Triad Guaranty Inc.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2008
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 0-22342
Triad Guaranty Inc.
(Exact name of registrant as specified in its charter)
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DELAWARE
(State or other jurisdiction of
incorporation or organization)
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56-1838519
(I.R.S. Employer
Identification No.) |
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101 South Stratford Road
Winston-Salem, North Carolina
(Address of principal executive offices)
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27104
(Zip Code) |
(336) 723-1282
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o |
Accelerated filer o |
Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company þ
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act) Yes o No þ
Number of shares of common stock, par value $0.01 per share, outstanding as of August 1, 2008, was
15,116,259.
TRIAD GUARANTY INC.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
TRIAD GUARANTY INC.
CONSOLIDATED BALANCE SHEETS
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June 30, |
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December 31, |
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(dollars in thousands, except per share data) |
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2008 |
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2007 |
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(unaudited) |
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(audited) |
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ASSETS |
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Invested assets: |
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Securities available-for-sale, at fair value: |
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Fixed maturities (amortized cost: $840,320 and $710,924) |
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$ |
843,951 |
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$ |
725,631 |
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Equity securities (cost: $2,270 and $2,520) |
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1,749 |
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2,162 |
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Short-term investments |
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23,322 |
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56,746 |
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Total invested assets |
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869,022 |
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784,539 |
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Cash and cash equivalents |
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19,669 |
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124,811 |
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Real estate acquired in claim settlement |
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6,202 |
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10,860 |
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Accrued investment income |
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10,820 |
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10,246 |
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Deferred policy acquisition costs |
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36,243 |
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Prepaid federal income taxes |
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63,183 |
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116,008 |
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Property and equipment |
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10,146 |
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11,421 |
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Reinsurance recoverable, net |
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55,316 |
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5,815 |
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Other assets |
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29,440 |
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32,910 |
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Total assets |
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$ |
1,063,798 |
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$ |
1,132,853 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Liabilities: |
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Losses and loss adjustment expenses |
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$ |
817,262 |
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$ |
359,939 |
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Unearned premiums |
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18,360 |
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17,793 |
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Amounts payable to reinsurers |
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6,525 |
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Deferred income taxes |
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30,386 |
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123,297 |
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Revolving line of credit |
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80,000 |
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Long-term debt |
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34,527 |
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34,519 |
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Accrued interest on debt |
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1,275 |
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1,355 |
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Accrued expenses and other liabilities |
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21,079 |
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10,574 |
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Total liabilities |
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922,889 |
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634,002 |
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Commitments and contingencies Note 4 |
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Stockholders equity: |
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Preferred stock, par value $0.01 per share
authorized 1,000,000 shares; no shares issued and
outstanding |
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Common stock, par value $0.01 per share authorized
32,000,000 shares; issued and outstanding 15,116,259
shares at June 30,2008 and 14,920,243 shares at December
31, 2007 |
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151 |
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149 |
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Additional paid-in capital |
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111,380 |
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109,679 |
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Accumulated other comprehensive income, net of income
tax liability of $1,392 at June 30, 2008 and $6,475 at
December 31, 2007 |
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2,585 |
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13,405 |
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Retained earnings |
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26,793 |
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375,618 |
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Total stockholders equity |
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140,909 |
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498,851 |
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Total liabilities and stockholders equity |
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$ |
1,063,798 |
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$ |
1,132,853 |
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See accompanying notes.
1
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(unaudited)
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Three Months Ended |
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Six Months Ended |
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June 30, |
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June 30, |
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(dollars in thousands, except per share data) |
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2008 |
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2007 |
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2008 |
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2007 |
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Revenue: |
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Premiums written: |
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Direct |
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$ |
84,561 |
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$ |
83,153 |
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$ |
173,946 |
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$ |
161,561 |
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Ceded |
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(15,480 |
) |
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(12,988 |
) |
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(31,475 |
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(25,689 |
) |
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Net premiums written |
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69,081 |
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70,165 |
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142,471 |
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135,872 |
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Change in unearned premiums |
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784 |
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(433 |
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(542 |
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(2,192 |
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Earned premiums |
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69,865 |
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69,732 |
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141,929 |
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133,680 |
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Net investment income |
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9,175 |
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7,673 |
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18,722 |
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15,022 |
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Net realized investment losses |
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(3,799 |
) |
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(3,867 |
) |
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(1,096 |
) |
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(3,105 |
) |
Other income |
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2 |
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2 |
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4 |
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4 |
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75,243 |
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73,540 |
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159,559 |
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145,601 |
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Losses and expenses: |
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Net losses and loss adjustment expenses |
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292,749 |
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41,893 |
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514,008 |
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74,474 |
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Net change in premium deficiency reserve |
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(15,000 |
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Interest expense on debt |
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696 |
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694 |
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2,172 |
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1,387 |
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Policy acquisition costs |
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4,670 |
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39,416 |
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9,293 |
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Other operating expenses (net of acquisition
costs deferred) |
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27,238 |
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10,716 |
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41,344 |
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21,047 |
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305,683 |
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57,973 |
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596,940 |
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106,201 |
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(Loss) income before income taxes (benefit) |
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(230,440 |
) |
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15,567 |
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(437,381 |
) |
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39,400 |
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Income taxes (benefit): |
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Current |
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2 |
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1,766 |
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(2 |
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3,525 |
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Deferred |
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(31,631 |
) |
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1,775 |
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(88,554 |
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6,526 |
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(31,629 |
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3,541 |
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(88,556 |
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10,051 |
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Net (loss) income |
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$ |
(198,811 |
) |
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$ |
12,026 |
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$ |
(348,825 |
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$ |
29,349 |
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(Loss) earnings per common and common
equivalent share: |
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Basic |
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$ |
(13.36 |
) |
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$ |
0.81 |
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$ |
(23.45 |
) |
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$ |
1.98 |
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Diluted |
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$ |
(13.36 |
) |
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$ |
0.80 |
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$ |
(23.45 |
) |
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$ |
1.96 |
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Shares used in computing (loss) earnings per
common and common equivalent share: |
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Basic |
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14,878,662 |
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14,834,500 |
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14,873,636 |
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14,824,460 |
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Diluted |
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14,878,662 |
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14,950,721 |
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14,873,636 |
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14,946,204 |
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See accompanying notes.
2
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(unaudited)
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Six Months Ended |
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June 30, |
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(dollars in thousands) |
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2008 |
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2007 |
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Operating activities |
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Net (loss) income |
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$ |
(348,825 |
) |
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$ |
29,349 |
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Adjustments to reconcile net income (loss) to net cash provided by
operating activities: |
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Losses, loss adjustment expenses and unearned premium reserves |
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457,890 |
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39,977 |
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Accrued expenses and other liabilities |
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9,904 |
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(1,503 |
) |
Reinsurance |
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(56,026 |
) |
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1,202 |
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Accrued investment income |
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(586 |
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(918 |
) |
Policy acquisition costs deferred |
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(3,173 |
) |
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(9,307 |
) |
Policy acquisition costs |
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39,416 |
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9,293 |
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Net realized investment losses |
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1,096 |
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3,105 |
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Provision for depreciation |
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2,338 |
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|
996 |
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Accretion of discount on investments |
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|
793 |
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317 |
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Deferred income taxes |
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(88,554 |
) |
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6,526 |
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Prepaid federal income taxes |
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52,825 |
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(3,168 |
) |
Real estate acquired in claim settlement, net of write-downs |
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4,658 |
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2,247 |
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Accrued interest on debt |
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(80 |
) |
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Other assets |
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4,104 |
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(6,235 |
) |
Other operating activities |
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2,433 |
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1,765 |
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Net cash provided by operating activities |
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78,213 |
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73,646 |
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Investing activities |
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Securities available-for-sale: |
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Purchases fixed maturities |
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(584,572 |
) |
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(128,370 |
) |
Sales fixed maturities |
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430,107 |
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|
80,120 |
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Maturities fixed maturities |
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20,333 |
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|
3,391 |
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Purchases equities |
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(55 |
) |
Sales equities |
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|
266 |
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|
7,086 |
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Net change in short-term investments |
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31,655 |
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(47,083 |
) |
Purchases of property and equipment |
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(1,080 |
) |
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(3,404 |
) |
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Net cash used in investing activities |
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|
(103,291 |
) |
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|
(88,315 |
) |
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Financing activities |
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Payments on revolving credit facility |
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(80,000 |
) |
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Excess tax benefits from share-based compensation |
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|
175 |
|
Proceeds from exercise of stock options |
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|
616 |
|
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Net cash (used in) provided by financing activities |
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(80,000 |
) |
|
|
791 |
|
|
|
|
|
|
|
|
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|
Foreign currency translation adjustment on cash and cash equivalents |
|
|
(64 |
) |
|
|
1,980 |
|
|
|
|
|
|
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Net change in cash and cash equivalents |
|
|
(105,142 |
) |
|
|
(11,898 |
) |
Cash and cash equivalents at beginning of period |
|
|
124,811 |
|
|
|
38,609 |
|
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Cash and cash equivalents at end of period |
|
$ |
19,669 |
|
|
$ |
26,711 |
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Supplemental schedule of cash flow information |
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Cash (received) paid during the period for: |
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|
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|
|
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|
Income taxes and United States Mortgage Guaranty
Tax and Loss Bonds |
|
$ |
(52,824 |
) |
|
$ |
9,091 |
|
Interest |
|
$ |
2,248 |
|
|
$ |
1,383 |
|
See accompanying notes.
3
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2008
(Unaudited)
1. The Company
Triad Guaranty Inc. (the Company) is a holding company which, through its wholly-owned
subsidiary, Triad Guaranty Insurance Corporation (Triad), provides mortgage insurance coverage in
the United States. Triad ceased issuing new commitments for mortgage insurance coverage on July 15,
2008 and is in the process of transitioning the business to run-off. In run-off, the Company
intends to continue to service its remaining insurance in force, including collecting renewal
premiums on the business in force and paying claims resulting from loans currently in default or
loans that may go into default in the future.
Another wholly-owned subsidiary, Triad Guaranty Insurance Corporation Canada (TGICC), was
formed in 2007 for the purpose of exploring opportunities for providing mortgage insurance in
Canada. TGICC did not write any business and only incurred start-up expenses since its formation.
In the first quarter of 2008, the Company discontinued its Canadian efforts. The Canadian
subsidiary is no longer a licensed insurance company. Effective June 30, 2008, there are no
Canadian employees and the subsidiary is in the process of being liquidated.
2. Accounting Policies and Basis of Presentation
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in conformity
with accounting principles generally accepted in the United States of America (GAAP) for interim
financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial statements. In the
opinion of management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the three months and
six months ended June 30, 2008 are not necessarily indicative of the results that may be expected
for the year ending December 31, 2008. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Triad Guaranty Inc. annual report on
Form 10-K for the year ended December 31, 2007.
Recent Accounting Pronouncements
Effective January 1, 2008, the Company adopted SFAS 157, Fair Value Measurements, which
establishes a framework for measuring fair value under GAAP, clarifies the definition of fair value
within that framework, and expands disclosures about the use of the fair value measurements. In
accordance with SFAS 157, the Company adopted the fair value measurement on a prospective basis and
accordingly has provided the required disclosures only for the most
4
recent interim reporting date. The following table summarizes the assets measured at fair
value and the source of the inputs in the determination of fair value:
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Fair Value Measurements at Reporting Date Using |
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|
|
|
|
|
|
Quoted |
|
|
|
|
|
|
|
|
|
|
|
|
|
Prices in |
|
|
|
|
|
|
|
|
|
|
|
|
|
Active |
|
|
Significant |
|
|
|
|
|
|
Six Months |
|
|
Markets for |
|
|
Other |
|
|
Significant |
|
|
|
Ended |
|
|
Identical |
|
|
Observable |
|
|
Unobservable |
|
|
|
June 30, |
|
|
Assets |
|
|
Inputs |
|
|
Inputs |
|
(dollars in thousands) |
|
2008 |
|
|
(Level 1) |
|
|
(Level 2) |
|
|
(Level 3) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities available-for-sale |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities |
|
$ |
843,951 |
|
|
$ |
|
|
|
$ |
810,743 |
|
|
$ |
33,208 |
|
Equity securities |
|
|
1,749 |
|
|
|
1,749 |
|
|
|
|
|
|
|
|
|
Real estate acquired in claim
settlement |
|
|
6,202 |
|
|
|
|
|
|
|
6,202 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
851,902 |
|
|
$ |
1,749 |
|
|
$ |
816,945 |
|
|
$ |
33,208 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We utilized significant unobservable inputs (Level 3) in determining the fair value on certain
bonds in our fixed maturities portfolio during this period. The following table provides a
reconciliation of the beginning and ending balances during the second quarter of 2008 of these
Level 3 bonds and the related gains and losses related to these assets.
|
|
|
|
|
|
|
Fair Value Measurement |
|
|
|
Using Significant |
|
|
|
Unobservable Inputs |
|
|
|
(Level 3) |
|
|
|
Certain Bonds in Fixed |
|
|
|
Maturities AFS |
|
(dollars in thousands) |
|
Portfolio |
|
|
|
|
|
|
Beginning balance |
|
$ |
7,402 |
|
Total gains and losses (realized and unrealized): |
|
|
|
|
Included in operations |
|
|
(130 |
) |
Included in other comprehensive income |
|
|
(343 |
) |
Purchases, issuances and settlements |
|
|
25,382 |
|
Transfers in and/or out of Level 3 |
|
|
897 |
|
|
|
|
|
Ending balance |
|
$ |
33,208 |
|
|
|
|
|
|
|
|
|
|
The amount of total gains and loss for the period included in
operations attributable to the change in unrealized gains
or
losses relating to assets still held at the reporting date. |
|
$ |
(347 |
) |
|
|
|
|
Gains and losses (realized and unrealized) included in operations or other comprehensive
income for the period ended June 30, 2008 are reported as net realized investment gains as a gain
of $20,000 and an unrealized loss through other comprehensive income of $347,000.
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting
Principles (SFAS 162). This statement identifies the sources of accounting principles and the
framework for selecting the principles used in the preparation of financial statements of
non-governmental entities that are presented in conformity with US GAAP. SFAS
5
162 is effective 60
days following the SECs approval of the Public Company Accounting Oversight Board amendments to AU
Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting
Principles. The Company does not anticipate that SFAS 162 will have a material impact on the
Companys financial position or results of operations.
In December 2007, the FASB issued SFAS 160, Noncontrolling Interests in Consolidated Financial
Statementsan amendment of ARB No. 51 (SFAS 160). This statement establishes accounting and
reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of
a subsidiary. This statement is effective prospectively, except for certain retrospective
disclosure requirements, for fiscal years beginning after December 15, 2008. This statement will
be effective for the Company beginning January 1, 2009. The Company does not anticipate SFAS 160
will have a material impact on the Companys financial position or results of operations.
In December 2007, the FASB issued SFAS 141(R), Business Combinationsa replacement of FASB
Statement No. 141 (SFAS 141(R)), which significantly changes the principles and requirements for
how the acquirer of a business recognizes and measures in its financial statements the identifiable
assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The
statement also provides guidance for recognizing and measuring the goodwill acquired in the
business combination and determines what information to disclose to enable users of the financial
statements to evaluate the nature and financial effects of the business combination. This
statement is effective prospectively, except for certain retrospective adjustments to deferred tax
balances, for fiscal years beginning after December 15, 2008. This statement will be effective for
the Company beginning January 1, 2009. The Company does not anticipate that SFAS 141(R) will have
a material impact on the Companys financial position or results of operations.
3. Consolidation
The consolidated financial statements include the accounts of Triad Guaranty Inc. and all of
its subsidiaries. All significant intercompany accounts and transactions have been eliminated.
4. Commitments and Contingencies
Reinsurance
Certain premiums and losses are ceded to other insurance companies under various reinsurance
agreements, the majority of which are captive reinsurance agreements with affiliates of certain
customers. Reinsurance contracts do not relieve Triad from its obligations to policyholders.
Failure of the reinsurer to honor its obligation could result in losses to Triad; consequently,
allowances are established for amounts deemed uncollectible. Triad evaluates the financial
condition of its reinsurers and monitors credit risk arising from similar geographic regions,
activities, or economic characteristics of its reinsurers to minimize its exposure to significant
losses from reinsurer insolvency.
