Triad Guaranty Inc.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|
|
|
þ |
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 |
For the quarterly period ended June 30, 2007
OR
|
|
|
o |
|
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
(State or other jurisdiction of
incorporation or organization)
|
|
56-1838519
(I.R.S. Employer
Identification No.) |
|
|
|
101 South Stratford Road
Winston-Salem, North Carolina
(Address of principal executive offices)
|
|
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, or a non-accelerated filer. See definition of accelerated filer and large accelerated
filer in Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer þ Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Act) Yes o No þ
Number of shares of Common Stock, par value $0.01 per share, outstanding as of August 3, 2007,
was 14,920,108.
TRIAD GUARANTY INC.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
TRIAD GUARANTY INC.
CONSOLIDATED BALANCE SHEETS
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
(dollars in thousands, except per share data) |
|
2007 |
|
|
2006 |
|
|
|
|
|
(unaudited) |
|
|
(audited) |
|
ASSETS |
|
|
|
|
|
|
|
|
Invested assets: |
|
|
|
|
|
|
|
|
Securities available-for-sale, at fair value: |
|
|
|
|
|
|
|
|
Fixed maturities (amortized cost: $614,182 and $568,992) |
|
$ |
618,034 |
|
|
$ |
586,594 |
|
Equity securities (cost: $3,744 and $9,530) |
|
|
3,781 |
|
|
|
10,417 |
|
Other investments |
|
|
|
|
|
|
5,000 |
|
Short-term investments |
|
|
52,384 |
|
|
|
5,301 |
|
|
|
|
|
|
|
|
|
|
|
674,199 |
|
|
|
607,312 |
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
|
26,711 |
|
|
|
38,609 |
|
Real estate acquired in claim settlement |
|
|
7,923 |
|
|
|
10,170 |
|
Accrued investment income |
|
|
8,972 |
|
|
|
8,054 |
|
Deferred policy acquisition costs |
|
|
35,157 |
|
|
|
35,143 |
|
Prepaid federal income taxes |
|
|
170,076 |
|
|
|
166,908 |
|
Property and equipment |
|
|
10,086 |
|
|
|
7,678 |
|
Other assets |
|
|
27,153 |
|
|
|
21,757 |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
960,277 |
|
|
$ |
895,631 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY |
|
|
|
|
|
|
|
|
Liabilities: |
|
|
|
|
|
|
|
|
Losses and loss adjustment expenses |
|
$ |
122,061 |
|
|
$ |
84,352 |
|
Unearned premiums |
|
|
15,461 |
|
|
|
13,193 |
|
Amounts payable to reinsurers |
|
|
6,272 |
|
|
|
5,909 |
|
Deferred income taxes |
|
|
177,889 |
|
|
|
176,483 |
|
Long-term debt |
|
|
34,514 |
|
|
|
34,510 |
|
Accrued interest on debt |
|
|
1,275 |
|
|
|
1,275 |
|
Accrued expenses and other liabilities |
|
|
8,182 |
|
|
|
9,685 |
|
|
|
|
|
|
|
|
Total liabilities |
|
|
365,654 |
|
|
|
325,407 |
|
Commitments and contingencies Note 4
|
|
|
|
|
|
|
|
|
Stockholders equity: |
|
|
|
|
|
|
|
|
Preferred stock, par value $0.01 per share - authorized
1,000,000 shares; no shares issued and outstanding |
|
|
|
|
|
|
|
|
Common stock, par value $0.01 per share - authorized
32,000,000 shares; issued and outstanding 14,920,108 shares
at June 30, 2007 and 14,856,401 shares at December 31, 2006 |
|
|
149 |
|
|
|
149 |
|
Additional paid-in capital |
|
|
107,541 |
|
|
|
104,981 |
|
Accumulated other comprehensive income, net of income tax
liability of $1,362 at June 30, 2007 and $6,471 at December 31, 2006 |
|
|
4,507 |
|
|
|
12,018 |
|
Retained earnings |
|
|
482,426 |
|
|
|
453,076 |
|
|
|
|
|
|
|
|
Total stockholders equity |
|
|
594,623 |
|
|
|
570,224 |
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity |
|
$ |
960,277 |
|
|
$ |
895,631 |
|
|
|
|
|
|
|
|
See accompanying notes.
1
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
(dollars in thousands, except per share data) |
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
|
Revenue: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums written: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct |
|
$ |
83,153 |
|
|
$ |
60,961 |
|
|
$ |
161,561 |
|
|
$ |
120,273 |
|
Ceded |
|
|
(12,988 |
) |
|
|
(11,603 |
) |
|
|
(25,689 |
) |
|
|
(22,573 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums written |
|
|
70,165 |
|
|
|
49,358 |
|
|
|
135,872 |
|
|
|
97,700 |
|
Change in unearned premiums |
|
|
(433 |
) |
|
|
1,309 |
|
|
|
(2,192 |
) |
|
|
857 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
|
69,732 |
|
|
|
50,667 |
|
|
|
133,680 |
|
|
|
98,557 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income |
|
|
7,673 |
|
|
|
6,535 |
|
|
|
15,022 |
|
|
|
12,757 |
|
Net realized investment (losses) gains |
|
|
(3,867 |
) |
|
|
772 |
|
|
|
(3,105 |
) |
|
|
1,672 |
|
Other income |
|
|
2 |
|
|
|
5 |
|
|
|
4 |
|
|
|
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
73,540 |
|
|
|
57,979 |
|
|
|
145,601 |
|
|
|
112,989 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net losses and loss adjustment expenses |
|
|
41,893 |
|
|
|
17,271 |
|
|
|
74,474 |
|
|
|
33,622 |
|
Interest expense on debt |
|
|
694 |
|
|
|
694 |
|
|
|
1,387 |
|
|
|
1,387 |
|
Amortization of deferred policy acquisition costs |
|
|
4,670 |
|
|
|
4,118 |
|
|
|
9,293 |
|
|
|
7,980 |
|
Other operating expenses (net of acquisition costs deferred) |
|
|
10,716 |
|
|
|
8,496 |
|
|
|
21,047 |
|
|
|
17,009 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
57,973 |
|
|
|
30,579 |
|
|
|
106,201 |
|
|
|
59,998 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
15,567 |
|
|
|
27,400 |
|
|
|
39,400 |
|
|
|
52,991 |
|
Income taxes: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current |
|
|
1,766 |
|
|
|
979 |
|
|
|
3,525 |
|
|
|
1,951 |
|
Deferred |
|
|
1,775 |
|
|
|
6,834 |
|
|
|
6,526 |
|
|
|
12,900 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,541 |
|
|
|
7,813 |
|
|
|
10,051 |
|
|
|
14,851 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
12,026 |
|
|
$ |
19,587 |
|
|
$ |
29,349 |
|
|
$ |
38,140 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per common and common equivalent share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
$ |
0.81 |
|
|
$ |
1.33 |
|
|
$ |
1.98 |
|
|
$ |
2.58 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted |
|
$ |
0.80 |
|
|
$ |
1.31 |
|
|
$ |
1.96 |
|
|
$ |
2.56 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used in computing earnings per common and
common equivalent share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
14,834,500 |
|
|
|
14,769,367 |
|
|
|
14,824,460 |
|
|
|
14,763,889 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted |
|
|
14,950,721 |
|
|
|
14,914,075 |
|
|
|
14,946,204 |
|
|
|
14,888,304 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes.
2
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(unaudited)
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
June 30, |
|
(dollars in thousands) |
|
2007 |
|
|
2006 |
|
|
Operating activities |
|
|
|
|
|
|
|
|
Net income |
|
$ |
29,349 |
|
|
$ |
38,140 |
|
Adjustments to reconcile net income to net cash provided by operating
activities: |
|
|
|
|
|
|
|
|
Losses, loss adjustment expenses and unearned premium reserves |
|
|
39,977 |
|
|
|
2,967 |
|
Accrued expenses and other liabilities |
|
|
(1,503 |
) |
|
|
(2,248 |
) |
Amounts due to reinsurer |
|
|
363 |
|
|
|
588 |
|
Accrued investment income |
|
|
(918 |
) |
|
|
(543 |
) |
Policy acquisition costs deferred |
|
|
(9,307 |
) |
|
|
(8,499 |
) |
Amortization of deferred policy acquisition costs |
|
|
9,293 |
|
|
|
7,980 |
|
Net realized investment losses (gains) |
|
|
3,105 |
|
|
|
(1,672 |
) |
Provision for depreciation |
|
|
996 |
|
|
|
1,231 |
|
Accretion of discount on investments |
|
|
317 |
|
|
|
(50 |
) |
Deferred income taxes |
|
|
6,526 |
|
|
|
12,900 |
|
Prepaid federal income taxes |
|
|
(3,168 |
) |
|
|
(12,443 |
) |
Real estate acquired in claim settlement, net of write-downs |
|
|
2,247 |
|
|
|
(2,893 |
) |
Other assets |
|
|
(5,396 |
) |
|
|
(442 |
) |
Other operating activities |
|
|
1,765 |
|
|
|
1,633 |
|
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
|
73,646 |
|
|
|
36,649 |
|
|
|
|
|
|
|
|
|
|
Investing activities |
|
|
|
|
|
|
|
|
Securities available-for-sale: |
|
|
|
|
|
|
|
|
Purchases fixed maturities |
|
|
(128,370 |
) |
|
|
(90,826 |
) |
Sales fixed maturities |
|
|
80,120 |
|
|
|
54,081 |
|
Maturities fixed maturities |
|
|
3,391 |
|
|
|
2,933 |
|
Purchases equities |
|
|
(55 |
) |
|
|
(4,647 |
) |
Sales equities |
|
|
7,086 |
|
|
|
3,001 |
|
Purchases of other investments |
|
|
|
|
|
|
(5,000 |
) |
Net change in short-term investments |
|
|
(47,083 |
) |
|
|
519 |
|
Purchases of property and equipment |
|
|
(3,404 |
) |
|
|
(1,358 |
) |
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(88,315 |
) |
|
|
(41,297 |
) |
|
|
|
|
|
|
|
|
|
Financing activities |
|
|
|
|
|
|
|
|
Excess tax benefits from share-based compensation |
|
|
175 |
|
|
|
280 |
|
Proceeds from exercise of stock options |
|
|
616 |
|
|
|
625 |
|
|
|
|
|
|
|
|
Net cash provided by financing activities |
|
|
791 |
|
|
|
905 |
|
|
|
|
|
|
|
|
|
|
Foreign currency translation adjustment |
|
|
1,980 |
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents |
|
|
(11,898 |
) |
|
|
(3,743 |
) |
Cash and cash equivalents at beginning of period |
|
|
38,609 |
|
|
|
8,934 |
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
26,711 |
|
|
$ |
5,191 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental schedule of cash flow information |
|
|
|
|
|
|
|
|
Cash paid during the period for: |
|
|
|
|
|
|
|
|
Income taxes and United States Mortgage Guaranty Tax and Loss Bonds |
|
$ |
9,091 |
|
|
$ |
15,343 |
|
Interest |
|
|
1,383 |
|
|
|
1,383 |
|
See accompanying notes.
3
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2007
(Unaudited)
1. The Company
Triad Guaranty Inc. is a holding company, which through its wholly-owned subsidiary, Triad
Guaranty Insurance Corporation (Triad), provides mortgage insurance coverage in the United
States. This allows buyers to achieve homeownership with a reduced down payment, facilitates the
sale of mortgage loans in the secondary market and protects lenders from credit default-related
expenses. Triad Guaranty Inc. and its subsidiaries are collectively referred to as the Company.
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 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, 2007 are not necessarily indicative of the results that may be expected for the year
ending December 31, 2007. 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, 2006.
Recent Accounting Pronouncements
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in
Income Taxes an interpretation of FASB Statement No. 109 (FIN 48), which clarifies the
accounting and disclosure for uncertainty in tax positions, as defined. FIN 48 seeks to reduce the
diversity in practice associated with certain aspects of the recognition and measurement related to
accounting for income taxes. The Company is subject to the provisions of FIN 48 as of January 1,
2007, and has analyzed tax positions in its filed income tax returns. The only periods subject to
examination for the Companys federal returns are the 2003 through 2006 tax years. In January 2007,
the Company received a final notice from the Internal Revenue Service stating that the examination
of its 2004 tax return was completed and no changes were made to the Companys reported tax. The
Company believes that its income and deduction filing positions in the remaining open tax years
would be sustained if subject to audit and does not anticipate any adjustments that will result in
a material change in its financial position. Therefore, no reserves for uncertain income tax
positions have been recorded pursuant to FIN 48. In addition, the Company did not record a
cumulative effect adjustment related to the adoption of FIN 48.
The Companys policy for recording interest and penalties, if any, associated with audits is
to record such items as a component of income before taxes. Penalties would be recorded in other
operating expenses and interest paid or received would be recorded as interest expense or interest
income, respectively, in the statement of income.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157), which
defines fair value, establishes a framework for measuring fair value in generally accepted
accounting principles, and expands disclosures about fair value measurements. SFAS 157 is effective
for the Company beginning January 1, 2008 and is not expected to have a material impact on the
Companys financial position or results of operations.
4
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities Including an Amendment of FASB Statement No. 115. (SFAS 159), which
allows companies to choose to measure certain financial assets and liabilities at fair value that
are not currently required to be measured at fair value. SFAS 159 also establishes presentation and
disclosure requirements designed to facilitate comparisons between entities that choose different
measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for the
Company beginning January 1, 2008. The Company is not expected to adopt the fair value option for
reporting financial assets and liabilities in accordance with SFAS 159.
