FORM 10-Q
---------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended March 31, 2002
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from _____ to _____
Commission File Number 0-22342
TRIAD GUARANTY INC.
(Exact name of registrant as specified in its charter)
DELAWARE 56-1838519
(State of Incorporation) (I.R.S. Employer Identification
Number)
101 SOUTH STRATFORD ROAD, SUITE 500
WINSTON-SALEM, NORTH CAROLINA 27104
(Address of principal executive offices)
(336) 723-1282
(Registrant's telephone number, including area code)
-----------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
Number of shares of Common Stock, $.01 par value, outstanding as of May 1, 2002:
14,092,197 shares.
TRIAD GUARANTY INC.
INDEX
Page
Number
------
Part I. Financial Information:
Item 1. Financial Statements:
Consolidated Balance Sheets as of March 31, 2002 (Unaudited)
and December 31, 2001................................................. 3
Consolidated Income Statements for the Three Month
Periods Ended March 31, 2002 and 2001 (Unaudited)..................... 4
Consolidated Statements of Cash Flow for the Three Month
Periods Ended March 31, 2002 and 2001 (Unaudited).................... 5
Notes to Consolidated Financial Statements............................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................. 9
Part II. Other Information:
Item 6. Exhibits and Reports on Form 8-K.................................16
Signatures...................................................................16
2
TRIAD GUARANTY INC.
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2002 2001
----------- ------------
(Unaudited)
(Dollars in thousands except per share information)
Assets
Invested assets:
Fixed maturities, available-for-sale, at fair value ............... $255,459 $245,986
Equity securities, available-for-sale, at fair value............... 12,782 12,476
Short-term investments............................................. 18,208 18,739
-------- --------
286,449 277,201
Cash............................................................... 1,876 854
Real estate........................................................ 64 162
Accrued investment income.......................................... 2,982 3,196
Deferred policy acquisition costs.................................. 27,549 25,944
Prepaid federal income taxes ...................................... 63,634 62,619
Property and equipment............................................. 11,166 11,169
Reinsurance recoverable............................................ 924 5
Other assets....................................................... 15,286 15,305
-------- --------
Total assets....................................................... $409,930 $396,455
======== ========
Liabilities and stockholders' equity
Liabilities:
Losses and loss adjustment expenses............................ $ 18,246 $ 17,991
Unearned premiums.............................................. 7,624 7,650
Amounts payable to reinsurer .................................. 2,145 2,445
Current taxes payable.......................................... 415 40
Deferred income taxes.......................................... 74,749 74,773
Unearned ceding commission..................................... 2,089 2,324
Long-term debt................................................. 34,475 34,473
Accrued interest on debt....................................... 584 1,275
Accrued expenses and other liabilities......................... 5,876 9,415
-------- --------
Total liabilities.................................................. 146,203 150,386
Commitments and contingent liabilities - Note 4
Stockholders' equity:
Preferred stock, par value $.01 per share --- authorized
1,000,000 shares; no shares issued and outstanding........... --- ---
Common stock, par value $.01 per share --- authorized
32,000,000 shares; issued and outstanding 14,092,197
shares at March 31, 2002 and 13,691,672
at December 31, 2001......................................... 141 137
Additional paid-in capital..................................... 78,262 69,057
Accumulated other comprehensive income, net of income
tax liability of $71 at March 31, 2002 and
$522 at December 31, 2001.................................... 138 975
Deferred compensation.......................................... (870) (118)
Retained earnings.............................................. 186,056 176,018
-------- --------
Total stockholders' equity......................................... 263,727 246,069
-------- --------
Total liabilities and stockholders' equity......................... $409,930 $396,455
======== ========
See accompanying notes.
3
TRIAD GUARANTY INC.