The Company maintains a $95 million Excess-of-Loss reinsurance treaty that provides a benefit
when Triads risk-to-capital ratio exceeds 25-to-1 and the combined ratio exceeds 100%
6
(the
attachment point). Once the attachment point has been reached, the treaty terminates and converts
to run-off coverage for a ten year period (the run-off period). During the run-off period,
following a one-time deductible of $25 million, the carrier is responsible for the reimbursement of
all paid losses in each quarter that the attachment point is breached up to the one-time $95
million policy limit. Additionally, terms of the treaty require the Company to continue the payment
of premiums to the reinsurer amounting to approximately $2 million per year for the entire ten year
run-off period.
Under the terms specified above, the reinsurance treaty reached the attachment point at the
end of the first quarter of 2008 and the Company notified the reinsurance carrier that the treaty
would convert to run-off coverage beginning in the second quarter of 2008. However, in April 2008,
the reinsurance carrier informed the Company that, in its opinion, the Company had not complied
with unspecified covenants in the reinsurance agreement and provided notice of termination of the
agreement. The Company has notified the reinsurance carrier that it disputes the carriers claim,
including the carriers alleged termination of the reinsurance agreement, and has demanded
arbitration as provided under the agreement. The Company believes that the reinsurance carriers
claims are without merit and the Company plans to contest such claims vigorously. As the matter is
in dispute, the Company has not recorded any ceded reserves or any recoverable from the reinsurance
carrier under the agreement in its financial statements prepared under generally accepted
accounting principles.
Insurance In Force, Dividend Restrictions, and Statutory Results
Historically, insurance regulators and rating agencies utilized the risk-to-capital ratio as a
general guideline to limit the risk a mortgage insurer could write with a 25-to-1 risk-to-capital
ratio as the maximum allowed. Capital for purposes of this computation includes the statutory
capital and surplus as well as the statutory contingency reserve. The amount of net risk for
insurance in force at June 30, 2008, December 31, 2007 and June 30, 2007, as presented below,
was computed by applying the various percentage settlement options to the insurance in force
amounts, adjusted by risk ceded under reinsurance agreements, any applicable stop-loss limits and
deductibles. Triads ratio is as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
June 30, |
|
(dollars in thousands) |
|
2008 |
|
|
2007 |
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net risk |
|
$ |
11,721,202 |
|
|
$ |
11,967,179 |
|
|
$ |
11,057,092 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Statutory capital and surplus |
|
$ |
192,096 |
|
|
$ |
197,713 |
|
|
$ |
102,942 |
|
Statutory contingency reserve |
|
|
82,615 |
|
|
|
387,365 |
|
|
|
589,661 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
274,711 |
|
|
$ |
585,078 |
|
|
$ |
692,603 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Risk-to-capital ratio |
|
|
42.7 to 1 |
|
|
|
20.5 to 1 |
|
|
|
16.0 to 1 |
|
|
|
|
|
|
|
|
|
|
|
In run-off, Triad will not be issuing any new commitments for insurance and any new insurance
written will come only from commitments issued up to July 15, 2008. The amount of new risk written
after June 30, 2008 is expected to be less than $100 million.
7
Triad and its wholly-owned U.S. subsidiaries are each required under their respective
domiciliary states insurance code to maintain a minimum level of statutory capital and surplus.
Triad, an Illinois domiciled insurer, is required under the Illinois Insurance Code (the Code) to
maintain minimum statutory capital and surplus of $5 million. The Code permits dividends to be
paid only out of earned surplus and also requires prior approval of extraordinary dividends. An
extraordinary dividend is any dividend or distribution of cash or other property, the fair value of
which, together with that of other dividends or distributions made within a period of twelve
consecutive months, exceeds the greater of (a) ten percent of statutory surplus as regards
policyholders, or (b) statutory net income for the calendar year preceding the date of the
dividend.
As determined in accordance with statutory accounting practices, Triad experienced a net loss
of $320.0 million for the six months ended June 30, 2008, compared to net income of $41.7 million
for the six months ended June 30, 2007 and a net loss of $121.3 million for the year ended December
31, 2007.
At June 30, 2008, there was no surplus available to be paid out in dividends to stockholders.
At December 31, 2007, the amount of Triads equity that could be paid out in dividends to
stockholders was $4.8 million, which was the excess of the earned surplus of Triad on a statutory
basis above the minimum required by the Illinois Insurance Code. Under a
corrective order issued by the Illinois Division of Insurance, Triad is currently prohibited,
and expects to be prohibited for the foreseeable future, from paying any dividends to the Company.
Triad also has a $25 million outstanding surplus note held by the Company. Under the terms of the
corrective order Triad is also currently prohibited from paying interest on the surplus note. See
Part II, Item 5 Other Information in this report for additional information concerning the
corrective order.
Loss Reserves
The Company establishes loss reserves to provide for the estimated costs of settling claims on
loans reported in default and estimates of loans in default that are in the process of being
reported to the Company as of the date of the financial statements. Consistent with industry
accounting practices, the Company does not establish loss reserves for future claims on insured
loans that are not currently in default. Amounts recoverable from the sale of properties acquired
in lieu of foreclosure are considered in the determination of the reserve estimates. Loss reserves
are established by management using historical experience and by making various assumptions and
judgments about claim rates (frequency) and claim amounts (severity) to estimate ultimate losses to
be paid on loans in default. The Companys reserving methodology gives effect to current economic
conditions and profiles delinquencies by such factors as default status, policy year, specific
lenders, and the number of months the policy has been in default, as well as whether the policies
in default were underwritten through the flow channel or as part of a structured bulk transaction.
Furthermore, based on recent experience, the Company believes a considerable amount of
misrepresentation and/or fraud may exist on insured policies originated by certain lenders and thus
the reserving methodology also accounts for expected rescissions. The assumptions utilized in the
calculation of the loss reserve estimate are continually reviewed,
8
and as adjustments to the
reserve become necessary, such adjustments are reflected in the financial statements in the periods
in which the adjustments are made.
Premium Deficiency
A premium deficiency is required to be recorded if the present value of expected future cash
outflows (consisting of projected paid claims, maintenance expenses and loss adjustment expenses)
net of the present value of expected cash inflows (consisting of renewal premiums) exceeds the
recorded reserves net of any unamortized deferred acquisition costs, or DAC, balance. This
computation is prepared on a gross basis, without consideration of reinsurance (either claim
recoveries or ceded premium), and a determination is made if a premium deficiency exists. If a
premium deficiency exists, a premium deficiency reserve is established. A receivable is then
recorded for the amounts that would be recoverable from reinsurers based upon the existing trust
balances of the lender captive reinsurers. After the initial establishment of a premium deficiency
reserve, the initial amounts can be adjusted based upon updated data relating to the assumptions
utilized in the calculation of expected future cash outflows and inflows as well as the actual
reserves recorded as of the date of the premium deficiency calculation.
Litigation
On November 5, 2007, American Home Mortgage Investment Corp. and American Home Mortgage
Servicing, Inc. filed a complaint against Triad in the U.S. Bankruptcy Court for the
District of Delaware. The plaintiffs are debtors and debtors in possession in Chapter 11
cases pending in the U.S. Bankruptcy Court. The lawsuit is an action for breach of contract and
declaratory judgment. The basis for the complaints breach of contract action is the cancellation
by Triad of its certification of American Home Mortgages coverage on 14 loans due to
irregularities that Triad uncovered following the submission of claims for payment and that existed
when American Home Mortgage originated the loans. The complaint alleges that these actions caused
American Home Mortgage to suffer a combined net loss of not less than $1,132,105.51 and seeks
monetary damages and a declaratory judgment. Since the initial filing, Triad has answered the
complaint and filed a counterclaim that denied all liability for the claims of American Home
Mortgage. During the quarter ended June 30, 2008, Triad filed a motion to amend its counterclaim
to include 28 more loans for which Triad seeks to rescind or deny coverage. Triad expects to
continue to rescind or deny coverage for additional loans originated by American Home Mortgage and
intends to contest the lawsuit vigorously.
5. Earnings (Loss) Per Share (EPS)
Basic and diluted EPS are based on the weighted-average daily number of shares outstanding.
For the three months and six months ended June 30, 2008, the basic and diluted EPS denominators are
the same weighted-average daily number of shares outstanding. In computing diluted EPS, only
potential common shares that are dilutive those that reduce EPS or increase loss per share
are included. Exercise of options and unvested restricted stock are not assumed if the result
would be antidilutive, such as when a loss from operations is reported. For the three months and
six months ended June 30, 2007, the denominator includes the dilutive effect of stock options and
unvested restricted stock on the weighted-average shares outstanding. The numerator used in basic
EPS and diluted EPS is the same for all periods presented. For the
9
three months and six months
ended June 30, 2008, options to purchase approximately 46,089 and 71,624, respectively, of the
Companys stock were excluded from the calculation of EPS because they were antidilutive.
6. Comprehensive Income (Loss)
Comprehensive income (loss) consists of net income or (loss) and other comprehensive income.
For the Company, other comprehensive income is composed of unrealized gains or losses on
available-for-sale securities and foreign currency exchange, net of income tax. For the three
months and six months ended June 30, 2008, the Companys comprehensive net loss was $198.6 million
and $359.6 million, respectively, while the comprehensive net income for the three months and six
months ended June 30, 2007 was $6.4 million and $21.8 million, respectively.
7. Income Taxes
Income tax expense (benefit) differs from the amounts computed by applying the Federal
statutory income tax rate to income before income taxes primarily due to tax-exempt interest that
the Company earns from its investments in municipal bonds. The intra-period tax rate utilized in
the six months of 2008 also reflects the Companys inability to record a benefit for expected tax
loss carry forwards. The effective tax rate for the second quarter of 2008 is lower than that
utilized in the first quarter of 2008 due to a change in the estimated tax rate for the full
2008 year.
10
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Managements Discussion and Analysis of Financial Condition and Results of Operations analyzes
our consolidated financial condition, changes in financial position, and results of operations for
the three months and six months ended June 30, 2008 and 2007. This discussion supplements
Managements Discussion and Analysis of Financial Condition and Results of Operations in our annual
report on Form 10-K for the year ended December 31, 2007, and should be read in conjunction with
the interim financial statements and notes contained herein.
Certain of the statements contained in this release are forward-looking statements and are
made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. These statements include estimates and assumptions related to economic, competitive,
regulatory, operational and legislative developments. These forward-looking statements are subject
to change, uncertainty and circumstances that are, in many instances, beyond our control and they
have been made based upon our current expectations and beliefs concerning future developments and
their potential effect on us. Actual developments and their results could differ materially from
those expected by us, depending on the outcome of a number of factors, including our ability to
transition our business into run-off, the possibility of general economic and business conditions
that are different than anticipated, legislative, regulatory, and other similar developments,
changes in interest rates, the housing market, the mortgage industry and the stock market, as well
as the relevant factors described under Risk Factors and under Safe Harbor Statement under the
Private Securities Litigation Reform Act of 1995 in our Annual Report on Form 10-K for the year
ended December 31, 2007 and in this report and other reports and statements that we file with the
Securities and Exchange Commission. Forward-looking statements are based upon our current
expectations and beliefs concerning future events and we undertake no obligation to update or
revise any forward-looking statements to reflect the impact of circumstances or events that arise
after the date the forward-looking statements are made.
Overview
Through our U.S. subsidiaries, we have historically provided Primary and Modified Pool
mortgage guaranty insurance coverage on U.S. residential mortgage loans. We classify insurance as
Primary when we are in the first loss position and the loan-to-value amount, or LTV, is 80% or
greater when the loan is first insured. We classify all other insurance as Modified Pool. The
majority of our Primary insurance has been delivered through the flow channel, which is defined as
loans originated by lenders and submitted to us on a loan-by-loan basis. We have also historically
provided mortgage insurance to lenders and investors who seek additional default protection
(typically secondary coverage or on loans for which the individual borrower has greater than 20%
equity), capital relief, and credit-enhancement on groups of loans that are sold in the secondary
market. These transactions are referred to as our structured bulk channel business. Those
individual loans in the structured bulk channel in which we are in the first loss position and the
LTV ratio is greater than 80% are classified as Primary. All of our Modified Pool insurance has
been delivered through the structured bulk channel.
Triad ceased issuing new commitments for mortgage guaranty insurance coverage on July 15, 2008
and we are in the process of transitioning our business to run-off. We have agreed
11
to the issuance of a corrective order from the Illinois Division of Insurance regarding
restrictions on the distribution of funds from the operating company to the holding company as well
as enhanced financial reporting requirements and other matters. See Part II, Item 5 Other
Information in this report for additional information concerning the corrective order. Under the
corrective order, we are required to submit a corrective plan to the Illinois Division of Insurance
and the corrective plan is subject to its approval.
Our Canadian subsidiary was formed in 2007 for the purpose of exploring the opportunities of
providing mortgage insurance in Canada, but did not write any business and incurred only start-up
expenses. In the first quarter of 2008, we made the decision to discontinue our Canadian efforts
and recorded a $2 million charge to record severance, lease commitments and impairment of fixed
assets. The Canadian subsidiary is no longer licensed as an insurance company in Canada.
Effective June 30, 2008, there are no employees and the subsidiary is in the process of being
liquidated.
In run-off, our revenues principally consist of (a) renewal earned premiums from flow business
(net of reinsurance premiums ceded as part of our risk management strategies), (b) renewal earned
premiums from structured bulk transactions, and (c) investment income on invested assets. We also
realize investment gains, net of investment losses, periodically as a source of revenue when the
opportunity presents itself within the context of our overall investment strategy.
Our expenses consist primarily of (a) amounts paid on claims submitted, (b) changes in
reserves for estimated future claim payments on loans that are currently in default, (c) general
and administrative costs of servicing existing policies, (d) other general business expenses, (e)
interest expense on long-term debt and any other borrowed funds, and (f) income taxes.
Our future profitability depends largely on (a) the conditions of the housing, mortgage and
capital markets that have a direct impact on mitigation efforts, cure rates and ultimately the
amount of claims paid, (b) the overall general state of the economy and job market, (c) persistency
levels, (d) operating efficiencies, and (e) the level of investment yield, including realized gains
and losses, on our investment portfolio.
Persistency is an important metric in understanding our premium revenue. The longer a policy
remains on our books, or persists, the greater the amount of revenue that we will derive from the
policy from renewal premiums. We define persistency as the amount of insurance in force at the
12-month end of a financial reporting period as a percentage of the amount of insurance in force at
the beginning of the period. Cancellations of policies originated during the past twelve months
are not considered in our calculation of persistency. This method of calculating persistency may
vary from that of other mortgage insurers. We believe that our calculation presents an accurate
measure of the percentage of insurance in force remaining at the end of the 12-month measurement
period. Cancellations result primarily from the borrower refinancing or selling insured mortgaged
residential properties and, to a lesser degree, from the borrower achieving prescribed equity
levels, at which point the lender no longer requires mortgage guaranty insurance.
12
For a more detailed description of our industry and operations, refer to Item 1, Business in
our annual report on Form 10-K for the year ended December 31, 2007.
Recent Developments
On June 19, 2008, we announced that we had ended negotiations with Lightyear Capital LLC, a
New York-based private equity firm, to form a new mortgage insurance company. We also reported that
Freddie Mac had denied our appeal of Triads suspension as an approved mortgage insurer. Effective
June 19, 2008, we were suspended as an approved mortgage insurer by both Fannie Mae and Freddie
Mac.
As a result of these developments, effective July 15, 2008, Triad ceased issuing commitments
for mortgage insurance and is transitioning its business to run-off. Run-off, as used in this
report, means writing no new mortgage insurance policies and continuing to service existing
policies. Servicing includes: receiving renewal premium on remaining policies; cancelling coverage
at the insureds request; terminating policies for non-payment of premium; working with borrowers
in default to remedy the default and/or mitigate our loss; and settling all legitimate claims filed
per our contractual obligations.
Following the announcement of the decision to transition our business to run-off, we agreed in
early August to the issuance of a corrective order from the Illinois Division of Insurance
regarding restrictions on the distribution of funds from the operating company to the holding
company as well as enhanced reporting requirements and other matters. See Part II, Item 5
Other Information in this report for additional information concerning the corrective order.
Under the corrective order, we are required to submit a corrective plan to the Illinois Division of
Insurance and other state insurance regulatory authorities and the corrective plan would be subject
to their approval. We are working with the Illinois Division of Insurance in the administration of
this corrective order.
Furthermore, we terminated the employment of approximately 100 employees as a result of
transitioning our business to run-off. The majority of the terminations were effective on June 30,
2008. These terminations affected all major areas of our business, but were concentrated in the
sales and marketing, underwriting, and information services areas. As a result of these
terminations, in the second quarter of 2008, we incurred approximately $9.1 million of expenses in
severance and other exit costs.