Share-Based Compensation
On January 1, 2006, the Company adopted the provisions of SFAS 123(R), Share-Based Payment
(SFAS 123(R)). SFAS 123(R) sets accounting requirements for share-based compensation to
employees and non-employee directors, including employee stock purchase plans, and requires
companies to recognize in the statement of operations the grant-date fair value of stock options
and other equity-based compensation.
The Company chose the modified-prospective transition alternative in adopting SFAS 123(R).
Under the modified-prospective transition method, compensation cost is recognized in financial
statements issued subsequent to the date of adoption for all stock-based payments granted, modified
or settled after the date of adoption, as well as for any unvested awards that were granted prior
to the date of adoption.
Foreign Currency Translation
The financial statements of the Companys foreign subsidiary have been translated into U.S.
dollars in accordance with SFAS No. 52, Foreign Currency Translation (SFAS 52). Assets and
liabilities denominated in non-U.S. dollar functional currencies are translated using the
period-end spot exchange rates. Revenues and expenses are translated at an average exchange rate
for the period. The effects of translating operations with a functional currency other than the
reporting currency are reported as a component of accumulated other comprehensive income included
in total shareholders equity.
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.
5
Insurance In Force, Dividend Restrictions, and Statutory Results
Insurance regulations generally 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
June 30, 2007, December 31, 2006 and June 30, 2006, 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 attributable to
Modified Pool transactions. Triads ratio is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
June 30, |
|
(dollars in thousands) |
|
2007 |
|
|
2006 |
|
|
2006 |
|
|
Net risk |
|
$ |
11,057,092 |
|
|
$ |
8,612,912 |
|
|
$ |
7,640,954 |
|
Statutory capital and surplus |
|
$ |
102,942 |
|
|
$ |
168,439 |
|
|
$ |
154,695 |
|
Statutory contingency reserve |
|
|
589,661 |
|
|
|
521,836 |
|
|
|
492,013 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
692,603 |
|
|
$ |
690,275 |
|
|
$ |
646,708 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Risk-to-capital ratio |
|
16.0 to 1 |
|
|
12.5 to 1 |
|
|
|
11.8 to 1 |
|
|
|
|
|
|
|
|
|
|
|
Triad and its wholly-owned 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.
Net income as determined in accordance with statutory accounting practices was $41.7 million
and $52.1 million for the six months ended June 30, 2007 and 2006, respectively, and $88.3 million
for the year ended December 31, 2006.
At June 30, 2007 and December 31, 2006, the amount of Triads equity that could be paid out in
dividends to stockholders was $19.2 million and $84.7 million, respectively, which was the earned
surplus of Triad on a statutory basis on those dates. On April 13, 2007, Triad paid a dividend of
$30 million to its parent, Triad Guaranty Inc.
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, 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. The
assumptions utilized in the calculation of the loss reserve estimate are continually
6
reviewed, 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.
Litigation
A lawsuit was filed against the Company in January 2004 in the ordinary course of the
Companys business alleging violations of the Fair Credit Reporting Act. The Company is vigorously
defending the lawsuit. In the opinion of management, the ultimate resolution of this pending
litigation will not have a material adverse effect on the financial position or results of
operations of the Company.
Credit Facility
On June 28, 2007, the Company entered into a three-year $80.0 million revolving unsecured
credit facility with three domestic banks to provide short term liquidity for insurance operations
and general corporate purposes. The facility has an increase option and may be increased to an
aggregate total of $100.0 million. Under the credit agreement, the Company must maintain a minimum
consolidated net worth level and not exceed a risk-to-capital ratio threshold of 22 to 1. In
addition, the agreement contains covenants restricting the Companys ability to incur liens, merge
or consolidate with another entity and dispose of all or substantially all of its assets. At June
30, 2007, the Company was in compliance with all such covenants and had no amounts outstanding
under the facility.
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 effects of stock
options and unvested restricted stock on the weighted-average shares outstanding. There are no
other reconciling items between the denominators 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.
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, and the gains or losses on the change in foreign currency
translation. For the three months ended June 30, 2007 and 2006, the Companys comprehensive income
was $6.4 million and $14.7 million, respectively. For the six months ended June 30, 2007 and 2006,
the Companys comprehensive income was $21.8 million and $29.4 million, respectively.
7. Income Taxes
Income tax expense 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.
8. Long-Term Stock Incentive Plan
In May 2006, the Companys shareholders approved the 2006 Long-Term Stock Incentive Plan (the
Plan). Under the Plan, certain directors, officers, and key employees are eligible to receive
various share-based compensation awards. Stock options, restricted stock and phantom stock rights
may be awarded under the Plan for a fixed number of shares with a requirement for stock options
granted to have an exercise price equal to or greater than the fair value of the shares at the date
of grant. Generally, most awards vest over three years. Options granted under the Plan expire no
later than ten years following the date of grant. As of June 30, 2007, 1,585,930 shares were
reserved and 940,733 shares were available for issuance under the Plan. Gross compensation expense
of
7
approximately $1.092 million along with the related tax benefit of approximately $382,000 was
recognized in the financial statements for the three months ended June 30, 2007, as compared to
gross compensation expense of approximately $896,000 and the related tax benefit of approximately $314,000 for the three
months ended June 30, 2006. For the six months ended June 30, 2007 and 2006, approximately $236,000
and $277,000, respectively, of share-based compensation was capitalized as part of deferred
acquisition costs.
A summary of option activity under the Plan for the six months ended June 30, 2007 is
presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
|
Weighted- |
|
|
Aggregate |
|
|
Average |
|
|
|
Number of |
|
|
Average |
|
|
Intrinsic |
|
|
Remaining |
|
(dollars in thousands) |
|
Shares |
|
|
Exercise Price |
|
|
Value |
|
|
Contractual |
|
|
Outstanding, January 1, 2007 |
|
|
564,712 |
|
|
$ |
38.36 |
|
|
|
|
|
|
|
|
|
Granted |
|
|
107,190 |
|
|
|
43.56 |
|
|
|
|
|
|
|
|
|
Exercised |
|
|
22,937 |
|
|
|
26.87 |
|
|
|
|
|
|
|
|
|
Cancelled |
|
|
3,768 |
|
|
|
45.06 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, June 30, 2007 |
|
|
645,197 |
|
|
|
39.60 |
|
|
$ |
1,866 |
|
|
5.1 years |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable, June 30, 2007 |
|
|
410,076 |
|
|
|
37.78 |
|
|
$ |
1,866 |
|
|
2.9 years |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The fair value of stock options is estimated on the date of grant using a Black-Scholes
pricing model. The weighted-average assumptions used for options granted during the six months
ended June 30, 2007 and 2006 are noted in the following table. The expected volatilities are based
on volatility of the Companys stock over the most recent historical period corresponding to the
expected term of the options. The Company also uses historical data to estimate option exercise and
employee terminations within the model; separate groups of employees with similar historical
exercise and termination histories are considered separately for valuation purposes. The risk-free
rates for the periods corresponding to the expected terms of the options are based on U.S. Treasury
rates in effect on the dates of grant.
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
June 30, |
|
|
2007 |
|
2006 |
|
Expected Volatility |
|
|
31.9 |
% |
|
|
34.0 |
% |
Expected dividend yield |
|
|
0.0 |
% |
|
|
0.0 |
% |
Expected term |
|
5.0 years |
|
|
5.0 years |
|
Risk-free rate |
|
|
4.6 |
% |
|
|
4.5 |
% |
The weighted-average grant-date fair value of options granted during the six months ended June
30, 2007 and 2006 was $16.13 and $16.28, respectively. The total intrinsic value of options
exercised during the six months ended June 30, 2007 and 2006 was approximately $470,000 and
$839,000, respectively.
8
A summary of restricted stock activity under the Plan for the six months ended June 30, 2007
is presented below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
Average |
|
|
Number of |
|
Grant-Date |
|
|
Shares |
|
Fair Value |
|
Outstanding, January 1, 2007 |
|
|
113,941 |
|
|
$ |
46.41 |
|
Granted |
|
|
47,219 |
|
|
|
44.61 |
|
Exercised |
|
|
36,584 |
|
|
|
50.29 |
|
Cancelled |
|
|
6,449 |
|
|
|
45.89 |
|
|
|
|
|
|
|
|
|
|
Outstanding, June 30, 2007 |
|
|
118,127 |
|
|
|
44.52 |
|
|
|
|
|
|
|
|
|
|
The fair value of restricted stock is determined based on the closing price of the
Companys shares on the grant date. The weighted-average grant-date fair value of restricted stock
granted during the six months ended June 30, 2007 and 2006 was $44.61 and $45.37, respectively.
As of June 30, 2007, there was $6.4 million of total unrecognized compensation expense related
to nonvested stock options and restricted stock granted under the Plan. That expense is expected to
be recognized over a weighted-average period of 1.9 years. The total fair value of stock options
and restricted stock vested during the six months ended June 30, 2007 and 2006 was $1.9 million and
$1.6 million, respectively.
The Company issues new shares upon exercise of stock options.
9
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
the consolidated financial condition, changes in financial position, and results of operations for
the three months and six months ended June 30, 2007 and 2006, of the Company. This discussion
supplements Managements Discussion and Analysis in the Companys Form 10-K for the year ended
December 31, 2006, and should be read in conjunction with the interim financial statements and
notes contained herein.
Certain of the statements contained herein, other than statements of historical fact, are
forward-looking statements. These statements are made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995 and include estimates and assumptions related to
economic, competitive, and legislative developments. These forward-looking statements are subject
to change and uncertainty, which are, in many instances, beyond our control and have been made
based upon our 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 certain factors, including the possibility of general economic and
business conditions that are different than anticipated, legislative developments, changes in
interest rates or the stock markets, stronger than anticipated competitive activity, as well as the
risk factors described in Item 1A of our Form 10-K for the year ended December 31, 2006 and the
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 with respect to
forward-looking statements contained herein. Additional risk factors are also described in Part II,
Item 1A Risk Factors of this document.
Update on Critical Accounting Policies and Estimates
Our Annual Report on Form 10-K for the year ended December 31, 2006 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 deferred policy acquisition costs (DAC) and subsequent adjustments to that amortization.
We believe that these continue to be the critical accounting policies applicable to the
Company and that these policies were applied in a consistent manner during the first six months of
2007. In the 10-K, we provided a sensitivity analysis around the impact on pre-tax income as a
result of a 10% increase or decrease in the frequency or severity factors utilized in the reserve
model. At December 31, 2006, we stated that a 10% increase or decrease in frequency or severity is
reasonably likely based on potential changes in future economic conditions and past experience.
During the first quarter of 2007, we raised the frequency factor by approximately 5% and made a
small upward adjustment to the severity factor as a result of recent conditions in the housing
market. The adjustments to both the frequency and severity factors made during the second quarter
were only marginally upward.
As detailed later under Losses and Expenses, the significant increase in reserves during the
second quarter was the result of an increase in the number of defaults and the larger loan size of
those loans in default and not necessarily the result of a change in the assumptions utilized in
setting the factors. Economic conditions that could give rise to a significant increase in the
frequency rate include a sudden increase, or a prolonged period of increase, in the unemployment
rate. A sudden nationwide or widespread regional decline in home prices or a continued prolonged
period of flat or slowly depreciating home prices are among the conditions that could increase the
severity factors.
Overview
Through our subsidiaries, we provide Primary and Modified Pool mortgage guaranty insurance
coverage to residential mortgage lenders and investors as a credit-enhancement vehicle. We classify
insurance as Primary in
10
those instances where we are in the first loss position and the loan to value (LTV) is 80%
or greater (with the LTV calculation determined when the loan is first insured). We classify all
other insurance as Modified Pool. The majority of our Primary insurance is delivered through the
flow channel, which is defined as loans originated by lenders and submitted to us on a loan-by-loan
basis. We also provide 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 is
delivered through the structured bulk channel.
Our revenues principally consist of a) initial and renewal earned premiums from flow business
(net of reinsurance premiums ceded as part of our risk management strategies), b) initial and
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 essentially consist 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 acquiring new business and servicing existing policies, d) other general
business expenses, and e) income taxes.
Our profitability depends largely on a) the volume of business insured combined with the
adequacy of our product pricing and underwriting discipline relative to the risks insured, b) 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, c) the overall general state of the
economy and job market, d) persistency levels, e) operating efficiencies, and f) the level of
investment yield, including realized gains and losses, on our investment portfolio.
We define persistency as the percentage of insurance in force remaining from twelve months
prior. 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 from twelve months prior. 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.
For a more detailed description of our industry and operations, refer to the Business
section of our Form 10-K.
