UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

 

Commission file number 0-22342

 

 

Triad Guaranty Inc.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(336) 723-1282

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:
None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o  No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o  No þ

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) Yes o  No þ

 

State the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $434,676,184 as of June 30, 2007, which amount excludes the value of all shares beneficially owned (as defined in Rule 13d-3 under the Securities Exchange Act of 1934) by executive officers, directors and 10% or greater stockholders of the registrant (however, this does not constitute a representation or acknowledgment that any such individual or entity is an affiliate of the registrant, or that there are not other persons who may be deemed to be our affiliates).

 

The number of shares of the registrant’s common stock, par value $0.01 per share, outstanding as of February 29, 2008, was 15,087,102.

 

 

TABLE OF CONTENTS

 

 

 

Overview of Triad and Industry

 

Triad Guaranty Inc. is a holding company that provides private mortgage insurance (“MI”) coverage in the United States through its wholly-owned subsidiary, Triad Guaranty Insurance Corporation (“Triad”). This allows buyers to achieve home ownership 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.”

 

Triad was formed in 1987 and was acquired by Collateral Mortgage, Ltd., now called Collateral Holdings, Ltd. (“CHL”), a mortgage banking and real estate lending firm, in 1989. As of December 31, 2007, CHL owns 17.2% of the outstanding common stock of the Company.

 

MI is issued in many home purchase and refinance transactions involving conventional residential first mortgage loans to borrowers with equity of less than 20%. If the homeowner defaults on the mortgage, MI reduces, and in some instances eliminates, any loss to the insured lender. MI also facilitates the sale of low down payment mortgage loans in the secondary mortgage market, with the largest percentage of sales being made to the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”), which are collectively referred to as “GSEs”. Investors and lenders also purchase MI to obtain additional default protection or capital relief on loans with equity of greater than 20%. Under risk-based capital regulations applicable to most financial institutions, MI reduces the capital requirement for such lenders on residential mortgage loans retained in the lender’s portfolio.

 

Currently, Triad is licensed to do business in all fifty U.S. states and the District of Columbia. In May 2007, the registrant’s Canadian subsidiary, Triad Guaranty Insurance Corporation Canada (“TGICC”) received its Order to Commence and Carry on Business from Canada’s Office of the Superintendent of Financial Institutions (“OSFI”). However, we made the decision to suspend our operations in Canada and in January 2008 repatriated $38.8 million of the original $45.0 million contributed. Presently, we are considering several options for our remaining Canadian interests, which could include the sale or liquidation of TGICC. TGICC has not written any mortgage insurance policies.

 

Our success is dependent both on internal factors, such as underwriting, adequacy of our pricing and operating efficiency, and external factors, such as the state of the housing, mortgage, and capital markets, interest rates and the regulatory environment. For a detailed description of the components of our revenue and expenses as well as the drivers of our profitability, please refer to the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this annual report on Form 10-K. A detailed description of the insurance regulations that we are subject to is discussed further in this Item 1.

 

Our principal executive offices are located at 101 South Stratford Road, Winston-Salem, North Carolina 27104 in properties that are leased. We do not require a significant amount of fixed assets for our operations and property and equipment consisting primarily of computer equipment and software are the extent of the long-lived assets. Our telephone number is (336) 723-1282.

 

Our web site is www.triadguaranty.com. Information contained on, or that can be accessed through, our web site does not constitute part of this annual report. We have included our website address as a factual reference and do not intend it as an active link to our web site. We make available on our web site our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports. This information is made available free of charge and as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission (“SEC”).

Overview of Market Conditions

 

The profitability and growth of the mortgage insurance industry is subject to conditions in the residential mortgage market which, over the long-term, has experienced a substantial amount of growth and profitability. However, during the past 30 years, the residential mortgage market has experienced regional recessions — the last being in the early 1990s in Southern California. Because Triad was incorporated in 1987 and grew slowly and conservatively throughout the 1990s, it was not significantly affected by the prior regional market recessions.

 

The residential mortgage market was particularly strong between 2001 and 2006. This period of time was marked generally by strong home price appreciation, the introduction of many new mortgage products, significant mortgage refinancing activity, a favorable interest rate environment, strong demand for mortgage securitizations in the secondary market, and favorable employment rates. However, we believe these conditions, particularly the strong demand for mortgage securitizations in the secondary market and the introduction of new mortgage products, gradually led to deterioration in underwriting practices over that five-year period.

 

The mortgage insurance industry also experienced strong growth and profitability during the 2001 through 2006 period. The ability to refinance with relative ease coupled with strong home price appreciation contributed to a lower default rate and facilitated loss mitigation efforts, particularly in fast growth states such as California and Florida. The emergence of securitizations in the secondary market that are insured through the structured bulk channel, in which Triad began participating in 2001, also contributed to growth and added a new channel to acquire business.

 

Beginning in early 2007, the residential mortgage market began slowing due to severe home price declines in certain regions, which has since expanded geographically and in severity. Declining home prices and the subsequent significant increase in the number of defaults, coupled with the liquidity crisis beginning in the summer of 2007, had a significant impact on the valuation of mortgage-backed securities. Large financial institutions world-wide have written down billions of dollars worth of residential mortgage assets and derivatives. Financial guarantors that insure the cash flow of mortgage-backed securities have been under increased pressure and a number of mortgage lenders have filed for bankruptcy protection. An oversupply in the housing marketplace now exists, brought on by declining house prices and a significant increase in foreclosures. The demand for mortgages has declined substantially and underwriting guidelines have been tightened across the industry. While the job market has been generally strong during this period, recent economic reports suggest that there are fewer employment opportunities.

 

During 2007, defaults and foreclosures increased across the country. In addition, we have identified four states, California, Florida, Arizona and Nevada, as distressed markets. Prior to 2007 these distressed markets experienced some of the largest increases in home prices. Over the past six to nine months, however, these distressed markets have experienced substantial growth in default rates and also have significantly higher average loan amounts. As a result, our average reserve and claim size on defaulted loans is significantly greater in these distressed markets than with respect to our overall portfolio.

 

These market conditions have resulted in credit losses being reported by a number of financial institutions, including all major mortgage insurers. Our loss ratio has increased from 44.7% for all of 2006, to 148.2% for the third quarter of 2007, to 262.1% for the fourth quarter of 2007 and 133.7% for all of 2007. We reported a net loss in the third quarter of 2007 for the first time since our inception and we also reported a net loss for all of 2007.

 

Triad and others in the industry have responded to these conditions by tightening underwriting guidelines on a number of products and, in some cases, by implementing more restrictive guidelines in certain market regions, such as California, Nevada, Arizona, and Florida. Fannie Mae and Freddie Mac have recently also taken steps to tighten their underwriting guidelines, which has served to reduce the risk associated with the loans they generally will accept. The impact of these tightened guidelines is to further reduce the availability of mortgage financing which in turn has contributed to a decline in home prices.

 

The Economic Stimulus Act of 2008, signed into law on February 13, 2008, establishes temporary increases to Fannie Mae and Freddie Mac’s conventional loan limits for first lien mortgages loans in high-cost areas, as defined by the U.S. Department of Housing and Urban Development (“HUD”). The new legislation is intended to bring stability, liquidity and affordability to an important part of the housing finance system. The new loan limits are applicable only to high-cost areas and will be calculated based on the subject property as follows: 125 percent of the

area median home price in high-cost areas, not to exceed $729,750 except in Alaska, Hawaii, Guam and the U.S. Virgin Islands. The Federal Housing Administration (“FHA”) will adopt these new loan limits as well. As of now, the new loan limits are in effect until December 31, 2008 but may be extended beyond that date. The effect of the Act may result in an increase of “jumbo conforming” loans originated for sale to the GSEs, thereby possibly increasing the average loan size insured by MIs. Subject to GSE and MI guidelines, in many cases private MI would be required on these loans. In addition, there may be an increase in FHA-originated loans that would not require private MI.

 

Current Developments

 

Our risk-to-capital ratio has risen dramatically over the past year, driven primarily by significant increases in our risk-in-force during the past 12 months and operating losses we incurred in the last two quarters of 2007. We believe the housing and mortgage markets in 2008 will continue to be adversely affected by a number of factors, including declining home prices, an oversupply of homes offered for sale and increased foreclosures, particularly in certain distressed markets. We expect we will incur additional operating losses as new defaults are reported. Based on our internal projections, we must significantly augment our capital resources in the second quarter of 2008 in order to preserve our ability to continue to write new insurance. Since the fourth quarter of 2007, we have been working with a prominent financial advisory firm to pursue alternatives for enhancing our capital. We have not yet succeeded in obtaining any commitments for an investment in our company, and there can be no assurance that we will be able to obtain any such commitments in the future.

 

The proposals that have been considered involve structures under which Triad would implement a “run-off” plan and a newly formed mortgage insurer would acquire certain of Triad’s employees, infrastructure, sales force and insurance underwriting operations. In addition, we would cease writing new business. These proposals do not involve a direct investment in Triad. Completing any such transaction would be subject to numerous conditions, including obtaining necessary consents and approvals from our stockholders, the Illinois Department of Insurance and other state insurance regulatory authorities, the GSEs, rating agencies and other third parties. No assurance can be given that such consents and approvals could be obtained or that we can complete any such transaction. In addition, no assurance can be given that we would have any ownership interest in any new mortgage insurer formed to acquire assets of Triad or have any opportunity to share in the potential financial returns available from insurance written by such an insurer.

 

Mortgage Insurance Products

 

We offer principally two products, Primary and Modified Pool mortgage insurance, which are described below. Risk-sharing products are a component of Primary insurance and serve to reduce our ultimate risk, which we insure through the payment of premiums to captive reinsurers. Revenues from Primary insurance represented approximately 76%, 73% and 82% of our total earned premiums for the three years ended December 31, 2007, 2006 and 2005, respectively. Modified Pool revenues represented approximately 24%, 27% and 18% of the total earned premium for the three years ended December 31, 2007, 2006 and 2005, respectively.

 

Primary Insurance

 

Primary insurance provides mortgage default protection to lenders on individual loans and covers a percentage of unpaid loan principal, delinquent interest and certain expenses associated with the default and subsequent foreclosure (collectively, the “insured amount” or “claim amount”). Our obligation to an insured lender with respect to a claim is determined by applying the appropriate coverage percentage to the claim amount. The insured lender selects the coverage percentage, which generally ranges from 12% to 37% and is typically based on their investors’ requirements to reduce investor loss exposure on loans they purchase. Under our master policies, we have the option of paying the entire claim amount and taking title to the mortgaged property or paying the coverage percentage on the claim amount in full satisfaction of our obligations. We classify a policy as Primary insurance when we are in the first loss position and the loan-to-value (“LTV”) ratio is 80% or greater when the loan is first insured. Primary insurance comprised approximately 68% and 60% of our total direct insurance in force at December 31, 2007 and 2006, respectively. Primary insurance written comprised approximately 85% and 49% of total insurance written during 2007 and 2006, respectively. Primary insurance may be written through the flow channel or the structured

bulk channel (see “Distribution Channel” below). During 2007 and 2006, Primary insurance written through the flow channel comprised approximately 81% and 91% of total Primary insurance written, respectively. Primary insurance written through the structured bulk channel comprised the remainder. We did not write any Primary insurance through the structured bulk channel in the fourth quarter of 2007 and do not anticipate any significant production through this channel in 2008.

 

Fannie Mae and Freddie Mac are the ultimate purchasers of a large percentage of the loans we insure. Generally, they require a coverage percentage that will reduce their loss exposure on loans they purchase to 75% or less of the property’s value at the time the loan is originated. Since 1999, Fannie Mae and Freddie Mac have accepted lower coverage percentages for certain categories of mortgages when the loan is approved by their automated underwriting services. The reduced coverage percentages limit loss exposure to 80% or less of the property’s value at the time the loan is originated.

 

Our premium rates vary depending upon various factors including the LTV ratio, loan type, mortgage term, coverage amount, documentation required, credit score and use of property, all of which may affect the risk of default on the insured mortgage loan. Usually, premium rates cannot be changed after issuance of coverage. We generally utilize a nationally based, rather than a regionally or locally based, premium rate structure for those loans originated by lenders and submitted to us on a loan-by-loan basis. However, special risk rates are often utilized as well.

 

Premiums on Primary insurance generally are paid either directly by the borrower (“borrower-paid”) or by the lender (“lender-paid”). Under our lender-paid plans, mortgage insurance premiums are charged to the mortgage lender or loan servicer that pays the premium to us. The lender may recover the premium through an increase in the borrower’s interest rate. Approximately 53% and 57% of Primary insurance was written under our borrower-paid plans during 2007 and 2006, respectively. The remainder was written under our lender-paid plans. Our lender-paid volume is concentrated among larger mortgage lender customers.

 

Premiums may be remitted monthly, annually or in one single payment with the majority being remitted on a monthly basis. Monthly premium plans represented approximately 89% and 91% of Primary insurance written in 2007 and 2006, respectively.

 

Modified Pool Insurance

 

Modified Pool insurance is written only on structured bulk transactions through the structured bulk channel. Structured bulk transactions involve underwriting and insuring a group of loans with individual coverage for each loan. Structured bulk transactions are typically initiated by underwriters of mortgage-backed securities, mortgage lenders and mortgage investors such as Fannie Mae and Freddie Mac, who seek additional default protection (typically on 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. Coverage on structured bulk transactions is determined at the individual loan level, sufficient to reduce the insured’s exposure on any loan in the transaction down to a stated percentage of the loan balance (“down-to” coverage), which is typically between 50% and 65%. We are provided loan-level information on the group of loans and, based on the risk characteristics of the entire group of loans, the requirements of the secondary mortgage market participant and any associated stop loss level or deductible amount, we submit a price for insuring the entire group of loans through a bid process. The majority of premiums for our Modified Pool insurance are remitted monthly. We compete primarily against other forms of credit enhancement provided by the capital markets for these transactions as well as other mortgage insurers.

 

Structured bulk transactions frequently include an aggregate stop-loss limit applied to the entire group of insured loans. Additionally, some of the structured bulk transactions we enter into include deductibles under which we pay no claims until the losses exceed the deductible amount. Modified Pool insurance comprised approximately 32% and 40% of our total direct insurance in force at December 31, 2007 and 2006, respectively. Modified Pool insurance written comprised approximately 15% and 51% of total insurance written during 2007 and 2006, respectively. We have not written any Modified Pool insurance since the quarter ended June 30, 2007 and do not currently expect any material production of Modified Pool insurance in 2008.

Traditional Pool Insurance

 

Traditional pool insurance generally has been offered by private mortgage insurers to lenders as an additional credit enhancement for certain mortgage-backed securities and provides coverage for the full amount of the net loss on each individual loan included in the pool, subject to an aggregate stop loss limit and/or a deductible. We have not offered traditional pool insurance.

 

Risk-sharing Products

 

We offer mortgage insurance structures designed to allow lenders to share in the risks of mortgage insurance. One such arrangement is our captive reinsurance program. Under the captive reinsurance program, a reinsurance company, generally an affiliate of the lender, assumes a portion of the risk associated with the lender’s insured book of business in exchange for a percentage of the premiums. Typically, the reinsurance program is an excess-of-loss arrangement with defined aggregate layers of coverage and a maximum exposure limit for the captive reinsurance company. Captive reinsurance programs may also take the form of a quota share arrangement, although we had no quota share arrangements in force under captive reinsurance programs as of December 31, 2007. Under our excess-of-loss programs, with respect to a given book year of business, Triad retains the first loss position on the first aggregate layer of risk and reinsures a second defined aggregate layer with the reinsurer. Triad generally retains the remaining risk above the layer reinsured. Of the reinsurance agreements in place at December 31, 2007, the first layer retained by Triad ranged from the first 3.0% to 6.5% of risk originated and the second layer ceded to reinsurers ranged from the next 4.0% to 10.0%. Ceded premiums, net of ceded commissions, under these arrangements ranged from 20.0% to 40.0% of premiums.

 

We require the counterparties to all of Triad’s captive reinsurance agreements to establish trust accounts to support the reinsurers’ obligations under the reinsurance agreements. The captive reinsurer is the grantor of the trust and Triad is the beneficiary of the trust. The trust agreement includes covenants regarding minimum and ongoing capitalization, required reserves, authorized investments and withdrawal of assets and is funded by ceded premiums and investment earnings on trust assets as well as capital contributions by the reinsurer.