On July 18, 2008, Mark K. Tonnesen, the Companys former President and Chief Executive Officer
and a former Director of the Company, and the Company mutually agreed that Mr. Tonnesen would
resign from these positions effective that day and will retire from the Company as of the close of
business on August 15, 2008.
Effective July 18, 2008, the Board of Directors appointed William T. Ratliff, III, the
Companys Chairman of the Board, as the Companys President and Chief Executive Officer. The
appointment of Mr. Ratliff as President and Chief Executive Officer is on an interim basis, pending
the identification and hiring of a permanent President and Chief Executive Officer.
13
In connection with the decision to transition Triads business into run-off, the Company has
notified Standard & Poors Ratings Services, Moodys Investor Services and Fitch Ratings
(collectively, the rating agencies) that the Company is terminating all agreements with the
rating agencies regarding the issuance of ratings for the Company and its subsidiaries, including
Triad. As a result, Standard & Poors Ratings Services announced that they have withdrawn their
BB- counterparty credit and financial strength ratings on Triad and their B- counterparty
credit rating on Triad Guaranty Inc. Moodys Investor Services and Fitch Ratings may withdraw
their existing ratings as well, but they have not done so as of the date of this filing. Moodys
Investor Services current financial strength rating on Triad is BB- and Fitch Ratings currently
maintains a counterparty credit and financial strength ratings on Triad of BB and a counterparty
credit rating on Triad Guaranty Inc. of CCC.
We maintain a $95 million Excess-of-Loss reinsurance treaty that provides a benefit when
Triads risk-to-capital ratio exceeds 25-to-1 and the combined ratio exceeds 100%. Once the
attachment point has been reached, the treaty terminates and converts to run-off coverage for a ten
year period. During the run-off period, following a one time deductible of $25 million, the carrier
is responsible for the reimbursement of all paid losses in each quarter that the attachment point
is breached up to the one-time $95 million policy limit. Additionally, terms of the treaty require
that we continue the payment of premiums to the reinsurer, amounting to approximately $2 million
per year for the entire ten year run-off period.
Under the terms specified above, the reinsurance treaty reached the attachment point at the
end of the first quarter of 2008 and we notified the reinsurance carrier that the treaty would
convert to run-off coverage beginning in the second quarter of 2008. However, in April 2008, the
reinsurance carrier informed us that, in its opinion, we had not complied with unspecified
covenants in the reinsurance agreement and provided notice of termination of the agreement. We
have notified the reinsurance carrier that we dispute the carriers claim, including the carriers
alleged termination of the reinsurance agreement, and have demanded arbitration as provided under
the agreement. We believe that the reinsurance carriers claims are without merit and we plan to
contest such claims vigorously. Management has reviewed the terms of the treaty, received advice
from outside experts in reinsurance arbitration, and concluded that we should prevail in the
arbitration proceedings. However, no assurances can be given that an independent arbitrator will
agree with our conclusions. The matter is proceeding in the arbitration process. While we believe
we will prevail in the arbitration proceedings, we have not recorded any ceded reserves or any
recoverable from the carrier under the agreement in our GAAP financial statements. However, in
consultation with our primary regulator, based upon our understanding of the facts, we have
recorded the full benefit of the reinsurance treaty, which included the $95 million benefit and an
accrual for the present value of the future 10-year premium expense due the reinsurer in our second
quarter statutory financial statements.
Included in Triads policyholders surplus is a surplus note of $25 million payable to the
registrant, its parent. The accrual of and payment of the interest on the surplus note must be
approved by the Illinois Division of Insurance, our primary regulator. Additionally, specific
covenants of Triads surplus note prohibit the accrual of or payment of interest on the note if the
most recently reported policyholders surplus is below the level at the time the note was
originated. In June of 2008, the Illinois Division of Insurance denied Triads request for the
payment of the semi-annual interest of $1.1 million due on the surplus note. In denying the
14
request, the Illinois Division of Insurance cited that Triads policyholders surplus as of May 31,
2008 was below the level at the time the note was originated. Pursuant to a corrective order
issued by the Illinois Division of Insurance, Triad is prohibited from paying principal or interest
on the surplus note for the foreseeable future. See Part II, Item 5 Other Information for
additional information concerning the corrective order. More information on debt service of the
Company can be found in the Liquidity and Financial Resources section of this report.
Consolidated Results of Operations
Following is selected financial information for the three months and six months ended June 30,
2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
(dollars in thousands, except per share data) |
|
2008 |
|
2007 |
|
% Change |
|
2008 |
|
2007 |
|
% Change |
|
Earned premiums |
|
$ |
69,865 |
|
|
$ |
69,732 |
|
|
|
0 |
% |
|
$ |
141,929 |
|
|
$ |
133,680 |
|
|
|
6 |
% |
Net losses and loss adjustment expenses |
|
|
292,749 |
|
|
|
41,893 |
|
|
|
599 |
|
|
|
514,008 |
|
|
|
74,474 |
|
|
|
590 |
|
Net (loss) income |
|
|
(198,811 |
) |
|
|
12,026 |
|
|
|
(1,753 |
) |
|
|
(348,825 |
) |
|
|
29,349 |
|
|
|
(1,289 |
) |
Diluted (loss) earnings per share |
|
$ |
(13.36 |
) |
|
$ |
0.80 |
|
|
|
(1,761 |
) |
|
$ |
(23.45 |
) |
|
$ |
1.96 |
|
|
|
(1,294 |
) |
A substantial increase in incurred losses and loss adjustment expenses, or LAE, for the three
months and six months ended June 30, 2008 was primarily responsible for our net loss for the
respective periods. Net losses and LAE for the quarter ended June 30, 2008 increased $250.9
million compared to the second quarter of 2007. The increase in net losses and LAE is comprised of
an increase in loss reserves and an increase in paid losses. We increased our loss and LAE reserves
by $195.5 million during the second quarter of 2008, primarily as a result of a 21% increase in the
number of loans in default (excluding those in structured bulk transactions with deductibles) and a
28% increase in the risk in default on those loans. The greater growth rate of risk in default
compared to loans in default is primarily attributable to the changing characteristics of the
default inventory, with new defaults having substantially higher average risk per loan than a year
ago. The growth in defaults and, more particularly, the risk in default, are primarily
attributable to certain segments of our business including: (i) loans on properties in California,
Florida, Arizona and Nevada (which we refer to collectively as distressed markets), (ii) the
adverse development of the 2006 and 2007 books of business, (iii) our Primary bulk business written
in 2006 and 2007, which is showing a significant amount of early payment defaults and has a
significant amount of high LTV loans, and (iv) our recent Modified Pool business, which also has
exhibited a significant amount of early payment defaults. At June 30, 2008, distressed markets
accounted for 34% of the gross risk in force but represented 57% of the gross risk in default and
58% of the gross reserves. At June 30, 2007, distressed markets
accounted for 34% of the gross risk in force and represented 34% of the gross risk in default
and 29% of gross reserves.
In addition to this increase in reserves, we also experienced substantial growth in paid
losses in terms of both total dollars and the average paid loss severity. Gross paid losses of
$68.4 million for the second quarter of 2008 were up $50.3 million, or 278%, as compared to the
second quarter of 2007. Average paid loss severity was $53,300 during the quarter ended June 30,
2008, compared to $30,500 during the 2007 second quarter. The increase in average paid
15
severity is
primarily the result of a higher percentage of claims from the more recent vintage years and from
the distressed markets, both of which reflect larger loan balances, and a decline in our ability to
mitigate losses.
During the second quarter of 2008, we reversed the net $15 million premium deficiency reserve,
recorded in the first quarter of 2008, reflecting the significant increase in recorded reserves.
See Update on Critical Accounting Policies and Estimates Premium Deficiency for discussion of
the details of the computation and sensitivity surrounding the computation.
Earned premiums were essentially flat for the second quarter of 2008 compared to the second
quarter of 2007 and up slightly for the six months ended June 30, 2008 compared to the six months
ended June 30, 2007. Total insurance in force decreased slightly from the level at June 30, 2007,
as increased persistency was offset by a reduced amount of new insurance written over the 12-month
period. Primary annual persistency increased to 85.1% at June 30, 2008 from 78.2% at June 30,
2007.
Other operating expenses for the second quarter of 2008 increased 154% compared to the second
quarter of 2007. Non-recurring charges amounting to $12.1 million were recognized during the
second quarter of 2008. These expenses were primarily severance costs and other expenses related
to our preparation for the transition of our business into run-off. Approximately $2.2 million of
these non-recurring expenses were for investment banking and professional services fees related to
our capital raising efforts.
We describe our results of operations in greater detail in the discussion that follows. The
information is presented in four categories: Production; Insurance and Risk In Force; Revenues; and
Losses and Expenses.
Production
On June 19, 2008, we were suspended as an approved mortgage insurer by both Fannie Mae and
Freddie Mac. On July 15, 2008, we ceased issuing commitments for mortgage insurance. Going
forward, our production will consist of certificates issued from commitments for mortgage insurance
that were entered into prior to July 15, 2008. We expect the amount of production to be less than
$400 million.
A summary of new insurance written (NIW) or production for the second quarter of 2008 and 2007
broken out between Primary and Modified Pool follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
(dollars in millions) |
|
2008 |
|
|
2007 |
|
|
% Change |
|
|
2008 |
|
|
2007 |
|
|
% Change |
|
|
Primary insurance written: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Flow |
|
$ |
1,148 |
|
|
$ |
5,089 |
|
|
|
(77 |
)% |
|
$ |
3,061 |
|
|
$ |
9,461 |
|
|
|
(68 |
)% |
Structured bulk |
|
|
|
|
|
|
1,702 |
|
|
|
(100 |
) |
|
|
|
|
|
|
3,029 |
|
|
|
(100 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Primary insurance
written |
|
$ |
1,148 |
|
|
$ |
6,791 |
|
|
|
(83 |
) |
|
$ |
3,061 |
|
|
$ |
12,490 |
|
|
|
(75 |
) |
Modified Pool insurance written |
|
|
|
|
|
|
1,406 |
|
|
|
(100 |
) |
|
|
|
|
|
|
3,331 |
|
|
|
(100 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total insurance written |
|
$ |
1,148 |
|
|
$ |
8,197 |
|
|
|
(86 |
)% |
|
$ |
3,061 |
|
|
$ |
15,821 |
|
|
|
(81 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16
Total NIW decreased significantly during the three and six months ended June 30, 2008 compared
to the same periods one year ago. We had no structured bulk production in either Primary or
Modified Pool in the first six months of 2008. We believe that the decrease in primary flow
production was primarily due to our customers uncertainty surrounding our long-term ability to
continue to write new mortgage insurance. We reported net losses during each of the previous three
quarters ended March 31, 2008 and our risk-to-capital ratio was 27.7-to-1 as of March 31, 2008,
which is above the maximum risk-to-capital ratio of 25.0-to-1 generally permitted by most states.
Although we began the second quarter of 2008 as an eligible mortgage insurer for both the GSEs and
we were writing new business, many of our large lenders, including five of our top ten customers
during the first quarter of 2008, notified us of their intention to stop insuring new business with
Triad.
Insurance and Risk in Force
The following table provides detail on our direct insurance in force at June 30, 2008 and
2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
|
|
(dollars in millions) |
|
2008 |
|
|
2007 |
|
|
% Change |
|
|
Primary insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Flow primary insurance |
|
$ |
41,646 |
|
|
$ |
38,591 |
|
|
|
8 |
% |
Structured bulk insurance |
|
|
4,248 |
|
|
|
4,133 |
|
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
|
Total Primary insurance |
|
|
45,894 |
|
|
|
42,724 |
|
|
|
7 |
|
|
|
|
|
|
|
|
|
|
|
|
Modified pool insurance |
|
|
20,439 |
|
|
|
23,649 |
|
|
|
(14 |
) |
|
|
|
|
|
|
|
|
|
|
|
Total insurance |
|
$ |
66,333 |
|
|
$ |
66,373 |
|
|
|
|
% |
|
|
|
|
|
|
|
|
|
|
|
Our Primary insurance in force at June 30, 2008 grew from June 30, 2007 primarily due to
production in the last two quarters of 2007 and improving persistency rates. Primary insurance
persistency increased to 85.1% at June 30, 2008 from 77.7% at June 30, 2007. Although Modified
Pool persistency increased to 86.4% at June 30, 2008 from 79.1% one year prior, insurance in force
decreased from 12 months prior as there was no Modified Pool production during this period. We
currently anticipate that persistency rates will continue near current levels throughout the
remainder of 2008 due to current housing market weakness and general lack of mortgage credit
available in the marketplace. However, persistency could decline if interest rates decline
significantly, credit becomes more available, or the housing and mortgage markets begin to improve.
Furthermore, if persistency was to decline, the decline may be concentrated in areas experiencing
economic expansion and home price appreciation, but may not decrease or may not decrease to the
same degree in areas experiencing economic contraction and declining home prices. As a result, our
remaining insurance in force would be more heavily concentrated in areas experiencing economic
contraction and declining home prices, resulting in increased risk and the possibility of a higher
percentage of defaults.
The following tables provide information on selected risk characteristics of our business
based on risk in force at June 30, 2008 and 2007. Risk in force is the total amount of coverage
for which we are at risk under our certificates of insurance. Of the risk factors addressed in the
table, the following is a list of what we believe are important indicators of increased risk:
17
|
|
|
The percentage of business defined as non-prime credit quality; |
|
|
|
|
The percentage of Alt-A business; |
|
|
|
|
The percentage of business with an LTV greater than 95%; |
|
|
|
|
The percentage of interest only loans and ARMs with potential negative amortization; |
|
|
|
|
The percentage of condominium property types; |
|
|
|
|
The percentage of non-primary residence occupancy status; |
|
|
|
|
The percentage of loans in excess of $250,000; |
|
|
|
|
The concentration of risk in distressed market states; and |
|
|
|
|
The presence of multiple risk factors on a single insured loan. |
18
Risk in Force(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary |
|
|
Modified Pool |
|
|
|
June, 30 |
|
|
June, 30 |
|
(dollars in millions) |
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
|
Gross Risk in Force |
|
$ |
11,943 |
|
|
$ |
11,128 |
|
|
$ |
5,965 |
|
|
$ |
6,920 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit Quality: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prime |
|
|
75.6 |
% |
|
|
73.6 |
% |
|
|
27.8 |
% |
|
|
29.6 |
% |
Alt-A |
|
|
20.9 |
|
|
|
22.8 |
|
|
|
71.4 |
|
|
|
69.6 |
|
A-Minus |
|
|
3.1 |
|
|
|
3.1 |
|
|
|
0.7 |
|
|
|
0.7 |
|
Sub Prime |
|
|
0.4 |
|
|
|
0.5 |
|
|
|
0.1 |
|
|
|
0.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LTV: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Greater than 95% |
|
|
25.1 |
% |
|
|
23.2 |
% |
|
|
|
% |
|
|
|
% |
90.01% to 95.00% |
|
|
32.5 |
|
|
|
33.6 |
|
|
|
0.2 |
|
|
|
0.3 |
|
90.00% and below |
|
|
42.4 |
|
|
|
43.2 |
|
|
|
99.8 |
|
|
|
99.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan Type: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed |
|
|
66.2 |
% |
|
|
62.7 |
% |
|
|
26.2 |
% |
|
|
26.8 |
% |
Interest Only |
|
|
10.4 |
|
|
|
9.6 |
|
|
|
23.3 |
|
|
|
22.9 |
|
ARM (amortizing) fixed period 5 years or
greater |
|
|
8.8 |
|
|
|
11.0 |
|
|
|
31.3 |
|
|
|
33.7 |
|
ARM (amortizing) fixed period less than 5
years |
|
|
2.2 |
|
|
|
2.7 |
|
|
|
5.7 |
|
|
|
4.1 |
|
ARM (potential negative amortization) |
|
|
12.4 |
|
|
|
14.0 |
|
|
|
13.5 |
|
|
|
12.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property Type: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Condominium |
|
|
10.6 |
% |
|
|
10.3 |
% |
|
|
9.5 |
% |
|
|
9.3 |
% |
Other (principally single-family detached) |
|
|
89.4 |
|
|
|
89.7 |
|
|
|
90.5 |
|
|
|
90.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Occupancy Status: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary residence |
|
|
87.7 |
% |
|
|
87.6 |
% |
|
|
73.5 |
% |
|
|
73.7 |
% |
Secondary home |
|
|
7.9 |
|
|
|
7.9 |
|
|
|
6.1 |
|
|
|
6.2 |
|
Non-owner occupied |
|
|
4.4 |
|
|
|
4.5 |
|
|
|
20.4 |
|
|
|
20.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage Amount: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$0 $50,000 |
|
|
0.8 |
% |
|
|
0.9 |
% |
|
|
0.5 |
% |
|
|
0.5 |
% |
$51,000 $100,000 |
|
|
9.3 |
|
|
|
10.4 |
|
|
|
5.3 |
|
|
|
5.4 |
|
$100,001 $250,000 |
|
|
51.8 |
|
|
|
52.7 |
|
|
|
45.4 |
|
|
|
45.8 |
|
$250,001 $500,000 |
|
|
32.2 |
|
|
|
29.9 |
|
|
|
42.2 |
|
|
|
41.8 |
|
Over $500,000 |
|
|
5.9 |
|
|
|
6.1 |
|
|
|
6.6 |
|
|
|
6.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Market Status: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distressed market states (AZ, CA, FL, NV) |
|
|
27.2 |
% |
|
|
26.6 |
% |
|
|
48.8 |
% |
|
|
47.1 |
% |
Non-distressed market states |
|
|
72.8 |
|
|
|
73.4 |
|
|
|
51.2 |
|
|
|
52.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
(1) |
|
Gross risk in force is on a per policy basis and does not account for risk ceded to captive reinsurers or
applicable stop-loss amounts and deductibles on Modified Pool structured bulk transactions.
