UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended June 30, 2006
		OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the transition period from            to

Commission file number: 0-22342

Triad Guaranty Inc.

DELAWARE (State or other jurisdiction of incorporation or organization)		56-1838519 (I.R.S. Employer Identification No.)
101 South Stratford Road Winston-Salem, North Carolina (Address of principal executive offices)		27104 (Zip Code)

(336) 723-1282
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No £

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer £          Accelerated filer R          Non-accelerated filer £

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

     Number of shares of Common Stock, par value $0.01 per share, outstanding as of August 2, 2006, was 14,887,944.

 

 

TRIAD GUARANTY INC.

INDEX

						Page
Part I. Financial Information
Item 1.		Financial Statements
				Consolidated Balance Sheets as of June 30, 2006 (Unaudited) and December 31, 2005			1
				Consolidated Statements of Income for the Three Months and Six Months Ended June 30, 2006 and 2005 (Unaudited)			2
				Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2006 and 2005 (Unaudited)			3
				Notes to Consolidated Financial Statements			4
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations					11
Item 3.		Quantitative and Qualitative Disclosures about Market Risk					38
Item 4.		Controls and Procedures					38
Part II. Other Information
Item 1.		Legal Proceedings					39
Item 1A.		Risk Factors					39
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds					39
Item 3.		Defaults Upon Senior Securities					39
Item 4.		Submission of Matters to a Vote of Security Holders					39
Item 5.		Other Information					39
Item 6.		Exhibits					39
Signature							40
Ex-31.1
Ex-31.2
Ex-32.1
Ex-32.2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

TRIAD GUARANTY INC.
CONSOLIDATED BALANCE SHEETS

		(Unaudited)
		June 30				December 31
		2006				2005
		(In thousands, except share data)
ASSETS
Invested assets:
Securities available-for-sale, at fair value:
Fixed maturities (amortized cost: $552,792 and $518,137)		$	556,378			$	534,064
Equity securities (cost: $9,605 and $7,001)			9,660				8,159
Other investments			5,000				—
Short-term investments			4,277				4,796
			575,315				547,019
Cash and cash equivalents			5,191				8,934
Real estate acquired in claim settlement			8,614				5,721
Accrued investment income			7,780				7,237
Deferred policy acquisition costs			34,203				33,684
Prepaid federal income taxes			151,908				139,465
Property and equipment			7,954				7,827
Income taxes recoverable			179				181
Reinsurance recoverable			1				948
Other assets			17,878				16,487
Total assets		$	809,023			$	767,503
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Losses and loss adjustment expenses		$	54,905			$	51,074
Unearned premiums			12,630				13,494
Amounts payable to reinsurers			5,398				4,810
Deferred income taxes			163,436				155,189
Long-term debt			34,505				34,501
Accrued interest on debt			1,275				1,275
Accrued expenses and other liabilities			5,721				7,969
Total liabilities			277,870				268,312
Commitments and contingencies — Note 4
Stockholders’ equity:
Preferred stock, par value $0.01 per share — authorized 1,000,000 shares; no shares issued and outstanding			—				—
Common stock, par value $0.01 per share — authorized 33,091,400 shares; issued and outstanding 14,887,984 shares at June 30, 2006 and 14,774,153 shares at December 31, 2005			149				148
Additional paid-in capital			103,056				103,657
Accumulated other comprehensive income, net of income tax liability of $1,274 at June 30, 2006 and $5,980 at December 31, 2005			2,367				11,106
Deferred compensation			—				(3,161	)
Retained earnings			425,581				387,441
Total stockholders’ equity			531,153				499,191
Total liabilities and stockholders’ equity		$	809,023			$	767,503

See accompanying notes.

TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

		Three Months Ended								Six Months Ended
		June 30								June 30
		2006				2005				2006				2005
		(In thousands, except share data)
Revenue:
Premiums written:
Direct		$	60,961			$	50,559			$	120,273			$	98,886
Ceded			(11,603	)			(9,948	)			(22,573	)			(19,564	)
Net premiums written			49,358				40,611				97,700				79,322
Change in unearned premiums			1,309				510				857				576
Earned premiums			50,667				41,121				98,557				79,898
Net investment income			6,535				5,743				12,757				11,158
Net realized investment gains			772				39				1,672				46
Other income			5				2				3				11
			57,979				46,905				112,989				91,113
Losses and expenses:
Net losses and loss adjustment expenses			17,271				17,288				33,622				27,918
Interest expense on debt			694				693				1,387				1,386
Amortization of deferred policy acquisition costs			4,118				3,695				7,980				7,352
Other operating expenses (net of acquisition costs deferred)			8,496				7,017				17,009				14,234
			30,579				28,693				59,998				50,890
Income before income taxes			27,400				18,212				52,991				40,223
Income taxes:
Current			979				707				1,951				1,401
Deferred			6,834				4,306				12,900				9,863
			7,813				5,013				14,851				11,264
Net income		$	19,587			$	13,199			$	38,140			$	28,959
Earnings per common and common equivalent share:
Basic		$	1.33			$	0.90			$	2.58			$	1.98
Diluted		$	1.31			$	0.89			$	2.56			$	1.96
Shares used in computing earnings per common and common equivalent share:
Basic			14,769,367				14,667,734				14,763,889				14,643,095
Diluted			14,914,075				14,812,532				14,888,304				14,795,243

See accompanying notes.

TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

		Six Months Ended
		June 30
		2006				2005
		(In thousands)
Operating activities
Net income		$	38,140			$	28,959
Adjustments to reconcile net income to net cash provided by operating activities:
Losses, loss adjustment expenses and unearned premium reserves			2,967				3,919
Accrued expenses and other liabilities			(2,248	)			(2,266	)
Income taxes recoverable			2				(293	)
Amounts due to/from reinsurers			1,535				323
Accrued investment income			(543	)			(414	)
Policy acquisition costs deferred			(8,499	)			(7,981	)
Amortization of deferred policy acquisition costs			7,980				7,352
Net realized investment gains			(1,672	)			(46	)
Provision for depreciation			1,231				1,660
Accretion of discount on investments			(50	)			(189	)
Deferred income taxes			12,900				9,863
Prepaid federal income taxes			(12,443	)			(9,550	)
Real estate acquired in claim settlement, net of write-downs			(2,893	)			(1,229	)
Other assets			(1,391	)			169
Other operating activities			1,633				2,557
Net cash provided by operating activities			36,649				32,834
Investing activities
Securities available-for-sale:
Purchases — fixed maturities			(90,826	)			(56,186	)
Sales — fixed maturities			54,081				10,143
Maturities — fixed maturities			2,933				4,934
Purchases — equities			(4,647	)			—
Sales — equities			3,001				1,153
Purchases of other investments			(5,000	)			—
Net change in short-term investments			519				7,539
Purchases of property and equipment			(1,358	)			(1,249	)
Net cash used in investing activities			(41,297	)			(33,666	)
Financing activities
Excess tax benefits from share-based compensation			280				—
Proceeds from exercise of stock options			625				3,261
Net cash provided by financing activities			905				3,261
Net change in cash and cash equivalents			(3,743	)			2,429
Cash and cash equivalents at beginning of period			8,934				10,440
Cash and cash equivalents at end of period		$	5,191			$	12,869
Supplemental schedule of cash flow information
Cash paid during the period for:
Income taxes and United States Mortgage Guaranty Tax and Loss Bonds		$	15,343			$	11,240
Interest			1,383				1,383

See accompanying notes.

TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2006
(Unaudited)

1. The Company

     Triad Guaranty Inc. is a holding company, which through its wholly-owned subsidiary, Triad Guaranty Insurance Corporation (“Triad”), provides mortgage insurance coverage in the United States. This allows buyers to achieve homeownership with a reduced down payment, facilitates the sale of mortgage loans in the secondary market and protects lenders from credit default-related expenses. Triad Guaranty Inc. and its subsidiaries are collectively referred to as the “Company”.

2. Accounting Policies And Basis Of Presentation

  Basis of Presentation

     The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months and six months ended June 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. For further information, refer to the consolidated financial statements and footnotes thereto included in the Triad Guaranty Inc. annual report on Form 10-K for the year ended December 31, 2005.

  Other Investments

     Other investments represent investments in equity securities for which there is no readily determinable market value and are stated at fair value. Other investments are reviewed regularly to determine if there are declines in value that are other than temporary. When an impairment is determined to be other than temporary, the impairment loss is recognized as a realized investment loss.

  Share-Based Compensation

     Prior to January 1, 2006, the Company accounted for stock option grants and grants of restricted stock under its 1993 Long-Term Stock Incentive Plan (the “Plan”), which is more fully described in Note 8, using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), as permitted by Statement of Financial Accounting Standards No. 123 (“SFAS 123”). In accordance with APB 25, compensation expense was recognized for grants of restricted stock, but not for grants of stock options. In December 2004, the Financial Accounting Standards Board issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS 123(R)”). SFAS 123(R) requires

compensation expense relating to share-based payment transactions to be recognized in financial statements. The Company adopted SFAS 123(R) effective January 1, 2006, utilizing the modified prospective application as defined in that statement. Under that transition method, compensation expense recognized in the second quarter of 2006 and the six months ended June 30, 2006 includes: a) compensation expense for all share-based payments granted prior to, but not yet vested as of January 1, 2006 based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123, and b) compensation expense for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). Results for prior periods have not been restated.

     The following table shows the effect of adopting SFAS 123(R) in the Company’s financial statements:

		Three Months Ended				Six Months Ended
		June 30, 2006				June 30, 2006
		(In thousands, except per share information)
Income before income taxes		$	(313	)		$	(593	)
Net income		$	(204	)		$	(386	)
Earnings per share — basic		$	(0.01	)		$	(0.03	)
Earnings per share — diluted		$	(0.01	)		$	(0.03	)

     Prior to the adoption of SFAS 123(R), the Company presented all tax benefits of deductions resulting from share-based compensation as operating cash flows in the Statement of Cash Flows. SFAS 123(R) requires the cash flows resulting from the tax benefits of tax deductions in excess of the compensation expense recognized for those share-based payments to be classified as financing cash flows. This amount was $280,000 for the six months ended June 30, 2006.

     The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123 to options granted in all periods presented. For purposes of this pro forma disclosure, the value of the options is estimated using a Black-Scholes option pricing model and amortized to expense over the options’ vesting periods:

		Three Months Ended				Six Months Ended
		June 30, 2005				June 30, 2005
		(In thousands, except earnings per share information)
Net income — as reported		$	13,199			$	28,959
Net income — pro forma		$	13,065			$	28,679
Earnings per share — as reported:
Basic		$	0.90			$	1.98
Diluted		$	0.89			$	1.96
Earnings per share — pro forma:
Basic		$	0.89			$	1.96
Diluted		$	0.88			$	1.94

3. Consolidation

     The consolidated financial statements include the accounts of Triad Guaranty Inc. and all of its subsidiaries. All significant intercompany accounts and transactions have been eliminated.

4. Commitments And Contingencies

  Reinsurance

     Certain premiums and losses are ceded to other insurance companies under various reinsurance agreements, the majority of which are captive reinsurance agreements with affiliates of certain customers. Reinsurance contracts do not relieve Triad from its obligations to policyholders. Failure of the reinsurer to honor its obligation could result in losses to Triad; consequently, allowances are established for any amounts that are deemed uncollectible. Triad evaluates the financial condition of its reinsurers and monitors credit risk arising from similar geographic regions, activities, or economic characteristics of its reinsurers to minimize its exposure to significant losses from reinsurer insolvency.

  Insurance In Force, Dividend Restrictions, and Statutory Results

     Insurance regulations generally limit the writing of mortgage guaranty insurance to an aggregate amount of insured risk no greater than 25 times the total of statutory capital and surplus and the statutory contingency reserve. The amount of net risk for insurance in force at June 30, 2006 and December 31, 2005, as presented below, was computed by applying the various percentage settlement options to the insurance in force amounts, adjusted by risk ceded under reinsurance agreements, any applicable stop-loss limits and deductibles. Triad’s ratio is as follows:

		June 30, 2006				December 31, 2005
		(Dollars in thousands)
Net risk		$	7,640,954			$	7,312,697
Statutory capital and surplus		$	154,695			$	131,582
Statutory contingency reserve			492,013				447,826
Total		$	646,708			$	579,408
Risk-to-capital ratio			11.8 to 1				12.6 to 1

     Triad and its wholly-owned subsidiaries are each required under their respective domiciliary states’ insurance code to maintain a minimum level of statutory capital and surplus. Triad, an Illinois domiciled insurer, is required under the Illinois Insurance Code (the “Code”) to maintain minimum statutory capital and surplus of $5 million. The Code permits dividends to be paid only out of earned surplus and also requires prior approval of extraordinary dividends. An extraordinary dividend is any dividend or distribution of cash or other property, the fair value of which, together with that of other dividends or distributions made within a period of twelve consecutive months, exceeds the greater of (a) ten percent of statutory surplus as regards policyholders, or (b) statutory net income for the calendar year preceding the date of the dividend.

     Net income as determined in accordance with statutory accounting practices was $52.1 million and $39.7 million for the six months ended June 30, 2006 and 2005, respectively, and $77.1 million for the year ended December 31, 2005.

     At June 30, 2006 and December 31, 2005, the amount of Triad’s equity that could be paid out in dividends to stockholders was $71.0 million and $47.9 million, respectively, which was the earned surplus of Triad on a statutory basis on those dates.

  Loss Reserves

     The Company establishes loss reserves to provide for the estimated costs of settling claims on loans reported in default and estimates of loans in default that are in the process of being reported to the Company as of the date of the financial statements. Consistent with industry accounting practices, the Company does not establish loss reserves for future claims on insured loans that are not currently in default. Amounts recoverable from the sale of properties acquired in lieu of foreclosure are considered in the determination of the reserve estimates. Loss reserves are established by management using historical experience and by making various

assumptions and judgments about claim rates (frequency) and claim amounts (severity) to estimate ultimate losses to be paid on loans in default. The Company’s reserving methodology gives effect to current economic conditions and profiles delinquencies by such factors as age, policy year, geography, chronic late payment characteristics, the number of months the loans have been in default, as well as whether the loans in default were underwritten through the flow channel or as part of a structured bulk transaction. The estimates are continually reviewed, and as adjustments to these liabilities become necessary, such adjustments are reflected in the financial statements in the periods in which the adjustments are made.

  Litigation

     A lawsuit was filed against the Company in January 2004 in the ordinary course of the Company’s business alleging violations of the Fair Credit Reporting Act. The Company is vigorously defending the lawsuit. In the opinion of management, the ultimate resolution of this pending litigation will not have a material adverse effect on the financial position or results of operations of the Company.

5. Earnings Per Share

     Basic and diluted earnings per share are based on the weighted-average daily number of shares outstanding. For diluted earnings per share, the denominator includes the dilutive effects of stock options and unvested restricted stock on the weighted-average shares outstanding. There are no other reconciling items between the denominators used in basic earnings per share and diluted earnings per share. The numerator used in basic earnings per share and diluted earnings per share is the same for all periods presented.

6. Comprehensive Income

     Comprehensive income consists of net income and other comprehensive income. For the Company, other comprehensive income is composed of unrealized gains or losses on available-for-sale securities, net of income tax. For the three months ended June 30, 2006 and 2005, the Company’s comprehensive income was $14.7 million and $19.7 million, respectively. For the six months ended June 30, 2006 and 2005, the Company’s comprehensive income was $29.4 million and $32.2 million, respectively.

7. Income Taxes

     Income tax expense differs from the amounts computed by applying the Federal statutory income tax rate to income before income taxes primarily due to tax-exempt interest that the Company earns from its investments in municipal bonds.

8. Long-Term Stock Incentive Plan

     In May 2006, the Company’s shareholders approved the 2006 Long-Term Stock Incentive Plan (the “Plan”). Under the Plan, certain directors, officers, and key employees are eligible to receive various share-based compensation awards. Stock options and restricted stock may be awarded under the Plan for a fixed number of shares with a requirement for stock options granted to have an exercise price equal to or greater than the fair value of the shares at the date of grant. Generally, both the stock options and restricted stock awards vest over three years.

Options granted under the Plan expire no later than ten years following the date of grant. In May 2006, the Company’s shareholders approved the termination as to future awards of the 1993 Long-Term Stock Incentive Plan, which was structured similar to the 2006 Long-Term Stock Incentive Plan. Upon termination, 86,024 shares available for issuance under the 1993 Long-Term Stock Incentive Plan were merged into the Plan. The number of shares authorized to be granted or issued through equity awards under the Plan is 1,091,400. As of June 30, 2006, 1,654,129 shares were reserved (including 656,843 shares granted as part of the 1993 Long-Term Stock Incentive Plan that have not been exercised or vested) and 1,087,627 shares were available for issuance under the Plan. The following table shows amounts recognized in the financial statements related to share-based compensation:

		Three Months Ended								Six Months Ended
		June 30								June 30
		2006				2005				2006				2005
		(In thousands)
Gross compensation expense		$	896			$	414			$	1,696			$	811
Tax benefit			314				145				594				284
Compensation expense capitalized as part of deferred acquisition costs			152				—				277				—

     A summary of option activity under the Plan for the six months ended June 30, 2006 is presented below:

														Weighted-
						Weighted-				Aggregate				Average
						Average				Intrinsic				Remaining
		Number of Shares				Exercise Price				Value				Contractual Term
		(In thousands)
Outstanding, January 1, 2006			588,780			$	37.21
Granted			13,594				43.00
Exercised			31,555				19.80
Cancelled			4,317				43.31
Outstanding, June 30, 2006			566,502				38.27			$	6,234			5.1 years
Exercisable, June 30, 2006			418,862				36.61			$	5,251			3.7 years

     The fair value of stock options is estimated on the date of grant using a Black-Scholes pricing model. The weighted-average assumptions used for options granted during the six months ended June 30, 2006 and 2005 are noted in the following table. The expected volatilities are based on volatility of the Company’s stock over the most recent historical period corresponding to the expected term of the options. The Company also uses historical data to estimate option exercise and employee terminations within the model; separate groups of employees with similar historical exercise and termination histories are considered separately for valuation purposes. The risk-free rates for the periods corresponding to the expected terms of the options are based on U.S. Treasury rates in effect on the dates of grant.

		2006				2005
Expected volatility			34.0	%			39.6	%
Expected dividend yield			0.0	%			0.0	%
Expected term		5.0 years				5.0 years
Risk-free rate			4.5	%			3.7	%

     The weighted-average grant-date fair value of options granted during the six months ended June 30, 2006 and 2005 was $16.28 and $21.85, respectively. The total intrinsic value of options exercised during the six months ended June 30, 2006 and 2005 was approximately $839,000 and $5.0 million, respectively.

     A summary of restricted stock activity under the Plan for the six months ended June 30, 2006 is presented below:

						Weighted-
						Average
		Number of				Grant-Date
		Shares				Fair Value
Nonvested, January 1, 2006			101,415			$	46.93
Granted			46,005				45.37
Vested			34,097				47.05
Cancelled			120				53.94
Nonvested, June 30, 2006			113,203				46.26

     The fair value of restricted stock is determined based on the closing price of the Company’s shares on the grant date. The weighted-average grant-date fair value of restricted stock granted during the six months ended June 30, 2006 and 2005 was $45.37 and $53.91, respectively.

     As of June 30, 2006, there was $6.4 million of unrecognized compensation expense related to nonvested stock options and restricted stock granted under the Plan. That expense is expected to be recognized over a weighted-average period of 2.1 years. The total fair value of stock options and restricted stock vested during the six months ended June 30, 2006 and 2005 was $1.6 million and $2.0 million, respectively.

The Company issues new shares upon exercise of stock options.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     Management’s Discussion and Analysis of Financial Condition and Results of Operations analyzes the consolidated financial condition, changes in financial position, and results of operations for the three months and six months ended June 30, 2006 and 2005, of the Company. This discussion supplements Management’s Discussion and Analysis in our annual report on Form 10-K for the year ended December 31, 2005, and should be read in conjunction with the interim financial statements and notes contained herein.

     Certain of the statements contained herein, other than statements of historical fact, are forward-looking statements. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and include estimates and assumptions related to economic, competitive, and legislative developments. These forward-looking statements are subject to change and uncertainty, which are, in many instances, beyond our control and have been made based upon our expectations and beliefs concerning future developments and their potential effect on us. Actual developments and their results could differ materially from those expected by us, depending on the outcome of certain factors, including the possibility of general economic and business conditions that are different than anticipated, legislative developments, changes in interest rates or the stock markets, stronger than anticipated competitive activity, as well as the risk factors described in Item 1A of our annual report on Form 10-K for the year ended December 31, 2005 and the Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 with respect to forward-looking statements contained herein.

Update on Critical Accounting Policies and Estimates

     Our annual report on Form 10-K for the year ended December 31, 2005 describes the accounting estimates and assumptions that we consider to be the most critical to an understanding of our financial statements because they inherently involve significant judgments and uncertainties. These critical accounting policies relate to the assumptions and judgments utilized in establishing the reserve for losses and loss adjustment expenses, determining if declines in fair values of investments are other than temporary, and establishing appropriate initial amortization schedules for deferred policy acquisition costs (“DAC”) and subsequent adjustments to that amortization.

     We believe that these continue to be the critical accounting policies applicable to the Company and that these policies were applied in a consistent manner during the first six months of 2006.

Overview

     Through our subsidiaries, we provide Primary and Modified Pool mortgage guaranty insurance coverage to residential mortgage lenders and investors as a credit-enhancement vehicle, typically when individual borrowers have less than 20% equity in the property. Business originated by lenders and submitted to us on a loan-by-loan basis is referred to as our flow channel business. The majority of our Primary insurance is delivered through the flow

channel. We also provide mortgage insurance to lenders and investors who seek additional default protection (typically secondary coverage or on loans for which the individual borrower has greater than 20% equity), capital relief, and credit-enhancement on groups of loans that are sold in the secondary market. These transactions are referred to as our structured bulk channel business. All of our Modified Pool insurance is delivered through the structured bulk channel.

     Our revenues principally consist of a) initial and renewal earned premiums from flow business (net of reinsurance premiums ceded as part of our risk management strategies), b) initial and renewal earned premiums from structured bulk transactions, and c) investment income on invested assets. We also realize investment gains, net of investment losses, periodically as a source of revenue when the opportunity presents itself within the context of our overall investment strategy.

     Our expenses consist of a) amounts paid on claims submitted, b) changes in reserves for estimated future claim payments on loans that are currently in default, c) general and administrative costs of acquiring new business and servicing existing policies, d) other general business expenses, and e) income taxes.

     Our profitability depends largely on a) the adequacy of our product pricing and underwriting discipline relative to the risks insured, b) persistency levels, c) operating efficiencies, and d) the level of investment yield, including realized gains and losses, on our investment portfolio. We define persistency as the percentage of insurance in force remaining from twelve months prior. Cancellations of policies originated during the past twelve months are not considered in our calculation of persistency. This method of calculating persistency may vary from that of other mortgage insurers. We believe that our calculation presents an accurate measure of the percentage of insurance in force remaining from twelve months prior. Cancellations result primarily from the borrower refinancing or selling insured mortgaged residential properties and, to a lesser degree, from the borrower achieving prescribed equity levels at which the lender no longer requires mortgage guaranty insurance.

     For a more detailed description of our industry and operations, refer to the “Business” section of our annual report on Form 10-K for the year ended December 31, 2005.

Consolidated Results of Operations

     Following is selected financial information for the three months and six months ended June 30, 2006 and 2005:

		Three Months Ended												Six Months Ended
		June 30												June 30
		2006				2005				% Change				2006				2005				% Change
		(In thousands, except percentages and per share information)
Earned premiums		$	50,667			$	41,121				23.2	%		$	98,557			$	79,898				23.4	%
Net losses and loss adjustment expenses			17,271				17,288				(0.1	)			33,622				27,918				20.4
Net income			19,587				13,199				48.4				38,140				28,959				31.7
Diluted earnings per share		$	1.31			$	0.89				47.2			$	2.56			$	1.96				30.6

     Net income for the second quarter of 2006 increased from the second quarter of 2005 driven principally by strong growth in earned premiums which exceeded the growth in expenses, while losses remained relatively flat. Earned premiums have increased primarily as a result of growth of our insurance in force due to increasing persistency rates and strong production of Modified Pool insurance in the last twelve months. Based on information available from the industry trade association (Mortgage Insurance Companies of America, or “MICA”) and other public sources, our estimated market share of net new insurance written, using MICA definitions, was 8.8% for the second quarter of 2006 compared to 6.3% for the second quarter of 2005. Additionally, the average basis points of premium on our Primary insurance written continues to increase as a result of our writing a greater percentage of new insurance with risk-adjusted rates such as Alt-A loans and adjustable rate mortgages (“ARMs”). We have defined Alt-A loans as individual loans having FICO scores greater than 619 and that have been underwritten with reduced or no documentation. Strong earned premium growth along with an increase in the average basis points of premium on Primary insurance written was also responsible for the growth in net income for the first six months of 2006 over that for the same period of 2005, although increased net losses and loss adjustment expenses for the first six months of 2006 partially offset this growth.

     Growth of our insurance in force combined with seasoning of our portfolio caused significant increases in net losses and loss adjustment expenses in prior quarters; however, this increase moderated in the second quarter of 2006. We increased reserves $2.3 million and $3.8 million for the second quarter and first six months of 2006, respectively, compared to $3.8 million and $4.5 million in the second quarter and first six months of 2005. The reserve increases in 2005 were a result of growth in severity trends and a larger concentration of seasoned segments in our default inventory than we had experienced in prior periods. In addition to the change in reserves, net losses and loss adjustment expenses also includes paid claims. The actual number of claims paid for the second quarter and first six months of 2006 increased 22.0% and 30.7% over the respective periods of 2005 due to growth in our number of insured loans and a greater percentage of loans entering the peak claim paying period. While the number of paid claims increased, our average severity of paid claims declined to $25,300 for the second quarter

of 2006 and $25,200 for the first six months of 2006 from $28,400 for the second quarter and $26,200 for the first six months of 2005.

     Diluted earnings per share for the second quarter and first six months of 2006 increased over the same periods of 2005 consistent with the increases in net income. Realized investment gains, net of taxes, increased diluted earnings per share by $0.03 and $0.07 in the second quarter and first six months of 2006, respectively, and had no impact in the second quarter or the first six months of 2005. Realized investment gains and losses per diluted share is a non-GAAP measure. We believe this is relevant and useful information to investors because, except for write-downs on other-than-temporarily impaired securities, it shows the effect that our discretionary sales of investments had on earnings. See further discussion of impairment write-downs in the Realized Losses and Impairments section below.

     In July 2006, we announced our intention to submit an application to incorporate a Canadian subsidiary to begin operations in Canada. The Canadian company will be a monoline provider of mortgage guaranty insurance and, pending regulatory approvals, could start operations sometime in 2007. We incurred approximately $250,000 of expenses in the first half of 2006 relating to legal fees, consultants and application fees in connection with this process. We expect these expenses to increase during the remainder of 2006 as we begin to put the necessary personnel and infrastructure into place in anticipation of the commencement of business in 2007.

     We describe our results in greater detail in the discussions that follow. The information is presented in three categories: Production and In Force, Revenues, and Losses and Expenses.

  Production and In Force

     A summary of new production for the three months and six months ended June 30, 2006 and 2005 broken out between Primary and Modified Pool follows:

		Three Months Ended												Six Months Ended
		June 30												June 30
		2006				2005				% Change				2006				2005				% Change
		(In millions, except percentages)
Primary insurance written		$	2,944			$	2,941				0.1	%		$	4,892			$	5,132				(4.7	)%
Modified pool insurance written			2,980				1,798				65.7				7,586				3,901				94.5
Total insurance written		$	5,924			$	4,739				25.0	%		$	12,478			$	9,033				38.1	%

     Net new primary insurance written, using MICA definitions, for the entire industry declined approximately 6% for both the second quarter and first six months of 2006 from the corresponding periods of 2005 based on information available from MICA and other public sources. This decline, along with a slight decrease in market penetration in our flow channel, led to the decline in our Primary insurance written in the first half of 2006 from that for the first half of 2005. We anticipate that the overall mortgage loan origination market will be smaller for all of 2006 than 2005, which could continue to reduce our Primary new insurance written for the

year. However, we believe that alternative credit enhancements such as 80-10-10’s, which can limit the need for mortgage insurance, have become less attractive to borrowers as short-term interest rates have risen. If interest rates remain at current levels or continue to rise, the erosion of mortgage insurance written caused by these arrangements may soften, which could partially mitigate the overall reduction of Primary insurance written.

     We write Modified Pool insurance only through our structured bulk channel. Our Modified Pool insurance written grew significantly in the second quarter and first six months of 2006 due to strong industry production and our successful bids to provide insurance on those transactions that meet our loan quality and pricing objectives. Structured bulk transactions for the entire industry declined approximately 9% for the second quarter of 2006 from that for 2005 and increased approximately 36% for the first six months of 2006 over the same period of 2005 according to information available from MICA and other publicly available data. Our Modified Pool insurance written is likely to vary significantly from period to period due to: a) the limited number of transactions (but with larger size) occurring in this market, b) the level of competition from other mortgage insurers, c) the relative attractiveness in the marketplace of mortgage insurance versus other forms of credit enhancement, and d) the changing loan composition and underwriting criteria of the market. We believe there will continue to be opportunities throughout the remainder of 2006 in the structured bulk transaction market that meet our loan quality and pricing objectives.

     The following table provides estimates of our national market share of net new insurance written, using MICA definitions, through our flow and structured bulk channels based on information available from MICA and other public sources for the three months and six months ended June 30, 2006 and 2005:

		Three Months Ended								Six Months Ended
		June 30								June 30
		2006				2005				2006				2005
Flow channel			5.7	%			6.2	%			5.5	%			5.9	%
Structured bulk channel			15.3	%			6.7	%			16.1	%			10.0	%
Total			8.8	%			6.3	%			9.4	%			7.0	%

     Our total market share increased for the second quarter and first half of 2006 over the same periods of 2005 due to strong production through our structured bulk channel combined with the increase of structured bulk transactions as a percentage of the total mortgage insurance written for the industry. As mentioned earlier, our structured bulk channel market share will vary from period to period since this market can have significantly larger transactions and our share of this market is dependent on the availability of transactions that meet our credit quality and pricing benchmarks and on our ability to bid successfully to provide insurance on these transactions.

     We continue to increase our participation in the Alt-A marketplace. The following table summarizes the credit quality characteristics of our Primary new insurance written during the three months and six months ended June 30, 2006 and 2005 and reflects the growth in our Alt-A production. We have defined A Minus loans as those having FICO scores greater than 574, but less than 620. We have defined Sub Prime loans as those with credit scores less than 575.

		Three Months Ended								Six Months Ended
		June 30								June 30
		2006				2005				2006				2005
Prime			65.5	%			73.7	%			69.3	%			75.6	%
Alt-A			32.3				19.0				28.5				17.0
A Minus			1.9				5.6				1.9				5.8
Sub Prime			0.3				1.7				0.3				1.6
Total			100.0	%			100.0	%			100.0	%			100.0	%

     The majority of our Modified Pool production has been in the Alt-A marketplace over the last two years.

     Risk characteristics that we consider in our underwriting discipline also include, among other factors, the percentage of ARMs and the percentage of loans with loan-to-value ratios (“LTVs”) greater than 95%. The following table summarizes the percentage of our Primary production in ARMs and higher LTV loans for the three months and six months ended June 30, 2006 and 2005:

		Three Months Ended								Six Months Ended
		June 30								June 30
		2006				2005				2006				2005
ARMs			45.8	%			43.7	%			40.5	%			41.3	%
LTV greater than 95%			12.2	%			11.6	%			11.3	%			12.2	%

     In the recent mortgage origination marketplace, there have been many different types of products classified as ARMs. One such ARM product has an initial time period for which the interest rate is fixed. After the initial time period, the interest rate adjusts based on current market rates. This adjustment typically occurs on an annual basis. These ARMs are commonly referred to as hybrid ARMs. In periods of rising interest rates, hybrid ARMs with a longer period of time with a fixed interest rate present less uncertainty than those that reset in a shorter period of time. The following table provides detail on the ARMs written as part of Primary production for the three months and six months ended June 30, 2006 and 2005:

		Three Months Ended								Six Months Ended
		June 30								June 30
		2006				2005				2006				2005
Fixed rate period:
Less than 1 year			34.6	%			14.7	%			27.7	%			10.7	%
1 year to less than 5 years			2.7				16.1				3.3				24.7
5 years or greater			8.5				12.7				9.5				5.9
Total ARMs			45.8	%			43.7	%			40.5	%			41.3	%

     Certain ARM products provide a fixed period of time for which the borrower has the option to pay monthly payments that are less than the interest accrued for those months. If the borrower elects this option, the LTV increases on the loan. This type of loan is commonly referred to as a Pay Option ARM (“POA”). Because the LTV can increase on a POA, these types of loans may present more risk to a mortgage insurer than traditional amortizing loans. POAs comprised approximately 34% and 27% of Primary new insurance written in the second quarter and first half of 2006 compared to approximately 13% and 9% in the second quarter and first half of 2005.

     LTVs on policies originated in the structured bulk channel are generally lower than those on policies we receive via the flow channel. Those policies may also have other Primary coverage in front of our risk. The percentages of ARMs included in our Modified Pool production approximate those included in our Primary production.

     Periodically we enter into structured bulk transactions involving loans that have insurance effective dates within the current reporting period but for which detailed loan information regarding the insured loans is not provided by the issuer of the transaction until later. When this situation occurs, we accrue premiums that are due but not yet paid based upon the estimated commitment amount of the transaction in the reporting period with respect to each loan’s insurance effective date. However, these policies are not reflected in our insurance in force, new insurance written, or related industry data totals until we verify the loan level detail. At June 30, 2006, we had approximately $0.4 billion of structured bulk transactions with effective dates within the second quarter for which loan level detail had not been received and, therefore, are not included in our own data or industry totals. These amounts will be reported as new production and insurance in force totals in the third quarter of 2006, when the issuer of the transactions provides accurate loan level detail to us. We have included in premium written and premium earned the respective estimated amounts due and earned during the first quarter of 2006 related to this insurance. At June 30, 2005 we had $1.7 billion of structured bulk transactions with effective dates within the second quarter of 2005 for which loan level detail had not been

received.

     The following table provides detail on our direct insurance in force at June 30, 2006 and 2005:

		2006				2005				% Change
		(In millions, except percentages)
Primary insurance		$	30,783			$	29,489				4.4	%
Modified Pool insurance			20,022				10,018				99.9
Total insurance		$	50,805			$	39,507				28.6	%

     Our Primary insurance in force at June 30, 2006 grew as compared to June 30, 2005 as a result of production during that period and improving persistency rates. Primary insurance persistency improved to 72.7% at June 30, 2006 compared to 70.9% at June 30, 2005. If interest rates remain near current levels, we anticipate that persistency rates will also continue near current levels throughout the remainder of 2006. However, persistency may be adversely affected if interest rates decline significantly from the levels experienced during the first six months of 2006.

     Our Modified Pool insurance in force at June 30, 2006 grew significantly as compared to June 30, 2005 due primarily to our strong production in the structured bulk channel in the past twelve months. Approximately 43% and 39% of our insurance written attributable to our structured bulk channel during the three months and six months ended June 30, 2006, respectively, was structured with deductibles that put us in the second loss position compared to 67% and 77% for the three months and six months ended June 30, 2005. The decline in Modified Pool insurance written with deductibles in the second quarter of 2006 from that of 2005 was the result of increased business with entities that do not utilize deductibles in their structures, although the use of deductibles remains an effective part of our Modified Pool risk management strategy.

     Similar to the trend in new insurance written discussed above, Alt-A continues to grow as a percentage of our Primary insurance in force. The following table shows the percentage of our Primary insurance in force that we have classified as Alt-A at June 30, 2006 and 2005:

		2006				2005
Primary insurance in force			12.3	%			8.4	%
Modified Pool insurance in force			68.0	%			64.7	%
Total insurance in force			34.3	%			22.7	%

     The following tables highlight the percentages of the Primary risk in force by credit quality and loan type at June 30, 2006 and 2005:

		2006				2005
Credit quality:
Prime			82.6	%			85.3	%
Alt-A			12.8				9.3
A Minus			3.9				4.5
Sub Prime			0.7				0.9
Total			100.0	%			100.0	%
Loan type:
Fixed			72.6	%			74.1	%
ARM			27.4				25.9
Total			100.0	%			100.0	%

     At June 30, 2006, approximately 44% of our ARMs in force could be classified as hybrid ARMs with an initial fixed rate period of five years or greater compared to 54% at June 30, 2005. Additionally, POAs comprised approximately 8% of Primary risk in force at June 30, 2006 compared to 2% at June 30, 2005.

     We offer mortgage insurance structures designed to allow lenders to share in the risks of mortgage 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. The following table shows the percentage of our Primary flow channel insurance in force as well as the percentage of our total insurance in force that was subject to captive reinsurance arrangements at June 30, 2006 and 2005.

		2006				2005
Primary flow insurance in force			62.7	%			57.2	%
Total insurance in force			37.1	%			41.8	%

     The growth of the Primary flow insurance in force that was subject to captive reinsurance arrangements at June 30, 2006 over June 30, 2005 was the result of increased production from lenders that participate in those arrangements. Specifically, one large lender entered into a captive agreement that had not previously participated. The decline in the total direct insurance in force subject to captive reinsurance at June 30, 2006 from June 30, 2005 reflects the fact that a greater portion of our insurance in force consists of Modified Pool insurance in force, which is written through the structured bulk channel and is not subject to captive reinsurance arrangements.

     We believe captive reinsurance arrangements are an effective risk management tool as selected lenders share in the risk under these arrangements. Additionally, captive reinsurance arrangements are structured so that we receive credit against the capital required in certain risk-based capital models utilized by rating agencies. We remain committed to structuring captive

reinsurance arrangements, including deep ceded arrangements where the net premium cede rate is greater than 25%, on a lender-by-lender basis as we deem it to be prudent. We will continue to be an active participant with our lender partners in captive reinsurance arrangements.

  Revenues

     A summary of the significant individual components of our revenue for the three months and six months ended June 30, 2006 and 2005 follows:

		Three Months Ended												Six Months Ended
		June 30												June 30
		2006				2005				% Change				2006				2005				% Change
		(In thousands, except percentages)
Direct premium written		$	60,961			$	50,559				20.6	%		$	120,273			$	98,886				21.6	%
Ceded premium written			(11,603	)			(9,948	)			16.6				(22,573	)			(19,564	)			15.4
Net premium written			49,358				40,611				21.5				97,700				79,322				23.2
Change in unearned premiums			1,309				510				156.7				857				576				48.8
Earned premiums		$	50,667			$	41,121				23.2	%		$	98,557			$	79,898				23.4	%
Net investment income		$	6,535			$	5,743				13.8	%		$	12,757			$	11,158				14.3	%
Total revenues		$	57,979			$	46,905				23.6	%		$	112,989			$	91,113				24.0	%

     We were able to grow direct premium written for the second quarter and first six months of 2006 over that of the same periods of 2005 as a result of increased insurance in force through the strong growth in our Modified Pool insurance written discussed above. Strong production of new insurance combined with favorable persistency levels increased renewal premiums, which is included in direct premium written, for the second quarter of 2006 by $12.4 million or 26.7% over the second quarter of 2005 and by $26.0 million or 29.0% over the first half of 2005. Annual persistency was 72.1% at June 30, 2006 compared to 69.3% at June 30, 2005. Additionally, the net basis points on our average Primary insurance in force has risen 6% since the second quarter of 2005, which has contributed to the increase in earned premium. The increase in net basis points is attributable to an increased percentage of production with additional risk-based pricing, such as Alt-A (credit quality) and ARMs (loan type). The basis points on our average Modified Pool insurance in force has declined 12% since the second quarter of 2005, reflecting changes in the deductibles and stop loss limits used in the structure of the transactions. The risk characteristics of the Modified Pool insurance in force include a larger percentage of ARMs, and this portfolio is primarily an Alt-A portfolio.

     Ceded premium written is comprised of premiums written under excess of loss reinsurance treaties with captive as well as non-captive reinsurance companies. The growth in ceded premium written in the second quarter of 2006 and the first half of 2006 over the same periods of 2005 was not as large as the growth in direct premium written, as a result of a larger percentage of direct premium written not being subject to captive reinsurance arrangements. The following table provides further data on ceded premiums for the three months and six months

ended June 30, 2006 and 2005:

		Three Months Ended								Six Months Ended
		June 30								June 30
		2006				2005				2006				2005
Premium cede rate (ceded premiums written as a percentage of direct premiums written)			19.0	%			19.7	%			18.8	%			19.8	%
Captive reinsurance premium cede rate (ceded premiums written under captive reinsurance arrangements as a percentage of direct premiums written)			17.8	%			18.1	%			17.5	%			18.2	%
Average captive premium cede rate (ceded premiums written under captive reinsurance arrangements as a percentage of direct premiums written under captive reinsurance arrangements)			36.7	%			36.1	%			36.9	%			36.3	%

     The table below provides data on insurance written that was subject to captive reinsurance arrangements for the three months and six months ended June 30, 2006 and 2005:

		Three Months Ended								Six Months Ended
		June 30								June 30
		2006				2005				2006				2005
Primary insurance written			53.2	%			54.6	%			54.0	%			51.3	%
Total insurance written			26.5	%			33.9	%			21.2	%			29.1	%

     The increase in the percentage of Primary insurance written subject to captive reinsurance arrangements for the first half of 2006 over the first half of 2005 was due to lower production in the first half of 2006 of certain lender-paid programs that are not subject to captive reinsurance arrangements. Because a greater portion of our total production in the second quarter and first half of 2006 came from Modified Pool insurance, the percentage of total insurance written subject to captive reinsurance for the second quarter and first six months of 2006 declined from those corresponding periods of 2005. None of our Modified Pool insurance written in 2006 or 2005 was subject to captive reinsurance arrangements.

     The difference between net written premiums and earned premiums is the change in the unearned premium reserve, which is established primarily on premiums received on annual products. Our unearned premium liability decreased $1.3 million in the second quarter of 2006 and $0.9 million for the six months ended June 30, 2006 compared to $0.5 million in the second quarter of 2005 and $0.6 million for the six months ended June 30, 2005 due to declines in annual premium business in the second quarter and first half of 2006.

     Assuming no significant decline in interest rates, we anticipate our persistency will remain near current levels during the remainder of 2006. We anticipate that this will continue to have a positive effect on renewal earned premiums and total earned premiums.

     Net investment income for the second quarter and the first six months of 2006 increased over that for the second quarter and first six months of 2005 due to growth in average invested assets, partially offset by declines in portfolio yields. Average invested assets at cost or amortized cost for the second quarter of 2006 grew by 16.1% over the second quarter of 2005 as a result of the investment of cash flows from operations. For the first six months of 2006, average invested assets at cost or amortized cost increased by 16.5% over that of 2005. Our investment portfolio tax-equivalent yield was 6.73% at June 30, 2006 compared to 6.86% at June 30, 2005. We anticipate a continuing decline in the overall portfolio tax-equivalent yield as current interest rates are still below our average portfolio rate. See further discussion of the Investment Portfolio section of this document.

  Losses and Expenses

     A summary of the individual components of losses and expenses for the three months and six months ended June 30, 2006 and 2005 follows:

		Three Months Ended												Six Months Ended
		June 30												June 30
		2006				2005				% Change				2006				2005				% Change
		(In thousands, except percentages)
Net losses and loss adjustment expenses		$	17,271			$	17,288				(0.1	)%		$	33,622			$	27,918				20.4	%
Amortization of deferred policy acquisition costs		$	4,118			$	3,695				11.4			$	7,980			$	7,352				8.5
Other operating expenses (net of acquisition costs deferred)		$	8,496			$	7,017				21.1			$	17,009			$	14,234				19.5
Loss ratio			34.1	%			42.0	%							34.1	%			34.9	%
Expense ratio			25.6	%			26.4	%							25.6	%			27.2	%
Combined ratio			59.7	%			68.4	%							59.7	%			62.1	%

     Net losses and loss adjustment expenses (LAE) for the second quarter of 2006 were essentially flat compared to the same quarter a year ago while amortization of DAC and other operating expenses both increased over the second quarter of 2005. The increases in other operating expenses and in the amortization of DAC reflect the growth of our insurance in force and the hiring of several new executives that have taken place in 2006. The discussion below provides more detail on both losses and expenses.

     The following table provides detail on paid claims and the average severity for our Primary and Modified Pool insurance for the three months and six months ended June 30, 2006 and 2005:

		Three Months Ended												Six Months Ended
		June 30												June 30
		2006				2005				% Change				2006				2005				% Change
		(Dollars in thousands)
Paid claims:
Primary insurance		$	13,501			$	12,147				11.1	%		$	26,785			$	20,828				28.6	%
Modified Pool insurance			930				1,150				(19.1	)			2,030				2,120				(4.2	)
Total		$	14,431			$	13,297				8.5	%		$	28,815			$	22,948				25.6	%
Number of claims paid:
Primary insurance			523				421				24.2	%			1,029				773				33.1	%
Modified Pool insurance			48				47				2.1				115				102				12.7
Total			571				468				22.0	%			1,144				875				30.7	%
Average severity:
Primary insurance		$	25.8			$	28.9							$	26.0			$	26.9
Modified Pool insurance		$	19.4			$	24.5							$	17.7			$	20.8
Total		$	25.3			$	28.4							$	25.2			$	26.2

     Paid claims for the second quarter of 2006 increased 8.5% over the second quarter of 2005 and 25.6% for the first six months of 2006 over the first six months of 2005. These increases are primarily due to overall growth in the insurance portfolio as well as the seasoning of our portfolio as a larger percentage of our insurance in force reaches its anticipated highest claim frequency period of years two to five from loan origination.

     The decrease in average severity shown above for the second quarter and first half of 2006 from that for the same periods of 2005 is reflective of abnormally high severity experienced in the second quarter of 2005. This unfavorable severity was driven by an unusually high amount of large claims paid during that quarter and the fact that one of our larger servicers expedited its claims processing procedures, which hindered our loss mitigation efforts. One of the loss mitigation techniques that we utilize in an attempt to lower claim severity is the purchase and subsequent sale of properties in lieu of foreclosure. We expanded the use of this technique in the second half of 2005 and are continuing to utilize this strategy in 2006. Through the use of this strategy and updated claims administration software, we are experiencing success in limiting the growth of claims severity. Alt-A and Modified Pool loans are growing as a percentage of both our insurance and risk in force, and these types of loans generally have a larger average loan balance than the remainder of our portfolio. We expect the average severity will trend upward as the newer policy years develop and the average loan amounts rise due to these factors.

     Net losses and loss adjustment expenses also include the change in reserves for losses and loss adjustment expenses. The following table provides further information about our loss reserves at June 30, 2006 and 2005:

		2006				2005				% Change
		(In thousands, except percentages)
Primary insurance:
Reserves for reported defaults		$	46,560			$	33,003				41.1	%
Reserves for defaults incurred but not reported			4,362				3,274				33.2
Total Primary insurance			50,922				36,277				40.4
Modified Pool insurance:
Reserves for reported defaults			3,193				1,661				92.2
Reserves for defaults incurred but not reported			685				534				28.3
Total Modified Pool insurance			3,878				2,195				76.7
Reserve for loss adjustment expenses			105				104				1.0
Total reserves for losses and loss adjustment expenses		$	54,905			$	38,576				42.3	%

     The reserve for losses and loss adjustment expenses at June 30, 2006 increased significantly from June 30, 2005 primarily due to an increase in the number of defaults and an increase in the frequency and severity factors utilized in our reserving methodology. We believe that it is prudent to increase these factors to recognize the uncertainties in the macro economic environment as we monitor the impact of higher energy costs and interest rates as well as a moderation of house price appreciation in certain markets. The number of loans in default includes all reported delinquencies that are in excess of two payments in arrears at the reporting date and all reported delinquencies that were previously in excess of two payments in arrears and have not been brought current.

     The following table shows default statistics at June 30, 2006 and 2005:

		2006				2005
Total business:
Number of insured loans in force			324,111				278,837
Number of loans in default			6,485				5,325
With deductibles			1,099				612
Without deductibles			5,386				4,713
Percentage of loans in default (default rate)			2.00	%			1.91	%
Percentage of loans in default excluding deductibles*			1.66	%			1.69	%
Primary insurance:
Number of insured loans in force			216,458				219,256
Number of loans in default			4,787				4,013
Percentage of loans in default			2.21	%			1.83	%
Modified Pool insurance:
Number of insured loans in force			107,653				59,581
Number of loans in default			1,698				1,312
With deductibles			1,099				612
Without deductibles			599				700
Percentage of loans in default			1.58	%			2.20	%
Percentage of loans in default excluding deductibles*			0.56	%			1.17	%
Primary Alt-A business**:
Number of insured loans in force			18,581				14,427
Number of loans in default			628				460
Percentage of loans in default			3.38	%			3.19	%

     The increase in the default rate for Primary insurance is attributable to the continued seasoning of our business as a greater percentage of the insurance in force moves into the peak claim paying period and the defaults from FEMA-designated areas as a result of hurricanes Katrina and Rita that occurred in the second half of 2005.

     As shown in the above table, the number of Modified Pool defaults subject to deductibles continued to increase while the number of Modified Pool defaults without deductibles declined at June 30, 2006 as compared to June 30, 2005. At June 30, 2006, no structured bulk transaction with deductibles as part of the structure had incurred total losses that were nearing its individual deductible amount. We do not provide reserves on Modified Pool defaults with deductibles until the incurred losses for that specific structured bulk transaction exceed the deductible.

     A significant portion of the increase in defaults occurred in FEMA-designated areas as a result of hurricanes Katrina and Rita that took place during the late summer of 2005. Primary and Modified Pool insurance defaults from these FEMA-designated areas totaled 612 at June 30, 2006. The following table shows the changes in the defaults in these areas for the six months ended June 30, 2006:

Number of defaults in FEMA-designated areas at December 31, 2005			891
Number of defaults in FEMA-designated areas cured during the first six months of 2006 with no loss incurred			(565	)
Number of new defaults in FEMA-designated areas reported during the first six months of 2006			286
Number of defaults in FEMA-designated areas at June 30, 2006			612
Number of defaults in FEMA-designated areas at June 30, 2006 without deductibles			483

     At December 31, 2005, there were 693 defaults without deductibles in FEMA-designated areas.

     The terms of our coverage exclude any cost or expense related to the repair or remedy of any physical damage to the property collateralizing an insured mortgage loan. We have not obtained detailed property assessments for the defaults in the FEMA-designated areas. Our exposure could be limited if such assessments demonstrate that there is significant un-repaired physical damage to properties securing loans for which we have provided mortgage insurance. Additionally, we believe that many borrowers living in these areas did not make scheduled mortgage payments due to forbearance granted by Fannie Mae, Freddie Mac and lenders, even though the individual borrower’s financial condition was not significantly impacted. Given the unique circumstances surrounding this situation and absent any evidence that these defaults would develop differently, we continued to reserve for these defaults at our normal level. At June 30, 2006, there were reserves of $5.1 million for defaults in the FEMA-designated areas compared to $4.5 million at December 31, 2005. We will continue to monitor this situation throughout the remainder of 2006 as the longer-term impacts develop.

     Accounting practices in the mortgage insurance industry dictate that reserves are not established until a loan becomes delinquent. We have mentioned the increase in our writings of products subject to risk-adjusted pricing such as Alt-A and ARMs. The incidence rates of delinquencies on these products typically increase in the second through fourth year following loan origination. Much of the business that we have added subject to risk-adjusted pricing, especially those ARMs that have potential negative amortization, have not yet reached an age where we would expect to see an increase in delinquencies. We anticipate our number of loans in default for both Primary and Modified Pool insurance will increase as a result of the overall growth of our insurance in force and as a larger percentage of our insurance in force reaches the period of the highest expected incidence of defaults, especially those newer products subject to risk-adjusted pricing. We also expect default rates to increase, as these products become a larger percentage of our insurance in force. Consequently, we expect reserves will increase.

     We are cautious about housing market conditions in certain regions that have recently experienced rapid house price appreciation. Changes in the economic environment, such as the

impact of significantly higher energy costs, could accelerate paid and incurred loss development. Our reserving model incorporates management’s judgments and assumptions regarding these factors; however, due to the uncertainty of future premium levels, losses, economic conditions, and other factors that affect earnings, it is difficult to predict the impact of such higher claim frequencies on future earnings.

     Amortization of DAC for the three months and six months ended June 30, 2006 increased over that for the same periods in 2005, reflecting growth in the asset balance, partially offset by improved persistency. A full discussion of the impact of persistency on DAC amortization is included in the Deferred Policy Acquisition Costs section below.

     Other operating expenses for the second quarter and first six months of 2006 increased over the corresponding periods of 2005 due to growth in our insurance in force and due to expenses related to several new executives hired during 2006. Further, the adoption of SFAS 123(R), which requires the expensing of stock options, increased other operating expenses by approximately $313,000 in the second quarter of 2006 and approximately $593,000 for the first six months of 2006. Because the growth in net premiums written was greater than the growth in expenses, the expense ratio (ratio of the amortization of deferred policy acquisition costs and other operating expenses to net premiums written) for both the second quarter and first six months of 2006 was 25.6%, compared to 26.4% and 27.2% for the second quarter and first six months of 2005. We anticipate incurring additional expenses throughout the remainder of 2006 associated with our intention to incorporate a Canadian company to begin operations in that country. However, given our expectations for premium growth, we anticipate continued improvements in our expense ratio throughout the remainder of 2006.

     Our effective tax rate was 28.5% and 28.0% for the second quarter and first six months of 2006 compared to 27.5% and 28.0% for the second quarter and first six months of 2005. The increase in the effective tax rate was due primarily to the decline in the portion of pre-tax income generated from tax-preferred interest income on investments. We expect our effective tax rate to remain near current levels, or increase slightly if the total pre-tax income grows faster than tax-preferred investment income.

Significant Customers

     Our objective is controlled, profitable growth in both Primary and Modified Pool business while adhering to our risk management strategies. Our strategy is to continue our focus on national lenders while maintaining the productive relationships that we have built with regional lenders. Competition within the mortgage insurance industry continues to increase as many large mortgage lenders have limited the number of mortgage insurers with whom they do business. At the same time, consolidation among national lenders has increased the share of the mortgage origination market controlled by the largest lenders and that has led to further concentrations of business with a relatively small number of lenders. Many of the national lenders allocate Primary business to several different mortgage insurers. These allocations can vary over time. Our ten largest customers were responsible for 80% and 79% of Primary insurance written during the second quarter and first six months of 2006. For the second quarter and first six months of 2006, we had three customers that were each responsible for more than 10% of Primary insurance written. These customers were responsible for 63% and 62% of

Primary insurance written during the second quarter and first six months of 2006. Through actively seeking business with other lenders that meet our criteria, we are broadening our customer base in order to limit our concentration among lenders. The loss of or considerable reduction in business from one or more of these significant customers without a corresponding increase from other lenders would have an adverse effect on our business.

Financial Position

     Total assets increased to $809 million at June 30, 2006, an annualized growth rate of 11% over December 31, 2005, with most of the growth in invested assets and prepaid federal income taxes. Total liabilities increased to $278 million at June 30, 2006 from $268 million at December 31, 2005, primarily driven by an increase in deferred tax liabilities. This section identifies several items on our balance sheet that are important in the overall understanding of our financial position. These items include deferred policy acquisition costs, prepaid federal income tax and related deferred income taxes. The majority of our assets are in our investment portfolio. A separate Investment Portfolio section follows the Financial Position section and reviews our investment portfolio, key portfolio management strategies, and methodologies by which we manage credit risk.

  Deferred Policy Acquisition Costs

     Costs expended to acquire new business are capitalized as DAC and recognized as expense over the anticipated premium paying life of the policy in a manner that approximates the estimated gross profits. We employ a dynamic model that calculates amortization of DAC separately for each year of policy origination. The model relies on assumptions that we make based upon historical industry experience and our own unique experience regarding the annual persistency development of each year of policy origination. Persistency is the most important assumption utilized in determining the timing of reported amortization expense reflected in the income statement and the carrying value of DAC on the balance sheet. A change in the assumed persistency can impact the current and future amortization expense as well as the carrying value on the balance sheet. Our model accelerates DAC amortization through a dynamic adjustment when actual persistency for a particular year of policy origination is lower than the estimated persistency originally utilized in the model. This dynamic adjustment is capped at the levels assumed in the models, and we do not decrease DAC amortization below the levels assumed in the model when persistency increases above those levels. When actual persistency is lower than that assumed in our models, the dynamic adjustment effectively adjusts the estimated policy life utilized in the model to a policy life based upon the current actual persistency.

     Our DAC models separate the costs capitalized and the amortization streams between transactions arising from structured bulk and flow delivery channels. Generally, structured bulk transactions have significantly lower acquisition costs associated with the production of the business and they also have a shorter original estimated policy life. We apply the dynamic adjustment to the structured bulk transaction DAC models utilizing the same methodology. At June 30, 2006, net unamortized DAC relating to structured bulk transactions amounted to 7.3% of the total DAC on the balance sheet compared to 6.8% at December 31, 2005.

     The following table shows the DAC asset for the three months and six months ended June 30, 2006 and 2005 and the effect of persistency on amortization:

		Three Months Ended								Six Months Ended
		June 30								June 30
		2006				2005				2006				2005
		(In thousands, except percentages)
Balance — beginning of period		$	33,904			$	33,023			$	33,684			$	32,453
Costs capitalized			4,417				3,754				8,499				7,981
Amortization — normal			(3,988	)			(3,262	)			(7,837	)			(6,577	)
Amortization — dynamic adjustment			(130	)			(433	)			(143	)			(775	)
Total amortization			(4,118	)			(3,695	)			(7,980	)			(7,352	)
Balance — end of period		$	34,203			$	33,082			$	34,203			$	33,082
Annual Persistency											72.1	%			69.3	%

     The growth in the normal DAC amortization is due to the growth in the DAC asset. As the annual persistency improved at June 30, 2006 from June 30, 2005, DAC amortization resulting from the dynamic adjustment for the three months and six months ending June 30, 2006 declined from that for the same periods of 2005.

     Assuming no significant declines in interest rates, we expect persistency to remain flat or to improve moderately throughout the remainder of 2006. Based on this assumption, we anticipate DAC amortization to increase at a rate similar to growth in the DAC asset.

  Prepaid Federal Income Taxes and Deferred Income Taxes

     We purchase ten-year non-interest bearing United States Mortgage Guaranty Tax and Loss Bonds (“Tax and Loss Bonds”) to take advantage of a special contingency reserve deduction specific to mortgage guaranty companies. We record these bonds on our balance sheet as prepaid federal income taxes. Purchases of Tax and Loss Bonds are essentially a prepayment of federal income taxes that will become due in ten years when the contingency reserve is released, and the Tax and Loss Bonds mature. The proceeds from the maturity of the Tax and Loss Bonds are used to fund the income tax payments. Prepaid income taxes were $151.9 million at June 30, 2006 compared to $139.5 million at December 31, 2005.

     Deferred income taxes are provided for the differences in reporting taxable income in the financial statements and on the tax return. The largest cumulative difference is the special contingency reserve deduction for mortgage insurers mentioned above. The remainder of the deferred tax liability has primarily arisen from book and tax reporting differences related to DAC and unrealized investment gains.

Investment Portfolio

  Portfolio Description

     Our strategy for managing our investment portfolio is to optimize investment returns while preserving capital and liquidity and adhering to regulatory and rating agency requirements. We invest for the long term, and most of our investments are held until they mature. Our investment portfolio includes primarily fixed income securities, and the majority of these are tax-preferred state and municipal bonds. We have established a formal investment policy that describes our overall quality and diversification objectives and limits. Our investment policy and strategies are subject to change depending upon regulatory, economic, and market conditions as well as our existing financial condition and operating requirements, including our tax position. We invest for the long term and most of our investments are held until they mature. We classify our debt and equity securities with readily determinable market values as available for sale. This classification allows us the flexibility to dispose of securities in order to pursue our investment strategy and meet our operating requirements. Investments classified as available for sale are carried on our balance sheet at fair value. Investments without readily determinable market values are classified as other investments and are also carried at fair value.

     The following table shows the growth and diversification of our investment portfolio:

		June 30, 2006								December 31, 2005
		Amount				Percent				Amount				Percent
		(In thousands, except percentages)
Available-for-sale securities:
Fixed maturity securities:
U. S. government obligations		$	11,570				2.0	%		$	12,124				2.2	%
State and municipal bonds			527,653				91.7				500,027				91.4
Corporate bonds			17,102				3.0				21,855				4.0
Mortgage-backed bonds			53				0.0				58				0.0
Total fixed maturities			556,378				96.7				534,064				97.6
Equity securities			9,660				1.7				8,159				1.5
Total available-for-sale securities			566,038				98.4				542,223				99.1
Other investments			5,000				0.9				—				0.0
Short-term investments			4,277				0.7				4,796				0.9
		$	575,315				100.0	%		$	547,019				100.0	%

     We seek to provide liquidity in our investment portfolio through cash equivalent investments and through diversification and investment in publicly traded securities. We attempt to maintain a level of liquidity and duration in our investment portfolio consistent with our business outlook and the expected timing, direction, and degree of changes in interest rates.

     We also manage risk and liquidity by limiting our exposure on individual securities. The following table shows the ten largest exposures to an individual creditor, or issuer in the case of equity securities, in our investment portfolio as of June 30, 2006:

		Carrying				% of Total
Name of Creditor/Issuer		Value				Invested Assets
		(In thousands, except percentages)
Atlanta, Georgia Airport		$	6,700				1.16	%
State of Connecticut			6,375				1.11
State of Pennsylvania			5,962				1.04
Federal National Mortgage Association			5,275				0.92
State of Hawaii			5,240				0.91
State of California			5,000				0.87
Structured Credit Holdings Plc (common stock)			5,000				0.87
Port of Seattle, Washington			4,526				0.79
City of Chicago, Illinois			4,373				0.76
Denver, Colorado City and County Airport			4,166				0.72

     As shown above, no investment in the securities of any single issuer exceeded 2% of our investment portfolio at June 30, 2006.

     The following table shows the results of our investment portfolio for the three months and six months ended June 30, 2006 and 2005:

		Three Months Ended								Six Months Ended
		June 30								June 30
		2006				2005				2006				2005
		(In thousands, except percentages)
Average investments at cost or amortized cost		$	558,506			$	481,131			$	550,804			$	472,904
Pre-tax net investment income		$	6,535			$	5,743			$	12,757			$	11,158
Pre-tax yield			4.7	%			4.8	%			4.6	%			4.7	%
Pre-tax realized investment gains		$	772			$	39			$	1,672			$	46

     The tax equivalent yield-to-maturity at June 30, 2006 was 6.7% compared to 6.9% at June 30, 2005. The decline in the tax-equivalent yield-to-maturity reflects the impact of the maturity or call of higher yielding investments and the subsequent investment purchases at available new money rates, which were lower than that of our overall portfolio. We anticipate this trend to continue throughout the remainder of 2006.

  Unrealized Gains and Losses

     The following table summarizes by category our unrealized gains and losses in our securities portfolio at June 30, 2006:

		Cost or				Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
		(In thousands)
Available-for-sale securities:
Fixed maturity securities:
U. S. government obligations		$	12,108			$	3			$	(541	)		$	11,570
State and municipal bonds			524,413				7,598				(4,358	)			527,653
Corporate bonds			16,220				917				(35	)			17,102
Mortgage-backed bonds			51				2				—				53
Subtotal, fixed maturities			552,792				8,520				(4,934	)			556,378
Equity securities			9,605				423				(368	)			9,660
Total available-for-sale securities			562,397				8,943				(5,302	)			566,038
Other investments			5,000				—				—				5,000
		$	567,397			$	8,943			$	(5,302	)		$	571,038