 

Reinsurance contracts do not relieve Triad from its obligations to policyholders. The ultimate trust funds may be inadequate to cover total ceded losses and the captive’s parent may be unwilling or unable to fund the shortage. Failure of the reinsurer to honor its obligation could result in losses to Triad; consequently, allowances are established for amounts deemed uncollectible from reinsurers.

 

On February 14, 2008, Freddie Mac announced that they were temporarily changing their private mortgage insurer eligibility requirements. One of the changes provides that approved mortgage insurers may not cede new risk if the premium ceded to captive reinsurers is greater than 25%. This temporary change is effective for any new risk ceded on or after June 1, 2008. This change does not apply to insurance in force that is currently subject to captive reinsurance treaties where the premium cede rate is greater than 25%. During 2007, Triad’s percentage of insurance written subject to captive reinsurance where the cede rate was greater than 25% was 19.7%. This change may result in a decrease to the percentage of insurance written in 2008 subject to captive reinsurance and may result in a decline in our total insurance written during 2008.

 

On February 26, 2008, Fannie Mae announced an identical position to Freddie Mac’s position regarding mortgage insurer eligibility and captive reinsurance cede rates greater than 25%.

 

The ultimate impact on our financial performance of an excess-of-loss captive reinsurance structure is primarily dependent on the total level of losses and the persistency rates during the life of the business. We define persistency as the percentage of insurance in force remaining from twelve months prior. We believe that our excess-of-loss captive reinsurance programs provide valuable reinsurance protection by limiting the aggregate level of losses and, under normal operating environments, potentially reduce the degree of volatility in our results of operations from the development of such losses over time. At December 31, 2007 and 2006, approximately 59% and 61% of our Primary flow insurance in force was subject to captive reinsurance programs. Through December 31, 2007, we had not used captive mortgage reinsurance or other risk-sharing arrangements with Modified Pool insurance or Primary bulk insurance.

Distribution Channels

 

We sell mortgage insurance through two distribution channels. Our flow channel consists of loans originated by lenders and submitted to us on a loan-by-loan basis. All insurance delivered through the flow channel is classified as Primary insurance.

 

Through the structured bulk channel, we participate in bids for structured bulk transactions that meet our loan quality and pricing criteria. Modified Pool insurance is only written through the structured bulk channel, and some Primary insurance is written through the structured bulk channel. We are currently not active in the structured bulk channel and do not expect any material production in 2008.

 

Cancellation of Insurance

 

We generally cannot cancel mortgage insurance coverage except for nonpayment of premiums, misrepresentation or fraud on the loan application or certain material violations of the master policy. Coverage generally remains renewable at the option of the insured lender. In most cases, mortgage insurance is renewable at a rate determined when the insurance on the loan was initially issued.

 

Insured lenders may cancel insurance acquired through the flow channel at any time at their option. Pursuant to the Homeowners Protection Act, lenders are required to automatically cancel the borrower paid MI on most loans made on or after July 29, 1999, when the outstanding loan amount is 78% or less of the property’s original purchase price and certain other conditions are met. A borrower may request that a loan servicer cancel borrower-paid mortgage insurance on a mortgage loan when the loan balance is less than 80% of the property’s current value, but loan servicers are generally restricted in their ability to grant those requests by secondary market requirements and by certain other regulatory restrictions.

 

Mortgage insurance coverage can also be cancelled when an insured loan is refinanced. If we provide insurance on the refinanced mortgage, the policy on the refinanced home loan is considered new insurance written (“NIW”). Therefore, continuation of coverage from one of our refinanced loans to a new loan results in both a cancellation of insurance and new insurance written. During periods of high refinance activity, our earnings and risk profiles are more subject to fluctuations. Our cancellation rate, defined as the percentage of insurance in force from twelve months prior that was cancelled during the preceding twelve-month period, was approximately 18% and 23% for 2007 and 2006, respectively.

 

Renewal premiums are a major source of revenue and are dependent on our insurance policies remaining in force. An increase in the cancellation rate or, alternatively, a decrease in the persistency rate, all else being equal, typically reduces the amount of our insurance in force and our renewal premiums.

 

Customers

 

Residential mortgage lenders such as mortgage bankers, mortgage brokers, commercial banks and savings institutions are the principal originators of our insurance written through the flow channel. To obtain insurance through our flow channel, a mortgage lender must first apply for and receive a master policy from us. The master policy sets forth the terms and conditions of our mortgage insurance coverage. The master policy does not obligate the lender to obtain insurance from us, nor does it obligate us to issue insurance on a particular loan.

 

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. These allocations can vary over time. Our strategy is to continue our focus on national lenders while maintaining the productive relationships that we have built with regional lenders.

 

During 2007, troubles within the mortgage industry affected a number of our customers. American Home Mortgage Corp. (“AHM”) was our largest customer for the first six months of 2007 in terms of new insurance written. AHM and certain of its affiliates filed for protection under Chapter 11 of the U.S. Bankruptcy Code during

the third quarter and, as a result, we received extremely limited production from AHM during the remainder of 2007 and anticipate no further business from AHM. In January of 2008, Bank of America announced that it had agreed to purchase Countrywide Credit Industries, Inc., our third largest customer during 2007 in terms of new insurance written. Bank of America is also one of our current customers.

 

In 2007, our ten largest customers were responsible for approximately 73% of our NIW through the flow channel compared to approximately 80% in 2006. The loss of, or considerable reduction in, business from one or more of our ten largest customers, without a corresponding increase from other lenders, would have an adverse effect on our business. AHM, which has already filed for bankruptcy protection, represented approximately 21% of 2007 flow NIW while Countrywide represented approximately 12% of our 2007 flow NIW. We believe that the loss of AHM as a customer, combined with a tightening of our underwriting guidelines and other industry factors, will significantly reduce our flow production in 2008. It is unclear what impact, if any, the acquisition of Countrywide by Bank of America will have on our flow production or our competitive position in the future.

 

Those customers whose revenue comprised more than 10% of our consolidated revenue are listed below:

 

 

Sales

 

We currently market our insurance products through a dedicated sales group of approximately 33 employees, including sales management. We are licensed to do business in all 50 states and the District of Columbia. During 2007 we terminated an exclusive sales agreement with a general agency that served a specific geographic market, with responsibility for that market being assigned to existing sales representatives. During 2007, new insurance written attributed to this general agency comprised less than 1% of our total flow new insurance written for the year.

 

Contract Underwriting

 

We provide fee-based contract underwriting services that enable customers to improve the efficiency of their operations by outsourcing all or part of their mortgage loan underwriting. The fee charged is intended to cover the cost of providing the services. Contract underwriting involves examining a prospective borrower’s information contained in a lender’s mortgage application file and making a determination whether the borrower is approved for a mortgage loan subject to the lender’s underwriting guidelines. In addition, we offer Fannie Mae’s Desktop Originator^® and Desktop Underwriter^® and Freddie Mac’s Loan Prospector^® as a service to our contract underwriting customers. These products, which are designed to streamline and reduce costs in the mortgage origination process, supply our customers with fast and accurate information regarding compliance with underwriting standards and Fannie Mae’s or Freddie Mac’s decision for loan purchase or securitization. We provide contract underwriting services through our own employees as well as independent contractors, and these services are provided for loans that require mortgage insurance as well as loans that do not require mortgage insurance. In the event that Triad fails to properly underwrite a loan subject to the lender’s underwriting guidelines, Triad may be required to provide monetary or other remedies to the lender customer.

 

Competition and Market Share

 

We and other private mortgage insurers compete directly with federal and state governmental and quasi-governmental agencies, principally FHA. In addition to competition from federal agencies, we and other private mortgage insurers face competition from state-supported mortgage insurance funds, some of which are either independent agencies or affiliates of state housing agencies. Indirectly, we also compete with mortgage lenders that

forego MI to self-insure against the risk of loss from defaults on all or a portion of their low down payment mortgage loans, and we compete with products designed to avoid mortgage insurance such as simultaneous seconds or “piggyback” mortgage products (a combination of loans, usually issued by the same lender, that allows the balance of each individual loan to be at or below 80% of the property’s current value).

 

Fannie Mae and Freddie Mac are the beneficiaries of the largest percentage of our mortgage insurance policies, so their business practices have a significant influence on us. Changes in their practices could reduce the number of loans they purchase that are insured by us and consequently reduce our revenues. Some of the programs put into place by Fannie Mae and Freddie Mac require less insurance coverage than they historically have required, and they have the ability to further reduce coverage requirements, which could reduce demand for mortgage insurance or reduce the level of coverage that we provide, both of which could have a material adverse effect on our business, financial condition and operating results.

 

Fannie Mae and Freddie Mac also have the ability to implement new eligibility requirements for mortgage insurers and to alter or liberalize underwriting standards on low-down-payment mortgages they purchase. We cannot predict the extent to which any new requirements may be enacted or how they may affect the operations of our mortgage insurance business, our capital requirements or our products. If for any reason we are unable to meet the eligibility requirements for providing mortgage insurance for loans purchased by Fannie Mae and Freddie Mac, our business, financial condition and operating results would be adversely affected. See “Financial Strength Rating” below for further discussion.

 

Various proposals have been periodically discussed by Congress and certain federal agencies to reform or modify the charters under which Fannie Mae and Freddie Mac do business. We are unable to predict whether any such proposals will be enacted into law, and if enacted, their scope and content and what effect they may have on us.

 

The MI industry consists of seven major mortgage insurance companies, including Triad, Mortgage Guaranty Insurance Corporation, Radian Guaranty Inc., PMI Mortgage Insurance Co., United Guaranty Corporation, Genworth Financial, Inc. and Republic Mortgage Insurance Company. Triad is the smallest private mortgage insurer based on 2007 market share and, according to estimated industry data, had a 6.4% share of total net new insurance written in 2007 compared to 9.1% in 2006.

 

We have historically competed in competitive bid transactions in the structured bulk market with both the other private mortgage insurers and providers of other forms of credit enhancements. We currently are not active in the structured bulk market.

 

Underwriting Practices

 

We consider effective risk management to be critical to our long-term financial stability. Market analysis, product analysis, prudent underwriting, the use of automated risk evaluation models, sophisticated risk modeling, auditing and knowledge of our customers are all important elements of our risk management process.

 

During the fourth quarter of 2007 and first quarter of 2008, we announced and began to implement adjustments in our underwriting guidelines specific to our flow business. These adjustments placed limitations on maximum LTVs, minimum Fair, Isaac and Co., Inc. (“FICO”) credit scores and acceptable documentation, among other items. Furthermore, these limitations are more restrictive in certain geographic markets that have depressed housing markets and high default rates. We expect that these adjustments will lead to significant reductions in the level of new insurance written in 2008 from the level written in 2007.

 

Risk Management Approach

 

We evaluate risk based on historical performance of risk factors and utilize automated underwriting systems in the risk selection process to assist the underwriter with decision-making. This process evaluates the following categories of risk:

 

Mortgage Lender.  We review each lender’s financial statements and management experience before issuing a master policy. We also track the historical risk performance, including loan level risk characteristics, of all significant customers that hold a master policy. This information is factored into determining the loan programs we

approve for various lenders. We assign delegated underwriting authority only to lenders with substantial financial resources and established records of originating loans that meet our underwriting guidelines.

 

Purpose and Type of Loan.  We analyze various general characteristics of a loan to evaluate its level of risk including, among others: (i) LTV ratio; (ii) type of loan instrument and the amortization schedule; (iii) purpose of the loan; (iv) level of documentation; (v) type of property; and (vi) occupancy.

 

 

 

Individual Loan and Borrower.  Individual insurance applications are evaluated based on analysis of the borrower’s ability and willingness to repay the mortgage loan and the characteristics and value of the mortgaged property. The analysis of the borrower includes reviewing the borrower’s housing and total debt ratios as well as the borrower’s FICO credit score, as reported by credit rating agencies. We believe, all else being equal, that claim incidence increases for loans made to borrowers with a lower credit score. However, there is limited historical evidence of the predictability of credit scores in stressed housing environments and there can be no assurance that this relationship will hold true in such an environment. In addition to the borrower’s willingness and ability to repay the loan, we believe that mortgage default risk is affected by a variety of other factors, including the borrower’s employment status. We believe insured mortgage loans made to self-employed borrowers have a higher risk of claim, all other factors being equal, than loans to borrowers employed by third parties.

 

Geographic Selection of Risk.  We place emphasis on the condition of the regional housing markets in determining marketing and underwriting policies. Using both internal and external data, our risk management department continually monitors the economic conditions in our active and potential markets.

 

Underwriting Process for Our Flow Distribution Channel

 

We generally utilize nationwide underwriting guidelines to evaluate the potential risk of default on mortgage loans submitted for insurance coverage. These guidelines have evolved over time and take into account the loss experience of the entire MI industry. They also are largely influenced by the underwriting guidelines of Fannie Mae and Freddie Mac. Specific underwriting guidelines applicable to a given local, state or regional market are utilized to address concerns resulting from our review of regional economies and housing patterns.

 

Subject to our underwriting guidelines and exception approval procedures, we expect our internal underwriters and contract underwriters to utilize their experience and business judgment in evaluating each loan on its own merits. Accordingly, our underwriting staff has discretionary authority to insure loans that deviate in certain minor respects from our underwriting guidelines. More significant exceptions are subject to management approval. In all such cases, other compensating factors must be identified. The predominant deviations involve instances where the borrower’s debt-to-income ratio exceeds our guidelines. To compensate for exceptions, our underwriters give favorable consideration to factors such as excellent borrower credit history, the LTV, the availability of satisfactory cash reserves after closing and borrower employment stability.

 

We accept applications for insurance under three basic programs: a fully-documented program; a credit-score driven reduced documentation program; and a delegated underwriting program that allows a lender’s underwriters to commit insurance to a loan based on strict, agreed-upon underwriting guidelines. We also accept loans approved through Freddie Mac’s or Fannie Mae’s automated underwriting systems.

 

We allow lenders to submit insurance applications with reduced documentation through automated and non-automated underwriting programs. Under the automated underwriting program, Triad issues a commitment of insurance based on the borrower’s FICO credit score or the approval of the loan through either Fannie Mae’s or Freddie Mac’s automated underwriting system. We issue a commitment of insurance without the standard

underwriting process if certain program parameters are met and the borrower has a credit score above established thresholds. We audit lenders’ files on loans submitted under the automated underwriting program randomly and through specific identification of selected risk factors. Documentation submission requirements for non-automated underwritten loans vary depending on the borrower’s credit score.

 

We utilize a delegated underwriting program to serve many of the larger, well-established mortgage originators. Under this program, standards for type of loan, property type and credit history of the borrower are established consistent with our risk strategy, and the lender’s underwriters are able to commit insurance to a loan based on these standards. Re-underwriting, re-appraisal, and similar procedures are utilized following issuance of the policy to ensure quality control. Our delegated underwriting program accounted for approximately 56% of applications received through the flow distribution channel in 2007 compared to approximately 63% in 2006. The use of Fannie Mae’s or Freddie Mac’s automated underwriting programs or our delegated underwriting programs with selected lenders could lead to loss development patterns different than those experienced when we control the entire underwriting process.

 

Underwriting Process for Our Structured Bulk Distribution Channel

 

Our pricing for structured bulk transactions is intended to be commensurate with our evaluation of the transaction’s overall risk profile based upon its individual loan-by-loan analysis as well as any associated stop loss level or deductible amount. We analyze structured bulk transactions during the bid process to evaluate the risk factors of the individual loans contained within the transaction and then determine whether we want to bid on the transaction. The risk factors that we evaluate include the mortgage lender, purpose and type of loan, individual borrower, geography, and our risk dispersion as discussed under “Risk Management Approach” above. The pertinent risk characteristics of each loan are evaluated to determine the impact on the entire transaction’s persistency and frequency as well as severity of loss. We may utilize an outside due diligence firm in this process as well as mortgage risk analysis models such as Standard & Poor’s LEVELS^® or LoanPerformance. We may request to remove certain loans from the transaction as a result of the risk review before we submit a competitive bid.

 

We did not write any Primary insurance through the structured bulk channel in the fourth quarter of 2007 and have not written any Modified Pool insurance since the second quarter of 2007. We do not anticipate any significant production from the structured bulk distribution channel in 2008.

 

Other Risk Management

 

We employ a comprehensive quality assurance audit plan to determine whether underwriting decisions being made are consistent with the policies, procedures and expectations for quality set forth by management. All areas of business activity that involve an underwriting decision are examined, with emphasis on new products, new procedures, contract underwritten loans, delegated loans, new employees, new master policyholders and new branches of an existing master policyholder. The process used to identify categories of loans selected for audit begins with identification and evaluation of certain defined and verifiable risk elements. Specialized selection procedures are applied to contract underwriters, delegated loans and early payment defaults. Each loan is then tested against these elements to identify loans that fail to meet prescribed policies or an identified norm. The procedure allows management to identify concerns that may exist within individual loans as well as concerns that may exist within a given category of business and take appropriate action.

