1998 and 1997, 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,
-----------------------
1998 1997 1996
---- ---- ----
Bonds $ 69,216 $ 65,149 $ 61,130
Equity investments 830 376 14
Short-term investments 7,376 5,452 3,525
Investment expenses (1,399) (1,334) (1,941)
-------- -------- --------
Net investment income $ 76,023 $ 69,643 $ 62,728
======== ======== ========
The credit quality of the fixed-income investment portfolio at December
31, 1998 was as follows:
Percent of Fixed-Income
Rating Investment Portfolio
------------------- -----------------------
AAA 68.7%
AA 21.3
A 9.3
BBB 0.4
Other 0.3
The amortized cost and estimated market value of bonds were as follows (in
thousands):
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Market
December 31, 1998 Cost Gains Losses Value
- ----------------- ---- ----- ------ -----
<S> <C> <C> <C> <C>
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 134,910 $ 2,297 $ (337) $ 136,870
Obligations of states and political
subdivisions 1,041,718 42,265 (637) 1,083,346
Mortgage-backed securities 261,322 3,911 (180) 265,053
Corporate securities 162,663 5,510 (463) 167,710
Asset-backed securities 30,481 493 (25) 30,949
---------- ---------- ---------- ----------
Total $1,631,094 $ 54,476 $ (1,642) $1,683,928
========== ========== ========== ==========
</TABLE>
9
<PAGE>
December 31, 1997
<TABLE>
<S> <C> <C> <C> <C>
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies $ 120,314 $ 800 $ (436) $ 120,678
Obligations of states and political
subdivisions 777,042 40,187 (135) 817,094
Foreign securities 8,252 (562) 7,690
Mortgage-backed securities 195,567 2,213 (28) 197,752
Corporate securities 72,388 1,375 (1,093) 72,670
Asset-backed securities 19,208 349 19,557
---------- ---------- ---------- ----------
Total $1,192,771 $ 44,924 $ (2,254) $1,235,441
========== ========== ========== ==========
</TABLE>
The change in net unrealized gains (losses) consisted of (in thousands):
Year Ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
Bonds $ 10,164 $ 28,671 $(16,299)
Equity investments 2,661 357
Other 1,017
-------- -------- --------
Change in net unrealized gains (losses) $ 13,842 $ 29,028 $(16,299)
======== ======== ========
The amortized cost and estimated market value of bonds at December 31,
1998, 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.
Estimated
Amortized Market
Cost Value
---- -----
Due in one year or less $ 1,002 $ 1,006
Due after one year through five years 135,398 137,917
Due after five years through ten years 211,500 219,185
Due after ten years 991,391 1,029,818
Mortgage-backed securities (stated maturities of 1 to
30 years) 261,322 265,053
Asset-backed securities (stated maturities of 3 to 30
years) 30,481 30,949
---------- ----------
Total $1,631,094 $1,683,928
========== ==========
Proceeds from sales of bonds during 1998, 1997 and 1996 were
$2,132,146,000, $1,124,848,000 and $1,096,568,000, respectively. Gross gains of
$26,373,000, $11,702,000 and $13,420,000 and gross losses of $4,156,000,
$6,007,000 and $11,569,000 were realized on sales in 1998, 1997 and 1996,
respectively.
Proceeds from sales of equity investments during 1998 and 1997 were
$22,571,000 and $3,568,000, respectively. Gross gains of $973,000 and $33,000
and gross losses of $1,323,000 and $7,000 were realized on sales in 1998 and
1997, respectively.
10
<PAGE>
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,
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Balance, beginning of period $ 171,098 $ 146,233 $ 132,951
--------- --------- ---------
Costs deferred during the period:
Ceding commission income (27,693) (18,956) (15,956)
Assumed commission expense 22 31 38
Premium taxes 8,081 5,554 3,718
Compensation and other acquisition costs 83,490 66,198 49,311
--------- --------- ---------
Total 63,900 52,827 37,111
--------- --------- ---------
Costs amortized during the period (35,439) (27,962) (23,829)
--------- --------- ---------
Balance, end of period $ 199,559 $ 171,098 $ 146,233
========= ========= =========
</TABLE>
5. 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 principal and interest have 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 (rather than a general reserve) is computed
based on the following statutory requirements:
(i) For all policies written prior to July 1, 1989, an amount equal
to 50% of cumulative earned premiums less permitted reductions, plus;
(ii)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;
- Surplus notes are recognized as surplus rather than a liability.