Percentages represent distribution of gross risk in force. |
The above table reflects that certain indicators of increased risk comprise a significant part
of our portfolio. Our portfolio contains significant exposure to Alt-A loans as well as loans
19
with the potential for negative amortization (PNAMs). An inherent risk in a PNAM loan is
the scheduled milestone in which the borrower must begin making amortizing payments. These
payments can be substantially greater than the minimum payments required before the milestone is
met. While most of these PNAMs have interest rates that will reset frequently, these loans
generally have only minimal payment increases until the amortizing payments begin, so in most
cases the borrower has not been required to make a significantly increased payment or to refinance,
adding uncertainty and potential risk to this product. As a group, the Alt-A loans and the PNAM
loans have performed significantly worse than the remaining prime fixed rate loans through June 30,
2008.
The more recent book years have a significantly higher average loan amount on which we are
providing coverage than previous book years. As indicated above, loans greater than $250,000 make
up a greater percentage of our risk in force at June, 30, 2008 than one year prior. In addition,
the percentage of our risk in force with LTVs greater than 95%, which historically produced higher
default rates, has increased from one year prior.
Due to the significant growth in our production in 2006 and 2007 and the amount of refinancing
that took place in 2002 through 2005, our insurance portfolio is relatively unseasoned, having a
weighted average life of 2.89 years at June 30, 2008, 2.50 years at December 31, 2007 and 2.24
years at June 30, 2007. The following table shows direct risk in force as of June 30, 2008 by year
of loan origination.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary |
|
|
Modified Pool * |
|
|
|
June 30, 2008 |
|
|
June 30, 2008 |
|
(dollars in millions) |
|
Direct Risk in Force |
|
|
Percent |
|
|
Direct Risk in Force |
|
|
Percent |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2002 and before |
|
$ |
573.3 |
|
|
|
4.8 |
% |
|
$ |
36.3 |
|
|
|
4.7 |
% |
2003 |
|
|
1,051.0 |
|
|
|
8.8 |
|
|
|
108.1 |
|
|
|
14.0 |
|
2004 |
|
|
1,015.2 |
|
|
|
8.5 |
|
|
|
126.6 |
|
|
|
16.4 |
|
2005 |
|
|
1,504.8 |
|
|
|
12.6 |
|
|
|
212.3 |
|
|
|
27.5 |
|
2006 |
|
|
2,531.9 |
|
|
|
21.2 |
|
|
|
257.1 |
|
|
|
33.3 |
|
2007 |
|
|
4,645.8 |
|
|
|
38.9 |
|
|
|
31.7 |
|
|
|
4.1 |
|
2008 |
|
|
621.0 |
|
|
|
5.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
11,943.0 |
|
|
|
100.0 |
% |
|
$ |
772.0 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
For Modified Pool, the Direct Risk in Force is calculated utilizing the particular stop-loss
limits and deductibles within each specific structure |
Mortgage insurance structures designed to allow lenders to share in the risks of such
insurance have long been a standard in the industry. One such structure is our captive reinsurance
program under which reinsurance companies that are affiliates of the lenders assume a portion of
the risk associated with the lenders insured book of business in exchange for a percentage of the
premium. Under the captive reinsurance program, the risk held by the captive is supported by
assets held in trust with Triad as the beneficiary. At June 30, 2008, we had approximately $239
million in captive reinsurance trust balances supporting the risk transferred to captives, helping
to limit our future loss exposure. Approximately 58% of our Primary flow insurance in force at
June 30, 2008 was subject to these captive arrangements compared to approximately 57% at June 30,
2007.
20
Revenues
A summary of the significant individual components of our revenue for the second quarter and
the first six months of 2008 and 2007 follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
(dollars in thousands) |
|
2008 |
|
|
2007 |
|
|
% Change |
|
|
2008 |
|
|
2007 |
|
|
% Change |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct premium written |
|
$ |
84,561 |
|
|
$ |
83,153 |
|
|
|
2 |
% |
|
$ |
173,946 |
|
|
$ |
161,561 |
|
|
|
8 |
% |
Ceded premium written |
|
|
(15,480 |
) |
|
|
(12,988 |
) |
|
|
19 |
|
|
|
(31,475 |
) |
|
|
(25,689 |
) |
|
|
23 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premium written |
|
|
69,081 |
|
|
|
70,165 |
|
|
|
(2 |
) |
|
|
142,471 |
|
|
|
135,872 |
|
|
|
5 |
|
Change in unearned
premiums |
|
|
784 |
|
|
|
(433 |
) |
|
|
(281 |
) |
|
|
(542 |
) |
|
|
(2,192 |
) |
|
|
(75 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
69,865 |
|
|
$ |
69,732 |
|
|
|
0 |
% |
|
$ |
141,929 |
|
|
$ |
133,680 |
|
|
|
6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income |
|
$ |
9,175 |
|
|
$ |
7,673 |
|
|
|
20 |
% |
|
$ |
18,722 |
|
|
$ |
15,022 |
|
|
|
25 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues |
|
$ |
75,243 |
|
|
$ |
73,540 |
|
|
|
2 |
% |
|
$ |
159,559 |
|
|
$ |
145,601 |
|
|
|
10 |
% |
Earned premium for the second quarter of 2008 was essentially flat compared to the second
quarter of 2007. For the six months ended June 30, 2008, earned premiums increased from the prior
year, reflecting the growth of insurance in force during 2007.
During 2008, premium written on new business declined in accordance with the decline in
production. However, renewal premiums grew substantially. The increase in direct renewal premium
written was primarily the result of an increase in average insurance in force during the respective
periods. The increase in direct renewal premium for the second quarter of 2008 was offset somewhat
by approximately $2 million of premium refunded as a result of rescission activity during the
second quarter of 2008. When an insurance policy is rescinded, insurance coverage from the date of
issuance is cancelled and all of the previously paid premium is refunded.
Ceded premium written is comprised of premiums written under excess of loss reinsurance
treaties with captives as well as non-captive reinsurance companies. Ceded premium during 2008
increased over 2007 due to the increase in both the insurance in force and the percentage of
insurance in force subject to captive reinsurance. Several of our larger lenders ceased reinsuring
their 2008 books at the beginning of the year, however, the prior book years remain under
reinsurance treaties for which the renewal premiums are still being remitted to the trusts.
The difference between net written premiums and earned premiums is the change in the unearned
premium reserve, which is established primarily on premiums received on annual and single payment
plans. Our unearned premium liability increased $2.9 million during the 12
months ending June 30, 2008, primarily due to our introduction of a single premium product
during the second half of 2007 and continuing into 2008. We do not expect the unearned premium
liability to continue to grow as a result of our decision to cease issuing commitments for mortgage
insurance.
21
Net investment income grew during the second quarter and the first six months of 2008 as
compared to the same periods of 2007 primarily due to the growth in average invested assets. During
the second quarter and first six months of 2008, average invested assets at cost or amortized cost
grew by 22.2% and 28.9%, respectively, compared to the same periods of 2007 as a result of the
investment of positive cash flows from operations which included $52.3 million from the redemption
of ten-year non-interest bearing United States Mortgage Guaranty Tax and Loss Bonds (Tax and Loss
Bonds). Our investment portfolio tax-equivalent yield decreased to 5.6% at June 30, 2008 from
6.6% at June 30, 2007. This decrease was primarily the result of the repositioning of the
investment portfolio out of tax-exempt municipal securities and into taxable securities with a
shorter duration. The book yield of the investment portfolio was 4.6% at June 30, 2008 compared to
4.6% at June 30, 2007. For a further discussion on the investment portfolio and the repositioning
of the investment portfolio, see Investment Portfolio.
Losses and Expenses
A summary of the individual components of losses and expenses for the three months and six
months ended June 30, 2008 and 2007 follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
(dollars in thousands) |
|
2008 |
|
2007 |
|
% |
|
2008 |
|
2007 |
|
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net losses and loss adjustment expenses |
|
$ |
292,749 |
|
|
$ |
41,893 |
|
|
|
599 |
% |
|
$ |
514,008 |
|
|
$ |
74,474 |
|
|
|
590 |
% |
Net change in premium deficiency |
|
|
(15,000 |
) |
|
|
|
|
|
|
n/a |
|
|
|
|
|
|
|
|
|
|
|
|
|
Policy acquisition costs |
|
|
|
|
|
|
4,670 |
|
|
|
(100 |
) |
|
|
39,416 |
|
|
|
9,293 |
|
|
|
324 |
|
Other operating expenses (net of
acquisition
costs deferred) |
|
|
27,238 |
|
|
|
10,716 |
|
|
|
154 |
|
|
|
41,344 |
|
|
|
21,047 |
|
|
|
96 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss ratio |
|
|
419.0 |
% |
|
|
60.1 |
% |
|
|
597 |
|
|
|
362.2 |
% |
|
|
55.7 |
% |
|
|
550 |
|
Expense ratio |
|
|
39.4 |
% |
|
|
21.9 |
% |
|
|
80 |
|
|
|
32.2 |
% |
|
|
22.3 |
% |
|
|
44 |
|
Combined ratio |
|
|
458.4 |
% |
|
|
82.0 |
% |
|
|
459 |
|
|
|
394.4 |
% |
|
|
78.0 |
% |
|
|
406 |
|
Net losses and LAE are comprised of both paid losses and the increase in the loss and LAE
reserve during the period. Net losses and LAE for the second quarter and first six months of 2008
increased significantly over the same periods of 2007 primarily due to significant increases in
reserves as well as growth in paid losses.
22
The following table provides detail on paid claims and the average severity for our Primary
and Modified Pool insurance for the three months and six months ended June 30, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
(dollars in thousands) |
|
2008 |
|
|
2007 |
|
|
% Change |
|
|
2008 |
|
|
2007 |
|
|
% Change |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Paid claims: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance |
|
$ |
48,187 |
|
|
$ |
16,687 |
|
|
|
188.8 |
% |
|
$ |
77,423 |
|
|
$ |
33,134 |
|
|
|
134 |
% |
Modified Pool
insurance |
|
|
20,192 |
|
|
|
1,386 |
|
|
|
1,356.9 |
|
|
|
31,044 |
|
|
|
2,667 |
|
|
|
1,064 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
68,379 |
|
|
$ |
18,073 |
|
|
|
278.3 |
% |
|
$ |
108,467 |
|
|
$ |
35,801 |
|
|
|
203 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of claims paid: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance |
|
|
919 |
|
|
|
540 |
|
|
|
70.2 |
% |
|
|
1,605 |
|
|
|
1,066 |
|
|
|
51 |
% |
Modified Pool
insurance |
|
|
363 |
|
|
|
52 |
|
|
|
598.1 |
|
|
|
530 |
|
|
|
106 |
|
|
|
400 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
1,282 |
|
|
|
592 |
|
|
|
116.6 |
% |
|
|
2,135 |
|
|
|
1,172 |
|
|
|
82 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The amount of paid claims increased significantly during second quarter and the first half of
2008 compared to the respective periods of 2007. The growth rate in the amount of paid claims
outpaced the growth rate in the number of paid claims due to a significant increase in average
severity on claims paid. Average severity on claims paid increased from $30,500 in the second
quarter of 2007 to $53,300 during the second quarter of 2008. This increase was primarily the
result of larger loan sizes on the claims paid and is reflective of (i) the development of the more
recent vintage years, specifically the 2005, 2006 and 2007 vintage years, which have significantly
higher average loan sizes than previous books, (ii) an increase in paid claims relating to loans
originated in the distressed markets, which have significantly higher average loan sizes in general
than other states, and (iii) a reduced ability to mitigate losses.
The following table reflects the average loan size and average per policy risk in force by
vintage year. As each of the more recent vintage years season and enter the period of peak
defaults, the amount of risk per default and, ultimately, the amount of paid claims as well as the
average paid claim are expected to increase. Furthermore, the 2006 and 2007 books are exhibiting
adverse development patterns and thus are expected to impact the amount of paid claims and the
average paid claim earlier than what we have experienced historically.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary |
|
Modified Pool |
|
|
Average |
|
Average |
|
Average |
|
Average |
|
|
Loan Size |
|
Insured Risk |
|
Loan Size |
|
Insured Risk |
Vintage Year |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2002 and Prior |
|
$ |
105,257 |
|
|
$ |
26,779 |
|
|
$ |
78,962 |
|
|
$ |
25,576 |
|
2003 |
|
|
117,560 |
|
|
|
28,317 |
|
|
|
144,123 |
|
|
|
42,564 |
|
2004 |
|
|
131,417 |
|
|
|
34,908 |
|
|
|
148,536 |
|
|
|
44,066 |
|
2005 |
|
|
156,526 |
|
|
|
40,937 |
|
|
|
177,739 |
|
|
|
57,859 |
|
2006 |
|
|
207,866 |
|
|
|
53,699 |
|
|
|
262,090 |
|
|
|
69,578 |
|
2007 |
|
|
208,179 |
|
|
|
56,278 |
|
|
|
272,252 |
|
|
|
79,505 |
|
2008 |
|
|
203,033 |
|
|
|
46,411 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Overall Average |
|
$ |
171,444 |
|
|
$ |
44,615 |
|
|
$ |
208,647 |
|
|
$ |
60,897 |
|
Beginning in late 2006, we experienced a reduction in our ability to reduce the severity of
our claims paid through our traditional mitigation processes, which was related to weakness in
23
the housing market at that time. Subsequent declines in home prices across almost all markets
with significant declines in the distressed markets have significantly impacted our ability to
mitigate losses on paid claims. In some cases, properties for which loans have defaulted are sold
during the foreclosure process, which generally reduces our loss. When the property does not sell
prior to foreclosure, or sells after foreclosure but prior to when the claim is paid, we often pay
the full amount of our coverage, which we call a full option settlement. Full option settlements as
a percentage of our paid claims have generally increased since the fourth quarter of 2006. During
the second half of 2007 and continuing into the first half of 2008, the rapid decline in home
prices in certain markets coupled with the overall uncertainty in the housing markets on a national
basis had a significant negative impact on our ability to mitigate claims and negatively impacted
the average severity.
As illustrated under Insurance and Risk in Force, we are insuring a larger percentage of
mortgages in excess of $250,000. Claim payments on larger mortgages are greater even if coverage
percentages remain constant. Claim payments on these larger mortgages are reflected in the
increase in average severity during the first half of 2008. We expect severity will continue to
trend upward as the more recent vintage years, which contain the majority of the mortgages in
excess of $250,000, continue to age. Additional deterioration in the housing market could further
reduce our loss mitigation opportunities, which could lead to an increase in severity.