 

Financial Strength Rating

 

Credit ratings generally are considered an important element in a mortgage insurer’s ability to compete for new business, indicating the insurer’s present financial strength and capacity to pay future claims. Certain national mortgage lenders and a large segment of the mortgage securitization market, including Fannie Mae and Freddie Mac, generally will not purchase high LTV mortgages or mortgage-backed securities containing high LTV mortgages unless the insurer issuing MI coverage has a financial strength rating of at least “AA-” by either Standard & Poor’s Ratings Services (“S&P”) or Fitch Ratings (“Fitch”) or a rating of at least “Aa3” from Moody’s Investors Service (“Moody’s”). Fannie Mae and Freddie Mac have different classifications for approved mortgage insurers. Fannie Mae’s classifications are Type 1 and Type 2, with Type 1 being the preferred rating. Freddie Mac’s

classifications are Type I and Type II, with Type I being the preferred rating. These classifications depend on, among other things, a mortgage insurer’s financial strength rating as determined by the rating agencies. In general, to be a Freddie Mac Type I insurer, a mortgage insurer must be rated by at least two of the three approved rating agencies (Standard & Poor’s, Moody’s and Fitch) and no rating can be less than “AA-”. In general, to be a Fannie Mae Type 1 insurer, a mortgage insurer must be rated by at least two of the three approved rating agencies (Standard & Poor’s, Moody’s and Fitch) and at least two ratings must be above “A+”. Triad is currently rated “AA-” by Fitch Ratings and by Standard and Poor’s and “Aa3” by Moody’s Investors Service. All of Triad’s ratings are currently on “credit watch” with a negative outlook or implications. If Triad were to be downgraded below “AA-” or “Aa3” by any rating agency, this could limit our ability to write new business, jeopardize our status as a Type 1 or Type I mortgage insurer with the GSEs, and potentially allow for the transfer of existing insurance in force to other mortgage insurers by the GSEs or other investors.

 

On February 14, 2008, in conjunction with modifying its private mortgage insurer eligibility requirements, Freddie Mac also announced that it had suspended the Type II insurer requirements for mortgage insurers receiving a downgrade below the required approved rating agency ratings, provided that any downgraded mortgage insurer submits a complete remediation plan within 90 days of the downgrade for review and approval by Freddie Mac. In such case, Freddie Mac will determine in its sole discretion whether to impose the additional Type II requirements.

 

On February 26, 2008, in conjunction with modifying its private mortgage insurer eligibility requirements, Fannie Mae also affirmed that in the event of a mortgage insurer credit downgrade by a rating agency below the agency’s eligibility thresholds, a current Type 1 insurer will not automatically be reclassified as a Type 2 insurer, provided that the mortgage insurer is in good standing with the agency’s requirements and submits a written remediation plan, together with supporting documentation, within 30 days from the adverse action. In such case, Fannie Mae will determine, in its sole discretion, whether to accept any written response, corrective action or plan for corrective action.

 

Our financial strength rating is also an element of the cost of our line of credit. In general, all fees associated with the line of credit, including the interest rate on the funds outstanding, increase as a result of a decrease in our financial strength rating.

 

When assigning a financial strength rating, S&P, Fitch and Moody’s generally consider: (i) the specific risks associated with the mortgage insurance industry, such as regulatory climate, housing price trends, market demand, growth, and competition; (ii) management depth, corporate strategy, risk management, and effectiveness of operations; (iii) historical operating results and expectations of current and future performance of the insurer’s specific portfolio; and (iv) long-term capital structure, the ratio of debt to equity, the ratio of risk to capital, near-term liquidity and cash flow levels, as well as any reinsurance relationships and the financial strength ratings of such reinsurers. Ratings are based on factors relevant to policyholders, including the sufficiency of capital to cover future claims. Such ratings are not directed to the protection of shareholders and do not apply to any securities issued by us.

 

Some rating agencies issue financial strength ratings based, in part, upon a company’s performance sensitivity to various economic depression scenarios. In determining capital levels required to maintain a company’s rating, the rating agencies may allow the use of different forms of capital including statutory capital, reinsurance and debt.

 

S&P, Fitch and Moody’s will periodically review Triad’s rating as they do with all rated insurers. Ratings can be withdrawn or changed at any time by a rating agency. During 2007, Fitch reduced its financial strength rating for Triad from “AA” to “AA-” based upon revisions implemented in its proprietary capital model for U.S. mortgage insurers. Also during 2007, S&P reduced its financial strength rating for Triad from “AA” to “AA-” because of challenges confronting the U.S. mortgage and housing sectors and Triad’s lower capitalization as compared to the rest of the industry. Triad is rated “Aa3” by Moody’s. All of our ratings currently are on “credit watch” with a negative outlook or implications. Private mortgage insurers are not rated by any other independent nationally-recognized insurance industry rating organization or agency (such as the A.M. Best Company). A reduction in our rating by S&P, Fitch or Moody’s could limit our ability to write new business, jeopardize our status as a Type 1 or Type I mortgage insurer with the GSEs, and potentially allow for the transfer of existing insurance in force to other mortgage insurers by the GSEs or other investors.

Reinsurance

 

Triad’s product offerings include captive mortgage reinsurance programs whereby an affiliate of a lender reinsures a portion of the insured risk on loans originated or purchased by the lender. These programs are designed to allow the lenders to share in the risk of the business. For a further discussion of these programs, see “Risk-sharing Products” above.

 

Pursuant to deeper coverage requirements imposed by Fannie Mae and Freddie Mac, certain loans eligible for sale to the GSEs with an LTV ratio over 90% require insurance with a coverage percentage of 30% or more. Certain states limit the amount of risk a mortgage insurer may retain with respect to coverage of a loan to 25% of the insured amount and, as a result, the deeper coverage portion of such insurance must be reinsured. To minimize reliance on third-party reinsurers and to permit it to retain the premiums and related risk on deeper coverage business, Triad reinsures this deeper coverage business with its wholly-owned subsidiary, Triad Guaranty Assurance Corporation (“TGAC”). As of December 31, 2007 and 2006, TGAC assumed approximately $213 million and $127 million in risk from Triad, respectively.

 

During 2007, we maintained excess-of-loss reinsurance with a stated value of $100 million. This reinsurance is provided by non-affiliated reinsurers that had financial strength ratings of “AA” or better from Standard & Poor’s. Effective January 1, 2008, one of the reinsurers elected to not to renew its $5 million coverage under the excess-of-loss reinsurance. The current reinsurance treaty expires on December 31, 2010.

 

The excess of loss reinsurance was obtained primarily to provide a source of capital in the rating agencies’ capital models and, as such, it was designed to limit our exposure in the event of a significant level of losses. This reinsurance arrangement contains a quota share feature that the reinsurer may choose to elect, at the reinsurer’s option, upon certain conditions being met regarding Triad’s financial performance and capitalization. We expect that those conditions will be met at March 31, 2008. Under the quota share arrangement, the reinsurer may elect to reinsure remaining books of business to reduce Triad’s risk in order to maintain a risk to capital ratio of 23 to 1. The terms on the quota share include payment of a ceding commission to Triad, along with a profit participation by Triad in the business reinsured.

 

The use of reinsurance as a source of capital and as a risk management tool is well established within the mortgage insurance industry. Reinsurance does not legally discharge an insurer from its primary liability for the full amount of the risk it insures, although it does make the reinsurer liable to the primary insurer. There can be no assurance that our reinsurers will be able to meet their obligations under their reinsurance agreements with Triad.

 

Defaults and Claims

 

Defaults

 

The claim process on MI begins with the lender’s notification to the insurer of a default on an insured’s loan. We define a default as an insured loan that is reported to be in excess of two payments in arrears at the reporting date and all reported delinquencies that were previously in excess of two payments in arrears and have not been brought current. The master policies require lenders to notify us of default on a mortgage payment within 10 days of either (i) the date on which the borrower becomes four months in default or (ii) the date on which any legal proceeding affecting the loan commences, whichever occurs first. Notification is required within 45 days of default if it occurs when the first payment is due.

 

The incidence of default is affected by a variety of factors including, but not limited to, declining value in the underlying property, changes in borrower income, unemployment, divorce, illness and the level of interest rates. The level of delinquencies has historically followed a seasonal pattern, in which delinquencies will generally decrease during the first part of the year and will generally increase during the latter part of the year. However, given the current state of the housing and mortgage market as well as the general state of the economy, this general decrease in the first part of the year may not materialize. In addition, the MI industry has little historical experience in projecting defaults in a market environment characterized by widespread declining houses prices. Such declines may cause otherwise financially capable borrowers to stop making mortgage payments and allow their mortgages to go into default if the LTV ratios on their homes exceed 100%. See “Risk Factors” below.

Borrowers may cure defaults by making all delinquent loan payments or by selling the property and satisfying all amounts due under the mortgage. Defaults that are not cured generally result in submission of a claim to us. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below for a summary of Triad’s default statistics at December 31, 2006 and 2007.

 

Claims

 

Claims result from defaults that are not cured. During the default period, we work with the insured as well as the borrower in an effort to reduce losses through the loss mitigation efforts described below. The frequency of claims may not directly correlate to the frequency of defaults due, in part, to our loss mitigation efforts and the borrower’s ability to overcome temporary financial setbacks. The likelihood that a claim will result from a default, and the amount of such claim, principally depend on the borrower’s equity at the time of default and the borrower’s (or the lender’s) ability to sell the home for an amount sufficient to satisfy all amounts due under the mortgage, as well as the effectiveness of loss mitigation efforts. The time frame from when we first receive a notice of default until the ultimate claim is paid generally ranges from six to eighteen months. Changes in various macroeconomic conditions such as house price appreciation/depreciation, employment, and other market conditions over that time frame also positively or negatively impact the amount of the ultimate claim paid.

 

Historically, the payment of claims is not evenly spread throughout the insurance coverage period. For Primary insurance, relatively few claims generally are paid during the first year following loan origination. A period of rising claim payments normally follows, which, based on industry experience, has historically reached its highest level in the second through fifth years after loan origination. Thereafter, the number of claim payments made has historically declined at a gradual rate, although the rate of decline can be affected by local economic conditions. For Modified Pool insurance, the claim pattern generally peaks somewhat earlier, with the highest claim payment levels reached in the second through fourth years. We are currently experiencing increased early default and claim activity on loans originated in 2006 and 2007 that differs significantly from historical levels. We believe this is primarily the result of a deterioration in the housing market marked by a decline in home prices as well as poor underwriting by the originators. It is difficult to project the claim pattern peak of these books of business given the early accelerations, the risk composition of the underlying loans and the general conditions in the housing market. Accordingly, we cannot predict when, if ever, the historical pattern of claims will return in the future.

 

Generally, our master policies provide that we are not liable to pay a claim for loss if the application for insurance for the loan in question contains fraudulent information, material omissions or misrepresentations that increase the risk characteristics of the loan. Where we find that these provisions of our master policies have been violated, we may rescind, or cancel, coverage on the loan retrospective to the date of insurance. Experience has shown that an early payment default, which is defined as a default that is reported within the first 12 months of insurance, has a higher probability of violating these provisions of the master policies. During 2007, we experienced a notable increase in the number of early payment defaults. Early payment defaults are reviewed by the Quality Assurance department to ensure the provisions of our master policies were complied with. During 2007, we reviewed approximately 3,300 early payment defaults and rescinded coverage on approximately 11% of these policies. This activity was concentrated in the latter part of the year and to policies originated during 2006 and 2007. We also experienced a higher rescission rate with policies originated through the structured bulk channel. We currently expect that this higher level of rescission activity will continue in 2008.

 

Our master policies also exclude any cost or expense related to the repair or remedy of any physical damage (other than “normal wear and tear”) to the property collateralizing an insured mortgage loan. Such physical damage may be caused by accident, natural occurrence or other conditions.

 

Under the terms of the master policies, the lender is required to file a claim with us no later than 60 days after it has acquired the borrower’s title to the underlying property through foreclosure, a negotiated short sale or a deed-in-lieu of foreclosure. A primary insurance claim amount includes (i) the amount of unpaid principal due under the loan; (ii) the amount of accumulated delinquent interest due on the loan (excluding late charges) to the date of claim filing; (iii) expenses advanced by the insured under the terms of the master policies, such as hazard insurance premiums, property maintenance expenses and property taxes prorated to the date of claim filing; and (iv) certain foreclosure and other expenses, including attorneys’ fees. Such claim amounts are subject to review and

possible adjustment by us. Our experience indicates that the claim amount on a policy generally ranges from 110% to 115% of the unpaid principal amount of a foreclosed loan.

 

Within 60 days after the claim has been filed, we have the option of either (i) paying the coverage percentage of the claim as specified on the certificate of insurance (generally 12% to 37% of the claim), with the insured retaining title to the underlying property and receiving all proceeds from the eventual sale of the property, or (ii) paying the full claim amount in exchange for the lender’s conveyance of good and marketable title to the property to us, and selling the property for our own account. We choose the claim settlement option believed to cost the least. In most cases, we settle claims by paying the coverage percentage of the claim amount; however, we continue to use the option to purchase properties in settlement of claims. At December 31, 2007, we held 57 properties with a combined net realizable value of approximately $10.9 million that were acquired by electing to pay the full claim amount compared to 68 properties with a combined net realizable value of approximately $10.2 million held at December 31, 2006. We record the estimated loss amount on properties purchased in settlement of claims at the time of acquisition and refine this estimate when appropriate until the property is sold. Where we choose to purchase the property in settlement of claims, our risk of loss may increase. However, in general, the claims severity has historically been lower on properties acquired than on those for which we paid the settlement option, although the number of claims paid under the settlement option is far greater than those utilizing the property acquisition option. There can be no assurance that our current inventory of purchased properties can be disposed of for the current net realizable value nor can there be any assurance that the purchase option method will be a viable option for settling claims in 2008.

 

Loss Mitigation

 

Once a default notice is received, we attempt to mitigate our loss. Through proactive intervention with insured lenders and borrowers, we have been successful in reducing the number and severity of our claims for loss, although mitigation efforts were much less successful in 2007. Loss mitigation techniques include pre-foreclosure sales, property sales after foreclosure, advances to assist distressed borrowers who have suffered a temporary economic setback and the use of repayment schedules, refinances, loan modifications, forbearance agreements and deeds-in-lieu of foreclosure. Such mitigation efforts typically result in reduced losses from the coverage percentage stated in the certificate of insurance. As a result of loss mitigation efforts, we paid out approximately 81% and approximately 77% of potential exposure on all claims in 2007 and 2006, respectively. We believe this increase is primarily the result of declining prices in the housing market and an increase in paid claims from the most recent vintage years.

 

Loss Reserves

 

We calculate our best estimate of the reserve for losses to provide for the estimated costs of settling claims on loans reported in default, and loans in default that are in the process of being reported to us, as of the date of our financial statements. Our reserving process incorporates various components in a model that gives effect to current economic conditions and segment defaults by a variety of criteria. The criteria include, among others, policy year, lender, geography and the number of months and number of times the policy has been in default, as well as whether the defaults were underwritten as flow business or as part of a structured bulk transaction. See the “Critical Accounting Policies” section of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a more detailed discussion of our loss reserving process. Detailed analysis of our activity in loss reserves is provided in the “Losses and Expenses” section of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 4 to the Consolidated Financial Statements.

 

Direct Risk in Force

 

We analyze our portfolio in a number of ways to identify any concentrations of risk or imbalances in risk dispersion. We believe that the quality of our insurance portfolio is affected predominantly by (i) trends in property values; (ii) the quality of loan originations (including the credit quality of the borrower and the marketability of the property); (iii) the attributes of loans insured (including LTV ratio, purpose of the loan, type of loan instrument (for example fixed or positively or negatively amortizing ARM) and type of underlying property securing the loan); (iv) the seasoning of the loans insured; (v) the geographic dispersion of the underlying properties subject to

mortgage insurance; and (vi) the quality, integrity and past performance of lenders from which we receive loans to insure.

 

We had $12.9 billion of direct risk in force as of December 31, 2007 compared to $9.4 billion as of December 31, 2006. Direct risk in force includes risk from both Primary and Modified Pool insurance, adjusted for applicable stop loss limits and deductibles.