11
<PAGE>
A reconciliation of net income for the calendar years 1998, 1997 and 1996
and shareholder's equity at December 31, 1998 and 1997, 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: 1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
GAAP BASIS $ 120,817 $ 100,259 $ 80,855
Premium revenue recognition (16,411) (23,130) (5,518)
Losses and loss adjustment expenses incurred 12,938 4,653 (2,138)
Deferred acquisition costs (28,461) (24,865) (12,482)
Deferred income tax provision (benefit) (8,039) 8,025 911
Amortization of bonds 56 566
Accrual of deferred compensation, net 33,268 26,681 12,737
Other 100 (61) 1,404
--------- --------- ---------
STATUTORY BASIS $ 114,212 $ 91,618 $ 76,335
========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
December 31,
------------
Shareholder's Equity: 1998 1997
---- ----
<S> <C> <C>
GAAP BASIS $ 1,104,591 $ 897,860
Premium revenue recognition (91,297) (74,863)
Loss and loss adjustment expense reserves 47,250 34,313
Deferred acquisition costs (199,559) (171,098)
Contingency reserve (367,454) (287,694)
Unrealized gain on investments, net of tax (55,851) (43,027)
Deferred income taxes 56,672 59,867
Accrual of deferred compensation 70,022 41,451
Surplus notes 120,000 50,000
Other (14,118) (12,841)
----------- -----------
STATUTORY BASIS SURPLUS $ 670,256 $ 493,968
=========== ===========
SURPLUS PLUS CONTINGENCY RESERVE $ 1,037,710 $ 781,661
=========== ===========
</TABLE>
6. FEDERAL INCOME TAXES
The Parent, the Company and its Subsidiaries (except Financial Security
Assurance International Ltd.) file a consolidated federal income tax return. The
calculation of each member's tax benefit or liability is controlled by a tax
sharing agreement that bases 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,
------------
1998 1997
---- ----
Deferred acquisition costs $ 69,079 $ 59,884
Deferred premium revenue adjustments 10,354 8,424
Unrealized capital gains 20,749 16,998
Contingency reserves 46,260 38,037
--------- ---------
Total deferred tax liabilities 146,442 123,343
--------- ---------
Loss and loss adjustment expense reserves (16,613) (12,009)
Deferred compensation (34,020) (20,328)
Tax and loss bonds (38,726) (30,520)
Other, net (411) (619)
--------- ---------
Total deferred tax assets (89,770) (63,476)
--------- ---------
Total deferred income taxes $ 56,672 $ 59,867
========= =========
12
<PAGE>
No valuation allowance was necessary at December 31, 1998 or 1997.
A reconciliation of the effective tax rate with the federal statutory rate
follows:
Year Ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
Tax at statutory rate 35.0% 35.0% 35.0%
Tax-exempt interest (8.1) (7.9) (8.9)
Other 1.1 0.3 0.4
---- ---- ----
Provision for income taxes 28.0% 27.4% 26.5%
==== ==== ====
7. 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. In addition, the dividend, 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, 1998, the Company had $65,726,000 available for the payment of
dividends over the next twelve months.
In 1998, the Company repurchased $8,500,000 of its shares from the Parent,
representing the balance remaining of $75,000,000 that had been approved for
repurchase by the New York Insurance Department.
8. CREDIT ARRANGEMENTS AND ADDITIONAL CLAIMS-PAYING RESOURCES
The Company has a credit arrangement aggregating $150,000,000 at December
31, 1998, which is provided by commercial banks and intended for general
application to transactions insured by the Company and the Subsidiaries. At
December 31, 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, the Company entered
into a facility agreement with Canadian Global Funding Corporation and Hambros
Bank Limited. Under the agreement, which expires in August 2004, the Company can
arrange financing for transactions subject to certain conditions. The amount of
this facility was $186,911,000, of which $44,974,000 was unutilized at December
31, 1998.
The Company has a standby line of credit commitment in the amount of
$240,000,000 with a group of international Aaa/AAA-rated banks 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
$230,000,000 or 5.75% of average annual debt service of the covered portfolio.