The table below provides the gross cumulative paid loss ratios by certificate year (calculated
as direct losses paid divided by direct premiums received, in each case for a particular policy
year) that have developed through June 30, 2008 and 2007. The data below excludes the effects of
reinsurance.
|
|
|
|
|
|
|
|
|
|
|
Cumulative Paid Loss Ratios as of June 30, |
Certificate Year |
|
2008 |
|
2007 |
1996 |
|
|
14.6 |
% |
|
|
14.5 |
% |
1997 |
|
|
10.3 |
|
|
|
10.1 |
|
1998 |
|
|
6.9 |
|
|
|
6.7 |
|
1999 |
|
|
9.9 |
|
|
|
9.7 |
|
2000 |
|
|
35.5 |
|
|
|
35.2 |
|
2001 |
|
|
31.9 |
|
|
|
30.0 |
|
2002 |
|
|
32.7 |
|
|
|
31.0 |
|
2003 |
|
|
18.3 |
|
|
|
15.0 |
|
2004 |
|
|
21.1 |
|
|
|
14.4 |
|
2005 |
|
|
35.2 |
|
|
|
9.9 |
|
2006 |
|
|
29.3 |
|
|
|
1.8 |
|
2007 |
|
|
5.3 |
|
|
|
|
|
2008 |
|
|
|
|
|
|
|
|
The table above reflects relatively higher cumulative ratios of losses paid to premium
received for the 2000 through 2002 policy years at this stage of development. This is due, in
part, to a large portion of this business being refinanced in subsequent years and the resulting
lower aggregate level of premiums received for these policy years. As discussed in Item 1,
Business of our Annual Report on Form 10-K for the year ended December 31, 2007, we
generally anticipate making higher claim payments in the second through the fifth years after
the loan is originated. The more recent vintage years have developed at a much faster rate from a
24
default and paid claim perspective than the historical trends primarily due to the rapid
decline in housing markets.
Net losses and loss adjustment expenses also include the change in reserves for losses and
loss adjustment expenses. The following table provides further information about our loss reserves
excluding the effects of captive reinsurance at June 30, 2008, December 31, 2007 and June 30, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
June 30, |
|
(dollars in thousands) |
|
2008 |
|
|
2007 |
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Reserves for reported defaults |
|
$ |
530,733 |
|
|
$ |
251,316 |
|
|
$ |
89,752 |
|
Reserves for defaults incurred but not
reported |
|
|
62,154 |
|
|
|
40,691 |
|
|
|
9,382 |
|
|
|
|
|
|
|
|
|
|
|
Total Primary insurance |
|
|
592,887 |
|
|
|
292,007 |
|
|
|
99,134 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Modified Pool insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Reserves for reported defaults |
|
|
193,506 |
|
|
|
54,876 |
|
|
|
20,482 |
|
Reserves for defaults incurred but not
reported |
|
|
17,689 |
|
|
|
8,340 |
|
|
|
1,004 |
|
|
|
|
|
|
|
|
|
|
|
Total Modified Pool insurance |
|
|
211,195 |
|
|
|
63,216 |
|
|
|
21,486 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserve for loss adjustment expenses |
|
|
13,180 |
|
|
|
4,716 |
|
|
|
1,441 |
|
|
|
|
|
|
|
|
|
|
|
Total reserves for losses and loss adjustment
expenses |
|
$ |
817,262 |
|
|
$ |
359,939 |
|
|
$ |
122,061 |
|
|
|
|
|
|
|
|
|
|
|
The following table shows the change in reserves for losses and LAE excluding the effects of
captive reinsurance for the three and six months ended June 30, 2008 and June 30, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
(dollars in thousands) |
|
2008 |
|
2007 |
|
% Change |
|
2008 |
|
2007 |
|
% Change |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase in reserve for
losses and
loss adjustment expenses |
|
$ |
269,496 |
|
|
$ |
23,340 |
|
|
|
1,055 |
% |
|
$ |
457,323 |
|
|
$ |
37,709 |
|
|
|
1,113 |
% |
Reacting to the rapidly changing housing markets and the shifting mix in the composition of
our defaults, such as geographic location, loan size and policy year, we have increased reserves by
570% from a year ago, and 127% for the first six months of 2008. The increase in reserves reflects
a growing number of loans in default and an increase in the average risk in default. In addition,
we experienced a general decline in our cure rates on reported defaults during 2007 that has
continued into the first half of 2008. Our reserving model incorporates managements judgments and
assumptions regarding the impact of the current housing and economic environment on the estimate of
the ultimate claims we will pay on loans currently in default. To reflect the significant changes
in the housing marketplace and economy that has occurred over the past year, both the frequency and
severity factors utilized in the calculation of the reserve have increased since June 30, 2007,
which also impacted the size of the reserve increase. Future economic conditions surrounding the
housing or mortgage markets could significantly impact the development of our default inventory and
the ultimate amount of claims paid.
25
Although defaults increased across the board geographically, defaults in the distressed
markets increased 507% from June 30, 2007 to June 30, 2008. Defaults related to the remaining
states, excluding the distressed markets, increased 83% from June 30, 2007 to June 30, 2008.
Additionally, the higher average loan balance in the distressed market states has resulted in a
significantly higher reserve per default, all else being equal, compared to the rest of the
portfolio. As of June 30, 2008, the gross case reserve per default for distressed market states
was $38,100, compared to the gross case reserve per default of $23,300 for the remaining states.
The following table indicates the growth in both the gross risk in default in these four
distressed market states and reserves attributable to these states at June 30, 2008, December 31,
2007 and June 30, 2007. The gross reserves related to the distressed market states were 58% of
total gross reserves at June 30, 2008, compared to 29% at June 30, 2007. Additionally, at June 30,
2008, these four states had average loan balances of $250,000 compared to $161,000 for the
remainder of the portfolio, which increases the potential adverse impact that further defaults in
these distressed markets may have on future growth in risk in default and reserves.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
June 30, |
|
(dollars in thousands) |
|
2008 |
|
|
2007 |
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Risk In Force: |
|
|
|
|
|
|
|
|
|
|
|
|
California |
|
$ |
2,629,211 |
|
|
$ |
2,683,853 |
|
|
$ |
2,644,006 |
|
Florida |
|
|
2,057,036 |
|
|
|
2,120,745 |
|
|
|
2,084,041 |
|
Arizona |
|
|
938,772 |
|
|
|
978,132 |
|
|
|
941,315 |
|
Nevada |
|
|
536,340 |
|
|
|
553,708 |
|
|
|
542,787 |
|
|
|
|
|
|
|
|
|
|
|
Total Distressed Market
States |
|
$ |
6,161,359 |
|
|
$ |
6,336,439 |
|
|
$ |
6,212,150 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Gross Risk in Force |
|
$ |
17,908,367 |
|
|
$ |
18,534,333 |
|
|
$ |
18,048,443 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% in Distressed Market States |
|
|
34.4 |
% |
|
|
34.2 |
% |
|
|
34.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
% of Gross Risk in Default: |
|
|
|
|
|
|
|
|
|
|
|
|
California |
|
|
23.3 |
% |
|
|
19.1 |
% |
|
|
13.2 |
% |
Florida |
|
|
23.0 |
% |
|
|
19.6 |
% |
|
|
13.4 |
% |
Arizona |
|
|
6.1 |
% |
|
|
5.3 |
% |
|
|
3.8 |
% |
Nevada |
|
|
4.2 |
% |
|
|
3.8 |
% |
|
|
3.6 |
% |
|
|
|
|
|
|
|
|
|
|
Total Distressed Market
States |
|
|
56.6 |
% |
|
|
47.8 |
% |
|
|
34.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
% of Gross Reserves: |
|
|
|
|
|
|
|
|
|
|
|
|
California |
|
|
23.3 |
% |
|
|
18.3 |
% |
|
|
11.3 |
% |
Florida |
|
|
24.6 |
% |
|
|
19.9 |
% |
|
|
10.9 |
% |
Arizona |
|
|
6.2 |
% |
|
|
5.4 |
% |
|
|
3.4 |
% |
Nevada |
|
|
4.2 |
% |
|
|
3.9 |
% |
|
|
2.8 |
% |
|
|
|
|
|
|
|
|
|
|
Total Distressed Market
States |
|
|
58.4 |
% |
|
|
47.4 |
% |
|
|
28.5 |
% |
Our default inventory has shifted and certificates originated during 2006 and 2007 comprise
59.3% of our loans in default, but 71.2% of the risk in default at June 30, 2008. The difference
in percentages of loans in default and risk in default reflects the higher loan amounts and a
changing mix of our business. To illustrate the impact of the changes in the frequency and
severity factors utilized in the reserve model, the following table details the amount of risk in
default and the reserve balance as a percentage of risk at June 30, 2008 and 2007.
26
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
December 31, |
|
June 30, |
(dollars in thousands) |
|
2008 |
|
2007 |
|
2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Case Reserves as a percentage of
risk in default (1) |
|
|
45.0 |
% |
|
|
36.6 |
% |
|
|
26.9 |
% |
|
|
|
(1) |
|
Reflects gross case reserves, which excludes IBNR and ceded reserves, as a
percent of risk in default for total primary delinquent loans and total modified
pool delinquent loans. |
The number of loans in default includes all reported delinquencies that are in excess of two
payments in arrears at the reporting date and all reported delinquencies that were previously in
excess of two payments in arrears and have not been brought current.
The following table shows default statistics as of June 30, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
December 31, |
|
June 30, |
(dollars in thousands) |
|
2008 |
|
2007 |
|
2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total business: |
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
365,649 |
|
|
|
378,907 |
|
|
|
371,888 |
|
With deductibles |
|
|
55,478 |
|
|
|
59,592 |
|
|
|
64,292 |
|
Without deductibles |
|
|
310,171 |
|
|
|
319,315 |
|
|
|
307,596 |
|
Number of loans in default |
|
|
26,601 |
|
|
|
16,821 |
|
|
|
9,853 |
|
With deductibles |
|
|
6,221 |
|
|
|
4,072 |
|
|
|
2,508 |
|
Without deductibles |
|
|
20,380 |
|
|
|
12,749 |
|
|
|
7,345 |
|
Percentage of loans in default (default rate) |
|
|
7.28 |
% |
|
|
4.44 |
% |
|
|
2.65 |
% |
Percentage of loans in default excluding
deductibles |
|
|
6.57 |
% |
|
|
3.99 |
% |
|
|
2.39 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
267,689 |
|
|
|
273,798 |
|
|
|
258,163 |
|
Number of loans in default |
|
|
16,075 |
|
|
|
10,419 |
|
|
|
5,940 |
|
Percentage of loans in default |
|
|
6.01 |
% |
|
|
3.81 |
% |
|
|
2.30 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Modified Pool insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
97,960 |
|
|
|
105,109 |
|
|
|
113,725 |
|
With deductibles |
|
|
55,456 |
|
|
|
59,569 |
|
|
|
64,267 |
|
Without deductibles |
|
|
42,504 |
|
|
|
45,540 |
|
|
|
49,458 |
|
Number of loans in default |
|
|
10,526 |
|
|
|
6,402 |
|
|
|
3,913 |
|
With deductibles |
|
|
6,221 |
|
|
|
4,072 |
|
|
|
2,508 |
|
Without deductibles |
|
|
4,305 |
|
|
|
2,330 |
|
|
|
1,405 |
|
Percentage of loans in default |
|
|
10.75 |
% |
|
|
6.09 |
% |
|
|
3.44 |
% |
Percentage of loans in default excluding
deductibles |
|
|
10.13 |
% |
|
|
5.12 |
% |
|
|
2.84 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary Alt-A business (included in above): |
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
33,660 |
|
|
|
35,980 |
|
|
|
34,955 |
|
Number of loans in default |
|
|
5,861 |
|
|
|
3,102 |
|
|
|
1,207 |
|
Percentage of loans in default |
|
|
17.41 |
% |
|
|
8.62 |
% |
|
|
3.45 |
% |
We do not provide reserves on Modified Pool defaults with deductibles until the incurred
losses for that transaction reach the deductible threshold. At June 30, 2008, 21 structured bulk
transactions with deductibles as part of the structure had incurred losses that had exceeded these
individual deductible amounts. The reserves recognized for these 21 contracts added $80.8
million to reserves at June 30, 2008. Based upon rapid growth in the reported defaults during 2007
and continuing into the first half of 2008 and the significant amount of early payment defaults in
some of our 2006 and 2007 vintage year structured bulk transactions, we believe that
27
we will
continue to provide additional reserves on these and additional structured bulk transactions with
deductibles.
Given the current state of the mortgage and housing market and the composition and age of our
insured portfolio, we anticipate that our number of loans in default for our entire portfolio will
continue to increase. Accordingly, we expect reserves to continue to increase as our business,
specifically the 2006 and 2007 vintage years, continues to season. We expect the overall default
rate to increase as well as the number of loans in default to increase. The default rate is also
affected by the number of policies in force, which is the denominator in the default rate
calculation. The decreased production in the second half of 2007 and in the first half of 2008,
combined with our decision to cease issuing commitments for mortgage insurance, is also expected to
result in an increase in the default rate compared to the rate that would result if our production
were consistent with 2007 levels. We also expect default rates to increase for business that has
increased risk characteristics such as Alt-A loans, higher LTV loans and PNAM ARMs.
As discussed earlier, we have experienced a faster and more severe increase in both defaults
and claims on our 2006 and early 2007 vintage years. As discussed in Item 1, Business in our
annual report on Form 10-K for the year ended December 31, 2007, generally our master policies
provide that we are not liable to pay a claim for loss if the application for insurance regarding
the loan in question contains fraudulent information, material omissions or misrepresentations that
would increase the risk characteristics of the loan. We are currently reviewing the majority of
the claims for losses and defaults that occur soon after loan origination, especially with respect
to the 2006 and 2007 vintage years, to determine whether the limitations on our liability contained
in our master policies are applicable. Triads ability to rescind or deny coverage as described
above with respect to certain loans originated by American Home Mortgage, formerly one of our
largest customers, is limited, and is the subject of a lawsuit that American Home Mortgage filed
against Triad on November 5, 2007. We expect rescissions or denials of coverage for additional
loans originated by American Home Mortgage for similar reasons, which may be the subject of further
litigation. Management currently does not expect the American Home Mortgage rescission or denial
of coverage litigation to have a material adverse impact on our results of operations or financial
condition.
As part of our overall risk management strategy, we have entered into excess of loss captive
reinsurance agreements with several of our lender customers. As detailed in Item 1, Business in
our annual report on Form 10-K for the year ended December 31, 2007, we retain the first loss
position on the first aggregate layer of risk and reinsure the second finite layer with the captive
reinsurer with each separate policy year standing on its own. During 2007, for the first time
since the establishment of these captives, certain captives exceeded their first loss layer in
incurred losses, which resulted in the ceding of reserves related to specific book years. At June
30, 2008, we ceded reserves of $62.7 million to twelve different captive reinsurers, all of which
are supported by trust balances at the individual captives. At June 30, 2008, actual paid losses
exceeded the first layer of two captive reinsurers. If the current default and paid claim
trends continue, we expect other vintage year layers and other captives to reach the
attachment points on both incurred losses and paid claims, especially the 2006 and 2007 vintage
years that have experienced a higher default rate at a faster pace than we have seen historically.
28
Premium Deficiency
At March 31, 2008, we established a premium deficiency reserve because the present value of
our estimated future paid losses and expenses, net of the present value of our estimated future
renewal premiums, exceeded our existing net reserves. We recalculate the premium deficiency
reserve each subsequent quarter.
At June 30, 2008, the present value of the expected future cash outflows on a gross basis
amounted to $2.0 billion while the present value of the expected future cash inflows, again on a
gross basis, amounted to $1.3 billion, resulting in an expected shortfall of $692 million on a
gross basis. This expected shortfall is then compared to the total net reserves of $780 million,
and as the net reserve is greater than the shortfall, no premium deficiency exists at June 30,
2008. This was primarily the result of the $219 million increase in loss reserves during the
second quarter without any significant changes to the assumptions used in calculating the expected
future cash outflows and inflows. We believe the current assumptions are appropriate and we will
continue to monitor these assumptions for any significant new development. We will modify the
assumptions accordingly if our actual experiences differ from our assumptions.
The computation of the premium deficiency requires significant judgments regarding the
assumptions utilized in the expected future cash flows. The most significant assumptions utilized
are the amount and timing of expected paid claims and the expected persistency of the renewal
premiums. The rapidly changing economic landscape could significantly alter the assumptions
utilized in the premium deficiency computation going forward, which could introduce a significant
amount of volatility into the results of this computation. See Update on Critical Accounting
Policies and Estimates later in this report for a discussion of the sensitivities surrounding this
computation.
Expenses and Taxes
As a result of the establishment of a premium deficiency reserve at March 31, 2008, we wrote
off the remaining DAC asset balance of $34.8 million during the first quarter of 2008. Furthermore,
we did not capitalize any costs to acquire new business in the second quarter of 2008. As such,
there was no DAC amortization during the second quarter of 2008.
Other operating expenses for the first three months of 2008 increased 154% over the one-year
prior period. During the second quarter of 2008, several non-recurring charges totaling
approximately $12.1 million were recognized and were primarily responsible for this large increase.
These non-recurring items related primarily to severance costs and lease termination costs incurred
as we prepared to transition our business to run-off. Other non-recurring expenses related to
ending negotiations with Lightyear Capital and amounted to approximately $2.2 million.