CONSOLIDATED INCOME STATEMENTS
(Unaudited)
Three Months Ended
March 31
-------------------------
(Dollars in thousands except per share information) 2002 2001
----------- ----------
Revenue:
Premiums written:
Direct.......................................... $27,838 $21,793
Assumed......................................... 2 2
Ceded........................................... (3,348) (1,983)
----------- ----------
Net premiums written............................... 24,492 19,812
Change in unearned premiums........................ 43 (129)
----------- ----------
Earned premiums.................................... 24,535 19,683
Net investment income.............................. 3,764 3,476
Realized investment gains (losses)................. (1,499) 452
Other income....................................... 27 1,867
----------- ----------
26,827 25,478
Losses and expenses:
Losses and loss adjustment expenses................ 2,521 2,199
Reinsurance recoveries............................. (5) 4
----------- ----------
Net losses and loss adjustment expenses............ 2,516 2,203
Interest expense on debt........................... 693 693
Amortization of deferred policy acquisition costs.. 2,986 2,334
Other operating expenses (net)..................... 6,069 4,351
----------- ----------
12,264 9,581
----------- ----------
Income before income taxes......................... 14,563 15,897
Income taxes:
Current......................................... 160 --
Deferred........................................ 4,365 4,977
----------- ----------
4,525 4,977
----------- ----------
Net income......................................... $10,038 $10,920
=========== ==========
Earnings per common and common equivalent share:
Basic........................................... $ .73 $ .82
=========== ==========
Diluted......................................... $ .71 $ .79
=========== ==========
Shares used in computing earnings per common
and common equivalent share:
Basic........................................... 13,834,467 13,354,873
========== ==========
Diluted......................................... 14,197,999 13,830,431
========== ==========
See accompanying notes.
4
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
Three Months Ended
March 31
----------------------
(Dollars in thousands) 2002 2001
-------- --------
Operating activities
Net income............................................. $ 10,038 $ 10,920
Adjustments to reconcile net income to net
cash provided by operating activities:
Loss and unearned premium reserves.................. 229 1,213
Accrued expenses and other liabilities.............. (6,687) (3,331)
Current taxes payable............................... 375 --
Amounts due to/from reinsurer....................... (1,237) (1,293)
Accrued investment income........................... 214 (239)
Policy acquisition costs deferred................... (4,591) (3,204)
Amortization of policy acquisition costs............ 2,986 2,334
Net realized investment losses (gains) ............. 1,499 (452)
Provision for depreciation.......................... 676 518
Accretion of discount on investments................ (1,025) (632)
Deferred income taxes............................... 4,365 4,977
Prepaid federal income tax.......................... (1,015) (580)
Unearned ceding commission.......................... (235) 1,702
Real estate acquired in claim settlement............ 98 (329)
Accrued interest on debt............................ (691) (691)
Other assets........................................ 132 324
Other operating activities.......................... 94 24
-------- --------
Net cash provided by operating activities.............. 5,225 11,261
Investing activities
Securities available-for-sale:
Purchases - fixed maturities....................... (25,551) (26,251)
Sales - fixed maturities........................... 17,464 10,735
Purchases - equities............................... (817) (1,512)
Sales - equities................................... 417 1,405
Purchase of property and equipment................... (673) (1,323)
-------- --------
Net cash used in investing activities.................. (9,160) (16,946)
Financing activities
Proceeds from exercise of stock options................ 4,426 25
-------- --------
Net cash provided by financing activities.............. 4,426 25
-------- --------
Net change in cash and short-term investments.......... 491 (5,660)
Cash and short-term investments at beginning of period. 19,593 18,525
-------- --------
Cash and short-term investments at end of period....... $20,084 $12,865
======== ========
Supplemental schedule of cash flow information
Cash paid during the period for:
Income taxes and United States Mortgage
Guaranty Tax and Loss Bonds..................... $ 1,228 $ 580
Interest........................................... $ 1,383 $ 1,383
See accompanying notes.
5
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2002
(Unaudited)
NOTE 1 -- THE COMPANY
Triad Guaranty Inc. (the "Company") is a holding company which, through its
wholly-owned subsidiary, Triad Guaranty Insurance Corporation ("Triad"),
provides private mortgage insurance coverage in the United States to mortgage
lenders or investors to protect the lender or investor against loss from
defaults on low down payment residential mortgage loans.
NOTE 2 -- BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States 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 ended March 31, 2002 are not necessarily indicative
of the results that may be expected for the year ending December 31, 2002. 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, 2001.