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 in the covered portfolio, including
certain installment premiums and other collateral. This commitment has a term
beginning on April 30, 1997 and expiring on April 30, 2004 and contains an
annual renewal provision subject to approval by the banks. No amounts have been
utilized under this commitment as of December 31, 1998.
At December 31, 1998, the Company has borrowed $120,000,000 from its
Parent in the form of Surplus Notes. These notes carried a simple interest rate
of 5.0% per annum. Principal of and interest on the Surplus Notes may be paid at
any time at the option of the Company, subject to prior approval of the New York
Insurance Department and compliance with the conditions to such payments as
contained in the New York Insurance Laws. These notes have no stated maturity.
The Company did not pay interest in 1998 or 1997.
9. 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 $2,380,000, $2,312,000 and $1,977,000 for the years ended
December 31, 1998, 1997 and 1996, respectively.
13
<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.
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 December 1995.
The 1993 Equity Participation Plan also contains provisions that permit the
Human Resources Committee to pay all or a portion of employees' 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 performance shares, stock options and equity
bonus awards is acquired by the Parent through open-market purchases by a trust
established for such purpose.
Performance shares are awarded under the Parent's 1993 Equity
Participation Plan. The Plan authorizes the discretionary grant of performance
shares by the Human Resources Committee to key employees of the Company. The
number of shares of the Parent's common stock earned for each performance share
depends upon the attainment by the Parent of certain growth rates of adjusted
book value per outstanding share over a three-year period. At each payout date,
each performance share is adjusted to pay out from zero up to two common shares.
No common shares are paid out if the compound annual growth rate of the Parent's
adjusted book value per outstanding share was less than 7%. Two common shares
per performance share are paid out if the compound annual growth rate was 19% or
greater. Payout percentages are interpolated for compound annual growth rates
between 7% and 19%.
Performance shares granted under the 1993 Equity Participation Plan were
as follows:
Outstanding
at Granted Earned Forfeited Outstanding Market
Beginning During During During at End Price at
of Year the Year the Year the Year of Year Grant Date
------- -------- -------- -------- ------- ----------
1996 1,109,150 282,490 17,300 1,374,340 $25.2500
1997 1,374,340 253,057 201,769 59,253 1,366,375 35.5000
1998 1,366,375 273,656 229,378 26,145 1,384,508 46.0625
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
$39,480,000, $28,439,000 and $12,737,000 for the years ended December 31, 1998,
1997 and 1996, 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 shareholders' 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. The Company recognized a benefit for the difference between
the market value of the Parent's common stock and the cost of the stock when it
was purchased by the independent trustee (which amount was reimbursed by the
Company to its Parent) for shares distributed under the performance share plan.
This benefit was recorded by the Company as a capital contribution which totaled
$5,418,000 and $2,900,000 in 1998 and 1997, respectively. In 1996, the Parent
adopted disclosure provisions of SFAS No. 123. Had the compensation cost for the
Parent's performance shares been determined based upon the provisions of SFAS
No. 123, there would have been no effect on the Company's reported net income.
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 and other employee benefit
plans and are presented as treasury stock in these financial statements. During
1998, 1997 and 1996, the total number of shares purchased by the trust was
496,940, 162,573 and 529,131, respectively, at a cost of $23,907,000, $5,434,000
and $14,111,000, respectively. In 1996, the Parent also repurchased stock from
its employees in satisfaction of withholding taxes on shares distributed under
its restricted stock plan.
14
<PAGE>
The Company does not currently provide post-retirement benefits, other
than under its defined contribution plans, to its employees, nor does it provide
post-employment benefits to former employees other than under its severance
plans.
10. 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,
-----------------------
1999 $ 2,489
2000 2,327
2001 2,014
2002 1,739
2003 1,739
Thereafter 3,333
--------
Total $ 13,641
========
Rent expense for the years ended December 31, 1998, 1997 and 1996 was
$4,025,000, $3,708,000 and $3,383,000, 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.
