<PAGE>
_______________________________
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported):
June __, 1997
EquiVantage Acceptance Corp. on behalf of EquiVantage Home Equity Loan Trust
1997-2
(Exact Name of Registrant as Specified in its Charter)
Delaware 333-22343 76-0448074
(State of Incorporation) (Commission (I.R.S. Employer
File Number) Identification No.)
13111 Northwest Freeway, Suite 301, Houston, Texas 77040
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (713) 895-1957
No Change
(Former Name or Former Address, if Changed Since Last Report)
_______________________________
<PAGE>
The financial statements of Financial Guaranty Insurance Company ("FGIC")
as of December 31, 1996 and 1995, that are included in this Form 8-K have
been audited by KPMG Peat Marwick LLP. The consent of KPMG Peat Marwick LLP to
the inclusion of their audit report on such financial statements in this Form
8-K and their being named as "experts" in the Prospectus Supplement relating to
EquiVantage Home Equity Loan Asset-Backed Certificates, Series 1997-2, is
attached hereto as Exhibit 23.1.
The financial statements of FGIC as of December 31, 1996 and 1995,
are attached hereto as Exhibit 99.1. The unaudited interim financial
statements of FGIC as of March 31, 1997, are attached hereto as Exhibit 99.2.
Item 7. Financial Statements; Pro Forma Financial Information and
Exhibits.
(a) Not applicable.
(b) Not applicable.
(c) Exhibits:
23.1 Consent of KPMG Peat Marwick LLP
99.1 Financial statements of FGIC, December 31, 1996 and 1995
99.2 Unaudited interim financial statements of FGIC as of March
31, 1997
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
EQUIVANTAGE ACCEPTANCE CORP.
By: /s/ John E. Smith
John E. Smith
President
Date: June __, 1997
<PAGE>
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Financial Guaranty Insurance Company:
We consent to the use of our report dated January 17, 1997 on the financial
statements of Financial Guaranty Insurance Company as of December 31, 1996
and 1995, and for each of the years in the three-year period ended December
31, 1996 included in the Form 8-K of EquiVantage Acceptance Corp., and to
reference to our firm under the heading "Experts" in the Prospectus
Supplement.
/s/ KPMG Peat Marwick LLP
New York, New York
June __, 1997
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY
Financial Statements
December 31, 1996, 1995 and 1994
(With Independent Auditors' Report Thereon)
<PAGE>
FINANCIAL GUARANTY INSURANCE COMPANY
- -------------------------------------------------------------------------------
AUDITED FINANCIAL STATEMENTS
December 31, 1996
<TABLE>
<S> <C>
Report of Independent Auditors................................. 1
Balance Sheets................................................. 2
Statements of Income........................................... 3
Statements of Stockholder's Equity............................. 4
Statements of Cash Flows....................................... 5
Notes to Financial Statements.................................. 6
</TABLE>
<PAGE>
Independent Auditor's Report
To the Board of Directors and Stockholder
Financial Guaranty Insurance Company:
We have audited the accompanying balance sheets of Financial Guaranty
Insurance Company as of December 31, 1996 and 1995, and the related
statements of income, stockholder's equity, and cash flows for each of the
years in the three years in the three year period then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Financial Guaranty Insurance
Company as of December 31, 1996 and 1995 and the results of its operations
and its cash flows for each of the years in the three year period then ended
in conformity with generally accepted accounting principles.
/s/
-----------------------------
KPMC-Peat Marwick LLP
January 17, 1997
<PAGE>
Financial Guaranty Insurance
Company Balance Sheets
- -------------------------------------------------------------------------------
($ in Thousands, except per share amounts)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
ASSETS 1996 1995
------------ ------------
<S> <C> <C>
Fixed maturity securities available-for-sale
(amortized cost of $2,190,303 in 1996 and $2,043,453 in 1995) $2,250,549 $2,141,584
Short-term investments, at cost, which approximates market 73,839 91,032
Cash 860 199
Accrued investment income 37,655 37,347
Reinsurance recoverable 7,015 7,672
Prepaid reinsurance premiums 167,683 162,087
Deferred policy acquisition costs 91,945 94,868
Property and equipment, net of accumulated depreciation
($15,333 in 1996 and $12,861 in 1995) 4,696 6,314
Receivable for securities sold 379 26,572
Prepaid expenses and other assets 19,520 12,627
---------- ----------
Total assets $2,654,141 $2,580,302
---------- ----------
---------- ----------
Liabilities And Stockholder's Equity
Liabilities:
Unearned premiums $ 681,816 $ 727,535
Loss and loss adjustment expenses 72,616 77,808
Ceded reinsurance balances payable 10,561 1,942
Accounts payable and accrued expenses 54,165 32,811
Payable to Parent 1,791 1,647
Current federal income taxes payable 52,016 51,296
Deferred federal income taxes 91,805 99,171
Payable for securities purchased 4,937 40,211
---------- ----------
Total liabilities $ 969,707 $1,032,421
---------- ----------
---------- ----------
Stockholder's Equity:
Common stock, par value $1,500 per share;
10,000 shares authorized, issued and 15,000 15,000
Additional paid-in capital 334,011 334,011
Net unrealized gains on fixed maturity securities available-
for-sale, net of tax 39,160 63,785
Foreign currency translation adjustment, net of tax (429) (1,499)
Retained earnings 1,296,692 1,136,584
---------- ----------
Total stockholder's equity 1,684,434 1,547,881
---------- ----------
Total liabilities and stockholder's equity $2,654,141 $2,580,302
---------- ----------
---------- ----------
</TABLE>
See accompanying notes to financial statements.