NOTE 3 -- CONSOLIDATION
The consolidated financial statements include Triad Guaranty Inc. and its
wholly-owned subsidiary, Triad Guaranty Insurance Corporation ("Triad"), and
Triad's wholly-owned subsidiaries, Triad Guaranty Assurance Corporation and
Triad Re Insurance Corporation. All significant intercompany accounts and
transactions have been eliminated.
NOTE 4 -- COMMITMENTS AND CONTINGENT LIABILITIES
REINSURANCE - Triad assumes and cedes certain premiums and losses from/to
reinsurers under various reinsurance agreements. Reinsurance contracts do not
6
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2002
(Unaudited)
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 when deemed uncollectible.
INSURANCE IN FORCE, DIVIDEND RESTRICTIONS, AND STATUTORY RESULTS - Insurance
regulations limit the writing of mortgage guaranty insurance to an aggregate
amount of insured risk no greater than 25 times the total of statutory capital
and surplus and the statutory contingency reserve. The amount of net risk for
insurance in force at March 31, 2002 and December 31, 2001, as presented below,
was computed by applying the various percentage settlement options and
applicable stop-loss parameters to the insurance in force amounts based on the
original insured amount of the loan. Triad's ratio is as follows:
March 31, December 31,
2002 2001
(Dollars in thousands)
Net risk............................ $ 4,671,413 $ 4,471,705
=========== ===========
Statutory capital and surplus....... $ 104,255 $ 105,306
Statutory contingency reserve....... 205,653 193,747
----------- -----------
Total............................... $ 309,908 $ 299,053
=========== ===========
Risk-to-capital ratio............... 15.1-to-1 15.0-to-1
=========== ===========
Triad and its wholly-owned subsidiaries, Triad Guaranty Assurance
Corporation and Triad Re Insurance Corporation, 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.
Net income as determined in accordance with statutory accounting practices
was $13.4 million for the three months ended March 31, 2002 and $55.4 million
for the year ended December 31, 2001.
7
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2002
(Unaudited)
At March 31, 2002 and December 31, 2001, the amount of Triad's equity that
could be paid out in dividends to stockholders was $20.5 million and $21.6
million, respectively, which was the earned surplus of Triad on a statutory
basis on those dates.
LOSS RESERVES - The Company establishes loss reserves to provide for the
estimated costs of settling claims with respect to loans reported to be in
default and loans in default which have not been reported to the Company. Due to
the inherent uncertainty in estimating reserves for losses and loss adjustment
expenses, there can be no assurance that the reserves will prove to be adequate
to cover ultimate loss development.
NOTE 5 - - EARNINGS PER SHARE
Basic and diluted earnings per share are based on the weighted-average
daily number of shares outstanding. For diluted earnings per share, the
denominator includes the dilutive effect of stock options on the
weighted-average shares outstanding. There are no other reconciling items
between the denominator used in basic earnings per share and diluted earnings
per share. The numerator used in basic earnings per share and diluted earnings
per share is the same for all periods presented.
NOTE 6 - - COMPREHENSIVE INCOME
Comprehensive income consists of net income and other comprehensive income.
For the Company, other comprehensive income is composed of unrealized gains or
losses on available-for-sale securities, net of income tax. For the three-month
periods ended March 31, 2002 and 2001, the Company's comprehensive income was
$9.2 million and $11.7 million, respectively.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Net income for the first quarter of 2002 was $10.0 million or $0.71 per
diluted share, down from $10.9 million or $0.79 per diluted share in the first
quarter of 2001. Net income for the first quarter of 2001 included the receipt
of a nonrecurring incentive payment of approximately $1.9 million or $0.09 per
diluted share relating to the cancellation of one of the Company's excess of
loss reinsurance contracts. Earnings per share for the first quarter of 2002
includes $0.07 per share of net realized investment losses compared to $0.02 per
share of net realized investment gains in the first quarter of 2001.
Operating earnings for the first three months of 2002 increased 3.6% to
$11.0 million from $10.6 million for the first three months of 2001. Operating
earnings exclude realized investment losses of $1.5 million in the first quarter
of 2002 and realized investment gains of $452,000 in the first quarter of 2001.