 

Geographic Dispersion

 

The following tables reflect the percentage of direct risk in force on our book of business for the top ten states and the top ten metropolitan statistical areas (“MSAs”) by location of property as of December 31, 2007.

 

 

While we continue to diversify our risk in force geographically, a prolonged regional recession, particularly in high concentration areas, or a prolonged national economic recession could significantly increase loss development.

 

See the “Production and In Force” section of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further detailed discussion on the characteristics of our direct risk in force.

 

Investment Portfolio

 

For a discussion of investments in our portfolio, see the “Investment Portfolio” section of “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Regulation

 

Direct Regulation

 

Our insurance subsidiaries are subject to comprehensive, detailed regulation, principally for the protection of policyholders rather than for the benefit of stockholders, by the insurance departments of the various states in which each insurer is licensed to transact business. Although their scope varies, state insurance laws, in general, grant broad powers to supervisory agencies or officials to examine companies and to enforce rules or exercise discretion over almost every significant aspect of the insurance business. These include the licensing of companies to transact business and varying degrees of control over claims handling practices, reinsurance requirements, premium rates, the forms and policies offered to customers, financial statements, periodic financial reporting, permissible investments and adherence to financial standards relating to statutory surplus, dividends and other criteria of solvency intended to assure the satisfaction of obligations to policyholders.

 

All states have enacted legislation that requires each insurance company in a holding company system to register with the insurance regulatory authority of its state of domicile and furnish to the regulator financial and other information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system. Generally, all

transactions within a holding company system between an insurer and its affiliates must be fair and reasonable and the insurer’s statutory policyholders’ surplus following any transaction with an affiliate must be both reasonable in relation to its outstanding liabilities and adequate for its needs. Most states also regulate transactions between insurance companies and their parents and/or affiliates. There can be no assurance that state regulatory requirements will not become more stringent in the future and have an adverse effect on us.

 

Because the parent company is an insurance holding company and Triad is an Illinois domiciled insurance company, the Illinois insurance laws regulate, among other things, certain transactions in the parent company’s common stock and certain transactions between Triad and the Company or affiliates. Specifically, no person may, directly or indirectly, offer to acquire or acquire beneficial ownership of more than 10% of any class of outstanding securities of the Company or its subsidiaries unless such person files a statement and other documents with the Illinois Director of Insurance and obtains the Director’s prior approval. These restrictions generally apply to all persons controlling or under common control with the insurance companies. “Control” is presumed to exist if 10% or more of Triad’s voting securities is owned or controlled, directly or indirectly, by a person, although the Illinois Director may find that “control”, in fact, does or does not exist where a person owns or controls either a lesser or greater amount of securities. Other states in addition to Illinois may regulate affiliated transactions and the acquisition of control of the Company or its insurance subsidiaries.

 

Triad is required by Illinois insurance laws to provide for a contingency reserve in an amount equal to at least 50% of earned premiums in its statutory financial statements. Such reserves must be maintained for a period of 10 years except in circumstances where prescribed levels of losses exceed regulatory thresholds. During 2007, Triad experienced a loss ratio in excess of 35%, which allowed it to release approximately $275 million of previously established contingency reserves to surplus. The contingency reserve, designed to provide a cushion against the effect of adverse economic cycles, has the effect of reducing statutory surplus and restricting dividends and other distributions by Triad. At December 31, 2007, Triad had statutory policyholders’ surplus of $197.7 million and a statutory contingency reserve of $387.4 million. At December 31, 2006, Triad had statutory policyholders’ surplus of $168.4 million and a statutory contingency reserve of $521.8 million. Triad’s statutory earned surplus was $114.0 million at December 31, 2007, and $84.7 million at December 31, 2006, reflecting a statutory net loss for 2007 and the release of the statutory contingency reserve to surplus.

 

The insurance laws of Illinois provide that Triad may pay dividends only out of statutory earned surplus and further establish standards limiting the maximum amount of dividends that may be paid without prior approval by the Illinois Director. Under such standards, Triad may pay dividends during any 12-month period equal to the greater of (i) 10% of the preceding year-end statutory policyholders’ surplus or (ii) the preceding year’s net income. In addition, insurance regulatory authorities have broad discretion to limit the payment of dividends by insurance companies. On April 13, 2007, Triad paid a dividend of $30 million to its parent, Triad Guaranty Inc. As of December 31, 2007, there are no specific restrictions or requirements for capital support arrangements between the parent company and Triad or its subsidiaries.

 

Although not subject to a rating law in Illinois, premium rates for mortgage insurance are subject to regulation in most states to protect policyholders against the adverse effects of excessive, inadequate or unfairly discriminatory rates and to encourage competition in the insurance marketplace. Any increase in premium rates must be justified, generally on the basis of the insurer’s loss experience, expenses and future trend analysis. The general mortgage default experience also may be considered.

 

TGAC, organized as a subsidiary of Triad under the insurance laws of the state of Illinois in December 1994, is subject to all Illinois insurance regulatory requirements applicable to Triad.

 

Triad Re, organized as a subsidiary of Triad under the insurance laws of the state of Vermont in November 1999, is subject to all Vermont insurance regulatory requirements.

 

Triad, TGAC and Triad Re are each subject to examination of their affairs by the insurance departments of every state in which they are licensed to transact business. The Illinois Insurance Director and Vermont Insurance Commissioner periodically conduct financial condition examinations of insurance companies domiciled in their states. The most recent examinations of Triad and TGAC were issued by the Illinois Insurance Division on June 27, 2005, and covered the period January 1, 1999, through December 31, 2003. No adjustments or material

recommendations were made as a result of these examinations. The most recent examination of Triad Re was issued by the Insurance Division of the State of Vermont on September 29, 2005, and covered the period of November 16, 1999 through December 31, 2003. No adjustments or material recommendations were made as a result of the examination.

 

On March 3, 2008, the Illinois Department of Insurance began examinations of Triad and TGAC for the fiscal years 2004 through 2007. We expect these examinations to take between six and nine months. The results of the examinations are reports on the condition of the companies, which are certified by the Illinois Department of Insurance and filed with all state insurance departments.

 

A number of states generally limit the amount of insurance risk that may be written by a private mortgage insurer to 25 times the insurer’s total policyholders’ surplus. This restriction is commonly known as the risk-to-capital requirement. At December 31, 2007 Triad’s risk-to-capital ratio was 20.5-to-1. The Illinois Department of Insurance has additional restrictions on the amount of risk that may be written. These restrictions apply different capital requirements to different types of insurance products and also consider LTV and covered percentage of the insured mortgage. As of December 31, 2007, Triad’s statutory capital was approximately 101% of the minimum capital required by the Illinois Department of Insurance and TGAC’s statutory capital was approximately 258% of the minimum required capital.

 

State insurance laws and regulations generally restrict mortgage insurers to writing residential mortgage guaranty insurance business only. This restriction generally prohibits Triad from using its capital resources in support of other types of insurance and restricts its noninsurance business. However, noninsurance businesses of the Company would not be subject to regulation under state insurance laws.

 

Regulation of reinsurance varies by state. Except for Illinois, Wisconsin, New York, Ohio, and California, most states have no special restrictions on reinsurance that would apply to private mortgage insurers other than standard reinsurance requirements generally applicable to property and casualty insurance companies. Certain restrictions, including reinsurance trust fund or letter of credit requirements, apply under Illinois law to domestic companies and under the laws of several other states to any licensed company ceding business to unlicensed reinsurers. If a reinsurer is not admitted or approved, the company doing business with the reinsurer cannot take credit in its statutory financial statements for the risk ceded to such reinsurer absent compliance with the reinsurance security requirements. In addition, some states in which Triad does business have limited private mortgage insurers to a maximum policy coverage limit of 25% of the insured’s claim amount and require coverages in excess of 25% to be reinsured through another licensed mortgage insurer.

 

The National Association of Insurance Commissioners (“NAIC”) adopted a risk-based capital (“RBC”) formula designed to help regulators identify property and casualty insurers in need of additional capital. The RBC formula establishes minimum capital needs based upon risks applicable to individual insurers, including asset risks, off-balance sheet risks (such as guarantees for affiliates and contingent liabilities) and credit risks (such as reinsurance ceded and receivables). The NAIC and the Illinois Insurance Division currently do not require mortgage guaranty insurers to file an RBC analysis in their annual statements.

 

As significant purchasers and sellers of conventional mortgage loans and beneficiaries of private mortgage guaranty insurance, Fannie Mae and Freddie Mac impose eligibility requirements on private mortgage insurers in order for such insurers to acquire business from them. These requirements include limitations on the types of risk insured, standards for geographic and customer diversification of risk, procedures for claims handling and acceptable underwriting practices. These requirements generally mirror the financial requirements of statutory insurance regulations and are subject to change from time to time.

 

While Triad is an approved mortgage insurer for both Fannie Mae and Freddie Mac and meets all existing eligibility requirements, there can be no assurance that such requirements or the interpretation of the requirements will not change, that the temporary suspension of Type II insurers announced by Freddie Mac and Type 2 insurers announced by Fannie Mae will not be lifted, or that Triad will continue to meet such requirements. In addition, to the extent Fannie Mae or Freddie Mac assumes default risk for itself that would otherwise be insured, changes current guaranty fee arrangements, allows alternative credit enhancements, alters or liberalizes underwriting guidelines on low down payment mortgages it purchases, or otherwise changes its business practices or processes with respect to

such mortgages, private mortgage insurers may be affected. Triad could be adversely affected if changes in eligibility requirements regarding deep cede captive arrangements, such as those announced by Freddie Mac on February 14, 2008 and by Fannie Mae on February 26, 2008, were to impede Triad’s ability to offer this form of captive reinsurance.

 

Fannie Mae and Freddie Mac both accept reduced mortgage insurance coverage from lenders that deliver loans approved by their automated underwriting services. Generally, Fannie Mae’s and Freddie Mac’s reduced mortgage insurance coverage options provide for (i) across-the-board reductions in required MI coverage on 30-year fixed-rate loans recommended for approval by their automated underwriting services to the levels in effect in 1994; (ii) a reduction in required MI coverage for loans with only a 5% down payment (a 95% LTV loan) from 30% to 25% of the mortgage loan covered by MI; and (iii) a reduction in required MI coverage for loans with a 10% down payment (a 90% LTV loan) from 25% to 17% of the mortgage loan covered by MI. In addition, Fannie Mae and Freddie Mac have implemented other programs that further reduce MI coverage upon the payment of an additional fee by the lender. Under this option, a 95% LTV loan will require 18% of the mortgage loan to have mortgage insurance coverage. Similarly, a 90% LTV loan will require 12% of the mortgage loan to have mortgage insurance coverage. In order for the homebuyer to have MI at these levels, such loans would require a payment at closing or a higher note rate.

 

Certain national mortgage lenders and a large segment of the mortgage securitization market, including Fannie Mae and Freddie Mac, generally will not purchase mortgages or mortgage-backed securities unless the MI on the mortgages has been issued by an insurer with a financial strength rating of at least “AA-” from S&P or Fitch or a rating of at least “Aa3” from Moody’s. See “Financial Strength Rating” above for a discussion of the impact of financial strength ratings on mortgage insurers.

 

The Real Estate Settlement and Procedures Act of 1974 (“RESPA”) applies to most residential mortgages insured by Triad, and related regulations provide that the provision of services involving mortgage insurance is a “settlement service” for purposes of loans subject to RESPA. Subject to limited exceptions, RESPA prohibits persons from accepting anything of value for referring real estate settlement services to any provider of such services. Although many states prohibit mortgage insurers from giving rebates, RESPA has been interpreted to cover many non-fee services as well.

 

Most originators of mortgage loans are required to collect and report data relating to a mortgage loan applicant’s race, nationality, gender, marital status and census tract to HUD or the Federal Reserve under the Home Mortgage Disclosure Act of 1975 (“HMDA”). The purpose of HMDA is to detect possible discrimination in home lending and, through disclosure, to discourage such discrimination. Mortgage insurers are not required pursuant to any law or regulation to report HMDA data, although under the laws of several states, mortgage insurers are currently prohibited from discriminating on the basis of certain classifications. All but one of the active mortgage insurers (including Triad), through their trade association, the Mortgage Insurance Companies of America (“MICA”), have entered into an agreement with the Federal Financial Institutions Examinations Council (“FFIEC”) to report the same data on loans submitted for insurance as is required for most mortgage lenders under HMDA.

 

Indirect Regulation

 

The Company, Triad, and Triad’s subsidiaries are also indirectly, but significantly, impacted by regulations affecting purchasers of mortgage loans, such as Fannie Mae and Freddie Mac, and regulations affecting governmental insurers, such as the FHA and the Department of Veterans Affairs (“VA”), as well as regulations affecting lenders. Private mortgage insurers, including Triad, are highly dependent upon federal housing legislation and other laws and regulations that affect the demand for MI and the housing market. FHA loan limits are adjusted in response to changes in the Freddie Mac/Fannie Mae conforming loan limits. Currently, the maximum single-family home mortgage that the FHA can insure is $362,790. However, recent legislation would increase the maximum loan amount that the FHA can insure to $729,750. This legislative change and any future legislation that increase the number of persons eligible for FHA or VA mortgages could have an adverse effect on Triad’s ability to compete with the FHA or VA.

 

Pursuant to the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”), the Office of Thrift Supervision (“OTS”) issued risk-based capital rules for savings institutions. These rules establish a lower capital requirement for a low down payment loan that is insured with MI, as opposed to an uninsured loan.

Furthermore, the guidelines for real estate lending policies applicable to savings institutions and commercial banks provide that such institutions should require appropriate credit enhancement in the form of either mortgage insurance or readily marketable collateral for any high LTV mortgage. Future changes, if any, to FIRREA’s risk-based capital rules or the guidelines for real estate lending policies applicable to savings institutions and commercial banks could affect demand for MI products.

 

In the first quarter of 2002, the Office of Federal Housing Enterprise Oversight (“OFHEO”) released its risk-based capital rules for Fannie Mae and Freddie Mac. 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 and a more preferential capital credit for insurance from a “AA” rated private mortgage insurer than for insurance from a “A” rated private mortgage insurer. The phase-in period for the new rule is ten years. We do not believe the new rules had an adverse impact on us when issued. If the new capital guidelines 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 credit rating, our financial condition could be significantly harmed.

 

Fannie Mae and Freddie Mac each provide their own automated underwriting system to be used by mortgage originators selling mortgages to them. These systems, which are provided by Triad as a service to the Company’s contract underwriting customers, streamline the mortgage process and reduce costs. The increased acceptance of these products is driving the automation of the process by which mortgage originators sell loans to Fannie Mae and Freddie Mac, a trend that is expected to continue. As a result, Fannie Mae and Freddie Mac could develop the capability to become the decision maker regarding selection of a private mortgage insurer for loans sold to them, a decision traditionally made by the mortgage originator. We, however, are not aware of any plans to do so. The concentration of purchasing power that would be attained if such development, in fact, occurred could adversely affect, from our perspective, the terms on which mortgage insurance is written on loans sold to Fannie Mae and Freddie Mac.

 

Additionally, proposals have been advanced which would allow Fannie Mae and Freddie Mac additional flexibility in determining the amount and nature of alternative recourse arrangements or other credit enhancements that could be utilized as substitutes for MI. We cannot predict if or when any of the foregoing legislation or proposals will be adopted, but if adopted, and depending upon the nature and extent of revisions made, demand for MI may be adversely affected. There can be no assurance that other federal laws affecting such institutions and entities will not change, or that new legislation or regulation will not be adopted.

 

In March, 2008 OFHEO announced that it was reducing the existing 30 percent OFHEO-directed capital requirement to a 20 percent level, and that it will consider further reductions in the future. The effect is to provide immediate liquidity to the mortgage-backed securities market. According to OFHEO, this should allow the GSEs to purchase or guarantee about $2 trillion in mortgages in 2008. The result of this change may assist the mortgage markets in regaining stability.

 

In 1996, the Office of the Comptroller of the Currency (“OCC”) granted permission to national banks to have a reinsurance company as a wholly-owned operating subsidiary for the purpose of reinsuring mortgage insurance written on loans originated, purchased, or serviced by such banks. Several subsequent applications by banks to offer reinsurance have been approved by the OCC including at least one request to engage in quota share reinsurance. The OTS, which regulates thrifts and savings institutions, has approved applications for such captive arrangements as well. The reinsurance subsidiaries of national banks or savings institutions could become significant competitors of ours in the future.