11. REINSURANCE
The Company reinsures portions of its risks with affiliated (see Note 13)
and unaffiliated reinsurers under quota share and first-loss treaties and on a
facultative basis. The Company's principal ceded reinsurance program consisted
in 1998 of two quota share treaties, one first-loss treaty and four automatic
facultative facilities. One treaty covered all of the Company's approved regular
lines of business, except U.S. municipal obligation insurance. Under this treaty
in 1998, the Company ceded 6.75% of each covered policy, up to a maximum of
$13,500,000 insured principal per policy. At its sole option, the Company could
have increased, and in certain instances did increase, the ceding percentage to
13.5% up to $27,000,000 of each covered policy. A second treaty covered the
Company's U.S. municipal obligation insurance business. Under this treaty in
1998, the Company ceded 6% of each covered policy that is classified by the
Company as providing U.S. municipal bond insurance as defined by Article 69 of
the New York Insurance Law up to a limit of $16,000,000 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. These cession percentages under both treaties
were reduced on smaller-sized transactions. The first-loss treaty applied to
qualifying U.S. mortgage-backed transactions. Under the four automatic
facultative facilities in 1998, the Company at its option could allocate up to a
specified amount for each reinsurer (ranging from $4,000,000 to $40,000,000
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 quota
share treaties and automatic facultative facilities allowed the Company to
withhold a ceding commission to defray its expenses. The Company also employed
non-treaty quota share and first-loss facultative reinsurance on various
transactions in 1998.
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.
15
<PAGE>
Amounts reinsured were as follows (in thousands):
Year Ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
Written premiums ceded $ 99,413 $ 63,513 $ 55,965
Written premiums assumed 935 1,352 1,873
Earned premiums ceded 55,939 41,713 38,723
Earned premiums assumed 4,271 5,121 6,020
Loss and loss adjustment expense payments
ceded 22,619 2,862 29,408
Loss and loss adjustment expense payments
assumed 3 2 3
Incurred (recovered) losses and loss
adjustment expenses ceded (4,673) 3,605 (2,249)
Incurred (recovered) losses and loss
adjustment expenses assumed (139) 161 38
December 31,
------------
1998 1997
---- ----
Principal outstanding ceded $32,914,844 $24,547,361
Principal outstanding assumed 1,360,916 1,670,468
Deferred premium revenue ceded 217,096 173,123
Deferred premium revenue assumed 10,799 14,128
Loss and loss adjustment expense reserves
ceded 3,907 30,618
Loss and loss adjustment expense reserves
assumed 723 865
12. 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, 1998 and 1997 (net of amounts ceded to other
insurers) and the terms to maturity are as follows:
December 31, 1998 December 31, 1997
----------------- -----------------
Terms to Maturity Asset-Backed Municipal Asset-Backed Municipal
- ----------------- ------------ --------- ------------ ---------
0 to 5 Years $ 8,468 $ 2,756 $ 7,553 $ 2,230
5 to 10 Years 7,516 7,495 5,637 5,683
10 to 15 Years 5,661 12,427 2,858 8,257
15 to 20 Years 670 20,265 524 14,340
20 Years and Above 15,308 24,107 11,917 16,479
------- ------- ------- -------
Total $37,623 $67,050 $28,489 $46,989
======= ======= ======= =======
The principal amount ceded as of December 31, 1998 and 1997 and the terms
to maturity are as follows (in millions):
December 31, 1998 December 31, 1997
----------------- -----------------
Terms to Maturity Asset-Backed Municipal Asset-Backed Municipal
- ----------------- ------------ --------- ------------ ---------
0 to 5 Years $ 2,727 $ 1,157 $ 3,828 $ 965
5 to 10 Years 1,859 2,143 2,118 1,693
10 to 15 Years 1,116 3,022 553 2,078
15 to 20 Years 591 4,852 257 3,005
20 Years and Above 3,230 12,218 3,373 6,677
------- ------- ------- -------
Total $ 9,523 $23,392 $10,129 $14,418
======= ======= ======= =======
16
<PAGE>
The Company limits its exposure to losses from writing financial
guarantees by underwriting investment-grade obligations, diversifying its
portfolio and maintaining rigorous collateral requirements on asset-backed
obligations, as well as through reinsurance. The gross principal amounts of
insured obligations in the asset-backed insured portfolio are backed by the
following types of collateral (in millions):
Net of Amounts Ceded Ceded
December 31, December 31,
------------ ------------
Types of Collateral 1998 1997 1998 1997
- ------------------- ---- ---- ---- ----