2
<PAGE>
Financial Guaranty Insurance
Company Statements of Income
- --------------------------------------------------------------------------
($ in Thousands)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------
<S> <C> <C> <C>
1996 1995 1994
---------- ---------- ----------
Revenues:
Gross premiums written............... $ 97,027 $ 97,288 $ 161,940
Ceded premiums....................... (29,376) (19,319) (46,477)
---------- ---------- ----------
Net premiums written.............. 67,651 77,969 115,463
Decrease in net unearned premiums.... 51,314 27,309 53,364
---------- ---------- ----------
Net premiums earned............... 118,965 105,278 168,827
Net investment income................ 124,635 120,398 109,828
Net realized gains................... 15,022 30,762 5,898
---------- ---------- ----------
Total revenues....................... 258,622 256,438 284,553
---------- ---------- ----------
Expenses:
Loss and loss adjustment expenses.... 2,389 (8,426) 3,646
Policy acquisition costs............. 16,327 13,072 15,060
Decrease (Increase) in Deferred
policy acquisition costs............. 2,923 (3,940) 3,709
Other underwriting expenses.......... 12,508 19,100 21,182
---------- ---------- ----------
Total expenses.................... 34,147 19,806 43,597
---------- ---------- ----------
Income before provision for
Federal income taxes................. 224,475 236,632 240,956
---------- ---------- ----------
Federal income tax expense:
Current........................... 41,548 28,913 43,484
Deferred.......................... 5,318 19,841 7,741
---------- ---------- ----------
Total Federal income tax expense.. 46,866 48,754 51,225
---------- ---------- ----------
Net income........................ $ 177,609 $ 187,878 $ 189,731
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
See accompanying notes to financial statements.
3
<PAGE>
Financial Guaranty Insurance
Company Statements of Stockholder's Equity
- -------------------------------------------------------------------------------
($ in Thousands)
<TABLE>
<CAPTION>
UNREALIZED
GAINS (LOSSES) ON
FIXED MATURITY
SECURITIES
ADDITIONAL AVAILABLE- FOREIGN
COMMON PAID-IN FOR-SALE, NET OF CURRENCY RETAINED
STOCK CAPITAL TAX ADJUSTMENT EARNINGS
--------- ---------- ------------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1994................... $ 15,000 $ 334,011 $ 90,708 $ (2,265) $ 783,975
Net income................................. -- -- -- -- 189,731
Change in fixed maturity securities
available for sale, net of tax of
($71,336)................................ -- -- (132,481) -- --
Foreign currency translation adjustment.... -- -- -- 1,044 --
--------- ---------- -------- ----------- ------------
Balance, December 31, 1994................. 15,000 334,011 (41,773) (1,221) 973,706
--------- ---------- -------- ----------- ------------
Net income................................. -- -- -- -- 187,878
Dividend paid.............................. -- -- -- -- (25,000)
Change in fixed maturity securities
available for sale, net of tax of
$56,839.................................. -- -- 105,558 -- --
Foreign currency translation adjustment.... -- -- -- (278) --
--------- ---------- -------- ----------- ------------
Balance, December 31, 1995................. 15,000 334,011 63,785 (1,499) 1,136,584
--------- ---------- -------- ----------- ------------
Net Income................................. -- -- -- -- 177,609
Dividend paid.............................. -- -- -- -- (17,500)
Change in fixed maturity securities
available for sale, net of tax of
($13,260)................................ -- -- (24,625) -- --
Foreign currency translation adjustment.... -- -- -- 1,070 --
--------- ---------- -------- ----------- ------------
Balance at December 31, 1996............... $ 15,000 $ 334,011 $ 39,160 $ (429) $ 1,296,692
--------- ---------- -------- ----------- ------------
--------- ---------- -------- ----------- ------------
</TABLE>
See accompanying notes to financial statements.
4
<PAGE>
Financial Guaranty Insurance Company Statements of Cash Flows
- -------------------------------------------------------------------------------
($ in Thousands)
<TABLE>
<CAPTION>
For the Year Ended December 31,
-------------------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income $ 177,609 $ 187,878 $ 189,731
Adjustments to reconcile net income
to net cash provided by operating activities:
Change in unearned premiums (45,719) (29,890) (45,927)
Change in loss and loss adjustment expense reserves (5,192) (20,938) 2,648
Depreciation of property and equipment 2,472 2,348 2,689
Change in reinsurance receivable 657 6,800 (304)
Change in prepaid reinsurance premiums (5,596) 2,581 (7,437)
Change in foreign currency translation adjustment 1,646 (427) 1,607
Policy acquisition costs deferred (16,327) (16,219) (18,306)
Amortization of deferred policy acquisition costs 19,250 12,279 22,015
Change in accrued investment income, and prepaid
expenses and other assets (7,201) 2,906 (5,150)
Change in other liabilities 30,117 (12,946) 2,577
Change in deferred income taxes 5,318 19,841 7,741
Amortization of fixed maturity securities 792 1,922 5,112
Change in current income taxes payable 720 (30,827) 33,391
Net realized gains on investments (15,022) (30,762) (5,898)
----------- ----------- -----------
Net cash provided by operating activities 143,524 94,546 184,489
----------- ----------- -----------
Investing Activities:
Sales and maturities of fixed maturity securities 891,643 836,103 550,534
Purchases of fixed maturity securities (1,033,345) (891,108) (721,908)
Purchases, sales and maturities of short-term investments, net 17,193 (15,358) (11,486)
Purchases of property and equipment, net (854) (750) (1,290)
----------- ----------- -----------
Net cash used in investing activities (125,363) (71,113) (184,150)
----------- ----------- -----------
Financing Activities:
Dividends paid (17,500) (25,000) --
----------- ----------- -----------
Net cash provided by financing activities (17,500) (25,000) --
----------- ----------- -----------
Increase (Decrease) in cash 661 (1,567) 339
Cash at beginning or year 199 1,766 1,427
----------- ----------- -----------
Cash at end of year $ 860 $ 199 $ 1,766
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See accompanying notes to financial statements.
5
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
(1) BUSINESS
Financial Guaranty Insurance Company (the "Company"), a wholly-owned
insurance subsidiary of FGIC Corporation (the "Parent"), provides
financial guaranty insurance on newly issued municipal bonds and
municipal bonds trading in the secondary market, the latter including
bonds held by unit investment trusts and mutual funds. The Company also
insures structured debt issues outside the municipal market.
Approximately 82% of the business written since inception by the Company
has been municipal bond insurance.