 

In November 1999, the Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act of 1999, became effective and allows holding companies of banks also to own a company that underwrites insurance. As a result of this Act, banking organizations that previously were not allowed to be affiliated with insurance companies may now do so. This legislation has had very little impact on us to date. However, the evolution of federal law making it easier for banks to engage in the mortgage guaranty business through affiliates may subject mortgage guaranty insurers to more intense competition and risk-sharing with bank lender customers in the future.

Available Information

 

Through our web site we make available, free of charge, our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports as soon as reasonably practicable after this material is electronically filed with or furnished to the SEC. This material may be accessed by visiting the Investors/Financials/SEC Filings section of our web site at www.triadguaranty.com. These filings are also accessible on the SEC’s website, www.sec.gov. You may read and copy any materials the Company files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at (800) 732-0330.

 

Employees

 

As of February 29, 2008, we employed approximately 270 persons. Employees are not covered by any collective bargaining agreement. We consider our employee relations to be satisfactory.

 

Executive Officers

 

Our executive officers are as follows:

 

 

Mark K. Tonnesen has been employed as our President, Chief Executive Officer, and a Director since September 2005. Previously, Mr. Tonnesen was employed by the Royal Bank of Canada, Toronto from April 1997 to September 2005, where he held a number of positions, including Vice Chairman and Chief Financial Officer, RBC Insurance and Executive Vice President, Card Services and Point of Sale. From 1987 to 1997, he was associated with Banc One Corporation, where he served in a variety of senior positions, including Chief Development Officer and President, Banc One Credit Card Services Company.

 

Gregory J. McKenzie has been employed as the President and Chief Executive Officer of our Canadian Subsidiary, Triad Guaranty Insurance Corporation Canada, since January 2007. Previously, Mr. McKenzie was the President of Post Linx, a subsidiary of Pitney Bowes Mail Services, Toronto, Canada from January 2004 to January 2007. Prior to that, Mr. McKenzie was the president of G. J. McKenzie and Associates, Toronto, Canada from September 2002 to December 2003 and was President and Chief Operating Officer of Metaca Corporation, Toronto, Canada, from February 1997 to August 2002.

 

Kenneth C. Foster has been employed as our Executive Vice President, Structured Transactions and Business Development of Triad since September 2006. Prior to his current position, Mr. Foster was the Senior Vice President, Structured Transactions and Business Development from August 2006 to September 2006 and the Senior Vice President, Risk Management from June 2002 to July 2006. Prior to joining Triad, Mr. Foster was a principal of Applied Mortgage Solutions from 1994 to 2001. Previously Mr. Foster was employed by Mortgage Guaranty Insurance Company from 1980 to 1994, most recently as Vice President of Business/Information Development. Mr. Foster has been associated with Triad for seven years and in the insurance/mortgage industry for over 30 years.

R. Bruce Van Fleet has been employed as our Executive Vice President, Sales and Marketing since March 2007. Previously, Mr. Van Fleet was employed by Radian Guaranty, Inc. from December 1995 to February 2007, where he held a number of senior management positions, including most recently serving as Executive Vice President, Chief Sales Officer since July 2006. Prior to July 2006, Mr. Van Fleet also served Radian Guaranty in various capacities in the sales function as the Executive Vice President, Strategic Accounts Channel and National Sales, and Senior Vice President, National Sales. Previously, Mr. Van Fleet was employed by Strategic Mortgage Services from August 1993 to November 1995 as the Senior Vice President, Corporate Sales.

 

Stephen J. Haferman has been employed as our Senior Vice President, Risk Management and Information Technology since March 2006. Mr. Haferman was previously with Cheryl and Company, Columbus, Ohio from February 2003 to March 2006, where he served as Senior Vice President, Chief Operating Officer. From June 2001 to January 2003, Mr. Haferman was employed by American Electric Power as Vice President, Marketing Information Management. From 1992 to 2001, he worked for Bank One Corporation in a number of divisions and a variety of senior management positions, including Senior Vice President, Direct Marketing for Bank One Retail; Senior Vice President, Technology Program Manager, Bank One Retail; and Vice President, Risk Department Manager. From 1988 to 1992, he worked for National City Bank where he was Risk Manager.

 

Kenneth W. Jones has been employed as our Senior Vice President and Chief Financial Officer since April 2006. Mr. Jones has over 25 years of experience in the financial management of companies. Prior to joining Triad, he was employed by RBC Liberty Insurance Corporation, where he served as Senior Vice President, Chief Financial Officer, from November 2000 to December 2005. Previously, Mr. Jones was associated with The Liberty Corporation, where he held a number of management positions, most recently Vice President, Controller and Acting Chief Financial Officer. Before joining The Liberty Corporation, Mr. Jones was with Ernst & Young LLP for 14 years.

 

Earl F. Wall has been Senior Vice President of Triad since November 1999, General Counsel of Triad since January 1996, and Secretary since June 1996. Mr. Wall was Vice President of Triad from 1996 until 1999. From 1982 to 1995, Mr. Wall was employed by Integon in a number of capacities including Vice President, Associate General Counsel, and Director of Integon Life Insurance Corporation and Georgia International Life Insurance Corporation, Vice President and General Counsel of Integon Mortgage Guaranty Insurance Corporation, and Vice President, General Counsel, and Director of Marketing One, Inc.

 

Officers of the Company serve at the discretion of the Board of Directors of the Company.

 

Our results could be affected by the risk factors discussed below. These factors may also cause our actual results to differ materially from the results contemplated by forward-looking statements made by us in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” or elsewhere. Investors should consider these factors carefully in reading this annual report on Form 10-K.

 

Risks Related to Capital, Rating Agencies and Regulatory Concerns

 

We believe our level of capital is inadequate to support our current ratings and to continue to satisfy applicable regulatory requirements. If our current ratings are downgraded or we violate regulatory requirements, absent the receipt of waivers from the GSEs and insurance regulators, we would not be able to write new insurance and would be limited to servicing our remaining book of business.

 

Our risk-to-capital ratio has risen dramatically over the past year, driven primarily by significant increases in our risk-in-force during the past 12 months and operating losses we incurred in the last two quarters of 2007. We believe the housing and mortgage markets in 2008 will continue to be adversely affected by a number of factors, including declining home prices, an oversupply of homes offered for sale and increased foreclosures, particularly in certain distressed markets. We expect we will incur additional operating losses as new defaults are reported. Based on our internal projections, we must significantly augment our capital resources in the second quarter of 2008 in order to preserve our ability to continue to write new insurance. Since the fourth quarter of 2007, we have been working with a prominent financial advisory firm to pursue alternatives for enhancing our capital. We have not yet

succeeded in obtaining any commitments for an investment in our company, and there can be no assurance that we will be able to obtain any such commitments in the future.

 

If we are unable to raise capital sufficient to address rating agency and regulatory requirements, we may suffer the following effects:

 

 

The proposals that have been considered involve structures under which Triad would implement a “run-off” plan and a newly formed mortgage insurer would acquire certain of Triad’s employees, infrastructure, sales force and insurance underwriting operations. In addition, we would cease writing new business. These proposals do not involve a direct investment in Triad. Completing any such transaction would be subject to numerous conditions, including obtaining necessary consents and approvals from our stockholders, the Illinois Department of Insurance and other state insurance regulatory authorities, the GSEs, rating agencies and other third parties. No assurance can be given that such consents and approvals could be obtained or that we can complete any such transaction. In addition, no assurance can be given that we would have any ownership interest in any new mortgage insurer formed to acquire assets of Triad or have any opportunity to share in the potential financial returns available from insurance written by such an insurer.

 

If we implement a run-off plan and our business is limited to servicing our remaining book of in-force insurance, we face additional regulatory and operating risks that could reduce or eliminate the market value of our common stock.

 

If our business is limited to running-off our remaining book of in-force insurance, we will be subject to numerous additional risks, including the following:

 

 

 

If further negative rating agency actions result in our inability to qualify as a Type 1 insurer under existing and proposed Fannie Mae guidelines, or as a Type I insurer under existing and proposed Freddie Mac guidelines, effectively we would be unable to write new business.

 

Fannie Mae and Freddie Mac have published guidelines that prescribe the requirements for a mortgage insurer to qualify as a Type 1 or Type I insurer, respectively (the highest levels recognized that enable the mortgage insurer to participate in all levels of activities). These guidelines provide that the mortgage insurer must be rated no lower than “AA-” by Fitch and S&P and “Aa3” by Moody’s. At December 31, 2007 Triad was rated “AA-” by both Fitch and S&P and “Aa3” by Moody’s, the lowest rating level allowed under published guidelines.

 

On February 14, 2008 Freddie Mac announced that it was suspending its Type II Insurer classifications, which are otherwise automatically applicable to mortgage insurers that are downgraded below “AA-” or “Aa3” by the rating agencies, provided the mortgage insurer commits to submitting a complete remediation plan within 90 days of the downgrade.

 

On February 26, 2008, Fannie Mae announced that in the event of a mortgage insurer credit downgrade by a rating agency below its eligibility thresholds, a current Type 1 insurer will not automatically be reclassified as a Type 2 insurer in the event of such a credit downgrade, provided that the mortgage insurer is in good standing with the agency’s requirements and submits a written remediation plan, together with supporting documentation, within 30 days of the adverse action.

 

Once a downgraded mortgage insurer submits a remediation plan, both Freddie Mac and Fannie Mae retain the right to determine, in their sole discretion, whether to accept such plan. If Triad were to be downgraded below “AA-” or “Aa3” by a rating agency, no assurance can be given that it would be in a position to take necessary corrective action or furnish an acceptable remediation plan, that the GSEs would approve any plan submitted or that Triad would maintain its status as a Type 1 or I insurer. As a result, lenders may limit the amount of mortgage insurance that they would place with Triad, which would significantly impair Triad’s ability to write new business and adversely affect its business and financial condition.

 

If our risk-to-capital ratio continues to increase, we could face adverse regulatory and rating agency action and be in violation of covenants in our credit agreements, which would adversely impact our ability to write new business.

 

At December 31, 2006, Triad’s risk-to-capital ratio was approximately 12.5-to-1. As a result of the growth in our risk in force coupled with our net loss in 2007, our risk-to-capital ratio grew to 20.5-to-1 at December 31, 2007. Most of the states that regulate us have general provisions that limit the risk-to-capital ratio to 25-to-1; however, some states have specific requirements depending on LTV and coverage percentages that may impose an even lower risk-to-capital ratio. Rating agencies generally utilize a risk-adjusted capital ratio that takes into consideration various portfolio characteristics; however, they monitor the overall risk-to-capital ratio as a general component of their overall ratings process. During the fourth quarter of 2007, the holding company contributed $50 million to

Triad, in part to ensure that the risk-to-capital ratio requirement of the holding company’s credit facility would be met. If we were to experience net losses for an extended period of time without an additional infusion of capital or a reduction in risk in force at the insurance company level, we could face negative regulatory and rating agency action that could limit or prevent Triad from writing new business.

 

If we fail to meet the various minimum required levels or maintain designated financial ratios detailed in the regulations of the states in which we write business, we could be declared to be in a hazardous financial condition, which could ultimately lead to restricting future business in those states.

 

Many states have separate safety and soundness regulations in addition to the risk-to-capital ratio. Some of these include minimum surplus levels, loss ratio and annual loss-to-surplus ratio, among others. Several states apply standard property and casualty benchmarks to our results that neglect to factor in the statutory contingency reserve, which is a part of our statutory capital. As a result of the September 30, 2007 statutory filings of Triad in which we had not yet released the contingency reserve back into surplus, several states sent inquiries to us requesting additional information and indicated that we could be placed in a hazardous condition status. This status designation means that our ability to write new business in those states may in the future be restricted or prohibited. If we are restricted or prohibited from writing future business in one or more states, lenders may not wish to continue to write business with us and our business, financial condition and results of operations may be adversely affected.

 

Changes in the business practices or legislation relating to Fannie Mae and Freddie Mac could significantly impact our business.

 

Fannie Mae and Freddie Mac are the beneficiaries of the majority of our policies, so their business practices have a significant influence on us. Changes in their practices could reduce the number of policies they purchase that are insured by us and, consequently, reduce our revenues. Some of Fannie Mae and Freddie Mac’s programs require less insurance coverage than they historically have required, and they have the ability to further reduce or eliminate coverage requirements, which would reduce demand for mortgage insurance and have a material adverse effect on our business, financial condition and operating results.

 

Fannie Mae and Freddie Mac also have the ability to implement new eligibility requirements for mortgage insurers and to alter or liberalize underwriting standards on low-down-payment mortgages they purchase, which thereby affect the quality of the risk and the availability of mortgage loans. Additionally, Fannie Mae and Freddie Mac can alter the terms on which mortgage insurance coverage can be canceled before reaching the cancellation thresholds established by law, and the circumstances in which mortgage servicers must perform activities intended to avoid or mitigate loss on insured mortgages that are delinquent.

 

Fannie Mae and Freddie Mac have both recently announced temporary changes to permitted captive reinsurance cede rates and their mortgage insurer requirements. Recent legislation has temporarily increased the maximum GSE loan limits up to $729,750 in certain markets. The Office of Federal Housing Oversight recently announced that it was removing portfolio growth caps on the GSEs’ retained mortgage portfolios. We cannot predict the extent to which these or any new requirements that may be enacted will affect the operations of our mortgage insurance business, our capital requirements and our products.

 

Legislation and regulatory changes, including changes impacting the GSEs, could significantly affect our business and could reduce demand for private mortgage insurance.

 

Mortgage origination transactions are subject to compliance with various federal and state consumer protection laws, including the Real Estate Settlement Procedures Act of 1974, or RESPA, the Equal Credit Opportunity Act, the Fair Housing Act, the Homeowners Protection Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act and others. Among other things, these laws prohibit payments for referrals of settlement service business, require fairness and non-discrimination in granting or facilitating the granting of credit, require cancellation of insurance and refunding of unearned premiums under certain circumstances, govern the circumstances under which companies may obtain and use consumer credit information, and define the manner in which companies may pursue collection activities. Changes in these laws or regulations could adversely affect our operations and profitability.

Congress is currently considering proposed legislation relating to the regulatory oversight of the GSEs, their affordable housing initiatives, the GSEs’ products and marketing activities, the GSEs’ minimum capital standards, and their risk-based capital requirements. If adopted in its present form, OFHEO would be replaced by a new federal agency, the Federal Housing Enterprise Regulatory Agency, and its director would be given significant authority over the GSEs including, among other things, oversight of the operations of the GSEs and their capital adequacy and internal controls and new program approval. The proposed legislation encompasses substantially all of the operations of the GSEs and is intended to be a comprehensive overhaul of the existing regulatory structure. The proposed legislation could limit the growth of the GSEs, which could result in a reduction in the size of the mortgage insurance market. We do not know what form any such legislation will take if it is enacted or its impact, if any, on our financial condition and results of operations.

 

Fannie Mae and Freddie Mac are subject to having their charters temporarily or permanently changed by their regulators. The recent housing turmoil has prompted a number of actions by the federal government to support the housing market in general as well as specifically supporting distressed borrowers. However, we have yet to see any meaningful impact on our operations resulting from federal government actions or proposals. However, we have yet to see any meaningful impact on our operations resulting from federal government actions or proposals.

 

In addition, recent increases in the maximum loan amount or other features of the FHA mortgage insurance program can reduce the demand for private mortgage insurance and we have already seen evidence that the FHA mortgage insurance program is much more competitive with private mortgage insurance. Future legislative and regulatory actions could decrease the demand for private mortgage insurance, which could harm our financial condition and results of operations.

 

Risks Related to Economic Conditions

 

If deteriorating economic conditions alter the frequency and severity patterns utilized in our estimates for reserves for losses, we may be required to take additional charges to results of operations.

 

We calculate our best estimate of the reserve for losses to provide for the estimated costs of settling claims on loans reported in default, and loans in default that are in the process of being reported to us, as of the date of our financial statements. Our reserving process incorporates various components in a model that gives effect to current economic conditions and segment defaults by a variety of criteria. The criteria include, among others, policy year, lender, geography and the number of months and number of times the policy has been in default, as well as whether the defaults were underwritten as flow business or as part of a Primary or structured bulk transaction.