11
Consolidated Results of Operations
Following is selected financial information for the three months and six months ended June 30,
2007 and 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
(dollars in thousands, except |
|
|
|
|
|
|
|
|
|
|
|
|
per share data) |
|
2007 |
|
2006 |
|
% Change |
|
2007 |
|
2006 |
|
% Change |
|
Earned premiums |
|
$ |
69,732 |
|
|
$ |
50,667 |
|
|
|
38 |
% |
|
$ |
133,680 |
|
|
$ |
98,557 |
|
|
|
36 |
% |
Net losses and loss adjustment expenses |
|
|
41,893 |
|
|
|
17,271 |
|
|
|
143 |
|
|
|
74,474 |
|
|
|
33,622 |
|
|
|
122 |
|
Net income |
|
|
12,026 |
|
|
|
19,587 |
|
|
|
(39 |
) |
|
|
29,349 |
|
|
|
38,140 |
|
|
|
(23 |
) |
Diluted earnings per share |
|
$ |
0.80 |
|
|
$ |
1.31 |
|
|
|
(39 |
) |
|
$ |
1.96 |
|
|
$ |
2.56 |
|
|
|
(23 |
) |
The net income and diluted earnings per share for the second quarter and six months ended
June 30, 2007 shown above are lower than those reflected in our press release dated July 25, 2007,
due to the subsequent recording of a material impairment of an equity investment after our earnings
release. For further discussion about this impairment, see Part II, Item 5. Other Information.
Net losses and loss adjustment expenses for the quarter ended June 30, 2007 increased $24.6
million compared to the same period a year earlier. Year-to-date, total incurred losses increased
$40.9 million compared to the first six months of 2006. While paid losses increased during 2007 for
the three months and six months ended June 30, we had a significant increase in reserves during the
same periods when compared to 2006. The principal reason for the reserve increases was the change
in characteristics of the loans entering the default pool, with the newer defaults having
substantially higher average risk per loan. Additionally, the number of filed claims included in
our default inventory increased by about 15% during the second quarter resulting in an increased
reserve under our methodology.
Paid losses of $18.1 million for the second quarter were up $3.6 million, or 25.2%, as
compared to the quarter ended June 30, 2006. Average paid loss severity was $30,500 for both the
second quarter and first six months of 2007 compared to $25,300 and $25,200, respectively, for the
second quarter and the first six months of 2006.
We experienced a 36% increase over the second quarter of 2006 in both the number of loans in
default for which we provide a reserve as well as the average risk in default on those loans which
compounded the increase in reserves. Additionally, the composition of the default inventory has
changed such that we had a significantly greater number of pending claims at June 30, 2007, which,
through our reserve methodology, carries a larger reserve percentage of the amount of risk in
default than other defaults for which a claim has yet to be filed.
Earned premiums for the second quarter and first six months of 2007 grew significantly when
compared to the same time periods of 2006, principally due to growth in Primary insurance in force.
Based on information available from the industry association and other public sources, our
estimated market share of net new insurance written including flow and bulk channels, using
industry definitions, was 8.3% for the second quarter of 2007 compared to 8.8% for the second
quarter of 2006.
Realized investment losses and gains, net of taxes, decreased diluted earnings per share by
$0.17 and $0.14, respectively, in the second quarter and first six months of 2007, compared to
increases of $0.03 and $0.07, respectively, in the second quarter and first six months of 2006.
Realized investment gains and losses per diluted share is a non-GAAP measure. We believe this is
relevant and useful information to investors because, except for write-downs on
other-than-temporarily impaired securities, it shows the effect that our discretionary sales of
investments had on earnings. For a further discussion of an impairment write-down that has been
recorded recently, see Realized Gains (Losses) and Impairments below.
12
We describe our results in greater detail in the discussions that follow. The information
is presented in three categories: Production and In Force, Revenues, and Losses and Expenses.
Production and In Force
The table below represents a summary of New Insurance Written (NIW), or production for the
second quarter and the first six months of 2007 and 2006 broken out between Primary and Modified
Pool:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
(dollars in millions) |
|
2007 |
|
|
2006 |
|
|
% Change |
|
|
2007 |
|
|
2006 |
|
|
% Change |
|
|
Primary insurance written: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Flow |
|
$ |
5,089 |
|
|
$ |
2,559 |
|
|
|
99 |
% |
|
$ |
9,461 |
|
|
$ |
4,506 |
|
|
|
110 |
% |
Structured bulk |
|
|
1,702 |
|
|
|
385 |
|
|
|
342 |
|
|
|
3,029 |
|
|
|
386 |
|
|
|
685 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Primary insurance written |
|
$ |
6,791 |
|
|
$ |
2,944 |
|
|
|
131 |
|
|
$ |
12,490 |
|
|
$ |
4,892 |
|
|
|
155 |
|
Modified pool insurance written |
|
|
1,405 |
|
|
|
2,980 |
|
|
|
(53 |
) |
|
|
3,330 |
|
|
|
7,585 |
|
|
|
(56 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total insurance written |
|
$ |
8,196 |
|
|
$ |
5,924 |
|
|
|
38 |
% |
|
$ |
15,820 |
|
|
$ |
12,477 |
|
|
|
27 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
According to estimates published by Fannie Mae, the overall mortgage loan origination
market for the second quarter of 2007 declined approximately 6% from the second quarter of 2006,
and approximately 2% for the first six months of 2007 as compared to the first six months of 2006.
The housing market slowed significantly during 2006, continuing into the first half of 2007, as
evidenced by reduced sales of existing homes and near record high levels of unsold inventories in
many markets. Although the overall loan origination market slowed during the quarter and for the
year, there continues to be an increase in the market penetration of mortgage insurance products
because piggyback or simultaneous second mortgages have lost favor from a lenders perspective.
The significant increase in Primary NIW in the second quarter and first six months of 2007
reflects the general increase in mortgage insurance penetration in the flow channel noted above.
NIW in the flow channel increased $2.5 billion and $5.0 billion, respectively, for the second
quarter and first six months of 2007 compared to the same periods in 2006. We believe it is
unlikely that this trend will continue in the second half of 2007 for the reasons described below:
|
|
|
Our largest lender in terms of production of NIW through the flow
channel was American Home Mortgage, Inc. (AHM), which comprised 30% and 34%
of our flow production for the second quarter and first six months of 2007,
respectively. On August 6, 2007, AHM formally announced that it was seeking
protection under Chapter 11 of the U.S. bankruptcy code. See Significant
Customers below. We currently expect that the loss of production from AHM will
have a significant impact on our NIW during the remainder of 2007. |
|
|
|
|
During the second quarter of 2007, we discontinued a specific
lender-paid program which was a significant contributor to NIW in the second
half of 2006. |
|
|
|
|
We are concerned with the increased risk involved with insuring loans
with higher LTV ratios such as 100% loans. We intend to monitor this activity
carefully and will continue to place emphasis on the credit quality of our
insurance written. |
Bulk insurance is a term that describes Primary and supplemental mortgage insurance written
for a large package of loans that are then securitized in the secondary market. Mortgage insurance
provides loss protection to the issuer and thus increases the credit rating and pricing of the
securitization. Primary bulk NIW increased $1.3 billion and $2.6 billion, respectively, for the
second quarter and first six months of 2007. Most of the Primary NIW
13
booked for the quarter came
from carryover transactions from the first quarter, or business placed under existing forward
contracts.
We write Modified Pool insurance only through our structured bulk channel. Structured bulk
transactions for the entire industry increased approximately 21% and 5%, respectively, during the
second quarter and first six months of 2007 according to information available from Mortgage
Insurance Companies of America (MICA) and other publicly available data. As noted above,
approximately $1.7 billion and $3.0 billion, respectively, of structured bulk transactions during
the second quarter and first six months of 2007 were classified as Primary. Structured bulk
transactions, which include both Primary and Modified Pool is likely to vary significantly from
period to period due to: a) the limited number of transactions (but with larger size) occurring in
this market, b) the level of competition from other mortgage insurers, c) the relative
attractiveness in the marketplace of mortgage insurance versus other forms of credit enhancement,
and d) the changing loan composition and underwriting criteria of the market. During the second
quarter of 2007, we viewed the structured bulk market as unsettled, with a wide variety of product
and a lack of clear direction in spreads and pricing. In this environment, we chose to stay on the
sidelines and much of the reported Modified Pool NIW from the bulk channel was the result of
carryover transactions. Approximately 18% and 35%, respectively, of our insurance written
attributable to our structured bulk channel during the second quarter and first six months of 2007
was structured with deductibles that put us in the second loss position compared to 43% for both
the second quarter and the first six months of 2006.
The following table provides estimates of our national market share of net new insurance
written, using industry definitions, through our flow and structured bulk channels based on
information available from MICA and other public sources for the three months and six months ended
June 30, 2007 and 2006:
Market Share by Channel
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
Flow channel |
|
|
6.9 |
% |
|
|
5.7 |
% |
|
|
7.8 |
% |
|
|
5.5 |
% |
Structured bulk channel |
|
|
12.3 |
% |
|
|
15.3 |
% |
|
|
12.7 |
% |
|
|
16.1 |
% |
Total |
|
|
8.3 |
% |
|
|
8.8 |
% |
|
|
9.2 |
% |
|
|
9.4 |
% |
Our total market share declined slightly in the second quarter and for the first six
months of 2007 due mostly to our decision to wait out some of the uncertainties in the structured
bulk market. As mentioned earlier, our structured bulk market share will vary from period to period
since this market can have significantly larger
transactions and our share of this market is dependent on the availability of transactions
that meet our credit quality and pricing benchmarks and on our ability to bid successfully to
provide insurance on these transactions. Our flow market share increased in the second quarter and
for the first six months of 2007 due mostly to two specific lender-paid programs that will not be
continued in the second half of 2007.
14
One of the risk characteristics that we pay particular attention to is credit quality. We have
defined Alt-A as individual loans having FICO scores greater than 619 and that have been
underwritten with reduced or no documentation. We have defined A Minus loans as those having FICO
scores greater than 574, but less than 620. We have defined Sub Prime loans as those with credit
scores less than 575. The following table summarizes the credit quality characteristics of our
Primary new insurance written during the second quarter and the first six months of 2007 and 2006:
Credit Quality of Primary NIW
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
Prime |
|
|
62.0 |
% |
|
|
65.5 |
% |
|
|
59.6 |
% |
|
|
69.3 |
% |
Alt-A |
|
|
34.2 |
|
|
|
32.3 |
|
|
|
37.5 |
|
|
|
28.5 |
|
A-Minus |
|
|
3.4 |
|
|
|
1.9 |
|
|
|
2.6 |
|
|
|
1.9 |
|
Sub Prime |
|
|
0.4 |
|
|
|
0.3 |
|
|
|
0.3 |
|
|
|
0.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The changes in the percentage makeup of the credit quality of Primary NIW for the second
quarter and first six months of 2007 are partially reflective of the impact of the structured bulk
transactions classified as Primary NIW. Bulk transactions are classified as either prime, Alt-A or
sub prime.
The following table summarizes the loan type characteristics of our Primary new insurance
written during the second quarter and the first six months of 2007 and 2006. The increase in loans
with fixed rates for the second quarter is reflective of the general marketplace as many borrowers
have refinanced ARM products to more stable fixed loan products.
Loan Type of Primary NIW
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
Fixed |
|
|
61.9 |
% |
|
|
54.1 |
% |
|
|
55.0 |
% |
|
|
59.4 |
% |
ARM (positive amortization) |
|
|
21.3 |
|
|
|
11.9 |
|
|
|
22.6 |
|
|
|
13.6 |
|
ARM (potential negative amortization) |
|
|
16.8 |
|
|
|
34.0 |
|
|
|
22.4 |
|
|
|
27.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ARMs with the potential for negative amortization declined significantly in the second
quarter of 2007 reflecting a trend in the overall marketplace. Our year-to-date production has been
limited to a few lenders where we believe we have a good understanding of both their product and
their underwriting guidelines. An inherent risk in this product is the scheduled milestone in which
the borrower must begin making amortizing payments. These payments can be substantially greater
than the existing minimum payments currently required. Many of these loans do not have scheduled
payment increases until 2008 or 2009, so the borrower has not been required to make an increased
payment or to refinance, adding uncertainty and potential risk to this product. However, we are
aware of the risks of concentration in this product and we have limits on the amount of potentially
negative amortizing ARMs that we will accept.
15
Another risk characteristic that we consider in our underwriting guidelines is the LTV of the
loan. The following table summarizes the percentage of our Primary production by LTV during the
second quarter and the first six months of 2007 and 2006:
Loan to Value of Primary NIW
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
Greater than 95% |
|
|
36.1 |
% |
|
|
12.2 |
% |
|
|
31.6 |
% |
|
|
11.4 |
% |
90.01% to 95.00% |
|
|
23.3 |
|
|
|
22.0 |
|
|
|
23.5 |
|
|
|
23.2 |
|
90.00% and below |
|
|
40.6 |
|
|
|
65.8 |
|
|
|
44.9 |
|
|
|
65.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The above table indicates an increase in the Primary production of NIW on loans with LTV
greater than 95%. These loans are coming from both the flow and bulk channels. As mentioned
earlier, many of the greater than 95% loans are the result of the change from lenders preferring
piggyback or simultaneous second mortgages to a loan product that has the higher LTV ratio. This
has produced an increase in risk that we will continue to monitor. We are committed to supporting
our customers in their lending efforts but want to ensure sound underwriting and appropriate
pricing of product for the risks that we assume.
The majority of our Modified Pool production has been in the Alt-A marketplace over the last
two years. LTVs on policies originated in the structured bulk channel are generally lower than
those on policies we receive via the flow channel. Those structures generally include loans that
have other Primary coverage in front of our risk or loans that are written with a LTV lower than
80%. As shown in the summary of NIW table, Modified Pool production for the second quarter of 2007
declined 53% as compared to the second quarter of 2006, and declined 56% for the first six months
of 2007 as compared to the first six months of 2006 as we wait for more clarity on pricing.