The Company insures only those securities that, in its judgment, are of
investment grade quality. Municipal bond insurance written by the Company
insures the full and timely payment of principal and interest when due on
scheduled maturity, sinking fund or other mandatory redemption and
interest payment dates to the holders of municipal securities. The
Company's insurance policies do not provide for accelerated payment of
the principal of, or interest on, the bond insured in the case of a
payment default. If the issuer of a Company-insured bond defaults on its
obligation to pay debt service, the Company will make scheduled interest
and principal payments as due and is subrogated to the rights of
bondholders to the extent of payments made by it.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that effect the reported amounts of assets and liabilities
and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
(2) SIGNIFICANT ACCOUNTING POLICIES
The accompanying financial statements have been prepared on the basis of
generally accepted accounting principles ("GAAP") which differ in certain
respects from the accounting practices prescribed or permitted by
regulatory authorities (see Note 3). The prior years financial statements
have been reclassified to conform to the 1996 presentation. Significant
accounting policies are as follows:
INVESTMENTS
The Company accounts for its investments in accordance with Statement of
Financial Accounting Standards No. 115 ("SFAS 115"), "Accounting for
Certain Investments in Debt and Equity Securities." The Statement defines
three categories for classification of debt securities and the related
accounting treatment for each respective category. The Company has
determined that its fixed maturity securities portfolio should be
classified as available-for-sale. Under SFAS 115, securities held as
available-for-sale are recorded at fair value and unrealized holding
gains/losses are recorded as a separate component of stockholder's
equity, net of applicable income taxes.
Short-term investments are carried at cost, which approximates fair
value. Bond discounts and premiums are amortized over the remaining terms
of the securities. Realized gains or losses on the sale of investments
are determined on the basis of specific identification.
6
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- -------------------------------------------------------------------------------
PREMIUM REVENUE RECOGNITION
Premiums for policies where premiums are collected in a single payment at
policy inception are earned over the period at risk, based on the total
exposure outstanding at any point in time. Financial guaranty insurance
policies exposure generally declines according to predetermined
schedules. For policies with premiums that are collected periodically,
premiums are reflected in income pro rata over the period covered by the
premium payment.
POLICY ACQUISITION COSTS
Policy acquisition costs include only those expenses that relate directly
to premium production. Such costs include compensation of employees
involved in underwriting, marketing and policy issuance functions, rating
agency fees, state premium taxes and certain other underwriting expenses,
offset by ceding commission income on premiums ceded to reinsurers (see
Note 6). Net acquisition costs are deferred and amortized over the period
in which the related premiums are earned. Anticipated loss and loss
adjustment expenses are considered in determining the recoverability of
acquisition costs.
LOSS AND LOSS ADJUSTMENT EXPENSES
Provision for loss and loss adjustment expenses is made in an amount
equal to the present value of unpaid principal and interest and other
payments due under insured risks at the balance sheet date for which, in
management's judgment, the likelihood of default is probable. Such
reserves amounted to $72.6 million and $77.8 million at December 31, 1996
and 1995, respectively. As of December 31, 1996 and 1995, such reserves
included $28.9 million and $28.8 million, respectively, established based
on an evaluation of the insured portfolio in light of current economic
conditions and other relevant factors. Loss and loss adjustment expenses
include amounts discounted at an interest rate of between 6.5 and 6.6 in
1996 and 5.5 % in 1995. The reserve for loss and loss adjustment expenses
is necessarily based upon estimates, however, in management's opinion the
reserves for loss and loss adjustment expenses is adequate. However,
actual results will likely differ from those estimates.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases. These temporary differences relate principally to unrealized
gains (losses) on fixed maturity securities available-for-sale, premium
revenue recognition, deferred acquisition costs and deferred
compensation. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the
enactment date.
Financial guaranty insurance companies are permitted to deduct from
taxable income, subject to certain limitations, amounts added to
statutory contingency reserves (see Note 3). The amounts deducted
must be included in taxable income upon their release from the reserves
or upon earlier release of such amounts from such reserves to cover
excess losses as permitted by insurance regulators. The amounts deducted
are allowed as deductions from taxable income only to the extent that
U.S. government non-interest bearing tax and loss bonds are purchased and
held in an amount equal to the tax benefit attributable to such
deductions.
7
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- -------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT
Property and equipment consists of furniture, fixtures, equipment and
leasehold improvements which are recorded at cost and are charged to
income over their estimated service lives. Office furniture and equipment
are depreciated straight-line over five years. Leasehold improvements are
amortized over their estimated service life or over the life of the
lease, whichever is shorter. Computer equipment and software are
depreciated over three years. Maintenance and repairs are charged to
expense as incurred.
FOREIGN CURRENCY TRANSLATION
The Company has established foreign branches in France and the United
Kingdom and determined that the functional currencies of these branches
are local currencies. Accordingly, the assets and liabilities of these
foreign branches are translated into U.S. dollars at the rates of
exchange existing at December 31, 1996 and 1995 and revenues and expenses
are translated at average monthly exchange rates. The cumulative
translation loss at December 31, 1996 and 1995 was $0.4 million and $1.5
million, respectively, net of tax, and is reported as a separate
component of stockholder's equity.
(3) STATUTORY ACCOUNTING PRACTICES
The financial statements are prepared on the basis of GAAP, which differs
in certain respects from accounting practices prescribed or permitted by
state insurance regulatory authorities. The following are the significant
ways in which statutory-basis accounting practices differ from GAAP:
(a) premiums are earned directly in proportion to the scheduled
principal and interest payments rather than in proportion to the
total exposure outstanding at any point in time.
(b) policy acquisition costs are charged to current operations as
incurred rather than as related premiums are earned;
(c) a contingency reserve is computed on the basis of statutory
requirements for the security of all policyholders, regardless of
whether loss contingencies actually exist, whereas under GAAP, a
reserve is established based on an ultimate estimate of exposure;
(d) certain assets designated as non-admitted assets are charged
directly against surplus but are reflected as assets under GAAP, if
recoverable;
(e) federal income taxes are only provided with respect to taxable
income for which income taxes are currently payable, while under
GAAP taxes are also provided for differences between the financial
reporting and the tax bases of assets and liabilities;
(f) purchases of tax and loss bonds are reflected as admitted assets,
while under GAAP they are recorded as federal income tax payments;
and
(g) all fixed income investments are carried at amortized cost rather
than at fair value for securities classified as available-for-sale
under GAAP.
8
<PAGE>
Financial Guaranty Insurance
Company Notes to Financial Statements (Continued)
- --------------------------------------------------------------------------------
The following is a reconciliation of net income and stockholder's equity
presented on a GAAP basis to the corresponding amounts reported on a
statutory-basis for the periods indicated below (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------------------------------
1996 1995 1994
------------------------ ------------------------ ------------------------
<S> <C> <C> <C> <C> <C> <C>
NET STOCKHOLDER'S NET STOCKHOLDER'S NET STOCKHOLDER'S
INCOME EQUITY INCOME EQUITY INCOME EQUITY
---------- ------------ ---------- ------------ ---------- ------------
GAAP basis amount.......................... $ 177,609 $1,684,434 $ 187,878 $1,547,881 $ 189,731 $1,279,723
Premium revenue recognition................ (9,358) (176,285) (22,555) (166,927) (4,970) (144,372)
Deferral of acquisition costs.............. 2,923 (91,945) (3,940) (94,868) 3,709 (90,928)
Contingency reserve........................ -- (460,973) -- (386,564) -- (328,073)
Non-admitted assets........................ -- (3,879) -- (5,731) -- (7,566)
Case basis loss reserves................... (3,197) (3,249) 4,048 (52) (3,340) (4,100)
Portfolio loss reserves.................... -- 24,000 (22,100) 24,000 (11,050) 46,100
Deferral of income taxes (benefits)........ 5,317 70,719 19,842 64,825 7,741 45,134
Unrealized gains (losses) on fixed maturity
securities held at fair value, net of
tax...................................... -- (39,160) -- (63,785) -- 41,773
Recognition of profit commission........... (441) (6,185) 3,096 (5,744) (2,410) (8,840)
Provision for unauthorized reinsurance..... -- -- -- -- -- (266)
Contingency reserve tax deduction (see Note
2)....................................... -- 85,176 -- 78,196 -- 55,496
Allocation of tax benefits due to Parent's
net operating loss to the Company (see
Note 5).................................. 313 10,603 637 10,290 (63) 9,653
---------- ------------ ---------- ------------ ---------- ------------
Statutory-basis amount..................... $ 173,166 $1,093,256 $ 166,906 $1,001,521 $ 179,348 $ 893,734
---------- ------------ ---------- ------------ ---------- ------------
---------- ------------ ---------- ------------ ---------- ------------
</TABLE>
9
<PAGE>
Financial Guaranty Insurance
Company Notes to Financial Statements (Continued)
- --------------------------------------------------------------------------------
(4) INVESTMENTS
Investments in fixed maturity securities carried at fair value of $3.1
million and $3.2 million as of December 31, 1996 and 1995, respectively,
were on deposit with various regulatory authorities as required by law.
The amortized cost and fair values of short-term investments and of
investments in fixed maturity securities classified as available-for-sale
are as follows (in thousands):
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR
1996 COST GAINS LOSSES VALUE
---- ------------ ----------- ----------- ------------
<S> <C> <C> <C> <C>
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies................. $ 57,987 $ 373 $ 1 $ 58,359
Obligations of states and political
subdivisions.............................. 2,098,486 65,254 4,854 2,158,886
Debt securities issued by foreign
governments............................... 33,830 -- 526 33,304
--------- ------ ----- ---------
Investments available-for-sale............. 2,190,303 65,627 5,381 2,250,549
Short-term investments..................... 73,839 -- -- 73,839
--------- ------ ----- ---------
Total...................................... $2,264,142 $65,627 $5,381 $2,324,388
---------- ------ ----- ---------
---------- ------ ----- ---------
</TABLE>
The amortized cost and fair values of short-term investments and of
investments in fixed maturity securities available-for-sale at December 31,
1996, by contractual maturity date, are shown below.
Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
call or prepayment penalties.
<TABLE>
<CAPTION>
AMORTIZED FAIR
1996 COST VALUE
---- ---------- ----------
<S> <C> <C>
Due in one year or less...................... $ 110,783 $ 110,888
Due after one year through five years........ 92,279 92,951
Due after five years through ten years....... 337,495 349,524
Due after ten years through twenty years..... 1,650,945 1,696,623
Due after twenty years....................... 72,640 74,402
--------- ---------
Total........................................ $2,264,142 $2,324,388
--------- ---------
--------- ---------
</TABLE>
10
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR
1995 COST GAINS LOSSES VALUE
- ------ ------------ ----------- ----------- ------------
<S> <C> <C> <C> <C>
U.S. Treasury securities and obligations of U.S. government
corporations and agencies.................................... $ 71,182 $ 1,696 -- $ 72,878
Obligations of states and political subdivisions............. 1,942,001 98,458 $ 1,625 2,038,834
Debt securities issued by foreign governments................ 30,270 152 550 29,872
------------ ----------- ----------- ------------
Investments available-for-sale............................... 2,043,453 100,306 2,175 2,141,584
Short-term investments....................................... 91,032 -- -- 91,032
------------ ----------- ----------- ------------
Total........................................................ $ 2,134,485 $ 100,306 $ 2,175 $ 2,232,616
------------ ----------- ----------- ------------
------------ ----------- ----------- ------------
</TABLE>
In 1996, 1995 and 1994, proceeds from sales and maturities of investments in
fixed maturity securities available-for-sale carried at fair value were
$891.6 million, $836.1 million, and $550.5 million, respectively. For 1996,
1995 and 1994 gross gains of $19.8 million, $36.3 million and $18.2 million
respectively, and gross losses of $15.0 million, $5.5 million and $12.3
million respectively, were realized on such sales.
Net investment income of the Company is derived from the following sources
(in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
<S> <C> <C> <C>
1996 1995 1994
---------- ---------- ----------
Income from fixed maturity securities..................... 119,290 $ 112,684 $ 108,519
Income from short-term investments........................ 6,423 8,450 2,479
---------- ---------- ----------
Total investment income................................... 125,713 121,134 110,998
Investment expenses....................................... 1,078 736 1,170
---------- ---------- ----------
Net investment income..................................... $ 124,635 $ 120,398 $ 109,828
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
As of December 31, 1996, the Company did not have more than 10% of its
investment portfolio concentrated in a single issuer or industry.