 

Frequency and severity are the two most significant assumptions in the establishment of our loss reserves. Frequency is used to estimate the ultimate number of paid claims associated with the current defaulted loans. The frequency estimate assumes that historical experience, taking into consideration criteria such as those described in the preceding paragraph, and adjusted for current economic conditions that we believe will significantly impact the long-term loss development, provides a reasonable basis for forecasting the number of claims that will be paid. An important consideration in determining the frequency factor is the cure rate. In general, the cure rate is the percentage of reported defaults that ultimately are brought current (1) through payments of all past due payments or (2) by disposing of the property securing the mortgage before foreclosure with no claim ever filed because the proceeds of the sale satisfied the mortgage. During 2007, our cure rate declined from historical levels as home prices declined and the ability to dispose of the property through a sale before foreclosure diminished. If our assumptions regarding anticipated cure rates as well as other considerations used in the frequency factor vary from those actually experienced in the future, actual paid claims on the existing delinquent loans may exceed the reserves that we have established and require an additional charge to results of operations.

 

Severity is the estimate of the dollar amount per claim that will be paid. The severity factors are estimates of the percentage of the risk in default that will ultimately be paid. The severity factors used in setting loss reserves are based on an analysis of the severity rates of recently paid claims, applied to the risk in force of the loans currently in default. An important component in the establishment of the severity factor is the expected value of the underlying home for loans in default compared to the outstanding mortgage loan amount. If our assumptions regarding anticipated house price depreciation as well as other considerations used in the severity factor vary from those

actually experienced in the future, actual paid claims on the existing delinquent loans may exceed the reserves that we have established and require an additional charge to results of operations.

 

The frequency and severity factors are updated quarterly to respond to the most recent data. The estimation of loss reserves requires assumptions as to future events, and there are inherent risks and uncertainties involved in making these assumptions. Economic conditions that have affected the development of loss reserves in the past may not necessarily affect development patterns in the future in either a similar manner or degree. To the extent that possible future adverse economic conditions such as declining cure rates or declining housing prices alter those historical frequency and severity patterns, actual paid claims on the existing delinquent loans may be greater than the reserves that we have provided and require a charge to results of operations.

 

Consistent with industry practice, we provide reserves only for loans in default that have been reported to us rather than on our estimate of the ultimate loss. As such, our results of operations in certain periods could be disproportionately affected by the timing of reported defaults.

 

Reserves are provided for the estimated ultimate costs of settling claims on both loans reported in default and loans in default that are in the process of being reported to us. Generally accepted accounting principles preclude us from establishing loss reserves for future claims on insured loans that are not currently in default. We generally do not establish reserves until we are notified that a borrower has failed to make at least two payments when due. During 2007, the loans in default for which we provide reserves grew 91% to 12,749 at December 31, 2007. A prolonged deterioration of general economic conditions such as increasing unemployment rates or declining housing prices could adversely alter the historical delinquency patterns, resulting in an even larger percentage increase in the level of loans in default than experienced in 2007. An increase in the number of loans in default would require additional reserves and a charge to results of operations as they are reported to us.

 

During 2007 the United States housing market experienced a significant amount of home price depreciation, which had a direct negative impact on our loss reserves and paid claims during 2007. If home prices continue to decline on a more significant and larger geographic basis than experienced in 2007, we may incur a higher level of losses from paid claims and also be required to increase our loss reserves.

 

A component of our mitigation efforts on mortgage insurance claims is our option of paying the coverage percentage in full satisfaction of our obligations under the policy (full payment option) or paying off the entire loan amount and taking title to the mortgaged property underlying a defaulted loan (purchase option). The critical assumption behind the purchase option is that the property has appreciated in value since the loan was originated and that we will be able to recover some portion of amount at risk, through the acquisition and subsequent sale of the property. The purchase option proved successful during most of 2006 in mitigating losses, but was less successful in 2007. The S&P/Case-Shiller^© Home Price Index for the 20-City Composite as of December 2007 indicated an annual 9.1% decline in home prices from one year ago, the largest annual decline since the index was first published. There were declines in every city comprising the index during the last several months of 2007, indicating that home price depreciation is not limited to several areas or locations in the United States. The assumptions utilized in our reserve methodology have factored in a certain amount of loss mitigation resulting from the utilization of the purchase option. If housing values fail to appreciate or decline on a more significant and larger geographic basis, the frequency of loans going into default and eventually to a paid claim could increase and our ability to mitigate our losses on defaulted mortgages may be further reduced, which could have a material adverse effect on our business, financial condition and operating results.

 

Because a significant portion of our business is sensitive to interest rates, a large increase in rates would cause higher monthly mortgage payments for borrowers that could potentially lead to a greater number of defaults, which would adversely impact our business.

 

At December 31, 2007, approximately 35% of our Primary risk in force and approximately 74% of our Modified Pool risk in force was comprised of adjustable-rate mortgage loans or ARMs. Monthly payments on these loans are altered periodically through an adjustment of the interest rate. Many ARMs have a fixed interest rate for a stated period of time, and accordingly, have not yet been subject to an interest rate adjustment. In periods of rising interest rates, a borrower’s monthly payment will increase. A large increase in interest rates over a short period of time could lead to “payment shocks” for borrowers that could potentially lead to more reported defaults.

At December 31, 2007, approximately 13% of both our Primary risk in force and our Modified Pool risk in force is comprised of pay option ARMs with the potential for negative amortization on the loan. These loans provide borrowers the option, for a stated period of time, to make monthly payments that do not cover the interest due on the loan. If the borrower chooses this payment option, the unpaid interest is added to the outstanding loan amount, which creates negative amortization. These pay option ARM loans may have a heightened propensity to default because of possible “payment shocks” after the initial low-payment period expires and because the borrower does not automatically build equity through loan amortization as payments are made. We already have experienced a higher default rate on pay option ARMs than the remainder of our portfolio, even before many of these loans are scheduled to shift to amortizing payments. The risk of default may be further increased if the interest rate paid during the payment option period is significantly below current market rates. Additionally, the lack of long-term historical performance data associated with pay option ARMs across all market conditions makes it difficult to project performance and could increase the volatility of the estimates used in our reserve models. If interest rates increase and cause “payment shocks” to borrowers with ARMs, our default rate could increase, which could have a material adverse impact on our business, financial condition and operating results.

 

Geographic concentration of our risk in force in certain distressed markets has resulted in increased defaults and higher risk in default from the significantly larger loans in these states. Ongoing house price depreciation in these distressed markets could lead to further increases in reserves and paid claims ,which could further significantly impact negatively our financial performance.

 

At December 31, 2007, our risk in force for California, Florida, Arizona and Nevada, which we classify as “distressed markets,” represented approximately 32% of our total risk in force on a per policy basis. These distressed markets have experienced some of the most rapid home price depreciation in 2007 and disruption in the housing markets when compared to the rest of the country. These distressed markets represent 32% of our total risk in force at December 31, 2007. Moreover, they represented 47% of both our risk in default and our loss reserves. The default rate at December 31, 2007 in these distressed markets amounted to 5.7% compared to 3.5% for the remainder of our portfolio. If the housing markets continue to decline at a steep rate or for an extended period of time in these distressed markets, we could experience additional adverse effects on our operating results and financial condition due to the large concentration of our business in these distressed markets.

 

We experienced a significant increase in reported defaults and paid claims during 2007. If the pace of declining home prices and ongoing credit problems in the mortgage marketplace continues or remains unsettled, we anticipate an increased number of defaults and paid claims, which would have a negative impact on our results of operations.

 

Beginning in 2006 and accelerating in 2007, home prices in most geographic areas declined. Additionally, after several years of relaxed credit standards, lenders have generally tightened their credit guidelines. Many borrowers that had qualified for mortgages under less restrictive credit standards have found it difficult to meet their ongoing mortgage payments. Faced with declining home values and a tight market for credit, these borrowers often are unable to refinance or sell their homes. Resulting borrower defaults have contributed to our 91% increase in defaults during 2007. The default rates on the 2006 and early 2007 vintage years, which contain increased risk factors such as Alt-A and pay option ARMs, especially in the distressed market states of California, Florida, Arizona and Nevada, have been particularly high. These factors contributed significantly to the substantial increase in our reserves during the year and, if they continue, are expected to result in additional and significant increases in our reserves in the future.

 

The inability of borrowers to sell their homes or refinance their mortgages in the current environment has resulted in a greater percentage of defaulted loans becoming claims by lenders against mortgage insurers. As a result, we have lowered our assumptions regarding the cure rates for the purpose of our reserve models, which in turn has increased our frequency factor. The increase in the frequency factor was a significant reason for the increase in our reserves during the third quarter. If the factors described above continue, we expect further increases in actual defaults, further increases in our frequency factor and corresponding increases in our reserves that would significantly and adversely affect our results of operations.

 

If the facts and estimates underlying the assumptions that we utilized at December 31, 2007, to determine both if a premium deficiency reserve is necessary or to ensure that the DAC is recoverable against future

profits change, we will need to adjust those assumptions in the future, which could result in the impairment of part or all of the DAC asset and require the establishment of a premium deficiency reserve, which would have a significant immediate adverse impact on results of operations.

 

The methodology used to assess whether a premium deficiency reserve is necessary or whether DAC is recoverable against future profits is essentially the same. We use a model that projects anticipated premiums, paid losses, and maintenance costs over the expected remaining life of the existing insurance in force portfolio to estimate the remaining net cash flow from the portfolio. To the extent the net cash flows plus recorded net reserves are positive there is no need for a premium deficiency reserve. Our assessment is performed on the entire in force portfolio as a whole based upon the homogenous performance of the various components of the portfolio to date. At December 31, 2007, our assessment indicated that no premium deficiency reserve was necessary and that DAC was recoverable against future profits.

 

The most significant assumptions that we make in this assessment are the persistency of the premium stream and the timing and severity of the paid losses. Each quarter, we will assess the need for a premium deficiency reserve on the remaining insurance in force. We will monitor the development of premiums, losses and expenses compared to our previous estimates and consider any variance from our prior estimates in making assumptions as to future results. Changes to any of these assumptions could have an effect on the determination of whether DAC is recoverable or a premium deficiency reserve needs to be recorded.

 

If the existing in force portfolio exhibits a significant amount of performance differentiation among the various products, we may need to segment the adversely performing product(s) in future periods for our assessment if a premium deficiency reserve is required. The breakout of adversely performing product(s) of the existing insurance in force would likely result in the need for a premium deficiency reserve on those product(s), which could have a significant immediate adverse impact on results of operations.

 

If we have an extended period of low mortgage interest rates, it could lead to increased refinancings that would have a negative impact on persistency, which could lead to reduced insurance in force and ultimately to reduced revenues.

 

Interest rates have been falling over the past several months and are widely expected to continue to fall and borrowers may take the opportunity to refinance their existing mortgages to receive a lower interest rate. Additionally, an extended period of low interest rates presents borrowers with an ARM product the opportunity to refinance to a fixed rate product. When borrowers refinance, our coverage terminates and we may or may not provide coverage on the refinanced loan, depending on many factors. An extended period of low mortgage interest rates could lead to increased refinancings, which would have a negative impact on persistency and could result in decreased revenues due to a reduction of insurance in force.

 

Risks Related to Products

 

The premiums we charge for mortgage insurance on non-prime loans, pay option ARMs and Alt-A loans may not be adequate to compensate for future losses from these products, especially under distressed conditions.

 

Over the past several years, the percentage of non-prime loans, pay option ARMs and Alt-A loans in our portfolio has grown significantly. On these non-prime loans, pay option ARMs and Alt-A loans, we charge an increased premium over prime, fixed rate and fully documented loans. The credit quality, loss development and persistency on these loans can vary significantly from our traditional prime loan business. For example, at December 31, 2007, the delinquency rate on the pay option ARMs was 6.4% compared to the entire portfolio (excluding pay option ARMs) of 3.8%. Additionally, the Alt-A loan portfolio at year end had a 7.2% delinquency rate compared to 3.1% for the remainder of our portfolio. We expect that we will continue to experience higher default rates for non-prime loans, Alt-A loans and pay option ARMs than for our prime fixed rate loans. Long-term historical performance data associated with non-prime loans, pay option ARMs and Alt-A loans across all market conditions, especially in the distressed markets, does not exist. We cannot be sure that the increased premiums that we apply to non-prime, pay option ARMs and Alt-A loans will adequately offset the associated risk, increased defaults and potentially larger amounts of claims, which could adversely impact our operating results.

A growing portion of our insurance in force consists of loans with high loan-to-value ratios, which could result in a greater number of defaults and larger claims than loans with lower loan-to-value ratios during periods of declining home prices.

 

At December 31, 2007, approximately 17% of our mortgage insurance in force consisted of insurance on mortgage loans with LTVs at origination greater than 95%. In periods of declining home prices, these loans have a greater propensity to default due to the limited equity investment of the borrower. Loans with greater than 95% LTV at origination have experienced a significantly greater default rate than lower LTVs as of December 31, 2007. Many of the high LTV loans also contain other risk factors such as geographic location in distressed markets and were originated with reduced documentation. Faced with mortgages that are greater than the value of the home, a number of borrowers are simply abandoning the property and walking away from the mortgage, without regard to their ability to pay. This limits the ability of the servicer to work with the borrowers to avoid defaults and foreclosure and increases the imbalance of the housing inventory for sale, which in turn further depresses home prices. If we are required to pay a claim on a high LTV loan, our loss mitigation opportunities are limited during periods of declining home prices and we generally are required to pay the full option payment, which is the highest amount that we could pay under our contracts with lenders. If we experience an increased default rate and paid claims on high LTV loans, our results of operations could be adversely affected.

 

Risks Related to Operations

 

Although we were successful in reducing our concentrations during 2007, our business remains concentrated among relatively few major lenders and our operating results could decline if we lose a significant customer.

 

Our mortgage originations continue to be concentrated within the Top 10 originators, which accounted for approximately 73% of our total originations during 2007 compared to approximately 80% in 2006. Our business remains dependent on a relatively small number of customers. Additionally, our top three lenders were responsible for approximately 54% of our Primary flow new insurance written during 2007 compared to approximately 65% in 2006. Further, one of the top three lenders representing over 20% of our flow NIW in 2007 filed for bankruptcy protection and is not currently originating any new loans. This concentration of business could increase as a result of announced consolidation in the lending industry or other factors. The loss of business from one or more of our major lenders in addition to the pending bankruptcy of a significant customer could have an adverse effect on our business, financial condition and operating results.

 

Our revenues and profits could decline if we lose market share as a result of industry competition or if our competitive position suffers as a result of our inability to introduce and successfully market new products and programs.

 

There are seven main mortgage insurance providers, of which we are the smallest. The mortgage insurance industry is highly dynamic and intensely competitive. The other private mortgage insurance providers are Mortgage Guaranty Insurance Corporation, Radian Guaranty Inc., PMI Mortgage Insurance Company, Genworth Financial Mortgage Insurance Company, United Guaranty Residential Insurance Company, and Republic Mortgage Insurance Company. All of these competitors are better capitalized than Triad and have lower risk-to-capital ratios. Two of these are subsidiaries of well-capitalized companies with stronger insurance financial strength ratings and greater access to capital than we have.

 

If we are unable to compete successfully against other private mortgage insurers, or if we experience delays in introducing competitive new products and programs or if these products or programs are less profitable than our existing products and programs, our production will suffer, which could ultimately lead to reduced revenue.

 

Because we generally cannot cancel mortgage insurance policies or adjust renewal premiums due to changing economic conditions, unanticipated defaults and claims could cause our financial performance to suffer significantly.

 

We generally cannot cancel the mortgage insurance coverage that we provide or adjust renewal premiums during the life of a mortgage insurance policy, even as economic factors change. As a result, the impact of unanticipated changes, such as the dramatic decline in home prices resulting in increased defaults and claims like those experienced in 2007, generally cannot be offset by premium increases on policies in force or cancellation of

insurance coverage. The premiums we charge may not be adequate to compensate us for the risks and costs associated with the insurance coverage provided to our customers, especially in distressed financial markets. An increase in the number or size of unanticipated defaults and claims could adversely affect our financial condition and operating results because we could not cancel existing policies or increase renewal premiums.

 

Our loss experience is likely to increase as our policies continue to age.

 

Historically, we expect the majority of claims on insured loans in our current portfolio to occur during the second through the fifth years after loan origination. However, during 2007 we experienced an earlier default and claim pattern, with 60% of our risk in default at December 31, 2007 coming from the 2006 and 2007 vintage years. While we have experienced an earlier default rate among our most recent vintages, we are still experiencing the normal seasoning on our older vintage years that are now in the peak default and claim paying period. Total insurance written from the period of January 1, 2003 through December 31, 2006 (vintage years within the historical highest default and claim paying period) represented 62% of our risk in force as of December 31, 2007. Accordingly, a significant majority of our portfolio is in, or approaching, its peak claim years. We believe our loss experience is likely to increase as our policies age. If the claim frequency on our risk in force significantly exceeds the claim frequency that was assumed in setting our premium rates, our financial condition and results of operations could be adversely affected.