Residential mortgages $15,647 $12,928 $ 3,324 $ 3,665
Consumer receivables 12,539 10,659 3,663 4,601
Government securities 821 787 267 120
Pooled corporate obligations 6,776 3,004 1,388 540
Commercial mortgage portfolio:
Commercial real estate 15 98 49 418
Corporate secured 42 55 314 481
Investor-owned utility obligations 757 643 464 229
Other asset-backed obligations 1,026 315 54 75
------- ------- ------- -------
Total asset-backed obligations $37,623 $28,489 $ 9,523 $10,129
======= ======= ======= =======
The asset-backed insured portfolio, which aggregated $47,146,604,000
principal before reinsurance at December 31, 1998, was collateralized by assets
with an estimated fair value of $53,754,485,000. At December 31, 1997, it
aggregated $38,618,244,000 principal before reinsurance and was collateralized
by assets with an estimated fair value of $44,382,716,000. Such estimates of
fair value are calculated at the inception of each insurance policy and are
changed only in proportion to changes in exposure. At December 31, 1998, the
estimated fair value of collateral and reserves over the principal insured
averaged from 110% for commercial real estate to 181% for corporate secured
obligations. At December 31, 1997, the estimated fair value of collateral and
reserves over the principal insured averaged from 100% for commercial real
estate to 172% 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 Collateral 1998 1997 1998 1997
- ------------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
General obligation bonds $25,337 $17,101 $ 4,517 $ 3,182
Housing revenue bonds 2,509 1,770 1,108 955
Municipal utility revenue bonds 9,218 5,892 5,489 2,294
Health care revenue bonds 5,812 3,924 3,348 2,175
Tax-supported bonds (non-general obligation) 14,731 11,210 5,238 3,526
Transportation revenue bonds 2,937 1,972 2,154 1,041
Other municipal bonds 6,506 5,120 1,538 1,245
------- ------- ------- -------
Total municipal obligations $67,050 $46,989 $23,392 $14,418
======= ======= ======= =======
</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.
17
<PAGE>
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, 1998:
<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 517 $10,233 15.3% $ 3,103
New York 388 5,836 8.7 4,137
Pennsylvania 356 4,821 7.2 834
Texas 414 4,128 6.1 1,441
Florida 130 4,091 6.1 1,616
New Jersey 275 3,475 5.2 1,486
Illinois 359 3,125 4.7 628
Massachusetts 126 2,259 3.4 976
Michigan 217 2,161 3.2 511
Wisconsin 252 1,685 2.5 228
Indiana 103 1,461 2.2 162
Minnesota 146 1,340 2.0 191
All Other States 1,453 20,993 31.3 6,812
Non-U.S 32 1,442 2.1 1,267
----- ------- ----- -------
Total 4,768 $67,050 100.0% $23,392
===== ======= ===== =======
</TABLE>
13. 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, 1998 and 1997
are $1,625,000 and $4,702,000, respectively, for unsettled expense allocations
due from the Parent.
The Company ceded premiums of $23,838,000, $21,216,000 and $19,890,000 to
Tokio Marine for the years ended December 31, 1998, 1997 and 1996, respectively.
The amounts included in prepaid reinsurance premiums at December 31, 1998 and
1997 for reinsurance ceded to Tokio Marine were $62,422,000 and $53,603,000,
respectively. Reinsurance recoverable on unpaid losses ceded to Tokio Marine was
$612,000 and $613,000 at December 31, 1998 and 1997, respectively. The Company
ceded losses and loss adjustment expenses of $603,000, $1,095,000 and $232,000
to Tokio Marine for the years ended December 31, 1998, 1997 and 1996,
respectively. The Company ceded premiums of $7,297,000 and $15,000 to X.L.
Insurance Company, Ltd., a subsidiary of XL, for the years ended December 31,
1998 and 1997, respectively. The amounts included in prepaid reinsurance
premiums at December 31, 1998 and 1997 for reinsurance ceded to X.L. Insurance
Company, Ltd. were $5,306,000 and $6,000, respectively.
The Company ceded premiums of $25,862,000, $16,890,000 and $15,409,000 on
a quota share basis to affiliates of MediaOne (Enhance Reinsurance Company,
Asset Guaranty Insurance Company and Commercial Reinsurance Company) for the
years ended December 31, 1998, 1997 and 1996, respectively. The amounts included
in prepaid reinsurance premiums for reinsurance ceded to these affiliates were
$61,088,000 and $51,980,000 at December 31, 1998 and 1997, respectively. The
amounts of reinsurance recoverable on unpaid losses ceded to these affiliates at
December 31, 1998 and 1997 were $1,755,000 and $24,195,000, respectively. The
Company ceded losses and loss adjustment expenses (recoveries) of $(11,956,000),
$2,105,000 and $(3,316,000) to these affiliates for the years ended December 31,
1998, 1997 and 1996, respectively.