The following table provides detail on our direct insurance in force at June 30, 2007 and
2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
|
|
(dollars in millions) |
|
2007 |
|
|
2006 |
|
|
% Change |
|
|
Primary insurance |
|
$ |
42,724 |
|
|
$ |
30,783 |
|
|
|
39 |
% |
Modified pool insurance |
|
|
23,649 |
|
|
|
20,022 |
|
|
|
18 |
|
|
|
|
|
|
|
|
|
|
|
Total insurance |
|
$ |
66,373 |
|
|
$ |
50,805 |
|
|
|
31 |
% |
|
|
|
|
|
|
|
|
|
|
|
Our Primary insurance in force at June 30, 2007 grew from June 30, 2006 as a result of
increased production and improved persistency rates. Primary insurance persistency improved to
77.7% at June 30, 2007 compared to 72.7% at June 30, 2006. We anticipate that persistency rates
will continue near current levels or increase moderately throughout the remainder of 2007 due to
current housing market weakness and the relative flatness of the yield curve. However, persistency
may be adversely affected if interest rates decline significantly from the levels experienced
during the first half of 2007. Over the past year, we have experienced a significant amount of
growth in Primary direct insurance in force, partially the result of the structured bulk
production. Of the $42.7 billion of Primary insurance in force at June 30, 2007, approximately $4.1
billion is attributable to structured bulk transactions compared to only $700 million a year ago.
16
Similar to the trend in NIW discussed above, Alt-A continues to grow as a percentage of our
Primary insurance in force and continues to comprise the majority of our Modified Pool insurance in
force. Because Alt-A loans lack the full documentation required in Prime loans, these present a
greater risk than fully documented loans. The following table shows the percentage of our insurance
in force that we have classified as Alt-A at June 30, 2007 and 2006:
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
2007 |
|
2006 |
|
Primary insurance in force |
|
|
21.5 |
% |
|
|
12.3 |
% |
Modified Pool insurance in force |
|
|
71.5 |
% |
|
|
68.0 |
% |
Total insurance in force |
|
|
39.3 |
% |
|
|
34.3 |
% |
The following tables provide information on selected slices of our business based on risk in
force at June 30, 2007 and 2006. Indicators of possible increased risk which could be also
characterized as non-traditional mortgages would include the following:
|
|
|
A decline in the percentage of business with prime credit quality |
|
|
|
|
An increase in the percentage of Alt-A business |
|
|
|
|
An increase in Primary LTV greater than 95% |
|
|
|
|
An increase in potential negative amortization loan types |
|
|
|
|
An increase in condominium property types |
|
|
|
|
A decline in Primary residence occupancy status |
|
|
|
|
A growing percentage of loans in excess of $250,000 |
17
Risk in Force (1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary |
|
|
Modified Pool |
|
|
|
June 30, |
|
|
June 30, |
|
(dollars in millions) |
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
|
Direct Risk in Force |
|
$ |
11,128 |
|
|
$ |
7,741 |
|
|
$ |
935 |
|
|
$ |
764 |
|
Net Risk In Force |
|
|
10,239 |
|
|
|
6,966 |
|
|
|
818 |
|
|
|
674 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit Quality: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prime |
|
|
73.6 |
% |
|
|
82.6 |
% |
|
|
29.6 |
% |
|
|
32.1 |
% |
Alt-A |
|
|
22.8 |
|
|
|
12.8 |
|
|
|
69.6 |
|
|
|
66.7 |
|
A-Minus |
|
|
3.1 |
|
|
|
3.9 |
|
|
|
0.7 |
|
|
|
1.0 |
|
Sub Prime |
|
|
0.5 |
|
|
|
0.7 |
|
|
|
0.1 |
|
|
|
0.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LTV: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Greater than 95% |
|
|
23.2 |
% |
|
|
14.7 |
% |
|
|
|
% |
|
|
|
% |
90.01% to 95.00% |
|
|
70.8 |
|
|
|
78.8 |
|
|
|
0.9 |
|
|
|
1.1 |
|
90.00% and below |
|
|
6.0 |
|
|
|
6.5 |
|
|
|
99.1 |
|
|
|
98.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan Type: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed |
|
|
65.4 |
% |
|
|
72.6 |
% |
|
|
26.8 |
% |
|
|
35.5 |
% |
ARM (positive amortization) |
|
|
20.3 |
|
|
|
19.8 |
|
|
|
60.2 |
|
|
|
58.7 |
|
ARM (potential negative amortization) |
|
|
14.3 |
|
|
|
7.6 |
|
|
|
13.0 |
|
|
|
5.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property Type: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Condominium |
|
|
10.3 |
% |
|
|
8.7 |
% |
|
|
9.3 |
% |
|
|
7.2 |
% |
Other (principally single-family detached) |
|
|
89.7 |
|
|
|
91.3 |
|
|
|
90.7 |
|
|
|
92.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Occupancy Status: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary residence |
|
|
87.6 |
% |
|
|
90.3 |
% |
|
|
73.7 |
% |
|
|
73.9 |
% |
Secondary home |
|
|
7.9 |
|
|
|
6.2 |
|
|
|
6.2 |
|
|
|
5.9 |
|
Non-owner occupied |
|
|
4.5 |
|
|
|
3.5 |
|
|
|
20.1 |
|
|
|
20.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage Amount: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$0 - $50,000 |
|
|
0.9 |
% |
|
|
1.3 |
% |
|
|
0.5 |
% |
|
|
0.5 |
% |
$51,000 - $100,000 |
|
|
10.4 |
|
|
|
15.0 |
|
|
|
5.4 |
|
|
|
6.8 |
|
$100,001 - $250,000 |
|
|
52.7 |
|
|
|
61.0 |
|
|
|
45.8 |
|
|
|
51.1 |
|
$250,001 - $500,000 |
|
|
29.9 |
|
|
|
20.5 |
|
|
|
41.8 |
|
|
|
39.0 |
|
Over $500,000 |
|
|
6.1 |
|
|
|
2.2 |
|
|
|
6.5 |
|
|
|
2.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
(1) |
|
Percentages represent distribution of direct risk in force on a per policy basis and
do not account for applicable stop-loss amounts or deductibles on Modified Pool. |
The above table indicates that non-traditional mortgages continue to grow as a percentage of
our risk in force. This is somewhat indicative of the move by the overall mortgage industry toward
these products. While we have generally stayed away from certain sectors in the marketplace such as
Sub Prime and second mortgages, our portfolio contains an increased exposure to Alt-A loans as well
as ARMs subject to potential negative amortization which carry an increased amount of risk. We have
also seen a significant increase in the amount of the mortgages
18
for which we are providing
coverage. Loans over $250,000 totaled 36.0% of total Primary risk in force at June 30, 2007
compared to 22.7% at June 30, 2006. Loans over $250,000 also totaled 48.3% of total Modified Pool
risk in force at June 30, 2007 compared to 41.6% at June 30, 2006. In addition, the increase in
loans with LTVs greater than 95% has increased our risk as our experience with these products is
that they have historically produced higher default rates.
Due to the recent significant growth in our production and the amount of refinancing that took
place in 2002 through 2005 that caused much of our earlier vintage years to lapse, our insurance
portfolio remains relatively unseasoned, having a weighted average life of 2.2 years at June 30,
2007 compared to 2.3 years at December 31, 2006 and 2.4 years at December 31, 2005. The following
table shows direct risk in force as of June 30, 2007 by year of loan origination.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary |
|
|
Modified Pool * |
|
|
|
June 30, 2007 |
|
|
June 30, 2007 |
|
|
|
Direct Risk |
|
|
|
|
|
|
Direct Risk |
|
|
|
|
(dollars in millions) |
|
in Force |
|
|
Percent |
|
|
in Force |
|
|
Percent |
|
|
2002 and before |
|
$ |
756.6 |
|
|
|
6.8 |
% |
|
$ |
46.6 |
|
|
|
5.7 |
% |
2003 |
|
|
1,302.0 |
|
|
|
11.7 |
|
|
|
113.7 |
|
|
|
13.9 |
|
2004 |
|
|
1,257.5 |
|
|
|
11.3 |
|
|
|
139.1 |
|
|
|
17.0 |
|
2005 |
|
|
1,802.8 |
|
|
|
16.2 |
|
|
|
229.9 |
|
|
|
28.1 |
|
2006 |
|
|
2,893.3 |
|
|
|
26.0 |
|
|
|
260.1 |
|
|
|
31.8 |
|
2007 |
|
|
3,115.9 |
|
|
|
28.0 |
|
|
|
28.6 |
|
|
|
3.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
11,128.1 |
|
|
|
100.0 |
% |
|
$ |
818.0 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
For Modified Pool, the Direct Risk in Force is calculated utilizing the particular stop-loss
limits and deductibles within each specific structure |
We also offer mortgage insurance structures designed to allow lenders to share in the risks of
such insurance. 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. The following table
shows the percentage of our Primary flow channel insurance in force as well as the percentage of
our total insurance in force that was subject to captive reinsurance arrangements at June 30, 2007
and 2006.
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
2007 |
|
2006 |
|
Primary flow insurance in force |
|
|
51.4 |
% |
|
|
62.7 |
% |
Total insurance in force |
|
|
33.0 |
% |
|
|
37.1 |
% |
The decline of the Primary flow insurance in force that was subject to captive reinsurance
arrangements at June 30, 2007 over June 30, 2006 was the result of a switch by some of our larger
lender partners to lender paid products that do not qualify for captive participation. The decline
in the total direct insurance in force subject to captive reinsurance at June 30, 2007 from June
30, 2006 also reflects the fact that a greater portion of our insurance in force consists of
Modified Pool insurance in force, which is written through the structured bulk channel and is not
subject to captive reinsurance arrangements.
We believe captive reinsurance arrangements are an effective risk management tool as selected
lenders share in the risk under these arrangements. Additionally, captive reinsurance arrangements
are structured so that Triad receives credit against the capital required in certain risk-based
capital models utilized by rating agencies. We remain committed to structuring captive reinsurance
arrangements, including deep ceded arrangements where
19
the net premium cede rate is greater than
25%, on a lender-by-lender basis as we deem it to be prudent. We will continue to be an active
participant with our lender partners in captive reinsurance arrangements.
Revenues
A summary of the significant individual components of our revenue for the second quarter and
the first six months of 2007 and 2006 follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
(dollars in thousands) |
|
2007 |
|
|
2006 |
|
|
% Change |
|
2007 |
|
|
2006 |
|
|
% Change |
|
Direct premium written |
|
$ |
83,153 |
|
|
$ |
60,961 |
|
|
|
36 |
% |
|
|
$ |
161,561 |
|
|
$ |
120,273 |
|
|
|
34 |
% |
|
Ceded premium written |
|
|
(12,988 |
) |
|
|
(11,603 |
) |
|
|
12 |
|
|
|
|
(25,689 |
) |
|
|
(22,573 |
) |
|
|
14 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net premium written |
|
|
70,165 |
|
|
|
49,358 |
|
|
|
42 |
|
|
|
|
135,872 |
|
|
|
97,700 |
|
|
|
39 |
|
|
Change in unearned premiums |
|
|
(433 |
) |
|
|
1,309 |
|
|
|
(133 |
) |
|
|
|
(2,192 |
) |
|
|
857 |
|
|
|
(356 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
69,732 |
|
|
$ |
50,667 |
|
|
|
38 |
% |
|
|
$ |
133,680 |
|
|
$ |
98,557 |
|
|
|
36 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income |
|
$ |
7,673 |
|
|
$ |
6,535 |
|
|
|
17 |
% |
|
|
$ |
15,022 |
|
|
$ |
12,757 |
|
|
|
18 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues |
|
$ |
73,540 |
|
|
$ |
57,979 |
|
|
|
27 |
% |
|
|
$ |
145,601 |
|
|
$ |
112,989 |
|
|
|
29 |
% |
|
Our direct premium written for the second quarter and first six months of 2007 grew
substantially over that of 2006 as a result of increased insurance in force over the past year and
the increased average basis points earned due to the change in the risk characteristics of our
portfolio discussed earlier in the section titled Consolidated Results of Operations. The
announcement by AHM to seek bankruptcy protection is not expected to have a significant impact on
premium income in the near term as the insurance in force would not be anticipated to drop
substantially. Total overall annual persistency was 78.2% at June 30, 2007 compared to 72.1% at
June 30, 2006.