 

Our revenues and DAC amortization depend on the renewal of policies that may terminate or fail to renew with Triad.

 

The large majority of our premiums each month are derived from the monthly renewal of policies that we previously have written. Factors that could cause an increase in non-renewals of our policies include falling mortgage interest rates (which tend to lead to increased refinancings and associated cancellations of mortgage insurance), appreciating home values, which can lead to more refinances and mortgage insurance cancellations, and changes in the mortgage insurance cancellation requirements applicable to mortgage lenders and homeowners. During 2007, persistency increased to near record levels as home prices declined and borrowers found it increasingly difficult to refinance or sell their existing homes due to the illiquidity in the marketplace, which had a positive impact on earned premiums. In addition to the impact on earned premiums, the amount of DAC amortization expense would be adversely impacted if policies terminate at a rate faster than was originally estimated in our DAC models. A decrease in the length of time that our mortgage insurance policies remain in force reduces our revenues and could have an adverse effect on our business, financial condition and operating results.

 

Our delegated underwriting program may subject our mortgage insurance business to unanticipated claims.

 

A significant percentage of our new insurance written is underwritten pursuant to a delegated underwriting program. These programs permit certain mortgage lenders to determine whether mortgage loans meet our program guidelines and enable these lenders to commit us to issue mortgage insurance. We may expand the availability of delegated underwriting to additional customers. If an approved lender commits us to insure a mortgage loan, we may refuse to insure, or we may rescind coverage on that loan if the lender fails to follow our delegated underwriting guidelines. Even if we terminate a lender’s underwriting authority, we generally remain at risk for any loans previously insured on our behalf by the lender before that termination, absent fraud or other similar circumstances. The performance of loans insured through programs of delegated underwriting has not been tested over a period of extended adverse economic conditions, meaning that the program could lead to greater losses than we anticipate. If losses are significantly greater than anticipated, our delegated underwriting program could have a material adverse effect on our business, financial condition and operating results.

 

If we fail to properly underwrite mortgage loans when we provide contract underwriting services, we may be required to provide monetary and other remedies to the customer.

 

Under the terms of our contract underwriting agreements with certain lenders, we agree to indemnify the lender against losses incurred in the event that we make material errors in determining whether loans processed by our contract underwriters meet specified underwriting or purchase criteria, subject to contractual limitations on liability. As a part of the contract underwriting services, we provide monetary and other remedies to our customers in the event that we fail to properly underwrite a mortgage loan. As a result, we assume credit and interest rate risk in connection with our contract underwriting services. Worsening economic conditions, a deterioration in the quality

of our underwriting services or other factors could cause our contract underwriting liabilities to increase and have an adverse effect on our financial condition and results of operations. Although we have established a reserve to provide for potential claims in connection with our contract underwriting services, we have limited historical experience that we can use to establish reserves for these potential liabilities, and these reserves may not be adequate to cover liabilities that may arise.

 

If the operating subsidiary, Triad, is prohibited from making interest payments on its $25 million surplus note to the holding company, then the holding company could be unable to make the required interest payments on its $35 million long-term debt outstanding.

 

Terms of the $25 million surplus note at Triad, the main operating subsidiary, restrict the accrual or payment of interest if the statutory surplus immediately before the scheduled interest payment is due falls below the level of the statutory surplus at origination of this loan. Statutory surplus is increased when the statutory contingency reserve is released under applicable regulations. In our September 30, 2007 statutory filings, we had not yet released the contingency reserve allowed to us due to the significant increase in our loss ratio. We released the contingency reserve in the December 31, 2007 statutory filings, which resulted in sufficient surplus that allowed for the accrual and payment of the interest on the $25 million surplus note. In addition to exceeding the required level of surplus, we must obtain approval to pay interest from our primary regulator, the Department of Insurance for the State of Illinois. If we are unable to obtain the approval from our primary regulator for the payment of interest on the surplus note or if we are unable to meet the required statutory surplus levels, then the holding company would only be able to meet its debt service requirements from its existing capital for a limited period of time and this could cause it to default on its existing long-term debt.

 

If many of our lender partners for which we have entered into risk-sharing agreements, such as captive reinsurance treaties, continue under financial stress for an extended period of time, then the ability of these lenders to meet their financial obligations under the captive reinsurance treaties may be limited to the trust balances maintained within the reinsurance structures, which could have an adverse impact on future results of operations.

 

Two of the 22 lenders for which we had established captive reinsurance programs are in bankruptcy, while several others are under financial duress. An integral component of the reinsurance treaties include trust balances, which remain under our control, to support a portion of the risk assumed by the reinsurer. As defaults increase and we reach the point where the attachment point is exceeded for individual vintage years, we cede reserves to the captive. When reserves are initially ceded to the captive, the requirement for additional trust balances generally increases. When the need for additional trust balances cannot be met through ceded reinsurance premiums, then additional capital contributions would be required by the lender. The ability of the lenders that are currently under financial duress to meet their future financial obligations under the captive reinsurance agreements beyond the trust balances may be limited, which could have an adverse impact on future results of operations. If for any reason a lender is unable to fund its reinsurance obligations, Triad would remain obligated to pay the claims, which would increase our losses.

 

If we are unsuccessful in our litigation with a bankrupt former lender over our ability to rescind or deny coverage for certain loans due to program violations or fraud, this could have an adverse impact on future results of operations.

 

We have been sued related to our rescission of or denial of coverage for loans originated by a bankrupt lender. The plaintiffs are debtors and debtors in possession in Chapter 11 cases pending in the U.S. Bankruptcy Court. The lawsuit is an action for breach of contract and declaratory judgment. The basis for the complaint’s breach of contract action is the cancellation by us of our certification of the bankrupt lender’s coverage on 14 loans due to irregularities that we uncovered following the submission of claims for payment and that existed when the bankrupt lender originated the loans. The complaint alleges that our actions caused the bankrupt lender to suffer a combined net loss of not less than approximately $1.1 million and seeks monetary damages and a declaratory judgment. We have identified additional program violations or instances of suspected fraud; however, we have not rescinded or denied coverage for additional loans since the lawsuit was filed as we attempt to research and clarify all of the facts. We expect to rescind or deny coverage for additional loans originated by the bankrupt lender and we intend to contest

the lawsuit vigorously. If we are unsuccessful in our litigation and we are prohibited from rescinding or denying coverage due to program violations or fraud, it could have a significant adverse impact on our future results.

 

If the financial strength ratings of the financial guarantors that enhance a significant portion of our investment portfolio are lowered, that could limit the ability to sell affected bonds and could be indicative of a permanent impairment, which could have an adverse impact on our future results of operations.

 

At December 31, 2007, approximately 77% of our municipal bond portfolio contained credit enhancements through financial guaranty companies resulting in an overall “AAA” rated portfolio. Most of the financial guaranty companies have recently come under significant financial pressure. A downgrade of the financial guaranty company would have the impact of lowering the rating of the individual municipal bonds in our portfolio. These lower rated bonds may be less attractive in the marketplace and their market value could be materially diminished. Additionally, our ability to sell the lower rated bonds, if necessary, at a price that recoups our cost could also be lessened. Further, if we determine that the bond has been other than temporarily impaired, we will be required to write it down and charge our results of operations.

 

If the lenders are unwilling or unable to continue our relationship going forward due to recent guideline changes and limitations imposed by us during the fourth quarter of 2007, then our future production could suffer and it could have a negative impact on future revenue and results of operations.

 

As part of our new underwriting guidelines instituted in the fourth quarter of 2007, we have limited the production of certain lenders from both a geographic and product standpoint. In some cases, our guidelines could no longer support all of the products offered by various lenders. Many lenders utilize allocation percentages to different mortgage insurers to avoid concentrations and adjust these allocations from time to time. If we are unable to support specific products offered by the lender, then we are at risk that our allocation could be lowered or eliminated completely. If the lenders are unwilling or unable to continue our relationship going forward, then our production and future operating results could suffer.

 

If we cannot reduce operating costs to meet the anticipated reduced production and in force amounts, then we may be unable to compete effectively with other mortgage insurers.

 

Our underwriting guideline changes reduced production in the fourth quarter of 2007 and early 2008. Although persistency remained near all-time high levels during 2007, a prolonged decline in production would eventually result in a lower insurance in force. The cost structure in place for the Company at December 31, 2007 was established with expectations of ongoing growth and increased production. Since year-end, we have reduced our sales staff as well as closed most of our underwriting offices. If we are unable to match our reductions in operating costs in a manner that would result in an expense ratio at or below that experienced in 2007, then we may not be competitive with other mortgage insurers.

 

Loan servicers have recently experienced a significant increase in their workload due to the rapid growth in defaults and foreclosures. If the loan servicer fails to act proactively with delinquent borrowers in an effort to avoid foreclosure, then the number of delinquent loans eventually going to claim status could increase.

 

The loan servicer maintains the primary contact with the borrowers throughout the life of the loan and we can become involved with any potential loss mitigation only with permission from the servicer. During periods of declining home prices and increased delinquencies, such as that currently being experienced in the mortgage business, it is important to us that the servicer be proactive in dealing with borrowers rather than simply allowing the loan to go to foreclosure. Historically, when a servicer becomes involved at an earlier stage of delinquency with workout programs and credit counseling, there is a greater likelihood that the loan will not go to foreclosure and we will not be forced to pay a claim. During periods of increased delinquencies, it becomes extremely important that the servicer be properly staffed and trained to assist borrowers to avoid foreclosure. From our perspective, it is also extremely important to involve us as part of the loss mitigation effort as early as possible. If some of the loan servicers do not properly staff and train their personnel or enlist our assistance in loss mitigation efforts, then the number of loans going to foreclosure may increase, resulting in a greater number of claims and/or a larger amount that we are required to pay, which will have an adverse impact on our future operating results.

If we fail to obtain additional capital resources or if losses continue for an extended period of time and the outlook for mortgage insurers remains uncertain, then we may be unable to retain key personnel from moving to other industries that may appear to offer a more promising outlook.

 

We have taken actions to reduce underwriting offices and personnel in response to the turbulent state of the current mortgage marketplace and our significant operating losses during 2007. Recent capital enhancement efforts have introduced some level of uncertainty among employees. Additionally, the outlook for mortgage insurers remains uncertain, and we may be unable to retain key personnel from moving to other industries that may offer better short-term opportunities and a more promising outlook. The loss of any key personnel could limit our ability to execute key strategic plans, including enhancement of our capital resources.

 

 

None.

 

 

The Company’s principal executive offices are located at 101 South Stratford Road, Winston-Salem, NC 27104. This five-story office building totals 79,254 square feet and the Company currently leases approximately 66,200 square feet under a lease that will expire in 2012. A majority of staff functions are located within this office complex.

 

The Company leases office space for its eight underwriting offices located throughout the country under leases expiring between 2008 and 2009, as well as office space in Toronto, Canada for its Canadian operations under a lease expiring in 2009. In the fourth quarter of 2007, the Company suspended its expansion efforts in Canada and in the first quarter of 2008, the Company took steps to close four of its underwriting offices, with corresponding reductions to its sales staff. The Company is seeking a purchaser for its Canadian operations and is pursuing subleases for all underwriting offices that were closed.

 

With respect to all remaining facilities, the Company either has renewal options or believes it will be able to obtain lease renewals on satisfactory terms. The Company believes its remaining existing properties are well utilized and are suitable and adequate for its present circumstances.

 

The Company maintains mid-range and micro-computer systems from its corporate data center located in its headquarters building to support its data processing requirements for accounting, policy administration, claims, marketing, risk management, and underwriting. The Company has in place back-up procedures in the event of emergency situations.

 

 

The Company is involved in litigation in the ordinary course of business including the named case below. No pending litigation is expected to have a material adverse affect on the financial position of the Company.

 

On November 5, 2007, American Home Mortgage Investment Corp. and American Home Mortgage Servicing, Inc. filed a complaint against Triad Guaranty Insurance Corp. in the U.S. Bankruptcy Court for the District of Delaware. The plaintiffs are debtors and debtors in possession in Chapter 11 cases pending in the U.S. Bankruptcy Court. The lawsuit is an action for breach of contract and declaratory judgment. The basis for the complaint’s breach of contract action is the cancellation by us of our certification of American Home Mortgage’s coverage on 14 loans due to irregularities that we uncovered following the submission of claims for payment and that existed when American Home Mortgage originated the loans. The complaint alleges that our actions caused American Home Mortgage to suffer a combined net loss of not less than $1,132,105.51 and seeks monetary damages and a declaratory judgment. We expect to rescind or deny coverage for additional loans originated by American Home Mortgage and we intend to contest the lawsuit vigorously.

 

 

None.

 

Item 5.  Market for Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Market information

 

The Company’s common stock trades on The NASDAQ Global Select Market^® under the symbol “TGIC.” At December 31, 2007, 14,920,243 shares were issued and outstanding. The following table sets forth the high and low sales prices of the Company’s common stock as reported by NASDAQ during the periods indicated.

 

 

Holders

 

As of February 29, 2008, the number of stockholders of record of the Company’s common stock was approximately 313. In addition, there were an estimated 5,700 beneficial owners of shares held by brokers and fiduciaries.

 

Dividends

 

Payments of future dividends are subject to declaration by the Company’s Board of Directors. The dividend policy is dependent on the ability of Triad to pay dividends to the parent company and is also restricted by covenants contained in the credit agreement. Currently, there are no intentions to pay dividends. See “Liquidity and Capital Resources” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a more detailed discussion of dividend payment restrictions.

 

Issuer purchases of equity securities and unregistered sales of equity securities

 

None.

 

 

 

 

 

The following discussion is intended to provide information that the Company believes is relevant to an assessment and understanding of the Company’s consolidated financial position, results of operations and cash flows and should be read in conjunction with the Consolidated Financial Statements and Notes contained herein. In addition, the current negative market conditions in the home mortgage and residential housing markets are unprecedented from an historical standpoint and have subjected our business, financial condition and results of operations to substantial risks, many of which are summarized under “Risk Factors” above, which should be read in conjunction with the following discussion.

 

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 factors described in the “Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995” section below with respect to forward-looking statements contained herein.

 

Overview

 

Through our U.S. 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 when we are in the first loss position and the LTV is 80% or greater when the loan is first insured. We classify all other insurance as Modified Pool. The majority of our Primary insurance 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 have also historically provided mortgage insurance to lenders and investors who seek additional default protection (typically secondary coverage or on loans for which the individual borrower has greater than 20% equity), capital relief, and credit-enhancement on groups of loans that are sold in the secondary market. These transactions are referred to as our structured bulk channel business. Those individual loans in the structured bulk channel in which we are in the first loss position and the LTV ratio is greater than 80% are classified as Primary. All of our Modified Pool insurance is delivered through the structured bulk channel. We do not expect any significant production of Modified Pool or Primary bulk business from the structured bulk channel in 2008. Our Canadian subsidiary was formed in 2007 for the express purpose of exploring the opportunities of providing mortgage insurance in Canada, but did not write any business and only had start up expenses in 2007. We suspended our Canadian expansion efforts in the fourth quarter of 2007 and we do not expect to write any business through our Canadian subsidiary.

 

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, (e) interest expense on long-term debt and line of credit, and (f) 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.

Persistency is an important metric in understanding our premium revenue. The longer a policy remains on our books, or “persists”, the greater the amount of revenue that we will derive from the policy from renewal premiums. We define persistency as the amount of insurance in force at the 12-month end of a financial reporting period as a percentage of the amount of insurance in force at the beginning of the period. Cancellations of policies originated during the past twelve months are not considered in our calculation of persistency. This method of calculating persistency may vary from that of other mortgage insurers. We believe that our calculation presents an accurate measure of the percentage of insurance in force remaining at the end of the 12-month measurement period. Cancellations result primarily from the borrower refinancing or selling insured mortgaged residential properties and, to a lesser degree, from the borrower achieving prescribed equity levels, at which point the lender no longer requires mortgage guaranty insurance.