18
<PAGE>
14. 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.
Bonds -- The carrying amount of bonds represents fair value. The fair
value of 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, 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 premiums retained by the Company to compensate it for
originating and servicing the insurance contracts.
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, 1998 December 31, 1997
----------------- -----------------
Carrying Estimated Carrying Estimated
(In thousands) Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
<S> <C> <C> <C> <C>
Assets:
Bonds $1,683,928 $1,683,928 $1,235,441 $1,235,441
Short-term investments 92,241 92,241 103,926 103,926
Cash 2,729 2,729 11,235 11,235
Receivable for securities sold 1,656 1,656 20,535 20,535
Liabilities:
Deferred premium revenue, net of
prepaid reinsurance premiums 504,603 417,130 422,073 347,855
Losses and loss adjustment
expenses, net of reinsurance
recoverable on unpaid losses 60,040 60,040 44,799 44,799
Notes payable 120,000 120,000 50,000 50,000
Payable for investments purchased 105,749 105,749 72,979 72,979
Off-balance-sheet instruments:
Installment premiums 163,239 116,888
</TABLE>
19
<PAGE>
15. 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,
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Balance at January 1 $ 75,417 $ 72,079 $ 111,759
Less reinsurance recoverable 30,618 29,875 61,532
--------- --------- ---------
Net balance at January 1 44,799 42,204 50,227
Incurred losses and loss adjustment expenses:
Current year 8,049 5,400 5,300
Prior years (4,100) 3,756 1,574
Recovered (paid) losses and loss adjustment expenses:
Current year (192) (2,850)
Prior years 11,484 (3,711) (14,897)
--------- --------- ---------
Net balance December 31 60,040 44,799 42,204
Plus reinsurance recoverable 3,907 30,618 29,875
--------- --------- ---------
Balance at December 31 $ 63,947 $ 75,417 $ 72,079
========= ========= =========
</TABLE>
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 a portion of the general reserve that had previously been
transferred 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.
During 1997, the Company increased its general reserve by $9,156,000, of
which $5,400,000 was for originations of new business and $3,756,000 was to
reestablish a portion of the general reserve that had previously been
transferred to case basis reserves. During 1997, the Company transferred
$4,503,000 from its general reserve to case basis reserves associated
predominantly with certain residential mortgage transactions. Giving effect to
these transfers, the general reserve totaled $34,313,000 at December 31, 1997.
During 1998, the Company increased its general reserve by $3,949,000, of
which $8,049,000 was for originations of new business offset by a $4,100,000
decrease in the amount needed to fund the general loss reserve because of
recoveries on certain commercial mortgage transactions. During 1998, the Company
transferred $18,403,000 to its general reserve from case basis reserves due to
those recoveries on commercial mortgage transactions. Also during 1998, the
Company transferred $9,414,000 from its general reserve to case basis reserves
associated predominantly with certain consumer receivable transactions. Giving
effect to these transfers, the general reserve totaled $47,251,000 at December
31, 1998.
Reserves for losses and loss adjustment expenses are discounted at
risk-free rates. The amount of discount taken was approximately $16,029,000,
$19,779,000 and $17,944,000 at December 31, 1998, 1997 and 1996, respectively.
16. RECENTLY ISSUED ACCOUNTING STANDARD
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities. SFAS 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. SFAS No. 133 is effective January 1, 2000.
The Company is in the process of determining the effect of these standards
on its financial statements, but management does not believe that it will have a
material effect on the Company's financial condition.
20
<PAGE>
17. FINANCIAL SECURITY ASSURANCE INTERNATIONAL LTD. AND MINORITY INTEREST
On November 3, 1998, the Parent funded the Company's $80,000,000
investment in Financial Security Assurance International Ltd. (International), a
new Bermuda-based financial guaranty insurer.
In November 1998, XL made a minority investment in International for
$20,000,000. This interest is in the form of Cumulative Participating Voting
Preferred Shares, which in total have a minimum fixed dividend of $1,000,000 per
annum. For the period ended December 31, 1998, the Company recognized minority
interest of $388,000.
21