20
Ceded premium written is comprised of premiums written under excess of loss reinsurance
treaties with captive as well as non-captive reinsurance companies. The growth in ceded premium
written in the second quarter and the first six months of 2007 over the same periods of 2006 was
not as large as the growth in direct premium written as a result of a larger percentage of direct
premiums written not subject to captive reinsurance arrangements. The following table provides
further data on ceded premiums for the three months and six months ended June 30, 2007 and 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
Premium cede rate (ceded premiums written as a
percentage of direct premiums written) |
|
|
15.6 |
% |
|
|
19.0 |
% |
|
|
15.9 |
% |
|
|
18.8 |
% |
Captive reinsurance premium cede rate (ceded premiums
written under captive reinsurance arrangements as a
percentage of direct premiums written) |
|
|
15.0 |
% |
|
|
17.8 |
% |
|
|
15.3 |
% |
|
|
17.5 |
% |
Average captive premium cede rate (ceded premiums
written under captive reinsurance arrangements as a
percentage of direct premiums written under captive
reinsurance arrangements) |
|
|
36.1 |
% |
|
|
36.7 |
% |
|
|
36.2 |
% |
|
|
36.9 |
% |
The table below provides data on insurance written that was subject to captive reinsurance
arrangements for the three months and six months ended June 30, 2007 and 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
Primary insurance in force |
|
|
34.3 |
% |
|
|
53.2 |
% |
|
|
31.4 |
% |
|
|
54.0 |
% |
Total insurance in force |
|
|
21.3 |
% |
|
|
26.5 |
% |
|
|
18.8 |
% |
|
|
21.2 |
% |
The percentage of Primary insurance written subject to captive reinsurance arrangements
for the second quarter and first six months of 2007 decreased from comparable periods in 2006 due
primarily to changes by two of our larger lenders to a lender paid product rather than a borrower
paid product. Generally, the lender paid product is not captive eligible. None of our Modified Pool
insurance written in 2007 and 2006 was subject to captive reinsurance arrangements.
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 products. One of the
most actively utilized lender paid programs during the first half of 2007 included annual premiums,
which was responsible for most of the increase in unearned premium during the second quarter and
first six months of 2007. Our unearned premium liability for June 30, 2007 increased $2.3 million
from December 31, 2006 compared to a decrease of $0.9 million from December 31, 2005 to June 30,
2006.
Net investment income increased for the second quarter and the first six months of 2007 as
compared to the same time periods in 2006, due primarily to growth in invested assets, partially
offset by declines in portfolio yields. Average invested assets at cost or amortized cost for the
second quarter of 2007 grew by 18.3% over the second quarter of 2006 and grew 14.7% year-to-date
compared to the first six months of 2006 as a result of the investment of cash flows from
operations for the past year. Our investment portfolio tax-equivalent yield was
6.58% at June 30, 2007 compared to 6.73% at June 30, 2006. We anticipate a continuing decline
in the overall
21
portfolio tax-equivalent yield as current interest rates are still below our average portfolio
rate. See further discussion of the Investment Portfolio section of this document.
Losses and Expenses
A summary of the individual components of losses and expenses for the three months and six
months ended June 30, 2007 and 2006 follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
(dollars in thousands) |
|
2007 |
|
2006 |
|
% Change |
|
2007 |
|
2006 |
|
% Change |
|
Net losses and loss adjustment expenses |
|
$ |
41,893 |
|
|
$ |
17,271 |
|
|
|
143 |
% |
|
$ |
74,474 |
|
|
$ |
33,622 |
|
|
|
122 |
% |
Amortization of deferred policy acquisition costs |
|
$ |
4,670 |
|
|
$ |
4,118 |
|
|
|
13 |
|
|
$ |
9,293 |
|
|
$ |
7,980 |
|
|
|
16 |
|
Other operating expenses (net of acquisition
costs deferred) |
|
$ |
10,716 |
|
|
$ |
8,496 |
|
|
|
26 |
|
|
$ |
21,047 |
|
|
$ |
17,009 |
|
|
|
24 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss ratio |
|
|
60.1 |
|
|
|
34.1 |
% |
|
|
76 |
|
|
|
55.7 |
|
|
|
34.1 |
% |
|
|
63 |
|
Expense ratio |
|
|
21.9 |
|
|
|
25.6 |
% |
|
|
(14 |
) |
|
|
22.3 |
|
|
|
25.6 |
% |
|
|
(13 |
) |
Combined ratio |
|
|
82.0 |
|
|
|
59.7 |
% |
|
|
37 |
|
|
|
78.0 |
|
|
|
59.7 |
% |
|
|
31 |
|
Net losses and loss adjustment expenses (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 2007 increased significantly over the same time periods of 2006 primarily
due to an increase in reserves. The reserve increase reflected both an increase in the number of
loans in default as well as an increase in the average risk per loan on the loans that were in
default at June 30, 2007. The growth in reserves is a result of the continued seasoning of our
portfolio, a change in the make up of our default inventory and the decline in the housing market
in general. We will focus separately on paid claims and the increase in reserves.
The following table provides detail on paid claims for our Primary and Modified Pool insurance
for the three months and six months ended June 30, 2007 and 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
Six Months Ended |
|
|
|
|
June 30, |
|
|
|
June 30, |
|
|
(dollars in thousands) |
|
2007 |
|
|
2006 |
|
|
% Change |
|
2007 |
|
|
2006 |
|
|
% Change |
|
Paid claims: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance |
|
$ |
16,687 |
|
|
$ |
13,501 |
|
|
|
24 |
% |
|
|
$ |
33,134 |
|
|
$ |
26,806 |
|
|
|
24 |
% |
|
Modified Pool insurance |
|
|
1,386 |
|
|
|
930 |
|
|
|
49 |
|
|
|
|
2,667 |
|
|
|
2,008 |
|
|
|
33 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
18,073 |
|
|
$ |
14,431 |
|
|
|
|
|
|
|
$ |
35,801 |
|
|
$ |
28,814 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of claims paid: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance |
|
|
540 |
|
|
|
523 |
|
|
|
3 |
|
|
|
|
1,066 |
|
|
|
1,029 |
|
|
|
4 |
|
|
Modified Pool insurance |
|
|
52 |
|
|
|
48 |
|
|
|
8 |
|
|
|
|
106 |
|
|
|
115 |
|
|
|
(8 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
592 |
|
|
|
571 |
|
|
|
4 |
|
|
|
|
1,172 |
|
|
|
1,144 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average severity remained relatively flat during the first three quarters of 2006, but
increased significantly in the fourth quarter of 2006 and again in the first quarter of 2007,
primarily the result of growth in the amount of risk in force on paid claims arising from increased
loan size. For the three months ended June 20, 2007 average severity remained stable with the
prior quarter as the majority of the paid claims continued to be from policy years 2005 and
earlier, and these insured loans have lower average balances than loans insured subsequent to 2005.
Loans from the 2006 and subsequent policy years will make up a larger percentage of paid claims
going forward
22
and we expect average severity to increase in future quarters. The following table
shows the average quarterly severity of paid claims during 2006 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
June 30, |
|
March 31, |
|
December 31, |
|
September 30, |
|
June 30, |
|
March 31, |
(dollars in thousands) |
|
2007 |
|
2007 |
|
2006 |
|
2006 |
|
2006 |
|
2006 |
|
Average severity: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance |
|
$ |
30.9 |
|
|
$ |
31.3 |
|
|
$ |
28.1 |
|
|
$ |
25.7 |
|
|
$ |
25.8 |
|
|
$ |
26.3 |
|
Modified Pool insurance |
|
|
26.6 |
|
|
|
23.7 |
|
|
|
26.2 |
|
|
|
18.8 |
|
|
|
19.4 |
|
|
|
16.1 |
|
Total |
|
|
30.5 |
|
|
|
30.6 |
|
|
|
27.9 |
|
|
|
25.3 |
|
|
|
25.3 |
|
|
|
25.1 |
|
Beginning in late 2006, we experienced a significant reduction in our ability to mitigate
claims through our traditional processes, which we believe was related to weakness in the housing
market. In many 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
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. In the fourth quarter of 2006 and continuing
into the first quarter of 2007, full option settlements represented a greater percentage of our
paid claims than in the prior sequential quarters. The lack of mitigation opportunities
contributed to the increase in severity for the fourth quarter of 2006 and the first quarter of
2007. However, mitigation efforts were more positive in the second quarter of 2007.
As shown in the Production and In Force section previously, we are insuring a larger
percentage of mortgages in excess of $250,000 which generally equates to a larger insured risk.
Claim payments and reserves on defaults of these larger mortgages are generally larger even if
coverage percentages remain constant. The following table shows the average loan size and risk in
force per policy 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 is expected to increase.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary |
|
Modified Pool |
|
|
Average |
|
Average |
|
Average |
|
Average |
|
|
Loan Size |
|
Insured Risk |
|
Loan Size |
|
Insured Risk |
|
Vintage Year |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2002 and Prior |
|
$ |
107,236 |
|
|
$ |
27,004 |
|
|
$ |
81,506 |
|
|
$ |
26,481 |
|
2003 |
|
|
121,206 |
|
|
|
28,990 |
|
|
|
147,545 |
|
|
|
43,477 |
|
2004 |
|
|
133,841 |
|
|
|
35,197 |
|
|
|
152,566 |
|
|
|
45,260 |
|
2005 |
|
|
157,866 |
|
|
|
40,798 |
|
|
|
179,369 |
|
|
|
58,263 |
|
2006 |
|
|
207,779 |
|
|
|
53,623 |
|
|
|
259,136 |
|
|
|
69,156 |
|
2007 |
|
|
219,833 |
|
|
|
60,581 |
|
|
|
270,177 |
|
|
|
78,889 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Overall Average |
|
$ |
165,491 |
|
|
$ |
43,105 |
|
|
$ |
207,951 |
|
|
$ |
60,851 |
|
We also expect severity will continue to trend upward as the average loan amounts in our
portfolio continue to rise. Continued deterioration in the housing market could reduce our loss
mitigation opportunities and serve to further increase severity. The expected increase in severity
and the seasoning of the insurance portfolio are expected to cause paid claims to increase during
the remainder of 2007.
Net losses and loss adjustment expenses also include the change in reserves for losses and
loss adjustment expenses. The following table breaks out the loss reserves between Primary and
Modified Pool at June 30, 2007, December 31, 2006 and June 30, 2006:
23
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
June 30, |
|
(dollars in thousands) |
|
2007 |
|
|
2006 |
|
|
2006 |
|
|
Primary insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Reserves for reported defaults |
|
$ |
89,752 |
|
|
$ |
65,417 |
|
|
$ |
46,560 |
|
Reserves for defaults incurred but not reported |
|
|
9,382 |
|
|
|
5,676 |
|
|
|
4,362 |
|
|
|
|
|
|
|
|
|
|
|
Total Primary insurance |
|
|
99,134 |
|
|
|
71,093 |
|
|
|
50,922 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Modified Pool insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Reserves for reported defaults |
|
|
20,482 |
|
|
|
11,477 |
|
|
|
3,193 |
|
Reserves for defaults incurred but not reported |
|
|
1,004 |
|
|
|
773 |
|
|
|
685 |
|
|
|
|
|
|
|
|
|
|
|
Total Modified Pool insurance |
|
|
21,486 |
|
|
|
12,250 |
|
|
|
3,878 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserve for loss adjustment expenses |
|
|
1,441 |
|
|
|
1,009 |
|
|
|
105 |
|
|
|
|
|
|
|
|
|
|
|
Total reserves for losses and loss adjustment expenses |
|
$ |
122,061 |
|
|
$ |
84,352 |
|
|
$ |
54,905 |
|
|
|
|
|
|
|
|
|
|
|
The following table shows the change in reserves for losses and loss adjustment expenses
for the second quarter and year-to-date ending June 30, 2007 and 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
(dollars in thousands) |
|
2007 |
|
2006 |
|
% Change |
|
2007 |
|
2006 |
|
% Change |
|
Net increase in reserve for
losses and loss adjustment
expenses |
|
$ |
23,340 |
|
|
$ |
2,291 |
|
|
|
919 |
% |
|
$ |
37,709 |
|
|
$ |
3,831 |
|
|
|
884 |
% |
We have increased our reserves significantly over the past six months reflecting a
growing number of loans in default as our insurance in force continues to season, as well as
increased severity and frequency factors utilized in the calculation of the reserves based upon the
development of claims paid in 2006 and 2007. The characteristics of the loans entering the default
pool in the first half of 2007 are notably different in terms of geographic region, average loan
size and vintage year. We have seen substantial increases in the number of defaults in those
regions that carry more risk because of higher housing prices such as California and Florida. As
noted earlier, we have also seen a substantial increase in defaults on newer and larger loans, as
well as early payment defaults (defined as being four or more months delinquent within twelve
months of issuing a certificate of insurance). Additionally, during the first quarter of 2007, we
noted a decline in our cure rates on reported defaults, which could impact the ultimate number of
claims eventually paid on existing defaults.
24
Reacting to the recent decline in the housing markets and the changing mix in the composition
of our defaults such as the changes in geographic location, size and policy year, we have increased
reserves by 122% from a year ago, and 45% for the first six months of 2007. Our default inventory
has shifted rapidly and policies originated during 2005 and 2006 comprise 48% of our loans in
default but 60% of the risk in default. This reflects the higher loan amounts and a changing of
the 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, 2007, December 31, 2006 and June 30,
2006.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
December 31, |
|
June 30, |
|
|
2007 |
|
2006 |
|
2006 |
|
Risk on loans in default excluding loans subject
to deductibles (in thousands of dollars) |
|
$ |
345,252 |
|
|
$ |
258,422 |
|
|
$ |
197,014 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserves as a percentage of risk at default |
|
|
35.4 |
% |
|
|
32.6 |
% |
|
|
27.9 |
% |
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.
We continually monitor our reserves and claim development. As new data emerges, we consider
its impact on our reserve calculation, and when necessary, refine our estimates. In the fourth
quarter of 2006 and continuing in the first quarter of 2007, we experienced a significant increase
in our paid loss severity due to the deteriorating developments in the housing market as well as
changes in our insured portfolio. For the second quarter of 2007, we experienced a slight decline
in paid loss severity primarily due to the mix of policy years and the average risk of the claims
paid. The results as of June 30, 2007 should not be considered an indicator of improved severity
as the Company expects further increases for the remainder of 2007.