 

Consolidated Results of Operations

 

Following is selected financial information for the last three years:

 

 

A substantial increase in the reserve for losses and LAE in 2007 was primarily responsible for our net loss for 2007. The increase in the reserves was directly related to the growth in the number of reported loans in default as well as an increase in the frequency and severity factors utilized in the reserve model. Additionally, the changing characteristics of the loans entering the default pool, with new defaults having substantially higher average risk per loan than a year ago, has contributed to the increase in reserves. These factors have been especially evident in (i) distressed markets (California, Florida, Arizona and Nevada), (ii) the development of the 2006 and 2007 books of business, (iii) our Primary bulk business written in 2007, which is showing a significant amount of early payment defaults and has a significant amount of high LTV loans, and (iv) our recent Modified Pool business, which also has exhibited a significant amount of early payment defaults. At December 31, 2007 distressed markets accounted for 32% of the total risk in force but represented 47% of both the risk in default and reserves. At December 31, 2006, distressed markets accounted for 31% of the total risk in force, but represented only 18% of the risk in default and 14% of reserves. These distressed markets contributed $156 million, or 57%, of the total reserve increase experienced in 2007, compared to $8 million, or 24%, of the total reserve increase experienced in 2006.

 

Net losses and LAE for the year ended December 31, 2007 increased $278.7 million compared to the year ended December 31, 2006. Loss and LAE reserves increased by $276 million during the year, driven by a 91% increase in the number of loans in default for which we provide a reserve and a 48% increase in the average risk in default on those loans. In addition to the substantial increase in reserves, there was also strong growth of paid losses in both total dollars and the average paid loss severity. Paid losses of $100.6 million for 2007 were up $41.6 million, or 70%, as compared to 2006. Average paid loss severity was $44,800 as of December 31, 2007, compared to $27,900 as of December 31, 2006. The increase in average paid severity is primarily the result of a higher percentage of claims from the more recent vintage years, which reflect larger loan balances, and a decline in our ability to mitigate losses.

 

Earned premiums for 2007 grew significantly when compared to 2006, principally due to growth in Primary insurance in force. Total insurance in force grew by $11.4 billion, or 20.1%, as a result of total NIW of $2.7 billion and a total annual persistency rate of 81.9%.

Other operating expenses for 2007 increased over 2006 due to organizational changes and staff additions to support our growth and strategic initiatives, including expenses associated with entering the Canadian market. We incurred approximately $3.3 million of expenses in 2007 relating to our start-up operations in Canada.

 

The change in diluted (loss) earnings per share for 2007 from 2006 was consistent with the change in our operating results. The denominator used in calculating diluted loss per share for 2007 shown above excludes exercise of options and unvested restricted stock, which is required when a loss from operations is being reported or the result would otherwise be antidilutive. Realized investment gains (losses), net of taxes, decreased diluted loss per share in 2007 by $0.13, increased diluted earnings per share in 2006 by $0.07 and had no impact on diluted earnings per share in 2005. Diluted realized gains and losses per 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 results of operations.

 

We describe our results of operations in greater detail in the discussion that follows. The information is presented in four categories: Production; Insurance and Risk In Force; Revenues; and Losses and Expenses.

 

Production

 

Below is a summary of new production:

 

 

Total NIW decreased slightly during 2007, however, 69% of total NIW that was written in 2007 was written in the first two quarters, with 19% and 12%, respectively, coming in the third and fourth quarters of 2007. Primary flow NIW increased $4.9 billion for 2007 compared to 2006, however 60% of the increase for 2007 was written in the first half of the year and, similar to total NIW, declined in the third and fourth quarters of 2007. We believe it is likely that Primary flow NIW will continue to decline into 2008 for a variety of reasons including those described below:

 

 

 

Bulk insurance is a term that describes Primary and Modified Pool mortgage insurance written for a group of loans that is generally securitized in the secondary market. Mortgage insurance provides loss protection to the issuer and thus increases the credit rating and pricing of the securitization. In the Primary bulk channel, we recorded $3.7 billion of NIW in 2007, much of which was attributable to a forward commitment created in the fourth quarter of 2006. A large percentage of the loans contained in this single transaction had loan amounts in excess of $500,000 with LTVs greater than 95%. We do not expect any further production in the Primary bulk channel for the foreseeable future.

 

Structured bulk transactions, which include both Primary and Modified Pool, are likely to vary significantly from period to period due to (a) the limited number of transactions occurring in this market, (b) the larger size of such transactions compared with Primary insurance, (c) the level of competition from other mortgage insurers, (d) the relative attractiveness in the marketplace of mortgage insurance versus other forms of credit enhancement, and (e) the changing loan composition and underwriting criteria of the market. During the second half of 2007, we viewed the structured bulk market as unsettled, with a wide variety of products that did not meet our criteria and a lack of clear direction in spreads and pricing. In this environment, we chose to decrease our participation in structured bulk transactions and we do not expect any further production of Modified Pool NIW in 2008.

 

The following table provides estimates of our national market share of NIW, using MICA definitions, through our flow and structured bulk channels based on information available from MICA and other public sources for the years ended December 31, 2007, 2006, and 2005:

 

 

Our total market share declined in 2007 due primarily to our decision to exit the structured bulk market during the second quarter. In addition, our flow market share declined in 2007 primarily due to the termination of two lender paid programs and the termination of production from AHM in the third quarter of 2007.

 

According to estimates published by Fannie Mae, the overall mortgage loan origination market for 2007 declined approximately 14%, and is estimated to decline another 21% in 2008. The housing market continued to slow throughout 2007, as evidenced by reduced sales of new and existing homes, near record high levels of unsold inventories in many markets and a general decline in home prices. Fannie Mae predicts total home sales to decline by 15% in 2007, and another 13% in 2008. A significant contributor to the decline in mortgage originations in the second half of 2007 was the liquidity crisis that developed in the secondary markets, which prevented many mortgage originators from selling their loans in the secondary markets. This development contributed to the failure of a number of large national lenders and has negatively altered the outlook for mortgage originations for the foreseeable future.

 

Many lenders have significantly reduced their emphasis on simultaneous seconds or “piggyback” mortgage products, which has created an opportunity for increased penetration of mortgage insurance in loan originations. However, these piggyback mortgage products have been replaced by products with greater than 95% LTV, which contains a higher amount of risk. These products present a higher level of risk as home values have declined, especially in the soft market areas where home values have declined at a more rapid pace. Evidence exists that important positive changes in the market are emerging, including the development of a more stringent and pragmatic underwriting environment.

 

In addition, we have further tightened our underwriting guidelines to help limit our exposure to high LTV loans, especially in the distressed markets that have experienced the greatest decline in home prices. We have limited the

amount of reduced documentation loans that we are willing to underwrite. We are also reducing our dependence on certain significant customers and are expanding existing relationships with customers that we believe share our focus on quality. Our enhanced quality standards will cause us to forgo some volume opportunities.

 

As part of our overall risk management, we monitor various risk characteristics in both our Primary and Modified Pool NIW. The following three tables detail certain risk characteristics — credit quality, loan type and LTV — of our Primary NIW during the respective periods.

 

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. A-Minus is defined as loans 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 NIW production during each of the last three years:

 

 

The following table summarizes the loan type characteristics of our Primary NIW production for the past three years. The increase in loans with fixed rates in 2007 reflects the conversion of ARM products to more predictable fixed-rate loan products. Most of the potentially negative amortization loan types were the result of production in the first two quarters of 2007. Production from this type of product had declined to less than 3% by the fourth quarter of 2007.

 

 

Adjustable rate mortgages that include a feature allowing for a potential negative amortization (“PNAMs”) declined significantly in 2007. An inherent risk in a PNAM loan is the scheduled milestone in which the borrower must begin making amortizing payments. These payments can be substantially greater than the minimum payments required before the milestone is met. While most of these PNAMs have interest rates that will reset on an annual basis, these loans do not have scheduled payment increases until later years, so the borrower has not been required to make an increased payment or to refinance, adding uncertainty and potential risk to this product. We limited our exposure to PNAMs by reducing the number of PNAMs for which we provide insurance in the third quarter of 2007. We also announced guideline changes to eliminate mortgage insurance eligibility on PNAMs in the fourth quarter of 2007. PNAM loans have experienced a higher delinquency rate than that of the remaining portfolio.

 

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 for 2007, 2006 and 2005:

 

 

The above table indicates a significant 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. We believe many of the greater than 95% loans are

the result of lenders turning away from “piggyback” or simultaneous second mortgages in favor of a loan product that has a higher LTV ratio. The majority of Primary bulk transactions that were included in 2007 NIW consisted of loans that were greater than 95% LTV, which impacted the overall Primary stratifications by LTV as shown above.

 

Almost all of the Modified Pool NIW over the last three years has been in the Alt-A credit quality classification. The risk associated with our Modified Pool NIW certificates differs from Primary NIW in that Modified Pool structures in which we participate generally include either loans that have Primary coverage by other insurers in front of our risk or loans that are originally written with an LTV lower than 80%, some of which may have a simultaneous second mortgage precipitating the lower LTV. The 2006 and 2007 structured bulk transactions that are classified as Modified Pool, while similar in many risk characteristics when compared to earlier years, have exhibited an earlier and greater default pattern in the early stages of development.

 

Insurance and Risk in Force

 

The following table provides detail on our direct insurance in force at December 31, 2007, 2006, and 2005:

 

 

Our Primary insurance in force grew in 2007 and in 2006 as a result of significant production during those years and improved persistency rates. Primary insurance annual persistency improved to 81.4% at December 31, 2007 compared to 76.6% at December 31, 2006 and 70.0% at December 31, 2005. We anticipate that persistency rates will be maintained near current levels for 2008 based upon the slowdown of the existing housing and mortgage markets. However, persistency could be adversely affected if interest rates decline significantly and the housing and mortgage markets begin to improve. Furthermore, if persistency were to decline, the decline may be concentrated in areas experiencing economic expansion and home price appreciation but may not decrease or may not decrease to the same degree in areas experiencing economic contraction and declining home prices. As a result, our remaining insurance in force would be more heavily concentrated in higher risk areas, areas experiencing economic contraction and declining home prices.

 

The following tables provide information on selected risk characteristics of our business based on risk in force at December 31, 2007, 2006 and 2005. Risk in force is the total amount of coverage for which we are at risk under our certificates of insurance. The following is a list of what we believe are important indicators of increased risk that are present in our risk in force as of December 31, 2007:

 

 

Risk in Force(1)

 

 

 

 

The above table reflects that certain indicators of increased risk continue to grow as a percentage of our risk in force, consistent with a general shift to these products and risk characteristics in the overall mortgage industry. While we have limited our exposure to 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 PNAMs. As discussed earlier in this report, PNAMs contain an additional future risk when scheduled positive amortization is required in later years. As a group, the Alt-A loans and the PNAM loans have performed worse than the remaining prime fixed rate loans through December 31, 2007. We also have experienced a significant increase in the size of the mortgages for which we are providing coverage. As noted above, loans greater than $250,000 make up an increasing percentage of our risk in force. Loans greater than $250,000 totaled 37.4% of total Primary risk in force at December 31, 2007 compared to 28.5% at December 31, 2006 and 19.4% at December 31, 2005. Loans greater than $250,000 also totaled 48.5% of total Modified Pool risk in force at December 31, 2007 compared to 46.0% at December 31, 2006 and 36.2% at December 31, 2005. In addition, the increase in loans with LTVs greater than 95%, which historically produced higher default rates, has increased our risk.

 

Due to the recent significant growth in our production and the amount of refinancing that took place in 2002 through 2005, our insurance portfolio is relatively unseasoned, having a weighted average life of 2.5 years at December 31, 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 December 31, 2007, 2006, and 2005 by year of loan origination.

 

 

 

 

As noted above, approximately 62% of the Primary and 35% of the Modified Pool risk in force at December 31, 2007 has been generated in 2006 and 2007. This is the result of increased production in the number of certificates and an increase in the size of the loans during these periods. The 2006 and 2007 vintage years have so far exhibited higher default rates at this stage of development than we have historically experienced from preceding vintage years. For additional information regarding these vintage years, see “Losses and Expenses,” below.

 

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 lender’s insured book of business in exchange for a percentage of the premium. Under the captive reinsurance program, the risk held by the captive is supported by assets held in trust with Triad as the beneficiary. At December 31, 2007, we had $202 million in captive reinsurance trust balances supporting the risk transferred to captives, helping to limit our loss exposure. Approximately 59% of our Primary flow insurance in force at December 31, 2007 was subject to these captive arrangements compared to approximately 61% at December 31, 2006 and 59% at December 31, 2005. The decline of the Primary flow insurance in force that was subject to captive reinsurance arrangements at December 31, 2007 compared to December 31, 2006 resulted from two of our larger lender customers moving to a lender-paid product that does not qualify for captive participation.

 

During 2007, 19.7% of our NIW subject to captive reinsurance had a premium cede rate greater than 25%. In February 2008, Freddie Mac and Fannie Mae each separately announced that it was temporarily changing its private

mortgage insurer eligibility requirements so that approved mortgage insurers may not cede new risk if the premium ceded to captive reinsurers is greater than 25%. This temporary change is effective on or after June 1, 2008. This change may affect the percentage of flow NIW in 2008 subject to captive reinsurance and may affect the total amount of flow NIW in 2008 if lenders choose other forms of credit enhancement over mortgage insurance. We remain committed to structuring captive reinsurance arrangements on a lender-by-lender basis depending on a number of considerations, including competition, market share and lender quality.

 

Revenues

 

A summary of the individual components of our revenue for the past three years follows:

 

 

We experienced strong growth in earned premiums in both 2007 and 2006 due to growth in direct premiums written in both years. Direct premium written is comprised of premiums written for both Primary and Modified Pool business. Our direct premium written for 2007 and 2006 grew substantially as a result of increases in both insurance in force and the average basis points, which is attributable to an increase in risk characteristics in the portfolio. Primary insurance in force at December 31, 2007 increased 36% compared to December 31, 2006 while Modified Pool insurance in force decreased 4% for the same period. Overall annual persistency was 81.9% at December 31, 2007 compared to 76.8% at December 31, 2006. Increased persistency has a positive effect on insurance in force.

 

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 2007 and 2006 was not as large as the increase in direct premium written because a larger percentage of direct premiums written were not 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 and single payment plans. Our unearned premium liability increased $4.3 million during 2007 compared to declines of $0.3 million and $2.4 million, respectively, in 2006 and 2005 primarily due to the introduction of a single premium product in 2007.

 

Net investment income grew in 2007 and in 2006 primarily due to the growth in average invested assets in both years, partially offset by declines in portfolio yields. In 2007, the increase in investment income was also enhanced by the investment of the entire $80 million that we drew down from our credit facility during the third quarter of 2007. Average invested assets at cost or amortized cost grew by 21.4% in 2007 and 13.4% in 2006 as a result of the investment of positive cash flows from operations. Our investment portfolio tax-equivalent yield was 6.45%, 6.71%, and 6.77% at December 31, 2007, 2006, and 2005, respectively. We anticipate a continuing decline in the overall portfolio tax-equivalent yield as current interest rates remain below our average portfolio rate. For a further discussion, see “Investment Portfolio”.

 

Net realized investment gains (losses), except for write-downs on other-than-temporarily impaired securities, are the result of our discretionary dispositions of investment securities in the context of our overall portfolio management strategies and are likely to vary significantly from period to period. We wrote down other-than-temporarily impaired investments by approximately $5.3 million in 2007 compared to $0.4 million in 2006 and $0.2 million in 2005. See “Realized Losses and Impairments” below.

Losses and Expenses

 

A summary of the significant individual components of losses and expenses and the year-to-year percentage changes follows:

 

 

Net losses and LAE are comprised of both paid losses and the increase in the loss and LAE reserve during the period. Net losses and LAE for 2007 increased over both 2006 and 2005 primarily due to significant increases in the reserve. The reserve increase reflects both an increase in the number of loans in default and an increase in the average risk per loan on the loans that were in default at December 31, 2007. We increased the frequency and severity factors utilized in the calculation of the reserve during 2007, which also impacted the size of the reserve increase. During the third and fourth quarters of 2007, we identified four specific states (California, Florida, Arizona and Nevada) that were experiencing declining home prices and increasing default rates at a faster pace than other states. We collectively refer to these four states as distressed markets. These distressed markets contributed $156 million, or 57%, of our total reserve increase in 2007.

 

We experienced a significant increase in the amount of paid claims during 2007 as both the number of claims and the average severity of the paid claims increased. The increases in the amortization of deferred policy acquisition costs in 2007 and 2006 are consistent with the growth in that asset balance. Other operating expenses increased in 2007 over 2006, reflecting the growth of our insurance in force as well as several key initiatives that have taken place in 2007. The discussion below provides more detail on both losses and expenses.

 

The following table provides details on both the amount and the number of paid claims of both Primary and Modified Pool insurance for the years ended December 31, 2007, 2006, and 2005: