FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2009
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 0-22342
Triad Guaranty Inc.
(Exact name of registrant as specified in its charter)
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DELAWARE
(State or other jurisdiction of
incorporation or organization)
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56-1838519
(I.R.S. Employer
Identification No.) |
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101 South Stratford Road
Winston-Salem, North Carolina
(Address of principal executive offices)
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27104
(Zip Code) |
(336) 723-1282
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act. (Check one):
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Large accelerated filer o
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Accelerated filer o
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Non-accelerated filer o
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Smaller reporting company þ |
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(Do not check if a smaller reporting company) |
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
Number of shares of common stock, par value $0.01 per share, outstanding as of May 1, 2009, was
15,215,378.
TRIAD GUARANTY INC.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
TRIAD GUARANTY INC.
CONSOLIDATED BALANCE SHEETS
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March 31, |
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December 31, |
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(dollars in thousands, except per share data) |
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2009 |
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2008 |
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(unaudited) |
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ASSETS |
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Invested assets: |
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Securities available-for-sale, at fair value: |
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Fixed maturities (amortized cost: 880,404 and $44,964) |
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$ |
904,904 |
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$ |
854,186 |
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Equity securities (cost: $488 and $566) |
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491 |
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583 |
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Short-term investments |
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13,136 |
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40,653 |
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Total invested assets |
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918,531 |
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895,422 |
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Cash and cash equivalents |
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21,394 |
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39,940 |
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Real estate acquired in claim settlement |
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526 |
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713 |
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Accrued investment income |
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10,676 |
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10,515 |
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Property and equipment |
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7,096 |
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7,747 |
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Reinsurance recoverable, net |
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182,589 |
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150,848 |
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Other assets |
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34,550 |
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25,349 |
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Total assets |
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$ |
1,175,362 |
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$ |
1,130,534 |
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LIABILITIES AND STOCKHOLDERS (DEFICIT) EQUITY |
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Liabilities: |
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Losses and loss adjustment expenses |
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$ |
1,262,746 |
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$ |
1,187,840 |
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Unearned premiums |
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15,958 |
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15,863 |
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Amounts payable to reinsurers |
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1,001 |
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719 |
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Long-term debt |
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34,532 |
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34,529 |
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Accrued interest on debt |
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584 |
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1,275 |
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Accrued expenses and other liabilities |
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41,934 |
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26,974 |
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Total liabilities |
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1,356,755 |
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1,267,200 |
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Commitments and contingencies Note # 5 |
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Stockholders deficit: |
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Preferred stock, par value $0.01 per share authorized 1,000,000
shares; no shares issued and outstanding |
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Common stock, par value $0.01 per share authorized 32,000,000
shares; issued and outstanding 15,215,378 shares at March 31,
2009 and 15,161,259 shares at December 31, 2008 |
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152 |
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151 |
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Additional paid-in capital |
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112,822 |
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112,629 |
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Accumulated other comprehensive income, net of income tax liability
of $5,521 at March
31, 2009 and $3,265
at December 31,
2008 |
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16,316 |
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6,063 |
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Retained earnings (accumulated deficit) |
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(310,683 |
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(255,509 |
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Total stockholders deficit |
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(181,393 |
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(136,666 |
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Total liabilities and stockholders deficit |
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$ |
1,175,362 |
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$ |
1,130,534 |
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See accompanying notes.
1
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
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Three Months Ended |
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March 31, |
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(dollars in thousands, except per share data) |
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2009 |
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2008 |
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Revenue: |
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Premiums written: |
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Direct |
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$ |
55,623 |
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$ |
89,386 |
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Ceded |
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(11,130 |
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(15,995 |
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Net premiums written |
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44,493 |
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73,391 |
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Change in unearned premiums |
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(135 |
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(1,326 |
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Earned premiums |
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44,358 |
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72,065 |
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Net investment income |
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11,192 |
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9,546 |
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Net realized investment (losses) gains |
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(4,565 |
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2,703 |
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Other income |
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2 |
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2 |
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50,987 |
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84,316 |
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Losses and expenses: |
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Net losses and loss adjustment expenses |
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101,577 |
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221,259 |
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Net change in premium deficiency reserve |
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15,000 |
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Interest expense on debt |
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694 |
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1,476 |
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Policy acquisition costs |
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39,416 |
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Other operating expenses (net of acquisition costs deferred) |
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9,411 |
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14,105 |
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111,682 |
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291,256 |
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Loss before income tax benefit |
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(60,695 |
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(206,940 |
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Income tax benefit: |
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Current |
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(3 |
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Deferred |
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(5,521 |
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(56,923 |
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(5,521 |
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(56,926 |
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Net loss |
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$ |
(55,174 |
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$ |
(150,014 |
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Loss per common and common equivalent share: |
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Basic |
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$ |
(3.68 |
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$ |
(10.09 |
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Diluted |
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$ |
(3.68 |
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$ |
(10.09 |
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Shares used in computing loss per common and
common equivalent share: |
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Basic |
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14,993,742 |
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14,868,610 |
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Diluted |
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14,993,742 |
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14,868,610 |
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See accompanying notes.
2
TRIAD GUARANTY INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(unaudited)
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Three Months Ended |
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March 31, |
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(dollars in thousands) |
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2009 |
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2008 |
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Operating activities |
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Net loss |
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$ |
(55,174 |
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$ |
(150,014 |
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Adjustments to reconcile net loss to net cash provided by
operating activities: |
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Losses, loss adjustment expenses and unearned premium reserves |
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75,001 |
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189,203 |
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Net change in premium deficiency reserve |
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15,000 |
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Accrued expenses and other liabilities |
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14,960 |
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(1,333 |
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Income taxes recoverable |
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78 |
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Reinsurance, net |
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(31,459 |
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2,676 |
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Accrued investment (loss) income |
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(161 |
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522 |
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Policy acquisition costs deferred |
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(3,173 |
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Policy acquisition costs |
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39,416 |
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Net realized investment losses (gains) |
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4,565 |
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(2,703 |
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Provision for depreciation |
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649 |
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1,566 |
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Accretion of discount on investments |
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285 |
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324 |
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Deferred income taxes |
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(5,521 |
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(56,923 |
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Prepaid federal income taxes |
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410 |
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Real estate acquired in claim settlement, net of write-downs |
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187 |
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1,867 |
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Accrued interest on debt |
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(691 |
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(771 |
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Other assets |
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357 |
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406 |
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Other operating activities |
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259 |
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(10,576 |
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Net cash provided by operating activities |
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3,335 |
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25,897 |
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Investing activities |
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Securities available-for-sale: |
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Purchases fixed maturities |
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(88,391 |
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(136,426 |
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Sales fixed maturities |
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38,938 |
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96,428 |
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Maturities fixed maturities |
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7,176 |
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Sales equities |
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4 |
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266 |
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Net change in short-term investments |
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27,566 |
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43,180 |
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Property and equipment |
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2 |
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(707 |
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Net cash (used in) provided by investing activities |
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(21,881 |
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9,917 |
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Financing activities |
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Repayment of revolving credit facility |
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(80,000 |
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Net cash used in financing activities |
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(80,000 |
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Foreign currency translation adjustment on cash and cash equivalents |
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(81 |
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Net change in cash and cash equivalents |
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(18,546 |
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(44,267 |
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Cash and cash equivalents at beginning of period |
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39,940 |
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124,811 |
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Cash and cash equivalents at end of period |
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$ |
21,394 |
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$ |
80,544 |
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Supplemental schedule of cash flow information |
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Cash (received) paid during the period for: |
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See accompanying notes.
3
TRIAD GUARANTY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2009
(Unaudited)
1. The Company
Triad Guaranty Inc. is a holding company which, through its wholly-owned subsidiary, Triad
Guaranty Insurance Corporation (TGIC), historically has provided mortgage insurance coverage in
the United States. Triad, as used in this report, includes the operations of TGIC and its
wholly-owned subsidiary, Triad Guaranty Assurance Corporation. Mortgage insurance 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 is an
Illinois-domiciled insurance company and the Illinois Department of Financial and Professional
Regulation, Division of Insurance (the Division) is our primary regulator. Triad ceased issuing
new commitments for mortgage guaranty insurance coverage on July 15, 2008 and is operating the
business in run-off under two Corrective Orders issued in August 2008 and March 2009 by the
Division. The term run-off, as used in these financial statements, refers to Triad no longer
writing new mortgage insurance policies, but continuing to service its existing policies.
Servicing existing policies includes: receiving premiums on policies that remain in force;
cancelling coverage at the insureds request; terminating policies for non-payment of premium;
working with borrowers in default to remedy the default and/or mitigate Triads loss; and settling
all legitimate filed claims per the provisions of the Corrective Orders. The Corrective Orders,
among other things, allow management to continue to operate Triad under close supervision, include
restrictions on the distribution of dividends or interest on notes payable to its parent by Triad,
and include restrictions on the payment of claims. Failure to comply with the provisions of the
Corrective Orders could result in the imposition of fines or penalties or subject Triad to further
legal proceedings, including receivership proceedings for the conservation, rehabilitation or
liquidation of Triad. Triad Guaranty Inc. and its subsidiaries are collectively referred to herein
as the Company.
2. Going Concern
The Company prepares its financial statements presented in this quarterly report on Form 10-Q
in conformity with accounting principles generally accepted in the United States of America
(GAAP). The financial statements for Triad that are provided to the Division and that form the
basis for our corrective plan were prepared in accordance with Statutory Accounting Principles
(SAP) as set forth in the Illinois Insurance Code. The primary differences between GAAP and SAP
for Triad at March 31, 2009 were the methodology utilized for the establishment of reserves, the
recognition of the net amount for the excess of loss reinsurance policy that is currently in
arbitration, and the reporting requirements stipulated in the second Corrective Order. A deficit
in assets occurs when recorded liabilities exceed recorded assets in financial statements prepared
under GAAP. A deficiency in policyholders surplus occurs when recorded liabilities exceed
recorded assets in financial statements prepared under SAP. A deficit in assets is not necessarily
a measure of insolvency. However, the Company believes that if Triad were to report a deficiency
in policyholders surplus, Illinois law may require the Director
to seek receivership in the courts, which could
compel the parent, Triad Guaranty Inc., to declare bankruptcy.
The Company has prepared its financial statements on a going concern basis under GAAP, which
contemplates the realization of assets and the satisfaction of liabilities and commitments in the
normal course of business. However, there is substantial doubt as to the Companys ability to
continue as a going concern. This uncertainty is based on the ability of Triad to comply with the
run-off provisions of the Corrective Orders, the Companys recurring losses from operations and a
deficit in assets being reported for each of the periods ended September 30, 2008, December 31,
2008, and March 31, 2009. The Companys financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset amounts or amounts of
liabilities that might be necessary should the Company be unable to continue in existence.
4
The Company incurred significant operating losses for the year ended December 31, 2008 and
continued to incur operating losses during the first quarter of 2009. At March 31, 2009, the
Company had a deficit in assets of $181.4 million. The operating losses are the result of
increased defaults and foreclosures arising from steeply declining home prices as the U.S.
recession continues to impact the mortgages that the Company has insured. Additionally and as
noted above, the Company is limited in its ability to offset these operating losses with revenue
from new business because Triad is operating in run-off under two Corrective Orders with the
Division and can no longer issue commitments for new insurance.
Terms of the initial Corrective Order required Triad to submit a corrective plan, which
included a five-year projection of operations and financial condition. The plan was submitted by
Triad in October 2008 and indicated a solvent run-off. Since the approval of the initial
corrective plan, the Company has revised the assumptions initially utilized as a result of
continued deteriorating economic conditions impacting its financial condition, results of
operations and future prospects. Triads new assumptions produced a range of potential ultimate
outcomes for the run-off and projected that Triad would report a deficiency in policyholders
surplus under SAP as early as March 31, 2009. As a result, the Division issued the second
Corrective Order on March 31, 2009 requiring Triad to settle its claim liabilities with 60% cash
and 40% by recording a deferred payment obligation (DPO) beginning June 1, 2009 or such later
date as is ordered by the Division. The DPO will be represented by a separate entry in Triads
financial statements and will accrue a carrying charge. Payment of the carrying charge and the DPO
will be subject to Triads future financial performance and will require approval of the Illinois
Director. Triad will be required to adjust its SAP balance sheet through the reduction of its
reserves under SAP to what will be required initially in cash with the resulting increase in
surplus providing a SAP policyholder surplus at March 31, 2009 of $393.3 million. Each DPO will
bear a carrying charge at Triads earned investment rate and the repayment of the DPO and related
interest is subject to the Divisions approval. If the Companys revised corrective plan is
unsuccessful, Illinois law may require the Director to seek
receivership in the courts, which, if successful, could compel the
parent, Triad Guaranty Inc., to declare bankruptcy. The ability to successfully implement the
revised corrective plan by management is unknown at this time and is dependent upon many factors,
including improved macroeconomic conditions in the United States.
3. Accounting Policies and Basis of Presentation
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in conformity
with GAAP for interim financial information and with the instructions to Form 10-Q and Article 8 of
Regulation S-X. Accordingly, they do not include all of the information and footnotes required by
accounting principles generally accepted in the United States for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the three months ended
March 31, 2009 are not necessarily indicative of the results that may be expected for the year
ending December 31, 2009 or subsequent quarterly periods. For further information, refer to the
consolidated financial statements and footnotes thereto included in the Companys Annual Report on
Form 10-K for the year ended December 31, 2008.
Recent Accounting Pronouncements
In April 2009, the Financial Accounting Standards Board (FASB) issued FASB Staff Position
(FSP) Statement of Financial Accounting Standards (SFAS) No. 157-4, Determining Fair Value When
the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and
Identifying Transactions That Are Not Orderly (FSP 157-4). FSP 157-4 provides guidelines for
making fair value measurements more consistent with the principles presented in SFAS No. 157, Fair
Value Measurements (SFAS 157). FSP 157-4 relates to determining fair values when there is no
active market or where the price inputs being used represent distressed sales. It reaffirms what
SFAS 157 states is the objective of fair value measurement to reflect how much an asset
5
would be sold for in an orderly transaction (as opposed to a distressed or forced transaction)
at the date of the financial statements under current market conditions. Specifically, it reaffirms
the need to use judgment to ascertain if a formerly active market has become inactive and in
determining fair values when markets have become inactive. FSP 157-4 is effective for interim and
annual reporting periods ending after June 15, 2009, and will be applied prospectively. The Company
is currently evaluating the impact of the implementation of FSP 157-4 on its consolidated financial
position, results of operations and cash flows.
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting
Principles (SFAS 162). This statement identifies the sources of accounting principles and the
framework for selecting the principles used in the preparation of financial statements of
non-governmental entities that are presented in conformity with GAAP. SFAS 162 is effective 60
days following the SECs approval of the Public Company Accounting Oversight Board amendments to AU
Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting
Principles. The Company does not anticipate that SFAS 162 will have a material impact on the
Companys financial position or results of operations.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
Financial Statements an amendment of Accounting Research Bulletin (ARB) No. 51 (SFAS 160),
which aims to improve the relevance, comparability and transparency of the financial information
that a reporting entity provides in its consolidated financial statements by establishing
accounting and reporting standards surrounding noncontrolling interests, or minority interests,
which are the portions of equity in a subsidiary not attributable, directly or indirectly, to a
parent. The ownership interests in subsidiaries held by parties other than the parent shall be
clearly identified, labeled and presented in the consolidated statement of financial position
within equity, but separate from the parents equity. The amount of consolidated net income
attributable to the parent and to the noncontrolling interest must be clearly identified and
presented on the face of the Consolidated Statements of Income. Changes in a parents ownership
interest while the parent retains its controlling financial interest in its subsidiary must be
accounted for consistently as equity transactions. A parents ownership interest in a subsidiary
changes if the parent purchases additional ownership interests in its subsidiary, sells some of its
ownership interests in its subsidiary, the subsidiary reacquires some of its ownership interests or
the subsidiary issues additional ownership interests. When a subsidiary is deconsolidated, any
retained noncontrolling equity investment in the former subsidiary must be initially measured at
fair value. The gain or loss on the deconsolidation of the subsidiary is measured using the fair
value of any noncontrolling equity investment rather than the carrying amount of that retained
investment. Entities must provide sufficient disclosures that clearly identify and distinguish
between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is
effective for fiscal years, and interim periods within those fiscal years, beginning on or after
December 15, 2008. The Company adopted SFAS 160 effective January 1, 2009, and the adoption did
not have any material impact on its consolidated financial condition and results of operations.
In December 2007, the FASB issued SFAS 141(R), Business Combinationsa replacement of FASB
Statement No. 141 (SFAS 141(R)), which significantly changes the principles and requirements for
how the acquirer of a business recognizes and measures in its financial statements the identifiable
assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The
statement also provides guidance for recognizing and measuring the goodwill acquired in the
business combination and determines what information to disclose to enable users of the financial
statements to evaluate the nature and financial effects of the business combination. This
statement is effective prospectively, except for certain retrospective adjustments to deferred tax
balances, for fiscal years beginning after December 15, 2008. This statement was effective for the
Company beginning January 1, 2009. SFAS 141(R) did not have any material impact on the Companys
financial position or results of operations.
In April 2009, the FASB issued FSP SFAS No. 115-2 and SFAS No. 124-2, Recognition and
Presentation of Other-Than-Temporary Impairments (FSP 115-2 and SFAS 124-2). FSP 115-2 and SFAS
124-2 provide additional guidance designed to create greater clarity and consistency in accounting
and in presenting impairment
6
losses on securities. FSP 115-2 and SFAS 124-2 are intended to bring greater consistency to
the timing of impairment recognition, and provide greater clarity to investors about the credit and
noncredit components of impaired debt securities that are not expected to be sold. The measure of
impairment in comprehensive income remains fair value. FSP 115-2 and SFAS 124-2 also require
increased and more timely disclosures regarding expected cash flows, credit losses, and an aging of
securities with unrealized losses. FSP 115-2 and SFAS 124-2 are effective for interim and annual
reporting periods ending after June 15, 2009, with early adoption permitted for periods ending
after March 15, 2009. Earlier adoption for periods ending before March 15, 2009 is not permitted.
The Company is currently evaluating the impact of the implementation of FSP 115-2 and SFAS 124-2 on
its consolidated financial position, results of operations and cash flows.
4. 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.
5. Commitments and Contingencies
Reinsurance
Certain premiums and losses are ceded to other insurance companies under various reinsurance
agreements, the majority of which are captive reinsurance agreements with affiliates of certain
customers. Reinsurance contracts do not relieve Triad from its obligations to policyholders.
Failure of the reinsurer to honor its obligation could result in losses to Triad; consequently,
allowances are established for amounts deemed uncollectible.
Under captive reinsurance agreements, the counterparties are required to establish trust
accounts to support the reinsurers obligations under the reinsurance agreements. At March 31,
2009, we had approximately $262 million in captive reinsurance trust balances supporting the risk
transferred to the captive reinsurers. In the first quarter of 2009, one of the captive reinsurance
agreements and the supporting trust agreement was terminated. As a result of the termination, all
coverage ceased, the trust balance supporting the reinsurers obligations was returned to Triad,
and the reinsurance recoverable was eliminated. As of March 31, 2009, there was one captive
reinsurance arrangement where the total ceded reserves, combined with any unpaid ceded claims, had
exceeded the trust balance and the recoverable was therefore limited to the trust balance.
Triad maintains a $95 million Excess-of-Loss reinsurance treaty that provides a benefit when
Triads risk-to-capital ratio exceeds 25-to-1 and the combined ratio exceeds 100% (the attachment
point). Once the attachment point has been reached, following a one-time deductible of $25
million, the carrier is responsible for the reimbursement of all paid losses in each quarter that
the attachment point is breached up to the one-time $95 million policy limit. The coverage period
is for 10 years. Additionally, terms of the treaty require Triad to continue the payment of
premiums to the reinsurer amounting to approximately $2 million per year for the entire ten year
period. The reinsurance treaty attached at the end of the first quarter of 2008; however, in April
2008 the reinsurance carrier provided a purported notice of termination of the agreement. By
letter dated May 5, 2008, Triad notified the reinsurer that the Company considered the treaty to
still be in effect and demanded arbitration seeking a ruling (i) stating that the reinsurance
remained in effect and (ii) requiring that the reinsurer comply with terms of the treaty. The
arbitration took place in front of a three-person panel in December 2008 and January 2009, with
post-hearing briefs and oral arguments in February 2009. The Company expects a decision to be
rendered by the arbitration panel in the second quarter of 2009.
7
Insurance In Force, Dividend Restrictions, and Statutory Results
Historically, insurance regulators and rating agencies utilized the risk-to-capital ratio as a
general guideline to limit the risk a mortgage insurer could write with a 25-to-1 risk-to-capital
ratio as the maximum allowed. Capital for purposes of this computation includes the statutory
capital and surplus as well as the statutory contingency reserve. The amount of net risk for
insurance in force at March 31, 2009, December 31, 2008, and March 31, 2008, 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. Several states have specifically allowed mortgage insurers to reduce the risk
outstanding by the amount of risk in default in their calculation of risk-to-capital. In the
calculation presented below, the Company has not reduced the risk outstanding for the risk in
default. Triads ratio is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
March 31, |
|
(dollars in thousands) |
|
2009 |
|
|
2008 |
|
|
2008 |
|
Net risk |
|
$ |
10,630,486 |
|
|
$ |
11,019,036 |
|
|
$ |
11,969,155 |
|
|
Statutory capital and surplus |
|
$ |
393,328 |
|
|
$ |
88,027 |
|
|
$ |
203,352 |
|
Statutory contingency reserve |
|
|
|
|
|
|
|
|
|
|
228,208 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
393,328 |
|
|
$ |
88,027 |
|
|
$ |
431,560 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Risk-to-capital ratio |
|
|
27.0 to 1 |
|
|
|
125.2 to 1 |
|
|
27.7 to 1 |
|
|
|
|
|
|
|
|
|
|
|
The increase in statutory policyholders surplus and the decline in the risk-to-capital ratio
at March 31, 2009 from the levels at December 31, 2008 is primarily the result of the impact on
statutory loss reserves of the additional Corrective Order that requires all valid claims be paid
60% in cash and 40% by recording a DPO. As a result of this requirement, loss reserves under SAP
at March 31, 2009 were reduced by $485.5 million. This accounting change under SAP was adopted on a
prospective basis, and, accordingly, the entire amount was recorded as a cumulative effect to
surplus. There was no such impact to loss reserves calculated on a GAAP basis.
In run-off, Triad will not be issuing any new commitments for insurance. Any new insurance
written will come only from commitments issued up to July 15, 2008 and this amount will be
immaterial. Even if Triads risk-to-capital ratio were to be reduced to 25.0 or lower as a result
of the additional Corrective Order, we would continue to be prohibited from issuing new commitments
for insurance.
As determined in accordance with SAP, Triad experienced a net loss of $171.0 million for the
three months ended March 31, 2009, a net loss of $573.9 million for the year-ended December 31,
2008, and a net loss of $155.0 million for the three months ended March 31, 2008. Effective
September 30, 2008, Triad changed its method of calculating the reserve for losses under SAP for
its statutory financial statements to comply with the Illinois insurance code, which requires that
reserves are to be provided on loans that were in default four months or greater or loans in
foreclosure. Previously, Triad had provided reserves on loans that were two months or greater in
default or loans in foreclosure, which was another acceptable method of statutory accounting. This
change had no impact on the Companys methodology for calculating reserves under GAAP.
Under the Corrective Orders issued by the Division, Triad is currently prohibited, and expects
to be prohibited for the foreseeable future, from paying any dividends to the Company. Triad also
has a $25 million outstanding surplus note held by the Company. Under the terms of the Corrective
Orders, Triad is also prohibited from paying interest on the surplus note.
8
Loss Reserves
The Company establishes loss reserves to provide for the estimated costs of settling claims on
loans reported in default and estimates of loans in default that are in the process of being
reported to the Company as of the date of the financial statements. Consistent with industry
accounting practices, the Company does not establish loss reserves for future claims on insured
loans that are not currently in default. Amounts recoverable from the sale of properties acquired
in lieu of foreclosure are considered in the determination of the reserve estimates. Loss reserves
are established by management using historical experience and by making various assumptions and
judgments about claim rates (frequency) and claim amounts (severity) to estimate ultimate losses to
be paid on loans in default. The Companys reserving methodology gives effect to current economic
conditions and profiles delinquencies by such factors as default status, policy year, specific
lenders, and the number of months the policy has been in default, as well as the combined original
loan-to-value (LTV) ratio. Also, the Company believes policies originated by certain lenders may
have involved misrepresentations, fraud or other underwriting violations that provide Triad with
the right to deny or rescind coverage and, accordingly, the reserving methodology also accounts for
expected rescissions. The assumptions utilized in the calculation of the loss reserve estimate are
continually reviewed, and as adjustments to the reserve become necessary, such adjustments are
reflected in the financial statements in the periods in which the adjustments are made.
Litigation
The Company is involved in litigation in the ordinary course of business as well as the case
named below. No pending litigation is expected to have a material adverse effect on the financial
position of the Company.
On February 6, 2009, James L. Phillips served a complaint against Triad Guaranty Inc., Mark K.
Tonnesen and Kenneth W. Jones in the United States District Court, Middle District of North
Carolina. The plaintiff purports to represent a class of persons who purchased or otherwise
acquired the common stock of the Company between October 26, 2006 and November 10, 2008 and the
complaint alleges violations of federal securities laws by the Company and two of its present or
former officers. The court has appointed lead counsel for the plaintiff and an amended complaint
is due June 15, 2009. We intend to contest the lawsuit vigorously.
Triad maintains a $95 million Excess-of-Loss reinsurance treaty that provides a benefit when
Triads risk-to-capital ratio exceeds 25-to-1 and the combined ratio exceeds 100% (the attachment
point). Once the attachment point has been reached, following a one-time deductible of $25
million, the carrier is responsible for the reimbursement of all paid losses in each quarter that
the attachment point is breached up to the one-time $95 million policy limit. The coverage period
is for 10 years. Additionally, terms of the treaty require Triad to continue the payment of
premiums to the reinsurer amounting to approximately $2 million per year for the entire ten year
period. The reinsurance treaty attached at the end of the first quarter of 2008; however, in April
2008 the reinsurance carrier provided a purported notice of termination of the agreement. By
letter dated May 5, 2008, Triad notified the reinsurer that the Company considered the treaty to
still be in effect and demanded arbitration seeking a ruling (i) stating that the reinsurance
remained in effect and (ii) requiring that the reinsurer comply with terms of the treaty. The
arbitration took place in front of a three-person panel in December 2008 and January 2009, with
post-hearing briefs and oral arguments in February 2009. The Company expects a decision to be
rendered by the arbitration panel in the second quarter of 2009.
6. Fair Value Measurement
The Company utilizes the provisions of SFAS 157 in its estimation and disclosures about fair
value. SFAS 157 defines fair value, establishes a framework for measuring fair value under GAAP,
and expands disclosures about fair value measurements. SFAS 157 applies to other accounting
pronouncements that require or permit fair value measurements. The Company adopted SFAS 157
effective for its fiscal year beginning January 1, 2008.
9
SFAS 157 establishes a fair value hierarchy that prioritizes the inputs to valuation methods
used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices
in active markets for identical assets or liabilities (Level 1 measurements) and the lowest
priority to unobservable inputs (Level 3 measurements). The three levels of the fair value
hierarchy under SFAS 157 are as follows:
|
Level 1: |
|
Unadjusted quoted prices in active markets that are accessible at the
measurement date for identical, unrestricted assets or liabilities. |
|
|
Level 2: |
|
Quoted prices in markets that are not active, or inputs that are
observable either directly or indirectly, for substantially the full term of the
asset or liability. |
|
|
Level 3: |
|
Prices or valuation techniques that require inputs that are both
significant to the fair value measurement and unobservable (i.e., supported with
little or no market activity). |
An assets or a liabilitys level within the fair value hierarchy is based on the lowest level
of input that is significant to the fair value measurement. The Company did not have any material
assets or liabilities measured at fair value on a non-recurring basis as of March 31, 2009. The
following table summarizes the assets measured at fair value on a recurring basis and the source of
the inputs in the determination of fair value as of March 31, 2009 and December 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements at Reporting Date Using |
|
|
|
|
|
|
|
Quoted Prices |
|
|
|
|
|
|
|
|
|
|
|
|
|
in Active |
|
|
Significant |
|
|
|
|
|
|
|
|
|
|
Markets for |
|
|
Other |
|
|
Significant |
|
|
|
|
|
|
|
Identical |
|
|
Observable |
|
|
Unobservable |
|
|
|
|
|
|
|
Assets |
|
|
Inputs |
|
|
Inputs |
|
(dollars in thousands) |
|
March 31, 2009 |
|
|
(Level 1) |
|
|
(Level 2) |
|
|
(Level 3) |
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities available-for-sale |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities |
|
$ |
904,904 |
|
|
$ |
|
|
|
$ |
903,146 |
|
|
$ |
1,757 |
|
Equity securities |
|
|
491 |
|
|
|
491 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
905,395 |
|
|
$ |
491 |
|
|
$ |
903,146 |
|
|
$ |
1,757 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements at Reporting Date Using |
|
|
|
|
|
|
|
Quoted Prices |
|
|
|
|
|
|
|
|
|
|
|
|
|
in Active |
|
|
Significant |
|
|
|
|
|
|
|
|
|
|
Markets for |
|
|
Other |
|
|
Significant |
|
|
|
|
|
|
|
Identical |
|
|
Observable |
|
|
Unobservable |
|
|
|
|
|
|
|
Assets |
|
|
Inputs |
|
|
Inputs |
|
(dollars in thousands) |
|
December 31, 2008 |
|
|
(Level 1) |
|
|
(Level 2) |
|
|
(Level 3) |
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities available-for-sale |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities |
|
$ |
854,186 |
|
|
$ |
|
|
|
$ |
851,651 |
|
|
$ |
2,535 |
|
Equity securities |
|
|
583 |
|
|
|
583 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
854,769 |
|
|
$ |
583 |
|
|
$ |
851,651 |
|
|
$ |
2,535 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Significant unobservable inputs (Level 3) were used in determining the fair value on certain
bonds in the fixed maturities portfolio
during this period. The following table provides a
reconciliation of the beginning and ending balances of these Level 3 bonds and the related gains
and losses related to these assets during the first three months of 2009.
10
Fair Value Measurement Using Significant
Unobservable Inputs (Level 3)
Certain Bonds in Fixed Maturities AFS Portfolio
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(dollars in thousands) |
|
2009 |
|
|
2008 |
|
Beginning balance |
|
$ |
2,535 |
|
|
$ |
7,402 |
|
Total gains and losses (realized and unrealized): |
|
|
|
|
|
|
|
|
Included in operations |
|
|
(288 |
) |
|
|
(131 |
) |
Included in other comprehensive income |
|
|
(83 |
) |
|
|
(43 |
) |
Purchases, issuances and settlements |
|
|
(407 |
) |
|
|
(3,883 |
) |
Transfers in and/or out of Level 3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending balance |
|
$ |
1,757 |
|
|
$ |
3,345 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The amount of total gains and losses for the period included in
operations attributable to the change in unrealized gains or
losses relating to assets still held at the reporting date. |
|
$ |
(371 |
) |
|
$ |
(63 |
) |
|
|
|
|
|
|
|
Gains and losses (realized and unrealized) included in operations or other comprehensive
income for the three months ended March 31, 2009 are reported as net realized investment losses as
a loss of $288,306 and an unrealized loss through other comprehensive loss of $82,439.
7. Earnings (Loss) Per Share (EPS)
Basic and diluted EPS are based on the weighted-average daily number of shares outstanding.
For the three months ended March 31, 2009 and 2008, the basic and diluted EPS denominators are the
same weighted-average daily number of shares outstanding. In computing diluted EPS, only potential
common shares that are dilutive those that reduce EPS or increase loss per share are included.
Exercise of options and unvested restricted stock are not assumed if the result would be
antidilutive, such as when a loss from operations is reported. The numerator used in basic EPS and
diluted EPS is the same for all periods presented. For the three months ended March 31, 2009,
options to purchase approximately 30,600 shares of the Companys stock were excluded from the
calculation of EPS because they were antidilutive.
8. Comprehensive Income (Loss)
Comprehensive income (loss) consists of net income (loss) and other comprehensive income
(loss). For the Company, other comprehensive income (loss) is composed of unrealized gains or
losses on available-for-sale securities and foreign currency exchange, net of income tax.
Effective with the issuance of the Corrective Order, the Company no longer has the ability to hold
unrealized losses until such time that the securities recover in value or mature due to the
possibility that Illinois law may require the Director to seek receivership if the corrective plan were deemed
ineffective. Thus, any security with a fair value less than the book value at the balance sheet
date is considered to be other-than-temporarily impaired and the loss is recognized as a realized
loss in the Statement of Operations. For the three months ended March 31, 2009 and March 31, 2008,
the Companys other comprehensive income was $10.3 million and $11.1 million, respectively, and the
Companys comprehensive loss was $44.9 million and $161.1 million, respectively.
11
9. Income Taxes
The income tax benefit for the first quarter of 2009 differs substantially from that which is
computed by applying the Federal statutory income tax rate of 35% to the loss before income taxes.
This difference is primarily due to the Companys inability to recognize a benefit for expected tax
loss carry forwards.
10. Exit Costs
In June 2008, the Company recorded an accrual for certain exit costs in connection with the
transition of its business into run-off. As part of the transition to run-off, Triad implemented a
reduction in workforce by terminating approximately 100 employees based primarily in the sales,
marketing, technology and underwriting functions. The remaining workforce of approximately 150
employees is focused on the payment of legitimate claims and servicing the
insurance portfolio during the run-off period.
As a result of the transition into run-off, the Company recorded an estimated pre-tax charge
of approximately $8.3 million in other operating costs on the Statement of Operations for the
period ended June 30, 2008. These charges included approximately $7.1 million in severance and
related personnel costs, approximately $1.0 million related primarily to the abandonment of a
portion of Triads main office lease that is expected to continue through 2012, and approximately
$0.2 million related to the termination of certain other leases, including those related to
underwriting offices, equipment and automobiles. At March 31, 2009, there remained approximately
$1.2 million of accrued severance and related personnel costs and $712,000 of lease abandonment
costs. There have been no significant changes to the original estimates since the initial
establishment of the exit cost accruals.
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Managements Discussion and Analysis of Financial Condition and Results of Operations analyzes
our consolidated financial condition, changes in financial position, and results of operations for
the three months ended March 31, 2009 and 2008. This discussion supplements Managements
Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on
Form 10-K for the year ended December 31, 2008, and should be read in conjunction with the interim
financial statements and notes contained herein.
Certain of the statements contained in this release are forward-looking statements and are
made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. These statements include estimates and assumptions related to economic, competitive,
regulatory, operational and legislative developments. These forward-looking statements are subject
to change, uncertainty and circumstances that are, in many instances, beyond our control and they
have been made based upon our current expectations and beliefs concerning future developments and
their potential effect on us. Actual developments and their results could differ materially from
those expected by us, depending on the outcome of a number of factors, including our ability to
operate our business in run-off, the possibility of general economic and business conditions that
are different than anticipated, legislative, regulatory, and other similar developments, changes in
interest rates, employment rates, the housing market, the mortgage industry and the stock market,
as well as the relevant factors described in this report under the headings Risk Factors and
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 in our Annual
Report on Form 10-K for the year ended December 31, 2008, as well as in other reports and
statements that we file with the Securities and Exchange Commission. Forward-looking statements
are based upon our current expectations and beliefs concerning future events and we undertake no
obligation to update or revise any forward-looking statements to reflect the impact of
circumstances or events that arise after the date the forward-looking statements are made.
12
Overview
Triad Guaranty Inc. (the Company) is a holding company that historically provided private
mortgage insurance coverage in the United States through its wholly-owned subsidiary, Triad
Guaranty Insurance Corporation (TGIC). Triad, as used in this report, includes the operations
of TGIC and its wholly-owned subsidiary, Triad Guaranty Assurance Corporation. Triad ceased
issuing new commitments for mortgage guaranty insurance coverage on July 15, 2008 and we are
operating our business in run-off. As used in this report, the term run-off means writing no new
mortgage insurance policies, but continuing to service existing policies. Servicing existing
policies includes: receiving premiums on policies that remain in force; cancelling coverage at the
insureds request; terminating policies for non-payment of premium; working with borrowers in
default to remedy the default and/or mitigate our loss; and settling all legitimate filed claims
per the provisions of the two Corrective Orders issued in August 2008 and March 2009 by the
Illinois Department of Financial and Professional Regulation, Division of Insurance (the
Division). These Corrective Orders, among other things, include restrictions on the distribution
of dividends or interest on notes payable to its parent by Triad, allow management to continue to
operate Triad under close supervision, and include restrictions on the payment of claims. Failure
to comply with the provisions of the Corrective Orders may result in the imposition of fines or
penalties or subject Triad to further legal proceedings, including receivership proceedings for the
conservation, rehabilitation or liquidation of Triad.
We have historically provided Primary and Modified Pool mortgage guaranty insurance coverage
on U.S. residential mortgage loans. We classify insurance as Primary when we are in the first loss
position and the loan-to-value amount, or LTV, is 80% or greater when the loan is first insured.
We classify all other insurance as Modified Pool. The majority of our Primary insurance has been
delivered through the flow channel, which is defined as loans originated by lenders and submitted
to us on a loan-by-loan basis. We have also historically provided mortgage insurance to lenders
and investors who seek additional default protection (typically secondary coverage or on loans for
which the individual borrower has greater than 20% equity), capital relief, and credit-enhancement
on groups of loans that are sold in the secondary market. These transactions are referred to as
our structured bulk channel business. Those individual loans in the structured bulk channel in
which we are in the first loss position and the LTV ratio is greater than 80% are classified as
Primary. All of our Modified Pool insurance has been delivered through the structured bulk
channel. Our insurance remains effective until one of the following events occurs: the policy is
cancelled at the insureds request; we terminate the policy for non-payment of premium; the policy
defaults and we satisfy our obligations under the insurance contract; or we rescind the policy for
violations of provisions of a master policy.
In run-off, our revenues principally consist of:
|
|
|
earned renewal premiums from the remaining insurance in force, net of: |
|
o |
|
reinsurance premiums ceded, primarily for captive reinsurance, and |
|
|
o |
|
refunds paid or accrued resulting from the
cancellation of insurance in force or for coverage anticipated to be
rescinded due to violations of certain provisions of a master policy;
and |
We may also realize investment gains and investment losses on the sale and impairment of
securities, with the net gain or loss reported as a component of revenue.
Our expenses consist primarily of:
|
|
|
paid claims; |
|
|
|
|
changes in reserves for estimated future claim payments on loans that are
currently in default; |
|
|
|
|
general and administrative costs of servicing existing policies; |
|
|
|
|
other general business expenses; and |
|
|
|
|
interest expense on long-term debt. |
13
Our results of operations in run-off depend largely on:
|
|
|
the conditions of the housing, mortgage and capital markets that have a
direct impact on default rates, mitigation efforts, cure rates and ultimately
the amount of claims paid; |
|
|
|
|
the overall general state of the economy and job market; |
|
|
|
|
persistency levels on our remaining insurance in force; |
|
|
|
|
operating efficiencies; and |
|
|
|
|
the level of investment yield, including realized gains and losses, on our
investment portfolio. |
Persistency is an important metric in understanding our premium revenue, especially in run-off
as no new business is being written, so our overall premium base is essentially fixed and will
decline over time. The longer a policy remains on our books, or persists, the greater the amount
of renewal premium revenue that we will earn from the policy. Cancellations result primarily from
the borrower refinancing or selling insured mortgaged residential properties, from policies being
rescinded due to fraud, misrepresentation or other underwriting violations, from a servicer
choosing to cancel the insurance, from the payment of a claim, and, to a lesser degree, from the
borrower achieving prescribed equity levels, at which point the lender no longer requires mortgage
guaranty insurance.
Recent Events Affecting our Business
Triad is an Illinois-domiciled insurance company and the Division is our primary regulator.
The Illinois Insurance Code grants broad powers to the Division and its Director to enforce rules
or exercise discretion over almost all significant aspects of our insurance business.
Triad has entered into two Corrective Orders with the Division. The first Corrective Order was
entered into on August 5, 2008 and remains in effect. This Corrective Order was implemented as a
result of our decision to cease writing new mortgage guaranty insurance and to commence a run-off
of our existing insurance in force as of July 15, 2008. Among other things, this Corrective Order:
|
|
|
Required Triad to submit a corrective plan to the Division; |
|
|
|
|
Prohibits all stockholder dividends from Triad to its parent company without
the prior approval of the Division; |
|
|
|
|
Prohibits interest and principal payments on Triads surplus note to its
parent company without the prior approval of the Division; |
|
|
|
|
Restricts Triad from making any payments or entering into any transaction
that involves the transfer of assets to, or liabilities from, any affiliated
parties without the prior approval of the Division; |
|
|
|
|
Requires Triad to obtain prior written approval from the Division before
entering into certain transactions with unaffiliated parties; |
|
|
|
|
Requires Triad to meet with the Division in person or via teleconference as
necessary; and |
|
|
|
|
Requires Triad to furnish to the Division certain reports, agreements,
actuarial opinions and information on an ongoing basis at specified times. |
We submitted a corrective plan to the Division as required under the Corrective Order. The
corrective plan we submitted included, among other items, a five-year statutory financial
projection for Triad and a detailed description of our planned course of action to address our
current financial condition. The financial statements that form the basis of our corrective plan
were prepared in accordance with Statutory Accounting Principles (SAP) set forth in the Illinois
Insurance Code. SAP differs from GAAP, which are followed to prepare the financial statements
presented in this report. We received approval of the corrective plan from the Division in October
2008.
14
Since the approval of our initial corrective plan, we revised the assumptions we initially
utilized in our run-off financial forecast model as a result of a number of factors, including
continued deteriorating economic conditions impacting our financial condition, results of
operations and future prospects. The new assumptions produced a range of potential ultimate
outcomes for our run-off, but included projections showing that absent additional action by the
Division or favorable changes in our business, we would report a deficiency in policyholders
surplus as calculated in accordance with SAP as early as March 31, 2009 and continuing at least
through 2011. This statutory insolvency would likely lead to the institution by the Division of
receivership proceedings against Triad if not corrected.
As a result, the Division issued a second Corrective Order on March 31, 2009. This Corrective
Order stipulates:
|
|
|
Effective June 1, 2009 or at a later date as determined by the Division, all valid
claims under Triads mortgage guaranty insurance policies will be paid 60% in cash and 40%
by recording a deferred payment obligation (DPO); |
|
|
|
|
At March 31, 2009, Triad was required to adjust surplus and reserves reflecting the
impact of the Corrective Order on future paid claims; |
|
|
|
|
The DPO will accrue a carrying charge based on the investment yield earned by Triads
investment portfolio; |
|
|
|
|
Payment of the carrying charge and the DPO will be subject to Triads future financial
performance and will require the approval of the Division; |
|
|
|
|
Procedures to follow to account for the impact of the Corrective Order in the financial
statements prepared in accordance with SAP; |
|
|
|
|
Upon payment of a claim under these provisions, Triad shall be deemed to have fully
satisfied its obligations under the respective insurance policy; |
|
|
|
|
Other restrictions and requirements affecting the payment and transferability of the
DPOs and associated carrying charge; and |
|
|
|
|
Certain reporting requirements. |
As the payment of the DPO is dependent on the approval by the Division, the DPO will be
reported as a component of policyholders surplus in our financial statements prepared in
accordance with SAP until such time as approval is given. However, the DPO will be reported as a
liability in our financial statements prepared in accordance with GAAP. We requested that the
Division hold a hearing on the Corrective Order to allow policyholders the opportunity to ask
questions and express their views either orally or by written statement. The hearing was held on
May 8, 2009. At the hearing, the Division extended the deadline for policyholders to provide
written comments regarding the Corrective Order to May 15, 2009. Pending the conclusion of the
comment period, we will await the Directors decision regarding whether to modify the Corrective
Order. We currently anticipate that we will adopt the requirements of the second Corrective Order
on June 1, 2009.
Failure to comply with the provisions of the Corrective Orders or any other violation of the
Illinois Insurance Code may result in the imposition of fines or penalties or subject Triad to
further legal proceedings, including receivership proceedings for the conservation, rehabilitation
or liquidation of Triad. See Item 1A, Risk Factors in our Annual Report on Form 10-K for the
year ended December 31, 2008 for more information.
Prior to the second Corrective Order, our recurring losses from operations and resulting
decline in policyholders surplus as calculated in accordance with SAP increased the likelihood
that Triad would be placed into receivership and raised substantial doubt about our ability to
continue as a going concern. As a result of the positive impact on surplus resulting from the
second Corrective Order, we believe it is less likely that Triad will be forced into receivership
in the very near term as a result of a surplus deficiency. However, we must continue to execute
the revised corrective plan under the terms of the Corrective Orders. Our consolidated financial
statements that are presented in this report do not include any adjustments that reflect the
financial risks of Triad entering
15
receivership proceedings and assume that we will continue as a going concern. We expect
losses from operations to continue and our ability to continue as a going concern is dependent on
the successful implementation of the revised corrective plan. See Item 1A, Risk Factors in our
Annual Report on Form 10-K for the year ended December 31, 2008 for more information.
At March 31, 2009, as calculated under GAAP, the Company reported a deficit in assets of
$181.4 million compared to a deficit in assets of $136.7 million at December 31, 2008 and
stockholders equity of $338.4 million at March 31, 2008. A deficit in assets occurs when recorded
liabilities exceed recorded assets and is not necessarily a measure of insolvency. The deficit in
assets is primarily the result of the substantial increase in loss reserves and paid claims over
the last six quarters. Although we have reported a deficit in assets at March 31, 2009, we had
approximately $939.9 million of cash and invested assets compared to $840.6 million at March 31,
2008. We expect to continue to report a deficit in assets in future periods.
We have identified a substantial number of underwriting or program violations and
misrepresentations in defaults reported to us and we have subsequently rescinded or cancelled
coverage on these policies at a rate substantially greater than we have historically experienced.
In the fourth quarter of 2008, we expanded the criteria used to determine whether a default would
be investigated for underwriting violations in accordance with our master policy provisions. While
we will continue to settle legitimate claims, we expect an increase in rescission activity in 2009
based on the number of policies under review and the number of occurrences of underwriting
violations identified during 2008. The impact of rescissions on reserves provided, claims not paid
and accruals for anticipated premium refunds has been significant. See Update on Critical
Accounting Policies and Estimates in this report for additional discussion on rescissions. Any
impediment to our ability to rescind coverage for underwriting violations would be detrimental to
our success in run-off.
Triad maintains a $95 million Excess-of-Loss reinsurance treaty that is currently in
arbitration. The arbitration hearing began in 2008 and we expect to have a decision in the second
quarter of 2009. As the matter is in dispute as a gain contingency, we have not recorded any
benefit from this reinsurance treaty in our GAAP financial statements. However, in consultation
with the Division, we recorded in our statutory financial statements for the three months ended
March 31, 2009 the net benefit of the reinsurance treaty of $41.2 million, which included the $95
million benefit and an accrual for the present value of the future 10-year premium expense due the
reinsurer, reduced by a required reserve reflecting the dispute and aging of the recoverable
required under SAP.
Over the past several months, several government programs have been initiated that, in
general, are designed to provide relief to homeowners and the financial markets. Some of these
programs involve modifying the terms of mortgages in an effort to reduce foreclosure rates. Many of
these programs have been expanded since originally developed and may continue to change. We are
active participants in certain of these programs. We are unable to predict the impact that these
recent government initiatives will have on our future results of operations and prospects.
Consolidated Results of Operations
Following is selected financial information for the three months ended March 31, 2009 and
2008:
16
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
March 31, |
(dollars in thousands, except |
|
|
|
|
|
|
|
|
|
% |
per share data) |
|
2009 |
|
2008 |
|
Change |
Earned premiums |
|
$ |
44,358 |
|
|
$ |
72,065 |
|
|
|
(38 |
) |
Net losses and loss adjustment expenses |
|
|
101,577 |
|
|
|
221,259 |
|
|
|
(54 |
) |
Net loss |
|
|
(55,174 |
) |
|
|
(150,014 |
) |
|
|
(63 |
) |
Diluted loss per share |
|
|
(3.68 |
) |
|
|
(10.09 |
) |
|
|
(64 |
) |
The first quarter net loss was primarily the result of the continued deterioration in the
housing market as net losses and loss adjustment expenses (LAE) exceeded premium earned by $57.2
million. Net losses and LAE consisted of an increase in the reserve for losses and LAE of $74.9
million and direct paid losses and LAE of $66.8 million, offset partially by an increase in
reinsurance recoverables of $40.1 million. Premium earned was negatively impacted by premium
refunds and the increase in the liability for expected premium refunds.
The reserve for losses and LAE continues to be impacted by the increase in the number of
reported loans in default as well as the characteristics of the loans in default. The number of
loans in default increased by 20% during the first quarter of 2009 from the number at December 31,
2008 while risk in default increased by 21%. Certain segments of our portfolio continue to perform
more adversely as compared to the rest of the portfolio. These segments include:
|
|
|
Loans on properties in California, Florida, Arizona, and Nevada (which we refer
to collectively as distressed markets). At March 31, 2009, the default rate for
the distressed markets was 29.0% compared to 9.6% for the remaining portfolio and
defaults in the distressed markets comprised 60.3% of the gross risk in default
while only comprising 34.5% of total risk in force. |
|
|
|
|
Policies originated in 2006 and 2007. At March 31, 2009, the default rate for
these policy years was 19.9% compared to 9.6% for the other policy years and
defaults in these policy years comprised 74.2% of the gross risk in default while
only comprising 57.4% of total risk in force. |
The increase in reserve for losses and LAE in the first quarter of 2009 was mitigated somewhat
by the impact of risk-sharing structures, both from lender-captives and modified pool contracts, as
well as by increases in the rescission factors used in the estimate of loss reserves. At March 31,
2009, total benefits received from risk-sharing structures amounted to 25.6% of gross calculated
reserves compared to 20.7% at December 31, 2008 and 14.3% at March 31, 2008. Our reserving
methodology incorporates a benefit to account for expected rescissions in the frequency factors.
During the first quarter of 2009, we increased this factor for certain segments of our portfolio,
which served to mitigate reserves. In cases where we do rescind coverage, we return all premiums
paid on the policy.
Net paid losses and LAE was $56.7 million in the first quarter of 2009. We continued to
experience a moderation in claims paid activity during the first quarter of 2009 due primarily to
government and lender foreclosure moratoriums, and continued efforts on our part to investigate
policies for fraud, misrepresentation or other underwriting violations.
Earned premium for the first quarter of 2009 decreased by 38% compared to the first quarter of
2008, primarily due to refunds and expected refunds of premium from rescission activity. A decline
in insurance in force at March 31, 2009 from March 31, 2008, resulting from low levels of new
insurance written during the preceding twelve months, also contributed to the decline in earned
premium.
Other operating expenses for the first quarter of 2009 decreased by 33% as compared to the
first quarter of 2008, primarily due to the elimination of a large percentage of our work force in
the second and third quarter of
17
2008 as we entered into run-off. Additionally, we wrote off all existing deferred acquisition
costs of approximately $34 million during the first quarter of 2008.
We describe our results of operations in greater detail in the discussion that follows. The
information is presented in four categories: Production; Insurance and Risk in Force; Revenues;
and Losses and Expenses.
Production
On July 15, 2008, we ceased issuing commitments for mortgage insurance. Going forward, our
production will consist of certificates issued from commitments for mortgage insurance that were
entered into prior to July 15, 2008. We wrote approximately $24 million of new insurance for the
three months ended March 31, 2009, all of which was from our Primary flow channel. For the three
months ended March 31, 2008, we wrote approximately $1.9 billion of new insurance. We do not
expect a material amount of production going forward.
Insurance and Risk in Force
The following table provides detail on our direct insurance in force at March 31, 2009 and
2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
|
|
(dollars in millions) |
|
2009 |
|
|
2008 |
|
|
% Change |
|
Primary insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Primary flow insurance |
|
$ |
37,881 |
|
|
$ |
42,086 |
|
|
|
(10 |
) |
Structured bulk insurance |
|
|
3,780 |
|
|
|
4,374 |
|
|
|
(14 |
) |
|
|
|
|
|
|
|
|
|
|
|
Total Primary insurance |
|
|
41,661 |
|
|
|
46,460 |
|
|
|
(10 |
) |
|
|
|
|
|
|
|
|
|
|
|
Modified Pool insurance |
|
|
18,825 |
|
|
|
21,187 |
|
|
|
(11 |
) |
|
|
|
|
|
|
|
|
|
|
|
Total insurance |
|
$ |
60,486 |
|
|
$ |
67,647 |
|
|
|
(11 |
) |
|
|
|
|
|
|
|
|
|
|
|
Insurance in force at March 31, 2009 declined 10.6% from March 31, 2008 due to the low amount of
insurance written over the preceding twelve months. This decline was moderated by very strong
persistency over the past year. Primary insurance persistency improved to 86.9% at March 31, 2009
compared to 83.3% at March 31, 2008 while modified pool insurance persistency improved to 88.8% at
March 31, 2009 compared to 84.9% at March 31, 2008. We believe the increase in our persistency
reflects the general inability of borrowers to refinance or sell their homes due to stricter
underwriting guidelines by lenders, as well as the nationwide decline in home prices. Mortgage
interest rates are at near historically low levels and the majority of our insurance in force has
associated interest rates greater than the current rates. Recent government and private industry
initiatives were developed, in part, to promote liquidity in the mortgage markets through
modifications to existing qualifying loans. Given the interest rate environment and these
initiatives, persistency could decline from current levels in the remainder of 2009, which could
have an adverse impact on our future earned premiums.
The following tables provide information on selected risk characteristics of our business
based on gross risk in force at March 31, 2009 and 2008. The following is a list of
characteristics we believe are important indicators of risk in our portfolios:
|
|
|
The percentage of business defined as non-prime credit quality; |
|
|
|
|
The percentage of Alt-A business; |
|
|
|
|
The percentage of business with a loan-to-value (LTV) greater than 95%; |
|
|
|
|
The percentage of interest only loans and adjustable rate mortgages
(ARMs), particularly ARMs with potential negative amortization; |
|
|
|
|
The percentage of condominium property types; |
|
|
|
|
The percentage of non-primary residence occupancy status; |
18
|
|
|
The percentage of loans in excess of $250,000; |
|
|
|
|
The concentration of risk in distressed market states; and |
|
|
|
|
The presence of multiple risk factors on a single insured loan. |
Risk in Force (1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary |
|
|
Modified Pool |
|
|
|
March 31, |
|
|
March 31, |
|
(dollars in millions) |
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
Gross Risk in Force |
|
$ |
10,853 |
|
|
$ |
12,126 |
|
|
$ |
5,468 |
|
|
$ |
6,194 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Credit Quality: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prime |
|
|
76.4 |
% |
|
|
75.2 |
% |
|
|
28.1 |
% |
|
|
27.8 |
% |
Alt-A |
|
|
20.2 |
|
|
|
21.2 |
|
|
|
71.1 |
|
|
|
71.4 |
|
A-Minus |
|
|
3.0 |
|
|
|
3.1 |
|
|
|
0.7 |
|
|
|
0.7 |
|
Sub Prime |
|
|
0.4 |
|
|
|
0.5 |
|
|
|
0.1 |
|
|
|
0.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LTV: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Greater than 95% |
|
|
24.9 |
% |
|
|
25.3 |
% |
|
|
|
% |
|
|
|
% |
90.01% to 95.00% |
|
|
32.7 |
|
|
|
32.6 |
|
|
|
0.2 |
|
|
|
0.3 |
|
90.00% and below |
|
|
42.4 |
|
|
|
42.1 |
|
|
|
99.8 |
|
|
|
99.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan Type: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed |
|
|
66.9 |
% |
|
|
65.5 |
% |
|
|
26.5 |
% |
|
|
26.1 |
% |
Interest Only |
|
|
10.3 |
|
|
|
10.6 |
|
|
|
23.0 |
|
|
|
23.4 |
|
ARM (amortizing) fixed period 5 years or
greater |
|
|
8.4 |
|
|
|
9.1 |
|
|
|
30.8 |
|
|
|
31.5 |
|
ARM (amortizing) fixed period less than 5
years |
|
|
2.1 |
|
|
|
2.3 |
|
|
|
5.6 |
|
|
|
5.8 |
|
ARM (potential negative amortization) |
|
|
12.3 |
|
|
|
12.5 |
|
|
|
14.1 |
|
|
|
13.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property Type: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Condominium |
|
|
10.8 |
% |
|
|
10.5 |
% |
|
|
9.7 |
% |
|
|
9.5 |
% |
Other (principally single-family detached) |
|
|
89.2 |
|
|
|
89.5 |
|
|
|
90.3 |
|
|
|
90.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Occupancy Status: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary residence |
|
|
87.7 |
% |
|
|
87.7 |
% |
|
|
73.2 |
% |
|
|
73.5 |
% |
Secondary home |
|
|
8.0 |
|
|
|
7.9 |
|
|
|
6.1 |
|
|
|
6.1 |
|
Non-owner occupied |
|
|
4.3 |
|
|
|
4.4 |
|
|
|
20.7 |
|
|
|
20.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage Amount: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$0 - $50,000 |
|
|
0.8 |
% |
|
|
0.9 |
% |
|
|
0.5 |
% |
|
|
0.5 |
% |
$51,000 - $100,000 |
|
|
9.3 |
|
|
|
9.5 |
|
|
|
5.3 |
|
|
|
5.3 |
|
$100,001 - $250,000 |
|
|
51.9 |
|
|
|
51.8 |
|
|
|
45.3 |
|
|
|
45.5 |
|
$250,001 - $500,000 |
|
|
32.3 |
|
|
|
31.9 |
|
|
|
42.1 |
|
|
|
42.2 |
|
Over $500,000 |
|
|
5.7 |
|
|
|
5.9 |
|
|
|
6.8 |
|
|
|
6.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Market Status: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distressed market states (AZ, CA, FL, NV) |
|
|
27.1 |
% |
|
|
27.1 |
% |
|
|
49.0 |
% |
|
|
48.3 |
% |
Non-distressed market states |
|
|
72.9 |
|
|
|
72.9 |
|
|
|
51.0 |
|
|
|
51.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
(1) |
|
Percentages represent distribution of gross risk in force on a per policy basis and does not
account for
risk ceded to captive reinsurers or applicable stop-loss amounts and deductibles on Modified
Pool
structured bulk transactions. |
19
The composition of our risk in force at March 31, 2009, based on certain of the risk factors
that we measure, including credit quality, LTV, loan type, property type, occupancy status, and
mortgage amount, remained relatively consistent with that of a year ago given the lack of
production over the previous twelve months and the high level of persistency. Additionally, while
our exposure to the distressed markets expressed as a percentage of the total has remained
consistent over the past twelve months, the contribution to losses from the distressed markets has
been adversely disproportional to the percentage of the portfolio. Our portfolio contains
significant exposure to Alt-A loans and pay option ARMS, as well as interest only loans. An
inherent risk in both a pay option ARM and an interest only 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. An additional risk to a
pay option ARM loan is that the payment being made may be less than the amount of interest
accruing, creating negative amortization on the outstanding principal of the loan. These features
add uncertainty and potential risk. Due in part to recent market conditions, the Alt-A loans, pay
option ARM loans, and interest only loans have, as a group, performed significantly worse than the
remaining prime fixed rate loans through March 31, 2009.
We believe that a policy with a high LTV, all else being equal, will have a greater risk of
default than a policy with a low LTV, especially in periods such as we are in currently with
declining home prices. In the table above, the percentage of risk in force by LTV is based on the
LTV at the time the loan was originated. We have not been provided with the mark-to-market LTV,
or the LTV using current loan amount and current market value, of our insured portfolio. To the
extent that an insured loan in our portfolio has experienced a decline in the underlying value, and
we believe this to be the case for a large percentage of our insured portfolio, the
mark-to-market LTV of the policy may be substantially higher than that at origination.
The premium rates we charge vary depending on the perceived risk of a loan at origination and
generally cannot be changed after issuance of coverage. The premium rates charged for business
originated in 2005, 2006 and 2007, and specifically for higher risk products including pay option
ARMs and Alt-A loans, may not generate ongoing premium revenue sufficient to cover future losses
associated with those products.
The following table shows gross risk in force as of March 31, 2009 by year of loan
origination. Business originated in 2006 and 2007 continues to comprise the majority of our risk in
force. This is due to the significant amounts of production during these two years as well as the
large number of policies that have been cancelled from prior origination years. In general,
policies originated during 2006 and 2007 have significantly higher amounts of average risk per
policy than policies originated prior to 2006. Furthermore, policies originated during these
vintage
years have exhibited higher default rates than preceding vintage years. For additional
information regarding these vintage years, see Losses and Expenses, below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2009 |
|
|
|
Primary |
|
|
Modified Pool |
|
|
|
Gross Risk |
|
|
|
|
|
|
Gross Risk |
|
|
|
|
(dollars in millions) |
|
in Force * |
|
|
Percent |
|
|
in Force * |
|
|
Percent |
|
Vintage Year |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004 and before |
|
$ |
2,331.0 |
|
|
|
21.5 |
|
|
$ |
781.7 |
|
|
|
14.3 |
|
2005 |
|
|
1,358.9 |
|
|
|
12.5 |
|
|
|
1,842.8 |
|
|
|
33.7 |
|
2006 |
|
|
2,288.4 |
|
|
|
21.1 |
|
|
|
2,057.7 |
|
|
|
37.6 |
|
2007 |
|
|
4,233.8 |
|
|
|
39.0 |
|
|
|
786.2 |
|
|
|
14.4 |
|
2008 |
|
|
640.5 |
|
|
|
5.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
10,852.6 |
|
|
|
100.0 |
|
|
$ |
5,468.4 |
|
|
|
100.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
Gross risk in force is on a per policy basis and does not account for risk ceded to captive
reinsurers or
applicable stop-loss amounts and deductibles on Modified Pool structured bulk transactions. |
20
The percentage of our primary flow insurance in force subject to captive reinsurance
arrangements at March 31, 2009 was 55.3%, a slight decrease from 56.1% at the end of the first
quarter of 2008. Under captive reinsurance programs, reinsurance companies that are affiliates of
the lenders assume a portion of the risk associated with the lenders insured book of business in
exchange for a percentage of the premium. The risk reinsured by the captive is supported by assets
held in trust with Triad as the beneficiary. At March 31, 2009, we had approximately $262.1
million in captive reinsurance trust balances with $186.9 million of reserves ceded to those
captives, which helps limit our future loss exposure.
During the first quarter of 2009, one of our captive reinsurance agreements and the supporting
trust agreement was terminated at the request of the reinsurer. As a result of the termination, all
coverage ceased, the trust balance of $8.1 million supporting the reinsurance agreement was
returned to Triad, and the 2008 year-end reinsurance recoverable of $7.6 million was eliminated.
Revenues
A summary of the significant individual components of our revenue for the first quarter of
2009 and 2008 follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(dollars in thousands) |
|
2009 |
|
|
2008 |
|
|
% Change |
|
Direct premium written before the
impact of
refunds |
|
$ |
79,997 |
|
|
$ |
91,160 |
|
|
|
(12 |
) |
Less: |
|
|
|
|
|
|
|
|
|
|
|
|
Cash refunds |
|
|
(5,323 |
) |
|
|
(1,376 |
) |
|
|
287 |
|
Change in accruals |
|
|
(19,051 |
) |
|
|
(398 |
) |
|
|
4,687 |
|
|
|
|
|
|
|
|
|
|
|
|
Direct premium written |
|
|
55,623 |
|
|
|
89,386 |
|
|
|
(38 |
) |
Ceded premium written |
|
|
(11,130 |
) |
|
|
(15,995 |
) |
|
|
(30 |
) |
|
|
|
|
|
|
|
|
|
|
|
Net premium written |
|
|
44,493 |
|
|
|
73,391 |
|
|
|
(39 |
) |
Change in unearned premiums |
|
|
(135 |
) |
|
|
(1,326 |
) |
|
|
(90 |
) |
|
|
|
|
|
|
|
|
|
|
|
Earned premiums |
|
$ |
44,358 |
|
|
$ |
72,065 |
|
|
|
(38 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income |
|
$ |
11,192 |
|
|
$ |
9,546 |
|
|
|
17 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized investment (losses) gains |
|
$ |
(4,565 |
) |
|
$ |
2,703 |
|
|
|
(269 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues |
|
$ |
50,987 |
|
|
$ |
84,316 |
|
|
|
(40 |
) |
The main reasons behind the decline in direct premium written are the drop in insurance in
force and the impact of premium refunds from rescissions. Insurance in force at March 31, 2009
declined by 10.6% since March 31, 2008, primarily a result of the negligible amount of new
insurance written over the one-year period. Rescission activity has increased dramatically since
the first quarter of 2008. The table above shows the effect of cash premiums refunded, primarily
due to rescission activity, in the first quarter of 2009, as well as the change in the accrual we
provide for expected premium refunds on policies that are currently under investigation for
rescission.
Ceded premium written is comprised primarily of premiums written under excess of loss
reinsurance treaties with captives. The decline in ceded premium during the first quarter of 2009
over the first quarter of 2008 was primarily due to a decrease in insurance in force subject to
captive reinsurance along with the establishment of an accrual to account for the rescission of
coverage on policies subject to captive reinsurance and the respective expected refunds of premiums
previously ceded. The premium cede rate increased to 20.0% for the first quarter of
21
2009 compared
to 17.9% for the first quarter of 2008, primarily reflecting the larger impact of refunds on direct
premium written.
Net investment income grew primarily due to the growth in average invested assets and an
increase in the yield of the portfolio. Average invested assets at cost or amortized cost grew by
16.5% during the past year as a result of the investment of positive operating cash flows. The
book yield on our investment portfolio was 4.77% at March 31, 2009 compared to 4.55% at March 31,
2008. Realized investment losses were $4.7 million in the first quarter of 2009 compared to a
realized investment gain of $2.7 million in the corresponding period in 2008. The realized
investment losses in the first quarter of 2009 were primarily due to other-than-temporary
impairment losses. For a further discussion, see Investment Portfolio.
Losses and Expenses
A summary of the individual components of losses and expenses for the three months ended March
31, 2009 and 2008 follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(dollars in thousands) |
|
2009 |
|
|
2008 |
|
|
% Change |
|
Net losses and loss
adjustment expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
Net paid claims |
|
$ |
53,920 |
|
|
$ |
40,471 |
|
|
|
33 |
|
Net change in loss reserves |
|
|
39,628 |
|
|
|
174,561 |
|
|
|
(77 |
) |
Loss adjustment expenses |
|
|
8,029 |
|
|
|
6,227 |
|
|
|
29 |
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
101,577 |
|
|
|
221,259 |
|
|
|
(54 |
) |
Net change in premium deficiency |
|
|
|
|
|
|
15,000 |
|
|
|
(100 |
) |
Policy acquisition costs |
|
|
|
|
|
|
39,416 |
|
|
|
(100 |
) |
Other operating expenses (net of acquisition
costs deferred) |
|
|
9,411 |
|
|
|
14,105 |
|
|
|
(33 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss ratio |
|
|
229.0 |
% |
|
|
307.0 |
% |
|
|
(25 |
) |
Expense ratio |
|
|
21.2 |
% |
|
|
25.5 |
% |
|
|
(17 |
) |
Combined ratio |
|
|
250.2 |
% |
|
|
332.5 |
% |
|
|
(25 |
) |
Net losses and LAE are comprised of paid losses and LAE as well as the increase in the loss
and LAE reserve during the period. The following paragraphs look at some of the specifics of the
individual components of net losses and LAE.
The following table provides detail on direct paid claims and number of paid claims for our
Primary and Modified Pool insurance prior to the effect of ceded paid claims for the first quarter
ended March 31, 2009 and 2008:
22
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(dollars in thousands) |
|
2009 |
|
|
2008 |
|
|
% Change |
|
Direct Paid claims: |
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance |
|
$ |
56,277 |
|
|
$ |
29,235 |
|
|
|
92.5 |
|
Modified Pool insurance |
|
|
7,735 |
|
|
|
10,852 |
|
|
|
(28.7 |
) |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
64,012 |
|
|
$ |
40,087 |
|
|
|
59.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of claims paid: |
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance |
|
|
1,044 |
|
|
|
686 |
|
|
|
52.2 |
|
Modified Pool insurance |
|
|
131 |
|
|
|
167 |
|
|
|
(21.6 |
) |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
1,175 |
|
|
|
853 |
|
|
|
37.7 |
|
|
|
|
|
|
|
|
|
|
|
|
The average paid loss increased to $54,500 during the first quarter of 2009 compared to
$47,000 during the same period of 2008. The increase in the average paid loss is primarily the
result of a higher percentage of claims from the more recent vintage years and from the distressed
markets, both of which reflect larger loan balances, as well as a decline in our ability to
mitigate losses. The paid loss activity in the first quarter of 2009 was tempered somewhat due to a
number of factors, including lender and GSE foreclosure moratoriums, delays by the servicers due to
a large increase in the number of defaults, our ongoing effort to identify fraud, misrepresentation
or other underwriting violations in policies which are currently in default, as well as increased
rescission activity. We expect paid losses will continue to increase throughout 2009. The recording
of a DPO as required by the second Corrective Order will not impact reported paid losses. We will
continue to report the entire amount as a paid loss and will establish a liability for the deferred
portion.
The following table shows the average loan size and average risk per policy by vintage year.
Policies originated during 2006 and 2007 comprised approximately 47% of our first quarter 2009 paid
claim inventory and
had an average paid loss of $61,700 and $69,700, respectively. We expect the average paid
loss to continue to increase in the remainder of 2009 as policies originated during 2006 and 2007
continue to comprise a greater proportion of our paid claims.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary |
|
Modified Pool |
|
|
Average |
|
Average |
|
Average |
|
Average |
|
|
Loan Size |
|
Insured Risk |
|
Loan Size |
|
Insured Risk |
Vintage Year |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004 and Prior |
|
$ |
117,271 |
|
|
$ |
29,935 |
|
|
$ |
139,883 |
|
|
$ |
41,636 |
|
2005 |
|
|
155,532 |
|
|
|
40,922 |
|
|
|
176,322 |
|
|
|
57,387 |
|
2006 |
|
|
207,178 |
|
|
|
53,565 |
|
|
|
263,235 |
|
|
|
69,209 |
|
2007 |
|
|
206,736 |
|
|
|
55,645 |
|
|
|
272,816 |
|
|
|
79,131 |
|
2008 |
|
|
203,791 |
|
|
|
46,875 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Overall Average |
|
$ |
171,062 |
|
|
$ |
44,560 |
|
|
$ |
207,891 |
|
|
$ |
60,389 |
|
Claims from the distressed markets comprised 56.3% and 38.8% of total gross paid losses in the
first quarter of 2009 and 2008, respectively, while they only comprised 39.8% and 21.7% of the paid
claim inventory in the respective periods reflecting the greater average loan size in these
markets. The following table shows the average loan size and average risk per policy for the
distressed markets compared to the remainder of the portfolio.
23
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary |
|
|
Modified Pool |
|
|
|
Average |
|
|
Average |
|
|
Average |
|
|
Average |
|
|
|
Loan Size |
|
|
Insured Risk |
|
|
Loan Size |
|
|
Insured Risk |
|
Distressed States: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
California |
|
$ |
336,689 |
|
|
$ |
84,203 |
|
|
$ |
331,926 |
|
|
$ |
88,560 |
|
Florida |
|
|
201,863 |
|
|
|
53,499 |
|
|
|
211,444 |
|
|
|
57,856 |
|
Arizona |
|
|
198,296 |
|
|
|
52,143 |
|
|
|
204,018 |
|
|
|
63,020 |
|
Nevada |
|
|
241,420 |
|
|
|
65,105 |
|
|
|
226,455 |
|
|
|
71,652 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average distressed states |
|
$ |
240,688 |
|
|
$ |
62,445 |
|
|
$ |
259,911 |
|
|
$ |
72,270 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average non-distressed states |
|
$ |
154,351 |
|
|
$ |
40,268 |
|
|
$ |
171,795 |
|
|
$ |
52,145 |
|
The increase in average paid loss was also influenced by our reduced ability to mitigate
claims. Beginning in late 2006, we began to experience a significant reduction in our ability to
reduce the severity of our claims paid through the sale of properties. Subsequent declines in home
prices across almost all markets, with significant declines in the distressed markets, have
continued to negatively impact our ability to mitigate losses through the sale of properties. We
expect our ability to mitigate losses will continue to be adversely affected by the continued
pressure on home prices combined with the limited availability of credit in the U.S. financial
markets.
The table below provides the gross cumulative paid loss ratios by book year (calculated as
direct losses paid divided by direct premiums received, in each case for a particular book year)
that have developed through March 31, 2009 and 2008. Book years with a significant amount of
refinancings such as the years 2000, 2001, and 2002 will show higher cumulative loss ratios than
those with stable persistency rates due to a smaller amount of premium collected over time. The
data below excludes the effects of reinsurance.
|
|
|
|
|
|
|
|
|
|
|
Cumulative Paid Loss Ratios |
|
|
as of March 31, |
Book Year |
|
2009 |
|
2008 |
1996 |
|
|
14.6 |
% |
|
|
14.5 |
% |
1997 |
|
|
10.5 |
|
|
|
10.3 |
|
1998 |
|
|
6.9 |
|
|
|
6.8 |
|
1999 |
|
|
9.9 |
|
|
|
9.8 |
|
2000 |
|
|
35.9 |
|
|
|
35.3 |
|
2001 |
|
|
32.5 |
|
|
|
31.3 |
|
2002 |
|
|
33.7 |
|
|
|
32.1 |
|
2003 |
|
|
20.9 |
|
|
|
17.6 |
|
2004 |
|
|
28.2 |
|
|
|
19.1 |
|
2005 |
|
|
53.5 |
|
|
|
27.3 |
|
2006 |
|
|
50.6 |
|
|
|
17.0 |
|
2007 |
|
|
27.9 |
|
|
|
1.6 |
|
2008 |
|
|
1.1 |
|
|
|
|
|
In the past twelve months, we have experienced large increases in the cumulative paid loss
ratios for the 2005, 2006, and 2007 vintage years and more gradual increases for the other vintage
years. While we have historically expected higher claim payments in the second through the fifth
years after loan origination, the more recent vintage years have developed at a much faster rate
from a default and claim perspective than historical trends would indicate. We do not expect this
adverse development to subside and expect the cumulative paid loss ratios for the 2005, 2006 and
2007 books of business to ultimately be significantly higher than our previous books of business
and possibly greater than 100%.
Net losses and loss adjustment expenses also include the change in reserves for losses and
loss adjustment expenses. The following table shows the change in reserves for losses and LAE for
the three months ended March 31, 2009 and March 31, 2008:
24
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
(dollars in thousands) |
|
2009 |
|
|
2008 |
|
|
% Change |
|
Increase in reserve for losses and
LAE on a gross basis before the
benefit of captives, Modified Pool
structures and rescissions |
|
$ |
184,642 |
|
|
$ |
217,814 |
|
|
|
(15 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: |
|
|
|
|
|
|
|
|
|
|
|
|
Ceded reserves to captive reinsurers |
|
|
30,018 |
|
|
|
8,633 |
|
|
|
248 |
|
Impact of Modified Pool structures |
|
|
67,629 |
|
|
|
11,063 |
|
|
|
511 |
|
Impact of anticipated rescissions |
|
|
42,104 |
|
|
|
18,924 |
|
|
|
122 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase in reserve for losses
and loss adjustment expenses |
|
$ |
44,891 |
|
|
$ |
179,194 |
|
|
|
(75 |
) |
|
|
|
|
|
|
|
|
|
|
|
The net increase in reserve for losses and loss adjustment expenses was much greater in the
first quarter of 2008 than in the first quarter of 2009 for a number of reasons:
|
|
|
We increased the rescission factors utilized in the reserve methodology for
certain segments of the default inventory in the first quarter of 2009, which
mitigated the reserve increase; |
|
|
|
|
The actual number of loans in default increased by 20% in the first quarter of
2009 while defaults increased by 30% during the first quarter of 2008; |
|
|
|
|
During the first quarter of 2008, the composition of our default inventory
experienced a large increase in the percentage of defaults from distressed markets,
which have higher risk per loan amounts. This percentage did not change during the
first quarter of 2009; and |
|
|
|
|
In the first quarter of 2009, we received a much greater benefit from structures,
both from captive reinsurance and modified pool, than we did in the first quarter of
2008. In the first quarter of 2009, the increase in benefits received from captive
reinsurance and modified pool structures amounted to 71% of the gross change in loss
reserves while this percentage was only 14% in the first quarter of 2008. |
The following table provides further information about our loss reserves excluding the effects
of captive reinsurance at March 31, 2009, December 31, 2008 and March 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
March 31, |
|
(dollars in thousands) |
|
2009 |
|
|
2008 |
|
|
2008 |
|
Primary insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Reserves for reported defaults |
|
$ |
779,633 |
|
|
$ |
728,981 |
|
|
$ |
388,805 |
|
Reserves for defaults incurred but not reported |
|
|
82,743 |
|
|
|
109,716 |
|
|
|
40,601 |
|
|
|
|
|
|
|
|
|
|
|
Total Primary insurance |
|
|
862,376 |
|
|
|
838,697 |
|
|
|
429,406 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Modified Pool insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Reserves for reported defaults |
|
|
364,930 |
|
|
|
309,112 |
|
|
|
102,118 |
|
Reserves for defaults incurred but not reported |
|
|
12,640 |
|
|
|
22,494 |
|
|
|
7,275 |
|
|
|
|
|
|
|
|
|
|
|
Total Modified Pool insurance |
|
|
377,570 |
|
|
|
331,606 |
|
|
|
109,393 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reserve for loss adjustment expenses |
|
|
22,800 |
|
|
|
17,537 |
|
|
|
8,967 |
|
|
|
|
|
|
|
|
|
|
|
Total reserves for losses and loss adjustment
expenses |
|
$ |
1,262,746 |
|
|
$ |
1,187,840 |
|
|
$ |
547,766 |
|
|
|
|
|
|
|
|
|
|
|
The above table does not account for reserves ceded to lender-sponsored captive reinsurers.
The amount recoverable under captive reinsurance contracts, net of amounts due the respective
reinsurers, is shown as an asset
25
on the balance sheet and amounted to approximately $186.9 million
and $15.9 million at March 31, 2009 and 2008, respectively.
The following table indicates the growth in both the gross risk in default in the four
distressed market states and reserves attributable to these states at March 31, 2009, December 31,
2008 and March 31, 2008.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
December 31, |
|
March 31, |
(dollars in thousands) |
|
2009 |
|
2008 |
|
2008 |
% of Gross Risk In Force: |
|
|
|
|
|
|
|
|
|
|
|
|
California |
|
|
14.6 |
% |
|
|
14.6 |
% |
|
|
15.2 |
% |
Florida |
|
|
11.7 |
% |
|
|
11.6 |
% |
|
|
12.1 |
% |
Arizona |
|
|
5.2 |
% |
|
|
5.2 |
% |
|
|
5.5 |
% |
Nevada |
|
|
3.0 |
% |
|
|
3.0 |
% |
|
|
3.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Distressed Market States |
|
|
34.5 |
% |
|
|
34.4 |
% |
|
|
35.9 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
% of Gross Risk in Default: |
|
|
|
|
|
|
|
|
|
|
|
|
California |
|
|
25.4 |
% |
|
|
25.1 |
% |
|
|
22.0 |
% |
Florida |
|
|
22.4 |
% |
|
|
23.1 |
% |
|
|
22.5 |
% |
Arizona |
|
|
7.4 |
% |
|
|
7.2 |
% |
|
|
5.9 |
% |
Nevada |
|
|
5.1 |
% |
|
|
5.0 |
% |
|
|
4.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Distressed Market States |
|
|
60.3 |
% |
|
|
60.4 |
% |
|
|
54.5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
% of Gross Reserves: |
|
|
|
|
|
|
|
|
|
|
|
|
California |
|
|
24.5 |
% |
|
|
24.4 |
% |
|
|
21.8 |
% |
Florida |
|
|
23.3 |
% |
|
|
23.5 |
% |
|
|
22.6 |
% |
Arizona |
|
|
8.1 |
% |
|
|
7.4 |
% |
|
|
5.7 |
% |
Nevada |
|
|
5.4 |
% |
|
|
5.0 |
% |
|
|
4.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Distressed Market States |
|
|
61.3 |
% |
|
|
60.3 |
% |
|
|
54.2 |
% |
Certificates originated during 2007 and 2006 comprise 65.3% of our loans in default, but 74.2
% of the risk in default at March 31, 2009. The difference in percentages of loans in default and
risk in default primarily reflects the higher loan amounts associated with these policy years.
To illustrate the impact of the changes in the frequency and severity factors utilized in the
reserve model, the following table details the amount of risk in default and the reserve balance as
a percentage of risk in default at March 31, 2009, December 31, 2008 and March 31, 2008.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
December 31, |
|
March 31, |
(dollars in thousands) |
|
2009 |
|
2008 |
|
2008 |
Risk on loans in default |
|
$ |
3,297,135 |
|
|
$ |
2,729,313 |
|
|
$ |
1,388,181 |
|
Gross Case Reserves as a percentage of
risk in default (1) |
|
|
50.1 |
% |
|
|
49.3 |
% |
|
|
42.4 |
% |
|
|
|
(1) |
|
Reflects gross case reserves, which excludes IBNR and ceded reserves and the benefit from
Modified Pool
structures, as a percent of risk in default for total Primary delinquent loans and total
Modified Pool delinquent
loans. |
26
The following table shows default statistics as of March 31, 2009, December 31, 2008 and March
31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
December 31, |
|
March 31, |
(dollars in thousands) |
|
2009 |
|
2008 |
|
2008 |
Total business: |
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
334,101 |
|
|
|
345,055 |
|
|
|
374,012 |
|
With deductibles |
|
|
51,356 |
|
|
|
52,414 |
|
|
|
57,515 |
|
Without deductibles |
|
|
282,745 |
|
|
|
292,641 |
|
|
|
316,497 |
|
Number of loans in default |
|
|
48,332 |
|
|
|
40,286 |
|
|
|
21,916 |
|
With deductibles |
|
|
11,135 |
|
|
|
9,058 |
|
|
|
5,128 |
|
Without deductibles |
|
|
37,197 |
|
|
|
31,228 |
|
|
|
16,788 |
|
Percentage of loans in default (default rate) |
|
|
14.47 |
% |
|
|
11.68 |
% |
|
|
5.86 |
% |
Percentage of loans in default excluding
deductibles |
|
|
13.16 |
% |
|
|
10.67 |
% |
|
|
5.30 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Primary insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
243,548 |
|
|
|
252,368 |
|
|
|
272,289 |
|
Number of loans in default |
|
|
28,646 |
|
|
|
24,241 |
|
|
|
13,322 |
|
Percentage of loans in default |
|
|
11.76 |
% |
|
|
9.61 |
% |
|
|
4.89 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Modified Pool insurance: |
|
|
|
|
|
|
|
|
|
|
|
|
Number of insured loans in force |
|
|
90,553 |
|
|
|
92,687 |
|
|
|
101,723 |
|
With deductibles |
|
|
51,262 |
|
|
|
52,393 |
|
|
|
57,492 |
|
Without deductibles |
|
|
39,291 |
|
|
|
40,294 |
|
|
|
44,231 |
|
Number of loans in default |
|
|
19,686 |
|
|
|
16,045 |
|
|
|
8,594 |
|
With deductibles |
|
|
11,135 |
|
|
|
9,058 |
|
|
|
5,128 |
|
Without deductibles |
|
|
8,551 |
|
|
|
6,987 |
|
|
|
3,466 |
|
Percentage of loans in default |
|
|
21.74 |
% |
|
|
17.31 |
% |
|
|
8.45 |
% |
Percentage of loans in default excluding
deductibles |
|
|
21.76 |
% |
|
|
17.34 |
% |
|
|
7.84 |
% |
The number of loans in default increased by 121% over the twelve months ended March 31, 2009.
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 percentage of loans in
default, or default rate, has increased by 147% over this same period. The default rate is affected
by the number of policies in default as well as the number of policies in force. As we are in
run-off and are no longer issuing commitments for mortgage insurance, we expect the number of
policies in force to continue to decrease which will have an adverse effect on the default rate.
We currently expect the overall default rate as well as the number of loans in default to increase
during the remainder of 2009.
We do not provide reserves on Modified Pool defaults with deductibles until the cumulative
incurred losses for that transaction reach the deductible threshold. For the transactions that
have exceeded this threshold, we recognized $259.3 million of losses at March 31, 2009. Although a
majority of our structured bulk transactions have not exceeded the individual deductible amounts,
most of the Modified Pool transactions that are exhibiting adverse development have exceeded the
respective deductible amount. As a result, we believe that we have realized the majority of the
benefit from the deductibles and do not expect any material benefit going forward.
We also do not provide reserves on Modified Pool defaults where the cumulative incurred losses
to date for the related structure have exceeded the stop loss amount. At March 31, 2009, our loss
reserves were limited by $119.5 million as a result of incurred losses for certain structured
transactions exceeding the respective stop loss
amount. This amount was $37.5 million at December 31, 2008 and $0 at March 31, 2008. We
believe that based on the recent development of our modified pool business, we will continue to
provide additional reserves on structured bulk transactions with deductibles and we will continue
to limit the addition of reserves due to Modified Pool contracts reaching stop loss limits.
27
As part of our overall risk management strategy, we have entered into excess of loss captive
reinsurance agreements with several of our lender customers. As detailed in Item 1,
BusinessReinsurance in our Annual Report on Form 10-K for the year ended December 31, 2008, we
retain the first loss position on the first aggregate layer of risk and reinsure a second finite
layer with the captive reinsurer. Certain captives have exceeded the first loss layer in incurred
losses, which resulted in the ceding of reserves and paid losses related to specific book years.
At March 31, 2009, we had ceded $186.9 million of reserves and $10.1 million of paid losses to
captive reinsurers, of which $8.1 million resulted from the termination of one captive reinsurance
contact and the return of the trust balance. At March 31, 2008,
we had ceded $15.9 million of
reserves to captive reinsurers. If the current default and paid claim trends continue, we expect to
cede additional reserves and paid losses to the captive reinsurers in the remainder of 2009.
Expenses and Taxes
Other operating expenses during the first quarter of 2009 decreased by 33% compared to the
period one year prior. This decrease is primarily the result of the large reduction in our work
force as well as expenses incurred during the first quarter of 2008 associated with the attempted
capital raising effort.
During the first quarter of 2008, we wrote off the remaining deferred policy acquisition costs
(DAC) asset balance of $34.8 million as the estimated gross loss in the remaining portfolio no
longer supported the asset value. Subsequently, we have had and will have no further deferred
acquisition cost.
At the end of the first quarter of 2008, a review of our outstanding book of business resulted
in the need to record a premium deficiency. The recording of the premium deficiency in the first
quarter of 2008 resulted from: (1) reducing the DAC asset to zero ($34.8 million); (2) recording a
premium deficiency reserve of $96.1 million; and (3) recording an estimated reinsurance recoverable
of $81.1 million. Subsequent to the first quarter of 2008, the quarterly review of our outstanding
book of business has not resulted in the need to establish any further premium deficiency. This is
primarily due to the large increases in our recorded loss reserves.
The income tax benefit recognized in the first quarter of 2009 of $5.5 million represents the
reduction of the allowance applied to the deferred tax assets as a result of the unrealized gain.
Going forward, we expect to continue to incur operating losses for tax purposes and generate net
operating loss carry forwards for federal income tax reporting purposes for which we will be unable
to receive any immediate benefit in our statement of operations.
Our effective tax rate was 9.1% at March 31, 2009, which reflects our inability to recognize
future tax benefits in accordance with GAAP. Our effective tax rate was 27.5% at March 31, 2008.
Financial Position
Total assets at March 31, 2009 were $1.2 billion compared to $1.1 billion at December 31,
2008. Total cash and invested assets at March 31, 2009 increased slightly from the year-end level.
Total liabilities increased to $1.4 billion at March 31, 2009 from $1.3 billion at December 31,
2008. This increase was primarily due to the growth in loss and LAE reserves. The deficit in assets
has increased to $181.4 million at March 31, 2009 from $136.7 million at December 31, 2008.
This section identifies several items on our balance sheet that are important in the overall
understanding of our financial position. These items include DAC as well as prepaid federal income
tax and related deferred income taxes. The majority of our assets are included in our investment
portfolio. A separate Investment Portfolio section follows the Financial Position section and
reviews our investment portfolio, key portfolio management strategies, and methodologies by which
we manage credit risk within the investment portfolio.
28
Deferred Policy Acquisition Costs
Prior to the write-off of the DAC asset at March 31, 2008, we capitalized costs to acquire new
business as DAC and recognized these as expenses against future gross profits. At March 31, 2008,
we determined that the net present value of the estimated future cash flows on the remaining book
of business exceeded the recorded reserves (net of the unamortized DAC) which required the
establishment of a premium deficiency reserve. The actual mechanics of recording the premium
deficiency reserve require that we first reduce the DAC balance to zero before recording any
additional premium deficiency reserve. Therefore, we wrote down the DAC asset by $34.8 million in
the first quarter of 2008. We have not capitalized any costs to acquire new business subsequent to
the first quarter of 2008, but included such costs in the line item Other operating expenses on
our statement of operations. We will not be capitalizing any costs to acquire new business going
forward.
Prepaid Federal Income Taxes and Deferred Income Taxes
During the period that the Company was reporting positive results of operations, we purchased
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 that mortgage guaranty
companies are allowed for tax purposes. We recorded these bonds on our balance sheet as prepaid
federal income taxes. Purchases of Tax and Loss Bonds are essentially a prepayment of federal
income taxes that are scheduled to become payable in ten years, when the contingency reserve is
scheduled to be released, and the respective Tax and Loss Bonds are scheduled to mature. The
scheduled proceeds from the maturity of the Tax and Loss Bonds were anticipated to be utilized to
fund the income tax payments.
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 has historically been
the special contingency reserve deduction for mortgage insurers mentioned above. During 2008,
deferred income taxes declined by $120.5 million, primarily the result of the reversal of the
contingency reserve. The remainder of the deferred tax liability arose from book and tax reporting
differences related to DAC and unrealized investment gains (losses).
In years when the taxable income of a mortgage insurer results in a loss before the
application of the special contingency reserve, the prior established contingency reserve can be
reversed earlier than originally scheduled (effectively recognizing as taxable income the prior
contingency reserve that had been deferred) to offset the current year loss. When the special
contingency reserve for tax purposes is reversed to offset a current year operating loss, the Tax
and Loss Bonds can be redeemed earlier than the originally scheduled ten years. During 2008, we
reversed $335.0 million of contingency reserve and redeemed all of the remaining $116.0 million of
Tax and Loss Bonds. During the second half of 2007, we reversed $113 million of contingency
reserve for tax purposes earlier than originally scheduled and redeemed $50.9 million of Tax and
Loss Bonds related to that reversal. The proceeds of the redemptions are reported on the cash flow
statement as a return of federal taxes paid and are invested in interest-earning assets. These
redemptions were a significant component of the growth in invested assets over the 12-month period
ended March 31, 2009. At March 31, 2009 and December 31, 2008, we had no contingency reserve and
our holdings of Tax and Loss Bonds were immaterial. There was no remaining contingency reserve for
tax purposes at December 31, 2008 and March 31, 2009.
29
Investment Portfolio
Portfolio Description
Our goal for managing our investment portfolio is to optimize investment returns, provide
liquidity when necessary, preserve capital and adhere to regulatory requirements. We have
established a formal investment policy that describes our overall quality and diversification
objectives and limits. Historically, the majority of our investment portfolio had been comprised
of tax-preferred state and municipal fixed income securities. Given the operating losses reported
since the third quarter of 2007, we currently do not anticipate the realization of tax benefits
normally associated with state and municipal securities. As a result, we made the decision in the
second quarter of 2008 to restructure the investment portfolio into taxable publicly-traded
securities, primarily corporate debt obligations, asset-backed securities, and mortgage-backed
securities. Furthermore, as we anticipate negative cash flow from operations in 2009 due to the
expected increase in claims paid, we expect the proceeds from the maturity and sale of securities
will be required to fund the shortfall. In connection with the restructuring of our investment
portfolio, we shortened the portfolio duration to better match the maturities with our anticipated
cash needs. At March 31, 2009, we had $132.9 million of municipal securities remaining in our
portfolio. In the current market, there are significant risks involved in attempting to liquidate
the remaining tax-preferred portfolio. These risks include execution risk in the selling of
securities, additional credit risk moving from primarily insured, highly rated municipal bonds to
lower rated corporate bonds, and potential deterioration in the market value of our municipal
holdings due to economic conditions or other reasons.
Our investment policy and strategies are subject to further change depending upon regulatory,
economic and market conditions as well as our existing financial condition and operating
requirements, including our tax position. We classify our entire investment portfolio as available
for sale. This classification allows us the flexibility to dispose of securities in order to meet
our investment objectives and operating requirements. All investments are carried on our balance
sheet at fair value.
The following table shows the growth and transition of our investment portfolio:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2009 |
|
|
December 31, 2008 |
|
(dollars in thousands) |
|
Amount |
|
|
Percent |
|
|
Amount |
|
|
Percent |
|
Fixed maturity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U. S. government obligations |
|
$ |
19,824 |
|
|
|
2.2 |
% |
|
$ |
20,168 |
|
|
|
2.3 |
% |
State and municipal bonds |
|
|
132,857 |
|
|
|
14.5 |
% |
|
|
159,394 |
|
|
|
17.8 |
% |
Corporate bonds |
|
|
629,205 |
|
|
|
68.5 |
% |
|
|
547,945 |
|
|
|
61.2 |
% |
Mortgage-backed bonds |
|
|
123,018 |
|
|
|
13.4 |
% |
|
|
126,679 |
|
|
|
14.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
|
904,904 |
|
|
|
98.6 |
% |
|
|
854,186 |
|
|
|
95.4 |
% |
Equity securities |
|
|
491 |
|
|
|
0.1 |
% |
|
|
583 |
|
|
|
0.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available-for-sale securities |
|
|
905,395 |
|
|
|
98.7 |
% |
|
|
854,769 |
|
|
|
95.5 |
% |
Short-term investments |
|
|
13,136 |
|
|
|
1.3 |
% |
|
|
40,653 |
|
|
|
4.5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
918,531 |
|
|
|
100.0 |
% |
|
$ |
895,422 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
30
The following table shows the results of our investment portfolio for the three months ended
March 31, 2009 and 2008:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
March 31, |
(dollars in thousands) |
|
2009 |
|
2008 |
Average investments at cost or amortized cost |
|
$ |
889,993 |
|
|
$ |
763,732 |
|
Pre-tax net investment income |
|
$ |
11,192 |
|
|
$ |
9,547 |
|
Book yield |
|
|
4.8 |
% |
|
|
4.6 |
% |
Pre-tax realized investment (losses) gains |
|
$ |
(4,565 |
) |
|
$ |
2,703 |
|
The increase in the book yield is partly attributable to write downs in the previous twelve
months due to other-than-temporary impairments. The taxable securities we have purchased since the
first quarter of 2008 generally have a lower duration but a similar book yield as the longer
duration municipal securities that comprised the majority of the portfolio at March 31, 2008. The
largest portion of the pre-tax realized investment losses in the first quarter of 2009 are from
write downs due to other-than-temporary impairments as described in Realized Gains (Losses) and
Impairments below. We did realize approximately $1.2 million of realized gains from the sale of
securities, primarily municipal securities, in the first quarter of 2009.
Unrealized Gains and Losses
The following table summarizes by category our unrealized gains and losses in our securities
portfolio at March 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost or |
|
|
Gross |
|
|
Gross |
|
|
|
|
|
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Fair |
|
(dollars in thousands) |
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Value |
|
Fixed maturity securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U. S. government obligations |
|
$ |
19,287 |
|
|
$ |
537 |
|
|
$ |
|
|
|
$ |
19,824 |
|
State and municipal bonds |
|
|
127,466 |
|
|
|
5,391 |
|
|
|
|
|
|
|
132,857 |
|
Corporate bonds |
|
|
614,884 |
|
|
|
14,321 |
|
|
|
|
|
|
|
629,205 |
|
Mortgage-backed bonds |
|
|
118,767 |
|
|
|
4,251 |
|
|
|
|
|
|
|
123,018 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subtotal, fixed maturities |
|
|
880,404 |
|
|
|
24,500 |
|
|
|
|
|
|
|
904,904 |
|
Equity securities |
|
|
488 |
|
|
|
3 |
|
|
|
|
|
|
|
491 |
|
Short term investments |
|
|
12,999 |
|
|
|
137 |
|
|
|
|
|
|
|
13,136 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total securities |
|
$ |
893,891 |
|
|
$ |
24,640 |
|
|
$ |
|
|
|
$ |
918,531 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Given our recurring losses from operations and the significant doubt regarding our ability to
continue as a going concern, we no longer have the ability to hold impaired assets for a sufficient
time to recover their value. As a result, we made the decision at December 31, 2008 to recognize
an impairment loss on all securities whose amortized cost is greater than the reported fair value
and thus have no unrealized losses at March 31, 2009. Going forward, we will continue to recognize
an impairment loss for all securities whose amortized cost is greater than the reported fair value.
The unrealized gains are partly due to previous impairment of our fixed income securities.
These unrealized gains do not necessarily represent future gains that we will realize. Changing
conditions related to specific securities, overall market interest rates, or credit spreads, as
well as our decisions concerning the timing of a sale, may impact values we ultimately realize.
Taxable securities typically exhibit greater volatility in value than tax-preferred securities and
thus we expect greater volatility in unrealized gains and realized losses going forward. Volatility
may increase in periods of uncertain market or economic conditions.
31
Credit Risk
Credit risk is inherent in an investment portfolio. One way we attempt to limit the inherent
credit risk in our portfolio is to maintain investments with high ratings. The following table
shows our investment portfolio by credit ratings.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2009 |
|
|
December 31, 2008 |
|
(dollars in thousands) |
|
Amount |
|
|
Percent |
|
|
Amount |
|
|
Percent |
|
Fixed Maturities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. treasury and agency bonds |
|
$ |
19,824 |
|
|
|
2.2 |
|
|
$ |
20,168 |
|
|
|
2.4 |
|
AAA |
|
|
217,032 |
|
|
|
24.0 |
|
|
|
236,975 |
|
|
|
27.7 |
|
AA |
|
|
216,624 |
|
|
|
23.9 |
|
|
|
183,916 |
|
|
|
21.5 |
|
A |
|
|
419,632 |
|
|
|
46.4 |
|
|
|
381,936 |
|
|
|
44.7 |
|
BBB |
|
|
14,872 |
|
|
|
1.6 |
|
|
|
25,203 |
|
|
|
3.0 |
|
BB |
|
|
13,206 |
|
|
|
1.5 |
|
|
|
1,239 |
|
|
|
0.1 |
|
B |
|
|
472 |
|
|
|
0.1 |
|
|
|
619 |
|
|
|
0.1 |
|
CCC |
|
|
1,868 |
|
|
|
0.2 |
|
|
|
1,523 |
|
|
|
0.2 |
|
CC and lower |
|
|
379 |
|
|
|
0.0 |
|
|
|
48 |
|
|
|
0.0 |
|
Not rated |
|
|
995 |
|
|
|
0.1 |
|
|
|
2,559 |
|
|
|
0.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
$ |
904,904 |
|
|
|
100.0 |
|
|
$ |
854,186 |
|
|
|
100.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity Securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred stocks: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
A |
|
|
281 |
|
|
|
57.2 |
|
|
|
429 |
|
|
|
73.6 |
|
BBB |
|
|
193 |
|
|
|
39.3 |
|
|
|
133 |
|
|
|
22.8 |
|
C |
|
|
17 |
|
|
|
3.5 |
|
|
|
21 |
|
|
|
3.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total equity securities |
|
$ |
491 |
|
|
|
100.0 |
|
|
$ |
583 |
|
|
|
100.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The change in the credit quality of the portfolio is primarily due to the restructuring of the
portfolio out of tax-preferred securities and into taxable securities. The credit ratings of most
municipal and state tax-preferred securities may benefit from credit enhancements provided by
financial guaranty insurers. Taxable securities generally do not have such credit enhancements and
the credit rating reflects the securities underlying credit qualities.
We evaluate the credit risk of a security by analyzing the underlying credit qualities of the
security. We also find value in the enhancements provided by the financial guaranty insurers to our
municipal and state tax-preferred securities, although this value has decreased given the rating
downgrades of these insurers. Furthermore, as we transition from a tax deferred portfolio to a
taxable portfolio, the importance of the credit enhancements becomes less relevant. The following
table indicates the credit quality of our fixed maturity portfolio without the benefit of the
credit enhancements as provided by financial guaranty insurers at March 31, 2009:
32
|
|
|
|
|
|
|
|
|
|
|
Credit Quality Without Benefit |
|
|
|
of Credit Enhancements |
|
(dollars in thousands) |
|
Amount |
|
|
Percent |
|
U.S. treasury and agency bonds |
|
$ |
7,613 |
|
|
|
0.8 |
|
AAA |
|
|
186,800 |
|
|
|
20.6 |
|
AA |
|
|
136,467 |
|
|
|
15.1 |
|
A |
|
|
521,275 |
|
|
|
57.6 |
|
BBB |
|
|
22,217 |
|
|
|
2.5 |
|
BB |
|
|
14,079 |
|
|
|
1.6 |
|
B |
|
|
1,637 |
|
|
|
0.2 |
|
CCC |
|
|
|
|
|
|
|
|
CC and below |
|
|
379 |
|
|
|
0.0 |
|
Not rated |
|
|
14,437 |
|
|
|
1.6 |
|
|
|
|
|
|
|
|
Total Fixed Maturities |
|
$ |
904,904 |
|
|
|
100.0 |
|
|
|
|
|
|
|
|
As of March 31, 2009, we did not invest directly in any financial guaranty insurers, but we
were indirectly exposed to the risk of financial guaranty insurer default through the credit
enhancements provided on the majority of our state and municipal fixed maturity bond portfolio.
At March 31, 2009, our state and municipal bond portfolio amounted to $132.9 million, with
approximately $112.4 million containing credit enhancements from financial guaranty insurers. The
following table indicates the approximate exposure to and percentage of our credit enhanced state
and municipal bond portfolio by financial guaranty insurer at March 31, 2009:
|
|
|
|
|
|
|
|
|
Financial Guarantors | |
|
|
|
|
Credit Enhanced State and |
|
|
|
Municipal Portfolio |
|
(dollars in thousands) |
|
Amount |
|
|
Percent |
|
MBIA |
|
$ |
30,506 |
|
|
|
27.1 |
|
FSA |
|
|
26,730 |
|
|
|
23.8 |
|
FGIC |
|
|
25,855 |
|
|
|
23.0 |
|
AMBAC |
|
|
16,880 |
|
|
|
15.0 |
|
Others (four companies ) |
|
|
12,471 |
|
|
|
11.1 |
|
|
|
|
|
|
|
|
Total |
|
$ |
112,442 |
|
|
|
100.0 |
|
|
|
|
|
|
|
|
Realized Gains (Losses) and Impairments
Realized gains (losses) include both write-downs of securities with other-than-temporary
impairments and gains (losses) from the sales of securities. Net realized losses for the first
quarter of 2009 totaled $4.7 million. The net realized loss was primarily composed of an
impairment loss of $5.7 million offset by gains on the sale of securities of $1.2 million.
Liquidity and Capital Resources
The accompanying consolidated financial statements have been prepared in accordance with GAAP
and assume that we will continue as a going concern, which contemplates the realization of assets
and the satisfaction of liabilities and commitments in the normal course of business. However, our
ability to continue as a going concern will be dependent on our ability to comply with terms of the
Corrective Orders. If we are unable to comply with the terms of the
Corrective Orders, Illinois law may require the Director to seek
receivership in the courts. If Triad were to be placed into
receivership, this would effectively remove all of the assets and future cash flows of
Triad from the ownership of the parent company and its stockholders and allocate it to Triads
policyholders. As
33
Triad is the Companys primary source of cash flow, if Triad were placed in receivership
proceedings by the Division, we could be forced to seek protection from creditors under Chapter 11
of the United States Bankruptcy Code and little or no funds would ever be available for
distribution to our stockholders. The report of our independent registered public accounting firm
with respect to our December 31, 2008 financial statements indicates that there is substantial
doubt about our ability to continue as a going concern.
The Corrective Order issued on March 31, 2009 requires that, effective June 1, 2009 or at a
later date as determined by the Division, all valid claims under Triads mortgage guaranty
insurance policies will be paid 60% in cash and 40% by recording a deferred payment obligation
(DPO). The DPO will accrue a carrying charge based on the investment yield earned by Triads
investment portfolio and payment of both the DPO and the carrying charge will be subject to Triads
future financial performance and will require the approval of the Division. The recording of a DPO
will positively impact our operating cash flows in the near term. However, as we will be accruing a
carrying charge based on the investment yield earned by Triads investment portfolio, we do not
expect any ultimate value from recording a DPO.
Generally, our sources of operating funds consist of premiums written and investment income.
Operating cash flow has historically been applied to the payment of claims, interest, expenses and
prepaid federal income taxes in the form of Tax and Loss Bond purchases. However, beginning in
2007 and 2008, the early redemption of Tax and Loss Bonds due to our operating losses has provided
a source of funds. See Prepaid Federal Income Taxes and Deferred Income Taxes for additional
information concerning the Tax and Loss Bonds. As our holdings of Tax and Loss Bonds were
negligible at December 31, 2008, we did not increase our cash flow in the first quarter of 2009 by
the early redemption of these bonds. We do not expect early redemption of Tax and Loss Bonds to be
a source of funds in the foreseeable future until such time as we become profitable, utilize our
net operating loss carryforwards and begin to purchase Tax and Loss Bonds again. During the first
quarter of 2008, we did not redeem any Tax and Loss Bonds.
During the first quarter of 2009, we generated positive cash flow from operating activities of
$3.3 million compared to $25.9 million in the first quarter of 2008. The decline in operating cash
flow compared to the first quarter of 2008 reflects the decline in premium and the increase in paid
losses.
Net cash received from premiums amounted to $61.3 million in the first quarter of 2009
compared to $74.1 million in the respective period of 2008. The decrease is due to the overall
decline in insurance in force as well as an increase in premium refunds due to rescission activity.
We anticipate more refunds of premiums related to rescission activity in the remainder of 2009 and
have established a $36.1 million liability to account for this.
Net paid claims increased to $57.8 million during the first quarter of 2009 from $40.9 million
during the first quarter of 2008. Net paid claims in the first quarter of 2009 reflect $10.1
million of reimbursed paid claims from captive reinsurers, of which $8.1 million resulted from the
termination of one captive reinsurance contract and the return of the trust balance. While the net
level of paid claims in the first quarter of 2009 increased substantially over the period one year
prior, it actually decreased from the amount in the fourth quarter of 2008. We believe the lower
than anticipated amount of paid claims was due to a number of factors that have delayed claim
payments, including GSE and state foreclosure moratoriums, delays by the servicers due to a large
increase in the number of policies in default, a continued effort on our part in investigating
policies for underwriting violations, and an increase in rescission activity. We believe that the
amount of paid claims will increase in subsequent quarters and the increase may be substantial.
As described under Investment Portfolio, we continue to execute the repositioning of our
investment portfolio from a primarily tax-preferred portfolio to a taxable portfolio and to shorten
the maturities given our operating outlook. An operating cash flow shortfall could be funded
through sales of short-term investments and other investment portfolio securities. See Investment
Portfolio for more information.
34
At March 31, 2009, the Company reported a deficit in assets of $181.4 million compared to a
deficit in assets of $136.7 million at December 31, 2008 and stockholders equity of $338.4 million
at March 31, 2008. A deficit in assets occurs when recorded liabilities exceed recorded assets.
The primary factor contributing to the change since the first quarter of 2008 is the increase in
the reserve for losses and LAE. We expect to continue to report a deficit in assets in future
periods. While we do not expect the deficit in assets to have a direct impact on our operations,
it could adversely impact our continued listing on The NASDAQ Stock Market.
The insurance laws of the State of Illinois impose certain restrictions on dividends that an
insurance subsidiary can pay its parent company. As discussed previously, the Corrective Orders
prohibit the payment of dividends by our insurance subsidiary to the parent corporation without
prior approval from the Division.
Included in policyholders surplus of the primary insurance subsidiary, Triad, is a surplus
note of $25 million payable to the registrant, its parent. The accrual of and payment of the
interest on the surplus note must be approved by the Division, which has broad discretion to
approve or disapprove any such payment. We do not expect Triad will be able to pay any principal or
interest on this note for the foreseeable future.
The parent company has limited sources of cash flow. The $35 million outstanding long-term
debt is the obligation of the parent company and not of Triad. Debt service amounts to $2.8
million per year and is paid by the parent company. The primary source of funds for the parent
company debt service has historically been the interest paid on the $25 million surplus note by
Triad, which has provided $2.2 million on an annual basis. We do not expect this source of cash to
be available for the foreseeable future. At March 31, 2009, the parent company had cash and
invested assets of approximately $9.4 million. While we currently believe that the cash resources
on hand at the parent company will be sufficient to cover the required debt service for 2009 on the
$35 million long-term debt, we cannot provide any assurance that this or any future debt service
payments will be made and the ultimate ability of the parent company to repay the entire $35
million is subject to substantial risks and cannot be assured unless a source of funds is secured.
The ability of the parent company to pay the debt service with funds obtained from Triad, whether
in the form of dividends, payments on the surplus note or otherwise, will require the approval of
the Division, and it is unlikely that such approval will be sought or obtained in the foreseeable
future.
Triad has historically reimbursed the parent company for a majority of its operating cash
expenses under a management agreement. Pursuant to the Corrective Orders, we are required to
submit to the Division a request for reimbursement of these expenses on a quarterly basis. These
parent company cash expenses range from approximately $250,000 to $600,000 per quarter depending on
certain activities and include legal, director, accounting, and consulting fees. There can be no
assurance these quarterly expenditures will not increase in the future. If the Division prohibits
or limits the reimbursement by Triad of the parent companys operating expenses, the cash resources
of the parent company will be adversely affected.
Triads ability to incur any material operating and capital expenditures, as well as its
ability to enter into any new contracts with unaffiliated parties, also requires the Divisions
approval (except for certain operating expenditures that have been preapproved by the Division).
In 2007, the Company established a Canadian subsidiary for the purpose of exploring the
opportunity to provide mortgage insurance in Canada. During the first quarter of 2008, in response
to the continued stress in the U.S. mortgage markets, the Company discontinued the effort in Canada
and repatriated most of the funds back to the U.S. parent company. The Canadian subsidiary was
liquidated during the fourth quarter of 2008 and all funds have now been returned to the parent
company.
Triad cedes business to captive reinsurance affiliates of certain mortgage lenders, primarily
under excess of loss reinsurance agreements. Generally, reinsurance recoverables on loss reserves
and unearned premiums ceded to these captives are backed by trust accounts where Triad is the sole
beneficiary. At March 31, 2009, total trust balances were approximately $262.1 million compared to
$225.0 million at March 31, 2008.
35
Triad ceased accepting commitments to write new mortgage insurance on July 15, 2008 and is
operating in run-off. The risk-to-capital ratio, which is utilized as a measure by many states and
regulators of an insurers capital adequacy and ability to underwrite new business, is no longer
relevant for Triad because we are operating in run-off.
Statutory capital, for the purpose of computing the net risk in force to statutory capital
ratio, includes both policyholders surplus and the contingency reserve. The following table
provides information regarding our statutory capital position at March 31, 2009, December 31, 2008
and March 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
March 31, |
|
(dollars in millions) |
|
2009 |
|
|
2008 |
|
|
2008 |
|
Statutory policyholders surplus |
|
$ |
393.3 |
|
|
$ |
88.0 |
|
|
$ |
203.4 |
|
Statutory contingency reserve |
|
|
|
|
|
|
|
|
|
|
228.2 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
393.3 |
|
|
$ |
88.0 |
|
|
$ |
431.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Risk-to-capital ratio |
|
|
27.0 to 1 |
|
|
|
125.2 to 1 |
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27.7 to 1 |
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The increase in statutory policyholders surplus and the decline in the risk-to-capital ratio
at March 31, 2009 compared to December 31, 2008 is primarily the result of the impact on statutory
loss reserves of the Corrective Order that requires all valid claims be paid 60% in cash and 40% by
recording a DPO. As a result of this requirement, statutory loss reserves under SAP at March 31,
2009 were reduced by $485 million from the level absent this requirement. This accounting change
was deemed to be a change in statutory accounting method adopted on a prospective basis, and,
accordingly, we recorded the entire amount as a cumulative effect to surplus. There was no such
impact to loss reserves calculated on a GAAP basis. Even if Triads risk-to-capital ratio were to
be reduced to 25.0 or lower, we would continue to be prohibited from writing new business.
Update on Critical Accounting Policies and Estimates
Reserve for Losses and LAE
In our Annual Report on Form 10-K for the year ended December 31, 2008, we disclosed that the
amount of loss reserves as well as our reported premium income have both been reduced by the
estimate of future rescissions in the existing default portfolio. In general, a rescission occurs
when we determine that fraud, misrepresentation or other specified violations occurred in the
origination of a loan. When these violations are identified, insurance coverage from the date of
issuance is cancelled and the entire previously paid premium is refunded.
During 2008 and continuing into 2009, we experienced a much higher level of rescission
activity than in previous years. This activity was concentrated in policies originated in 2006 and
2007. We have also identified concentrations with specific lenders and by delivery channel.
Beginning in late 2007, we began to incorporate a factor in our computation of loss reserves to
account for expected rescissions. The effect of the factor is to reduce the loss reserve by
reflecting the probability that we may rescind coverage on a certificate. The impact of this
factor in our calculation of loss reserves has increased over the last five quarters.
We also account for the impact of expected rescissions on our future premium revenue by
establishing an accrual for expected premium refunds. In establishing this accrual, we consider
the probability that a policy will be rescinded, which is consistent with the factor used in the
calculation of loss reserves. The impact of this accrual has also increased over the last five
quarters.
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In estimating the accrual for expected premium refunds, we rely on recent historical
experience but also use a substantial amount of judgment. While recent rescission activity has
been significantly elevated from our historical experience, our recent level of rescission activity
is not necessarily indicative of future trends. Furthermore, our ability to rescind a policy may be
adversely impacted by the insured disputing our rights and prevailing in court or arbitration. Any
increase or decrease in rescission factors would impact our reserves in the period in which the
rescission factor is adjusted.
Off Balance Sheet Arrangements and Aggregate Contractual Obligations
We had no material off-balance sheet arrangements at March 31, 2009.
We lease office facilities and office equipment under operating leases with minimum lease
commitments that range from one to five years. We had no capitalized leases or material purchase
commitments at March 31, 2009.
Our long-term debt has a single maturity date in 2028. There were no material changes during
the period ended March 31, 2009 to the aggregate contractual obligations shown in our Annual Report
on Form 10-K for the year ended December 31, 2008.
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
Managements Discussion and Analysis of Financial Condition and Results of Operations and
other portions of this report contain forward-looking statements relating to future plans,
expectations and performance, which involve various risks and uncertainties, including, but not
limited to, the following:
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a deeper or more prolonged recession in the United States coupled with the
tightening of the mortgage credit markets could increase defaults and limit
opportunities for borrowers to cure defaults or for Triad to mitigate losses, which
could have an adverse material impact on our business or results of operations; |
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the possibility that the Division may take various actions regarding Triad if it
does not operate its business in accordance with its revised
financial and operating plan and the Corrective Orders, including
seeking receivership proceedings, which would effectively eliminate all remaining
stockholder value; |
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our ability to continue as a going concern; |
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the ability of the parent company to pay the debt service with funds obtained from
Triad, whether in the form of dividends, payments on the surplus note or otherwise,
will require the approval of the Division, and it is unlikely that such approval will
be sought or, if sought, will be obtained in the foreseeable future; |
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whether we ultimately prevail in arbitration with the Excess-of-Loss reinsurance
treaty, which will have an impact on our financial performance in run-off; |
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if house prices continue to fall, additional borrowers may default and claims
could be higher than anticipated; |
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if unemployment rates continue to rise, especially in those areas that have
already experienced significant declines in house prices, defaults and claims could
be higher than anticipated; |
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further economic downturns in regions where we have larger concentrations of risk
and in markets already distressed could have a particularly adverse effect on our
financial condition and loss development; |
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the appointment of FHFA as the conservator of both Fannie Mae and Freddie Mac has
resulted in changes in the business practices of the GSEs; |
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the impact of recently adopted programs affecting modifications and refinancings
of mortgages could materially impact our financial performance in run-off; |
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our financial condition and performance in run-off could be affected by recently
adopted legislation, such as EESA and HASP; |
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our financial condition and performance in run-off could be affected by
legislation adopted in the future, if any, impacting the mortgage industry, the GSEs
specifically, or the financial services industry in general; |
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if the GSEs or our lender customers choose to cancel the insurance on policies
that we insure, our financial performance in run-off could be adversely affected; |
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a significant decline in interest rates coupled with an increase in available
credit could increase refinancings and decrease the persistency of renewal premiums
and the quality of our insurance in force; |
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if we have failed to properly underwrite mortgage loans under contract
underwriting service agreements, we may be required to assume the costs of
repurchasing those loans or face other remedies; |
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any impediment to our ability to rescind coverage on insurance policies, which
would be detrimental to our success in run-off; |
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our ability to lower operating expenses to the most efficient level while still
providing the ability to mitigate losses effectively during run-off, which will
directly impact our financial performance in run-off; and |
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if we are unable to satisfy its continued listing requirements, we may be delisted
from The NASDAQ Stock Market. |
Accordingly, actual results may differ from those set forth in these forward-looking
statements. Attention also is directed to other risks and uncertainties set forth in documents
that we file from time to time with the SEC.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
The information required by this Item 3 is not required to be provided by issuers, such as
us, that satisfy the definition of smaller reporting company under SEC rules.
Item 4T. Controls and Procedures
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We carried out an evaluation, under the supervision and with the participation of our
management, including our Principal Executive Officer (PEO) and Principal Financial
Officer (PFO), of the effectiveness of our disclosure controls and procedures pursuant to
Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the Exchange Act).
Based on that evaluation, our management, including our PEO and PFO, concluded, as of the
end of the period covered by this report, that our disclosure controls and procedures were
effective to ensure that information required to be disclosed by us in the reports that we
file or submit under the Exchange Act is (a) accumulated and communicated to our
management, including our PEO and PFO, as appropriate to allow timely decisions regarding
required disclosure, and (b) recorded, processed, summarized and reported within the time
periods specified in the SECs rules and forms. In designing and evaluating disclosure
controls and procedures, we recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the desired
control objectives, as ours are designed to do. |
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There were no changes to our internal control over financial reporting during the
period ended March 31, 2009 that materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting. |
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is involved in litigation in the ordinary course of business as well as the case
named below. No pending litigation is expected to have a material adverse effect on the financial
position of the Company.
On February 6, 2009, James L. Phillips served a complaint against Triad Guaranty Inc., Mark K.
Tonnesen and Kenneth W. Jones in the United States District Court, Middle District of North
Carolina. The plaintiff purports to represent a class of persons who purchased or otherwise
acquired the common stock of the Company between October 26, 2006 and November 10, 2008 and the
complaint alleges violations of federal securities laws by the Company and two of its present or
former officers. The court has appointed lead counsel for the plaintiff and an amended complaint
is due June 15, 2009. We intend to contest the lawsuit vigorously.
Triad maintains a $95 million Excess-of-Loss reinsurance treaty that provides a benefit when
Triads risk-to-capital ratio exceeds 25-to-1 and the combined ratio exceeds 100% (the attachment
point). Once the attachment point has been reached, following a one-time deductible of $25
million, the carrier is responsible for the reimbursement of all paid losses in each quarter that
the attachment point is breached up to the one-time $95 million policy limit. The coverage period
is for 10 years. Additionally, terms of the treaty require Triad to continue the payment of
premiums to the reinsurer amounting to approximately $2 million per year for the entire ten year
period. The reinsurance treaty attached at the end of the first quarter of 2008; however, in April
2008 the reinsurance carrier provided a purported notice of termination of the agreement. By
letter dated May 5, 2008, Triad notified the reinsurer that the Company considered the treaty to
still be in effect and demanded arbitration seeking a ruling (i) stating that the reinsurance
remained in effect and (ii) requiring that the reinsurer comply with terms of the treaty. The
arbitration took place in front of a three-person panel in December 2008 and January 2009, with
post-hearing briefs and oral arguments in February 2009. The Company expects a decision to be
rendered by the arbitration panel in the second quarter of 2009.
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Item 1A. Risk Factors
We
may not continue to realize benefits from rescissions at the levels we have recently experienced,
which could materially and adversely affect our financial condition and results of operations.
We have experienced a significant increase in rescission activity and expect to rescind
additional policies in the future as we continue to investigate early payment defaults and identify
instances of fraud, misrepresentation or other violations of our master policies. There can be no
assurance that the recent level of rescission activity, which has positively impacted both our paid
claims and reserves, will continue for an extended period or at all. Furthermore, any decision to
rescind coverage may be challenged by lenders and our policyholders. If we are unsuccessful in
defending our right to rescind coverage, the reduced level of rescission activity may have a
material adverse impact on our financial condition or results of operations.
Item 6. Exhibits
The exhibits filed with this quarterly report on Form 10-Q are set forth in the Exhibit Index
on page 42 and are incorporated herein by reference.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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TRIAD GUARANTY INC. |
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Date: May 15, 2009 |
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/s/ Kenneth S. Dwyer
Kenneth S. Dwyer
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Vice President and Chief Accounting Officer |
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(Duly Authorized Officer and Principal Accounting Officer) |
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EXHIBIT INDEX
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Exhibit Number |
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Description |
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10.58
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Form of Executive/Key Employee Phantom Stock Award
Agreement, previously filed as Exhibit 10.58 to the
Companys Current Report on Form 8-K, filed on January 29,
2009, and herein incorporated by reference.* |
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31.1
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Certification of Principal Executive Officer and Principal
Financial Officer pursuant to Exchange Act Rule 13a-14(a),
as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002. |
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32.1
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Certification of Principal Executive Officer and Principal
Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002. |
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* |
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Management contract or compensatory arrangement. |
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