Hurricanes Katrina and Rita had a significant impact on reported delinquencies at December 31,
2005. In the FEMA-designated areas affected by these hurricanes, we reported 891 defaults at
December 31, 2005 and had established reserves of $4.5 million utilizing our normal reserving
methodology. As of June 30, 2007, there remained 169 defaults of the 891 existing at December 31,
2005 with a reserve of $1.2 million after payment of approximately $3.3 million. Many of the
remaining loans in default have suffered un-repaired physical damage to the property which could
preclude us from paying a mortgage insurance claim. We will continue to monitor this situation as
the longer-term impacts develop.
25
The following table shows default statistics as of June 30, 2007, December 31, 2006 and June
30, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
December 31, |
|
June 30, |
(dollars in thousands) |
|
2007 |
|
2006 |
|
2006 |
|
Total business: |
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
371,888 |
|
|
|
338,086 |
|
|
|
324,111 |
|
With deductibles |
|
|
64,292 |
|
|
|
61,483 |
|
|
|
60,373 |
|
Without deductibles |
|
|
307,596 |
|
|
|
276,603 |
|
|
|
263,738 |
|
Number of loans in default |
|
|
9,853 |
|
|
|
8,566 |
|
|
|
6,945 |
|
With deductibles |
|
|
2,508 |
|
|
|
1,898 |
|
|
|
1,331 |
|
Without deductibles |
|
|
7,345 |
|
|
|
6,668 |
|
|
|
5,614 |
|
Percentage of loans in default (default rate) |
|
|
2.65 |
% |
|
|
2.53 |
% |
|
|
2.14 |
% |
Percentage of loans in default excluding deductibles |
|
|
2.39 |
% |
|
|
2.41 |
% |
|
|
2.13 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
258,163 |
|
|
|
225,531 |
|
|
|
216,458 |
|
Number of loans in default |
|
|
5,940 |
|
|
|
5,565 |
|
|
|
5,001 |
|
Percentage of loans in default |
|
|
2.30 |
% |
|
|
2.47 |
% |
|
|
2.31 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Modified Pool insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
113,725 |
|
|
|
112,555 |
|
|
|
107,653 |
|
With deductibles |
|
|
64,267 |
|
|
|
61,456 |
|
|
|
60,342 |
|
Without deductibles |
|
|
49,458 |
|
|
|
51,099 |
|
|
|
47,311 |
|
Number of loans in default |
|
|
3,913 |
|
|
|
3,001 |
|
|
|
1,944 |
|
With deductibles |
|
|
2,508 |
|
|
|
1,897 |
|
|
|
1,330 |
|
Without deductibles |
|
|
1,405 |
|
|
|
1,104 |
|
|
|
614 |
|
Percentage of loans in default |
|
|
3.44 |
% |
|
|
2.67 |
% |
|
|
1.81 |
% |
Percentage of loans in default excluding deductibles |
|
|
2.84 |
% |
|
|
2.16 |
% |
|
|
1.30 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary Alt-A business (included in above): |
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
34,955 |
|
|
|
22,385 |
|
|
|
18,581 |
|
Number of loans in default |
|
|
1,207 |
|
|
|
814 |
|
|
|
628 |
|
Percentage of loans in default |
|
|
3.45 |
% |
|
|
3.64 |
% |
|
|
3.38 |
% |
As shown in the above table, the number of Modified Pool defaults subject to deductibles
and those without deductibles increased at June 30, 2007 from June 30, 2006. This is reflective of
the strong growth in the Modified Pool insurance portfolio over the past three years. We generally
expect to receive the largest number of defaults in years two through four and, as these parts of
our portfolio age, this is being reflected in these default statistics. At June 30, 2007, no
individual structured bulk transaction with deductibles as part of the structure had incurred total
losses that were nearing these individual deductible amounts. We do not provide reserves on
Modified Pool defaults with deductibles until the incurred losses for that specific structured bulk
transaction reach the deductible threshold.
Given the growth of our insurance in force and the current state of the mortgage and housing
market, we anticipate that our number of loans in default for both Primary and Modified Pool
insurance will continue to increase as our insurance in force reaches its peak claim paying period.
We also expect default rates to increase in the non-traditional business, such as Alt-A loans,
higher LTV loans, and potential negative amortization ARMs. We expect the overall default rate to
increase as non-traditional business becomes a larger percentage of our insurance in force. We
expect reserves will increase as our business continues to grow and season.
26
The housing market continues to be sluggish in most parts of the country. According to
Case-Schiller Home Price Index as of April 2007, home prices in 10 major U.S. cities have fallen
2.7% year over year, the fastest pace in 16 years. Prices in the 20 cities comprising the index
dropped 2.1%, with declines in 14 cities. The lack in liquidity in the secondary mortgage and
capital markets has resulted in additional downward pressure on the housing and mortgage markets.
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; however, future changes in economic conditions surrounding the housing
or mortgage markets could significantly impact the ultimate amount of claims paid.
Amortization of DAC for the second quarter and first six months of 2007 increased moderately
over that for the same periods in 2006, reflecting growth in the asset balance and, in some part,
changes in the assumptions in the DAC amortization models that lowered the expected life of the
policy years 2006 and thereon from seven to five years. This was partially offset by improved
persistency. A full discussion of the impact of persistency on DAC amortization is included in
the Deferred Policy Acquisition Costs section below.
Other operating expenses for the second quarter and the first half of 2007 increased over the
same time periods of 2006 due to expenses incurred in connection with organizational changes and
costs associated with our Canada expansion. Direct expenses relating to the Canadian expansion
amounted to approximately $504,000 and $957,000, respectively, during the second quarter and first
six months of 2007 compared to none in 2006. Because the growth in net premiums written was
greater than the growth in expenses, the expense ratio (ratio of the amortization of deferred
policy acquisition costs and other operating expenses to net premiums written) for the second
quarter and first six months of 2007 was 21.9% and 22.3%, respectively, compared to 24.9% and
25.6%, respectively, for the second quarter and first six months of 2006.
Our effective tax rate was 22.7% and 25.5%, respectively, for the second quarter and the first
six months of 2007 compared to 28.5% and 28.0%, respectively, for the second quarter and the first
six months of 2006. The decline in the effective tax rate was due primarily to an increase in
tax-exempt interest resulting from growth of investments in tax-preferred municipal securities.
Significant Customers
Our objective is controlled, profitable growth in both Primary and Modified Pool business
while adhering to our risk management strategies. Our strategy is to continue our focus on
national lenders while maintaining the productive relationships that we have built with regional
lenders. Competition within the mortgage insurance industry continues to increase as many large
mortgage lenders have limited the number of mortgage insurers with whom they do business. At the
same time, consolidation among national lenders has increased the share of the mortgage origination
market controlled by the largest lenders and that has led to further concentrations of business
with a relatively small number of lenders. Many of the national lenders allocate Primary business
to several different mortgage insurers or accept competitive bids on certain lender paid products.
These lender allocations and our success in the bidding process for lender paid products can vary
over time, even quarter to quarter.
Our ten largest customers were responsible for 77.8% and 80.9%, respectively, of Primary
insurance written during the second quarter and the first six months of 2007 compared to 79.6% and
78.7%, respectively, of Primary insurance written during the second quarter and the first six
months of 2006. As of June 30, 2007, two of our customers were each individually responsible for
more than 10% of the total insurance written through the flow channel. In aggregate, these two
customers were responsible for 53.9% and 58.7%, respectively, of Primary insurance written during
the second quarter and the first six months of 2007.
One of the two lenders mentioned in the previous paragraph and identified in Part 1, Item 1 of
our Form 10-K under the heading Customers that comprised more than 10% of consolidated revenue
was AHM, which accounted for 11% of consolidated revenue in 2006. For the six months ended June
30, 2007, AHM accounted for approximately 19% of our consolidated revenue. On August 6, 2007, AHM
announced that it had filed for
27
protection from its creditors under Chapter 11 of the U.S.
bankruptcy code. As of August 6, 2007, we had a receivable of approximately $3 million
representing monthly premiums on loans that are serviced by AHM.
AHM was our single largest customer in terms of production and contributed 26% of Primary NIW
and 15% of Modified Pool NIW for the first six months of 2007. Based upon the bankruptcy
announcement by AHM, we currently expect our NIW production to decrease for the remainder of 2007.
We plan to closely monitor the AHM bankruptcy process in order to assess whether it will result in
adverse impacts to other aspects of our business, although due to the recent timing of the AHM
bankruptcy filing, we currently cannot predict the nature and materiality of any such adverse
impacts.
By actively seeking business with other lenders that meet our criteria, we are broadening our
customer base in order to limit our lender concentration. While we will attempt to replace the
production from AHM from an expansion of our customer base, we currently expect this will not be
accomplished by the end of 2007. The loss of, a considerable reduction in business from or a
decline in the quality of business from the other significant customer without a corresponding
increase from other lenders would have an adverse effect on our short-term production and
eventually on our long-term financial results.
Financial Position
Total assets increased to $960 million at June 30, 2007, an annualized growth rate of 14% over
December 31, 2006, with most of the growth in invested assets. Total liabilities increased to $366
million at June 30, 2007 from $325 million at December 31, 2006, primarily driven by the increase
in reserves. 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. The majority of our assets
are in our investment portfolio. A separate Investment Portfolio section follows the Financial
Position section and reviews our investment portfolio, key portfolio management strategies, and
methodologies by which we manage credit risk.
Deferred Policy Acquisition Costs
Costs expended to acquire new business are capitalized as DAC and recognized as expense over
the anticipated premium paying life of the policy in a manner that approximates the estimated gross
profits. We employ a dynamic model that calculates amortization of DAC separately for each year of
policy origination. The model relies on assumptions that we make based upon historical industry
experience and our own unique experience regarding the annual persistency development of each year
of policy origination. The base persistency assumption is the most important factor utilized in
determining the timing of reported amortization expense reflected in the income statement and the
carrying value of DAC on the balance sheet. A change in the assumed base persistency will impact
the current and future amortization expense as well as the carrying value on the balance sheet.
During 2006, based upon a study performed on the entire mortgage industry and specifically on our
own experience, we altered our base persistency assumption on that origination year and all future
years going forward to recognize a shorter expected life due to the amount of the refinancing over
the past several years. Our model accelerates DAC amortization through a dynamic adjustment when
actual persistency for a particular year of policy origination is lower than the estimated base
persistency utilized in the model. This dynamic adjustment is capped at the levels assumed in the
models, and we do not decrease DAC amortization below the levels assumed in the model when
persistency increases above those levels. When actual persistency is lower than that assumed in
our models, the dynamic adjustment effectively adjusts the estimated policy life utilized in the
model to a policy life based upon the current actual persistency. Due to the increase in actual
persistency over the past several quarters, the dynamic adjustment has not been a significant
factor in the quarterly DAC amortization as it was during periods of high refinancing and low
persistency.
Our DAC models separate the costs capitalized and the amortization streams between
transactions arising from structured bulk and flow delivery channels. Generally, structured bulk
transactions have significantly lower
28
acquisition costs associated with the production of the
business and they also have a shorter original estimated policy life. We apply the dynamic
adjustment to the structured bulk DAC models utilizing the same methodology. Net unamortized DAC
relating to structured bulk transactions amounted to 7.6% of the total DAC on the balance sheet at
June 30, 2007 compared to 7.3% at December 31, 2006.
The following table shows the DAC asset for the three months and six months ended June 30,
2007 and 2006 and the effect of persistency on amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, |
|
|
June 30, |
|
(dollars in thousands) |
|
2007 |
|
|
2006 |
|
|
2007 |
|
|
2006 |
|
|
Balance beginning of period |
|
$ |
35,035 |
|
|
$ |
33,904 |
|
|
$ |
35,143 |
|
|
$ |
33,684 |
|
Costs capitalized |
|
|
4,792 |
|
|
|
4,417 |
|
|
|
9,307 |
|
|
|
8,499 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization normal |
|
|
(4,542 |
) |
|
|
(3,988 |
) |
|
|
(9,036 |
) |
|
|
(7,837 |
) |
Amortization dynamic adjustment |
|
|
(128 |
) |
|
|
(130 |
) |
|
|
(257 |
) |
|
|
(143 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total amortization |
|
$ |
(4,670 |
) |
|
$ |
(4,118 |
) |
|
$ |
(9,293 |
) |
|
$ |
(7,980 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance end of quarter |
|
$ |
35,157 |
|
|
$ |
34,203 |
|
|
$ |
35,157 |
|
|
$ |
34,203 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annual Persistency |
|
|
|
|
|
|
|
|
|
|
78.2 |
% |
|
|
72.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The growth in the normal DAC amortization is due to the growth in the DAC asset and a
decrease in the base assumption of the expected life of the flow and bulk portfolios. Assuming no
significant declines in interest rates, we expect persistency to remain at the current rates or
improve moderately throughout the remainder of 2007.
Prepaid Federal Income Taxes and Deferred Income Taxes
We purchase ten-year non-interest bearing United States Mortgage Guaranty Tax and Loss Bonds
(Tax and Loss Bonds) to take advantage of a special contingency reserve deduction specific to
mortgage guaranty companies. We record 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
generally will become due in ten years when the contingency reserve is released, and the Tax and
Loss Bonds mature. The proceeds from the maturity of the Tax and Loss Bonds are used to fund the
income tax payments. Prepaid income taxes were approximately $170.1 million at June 30, 2007
compared to $166.9 million at December 31, 2006.
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. The remainder of the deferred
tax liability has primarily arisen from book and tax reporting differences related to DAC and
unrealized investment gains.
29
Investment Portfolio
Portfolio Description
Our strategy for managing our investment portfolio is to optimize investment returns while
preserving capital and liquidity and adhering to regulatory and rating agency requirements. We
invest for the long term, and most of our investments are held until they mature. Our investment
portfolio includes primarily fixed income securities, and the majority of these are tax-preferred
state and municipal bonds. 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. While we
invest for the long term and most of our investments are held until they mature, 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.
The following table shows the growth and diversification of our investment portfolio:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2007 |
|
|
December 31, 2006 |
|
(dollars in thousands) |
|
Amount |
|
|
Percent |
|
|
Amount |
|
|
Percent |
|
|
Fixed maturity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U. S. government obligations |
|
$ |
11,779 |
|
|
|
1.8 |
% |
|
$ |
11,842 |
|
|
|
1.9 |
% |
State and municipal bonds |
|
|
592,103 |
|
|
|
87.8 |
% |
|
|
558,131 |
|
|
|
91.9 |
% |
Corporate bonds |
|
|
14,152 |
|
|
|
2.1 |
% |
|
|
16,572 |
|
|
|
2.7 |
% |
Mortgage-backed bonds |
|
|
|
|
|
|
0.0 |
% |
|
|
49 |
|
|
|
0.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
|
618,034 |
|
|
|
91.7 |
% |
|
|
586,594 |
|
|
|
96.6 |
% |
Equity securities |
|
|
3,781 |
|
|
|
0.6 |
% |
|
|
10,417 |
|
|
|
1.7 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available-for-sale securities |
|
|
621,815 |
|
|
|
92.3 |
% |
|
|
597,011 |
|
|
|
98.3 |
% |
Other investments |
|
|
|
|
|
|
0.0 |
% |
|
|
5,000 |
|
|
|
0.8 |
% |
Short-term investments |
|
|
52,384 |
|
|
|
7.7 |
% |
|
|
5,301 |
|
|
|
0.9 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
674,199 |
|
|
|
100.0 |
% |
|
$ |
607,312 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
We seek to provide liquidity in our investment portfolio through cash equivalent
investments and through diversification and investment in publicly traded securities. We attempt
to maintain a level of liquidity and duration in our investment portfolio consistent with our
business outlook and the expected timing, direction, and degree of changes in interest rates. The
increase in short-term investments at June 30, 2007 primarily reflects the initial investment of
funds associated with the capitalization of our Canadian affiliate.
30
We also manage risk and liquidity by limiting our exposure on individual securities. As shown
below, no investment in the securities of any single issuer exceeded 1% of our total investment
portfolio at June 30, 2007. The following table shows the ten largest exposures to an individual
creditor in our investment portfolio as of June 30, 2007:
|
|
|
|
|
|
|
|
|
|
|
June 30, 2007 |
|
|
|
Carrying |
|
|
% of Total |
(dollars in thousands) |
|
Value |
|
Invested Assets |
|
Name of Creditor / Issuer |
|
|
|
|
|
|
|
|
City of Atlanta, Georgia Airport |
|
$ |
6,664 |
|
|
|
0.99 |
% |
Commonwealth of Massachusetts |
|
|
6,488 |
|
|
|
0.96 |
% |
State of Connecticut |
|
|
6,422 |
|
|
|
0.95 |
% |
Commonwealth of Pennsylvania |
|
|
6,068 |
|
|
|
0.90 |
% |
Clark County School District |
|
|
5,446 |
|
|
|
0.81 |
% |
Colorado Housing Authority |
|
|
5,400 |
|
|
|
0.80 |
% |
State of Hawaii |
|
|
5,352 |
|
|
|
0.79 |
% |
Indiana State Finance Authority |
|
|
5,225 |
|
|
|
0.77 |
% |
Utah Transit Authority |
|
|
5,066 |
|
|
|
0.75 |
% |
Ohio Housing Finance Authority |
|
|
5,000 |
|
|
|
0.74 |
% |
The following table shows the results of our investment portfolio for the three months
and six months ended June 30, 2007 and 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
(dollars in thousands) |
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
Average investments at cost or amortized cost |
|
$ |
664,416 |
|
|
$ |
561,456 |
|
|
$ |
634,566 |
|
|
$ |
553,304 |
|
Pre-tax net investment income |
|
$ |
7,673 |
|
|
$ |
6,535 |
|
|
$ |
15,022 |
|
|
$ |
12,757 |
|
Pre-tax yield |
|
|
4.6 |
% |
|
|
4.7 |
% |
|
|
4.7 |
% |
|
|
4.6 |
% |
Tax-equivalent yield-to-maturity |
|
|
6.6 |
% |
|
|
6.7 |
% |
|
|
6.6 |
% |
|
|
6.7 |
% |
Pre-tax realized investment (losses) gains |
|
$ |
(3,867 |
) |
|
$ |
772 |
|
|
$ |
(3,105 |
) |
|
$ |
1,672 |
|
The small decline in the tax-equivalent yield-to-maturity for the quarter shown above
reflects the impact of the maturity or call of higher yielding investments and the subsequent
investment purchases at new money rates available, which were lower than that of our overall
portfolio. We anticipate this trend to continue throughout the remainder of 2007.
31
Unrealized Gains and Losses
The following table summarizes by category our unrealized gains and losses in our securities
portfolio at June 30, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost or |
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
|
|
(dollars in thousands) |
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Fair Value |
|
|
Fixed maturity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U. S. government obligations |
|
$ |
12,130 |
|
|
$ |
3 |
|
|
$ |
(354 |
) |
|
$ |
11,779 |
|
State and municipal bonds |
|
|
588,668 |
|
|
|
8,154 |
|
|
|
(4,719 |
) |
|
|
592,103 |
|
Corporate bonds |
|
|
13,384 |
|
|
|
778 |
|
|
|
(10 |
) |
|
|
14,152 |
|
Mortgage-backed bonds |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal, fixed maturities |
|
|
614,182 |
|
|
|
8,935 |
|
|
|
(5,083 |
) |
|
|
618,034 |
|
Equity securities |
|
|
3,744 |
|
|
|
70 |
|
|
|
(33 |
) |
|
|
3,781 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total securities |
|
$ |
617,926 |
|
|
$ |
9,005 |
|
|
$ |
(5,116 |
) |
|
$ |
621,815 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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. 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. Of the gross unrealized losses on
fixed maturity securities shown above, approximately $3.8 million related to bonds with a maturity
date in excess of ten years. The largest unrealized loss on any individual security at June 30,
2007 was approximately $168,000 on a municipal bond with an amortized cost of $3.4 million. Gross
unrealized gains and (losses) at June 30, 2006 were $8.9 million and $(5.3 million), respectively.
All unrealized losses are not considered to be other-than-temporarily impaired as we have the
intent and ability to hold such investments until they recover in value or mature.
32
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, 2007 |
|
|
December 31, 2006 |
|
(dollars in thousands) |
|
Amount |
|
|
Percent |
|
|
Amount |
|
|
Percent |
|
|
Fixed Maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. treasury and agency bonds |
|
$ |
11,779 |
|
|
|
1.9 |
% |
|
$ |
11,842 |
|
|
|
2.0 |
% |
AAA |
|
|
508,981 |
|
|
|
82.4 |
|
|
|
464,042 |
|
|
|
79.1 |
|
AA |
|
|
62,518 |
|
|
|
10.1 |
|
|
|
72,051 |
|
|
|
12.3 |
|
A |
|
|
22,742 |
|
|
|
3.7 |
|
|
|
25,054 |
|
|
|
4.3 |
|
BBB |
|
|
8,835 |
|
|
|
1.4 |
|
|
|
10,782 |
|
|
|
1.8 |
|
BB |
|
|
50 |
|
|
|
0.0 |
|
|
|
50 |
|
|
|
0.0 |
|
CC and lower |
|
|
55 |
|
|
|
0.0 |
|
|
|
279 |
|
|
|
0.0 |
|
Not rated |
|
|
3,074 |
|
|
|
0.5 |
|
|
|
2,494 |
|
|
|
0.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
$ |
618,034 |
|
|
|
100.0 |
% |
|
$ |
586,594 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred stocks: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AA |
|
$ |
913 |
|
|
|
24.2 |
% |
|
$ |
1,708 |
|
|
|
16.4 |
% |
A |
|
|
2,240 |
|
|
|
59.2 |
|
|
|
2,035 |
|
|
|
19.5 |
|
BBB |
|
|
628 |
|
|
|
16.6 |
|
|
|
1,132 |
|
|
|
10.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,781 |
|
|
|
100.0 |
|
|
|
4,875 |
|
|
|
46.8 |
|
Common stocks |
|
|
|
|
|
|
|
|
|
|
5,542 |
|
|
|
53.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equities |
|
$ |
3,781 |
|
|
|
100.0 |
% |
|
$ |
10,417 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
We regularly review our investment portfolio to identify securities that may have
suffered impairments in value that will not be recovered, termed potentially distressed securities.
In identifying potentially distressed securities, 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 |
|
|
§ |
|
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 or outside consultants,
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
33
other-than-temporary impairments to reflect fair value at the time
of the impairment. We consider factors that lead
to an other-than-temporary impairment of a particular security in order to determine whether
these conditions have impacted other similar securities.
The entire $5.1 million of gross unrealized losses at June 30, 2007 had a fair value to cost
or amortized cost ratio of greater than 90%. All unrealized losses are not considered to be
other-than-temporarily impaired as we have the intent and ability to hold such investments until
they recover in value or mature.
Information about unrealized gains and losses is subject to changing conditions. Securities
with unrealized gains and losses will fluctuate, as will those 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.
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.
In the second quarter of 2007, we wrote down as an other-than-temporary impairment our entire
$5.0 million equity position in a non-public company providing structured credit derivatives to
lenders and investment bankers that had previously shown as Other investments. For further
discussion about this impairment, see Part II, Item 5 Other Information. Also in the second
quarter, we liquidated our entire S&P 500 common stock portfolio recognizing a realized gain of
approximately $1.2 million. In the first quarter of 2007, gains were realized from securities sold
to provide funds for the capitalization of our Canadian subsidiary. Total write-downs for the
first six months of 2007 totaled approximately $5.2 million with the most significant being the
equity investment previously mentioned. The circumstances surrounding the recording of these
impairments did not impact any other securities in our portfolio.
In the first six months of 2006, we modified our common stock investment strategy from
investing in individual stock positions to holding the common stock of those companies comprising
the S&P 500 index. We recognized a realized gain of approximately $1.0 million from selling our
existing common stock holdings to fund the acquisition of our S&P 500 index portfolio. We disposed
of certain corporate bond holdings, realizing a gain of approximately $893,000, to fund this equity
investment. We wrote down securities during first six months of 2006 recognizing a realized loss
of $275,000.
34
Liquidity and Capital Resources
Our sources of operating funds consist primarily of premiums written and investment income.
Operating cash flow is applied primarily to the payment of claims, interest, expenses, and prepaid
federal income taxes in the form of Tax and Loss Bonds.
We generated positive cash flow from operating activities of $73.6 million in the first half
of 2007 compared to $36.6 million for the first half of 2006. The increase reflects the strong
growth in premiums collected and a substantial increase in non-cash expenses, primarily the reserve
for losses. During the first quarter of 2006, purchases of properties, net of sales, as part of
our loss mitigation strategy resulted in a cash outflow of $2.9 million compared to a cash inflow
of $2.2 million in the first half of 2007. The amount of cash outflow from the purchase of
properties during the first half of 2006 is reflective of the limited past use of the program, as
the purchases outnumbered the sales during that time period.
Positive cash flows are invested pending future payments of claims and expenses. Our business
does not routinely require significant capital expenditures other than for enhancements to our
computer systems and technological capabilities. Cash flow shortfalls, if any, could be funded
through sales of short-term investments and other investment portfolio securities.
On June 28, 2007, the Company entered into a three-year $80.0 million revolving unsecured
credit facility with three domestic banks to provide short term liquidity for insurance operations
and general corporate purposes. See Note 4 to the Consolidated Financial Statements for a more
detailed description of this agreement.
The insurance laws of the State of Illinois impose certain restrictions on dividends that an
insurance subsidiary can pay the parent company. These restrictions, based on statutory accounting
practices, require that dividends 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. There
are no imposed restrictions or requirements for capital support arrangements between the parent
company and Triad or its subsidiaries.
We cede business to captive reinsurance affiliates of certain mortgage lenders (captives),
primarily under excess of loss reinsurance agreements. Generally, reinsurance recoverables on loss
reserves and unearned premiums ceded to these captives are backed by trust funds or letters of
credit.
Total stockholders equity increased to $597.9 million at June 30, 2007 from $570.2 million at
December 31, 2006. This increase resulted primarily from net income for the first six months of
2007 of $32.6 million and additional paid-in-capital of $2.6 million resulting from share-based
compensation to employees and the associated tax benefit, partially offset by a decrease in net
unrealized gains on investments of $9.5 million.