-11-
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- ------------------------------------------------------------------------------
(5) INCOME TAXES
------------
The Company files a federal tax return as part of the consolidated return of
General Electric Capital Corporation ("GE Capital"). Under a tax sharing
agreement with GE Capital, taxes are allocated to the Company and the Parent
based upon their respective contributions to consolidated net income. The
Company's effective federal corporate tax rate (20.8 percent in 1996, 20.6
percent in 1995 and 21.3 percent in 1994) is less than the corporate tax rate
on ordinary income of 35 percent in 1996, 1995 and 1994.
Federal income tax expense relating to operations of the Company for 1996,
1995 and 1994 is comprised of the following (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
<S> <C> <C> <C>
1996 1995 1994
--------- --------- ---------
Current tax expense........................................... $ 41,548 $ 28,913 $ 43,484
Deferred tax expense.......................................... 5,318 19,841 7,741
--------- --------- ---------
Federal income tax expense.................................... $ 46,866 $ 48,754 $ 51,225
--------- --------- ---------
--------- --------- ---------
</TABLE>
The following is a reconciliation of federal income taxes computed at the
statutory rate and the provision for federal income taxes (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
<S> <C> <C> <C>
1996 1995 1994
--------- --------- ---------
Income taxes computed on income before provision for federal
income taxes, at the
statutory rate................................................................. $ 78,566 $ 82,821 $ 84,334
Tax effect of:
Tax-exempt interest............................................................ (32,609) (30,630) (30,089)
Other, net..................................................................... 909 (3,437) (3,020)
--------- --------- ---------
Provision for income taxes....................................................... $ 46,866 $ 48,754 $ 51,225
--------- --------- ---------
--------- --------- ---------
</TABLE>
-12-
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- ------------------------------------------------------------------------------
The tax effects of temporary differences that give rise to significant
portions of the net deferred tax liability or asset at December 31, 1996 and
1995 are presented below (in thousands):
<TABLE>
<CAPTION>
1996 1995
--------- ---------
<S> <C> <C>
Deferred tax assets:
Loss reserves......................................................... $ 9,249 $ 8,382
Deferred compensation................................................. 2,531 5,735
Tax over book capital gains........................................... 2,144 1,069
Other................................................................. 2,601 3,248
--------- ---------
Total gross deferred tax assets......................................... 16,525 18,434
--------- ---------
Deferred tax liabilities:
Unrealized gains on fixed maturity securities, available-for-sale..... 21,086 34,346
Deferred acquisition costs............................................ 32,181 33,204
Premium revenue recognition........................................... 37,159 32,791
Rate differential on tax and loss bonds............................... 9,454 9,454
Other................................................................. 8,450 7,810
--------- ---------
Total gross deferred tax liabilities.................................... 108,330 117,605
--------- ---------
Net deferred tax liability.............................................. $ 91,805 $ 99,171
--------- ---------
--------- ---------
</TABLE>
Based upon the level of historical taxable income, projections of future
taxable income over the periods in which the deferred tax assets are
deductible and the estimated reversal of future taxable temporary
differences, the Company believes it is more likely than not that it will
realize the benefits of these deductible differences and has not established
a valuation allowance at December 31, 1996 and 1995. The Company anticipates
that the related deferred tax asset will be realized.
Total federal income tax payments during 1996, 1995 and 1994 were $33.9
million, $59.8 million, and $10.1 million, respectively.
-13-
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- ------------------------------------------------------------------------------
(6) REINSURANCE
-----------
The Company reinsures portions of its risk with other insurance
companies through quota share reinsurance treaties and, where warranted,
on a facultative basis. This process serves to limit the Company's
exposure on risks underwritten. In the event that any or all of the
reinsuring companies were unable to meet their obligations, the Company
would be liable for such defaulted amounts. The Company evaluates the
financial condition of its reinsurers and monitors concentrations of
credit risk arising from activities or economic characteristics of the
reinsurers to minimize its exposure to significant losses from reinsurer
insolvencies. The Company holds collateral under reinsurance agreements
in the form of letters of credit and trust agreements in various amounts
with various reinsurers totaling $32.9 million that can be drawn on in
the event of default.
Net premiums earned are presented net of ceded earned premiums of $23.7
million, $21.9 million and $39.0 million for the years ended December
31, 1996, 1995 and 1994, respectively. Loss and loss adjustment expenses
incurred are presented net of ceded losses of $(0.8) million, $1.1
million and $0.3 million for the years ended December 31, 1996, 1995 and
1994, respectively.
-14-
<PAGE>
Financial Guaranty Insurance
Company Notes To Financial Statements (Continued)
- ------------------------------------------------------------------------------
(7) LOSS AND LOSS ADJUSTMENT EXPENSES
Activity in the reserve for loss and loss adjustment expenses is
summarized as follows (in thousands):
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Balance at January 1,.............................................. $ 77,808 $ 98,746 $ 96,098
Less reinsurance recoverable..................................... (7,672) 14,472 14,168
----------- ----------- -----------
Net balance at January 1,.......................................... 70,136 84,274 81,930
Incurred related to:
Current year....................................................... -- 26,681 15,133
Prior years........................................................ 2,389 (1,207) (437)
Portfolio reserves................................................. -- (33,900) (11,050)
----------- ----------- -----------
Total Incurred..................................................... 2,389 (8,426) 3,646
----------- ----------- -----------
Paid related to:
Current year....................................................... -- (197) (382)
Prior years........................................................ (6,924) (5,515) (920)
----------- ----------- -----------
Total Paid......................................................... (6,924) (5,712) (1,302)
----------- ----------- -----------
Net balance at December 31,........................................ 65,601 70,136 84,274
Plus reinsurance recoverable...................................... 7,015 7,672 14,472
----------- ----------- -----------
Balance at December 31,............................................ $ 72,616 $ 77,808 $ 98,746
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The changes in incurred portfolio and case reserves principally relates
to business written in prior years. The changes are based upon an
evaluation of the insured portfolio in light of current economic
conditions and other relevant factors.
15
<PAGE>
Financial Guaranty Insurance
Company Notes To Financial Statements (Continued)
- ------------------------------------------------------------------------------
(8) RELATED PARTY TRANSACTIONS
The Company has various agreements with subsidiaries of General Electric
Company ("GE") and GE Capital. These business transactions include
appraisal fees and due diligence costs associated with underwriting
structured finance mortgage-backed security business; payroll and office
expenses incurred by the Company's international branch offices but
processed by a GE subsidiary; investment fees pertaining to the
management of the Company's investment portfolio; and telecommunication
service charges. Approximately $8.1 million, $3.2 million and $3.2
million in expenses were incurred in 1996, 1995 and 1994, respectively,
related to such transactions.
The Company also insured certain non-municipal issues with GE Capital
involvement as sponsor of the insured securitization and/or servicer of
the underlying assets. For some of these issues, GE Capital also provides
first loss protection in the event of default. Gross premiums written on
these issues amounted to $0.6 million in 1996, $1.3 million in 1995, and
$2.5 million in 1994.
The Company insures bond issues and securities in trusts that were
sponsored by affiliates of GE (approximately 1 percent of gross premiums
written) in 1996, 1995 and 1994.
(9) COMPENSATION PLANS
Officers and other key employees of the Company participate in the
Parent's incentive compensation, deferred compensation and profit sharing
plans. Expenses incurred by the Company under compensation plans and
bonuses amounted to $4.5 million, $7.5 million and $12.2 million in 1996,
1995 and 1994, respectively, before deduction for related tax benefits.
(10) DIVIDENDS
Under New York insurance law, the Company may pay a dividend only from
earned surplus subject to the following limitations: (a) statutory
surplus after such dividend may not be less than the minimum required
paid-in capital, which was $66.4 million in 1996 and 1995, and
(b) dividends may not exceed the lesser of 10 percent of its surplus or
100 percent of adjusted net investment income, as defined by New York
insurance law, for the 12 month period ending on the preceding
December 31, without the prior approval of the Superintendent of the
New York State Insurance Department. At December 31, 1996 and 1995, the
amount of the Company's surplus available for dividends was approximately
$91.8 million and $100.2 million, respectively.
During 1996 and 1995, the Company paid dividends of $17.5 milion and
$25.0 million, respectively. No dividends were paid during 1994.
16
<PAGE>
Financial Guaranty Insurance
Company Notes To Financial Statements (Continued)
- ------------------------------------------------------------------------------
(11) FINANCIAL INSTRUMENTS
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in
estimating fair values of financial instruments:
Fixed Maturity Securities: Fair values for fixed maturity securities are
based on quoted market prices, if available. If a quoted market price is
not available, fair values is estimated using quoted market prices for
similar securities. Fair value disclosure for fixed maturity securities
is included in the balance sheets and in Note 4.
Short-Term Investments: Short-term investments are carried at cost, which
approximates fair value.
Cash, Receivable for Securities Sold, and Payable for Securities
Purchased: The carrying amounts of these items approximate their fair
values.
The estimated fair values of the Company's financial instruments at
December 31, 1996 and 1995 are as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995
--------------------------- ---------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- ----- -------- -----
<S> <C> <C> <C> <C>
Financial Assets
Cash
On hand and in demand accounts......................... $ 860 $ 860 $ 199 $ 199
Short-term investments.................................... $ 73,839 $ 73,839 $ 91,032 $ 91,032
Fixed maturity securities................................. $ 2,250,549 $ 2,250,549 $ 2,141,584 $ 2,141,584
</TABLE>
Financial Guaranties: The carrying value of the Company's financial
guaranties is represented by the unearned premium reserve, net of
deferred acquisition costs, and loss and loss adjustment expense
reserves. Estimated fair values of these guaranties are based on amounts
currently charged to enter into similar agreements (net of applicable
ceding commissions), discounted cash flows considering contractual
revenues to be received adjusted for expected prepayments, the present
value of future obligations and estimated losses, and current interest
rates. The estimated fair values of such financial guaranties range
between $358.7million and $387.4 million compared to a carrying value of
$487.8 million as of December 31, 1996 and between $412.8 million and
$456.2 million compared to a carrying value of $540.6 million as of
December 31, 1995.
17
<PAGE>
Financial Guaranty Insurance
Company Notes To Financial Statements (Continued)
- ------------------------------------------------------------------------------
CONCENTRATIONS OF CREDIT RISK
The Company considers its role in providing insurance to be credit
enhancement rather than credit substitution. The Company insures only
those securities that, in its judgment, are of investment grade quality.
The Company has established and maintains its own underwriting standards
that are based on those aspects of credit that the Company deems
important for the particular category of obligations considered for
insurance. Credit criteria include economic and social trends, debt
management, financial management and legal and administrative factors,
the adequacy of anticipated cash flows, including the historical and
expected performance of assets pledged for payment of securities under
varying economic scenarios and underlying levels of protection such as
insurance or overcollateralization.
In connection with underwriting new issues, the Company sometimes
requires, as a condition to insuring an issue, that collateral be pledged
or, in some instances, that a third-party guarantee be provided for a
term of the obligation insured by a party of acceptable credit quality
obligated to make payment prior to any payment by the Company. The types
and extent of collateral pledged varies, but may include residential and
commercial mortgages, corporate debt, government debt and consumer
receivables.
As of December 31, 1996, the Company's total insured principal exposure
to credit loss in the event of default by bond issuers was $104.4
billion, net of reinsurance of $30.8 billion. The Company's insured
portfolio as of December 31, 1996 was broadly diversified by geography
and bond market sector with no single debt issuer representing more than
1% of the Company's principal exposure outstanding, net of reinsurance.
As of December 31, 1996, the composition of principal exposure by type of
issue, net of reinsurance, was as follows (in millions):
<TABLE>
<CAPTION>
NET
PRINCIPAL
OUTSTANDING
-----------
<S> <C>
Municipal:
General obligation............................................................. $ 50,213.1
Special revenue................................................................ 33,037.8
Industrial revenue............................................................. 366.5
Non-municipal.................................................................. 20,776.2
------------
Total........................................................................... $ 104,393.6
------------
------------
</TABLE>
The Company's net exposure outstanding is $188,646.00 million as of
December 31, 1996.