Additionally, in connection with our decision to establish a premium deficiency reserve as of March
31, 2008 and write off the DAC asset, we did not capitalize approximately $4.5 million of
acquisition costs incurred during the second quarter of 2008, which were recognized
as other operating expenses. We do not expect material acquisition costs during the remainder
of 2008 as we ceased issuing commitments for mortgage insurance effective July 15, 2008. Other
operating expenses for the first six months of 2008, which increased 96% from the first six months
of 2007, were further impacted by capital raising activities, personnel reductions,
and
29
terminating
our efforts in Canada, all of which occurred in the first quarter of 2008.
Our effective tax rate was 13.7% and 20.2%, respectively, for the three months and six months
ended June 30, 2008 compared to 22.7% and 25.5% for the same periods of 2007. Accounting for
income taxes for interim financial reporting requires the expected annual tax rate to be applied to
the interim period financial statements. During the second quarter of 2008 the calculation of
effective annual tax rate changed and, as of June 30, 2008, the expected annual tax rate was a
benefit of 20.2%. This compares to an expected annual tax rate of 27.5% calculated at the end of
the first quarter of 2008. The tax benefit recorded in the second quarter of 2008 reflects the
adjustment to reduce the rate used at the end of the first quarter to the estimated annual rate
calculated as of June 30, 2008. The decrease in the effective tax rate from 2007 is due primarily
to the net loss realized during the first six months of 2008, the resulting elimination of the
contingency reserve, and the inability to recognize the expected net operating loss carry forward.
Federal tax law permits mortgage guaranty insurance companies to deduct from taxable income,
subject to certain limitations, the amounts added to contingency loss reserves. As a result of
operating losses for 2007 and through the second quarter of 2008, the previously established
contingency reserve was released earlier than the scheduled ten years in an amount that offset the
operating loss for federal tax reporting purposes. Accordingly, the previously purchased Tax and
Loss Bonds associated with the contingency reserve release were redeemed earlier than originally
scheduled. Substantially all previously purchased Tax and Loss Bonds have been redeemed
(approximately $63.2 million were redeemed after June 30, 2008); however we expect to continue to
incur operating losses for tax purposes for which we will be unable to record a tax benefit. We
expect to generate net operating loss carry forwards for federal income tax reporting purposes for
which we will be unable to receive any immediate benefit in our statement of operations.
Financial Position
Total assets at June 30, 2008 declined by $69.1 million from December 31, 2007. The decline
in total assets reflected the liquidation of certain assets in connection with the repayment of the
$80.0 million credit facility and the write-off of the remaining $34.8 million of DAC in connection
with the premium deficiency in the first quarter of 2008, offset by an increase of $55.3 million of
ceded reinsurance recoverable from lender captives. Total liabilities increased to $922.9 million
at June 30, 2008 from $634.0 million at December 31, 2007. The growth in total liabilities
included an increase of $457.3 million in gross reserves for losses during the first half of 2008.
This increase was offset by decreases of $80.0 million related to the repayment of the credit
facility in the first quarter of 2008 and a $92.9 million decline in deferred income taxes related
to the losses incurred in the first six months of 2008.
This section identifies several items on our balance sheet that are important in the overall
understanding of our financial position. These items include deferred policy acquisition costs,
prepaid federal income tax and related deferred income taxes, and the premium deficiency
reserve. The majority of our assets are included in our investment portfolio. A separate
Investment Portfolio section follows the Financial Position section and reviews our investment
30
portfolio, key portfolio management strategies, and methodologies by which we manage credit risk
within the investment portfolio.
Deferred Policy Acquisition Costs
Prior to the need for the establishment of a premium deficiency initially recognized at March
31, 2008, we capitalized costs to acquire new business as DAC and recognized these as expenses
against future gross profits. In accordance with generally accepted accounting principles, we
regularly prepare an analysis to determine if the DAC asset on our balance sheet is recoverable
against the future profits in the existing book of business. At March 31, 2008, we determined that
the net present value of the estimated future cash flows on the remaining book of business exceeded
the recorded reserves (net of the unamortized DAC) which required the establishment of a premium
deficiency reserve, which is discussed in more detail below under Liquidity and Capital Resources
Premium Deficiency. The actual mechanics of recording the premium deficiency reserve require
that we first reduce the DAC balance to zero before recording any additional premium deficiency
reserve. Therefore, we wrote down the DAC asset by $34.8 million in the first quarter of 2008. We
did not capitalize any costs to acquire new business in the second quarter of 2008, but included
such costs in the line item Other operating costs on the statement of operations.
Prepaid Federal Income Taxes and Deferred Income Taxes
While we were reporting income, we purchased Tax and Loss Bonds to take advantage of a special
contingency reserve deduction that mortgage guaranty companies are allowed for tax purposes. We
recorded these bonds on our balance sheet as prepaid federal income taxes. Purchases of Tax and
Loss Bonds are essentially a prepayment of federal income taxes that are scheduled to become
current in ten years, when the contingency reserve is scheduled to be released, and the Tax and
Loss Bonds are scheduled to mature. The scheduled proceeds from the maturity of the Tax and Loss
Bonds are used to fund the income tax payments that would be due in the same year as a result of
the scheduled reversal of the contingency reserve for tax purposes.
Deferred income taxes are provided for the differences in reporting taxable income in the
financial statements and on the tax return. The largest cumulative difference is the special
contingency reserve deduction for mortgage insurers mentioned above. During the first half of
2008, deferred income taxes declined by $92.9 million, primarily the result of the reversal of the
contingency reserve mentioned above. The remainder of the deferred tax liability has primarily
arisen from book and tax reporting differences related to DAC and unrealized investment gains
(losses).
In years when the taxable income of a mortgage insurer results in a loss before the
application of the special contingency reserve, the prior contingency reserve that was established
can be reversed earlier than originally scheduled (effectively recognizing as taxable income the
prior contingency reserve that had previously been deferred) to offset the current year loss. When
the special contingency reserve for tax purposes is reversed earlier than scheduled to offset
a current year operating loss, the Tax and Loss Bonds can be redeemed earlier than originally
scheduled. In the first half of 2008, we reversed $305.8 million of contingency reserve and
redeemed $52.3 million of Tax and Loss Bonds with more redemptions expected during the third
31
quarter. During the second half of 2007, we reversed $113 million of contingency reserves for tax
purposes earlier than originally scheduled and redeemed $51 million of Tax and Loss Bonds related
to that reversal.
Substantially all of the remaining Tax and Loss Bonds, amounting to approximately $63.2
million, have been redeemed subsequent to June 30, 2008; nevertheless, we may continue to generate
operating losses. If operating losses continue beyond 2008, it is unlikely we will be able to
recognize any tax benefit from these losses in our financial statements until the losses are
utilized.
Premium Deficiency Reserve
As previously discussed, we established a premium deficiency reserve of $96.1 million at March
31, 2008. A premium deficiency is recognized when the present value of the estimated future paid
losses and expenses, net of the present value of the estimated future renewal premiums, exceeds the
existing net reserves. For the purposes of the premium deficiency computation, we assumed a ten
year run-off period for each vintage year and utilized a discount rate of 4.6%, approximating the
pre-tax investment yield of our investment portfolio.
Each subsequent quarter, we recalculate the amount of the premium deficiency reserve, if any,
on our remaining insurance in force. The need to establish a premium deficiency will change from
quarter to quarter primarily as a result of two factors. First, it will change as the actual
premiums, losses and expenses that were previously estimated are recognized. Each period such items
will be reflected in our financial statements as earned premium, losses incurred and expenses. The
difference between the amount and timing of actual earned premiums, losses incurred and expenses
and our previous estimates used to establish the premium deficiency reserves will have an effect
(either positive or negative) on that periods results. Second, the premium deficiency will change
as our assumptions relating to the present value of expected future premiums, losses and expenses
on the remaining in force change. Changes to these assumptions will also have an effect on results
of the period when the change is made.
During the second quarter of 2008, we did not make any significant changes to the assumptions
utilized in projecting the estimated future cash outflows and inflows as actual experience was
consistent with our assumptions. Therefore, at June 30, 2008, the projected cash shortfall
consisting of the present value of the net outflows and inflows remained relatively consistent with
those calculated at March 31, 2008. However, during the second quarter of 2008, we added
approximately $219 million of additional reserves based upon the actual defaults reported to us as
well as the normal provision for IBNR at June 30, 2008. This significant addition of reserves
during the second quarter of 2008 eliminated the need for a premium deficiency reserve at June 30,
2008. As a result, we reversed the premium deficiency reserve initially established at March 31,
2008, of $96.1 million as well as the reinsurance recoverable from lender captives of $81.1
million.
32
Investment Portfolio
Portfolio Description
Our strategy for managing our investment portfolio has been to optimize investment returns
while preserving capital and liquidity and adhering to regulatory and rating agency requirements.
We have established a formal investment policy that describes our overall quality and
diversification objectives and limits. Our investment policy and strategies are subject to change
depending upon regulatory, economic and market conditions as well as our existing financial
condition and operating requirements, including our tax position. We classify our entire
investment portfolio as available for sale. This classification allows us the flexibility to
dispose of securities in order to meet our investment strategies and operating requirements. All
investments are carried on our balance sheet at fair value.
Historically, the majority of our investment portfolio has been comprised of tax-preferred
state and municipal fixed income securities. Given the operating losses realized by the Company in
the previous four quarters, we do not expect to realize the tax-advantage previously provided by
state and municipal fixed income securities. As a result, the Company made the decision in the
second quarter of 2008 to restructure the investment portfolio into taxable publicly-traded
securities, primarily corporate debt obligations, asset-backed securities, and mortgage-backed
securities. Furthermore, as we expect cash flow from operations to be negative in 2009, we expect
the proceeds from the maturity and sale of securities will be required to fund the shortfall. In
connection with our repositioning of our investment portfolio, we are positioning the portfolio
with a shorter duration in order to match the maturities with the anticipated cash needs.
The following table shows the growth and diversification of our investment portfolio:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2008 |
|
|
December 31, 2007 |
|
(dollars in thousands) |
|
Amount |
|
|
Percent |
|
|
Amount |
|
|
Percent |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U. S. government obligations |
|
$ |
13,280 |
|
|
|
1.5 |
% |
|
$ |
11,762 |
|
|
|
1.5 |
% |
State and municipal bonds |
|
|
381,442 |
|
|
|
43.9 |
% |
|
|
673,264 |
|
|
|
85.8 |
% |
Corporate bonds |
|
|
363,098 |
|
|
|
41.8 |
% |
|
|
40,605 |
|
|
|
5.2 |
% |
Mortgage-backed bonds |
|
|
86,131 |
|
|
|
9.9 |
% |
|
|
|
|
|
|
0.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
|
843,951 |
|
|
|
97.1 |
% |
|
|
725,631 |
|
|
|
92.5 |
% |
Equity securities |
|
|
1,749 |
|
|
|
0.2 |
% |
|
|
2,162 |
|
|
|
0.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available-for-sale securities |
|
|
845,700 |
|
|
|
97.3 |
% |
|
|
727,793 |
|
|
|
92.8 |
% |
Short-term investments |
|
|
23,322 |
|
|
|
2.7 |
% |
|
|
56,746 |
|
|
|
7.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
869,022 |
|
|
|
100.0 |
% |
|
$ |
784,539 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
33
The following table shows the results of our investment portfolio for the three months ended
June 30, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
(dollars in thousands) |
|
2008 |
|
2007 |
|
2008 |
|
2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average investments at cost or amortized cost |
|
$ |
811,592 |
|
|
$ |
664,416 |
|
|
$ |
818,051 |
|
|
$ |
634,566 |
|
Pre-tax net investment income |
|
$ |
9,175 |
|
|
$ |
7,673 |
|
|
$ |
18,722 |
|
|
$ |
15,022 |
|
Tax-equivalent yield-to-maturity |
|
|
5.6 |
% |
|
|
6.6 |
% |
|
|
5.6 |
% |
|
|
6.6 |
% |
Pre-tax realized investment (losses) gains |
|
$ |
(3,799 |
) |
|
$ |
(3,867 |
) |
|
$ |
(1,096 |
) |
|
$ |
(3,105 |
) |
The pre-tax yield is comparable for all periods as the taxable securities purchased during the
second quarter of 2008 generally have a lower duration but a similar yield as the longer duration
municipals that comprised the majority of the portfolio during the first six months of 2007.
Unrealized Gains and Losses
The following table summarizes by category our unrealized gains and losses in our securities
portfolio at June 30, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost or |
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Fair |
|
(dollars in thousands) |
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Value |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U. S. government obligations |
|
$ |
13,275 |
|
|
$ |
116 |
|
|
$ |
(111 |
) |
|
$ |
13,280 |
|
State and municipal bonds |
|
|
376,642 |
|
|
|
5,014 |
|
|
|
(214 |
) |
|
|
381,442 |
|
Corporate bonds |
|
|
364,605 |
|
|
|
635 |
|
|
|
(2,142 |
) |
|
|
363,098 |
|
Mortgage-backed bonds |
|
|
85,798 |
|
|
|
430 |
|
|
|
(97 |
) |
|
|
86,131 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal, fixed maturities |
|
|
840,320 |
|
|
|
6,195 |
|
|
|
(2,564 |
) |
|
|
843,951 |
|
Equity securities |
|
|
2,270 |
|
|
|
|
|
|
|
(521 |
) |
|
|
1,749 |
|
Short term investments |
|
|
23,322 |
|
|
|
|
|
|
|
|
|
|
|
23,322 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total securities |
|
$ |
865,912 |
|
|
$ |
6,195 |
|
|
$ |
(3,085 |
) |
|
$ |
869,022 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
These unrealized gains and losses do not necessarily represent future gains or losses that we
will realize. Changing conditions related to specific securities, overall market interest rates,
or credit spreads, as well as our decisions concerning the timing of a sale, may impact values we
ultimately realize. Taxable securities typically exhibit greater volatility in value than
tax-preferred securities and thus we expect greater volatility in unrealized gains and unrealized
losses going forward. We monitor unrealized losses through further analysis according to maturity
date, credit quality, individual creditor exposure and the length of time the individual security
has continuously been in an unrealized loss position. The largest individual unrealized loss on
any one security at June 30, 2008 was approximately $241 thousand on a corporate bond with an
amortized cost of $5.1 million. Gross unrealized gains and (losses) at June 30, 2008 were $6.2
million and $(3.1) million, respectively.
34
Credit Risk
Credit risk is inherent in an investment portfolio. We manage this risk through a structured
approach to internal investment quality guidelines and diversification while assessing the effects
of the changing economic landscape. One way we attempt to limit the inherent credit risk in the
portfolio is to maintain investments with high ratings. The following table shows our investment
portfolio by credit ratings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2008 |
|
|
December 31, 2007 |
|
(dollars in thousands) |
|
Amount |
|
|
Percent |
|
|
Amount |
|
|
Percent |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed Maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. treasury and agency bonds |
|
$ |
13,280 |
|
|
|
1.6 |
% |
|
$ |
11,762 |
|
|
|
1.6 |
% |
AAA |
|
|
255,012 |
|
|
|
30.2 |
|
|
|
518,769 |
|
|
|
71.5 |
|
AA |
|
|
283,125 |
|
|
|
33.5 |
|
|
|
150,820 |
|
|
|
20.8 |
|
A |
|
|
269,359 |
|
|
|
31.9 |
|
|
|
25,774 |
|
|
|
3.6 |
|
BBB |
|
|
11,722 |
|
|
|
1.4 |
|
|
|
8,738 |
|
|
|
1.2 |
|
BB |
|
|
1,823 |
|
|
|
0.2 |
|
|
|
1,072 |
|
|
|
0.1 |
|
CCC |
|
|
4,251 |
|
|
|
0.5 |
|
|
|
5,591 |
|
|
|
0.8 |
|
CC and lower |
|
|
|
|
|
|
|
|
|
|
2 |
|
|
|
0.0 |
|
Not rated |
|
|
5,379 |
|
|
|
0.6 |
|
|
|
3,103 |
|
|
|
0.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
$ |
843,951 |
|
|
|
100.0 |
% |
|
$ |
725,631 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred stocks: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AA |
|
$ |
705 |
|
|
|
40.3 |
% |
|
$ |
745 |
|
|
|
34.5 |
% |
A |
|
|
509 |
|
|
|
29.1 |
|
|
|
883 |
|
|
|
40.8 |
|
BBB |
|
|
535 |
|
|
|
30.6 |
|
|
|
534 |
|
|
|
24.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,749 |
|
|
|
100.0 |
|
|
|
2,162 |
|
|
|
100.0 |
|
Common stocks |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equity securities |
|
$ |
1,749 |
|
|
|
100.0 |
% |
|
$ |
2,162 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
The change in the credit quality of the portfolio is primarily due to the restructuring of the
portfolio out of tax-preferred securities and into taxable securities. Most municipal and state
tax-preferred securities historically carried credit ratings of AAA as a result of credit
enhancements provided by financial guaranty insurers. The credit rating of a bond will carry the
higher of a financial guarantors credit rating or the credit rating on the bonds underlying
credit qualities if such a credit rating exists. Taxable securities generally do not have credit
enhancements and the credit rating reflects the securities underlying credit qualities.
35
The following table indicates the credit quality of our fixed maturity portfolio with and
without the benefit of the credit enhancements as provided by financial guaranty insurers at June
30, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit Quality Without |
|
|
|
Credit Quality With Benefit |
|
|
Benefit of Credit |
|
|
|
of Credit Enhancements |
|
|
Enhancements |
|
(dollars in thousands) |
|
Amount |
|
|
Percent |
|
|
Amount |
|
|
Percent |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. treasury and agency bonds |
|
$ |
13,280 |
|
|
|
1.6 |
% |
|
$ |
13,280 |
|
|
|
1.6 |
% |
AAA |
|
|
255,012 |
|
|
|
30.2 |
|
|
|
178,655 |
|
|
|
21.2 |
|
AA |
|
|
283,125 |
|
|
|
33.5 |
|
|
|
248,330 |
|
|
|
29.4 |
|
A |
|
|
269,359 |
|
|
|
31.9 |
|
|
|
340,009 |
|
|
|
40.3 |
|
BBB |
|
|
11,722 |
|
|
|
1.4 |
|
|
|
16,803 |
|
|
|
2.0 |
|
BB |
|
|
1,823 |
|
|
|
0.2 |
|
|
|
3,918 |
|
|
|
0.5 |
|
CCC |
|
|
4,251 |
|
|
|
0.5 |
|
|
|
|
|
|
|
|
|
CC and below |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Not rated |
|
|
5,379 |
|
|
|
0.6 |
|
|
|
42,956 |
|
|
|
5.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Fixed Maturities |
|
$ |
843,951 |
|
|
|
100.0 |
% |
|
$ |
843,951 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2008, we were not directly exposed to the risk of financial guaranty insurer
default because we did not invest directly in any financial guaranty insurers. We were, however,
indirectly exposed to the risk of financial guaranty insurer default through the credit
enhancements provided on the majority of our state and municipal fixed maturity bond portfolio as
of June 30, 2008.
At June 30, 2008, our state and municipal bond portfolio amounted to $381.4 million, with
approximately $301.0 million containing credit enhancements from financial guaranty insurers. We
attempt to limit our indirect exposure to financial guaranty insurer default by spreading our
exposure among some of the larger, better known financial guaranty insurers. The following table
indicates the approximate exposure to and percentage of our credit enhanced state and municipal
bond portfolio:
Financial Guarantors
|
|
|
|
|
|
|
|
|
|
|
Credit Enhanced State and |
|
|
|
Municipal Portfolio |
|
(dollars in thousands) |
|
Amount |
|
|
Percent |
|
|
|
|
|
|
|
|
|
|
MBIA |
|
$ |
75,970 |
|
|
|
25.2 |
% |
FSA |
|
|
46,272 |
|
|
|
15.4 |
|
FGIC |
|
|
62,112 |
|
|
|
20.6 |
|
AMBAC |
|
|
73,633 |
|
|
|
24.5 |
|
Others (four companies) |
|
|
42,991 |
|
|
|
14.3 |
|
|
|
|
|
|
|
|
Total |
|
$ |
300,978 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
We regularly review our entire investment portfolio to identify securities that may have
suffered impairments in value that will not be recovered, termed potentially distressed
securities. If a decision is made to sell a security or type of security, we would recognize an
impairment loss on those securities whose book value was greater than the market value. The
impairment loss would be recognized at the time the decision to sell the security was made. In the
second quarter of 2008, we made the decision to liquidate the tax-preferred bond portfolio
36
and
recognized a resulting impairment loss of approximately $7.5 million specifically on that
portfolio.
In identifying potentially distressed securities where a decision to sell a security has not
been made, we screen all securities held with a particular emphasis on those that have a fair value
to cost or amortized cost ratio of less than 80%. Additionally, as part of this identification
process, we utilize the following information:
|
|
|
Length of time the fair value was below amortized cost; |
|
|
|
|
Industry factors or conditions related to a geographic area negatively affecting
the security; |
|
|
|
|
Downgrades by a rating agency; |
|
|
|
|
Past due interest or principal payments or other violation of covenants; and |
|
|
|
|
Deterioration of the overall financial condition of the specific issuer. |
In analyzing our potentially distressed securities list for other-than-temporary impairments,
we pay special attention to securities that have been on the list continually for a period greater
than six months. Our ability and intent to retain the investment for a sufficient time to recover
its value is also considered. We assume that, absent reliable contradictory evidence, a security
that is potentially distressed for a continuous period greater than nine months has incurred an
other-than-temporary impairment. Such reliable contradictory evidence might include, among other
factors, a liquidation analysis performed by our investment advisors, improving financial
performance of the issuer, or valuation of underlying assets specifically pledged to support the
credit.
When we conclude that a decline is other than temporary, the security is written down to fair
value through a charge to realized investment gains and losses. We adjust the amortized cost for
securities that have experienced other-than-temporary impairments to reflect fair value at the time
of the impairment. We consider factors that lead to other-than-temporary impairment of a
particular security in order to determine whether these conditions have impacted other similar
securities.
Of
the approximate $3.1 million of gross unrealized losses at June 30, 2008, securities with a
fair value to cost or amortized cost ratio of less than 90% had a combined unrealized loss of
approximately $521 thousand.
Information about unrealized gains and losses is subject to changing conditions. The values
of securities with unrealized gains and losses will fluctuate, as will the values of securities
that we identify as potentially distressed. Our current evaluation of other-than-temporary
impairments reflects our intent to hold securities for a reasonable period of time sufficient for a
forecasted recovery of fair value. However, our intent to hold certain of these securities may
change in future periods as a result of facts and circumstances impacting a specific security. If
our intent to hold a security with an unrealized loss changes, and we do not expect the security to
fully recover prior to the expected time of disposition, we will write down the security to its
fair value in the period that our intent to hold the security changes.
37
Realized Gains (Losses) and Impairments
Realized gains (losses) include both write-downs of securities with other-than-temporary
impairments and gains (losses) from the sales of securities. Net realized losses for the second
quarter of 2008 totaled $3.8 million. The net realized loss was composed of: (1) an impairment loss
of $7.5 million on municipal securities as a result of our decision to restructure the investment
portfolio and liquidate our municipal holdings and hence no longer had the intent to hold these
securities until they recover in value, and (2) a gain of $3.7 million from the sale of securities,
primarily the municipal securities, during the quarter.
Liquidity and Capital Resources
Generally, our sources of operating funds consist of premiums written and investment income.
Operating cash flow has historically been applied to the payment of claims, interest, expenses and
prepaid federal income taxes in the form of Tax and Loss Bond purchases. However, in recent
quarters, the early redemption of Tax and Loss Bonds due to our operating losses has provided a
source of funds. See Prepaid Federal Income Taxes and Deferred Income Taxes for additional
information concerning the Tax and Loss Bonds. We redeemed $52.3 million of Tax and Loss Bonds in
the second quarter of 2008 related to the operating loss in the first quarter of 2008 and redeemed
an additional $63.2 million of Tax and Loss Bonds subsequent to June 30, 2008.
We generated positive cash flow from operating activities of $78.2 million during the first
six months of 2008 compared to $73.6 million in the first half of 2007. The small growth in cash
flow from operations compared to the first half of 2007 reflects the growth in premiums and
the redemption of Tax and Loss Bonds mentioned above, offset by a significant increase in paid
losses and higher operating expenses.
In the first half of 2008, we experienced significant operating losses, primarily the result
of an increase in net loss reserves of $393.5 million, which did not impact our operating cash flow.
Generally, there is about a 12 to 18 month delay from when reserves are initially established on a
default to when a claim is ultimately paid. In the first half of
2008, direct paid losses amounted to
$108.5 million compared to $35.8 million for the first six months of 2007. However, we expect paid
losses to increase significantly during the remainder of 2008 and into 2009. We anticipate almost
all of this cash outflow requirement related to the payment of claims in 2008 will be met by
premiums, investment income, and the early redemption of Tax and Loss Bonds; however, the
liquidation of some short-term investments may be required to meet the expected claim payment
requirements in 2008. As described under Investment Portfolio, we are in the process of
repositioning our investment portfolio to convert from a primarily tax-preferred portfolio to a
taxable portfolio and attempting to match the maturities of the recent purchases to our anticipated
cash needs in 2009 and 2010 to fund the cash needs necessary to pay anticipated claims. See
Investment Portfolio for more information concerning the repositioning.
Positive operating cash flows are invested, even on a short term basis, pending the need for
the payment of claims and expenses. We are presently repositioning our portfolio to shorten the
effective duration. Maturities within our fixed income investment portfolio are being
38
structured to provide options to reinvest those funds or have such funds available to meet operating cash needs,
such as the payment of claims. At June 30, 2008, maturities scheduled within the next twelve
months within our fixed income portfolio amount to $150.0 million. An operating cash flow
shortfall could be funded through sales of short-term investments and other investment portfolio
securities. Our business does not routinely require significant capital expenditures other than
for enhancements to our computer systems and technological capabilities.
The insurance laws of the State of Illinois impose certain restrictions on dividends that an
insurance subsidiary can pay its parent company. These restrictions, based on statutory accounting
practices, include requirements that dividends may be paid only out of statutory earned surplus and
that limit the amount of dividends that may be paid without prior approval of the Illinois Division
of Insurance. In addition to these statutory limitations on dividends, Illinois regulations
provide that a mortgage guaranty insurer may not declare any dividends except from undivided
profits remaining on hand over and above the amount of its policyholder reserve. In the second
quarter of 2007, Triad declared and paid a dividend of $30 million to its parent company to
partially fund the initial capital required to commence business in Canada. In the fourth quarter
of 2007, the parent company made an additional capital contribution of $50 million to Triad that
was recorded as additional paid in capital on the books of Triad. There were no capital
transactions during the first half of 2008. As discussed previously, the corrective order from the
Illinois Division of Insurance prohibits the payment of dividends by our insurance subsidiary to
the parent corporation.
Included in policyholders surplus of the U.S. insurance subsidiary, Triad, is a surplus
note of $25 million payable to the registrant, its parent. The surplus note is included as
statutory capital for the purpose of the calculation of all regulatory ratio analyses. The accrual
of and payment of the interest on the surplus note must be approved by the Illinois Division of
Insurance, which has broad discretion to approve or disapprove any such payment. Additionally,
specific covenants of Triads surplus note prohibit the accrual of or payment of interest on the
note if the most recently reported policyholders surplus is below the level at the time the note
was originated. In June of 2008, we requested permission to accrue and pay the interest on the $25
million surplus note from the Illinois Division of Insurance. Our request was formally denied.
Subsequently, a corrective order issued by the Illinois Division of Insurance prohibits our
insurance subsidiary from paying interest on the surplus note to its parent corporation and we do
not expect Triad will be able to pay any principal or interest on this note for the foreseeable
future.
The parent company has limited sources of cash flow. Debt service on the $35 million
long-term debt amounts to $2.8 million per year and is paid by the parent company. The primary
source of the cash flow for the parent company debt service has historically been the interest paid
on the $25 million surplus note by our insurance subsidiary, which has provided $2.2 million on an
annual basis. At June 30, 2008, the parent company had cash and cash equivalents of approximately
$6.4 million. Subsequent to June 30, the parent company paid the regularly scheduled semi-annual
debt service of $1.4 million and repatriated approximately $3.8 million of cash from its Canadian
subsidiary that is in the process of liquidation. While we currently believe that the cash
resources on hand at Triad will be sufficient to cover debt service on the $35 million long-term
debt for at least the next two years, Triad will eventually have to refinance
39
or retire this debt, seek approval from the Illinois Division of Insurance for dividends or
payments on the surplus note or secure capital from other sources in order to meet its obligations
on this debt.
We cede business to captive reinsurance affiliates of certain mortgage lenders, primarily
under excess of loss reinsurance agreements. Generally, reinsurance recoverables on loss reserves
and unearned premiums ceded to these captives are backed by trust accounts where we are the sole
beneficiary. When ceded loss reserves exceed the trust balances, we address the counter-party
credit risk of the reinsurance recoverable on a case-by-case basis and provide for a provision for
uncollectible accounts where appropriate.
Total stockholders equity declined to $140.9 million at June 30, 2008, from $498.9 million at
December 31, 2007 and $594.6 million at June 30, 2007. The decline in the first half of 2008 and
from the preceding year was the result of continuing operating losses, including $348.8 million in
the first six months of 2008.
Statutory capital, for the purpose of computing the net risk in force to statutory capital
ratio, includes both policyholders surplus and the contingency reserve. The following table
provides information regarding our statutory capital position at June 30, 2008, December 31, 2007
and June 30, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
June 30, |
|
(dollars in millions) |
|
2008 |
|
|
2007 |
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Statutory policyholders surplus |
|
$ |
192.1 |
|
|
$ |
197.7 |
|
|
$ |
102.9 |
|
Statutory contingency reserve |
|
|
82.6 |
|
|
|
387.4 |
|
|
|
589.7 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
274.7 |
|
|
$ |
585.1 |
|
|
$ |
692.6 |
|
|
|
|
|
|
|
|
|
|
|
During the second quarter of 2008, with the knowledge of the Illinois Division of Insurance,
we recorded the full impact of the Excess of Loss reinsurance treaty (EOL treaty) for statutory
reporting purposes based upon our understanding of the facts and circumstances and advice from
outside counsel. We recorded a reinsurance recoverable, ceded loss reserves and accrued premiums
in accordance with the terms of the contract, which had the effect of increasing policyholders
surplus at June 30, 2008 by approximately $78 million. Therefore, at June 30, 2008, a difference
exists between the net loss reserves and loss expense reported in the statutory financial
statements and the financial statements prepared under generally accepted accounting principles.
Prior to June 30, 2008, the primary differences between statutory policyholders surplus and
equity computed under generally accepted accounting principles was the statutory contingency
reserve, deferred policy acquisition costs (DAC) (reduced to $0 as of March 31,
2008 in connection with the establishment of a premium deficiency reserve) and deferred income
taxes. Generally, mortgage insurance companies are required to add to the statutory contingency
reserve through a charge to surplus an amount equal to 50% of calendar year earned premiums and
retain the contingency reserve in the statutory statements for a period of ten years. The
contingency reserve can be released earlier than the scheduled ten years if the loss ratio exceeds
35%. The loss ratio substantially exceeded 35% in the first six months of 2008 and marginally
40
exceeded 35% in the first six months of 2007. Accordingly, we released approximately $305.8
million of contingency reserve in the first half of 2008, but did not release any contingency
reserves in the first half of 2007.
Triad ceased accepting commitments to write new mortgage commitments on July 15, 2008 and has
begun the transition of its business to run-off. The risk-to-capital ratio, which is utilized as a
measure by many states, rating agencies, and regulators to measure capital adequacy, is no longer
relevant to Triad. Generally, states limit a mortgage insurers statutory risk-to-capital ratio to
25-to-1 and Triad had exceeded that at March 31, 2008 and had substantially exceeded that level at
June 30, 2008 due to the losses recognized during the second quarter.
Off Balance Sheet Arrangements and Aggregate Contractual Obligations
We had no material off-balance sheet arrangements at June 30, 2008.
We lease office facilities, automobiles, and office equipment under operating leases with
minimum lease commitments that range from one to five years. We have no capitalized leases or
material purchase commitments.
Our long-term debt has a single maturity date in 2028. There have been no material changes to
the aggregate contractual obligations shown in our annual report on Form 10-K for the year ended
December 31, 2007.
Update on Critical Accounting Policies and Estimates
Our annual report on Form 10-K for the year ended December 31, 2007 describes the accounting
estimates and assumptions that we consider to be the most critical to an understanding of our
financial statements because they inherently involve significant judgments and uncertainties.
These critical accounting policies relate to the assumptions and judgments utilized in establishing
the reserve for losses and loss adjustment expenses, determining if declines in fair values of
investments are other than temporary, and establishing appropriate initial amortization schedules
for DAC and subsequent adjustments to that amortization.
Since the filing of our Form 10-K, we have determined that our existing insurance portfolio
has a premium deficiency that required the elimination of the recorded DAC. Therefore, the
establishment of initial DAC amortization schedules is no longer a critical accounting policy
requiring significant judgment on our part. However, we have now identified the computation of the
premium deficiency as a new critical accounting policy that requires a significant amount of
judgment by management with respect to the estimates utilized in the computation.
41
Premium Deficiency
A premium deficiency is recognized when the present value of the embedded estimated future
loss from the existing insurance portfolio is greater than the existing net reserves. Computations
of premium deficiency reserves requires the use of significant judgments and estimates to determine
the present value of future premiums and present value of expected losses and expenses on our
business. The present value of future premiums relies on, among other things, assumptions about
persistency and repayment patterns on underlying loans. The present value of expected losses and
expenses depends on assumptions relating to severity of claims and claim rates on current defaults,
and expected defaults in future periods. Assumptions used in calculating the deficiency reserves
can be affected by volatility in the current housing and mortgage lending industries. To the
extent premium patterns and actual loss experience differ from the assumptions used in calculating
the premium deficiency, the differences between the actual results and our estimate will affect
future period earnings.
The most critical assumptions that we utilize in the computation of the premium deficiency is
the amount and timing of estimated future claim payments and the persistency assumptions related to
the amount of future renewal premiums. We have made our best estimate of the future estimated
claim payments, future estimated expenses paid, and future estimated renewal premiums received
based upon the recent trends in our existing portfolio, our assumptions concerning the condition of
the current and future housing markets, our understanding of the current economic conditions in the
housing markets, and our projections about future changes that would impact the housing market.
Home prices will have the most significant impact on the frequency and severity of future claims as
well as the level of persistency impacting renewal premiums. Additional factors that could impact
the assumption utilized in the premium deficiency computation include unemployment rates, interest
rates, worsening general economic conditions, especially in certain geographic regions, and
governmental intervention in the housing markets, among others. There have been a number of
projections concerning house price depreciation and widely ranging views regarding the eventual
economic impact of any potential recession. We evaluate relevant information and make our best
estimate of the assumptions used to estimate future claims, expenses and claims.
An initial premium deficiency was noted and recorded at March 31, 2008, with the net impact of
writing off the remaining DAC of $34.8 million and a change in the premium deficiency reserve of
$15.0 million. At June 30, 2008, we recalculated the premium deficiency reserve based upon the
amount and timing of actual earned premiums, losses incurred (including actual paid losses and the
increase in reserves during the second quarter) and expenses compared to our updated estimates of
the embedded net loss in the existing portfolio. At June 30, we determined that a premium
deficiency no longer existed primarily due to the significant increase in the reserves during the
second quarter of 2008. As a result, we reversed the $15 million net change in the premium
deficiency reserve. However, once the DAC has been written off, we are not allowed to restore it
under generally accepted accounting practices.
The estimation of the premium deficiency reserve requires assumptions as to future events, and
there are inherent risks and uncertainties involved in making these assumptions. The computation
is extremely sensitive to future economic conditions. Economic conditions that have impacted our
judgment and affected our computation of the premium deficiency at June 30,
42
2008 may not necessarily affect development patterns in the future in either a similar manner
or degree. To provide a measure of the sensitivity on pretax income, we have provided the
following table that quantifies the impact of percentage increases and decreases in both the amount
of paid claims and renewal premiums as of June 30, 2008:
|
|
|
|
|
|
|
|
|
|
|
Sensitivity Analysis as of June 30, 2008 |
|
|
Effect on Pretax Income from Changes |
|
|
in Assumptions in the Premium |
|
|
Deficiency Computation |
|
|
|
|
|
|
Increase in Paid |
|
|
Decrease in Paid |
|
Claims or Decrease |
|
|
Claims or Increase in |
|
in Premium |
|
|
Premium Resulting |
|
Resulting in a |
|
|
in an Increase in |
|
(Decrease) in Pretax |
(dollars in thousands) |
|
Pretax Income |
|
Income |
|
5% Increase (Decrease)
in the paid claims
utilized in the
computation of the
premium deficiency. |
|
$ |
|
|
|
$ |
(14,000 |
) |
5% Increase (Decrease)
in the amount of
premium utilized in the
computation of the
premium deficiency. |
|
$ |
|
|
|
$ |
|
|
5% Increase (Decrease)
in both the amount of
paid claims and amount
of premium utilized in
the computation of the
premium deficiency. |
|
$ |
|
|
|
$ |
(79,000 |
) |
As the table above reflects, due to the fact that the full $15.0 million of the previously
established premium deficiency reserve was released at June 30, 2008, there would be no positive
impact on pretax income from a decrease in paid claims or increase in premiums. The positive impact
can only be realized if there is an existing premium deficiency reserve established. We believe
there may be an increase in volatility of our financial results going forward as these factors are
extremely sensitive to future economic events.
Each quarter, we will recalculate the premium deficiency reserve on the remaining insurance in
force. The premium deficiency reserve will primarily change from quarter to quarter as a result of
two factors. First, it will change as the actual premiums, losses and expenses that were
previously estimated are recognized. Each period such items will be reflected in our financial
statements as earned premiums, losses incurred and expenses. The difference between the amount and
timing of actual earned premiums, losses incurred and expenses and our previous estimates used to
establish the premium deficiency reserves will have an effect (either positive or negative) on that
periods results. Second, the premium deficiency reserve will change as our assumptions relating
to the present value of expected future premiums, losses and expenses on the remaining in force
change. Changes to these assumptions
will also have an effect on that periods results. See Premium Deficiency Reserve under
Financial Position above for further discussion of the premium deficiency reserve.
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
Managements Discussion and Analysis of Financial Condition and Results of Operations and
other portions of this report contain forward-looking statements relating to future plans,
expectations and performance, which involve various risks and uncertainties. Because we ceased
43
issuing new mortgage commitments effective July 15, 2008 and are in the process of transitioning
our business into run-off, certain risk factors, primarily those associated with our ability to
write new business and our competitive position as a mortgage insurer, which we previously included
in our Exchange Act filings are no longer relevant to our business. Risks and uncertainties
relating to Triad operating in run-off include, but are not limited to the following:
|
|
|
if we are unable to satisfy the enhanced regulatory obligations imposed on us in
run-off, the Illinois Division of Insurance could impose penalties on us, place us
in rehabilitation and impose further restrictions on our business or appoint a
receiver to liquidate our insurance subsidiary; |
|
|
|
|
if the significant assumptions utilized in the corrective plan related to the
timing and amount of claims, the persistency of renewal premiums, and the expenses
related to servicing the remaining portfolio prove to be materially and adversely
inaccurate, the Illinois Division of Insurance may be forced to place Triad in
rehabilitation or appoint a receiver to liquidate our business; |
|
|
|
|
our ability to lower operating expenses to the most efficient level while still
providing the ability to mitigate losses effectively as we transition to run-off
status will have an impact on our financial performance in run-off; |
|
|
|
|
whether we ultimately prevail in arbitration with the Excess-of-Loss reinsurance
treaty will have an impact on our financial performance in run-off; |
|
|
|
|
if housing prices continue to fall, additional borrowers may default and claims
could be higher than anticipated; |
|
|
|
|
if unemployment rates continue to rise, especially in those areas that have
already experienced significant declines in home prices, defaults and claims could
be higher than anticipated; |
|
|
|
|
if we are unsuccessful in defending the American Home Mortgage lawsuit, our
financial performance will be adversely affected; |
|
|
|
|
a significant decline in interest rates coupled with an increase in available
credit could increase refinancings and decrease the persistency of renewal premiums
and the quality of our insurance in force; |
|
|
|
|
ongoing credit tightening in the mortgage marketplace may continue and cause an
increased number of defaults and paid claims due to the unavailability of
refinancing options; |
|
|
|
|
our financial condition could be affected by legislation or regulation impacting
the mortgage guaranty industry or the GSEs specifically, and the financial services
industry in general; |
|
|
|
|
if we have failed to properly underwrite mortgage loans under contract
underwriting service agreements, we may be required to assume the costs of
repurchasing those loans or face other remedies; |
|
|
|
|
our performance may be impacted by changes in the performance of the financial
markets and general economic conditions; and |
|
|
|
|
further economic downturns in regions where we have larger concentrations of risk
and in markets already distressed could have a particularly adverse effect on our
financial condition and loss development. |
44
Accordingly, our actual results may differ from those set forth in the forward-looking
statements. Attention also is directed to other risk factors set forth in this report and other
reports and statements that we file from time to time with the SEC.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Our market risk exposures at June 30, 2008 have not materially changed from those identified
in our annual report on Form 10-K for the year ended December 31, 2007.
Item 4. Controls and Procedures
|
a) |
|
We carried out an evaluation, under the supervision and with the participation of our
management, including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO),
of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15
under the Securities Exchange Act of 1934 (Act). Based on that evaluation, our management,
including our CEO and CFO, concluded, as of the end of the period covered by this report,
that our disclosure controls and procedures were effective to enable us to record, process,
summarize and report in a timely manner the information that we are required to disclose in
our reports under the Act. Disclosure controls and procedures include controls and
procedures designed to ensure that management, including our CEO and CFO, is alerted to
material information required to be disclosed in our filings under the Act so as to allow
timely decisions regarding our disclosures. In designing and evaluating disclosure controls
and procedures, we recognized that any controls and procedures, no matter how well designed
and operated, can provide only reasonable assurance of achieving the desired control
objectives, as ours are designed to do. |
|
|
b) |
|
There have been no changes in internal control over financial reporting during the
second quarter of 2008 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting. |
45
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On November 5, 2007, American Home Mortgage Investment Corp. and American Home Mortgage
Servicing, Inc. filed a complaint against Triad in the U.S. Bankruptcy Court for the District of
Delaware. The plaintiffs are debtors and debtors in possession in Chapter 11 cases pending in the
U.S. Bankruptcy Court. The lawsuit is an action for breach of contract and declaratory judgment.
The basis for the complaints breach of contract action is the cancellation by Triad of its
certification of American Home Mortgages coverage on 14 loans due to irregularities that Triad
uncovered following the submission of claims for payment and that existed when American Home
Mortgage originated the loans. The complaint alleges that these actions caused American Home
Mortgage to suffer a combined net loss of not less than $1,132,105.51 and seeks monetary damages
and a declaratory judgment. Since the initial filing, Triad has answered the complaint and filed a
counterclaim that denied all liability for the claims of American Home Mortgage. During the
quarter ended June 30, 2008, Triad filed a motion to amend its counterclaim to include 28 more
loans for which Triad seeks to rescind or deny coverage. Triad expects to continue to rescind or
deny coverage for additional loans originated by American Home Mortgage and intends to contest the
lawsuit vigorously.
Item 1A. Risk Factors
By transitioning our business into run-off, our business is now subject to more comprehensive
regulation and oversight by the Illinois Division of Insurance, which will continue on an ongoing
basis for the foreseeable future. If we fail to satisfy applicable regulatory obligations, our
business could be adversely affected and the market value of our common stock could be reduced or
eliminated.
By transitioning our business into run-off, we have significantly increased the oversight by
the Illinois Division of Insurance of, and restrictions on, our business and operations. As a
first step in this process, we have consented to the entry of a corrective order that (among other
things) restricts transactions and the movement of funds between our insurance subsidiaries and the
parent company without the Divisions permission and imposes additional financial reporting
obligations on us. We must file a corrective plan with the Illinois Division of Insurance by
August 15, 2008 that is acceptable to the Division and we must conduct our future operations in
conformity with that plan, any corrective orders issued by the Division and other applicable
regulatory requirements. This enhanced regulatory environment subjects us to numerous additional
risks, including the following:
|
|
|
If we fail to file a corrective plan that is acceptable to the Illinois Division of
Insurance or violate any orders or regulations, the Division could impose civil penalties
on us or determine that we are operating in a condition that is hazardous to our
policyholders or creditors and seek to place us in rehabilitation or appoint a receiver to
liquidate our assets, in which case it is likely that the market value of our common stock
would be reduced or eliminated and little or no funds would ever be available for
distribution to our stockholders. |
46
|
|
|
Restrictions on the movement of funds between our insurance subsidiary and the holding
company could adversely affect our ability to pay operating expenses that were previously
paid by our insurance subsidiary or to pay interest on our $35 million long-term debt. If
we cannot pay such obligations, we may be forced to seek protection from creditors under
Chapter 11 of the United States Bankruptcy Code. |
As a mortgage insurer in run-off, the future value of our company will be tied directly to the
future financial performance of our existing mortgage insurance in force, including the timing and
amount of our claims payments, the persistency of our existing insurance in force and the level of
our expenses. If our performance in the future varies significantly from the projections we use in
our corrective plan, we may become insolvent or otherwise be unable to continue operations and may
be forced into liquidation under the oversight of the Illinois courts, in which case the market
value of our common stock could be reduced or eliminated.
When we ceased writing new insurance on July 15, 2008, the future ultimate value of our
company to its stockholders became primarily limited to the net proceeds, if any, that can be
derived from our gross receipts (including the collection of premiums on our existing insurance in
force and investment income) after the payment of claims and expenses. Any ultimate proceeds will
not be determinable for a number of years and will depend on numerous factors both within and
outside our control. The amount and timing of our future claims and losses will erode and may
eliminate our book value on both a financial reporting and statutory accounting basis. If we
experience losses earlier or at magnitudes greater than projected, or if other expectations we have
with respect to our future premiums and expenses do not materialize, we may be become insolvent,
which could result in a determination by the Illinois Division of Insurance that we are operating
in a condition that is hazardous to our policyholders or creditors. In such event, the Division
could seek to place us in rehabilitation or appoint a receiver to liquidate our assets, in which
case it is likely that the market value of our common stock would be reduced or eliminated and
little or no funds would ever be available for distribution to our stockholders.
Item 5. Other Information
On August 5, 2008, our insurance subsidiaries, Triad Guaranty Insurance Corporation and Triad
Guaranty Assurance Corporation (collectively, TGIC), entered into an agreed corrective order (the
Order) with the Illinois Division of Insurance (the Division). Pursuant to the Order, TGIC has
agreed, among other things, to the following:
|
|
|
By August 15, 2008, TGIC must file a written corrective plan with the Division that
contains specified financial, business and operating information; |
|
|
|
|
All stockholder dividends by TGIC to its parent company are prohibited without the prior
approval of the Division; |
|
|
|
|
All interest and principal payments on TGICs surplus note are prohibited without the
prior approval of the Division; |
|
|
|
|
TGIC is prohibited from making any payments or entering into any transaction that
involves the transfer of assets to, or liabilities from, any affiliated parties without the |
47
|
|
|
prior approval of the Division; |
|
|
|
TGIC must obtain prior written approval from the Division before entering into certain
transactions with unaffiliated parties; and |
|
|
|
|
TGIC must satisfy certain financial reporting requirements. |
During the pendency of the Order, any failure by TGIC to comply with the terms of the Order could
result in the imposition of fines or penalties by the Division or the Division could seek to place
TGIC in rehabilitation or seek approval from the Illinois courts to appoint a receiver to liquidate
TGICs assets.
Item 6. Exhibits
The exhibits filed with this quarterly report on Form 10-Q are set forth in the Exhibit Index
on page 50 and are incorporated herein by reference.
48
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
|
|
|
|
|
TRIAD GUARANTY INC.
|
|
Date: August 11, 2008
|
|
|
/s/ Kenneth W. Jones
|
|
|
Kenneth W. Jones |
|
|
Senior Vice President and Chief Financial Officer
(Duly Authorized Officer and Principal
Financial Officer) |
|
49
EXHIBIT INDEX
|
|
|
Exhibit Number |
|
Description |
|
|
|
10.54
|
|
Letter agreement, dated July 17, 2008, between Triad
Guaranty Inc. and Mark K. Tonnesen, previously filed as
Exhibit 10.54 to the Companys Current Report on Form 8-K
filed on July 17, 2008, and incorporated herein by
reference.* |
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|
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10.55
|
|
Letter agreement, dated July 17, 2008, between Triad
Guaranty Inc. and William T. Ratliff, III, previously filed
as Exhibit 10.55 to the Companys Current Report on Form
8-K filed on July 17, 2008, and incorporated herein by
reference.* |
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|
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31.1
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Certification of Chief Executive Officer pursuant to
Exchange Act Rule 13a-14(a), as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002. |
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31.2
|
|
Certification of Chief Financial Officer pursuant to
Exchange Act Rule 13a-14(a), as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002. |
|
|
|
32.1
|
|
Certifications of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002. |
|
|
|
32.2
|
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Certifications of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002. |
|
|
|
* |
|
Management contract or compensatory plan or arrangement. |
50