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, 2007, December 31, 2006
and June 30, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
|
December 31, |
|
|
June 30, |
|
(dollars in millions) |
|
2007 |
|
|
2006 |
|
|
2006 |
|
|
Statutory policyholders surplus |
|
$ |
102.9 |
|
|
$ |
168.5 |
|
|
$ |
154.7 |
|
Statutory contingency reserve |
|
|
589.7 |
|
|
|
521.8 |
|
|
|
492.0 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
692.6 |
|
|
$ |
690.3 |
|
|
$ |
646.7 |
|
|
|
|
|
|
|
|
|
|
|
The primary difference between statutory policyholders surplus and equity computed under
generally accepted accounting principles is the statutory contingency reserve. Mortgage insurance
companies are required to add to the contingency reserve an amount equal to 50% of calendar year
earned premiums and retain the reserve for
35
10 years, even if the insurance is no longer in force.
Therefore, a growing company such as Triad normally has an increase in its contingency reserve
rather than in its statutory surplus. Additionally, in April of 2007, Triad paid a $30 million
dividend which further reduced policyholders surplus.
Triads 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 Triads ability to write additional insurance.
A number of states also generally limit Triads risk-to-capital ratio to 25-to-1. As of June 30,
2007, Triads risk-to-capital ratio was 16.0-to-1 as compared to 12.5-to-1 at December 31, 2006.
The risk-to-capital ratio is calculated using net risk in force as the numerator and statutory
capital as the denominator. Net risk in force accounts for risk ceded under reinsurance
arrangements, including captive risk-sharing arrangements as well as any applicable stop-loss
limits and deductible amounts.
Triad is rated AA by both Standard & Poors Ratings Services and Fitch Ratings and Aa3 by
Moodys Investors Service. S&P has not changed its Stable rating outlook for the U.S. private
mortgage insurance industry that was issued in February of 2005. In June 2007, Fitch issued a
Stable rating outlook for the U.S. private mortgage insurance industry. Currently, Fitch, S&P,
and Moodys all report a Stable ratings outlook for Triad. A reduction in Triads rating or
outlook could adversely affect our operations.
Fannie Mae has revised its approval requirements for mortgage insurers. The new rules require
prior approval by Fannie Mae for many of Triads activities and new products, allow for other
approved types of mortgage insurers rated less than AA, and give Fannie Mae increased rights to
revise the eligibility standards of mortgage insurers. We do not see any material impact on our
current or future operations as a result of the new rules, although a material impact could still
occur if Fannie Mae were to begin to utilize mortgage insurers rated below AA or revise
eligibility standards of mortgage insurers in a way that would be adverse to Triad.
The Office of Federal Housing Enterprise Oversight (OFHEO) issued its risk-based capital rules
for Fannie Mae and Freddie Mac in the first quarter of 2002. The regulation provides capital
guidelines for Fannie Mae and Freddie Mac in connection with their use of various types of credit
protection counterparties including a more preferential capital credit for insurance from a AAA
rated private mortgage insurer than for insurance from a AA rated private mortgage insurer. The
phase-in period for OFHEOs risk-based capital rules is ten years. We do not believe the new
risk-based capital rules had an adverse impact on our financial condition or operations through the
first six months of 2007 or that these rules will have a significant adverse impact on our
financial condition or operations in the future. However, if the risk-based capital rules result
in future changes to the preferences of Fannie Mae and Freddie Mac regarding their use of the
various types of credit enhancements or their choice of mortgage insurers based on their credit
rating, our operations and financial condition could be significantly impacted.
36
Off Balance Sheet Arrangements and Aggregate Contractual Obligations
On June 28, 2007, the Company entered into a three-year $80.0 million revolving unsecured
credit facility with three domestic banks to provide short term liquidity for insurance operations
and general corporate purposes. See Note 4 to the Consolidated Financial Statements for a more
detailed description of this agreement.
We lease office facilities, automobiles, and office equipment under operating leases with
minimum lease commitments that range from one to six years. We have no capitalized leases or
material purchase commitments.
Our long-term debt has a single maturity date of 2028. There have been no material changes to
the aggregate contractual obligations shown in our Form 10-K.
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
Managements 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 or decrease from their current levels; |
|
|
§ |
|
housing prices may increase or decrease from their current levels; |
|
|
§ |
|
housing transactions requiring mortgage insurance may decrease for many reasons
including changes in interest rates or economic conditions or alternative credit
enhancement products; |
|
|
§ |
|
our market share may change as a result of changes in underwriting criteria or
competitive products or rates; |
|
|
§ |
|
the amount of insurance written could be adversely 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 (Government Sponsored
Enterprises); |
|
|
§ |
|
our financial condition and competitive position could be affected by legislation
or regulation impacting the mortgage guaranty industry or the Government Sponsored
Entities, specifically, and the financial services industry in general; |
|
|
§ |
|
rating agencies may revise methodologies for determining our 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 in insurance in force or risk in
force as well as our performance may be adversely impacted by the competitive
environment in the private mortgage insurance industry, including the type,
structure, mix and pricing of our products and services and our competitors; |
|
|
§ |
|
if we fail to properly underwrite mortgage loans under contract underwriting
service agreements, we may be required to assume the costs of repurchasing those
loans; |
|
|
§ |
|
with consolidation occurring among mortgage lenders and our concentration of
insurance in force generated through relationships with significant lender customers,
our margins may be compressed and the loss of a significant customer or a change in
their business practices affecting mortgage insurance may have an adverse effect on
our earnings; |
|
|
§ |
|
our performance may be impacted by changes in the performance of the financial
markets and general economic conditions; |
|
|
§ |
|
economic downturns in regions where our risk is more concentrated could have a
particularly adverse effect on our financial condition and loss development; |
|
|
§ |
|
revisions in risk-based capital rules by the Office of Federal Housing Enterprise
Oversight for Fannie Mae and Freddie Mac could severely limit our ability to compete
against various types of credit protection counterparties, including AAA rated
private mortgage insurers; |
37
|
§ |
|
changes in the eligibility guidelines of Fannie Mae or Freddie Mac could have an
adverse effect on the Company; |
|
|
§ |
|
proposed regulation by the Department of Housing and Urban Development to exclude
packages of real estate settlement services, which may include any required mortgage
insurance premium paid at closing, from the anti-referral provisions of the Real Estate Settlement Procedures
Act could adversely affect our earnings; |
|
|
§ |
|
our financial and competitive position could be affected by regulatory activity
requiring changes to mortgage industry business practices, such as captive
reinsurance. |
|
|
§ |
|
the performance of our international subsidiary, including changes in the
economic, political, legal, regulatory and competitive environments and fluctuations
in foreign currency exchange rates could impact our earnings. |
Accordingly, actual results may differ from those set forth in the forward-looking statements.
Attention also is directed to other risk factors set forth in documents filed by the Company with
the Securities and Exchange Commission.
38
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Companys market risk exposures at June 30, 2007 have not materially changed from those
identified in the Form 10-K for the year ended December 31, 2006.
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
Securities Exchange Act of 1934 (Act) Rule 13a-15. 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. 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 controls over financial reporting during the
second quarter or first half of 2007 that have materially affected, or are reasonably
likely to materially affect, our internal controls over financial reporting. |
39
PART II. OTHER INFORMATION
Item 1. Legal Proceedings None material, except for those previously disclosed.
Item 1A. Risk Factors
Except for the following, there have been no material changes with respect to the risk factors
disclosed in our Annual Report on Form 10-K for the year ended December 31, 2006.
Illiquidity in the mortgage funding marketplace could have an adverse impact on borrowers ability
to purchase or sell an existing home or to refinance an existing mortgage, which in turn could have
a negative impact on new mortgage originations as well as our ability to mitigate claims leading to
increased reserves, claims and ultimately to decreased earnings.
Illiquidity in the mortgage funding marketplace could adversely impact borrowers ability to
purchase or sell their homes or to refinance their existing mortgages. A common source of funding
for many mortgage lenders is the sale of loans into the secondary mortgage market. Disruptions in
the secondary market may impact liquidity in the marketplace. For example, recently, as valuations
in the Sub Prime secondary market have collapsed due to increasing defaults and foreclosures in
that specific market, funding through the secondary markets in general has become extremely
difficult. This in turn could have a negative impact on the volume of new mortgage originations
and thus new insurance written. The reduced availability of mortgage financing could also put
downward pressure on home values which could result in increased defaults and a reduction in our
ability to mitigate claims, leading to increased reserves and claims.
A decline in new insurance written in a year following higher volume years may result in reduced
earnings.
The majority of underwriting profit for each vintage year generally occurs in the early
stages, with the largest portion of the underwriting profit realized in the first year. Subsequent
years generally result in either modest profit or losses. This is the result of lower defaults and
paid claims occurring in the first few years of each vintage year when premium revenue is highest,
while subsequent years are affected by declining premium revenues and higher losses. Earnings
during any reporting period are comprised of numerous vintage years at various stages of their
expected lives. A significant decline in new insurance written in any one vintage year could
impact the amount of underwriting profit that it contributes to that reporting period.
The impact on earnings from a reduction in the volume of new insurance written will ultimately
depend on a number of factors, including the magnitude of the year-over-year decline in volume.
Other factors, such as higher persistency and a mix of business with higher average premiums, could
have the effect of increasing revenue, while improvements in the economy could have the effect of
reducing losses. Moreover, reduced earnings from lower volumes may be offset by decreases in
expenses that are unrelated to claim or default activity.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None
Item 3. Defaults Upon Senior Securities None
40
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Stockholders was held on May 17, 2007. Shares entitled to vote at the
Annual Meeting totaled 14,908,523 of which 13,482,644 shares were represented.
The following nine directors were elected at the Annual Meeting. Shares voted for and
authorized withheld for each nominee were as follows:
|
|
|
|
|
|
|
|
|
|
|
Voted in |
|
Shares |
Election of Directors |
|
Favor |
|
Withheld |
|
Glenn T. Austin, Jr. |
|
|
13,178,074 |
|
|
|
304,570 |
|
Robert T. David |
|
|
12,919,754 |
|
|
|
592,890 |
|
H. Lee Durham, Jr. |
|
|
12,747,479 |
|
|
|
735,165 |
|
William T. Ratliff, III |
|
|
13,007,183 |
|
|
|
475,461 |
|
Michael A. F. Roberts |
|
|
13,039,641 |
|
|
|
443,003 |
|
Richard S. Swanson |
|
|
13,176,878 |
|
|
|
305,766 |
|
Mark K. Tonnesen |
|
|
13,005,768 |
|
|
|
476,876 |
|
David W. Whitehurst |
|
|
13,006,734 |
|
|
|
475,910 |
|
Henry G. Williamson, Jr. |
|
|
12,743,959 |
|
|
|
738,685 |
|
Shareholders also voted to ratify the selection of Ernst & Young LLP as the independent
registered public account firm for Triad Guaranty Inc. for 2007, as well as to approve the proposal
to adopt the Triad Guaranty Inc. 2007 Key Executive Incentive Compensation Plan. These proposals
were approved by the votes set forth in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Voted |
|
Voted |
|
Shares |
Other Proposals |
|
in Favor |
|
Against |
|
Withheld |
|
Ratification of the selection
of Ernst & Young LLP as the
independent registered public
accounting firm for Triad
Guaranty Inc. for 2007. |
|
|
13,362,344 |
|
|
|
117,125 |
|
|
|
3,175 |
|
Approval of the proposal to
adopt the Triad Guaranty
Inc. 2007 Key Executive
Incentive Compensation Plan |
|
|
11,679,816 |
|
|
|
868,829 |
|
|
|
933,999 |
|
41
Item 5. Other Information
On August 7, 2007, we concluded that a material impairment had taken place related to an
equity investment (representing less than 1% of the Companys invested assets at June 30, 2007) in
a non-public company that provides structured credit derivatives to lenders and investment bankers.
We reached this conclusion based upon the fact that the non-public company could not post
sufficient additional collateral required by certain derivative contracts due to rapidly declining
valuations of the underlying security. The company is currently seeking a capital support
agreement from its other shareholders; however, we believe that our equity investment has been
other-than-temporarily impaired. Accordingly, we recorded a pre-tax realized loss of $5 million,
representing the full cost of our investment. This investment was initiated as part of a
diversification strategy to investigate potential expansion of our
lines of business. However, in order to limit our exposure to new lines of business, these types of
investments were given a limited amount of capital up to $5 million. There are no other
investments made in pursuit of this strategy and we will not have any future charges or cash
expenditures as a result of our decision to impair this investment.
The Companys investment had been reported in its financial statements under invested assets
as Other Investments. We had previously announced quarterly earnings and filed a Form 8-K with
our June quarterly earnings release on July 25, 2007. As a result of our subsequent determination
of the other-than-temporary impairment of this investment, net income for both the quarter and six
months ended June 30, 2007 was reduced by $3.25 million or $0.22 per diluted share from the
previously announced amounts. This write-down and the associated effects have been reflected in
our second quarter financial statements and Managements Discussion and Analysis of Financial
Condition and Results of Operations included in Part I of this Form 10-Q.
Item 6. Exhibits See exhibit index on page 44.
42
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: May 9, 2007 |
/s/ Kenneth W. Jones
|
|
|
Kenneth W. Jones |
|
|
Senior Vice President and Chief Financial Officer |
|
|
43
EXHIBIT INDEX
|
|
|
Exhibit Number |
|
Description |
|
|
|
|
10.47
|
|
Credit Agreement dated June 28, 2007 |
|
|
|
31.1
|
|
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. |
|
|
|
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
|
|
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. |
44