18
<PAGE>
Financial Guaranty Insurance
Company Notes To Financial Statements (Continued)
- ------------------------------------------------------------------------------
The Company is authorized to do business in 50 states, the District of
Columbia, and in the United Kingdom and France. Principal exposure
outstanding at December 31, 1996 by state, net of reinsurance, was as
follows (in millions):
<TABLE>
<CAPTION>
NET
PRINCIPAL
OUTSTANDING
-----------
<S> <C>
California....................................................................... $ 11,251.7
Florida.......................................................................... 9,838.4
Pennsylvania..................................................................... 9,325.3
New York......................................................................... 8,184.5
Illinois......................................................................... 6,721.2
Texas............................................................................ 5,799.1
New Jersey....................................................................... 4,465.3
Michigan......................................................................... 4,166.6
Arizona.......................................................................... 2,808.9
Ohio............................................................................. 2,616.0
------------
Sub-total 65,177.0
Other states and International 39,216.6
------------
Total $ 104,393.6
------------
------------
</TABLE>
(12) COMMITMENTS
Total rent expense was $2.8 million, $2.2 million and $2.6 million in
1996, 1995 and 1994, respectively. For each of the next five years and in
the aggregate as of December 31, 1996, the minimum future rental payments
under noncancellable operating leases having remaining terms in excess of
one year approximate (in thousands):
<TABLE>
<CAPTION>
YEAR AMOUNT
- ---- ------
<S> <C>
1997................................................................. $ 2,909
1998................................................................. 2,909
1999................................................................. 2,909
2000................................................................. 2,909
2001................................................................. 2,911
---------
Total minimum future rental payments................................. $ 14,547
---------
---------
</TABLE>
19
<PAGE>
FINANCIAL GUARANTY INSURANCE COMPANY
- ------------------------------------------------------------------------------
UNAUDITED INTERIM FINANCIAL STATEMENTS
March 31, 1997
Balance Sheets..........................................................1
Statements of Income....................................................2
Statements of Cash Flows................................................3
Notes to Unaudited Interim Financial Statements.........................4
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY BALANCE SHEET
- ------------------------------------------------------------------------------
($ in Thousands)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1997 1996
------------- ------------
<S> <C> <C>
ASSETS (UNAUDITED)
Fixed maturity securities, available for sale, at fair value
(amortized cost of $2,141,691 in 1997 and $2,190,303 in 1996)... $ 2,165,694 $ 2,250,549
Short-term investments, at cost, which approximates market........ 165,686 73,839
Cash.............................................................. 1,050 860
Accrued investment income......................................... 36,173 37,655
Reinsurance receivable............................................ 6,986 7,015
Deferred policy acquisition costs................................. 90,960 91,945
Property, plant and equipment net of accumulated depreciation of
$15,962 in 1997 and $15,333 in 1996............................. 4,343 4,696
Prepaid reinsurance premiums...................................... 167,643 167,683
Prepaid expenses and other assets................................. 23,773 19,899
------------ ------------
Total assets.................................................. $ 2,662,308 $ 2,654,141
------------ ------------
------------ ------------
Liabilities and Stockholder's Equity
Liabilities:
Unearned premiums................................................. $ 673,704 $ 681,816
Losses and loss adjustment expenses............................... 70,713 72,616
Ceded reinsurance payable......................................... 373 10,561
Accounts payable and accrued expenses............................. 57,144 54,165
Due to parent..................................................... -- 1,791
Current federal income taxes payable.............................. 65,679 52,016
Deferred federal income taxes payable............................. 80,354 91,805
Payable for securities purchased.................................. 8,026 4,937
------------ ------------
Total liabilities............................................. 955,993 969,707
------------ ------------
------------ ------------
Stockholder's Equity:
Common stock, par value $1,500 per share at March 31, 1997 and at
December 31, 1996: 10,000 shares authorized, issued and
outstanding..................................................... 15,000 15,000
Additional paid-in capital........................................ 334,011 334,011
Net unrealized gains on fixed maturity securities available for
sale, net of tax................................................ 15,602 39,160
Foreign currency translation adjustment........................... (423) (429)
Retained earnings................................................. 1,342,125 1,296,692
------------ ------------
Total stockholder's equity.................................... 1,706,315 1,684,434
------------ ------------
Total liabilities and stockholder's equity.................... $ 2,662,308 $ 2,654,141
------------ ------------
------------ ------------
</TABLE>
See accompanying notes to interim financial statements.
1
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY STATEMENT OF INCOME
- ------------------------------------------------------------------------------
($ in Thousands)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1997 1996
---------- ---------
(UNAUDITED)
<S> <C> <C>
Revenues:
Gross premiums written....................................... $ 28,518 $ 21,277
Ceded premiums............................................... (7,137) (3,300)
---------- ---------
Net premiums written......................................... 21,381 17,977
Decrease in net unearned premiums............................ 8,072 17,018
---------- ---------
Net premiums earned.......................................... 29,453 34,995
Net investment income........................................ 31,597 31,063
Net realized gains........................................... 6,069 5,074
---------- ---------
Total revenues............................................. 67,119 71,132
---------- ---------
Expenses:
Losses and loss adjustment expenses.......................... (249) (1,165)
Policy acquisition costs..................................... 3,851 6,790
Other underwriting expenses.................................. 3,851 4,207
---------- ---------
Total expenses............................................. 7,453 9,832
---------- ---------
Income before provision for federal income taxes........... 59,666 61,300
Provision for federal income taxes............................ 14,233 13,346
---------- ---------
Net income................................................. $ 45,433 $ 47,954
---------- ---------
---------- ---------
</TABLE>
See accompanying notes to interim financial statements.
2
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY STATEMENT OF CASH FLOW
- ------------------------------------------------------------------------------
($ in Thousands)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
<S> <C> <C>
1997 1996
----------- -----------
(UNAUDITED)
Operating activities:
Net income......................................................... $ 45,433 $ 47,954
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for deferred income taxes................................ 562 917
Amortization of fixed maturity securities.......................... 227 41
Policy acquisition costs deferred.................................. (2,866) (4,258)
Amortization of deferred policy acquisition costs.................. 3,851 6,790
Depreciation of fixed assets....................................... 629 612
Change in reinsurance receivable................................... 29 124
Change in prepaid reinsurance premiums............................. 40 1,398
Foreign currency translation adjustment............................ 9 (1,218)
Change in accrued investment income, prepaid expenses and other
assets........................................................... (2,392) 15,127
Change in unearned premiums........................................ (8,112) (18,416)
Change in losses and loss adjustment expense reserves.............. (1,903) (3,005)
Change in other liabilities........................................ (9,000) (552)
Change in current income taxes payable............................. 13,663 12,429
Net realized gains on investments.................................. (6,069) (5,074)
----------- -----------
Net cash provided by operating activities.......................... 34,101 52,869
----------- -----------
Investing activities:
Sales or maturities of fixed maturity securities................... 272,200 199,015
Purchases of fixed maturity securities............................. (213,987) (240,781)
Sales or maturities (purchases) of short-term investments, net..... (91,847) (10,101)
Purchases of property and equipment, net........................... (277) (381)
----------- -----------
Net cash used for investing activities............................. (33,911) (52,248)
Increase in cash................................................... 190 621
Cash at beginning of period........................................ 860 199
----------- -----------
Cash at end of period.............................................. $ 1,050 $ 820
----------- -----------
----------- -----------
</TABLE>
See accompanying notes to interim financial statements.
3
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
MARCH 31, 1997 AND 1996
(UNAUDITED)
(1) BASIS OF PRESENTATION
---------------------
The interim financial statements of Financial Guaranty Insurance
Company (the Company) in this report reflect all adjustments
necessary, in the opinion of management, for a fair statement of
(a) results of operations for the three months ended March 31, 1997
and 1996, (b) the financial position at March 31, 1997 and December
31, 1996, and (c) cash flows for the three months ended March 31,
1997 and 1996.
These interim financial statements should be read in conjunction
with the financial statements and related notes included in the
1996 audited financial statements.
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that effect the reported amounts of
assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
(2) STATUTORY ACCOUNTING PRACTICES
------------------------------
The financial statements are prepared on the basis of GAAP, which
differs in certain respects from accounting practices prescribed or
permitted by state insurance regulatory authorities. The following
are the significant ways in which statutory basis accounting
practices differ from GAAP:
(a) premiums are earned directly in proportion to the scheduled
principal and interest payments rather than in proportion to the total
exposure outstanding at any point in time;
(b) policy acquisition costs are charged to current operations as
incurred rather than as related premiums are earned;
(c) a contingency reserve is computed on the basis of statutory
requirements for the security of all policyholders, regardless of whether
loss contingencies actually exist, whereas under GAAP, a reserve is
established based on an ultimate estimate of exposure;
(d) certain assets designated as "non-admitted assets" are charged
directly against surplus but are reflected as assets under GAAP, if
recoverable;
(e) federal income taxes are only provided with respect to taxable
income for which income taxes are currently payable, while under GAAP taxes
are also provided for differences between the financial reporting and tax
bases of assets and liabilities;
(f) purchases of tax and loss bonds are reflected as admitted assets,
while under GAAP they are recorded as federal income tax payments; and
(g) all fixed income investments are carried at amortized cost, rather
than at fair value for securities classified as "Available for Sale" under
GAAP.
4
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
The following is a reconciliation of the net income and stockholder's equity
of Financial Guaranty prepared on a GAAP basis to the corresponding amounts
reported on a statutory basis for the periods indicated below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
------------------------------------------------
1997 1996
----------------------- -----------------------
NET STOCKHOLDER'S NET STOCKHOLDER'S
INCOME EQUITY INCOME EQUITY
--------- ------------ --------- ------------
<S> <C> <C> <C> <C>
GAAP basis amount............................................... 45,433 1,706,315 $ 47,954 $1,553,480
Premium revenue recognition..................................... (2,466) (178,751) (1,933) (168,861)
Deferral of acquisition costs................................... 985 (90,960) 2,532 (92,336)
Contingency reserve............................................. -- (474,460) -- (403,087)
Non-admitted assets............................................. -- (3,257) -- (5,283)
Case-basis losses incurred...................................... (661) (3,910) (1,750) (1,798)
Portfolio loss reserves......................................... -- 24,000 -- 24,000
Deferral of income tax.......................................... 570 71,274 917 65,315
Unrealized gains on fixed maturity securities held at fair
value, net of taxes........................................... -- (15,602) -- (22,222)
Profit commission............................................... (343) (6,528) 782 (4,965)
Contingency reserve tax deduction............................... -- 85,176 -- 78,196
Allocation of tax benefits due to Parent's net operating loss to
the Company................................................... 94 10,628 (55) 10,236
--------- ------------ --------- ------------
Statutory basis amount.......................................... 43,612 1,123,724 $ 48,447 $1,032,675
--------- ------------ --------- ------------
--------- ------------ --------- ------------
</TABLE>
5
<PAGE>
FINANCIAL GUARANTY INSURANCE
COMPANY NOTES TO FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
MARCH 31, 1997 AND 1996
(Unaudited)
(3) DIVIDENDS
---------
Under New York Insurance Law, the Company may pay a dividend only from
earned surplus subject to the following limitations:
- Statutory surplus after dividends may not be less than the minimum
required paid-in capital, which was $2,100,000 in 1996.
- Dividends may not exceed the lesser of 10 percent of its surplus or
100 percent of adjusted net investment income, as defined therein,
for the twelve month period ending on the preceding December 31,
without the prior approval of the Superintendent of the New York
State Insurance Department.
The amount of the Company's surplus available for dividends during 1997
is approximately $112.4 million.
(4) INCOME TAXES
------------
The Company's effective Federal corporate tax rate (23.9 percent
and 21.8 percent for the three months ended March 31, 1997 and
1996, respectively) is less than the statutory corporate tax rate
(35 percent in 1996 and 1995) on ordinary income due to permanent
differences between financial and taxable income, principally
tax-exempt interest.
(5) REINSURANCE
-----------
In accordance with Statement of Financial Accounting Standards No.
113 ("SFAS 113"), "Accounting and Reporting for Reinsurance of
Short-Duration and Long-Duration Contracts", the Company reports
assets and liabilities relating to reinsured contracts gross of the
effects of reinsurance. Net premiums earned are shown net of
premiums ceded of $7.2 million and $7.3 million, respectively, for
the three months ended March 31, 1997 and 1996.
6