Operating earnings per share on a diluted basis were $0.78 for the first three
months of 2002 compared to $0.77 per share for the first three months of 2001.
Excluding the effects of the nonrecurring incentive payment from first quarter
2001, operating earnings increased 17% and operating earnings per diluted share
for the first quarter of 2002 increased 14% compared to the first quarter of
2001. The improvement in operating earnings is attributable primarily to a 24.7%
increase in earned premiums and an 8.3% increase in net investment income.
Insurance written was $2.8 billion for the first three months of 2002 as
compared to $2.7 billion for the first three months of 2001, an increase of less
than 1%. Traditional flow production for the first quarter of 2002 increased
95.6% to $2.8 billion from $1.4 billion in the first quarter of 2001. The
increase in new insurance written from traditional flow production was primarily
the result of expanding relationships with national lenders, strong demand for
risk-sharing arrangements, and a lower interest rate environment. There was no
insurance written in the first quarter of 2002 attributable to structured bulk
transactions while insurance written in the first quarter of 2001 included $1.3
billion of structured bulk transaction volume.
Consolidation within the mortgage origination industry and Triad's
continued focus on national lenders has resulted in a greater percentage of
production volume being concentrated among a smaller customer base. The loss of
one or more of these significant customers could have a significant adverse
effect on the Company's business. According to industry data, Triad's national
market share of net new primary insurance written increased to 3.6% for the
first three months of 2002 compared to 2.8% for the first three months of 2001.
Market share for the first three months of 2001 excludes $1.0 billion in bulk
production in the first quarter of 2001 that did not meet the industry's
definition of new insurance written. Net new primary insurance written excludes
insurance placed upon loans more than 12 months after loan origination,
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CONTINUED
insurance placed upon loans already covered by primary mortgage insurance, and
insurance placed upon loans where lender exposure is effectively reduced below
defined minimums. This treatment is consistent with the new definitions adopted
by the Company and the industry in the third quarter of 2001 regarding the
computation of new insurance written for market share purposes. Total direct
insurance in force reached $22.1 billion at March 31, 2002, compared to $16.9
billion at March 31, 2001, an increase of 30.7%.
Total direct premiums written were $27.8 million for the first three months
of 2002, an increase of 27.7% from $21.8 million for the first three months of
2001. Net premiums written increased by 23.6% to $24.5 million in the first
quarter of 2002 from $19.8 million for the same period of 2001. Earned premiums
increased 24.7% to $24.5 million for the first three months of 2002 from $19.7
million for the first three months of 2001. This growth in written and earned
premiums resulted from strong levels of new insurance written offset by the
impact of a declining persistency rate due to a high level of mortgage
refinancings.
Growth in direct premiums written was offset somewhat by the increase in
ceded premiums written. Driven by increases in risk-sharing arrangements, ceded
premium written increased 68.9% to $3.3 million for the first three months of
2002 from $2.0 million for the first three months of 2001. The Company's premium
cede rate (the ratio of ceded premiums written to direct premiums written) was
12.0% in the first quarter of 2002 compared to 9.1% in the same period of 2001.
Approximately 49% of flow insurance written during the first quarter of 2002 is
subject to risk-sharing arrangements compared to 52% of insurance written (27%
including bulk transactions) in the first quarter of 2001. Management
anticipates ceded premiums will continue to increase as a result of the expected
increase in risk-sharing programs.
Refinance activity was 48.6% of flow insurance written in the first quarter
of 2002 compared to 33.6% of insurance written (22.7% including bulk
transactions) in the first quarter of 2001. Persistency, or the amount of
insurance in force remaining from one-year prior, was 60.9% at March 31, 2002,
compared to 67.6% at December 31, 2001, and 81.4% at March 31, 2001. The
increase in refinance activity and the decrease in persistency were reflective
of the low interest rate environment.
Net investment income for the first three months of 2002 was $3.8 million,
an 8.3% increase over $3.5 million in the first three months of 2001. This
increase in investment income is the result of growth in the average book value
of invested assets by $46.7 million to $281.0 million at March 31, 2002, from
$234.3 million at March 31, 2001. The growth in invested assets is attributable
to normal operating cash flow. The pre-tax yield on average invested assets
decreased to 5.4% for the first three months of 2002, as compared to 5.9% for
the first three months of 2001, reflecting the current low interest rate
environment and the disposal of a number of higher yielding, lower quality
securities during the past twelve months to enhance the overall quality of the
portfolio. The Company has been investing new money in shorter duration
securities, which are currently producing lower yields than longer duration
securities. This strategy is based on the expectation that interest rates will
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CONTINUED
rise in the future, so that the maturing shorter duration investments can be
reinvested in a higher interest rate environment. The portfolio's tax-equivalent
yield was 7.8% for the first quarter of 2002 versus 8.1% for the first quarter
of 2001. Based on fair value, approximately 75% and 69% of the Company's fixed
maturity portfolio at March 31, 2002 and 2001, respectively, was composed of
state and municipal tax-preferred securities. At March 31, 2002, based on fair
value, approximately 94% of the Company's fixed maturity portfolio was either a
U.S. government or U.S. agency obligation or was rated investment grade by at
least one nationally recognized securities rating organization compared to
approximately 91% of the Company's fixed maturity portfolio at March 31, 2001.
Realized losses in 2002 included a $755,000 impairment writedown on a bond held
in the Company's portfolio
Net losses and loss adjustment expenses (net of reinsurance recoveries)
increased by 14.2% in the first quarter of 2002 to $2.5 million from $2.2
million for the same period of 2001. This rise reflects an increase in paid
losses and delinquent loans as the Company's insurance in force matures. The
Company's loss ratio (the ratio of incurred losses to earned premiums) was 10.3%
for the first quarter of 2002 as compared to 11.2% for the first quarter of 2001
and 10.7% for all of 2001.
As of March 31, 2002, approximately 77% of the Company's insurance in force
was originated in the last 36 months. Management believes, based upon its
experience and industry data, that claims incidence for it and other private
mortgage insurers is generally highest in the third through sixth years after
loan origination. Although the claims experience on insurance written in
previous years has been quite favorable, management does not expect losses to
remain at the low levels currently reported. The Company expects its incurred
losses to increase as a greater amount of its insurance in force reaches its
anticipated highest claim frequency years. Furthermore, changes in the economic
environment could accelerate paid and incurred loss development. Due to the
inherent uncertainty of future premium levels, losses, economic conditions, and
other factors that affect earnings, it is impossible to predict with any degree
of certainty the impact of such higher claim frequencies on future earnings.
Amortization of deferred policy acquisition costs increased by 27.9% to
$3.0 million in the first three months of 2002 from $2.3 million for the first
three months of 2001. The increase in amortization reflects growth in deferred
policy acquisition costs related to the expansion of the Company's insurance in
force and accelerated amortization due to higher cancellations from refinance
activity in the first quarter of 2002.
Other operating expenses increased 39.5% to $6.1 million for the first
quarter of 2002 from $4.4 million for the same period in 2001. This increase in
expenses is primarily attributable to personnel, technology amortization, and
equipment costs required to support the Company's increased levels of
production, product development, system enhancements, and geographic expansion.
The expense ratio (ratio of underwriting expenses to net premiums written) for
the first quarter of 2002 was 37.0% compared to 33.7% for the first quarter of
2001 and 35.1% for all of 2001.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CONTINUED
The effective tax rate for the first three months of 2002 was 31.1% as
compared to 31.3% for the first three months of 2001. Management expects the
Company's effective tax rate to remain about the same as long as yields from new
funds invested in tax-preferred securities remain favorable in relation to fully
taxable securities.
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of operating funds consist primarily of premiums
written and investment income. Operating cash flow is applied primarily to the
payment of claims, interest, operating expenses, and taxes.
The Company generated positive cash flow from operating activities for the
first quarter of 2002 of $5.2 million compared to $11.3 million for the same
period of 2001. Triad's positive operating cash flow in the first quarter of
2002 reflects premiums and investment income received that were greater than
expenses and losses paid. The decrease in operating cash flow from the
prior-year level reflects increases in paid expenses and losses exceeding growth
in collected premiums and the $1.9 million cash payment in the prior-year period
from cancellation of an excess of the loss reinsurance contract.
The Company's business does not routinely require significant capital
expenditures other than for enhancements to its computer systems and
technological capabilities. Positive cash flows are invested pending future
payments of claims and expenses. Cash flow shortfalls, if any, could be funded
through sales of short-term investments and other investment portfolio
securities.
The parent company's cash flow is dependent on interest income and payments
from Triad including cash dividends, management fees, and interest payments
under surplus notes. The insurance laws of the State of Illinois impose certain
restrictions on dividends from Triad. These restrictions, based on statutory
accounting practices, include requirements that dividends may be paid only out
of statutory earned surplus and limit the amount of dividends that may be paid
without prior approval of the Illinois Insurance Department. The Illinois
Insurance Department permits expenses of the parent company to be reimbursed by
Triad in the form of management fees.
Consolidated invested assets were $286.4 million at March 31, 2002,
compared to $277.2 million at December 31, 2001. Fixed maturity securities and
equity securities classified as available-for-sale totaled $268.2 million at
March 31, 2002. Net unrealized investment gains were $1.0 million on equity
securities and net unrealized investment losses were $804,000 on fixed maturity
securities at March 31, 2002. Based on fair value, the fixed maturity portfolio
consisted of approximately 75% municipal securities, 20% corporate securities,
and 5% U.S. government obligations at March 31, 2002.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CONTINUED
The Company's loss reserves were $18.2 million at March 31, 2002, compared
to $18.0 million at December 31, 2001. Reserves are established for reported
insurance losses and loss adjustment expenses based on when notices of default
on insured mortgage loans are received. Reserves are also established for
estimated losses incurred on notices of default not yet reported by the lender.
Consistent with industry practices, the Company does not establish loss reserves
for future claims on insured loans which are not currently in default. The
growth in loss reserves is the result of the increase in reported defaults and
the maturing of the Company's risk in force. The Company expects loss reserves
will continue to grow, reflecting the growth and aging of its insurance in
force. Including bulk loans, the Company's delinquency ratio, the ratio of
delinquent insured loans to total insured loans, was 0.91% at March 31, 2002,
compared to 0.89% at December 31, 2001.
Reserves are established by management using estimated claim rates
(frequency) and claim amounts (severity) to estimate ultimate losses. The
reserving process incorporates a multi-dimensional analytical form that gives
effect to current economic conditions and profiles delinquencies by such factors
as policy year, geography, and chronic late payment characteristics in addition
to profiling them by age. Because the estimate for loss reserves is sensitive to
the estimates of claims frequency and severity, management performs sensitivity
analyses to test the reasonableness of the best estimate generated by the loss
reserve estimation process. These sensitivity analyses allow management to use
alternative assumptions related to claims frequency and claims severity to
develop a range of reasonably possible loss reserve outcomes that can be used to
challenge the best estimate. The loss reserve estimation process and the
sensitivity analyses support the reasonableness of the best estimate of loss
reserves recorded as a liability in the financial statements. Management
periodically reviews the loss reserve process in order to improve its estimate
of ultimate losses on loans currently in default. Adjustments to reserve
estimates are reflected in the financial statements in the periods in which the
adjustments are made.
Total stockholders' equity increased to $263.7 million at March 31, 2002,
from $246.1 million at December 31, 2001. This increase resulted primarily from
net income of $10.0 million for the first quarter of 2002 and from additional
paid-in capital of $8.4 million resulting from the exercise of employee stock
options and the related tax benefit, offset somewhat by a decline in net
unrealized gains on invested assets classified as available-for-sale of $837,000
(net of income tax).
Triad's total statutory policyholders' surplus decreased to $104.3 million
at March 31, 2002, from $105.3 million at December 31, 2001. Triad's statutory
earned surplus decreased to $20.5 million at March 31, 2002 from $21.6 million
at December 31, 2001. The decrease in Triad's statutory policyholders' surplus
and statutory earned surplus resulted from the increase in the statutory
contingency reserve and the timing of the purchase of United States Mortgage
Guaranty Tax and Loss Bonds which offset the increase in statutory net income.
The balance in the statutory contingency reserve was $205.7 million at March 31,
2002, compared to $193.7 million at December 31, 2001.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CONTINUED
Triad's ability to write insurance depends on the maintenance of its
financial strength ratings and the adequacy of its capital in relation to risk
in force. A significant reduction of capital or a significant increase in risk
may impair Triad's ability to write additional insurance. A number of states
also generally limit Triad's risk-to-capital ratio to 25-to-1. As of March 31,
2002, Triad's risk-to-capital ratio was 15.1-to-1, as compared to 15.0-to-1 at
December 31, 2001, and 11.2-to-1 for the industry as a whole at December 31,
2000, the latest industry data available.
Triad is rated "AA" by both Standard & Poor's Ratings Services and Fitch
Ratings and "Aa3" by Moody's Investors Service.
In July 2001, the Office of Federal Housing Enterprise Oversight (OFHEO)
released its initial risk-based capital rules for Fannie Mae and Freddie Mac.
The regulation provided a more preferential capital credit for insurance from a
"AAA" rated private mortgage insurer than for insurance from a "AA" rated
private mortgage insurer. In December 2001, OFHEO announced proposed revisions
to the risk-based capital rules for Fannie Mae and Freddie Mac. Among the
proposed revisions, the new rule reduced, but did not eliminate, the capital
charge differential between insurance from a "AAA" rated private mortgage
insurer and insurance from a "AA" rated private mortgage insurer. In addition,
the proposed phase-in period was extended from five years to ten years. The rule
was finalized in February 2002 and became effective in March 2002. The continued
presence of a capital charge differential could adversely affect Triad. Triad is
evaluating various business approaches and options available to address the
capital differential contained in the rule. What response, if any, Triad makes
and the ultimate impact of the regulation on Triad is unknown at this time.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Management's Discussion and Analysis and this Report contain
forward-looking statements relating to future plans, expectations, and
performance which involve various risks and uncertainties, including but not
limited to the following: interest rates may increase from their current levels;
housing transactions and mortgage issuance may decrease for many reasons
including changes in interest rates or economic conditions; the Company's market
share may change as a result of changes in underwriting criteria or competitive
products or rates; the amount of insurance written could be affected by changes
in federal housing legislation, including changes in the Federal Housing
Administration loan limits and coverage requirements of Freddie Mac and Fannie
Mae; the Company's financial condition and competitive position could be
affected by legislation impacting the mortgage guaranty industry specifically
and the financial services industry in general; rating agencies may revise
methodologies for determining the Company's financial strength ratings and may
revise or withdraw the assigned ratings at any time; decreases in persistency,
which are affected by loan refinancings in periods of low interest rates, may
have an adverse effect on earnings; the amount of insurance written and the
growth of insurance in force or risk in force as well as the performance of the
Company may be adversely impacted by the competitive environment in the private
mortgage insurance industry, including the type, structure, and pricing of
products and services offered by the Company and its competitors; with
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- CONTINUED
consolidation occurring among mortgage lenders and the Company's concentration
of insurance in force generated through relationships with significant lender
customers, the loss of a significant customer may have an adverse effect on
earnings; the Company's performance may be impacted by changes in the
performance of the financial markets and general economic conditions. Economic
downturns in regions where Triad's risk is more concentrated could have a
particularly adverse effect on Triad's financial condition and loss development.
New OFHEO risk-based capital rules for Fannie Mae and Freddie Mac could
severely limit the ability of Triad to compete with "AAA" rated private mortgage
insurers. The ultimate effect of the new rules on Triad and the mortgage
insurance industry in general is not known at this time and will not be known
until Fannie Mae and Freddie Mac determine their requirements under the rules.
Accordingly, actual results may differ from those set forth in the
forward-looking statements. Attention is also directed to other risk factors set
forth in documents filed by the Company with the Securities and Exchange
Commission.
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PART II
ITEM 1. LEGAL PROCEEDINGS - None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS - None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - None
ITEM 5. OTHER INFORMATION - None
ITEM 6. A. EXHIBITS AND REPORTS ON FORM 8-K - None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TRIAD GUARANTY INC.
Date: May 15, 2002
/s/ Michael E. Crow
---------------------
Michael E. Crow
Vice President and Controller,
Principal Accounting Officer
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